Good afternoon. Thank you for attending the 8x8 fiscal third quarter earnings call. My name is Matt, and I'll be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. I'll now pass the conference over to our host, Kate Patterson, Vice President of Investor Relations. Kate, please go ahead.
Thank you, operator. Good afternoon, everyone. Today's agenda will include a review of our third quarter results with Samuel Wilson, our Interim Chief Executive Officer, and Kevin Kraus, our Interim Chief Financial Officer. Following our prepared remarks, there will be a question and answer session. Before we get started, let me remind you that our discussion today includes forward-looking statements about our future financial performance, including our increased focus on profitability and cash flow, as well as our business, products, and growth strategies. We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that may cause actual results to vary materially from forward-looking statements as described in our risk factors in our report filed with the SEC.
Any forward-looking statements made on this call and in the presentation slides reflect our analysis as of today. We have no plans or obligation to update them. Certain financial measures that will be discussed on this call, together with year-over-year comparisons in some cases, were not prepared in accordance with the U.S. generally accepted accounting principles or GAAP. A reconciliation of those non-GAAP measures to the closest comparable GAAP measure is provided in our earnings press release and earnings presentation slides, which are available on 8x8's investor relations website at investors.8x8.com. With that, I'll turn the call over to Samuel Wilson.
Thank you, Kate, and thank you to everyone joining us on the call today. I believe our solid third quarter results were a strong indicator of our ability to perform against our objectives. We said we would forego some near-term revenue growth for profitability as we build a sustainable long-term business. That's exactly what our teams did in the quarter. Despite the lower than expected total revenue, we delivered almost 10% operating income, increased deferred revenue and RPO, and experienced high customer retention, all early indicators of future success for a SaaS business. I am impressed with the quality of our performance in the third quarter. I want to thank our employees and everyone in the 8x8 community for their hard work.
Turning to the future, I have been working closely with the leadership team and the board of directors on a multi-year strategy to grow our business and create value for our stakeholders. We laid the foundation for our next step several years ago when we re-architected our core technology. We built a modern microservices-based platform that powers both our current UCaaS and CCaaS solutions. We have fully embraced continuous integration and continuous deployment and are delivering more than 1,000 microservice updates every quarter. This enabled near perfect uptime for the third quarter and reduced the number of customer-identified defects to single digits. We are innovating faster than we ever have before. At the same time we embarked on this journey, we could not have predicted the global COVID pandemic or how it would accelerate adoption of cloud-based telephony and internal collaboration tools, especially Microsoft Teams.
While UCaaS migration continues to create revenue and profit opportunities for efficient providers like 8x8, I believe the opportunities to differentiate based on standalone UCaaS are becoming increasingly rare. Our XCaaS platform, which delivers the high availability, scalability, and security of a unified cloud-native solution at a lower TCO, is highly differentiated. By focusing on CCaaS innovation within the platform, we can continue to extend our leadership. Specifically, I believe the contact center market is at an inflection. According to PwC's Future of Customer Experience survey, one in three customers would leave a brand they love after one poor experience. No longer can the contact center be viewed solely through a cost lens. It has become the primary way for companies to interact with their customers and build brand loyalty.
At the same time, advances in ML AI technologies, as well as customers' growing preference for high-quality digital and self-service interactions, set the stage for a new wave of contact center migrations and upgrades. Technologies like large language models, such as ChatGPT, have the potential to transform the customer experience. Our modern platform enables these technologies today, and I believe we are well-positioned as this opportunity evolves. We have identified six areas I believe are critical to our future success. One, further acceleration in CCaaS innovation while maintaining our leadership position in cloud telephony. We began our shift to an innovation-led company with the acquisition of Fuze, which doubled the R&D resources dedicated to innovation. We have successfully accelerated the pace of project completion and are already seeing the results of our increased investment.
We are already in beta on a number of new CCaaS features, including capabilities based on advanced machine learning and large language models. We remain committed to our leadership position in cloud telephony as an important component of the XCaaS platform. Our ability to deliver both voice and CCaaS solutions for Microsoft Teams users is increasingly a deciding factor in new business wins around the world. We saw triple-digit growth in Voice for Teams seats in the third quarter and have now sold more than 300,000 licenses. Our first and largest Teams customer has already deployed the technology to more than 30 countries. Global coverage matters. Recent XCaaS with Teams wins include the Australian Computer Society selected 8x8 XCaaS with Voice for Teams to help drive operational efficiencies, productivity gains, and enhance their contact center performance.
This channel-led win demonstrates the competitive differentation of XCaaS solution within the Teams environment. In the U.K., Gateshead Metropolitan Borough selected 8x8 XCaaS with Voice for Teams to support hybrid work for their nearly 3,000 employees and enhance their 200+ agent contact center. 2, increasing our focus on small and mid-sized enterprise customers. Small and mid-sized enterprise customers need the same automation and ML/AI contact center capabilities as large enterprises, but don't have the large enterprise budgets or a team of in-house developers. Our mix-and-match pricing model, unified communications, and enterprise-class APIs make XCaaS the natural choice for these customers. Just as important, our modern platform enables the adoption of advanced contact center capabilities, future-proofing their investments. The strong product-market fit improves customer satisfaction, often leading to follow-on sales and reference sales down the line.
A great example of a win directly tied to a happy existing customer is Chubb Group Security Limited, a global fire safety and security solutions provider protecting more than 1 million locations worldwide. After acquiring a division from an existing 8x8 CCaaS customer, Chubb reviewed and selected 8x8 CCaaS for a complete secure cloud contact center solution. Another example of a customer satisfaction driving new business is Indiana Hemophilia & Thrombosis Center, the only federally recognized comprehensive hemophilia treatment center in Indiana and one of the largest centers in the nation. With a key decision-maker having previous experience with 8x8, the nonprofit entity selected 8x8 XCaaS for its comprehensive CCaaS solution that is certified for Microsoft Teams. Our best-in-class reliability was also a factor in the decision. Three, increasing XCaaS win rates and sales and marketing productivity.
As we continue to innovate and expand our XCaaS platform, our win rates should increase. We are attracting more go-to-market and technology partners every day, especially around our market-leading Teams integration. This expands our market reach, increases our capacity for innovation, and creates an ecosystem of application and features that allow our customers to tailor their customer experience to their business needs. A customer that fits squarely in our sweet spot is Pennine Care NHS Foundation Trust in the U.K., a provider of mental health, learning disability, and autism services to 1.3 million people across Greater Manchester and beyond. They selected 8x8 XCaaS to upgrade to modern, reliable cloud communications and deliver enhanced patient engagement capabilities for over 3,000 staff.
Another U.K. win, the Southampton Football Club in the English Premier League, is a good example of how unified XCaaS platform delivers contact center features to users across the organization to enhance the customer experience. The Saints, selected 8x8 XCaaS with 8x8 Frontdesk to deliver a premier fan and hospitality experience and introduce new communications channels such as email and web chat because they are customer obsessed. Four, maintaining an outstanding experience for customers so they can focus on theirs. The investments we've made in customer success, including more than 8,500 hours of training for our tier one support engineers, are evident in our statistics and customer success scores. We've seen a 50% reduction in escalated issues, a 20% improvement in first-day resolutions, and a 49% reduction in global backlog.
As a result, our customer satisfaction scores are up double-digits versus a year ago. We still have a lot of work to do, but are passionate about leveraging our platform and the solutions of our technology partners to drive continuous improvement in customer experience and customer satisfaction. We use our own products and intend to document our progress as an early adopter of each new innovation in an ongoing case study. In this way, we remain accountable to our commitment for improving the experiences of our customers and we provide a roadmap for our customers to do the same in their organizations. Five, establish CPaaS leadership in the Asia-Pacific region. CPaaS was down year-over-year and sequentially again this quarter. It was the single largest factor in our third quarter revenue miss and downward revision to our revenue guidance for the fiscal year.
That said, the CPaaS technology is important to the XCaaS platform and we continue to add new customers on a regular basis. We are going through a transition in the business and there are some signs of stability. This gives me confidence that CPaaS will make a positive contribution to our operating performance in the future. Several third quarter wins illustrate this point. Plugo, an Indonesian D2C e-commerce platform with a vision to democratize e-commerce, uses a combination of 8x8 SMS APIs and WhatsApp through 8x8 Chat Apps API, t o send secure one-time passwords as well as for customer care.
Privy, Indonesia's first and leading legally binding digital signature with more than 37 million users and 1,800 enterprise customers uses 8x8 SMS API to keep all users secure with one-time passwords. Plus Dane Housing, a U.K. housing association that owns and manages over 13,000 homes across Northwest of England. They selected 8x8 XCaaS with 8x8 CPaaS, Voice for Teams, and Verint Workforce Management to support their over 500 employees and drive customer satisfaction with greater omnichannel capabilities. We love our triple-play customers. Six, increase our profitability and cash flow to delever our balance sheet and fund investments in innovation that will drive our future growth. We have already shown tremendous progress in fiscal 2023, and we have come very close to our second-half 2024 target of double-digit non-GAAP operating margin this quarter, a full year ahead of schedule.
As Kevin Kraus will discuss, we believe we can drive our margins higher again in fiscal 2024 as we align our investments in cost structure and improve our sales productivity. We intend to leverage improvements in our operating margin to pay down debt, which will reduce our interest payments and allow more enterprise value to accrue to our equity holders. We began this process in Q2 when we repurchased $6 million in aggregate principal value of our 2024 notes. We continued in the third quarter with the repurchase of approximately $22 million in principal. What I have outlined here is a long-term strategy based on an efficient, focused innovation engine and a modern cloud-native platform. At the heart of this strategy is delivering superior customer experiences.
The experiences of our customers and partners as they engage with us, and the experiences they can deliver to their customers and their employees with our XCaaS platform. This is our North Star. Every customer interaction is an opportunity to delight, and our goal is to make every touch matter, whether digital or in person. This commitment to our customer's experience is already built into our D&A. Our financially backed commitment to f ive nines availability is just one example. We are already well on our way on our multi-year plan to lead with innovation and be the customer success platform of choice for our customers. The best measurement of our continued progress is the willingness of our customers to recommend our solutions to their peers. Our goal is to achieve 100% reference ability within our targeted customer segment.
It is a lofty goal, but one I believe will allow us to deliver sustained growth and profitability for many years to come. I will turn the call over to CFO Kevin Kraus for a more detailed review of our financial performance.
Thanks, Sam, and good afternoon to everyone. We remained financially disciplined and delivered solid profit and cash results for the third fiscal quarter. In the third quarter, despite service and total revenue being slightly below our guidance ranges, we delivered non-GAAP gross margin, non-GAAP operating profit, and cash from operations above our expectations. Total revenue for the quarter was $184.4 million, and we generated $175.8 million in service revenue, both an increase of 18% year-over-year. Our revenue performance reflected strong customer retention and renewals, partially offset by a continued decline in our CPaaS business in the Asia Pacific region. Other revenue for the quarter was $8.6 million, roughly flat with the prior quarter and in line with expectations.
Fuze accounted for $26.5 million of service revenue and total revenue, and was impacted by a $1 million third quarter reserve adjustment we made as part of our integration of back-office processes. Fuze customer retention remains strong, and the business continues to outperform our initial expectations. Strong retention across the customer base was reflected in our RPO and ARR metrics. Remaining performance obligation was approximately $750 million for the quarter, up from $715 million in the second quarter on solid bookings performance. Customer renewals were notably strong, and our customer retention was the highest it has been in many quarters. Total ARR was $698 million at quarter end, up 22% year-over-year.
Enterprise customers accounted for 57% of total ARR, and enterprise ARR was up 30% year-over-year, but down approximately $1 million sequentially due to the continued decline in CPaaS ARR. We had hoped this part of the business had stabilized last quarter, but due to continued challenges, we are taking a conservative view of the potential revenue contribution going forward. Turning to gross margin, operating expenses, and operating profit, please remember that all items discussed are non-GAAP unless otherwise noted. Service revenue gross margin came in at 75.7%, an increase of approximately 600 basis points from Q3 2022 and 160 basis points sequentially, driven by continued cost improvement programs which drove down unit costs and to a lesser extent, lower CPaaS revenue.
Other revenue gross margin came in at negative 1.4% for the quarter, compared with negative 32.2% in Q3 2022. Other revenue gross margin has shown consistent improvement over the past few quarters due to increased professional services operational efficiencies plus better product margins. Overall, second quarter gross margin was 72.1%, an increase of over 700 basis points year-over-year and up 200 basis points sequentially. Turning to operating expenses, R&D was 14.5% of revenue, which was in range of our 15% target. We improved sales and marketing leverage as we realigned costs early in the quarter, with sales and marketing expenses down $3.3 million sequentially, and sales and marketing as a percentage of revenue declining over 100 basis points sequentially.
We expect further improvements in sales and marketing efficiency as a result of our most recent cost alignment action in January, which further reduced our investment in sales and marketing initiatives and non-strategic areas of the business. This will be partially offset by the seasonal increase in employee-related costs in the first calendar quarter. G&A declined $3 million sequentially, improved 140 basis points as a percentage of revenue to 11.4%. Total non-GAAP spending as measured by cost of goods sold plus R&D plus sales and marketing plus G&A was up approximately 8% year-over-year, primarily due to the addition of Fuze operations, it was well below our 18% total revenue growth. Non-GAAP operating profit was $18.3 million, up nearly six times from fiscal Q3 2022 and more than double sequentially.
As Sam mentioned in his opening remarks, we achieved approximately 10% operating margin in Q3, nearly a full year ahead of previous expectations. As you can see, we are committed to improved operational efficiency and delivering enhanced operating profit. Turning to the balance sheet, total cash equivalents and restricted cash ended the third quarter at approximately $132 million, substantially equal to last quarter despite consuming $20 million in cash for debt repurchases. As Sam mentioned in his prepared remarks, during the quarter, we made notable progress delevering our balance sheet by repurchasing approximately $22 million in aggregate principal amount of 2024 Convertible Senior Notes after repurchasing $6 million in Q2 2023. These debt repurchases and the exchange transaction from August third leave approximately $68 million of aggregate principal value of 2024 Convertible Senior Notes remaining.
Given our current cash balance and expected future positive cash flow, we see no issues with repaying the 2024 debt with cash at maturity in February 2024. Going forward, we expect cash flow will increase with operating leverage, subject to timing differences in collections and other payables. We intend to use the excess cash generated to opportunistically prepaid debt, including our term loan. This will lower our interest payments and will enable continued investment in product innovation while simultaneously shifting more of our enterprise value to our equity holders. Cash from operations was over $15 million for the quarter, ahead of our expectations and approximately $2 million higher than Q2, despite paying approximately $3 million more in interest expense in the third quarter. We continue to actively manage cash flow and customer collections remain solid in Q3.
Free cash flow was over $12 million for the quarter, a greater than $1 million sequential increase. Our CapEx costs have been declining over time as we have focused on capital efficiency. As previously stated, we took action in January to realign our workforce to accelerate innovation as we continue to shift to enterprise and XCaaS, and this included the difficult decision to further reduce our total headcount. When completed, the action will impact approximately 7% of our employee population. This action will be factored into our non-GAAP guidance, and we expect some one-time severance and restructuring costs will impact our fourth quarter cash flow and GAAP results. Before turning to guidance, let me provide some context based on our commitment to building a sustainable growth business with SaaS-like operating metrics.
We have been doing a top-to-bottom strategic review of our business to ensure that all areas are operating efficiently. The strategic cost realignment activities from last October and in January allow us to reallocate limited resources to the areas of focus for the future while improving our operating metrics in the near term. We are raising our exit operating margin target for the fiscal year based on improving efficiency and discipline around the business we are pursuing. For operating expenses, we plan to control sales and marketing spend and would like to exit fiscal year 2023 between 33% and 35% of revenue, down from 39% four quarters ago.
We plan to focus our R&D efforts on our core product offerings and expect R&D as a percent of revenue to remain about 15% as we continue on the path of investment in our customer-focused product strategy with an emphasis on contact center features and functions. We are focused on extracting more leverage from our G&A functions as we work to improve operating efficiencies in those areas. We are establishing guidance for fourth quarter fiscal 2023, ending March 31, 2023 as follows. We anticipate service revenue to be in the range of $175 million-$178 million, up sequentially from Q3 at the midpoint and representing approximately 1%-3% year-over-year growth as we pass the Fuze one-year anniversary and remain cautious on the CPaaS revenue outlook.
We expect that Fuze's service revenue contribution will be roughly flat with Q3 at approximately $26 million. Please note that next quarter will be the last time we provide Fuze revenue contribution as we will have passed the one-year anniversary, and the businesses are now integrated. We anticipate total revenue to be in the range of $184 million-$187 million, up sequentially at the midpoint and representing approximately 1%-3% year-over-year growth. This guidance reflects the one-year anniversary of Fuze and our cautious approach to the CPaaS revenue outlook. We expect other revenue to be approximately flat compared to Q3. We are targeting an operating margin of approximately 10%, roughly flat with fiscal Q3 2023 as we experience our normal expense headwinds related to the restart of employer taxes and other benefits such as the 401(k) match.
These expense headwinds impact all cost lines in the consolidated statement of operations. We expect cash flow from operations to be positive but down quarter-over-quarter as we make semi-annual interest payments on our 2024 and 2028 Convertible Senior Notes and absorb severance costs from our January headcount reductions. We are updating our guidance for fiscal 2023, ending March 31st, 2023 as follows: We anticipate service revenue to be in the range of $708.5 million-$711.5 million, representing approximately 18% year-over-year growth at the midpoint. We continue to be cautious regarding our CPaaS business, and with the Fuze one-year anniversary past us, we expect to exit fiscal 2023 with service revenue growth in the low single digits on a year-over-year basis.
We anticipate total revenue to be in the range of $743.4 million-$746.4 million, representing approximately 17% year-over-year growth at the midpoint. Our total revenue guidance for the fiscal year reflects the combined Q3 and Q4 impact, resulting in a reduction of approximately $5 million at the guidance midpoint. We continue to focus on improving operating margin over time and anticipate landing at approximately 7.5% for fiscal 2023. We also would like to provide some directional color on fiscal 2024, which commences April 1, 2023. We anticipate total revenue and service revenue growth in the low single digits as the revenue step-up from the Fuze acquisition will be reflected in every quarter of fiscal 2023. Additionally, we remain cautious regarding the revenue trend for the CPaaS business.
We anticipate non-GAAP operating margin steadily growing from the expected Q4 2023 base of approximately 10%, hitting double digits every quarter in fiscal 2024. For the full year, we expect operating margin to be four to five percentage points higher than full year fiscal 2023. We anticipate cash flow from operations to be directionally aligned with the non-GAAP operating profit trend. Additionally, I would like to mention that we are reviewing our key metrics to ensure that we are providing the appropriate insight into our revenue growth drivers. We will follow up in subsequent earnings calls on this matter. In closing, I believe the continued focus on our operating margin and cash flow is the correct strategy for us at this time. This strategy enables us to remain an innovation-led company as we fund investments in key product areas.
On a personal note, I also would like to say that I'm happy to be continuing my business partnership with Sam in my new role as interim CFO. With 8x8's modern unified XCaaS platform, we are well positioned to deploy our strategy to capture more of the contact center market, to delight our customers, and to deliver on our commitment to improve profitability and cash flow generation. Operator, we are ready for questions.
Absolutely. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. This question is from the line of Matthew VanVliet with BTIG. Your line is now open.
Hey, good afternoon. Thanks for taking the question. I guess as you look at sort of the realigned cost structure here, and an outlined kind of focus around servicing smaller customers and also the Teams ecosystem, just curious sort of where within the sales and go-to-market organization are we seeing the most cuts? And it sort of feels like some of these investments are in areas that were maybe less focal for the previous leadership team. Just curious how much of this is a change versus just kind of moving from one pocket to another. Thanks.
I'm gonna give you one of those great answers that CEOs like to give, which is a little bit of both. I mean, we are in line with what we've said in the past. We continue to moderate our investment in our smaller customer segments, so the small business side of the house, while we continue to invest in mid-market and enterprise. We have made some, reduced some investments in the sales and marketing front, in line with what we have, again, said in the past, where we're willing to forego some revenue growth for increased profitability, and the 9.9% operating margins clearly shows that we're taking that seriously. I think the things, Matt, that we changed a little bit is we're a little bit more aggressive about making those changes sooner than later.
You know, we're continuing to focus on investing in contact center, XCaaS, and innovation, those three things. I think we're a little bit more aggressive behind those investments also. A bit of both, if I can give you that answer.
Okay. Fair enough. I guess as you look at the Fuze business that you acquired, you know, we're understandably lapping that and, you know, it creates some headwinds on growth. Curious, as you look at that customer base, is that, you know, should we think about that growing at any different pace than the legacy 8x8? Is there limitations on sort of how much you can grow in that base and as much of the acquisition is around the technology and the development team? I guess maybe just help us think about what that Fuze base looks like, and eventually is there still plans to move them to XCaaS?
Okay. In order, the first and most important thing, and we have not done a great job of this yet, is cross-selling our contact center into that UC base. There's a tremendous opportunity, and that wouldn't show up necessarily in the Fuze numbers if we continue to report those. I mean, we're not gonna report after next quarter, but if you could imagine, it wouldn't show up in the Fuze number. It'd show up in the 8x8 side of the house. We've already started upgrading some of the customers to the 8x8 platform, and we'll continue to do that. That's part of the reason Kevin said in his prepared remarks that as we anniversary, it just gets kind of meaningless to report these. Remember, we're not investing in new logo acquisition on the Fuze side of the house.
We're investing on the 8x8 side of the house. In a notional sense, the Fuze number we report is the Fuze UC base. With natural sort of things, we'd expect that to slowly degrade a little bit over time. As the numbers show, it's been a very slow over the last year. It's done much better, kudos to the GCC team. It's done much better than we expected when we originally did the acquisition. I would expect that to continue. The number one areas of focus besides retaining the revenue is cross-selling our contact center into it.
Okay. Thanks for taking the questions.
Thanks, Matt.
Thank you for your question. The next question is from the line of Meta Marshall with Morgan Stanley. Your line is now open.
Great. Thanks. Maybe as you look to fiscal 2024 and just kind of the low single-digit outlook that you gave, you guys mentioned a lot of conservatism around CPaaS or conservatism, just on Fuze term. Just if you could give kind of an update as far as, like, what you're seeing as far as deal activity, trajectory, just given kind of the macro environment. Maybe as a follow-up question on the CPaaS business, I guess just, like, what is the ongoing rationale, particularly just given it's in a region that you guys don't do a tremendous amount of business in? Of, like, what is the business rationale of kind of continuing to kind of invest in that business, you know, when you're making kind of cost decisions elsewhere? That's it. Thanks.
Thanks. Okay, this is Kevin. In terms of the 2024 growth of low single digits, we are being conservative with respect to the CPaaS business, as we said. We do see signs of stabilization in that business, but since it's usage-based, it's a pretty dynamic market. We're just going to continue our conservatism into the forward-looking forecast on that until we see absolute signs of change. In terms of the rationale for the investments in that business, that business can really turn revenue up pretty quickly, we're very interested in that business. It can provide a lot of growth in pretty short order, more so than our typical recurring revenue business does. That's one of the areas where we're looking at potentially ramping up our growth.
Yeah. A couple small things I'd add is, when you talk about economic sensitivity, probably in some place like CPaaS, which isn't contracted revenue, we're seeing a little bit more of that economic sensitivity. I think on the core business where it's really interesting is our collections were absolutely fantastic. As Kevin talked about, our cash and cash, you know, balance was sort of in excess of what we expected for the quarter. Our collections portfolio is the best it's been in a long time, and that's also a clear sign in our retention metrics. If you look, our retention metrics were, you know, highest in many quarters, months, I forget exactly what Kevin said, but in one of those. The quality of our portfolio from an economic perspective is absolutely fantastic.
You did see RPO trended up, right? You know, the contracted revenue had a pretty good quarter, you know, relative to some of the other things. I think from an economic front, I'm not super stressed right now about the economic health of both on the recurring side and the ability to add new logos. Then lastly, just on the conservative nature of the model, look, it's my first quarter. I'm definitely not gonna stick my neck far out with a super aggressive model. We've got a ton of new innovation that's going into beta, which we basically have zero in the model for. We're trying to be really conservative on the CCaaS side of the or sorry, CPaaS side of the house, also. Yeah, Meta, cut me a bit of slack.
I'm conservative on the first quarter out.
All right, thanks.
Thank you for your question. The next question is from the line of Siti Panigrahi with Mizuho. Your line is now open.
Hi, thanks for taking my question. Sam, it's good to see focus on profitability side. Just want to ask on the revenue side, your service revenue side, let's say, organic services revenue growth was flat, excluding Fuze. You did talk about CCaaS, but what do you see in terms of, you know, macro trend, anything on the enterprise side? Is it definitely decelerated? What are you seeing in the market right now?
It's a, it's a fair question. Yes, your math is correct. It's a little hard for me to tell. We took an action in the beginning of October, we took another action in January. Both of those, you know, had consequences. As we said earlier, we're walking away from low margin or negative margin revenue for improved profitability. We think the improved profitability allows us to delever our balance sheet, you know, just makes the company better off and allows us to reallocate investments in the better ROIC areas. I think absolutely, economics played a relatively small role in the revenue performance. It was really self-generated. The other thing I would say is, I think that reallocation investment is working.
Deferred revenue up quarter-over-quarter, deferred commissions up quarter-over-quarter, RPO up quarter-over-quarter, and retention at the highest levels we've seen in a long time. In terms of the underlying indicators of a healthy SaaS business, they all got better last quarter. I sort of believe that the right play right now is to sacrifice a little bit of revenue growth to make all those things substantially better.
Okay. thanks for that color. in the CPaaS business, I know you talked about weakness, on that CPaaS business last few quarters. wondering what's the current run rate of CPaaS right now?
We don't disclose that. As Kevin mentioned in his script, it's one of the things that we're looking at disclosing potentially in future quarters. He kind of put the breadcrumbs out there that it's under review.
Okay. Thank you.
Thank you for your question. The next question is from the line of Catharine Trebnick with Roth Capital Partners. Your line is now open.
Hi. thanks for taking my question. Sam, when you talked about your build up point number 5, Asia Pac and CPaaS revenue has been down. What other assets are you looking to build that up with so you can really drive that as a key growth driver?
It's a completely fair question. I think in the past, we missed a bit of a product cycle in CPaaS in Asia. You could Like, I can get into more details at another time, but just we missed a product cycle, and we've sort of caught up on that. We're investing in the platform and the business. Our unit volumes have continued to increase, and we continue to land, you know, brand name customers, as I mentioned in the prepared remarks. I think the business funnel is there, et cetera. We just need to close the gap on a few product features. You know, there's some other news that's coming in the near future on that front, also in the CPaaS business. I think that the stars are starting to align for us to turn that business around.
It is taking longer than we had expected, I grant that to everyone. I think the stars are there for it to turn around and do better.
Well, will you also layer on your CCaaS business in like the Australian market? It seems like that would be the right market for you.
I don't know. I don't want to poo-poo the Australian market. It just happens to be that Australia is like the 58th-
Oh
... largest population country in the world, and the state of California is the sixth. I'm not sure if I wouldn't rather invest in California than in Australia. Right now we're investing pretty aggressively in the U.S., U.K., California, I'm sorry, Canada, Ireland, because those are just great contact center markets right now for us.
All right. That helps out. Thank you.
Thank you for your question. The next question is from the line of George Sutton with Craig-Hallum. Your line is now open.
Thank you. Sam, you talked about the importance of your customer recommendations to their peers as being a driver of your business. Can you talk about that in a little more detail? Is that something you've actually seen? Is there something you can quantify there?
Kate might know the quantification numbers off the top of her head, one of the things that we've been very focused on over the last few quarters has been improving our referenceability. We're really talking about NPS or this notion of referenceability. We saw a pretty substantial increase in our referenceability. This all goes sort of full circle, right? In my prepared remarks, I talked about our investment in customer success. Kevin talked about the very high retention rates we're having. That in turn leads to happy customers. Happy customers give good references, which then in turn drives RPO improvements and deferred revenue improvements and those kinds of things, right? We're trying to get that virtuous cycle maybe spinning a little faster than it has in the past.
Gotcha. Just as a follow-up, you mentioned customer churn is something you're comfortable with. I'm curious if you can talk about seat churn? Of course, as we're starting to see some layoffs around the market, is that starting to have an impact in the results?
I'll let Kevin Kraus follow up if he wants to add anything. Look, when we talk about retention, we talk about logo plus seats, right? If a customer downsells from 100 seats to 90 seats, or a customer goes from 10 seats to zero, we count that the same. Last quarter, we had, you know, the highest retention in many years. I don't think it's that much. I think what's interesting is we're launching a lot of really important things, 8x8 Conversation IQ, some of the things we have in beta, et cetera. Even if we're seeing a little bit of ARPU decrease from the core product, just the number of seats, we are seeing an uptick in the number of add-ons going into our contact center.
I think on the customer retention, we need to go back over more than three years to get. I just can't find any numbers for more than three years that are better than the ones that we just put up this quarter. I will also say that we're making the right investments in Global Customer Care and delighting our customers. It's really starting to pay dividends for us, and we're, you know, we're keeping the right high-value customers. Looking forward, although we don't give guidance on this, but, you know, we do look out. We're very, very proactive about what customers are renewing, what's coming up, and we address any risks that way. We're doing a really good job of that right now.
I think that's reflected in our recent trend.
Next question, please.
Thank you for your question. The next question is from the line of William Power with Baird. Your line is now open.
Okay, great. Thanks. I guess I had a question on the revenue guidance, both for fiscal Q4 and 2024. Thanks for the initial framework there. I guess I recognize that, you know, CPaaS is gonna be a headwind. You've talked about that. Is there any way to kinda help us parse apart what you're seeing in kinda XCaaS and CCaaS, which I know is the strategic priority, versus UCaaS? I mean, are there, you know, demonstrably different growth rates there? Any color you could provide on that front?
Yeah. I mean, I'll start, and I'll let Kevin fill in. A couple things, right? XCaaS is now for almost 40% of our ARR and, you know, has growth rates well in excess of what we're seeing across the whole business, right? The whole business flat and, you know, our growth rate in XCaaS, high 20s. Definitely, a situation where we've got a lot of moving pieces under the table. CPaaS, you mentioned. Small business, UCaaS, it had an okay quarter. This quarter was kinda flattish on a year-over-year basis, right? You know, up 4%, those kinds of things. Not, not blowout numbers. We are still under the covers. I think all this is starting to show up in a complete soup, though, right? XCaaS, our contact center doing better.
That's driving higher growth rates in enterprise. Small business is starting to become a smaller and smaller component of the overall ARR mix. As all that fleshes out over time, we should naturally see a lift in growth rates.
Let me ask you, too, then, maybe this ties into that. I mean, you noted, RPO, you know, was had a nice, you know, sequential increase. What's helping drive that? I mean, is that, is that XCaaS adoption? What, what are kinda the key pieces of that?
Yeah. No, I mean, I'd love to make it super sophisticated and cool, we had a good quarter for XCaaS sales, right? You know, the combination of UCCC and a world-class Microsoft Teams integration. I mean, we mentioned, right? Microsoft Teams triple-digit growth year-over-year. That's pulling in our contact center. Our contact center then has higher dollar ARPUs attached to it and good margins associated with it. If we can just keep rinsing and repeating that, the numbers will continue to get better.
We also, I mean, in addition to the strong, you know, the strong new logo bookings, we had a great renewals quarter as well, which is indicative of the investments we're making in delighting the customers.
Thank you for calling that out, Kevin.
The, you know, that's reflected in our RPO. Our deferred revenue is also up quarter-over-quarter as well.
Yeah. XCaaS has a net dollar retention well in excess of 100, right? Like, the more that XCaaS becomes a bigger part of the business, the more the math starts to work itself out.
Okay. Then, I'm sorry, maybe just a quick clarification. On the for fiscal 2024 on the operating margin guidance, I think you said 400-500 basis points. Was that above the full year fiscal 2023, or is that above the exit rate of 2023?
It's above the full year.
That's for 2024.
Sorry. Yeah. We think.
Okay
... about 7.5% we'll have for the full year. Then just add 400-500 basis points on top of that for the full year. We do expect a steady improvement.
Strength
... Yeah, you know, on the strength of the balance sheet.
Okay. Thank you.
Thank you for your question. The next question is from the line of Peter Levine with Evercore ISI. Your line is now open.
Great. Thanks for squeezing me in here. When we think about, you know, foregoing, I think, near-term growth and profitability, you know, managing the business for more cash, I think your comments on having eight become more of an innovation-led company, but it does sound like the offset to that would be sales and marketing. Is the idea to rely more on partners for NetNew, or is the strategy to kind of focus more back on the base? Just what initiatives are in play, I think, today deliver, I think, greater sales and marketing efficiencies if you're gonna be pulling back a little bit on the sales front?
Yeah. We, we are a partner-led company, and so we're pulling... I think the key is, and there's a timing aspect to this, and I know that everybody sort of gets that. But, you know, if we invest today in innovation, it takes a little while before that to show up in pipeline. What we have done is we've really worked on improving the sales and marketing efficiency at the company while we incubate, you know, a solid innovation roadmap, particularly around contact center. Once that innovation roadmap starts to get into the market, whatever, we should be more of a customer pull model instead of a sales or partner push model, and that's much more efficient over time. There is a timing aspect to this.
We'll deal with some quarters of relatively low growth rates as we make this transition to XCaaS being a larger part, to innovation, to new products driving more of the business. That's really what we're focusing on to improve that efficiency number instead of, you know, some of the things we've done in the past.
Apologize if I missed it, but can you quantify, I think, the CPaaS headwind this quarter? If I look at organic growth year-over-year, I'm just trying to understand how much of that was attributed to the CPaaS headwind versus kind of macro just impacting customer purchasing decisions?
We don't break out CPaaS separately. You know, we want to run afoul of the segment reporting rules of the SEC and some of the other rules that are out there. I would just tell you that it was the difference between our guidance and what we actually produced, the vast majority of that was the CPaaS business, if that helps you quantify it.
Okay. Great. Thanks for the color. Thank you.
Thank you for your question. The next question is from the line of Ryan Koontz with Needham. Your line is now open.
Hi, thanks for the question. Sam, I wanted you to look at the kind of broader UC space and, you know, the obviously slowing growth across the board. Are you seeing signs yet of consolidation that could improve the health of the industry?
We consolidated Fuze and the Street didn't like that deal, so I'm not sure anybody is gonna be consolidating anything, you know, anything too soon. Fuze for us has been a big success. I would do it all over again. So far, no, I don't see a whole lot in the consolidation space.
Got it. In terms of the Fuze install base, update there in terms of customer migration or how we should expect any kind of impact on the model going forward at this point?
Well, we're accelerating upgrades. I was about to say migration. We're accelerating upgrades, and we've got automated tools, and the work we've done on the engineering front to make that just a really easy, seamless transition is starting to come into market. We would expect that those upgrades to start to accelerate over the next couple quarters.
Got it. That's helpful. That's all I have. Thanks.
If any Fuze customers are listening, we're not gonna force you to migrate. We're not gonna force you to upgrade. We're gonna do it when you're ready.
Thank you for your question. The next question is from the line of Ryan MacWilliams with Barclays. Your line is now open.
Thanks for taking the question. Sam, also nice to see the improvement quarter-over-quarter in non-GAAP gross profit. Seems like you're certainly targeting the right revenue. For the 2024 target for low single-digit top-line growth, and look, I'll cut you some slack on this one, but on a quarterly basis, should we think about any differences in the year-over-year revenue growth rates for the first half of the year versus the second half? At this point, are you thinking stronger year-over-year growth later in the year?
Yeah. I mean, we haven't baked really any of the new products in, but because of the comps and some of the other things, the growth rates will naturally lift as the year goes on. Thank you for calling it out, right? Last quarter, you know, 31% year-over-year growth in gross profits, and we would expect that next year gross profit growth is in excess of revenue growth. We continue to get solid gross margin improvements. Yes, more back half of the year. Kevin, anything you wanna add?
Yeah. You know, provided what you know, happens with CPaaS, you know, we're gonna be taking a look at that.
Yeah
... and doing what we can to help ramp that above our conservative estimation.
Yeah. Good, good to hear that, for sure. We also noticed that your disclosure for Microsoft Teams licenses went from 200,000 last quarter to over 300,000 in this quarter. Do you have a sense of what % of 8x8's net new business comes with the Microsoft Teams integration? Separately, you know, the strength around renewals, did you notice any additional price headwinds, perhaps from competition, around those renewals in the quarter?
Okay. I have to get back to you on the first one because we give away the integration for Microsoft Teams for effectively free, so it has no real consequence on the UCaaS number. Just before everybody freaks out, it's not I'm giving seats away for free. They still have to buy an X1 or X2 or X3 or X4 seat to go with it. The integration is free. It's easy for me to get the seat number, but I have to go do some math to say what % of new logo dollars that was. Microsoft Teams is an important aspect, and obviously, if we're talking about organic growth at zero and Microsoft Teams growing at triple digits, it's becoming a larger share of our new logo wins.
I think it is pulling through Contact Center and some of the other things.
Sure. just around the renewals in the quarter, did you notice any, like, additional?
Oh
... around price-
Pricing
... on those renewals? Was it pretty similar?
Yeah, if I speak really candidly, it's the fiscal fourth quarter, December, for a number of our competitors. I swear at the end of the year and at the end of their fiscal years, they have absolutely no pricing discipline at all. Did we see mud thrown in several directions? Sure. I suspect that while they're busy with their SKOs now and posting on LinkedIn, they'll forget to do that this quarter.
Fair enough, Sam. I think we know who you're talking about, but appreciate the color. Thanks, guys.
Thank you for your question. The next question is from the line of Michael Turrin with Wells Fargo. Your line is now open.
Hey, guys. Thanks for taking the question. This is Austin Williams on for Michael Turrin. I wanted to go back to margins. I'm wondering if there's any way to quantify how much of a margin improvement that you've seen thus far are from taking costs out of Fuze and, you know, how that compares to just the core business efficiencies.
We have really gotten a lot of great margin out of the core business as well as Fuze. It's really on both sides. And the Fuze you know, the Fuze gross margin's comparable with the 8x8 organic gross margins, and we've done the same kind of work on, say, COGS that we did over the past several quarters for 8x8. We also did it with the Fuze base. It's kind of been done in tandem. I would say that there's a fairly equal distribution of margin improvement from both entities, if you will.
Got it. That's helpful. Just one follow-up. RPO was up nicely on a sequential basis. I'm just wondering if there's anything to call out as it relates to deal duration, if there are any longer-term deals in there.
Yeah. We saw a slight change, but a vast majority of it was just more contracts.
It's roughly the same.
It's roughly the same.
Got it. Thank you.
Thank you for your question. The next question is from the line of Michael Funk with Bank of America. Your line is now open.
Yeah. Thank you for the question. Couple if I could. Earlier you mentioned, hoping to see a cash rate of CCaaS increase over time. Just wondering more details on what's gonna make that happen. Is that just a, you know, sales training and processes, you know, better partner training? Is it technical integration? What's the gating factor there?
I believe that. I believe as the innovation we're investing in, particularly on the contact center side of the house, comes into market, our contact center is gonna start to pull through more and more. Given the fact that we have things like 8x8 Conversation IQ, which gives a distinct advantage to moving your base onto UC from the same vendor on the same platform. As our contact center gets better, it gets us involved in more deals. That in turn makes the prospects look at the fact that we have five nines SLA, a single platform, high availability, high reliability, a tremendous feature set, and all those other things, just makes it a layup to buy it all together in one package. I think that's why we're seeing XCaaS resonate with the market, right? 40% of ARR-
Mm-hmm.
Higher retention rates, higher Net Dollar Retention numbers, all those things. The more we invest on the contact center side, the more I think that flywheel spins faster and faster because contact center is where there's a tremendous amount of white space in terms of innovation room today.
Understood. Thank you for that. Also I think the comment was made about addressing risk of upcoming expirations and that being helpful with the retention rate. You know, is that related to some of the competitive pricing pressure you were seeing in the market? How are you addressing those risks? Is that through discounting, incremental product additions? How are you addressing that with customers?
Go ahead. I think, yeah, I think that was my comment about how we're looking for-.
Yeah.
Yeah.
Yeah. Exactly. Thank you.
What we're trying to do is first of all, we have a pretty good we've operationalized fairly well, an understanding of the customer renewals and when they're coming up, and well in advance of their renewal, just make sure that the customer, you know, is using the product, it's working, as promised, making sure that they're delighted in the performance of the product and so forth. That's where the investment came in, the investment comment comes in that I mentioned about making sure that, you know, the customers are happy. By doing so, we don't necessarily have to go discount on renewal. You know, it could happen, but basically, we just wanna make sure that we get ahead of it.
Yeah. I would sort of piggyback on what Kevin said, right? Switching costs are not low in this industry with line number porting and everything else, or training agents or doing those other things, right? Really, like, once we land a customer, they're ours to lose, and the GCC organization here has just done an exceptional job of removing the bottlenecks to renewal, number one. Then the engineering organization's done an exceptional job with just very high reliability. I mean, we have five nines platform SLA, and most of our competitors don't because they can't meet those kinds of numbers.
Great. Sam, Kevin, thank you for the time.
Thank you.
Thank you.
Thank you for your question. The next question is from the line of Josh Nichols with B. Riley. Your line is now open.
Yeah. Thanks for the question. Good to see the improving operating margin guidance, as the company continues to make progress on the deleveraging frontier. Just, most of my questions have been answered, but I guess I'd say if you could kinda compare and contrast what you're seeing in the U.S. versus other markets such as the U.K., that'd be interesting given the economic weakness that we're seeing in that foreign markets have been a lot faster growing from you of late. Just curious what that looks like today.
I know, Kevin, you should chime in. I think the biggest difference I see is our XCaaS messaging resonates, and our Microsoft Teams messaging resonates really strongly in the U.K. market and in the foreign markets a little bit better. In the U.S., there's still a little bit of the Microsoft channel and the telecom channel being two separate channels. Our channel team has done a tremendous yeoman's work building our Microsoft Teams channel, and that's paying dividends. I see economics less. It's just two different structured markets in particular. And it's easier for us to gain that sweet traction in our foreign markets.
Thanks. Last question for me. I guess sounds like the, you know, CPaaS business has been a little bit of a headwind. I know that's a lower margin offering, but likely stabilizing over the next couple quarters here. One, I guess, like, while the company's focused on deleveraging, like, one, would you consider that like a core business or potentially not as you look at opportunities to kind of accelerate this deleveraging process? Are there any also, like, repayment restrictions that you have on your debt aside from the remaining notes that are due in 2024?
I'll let Kevin take the second one. Well, the CPaaS business is a great business. It's got beautiful unit economics when it's running right. We need... You know, step one is get it running right, and then we can talk about strategic options for it. Josh, as you know me, I'm a seller from strength, not from weakness.
Yeah, on the debt question, we have February 1, 2024 is when the remaining 2024 converts are due.
He's asking, though, on the term notes, we can pay back.
Without a prepaid penalty.
Without with a prepaid penalty next year.
Starting in August. Yeah, that's what we have. There is a prepayment penalty for the succeeding year, small prepayment penalty, and then after that, there's none.
That's right.
Great. Thank you.
Thank you.
Thank you for your question. There are no additional questions waiting at this time, so I will pass the conference back to Samuel Wilson, CEO, for any closing remarks.
All right. Thank you, Matt. Thank you for your continued support. I hope we have conveyed some of the excitement about our opportunity and our future path, tempered by the recognition that success will require commitment and hard work. I am confident we can do this. We are a vibrant and financially strong organization, and we are accelerating the pace of innovation. With a steady stream of new products coming this calendar year, including ML/AI-based features and tailored experiences, we are well-positioned for the future. Thank you so much, and I look forward to reporting our progress next quarter.
That concludes the conference call. Thank you for your participation.