RingCentral, Inc. (RNG) Earnings Call Transcript & Summary

Showing up to our second to last presentation we expect a great week at the 2022 Bank of America Technology Conference. If you haven't already met me, I am Michael Funk. I'm your New York based software analyst at the bank, really happy to have these guys here with me today, Sonalee and Mo from RingCentral. Wondering your chance maybe just to quickly introduce yourselves? Any key comments that you wanted to make about most recent quarter and then we can go right into Q&A.

So I am Sonalee Parekh. I am the newly minted CFO at RingCentral. I am officially second week on the job. So please keep all the tough questions for Mo over here. I'm delighted to be here. I've always had a great relationship with Bank of America, lots of familiar faces here and friendly faces. A couple of people have asked me at the conference today, why did I choose to join RingCentral. And I thought I'd start with that.

That's a great place to start.

Before I hand over to Mo. So a couple of things that I would really highlight. So firstly was the phenomenal team that exists at RingCentral, starting with Mo here. [indiscernible] and other colleagues of mine, where there is an incredibly supportive yet flat structure. So decisions can be made really quickly. We are super agile and particularly in this type of dynamic market, it's amazing to have that environment to work in. Secondly, I would say, just the opportunity to go and create value. It's astounding from my perspective. I think the opportunity for growth ahead of us is massive just structurally, but I also think that we're in this very enviable position in terms of being a SaaS company at scale, $2 billion revenue run rate, profitable and generating free cash flow. That's a very small number of companies. And particularly given the environment we're operating in, I think we are in a very ample position. And then lastly, the product is first class. And I now use it exclusively. So if anyone wants to put a call with us, it will be on RingCentral. But not only that, it's the way that customers value our product and the value proposition. It's incredible to hear from our salespeople, how much customers love RingCentral. So I think it was all those things combined that just made this such a unique and amazing opportunity. And again, 2 weeks into the job, but I love coming into work. I love coming into the office.

That's a great overview. Thank you.

Mo Katibeh, President and COO of RingCentral. And essentially, between Sonalee and I, we represent all of the functions that RingCentral other than legal. And I think Sonalee said it all. I'm approaching month 6 on the job. And someone asked me a little bit earlier today, hey, what do you think after your first 6 months? And I said I only have even more conviction than I did on day 1. Securing to RingCentral was the right decision. The market opportunity ahead of us is staggering as Sonalee articulated. We've continued to put up amazing numbers quarter-over-quarter and that will continue. With that, why don't we get.

I think that's a great place to start. And I wanted to actually start with the idea that both of you being relatively new to the roles and fresh eyes bring fresh ideas, right? And it's a pretty rapidly shifted market environment, not just in the space where you compete, but also in the capital markets in general, right? And we've seen this myopic focus on revenue growth at any cost now shift to profitability, right? Investors want to see margin increases, they want to see free cash flow improve. And so just wondering with the kind of the fresh eyes that you bought to the story, how you're prioritizing those things or think about prioritizing revenue growth, right, gaining market share in this massive TAM versus, say, improving profitability in the short term.

Sure. Shall I start with that one. You articulated it really well, and what I will say -- and of course, we are aware of the broader capital markets and macro. From our perspective, we are a growth company, but we are not a company that will grow at all cost. We are also laser-focused and will be increasingly focused and emphasizing our profitability and our ability to generate cash flow. And what I'll say there is that Mo and I are going to be very disciplined about the types of investments that we make. It will be ROI-based decision-making, ROI-based investing. And most importantly, from my perspective, we're at a stage of our growth where the operational leverage is really starting to kick in, and you saw that last quarter. We significantly beat our OP margins, and we guided to significant upside in OP margins. And we feel very confident about the way we guided last quarter. And we talked a lot about our partnerships kicking in and the unit economics there and how they improve the overall profitability of the model. So again, I just think we are in a very, very unique position to not only continue our growth, but to do it at durable and profitable OP margin and free cash flow.

And I want to give Mo a chance to answer that question, too, but I want to stick with you for one second because you mentioned guidance. I don't think I've asked you this yet, but what is your guidance philosophy?

Yes. So I haven't been explicit about it. And a couple of people have asked me, were you there last quarter, and I wasn't actually an employee of RingCentral when we print at our last earnings. But I was part of some of those conversations in meetings. So my name is, I feel very much on that guide, and again, we feel very comfortable with it. I think in general, I'm someone who tends to be realistic in the way that I guide and I would say, borderline conservative, particularly given the current macro. Now again, we aren't seeing an impact on demand today, but we don't know what we don't know. So what I would say from what you can expect from me is very, very realistic guidance and perhaps guidance that is slightly closer to the pin, and I'm not even necessarily talking about RingCentral in general. I'm talking about SaaS companies in general that tend to provide guidance that is often way above where consensus estimates are. I haven't set any new guide, but I will be very cognizant of the macro environment that we're operating in. And as I said before, I feel really comfortable about our financial profile and our ability to weather any macro storm should it come. And we're not seeing that for now. So we feel very, very comfortable with what we said at the quarter.

So what I take from that is, number one, conservatism. So guidance that you feel comfortable achieving and hopefully beating but also guidance that shows a high degree of forecasting capability, right, that you don't want to be beating by 10% because that also potentially impacts the market's confidence, right? Because can't this company work has in a reasonable range, right? So is that the right takeaway?

Yes. I mean use a 10%, that was your number, not mine, but yes. I want my guidance to and our guidance to correlate with reality.

Sure. Makes perfect sense. And then -- and then Mo, sorry, kind of same question for you, not in the guidance, but on the fresh eyes, new ideas, kind of what you're seeing and what might you change?

Yes. So as I came in as part of the -- my first earnings, we were pretty explicit that we said, look, we're going to go look at every aspect of this business. We're going to have operational rigor and anywhere that we see an improvement opportunity we're going to go execute on that. And relative to that point on both top line and bottom line, Sonalee said this extremely well. We are incredibly focused on driving top line growth, but also being multidimensional growth. We both think it's incredibly important that companies grow both top line and the bottom line in terms of the op margin and free cash flow. And just building out a comment that Sonalee made, she said, look, this is an inherently profitable business of scale. There is leverage in the model. You're starting to see that. As we came into the year, we guided to 40 basis points of op margin expansion. After 1 quarter, we delivered 120. We delivered 170 basis points of expansion on free cash flow, and we increased, we tripled our op margin guidance for the year. And I've gotten several questions on, well, how exactly did you do that? And we said, well, beyond just the inherent scale and profitability of the model really as a management team focus on 3 things: Very, very disciplined hiring, and how do we think about the accretion and the value that every single incremental person that gets added to RingCentral brings. Second is supply chain and logistics as a scaled company. You can imagine we're looking at every single supplier. We're using domain consolidation, recontracting, driving unit cost savings. And then third is ROI-based decision-making, whether it's program dollars, whether it's R&D, ensuring that we have business cases around everything we do. We have gates so that we can measure the efficacy of the action and that it's delivering what we want. And then these things together is how you drive both top line while expanding your margins.

Sure. And so I mean, I guess, what I'm also hearing is that you can't sacrifice longer-term growth and market share simply to a short-term profitability focus, right? And I mean, I've been doing this long enough. I remember in the early 2000s when the market flipped and only cared about free cash flow. And it was a company called AT&T Wireless that said they're going to hit free cash flow positive and they stopped investing in the network, they stopped investing in customer acquisition, we all know how the story ended, It end up having the worst quality wireless network in the industry and just didn't survive independently, right? And the companies that did continue to invest at Verizon were the ones that ultimately won that battle. So are you guys of Verizon? Do you guys keep investing and outspending your peers in this environment? Because you think in 3 or 4 years that things are going to stabilize and the company that has the dominant market share is going to being the winner or do you kind of fold the near-term pressure that's telling you you're spending too much on sales and marketing and you're just buying revenue and pull that back.

Look, I would reiterate what I said a moment ago, which is appropriate investments with the right ROI characteristics on them. We're extraordinarily fortunate. We're coming into a company that has a $2 billion run rate. That's an extraordinary amount of cash when you think about the ability to continue investing in R&D and innovation that has allowed us to maintain strong ARPUs quarter-over-quarter, year-over-year that are stable as you think about new capabilities to delight your customers, as you think about, to your point, sales and marketing and the motion to keep driving pipe and keep driving growth, while at the same time, meaningfully expanding your margins.

Yes. I would -- just to add to that. And I don't know if you could ever call yourself Verizon. AT&T has spent many years as AT&T.

Both are our partners, and we like them both.

Yes, I'm sure.

But what I would say is certainly, as a company that is IP-rich, R&D investment is something that's extremely important to us and close to our heart. That is not something that we will pull back on significantly. What we'll do is make sure that we drive the right economic return from the investments that we make. We will continue to invest in growth and innovation and features that will add to the value proposition to our customers.

That makes a lot of sense. And you just mentioned ARPU stability and that kind of addresses, I guess, another fear in the market that's been around for several quarters, and that's competition, right? and the idea that it's a commoditized or commoditizing industry and what generally happens there is you compete more on the base of the price and/or bundling. And so that's been overriding fear. But you just mentioned that ARPU has been stable, right? So I guess, where are you seeing competitive pressure -- maybe you aren't? And then how are you able to keep ARPU stable? And when we all keep hearing that pricing is coming down and competitors giving away seats for free. And so I guess what's driven that stability?

Yes. So just stepping it up for a moment and in case people aren't aware of what we've disclosed recently. But first and foremost, our all-in ARPU has been stable quarter-over-quarter year-over-year. Our acquisition ARPU, so new customers that we won in quarter stable quarter-over-quarter year-over-year and renewals, so as our customers are coming up for recontracting and again, on about $2 billion run rate. Our renewal ARPU has been stable quarter-over-quarter, year-over-year. And in aggregate has had $30-plus handle on that. And to your point, so then the question becomes how and the answer is twofold, one, very rich IP that has allowed us to differentiate the product in a way, world-class, market-leading feature functionality telephony in the cloud that's almost on instantly enable to serve any business of any size, check, five [indiscernible] reliability, geographic coverage, rich features. These are the things that any business that has strong connections with customers, right, call it consumer to business oriented businesses, financials, healthcare, insurance, logistics, TMC, manufacturing, education, government services anyone that as part of their business identity needs to talk to their customers needs our services. And those customers value the capabilities that we're bringing the feature richness which has allowed us to maintain, that's one. And then the second one is, as I articulated a little bit ago, we are world class in terms of the investments that we're making in our R&D and continuing to bring new innovation. And we're seeing more and more of our customers evolve up the SKU stack, if you will, to more and more premium SKUs as part of the renewal cycle, which is also helping. And tied to that, we have -- we're the only company with market-leading Gartner, UC, NCC that is built together, delivered together. You put all those things together, it's leading to the ARPU outcomes that we just articulated.

No, that's great. And just to be clear, I mean, part of the renewal rate stability and then even the new customer acquisition. Part of that is the customer is trading up to a higher price SKU within that. So part of it is also the mix and the bundle that they're taking, right? So I'm not -- so I guess part of what the market is hearing and seeing is more kind of a like-for-like maybe pricing pressure. We're talking about to simple voice. But then all in ARPU is actually stable because you're just selling more product into that customer.

Michael, just to address that. We've also said, look, if you just look at UCaaS set aside the multiproduct dimensions what we do, UCaaS has been stable quarter-over-quarter year-over-year on base acquisition and renewal as well.

That's a great point. I wanted to shift a little bit and just talk about CCaaS. And then also after that, some of your partnerships, which I think differentiates the RingCentral story relative to some of the peers and competitors. But first, maybe to CCaaS some success -- some of the success that you're seeing there.

Yes. So first and foremost, we've disclosed that CCaaS is now over 10% of the company's revenues. We are seeing over 60% of our larger deals have CCaaS attached. The take rate is increasing year-over-year in the first quarter and the average deal size is increasing year-over-year in first quarter, again, for the larger deals that we're doing with our customers. Historically, we've gotten quite a few questions this morning around kind of the market dynamics.

Yes, there's been some shifting dynamics here to, opt that you might comment on.

But a high level, if you kind of step back and you think about the legacy profit pools and customer base from which we're winning, right, the on-prem UC and CC business, if you will, historically, 60% of all of the UC and CC seats that have been sold ever were bought from single suppliers. And so this shows you that CIOs and other decision-makers inside of businesses. They're used to buying in this way. They're buying in this way because of the differentiated capabilities and integrations with broader company OS the stack that you get. And it's why we're winning because it's aligned with the historical motion, if you will.

Great. That makes a lot of sense. And then I think you prefaced that by saying some of the shifting dynamics in CCaaS 2 has been announced recently, but some other partnerships that [indiscernible] recently. What do you make of that? How competitive do you think that they can be. You've seen -- added focus over there and adding increased functionality, right, onto their core video product, you talked a lot about phone now moving to contact center. So I guess, how competitive or meaningful do you think that, that announcement is?

Well, they say invitations is the greatest form of flattery, if you will, but it seems to just revalidate what we've been saying for quite some time. The only additional comment I'd make because obviously, I'm not here to talk about other people's announcements is. What truly differentiates what we have done with UC and CC and why customers are buying both solutions from us is the deep integration of the products that differentiates both the employee experience and the customer experience when they're interacting with our customers. And that is not something that you get from a, call it, a BAU channel relationship where someone says, "Hey, I'm just going to bolt on your thing and sell it." That deep integration takes investment. It takes time. It takes your sellers understanding that and the value creation that comes with it and then moving into the market. So frankly, I don't expect any sort of near-term implication and then time will tell on if those investments are made and how that might be differentiated.

No. It's a great comment. That goes back to your earlier comment about customers want a single source that you see and then the contact center. So that's what you're hearing more from your customers?

Yes, especially as you move up market. As I think about who we sell to by segments. Generally, you find in, call it, more mid-market, it's line of business buyers. But the larger a customer gets CIO supply chain becomes very heavily involved. And that's where we're having both solutions together is very, very powerful, especially when you even in with the integrations, feature functionality that we speak in -- we've spoken about so far.

Yes. And I wanted to take that last comment about the kind of incremental product and functionality. And to tie it back to value creation, creating value through reducing customer churn, right? We all think about ARPU as one way to kind of improve profitability or corporate value, but reducing churns are a very powerful way, right, of improving profitability. So what kind of are you seeing from customers as they take more product? Are you able to quantify that where you say enterprise customer that takes 3 of our products or 4, they churn at a 10% lower rate. Is there any quantification to that.

Yes. That's spot on broadly. So the way we've discussed this externally is last year, we saw the lowest churn rate that we've ever had as a company for the year. And we said in Q1 that generally, we've seen churn steady, flat coming into the year. And there's 2 key reasons that's driving that improving churn. The first one is moving further and further upmarket. And tied to that, the product bundling as we talk about more than 60% of our larger deals are adding on contact center. That's absolutely having a positive impact on the stickiness, the value creation, et cetera? And then the second one is we spent a lot of time and effort like truly understanding for lack of a better term, the signatures of customers that churn or down sell and being able to use that understanding to proactively using AI techniques, flag customers because at a $2 billion business, you can imagine there's many, many seats and many customers to zero-in on those customers that we think we need to actively lean in on and do something in order to help them see the value of the product and minimize churn in that.

Preemptively you address potential churns, you take characteristics I think you did, your main quality of service or service calls and you probably triangulate that back and say, "Hey, this is a higher churn risk client. Let's go ahead and address it now" rather than trying to do a save later.

Exactly right.

Makes a lot of sense.

One thing I would just add, I think you started off asking where would we focus and where is the emphasis likely to be going forward as we think about being even more profitable. And you hit the nail on the head, churn reduction and managing churn is an unbelievable tool. And I think it's sometimes overlooked. And if you look at our partnership deals for example. And we gave some disclosure. We don't give unit economic disclosure, but we give disclosure around LTV to CAC. And our partnership seeds are accretive overall to our profitability. And part of that is lower churn. And it's a tool that we will use and a metric we will use absolutely as we manage the business now and going forward. So you should expect to see improvement just on that basis alone to our overall profitability.

No, it's great. It's great to hear. It's good color. I agree. I think the market part isn't focused enough on the doll improved churn and how important that is. Talking about the partnerships. I think I mentioned I wanted to go into that next. Can you just describe how this is so important and how they differentiate your sales motion versus some of the peers, the competitors out there just don't have that kind of strength of partnerships.

Yes, I'll start by saying really our intent is to create as many avenues to the cloud for our customers as you can. It's a very large TAM as has been articulated so far. And so we've created, call it, 3 types of strategic partnerships: the first one is channel and VAR. And we've said, look, we have over 10,000 partners from a channel perspective. Last year, we disclosed growing at double digits year-over-year, and that's continuing to grow this year. And that's everyone from very large companies with sub companies that have worked for them down to a 2-person company that's selling locally in a given metro around America. Second type of partnership is what we call our strategic partnerships, Avaya, ALE, Atos and Mitel. These are the holders and the companies that sold the majority of the legacy on-prem PBX seats that we have been migrating to the cloud via the new feature functionality capabilities that we've talked about already. And then the third one is our global service providers. These are, as Sonalee articulated earlier, really large mobility companies, cable companies, telecommunications companies like AT&T, Verizon, British Telecom, Vodafone, DT, et cetera. And each one of these opens up new TAM, new segments, new countries for us to bring RingCentral to customers that need the capabilities that we can provide as we talked about, especially for customers and verticals where they're actively working with consumers every single day as part of their business identity.

I think I over look sometimes, too, is that people don't fully appreciate some of the larger enterprise, they only buy through a trusted partner, right? I mean they're not going to go with an unknown commodity to provide a mission-critical service like voice or messaging or contact center. So having that partnership with an AT&T or others does provide that avenue into these large enterprises.

This goes to Sonalee's point earlier on the economics of using these partnerships. And then on the strategic partnerships, specifically the LTV CAC is accretive to the overall LTV CAC of the company exactly because of this point in my [indiscernible].

You have a great metric to go.

Yes.

I'm asking a few common questions of everyone this week as we can kind of get a sense of where companies are. And one of them is around stock-based compensation is something investors are asking a lot about recently because obviously, most stocks were lower than they were 12 months ago, right? So what we're asking is whether not company is thinking about restriking right, previous granted? Or if they're thinking about shifting the mix between cash and noncash compensation for employee retention and attraction. I know in your 2 weeks, if you've had a chance to formalize this yet. But any comment will be appreciated.

Do you want to take it off.

You go ahead and kick it off.

No problem. Broadly, our goal as a company is to remain highly competitive in terms of how we compensate our teams. And so what we're always looking at what's changing, who's doing what, twice a year, call it, an annual refresh of what's happening in the open market to make sure that we're remaining competitive. And from that standpoint, I mean, frankly, we know we're a very competitive giver in terms of overall target compensation, both cash-based bonus as well as long-term grants. Relative to your question on the SPC component and how we're thinking about that longer term. What we've publicly said is, look, we expect that our SBC as a percentage of revenue is going to continue to come down over time. This year, we expect it to improve by about 200 basis points relative to 2021. And if you go back to one of my earlier comments around how we're ensuring that we're driving top line growth and bottom line is being very disciplined around hiring. There are specific functions where, obviously, as you continue to scale a business, you need more people. As an example is you have more customers, those customers want to interact with the company, you need more care agents on -- of course, with improving productivity year-over-year. If you're driving top line growth, then as you're looking at your partnerships and your direct, et cetera, then you may consciously choose to invest in more direct sellers as part of that growth. As a $2 billion company, we now have the opportunity to look at every other function and really make conscious decisions around ongoing hiring. So that ongoing hiring and being disciplined around. It also means that we can very effectively manage the way we think about our SBC as a relative percentage of future revenue growth as well.

Is there an opportunity to bring compensation costs down. I had a meeting earlier where one of the executives said that look, they think that last few years, compensation has got out of hand, right? And part of that was obviously the battle for talent. There wasn't enough talent for each [indiscernible]. But their thought was that there's an opportunity now to actually bring that compensation cost back down maybe where it was a couple of years ago. I mean, do you have a view on that?

Two comments and then Sonalee can chime in as well. One is, as I already said, fully expected SBC as a percentage of revenue, which I think is honestly the right way of looking at it, is expected to continue to trend back down. The other one is, as we've continued to grown as a company, we also made conscious decisions around, call it, office locations. We've got hubs around the U.S. as well as in Western Europe. And absolutely, we continue to look at like what cities should we be investing in and you can imagine some cities are just inherently because of the cost of living lower-cost cities to operate in as well. So as you think about new growth if you're consciously deciding to hire in lower-cost cities, then yes, that's also another way that you can drive down, call it, the broader cost profile of the company. Anything you'd add to that?

You know that was such a complete answer. I don't think there's a lot for me to add.

The next one was just the -- any impact from the war in Ukraine. You guys feel on any financial impact from that operational impact.

I mean, we're very fortunate in that less -- or around 10% of our revenues is from international. We're mostly domestic. So we don't feel any strong impact from that specifically. We did call out in our earnings FX impact in Q1. All of us in the room here know about the strengthening of the dollar. But we incorporate at least some of that into our full year guide. Again, nobody knows exactly what's yet to come, but we feel very comfortable with the guidance we have out there, at least capturing where we are today. And from our perspective, actually, international remains a very significant growth opportunity. So we see a lot of potential there and Mo talk to our partnerships, but that's one of the great attributes of our partnerships is that global geographic footprint.

It improves that reach, right?

It sure does.

Of course a multiplier for you.

Yes.

I wanted to ask about M&A. We've got 4 minutes left. We'll open to the audience here in a minute. But just quick thoughts on potential for M&A? Obviously, public and private valuations have come have come down. So anything is cheaper today than it would have been 12 months ago. Just any thoughts on the potential for M&A? And then maybe where in your product portfolio, inorganic might be a better solution than organic growth?

We're -- over the last several years, we've done a handful of small tuck-in M&As. As an example, in the first quarter, we announced the first of its kind AI meeting summary. They're back to the higher SKUs, higher ARPUs, et cetera, live transcription of a meeting so that if you're 4 or 5 minutes late, you can quickly scan -- I know, Michael, you'd never late to a meeting, but just.

I'm always early.

Always early, early is on time, right? But if you happen to roll in a few minutes late, you can quickly scan through and see who said what and get caught up. We also have this AI meeting summary capability that at the end of the meeting, it gives you the key points. They're editables, you can go in and tweak them slightly, hyperlink to keywords to let you go in and read portions of the transcript that are -- might be relevant to the thing that you're interested in. And that capability is something that came from a tuck-in transaction that we did a couple of years ago. And so while we have certainly nothing to announce at this time, of course, we're always looking for opportunities that help us continue differentiating both our core product as well as potential adjacencies that allow us to bolt on new things to what we do and/or create additional value on higher ARPU SKUs. That will maintain the ARPU stability that we've been talking about here.

That was great. Do you have any quick thoughts on M&A or even what your thresholds are for accretion, dilution, multiples?

What I will say, though, is we are aware of SaaS valuations at the moment, and we wouldn't look to do something that was extremely dilutive. And we're aware shareholders' views on those types of transactions. But as Mo said, there is a chessboard. There are a lot of pieces out there, and we feel very well positioned to be able to take advantage of opportunities should they arise. And I'll finish as I started, we're a $2 billion revenue run rate company that's becoming increasingly profitable. and throwing out cash flow that is going to grow. So we just feel very, very well placed relative to the peer group.

That's great. Thank you both for the overview. We have a minute or 2, if there are any questions from the audience. I can go on and raise your hand, they'll ring you around a microphone. If not, we can go ahead and end to there. Okay. Great. Thank you, guys, both.

Thank you.

Thank you so much.