8X8 Inc /De/ Q4 FY2022 Earnings Call

Good evening. Thank you for attending today's 8x8 Q4 2022 Earnings Call. My name is Joel and I will be your moderator for today's call. The presentation portion of the call will be followed by an opportunity for questions and answers at the end. I'd now like to pass the conference over to our host, Kate Patterson, Head of Investor Relations at 8x8. Please go ahead.

Thank you, operator. Good afternoon, everyone. Today's agenda will include a review of our fourth quarter and full fiscal year results with Dave Sipes, 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, I just want to remind you that our discussion today includes forward-looking statements about our future financial performance, including the impact of the Fuze acquisition, and 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 those projected in our statements as described in our risk factors in our reports 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 discussed on this call, along with year-over-year comparisons, were not prepared in accordance with US generally accepted accounting principles or GAAP. A reconciliation of those non-GAAP measures to the closest comparable GAAP measures is provided in our earnings press release and earnings presentation slides, which are available on the 8x8 Investor Relations website at investors.8x8.com. With that, I will turn the call over to our CEO, Dave Sipes.

Thank you, Kate. Good afternoon, everyone, and thank you for joining us today. On the call today, I will review the quarter and fiscal year using the strategic priorities we outlined on our fourth quarter 2021 call as a framework. I will also give an update on the integration of Fuze and our progress and plans for fiscal year 2023. We delivered another solid quarter of ARR growth, non-GAAP profitability, and positive cash flow as we continue to advance our strategy of empowering Personas company-wide through integrated contact center and unified communication capabilities. We have made tremendous progress over the past year and our focused XCaaS strategy and the investments we have been making in innovation are showing up with several recent contact center-focused product launches. For example, our reimagined agent workspace won an award for customer experience innovation at Enterprise Connect during the quarter. Enterprise adoption of our integrated XCaaS platform continues to expand, with XCaaS ARR growth accelerating to more than 35% year-over-year, not including Fuze. XCaaS now accounts for approximately 35% of combined 8x8 and Fuze ARR, and given the Fuze enterprise base, we see an opportunity to grow this materially over the next several years. Our continued focus on operational excellence resulted in higher gross profit, with fourth quarter non-GAAP service revenue gross margins at a multi-year high of 72%. The improvement in gross margins resulted in sequential and year-over-year increases in non-GAAP profitability and operating cash flow. As a result, we delivered positive non-GAAP operating income on an annual basis and generated positive operating cash flow for the full year. Total revenue was within our guidance range as sequential growth in professional services and product revenue resulted in other revenue above the high end of our guidance range. Fuze also outperformed our expectations with strong customer retention and partner engagement. Service revenue was $172.8 million, approximately $0.7 million below our guidance range, due to a combination of lower-than-expected CPaaS usage revenue and flat small business ARR as we continue to focus on a higher-margin and longer-lived business. As we look to fiscal 2023 and beyond, our commitment to operational discipline will allow us to continue investing in XCaaS innovation and deliver operating leverage and increased cash flows. As Sam will discuss in greater detail, our fiscal year '23 guidance ranges for revenues and operating margin imply a non-GAAP operating margin of roughly 2.5%, an increase from fiscal 2022. Given the current market environment, we remain more committed than ever to delivering robust increases in operating income and cash flow while continuing to grow. I believe we have line of sight to potentially more than double operating margin in fiscal year '24. Digital transformation, agile workplaces, and an increasing mobile workforce are creating a massive opportunity to transform employee and customer experiences through integrated cloud-based communications. As the only fully-owned unified cloud-based UC and contact center platform, 8x8 XCaaS is uniquely positioned to capitalize on this opportunity and advance our industry. We are leading the innovation and offering customers new basis experiences, advanced AI-driven analytics, and a modern intuitive interface. I believe our balanced approach to investing in that innovation that will drive future growth while increasing operating margin and cash flows is the right approach to build shareholder value in today's environment. Turning to Q4, I want to spend a little time discussing the evolution in our CPaaS business today and our strategy for this area of our business. CPaaS represents a relatively small portion of our total revenue, but it remains an area of strategic focus for us in the Asia Pacific region. As the volume leader and low-cost provider in that region, we're in a strong position to extend our lead and drive improved unit economics over time. Our strategy has been to diversify the customer base to reduce volatility and increase usage and focus on higher-margin enterprise customers. Until Q4, this strategy was working well, and CPaaS has been a solid contributor to enterprise ARR growth and gross profit dollars. Usage by a few large customers dropped significantly in the last half of the quarter, resulting in an unexpected sequential decline in CPaaS revenue of several million dollars. The decline is reflected in our service revenue and enterprise ARR. While this was a tough CPaaS quarter, we are working with existing customers to grow their business and continue to add new customers to further diversify the business. We hit a speed bump and we're working to actively fix it. Turning to the UC/CC portion of our business, growth was robust in enterprise, with the addition of 120 new customers in 8x8. The Fuze acquisition further expands our enterprise customer base and the XCaaS upgrade and cross-sell opportunity with nearly 300 additional customers, for an increase of more than 400, bringing our enterprise total to 1,320 customers. Adoption of XCaaS has been broadly spread across a range of industry verticals and geographic regions, including the public sector. A few recent examples of new XCaaS customers include Radian, which provides industry-leading mortgage and real estate products and services as part of their digital transformation initiative. They turned to 8x8 XCaaS and 8x8 Voice for Microsoft Teams to support over 1,700 employees. The University of Strasbourg, a public university in Greater Manchester, UK, serving the higher education needs of more than 23,000 students, turned to 8x8 XCaaS and 8x8 Voice for Microsoft Teams to empower over 1,600 staff with a robust communications and customer engagement platform for hybrid work. 8x8 CCaaS powerful analytics will help reduce call handling response times with flexible burst licenses, providing extra support during busy admissions clearing periods. Think Research provides knowledge-based digital health software solutions to more than 300,000 clinicians and over 11,000 facilities in eight countries. By implementing the full power of 8x8 XCaaS with Voice for Microsoft Teams and CPaaS SMS API, Think Research will enhance overall customer experience, as they improve agent efficiency and productivity, using new channels to confirm appointments and recruit beta testers for drug trials and new therapies. Cross-sell is an important aspect of our XCaaS strategy. Some significant land and expand wins in Q4 include Habasit America, which delivers premium quality conveyor and power transmission belts supporting businesses in achieving optimal processing efficiency. Starting as an 8x8 UCaaS customer, they recognized the business benefits of the integrated 8x8 XCaaS platform and added 8x8 CCaaS to gain analytics and reporting insights to better serve their clients. A global sporting goods manufacturer with some of golf's most renowned brands expanded their 8x8 investments by increasing their UC licenses and adding contact center seats to support nearly 2,000 employees around the world. The 8x8 Voice for Teams direct routing solution was also a significant contributor to the growth in enterprise customers and ARR, as momentum continued to build in the fourth quarter. Our feature-rich direct routing solution for Teams continues to be an important competitive differentiator for our UC solutions and is becoming a significant driver of new logos. Customers choosing 8x8 Voice for Teams in Q4 included one of the UK's top 10 universities, the University of Bristol. They turned to 8x8 XCaaS and 8x8 Voice for Microsoft Teams to provide over 27,000 students access to new channels. They will leverage the Microsoft-certified for Teams 8x8 Contact Center for its analytics capabilities as an integral part of their student welfare initiatives. The Indianapolis Motor Speedway, the racing capital of the world and home to the Indianapolis 500, selected the 8x8 Contact Center for Microsoft Teams solutions for its ticket office to help drive a premier customer experience. This customer is an excellent example of how our global coverage complements our Voice for Teams solution and creates a strong competitive advantage for us with multinational organizations. In the fourth quarter, we expanded our global reach to Indonesia, which is another industry first, and to Thailand. This follows our announcements earlier this fiscal year of delivering an industry-first integrated cloud, phone and contact center solution in the Philippines and China. Our cloud-based global UCaaS solution is now available in 50 countries with full cloud public switch telephone network support and territories, up from 41 a year ago, and covers more than 85% of the world's GDP. Examples of new global customer wins include Trek Bicycle, the largest US manufacturing distributor of bicycles. They selected 8x8 XCaaS and 8x8 Voice for Microsoft Teams as a key part of their digital transformation, providing a global communications and omnichannel contact center capabilities to support over 1,300 employees in 19 countries. Additionally, a French luxury group with world-renowned fashion brands turned to 8x8 UCaaS and 8x8 Voice for Teams to support over 12,000 employees across 270 stores and 75 office locations around the globe. French-speaking support in France from the Fuze acquisition was instrumental in winning the business and will lead the deployment. We have been excited by the response we are seeing from customers and partners, and our strengthened European presence is just some examples of the additive impact of the Fuze acquisition across the business. Customer retention among the Fuze base has been strong, and revenue of $24 million was above our expectations for the quarter. We moved swiftly, after the transaction closed, to integrate the two organizations and streamline the combined cost structure. As a result, Fuze was accretive to operating profits this quarter, and we are already seeing an acceleration in the innovation roadmap as R&D teams around the world work together. We have made rapid progress on our XCaaS product roadmap this year, including the recent release of significant contact center capabilities and enhancements, including 8x8 Agent Workspace and 8x8 Conversational IQ. 8x8 Agent Workspace transforms the contact center agent experience with powerful contact routing and handling features to enhance productivity and personalize both agent and customer engagement. The browser-based design-led user interface delivers a tailored and intuitive experience that uniquely blends Contact Center and Unified Communication capabilities in a single application. Conversation IQ extends formal contact center capabilities such as quality management and speech analytics to all 8x8 Cloud Communications users. 8x8 Conversation IQ delivers AI-infused automated evaluation, reporting, and analytics capabilities across the organization to improve effectiveness and compliance. Conversation IQ also supports voice interactions on Microsoft Teams endpoints through the 8x8 Voice for Microsoft Teams integration. An example of a customer implementation of Conversation IQ is Thrive, a global software and marketing services company, with over 46,000 businesses on their SaaS platform. Supporting more than 3,700 employees on 8x8 XCaaS since 2019, Thrive recently added 8x8 Conversation IQ to apply conversational AI to uncover insights across the company to enhance team performance and optimize customer experience. With these two product releases, we reimagine the agent experience and highlight the advantages of our unified platform. Customer and industry response to the releases has been very positive, including the Best Customer Experience Innovation Award that Agent Workspace won. We have orders for Conversation IQ from our great beta customers even before the product was generally available, which it is today. It was exactly one year ago that we outlined our long-term vision for 8x8 and set our strategic priorities for 2022. A comparison of 8x8 then and now shows just how much progress we've made across multiple fronts: first, we accelerated the shift to the enterprise. Even before adding the Fuze customer base, Enterprise customers now represent more than half of our ARR. The shift in mix to higher quality Enterprise ARR has been a driving force behind the improvements in our retention metrics, our channel engagement, and our financial performance. Retention in Q4 increased again from record levels in Q3 and reflects our increased emphasis on platform reliability including our financially backed Five 9's SLA as well as investments we've made in customer success. Channel engagement and contribution is also at an all-time high, with the channel accounting for more than half of our ARR. We also focused our strategy on the XCaaS platform and increased our investment in R&D, especially contact center capabilities. As a result, we launched a steady stream of product enhancements and new capabilities throughout the year, including the March Contact Center and Analytics launches. We completed our acquisition of Fuze, accelerating our progress on the shift to enterprise and expanding our capacity for innovation. And finally, we delivered continuous improvement in our financial results, with gross margin up 550 basis points year-over-year. We achieved our operating margin target a full quarter ahead of schedule and achieved over $34 million of positive cash flow from operations for the year. I want to thank our teammates here at 8x8 for their hard work and commitment in achieving these milestones. We've made tremendous progress on the product front and improved our financial performance and are on track to achieve our operating margin targets for our intermediate and long-term model. Given the current environment, we feel it prudent to continue to focus on operating margin and tighten our criteria for investment, which will favor profit over near-term growth but will set the stage for our long-term performance. This balanced approach is reflected in our 2023 guidance ranges for revenue and margin. The trajectory of XCaaS adoption and the growth we've seen in Enterprise ARR and customers gives me confidence our strategy is the right one to build value for all our stakeholders over the long term. The bold moves we made in fiscal year 2022 to strengthen our leadership, increase our innovation capacity, and expand our base have all created the foundation on which we will build long-term value. For fiscal year '23, we will continue to focus on XCaaS innovation as well as driving sales efficiency and operational excellence across the organization. I look forward to reporting our progress in future quarters. We're incredibly excited by the work our development teams are doing and we plan on sharing our innovation roadmap on our Q1 call. I will now turn the call over to Sam.

Thanks, Dave, and good afternoon. We experienced some challenges in our CPaaS and small business segments during the fourth quarter, which impacted service revenue performance. At the same time, we continue to post broad improvements in gross margin, delivered solid operating income, turned Fuze accretive to our non-GAAP earnings, and exited the quarter with more cash than expected. We remain financially agile and disciplined. Total revenue for the quarter was $181.4 million, an increase of 25% year-over-year, and within our $180 million to $182 million guidance range. We saw a bit of a bounce back in other revenue driven by the supply chain, which is slightly opening but still constrained, and milestone completions in professional services. We generated $172.8 million in service revenue, an increase of 29% year-over-year, which was below our guidance range of $173.5 million to $175.5 million. As Dave stated, the shortfall was due to CPaaS volumes dropping during the second half of the quarter when a few large customers stopped their marketing programs in late February and March. The shortfall to expectations in CPaaS was approximately $3 million in lower-margin SMS. We are facing some inflationary pressure from international carriers and are favoring margins over revenue growth when they conflict. Looking forward, we are executing plans to leverage our scale in the region to further lower costs and drive incremental customer demand. Fuze accounted for $23.9 million of service revenue and total revenue of $24.1 million. Service revenue from Fuze was higher than expected, driven by higher retention. The integration has been humming along and I'm super impressed at how quickly we have combined some back office operations. We did make a cost reduction in mid-February, and on the whole used it better than expected in revenue cost and therefore was accretive to non-GAAP operating income. We have already started moving some additional Fuze customers to the 8x8 platform at their request. Total ARR was $687 million at the quarter's end, up 33% year-over-year. Since we have started merging the customer bases, we will not be breaking out Fuze from 8x8 separately for ARR reporting but will report revenue. Enterprise ARR now makes up 57% of total ARR, and was up 55% year-over-year. Mid-market is 19% of ARR and up 31% year-over-year, while small business is down to 24% of ARR and declined 1% year-over-year. Growing our enterprise business is one of the core tenets of our long-term strategy, due to its longer commitments, higher retention rates, and better efficiency ratios. A note on the small business segment, which declined 1% year-over-year: small business is non-strategic for us because of the lower efficiency metric and the absence of contact center needs. We would expect it to continue to shrink as a percentage of total ARR. For expense items mentioned below, they are all non-GAAP unless otherwise noted. The fourth quarter gross margin was 66.7%, driven by CPaaS being lower than expected and our COGS improvement programs at Fuze happening faster than expected. Total service gross margin came in at 72.2%. Non-GAAP other margin came in at minus 44.6% for the quarter reflecting that achieving cost savings from Fuze in this segment will take longer because we need to continue Fuze deployments until complete. As a reminder, other revenue represented less than 5% of total revenue for the quarter, so the decline in other gross margin had minimal impact. Non-GAAP operating profit grew to $4.3 million quarter-over-quarter as we focused on higher-margin portions of our business such as XCaaS and continued to drive unit improvements in COGS. Looking ahead to the first quarter, we expect overall gross margins to be generally flat sequentially driven by changes in product mix between applications and CPaaS. Turning to our fourth quarter operating expenses, this is our first combined quarter with Fuze and that's the reason for the significant step-up in several areas. The OpEx guidance per line item I gave was incorrect, and I would expect some reallocations in future quarters as I said on the last call. The total was in line with our expectations. We had guided total fourth quarter OpEx in the range of $115 million to $118.5 million and came in at $114.6 million. Total spending, as measured by COGS plus R&D plus sales and marketing plus G&A was up 23% year-over-year, below our 25% total revenue growth. In the future, we expect total spending to grow more slowly than total revenue on a rolling four-quarter basis as we drive efficiencies throughout the business. There can be some quarter-to-quarter variability. Turning to the balance sheet, total cash, restricted cash, and investments ended the fourth quarter at approximately $148.2 million. Excluding restricted cash, the balance was $138.7 million. Quarter-on-quarter total cash is down by about $112 million, better than expected, driven by solid collections and lower-than-anticipated Fuze integration costs. As a reminder, we paid $132 million in cash and 5.6 million shares, or approximately $250 million in total consideration, to purchase Fuze based on the share price at the time of the announcement when the deal closed in January. Cash from operations came in at over $16 million for the quarter, and we remain free cash flow positive for the second quarter in a row. The overperformance was driven by conservative cash management and strong collections. Deferred revenue climbed to over $45 million, up 90% year-over-year, and up over 75% quarter-on-quarter. RPO was approximately $715 million for the fourth quarter, up from $565 million in the third quarter. About $125 million of that was from Fuze and the remainder was from 8x8. Back to Fuze: revenue came in ahead of expectations, and the acquisition was accretive to non-GAAP operating income. We guided to remain non-GAAP profitable, and so far, so good. We expect further cost savings in owning Fuze, but it will take some time. Next, a few short comments about fiscal year 2022, which we just closed. We grew revenues above our initial guidance for the year and managed expenses reasonably well. The gross margin was better than expected, mainly due to programs we have been running. Operating expense management was solid, but we know we have further work to do. We were cash flow from operations positive for each quarter and returned to free cash flow positive during the year. Business is a team sport, and many 8x8 infused employees got us here. Thank you. Taking the current business performance and market environment into account, including the recent performance of CPaaS, we are establishing guidance for the fiscal first quarter of 2023 ending June 30, 2022, as follows: we anticipate service revenue to be in a range of $177 million to $180 million, representing 28% to 31% year-over-year growth. We expect that Fuze's revenue contribution will be between $26 million and $28 million. We anticipate total revenue to be in the range of $185 million to $188 million. We have uncertain visibility on the supply chain for endpoint hardware shipments; the news changes weekly. We are balancing growth with improving profitability and targeting an operating margin in the 2% to 2.5% range for the quarter. We are starting our guidance for fiscal 2023 ending March 31, 2023, as follows: we anticipate total revenue to be in the range of $775 million to $790 million, representing approximately 21% to 24% year-over-year growth. We anticipate service revenue to be in a range of $740 million to $755 million. In January, when we reported, we suggested revenue would be in the mid-20% growth range, and this guidance confirms that approximate number. We are balancing growth with improving profitability, and we'd like to see operating margins in a 2% to 3% range for the year, with exiting above 3% as a goal. In closing, I remain confident in our strategy and our market opportunity. In FY 2022, we reinforced our strong financial foundation and remain an agile organization. We look forward to further gains in fiscal 2023. Thank you. And operator, we'll now be open for questions.

Thank you. We will now begin the question-and-answer session. The first question is from the line of Siti Panigrahi with Mizuho. You may proceed.

Hi. Thanks for taking my questions. This is for Siti Panigrahi, and again, congrats on the quarter. How would you characterize the competitive environment you're seeing with Microsoft Teams? Obviously, as you mentioned, your feature-rich direct routing is doing a great job with new logos. But as you called out last quarter, how are you dealing with competitors in the space? And how is that matching up against their offerings?

Yeah. This is Dave Sipes. One of the biggest trends we see is that customers are looking to integrate Teams users with their Enterprise Communication platforms. And they're doing it fundamentally through direct routing and Operator Connect solutions. We compete in the direct routing solution and have a very popular direct routing solution. As you can see by a lot of our wins that I mentioned throughout the call today, it's obviously having a significant positive impact for us. Additionally, we've been recognized in the channel as having the best direct routing solution in the market. We continue to hone that offering, as we look at the other solutions in the market, including Operator Connect, which tends to be carriers or national service providers that are generally less global, less feature-rich, and siloed, servicing only the Teams users in the enterprise. Our offering brings functionality to those users as well as powering every employee in the organization, not just the Teams app endpoint users, but also frontline workers and contact center users. So it's a big trend, as the Teams messaging application is prevalent in many of our customers. But powering that with the communication platform is really something we've just scratched the surface on. It's a big initiative for a lot of our customers today, and they've really attached themselves or moved towards our direct routing solution.

That's very helpful. Thank you. And then, just one follow-up: you guys guided to about $50 million in CCaaS cross-sell opportunity after FY 2023 last quarter. Do you expect any upside to that estimate, maybe earlier into FY 2023, or is it about the same?

Yeah, I’ll take that one. This is Sam. We still estimate the opportunity size at $50 million. The average sales cycle for a contact center is 12 months, especially with larger enterprise customers. Therefore, I would expect any results to become evident more in fiscal 2024. I believe the market size and opportunity we discussed last call is accurate. Further activities we’ve observed continue to support that estimate. However, I don’t expect it to materialize anytime soon.

Thank you. The next question is from the line of Mike Funk with Bank of America. You may proceed.

Yes. Thank you for the questions. A couple if I could: just go back to your comments about the large enterprise customer or customers that had lower usage in the quarter. I'm just wondering if there are any lessons to be learned from that? What drove the lower usage? The ability to forecast lower usage based on customer patterns? Just what you took away from that event.

Yes. So, this is Dave. This is all within our CPaaS offering and the drop-off was from several large customers who pulled back from some marketing campaigns in the second half of Q4. We're in good standing with those customers, and we're working with them for the reintroduction of some of those campaigns when the market conditions are right for them. For the longer term, we continue to diversify and broaden the customer base through the addition of new customers. We have a very robust pipeline, and we continue to do that with the diversification. Additionally, we already have plans in place to leverage our regional scale to drive lower costs, which can then be leveraged with some of these large customers to help support the performance of these large marketing campaigns in the market.

And then just on Fuze, if I could quickly. I know you mentioned it came in line with your expectations so think about a $24 million contribution. If I simply take the revenue number you gave us back in December and then you'll adjust for the close date, that would have implied, I think, slightly more revenue. So tying that back to your comments about the churn being as expected. Is the difference there just the breakage post-deal? And if so, how much breakage were you projecting after the merger close?

Breakage is a new concept for me. The numbers actually turned out better than we anticipated. We initially projected $20 million for the quarter, but it ended up being $24 million. I was expecting a bit more churn or less retention, but it exceeded our expectations. The Fuze base is doing well, and I'm very pleased with how our GCC organization has managed it. We can discuss any miscommunication regarding the math later. Overall, it performed better than we originally anticipated for the quarter.

Thank you, Mr. Funk. The next question is from the line of Meta Marshall with Morgan Stanley. You may proceed.

Great. Thanks. A couple of questions for me. Understanding on the CPaaS side that you have ongoing positive relationships with those customers. But just as we look forward to your guidance, both for the quarter and for the fiscal year, just what are you embedding as far as – are you flatlining those customers? Are you expecting some sort of comeback from those customers? Maybe that's the first one, and then I'll let you guys answer before I jump into the second one.

Yes, Meta, this is Sam. I'll take that one. So, per our usage-based components, we look at where they exited the quarter, and since they were both low for the quarter, we ran that through to the next quarter and year. So we always try to take the latest data points and run it through. Obviously, if they come back, it would be a positive, but we've generally assumed that whatever low level they're at will continue.

Okay. And then I mean, similar question: just you guys had noted last quarter that you were basically assuming twice the industry churn for Fuze as you look ahead kind of to the next year. Just as that clearly outperformed in your first quarter, do you think that those are too aggressive of churn expectations and that you've kind of taken this slightly? The fact that the installed base is in better shape into account into the guidance or just how should we think of churn on the Fuze base as we head throughout fiscal 2023?

So this is our first real quarter with those customers. They are in a healthy state and well contracted. So I would say in the quarter, they came closer to industry standard levels. I think forecasting-wise, that was probably still conservative looking forward through next year. As we get more quarters under our belt, we will have a better feel for the long-term propensity of those customers to retain.

Okay. Perfect. I will hand it off. Thanks.

Thanks, Meta.

Thank you, Ms. Marshall. The next question is from the line of Peter Levine with Evercore. You may proceed.

Thank you for taking my questions. Maybe Sam, if I think about organic growth once you anniversary Fuze, should we think about the model calling it high teens, 20%?

I think I’d be a little bit aggressive right now. I mean you're asking me about four-plus quarters. So, I think right now I'm a bit more conservative than that. I'm considering something in the mid-teens range, around 13% to 15% is where I would start. Let me get a little bit further ahead right now, but that's where I would begin.

Okay. And then yes, I think 25% to 30% of revenues come from international. Anything you can share with us in terms of sales cycles, or are you seeing deals taking longer to close or delays? Just any incremental color on the international front given the current environment? And kind of what are you factoring into your guide?

Yes. Our international business is predominantly in the UK and APAC with our CPaaS business. So, we've talked about the CPaaS business in the UK; it has trended well in the last quarter, consistent with the previous period. It continues to grow quite robustly for us. We have a good brand and concentration, focusing on the public sector in addition to enterprise in that market. So, we haven't seen any adverse effects from macroeconomic trends in that market.

Thank you, Mr. Levine. The next question is from the line of George Sutton with Craig-Hallum. You may proceed.

Hey, guys. This is James on for George. Thanks for taking my questions. Appreciate the color on ex-cas being 35% of your ARR, but I'm just kind of curious if you could provide any detail on the percentage of your customer base that's on excess and potentially if you could quantify the uplift from a customer going from just UCaaS to XCaaS.

I’ll address these in reverse order. We’ve mentioned in a previous call that typically, when we look at a UCaaS deal, we find the dollar amounts for UCaaS and CCaaS are roughly equal. The number of seats varies, but the price difference is managed. From our observations, this 50-50 split is a useful trend. Regarding our customer base, we haven’t disclosed the exact number, only that UCaaS accounts for 35% of our ARR. This is mainly skewed towards our enterprise customers, reflecting our strategy to target larger markets, which shows a greater willingness to purchase. Therefore, while the total number of customers is less than 35%, their size is greater.

Makes sense. And then service margins were great in the quarter. Just kind of curious, are those sustainable, or will CPaaS, sort of coming back, will those come in a little bit?

CPaaS showed a strong recovery. While we might see a slight adjustment, we have been implementing various initiatives focused on gross margin improvements, which are starting to yield results. Additionally, I want to commend the Fuze team for successfully aligning their gross margins with our cost structures more quickly than we initially anticipated. Overall, this is due to several factors, including our internal programs and the swift progression of Fuze towards our margin goals.

Okay. Thanks for taking my questions.

Thank you. The next question is from the line of James Breen with William Blair. You may proceed.

Thanks for taking the questions. Have you seen any change in the sales environment given sort of the fits and starts of COVID? Has it changed sort of how the markets come together?

This is Dave Sipes. We are concentrating on the Enterprise segment and are observing typical deal cycles, similar to what we experienced before COVID, as customers decide to transition from legacy solutions to the cloud and identify the appropriate integrations I mentioned earlier, particularly with Microsoft Teams messaging apps and their communication platforms. I would say that deal cycles appear to align with pre-COVID timelines, generally falling within the nine to twelve-month range for enterprise accounts, and we are noticing a normal progression in these deals.

And then maybe just for Sam, from a model perspective, there was a pretty good jump up in G&A on a sequential basis. How do you think about that in terms of synergies and trying to take from the Fuze deal?

I wanted to emphasize that in the previous call, I acknowledged a mistake I made regarding the per line guidance last quarter. We didn't get some classifications correct. First, you will likely see some reclassifications of G&A into R&D and sales and marketing, aligning more closely with our initial expectations. Secondly, it will take some time to realign certain G&A costs. For instance, we need to complete the 2021 audit at Fuze, among other things, which requires time. Overall, it's a mix of reclassification and longer-term cost savings that I've mentioned before.

Great. Thanks.

Thank you, Mr. Breen. The next question is from the line of Will Power with Baird. You may proceed.

Hey guys, this is Charlie Erlikh on for Will. Thanks for taking the question. Sam, I just wanted to ask about the free cash flow. It was a strong number in the quarter. How should we think about that for the rest of the year? Should we think about it growing off of the Q4 levels, or how should we think about that?

We'd like to see it continue to grow. As Dave mentioned, we are very focused. Right now, we're a little bit more biased to margin, which means we're a little bit more biased to generating free cash flow. There are some non-GAAP reconciling items that will flow through on cash flow that will influence a little bit. So, it won't be a purely highly correlated thing to non-GAAP operating margins, but it will be pretty darn close. Since we expect non-GAAP operating margins to exit above three, that's our target, and we'd like to see cash flow grow throughout the year.

Awesome, thanks. Can you explain the unit economics of Microsoft Teams compared to a direct sale of the 8x8 platform? Is there a difference in revenue or profit? Additionally, could you provide details about the size of that business, such as the percentage of new customers from Teams during the quarter? That information would be very helpful. Thank you.

Let me discuss the economics of Voice for Teams. Generally, the average selling price is lower because Microsoft Teams manages the chat and video aspects while we manage the voice component. However, we designed the SKUs to maintain margins that align with the rest of our business. Since we are primarily selling to larger enterprises, the volume of the deals we are closing compensates for this. We did not report the number of new customers on this call, but I will consider that for future calls. In the last call, we indicated a 40% quarter-on-quarter growth in CCaaS, and we continue to observe strong growth in CCaaS related to Teams. I will leave you with that information and promise to provide a more concrete answer next time.

Great. That’s helpful. Thanks, Sam.

Thank you.

Thank you. The next question is from the line of Ryan Koontz with Needham and Co. You may proceed.

I think the question, Sam you can give us on the other revenue line in terms of margins there on professional services and supply chain how to think about that going forward? Thanks.

Okay. There are two points to address. First, as I mentioned earlier, aligning costs with Fuze requires a longer-term perspective. Other revenue is one of the areas impacted by this. When we acquired Fuze, we had to maintain all their ongoing deployments, which resulted in a large professional services team that we have built. Over time, we will adjust that team to better fit our needs. I'm not indicating any drastic changes, just that we will optimize resource allocation to fully utilize the team, currently focused on completing deployments for Fuze customers. On the hardware front, it's quite challenging right now. At the beginning and middle of the quarter, we experienced a slight easing in the supply chain, but it tightened again towards the end of the quarter. This supply chain situation is tough; when revenues drop, our costs remain relatively fixed. Although that may sound unusual, it's true that the number of people involved in that area doesn't fluctuate much. This leads to decreased margins, and when revenues rise, we can achieve some economies of scale. Overall, the other revenue segment is challenging, and while we are paying attention to it, I believe you will see margin improvements in the long term.

Got it. Thanks, Sam.

Thank you.

Thank you. The next question is from the line of Matt VanVliet with BTIG. You may proceed.

Hey, good afternoon. Thanks for taking my question. I wanted to look at the CPaaS business a little closer and just kind of see where you're seeing the most traction? And if you're finding some of your existing maybe X Series customers looking at adding some of those capabilities and maybe even kind of net new use cases that are popping up across the system. Thanks.

Yes. So, CPaaS tends to be Southeast Asia for us and some in Europe. Countries in Singapore, Indonesia, Thailand, as well as our sales into European countries, mostly API-driven sales with some cross-sell customization onto contact center sales that are looking to do primarily SMS customizations into contact centers for call and text campaigns. That's where we see that integrated or synergy with our XCaaS business.

All right. Wonderful. And then as you look at the contact center market as a whole, how are you seeing in terms of pricing trends and the ability to continue to cross-sell to existing customers that may be just now getting around to migrating legacy contact centers to the cloud?

Yes. Obviously, we're having a lot of success there with XCaaS continuing to grow robustly with 35% growth and now 35% of our ARR. We are putting a lot of innovation into that. You've seen things like our Agent Workspace and Conversation IQ, which takes traditional contact center features, such as speech analytics and quality management, and spread it across the whole organization really cool product allows more informal queues to have the ability for visibility for the supervisor to manage professionalism and unified approach to customers. So those are areas that we're seeing like I see both innovation driving growth. We see the marketplace already migrating in that direction. You hear about it, UC and CC attach across the whole industry, with other players in the market trying to replicate that strategy. I feel like we have a good lead in that area, and that's why we're working so hard on our innovation roadmap to continue lengthening that lead for us to get that XCaaS percentage up even higher.

All right. Wonderful. Thank you.

Thank you, Mr. VanVliet. There are no additional questions waiting in queue. This concludes our Q&A session as well as today's conference call. Thank you all for joining today, and enjoy the rest of your day.