Earnings Call Transcript
8X8 Inc /De/ (EGHT)
Earnings Call Transcript - EGHT Q4 2023
Operator, Operator
Good day, everyone, and thank you for joining us. Welcome to the Fourth Quarter 2023 8x8, Inc. Earnings Conference Call. At this time, I would like to hand it over to Ms. Kate Patterson. Ms. Patterson, you may proceed.
Kate Patterson, Moderator
Thank you, operator. Good afternoon, everyone. Today's agenda will include a review of our fourth quarter results with Sam Wilson, our Chief Executive Officer; and Kevin Kraus, our Chief Financial Officer. Following our prepared remarks, there will be a question-and-answer session. Before we get started, let me remind you that our discussion today includes forward-looking statements about our future financial performance including our increased focus on profitability and cash flow as well as our business, products and growth strategies. We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that may cause actual results to vary materially from forward-looking statements. As described in our risk factors in our report filed with the SEC, any forward-looking statements made on this call and in the presentation slides reflect our analysis as of today, and we have no plans or obligation to update them. Certain financial metrics that will be discussed on this call, together with year-over-year comparisons, in some cases, were not prepared in accordance with U.S. generally accepted accounting principles or GAAP. A reconciliation of these non-GAAP measures to the closest comparable GAAP measures is provided in our earnings release and earnings presentation slides, which are available on 8x8 Investor Relations website at investors.8x8.com. With that, I'll turn the call over to Sam.
Samuel Wilson, CEO
Much appreciated, Kate, and thank you for joining us today. Financial results reflect our company's ability to meet expectations and balance priorities. One year ago, we made the decision to turn our focus from near-term revenue growth towards expanded profitability and cash flow while continuing to invest in innovation for the future. Our fourth quarter and fiscal 2023 results are a reflection of these priorities. Let me walk you through the highlights of our performance. Service revenue growth was 2% in the fourth quarter as we anniversaried the Fuze acquisition and saw the expected year-over-year decline in CPaaS revenue. ARR mix continues to shift to enterprise customers with XCaaS deployments. Enterprise and XCaaS ARR were both up year-over-year with XCaaS increasing in the mid-teens percentage year-over-year. Furthermore, our CPaaS business was up quarter-on-quarter in the fourth quarter, a first step in the right direction. We invested more than $109 million in non-GAAP R&D in fiscal 2023, an increase of 42% from fiscal 2022 and nearly double what we spent in 2021. About 60% of the R&D spending is focused exclusively on innovations to drive revenue growth, including deep integration with AI technology across the platform, advanced analytics, UI/UX improvements, broad developer APIs, and other efforts to expand functionality. We invest the remaining 40% of R&D in our best-in-class communications platform to deliver the quality of service, high availability, and security our customers expect. This is much more than maintenance work. We see multiple opportunities to lead the industry forward in areas like platform flexibility, usability, simplified administration, self-service, accessibility, and anything that results in the greatest possible reliability. These advances are often delivered automatically through our modern cloud-based architecture. Despite the lack of fanfare, these micro innovations at the platform level are crucial to differentiating our solutions and maintaining our technology leadership. We increased efficiency in our operations, primarily in sales and marketing and the cost of service delivery, which more than offset the increase in R&D investment. We exited fiscal 2023 with non-GAAP operating income of 13.5%, well above our 10% guidance. This compares to operating margin of just 2% in the fourth quarter of 2022 and breakeven at the end of fiscal 2021. To put the magnitude of year-over-year improvements in real dollars, our non-GAAP operating income increased nearly 500% year-over-year for the fourth quarter and for the fiscal year. Looking at our performance on an annual basis, we generated more than $62 million in non-GAAP operating profits for FY '23. In fiscal 2020, just 3 years ago, we posted a non-GAAP operating loss of $61 million. Cash flows similarly improved. Fiscal 2023 cash from operations increased 41% year-over-year to $49 million, despite a $20 million increase in cash-based interest expense from fiscal 2022 to $22 million for fiscal '23. Our strong financial performance allowed us to accelerate debt repayment while maintaining a cash and investment balance in excess of $100 million. In the fourth quarter, we again repurchased debt. Kevin will provide the details. Turning to the future, we are planning to level out operating margins in the near term and continue to invest in R&D for the future. We will continue to use excess cash generated by our operations to deleverage our balance sheet and return value to shareholders. We intend to return at least $250 million to our investors over the next 3 years through debt retirement and, if possible, share repurchases. We have started down this path with the voluntary early $25 million debt repayment on our 2027 term loans we made earlier this week. This is a sign of management and the Board of Directors' confidence in our future. Speaking of which, I was surprised to hear a U.S.-based wholesale carrier report their voice traffic declined in Q1, which they attributed to softness in demand from leaders in the UCaaS Gartner Magic Quadrant. Let me caution you that the most logical read-through is not always accurate. Speaking purely from an 8x8 perspective, our overall UC and CC traffic has been increasing. We have built a global network of carriers and a super-efficient model for allocating traffic between carriers based on price, capacity, and quality. This quarter, we launched our customer-obsessed branding, which I approach in 3 lanes. First, we enable agile workforces. This means much more than simply extending voice service to a work-from-home user, although even basic voice delivered worldwide is extremely complex. Our solutions allow users the ability to move across devices and locations, toggling from chat to voice to video and back easily. We deliver these seamless capabilities through our 8x8 work app or through a seamless integration with Microsoft Teams. Across collaboration environments, our scalable, highly available communications platform reduces the administrative burden for IT departments, eliminates the need for multiple carrier contracts, and delivers the highest levels of security and data privacy. We have over 20 years' experience, and we own the platform, patents, and know-how. Second, we empower users across an organization to deliver great customer experiences. Surveys show that every interaction counts when it comes to customer loyalty. In a typical B2B or B2C organization, more than half of all customer engagements are with employees outside of the contact center. Our unified platform provides contact center functionality to these crossover users who typically outnumber contact center agents by about 5 to 1. This is a large and underserved market opportunity. We estimate it is at least twice the size of either the UC or CCaaS stand-alone, and we are uniquely capable of addressing it with our unified platform. Third, we harness the powers of AI and machine learning. Artificial intelligence and machine learning have catapulted into the public eye with ChatGPT, but 8x8 has been preparing for this moment, building our experience and talents back along this potentially evolutionary technology lead. We are pursuing an ecosystem path and have partnered with a number of players, including most of the companies in the leaders of various quadrants with Gartner. For example, this week, Converse360, a leading provider of automated customer journey across voice and digital channels released their integration with our contact center. Please check out the video on their website. We have a dozen more technology partnerships in development and the waiting list. This will continue to expand the capabilities of our platform in numerous directions. Lastly, we have brought some of the AI technologies in-house for common services, enabling our customers to tailor solutions to their specific use cases and offer a higher level of service at a lower cost. At our events at the NASDAQ market site in March, we introduced several important new products, including Intelligent Customer Assistant and supervisor workspace as well as a platform-wide integration of Open AI's generative AI solutions. Our spring software release announced at the end of April included additional enhancements to the platform, including deeper integration with Microsoft Dynamics 365 and Salesforce sales engagement. By rapidly growing investment in R&D, we are increasing the pace and the significance of our innovation cycles, particularly in the contact center. In January, we aligned our sales and marketing resources to better serve our target customers, businesses that deliver a tailored Fortune 100 experience via our customer experience without the dedicated IT developers or unlimited funds. With this increased focus, we are already seeing our retention, cross-sell, and new business win rates improve. We have included several case studies of fourth quarter wins in our earnings slides to illustrate how the unified platform enables our customers to serve their customers. One of our newest wins, Trajector, helps people who are underserved, at risk, or disabled receive the benefits they are medically, legally, and ethically qualified for from both government and private entities. Last October, Trajector began a small proof of concept with 8x8, testing our XCaaS platform with intelligent IVR and an integration with their Zoho CRM. They liked what they experienced: 8x8 uptime, our all-in-one XCaaS story, and our ability to integrate APIs. By March, they were ready to make a significant expansion with 8x8 substantially within the contact center to enhance customer experience. Personally, I'm excited to see 8x8 supporting Trajector because of their work helping veterans pursue VA benefits. As someone who had the privilege of serving in the United States Army, supporting our veterans is near and dear to my heart. We also showcased several other customer-obsessed organizations who are using the XCaaS platform to build innovative solutions. Jackson Lewis, a U.S.-based law firm with more than 950 attorneys worldwide focused on labor and employment law, wanted to move to a cloud-centered, single integrated CCaaS and UCaaS solution to provide performance-wide analytics and work out-of-the-box with Microsoft Teams and ServiceNow. They also needed open APIs to build an integration with their billing system. 8x8 will simplify administration for their IT organization and add contact center to their platform. Agilysys is one of the U.K.'s fastest-growing cloud and digital transformation specialists. Agilysys wanted to move to the cloud with an integrated CC and UC platform to support a hybrid workforce while using quality monitoring and speech and text analytics to gain better customer insights into the overall customer journey. As a participant in our early adopter program, they are adding 8x8 Intelligent Customer Assistant to further enhance the customer experience through the use of conversational AI and self-service technologies. Mayden, a healthcare company based in Bath, whose life work is creating digital technology that changes what's possible for medical professionals and patients, designs, builds, and supports insightful cloud-based systems for healthcare services in the U.K. and abroad, including iaptus, a SaaS patient management system for over 200 mental health providers in the U.K. and abroad, supporting over 1 million patients per year. One of the things I love about the native iaptus solution is that it uses 8x8 CPaaS video to allow healthcare clinicians to generate video links for appointments from the patient's iaptus record. This is then shared with the patient via text in an effortless workflow. We included a link in the slide to a video created if you want to see exactly how all this works. As these customers show, this is what we mean by communications for the customer-obsessed, omnichannel, data-driven, AI-enabled, and only possible with a scalable, global, highly available communications platform that spans the organization. We want XCaaS to be the standard toolset for the customer-obsessed communications. Our business starts and ends with great people. We are coalescing behind a nimble, efficient teamwork orientation. The vision and road map we developed this year are resonating with our customers and partners. I also want to note that most of our wins have come through our go-to-market partners, which is a strategy we have embraced and are looking forward to strengthening. In summary, we have a lot of work ahead, but we have a plan. Thanks to 8x8's phenomenal employees, partners, and customers, we have a large installed base. We own core technologies and we plan to spend over $100 million a year annually in R&D for future development. All of this in a large and vibrant market. It is up to us to execute, and as our financial performance for the quarter highlights, we know how to do that. With that, I turn the call over to Kevin.
Kevin Kraus, CFO
Thanks, Sam, and good afternoon, everyone. We remain financially disciplined and delivered solid revenue in the fiscal fourth quarter, exceeding our guidance range for non-GAAP operating margin and our expectations for operating cash flow for the fourth quarter and for the full year. We have now delivered positive cash flow and non-GAAP operating income for 9 consecutive quarters. Total revenue for the quarter was $184.5 million, and service revenue was $176.6 million, both increasing 2% year-over-year and within our guidance range. Our revenue performance reflected strong customer retention and renewals partially offset by a year-over-year decline in our CPaaS business in the Asia Pacific region as expected. However, revenue from our CPaaS business modestly increased sequentially from Q3 '23. Other revenue for the quarter was approximately $8 million, about $600,000 below the prior quarter driven by lower physical device shipments. We have seen a trend to increase use of soft phones versus desktop hardware over the last two quarters. It is still not apparent if this is a permanent or temporary change, but our guidance assumes this trend will continue throughout fiscal 2024. Fuze accounted for $26.7 million of service revenue and $26.9 million of total revenue in Q4. Fuze's performance remains strong, and the business continues to outperform our initial expectations. Please note, as stated on our previous earnings call, Q4 will be the last quarter we will provide separate Fuze revenue as the 1-year anniversary of this acquisition has passed and the businesses are now integrated. We have started upgrading Fuze customers to the 8x8 platform, making legacy Fuze revenue less relevant. As we mentioned in our previous earnings call, we continue to review our metrics to provide enhanced insight into business trends. In that vein, I would like to share the annual usage numbers in our service revenue, so you can understand the underlying growth rate of our contracted recurring service revenue. Our usage revenue, which is primarily CPaaS but also includes a small amount of UCaaS and CCaaS revenue, was approximately 17% and 11% of total service revenue in fiscal years 2022 and 2023, respectively. This means that the underlying contracted recurring service revenue growth rate was approximately 26% in fiscal 2023 and approximately 9%, excluding Fuze. Strong retention across the customer base was reflected in our RPO and ARR metrics. Remaining performance obligation was approximately $775 million for the quarter, up from $750 million in the third quarter on solid bookings performance. 8x8 customer retention was the highest it has been in 4 years. Total ARR was $703 million at quarter end, up 2% year-over-year, reflecting the anniversary of the Fuze acquisition plus CPaaS headwinds Sam mentioned earlier. Excluding usage, our total ARR grew approximately 5% year-over-year. ARR enterprise customers accounted for 58% of total ARR, and enterprise ARR was up 3% year-over-year and approximately $5 million sequentially. Usage increased slightly on a sequential basis but with still a significant headwind to the year-over-year growth in the enterprise segment. Turning to gross margin, operating expenses, and operating profit. Please remember that all items discussed are non-GAAP unless otherwise noted. Service revenue gross margin came in at 75.3%, more than 300 basis points higher than Q4 '22. We continuously focus on managing our costs and expect service margins to remain healthy. Other revenue gross margin came in at positive 8.6% for the quarter compared to negative 44.6% in Q4 '22 and negative 1.4% in Q3 '23. Other revenue gross margin has shown consistent improvement over the past several quarters due to a combination of increased efficiency in our professional services organization, better product margins on physical endpoint devices, and a more favorable mix of endpoints shift. Overall, fourth quarter gross margin was 72.5%, an increase of 580 basis points year-over-year and up approximately 40 basis points sequentially. For the fiscal fourth quarter of 2023, gross profit dollars grew approximately 11% year-over-year, significantly higher than overall revenue growth as we focused on improving the profitability of our highest value products and services. Turning to operating expenses. R&D was 15.4% of revenue, slightly above our 15% target due to a seasonal increase in employee-related expenses at the beginning of the calendar year. We improved sales and marketing leverage as we realign costs in the second half of the fiscal year. Sales and marketing expenses were down $7.5 million sequentially and $11.8 million from Q4 '22 as we realize synergies from the integration of Fuze and 8x8 sales and marketing organizations and realigned our resources to focus on our target markets. G&A was approximately flat sequentially and down about $800,000 from the fourth quarter of 2022. As a percentage of revenue, it was 11.4%. We are committed to improving G&A efficiencies over time as we operationalize more automation in our back-office processes. Total non-GAAP spending as measured by COGS plus R&D, plus sales and marketing plus G&A, was down approximately 10% year-over-year and reflective of our recent strategic cost realignment efforts. The combination of improved gross margins and lower sales and marketing expenses resulted in non-GAAP operating profit of $24.8 million, up almost 500% year-over-year and up 35% sequentially. We achieved a 13.5% operating margin in Q4 versus our 10% guidance. Full year non-GAAP operating profit was $62.3 million and up nearly 500% year-over-year. Cash from operations was nearly $14 million for the quarter, about $2 million lower than fiscal Q3 primarily due to higher cash interest payments as cash interest expense was over $4 million more in the fourth quarter compared to Q3 as we paid the semiannual coupon on the convertible notes in addition to the quarterly interest payments on our term loan. Customer collections remained robust in Q4. As noted earlier, cash flows from operating activities have been positive for 9 consecutive quarters and were approximately $49 million in fiscal 2023, an increase of 41% from fiscal 2022, even though we made approximately $20 million more in interest payments in 2023. Reducing our interest expense by using excess cash to reduce the principal amount of the term loan has a significant and immediate impact on our operating cash flow, and it is our intention to use excess cash to reduce the principal outstanding as quickly as possible while maintaining cash and investments at or above $100 million. Turning to the balance sheet. Total cash, cash equivalents, and restricted cash ended the fourth quarter at approximately $139 million, approximately $7 million higher than last quarter despite consuming $4.7 million in cash to prepay $5 million of aggregate principal amount of our 2024 convertible senior notes and paying higher cash interest expense, as noted earlier. There is approximately $63 million of aggregate principal value of 2024 convertible senior notes remaining, which is now shown as a current liability on the balance sheet. Given our current cash balance and expected future cash flows, we see no issues with repaying the remaining 2024 convertible notes with cash when they mature in February 2024. Going forward, we expect to generate positive cash flow, and we intend to use the excess cash generated to prepay our 2027 term loan. As Sam stated earlier, this week, we prepaid $25 million of principal on our term loan with no prepayment penalty. Including this prepayment, we have reduced the principal amount of debt outstanding by a total of $58 million, more than 10% of total outstanding debt since August 2022. Our continued progress deleveraging the balance sheet will reduce our interest expense and will apportion more of our enterprise value to our stockholders. Before turning to guidance, I want to emphasize our ongoing commitment to building a sustainable and profitable growth business. The strategic cost realignment activities executed in the second half of fiscal 2023 enabled us to maintain a substantial investment in product innovation and in our channel go-to-market model while delivering strong operating results. For forward modeling, we assume no revenue from the new contact center products we announced at our March event in New York. Even though these products have been released through our early adopter program and customer feedback has been positive so far, we are taking a conservative approach as we build and close the pipeline. As I noted earlier, we have exceeded our profit targets for fiscal 2023 on improved operating efficiency and greater focus on our target customers, and we expect solid profitability to continue throughout fiscal 2024. At a high level, we anticipate gross margin to remain fairly consistent with Q4 '23. We expect to continue to drive some incremental COGS efficiencies in our service revenue, and we expect gross margin on other revenue in the negative mid-single digits. For operating expenses, we plan to continue making the appropriate level of investment in sales and marketing and expect sales and marketing to be in the range of 33% to 34% of revenue throughout fiscal 2024, down from 36% in fiscal 2023. We plan to focus our R&D efforts on continued product innovation and expect R&D as a percentage of revenue to remain about 15% as we continue on the path of investment in our customer-focused product strategy, which emphasizes contact center. We are focused on extracting more leverage from our G&A functions over time as we work to improve operating efficiencies in those areas. We are establishing guidance for the first quarter of fiscal 2024, ending June 30, 2023, as follows: we anticipate service revenue to be in the range of $178.5 million to $180.5 million, up $3 million sequentially from Q4 at the midpoint and representing approximately flat year-over-year growth at the midpoint as we still have a challenging comparison for CPaaS. We anticipate total revenue to be in the range of $186 million to $188 million, up $2.5 million sequentially at the midpoint and representing approximately flat year-over-year growth at the midpoint. We expect other revenue to be approximately flat compared to Q4 '23 as we are assuming that our endpoint shipments will remain at recent lower levels. We anticipate gross margin to be roughly flat with Q4 2023. We are targeting an operating margin between 12.5% and 13% as we have fully realized the operating efficiencies resulting from our second-half 2023 strategic cost realignment actions, and Q4 '23 included some nonrecurring expense benefits in the range of $1 million to $2 million. We expect cash flow from operations to be positive but down sequentially as we pay our semiannual bonus in Q1 '24. We anticipate interest expense of approximately $9 million and cash interest payments of approximately $7 million. Note that these amounts can change as our term loan is subject to monthly interest rate adjustments. We estimate a fully diluted share count of approximately 120 million shares. We are establishing guidance for fiscal 2024 ending March 31, 2024, as follows: we anticipate service revenue to be in the range of $725 million to $732 million, representing between 2% and 3% growth year-over-year and consistent with the low single-digit growth rate articulated in our prior earnings call. We continue to be cautious regarding our CPaaS business, although that business did stabilize in Q4 '23. Please note that this full-year guidance assumes a higher year-over-year growth rate for the second half of the year versus the first half as we expect an improving revenue trajectory throughout fiscal 2024. We anticipate total revenue to be in the range of $755 million to $763 million, representing approximately 2% year-over-year growth at the midpoint. As noted earlier, we have reduced our product revenue expectations by approximately $4 million for the year relative to earlier expectations as our customers appear to be opting for more soft phones. This has an impact on total revenue growth expectations. Similar to service revenue growth rates, we expect total revenue growth rates on a year-over-year basis to be higher in the second half of fiscal 2024. We anticipate gross margin to be between 72% and 73%. We continue to focus on delivering a solid operating margin and anticipate achieving roughly 12% to 13% for the year versus the 8.4% achieved in fiscal 2023. This operating margin guide is slightly higher than the 11.5% to 12.5% directional color we provided in last quarter's earnings call. Please note that we have changed our compensation structure to focus on higher cash and lower equity-based pay for the majority of our people. We believe this change, which reduces the impact of market fluctuations on employees' income, will help us attract and retain talent in a competitive market. All employees still have the opportunity for equity ownership through our employee stock purchase plan, but this will reduce stock-based compensation and shareholder dilution over time. This is why our full-year guidance range for operating margin is slightly below Q1 guidance. We expect cash flow from operating activities to be directionally aligned with the non-GAAP operating profit trend subject to timing differences in collections and other payables. We anticipate debt interest expense and cash paid for debt interest of $35 million to $36 million, again, noting that our term loan is subject to monthly interest rate adjustments. We estimate fully diluted share count growth averaging approximately 2 million shares per quarter throughout fiscal 2024. In closing, I continue to believe that our ongoing focus on operating margin and cash flow is the correct strategy for us at this time. This strategy enables us to remain an innovation-led company as we fund investments in key product areas. I would like to personally thank the entire 8x8 team for working together to execute our profitability enhancements, which enabled us to increase our non-GAAP operating margin earlier than anticipated. I'm looking forward to the continued execution of our strategy to capture more of the contact center market to delight our customers and to deliver on our commitment to solid profitability and cash flow generation. Operator, we are ready for questions.
Operator, Operator
Our first question or comment comes from Matthew VanVliet from BTIG.
Matthew VanVliet, Analyst
I guess, Sam, as you look at the overall trends you're laying out for the year, it seems like enterprise will continue to march a little bit higher, although the enterprise logo count did decline quarter-over-quarter. So wonder if you could just sort of connect for us what levels of churn you're seeing? And then what levels of sort of net new business you're assuming coming in? And how much you think is sort of purely attributable to the macro versus other factors that you're seeing in the market?
Samuel Wilson, CEO
Thank you, Matt. To address your question, we do anticipate continued growth in the Enterprise sector. We expect that as our new products, currently in beta, start to launch, we will see revenue acceleration in the latter half of the year. This aspect is our primary focus. Currently, we have not incorporated this into our financial model, as Kevin tends to be cautious, which I appreciate. However, we are optimistic about observing this growth, particularly within the Enterprise segment since, as mentioned, most of our innovations are centered around the contact center. Regarding the macro environment and the dynamics between new logos and our existing installed base, our retention rates remain very high, which is encouraging. While we have observed a slight decline in new logo acquisition, I am uncertain if this is due to macroeconomic factors or a shift toward on-premise solutions. We have adjusted our model to reflect this change, so I am not overly concerned. My focus is more on our strong retention rates. The macro conditions will fluctuate, but I believe that as the economy improves, we will likely see an uptick in new logos. Additionally, as our new products move out of beta and become generally available, we should also experience increased new logo growth.
Matthew VanVliet, Analyst
All right. Very helpful. And then when you look at the R&D spend, obviously, getting to a more flattish mix of revenue as you gain more leverage there and have a number of new products in the market. How should we think about that rate, though, on maybe a 5-year horizon? Is it getting to the point where maybe similar dollar levels will be spent and that as the top line grows, you see leverage there? Or are there projects that are on sort of the tail end on the innovations side, whether it's some of these new contact center products or integrating AI that will give maybe incremental leverage over the top than just top line growth as we look ahead?
Samuel Wilson, CEO
So Matt, let me address your question. I would really like to see our research and development turn into revenue growth, and I plan to keep increasing our spending on R&D. I anticipate spending around 15%, with some variation based on different factors each quarter. As our revenues grow, I want to continue expanding our R&D. The reason for this is that I don’t see R&D as a way to create leverage in the next five years. The contact center market presents a $220 billion opportunity for us to pursue. The shift towards improved customer experience and retention has only just begun in the past couple of years. I see immense possibilities for adding value to enterprise customers, and I aim to pursue all those opportunities. That said, I believe we can achieve continued leverage in sales and marketing, general and administrative expenses, and gross margins over time. I’m not suggesting to the market that I intend to reduce my operational margins. I just want to emphasize that I expect to gain leverage in those other areas while continuing to invest in R&D and grow revenues through innovation.
Operator, Operator
Our next question or comment comes from the line of Ryan MacWilliams from Barclays.
Unknown Analyst, Analyst
This is Damon sitting in for Ryan MacWilliams. Good to see that UC and CC traffic is increasing, can you provide any insight on how your renewals are in the first quarter compared to the fourth quarter? And have you seen any changes in these customer renewals as a result of macro?
Samuel Wilson, CEO
Okay. Kevin can provide more details. I want to be careful how I answer this since you use calendar quarters, and I’ll refer to my fiscal quarter, which ended on March 31. We achieved record high retention rates. The data we have from Fuze and the past 4 to 5 years shows we have the highest retention rate. Our retention rates are even better than they were before the pandemic, which gives me great confidence. Kevin, do you have anything to add?
Kevin Kraus, CFO
Yes, I'd just emphasize that. And I think we're seeing a lot of that improvement in the customer retention rates because we are making the right amount of investment in our customer success organization. So we're seeing that play through in customer retention. So good ROI on that investment.
Samuel Wilson, CEO
All right. So I'll add maybe one more thing. Our collections and our DSO were absolutely fantastic. So not only are we seeing high retention, our collections, our aged receivables, our credit card default rates, all of the things that you would expect to see that could be leading indicators to retention, all remain at just pristine levels right now. So knock on wood because I'm always nervous about that stuff, but all the leading signs we see around retention are also good.
Unknown Analyst, Analyst
Got it. Perfect. And then could you provide some insight into the linearity of operating margins over the course of fiscal year '23? Just wanted to try to understand what's factored into the 12.5 to 13 1Q guide versus the 12 to 13 fiscal year '23 guide?
Kevin Kraus, CFO
Sure. Typically, the expenses vary each quarter based on the calendar. You usually see more expense pressure in the January through March quarter, our Q4, because in the U.S., employer taxes for FICA restart along with the 401(k) match at the beginning of the calendar year. Then, starting in Q2 around July, we implement our annual merit increases. Typically, you would notice an increase in operating expenses during that quarter, which then levels off later in the year as employer taxes and similar costs gradually decrease. This outlines the general seasonality we'd observe in our profit and loss statement. There are additional factors in sales and marketing related to industry conferences and trade shows we participate in, but that sums up our expense seasonality.
Operator, Operator
Our next question or comment comes from the line of Siti Panigrahi from Mizuho.
Sitikantha Panigrahi, Analyst
Very impressive margin expansion I understand you're benefiting from some of the restructuring or headcount reduction earlier. But as we look forward, I know you talked about you're going to spend on R&D, but what other initiatives you are taking that we can expect sustainable margin expansion going forward?
Kevin Kraus, CFO
So on the gross margin side, we're continuously looking at our COGS costs, the carrier costs, and bandwidth and things like that. And we've got a great underlying program of looking at various carriers to get the best rates, the best quality, etc. So that's a continuous process within the company for us on the gross margin side. On the OpEx side, I mentioned in my prepared remarks that we're continuously looking at automation of back-office processes sales and marketing. We're doing some interesting and innovative things there with lead generation efficiencies and conversion rate improvements from lead generation to convert it into an order. So there's constant improvement going on in those areas that we would generally refer to as efficiency to keep our operating margins at a flat or upward trajectory over time.
Sitikantha Panigrahi, Analyst
That's great color. And then, Sam, we keep hearing about small businesses in this environment, not ready to commit to any investment kind of thing. So what are you hearing in your different segments, small to mid-market and enterprise segments?
Samuel Wilson, CEO
I think the small business segment, look, as I mentioned earlier, our credit card default rates and those kinds of things that we would look at because small business is more likely to be on a credit card are all fine. So I think in general, small businesses are relatively healthy. That being said, I do think there are economic headwinds. I mean, I can read the news as much as you guys can. So I do think there are some economic headwinds. And so I do think there’s some reluctance to invest in that segment. I would also say that we're reluctant to invest in that segment. So that's the second factor. I mean, we've reduced our digital marketing spends and those kinds of things that drives that segment. I think in that enterprise side, you definitely see digital transformation, continued movement from on-prem to cloud. As I've mentioned at the NASDAQ market site and in other places recently, I mean, everybody is talking about AI technologies and the effects it can have on the contact center. We obviously have opened up our platform. We announced Converse360 this week on our platform, and other leading AI vendors are integrating with our contact center platform. So I think that's a big opportunity for us to bring best-in-class AI solutions to market for our customers to go after the opportunities around customer retention and the overall labor market around contact center.
Operator, Operator
Our next question or comment comes from the line of Meta Marshall from Morgan Stanley. Mr. Marshall, your line is open.
Meta Marshall, Analyst
I have a question. Do you believe your pipeline remains strong but with longer deal cycles, or are you noticing any changes to the pipeline? Additionally, regarding your R&D budget of over $100 million, how do you decide how much to allocate to internal development versus collaborating with partners while focusing on core competencies?
Samuel Wilson, CEO
Thanks, Meta. So first, on your pipeline question, look, our pipeline numbers be planned for the quarter, so that's always a positive. So that bodes well, I think, for the future and potentially getting the revenues to reaccelerate a little bit more from an organic side from 0% to 2% sequentially that they did so we can do better, and the pipeline suggests we are. Obviously, there's timing. So as we go through this transition from small business to enterprise, small businesses can close deals in 30 to 45 days versus 6 to 12 months for a larger enterprise deal. And we are closing TCV deals over $1 million. Actually, it's not total contract value, more than $1 million in ARR per year from customers. I mean, they're like $5 million TCV deals. So those just take time. And so we are in the midst of a bit of that transition.
Kevin Kraus, CFO
I apologize for interjecting. I also want to emphasize that we are concentrating on the highest quality pipeline, as we believe this will significantly improve our close rates.
Samuel Wilson, CEO
All right. Regarding internal versus external R&D, that's a very insightful question. Sand Hill Road and the venture capital communities have allocated about $130 billion to different segments in the contact center space, based on various third-party analyses. In areas where significant funding has been dedicated, it may be unwise for a company to develop those technologies in-house. Some of my competitors are attempting this, but I think they'll struggle against the specialists, and we aim to collaborate with those specialists. For instance, with chatbots, there are around 400 to 500 different vendors identified by Gartner, and we want to partner with all of them instead of creating our own chatbot solution. The key areas we need to maintain in-house are omnichannel, UI/UX, data and analytics, which ensure the bot operates properly and produces useful outputs, as well as intelligent routing. These are crucial workflow components for us. We provide excellent capabilities for this ecosystem of venture-funded companies to leverage. For example, with Converse360, Cognigy, and other chatbot vendors, we can forward a chat case to a bot. If the bot fails to respond correctly, we can retrieve that case and escalate it to a live agent, including all prior information. This means if you've verified your identity or answered initial questions, you won't have to repeat yourself, and all associated metadata is shared with the live agent. This can also enhance an agent assist model from another vendor. These advanced technologies offer significant advantages to the ecosystem. Therefore, we will invest in areas where we need to own aspects such as case management, routing, and channels.
Operator, Operator
Our next question or comment comes from the line of George Sutton from Craig Hallum.
George Sutton, Analyst
So your retention, your cross-sell, and your win rates have all begun to improve. I'm curious if you can give us an extent and kind of a timeframe to that.
Samuel Wilson, CEO
Well, those are all based on last quarter. So last quarter, quarter-on-quarter, we saw retention better quarter-on-quarter. We saw the amount of sales to our installed base relative to what we've done in the past, better. In particular, one of the things that I mentioned last quarter that we have not done exceptionally well on that we're starting to get some traction around is cross-selling our contact center to UC-only customers. And then overall, our win rates are improving. That's driven by, I think, innovation, right? So you're seeing the first signs, and they're very preliminary signs, George. I don't want to overstate these, right? They're very preliminary signs. But quarter-on-quarter, on those 3 key metrics, we saw improvement.
George Sutton, Analyst
Got you. So I know that CPaaS has caused you great angst for some time, and it has now started to stabilize. I wondered if you can just tell us why has it stabilized? What are you doing to try to get it to actually see some growth?
Samuel Wilson, CEO
All right. So I would say, first and foremost, we have a new General Manager there. He's phenomenal, and he's really rallied the team. He's made some changes to various people, objectives, structure, leadership, all those kinds of things. But at the core, leadership matters, and we have a great new leader running our CPaaS business, and I think that's the first big step. And he's really focused on the right things and getting the right direction on a very tactical day-to-day basis. Taking a step back, we're in a good position with our CPaaS business, and I'll just loosely refer to it as the Wavecell business or the CPaaS business. It's got brand recognition in Southeast Asia. It's got market presence. It's got competitive pricing advantages and it's got great technology underneath it. It just needed to focus in those key areas and bring it to bear for more success. And I think that we're starting to see the benefits of having a new leader. It's in the 3, 4-month mark now, but I'm already seeing tangible benefits, including the stabilization of revenue. His next objective now is to grow the revenue.
Operator, Operator
Our next question or comment comes from the line of Catharine Trebnick from Rosenblatt.
Catharine Trebnick, Analyst
Sam, can you give us more detail around Microsoft Teams? You said it grew 100% year-over-year. But can you punch in on where you're seeing that you're successful versus some of your competitors who are also saying that they're very successful doing Microsoft Teams integration?
Samuel Wilson, CEO
Yes, I've heard some of my competitors claim similar growth rates. However, I've been achieving those growth rates for a significantly longer period, resulting in a much larger customer base. This is largely due to our strategy of early investment and collaboration with Microsoft rather than positioning ourselves adversarially against them. Our key approach is to partner with Microsoft without trying to develop solutions that intentionally bypass E5 licenses or create friction with the channel. A significant advantage for us, highlighted in the investor relations deck, is our leading Microsoft Teams customer base operating seamlessly across 35 countries, which I believe no one else can claim. Running this through Operator Connect would require managing six different carriers, contracts, setups, and issues. We manage direct routing across 35 countries effortlessly, and this customer serves as an excellent reference for further major Microsoft Teams successes. Our growth is ongoing. Will we maintain a 100% growth rate indefinitely? No, the law of large numbers will catch up eventually, but for now, our growth remains robust. We've made early and aggressive investments in Teams, and many more opportunities lie ahead. The next significant step is to enhance our go-to-market strategy for Microsoft Teams, which will become evident in the coming quarters.
Operator, Operator
Our next question or comment comes from the line of William Power from RW Baird.
Unknown Analyst, Analyst
This is Yani Simonis on for Will. Just one question from us. So as we look to fiscal '24 revenue growth that you guided to, is one of the components of that. Does a lot of it come from XCaaS? Does more of it come from CPaaS? Any broader trends you could hit on there would be great.
Kevin Kraus, CFO
Yes, we are primarily focused on XCaaS. There is a small amount of growth in CPaaS expected in the latter half of the year, but our main emphasis is on our ideal customer profile and enterprise customers in the contact center space.
Samuel Wilson, CEO
I'll add a bit of detail. There are a couple of factors to consider. We expect to see continued slow or no growth in our small business sector, while enterprise growth should remain strong. This shift towards higher-value enterprise customers should lead to improved retention rates. Additionally, while Kevin is being conservative, it's important to note that our current model does not account for new products, as most are still in beta or set to launch next quarter. We prefer to avoid being overly optimistic about potential uplifts from new products throughout this year.
Operator, Operator
Our next question or comment comes from the line of Peter Levine from Evercore.
Peter Levine, Analyst
Maybe the first one, Sam, is what's your level of confidence that you could see revenue accelerate here in the second half of your fiscal year? Like what has to go right? And then what do you think could go wrong for that not to play out?
Samuel Wilson, CEO
You're not going to start with a question that has 20 parts. I appreciate that, Peter. Thank you. So concerning 2% revenue growth, I would say just don't mess it up. I believe the plan is solid, and the conditions are favorable for accelerating revenue. How much that revenue acceleration will be, I'm not going to make any bold predictions on that. Kevin has a good handle on the numbers related to this. But my confidence level is high. What could go wrong? Honestly, the only major risk is if the U.S. Federal Reserve pushes the economy into a severe recession. We're witnessing banks fail and being sold at very low prices, which can create ripple effects affecting the confidence of CIOs who we sell to. When dealing with enterprises, especially those signing multi-year contracts, confidence is crucial. Our increasing RPO and ARR indicate further growth potential. The only thing that could disrupt this is a lack of confidence in making those investments.
Peter Levine, Analyst
And then if you think about all the process innovation, the investments on the R&D side, all the products that are coming out, how much of that is a function of retaining customers versus seeing like an ARPU uplift?
Samuel Wilson, CEO
Most of the 60% we're discussing is related to an increase in average revenue per user. The remaining 40% in research and development is primarily aimed at retention, among other factors. However, the distinction is not always clear-cut, as aspects such as high reliability and accessibility also contribute to generating new sales. That said, I would note that we receive very few requests from existing customers emphasizing, "You must do this or we'll leave." Typically, the requests we receive are more about suggestions for features that would be beneficial, and that is where much of our ecosystem development is focused.
Operator, Operator
Our next question or comment comes from the line of Imtiaz Koujalgi from Wedbush.
Imtiaz Koujalgi, Analyst
I have a question on pricing trends; can you comment on pricing trends for UCaaS and CCaaS, how is it for the quarter and what do you expect going forward?
Samuel Wilson, CEO
Yes. I would say UCaaS pricing was maybe a tad more aggressive this last quarter. It's always hard to tell in the first calendar quarter of the year. Maybe a little tad more aggressive, all at the low end, the midrange of UCaaS, I really didn't see much movement, but at the low end, and more of it's a function of Microsoft Teams Operator Connect solution. That's a relatively low feature, low-priced product. And as I've said many times, we're selling a lot of Microsoft Teams almost every time. In our Microsoft Teams, it's us versus a direct routing solution versus a Microsoft Teams generally a carrier with an Operator Connect solution. I don't see a lot of other traditional UCaaS vendors in those deals, and we do a lot of them. And so that's where I'm seeing a little bit at the low end. On the contact center side, I don't really see much pricing pressure there. I think the conversation at contact center is all about capabilities.
Imtiaz Koujalgi, Analyst
Got it. And one follow-up. The gap between your operating margin and free cash flow margin expanded a little bit in fiscal '23 or '22? How should we expect that to trend in '24? You gave us the guide for operating margin, any comments or color on what to expect for free cash flow margin?
Kevin Kraus, CFO
Yes. So the free cash flow margin will trend with the operating margin over the course of time. We do have various things that we'd say, there's some timing effects and so forth. But it's really the interest expense, things like that because we do have some interest expense that's paid semiannually and some that's paid quarterly, and that helps you with the timing. But we think that...
Samuel Wilson, CEO
And Kevin, I mean, the biggest difference between the two is interest, right? So as Kevin was able to do this week, he prepaid $25 million on our high-interest term loans. And so as we further pay off our term loans over time, our operating margin and our free cash margin should narrow significantly.
Operator, Operator
Our next question or comment comes from the line of Austin Williams from Wells Fargo.
Austin Williams, Analyst
This is Austin Williams on for Michael Turrin. I wanted to touch on the Fuze side. It looks like it was another really strong quarter for that business. Is there anything that you'd call out that's just making that perform better than expected?
Samuel Wilson, CEO
We love our Fuze customers. We love our Fuze customers. If you're listening, we love you. And we continue to sort of put them on a good path. We treat them as first-class citizens. We have a fantastic customer support operation that’s taking care of them. And I think we're showing them a good path for the future. And so the idea that people would just be able to come in and I heard all the rumors they're going to RFP and then other people are targeting them and all those kinds of things, I think just has to come to pass. Now that being said, I think we can do better on some of the cross-selling in particular. And so that's an area we're focusing on. But in terms of retention, we've done absolutely fantastic, and huge credit to the finance team and my customer support success teams around that. They've done an absolutely fantastic job on that.
Operator, Operator
Thank you. I'm showing no additional questions in the queue at this time. I'd like to turn the conference back over to management for any closing remarks.
Samuel Wilson, CEO
Thank you all for being here today. We will be attending several conferences in the next 30, 60, and 90 days. Kate will issue a press release detailing all the locations we will be visiting, so we hope to see you at one of the conferences. If you are unable to attend, please feel free to reach out to Kate Patterson in Investor Relations for any follow-up questions. Enjoy your Thursday.
Kevin Kraus, CFO
Thanks, everybody.
Operator, Operator
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful evening.