8X8 Inc /De/ Q3 FY2022 Earnings Call

Thank you, ladies and gentlemen, for joining, and welcome to the 8x8 Fiscal Q3 2022 Earnings Conference Call. My name is Elena, and I'll be facilitating your call today. I now have the pleasure of handing over to your host today, Kate Patterson, VP of Investor Relations to begin. Kate, please go ahead.

Thank you, and good afternoon. Today's agenda will include a review of our third quarter results with Dave Sipes, our Chief Executive Officer; and Sam Wilson, 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 the impact of the Fuze acquisition 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, and we have no plans or obligation to update them. Certain financial measures that will be discussed on this call, together with the year-over-year comparisons, in some cases, were not prepared in accordance with US Generally Accepted Accounting Principles or GAAP. A reconciliation of these non-GAAP measures to the closest comparable GAAP measures is provided in our earnings press release and our earnings presentation slides, which are available on 8x8 Investor Relations website at investors.8x8.com. With that, I'll turn the call over to our CEO, Dave Sipes.

Thank you, Kate. Good afternoon, everyone, and thank you for joining us today. Let's turn to a review of our third quarter, an update on our acquisition of Fuze and our progress and plans for the future. In fiscal Q3, we delivered service and total revenue above the high end of our guidance ranges. Additionally, we delivered positive operating cash flow for the fourth consecutive quarter and achieved our year-end operating margin target a quarter ahead of plan. We also announced our acquisition of Fuze, which increases our enterprise customer base and adds resources for innovation. This transaction closed on January 18th. The market opportunity to migrate business communications to the cloud is massive. We are beginning to see the impact of our focused investments in XCaaS, go-to-market and especially channel and global coverage in our Q3 results. We have built a strong foundation for growth. I believe we are well-positioned as the market evolves. I will frame my comments today around three pillars of our competitive advantage; our XCaaS platform, our leadership with 8x8 Voice for Microsoft Teams, and our Global Coverage. Looking now at 8x8 XCaaS. Capitalizing on the demand for integrated UCaaS, CCaaS and CPaaS offerings, XCaaS provides a single platform for customer and employee engagement. XCaaS eliminates silos and speeds information flow across the enterprise, enabling organizations to be more agile and responsive to customer needs while operating at a lower cost of ownership. 8x8 XCaaS was recently awarded the 2021 CRN Tech Innovator Award. Additionally, we were named a leader in the IDC MarketScape: Worldwide Unified Communication and Collaboration 2021 Vendor Assessment. XCaaS ARR is now more than 35% of total ARR and continues to grow at more than 35% year-over-year. On a dollar basis, we delivered our best ever sequential and year-over-year growth in XCaaS ARR. Adoption of XCaaS, often with our 8x8 Voice for Teams capability is gaining momentum across a broad range of industrial verticals and geographic regions, including the public sector. A few recent examples of both new logo and land and expand XCaaS deals include Kubota North America, a leading manufacturer of agricultural construction equipment implemented their One Kubota initiative to bring multiple business units onto a single communication platform. Following a successful pilot led by 8x8 Center of Excellence, Kubota selected 8x8 XCaaS for 1,000 UC and 200 contact center seats to enable streamlined business communications across the organization. A second win was the London Borough of Newham, which provides service for more than 350,000 residents in East London. They most recently expanded their 8x8 Contact Center by more than 90%, bringing the total number to over 220 CCaaS seats. 8x8 XCaaS is deployed across more than one-third of London's 32 boroughs now. Hays County in the Austin, Texas metro area is one of the fastest-growing counties in the US with more than 240,000 residents. The local government sought a single cloud communications platform with high availability. Working with a channel partner, they selected 8x8 XCaaS with Voice for Microsoft Teams to support nearly 1,000 users. Looking now at 8x8 Voice for Teams, we are seeing increased adoption as organizations seek to provide their distributed workforces with the ability to interact with colleagues. In September, we announced that we had surpassed 100,000 business users for our team's integration and we continue to see strong momentum. In the third quarter, we experienced business user growth of more than 30% quarter-over-quarter as a growing number of new and existing customers adopt 8x8 Voice for Teams. Customers choosing 8x8 Voice for Teams in Q3 included the Financial Ombudsman Service in the UK, which investigates and settles complaints between consumers and businesses that provide financial services. Working with our partner, Virgin Media-O2, the Financial Ombudsman Service selected 8x8 XCaaS with over 1,000 UCaaS seats and several hundred CCaaS seats. Our ability to help them advance their digital strategy, combined with our tight integration with Microsoft Teams and direct agent routing, was integral in their decision to select 8x8. Inpro, which is a global manufacturer of high-performance architectural products for commercial buildings, selected 8x8 XCaaS and Voice for Microsoft Teams to support more than 600 employees around the world. They chose XCaaS for composed experiences such as Frontdesk, which will empower receptionists with advanced call handling capabilities and for tight integration with Salesforce. Turning to our global coverage, which further differentiates our solutions and creates a strong competitive advantage with multinational organizations. In the third quarter, we expanded our coverage to include the Philippines, another industry first and also to Panama. The Philippines expansion follows our announcement earlier this year of delivering an industry-first integrated cloud phone and contact center solution in China and Russia. Our regulatory compliant cloud-based global UCaaS solution is now available in 48 countries and territories, up from 41 a year ago. Our global reach service now covers more than 80% of the world's GDP. Examples of new and expanding global customer wins include Beam Suntory, a great example of a customer that is standardized on XCaaS with 8x8 Voice for Teams on a global basis. Beam Suntory is one of the world's largest producers of distilled beverages, including the world's best-selling bourbon, Jim Beam. An 8x8 customer since 2020, Beam Suntory most recently added more UC and Teams licenses in Scotland and Germany to now support over 2,600 employees in 35 sites across 17 countries. Headquartered in Brisbane, Australia, ALS Limited provides testing, inspection, certification and verification services for over 370 sites across 65 countries. They continue to increase their global 8x8 investment, most recently adding another 800 users with Microsoft Teams integration to support employees in Australia, Canada, New Zealand and the US. Integral to our global strategy is growing our CPaaS share in the Asia Pacific region. CPaaS revenue continued strong year-over-year growth as we added new customers across the region. For example, Sell Here, a leading e-commerce platform with more than 6 million users in Thailand, uses 8x8 SMS APIs for its marketing campaigns as well as updates and notifications to boost customer experience. Ula, Indonesia's leading e-commerce marketplace for more than 70,000 traditional small and micro retailers, uses 8x8 SMS APIs to enhance its customer experience with marketing promotions, notifications, as well as one-time passwords. Welsh Water, the only not-for-profit water company in England and Wales, uses 8x8 video interaction APIs to provide remote customer support, in turn, boosting customer satisfaction while improving operational efficiency. With our XCaaS strategy, Teams integration, and global coverage, our shift up market is well underway. Enterprise ARR now accounts for 54% of total ARR and increased 30% year-over-year. The shift to Enterprise is also evident in our third-quarter retention metrics, which were the best we've seen in the last several years. This performance reflects our customer-first culture and changes we've implemented in our customer success organization. Our focus on Enterprise customers and global approach to the market are among the reasons the Fuze acquisition makes so much sense. With the acquisition now closed, we increased our installed base of enterprise customers by about 30% and created a large cross-sell opportunity for our contact center solution. In the two weeks since the acquisition closed, we are already talking with a number of customers who are excited about the additional solutions 8x8 can provide. In particular, we see the potential for many customers to add 8x8 Contact Center solution even before they upgrade to an overall XCaaS platform. Many customers have also acquired about 8x8 solution for Microsoft Teams. Finally, Fuze partners, many of whom were already 8x8 partners, are excited about the prospect of delivering more complete solutions for our mutual customers. Although it's still early in the integration process, we are excited by the response we're seeing from customers and partners. I am also pleased to report that our R&D and customer success teams are working together and mapping out strategies to accelerate our product roadmap that will increase XCaaS adoption worldwide. We have already integrated the Fuze development teams and redeployed Fuze engineers to fuel our innovation. Watch for some of the exciting XCaaS and contact center announcements later this quarter. In summary, in the third quarter, we delivered strong revenue performance, demonstrated continued operational discipline and excellence, and expanded our base of enterprise customers. As the customer wins show, it is often the combination of all three competitive advantages: XCaaS, 8x8 Voice for Teams, and our unparalleled global coverage that makes our solutions compelling for customers as they migrate to the cloud. Our channel contribution continues to increase globally, but we recognize that there is further opportunity. We recently hired Lisa Del Real as our Global Channel Chief to lead and scale our channel organization. Lisa was most recently Vice President of Strategic Partnerships at RingCentral, and I'm confident she will take our channel programs to a higher level. We also announced that Stephanie Garcia joined 8x8 as our Chief Human Resource Officer. Stephanie is a recognized HR executive in cloud and SaaS industries with experience at Salesforce and PayPal, leading and scaling high-performing global HR operations at dynamic fast-growth companies. She will be responsible for leading the HR organization and expanding the company's team-first culture as we enter the next phase of growth. I welcome them both to the 8x8 team and our customer-first, product-first, team-first culture. I will now turn over the call to Sam Wilson, our CFO.

Thanks, Dave, and good afternoon. We are pleased to deliver results for the third quarter that exceeded guidance, showed improved operating leverage, and generated positive free cash flow. Better-than-expected performance from our product categories were the key drivers with both XCaaS and CPaaS strong performers. Total revenue for the quarter was $156.8 million, an increase of 15% year-over-year and above our guidance of $152.7 million to $154.2 million range. CPaaS and contact center revenue was more substantial than expected during the quarter, contributing to the overperformance in service revenue. This offset weaker endpoint shipments and other revenue due to ongoing supply chain shortages. Looking at service revenue, we generated $149.4 million, an increase of 18% year-over-year and above our $144 million to $145 million guidance range. Adjusted for exiting the wholesale business last year, service revenue growth would have been about 21% year-over-year, or 3% higher. Total ARR growth was $572 million at quarter's end, up 16% year-over-year. Enterprise ARR accounted for 54% of the total and increased 30% year-over-year. The shifts we have made in our demand generation efforts towards Enterprise resulted in strong sequential growth in Enterprise ARR, up approximately $25 million, or 9% quarter-on-quarter. Growing our Enterprise business is one of the core tenets of our long-term strategy due to its longer commitments, higher retention, and better efficiency ratios. The third quarter non-GAAP gross margin was 64.7%, and higher sequentially as service revenue accounted for a more significant percentage of total revenue. Non-GAAP service revenue margin increased approximately 20 basis points over the previous quarter to nearly 70% and was up over 350 basis points versus the third quarter of 2021, driven by our focus on improved spending efficiency. Non-GAAP other revenue margin came in at minus 32.2% for the quarter, reflecting the decline in endpoint shipments and some increased investment in our professional services organization as we prepare to welcome the Fuze customers to 8x8. As a reminder, other revenue represented only 5% of our total revenue for the quarter. So, the decline in other gross margin had minimal impact. In total, gross profit dollars grew 25% year-over-year as we focus on the higher-margin portions of our business, such as XCaaS, and continue to drive unit cost improvement in COGS. Looking ahead to the fourth quarter, we expect overall gross margins to be generally flattish sequentially. Turning to third-quarter operating expenses. We continue to make focused investments in R&D, mainly in the contact center capabilities within the XCaaS platform and in sales and marketing while keeping G&A cost tight. We have made significant investments in sales and marketing over the last four quarters to increase awareness for XCaaS to expand our partner programs and target enterprise customers. Going forward, we expect year-to-year dollar growth in this category to slow compared with the growth of the past few quarters after just adjusting for the step up due to the addition of Fuze. Total spending as measured by non-GAAP cost of goods sold, R&D, sales and marketing, and G&A was up 11% year-over-year below our 15% total revenue growth. We had focused non-GAAP operating margins to exit this fiscal year at approximately 2% and hit that target in Q3, a quarter earlier than expected. Going forward, we expect total spending to grow more slowly than total revenue on a rolling four-quarter basis as we drive efficiencies throughout the business, but there can be some quarter-to-quarter variability. Turning to the balance sheet. Total cash, restricted cash, and investments ended the third quarter at approximately $260.4 million. Excluding $8.6 million of restricted cash, the balance was $251.8 million, increasing roughly $94 million quarter-on-quarter. Cash from operations was a positive $9 million for the quarter, much better than expected on collections and expense management. We were free cash flow positive for the quarter. After we announced the Fuze acquisitions, several of our noteholders indicated an interest in increasing their positions, so we opportunistically raised capital. During the quarter, we raised $139 million by offering more of our 0.5% notes due in 2024 and simultaneously conducted a buyback of $45 million or 2.3 million shares. The buyback helped offset any dilution from the offering and reduce our paid discount and resulted in a net increase in cash of approximately $89 million after transaction costs. Excluding the capital raise, quarter-on-quarter total cash increased by about $5 million, better than the small burn forecasted. This was driven by strong collections and higher-than-expected revenue. For the fourth quarter, we expect total cash balance to decline due to the Fuze purchase, but cash from operations should be stronger on a combined basis, excluding one-time cash items around restructuring and transaction costs. One item I'd like to mention on liabilities is deferred revenue, which was over $25 million during the quarter and up 23% year-over-year as we move towards building in advance of service delivery. RPO was approximately $565 million for the third quarter, up from $550 million in the second quarter. Okay. Let's talk about Fuze. We closed the acquisition on January 18 earlier than we had expected. We sent them about $132 million in cash and 5.8 million shares, or approximately $250 million in total consideration based on the share price at the time of the announcement. As expected, we will report a stub period of about 10 weeks for Fuze in the fourth quarter and an entire quarter in the first quarter of fiscal 2023. The guidance provided in a moment will be for the combined company. We intend to provide commentary for the first few quarters on revenue contribution from Fuze customers. As we further integrate the two companies, this will become less relevant, especially around items like cross-selling and upgrades. Next, turning to cost synergies. We had said we expected to remain non-GAAP profitable when we announced the transaction. At the time of the announcement, Fuze was losing money and had a non-GAAP operating line around $16 million on an annualized basis. We believe we can generate over $20 million in annual cost savings, though it will take a few quarters to be fully realized. If we execute the plan, Fuze will be additive to our non-GAAP operating income over time, but a small headwind in the short-term. This week, we took a step in this direction with a restructuring that will appear in the March quarter numbers. As we move into fiscal 2024, we believe we could find further cost synergies as we integrate. Taking all this into account, we are establishing guidance for the fourth quarter fiscal 2022 ending March 31, 2022, as follows: we anticipate service revenue to be in the range of $173.5 million to $175.5 million, representing approximately 30% to 31% year-over-year growth; we expect that Fuze's revenue contribution will be about $20 million for the rough 10 weeks of the period; we anticipate total revenue to be in a range of $180 million to $182 million representing approximately 24% to 26% year-over-year growth. Please note that we expect to have continued supply chain issues with endpoint hardware shipments and expect other revenue to be down about $1 million sequentially from the third quarter because of these. We expect non-GAAP operating margin to remain positive on a non-GAAP basis but down on a quarter-over-quarter basis as we begin integration and employee-related FICA and benefit expenses increased again at the beginning of the calendar year. We believe integration will take approximately six to nine months and expect to show some financial leverage on the operating line throughout the year. Some modeling notes. These numbers reflect the combination of 8x8 and Fuze as well as ongoing investments we are making. Please note that Q4 FY 2022 ranges below are based on the stub period I mentioned for Fuze. We are keeping a majority of Fuze's R&D. So, on a combined company basis, we expect to step up R&D to approximately $25 million to $26 million for fiscal Q4 2022. On the non-GAAP sales and marketing, we expect to step up into a range of $73 million to $74.5 million for fiscal Q4 2022. On a non-GAAP G&A, we expect to step up to a range of $17 million to $18 million for fiscal Q4. We are giving line item guidance for this quarter only, so you can adjust your models to include Fuze expenses, but there may be some reallocations as we integrate. Combining our outperformance for the third quarter with the outlook above, we are raising revenue guidance for the full year fiscal 2022 ending March 31, 2022, as follows: we are raising total revenue outlook to a range of $636 million to $639 million, approximately 20% year-over-year growth. We are raising service revenue range to $603 million to $605 million, representing approximately 22% year-over-year growth. We have raised our outlook every quarter this year, and our update for Q4 shows that we continue to execute our plan we outlined last May. We believe the business is trending in the right direction. Looking a little further into fiscal 2023, which begins on April 1, 2022, we currently expect the year-over-year growth rate for fiscal 2023 service revenue, including the revenue contribution from the Fuze customer base, will be in the mid-20% range. We only closed Fuze a few weeks ago, and this is a very preliminary view. We will be able to give you more details when we announce our fourth quarter results in early May. Let me end with some closing thoughts. Since Dave joined 8x8 a little over a year ago, we have concentrated our investments in select areas to reaccelerate growth and deliver improved operating profit and cash flows. The Fuze acquisition is a key component of this strategy. We still have work to do, but the investments we have made and the focus Dave has brought to our business are beginning to take root. With the investments in XCaaS, Global Coverage, Voice for Teams, and sales efficiency, including key leadership team additions, we are well positioned to execute against these goals in the upcoming fiscal year. We remain focused on reaccelerating our core business, integrating our Fuze acquisition to achieve cost and revenue synergies, including cross-selling and customer retention. We believe the cloud communications market is large, growing and dynamic and that we are well positioned for our XCaaS platform, our global reach, and our market-leading Microsoft Teams integration. With that, thank you, and let me turn the call over to the operator for questions.

Thank you. The first question comes from Siti Panigrahi with Mizuho.

Hey, everyone. This is Matt Diamond speaking on behalf of Siti. Congratulations on the solid results. It’s great to see that Fuze is performing well. I have a question about the cross-sell opportunity. There are obviously some promising cost synergies in play, but I understand it’s early in the integration. Dave, after your initial weeks following the completion of the deal, can you share your level of confidence regarding the $50 million incremental ARR that was mentioned when the deal was announced?

We just closed the deal two weeks ago, and we're having conversations with customers currently, and they're very positive. So encouraged overall, although it's too early to give updates on the quantifiable number of the cross-sell, and I'll let Sam talk.

Yes. So as Dave said, look, the feedback so far from the customer base is very positive, I would say. We're going through and validating customer by customer. As Dave said, we only closed it two weeks ago. So we actually literally got the names of the actual customers two weeks ago. And so we're working through all that, I would say, incrementally more positive, not ready to change numbers.

Got it. And around the margin front, it sounds like there's a promising trajectory on the cost saves. I'm curious how you're thinking about inflationary costs this year, if there's anything we need to keep in mind when we're modeling the magnitude of spending growth and margins for fiscal 2023?

No. Specifically around inflation, look, we're dealing with it internally. So we are seeing things like wage inflation, some T&E inflation, those kinds of things. We're dealing with it within the overall guidance we're giving that total spending increases should be less than revenue growth. That's for us to deal with.

Okay. Thanks so much.

Thank you.

Thank you. The next question comes from Matt VanVliet with BTIG. Please proceed.

Hello. Good afternoon. Thanks for taking the questions and nice job on the quarter. Dave, I guess, bringing in Lisa to run the channel group here, what incremental sort of improvements or strategy do you think will help push through not only given your experience working with her, but maybe where you're trying to take the channel program from here now that you've built up a nice big stable of partners that are helping out?

Yes, the channel is essential to our overall strategy. We view the reseller network as a critical component that has historically supported these customers, guiding them from legacy solutions to the cloud. As we have developed our channel program over the years, our goal has been to be the most approachable and trustworthy partner for the channel. This is already evident in the strength of our team and the expanded channel relationships we've formed. However, we recognize there is still much work ahead. Lisa brings over a decade of channel experience, which will enhance our operational efficiency and foster trust within the channel globally. I see significant opportunities ahead as we implement our unique approach, including the successful agency and wholesale billing models we've utilized in Europe, and applying those in the US. Additionally, we aim to leverage the exciting Microsoft Teams opportunity through the channel. While we have made positive strides, we have more progress to achieve, and I am confident that Lisa will help elevate our efforts.

All right. Great. When examining both the mid-market and SMB groups, there seems to be slower growth, even with SMB showing a bit of contraction. Can you help us understand what factors are influencing this? Did you notice any increase in churn? Are there signs of pricing compression as contracts are renewed? Additionally, what new growth strategies might help counterbalance any of this decline? Thanks.

Churn in small businesses tends to be higher due to factors like business turnover and seasonal product usage. Our main focus, which aligns with our strategy, is on enhancing our go-to-market efforts and investing additional resources in sales and marketing within the enterprise sector. The enterprise market closely ties with our XCaaS strategy. When considering XCaaS, which integrates employee experiences on the UC side and agent experiences on the contact center side, only larger customers typically need that contact center capability. This alignment directs us towards the enterprise market. Additionally, our strengths with Microsoft Teams and our presence in 48 countries support this focus. Recently, we experienced significant growth in our enterprise ARR this quarter. Although growing the enterprise business takes time as we establish and develop our sales pipeline, we are already witnessing some positive results from our efforts, which is encouraging. This continued emphasis will be reflected in our key performance metrics.

All right. Great. Thank you.

Thank you, Mr. VanVliet. The next question comes from Ryan MacWilliams with Barclays. Please proceed.

Hey, guys. Thanks for taking the question. Excluding Fuze for a second, it looks like a strong fourth-quarter guidance in terms of sequential service revenue dollars added, compared to your guidance from the previous quarters. So anything in your business or anything in your market opportunity that's given you confidence for fiscal 4Q?

I'd love to say something insightful at this moment, but it's business as usual. Like we've got a great product. The team is doing really, really well. Our Global Reach message is resonating. And so, I have nothing incredibly insightful to say other than, I think we're doing really great and all the investments that we've made are just paying off.

That works for me. And just as we think about Fuze and in addition to 8x8. How should we think about the year-over-year growth rate for Fuze in 2021? And is there anything since getting your hands on the company? I know it's just been in the last few weeks that maybe you're more excited about from a revenue or synergy standpoint? Thanks, guys.

I'll address those points in reverse order. As I mentioned earlier, we have identified a cross-sell opportunity, but we previously stated that we had not projected anything for cross-sell, and that remains true. While there are some positive indicators, it is still too early to include anything in our guidance. Regarding the year-over-year growth from Fuze customers, it is a bit unclear, and I regret to say this, but we anticipate that Fuze revenue will decrease from the current customer base. This decline will be driven by natural attrition as well as our efforts to migrate or upgrade customers to the 8x8 platform. These factors are the primary drivers in this situation.

Can you provide an update on the timing of the migration? Is it something we can track, and how do you plan to incentivize it? What’s the best way for us to monitor the progress?

So, I mean, the big thing is customer choice, number one. Right? So we’re not going to force anything, any that sort of stuff. Customer choice, we’re analyzing it now. Can I beg you to ask me that again in 90 days, and I'll give you a more coherent answer? But it's still early. We want to make sure that customers get the best of both worlds. That's something we said earlier. We absolutely want to stick with that. So choice is the number one thing and trying to bring forth that best of both world solution.

And this is something that's going to be a positive for customers, as they get to add a greater breadth of product, contact center solution from 8x8, both with their current platform as well as getting the full XCaaS experience when they decide to upgrade to the XCaaS platform. We do expect some of that to happen very quickly and continue to happen for multiple years.

Appreciate the color. Thanks, guys.

Thank you, Mr. MacWilliams. The next question comes from Michael Turrin with Wells Fargo. Please proceed.

Great. Thanks for taking my question, guys. Maybe the first one is, as you think about the service revenue reacceleration at or above that 20% three-year target, first, can you just clarify that's an organic target? And then second, the go-to-market investments that you guys made internally and towards expanding the partner ecosystem, obviously, that's gaining traction. So really, what has to work to get to that 20% number? And then the reverse is where does the risk lie?

I'll address the first part of your question, and then I'll let Dave discuss the risks. We haven't clarified whether the growth is organic or inorganic, but we have pursued both in the past. Regarding the 20% growth, I believe you're reading too much into it; that's simply the level of revenue growth we expect. To achieve this, one aspect we need to focus on is improving our sales and marketing efficiency, which will naturally drive a higher growth rate. This remains a key area for our investment strategy, and it's essential that we continue to make progress in this area to drive increased growth rates.

And where we'll get that acceleration and improve sales and marketing efficiency is as we have success selling XCaaS. And we've seen now it's more than 35% of our ARR and growing at over 35% year-over-year to drive Enterprise customers, which I talked about earlier, as well as keeping those customers very happy. And that's where we've made a lot of progress today. It would always be your ongoing risk, but we have driven the customer retention improvement every quarter that I've been here and we had a multiyear record on that this quarter. So those are the key elements to drive customer retention of large accounts, to drive the Enterprise business and to drive the XCaaS adoption over time and doing that also with our differentiators of Teams and Global.

And then just one last one, a housekeeping question. I don't know if I missed it on the call, but can you sort of give us the RPO number? I didn't catch it.

I said it's $565 million.

Thank you, Mr. Levine. The next question comes from Meta Marshall with Morgan Stanley. Please proceed.

Great. Thanks. Sam, I just wanted to know if you could just kind of give what the headwind was from just the exiting of the wholesale business either through this quarter or into the guide? And then just maybe as a question for Dave. Clearly, you guys have made efficiencies to the services organization and maybe deemphasize that smaller business or book of business. Should we consider that as there any growth opportunity or additional churn we should be mindful of? Just anything to note on the smaller end of the business as you just deemphasized or change the services organization around that business?

Yes. The impact from exiting the wholesale business resulted in about a 3% reduction in service revenue growth. As I mentioned earlier, if we had not exited that business and it remained stable, the overall service revenue growth would have been approximately three percentage points higher.

And same to the guidance, correct?

Yes, yes.

And then to your question on our services organization and business. Obviously, as a SaaS business, one thing we're striking as we go through reorganization of the product and that organization is to make deployment easier, more out of the box for customers. We've made some progress on that. But that creates inherently a little bit of revenue headwind. But obviously, we're focused on the service revenue component of the business. And we believe easier deployment, implementation, configuration creates strong advantages, strong TCO opportunities for customers. So that will be a continued focus for us as a business.

Got it. Thanks.

Thank you, Ms. Marshall. The next question comes from Michael Latimore with Northland Capital Markets. Please proceed.

Great. Thanks. On the record revenue retention, can you just give a little more data on that?

Yes. I mean basically, our retention rates are the highest we've seen pre-pandemic even before that. Churn has really come down. I mean, it's been a key area of Dave's focus the last year. Terms have really come down to last year. And it's arguably it across the board. We saw some of the lowest credit card decline rates we've ever seen, and we saw great enterprise retention. It's across the board.

We've made significant investments in our customer success organization over the last year, as well as product usability, stability enhancements. And I think those are paying off. Obviously, there's other macro trends possibly affecting those, I think, are really critical for what we're doing here and getting greater customer happiness.

Great. In terms of the XCaaS vertical, is there any significant difference between the verticals in the XCaaS business compared to UCaaS, excluding excess or invention, or are the verticals quite similar in mix?

To date, the verticals have been quite similar as we emphasize a blend between UC users and contact center users. We have concentrated on informal cues and integrating contact center capabilities into UC users, with our front desk product being one example of this. There is a significant overlap in verticals for us, particularly in the EMEA market, which is also purchasing XCaaS. We are observing this trend across the board.

Yes. Thanks.

Thank you, Mr. Latimore. The next question comes from George Sutton with Craig-Hallum. Please proceed.

Thank you. I'm glad to hear you're going to continue to focus heavily on R&D. You did mention bringing over a few developers in large part, can you just talk about how does that influence the product roadmap going forward? In other words, how might the product look different in a couple of years as a result of this move?

Sure. I'm happy to report that we've successfully integrated that team into our organization. This is a relatively new development, but it was planned, and it enhances our capacity for innovation as we can allocate more resources to key product areas now that we have the foundational elements in place from an R&D standpoint. Additionally, it's encouraging that we can achieve this while still contributing to profit over the next year. Our primary focus will continue to be on the core pillars of XCaaS, our Team's product, and our Global Reach. We've made significant progress in all these areas over the past year, and there are more innovations coming soon. Expect to see an increase in the pace of innovation over the next nine months, particularly in improving admin usability for managing large organizations, enhancing our omni-channel and AI capabilities, and developing deeper integrations. We're also exploring additional user personas, building on our initial focus with front desk capabilities. We have several exciting announcements planned for later this quarter, so stay tuned for more details.

Appreciate the details. Thanks, guys.

Thank you.

Thank you, Mr. Sutton. The next question comes from James Breen with William Blair. Please proceed.

Thank you for your question. You mentioned some supply chain issues earlier. I'm curious about how you've had to adjust the business because of that and whether you've seen any improvements. Also, does this situation affect your sales cycles as the supply chain begins to stabilize? Thank you.

Okay. So here's what happens. Yes. I think it does have some effect. It's hard to quantify. But I think we are seeing some Enterprise customers place smaller orders upfront, because they have to have a slightly different deployment schedule. And so there may be some pent-up demand. There's certainly we've got the largest back orders that we've had in a long time backlog, if you will, of hardware, and that is a statement. As it alleviated not really, it's still something we manage every day, every week right now. I'm hoping that at some point in the next four quarters, it alleviates, but there's nothing that I can concretely say that we have designed on the horizon that it's going to be alleviated.

So you basically, you've adjusted to the working environment that you're now haven't seen necessarily a change, but it just hasn't come to a completion yet?

Yes. I mean, there's a change. I think like I said, I think just some of the enterprise orders, the bigger orders are probably a little smaller than they would have been because they're placing the first order and they'll place a second order here in a couple of months when we get more hardware to meet their deployment needs.

And we're building a great approach of hardware option to create more flexibility for customers.

Okay. And then just qualitatively, you mentioned a little bit about the cross-sell with Fuze. Any real difference in the size of their customer base relative to the size of your customer base, small, large, et cetera?

Well, on average

In terms of the size of the company?

Thank you, Mr. Breen. The next question comes from Catharine Trebnick with Colliers. Please proceed.

Hi, thanks for taking my question. Congratulations on a good quarter. So you spent some time talking about Microsoft Voice with Teams. And I'm wondering why aren't you pursuing a relationship with Black and it seems to me that would be another avenue of good growth? Thank you.

Thanks, Catharine. So on the Team's opportunity, I do think it is like more partners is always good. So we're open to that relationship. The Team's platform itself is a larger platform, honestly. And they create an opportunity that I think is still just lightly touched. And we are doing a lot in that regard to help penetrate these users that don't have an enterprise communication system attached to their Team's usage, and we're doing that through direct routing, and we're adding a lot of value through our contact center, powering all our employees, global coverage. We do have a strong relationship with Salesforce overall. And obviously, with integrations across both our UC and CC products, and we see that as a very important relationship overall for us.

All right. Thanks. Appreciate it.

Thanks, Catharine.

Thank you, Ms. Trebnick. The next question comes from Will Power with Baird. Please proceed.

Great, thanks. I guess, a couple of questions. Maybe just starting with the service revenue upside in the quarter. I think, Sam, you indicated it was really driven by strength in CPaaS and CCaaS. And just wondering if we could get any other color there? Was there any particular products or areas within CPaaS and then within CCaaS, is that seat? Is it usage? Any other color and just the sustainability of that upside, I guess, as we move into Q4?

So on the CPaaS side, it was Southeast Asian usage. And so I think we've got a great presence there. We've won some new customers. I mean, I think Dave has mentioned some pretty big brand names over the last few earnings calls. You can imagine those flowing through as usage as they ramp up starts to show up. And then on the Contact Center side, it was just minute usage. And so do I think it's sustainable? Yes, it feels like the world is opening up, and there's a lot more business activity going on, and that just correspondingly shows up as more usage.

Okay. That's great. And then just a question on ARR growth. It looks like the XCaaS ARR growth accelerated. I know you called that out. I know that's the primary focus. And I think as you touched on, as you look at mid-market and the SMB a bit weaker. So I guess one was a big question or one of the big questions is when do we get to an inflection point where that XCaaS ARR can more than offset some of the pressure points in mid-market and SMB to help drive an acceleration in ARR growth? What are the key drivers of that, any rough timeline to how to think about that?

Dave and I exchanged glances, contemplating whether you preferred a detailed response down to the minute or just a summary of the key factors at play. A bit of humor aside, what’s truly driving our success is the investments we’re making in demand generation, branding, and channel strategies. These efforts are yielding results. Our growth is outpacing the overall market rate, leading to a greater share of our business, which aligns perfectly with Dave's objectives that he has been pursuing for over a year. I hope to continue reporting that this segment is growing as an increasing part of our business in future calls, as it is a key principle for enhancing the company's overall growth rate.

Great. Okay. Thank you.

Thank you, Mr. Power. The next question comes from Tim Horan with Oppenheimer. Please proceed.

Thanks, guys. Can you go into Teams a little bit deeper? Where are you developing the channel there? I would think it's a very different channel than the legacy channel. And where are you just like the processes to kind of implement? And I guess just lastly, what inning are we in, do you think, in terms of your ability to kind of execute on that and penetrate that market?

I'm sorry. Can I ask you the first part came a little muffled. Did you say Teams channel?

Yes. Regarding Microsoft Teams, where are you developing the channel that can sell into legacy Microsoft systems integrator support?

Yes. I'll begin with the last part. It’s still early since many Microsoft Teams users, as seen in the monthly active users, primarily use it for messaging. Integrating Enterprise Communications with that is still in its early stages, and only a small number have truly adopted it. There are various methods to implement this, such as direct routing, operator connect, or calling plans, but currently, direct routing is the most common solution where we stand out. We recognize this early opportunity, and we've been capitalizing on it, evident from our 30% quarter-over-quarter growth. However, I believe we haven’t fully tapped into the complete channel opportunity yet. This is a key initiative for us. While we primarily depend on our existing channel relationships, there's significant potential to engage with an additional set of channel partners. This is something we will focus on as we move forward and enhance our approach. We are already making strides in this direction, as we aim to empower all employees, including those in contact centers, providing global coverage and enhanced functionalities like SMS and fax services. We’ve seen considerable success, and I believe there's a much larger opportunity for us to grow further.

And where are you with the ability to provision and support customers and just quality of the product and Teams?

Yes, that's a great question. Those customers are mostly set up and operational. Our focus is on maintaining a high level of service quality and reliability. I believe we have the capability to achieve this. While we're still working through some of the details, I think we perform better than others, which is a key strength of ours in delivering a high-quality and reliable service.

Thank you.

Thank you. The next question comes from Michael Funk with Bank of America. Please proceed.

Yes. Thank you for taking the question. It's good to be here. A couple if I could. First on the enterprise deal funnel, any kind of comment you can give on the change in the size of that funnel and then early and late stage?

We appreciate the recent initiation, Mike; it was a great read. However, we do not provide those types of funnel metrics. It would be inappropriate, especially since we know our competitors listen to our calls, so it would not be wise to share that information at this time.

I can just try one time at least. So on the broader question of enterprise adoption. Obviously, there have been different rates of inflection over time for UCaaS and CCaaS. Can you just kind of peel apart kind of the broader acceleration in market adoption versus the success that you're having in terms of the market share gains?

The movement to the cloud has been occurring for almost a decade, but we barely scratched it. It's accelerated at this point. And the enterprises have been the latter ones to migrate over time. And so I still think there's a lot of large enterprises on legacy solutions. But we are seeing a greater acceptance partly because of the work-from-home mandates. But partially, it also causes people to realize that's where the innovation investment is going into the cloud solutions over legacy solutions. So I think when people are choosing their future platform, it's becoming obvious to move to a cloud platform in this next replacement cycle. That replacement cycle could still be up to 7 to 10 years. So I still think it's going to be a long run in that regard, but the propensity to move to cloud has increased.

Understood. And maybe kind of more quantitative then, how much breakage are you modeling into the Fuze acquisition? You mentioned earlier, you're modeling in some churn. How much breakage are you modeling in?

So by breakage you mean churn, right?

Yes. Sure.

So, I mean, you have some rough estimates of what their small base looks like, and I've taken industry norms and doubled it. So just to be safe, I doubled the industry average churn rate for their portfolio, and that's what I've been running through the model.

Great. Thank you, guys, so much. Appreciate it.

I think we have time for one more question, operator.

Absolutely. The last question comes from Ryan Koontz with Needham. Please proceed.

Thanks for the question. I wanted to double back on Teams a little bit more, and it sounds like an increasingly important part of your new bookings. Can you give us any help there? Is it I hear it's up 30% in terms of ARR? Is that Q-over-Q? Any more color you can give us on where that stands as a percentage of new enterprise bookings and things like that?

Yes. A quarter ago, we mentioned that we had 100,000 users in the first five quarters since the launch, and that number increased by 30% quarter-over-quarter. This is significant as we are observing growth in both new bookings and in our land-and-expand deals, such as with Beam Suntory and London Borough of Newham. We are experiencing growth in both new business and expansions.

That’s helpful, Dave. Thank you.

There are no additional questions at this time, and that concludes the Q&A session. I will pass the conference back to the management team for closing remarks.

There's a replay available on the web, and thank you very much for your time today.

That concludes the 8x8 Fiscal Q3 2022 Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.