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

Good morning. Thanks for joining us. This is -- my name is Fred Lee, and I'm the small and mid-cap software analyst at Credit Suisse. I recently rejoined a year ago and launched coverage just 2 months ago. Rejoined after 18 years on the other side of the business that's actually started here at Credit Suisse. Welcome to our 26th Annual Technology Conference. And with us today, we have RingCentral. We have Founder and CEO, Vlad Shmunis. We have CFO, Sonalee Parekh, and we have President and COO, Mo Katibeh. And so thank you for all 3 joining us today. So this is going to be an incredible conversation. I wanted to start off with the high level overall opportunity for Ring. Since we have you here with us, Vlad and would love to understand how your vision has evolved over the past 20 years and where we stand today and what's next?

Yes. No, thank you for having us. It's a nice intro. Okay. Great to see everyone. Yes. For those who are maybe new to the story -- so we are the leader in unified communications as a service. And in human speak, what it means is that we replace traditional on-prem PBXs with a pure cloud solution. We are one of the original SaaS providers, one of the pioneers in this space. And we are, as we sit here today, the leader by seat count and by revenue as well according to multiple industry reports. So obviously, things have been changing and evolving over the last 2 decades, which is how the company is. But the underlying premise remains the same, which is everything that is on-prem will eventually go to the cloud. We have invested a lot of time and resources into coming up with today's widely considered to be a leading solution. Another major analyst just recognized us as a leader in their quadrant. This report will actually -- our press release, I think, is going to hit today on this. And I think this is our 7th, 8th year in a row that we're leading there. So opportunity is a very, very large. Research suggests that there is upward of 400 million seats of on-prem PBX seats that have been sold over time worldwide. We have, as of our last disclosure, a bit over 5 million seats and people usually credit us with, depending on the report 20% to 25% market share. So if you do the math, then you can see that overall penetration industry-wide is still not even close to double digits, okay? So a huge amount of runway ahead of us, us as a company and us as the industry. And we're just continuing redoubling on our core strengths, which is replacing on-prem PBXs with a cloud solution. Of course, given the latest technology advances and megatrends, we have added other means and modes of communications. So video, messaging, contact center, I think we have recently announced that contact center [indiscernible] billion for us. So that's definitely a strength. And we continue investing across all of those vectors and winning our share; hopefully, more than our fair share.

And with regard to the product set that you just outlined, where do you see the greatest near-term demand? So for example, when we think about messaging, how do we think about messaging versus in the context of video and the context of cloud PBX, where are you seeing the greatest near-term demand?

Look, so it depends. It depends on the customer by customer. But in general, if you think about leaders in this space, obviously, we're not the only player with -- who is trying to address this market. But if you were to look at, call it, top 3 breakaway companies, so there is ourselves. There is Microsoft, there is Zoom, and we each lead from different angles. Microsoft is leading with Teams messaging, doing very well there, Zoom, but they also have other modalities -- of those -- their video. It seems to be okay for intercompany use primarily. Their phone, good, not great. So we have quite a nice following across Teams users selecting Teams for messaging and RingCentral for telephoning. So that's actually more of an opportunity for us, I would say, than anything else. Zoom, as probably people realize is [indiscernible] very strong video product, less so messaging, less so phone. We're living with the phone, okay? So people who come to us are companies and we are only B2B, we don't have any consumer -- users. So people who come to us are people who are particularly serious about their voice communications. And what companies are those. If you think about it, these are the enterprises or brands, if you will, with direct consumer exposure because there is a lot of talk out there as well, who needs to happen? Who needs -- who is using the phone. Well, all of us use the phone, still the iPhone. It's not an iMessage. It's not an [indiscernible]. It's an iPhone, okay? And if you're talking -- calling your local pizza parlor, you're going to call them or if you're calling your dentist, your gardener, whatever small business you think -- or not so small, we have some very, very large businesses, some of the leading universities. We are strong in the public sector. We have large insurance companies using us. What ties them all together? They're interfacing, interacting and providing a face to deal with regular folks. And this communication is vibrant well, this mode of communications. And people talk about customer-centric communications, and that's where we're the strongest.

So how do we think about the catalyst that will drive the, call it, the transition from legacy PBXs to cloud solutions. You talked about 400 million lines out there. Ring only having 5 million today, a large runway for growth. And so with COVID, there was a lot of change in cloud communications, the way people talk and communicated. What are some of the future catalysts -- where we still experience some of the post-COVID catalysts? What are some of those key drivers that we can expect over the next 5 years to further penetration and adoption?

Right. Look, the opportunity is there, and it's a moving train. Yes, I mean, some people have thought that maybe -- it would be moving faster than [indiscernible] moving, but it is moving. No one ever goes from back. No one ever goes from the cloud back on-prem, okay? And there is no innovation left in on-prem. I shouldn't say left, but nobody is innovating in on-prem. So it's only moving in 1 direction. Look, as far as catalyst, it's going to be interesting. Many people gave us -- maybe credits saying, okay, well, Ring is another COVID story. We were not. We were not. We're always about communications, any mode, any device anywhere that was pre-COVID, during COVID and now after COVID. So if anything, during over, people froze on making strategic decisions, okay? So we are now is coming out of that mode. Obviously, there are other factors in play now. There is a macro, which is not quite what would was for last number of years, but hopefully, that will pass too. Look, to your question, what is the catalyst? Look, eventually, this hardware ages and dies, okay? Catalysts are continual improvements in broadband. 5G is definitely a catalyst. You can just do so much more if you have reliable connectivity, which is wide band, okay? And look, a lot of continued innovation everywhere. So we are now -- and we're leading there. We're adding AI. We're adding analytics, okay? We're adding chatbots into our portfolio, not just into our contact center or videos that some people are doing, but across our entire portfolio, which is -- which starts with voice in the end, okay? So the more we can provide, we're very tech -- I don't like that word, but I don't know another one tech-heavy company, okay? So we have historically out-invested our competitors. And we continue being very committed to winning through IP and winning through innovation. And it's been carrying the day for us, and we're going to continue betting on that horse.

Mo, I wanted to ask about your go-to-market strategy. So I've always been impressed with your strategic partnerships, the reseller ecosystem and wondering about your go-to-market strategy overall, how it's evolved in this environment. And if the playbook has changed at all over the past 9 months.

Good question. I think relative to how has the playbook changed? And building on the question that you asked Vlad, which is catalysts. I think a very key one that's playing out right now is line of business buyers -- IT buyers being very conscientious of cost, value, TCO, how do they drive savings, budgets getting smaller, more strategic spend, creating better customer experiences, better employee experiences. And you wrap all that up together, you can see that one of the things that we're doing is in this sort of economic environment, really doubling down on the TCO benefits of transitioning from on-prem to cloud. And we have many years of data, customer testimonials, surveys of thousands of customers, years after the fact. And we know empirically that as part of that transition, payback is sub 1 year, 30% to 50% savings and really driven by 3 things. The first one is inherently, I call it the cost of the solution. Two is the associated telco costs, carrier costs that come along with it. And three is the sort of human surround that is required to manage an on-prem system, which simply goes away as you move to a cloud-based solution. So absolutely doubling down on that message. Another one building again on what Vlad articulated is selling through curiosity on what is your existing solution? Some customers may have hybrid on-prem, they may have adopted teams for messaging or intracompany communications, video, et cetera, and are in need of a world-class telephony solution to power that. And so those would be 2 key evolutionary trends that we've seen in terms of our go-to-market this year. As we see what's happening in the broader economy as well.

Can you talk a little bit about how your customer conversations have evolved? And if there is more of a pull considering the TCO of 30% to 50% savings versus a legacy PBX solution, are you seeing incremental demand there? And are customer -- do you see an uptick because of the cost savings shifting to cloud PBX?

It's a great question. It's an interesting year as we all know. And we're definitely seeing a tension of realization of the cost benefits that are involved with the migration coupled with, call it, top-down pressure within each company on examining every penny of spend? Is this the right time? Uncertainty about what the next 12 months holds. And as we talked about the last 2 quarters, we've also seen that manifest in frankly, really strong leads and pipe, but the longer sales cycle times and smaller initial opportunity/deployments. And so that's the confluence of things that are playing out. And then obviously, what we're trying to do is elevate the conversation, take it to whatever the decision maker is, in many cases, the CFO. And we resemble this, like we've been changing our own PO policy so that more and more things come to us. And we're seeing that play out across the broader upmarket environment, if you will.

Can you talk a little bit about demand trends across the different types of customer sizes and verticals as well as geography?

Yes. As we talked about during our last earnings what I think is quite surprising for many people is the SOHO/SMB base has been quite resilient. I've been asked if I saw those trends continuing into October as well. Our earnings was at the beginning of November, and we reiterated that we did. SMB has been resilient for us, which, frankly, in many cases, is not even an on-prem PBX to cloud migration opportunity. It's an entirely new TAM, if you will, but was using other legacy telephony solutions or their mobile users that they want a separate business identity on their mobile devices. Lots of ways to sell into that base, and they're seeing the value of the multimodal and capabilities that we're bringing to market. Upmarket, I think we just -- we talked about that dynamic. And obviously, no surprise, Europe is seeing more pressure than other geographies. For us, that has not been a meaningful impact on our go-to-market because it's been about 10% of our revenue base. So it's a very low share opportunity potential upside as we look ahead. And then Sonalee can build on this. For us, it's been more about the FX headwinds that have come with the fluctuations in the pound primarily, and that's where that's manifested for us.

So maybe that's a good segue into some of the happenings in the third quarter. You delivered upside to margins, which the market greatly appreciated.

For the fourth time. Just saying.

And so the pulling forward of your profitability targets that's something that I think is well received. And I was wondering if you could talk a little bit about how you're thinking about the balance of growth versus profitability. It's a common question we get from investors. Can the business continue to sustain momentum if there driving -- if they're driving greater profitability?

Sure. So you're absolutely right. We did exceed our profitability guide for the quarter and we took the opportunity to raise our guidance, and we're now guiding to 12.4% OP margins for the full year. And then for 2023, we have guided to at least 350 basis points further improvement from there. And that's driven by a couple of levers. Firstly, we are enjoying the benefits of scale. Now that we are a $2 billion recurring revenue business. That's natural in the SaaS model, and we are at that point in our evolution as a company. Secondly, we have been maniacal about discretionary spend, and we will continue to be maniacal. We have looked at literally every spend category across the board. And we did find not to use a cliche, but there were some low-hanging fruit there, that we just took the opportunity to address immediately. And then there's the tougher decisions that we took, which included a reduction in our employee base, our FTEs of about 10%. And there's the reduction in actual numbers, but then there's also getting more productivity out of our people. And what we found was, again, there were some opportunities there that you'll see come through mostly starting from about Q1 of next year, but that will help to drive the profitability further. And then finally, we looked at spend across the board on procurement. And we're doing what many other companies are doing, but again, just super judicious about consolidating vendors. Mo alluded to the delegation of authority, if you want to spend over a certain amount of money, you now need to come to CEO, CFO and COO. And what we're finding is it makes people pause before they actually pull the trigger. And it really works. So taking all that into consideration, we feel very, very confident about the profitability guidance we gave. And we also feel very confident that we can continue to invest through the cycle. And one of the great things about being a company at scale is we can pull back spend in certain areas and continue to invest in others. And Vlad alluded to R&D, innovation and product being core to our DNA. And we have the industry-leading gross margins we have because of the richness of our IP, that won't change. That is who we are and it's part of our identity. And that's why I always say I never really saw that as a trade-off between growth and profitability. I believe we can drive efficient growth. And we're seeing that come through, and you saw it in our Q3 results. And on the macro side, Mo alluded to this a bit, we are seeing certain trends, particularly in the enterprise customers upmarket, which is the longer sales cycles, more approvals, smaller initial deployments, that is having an impact. However, what I would say is we haven't really seen any incremental deterioration to what we communicated to you at our results earlier this month. So we're seeing actually quite a bit of stability in terms of the macro front. And we believe and believe strongly that this macro environment, it's a temporary thing. And we are making the investments we need to make to ensure that we can be a healthy profitable grower, as we come out of this, to which we're really confident about.

You mentioned low-hanging fruit. And I'm just curious what some of that low-hanging fruit was if it was related to advertising or marketing or G&A?

Yes.

Where some of the savings were.

Okay. So one of them, I would say, was marketing related. And it was -- we made a very big splash in brand spend earlier this year. And I think as a team, we had decided anyway it was something that was unlikely to repeat in that same kind of -- in terms of absolute dollars. We -- it was always going to be onetime in nature. So that was an easy one to. We haven't cut it back fully, but we've reduced the spend there. But the other thing was the way we were organized in marketing was not as efficient as it could have been. And we found that there was actually some overlap in certain areas. And that was another easy one. And then there's things like events, do you really need to spend as much as you did the prior year, like often in budgeting, what happens as you look at last year's budget and then it's -- you apply up, we're growing this much and it's a plus x percent. And we just all asked ourselves like, can we still do a great event where customers will have a bad time or sales force will feel motivated and incentivized, but just spend a bit less money. And we've done that. And another one is travel. And not for anything that's customer related. But some of the internal stuff, we felt like we could pull back. And what I would say is we found broad support from our employee base on this as well.

I think in general, just to summarize, look, it's relatively recent, but it does seem that we're able to achieve more with less. And in our cutback, we largely spared product and technology, so product and R&D will largely spared quota-carrying heads. And a company of our size, many thousands of people, there is -- there are pockets of inefficiencies, G&A, some marketing functions, Sonalee already mentioned, nothing customer-facing. So another pocket we spared is customer-facing representatives on customer care. And look, over time, and especially during COVID, there was very rapid growth. We literally onboarded a few thousand people during COVID. Many of them have never met their teams. So they never kind of really took root, if you will. And now that we are reverting to normal and our offices are open, and we're hybrid and we'll stay hybrid, but it's certainly not you're going to -- you don't ever need to show up and you don't know what your team mates look like. Those days are done. So by just cutting out all of that extra weight, again, a lot of which was very, very recent anyways and never really contributed. Yes. So far, so good.

Understood. Wondering if we could shift gears a little bit and talk about your competitive moats. So over the past 3 years, how that has changed and then the defensibility of that moat and how you see that evolving over the next few years?

Yes. No, I'll take that at a high level. Look, it's -- to quote someone, everybody remember, I'm sure or paraphrase, it's quality. He said there's the economies too, but it's quality, okay? We simply have world's best cloud PBX, okay? That's a huge moat. Again, if someone is serious about customers that are consumer-facing communications, we are the go-to company. So in the end, that's our largest moat, okay? Now what does it mean a little bit more practically? It means not world-class, but world's best reliability, always knock on something. But Five 9s' reliability for, I think, at least 3 years and counting. That's unprecedented. Nobody has that. Going down detector, see what people say about RingCentral's uptimes versus any and all of our competitors, okay? Geographical coverage, huge, modern world businesses of any size, most are distributed and largely -- and most of them are international. We have -- we believe the world's largest regulatory compliance. People will throw -- and we're talking about multiple, multiple dozens of companies here with full regulatory compliance, okay? Including some of the fairly stringent, if not aggressive European data privacy data residency requirements that we have just checked the box of that with some of our largest partners and resellers, okay? And which brings me to our second moat, which is an unmatched partner network, starting with some of the world's leading what we call GSPs, global service providers, [indiscernible] companies, okay? So people who are reselling RingCentral and doing well with it, AT&T and Mo used to lead AT&T business. It used to be a customer for about 5, 6 years, before he joined us. But that was our first major partnership like that. Since then, we've added British Telecom, TELUS, one was a leading Canadian providers, Vodafone, Deutsche Telekom, just to name a few, okay? And that is growing. So -- in addition to that, and many people know this, we have relationships with some of the leading on-prem providers, in particular, starting with Avaya, but a few others -- Alcatel like that. And look, as Avaya's issues are well publicized. So I don't think I'm spilling any beans here. But I can say that they've been doing better and better quarter-over-quarter, which goes back to the underscoring value prop. We provide people with more for less. And regardless what any partner of ours, whatever their financial health may be, the end customer is still benefiting from this digital transformation migration to the cloud. And we simply have the world's best mouse jobs there at this time. So again, it's our technology. It's our partnerships, okay? And we -- and so cheese for technology piece or partnerships that is for innovation, okay? We provide people with -- I don't know if it's bleeding edge, but certainly leading-edge technology. And that's been carrying today for us.

And on your second moat with regard to Avaya. So when you inked that deal in 2019, a watershed deal, a big moat for the company. And they talked about having 100 million lines at the time. And since COVID, we have some industry update where there's been some -- somewhere around 85 million or 90 million lines out of Avaya today, and you've accrued around 0.5 million of those. And I guess one question for me is, where are the other 14.5? And then as it relates to the commissions that you prepaid, what are you seeing inside of Avaya? Are they still motivated? And are they still properly incentivized to drive your business?

Yes. Look, so we, in a way, got our money back on the prepaid because of [indiscernible] more than what we -- what the prepaid was, okay? So from that perspective, no regrets. Look, we all would want of more seats always, okay? But Avaya is still the world's absolute undisputed world lever by count of deployed seats and it's a little bit hard to make -- to be 100% sure, but every indication sales by also the lead in the number of currently active seats, okay? So there is still a huge part of opportunity out there. Look, many things happened, COVID happened. COVID was not good for any of this. Again, people just froze. And certainly many, many people said, we're just not going to do anything with our telephony but now if we're ever going back to the office, we'll do video. Well, guess what? Here we are, we're back in the office. So it continues to be an important relationship for us. We're certainly doing what we can and working very, very hard for them to stay as an independent going concern. But in the unfortunate event that does not meant to be, then we're very confident that was our technology that still is a natural destination for their entire customer base in the UC space. They also have the contact center space, which is a different story. But for their multiple tens of millions of on-prem phone customers, PBX customers, look we're the only cloud service that can support their end points. Those 100 million endpoints of iPhones that are out there that you have probably seen in a majority of meetings you take with people, who [indiscernible] the cloud only in RingCentral.

I wish we had more time. Thank you very much for attending and being with us here today.

Thank you.

Thank you.