8X8 Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 11, 2023

Key Takeaways

  • 2% service revenue growth in 4Q23 with total ARR up 2% year-over-year and enterprise ARR up 3%, while CPaaS revenue stabilized and grew sequentially.
  • Non-GAAP operating margin jumped to 13.5% in 4Q23 from 2% a year ago, driving a nearly 500% increase in operating income and marking 9 consecutive quarters of positive operating cash flow.
  • Fiscal 2023 R&D investment rose 42% to $109 million, with 60% allocated to AI integrations, advanced analytics, and developer APIs, and 40% dedicated to platform reliability, security, and micro innovations.
  • Strong cash generation ($49 million in FY23) enabled over $58 million of debt repayments since August 2022 and the commitment to return $250 million to shareholders through debt retirement and share buybacks over three years.
  • For FY24, 8x8 guides service revenue of $725–732 million (2–3% growth) with sustained gross margins near 72–73% and targeted non-GAAP operating margin of 12–13%, reflecting continued focus on profitable enterprise expansion.
AI Generated. May Contain Errors.
Earnings Conference Call
8X8 Q4 2023
00:00 / 00:00

There are 9 speakers on the call.

Operator

Day, ladies and gentlemen, and thank you for standing by. Welcome to the 4th Quarter 2023 8x8 Incorporated Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer At this time, I would like to turn the conference over to Ms. Kate Patterson.

Operator

Ms. Patterson, you may begin.

Speaker 1

Thank you, operator. Good afternoon, everyone. Today's agenda will include a review of our 4th quarter results with Sam Wilson, our Chief Executive Officer and Kevin Krause, our 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.

Speaker 1

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, and we have no plans or obligation to update them. Certain financial metrics that will be discussed on this call, together with year over year comparisons in some cases, were not prepared in accordance with U. S. Generally Accepted Accounting Principles or GAAP.

Speaker 1

A reconciliation of these non GAAP measures to the closest comparable GAAP measures is provided in our earnings 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 Sam.

Speaker 2

Much appreciated, Kate, and thank you for joining us today. Financial results reflect our company's ability to meet expectations and balance priorities. 1 year ago, we made the decision to turn our focus from near term revenue growth towards expanded profitability and cash flow, while continuing to invest in innovation for the future. Our 4th quarter and fiscal 2023 results are a reflection of these priorities. Let me walk you through the highlights of our performance.

Speaker 2

Service revenue growth was 2% in the 4th quarter as we anniversaried The Fuze acquisition and saw the expected year over year decline in CPaaS revenue. ARR mix continues to shift to enterprise customers with Enterprise and xCast ARR were both up year over year with xCast increasing in the mid teens percentage year over year. Furthermore, our CPaaS business was up quarter on quarter in the 4th quarter, a first step in the right direction. We invested more than $109,000,000 in non GAAP R and D in fiscal 2023, an increase of 42% from 2020 2 and nearly double what we spent in 2021. About 60% of the R and D spending is focused exclusively on innovations to drive revenue growth, including deep integration with AI technology across the platform, Advanced analytics, UI UX improvements, broad developer APIs and other efforts to expand functionality.

Speaker 2

We invest the remaining 40% of R and D in our best in class communications platform to deliver the quality of service, high availability And security our customers expect. This is much more than maintenance work. We see multiple opportunities to lead the industry forward in areas Like platform flexibility, usability, simplified administration, self-service, accessibility And anything that results in the greatest possible reliability. These advances are often delivered automatically through our modern cloud based architecture. Despite the lack of fanfare, these micro innovations at the platform level are crucial to differentiating our solutions and maintaining our technology leadership.

Speaker 2

We increased efficiency in our operations, primarily in sales and marketing and the cost of service delivery, which more than offset the increase in R and D investment. We exited fiscal 2023 with non GAAP operating income of 13.5%, well above our 10% guidance. This compares to operating margin of just 2% in the Q4 of 2022 and breakeven at the end of fiscal 2021. To put the magnitude of year over year improvements in real dollars, our Non GAAP operating income increased nearly 500% year over year for the Q4 and for the fiscal year. Looking at our performance on an annual basis, we generated more than $62,000,000 in non GAAP operating profits for FY 'twenty three.

Speaker 2

In fiscal 2020, just 3 years ago, we posted a non GAAP operating loss of $61,000,000 Cash flow similarly improved. Fiscal 2023 cash from operations increased 41% year over year to $49,000,000 This is despite a $20,000,000 increase in cash based interest expense from fiscal 2022 to $22,000,000 for fiscal Our strong financial performance allowed us to accelerate debt repayment while maintaining cash Investments balance in excess of $100,000,000 In the Q4, we again repurchased debt. Kevin will provide the details. Turning to the future, we are planning to level out operating margins in the near term and continue to invest in R and D for the future. We will continue to use excess cash generated by our operations to delever our balance sheet and return value to shareholders.

Speaker 2

We intend to return at least $250,000,000 to our investors over the next 3 years through debt retirement and if possible share repurchases. We have started down this path with the voluntary early $25,000,000 debt repayment on our 20 27 term loans we made earlier this week. This is a sign of management and the Board of Directors' confidence in our future. Speaking of which, I was surprised to hear a U. S.-based wholesale carrier report their voice traffic declined in Q1, which they attributed to softness in demand from leaders in the UCaaS, As Gartner Magic Quadrant.

Speaker 2

Let me caution you that the most logical read through is not always accurate. Speaking purely from an 8x8 Our overall UC and CC traffic has been increasing. We have built a global network of carriers and a Super efficient model for allocating traffic between carriers based on price, capacity and quality. This quarter, we launched our customer obsessed branding, which I approach in 3 lanes. 1st, we enable agile workforces.

Speaker 2

This means much more than simply extending voice service to a work from home user, although even basic voice delivered worldwide is extremely complex. Our solutions allow users the ability to move across devices and locations, toggling from chat to voice to video and back easily. We deliver these seamless capabilities through our 8x8 Work app or through a seamless integration with Microsoft Teams. Across collaboration environments, our scalable, highly available communications platform reduces the administrative burden for IT departments, Eliminates the need for multiple carrier contracts and delivers the highest levels of security and data privacy. We have over 20 years experience and we own the platform, patents and know how.

Speaker 2

2nd, we empower users across an organization to deliver great customer experiences. Surveys show that every interaction counts when it comes to customer loyalty. In a typical B2B or B2C organization, more than Half of all customer engagements are with employees outside of the contact center. Our unified platform provides contact center functionality to these crossover users We typically outnumber contact center agents by about 5:one. This is a large and underserved market opportunity.

Speaker 2

We estimate it's at least Twice the size of either the UC or CCaaS standalone and we are uniquely capable of addressing it with our unified platform. Sir, we harness the power of AI and machine learning. Artificial intelligence and machine learning have catapulted into The public eye was Chad CPT, but 8x8 has been preparing for this moment, building our experience and talents back along this potentially evolutionary technology lead. We are pursuing an ecosystem path and have partnered with a number of players, including most of the companies in the leaders of various quadrants from Gartner. Please check out the video on their website.

Speaker 2

We have a dozen more technology partnerships in development and a waiting list. This will continue to expand the capabilities of our platform in numerous directions. Lastly, we have brought some of the AI technologies in house For common services, enabling our customers to tailor solutions to their specific use cases and offer a higher level of service at a lower cost. At our event at the NASDAQ Marketsite in March, we introduced several important new products, including intelligent customer assistant and supervisor workspace, as well as a platform wide integration of OpenAI's generative AI solutions. Our spring software release announced at the end of April included Additional enhancements to the platform, including deeper integration with Microsoft Dynamics 365 and Salesforce Sales Engagement.

Speaker 2

By rapidly growing investment in R and D, we are increasing the pace and the significance of our innovation cycles, particularly in the contact center. In January, we aligned our sales and marketing resources to better serve our target customer, businesses that deliver a tailored With the increase in focus, we are already seeing our retention, cross sell and new business win rates improved. We have included several case studies of 4th quarter wins And our earnings slides illustrate how the Unified platform enables our customers to serve their customers. One of our newest wins, Sajektor, helps people who are underserved, at risk or disabled receive the benefits they are medically, legally and ethically qualified for from both government and private entities. Last October, ToJakjor began a small proof of concept with 8x8, Testing our XCast platform with intelligent IVR and an integration with their Zoho CRM.

Speaker 2

They like what they experienced, 8x8 uptime, Our all in one XCAS story and our ability to integrate APIs. By March, they were ready to make a significant expansion with 8x8 Substantially within the contact center to enhance customer experience. Personally, I'm excited to see 8x8 supporting Director because of their work helping veterans pursue VA benefits. As someone who had the privilege of serving in the United States Army, supporting our veterans is near and dear to my heart. We also showcased several other customer obsessed organizations who are using XCast platform to build innovative solutions.

Speaker 2

Jackson Lewis, a U. S.-based law firm with more than 950 attorneys worldwide focused on labor and employment law. Jackson Lewis wanted to move to a cloud with a single integrated CCaaS and UCaaS solution to provide Performance wide analytics and work out of the box with Microsoft Teams and ServiceNow. Also, they needed open APIs to build an integration with their billing 8x8 will simplify administration for their IT organization and add contact center to their platform. Agilysys, one of the U.

Speaker 2

K. Fastest growing cloud and digital transformation specialists. Agilysys wanted to move to the cloud with an integrated CC and UC platform to support a hybrid workforce, while using quality monitoring and the speech and text analytics to gain better customer insights into the overall customer journey. As a participant in our early adoptive program, they are adding 8x8 intelligent customer assistance to further enhance the customer experience through the use of conversational AI and self-service technologies. Maiden, a healthcare company based in Bath whose life work is creating Digital technology that changes what's possible for medical professionals and patients.

Speaker 2

They design, build and support insightful cloud based systems for healthcare services in the U. K. And abroad, including iAptis, a SaaS patient's management system for over 200 mental health providers in the U. K. And abroad supporting over 1,000,000 patients per year.

Speaker 2

One of the things I love about Maitre's IAPTIS solution is that it uses 8x8 CPaaS video to allow healthcare clinicians to generate video length for appointments from the patient's IAPTIS record. This is then shared with the patient via tech in an effortless workflow. We include a link in the slide to a video created if you want to see exactly how all this works. As these customers show, This is what we mean by communications for the customer obsessed. Omni channel, data driven, AI enabled and only possible with a scalable global highly available Communications platform that spans the organization.

Speaker 2

We want SCAS to be the standard toolset for the customer obsessed communications. Our business starts and ends with great people. We are coalescing behind a nimble, efficient teamwork orientation. The vision and roadmap we developed this year are resonating with our customers and partners. I also want to note that most of our wins have come through our go to market partners, which is a strategy we have embraced and are looking forward to strengthening.

Speaker 2

In summary, we have a lot of work ahead, but we have a plan. Thanks to 8x8's phenomenal employees, partners and customers, we have a large installed base, we own core technologies And we plan to spend over $100,000,000 a year annually in R and D for future development. All of this in a large and vibrant market. It is up to us to execute and as our financial performance for the quarter highlights, we know how to do that. With that, I turn the call to Kevin.

Speaker 3

Thanks, Sam, and good afternoon, everyone. We remained financially disciplined and delivered solid revenue in the fiscal 4th quarter, exceeding our guidance range for non GAAP operating margin and our expectations for operating cash flow for the Q4 and for the full year. We have now delivered positive cash flow and non GAAP operating income for 9 consecutive quarters. Total revenue for the quarter was $184,500,000 and service revenue was $176,600,000 both increasing 2% year over year and within our guidance range. Our revenue performance reflected strong customer retention and renewals, partially offset by a year over year decline in our CPaaS business in the Asia Pacific region as expected.

Speaker 3

However, revenue from our CPaaS business modestly increased sequentially from Q3 2023. Other revenue for the quarter was approximately $8,000,000 about $600,000 below the prior quarter driven by lower physical device shipments. We have seen a trend to increased use of softphones versus desktop hardware over the last two quarters. It is still not apparent if this is a permanent or temporary change, but our guidance assumes this trend will continue throughout fiscal 2024. Fuze accounted for $26,700,000 of service revenue and $26,900,000 of total revenue in Q4.

Speaker 3

Fuze performance remains strong and the business continues to outperform our initial expectations. Please note, as stated on our previous earnings call, Q4 will be the last quarter we will provide separate SKUs revenue as the 1 year anniversary of this acquisition has passed and the businesses are now integrated. We have started upgrading Fuze customers to the 8x8 platform making legacy Fuze revenue less relevant. As we mentioned in our previous earnings call, we continue to review our metrics to provide enhanced insight into business trends. In that vein, I would like to share the annual usage numbers in our service revenue, so you can understand the underlying growth rate of our contracted recurring Service revenue.

Speaker 3

Our usage revenue, which is primarily CPaaS, but also includes a small amount of UCaaS and CCaaS revenue, was approximately 17% 11% of total service revenue in fiscal years 2022 2023 respectively. This means that the underlying contracted recurring service revenue growth rate was approximately 26% in fiscal 2023 and approximately 9% excluding Fuse. Strong retention across the customer base was reflected in our RPO and ARR metrics. Remaining performance obligation was approximately $775,000,000 for the quarter, up from $750,000,000 in the 3rd quarter on solid bookings performance. 8x8 customer retention was the highest it has been in 4 years.

Speaker 3

Total ARR was $703,000,000 at quarter end, up 2% year over year, reflecting the anniversary of the Fuze acquisition plus CPaaS headwinds Sam mentioned earlier. Excluding usage, our total ARR grew approximately 5% year over year. ARR Enterprise customers accounted for 58% of total ARR and Enterprise ARR was up 3% year over year And approximately $5,000,000 sequentially. Usage increased slightly on a sequential basis, but was still a significant headwind to the year over year growth in the Enterprise segment. Turning to gross margin, operating expenses and operating profit, please remember that all items discussed are non GAAP unless otherwise noted.

Speaker 3

Service revenue gross margin came in at 75.3 percent, more than 300 basis points higher than Q4 2022. We continuously focus on managing our COGS and expect service margins to remain healthy. Other revenue gross margin came in at positive 8.6 percent for the quarter compared to negative 44 point 6% in Q4 2022 and negative 1.4% in Q3 2023. Other revenue gross margin has shown consistent improvement over the past several quarters due to a combination of increased efficiency in our professional services organization, better product margins on physical endpoint devices and a more favorable mix of endpoints shipped. Overall, 4th quarter gross margin was 72.5%, an increase of 580 basis points year over year and up approximately 40 basis points sequentially.

Speaker 3

For the fiscal Q4 of 2023, gross profit dollars grew approximately 11% year over year, significantly higher than overall revenue growth as we focused on improving the profitability of our highest value products and services. Turning to operating expenses. R and D was 15.4% of revenue, slightly above our 15% target due to a seasonal increase in employee related expenses at the beginning of the calendar year. We improved sales and marketing leverage as we realigned costs in the second half of the fiscal year. Sales and marketing expenses were down $7,500,000 sequentially and $11,800,000 from Q4 2022 as we realized synergies from the integration of Fuze and 8x8 sales and marketing organizations and realigned our resources to focus on our target markets.

Speaker 3

G and A was approximately flat sequentially and down about $800,000 from the Q4 of 2022. As a percentage of revenue, it was 11.4%. We are committed to improving G and A efficiencies over time as we operationalize more automation in our back office processes. Total non GAAP spending as measured by COGS plus R and D plus sales and marketing plus G and A was down approximately 10% year over year and reflective of our recent strategic cost realignment efforts. The combination of improved gross margins and lower sales and marketing expenses resulted in non GAAP operating profit of $24,800,000 up almost 500% year over year and up 35% sequentially.

Speaker 3

We achieved 13.5% operating margin in Q4 versus our 10% guidance. Full year non GAAP operating profit was $62,300,000 and up nearly 500% year over year. Cash from operations was nearly $14,000,000 for the quarter, about $2,000,000 lower than fiscal Q3, primarily due to higher cash interest payments as cash interest expense was over $4,000,000 more in the Q4 compared to Q3 as we paid the semi annual coupon on the convertible notes in addition to the quarterly interest payments on our term loan. Customer collections remained robust in Q4. As noted earlier, cash flows from operating activities have been positive for 9 2nd quarters and were approximately $49,000,000 in fiscal 2023, an increase of 41% from fiscal 2022, even though we made approximately $20,000,000 more in interest payments in 2023.

Speaker 3

Reducing our interest expense by using excess cash to reduce the principal amount of the term loan has a significant and immediate impact on our operating cash flow, and it is our intention to use excess cash to reduce the principal outstanding as quickly as possible while maintaining cash and investments at or above $100,000,000 Turning to the balance sheet. Total cash, cash equivalents and restricted cash ended the 4th quarter at approximately $139,000,000 Approximately $7,000,000 higher than last quarter despite consuming $4,700,000 in cash to prepay $5,000,000 of aggregate principal amount of our 2024 convertible senior notes and paying higher cash interest There is approximately $63,000,000 of aggregate principal value of 2024 convertible senior notes remaining, which is now shown as a current liability on the balance sheet. Given our current cash balance and expected future cash flows, we see no issues with repaying the remaining 2024 convertible notes with cash when they mature in February 2024. Going forward, we expect to generate positive cash flow and we intend to use the excess cash generated to prepay our 2027 term loan. As Sam stated earlier, This week, we prepaid $25,000,000 of principal on our term loan with no prepayment penalty.

Speaker 3

Including this prepayment, We have reduced the principal amount of debt outstanding by a total of $58,000,000 more than 10% of total outstanding debt since August 2022. Our continued progress delevering the balance sheet will reduce our interest expense and will apportion more of our enterprise value to our stock Before turning to guidance, I want to emphasize our ongoing commitment to building a sustainable and profitable growth business. The strategic cost realignment activities executed in the second half of fiscal twenty twenty three enabled us to maintain A substantial investment in product innovation and in our channel go to market model, while delivering strong operating results. For forward modeling, we assume no revenue from the new contact center products we announced at our March event in New York. Even though these products have been released through our early adoptive program and customer feedback has been positive so far, we are taking a conservative approach as we build and close the pipeline.

Speaker 3

As I noted earlier, we have exceeded our profit targets for on improved operating efficiency and greater focus on our target customers, and we expect solid profitability to continue throughout fiscal 2024. At a high level, we anticipate gross margin to remain fairly consistent with Q4 2023. We expect to continue to drive some incremental COGS efficiencies in our service revenue and we expect gross margin on other revenue in the negative mid single digits. For operating expenses, we plan to continue making the appropriate level of investment in sales and marketing and expect sales and marketing to be in the range of 33% to 34% of revenue throughout fiscal 2024, down from 36% in fiscal 2023. We plan to focus our R and D efforts on continued product innovation and expect R and D as a percentage of revenue to remain about 15% as we continue on the path of investment and our customer focused product strategy, which emphasizes contact center.

Speaker 3

We are focused on Extracting more leverage from our G and A functions over time as we work to improve operating efficiencies in those areas. We are establishing guidance for the Q1 of fiscal 2024 ending June 30, 2023 as follows. We anticipate service revenue to be in the range of $178,500,000 to $180,500,000 up $3,000,000 sequentially from Q4 at the midpoint and representing approximately flat year over year growth at the midpoint as we still have a challenging comparison for CPaaS. We anticipate total revenue to be in the range of 186,000,000 to $188,000,000 up $2,500,000 sequentially at the midpoint and representing approximately flat year over year growth at the midpoint. We expect other revenue to be approximately flat compared to Q4 2023 as we are assuming that our endpoint shipments will remain at recent lower levels.

Speaker 3

We anticipate gross margin to be roughly flat with Q4 2023. We are targeting an operating margin between 12.5% 13% as we have fully realized the operating efficiencies resulting from our 2nd half twenty twenty three strategic cost realignment actions and Q4 2023 included some non recurring expense benefits in the range of 1 We expect cash flow from operations to be positive, but down sequentially as we pay our semi annual bonus in Q1 24. We anticipate interest expense of approximately $9,000,000 and cash interest payments of approximately $7,000,000 Note that these amounts can change as our term loan is subject to monthly interest rate adjustments. We estimate a fully diluted share count of approximately 120,000,000 shares. We are establishing guidance for fiscal 2024 ending March 31, 2024 as follows.

Speaker 3

We anticipate service revenue to be in the range of $725,000,000 to $732,000,000 representing between 2% and 3% growth year over year and consistent with the low single digit growth rate articulated in our prior earnings call. We continue to be cautious regarding our CPaaS business, although that business did stabilize in Q4 2023. Please note that this full year guidance assumes a higher year over year growth rate for the second half of the year versus the first half of the year, as we expect an improving revenue trajectory throughout fiscal 2024. We anticipate total revenue to As noted earlier, we have reduced our product revenue expectations by approximately $4,000,000 for the year relative to earlier expectations as our customers Similar to service revenue growth rates, we expect total revenue growth rates on a year over year basis to be higher in the second half of fiscal twenty twenty four. We anticipate gross margin to be between 72% 73%.

Speaker 3

We continue to focus on delivering a solid operating margin and anticipate achieving roughly 12% to 13% for the year versus the 8.4% achieved in fiscal This operating margin guidance is slightly higher than the 11.5% to 12.5% directional color we provided and last quarter's earnings call. Please note that we have changed our compensation structure to focus on higher cash and lower equity based pay for the majority of our people. We believe this change, which reduces the impact of market fluctuations on employees' income, will help us attract and retain talent in a competitive market. All employees still have the opportunity for equity ownership through our employee stock purchase plan, but this will reduce stock based compensation and shareholder dilution over time. This is why our full year guidance range for operating margin is slightly below Q1 guidance.

Speaker 3

We expect cash flow from operating activities to be directionally aligned with the non GAAP operating profit trend subject to timing differences in collections and other payables. We anticipate debt interest expense and cash paid for debt interest of $35,000,000 to $36,000,000 again noting that our term loan is subject to monthly interest rate adjustments. We estimate fully diluted share growth averaging approximately 2,000,000 shares per quarter throughout fiscal 2024. In closing, I continue to believe that our ongoing focus on 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.

Speaker 3

I would like to personally thank the entire 8x8 team for working together to execute our profitability enhancements, which enabled us to increase our non GAAP operating margin earlier than anticipated. I'm looking forward to the continued execution of our strategy to capture more of the contact center market to delight our customers and to deliver on our commitment to solid profitability and cash flow generation. Operator, we are ready for questions.

Operator

Our first question or comment comes from the line of Matthew VanVellet from BTIG. Mr. VanVellet, your line is open.

Speaker 4

Great. Thanks. Good afternoon. I appreciate you taking the question. I guess, Sam, as you look at the overall trends you're laying out for the year.

Speaker 4

It seems like enterprise will continue to march a little bit higher, although the enterprise logo count did decline quarter over quarter. So Wonder if you could just sort of connect for us what levels of churn you're seeing and then what levels of sort of net new business you're assuming coming in and how much you think is sort of purely attributable to the macro versus other factors that you're seeing in the market?

Speaker 2

Thanks, Matt. So a few answers to your questions. So first off, yes, we expect Enterprise to continue to grow. And overall, we're hoping that as our new products, which are mainly in beta right now and exit start to hit, we'll start to see back half of the year revenue acceleration. That's kind of what we're focused on.

Speaker 2

None of it's in the model right now. Kevin is always very cautious about it and I appreciate that greatly from him. But we do hope that in the back half of the year we'll start See that and predominantly on the enterprise side because most of our as we said in the script, most of our innovations on the contact center side. In terms of macro and some of the things that are going on, new logo versus installed base, retention was, As Kevin mentioned in his script, at very high levels, very happy with the retention numbers that we have right now. We are seeing some reduced new logo business.

Speaker 2

Is it macro? Is it the world? Is it Shift to on premise or whatever. I'm not 100% sure. There is just a little bit less right now.

Speaker 2

We've adjusted accordingly in the model, so I'm not too stressed about that. I'm more concerned actually, I'm more focused on the fact that we have very high retention rates and the macro will come and go. I think once the economy picks up, we'll probably See a bounce back in new logo. And as our new products, sort of exit beta and hit GA, we should see an acceleration of new logo also.

Speaker 4

Right, very helpful. And then when you look at the R and D spend, obviously getting to a more flattish mix of revenue As you gain more leverage there and have a number of new products in the market, how should we think about that rate though on maybe a 5 year horizon? Is it Getting to the point where maybe similar dollar levels will be spent and that as the top line grows you see leverage there? Or are there projects that are on sort of the tail end on the innovation side, whether it's some of these new contact center products or integrating AI, that will give maybe incremental leverage over the top than just top line growth as we look ahead? Thanks.

Speaker 2

So Matt, let me answer the question this way. I would very much like to see our R and D translate into revenue growth and I'd like to continue to grow the amount of money I spend on R and D. I I would expect to spend around 15% with some variability based on various things going on a quarter to quarter basis. But as we grow revenues, I'd like to continue to grow the R and D. And let me tell you why.

Speaker 2

I don't view R and D necessarily as a place to get leverage anywhere in the next 5 years. The contact center market is a $220,000,000,000 Mackenzie's number Labor market opportunity for us to go after, the customer experience and customer retention notion is really just that Shift has just started in the last year or 2. And so I think there's such tremendous opportunities for value add to enterprise customers. I don't want to I think I want to go after all those opportunities. That being said, I think we can get continued leverage on sales and marketing G and A and gross margins over time.

Speaker 2

So it's not that I am implying to The Street that I plan on lowering my op margins at all. I just want to say, I think I can get leverage on all those other lines while continuing to invest in R and D And grow revenues through innovation.

Speaker 4

All right. Very helpful. Thanks for taking the question.

Speaker 2

Thanks, Matt.

Operator

Thank you. Our next question or comment comes from the line of Ryan McWilliams from Barclays. Mr. McWilliams, your line is open.

Speaker 3

Hi, Sam. This is Damon sitting in for Ryan McWilliams. Good to see that UC and CC traffic is increasing. Can you provide any insight how your renewals fared in the Q1 compared to the Q4? And Have you seen any changes in these customer renewals as a result of macro?

Speaker 2

Thanks. Okay. So Kevin, can you provide probably And I just want to I'm going to be careful how I answer this because you use the calendar quarters. I'm going to use my fiscal quarter. So my fiscal Q4 ended March 31.

Speaker 2

We had record high retention rates. So we've got really solid data given Fuze and everything else going back about 4 or 5 years and we've had the highest retention rates. Our retention rates are even better than they were pre pandemic, and those kinds of things. And so I think that's a lot of that's driven by the fact that As enterprise becomes a greater mix of the business, we should be seeing higher retention rates and we are seeing that. Kevin, I don't know if there's anything you want to add here.

Speaker 3

Yes. No, I'd just emphasize that. And I think we're seeing a lot of that improvement in the customer retention rates because we are making the right amount Investment in our customer success organization. So we're seeing that play through in customer retention. So good ROI on that investment.

Speaker 2

So I'll add maybe one more thing. Our collections and our DSO were absolutely fantastic. So not only are we seeing high retention, Our collections, our aged receivables, our credit card default rates, all the things that you would expect to see that could be leading indicators to retention, All remain at just pristine levels right now. So knock on wood, because I'm always nervous about that stuff. But all the leading signs we see around retention are also good.

Speaker 3

Got it. Perfect. And then could you provide some insight into the linearity of operating margins over the course Of fiscal year 'twenty three, just wanted to try to understand what is factored into the 12.5% to 13% 1Q guide versus the 12 to 13, fiscal 2020, yes. Sure. So typically what we see is It varies by quarter based upon calendar quarter.

Speaker 3

So you'll generally see more expense headwind In our January through March quarter, our Q4, as in the U. S, we have the restart of employer Taxes for FICA and things like that in the 401 match restarts at the beginning of the calendar year. Then starting in Q2, the July timeframe, we also do our annual merit increases. So you'll see Typically, we'd see a bump up in OpEx during that particular quarter and then offset as we go throughout Calendar year of the things like employer taxes and so forth gradually falling off. So that's basically the seasonality we generally have in our P and L.

Speaker 3

There are some other things in sales and marketing Related to some maybe some industry conferences and trade shows that we attend, but generally that's our seasonality on the expense side.

Speaker 5

Got it. Okay. Thanks.

Speaker 2

Thank you. Thanks, Damon.

Operator

Thank you. Our next question or comment comes from the line of Siti Panagrahy from Mizuho. Mr. Panagrahy, your line is open.

Speaker 5

Thanks for taking my question. Very impressive margin expansion. I understand you're benefiting Some of the restructuring or headcount reduction earlier. But as we look forward, I know you talked about You're going to spend on R and D, but what other initiatives you're taking that we can expect some kind of sustainable Margin Expense and going forward.

Speaker 3

So on the gross margin side, we're continuously looking at Our COGS costs, the carrier costs and bandwidth and things like that, we've got a great underlying program Looking at various carriers to get the best rates, the best quality, etcetera. So that's a continuous process within the company for us on the gross margin side. On the OpEx side, I mentioned in my prepared remarks That we're continuously looking at automation of back office processes, sales and marketing. We're doing some interesting and innovative things there with lead gen efficiencies, conversion rate improvements from lead gen to convert it into an order. So there's constant improvement going on in those areas that we would generally refer to as efficiency to keep our operating Margins at a flat or upward trajectory over time.

Speaker 5

That's great color. And then Sam, we keep hearing about small businesses in this environment not ready to Commit to any investment kind of thing. So what are you hearing in your different segments, small to mid market enterprise segment?

Speaker 2

I think the small business segment, look, as I mentioned earlier, our credit card default rates and those kinds of things that we would look at because small business more likely Credit card are all fine. So I think in general, small businesses are relatively healthy. That being said, I do think there's economic headwinds. I can read the news as much as you guys can. So I do think there's some economic headwinds.

Speaker 2

And so I do think there's some reluctance to invest in that segment. I would also say that we're reluctant to invest in that segment. So that's the second factor. I mean, we've reduced our digital marketing spends and those kinds of things that drives That segment. I think in the enterprise side, you definitely see continued digital transformation, Continued movement from on prem to cloud.

Speaker 2

As I've mentioned at the NASDAQ market site and in other places recently, I mean everybody is talking about MLAi Technologies and the effects it can have on the contact center. We obviously have opened up our platform. We announced Converse 360 this week On our platform and other leading MLAI vendors are integrating with our contact center platform. So I think that's a big opportunity for us to bring best in class MLAi solutions to market for our customers to go after sort of the opportunities around customer retention in the overall labor market around contact center.

Speaker 5

That's great. Thank you. Good to see the progress on margin side. Thank you so much.

Operator

Thank you. Our next question or comment comes from the line of Meta Marshall from Morgan Stanley. Mr. Marshall, your line is open.

Speaker 6

Maybe just a question for me. I know it's kind of hard to discern, but do you feel like it's Your pipeline is still as healthy and it's just longer deal cycles? Are you kind of seeing any changes to pipeline as well? Maybe as a first And then the second question, I think what you guys are doing with the platform and opening it up is interesting. I guess just In your seat, how do you determine with your kind of $100,000,000 plus R and D budget of how much of that to kind of Focus on internal development versus utilizing partners for other things that could and kind of focusing on core competencies.

Speaker 6

Thanks.

Speaker 2

Thanks, Meta. So, 1st on your pipeline question, look, our pipeline numbers be planned for the quarter, so that's always a positive. So that bodes well, I think, for the future And potentially getting the revenues to reaccelerate a little bit more from on an organic side from the 0% to 2% sequentially that they did that we can do better and the Pipeline suggests we are. Obviously, there's timing. So as we go through this transition from small business to enterprise, small businesses can close deals in 30 to 45 versus 6 to 12 months for a larger enterprise deal.

Speaker 2

And we are closing TCV deals over $1,000,000 or Actually, it's not total contract value, more than $1,000,000 in ARR per year from customers. I mean, they're like $5,000,000 TCV deals. So, those just take time. And so we are in the midst of that a bit of that transition. I

Speaker 3

will sorry to jump in. Like I would also say that we're really focusing on higher like the highest quality pipeline as well. So that we believe that doing so obviously will help improve our close rates there.

Speaker 2

All right. And then on internal versus external R and D, I I think it's a great question. It's actually a really insightful question, Meta, to push it even further. So Sand Hill Road or the venture capital communities Allocated like $130,000,000,000 to various segments around the contact center. That's our best guess based on a whole bunch of third party analysis.

Speaker 2

And I think in areas where Sand Hill Road has dedicated a lot of money, it would be foolish for a company to try to develop these in house. And I know that's what some of my rivals are doing in the space. Good luck to them, but I think they're going to get beaten by the specialists and we're going to want to open our platform up And so areas like chatbots, as an example, there are Gartner says there are 400, 500 different chatbot vendors. We want to partner with all of them. We're not going to build our own chatbot internally.

Speaker 2

The main areas I think that we have to own internally Is Omnichannel, UI, UX, Data and Analytics, which is the bot actually working and what's the outputs from that? And then, intelligent routing. I think those are the key workflow areas around the case. And we offer incredible capabilities for this ecosystem of venture funded companies to ride on. The best example I can give you is Converse 360 or Cognigy or the other chatbot vendors we're working with.

Speaker 2

We can deliver a case, a chat case to a bot. And if the bot fails to answer the question, we can pull it back and escalate it to a live agent, Including all the information. So if you've authenticated, if you've answered the simple questions, none of that stuff has to be repeated. All the metadata gets passed to the live agent and then that can also feed an agent assist model from a different vendor. And so I think these are pretty intricate advanced technologies.

Speaker 2

They're a real benefit to the ecosystem. So places where they benefit, We fund that places that we need to own that case management, the routing, the channels, those kinds of things, we'll invest our money there.

Speaker 6

Great. Thanks so much.

Speaker 2

Thanks, Meta.

Speaker 5

Next question please.

Operator

Sorry, it's on mute. Our next question or comment comes from the line of George Sutton from Craig Hallum. Mr. Hallum, your line is open.

Speaker 2

Mr. Hallum, so your retention, your cross sell and your win rates have all begun to improve. I'm curious if you can give us an extent and kind of a timeframe to that? Well, those are all based on last quarter. So last quarter, quarter on quarter, we saw our retention better quarter on quarter.

Speaker 2

We saw the amount of Sales to our installed base relative to what we've done in the past better. And in particular, one of the things that I mentioned last quarter that we have not done exceptionally well on that we're starting to get Action around is cross selling our contact center to UC only customers. And then overall, our win rates are improving. That's driven by, I think innovation, right? So you're seeing the first signs and they're very preliminary signs, George.

Speaker 2

I don't want to overstate these, They're very preliminary size, but quarter on quarter on those three key metrics we saw improvement.

Speaker 3

Got you.

Speaker 2

So I know That CPaaS has caused you great angst for some time and it has now started to Stabilized. I wondered if you can just tell us why has it stabilized? What are you doing to try to get it

Speaker 3

to actually see some growth?

Speaker 2

All right. So, I would say, 1st and foremost, we have a new General Manager there. He's phenomenal, And he's really rallied the team. He's made some changes to various people, objectives, structure, leadership, all those kinds of things. But at the core, Leadership matters and we have a great new leader running our CPaaS business.

Speaker 2

And I think that's the first big step. And he's really focused On the right things and getting the right direction on a very tactical day to day basis. Taking a step back, we're in a good position with our CPaaS And I'll just loosely refer to it as the Wavetel business or the CPaaS business. It's got brand recognition in Southeast Asia. It's got market presence.

Speaker 2

It's got competitive pricing advantages and It's got great technology underneath it. It just needed to focus in those key areas and bring it to bear for more success. And I think that we're starting to see the benefits of Having a new leader, it's the 3, 4 month mark now, but I'm already seeing tangible benefits including the stabilization of revenue. His next objective now he needs to grow the revenue.

Speaker 3

Perfect. Thank you.

Speaker 2

Thanks, George.

Operator

Thank you, Mr. Sutton. My apologies. Our next question or comment comes from the line of Catharine Trebnick from Rosenblatt. Ms.

Operator

Trebnick, your line is open.

Speaker 7

Sam, can you give us more detail around Microsoft Teams? You said it grew 100% year over year. But can you punch in on where you're seeing that you're successful versus some of your competitors who are also saying that they're very successful doing Microsoft Teams integration. Thank you.

Speaker 2

Yes, I've heard some of my rivals claim growth rates similar to mine. I've just been growing them at those growth rates for a heck of a lot longer. So I'm sure my RASD count is significantly larger. And that's purely a function of investing early and partnering with Microsoft and not being adversarial against them. So we would our key things are we partner with Microsoft.

Speaker 2

We don't try to build technologies to purposely avoid E5 licenses to upset Microsoft Or those types of things that would roll the channel also. And so I think what our key advantage and I think Kate put a slide in the IR deck that's really important, Which is our leading Microsoft Teams customers running it flawlessly in 35 countries. And I don't believe anyone else can say that. And if you wanted to run that using Operator Connect, it would take you 6 different carriers, 6 different carrier contracts, 6 different Set ups and configurations and issues. We run direct routing 35 countries flawlessly and that and let me tell you That customer is a great reference for us for more big Microsoft Teams wins.

Speaker 2

And so we continue to grow. Now, are we going to grow at 100% forever? No. The law of large numbers will catch up Eventually, but right now the growth rate remains very high. We've invested early.

Speaker 2

We invest aggressively in Teams and we have a lot more opportunity in front of us. The next big step is to improve our go to market on the Microsoft Teams side and that's what I think you'll see over the next few quarters.

Speaker 7

All right. Thank you very much.

Speaker 2

Thanks, Catherine.

Operator

Thank you. Our next question or comment comes from the line of William Power from R. W. Baird. Mr.

Operator

Power, your line is open.

Speaker 2

Hi. This is Yannis Amoulis on for Will. Just one question from us. So As we look to fiscal 'twenty four revenue growth that you guided to, is one of the components of that? Does a lot of it come from X Cast?

Speaker 2

Does more of it come from CPaaS? And any broader trend to get it on there would be great.

Speaker 3

Thank you. Yes. So we obviously were focused on ex cast. There is a little bit of CPaaS, not much, but a little bit of CPaaS growth in the back half of the year for that. But primarily, it's our we're focused on our ideal customer profile and Enterprise Customers Contact Center.

Speaker 2

All right. So I'll add just a little bit of color. I think it's so there's a couple of variables here, right? So We would expect to see continued slow growth, no growth type of area in our small business and continued higher growth in enterprise. So we're going to continue to see that mix shift over To the higher valued enterprise and correspondingly, I hope we start to see we continue to see I shouldn't say we hope to say we continue to see better improving retention rates Along with that.

Speaker 2

The other thing I would and Kevin's being conservative and I love him for it is nothing around new products is really based in our model right And that's really just a function of most of them are in beta right now or they're releasing next quarter and we just don't want to be too aggressive And those types of things. So I think the other thing you have to realize is there's not a lot baked in, in terms of any type of new product uplift going in through this year. Awesome. Thank you very much. Thank you.

Operator

Thank you. Our next question or comment comes from the line of Peter Levine from Evercore. Mr. Levine, your line is open.

Speaker 4

Thanks for squeezing me in. Maybe the first one, Sam, is what's your level of confidence That you could see revenue accelerate here in the second half of your fiscal year, like what has to go right? And then what do you think Could go wrong for that not to play out.

Speaker 2

You're not going to give me one question with 20 parts to begin with. I love you Peter for doing that. Thank you. All right. So from 2% revenue growth, I would say don't screw it up.

Speaker 2

I think the plan is there. The stars are aligning to see accelerating revenue. Now how high is that revenue acceleration? I would I'm not going to stick my neck out too far on that. Kevin has got a pretty accurate grasp of the numbers around those things.

Speaker 2

But I think what's my level of confidence? High. What can go wrong? Honestly, I think the only thing can go wrong is that the U. S.

Speaker 2

Fed drives the economy into a recession that's deep and nasty. I mean, we're seeing banks collapse and get sold to and fire sale prices and those kinds of things. That does Cause some ripple effects in the confidence of CIOs that we're selling to. When we're selling to enterprises and those kinds of things, especially when they're signing 3 5 year deals, Confidence does matter. You see our RPO increased, you see our ARR increased.

Speaker 2

I think the signs are there for further growth. I think the only thing that can crack it is confidence in making those investments. And And if you think about all

Speaker 4

the product innovation, the investments on the R and D side, all the products that are coming out, how much of that is a function of Retaining customers versus seeing like an ARPU uplift?

Speaker 2

Most of the 60% that we're talking about is all ARPU uplift. And then the 40% of R and D is more focused on retention, etcetera. I mean, obviously, the lines blur, right? Because Things like high reliability or accessibility or those kinds of things also drive new sales also. But I would say there's very little that is on retention.

Speaker 2

We don't I mean, To sort of Peter to say kind of bluntly, I don't get a lot of feature requests and I'm sort of nervous to say this on a call because I don't want to start. We don't get a lot of feature requests from existing customers that are like, you need to do this or else. I get some feature requests would be nice if you could do this and that's a lot of our ecosystem is coming in. But really it's about we love your product, we want to take it to the next level, we want to do the next thing with it, we want to expand.

Speaker 4

Thank you for the color.

Speaker 2

Thank you.

Operator

Thank you. Our next question or comment comes from the line of Taj Kujalgi from Wedbush. Mr. Kujalgi, your line is open.

Speaker 5

Thanks for taking my question. I have a

Speaker 8

question on pricing Trent, if you can comment on pricing trends for UCaaS and CCaaS, how is it for the quarter and what do you expect going forward?

Speaker 2

Yes, I would say UCaaS pricing was maybe a tad more aggressive this last quarter. It's always hard to tell in the 1st calendar quarter of the year. Maybe a little tad more aggressive, all at the low end. The mid range of UCaaS, I really didn't see much movement, But at the low end and more it's a function of Microsoft Teams Operator Connect solution. That's a relatively low feature, low priced product.

Speaker 2

And as I've said many times, we're selling a lot of Microsoft Teams almost every time in our Microsoft Teams. It's Us versus a direct routing solution versus a Microsoft Teams generally a carrier with an operator connect solution. I don't see a lot of other traditionally UCaaS vendors in those deals and we do a lot of them. And so that's where I'm seeing a little bit at the low end. On the contact center side, I don't really see much pricing pressure there.

Speaker 2

I think the conversation at contact center is all about capabilities.

Speaker 4

Got it. I want to follow-up.

Speaker 8

The gap between your operating margin and free cash flow margin expand a little bit In fiscal 2020 or 2022, how should we expect that to trend in 2024? You gave us the guide for operating margin. Any comments or color on

Speaker 3

Yes. So the free cash flow margin will trend with the operating margin over the course of We do have various things that we pay. There's some timing effects and so forth. But it's really the Interest expense, things like that, because we do have some interest expense that's paid semiannually and some that's paid quarterly. That helps you with the timing.

Speaker 3

But we think that

Speaker 2

And Kevin, I mean, the biggest difference between the two is interest, right? So As Kevin was able to do this week, he paid prepaid $25,000,000 on our high interest term loans. And so as we Further pay off our term loans over time, our operating margin and our free cash margin should narrow significantly.

Speaker 8

Got it. Cool. Thank you very much.

Operator

Thank you. Our next question or comment comes from the line of Austin Williams from Wells Fargo. Mr. Williams, your line is now open.

Speaker 3

Hey, guys. This is Austin Williams on for Michael Turrin. I wanted to touch on the SKU side. It looks like it was another really strong quarter for that business. Anything that you call out that's just making that perform better than expected?

Speaker 3

Thanks.

Speaker 2

We love our Fuze customers. We love our Fuze customers. If you're listening, we love you. And we continue to sort of put them on a good path. We treat them as 1st class citizens.

Speaker 2

We have a fantastic customer support operation that's taking care of them. And I think we're showing them a good path for the future. And so, the idea that people would just be able to come in and I heard all the rumors they're going to RFP and other people are targeting them and all those kinds of things. I think just has to come to pass. Now that being said, I think we can do better on some of the cross selling in particular and so that's an area we're focusing on.

Speaker 2

But in terms of retention, We've done absolutely fantastic and huge credit to the finance team and to my customer support success teams around that have done an absolutely fantastic job on that. Thanks, Austin.

Operator

Thank you. I'm showing no additional questions in the queue at this time. I'd like to turn the conference back over to management for any closing remarks.

Speaker 2

Thank you everyone for joining us today. We'll be on a number of Conferences over the next 30, 60, 90 days. So Kate will be more than happy, she's going to put out a press release on all the places we're visiting. So come see us at a conference. If you can't make it to a conference, just always feel free to call Kate Patterson and Investor Relations if you have any follow-up questions.

Speaker 2

And with that, Enjoy your Thursday. Thanks everybody.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a

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