8x8, Inc. (EGHT) Earnings Call Transcript & Summary

Thank you, Sam. All right. It looks like we're audio's queued. Okay, we're on, we're live and ready to go. Thanks, everybody, for joining. Okay. Welcome back. We have got the financial breakout session here. I'm Kevin Kraus, CFO of 8x8. I'm here with Sam Wilson, our CEO; and Kate Patterson, who heads up our Investor Relations. I'll begin with a brief review of our financial performance and how it feeds our innovation engine. And then at the end of the session, I'll open it up to Q&A. For those of you listening online, you should have a box at the bottom of your screen, so you can submit a question if you have one. I'm going to read some safe harbor language here for you, so just bear with me. So before I begin, please note, we may make forward-looking statements during the course of today's discussion. These statements are predictions only, and actual events or results may differ materially depending on a number of factors. These factors include, but are not limited to, the risks and uncertainties listed on this slide. For a full discussion of risks and uncertainties that could cause our actual results to differ from our forward-looking statements, see the risk factor discussions in our 10-K and 10-Q filings. Also, the financial metrics we will be discussing are non-GAAP with the exception of revenue and operating cash flow. We have provided a reconciliation of our non-GAAP to GAAP metrics -- to the nearest GAAP equivalents in the appendix. Okay. So let's get started. Thanks, everybody, once again for joining. I would like to run through some key messages from today's sessions that most of you have probably heard already, those -- at least those of you who are here in-person, we address a large market opportunity. You heard from Sam earlier today that we have an $80 billion cost saving opportunity for the year. Gartner estimates that replacing human agents with AI chat box can save the call center labor market $80 billion annually by 2026. You've heard about our platform and product strategy, which involves leveraging a well-funded partner ecosystem. You heard that earlier from Sam as well, $100 billion investment in 1,000 companies. And so our continued investment of in-house innovation, combined with our partner ecosystem, will drive customer demand through improved product features and functionality. Our operating leverage will improve our non-GAAP operating income and cash flow, and that will enable us to delever our balance sheet. So this is the flywheel of our strategy to deliver value to our customers, partners, employees and shareholders. We've already improved our unit economics. We -- you know that we had a couple of actions that we did recently. We expect that unit economic improvements to continue throughout time. We have improved efficiency that enables us to continue investing in innovation. That part of the wheel, which -- and that innovation actually drove some of the product announcements that you heard today. And as we scale, the flywheel continues, and we generate more cash to delever and potentially buy back stock, and under the right circumstances, we can do acquisitions that are accretive to operating profit and cash flow, just like we did with Fuze. All right. So let's review the three value creation priorities that we have at the company. First, increased profitability and cash flow. Our approach is that OpEx increases based on revenue growth, right, not the other way around. We improved sales and marketing efficiency through go-to-market, channel leverage and ecosystem pull-through, and then the incremental gross margins may occur as we increase with scale. Second, use increased cash flow to reduce debt and moderate the dilution associated with equity-based compensation, so we'll talk about that later on. And then third, invest approximately 15% of revenue in R&D to drive durable long-term growth. We intend to expand the XCaaS platform to become a leading customer success platform for our small and midsized enterprise customers. So we look at increasing the value of the company over three time horizons, and they're overlapping time horizons. Horizon one, drive immediate profitability, which we already did. And we want to generate cash flow improvements while maintaining a target level of R&D that I just mentioned, 15%. The horizon two, continue using excess cash flow to reduce the term loan, and therefore, reduce interest payments, while continuing to cross-sell within our installed base, including Fuze. And then driving contact center led new logo deals, and that will include teams environments as well. And then -- we do expect some revenue growth in this time horizon. But as we experienced momentum in the XCaaS platform, it's somewhat offset with some headwinds from our small business customers, which we're not heavily investing in at this time. Horizon three, the flywheel is turning, reflecting high retention, cross-sell within our installed base, new customer logo acquisition, and then the headwinds from the small business decline in Horizon three. Okay. Now let's dig a bit deeper into each of these value creation priorities. So increased non-GAAP profitability and cash flow. So you can see we've had significant revenue growth in fiscal 2023 primarily driven by the Fuze acquisition. And this anniversaried in January of this calendar year. We focus on prioritizing profitable growth, and we do see signs of stabilization in CPaaS right now. We've hired a new leader in CPaaS. And then the resumption of revenue growth is still several quarters away, as I mentioned on the earlier slide when we talk about horizons two and three. We do expect our revenue mix to transition to customer segments with higher long-term value, which you'll see later in this presentation. So I want to highlight that we have a well-diversified revenue base. We have good geographic go-to-market and product segment characteristics. So let's talk about Fuze 1 year later. So recall, we acquired Fuze for the engineering and enterprise customer base, okay? So we've experienced better results from Fuze than we anticipated when we modeled the deal and consummated the transaction. We've improved COGS to be in-line with the rest of the organic 8x8. So it's a higher -- much better 8x8 COGS levels. Product maintenance costs are lower than anticipated when we looked at the company. And some of the product announcements you saw today were actually developed by Fuze engineers, for example, the Supervisor Workspace, which actually was highlighted in the earlier sessions. And again, as I just stated, we bought Fuze for the engineering team and the enterprise customers, and selling contact center into that installed base is still an opportunity for us. All right. Let's talk about gross margin improvement. So we've increased our gross margin by over 1,000 basis points over 3 years' time. And we did this through cost reduction initiatives, favorable mix and increased scale. So some of the gross margin improvement initiatives included reduced direct COGS like carrier costs. In public cloud, we improved efficiencies in customer support. We improved efficiencies in the professional services and deployment organizations as well. So the service and application gross margin, excluding CPaaS, is actually at best-in-class levels right now. So we have a cultural mindset of continuous improvement when it comes to gross margin. And as you can see, over the course of the recent years, we've really ramped up the gross -- the non-GAAP gross margin. Okay. Let's talk about operating leverage. So nearly all of our margin expansion, our op margin expansion has come at the gross margin level. Now what are we doing about the operating margin right now coming through OpEx. So we stated in the last earnings call that we were giving color on 400 to 500 basis point improvement from our year-ending 2023 operating margin. So how do we get there? About half of that is going to come from gross margin improvements. So more incremental gross margin improvements, about half is going to come from OpEx. Okay. We are going to continue our focus on sales and marketing efficiency. The recent cost reduction actions that we did in October and January were targeted, and we're expected to generate these efficiencies will show up in our operating profits in 2024. We're also focused on target customer segments and channel efficiencies. So we're very precise about how we approach sales and marketing expense, which I'll show later on in this presentation. The higher G&A that we're showing here is, we completed the Fuze acquisition. We had some back office integration. We had some onetime items associated with that. So that has spiked up our G&A as a percentage of revenue, but we expect that will come down as the business scales. We're certainly not -- we're targeting lower than what we're showing here. And then R&D, again, it's near our target we expect for 2023, it's near our target level of 15% of revenue. So we expect to maintain this level of R&D spending in 2024 as we continue to invest for innovation. So let's take a look at sales and marketing efficiency over time. So at the end of fiscal 2021, we began really increasing sales and marketing spend to drive growth. And we felt at the time, it seemed like the right thing to do because the market was assigning a much higher multiple to growth and profitability at the time. So as we began integrating Fuze, we decided to shift to a profitability and cash flow focus. So we changed our approach to sales and marketing spend. And so as a result, you can see that the sales and marketing spend has declined as a percentage of revenue fairly significantly and it's also declined in absolute dollars. So the other interesting note here is that for the fourth quarter, our expectation is that our sales and marketing costs will be in the same general range as the quarter we bought of the quarter prior to the purchase of Fuze and the revenue is approximately 20% higher. So we're really generating a lot of sales and marketing efficiencies in the business right now. Okay. One of my favorite slides, this increasing non-GAAP profitability. So our total revenue growth on a year-over-year basis has outpaced our total spending growth on a year-over-year basis every quarter since fiscal Q1 2021. And that's showing up in higher non-GAAP operating profit and operating margin. And our prioritization of profitability over revenue growth is amplified the turnaround, and we expect to show improvement in fiscal 2024 for the guidance we gave in the last earnings call for 2024. So this chart talks to the quality of our earnings. So you can see here operating cash flow in green, how that slipped since 2020, where we were in a negative position. The majority of our Op income translates into cash from Ops this fiscal year, adjusted for interest expense and other onetime items such as severance costs for our cost actions that we did. The new debt resulting from our debt refi that we did in August is generating the interest expense increase that you can see here. Now keep in mind, the increase in cash interest paid that's shown on this chart is primarily from our $250 million term loan. That was outstanding for about -- or will be outstanding for about 7.5 months of this fiscal year, it was mid-August. So going forward, you should expect roughly $8 million per quarter interest expense, plus minus $1 million or so depending on what interest rates do. Okay. The -- without this term debt, our cash would have been more aligned with non-GAAP Op income. So we do have this term loan, but the great thing about this term loan is we've got a tremendous amount of prepayment flexibility. So our objective is to pay this down with the excess cash, which I'll go through later. All right, let's take a closer look at debt reduction, and we also want to reduce the dilution from employee stock programs. So this is an indicative view of a debt payback schedule. Assuming a $1 billion constant -- $1 billion enterprise value from Q3 '23, so 100% chart. You can see as we reduce the debt load off our balance sheet over time, keeping the enterprise value constant, more value, more enterprise value accrues to the shareholders and debt holders. So this, at the end of the period here, only the $202 million of 2028 converts remain. And as our -- our plan here is to keep always at least $100 million of cash plus investment on the balance sheet at all times while we go through our debt paydown program. Here is an indication on employee stock program. So what we had done, in addition to creating value through debt paydown, where we're increasing value to shareholders by reducing dilution, we are moving nonexecutives to a cash-based comp plan -- the cash-based comp structure. And that's already embedded in the 2024 commentary that we gave in our last earnings call. So it's a headwind to non-GAAP operating margin and operating profit. But that's already built in there. We will continue to issue RSUs to executives in the company. All employees will still be able to participate in equity appreciation through the employee stock purchase plan. So with this program, you can see that, as a result, in fiscal 2024, we expect the number of RSU grants to significantly decline. And I think, actually, we're -- I think we're a thought leader in this area. We're making this transition carefully, and we are a thought leader in structuring competitive compensation programs that are less equity dependent. All right. So much of what we talked about so far in this presentation has been what we've done in the near term to improve shareholder value and drive profitability and cash flow. But we know that creating durable growth is the way to deliver long-term value. So we'll turn to a value creation priority, drive durable long-term growth through innovation and investment to meet the needs of our targeted customer base, which is small to medium enterprise customers. As I stated earlier, we have been shifting to market segments with higher long-term value. Small business is still a good business, generates good cash for us, but we want to expand our XCaaS platform to become the leading customer success platform for the small to midsized enterprise customers. And actually, you can see our strategy is already resonating because we -- the customer ARR is shifting more toward mid-market and enterprise customers. So that is already happening in our space. So enterprise customers have more than doubled in 3 years. This is with significant organic contact center attach rates. Now it's greater than 50%, including Fuze. But remember, Fuze is mostly UC only. Organically, 8x8, without Fuze, the attach rate of contact center in the enterprise space is more than 70%. So the ability to cross-sell the Fuze customer base with contact center is still the remaining opportunity -- that represents the remaining opportunity, as I mentioned before. So good thing there. Here is XCaaS increasing. It was less than 30% 3 years ago. It's about 40% now. It's growing over 30% CAGR. And again, this is XCaaS, so this is largely organic growth. When you add -- when we start cross-selling Fuze to the mix, this can start moving up once we cross-sell into contact center. So concluding this, we're already executing the strategy. We're delivering value to customers, partners, employees and shareholders. And today's product announcements represent the innovation that we're the innovation investment we're making to drive the growth. So let me open it up to Q&A here. And remember, those people who are on the web can submit a question on the web. I don't know, Kate, if you're monitoring it or it will show up here. Thank you very much.

[indiscernible].

No problem.

[indiscernible] So two, if I could, you mentioned expectation for attrition of the SMB customer as you focus less there, can you frame that for us a bit better? I mean, what is the expectation for churn attrition and some of the projections that you gave? And then second part here, I know you're doing things internally, but there are external factors that could also affect rates of revenue growth. So what is your expectation for the competitive environment and pricing pressure? What's baked into that forecast you laid out?

All right. I'll take the first part, and I'll let Kevin take the second part about the competition and pricing baked in the financial model. I don't know. I don't -- I guess I don't see it as that -- okay. Let me take a try to give you some answer I give it nuanced answer. So when we look at the SMB segment, we are not churning out the SMB customers. So if you think about an SMB customer, the LTV to CAC ratios are not as good as on an enterprise customer. The NRR numbers aren't as good. Like the overall life LTV of a small business customer just isn't as good as an enterprise customer. And so -- but however, we've already -- the CAC is already some cost. So what we're doing is we're just not filling up the funnel the way we used to. And the way we've done that is we've withdrawn demand generation spending and those kinds of things. We've reduced some sales capacity in those areas, right, et cetera, to try to make our CAC more efficient and just less. And then we'll naturally let the small business customers attrit. Now what can influence that tremendously is obviously economic stuff, right? So if the economy comes under tremendous pressure, obviously, small business mortality can increase slightly. But really, what we expect is we expect to lose sort of customers to business mortality and those kinds of things. They're happy customers. Our base is relatively happy, healthy. As we said recently, our retention rates are the highest they've been in years. So I don't really see an issue. I think it's just about the fact that if you look at any kind of traditional small business number you see, I don't know, it depends on how you look at Bureau of Labor statistics -- you guys, whatever, it's 9%, 10%, 11%, 12% kind of business mortality. And we're just now working on filling it in that quickly. And we're really driving it more for cash flow to fund debt repurchases and those kinds of things and all the things that Kevin talked about. So when I view the small business segment, I think the hard part and the thing that drives me nuts and Kevin nuts and all you guys nuts is, well, it's something that's hard to model on a 90-day basis, right? It can sometimes go a little all over the place. Obviously, during the pandemic, when I was CFO, I could see, when the government was putting subsidies in the system and when they weren't, we could see credit card default, rates changed very rapidly and those kinds of things. And so those types of things can cause a little bit of volatility. And you see it, right? You see, for example, our small business segment in ARR had negative growth for a couple of quarters, then it bounced positive. And we actually got a fair number of questions after the call like, "Oh my god, are you investing in that space? What's changed? And whatever," and we're like -- it's like minus 2 to plus 4. Like this is still -- this is kind of in the volatility band of nothing fundamentally really changing. So on the small business side, I would say it's just a lack of investment in keeping that funnel really robust because we just have better ROIs investing higher up.

But I will add to what Sam is saying about the investment. We've made consciously fairly significant investments over the last couple of years in our customer success organization. So while we're not maybe investing in funnel demand generation as much in the small business area, we certainly have invested in our customer success organization. So that has -- and this is across all customer segments in the company, and that's reflected in these retention rates that have been the best in years.

Before he dives into the competitive thing, one last thing I'll say though is, I'll tell you where it sucks. I mean I was believing, being really frank with the Wall Street community, right, is it expresses our revenue growth, right? So if I have a segment of my business that's generating a lot of cash, but it's growing zero when it's 24% segment, right, it becomes a boat anchor to this overall headline growth number.

[indiscernible].

Right. It becomes a boat anchor to the -- it's a drag on the overall -- and it's frequent -- it's interesting how frequently you guys like "Write it off, discontinue operation. No. Like it's really -- like it's got a lot of cash." It generates -- I mean these are won customers. We've already paid the channel spiffed -- odds and ends and all that other stuff, right? The number of support tickets we get from that base especially with all the MLAI stuff we've done, is really small. Like it's -- they're very profitable after they age, after the vintages age. It's just the cost to acquire. And that LTV is just -- it's not where it needs to be, compared to an enterprise customer. And you want to ask about pricing in the model and pricing and competition and these sorts of things.

Yes. I mean there -- I wouldn't say anything particularly specific. I mean the pricing come-- I mean that comes up at renewal time, right? So if you have deals that are 2, 3 years, we're not seeing a ton of that. Maybe if there's a new customer coming out in that segment that comes out, like, then maybe you can see some of the pressures. But I don't -- we don't have anything particularly baked in there.

[indiscernible].

We've modeled status quo, right? Zoom's already tried to be disruptive on the pricing front. I don't know maybe they'll decide to get more disruptive. And like, we'll have to deal with that accordingly. But there's a switching cost. And what I'm certainly not going to do is, I'm not going to raise to the bottom. Like I don't understand having 5 million seats in smaller ARR than we have. And like I just -- I don't understand shrinking the TAM. That makes no sense to me in logical business terms.

Can we take a question from -- we have a question that is, what is the relationship between 8x8 and OpenAI?

So they're an ecosystem partner/vendor to us. As we discussed today, we're using their Whisper technology. So the week that they made it available, we were already on the phone with them. In under 6 months, we have customers in production live, and we're getting better transcription results with lower costs than our previous transcription vendors.

[indiscernible]

It's fine. I'll repeat it.

I asked a question with OpenAI and the contract that you guys have with them and things of that nature. Like as you get more customers using the AI capabilities that you're looking to implement through OpenAI, is that a significant cost for you guys to add on to it? And like, is the contract itself with OpenAI significant?

Well, it's [ cheaper ] than what we're saying for transcription with better results. So right now, it's a cost savings. So let me take a second because having spent some time with the technologist on this topic on OpenAI, right? So right now, we're pulling the Whisper technology for transcription, right? So transcription is really core to our speech analytics, to agent assist and these kinds of things. It's like a core foundational technology. Some of our ecosystem partners are using ChatGPT 3.5 and 4.0 and as are we, inside of their products. So what's an example we're using it for? Call summary. So it doesn't have to be super technical, but if you can just feed a whole bunch of information to ChatGPT and get a 4-line summary, customer is happy. This was the core problem, et cetera, et cetera. These kinds of things and their [ future ] functionality capabilities, and they're not overly expensive compared to other technologies that we were using already in that area. Is there anything else? We're online?

From the web, we have a question here.

You guys are too nice. That was nice in person.

Okay. This is another question from our Internet viewers. So when you say less sales focus, Kevin, do you mean fewer direct salespeople and more channel or something else?

In the small business context?

I think I said that, to be fair.

Okay. Sam said that, if you would like to answer it, there's no context in the question.

Okay. So yes, we've reduced some sales capacity. One of the actions we took, we reduced sales capacity that small business level. We've also moved some of the sales capacity to lower-cost regions. Because, look, if you're investing less demand-generation dollars, i.e., producing less leads, then you need less raw salespeople to produce those leads, et cetera, et cetera. That's really just what it comes down to. And then there was a question about direct versus channel, I should address that, right? So if you look at a vast majority of our channel, it's master subagent. And the master subagent channel is a reference channel. That means it's -- the customer is still direct with us. The contract is between us and the end customer. And we pay a commission coming for as a residual to that subagent, to the master subagent community. But it's our sales reps closing those deals. So the concept, we don't really have the concept side of the company of a direct rep and a channel rep. They're just a rep. It's the same thing, and their job is to get deals closed.

And we do have CAMs, channel account managers, inside salespeople, but they're not the AE on the deal.

[indiscernible] Kevin, see before I understand the slide showing the shift in value, assuming constant multiple of EV from debt to equity, I get that. But there must be some longer-term target leverage, right, for this company, assuming that you get to a more stable rate of revenue growth, profitability increases that I presume is above what you were showing in that screen earlier. Is that right or is that not right?

I'm an old school CFO. Like when I came in -- when I got to Silicon Valley in the '90s, tech companies didn't run with debt. So like my dream is to be a debt-free company. And there's a very specific reason why tech companies didn't run with debt. And it was because like -- what we're going through shouldn't happen. And it's a trick. You want incredible optionality when you run a technology company. So #1, you never want to be pushed between R&D spending and debt payments, like you can never get yourself in a position where you have to sacrifice R&D spending because as soon as you are sacrificing R&D spending, you are really risking the company and obsolescence risk. And #2 is the greatest tech companies use periodic market downturns. I'm telling you guys, this market is kind of cyclical times like it's happy and a sad, it's happy and it's sad, right? Use those sad times to buy back stock or acquire competitors to do any of those other things, right? And that becomes really hard to do when you're sitting on a pilot debt and your investors something become very concerned about debt levels. So maybe there is, but like in the intermediate term, I'd like to be debt-free. I'd really -- I'd like to -- we can pay off the term loans. So -- and as we -- that gets self-reinforcing very quickly because when we've had the term [ loan ], we can get the cash interest back, that [ loss ] to a term loans faster. And the last $200 million of 28 converts -- converts at $7.15. So it is not inconceivable to be completely debt-free in 5 years or less. And then that either gives us optionality to invest more in R&D, buy back stock, and we'd invest in R&D if we have good ROIC, right? If the ROIC is greater than our cost of capital, we're all good like business school students. We can invest more in R&D, maybe we bump it to 20% at that time. We can invest in buying back stock or we can invest in inorganic growth.

Yes. And the R&D, look, the R&D investment is well over $100 million a year. So we're expecting that to translate into growth opportunities to future -- through product features and functionality. So we expect pull on that over time.

And I push you all the time spent today on contact center and partnership with best-of-breed AI, ML and why that makes sense. Other contact center companies are either trying to build internally like a nice thing Genesys is doing some as well. Then you have companies like Five9 that are also, I believe, doing more partnership or using more of best-of-breed. So is there a way you can compare your offering with some of your peers, maybe what you can offer that they can't? And also, if there are specific markets where you believe maybe you can punch above your weight, either verticals or enterprise size, we believe that you just have a right to win that market share?

So I'm going to take these in reverse order. So in terms of punching above our weight, look, I think we do great in the U.K., I think we do great in some of the international markets. So I think we're -- I think I haven't seen the latest market share numbers, but I think we're still the largest cloud business communications company in the U.K. And that's a market we can double or triple, and it still -- not still scratch the surface because especially since they have PSD and [ turn off ] coming. And so I think that's an area we definitely punch above our weight. We have a large presence in public sector and some of those kinds of things. The interest in the compare capacity against my rivals. What I would say is -- I think you nailed it by the way, Michael, which is the several of them believe in everything natively in-house, and Five9 has been -- and I really respect Five9. It has a bit of a hybrid strategy. There's things they can be good at. There's things they can't. I want to just use a case study in sort of how I think -- how we think about this and how we develop this strategy. So as some of you may or may know [indiscernible]. It's a Sequoia and Andreessen Horowitz backed start-up company in Silicon Valley. Last raise was $300 million on $1.6 billion valuation just to do agent assist. That's all they're doing, just agent assist. Now you have a company, a start-up company that's spending $300 million on a segment of MLAI that's this big. And for those on the web, my fingers are very close together, right? Okay. All right, very close together, right? How, if you're native NICE or Genesys, are you really going to compete with that? How are you really going to compete with that? Because they're not spending -- they don't have $300 million invested. Now by the way, Five9 was an investor in Cresta. So I can see how Five9 is doing it. But a lot of these like Cisco, et cetera, are they really -- are you -- they're not spending $300 million. So unless Cresta is terrible at R&D spending, which didn't happen, they're going to have a better product than people that are spending radically less. And what we generally see is first-generation MLAI products were relatively crude. And I want to be clear, I don't blame these companies. I don't think they're incompetent or stupid or dumber. I don't think we see anything that we don't see, et cetera. I think the difference is we -- actually, we happen to be a little late to the market. And a lot of them started a lot of their MLAI strategies. And I remember when I first got to 8x8, we had an MLAI strategy, and we were doing some stuff in that space. And that was 2018, 2019, those types of periods, right? But we're actually a little late to the market. And in 2020, everything changed. I think the big difference between us and them right now is we're willing to embrace the change. We believe this is a fundamental inflection point in this market because of the venture capital community, because of the investments being made across the board and the applicability of that. And so I just -- I really think it's -- the compare and contrast is they still want to -- and I -- some of the third-party analysts that are not in this room right now are big proponents of telling customers you should buy everything from one vendor. And I think they will turn out to be wrong. Because, by definition, and if you look at large parts of SaaS software, it's actually the case. If you go -- I don't think anybody runs Salesforce by itself anymore. Salesforce will have Groove or Apttus or whatever Aptis' new name is. et cetera, all plugged into their Salesforce implementation to make it more of a complete solution for that company.

Another part of my question about if there are certain markets that are vertical, so I think that different sized enterprises and even different industries have various purchasing patterns. I mean it's some -- buy the box and you get everything inside it, but others might want to buy best of breed.

Well, so I do think if you go to a big enterprise, let's say, mega big enterprise, if you say United Air, and I just use your Bank of America where you're from, you got huge credit card, or Capital One or United Airlines or one of these kinds of things, there, you probably have a vested interest in going fully custom, have your own developers in-house.

We absolutely do.

Yes, be fully custom. That's not our market. We're looking at the person who says, "Look, I need to mix and match off-the-shelf technologies." And that's why we generally say, and Kevin said this over and over again, right, sort of small- to medium-sized enterprises, not the mega guys, not [ be ] like -- I'll never call on your IT department, ever. All right. Instead, it's more about mixing, matching off-the-shelf technologies.

I have a couple, but anyone else here?

Over here.

All right. We'll take one more here, then we'll switch to web.

In 3Q, CPaaS was a little bit of a headwind in the quarter, and you mentioned some stabilization you're seeing recently. Could that potentially drive upside to guidance or...

So we -- when we gave the 2024 -- been upside to guidance in this quarter?

For '24.

So we deliberately did not forecast really a significant uptick in the CPaaS business in 2024 because we wanted to be sure that stabilization actually was happening. So we had said that before, I said it again today. So we do see the signs, right? But the 2024, it could be an upside in 2024, to answer your question directly. But right now, we're not including that in there because we just want to be a bit conservative really.

And I'd give it a little bit of history the way we model, right? We generally -- on our usage-based components. So CPaaS, toll-free minutes, those kinds of things. We generally take the exit run rate of the quarter and model that flat, right? And then like sometimes we'll layer in, if we know particularly we're winning a large customer, something that's going to start, we'll sort of stay on top of that. But generally, it's exit run rate flat on a go-forward basis. Now, for a couple -- for a while there, we were beating revenue numbers every quarter because it turned out our usage revenues were increasing. And so we had modeled flat, and then our usage comes in above and you guys would beat me up. And then for the last couple of quarters, we had the usage revenue come in below what that exit rate is as the business trended down in those headwinds. But usage -- and look, SaaS is getting more and more consumption-based. The ICA stuff we're talking about today is all consumption-based models, right? So you'll see more of that, and you'll see a little bit more variability in our revenue performance, on a quarter-to-quarter basis, over the future as we adopt more of this consumption-based stuff because it's just that philosophy of exit run rate flat. Kate?

I'm going to combine a few of these questions as soon as I get back to my computer, but we've got a number of questions about Teams and the Teams integration. The first is how much actual innovation is built into that innovation? And then as a follow-on to that, maybe discuss how people are using Teams within the contact center infrastructure?

Okay. One second, just stop there because you are going to give me that one question in 12 parts, and I'll forget the [indiscernible].

Maybe do the 3 doors into Teams. Do that.

Just for everyone's benefit on the web, and I'm sure I'll be in the room [ now ], right? So when Microsoft built Teams, they built an ecosystem strategy around it, and there's 3 doors to providing voice into teams. There's Microsoft dialing plans, and I start from least popular to maybe most popular, in between popular, right? But the least popular is Microsoft dialing plans. It's for business stuff, not very popular kind of a fallback option if you have nothing else. There's Operator Connect and there's Direct Connect. So operator Connect is a SIP trunk. It's just simple dial tone. There's a pad that comes up, you can type a phone number in and make a phone call out. And then you have Direct Connect, which is a rich set of APIs. When you work with a SIP trunk, you get a set of APIs. When you work in Direct Connect, you have a rich set of APIs. And we've helped develop those APIs. I mean people ask me often, does Microsoft resell our product? No, they do not. However, our developers sit down with Microsoft developers and say, we need an API to do this, this and this, can you help us? And Microsoft is very complementary and very helpful because they want to solve customer problems. So the question is, do we add innovation on top? Yes, we add tremendous innovation on top because we have a set of APIs that allowed us. So if it means changing queuing or SMS messages or MMS messages, as it stands today, Microsoft Teams cannot send a text message or receive a text message unless you're using 8x8 direct routing and then -- or maybe I don't know some of the other competitors may have done it now. But we were the first guys to ever come out with the ability to text in and out through the phone system to using texting in inside and out of Microsoft Teams. Presence is a big thing, and this gets into the contact center stuff. Presence is a big thing, right? So if you're in a contact center. And let's say we have an inbound phone call from a customer on -- and our agents are on Microsoft Teams, and it's a billing question and they need to transfer to a billings specialist, billings specialists will usually be on a UC solution, that agent can see immediately through presence through Teams in the panel that they're used to working with, that UI they are used to working with, whether the billing person is on the phone or not and available or not. If they are, then they can send them a message or do whatever, or if they're not, they can immediately warm transfer the call over to that team's person through Teams and get the customer over there. And so this is why we were the first Microsoft's Teams certified contact center. Bryan is in the corner because you've asked me a bunch more technical questions, I'm going to throw it at him. Cloud contact center. But yes. And the thing that Hunter didn't talk about today, but there is a very robust roadmap for further innovation on top of Microsoft Teams -- with Microsoft Teams, on top of which -- I'm not what the right [indiscernible] there is. But we've got a lot of further things that we want to do to that Direct Connect route. Operator Connect is really the cheap solution, right? And Direct Connect is the rich solution for a few dollars more. And so one of the questions that's probably coming up from, Kate, in a second is, like how does that work? And it really comes down to in our sales cycle. Our sales reps need to explain to the customer that for a few dollars extra per seat per month, you get all this additional feature functionality and is that worthwhile. And if we get into the sales cycle, usually it is, that's why that Teams business is growing triple digits year-over-year.

With a good contact center attached.

Yes. Oh, yes. And to be fair, we are purposely not trying to sell Teams seats. We are purposely trying to sell Teams plus contact center seats. So if it's a pure Teams-only integration telephony type of thing, those typically go more towards the Operator Connect route, and it becomes a bit of a price war, and I generally try not to participate in those.

Okay. That was the combination. I think you answered the combination of those questions. Any other questions around the room? Okay, so here's another one. We have a question about -- you talked about a 400- to 500-basis-point improvement in operating margin in fiscal year '24. Where does that come from out of the income statement?

Yes. So as I mentioned in the remarks earlier, we're going to get some incremental gross margin. We're expecting incremental gross margin improvement. So maybe roughly half of it will come from gross margin, and the other half will come from operating expense. So we've done a great job, as you guys saw, on improving the gross margin over the last 3 years, over 1,000 basis points. So any kind of -- we're not going to see another big step-function in gross margin any more.

Kevin, R&D is at 15, right?

R&D is at 15 yes, absolutely.

We get sales and marketing and G&A half...

Yes, roughly half-half. And look, as we gain scale in the future, we'll see nominal incremental improvement, hopefully, in GM over time.

And look, for everyone that's listening, there's always a little variability. I mean everybody likes to think on -- it's one of the first things I learned switching sides from being on Wall Street to those out of the house. When you're inside of company, there's a little more variability. Like it's not every quarter you may have an expense or a change in accounting policies or the thing of those kinds of things that come naturally. And so please don't make that like an absolute every quarter, but that's kind of the trend we're going in.

And also, don't forget, we have some -- a little bit of seasonality in our OpEx, too.

That's true.

So we do our annual pay increase in July 1, so our Q2, July, August, September. And then in Q4, each year, in the U.S., that's January, February, March, we reset FICA tax withholding, the employer taxes as well as 401(k) match restart. So those are the kinds of things that affect us in Q4.

Okay. More questions from the room? We started a little late, so we'll go a few minutes over.

I was really looking at like 1 minute last question.

I think your -- we stand in between this group and like cocktail hours.

I think it's a little [ like ] cocktail hours.

What's in that cup?

Okay. So here is, you mentioned, Sam, that you might opportunistically buy revenue growth. So the question is, what's your M&A strategy? And do you foresee industry consolidation?

All right. So I think our strategy is -- look, there's -- in my mind, there's two types of acquisitions. There's technology acquisitions and there's customer revenue acquisitions. So in a technology acquisition, it's a simple make versus buy decision. So you can sit down in your engineering department and you say "We're buying a set of capabilities, how long would it take us -- how many engineering man hours would it take us to build that same capability, and those kinds of things." Generally, I'm not a big fan of technology acquisitions, mainly because we're focused on the enterprise and most technology acquisitions aren't enterprise-ready, so you end up buying it and then you end up sort of rewriting it or whatever the case would be as you go on. And then on the customer side, the customer side, to me, is all about acquiring recurring revenue below what you can acquire it for organically in your own sales and marketing engine. And then the question is how far below is based on kind of intangibles around a couple of things, integration costs, how good is their engineering? [ Are they ] planning on keeping it or not keeping it? Those kinds of things, right? So in Fuze's case, we bought it at about 2x ARR, so below what we could acquire at in the open market, through our own sales and marketing engine. And then when you adjust for integration costs or whatever, it's like 2.25 was the acquisition price. And it's turned out to be even way better than that. So that's an example of where we would look opportunistically if the stars align. So it's -- I'm a very price-sensitive acquirer. In terms of industry consolidation, I mean, honestly, I'd welcome it. I'd welcome a few less competitors on both the UC and CC side.

And these -- look, what we did with Fuze is helpful in terms of cash flow generation, right? So this really enables us to pay down our debt. So if we could do that again, we would.

Fuze is probably what? 25%, 35% operating margin right now?

The contribution, manufacturing and everybody?

Yes.

Yes, It's high. It's definitely accretive to our total, for sure.

Okay. Last question, unless there's anything from the room, do you have any exposure to Silicon Valley Bank?

So in the Fuze transaction, we inherited a small banking relationship with Silicon Valley Bank. Fuze received some payments from some customers to SVB, and there are some payments that to go out from SVB. We keep no cash, we keep de minimis cash there. We sweep it out regularly to our primary banking relationship we have in Wells Fargo.

Okay. All right. Well, thanks for joining us. For those of you listening online, we'll be posting the slides later today when the archive of the webcast is available. And please feel free to reach out if you have any questions.

So I think it's -- there's like a 1-hour check e-mails network, check with the industry analysts, do whatever you want. And then we're sort of gearing up for the closing bell ceremonies, if you care to stay. And then after that, it's drinks on us.

Thanks, everybody. Appreciate it.

Thanks. Thanks for making the trip.