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

Good morning. Thanks for joining us. This is Day 2 of the Wells Fargo TMT Summit. I'm Michael Turrin, the software analyst here at Wells. Very pleased to have a couple of distinguished speakers from RingCentral with us for our morning session, early morning session in Vegas. Mo, President and COO of the company, joined in 2022 from AT&T; and then Sonalee, CFO, joined in May 2022 from HP. And so I kind of wanted to start there with the intro question on just what brought you to RingCentral, what your initial observations have looked like? And what your kind of key points of focus are. We can start with Mo maybe and then transition to Sonalee if that works?

For me, there were 3 key reasons. One, I've been fortunate to know the RingCentral team for about 5 to 6 years at that point. RingCentral has been a key partner for us at AT&T business in terms of our go-to-market and UCaaS solution that we were selling. And for me, there were really 3 things. One was having had the opportunity to work with, sell, partner with so many different UCaaS and collaboration companies. I knew RingCentral's product and solution was best in class in the world, like without a doubt. And building on that, I knew that the innovation engine and, frankly, just the amount of money that we were spending and innovating every single year, was going to ensure that product leadership and world-classness for many years to come. The second key reason was I knew that this was going to be a company that was going to drive healthy organic growth for many years to come. I'm sure we'll talk more about the market opportunity and seats, et cetera. But again, from a historic vantage point, just truly understanding the sheer number of PBX seats that were remaining, one, the sheer number of other legacy copper or TDM-based technologies that we're going to need to migrate to the cloud. And then even beyond that, in SoHo and SME customers, businesses that have never used a PBX solution, but we're going to want the capabilities that UCaaS brings. It was going to be a healthy organic growing company for a long time. And then the third one, and he's not here, but I really like Vlad. I really like the leadership team, and I wanted to be part of that culture.

That's great. Sonalee, would you care to join on that?

Sure. So I joined because of Mo. No, but...

We spend a lot of time to go in.

Exactly. All joking aside, the team was a major reason. As Mo said, Vlad is a visionary. And he's one of those people who is not just visionary in terms of product and innovation and where he wants to take the company. He's also visionary in his leadership style, and I love that. And I come from an M&A background. And I worked with a lot of founders through M&A. And I always knew that I wanted to join a company that was found or led because I think it comes with a certain degree of passion and love for what you do, and Vlad brings that every single day. Secondly, I really saw RingCentral as a totally unique opportunity in the SaaS landscape. There are so few $2 billion recurring revenue businesses operating at scale, growing at the pace that we're growing that are actually profitable. And I knew that we were going to be hitting that sweet spot in terms of operational leverage, which you've now seen come through in our last couple of quarters and lots more to come. But I really saw that as being one of, say, 5 companies out there in SaaS land. So I really saw a huge value creation opportunity. And then Mo's point about R&D leadership and product leadership, I wanted to join a team and a company that had a leading position that we could build upon. And one of the things that I think is so great about RingCentral is we are, like R&D, innovation, product, it runs through our DNA, and you see it in everything we do. And I'm sure you'll ask more about where we're investing, but R&D is a big area.

No, that's great. I'm going to -- you both give me something to follow up on. I'm going to go back to Mo first. Just I'm sure you have a fairly well-established view of the seat base, the market opportunity just from historical time at AT&T and now having a chance to evaluate from the RingCentral side. We see statistics that are very kind of large in terms of the potential installed base is a 400 million seats, 20 million, 21 million UCaaS seats currently. Can you just help level set from your perspective, what's out there? How you think about penetration and just RingCentral's path to slowly continue to grab onto those seats and maintain the leadership status in the UCaaS market?

Absolutely. And I think you nailed a couple of the key ones. A couple of quarters ago, we disclosed a fun fact that we crossed over 5 million paying seats. And to your point, as you think about the third-party data that's out there, multiple studies show that we are twice as high in terms of our market share vis-a-vis the next closest competitor. And so then you do the math that says, "Hey, there's $20 million, $21 million-ish paying UCaaS seats out there today. And we know factually there are hundreds of millions more of opportunity out there today. I mean, just if you look at the competitive landscape and the key legacy PBX players, their revenue, their seat counts, et cetera, just alone there, it adds up to well north of $100 million to $200 million. And the market opportunity is rich. And that's even before you get into the other TAMs in which we're operating, which is CCaaS is a completely separate TAM. I mentioned this briefly a little bit ago, but as you think about our multiple segment, multiple geography strategy, Soho and SMB, many of those customers have never had a legacy PBX. They're mobile-first customers. Their hybrid customers, they're small business owners. And they're looking for UCaaS capabilities to bolt-on and make their small business feel really large. And that's an area that we're doing quite well in. Early innings is the bottom line.

So one more on this. Just I think there's been a perception because of some of the surrounding markets that this was COVID beneficiary, there was a tailwind. And so migration activity had a catalyst. And now that, that's kind of changing, there's not as much opportunity ahead. I mean the numbers wouldn't support that. But your view in the field just around the -- just stability of the growth profile in the market and then Ring's points of differentiation within the market, I think, are reasonable.

Okay. So a couple of questions. Let me hit on each one there. One is the -- look, I think that COVID was actually misunderstood what we saw. And again, you can go look at other players' numbers in the market and supports this. As many people double down. Many businesses double down on the solution that they had at that exact moment in time. And so what have we seen? We've seen a lot of that PBX market, 100% is not transitioned. They've moved into subscription models or maintenance models or other sorts of models that are out there. Those seats are real. It's a question of when they're going to move, not if they're going to move. The capabilities, there's no real innovation happening on-prem, not that there couldn't be, but no one is investing in it. All of the innovation is happening in the cloud, the capabilities that have one already been launched and that are coming as you think about things like line of business analytics and AI capabilities that we can touch on later, will only 5G edge compute. All of these things are only going to give prem-based customers more and more reason to move. And that's even beyond the clear TCO savings that's involved as customers migrate to cloud-based solutions.

That's great. Sonalee, I'll go to you. Just 3Q, maybe you can help level set, you alluded to the margin expansion that you're starting to deliver, but just the high-level takeaways from investors, maybe ARPU sort of top of mind with RingCentral currently? And then I can ask some follow-ups from there.

Yes, absolutely. So we had an extremely strong Q3, which we were very proud of. And we actually upgraded our OP margin guidance for -- I think it was the fourth quarter in a row. So really proud of that. We also delivered very, very strong growth. And I think unlike many of our peers, not just in the communications space, but broadly, we were also able to reiterate our guidance on the topline on a constant currency basis. So when you think about RingCentral and what we've delivered over the last couple of years, I think what I'd really point to in Q3 is a step change in the OP margin profile of our business. And if you think about going back, say, 3 or 4 quarters where we were producing very, very strong growth. We were a profitable company but we were a company that I would say, had opportunities where we could do things a lot more efficiently and be more productive. And I think in the last 2 quarters and particularly in Q3, we made huge strides. So truly a step change in that profile. The other thing I would point to for Q3 is our leading -- industry-leading gross margins. So our subscription gross margins came in above 82%. And a couple of points to make there. One is I think there's always this fear around discounting and protecting our ARPUs. And I always go back and point to those industry-leading gross margins. And it shows you that One, we do have a differentiated product that customers are willing to pay for. And that's how we end up defending our ARPUs, and we've had stable ARPUs around the $30 level, actually above $30. And we also, at the same time, have gross margins 82% and above, and then that profile of improving OP margin. So I think when you think about the financial profile on a going-forward basis. There's a lot more we can do on the OP margin side, and you can see that we're already executing there. And we pointed to our guidance for 2023 on OP margin to expect at least a further 350 basis point improvement from where we end fiscal year '22. So growing strongly but most importantly, really, really expanding that profitability at a very, very healthy pace.

Yes. Now the offset is greatly appreciated. On the growth side, just to kind of ask the question, the growth -- the implied growth for subscription revenue was around 20% in Q4. It is slightly decelerating from what you have seen over the past year. And so can you just help unpack how much of that might be macro or some of the things that you're seeing with deal cycles and some of the things you're seeing across software?

Yes. So of course, like any other company, we are not immune to the current macro and as a management team, it's something that we are constantly evaluating, which is, again, why I said we're so proud of the results we delivered in Q3 and our ability to reiterate our guide and actually upgrade the OP guidance. So on the revenue side, you're right, we did see a deceleration. And if you look at what's implied in our Q4 guide, there is a deceleration. It's a 17% to 18% growth implied in Q4. At the time that we gave the guide, it was based on what we were seeing in the market at the time on a macro basis. A couple of the trends that we called out were, firstly, on the end product and end user demand, we're still seeing very, very strong trends there, which is unsurprising given we do help customers save money. And in the current environment, that's really important. But we also saw, particularly on the enterprise side, going slightly more upmarket, longer deal cycles. And we did see a slight deterioration Q3 on Q2 on that trend. We also saw extra layers of approval, which also causes deals to longer to close, and we're seeing that even internally. We're doing...

Are you doing more things?

Yes, yes. Exactly, exactly. And then finally, some smaller initial deployments. However, we haven't -- as I sit here today, we haven't seen any deterioration since we spoke to you in early November when we posted our results. So the guidance we gave was based on what we saw in the market then, and that is still what we see today, no further deterioration. So very comfortable with how we guided.

That's helpful. And then one more just on the margin side. You've made some significant strides for having joined fairly recently. So what are you finding just in terms of the initial view as CFO? And what are the sources of leverage that you're able to drive towards 350 basis points just the initial outlook for next year?

Sure. So couple of points to make there. When I first joined, of course, like as any good CFO would do, I had to look at all the cost buckets and we do have a very large OpEx base, given we're a $2 billion recurring revenue business. And there were certain areas. Sales and marketing, in particular, as a percentage of our overall revenue with off benchmark. And that's an area where, as you look forward, you should expect to see progress. The other point I would make is we're being very, very judicious and careful about how, Mo describes it as surgery. It's surgical the way we're doing this. We are making sure that we are not touching anything that will impact our ability to innovate, to invest in R&D through this cycle because we all know everyone in this room knows the macro cycle is a temporary thing. And we are making sure that where we are driving efficiencies it is not where there's a revenue-facing function. So on sales and marketing, we're not touching our front line sellers. It's more of the sales around. And there were opportunities. Someone said the other day, Silicon Valley is fat. There were some opportunities that were easier than others. We also made an incredibly difficult decision to reduce 10% of our workforce, which we announced with our earnings. But before we did that, we were maniacal just chasing down every bit of discretionary spend we could cut ahead of making that decision. So as you look forward, I would point to the fact that we said at least 350 basis points of improvement because there's more that we're going to be doing on the procurement side. I think we have over 50 initiatives going through the company right now. So more good stuff to come there.

Great. We'd like to say, maybe not fat, but often under dress in silicon Valley is generally the profile. Mo, I want to go back to you and talk about just the price phenomenon and suddenly touch on the gross margins and what that enables and what that demonstrates from a competitive positioning standpoint. But what do you see that allows the ARPU to hold stay at this above $30 range, particularly as you're moving upmarket, some of the seat counts are larger, there's an international piece. So I'd be surprising that, that's holding in so well.

Yes. Great question. So for those who may not know the story, for the last 3 quarters, we've been quite intentional in providing substantial disclosures on our ARPU. And essentially, what we've been showing is that ARPU is staying very stable and steady quarter-over-quarter, year-over-year during this time period, north of $30. So then to explicitly answer your question, this really boils down to our cross-segment cross-geography strategy as well as cross product. And we've got a very healthy mix of small business buyers that you can imagine are buying essentially at list price, e-commerce et cetera. We have larger customers, and I think no surprise to anyone in this room, enterprise customers for many decades have had large procurement organizations, supply chain engagement, RFPs, et cetera. So for sure, the ARPU there is a little bit lower. But as you think about those enterprise customers, they're also significantly more likely to be buying premium SKUs, one, for more capabilities for line of business. Two, as we've disclosed fairly regularly, over 60% of our larger deals also have contact center attached to them. And so when you put all that together, as well as the innovation and new capabilities that we're continuing to bring out to support our tiered pricing structure to incent customers at renewal also to be going up the SKU stack, if you will. That is the driver of staying north of 30%. And just to answer the next question, one of the ones I always look getting is, but how do you know we will hold 5 years from now. And none of us have a crystal ball. But what we do know is that our acquisition ARPU, point-of-sale ARPU has also been holding fairly stable and steady. And that, to me, is the single best indicator of what will happen in the next 3 years because any time point of sale comes down, then as customers are coming up for renewal, they will very logically say, "Well, did I want that pricing?" So as the 2 together base and acquisitions stay stable, it gives you more and more conviction that this pricing is going to hold for the future.

Can you just expand on what the upsell opportunities are with the premium SKUs enable because I think there's just an intuition that everyone kind of thinks that base price is set and is not appreciative of what the upsell like what the offsets are for a larger customer?

Yes. Great question. So there's a lot of things. So as an example, you can bolt on 1-800 -- bolt-on SMS packages. Many of our customers -- if I just back up for a moment. Our sweet spots are businesses that are in modes of communication with consumers. So think of it as B2B2C. And they are the verticals that truly value phone-led UCaaS and the capabilities we bring, okay? So with that in mind, 1-800 numbers, obviously, for inbound calls for customers, SMS for marketing campaigns and outreach or bolt-on opportunities, larger calling plans are an opportunity, analytics capabilities that gives you more insights into things like time of day the calls are coming in, day of week so that you can optimize your staffing. So lots and lots of analytics capabilities. Fairly recently, we were recognized as having the best analytics capabilities of any UCaaS company by the Tally Group, third party. So those are key items. And then that's before you get into cross-sell, which is obviously contact center and contact center light-like capabilities as well.

So we touched on the growth margin framework. You mentioned you have a background in M&A. Mo referenced the organic growth and the healthy growth within RingCentral. And so just thinking about how you weigh the trade-offs in the current environment using cash for buyback, evaluating opportunities in the market, just given where multiples have fallen. What's your framework?

Sure. So I think a couple of points I would make there. Our capital allocation framework is a dynamic one. And as you say, we would always want to remain flexible and opportunistic. We feel like we're in a very good position in terms of our strengthening financial profile. And you didn't mention our convert, but I'm going to mention it. That's another factor in terms of the way we think about our financial profile. And what I would say there is if you consider the guidance that we gave on OP margin and what that means for EBITDA and what that means for actual OP growth and then free cash flow growth. And you think about when our convert is due, which is the first tranche is March 2025. That was a long way out. But it means that we're going to have a lot of optionality and flexibility around how we deal with that. But we balance use of cash around our organic investments. And I personally feel like we have an incredible organic opportunity ahead of us. When you asked me why did I join? I see a huge opportunity to create value with what we have today. That being said, never say never to things that become available and the market is changing very, very quickly. And buybacks are also an important part, and I think will become an increasingly important part of the way we think about capital allocation. We have currently a $100 million authorization at the end of Q3, we had used up $50 million of that authorization. And then, of course, it's really important to continue investing in our own product suite and capabilities on the R&D side to ensure that we emerge stronger as we come out of this macro and also with a product suite and set that is extremely relevant to our customers. So I'd say it's all 3 of those.

Mo, is it important? How important is it at all to have this organic focus on quality and what RingCentral has built. I know the communication space is fragmented, and there are a lot of kind of roll-up strategies in the market. So is that make the vision clear when you're bringing to market something that has the call quality stats and the organic development that RingCentral has had historically?

Yes, 100%. Every quarter, we talk about TIP, Trust, Innovation, Partnership. And trust is the first letter of that because the customer is at the center of everything that we do and the trust that they put in us. And for us, the Five9 promise the uptime promise where we've been at Five9 for over 3 years now is core to the way that we think about our innovation, our R&D and what we do for our customers. There's a website we are quite fond of it called downdetector.com, and it looks at various services and are they up or down? And as part of our selling motion, we guide customers there. And if the ability to communicate with your customers, your colleagues, your partners is core to your revenue, your employee experience, your customer experience, if that matters to you, the choice is simple. It's come to RingCentral. And it's why we're seeing success via other routes to market as well, even embedding into other platforms and OSs that are seeing broader success being led by other products, not from.

There's been a lot of emphasis on partnerships with RingCentral. You had experience there on the other side with AT&T. How important are those partnerships with the go-to market? I'll start with Mo there and maybe suddenly from a margin perspective, I'm curious what that allows as well.

Well, I'll come back to TIP. So trust, innovation, partnerships. The go-to markets, the channel motion starting with the global service providers, telcos, cable companies, et cetera. Also the channel, 15,000 strong now. plus as well the legacy partners that you referenced earlier. Absolutely. This has been a key part of our growth. They provide us abilities to go into new geographies. They allow us to unlock specific segments within those geographies. So as you think about that TAM that we started the conversation and then the SAM, the sales addressable market within it, the partnerships are a key part of unlocking further and further SAM to be able to access that larger TAM. Now I'm sure you've got additional questions on certain partners that how do we think about them, et cetera? I sense that's your next question as you're looking at me. And I think it's clear, as you think about a couple of those legacy partners, Avaya specifically. That they're having their own challenges that they're contending with right now. The way we think about that one is, look, 3 quarters in a row, they've seen quarter-over-quarter growth with Avaya Cloud Office powered by RingCentral. Those customers are operating on our platform. They're on our paper, no matter what happens in terms of next steps with Avaya, those customers are certain and confident in their service. More broadly, and we've been quite public on this. Obviously, we would love for Avaya to remain a going concern. At the same time, being good leaders. Operationally, we've prepared for any potential outcome. And what we know is that we are a very, very obvious destination for any Avaya customer today or at any point in the future because of the unique integrations that we've created, the ability to use Avaya endpoints. We're the only UCaaS provider that has enabled this. And so we're confident in our ability to continue addressing that market no matter what happens.

And do you want to build?

Yes. So we don't typically comment specifically on partner economics because there is obviously commercial sensitivity there even between the partners themselves. What I would say, and this is something that we've shared in the past is that on an LTV to CAC basis, the partnerships and the seats that we take from the partners is actually accretive to that ratio. That's partly because they have very large, strong sales and marketing motions, and then we don't have to pay those costs, double up on it or whatever costs we incur are lower than if we went direct ourselves. And then the other point I would make, and I think it's particularly important is we drive to and strive to be significantly more profitable is seats that we inherit or seats that we take from partners have much lower churn associated with them. And anybody who's covered SaaS before knows that it is like from a profitability standpoint, you would way rather keep a customer than go out and acquire any one. And I think that's a very, very important dynamic. And it's another one of the levers that will help with our drive towards greater and greater profitability, growth and profitability.

Almost up on time. So just one more out. I'll start with Sonalee and then Mo, you can follow on. Just key points of focus as you're going through 2023 planning priorities for the business, things you think we'll be talking about at this time next year?

Yes. Great question. So I think on the last earnings call, I said my top priority is driving efficient growth. So it's really ensuring that we are going for that growth but getting more for less, really. So I'm all about the leverage in the model and ensuring that we capitalize on that and exploit it.

Great question. For me, there's 4 key priorities. One is continuing to provide an incredible customer experience back to your point on trust, quality, QOS, et cetera. A lot of investment and work happening operationally internally how we are investing from a product and technology perspective, how do we think about the customer journey from the moment that they sign on? How do we think about renewals and working with our customers back to Sonalee's point on. We love new customers and we love our existing customers just as much. So the customer experience and keeping it at the heart of everything we do is absolutely priority one. Priority 2 is driving that healthy organic growth that we've talked about. Priority 3 is the path to 20% plus operating margin. We've guided to 20. That is the beginning, not the end. And then the fourth one is just keeping RingCentral an amazing place to work. We're very proud of what we do around ESG. We're very proud of the incredible number of comparably awards that we win every single year. And so we're always mindful of our employees, the RingCentral family and what we're doing to keep the culture what it is.

Sonalee, Mo, very informative. Thanks for joining. Appreciate it.

Thanks.