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

Okay. This is great. Well, RingCentral, thanks for being here at the Barclays TMT Conference Day 2. Guys, we're halfway through. We're getting there. So I'm Ryan MacWilliams, mid-cap software analyst here at Barclays. With me today from RingCentral is CEO and Founder, Vlad Shmunis and Chief Accounting Officer, Vaibhav Agarwal.

So Vlad, quite a run from 2 guys in the garage to $2 billion in annual recurring revenue. I'm always impressed by the size of UCaaS deals. Like 4 years ago, 10,000 seats was like a great enterprise win. And now we're talking about 50,000, 100,000 seat opportunities. The question I get a lot on RingCentral is what's next. So from your point of view, how do you think about the strategy ahead for Ring?

Yes. Well, that's okay, I guess, number one. So strategy ahead for Ring. Look, we've had a pretty good run. And like you say, from $0 to $2 billion and counting. And the formula has been consistent throughout, which is provide people with world's best cloud PBX replacement. We call it UCaaS or UC to UCaaS migration. And we've been fortunate to be in the leadership circles there and just winning out, right? So a short answer to the question is more of the same. We'll continue doubling down on our best-in-class cloud PBX. We win on reliability. We win on global coverage. We win on security and we win very important on the feature set. We don't tell people that they don't need this or that feature. We ask them what they need, and then we implement it. And this is the reason why we were able to assemble a cadre of partners from some of the world's leading carriers. This is one of the things that many people maybe under appreciate about us is we really are the only people out there with a well-proven, not enterprise, but carrier-grade solutions. That's a higher bar, okay? So AT&T, British Telecom, TELUS, Vodafone, Deutsche Telekom, I'm sure I'm missing a few here. So there is that, well-publicized deals with some of the leading on-prem incumbents in particular, Avaya and Mitel which are global share leaders. All of those, a, speak to our differentiation, but it feeds on itself. It provides additional barriers of entry. We understand their user bases better. We understand their endpoints better. We understand their channel better. So we'll continue with that. Now beyond that, we are very cognizant of the fact that when the company was started over 20 years ago, it was about voice. We won that battle. Voice is not dead. It will never go dead. Consumers speak to their brands, their providers in voice. But intra-enterprise communications, a lot of it is not voice. So we have our MVP solution, message, video, phone. Phone, we've talked about already. That leaves messaging and video. Messaging, we see a lot of teams. And we are very much part of that ecosystem. Video is a different thing. We think that video is still quite open. Yes, there is Teams, but that's mostly for intracompany communications. There is all this Zoom doing not as well as they used to, let's say. And we think that presents an opportunity. We have a good video solution, is up and coming. We continue investing there, expect more from us there. Very importantly, by far not least, is a contact center. We today have the only available implementation on this planet between a Gartner leading CCaaS and the Gartner leading UCaaS. And that's between us and NICE & Company, and this is in our paper. So this solution does not exist elsewhere, between that and our own internal contact center product or platform called -- which we call Engage. Two quarters ago, we announced it was a $0.25 billion business. That in itself would make us #4 by revenue worldwide in CCaaS. You can safely assume that base has grown since those 2 quarters ago. So stay tuned for future announcements. And it's been a winning strategy for us. Short answer to your question, sorry about the long expose. But look, more of the same, doubling down, leading with product, leading with partnerships, differentiating with footprint security, et cetera.

And it's great to hear from you that voice is not dead. And I hear a lot too, like, oh, voice is so easy. I'm like, all of you ever try to do it at scale. So like could you just talk about like as we move into this under-penetrated like enterprise opportunity that hasn't really fully adopted cloud voice solutions, what about RingCentral from a go-to-market standpoint like having these partnerships globally and also from like a global service coverage and teacher standpoint, that makes you the best option there?

Well, best option there is what you just said. We have the features set. We have the channel. We have analysts recognition, industry analysts here. And we have constant reference cases and people like our products. So in the end, that's what we're banking on. As far as the enterprise it's an interesting dynamic out there. Many people -- I would say most people thought that we were a COVID story. To me, it was a little bit kind of noninteresting to see that because I founded the company in 1999. That was before COVID. And we did well. But what happened during COVID was that people throw their decisions, right? And yes, look, yes, everybody grew. And we grew except that we've grown before COVID, during COVID, will continue our growth after COVID. Yes, very difficult macro and obviously we're not immune from that. But one specific dynamic was that specifically in the enterprise, as COVID hit, it was at the same time that the incumbents, by the way, including Avaya, introduced this subscription motion. And what is subscriptions? It takes their perpetual licenses. They strip away maintenance, and basically start charging for it on a recurring revenue basis. It painted blue. It doesn't make it not an on-prem system. And many people went for that because the decision-making was frozen during COVID. What's very interesting is that we are coming up on the third anniversary of COVID, February '23 -- March '23. What does this mean? People who have signed 3-year contracts, like [ Xantrex ] coming up for renewal. Who were the people signing up 3-year contracts? Well, lots of people on Zoom. So Zoom is having -- seeing those headwinds. Guess what? A lot of people on Avaya subscriptions. We expect there will be an opportunity, at least for a jumble there. And that technology hasn't changed in the time. So we think that we are well positioned into '23. And look, we're not going to win every deal, but we'll continue winning our fair share or more. And to remind everyone, we are more or less at least 20%, 25% shareholder in UCaaS. We expect that to continue.

I think that's a good place to go next. Like what would make RingCentral a better option for existing Avaya customers that are maybe looking to make a switch? Or just in general, with the CloudLink acquisition, why that on-prem to cloud transition favors Ring?

Because we have the world's best cloud PBX is the short answer. With Avaya, in particular, that we know of we're the only cloud provider that supports their endpoint, do not discount the endpoints. You go into a traditional office. You still see those desktop phones. Less of them, but you still see many of them, and nobody wants to lift them up.

$100 a phone.

No. Multiple hundred dollars a phone, yes. Multiple hundred dollars per phone. We suppose that nobody else does. There are migration scripts that's been developed between Avaya and yourselves. Making migration -- I am not going to mislead. It's not like just a flip-a-switch thing because those are very involved installations but there is a lot of help there. And then there is a people aspect. There is a channel. There is knowing your customer, knowing your channel partner, understanding the use cases, having other Avaya, ex-Avaya customers or Avaya ACO customers recommend this joint solution, all of this place.

Yes. I always talk about how the channel is a lot more manual or personal than people think, right? And since RingCentral always been around for a while, people know what it is, how to sell it and also you have the enterprise features that they need. Like it's not just a cellphone that these multinational enterprises require.

And with the basic things like we pay our channel partners, not attribute to that.

So that's probably a good segue into kind of a lot of the questions I get, too, about what 2023 looks like for RingCentral? You guys are focusing on profitability, right? We're seeing steps broadly in the channel go down. I think that makes sense kind of given the market opportunity. But I think, ultimately, investors are wondering about how profitable can the UCaaS business be. So I'll start with you, Vlad. Just like what do you think about the unit economics of the UCaaS model makes it really strong?

Margins, gross margin. 80% plus. What is it, say, 82%, 83%?

82%.

82%, world class, not just for UCaaS or SaaS as a whole. So we can make an argument that in the end it could be up to 80% operating margin. Now I don't think we're shooting for that, but no, but then that also means no growth, right? So yes, because you have to invest in product. You have to invest in GTM like that. But look, it's a very, very profitable model. Again, many people -- they look at it and go, hey, communications here is just another telco. Well, no, because we don't have any CapEx. Our margins -- again, we have an 8 candle in front of it. We don't run facilities. We are like a pure cloud solution, and we're growing. So that's not a telco. So yes -- no, we feel pretty good about it. Look, I mean, it's no secret. We had -- we've announced the lift a few months ago. You know what, business has not slowed down, to say the least. There was a lot of inefficiencies -- many inefficiencies, because, frankly, we acquired during COVID ourselves, where people were hired who never met their teammates or their teams or their managers. It makes no sense. Lots of program spend we were able to rationalize. Lots of product spend we were able to rationalize. The thing with Ring is -- it's a nice position to be in. We are a mission-critical app. For a business to drop us, it's one of the things. Replace us with a competitor, well, we have a pretty good solution or they're going out of the business, which is why people are asking why is your SMB holding up? But because no communications, then they are out. But that doesn't apply to many, many other providers. And we use countless of providers, and we were able to rationalize and we use less providers now and it's fine. It's just forces more discipline internally. So yes, there will be further, what's the word, rationalizations of spend. We already preguided to at least 300 bps expansion, and that's on 220 bps gross year. So that's meaningful. That's over 5 points, right?

Absolutely. Yes. And Vaibhav, I want to go to you for the numbers, but do you think Ring can get better leverage on your past investments next year? Things like the partnerships you talked about and also like your extensive investment in the channel, right? Like how can that also help as maybe you're not investing as much in 2023?

It's addressed to you.

Yes. So I think, look, we have a multifaceted GTM channel, right? The idea, as Vlad, I think, mentioned in his first comment is we have the best-in-class UCaaS product. How can you get the product in the hands of as many customers as we can. So we have a very profitable direct motion. We've built a channel motion over a period of time wherein we have almost, what greater than 10,000 channel partners. And that motion has been very fruitful for us, very accretive for us because the channel carries. We are utilizing their GTM motion and it's become incremental for us. And then on top of that, we have the partnerships. Again, the idea is we are utilizing the partners marketing motions, the sales engines, if you will. We don't need to stand up our old sales teams. So from a unit economics profitability standpoint, we have these multifaceted channels. They all contribute in a different way to overall profitability, and that's kind of the overall idea behind having these channels.

And you mentioned the guidance for next year for the margin improvement. I guess, how do you think about that near-term margin opportunity was at least 50 bps? And what could that translate to free cash flow for RingCentral?

Yes. So if you look at our historical kind of margin profile, we generally expanded 50 bps year-over-year. This year, we are expanding to 220 bps and at least 350 bps next year. So clearly, one of the priorities for us is driving more efficient, more healthy and profitable growth. Now where that's driven from is some of the areas that Vlad talked about. It's labor rationalization, getting more productivity which will flow through in Q4 and Q1. And on top of that, we have other levers, like rationalizing program spend, rationalizing our marketing -- where our marketing dollars are going, are being inefficient or not. So I think if you look at this framework, and then I think in the last quarter's earnings call, we had talked about a margin -- a commitment of 20%. So if you apply this framework, then you can kind of do the calculation as to that 20%. So in the near term, clearly, more margin expansion and with margin expansion will follow a lot more free cash flow generation as well. Now in the longer term, the business is profitable on a unit economic basis and the recurring margins on the business when you -- once you take out the upfront costs are a lot higher than what we are printing today or what we are guiding to.

And I always tell people these UCaaS installations are for a long period of time. Like in my old place, I still had a Nortel phone on my desk.

We got just 3 or 6 years.

But before we go down the macro rabbit hole, I guess, can you just give your present thoughts around SBC for RingCentral?

Yes. So look, we use stock as a means of compensation, as a means of retention like a lot of other companies -- like every other company, right? And frankly speaking, we want our employees and our executives compensation to align with shareholders. I think you guys would all want that. Having said that, so SBC, the way it runs in the P&L, is through 2 means. It's the waterfall impact from our prior grants, which were granted at a higher price. And then it's also a function of how many new grants you are giving out to new and existing employees. So the commentary that we talked about in terms of being more disciplined, rationalizing and finding efficiencies across all areas of the business, would also apply to SBC. So our discipline in hiring, our discipline in terms of how much stock we are giving out and to who would kind of help manage that. And case in point, if you look at the 2022 guidance for SBC, it's already come down 400 basis points as a percent of revenue. So I think over time we will continue to be mindful of that. And then the other thing we look at is stock dilution, which has historically been in the 2% to 3% range from a burn rate standpoint. So we, as a management team, are very mindful of that. We'll continue to manage that. We also have a buyback program. We have an authorization from the Board for $100 million. We purchased about half of the stock under that. So yes, as a management team, we are mindful of this dynamic and we'll continue to take the right steps.

Excellent. We've asked every management team about heading into a tough macro, not your first rodeo here. But can you just give investors some perspective on your past experience going through a rougher period in UCaaS and maybe kind of what to expect.

Yes. You see no different story there. I mean, really tough macro in historic terms. And certainly as a public company, we've been benefiting from all those multimodal market, yes, so over now. Look, again, it's a little bit what I said. Macro is macro. We're not immune. But we are a mission-critical app. So on the -- we'll talk a little bit about football, right? There is defense. There is offense. They say championships are won with defense. I personally subscribe to that. What's defense for us? Holding on to the customer base, retention, right. Again, mission-critical app. As long as the app works, people will hold on. Our retention patterns, including in SMB, are very, very stable. That was a huge concern at the beginning of the year that you lose -- like what's the better case? You lose your enterprise to Microsoft. You lose your SMB to Zoom or else they just go away. They close shop. None of that have happened. We are holding our own everywhere. Our pools are stable everywhere. Retention patterns are stable everywhere. Yes, sales cycles have reverted to their pre-COVID normals in the enterprise for the industry, ourselves included. Yes, deal sizes in the enterprise reverted to pre-COVID normals. But again we've been through that. SMB, again, steady as she goes. So again, moving forward, look, firstly, we think that this -- we hope anyway that this macro is not forever. The social and, as you say, there will be economic expansion at some point in time. Certainly, I'm not going to call it, that it's going to happen March 13 next year, but maybe it will.

That would be great.

That would be great. But look, we'll be ready for it. But meanwhile, because of our scale and because of the fundamental profitability of our model, because of our 82% gross margin, and because of all of the past investments, we are in a position, to be blunt, to be printing cash, managing our dilution, our actual net dilution. Forget the dollar amount. That was way of address. Given our growth -- I mean that's my -- without guiding, but you can safely assume that our actual growth will meaningfully outpace our actual dilution. And you will not be faced with the situation. Again, there may be blips. But you will not be -- we will not be in a situation to where per share EPS is under a secular pressure. We've invested enough to not be there. And then any news will be good news.

Investors love to hear that. You kind of beat me to it, but just to put a finer point around it. Around your recent renewals, have you seen any changes there? And I only ask because investors are seeing -- other software companies see seat count pressures. Anything different right now for RingCentral?

Our pools are holding stable on renewal business and on new logos. Again, because of macro and also, at least for March of this year, because of FX, yes, overall upgrades, upsells and new seats have been under pressure. But having said that, again, numbers speak for themselves. We're still a strong grower. Profitability is improving and will continue to improve. And the minute economy switches back on, we should be a beneficiary of that.

And gross retention trends have held stable. So if there was any impact on renewals that will show up in churn.

Yes, from like a company perspective.

From a company perspective.

Excellent. Vlad, you had a lot of great partnerships and you have made some acquisitions in the past. Going forward, do you think RingCentral could be a potential industry consolidator in the UCaaS market?

Just by the cycle alone. So another way to ask it is, look, there is a number of players in the industry now. It's a very large industry but we had a much larger list of players before as they had in some consolidations and some people just fell off, frankly. Will there be more players or less players 5 years from now? I would say there is less players. It will not be a one player. It will not be just Microsoft or just Zoom. It should be at least 3 players with us being at least a third player. Why? Because message, video, phone, MVP, we have the best phone. Zoom, good video and Microsoft best messaging with that. So never say never, if it make sense.

And would just love to get your perspective. I mean, we touched on potential opportunities with Avaya, but just maybe put a finer point around like how you view that partnership is going? What ACO's like? And any update there?

Look, I think we've announced we've been all partners, but clearly led by Avaya, we said about 0.5 million seats. That's 10% of our base, 5 million. They're all paying seats. They are all strong ARPU seats. So nobody is playing any games there. Look, I think many people, ourselves included, wanted and anticipated faster migrations from on-prem to the cloud, in particular with Avaya. Many things happened starting with COVID, and already, as I mentioned, people just choosing to stick with what they've got and Avaya introduced its subscriptions motion. Look in the end, it also defeating for them because, sure, I mean the 606 accounting, all of that doesn't mean the customers make anymore. You recognize the revenue faster. So that got them to their current precarious state of affairs. But having said that, seats have been flowing every quarter, Q3 more seats than Q2 from Avaya, Q2 more than Q1. So, so far, going on, can it move faster? It can and it should. And have they disclosed their subscription base?

No.

They have not, but it's a large base. It's a large base. If people can figure it out from their filings, fine. But we feel that at this point, there is an opportunity. As those subscription seats are coming up for renewal, we feel there is a meaningful opportunity to -- for either us as stand-alone, if they end up going Chapter 11, we hope they don't or in partnership using the ACO product to go after that base and to go after the remainder of their on-prem base.

I also tell people these partnerships take time. You have to train the trainers. I mean investors really want these things to happen. I'm sure you wanted the same way. But that Avaya deal -- we were at the Avaya conference in Phoenix a week before COVID happened. So there's going to be a setback to get people to catch things up. Just on another partnership and competition aspect. I get a lot of questions on Microsoft. Just how would you view like your opportunity in direct routing there and how that can help you get to larger deals and upsell.

You know what, it's a little bit like when the iPhone first came out, 2007? And people, including internally, were saying this thing is going to kill you. This little thing has just got everything. Who needs RingCentral? It was -- our best accelerator was iPhone because we could innovate within that platform. It's a platform and it's an endpoint for us. And I can tell you that vast majority of my personal use of RingCentral is on this device. Same with Teams. It's not -- yes, it has components that at the face level compete with us. That's fine. But this is also a platform. Teams is the new Windows. That's how we see it. It's an opportunity. What does it mean? It means that the customer is now fully in the cloud. It's so much easier for us to integrate into that environment. So for as long as Microsoft has direct routing open and embedded dialog open, we'll be just fine. Teams -- people think that I'm making a joke or what have you. And it's not. When I go that Teams is not a foe, but a friend. Teams is a growth driver for us. We have a viable industry-leading Teams integration. I can tell you there is a lot of work within Ring to make it a breakaway leader. Customers will always have choices. And if a customer has decided the Teams is -- the infrastructure is a new operating system, they just wait. We just want the phone piece of it and many people are choosing us as a phone piece for Microsoft.

That's a good point. I mean we talk about how inertia is so important to get enterprise customers to move to Cloud Voice. I mean I mentioned a 20-year-old my cell phone -- or sorry, Nortel phone on my desk. Do you think Teams could also be a forcing function for enterprise?

Yes, I just said that. That's exactly what I just said. Absolutely. Can be and is and will be.

And that would be like much larger deployments and...

One would hope, yes. But enterprises are clearly growing Teams. SMBs are not. So SMBs -- that's where we have our MVP and we're quite viable there and there are messaging. It's good messaging. But yes, we're not going into Microsoft strength and not going to compete with them. And again, some other people are taking different positions. Some other people are saying, what we're going to go compete against Microsoft and Google e-mail. But that's not our play.

Just kind of the last question here as a contact center guy. I'd love to hear how that market is doing and how you're seeing like really good momentum with your NICE partnership.

It's a strong market, smaller than UCaaS, but it's earlier in digital transformation. That means that growth in CCaaS is probably going to be above that in UCaaS. Analyst community, I think, see that the same way. We are a very large shareholder, again, 0.25 billion as of 2 quarters ago. Number 4 worldwide by revenue, not a bad position to start. Partnership was one of the breakaway industry leaders to this day as well as ongoing developments in-house. We think we're well positioned. It's a strength for us.

Excellent. Well, with that, we'd like to thank the RingCentral team for being here today. I appreciate it, Vlad.

Wonderful. Okay. Thank you.

Thank you.