8x8 [EGHT] Conference call transcript for 2021 q4
2022-02-02 19:53:03
Fiscal: 2022 q3
Operator: Thank you, ladies and gentlemen, for joining, and welcome to the 8x8 Fiscal Q3 2022 Earnings Conference Call. My name is Elena, and I'll be facilitating your call today. I now have the pleasure of handing over to your host today, Kate Patterson, VP of Investor Relations to begin. Kate, please go ahead.
Kate Patterson: Thank you, and good afternoon. Today's agenda will include a review of our third quarter results with Dave Sipes, our Chief Executive Officer; and Sam Wilson, our Chief Financial Officer. Following our prepared remarks, there will be a question-and-answer session. Before we get started, let me remind you that our discussion today includes forward-looking statements about our future financial performance, including the impact of the Fuze acquisition as well as our business, products and growth strategies. We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that may cause actual results to vary materially from forward-looking statements as described in our risk factors in our report filed with the SEC. Any forward-looking statements made on this call and in the presentation slides reflect our analysis as of today, and we have no plans or obligation to update them. Certain financial measures that will be discussed on this call, together with the year-over-year comparisons, in some cases, were not prepared in accordance with US Generally Accepted Accounting Principles or GAAP. A reconciliation of these non-GAAP measures to the closest comparable GAAP measures is provided in our earnings press release and our earnings presentation slides, which are available on 8x8 Investor Relations website at investors.8x8.com. With that, I'll turn the call over to our CEO, Dave Sipes.
Dave Sipes: Thank you, Kate. Good afternoon, everyone, and thank you for joining us today. Let's turn to a review of our third quarter, an update on our acquisition of Fuze and our progress and plans for the future. In fiscal Q3, we delivered service and total revenue above the high end of our guidance ranges. Additionally, we delivered positive operating cash flow for the fourth consecutive quarter and achieved our year-end operating margin target a quarter ahead of plan. We also announced our acquisition of Fuze, which increases our enterprise customer base and adds resources for innovation. This transaction closed on January 18th. The market opportunity to migrate business communications to the cloud is massive. We are beginning to see the impact of our focused investments in XCaaS, go-to-market and especially channel and the global coverage in our Q3 results. We have built a strong foundation for growth. I believe we are well-positioned as the market evolves. I will frame my comments today around three pillars of our competitive advantage; our XCaaS platform, our leadership with 8x8 Voice for Microsoft Teams, and our Global Coverage. Turning to a discussion of XCaaS first. Capitalizing on the demand for integrated UCaaS, CCaas and CPaaS offerings, XCaaS provides a single platform for customer and employee engagement. XCaaS eliminate silos and speeds information flow across the enterprise, enabling organizations to be more agile and responsive to customer needs while operating at a lower cost of ownership. 8x8 XCaaS was recently awarded the 2021 CRN Tech Innovator Award. Additionally, we were named a leader in the IDC MarketScape: Worldwide Unified Communication and Collaboration 2021 Vendor Assessment. XCaaS ARR is now more than 35% of total ARR and continues to grow at more than 35% year-over-year. On a dollar basis, we delivered our best ever sequential and year-over-year growth in XCaaS ARR. Adoption of XCaaS, often with our 8x8 Voice for Teams capability is gaining momentum across a broad range of industrial verticals and geographic regions, including the public sector. A few recent examples of both new logo and land and expand XCaaS deals include Kubota North America, a leading manufacturer of agricultural construction equipment implemented their One Kubota initiative to bring multiple business units onto a single communication platform. Following a successful pilot led by 8x8 Center of Excellence, Kubota selected 8x8 XCaaS for 1,000 UC and 200 contact center seats to enable streamlined business communications across the organization. A second win was the London Borough of Newham, which provides service for more than 350,000 residents in East London. They most recently expanded their 8x8 Contact Center by more than 90%, bringing the total number to over 220 CCaaS seats. 8x8 XCaaS is deployed across more than one-third of London's 32 boroughs now. Hays County in the Austin, Texas metro area is one of the fastest-growing counties in the US with more than 240,000 residents. The local government sought a single cloud communications platform with high availability. Working with a channel partner, they selected 8x8 XCaaS with Voice for Microsoft Teams to support nearly 1,000 users. Looking now at 8x8 Voice for Teams, we are seeing increased adoption as organizations seek to provide their distributed workforces with the ability to interact with colleagues. In September, we announced that we had surpassed 100,000 business users for our team's integration and we continue to see strong momentum. In the third quarter, we experienced business user growth of more than 30% quarter-over-quarter as a growing number of new and existing customers adopt 8x8 Voice for Teams. Customers choosing 8x8 Voice for Teams in Q3 included the Financial Ombudsman Service in the UK, which investigates and settles complaints between consumers and businesses that provide financial services. Working with our partner, Virgin Media-O2, Financial Ombudsman Service selected 8x8 XCaaS with over 1,000 UCaaS seats and several hundred CCaaS seats. Our ability to help them advance their digital strategy, combined with our tight integration with Microsoft Teams and direct agent routing were integral in their decision to select 8x8. Inpro, which is a global manufacturer of high-performance architectural products for commercial buildings, they selected 8x8 XCaaS and voice for Microsoft Teams to support more than 600 employees around the world. They chose XCaaS for composed experiences such as Frontdesk, which will empower receptionists with advanced call handling capabilities and for tight integration with Salesforce. Turning to our global coverage, which further differentiates our solutions and creates a strong competitive advantage with multinational organizations. In the third quarter, we expanded our coverage to include the Philippines, another industry first and also to Panama. The Philippines expansion follows our announcement earlier this year of delivering an industry-first integrated cloud phone and contact center solution in China and Russia. Our regulatory compliant cloud-based global UCaaS solution is now available in 48 countries and territories, up from 41 a year ago. Our global reach service now covers more than 80% of the world's GDP. Examples of new and expanding global customer wins include Beam Suntory, a great example of a customer that is standardized on XCaaS with 8x8 Voice for Teams on a global basis. Beam Suntory is one of the world's largest producers of distilled beverages, including the world's best-selling bourbon, Jim Beam. An 8x8 customer since 2020, Beam Suntory most recently added more UC and Teams licenses in Scotland and Germany to now support over 2,600 employees in 35 sites across 17 countries. Headquartered in Brisbane, Australia, ALS Limited, provides testing, inspection, certification and verification services for over 370 sites across 65 countries. They continue to increase their global 8x8 investment, most recently adding another 800 users with Microsoft Teams integration to support employees in Australia, Canada, New Zealand and the US. Integral to our global strategy is growing our CPaaS share in the Asia Pacific region. CPaaS revenue continued strong year-over-year growth as we added new customers across the region. For example, Sell Here, a leading e-commerce platform with more than 6 million users in Thailand use 8x8 SMS APIs for its marketing campaigns as well as updates and notifications to boost customer experience. Ula, Indonesia's leading e-commerce marketplace for more than 70,000 traditional small and micro retailers use 8x8 SMS APIs to enhance its customer experience with marketing promotions, notifications as well as onetime passwords. Welsh Water, the only not-for-profit water company in England and Wale uses 8x8 video interaction APIs to provide remote customer support in turn, boosting customer satisfaction while improving operational efficiency. With our XCaaS strategy, Teams integration and global coverage, our shift up market is well underway. Enterprise ARR now accounts for 54% of total ARR and increased 30% year-over-year. The shift to Enterprise is also evident in our third quarter retention metrics, which were the best we've seen in the last several years. This performance reflects our customer-first culture and changes we've implemented in our customer success organization. Our focus on Enterprise customers and global approach to the market are among the reasons the Fuze acquisition makes so much sense. With the acquisition now closed, we increased our installed base of enterprise customers by about 30% and created a large cross-sell opportunity for our contact center solution. In the two weeks since the acquisition closed, we are already talking with a number of customers who are excited about the additional solutions 8x8 can provide. In particular, we see the potential for many customers to add 8x8 Contact Center solution even before they upgrade to an overall XCaaS platform. Many customers have also acquired about 8x8 solution for Microsoft Teams. Finally, Fuze partners, many of whom were already 8x8 partners are excited about the prospect of delivering more complete solutions for our mutual customers. Although, it's still early in the integration process, we are excited by the response we're seeing from customers and partners. I am also pleased to report that, our R&D and customer success teams are working together and mapping out strategies to accelerate our product road map that will increase XCaaS adoption worldwide. We have already integrated the Fuze development teams and redeployed Fuze engineers to fuel our innovation. Watch for some of the exciting XCaaS and contact center announcements later this quarter. In summary, in the third quarter, we delivered strong revenue performance, demonstrated continued operational discipline and excellence and expanded our base of enterprise customers. As the customer wins show, it is often the combination of all three competitive advantages: XCaaS, 8x8 Voice for Teams and our unparalleled global coverage that makes our solutions compelling for customers as they migrate to the cloud. Our channel contribution continues to increase globally, but we recognize that there is further opportunity. We recently hired Lisa Del Real, as our Global Channel Chief to lead and scale our channel organization. Lisa was most recently Vice President of Strategic Partnerships at RingCentral, and I'm confident she will take our channel programs to a higher level. We also announced that Stephanie Garcia joined 8x8 as our Chief Human Resource Officer. Stephanie is a recognized HR executive in cloud and SaaS industries with experience at Salesforce and PayPal leading and scaling high-performing global HR operations at dynamic fast growth companies. She will be responsible for leading the HR organization and expanding the company's team-first culture, as we enter the next phase of growth. I welcome them both to 8x8 team and our customer first, product first, team-first culture. I will now turn over the call to Sam Wilson, our CFO.
Sam Wilson: Thanks, Dave, and good afternoon. We are pleased to deliver results for the third quarter that exceeded guidance, showed improved operating leverage and generated positive free cash flow. Better-than-expected performance from our product categories were the key drivers with both XCaaS and CPaaS, both strong performers. Total revenue for the quarter was $156.8 million, an increase of 15% year-over-year and above our guidance of $152.7 million to $154.2 million range. CPaaS and contact center revenue was more substantial than expected during the quarter, contributing to the overperformance in service revenue. This offset weaker endpoint shipments and other revenue due to ongoing supply chain shortages. Looking at service revenue, we generated $149.4 million, an increase of 18% year-over-year and above our $144 million to $145 million guidance range. Adjusted for exiting the wholesale business last year, service revenue growth would have been about 21% year-over-year, or 3% higher. Total ARR growth was $572 million at quarter's end, up 16% year-over-year. Enterprise ARR accounted for 54% of the total and increased 30% year-over-year. The shifts we have made in our demand generation efforts towards Enterprise resulted in strong sequential growth in Enterprise ARR, up approximately $25 million, or 9% quarter-on-quarter. Growing our Enterprise business is one of the core tenets of our long-term strategy due to its longer commitments, higher retention and better efficiency ratios. The third quarter non-GAAP gross margin was 64.7%, and higher sequentially as service revenue accounted for a more significant percentage of total revenue. Non-GAAP service revenue margin increased approximately 20 basis points over the previous quarter to nearly 70% and was up over 350 basis points versus the third quarter of 2021 driven by our focus on improved spending efficiency. Non-GAAP other revenue margin came in at minus 32.2% for the quarter, reflecting the decline in endpoint shipments and some increased investment in our professional services organization as we prepare to welcome the Fuze customers to 8x8. As a reminder, other revenue represented only 5% of our total revenue for the quarter. So the decline in other gross margin had minimal impact. In total, gross profit dollars grew 25% year-over-year as we focus on the higher-margin portions of our business, such as XCaaS, and continue to drive unit cost improvement in COGS. Looking ahead to the fourth quarter, we expect overall gross margins to be generally flattish sequentially. Turning to third quarter are operating expenses. We continue to make focused investments in R&D, mainly in the contact center capabilities within the XCaaS platform and in sales and marketing while keeping G&A cost tight. We have made significant investment in sales and marketing over the last four quarters to increase awareness for XCaaS to expand our partner programs and the target enterprise customers. Going forward, we expect year to year dollar growth in category to slow compared with the growth of the past few quarters after just adjusting for the step up due to the addition of Fuze. Total spending as measured by non-GAAP cost of goods sold, R&D, sales and marketing and G&A was a up 11% year to year below our 15% total revenue growth. We had focused non-GAAP operating margins to exit this fiscal year at approximately 2% and hit that target in Q3, a quarter earlier than expected. Going forward, we expect total spending to grow more slowly than total revenue on a rolling 4-quarter basis as we drive efficiencies throughout the business, but there can be some quarter-to-quarter variability. Turning to the balance sheet. Total cash, restricted cash and investments ended the third quarter at approximately $260.4 million. Excluding $8.6 million of restricted cash, the balance was $251.8 million, increasing roughly $94 million quarter-on-quarter. Cash from operations was a positive $9 million for the quarter much better than expected on collections and expense management. We were free cash flow positive for the quarter. After we announced the Fuze acquisitions, several of our noteholders indicated an interest in increasing their positions so we opportunistically raised capital. During the quarter, we raised $139 million by offering more of our 0.5% notes due in 2024 and simultaneously conducted a buyback of $45 million or 2.3 million shares. The buyback helped offset any dilution from the offering and reduce our paid discount and resulted in a net increase in cash of approximately $89 million after transaction costs. Excluding the capital raise, quarter-on-quarter total cash increased by about $5 million better than the small burn forecasted. This was driven by strong collections and higher-than-expected revenue. For the fourth quarter, we expect total cash balance to decline due to the Fuze purchase, but cash from operations should be stronger on a combined basis, excluding onetime cash items around restructuring and transaction costs. One item I'd like to mention on liabilities is deferred revenue, which was over $25 million during the quarter and up 23% year-over-year as we move towards building in advance of service delivery. RPO was approximately $565 million for the third quarter, up from $550 million in the second quarter. Okay. Let's talk about Fuze. We closed the acquisition on January 18 earlier than we had expected. We sent them about $132 million in cash and 5.8 million shares or approximately $250 million in total consideration based on the share price at the time of the announcement. As expected, we will report a stub period of about 10 weeks for Fuze in the fourth quarter and an entire quarter in the first quarter of fiscal 2023. The guidance provided in a moment will be for the combined company. We intend to provide commentary for the first few quarters on revenue contribution from Fuze customers. As we further integrated two companies, this will become less relevant, especially around items like cross-selling and upgrades. Next, turning to cost synergies. We had said we expected to remain non-GAAP profitable when we announced the transaction. At the time of the announcement, Fuze was losing money and a non-GAAP operating line around $16 million on an annualized basis. We believe we can generate over $20 million in annual cost savings, though it will take a few quarters to be fully realized. If we execute the plan, Fuze will be additive to our non-GAAP operating income over time, but a small headwind in the short-term. This week, we took a step in this direction with a restructuring that will appear in the March quarter numbers. As we move into fiscal 2024, we believe we could find further cost synergies as we integrate. Taking all this into account, we are establishing guidance for the fourth quarter fiscal 2022 ending March 31, 2022, as follows: we anticipate service revenue to be in the range of $173.5 million to $175.5 million, representing approximately 30% to 31% year-over-year growth; we expect that Fuze's revenue contribution will be about $20 million for the rough 10 weeks to period; we anticipate total revenue to be in a range of $180 million to $182 million representing approximately 24% to 26% year-over-year growth. Please note that we expect to have continued supply chain issues with endpoint hardware shipments and expect other revenue to be down about $1 million sequentially from the third quarter because of these. We expect non-GAAP operating margin to remain positive on a non-GAAP basis but down on a quarter-over-quarter basis as we begin integration and employee-related FICA and benefit expenses increased again at the beginning of the calendar year. We believe integration will take approximately six to nine months and expect to show some financial leverage on the operating line throughout the year. Some modeling notes. These numbers reflect the combination of 8x8 and Fuze as well as ongoing investments we are making. Please note that Q4 FY 2022 ranges below are based on the stub period I mentioned for Fuze. We are keeping a majority of Fuze's R&D. So, on a combined company basis, we expect to step up R&D to approximately $25 million to $26 million for fiscal Q4 2022. On the non-GAAP sales and marketing, we expect to step up into a range of $73 million to $74.5 million, for fiscal Q4 2022. On a non-GAAP G&A, we expect to step up to a range of $17 million to $18 million for fiscal Q4. We are giving line item guidance for this quarter only, so you can adjust your models to include Fuze expenses, but there maybe some reallocations as we integrate. Combining our outperformance for the third quarter with the outlook above, we are raising revenue guidance for full year fiscal 2022 ending March 31, 2022, as follows: we are raising total revenue outlook to a range of $636 million to $639 million, approximately 20% year-over-year growth. We are raising service revenue range to $603 million to $605 million, representing approximately 22% year-over-year growth. We have raised our outlook every quarter this year, and our update for Q4 shows that we continue to execute our plan we outlined last May. We believe the business is trending in the right direction. Looking a little further into fiscal 2023, which begins on April 1, 2022, we currently expect year-over-year growth rate for fiscal 2023 service revenue, including the revenue contribution from the Fuze customer base will be in the mid-20% range. We only closed Fuze a few weeks ago, and this is a very preliminary view. We will be able to give you more details when we announce our fourth quarter results in early May. Let me end with some closing thoughts. Since Dave joined 8x8 a little over a year ago, we have concentrated our investments in select areas to reaccelerate growth and deliver improved operating profit and cash flows. The Fuze acquisition is a key component of this strategy. We still have work to do. But the investments we have made and the focused Dave has brought to our business are beginning to take root. With the investments in XCaaS, Global Coverage, Voice for Teams and sales efficiency, including key leadership team additions, we are well positioned to execute against these goals in the upcoming fiscal year. We remain focused on reaccelerating our core business, integrating our Fuze acquisition to achieve cost and revenue synergies, including cross-selling and customer retention. We believe the cloud communications market is large, growing and dynamic and that we are well positioned for our XCaaS platform, our global reach and our market-leading Microsoft Teams for Integration. With that, thank you, and let me turn the call over to the operator for questions.
Operator: Thank you. The first question comes from Siti Panigrahi with Mizuho.
Matt Diamond: Hey, guys. This is actually Matt Diamond on Siti's behalf. Congrats on the very solid print. It's glad to see that Fuze is working out. The question I have is around the cross-sell opportunity. There was obviously some promising cost synergies here, but -- and I know it's early in the integration to maybe speak about this concretely but, Dave, after your first couple of weeks of closing the deal, could you give us any sense of your confidence in that $50 million incremental ARR that was talked about when the deal was announced?
Dave Sipes: We just closed the deal two weeks ago, and we're having conversations with customers currently, and they're very positive. So encouraged overall, although it's well too early to give updates on the quantifiable number of the cross-sell, and I'll let Sam talk.
Sam Wilson: Yes. So as Dave said, look, the feedback so far from the customer base is very positive, I would say. We're going through and validating customer by customer. As Dave said, we only closed it two weeks ago. So we actually literally got the names of the actual customers two weeks ago. And so we're working through all that, I would say, incrementally more positive, not ready to change numbers.
Matt Diamond: Got it. And around the margin front, it sounds like there's a promising trajectory on the cost saves. I'm curious how you're thinking about inflationary costs this year, if there's anything we need to keep in mind when we're modeling the magnitude of spending growth and margins for fiscal 2023?
Sam Wilson: No. Specifically around inflation, look, we're dealing with it internally. So we are seeing things like wage inflation, some T&E inflation, those kinds of things. We're dealing it within the overall guidance we're giving that total spending increases should be less than revenue growth. That's for us to deal with.
Matt Diamond: Okay. Thanks so much.
Sam Wilson: Thank you
Operator: Thank you. The next question comes from Matt VanVliet with BTIG. Please proceed.
Matt VanVliet: Hello. Good afternoon. Thanks for taking the questions and nice job on the quarter. Dave, I guess, bringing in Lisa to run the channel group here, what incremental sort of improvements or strategy do you think will help get pushed through not only given your experience working with her, but maybe where you're trying to take the channel program from here now that you've built up a nice big stable of partners that are helping out?
Dave Sipes: Yes. And channel is core to our overall strategy. We see the reseller network as the key element that's worked with these customers historically, been with them on legacy solutions and are helping them through the migration to the cloud. And so as we built up our channel program, and it's been several years as we've done that, we continue to aspire to be the easiest to work with and build the most trust with the channel itself. That's shown already with the strength of our team as well as the strength of the channel that we've added. But I think there's still a long ways to go. Lisa has a decade-plus of experience with the channel and she'll bring a lot of operational excellence and ease of -- ease and trust that we will continue to build with that channel and do that globally. And I see a lot of opportunities still as we work some of the elements of our differentiated approach to offering both agency and wholesale billing models to channel that's been very successful for us in Europe to bring that into the US as well as capitalizing on this tremendous Microsoft Teams opportunity that's ahead of us and using the channel to do that. So we still have a ways to go, but I think it's been a positive experience for us today. And I know Lisa is going to help us move that to the next level.
Matt VanVliet: All right. Great. And then looking at both the mid-market and the SMB groups, a little slower growth even on SMB, a little bit of contraction here. Can you just help us kind of break down what some of the puts and takes are around there? Did you see any sort of elevated churn? Are you seeing pricing compression as contracts are renewed? And then what maybe kind of new growth help offset that -- any of that downward movement there. Thanks.
Dave Sipes: Yes. Churn in small business is inherently higher as you have business mortality and seasonal use of the product. And our core focus, which goes along with our strategy, is really focusing our go-to-market exercise and activities and incremental dollar, both sales and marketing on the enterprise market. The enterprise is core aligned to our strategy of XCaaS. If you think about XCaaS combined, both the employee experience on the UC side and the agent experience on the contact center side, only the larger customers have that Contact Center need. So it inherently aligns us with enterprise as well as if you look at our other advantages of Microsoft Teams and our global capabilities, taking that to 48 countries. Those are really aligned with enterprise. So that's where we've been leaning in and focusing our go-to-market activities. And we had one of our best enterprise ARR growth this quarter. So while it takes time to grow that Enterprise business, as you build pipeline and then mature that pipeline into deals, we are already seeing some of the benefits of that work, which I'm happy about. And that's where you're going to see -- I think we've talked about it on previous calls, that's where you're going to see our continued focus. So that's where we'll focus our metrics on what's important to us.
Matt VanVliet: All right. Great. Thank you.
Operator: Thank you, Mr. VanVliet. The next question comes from Ryan MacWilliams with Barclays. Please proceed.
Ryan MacWilliams: Hey, guys. Thanks for taking the question. Excluding Fuze for a second, it looks like a strong fourth quarter guide in terms of sequential service revenue dollars added, compared to your guide from the previous quarters. So anything in your business or anything in your market opportunity that's given you confidence for the fiscal 4Q?
Sam Wilson: I'd love to say something insightful at this moment, but its business as usual. Like, we've got a great product. The team is doing really, really well. Our Global Reach message is resonating. And so, I have nothing incredibly insightful to say other than, I think we're doing really great and all the investments that we've made are just paying off.
Ryan MacWilliams: That works for me. And just as we think about Fuze and in addition to 8x8. How should we think about the year-over-year growth rate for Fuze in 2021? And is there anything since getting on your hands in the company? I know, it's just been in the last few weeks that maybe you're more excited about from a revenue or synergy standpoint? Thanks, guys.
Sam Wilson: All right. So I'll take those in reverse order. Look, as I mentioned on an earlier question, I think the cross-sell opportunity, we had said on the call that we had zero modeled in for cross-sell. That's still the case right now. And so, I think, there is some positive stuff there, but too early -- nothing in guidance, those kinds of things. And so, when you talk about the year-over-year growth from Fuze customers, it gets a little mushy, and I'm sorry to say that, but what we would expect is we expect Fuze revenue to decline from the customer base. Part of that will be natural attrition. Part of that will be we're going to migrate them or upgrade them over to the 8x8 side. And so, I think it's purely that that's the key drivers right there.
Ryan MacWilliams: If I get a follow up on that real quick, I guess, how should we think about, like, the timing of that migration? Or is that something we can track or is that just -- like, how are you going to incentivize that? Like, what's the best way for us to monitor the progress there?
Sam Wilson: So I mean, the big thing is customer choice, number one. Right? So we’re not going to force anything, any that sort of stuff. Customer choice, we’re analyzing it now. Can I beg you to ask me that again in 90 days and I'll give you a more coherent answer. But it's still early. We want to make sure that customers get the best of both worlds. That's something we said earlier. We absolutely want to stick with that. So choice is the number one thing and trying to bring forth that best of both world solution.
Dave Sipes: And this is something that's going to be a positive for customers, as they get to add a greater breadth of product, contact center solution from 8x8, both with their current platform as well as getting the full XCaaS experience when they decide to upgrade to the XCaaS platform. We do expect some of that to happen very quickly and continue to happen for multiple years.
Ryan MacWilliams: Appreciate the color. Thanks, guys.
Operator: Thank you, Mr. MacWilliams. The next question comes from Michael Turrin with Wells Fargo. Please proceed.
Austin Williams: Hey guys. This is Austin Williams on for Michael. Thanks for taking my question. I just wanted to follow up on the question on the fee guide. The guide is the $20 million for the partial quarter. I think the previous disclosure was $100 million or $125 million run rate. Are there any purchase accounting adjustments or other callouts as to why that might be lower than we were previously modeling?
Sam Wilson: Well, yes. So I mean, first off, it's service revenue and second off, it's a stub period, right? So I think at the time I own them. I can't take the full quarter. I'd love to, but I can't. So I mean, you'll see another step -- that's why I tried to be really clear in the script. You'll see a full -- the first full quarter on that kind of run rate will be our fiscal first quarter of '23.
Austin Williams: Got it. Thank you.
Operator: Thank you. The next question comes from Peter Levine with Evercore. Please proceed.
Peter Levine: Great. Thanks for taking my question guys. Maybe the first one is, as you think about the service revenue reacceleration at or above that 20% three-year target, first, can you just clarify, that's an organic target? And then second, the go-to-market investments that you guys made internally and towards expanding the partner ecosystem, obviously, that's gaining traction. So really, what has to work to get to that 20% number? And then the reverse is where does the risk lie?
Sam Wilson: All right. I'll take the first part of that, and maybe I'll let Dave talk about the risks. So we weren't clear organic or inorganic. We've done both in the history of the company. And I -- like I think you're reading too much into it is 20% growth, like it's just what we expect the revenue growth side to be. In terms of what has to work, this question was asked a lot when I gave the long-term guidance, the thing I tried to make very clear is that we need to improve our sales and marketing efficiency. That naturally lifts the growth rate. And so that's one of the areas that we continue to work on how we invest, where we invest is a key part of that strategy. But that's one of the things that has to continue to work in our favor to drive higher growth rates.
Dave Sipes: And where we'll get that acceleration and improve sales and marketing efficiency is as we have success selling XCaaS. And we've seen now it's more than 35% of our ARR and growing at over 35% year-over-year to drive Enterprise customers, which I talked about earlier, as well as keeping those customers very happy. And that's where we've made a lot of progress today. It would be always your ongoing risk, but we have driven the customer retention improvement every quarter that I've been here and we had a multiyear record on that this quarter. So those are the key elements to drive customer retention of large accounts, to drive the Enterprise business and to drive the XCaaS adoption over time and doing that also with our differentiators of Teams and Global.
Peter Levine: And then just one last one, a housekeeping question. I don't know if I missed it on the call, but can you sort of give us the RPO number? I didn't catch it.
Sam Wilson: I said it's $565 million.
Peter Levine: Great. Thanks again guys.
Operator: Thank you, Mr. Levine. The next question comes from Meta Marshall with Morgan Stanley. Please proceed.
Meta Marshall: Great. Thanks. Sam, I just wanted to know if you could just kind of give what the headwind was from just the exiting of the wholesale business either through this quarter or into the guide? And then just maybe as a question for Dave. Clearly, you guys have made efficiencies to the services organization and maybe deemphasize that smaller business or book of business. Should we consider that as there any growth opportunity or additional churn we should be mindful of? Just anything to note on the smaller end of the business as you just deemphasized or change the services organization around that business?
Sam Wilson: Yes. So the headwind from the -- exiting the wholesale business was about 3% service revenue growth. So I think I said in the script that the total -- the service revenue growth would have about three percentage points higher if assuming that we hadn't exited and the business was flat.
Meta Marshall: And same to the guidance, correct?
Sam Wilson: Yes, yes.
Meta Marshall: Fiscal Q1? Okay.
Sam Wilson: Yes.
Dave Sipes: And then to your question on our services organization and business, Obviously, as a SaaS business, one thing we're striking as we go through reorganization of the product and of that organization is to make deployment easier, more out of the box for customers. We've made some progress on that. But that creates inherently a little bit of revenue headwind. But obviously, we're focused on the service revenue component of the business. And we believe easier deployment, implementation, configuration creates strong advantages, strong TCO opportunities for customers. So that will be a continued focus for us as a business.
Meta Marshall: Got it. Thanks.
Operator: Thank you. Ms. Marshall. The next question comes from Michael Latimore with Northland Capital Markets. Please proceed.
Michael Latimore: Great. Thanks. On the record revenue retention, can you just give a little more data on that?
Sam Wilson: Yes. I mean basically, our retention rates are the highest we've seen pre-pandemic even before that. Churns really come down. I mean, it's been a key area of Dave's focus the last year. Terms really come down to last year. And it's arguably it across the board. We saw some of the lowest credit card decline rates we've ever seen, we saw great enterprise retention. It's across the board.
Dave Sipes: We've made significant investments in our customer success organization over the last year as well as product usability, stability enhancements. And I think those are paying off. Obviously, there's other macro trends possibly affecting those, I think, are really critical for what we're doing here and getting greater customer happiness.
Michael Latimore: Great. And then in terms of the XCaaS vertical, are they -- is there any material difference between the verticals that are in the XCaaS business versus, say, UCaaS independent of excess or invention or the vertical is pretty much similar -- the mix of vertical is similar between the two?
Dave Sipes: For us to date, the verticals have been similar as we focus on a lot of blend between the UC user and the contact center user. We focused on informal cues and bringing in contact center capability into UC users. We talked about our front desk product as one of those. So we are -- there is -- for us, there's a high crossover in verticals. Our core vertical being led out in the EMEA market and that also is buying XCaaS. So we're seeing it across the board.
Michael Latimore: Yes. Thanks.
Operator: Thank you. Mr. Latimore. The next question comes from George Sutton with Craig-Hallum. Please proceed.
George Sutton: Thank you. I'm glad to hear you're going to continue to focus heavily on R&D. You did mention bringing over a few developers in large part, can you just talk about how does that influence the product road map going forward? In other words, how might the product look different in a couple of years as a result of this move?
Dave Sipes: Sure. And we are -- I am happy to say, we've brought over that team. We've been able to align them into our organization. This is all relatively new, but obviously planned. And it does create a force multiplier on innovation for us as we're able to put incremental resources on key product innovation areas as we have the basics covered, right, from an R&D perspective. And we -- and it's nice that we're able to do it well, making this profit -- being able to contribute to profit over the next 12 months. What we will focus on, obviously, is those core pillars of XCaaS, our Team's product and our Global Reach. We have made progress across all of those already in the last year. So there are already additional innovations in the pipe. But what you'll see is increased velocity of innovation over the next nine-plus months. And areas that we'll focus on are things like admin usability for managing very, very large organizations, some of the polish around our omni-channel and AI capabilities, additional deeper integrations that go with that. And additional personas that front desk was an initial or first foray into personas, and we have some additional ideas there. So I would say, we have a couple of interesting announcements planned for late this quarter and I would say stay tuned for the specific, right?
George Sutton: Appreciate the details. Thanks, guys.
Sam Wilson: Thank you.
Operator: Thank you, Mr. Sutton. The next question comes from James Breen with William Blair. Please proceed.
James Breen: Thanks for taking the question. You had mentioned a little bit about some of the supply chain issues. Just wondering sort of how maybe you've got to change the business a little bit around some of that and if you're seeing it alleviated at all -- and does it impact your sales cycles as the supply chain starts to right itself? Thanks.
Sam Wilson: Okay. So here's what happens. Yes. I think it does have some effect. It's hard to quantify. But I think we are seeing some Enterprise customers place smaller orders upfront, because they have to have a slightly different deployment schedule. And so there may be some pent-up demand. There's certainly we've got the largest back orders that we've had in a long time backlog, if you will, of hardware, and that is a statement. As it alleviated not really, it's still something we manage every day, every week right now. I'm hoping that at some point in the next four quarters, it alleviates, but there's nothing that I can concretely say that, we have designed on the horizon that it's going to be alleviated.
James Breen: So you basically, you've adjusted to the working environment that you're now haven't seen necessarily a change, but it just hasn't come to a completion yet?
Sam Wilson: Yes. I mean, there's a change. I think like as I said, I think just some of the enterprise orders, the bigger orders are probably a little smaller than they would have been because they're placing the first order and they'll place a second order here in a couple of months when we get more hardware to meet their deployment needs.
Dave Sipes: And we're building a great approach of hardware option to create more flexibility for customers.
James Breen: Okay. And then just qualitatively, you mentioned a little bit about the cross-sell with Fuze. Any real difference in the size of their customer base relative to the size of your customer base, small, large, et cetera?
Sam Wilson: Well, in average --
James Breen: In terms of the size of the company?
Sam Wilson:.:James Breen: Okay. Good. Thanks.
Operator: Thank you, Mr. Breen. The next question comes from Catharine Trebnick with Colliers. Please proceed.
Catharine Trebnick: Hi, thanks for taking my question. Congratulations on a good quarter. So you spent some time talking about Microsoft Voice with Teams. And I'm wondering why aren't you pursuing a relationship with Black and it seems to me that would be another avenue of good growth? Thank you.
Dave Sipes: Thanks, Catharine. So on the Team's opportunity, I do think it is like more partners is always good. So we're open to that relationship. The Team's platform itself is a larger platform, honestly. And they create an opportunity that I think is still just lightly touched. And we are doing a lot in that regard to help penetrate these users that don't have an enterprise communication system attached to their Team's usage, and we're doing that through direct routing, and we're adding a lot of value through our contact center, powering all our employees, global coverage. We do have a strong relationship with Salesforce overall. And obviously, with integrations across both our UC and CC products, and we see that as a very important relationship overall for us.
Catharine Trebnick: All right. Thanks. Appreciate it.
Sam Wilson: Thanks, Catharine.
Operator: Thank you, Ms. Trebnick. The next question comes from Will Power with Baird. Please proceed.
Will Power: Great, thanks. I guess, a couple of questions. Maybe just starting with the service revenue upside in the quarter. I think, Sam, you indicated it was really driven by strength in CPaaS and CCaaS. And just wondering if we could get any other color there? Was there any particular products or areas within CPaaS and then within CCaaS, is that seat? Is it usage? Any other color and just the sustainability of that upside, I guess, as we move into Q4?
Sam Wilson: So on the CPaaS side, it was Southeast Asian usage. And so I think we've got a great presence there. We've won some new customers. I mean, I think Dave has mentioned some pretty big brand names over the last few earnings calls. You can imagine those flowing through as usage as they ramp up starts to show up. And then on the Contact Center side, it was just minute usage. And so do I think it's sustainable? Yes, it feels like the world is opening up, and there's a lot more business activity going on, and that just correspondingly shows up as more usage.
Will Power: Okay. That's great. And then just a question on ARR growth. It looks like the XCaaS ARR growth accelerated. I know you called that out. I know that's the primary focus. And I think as you touched on, as you look at mid-market and SMB a bit weaker. So I guess one was a big question or one of the big questions is when do we get to an inflection point where that XCaaS ARR can more than offset some of the pressure points in mid-market and SMB to help drive an acceleration in ARR growth? What are the key drivers of that, any rough time line to how to think about that.
Sam Wilson: Dave and I look at each other. We're wondering if you want us to give you an answer of like three months, six days, four hours and eight minutes? Or just the key drivers, right? So the -- sorry, a little bit of humor today. So look, what's really driving it is we're pushing in there. We're seeing the first line with the investments we're making in the demand generation, in the branding, in the channel and all those kinds of things are paying off. Yes, it's continuing to grow faster than overall growth rate. So, it's becoming a larger percentage of our business, exactly what Dave wants and he's been driving towards in excess of a year now. And I'm hoping that every call from this point on, we keep saying it's a bigger percentage of the business, because it is one of our tenants to drive the overall growth rate of the company up.
Will Power: Great. Okay. Thank you.
Operator: Thank you, Mr. Power. The next question comes from Tim Horan with Oppenheimer. Please proceed.
Tim Horan: Thanks, guys. Can you go into Teams a little bit deeper? Where are you developing the channel there? I would think it's a very different channel than the legacy channel. And where are you just like the processes to kind of implement? And I guess just lastly, what inning are we in do you think in terms of your ability to kind of execute on that and penetrate that market?
Sam Wilson: I'm sorry. Can I ask you the first part came a little muffled. Did you say Teams channel?
Tim Horan: Yes. Sorry, on Microsoft Teams, yes, where are you developing the channel that kind of can sell into a legacy kind of Microsoft -- basically, systems integrator supportive?
Dave Sipes: Yes. So -- and I'm going to start with the last part. I think it's early in that there are a lot of Microsoft Teams users when you look at the MAUs but they're predominantly all using it for messaging, right? And so attaching Enterprise Communications to that, I think, is what's early and I think just a small fraction have really attached Enterprise Communications. And when you do, do that, there's different ways to do it, whether it's direct routing or operator connect or calling plans, I think we're -- what we see as the predominant solution today is direct routing, and that's where we're differentiated. So I think we sense this. We got into this early, and we've been capitalizing on it. Obviously, we had 30% quarter-over-quarter growth, but I don't think we have yet really capitalized on the full channel opportunity. And so, that is something that is a key initiative for us. We've been mostly riding in our current channel relationships, and there is overlap there, but I think there's a whole additional set of channel partners to exploit to your point. And so that's something that we will be working on over time as we go ahead and improve this. And obviously, we've been doing it. When we do it, we do it by the advantages we bring here is really powering all employees, your contact center employees, giving global coverage to those and these enhanced capabilities of SMS called used facts, things like that. So, we've been having a lot of success. I think there is an opportunity for a much bigger opportunity for success here.
Tim Horan: And where are you with the ability to provision and support customers and just quality of the product and Teams?
Dave Sipes: Yes, it's a great question. We -- those customers are predominantly provisioned and deployed. And we work on quality of service -- uptime reliability of service is our core tenants, that's where we come from. And so I would say we have an ability to do that. We are still figuring out some of those components, but I think it's better than anyone else and a core special sauce for us to do that in a high quality and high reliability environment.
Tim Horan: Thank you.
Operator: Thank you. The next question comes from Michael Funk with Bank of America. Please proceed.
Michael Funk: Yes. Thank you for taking the question. It's good to be here. A couple if I could. First on the enterprise deal funnel, any kind of comment you can give on the change in the size of that funnel and then early and late stage?
Sam Wilson: We don't -- look, Mike, first, thank you for the recent initiation. It was a great read. I appreciate it. Second, look, we don't give those kind of funnel metrics. I think it would be inappropriate with -- we certainly know our competitors listen to our calls. And so I think it would just be the wrong thing to give out right now.
Michael Funk: I can just try one time at least. So on the broader question of enterprise adoption. Obviously, there have been different rates of inflection over time for UCaaS and CCaaS. Can you just kind of peel apart kind of the broader acceleration in market adoption versus the success that you're having in terms of the market share gains?
Dave Sipes: The movement to the cloud has been occurring for almost a decade, but we barely scratched it. It's accelerated at this point. And the enterprises have been the latter ones to migrate over time. And so I still think there's a lot of large enterprises on legacy solutions. And -- but we are seeing a greater acceptance partly because of the work-from-home mandates. But partially, it also causes people realize that's where the innovation investment is going into the cloud solutions over legacy solutions. So I think when people are choosing their future platform, it's becoming obvious to move to a cloud platform in this next replacement cycle. That replacement cycle could still be up to 7 to 10 years. So I still think it's going to be a long run in that regard, but the propensity to move to cloud has increased.
Michael Funk: Understood. And maybe kind of more quantitative then, how much breakage are you modeling into the Fuze acquisition? You mentioned earlier, you're modeling in some churn. How much breakage are you modeling in?
Sam Wilson: So by breakage you mean churn, right? So we --
Michael Funk: Yes. Sure.
Sam Wilson: So I mean, you have some rough estimates of what their small base looks like, and I've taken industry norms and doubled it. So just to be safe, I doubled the industry average churn rate for their portfolio, and that's what I've been running through the model.
Michael Funk: Great. Thank you, guys, so much. Appreciate it.
Kate Patterson: I think we have time for one more question, operator.
Operator: Absolutely. The last question comes from Ryan Koontz with Needham. Please proceed.
Ryan Koontz: Thanks for the question. I wanted to double back on Teams a little bit more, and it sounds like an increasingly important part of your new bookings. Can you give us any help there? Is it I hear it's up 30% in terms of ARR? Is that Q-over-Q? Any more color you can give us on where that stands as a percentage of new enterprise bookings and things like that?
Dave Sipes: Yes. I think what we said is we -- a quarter ago, we said we had 100,000 users in the first five quarters of launching that, and that user number went up 30% quarter-over-quarter. The -- and then it is important but we are seeing it both on new bookings, but also even the land and expand deals I mentioned today Beam Suntory and London Borough of Newham. All have expansion of Teams also. So we're seeing it in both new and land-and-expand.
Ryan Koontz: That’s helpful, Dave. Thank you.
Operator: There are no additional questions at this time, and that concludes the Q&A session. I will pass the conference back to the management team for closing remarks.
Sam Wilson: There's a record -- there's a replay from those days. There's a replay available on the web, and thank you very much for your time today.
Operator: That concludes the 8x8 Fiscal Q3 2022 Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.
