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

You mean our partners just doing it themselves?

Yes, the AT&Ts, the Vodafones.

Yes. I don't think that those -- I spent the first part of my career analyzing those stocks. I don't think that they are great in terms of innovating. I -- like the plain old telephony, the old telcos. It's -- they didn't come up with any -- they don't have big software -- they don't have software DNA. It's -- like we're cloud native, right? And look, you don't have to be born in the cloud to be good at the cloud. I think there are others that are shifting their business models. But the telcos are not or the GSPs are not where I see a lot of great innovation. I remember a couple of them did some M&A over the years that kind of never really amounted to much. And it ends up being kind of a rounding error for them because the rest of their businesses are very large and cash flow basis that they need to protect. So -- and the other thing I would say is, it's not that easy to do. Just ask some of those competitors that I just mentioned. They haven't been able to do it on the phone. Like our phone is significantly unequivocally in terms of features, integrations, reliability, security, like no one else is close. So it's not that easy. And we've got a 20-year head start. We've been public for 10 years, but the company has kind of been around for 20 years. So I'm actually -- that's one thing I'm not worried about. There's suddenly you can come up with their own offering.

So before -- you touched upon profitability. Before we dive into that, I want to go back to innovation put at RingCentral. You talked about the 4 new products that have come out. What has you excited about some of the new offerings? And what could it do to the top line and the market opportunity?

Yes. So I think the one that I'm most excited about is RingSense AI. I was just saying in another meeting that my kids finally think I have a cool job because I'm working -- doing a bit in AI. So I think if you consider what UCaaS really is at the end of the day, it's -- we're facilitating -- we have this MVP product, but we have all this data in terms of call -- call logs, call volumes, words. All this unstructured data that we -- it's proprietary to us and our customers that we can drive insights for our customers. That they can then use to help them sell better, help them make better decisions, all of those things. And we haven't even scratched the surface in terms of what we can do. And this is billions and billions of minutes of calls. So we haven't yet disclosed how we're going to price RingSense, which is our proprietary AI platform. But what I do believe is we can bundle it with MVP, but we will also be able to sell it stand-alone, and that will definitely be an incremental revenue stream like selling it standalone. The other thing is, we talked earlier about upsell. I mean I'm excited to have more things to sell into our customers. We have this amazing go-to-market that we've built. We have, again, channel VAR, direct GSPs, it's all there. So to just take new products and add them to our stable, I think it could have -- we haven't given any revenue forecast or targets. It's certainly not embedded in our guidance, but I do get excited by that. The other thing I would say is Teams 2.0 or RingCentral for Teams 2.0. We now have the embedded dialer on one single pane of glass. So you're all in your Teams -- so say, for example, where I used to work, we happen to use Teams, but we didn't use Teams or phone. Now you don't need to toggle between RingCentral and Teams. It's all on one screen. It's just so easy and don't underestimate the number of Teams users that actually go external for their UCaaS. It's about 47% that use an external UCaaS provider, including RingCentral. So that -- and no one else -- again, when you talk about competition, no one else has that, that embedded dialer on a single pane of glass. So I think that, that will be a very -- I think adoption will be high on that product.

Why do you think such a high percentage goes outside for a UCaaS provider?

You know what? -- again, don't want to be -- don't want to criticize competition, but I was describing it in an earlier meeting, so where I used to work, we use Teams. And I used to sometimes have palpitations when I knew I had a Board call because I was so scared it wasn't going to work and -- like maybe they fixed it and hopefully they have. But obviously -- exactly. And I used to have my assistant like dial-in just in case because I think that's wise, people just want the reliability. And Microsoft themselves, I believe they recognize that because they make it easy for us to integrate into them. And I think -- and it's not just us, there are others that integrate into Microsoft. Ours happens to be the best integration. We also have the best integration. When you talk about differentiation, the best integration with a lot of like Salesforce.com, ServiceNow, HubSpot, we have over 10,000 integrations, which, again, is like why people use us. You'd struggle to find something where we don't have an integration.

You talked about that you haven't disclosed how you're going to price or monetize for RingSense, but is there a sense of timing and what RingSense will look like as a product? In other words, does it have a front end? Is it really something that's under the covers? What...

Yes. So you can go on our website right now and actually have a little look around. So in terms of pricing, I would say it's even internally, it's somewhat early days. It's still being discussed. I think in general, we tend to at least price about the in line with where others are. If you look at some of our other offerings. For newer products, it's possible that at the beginning, we do it as a slightly discounted price just to drive adoption. And then I talked earlier about bundling it. I think with certain customers, there may be some considerations around bundling. But what I know is that our sales force is currently using RingSense for sales. And we previously used a third party who I won't mention. And our sellers, we haven't forced them to use RingSense. We're like decide. It's been -- there has been a huge adoption of RingSense for sales internally and they love it. So I think that's a great endorsement, and that's one of the reasons that I'm so excited about RingSense.

It would be very difficult if it was the other way. How could you go on sell it if your own?

Exactly. Exactly. But you know what, you'd be surprised. They're good at complaining, too.

Well, you're getting real-time feedback?

Yes, exactly.

So you talked about how EBIT margins are now over 17%. There were sub-10% when you joined. What's the big difference? How are you able to drive? That's a lot of operating leverage in a short period of time.

It is. I mean you asked me why did you join Ring and I said, I wanted to join a SaaS company at scale with a visionary founder. I will say, when I first arrived at Ring, one of the things that surprised me was that the margins weren't higher. It did. And it was one of the natural places like -- this is even before the macro was super clear that -- because I joined in June -- or I think I announced May 9. But like June, the world was still like, "Oh, is there something happening macro-wise. And I felt -- and I think this is not just RingCentral, this is many SaaS companies in the valley. When interest rates were 0, money was free, there was this growth at all cost mentality. We were guilty of it." And I always felt like for a company running at $2 billion plus of ARR, there has to be more leverage in the model. And what we found was that there were certain areas and where we've seen the most significant savings is in sales and marketing. And what I'm going to tell you there is that we actually have managed to take 400 basis point. So out of the 700 year-over-year improvement, 420 basis points came from sales and marketing. We did not touch any frontline sellers, a lot of it was marketing. Some of it was brand spend, but a lot of it was demand gen. And what we found is we were kind of -- I said earlier, it was like the Jackson Pollock, we were just throwing, money was free. We were -- and we were ending up with pipe that wasn't very focused. And now we're generating pipe based on customer persona. And I think the verticalization strategy has helped there a lot as well. So what we're finding though is we're getting for significantly less money, I mean you see it through the P&L, way higher quality pipeline for our sales team to go out and mine and convert. The other thing that jumped out at me was procurement was not merely as sophisticated as it should have been for a company of our size. I mean, again, $2 billion, right, not a small company. But the thing is it grew so quickly. So some of the processes perhaps didn't grow as quickly is the top line. And there was a lack of automation in finance, I can tell you alone from procurement to payment, so many of the processes were manual. We've brought in a third-party software vendor on procurement that we're implementing now. That alone is driving $9 million of permanent savings. That's just in finance. And we're going through every single vendor relationship. And the guy who's running the project for me, I always say to him like, don't come and update me unless you've made a saving or like completely cut the need for the cost. And he's good, like he's delivering. So a big number is going to come from that. And then, look, we took the really difficult decision to let some of our workforce go last year. That was super hard and painful and we did everything we could in terms of cutting discretionary spend before we did that, that is very much our mantra, but it was necessary because we were planning based on a certain macro and a certain growth profile. And ultimately, we had overhired. And then even today, we're managing our workforce such that we are hiring in lower cost locations like Dallas and Charlotte, where people are super excited to work for a software company. And we actually find -- we're finding great talent and it's more efficient. They're willing to work for less money. It's a lower cost of living there. So all of those things combined. And then there's the beauty of the actual operating leverage because we're growing revenues. Last quarter, we grew subscription revenue about 16%. And yes, you get the incremental bookings and revenue, but it doesn't come as at higher cost. So it's just the natural evolution of the operating model working.

How have you gone through those changes without negatively impacting employee morale and how clear was it that you're like, you know what, we can see to here, we're cutting fat; from here, we're cutting muscle; from there, we'll be cutting bone?

Yes. Yes, it's a great question and one that we discussed a lot as a management team. I mean a lot of the cuts were programmed, so not people. On the people side, we were surgical in terms of no one who had a frontline selling job was touched. Now there were some frontline sellers that were not meeting their quotas, were underperformers, bottom whatever it was, a couple of percent. They may have gone, but then we backfilled them. So it was really areas where we found there was overlap, and there were. There was -- again, you asked when I first arrived, like there was quite a bit of duplication. A lot of the same people touching one sale. And my colleague, Mo, who's our COO, would call it overlay, but it was duplication. And then on the market side, again, it was just -- a lot of it was program dollars, but where it was people, it was areas where -- they were kind of shadow organizations where there was a lot of duplication whereas now we do a more center of excellence. It just -- the way we were organized in marketing didn't make a lot of sense. We did use a strategy consultancy to help us with some of the org structure and org design because we want best practice and best in class. But that was really how we did it or thought about it.

That makes sense. Another question that came in was going back to your comment on AI in the billions of minutes. Are your contracts structured such that it allows you like anonymous use or how...

So we wouldn't be able to use it without the customer, but the -- so what we believe is that customers and certainly, we wouldn't be using customer data without their permission. We believe customers would want to use their data on that.

So you bring the AI, they bring the data. You get together and really you're helping it on a case-by-case basis?

Helping them to -- exactly. For greater insights with that data and better decision-making and analytics, and we see -- there are actually some analytics products that we're already selling to our customers using AI. So AI or LLM, it's sort of new in terms of the -- or lots of people are talking about today, but it's something that we -- like we made an acquisition in 2020. It was a company called DeepAffects and they were and our an AI company and RingSense is kind of built on that. We've taken our engineering and product teams and build on that. So it's something that we had already been doing with and for our customers, just RingSense has taken it to another level.

Got it. Got it. The -- we talked about the global service providers, but I want to dive into some of the ownerships, the Mitels, the Avayas, et cetera. You've signed a number of notable, when we look at the installed base of legacy phone lines, you've got a massive coverage in terms of your partnership exposure. Where are you kind of in the evolution and ramping of those partnerships? So are they all fully productive? Or is there some milestones that you're looking for...

So we'll leave -- yes, we'll leave GSPs aside because some of those are ramping and I won't go through every one. But -- so on the Avaya side, let's start with the Avaya because it's the largest. And Avaya is and remains today the largest holder owner of on-prem legacy seats in the market and we have an exclusive partnership with them. It's exclusive on UCaaS. And we recently negotiated that partnership as a result of their unfortunate bankruptcy, which they literally just emerged from like a week ago. It was a slow burn a long time, but it was about a week ago that they finally reemerged as a private company, but still now very much a going concern. And one of the things that we did when we renegotiated that partnership was include minimum commitments in the contract, which we felt was a big win. And obviously, we're -- it's early days. The partnership is re-ramping, and we expect to see the fruits from that much more so in the second half of this year than we did, for example, in Q1, naturally because they were going through -- they were very heavily going through the bankruptcy then. And we are their natural destination for those seats. We have all the integrations. And we absolutely expect to continue being a good partner to Avaya. And we'll hopefully have good news to share with you as we progress through the year. Mitel is the other one you referred to. So Mitel, the partnership is going very well. It's a really good partnership. And we don't disclose seats by partner, but Q1 was a very good quarter for Mitel, I can say, where we exceeded our expectations. I'm not going to give you the number of seats, but it was above plan. So as you know, we upgraded our -- or we beat our revenues -- we beat our revenues, our OP in bottom line in Q1, but Mitel was a contributor to that beat. So good things there. And then we have other partnerships with Atos and ALE. Those are much smaller, and those are nonexclusive. So I think in terms of order of impact, Avaya at the top, we're really pleased with what we've renegotiated there. We think it was a good outcome. And no more prepaid. We pay as they deliver seats, which is a better model as far as I'm concerned, and it's accretive to us.

It's a healthy match.

It's a healthy match. It's how it should be. Yes.

Yes. So if we bring a lot of this back together, you had some pull forward because of COVID, but it was a massive benefactor. You still have a huge installed base of on-premise PBX systems that have yet to migrate. You've got the elongated sales cycles because of macro. How should investors just think about -- I think about the one slide in your earnings presentation was, a, it's about innovation, it's about reasonable growth, and it's about improving profitability. So how should investors think about that reasonable growth profile going forward?

Yes. I think that's a good way of framing it actually durable profitable growth or resilient profitable growth. So what I think and again, a tenant of RingCentral is we continue to invest in innovation and we continue to invest in product. And our UCaaS product is the best. We have announced 4 new products. Actually, we didn't talk about 2 others. One is push to talk for frontline workers and the other one is webinar. We have a lot of new products coming out all the time, that we absolutely intend to leverage and upsell into our base. So we're excited about the opportunity ahead. That being said, we are not going to buy growth. Profitability is very important. It's that earlier, we manage or I manage the business very much on a contribution margin basis. That does require a degree of discipline. So we are disciplined about our growth. And what I think is important is in times like this, when the macro is creating challenges, ensuring that we free up capacity and investment dollars to invest in the highest ROI opportunities is exactly what we should be doing, and that's where we're focused. So we're focused on durable growth, becoming even more profitable. As you know, we guided to at least 18.5% operating margins this year. We're going to exit the year at above 20% OP margins. When you think about that versus a year ago, that's a 1,000 basis point improvement. And cash flow was a record quarter this quarter as well. So keep watching that. I think Overall, I'm really excited about the financial profile we're driving and the strength of that financial profile. And you didn't ask about our converts, but the strength of that financial profile is also really important in terms of thinking about how we address the converts. And I have very high conviction about having a lot of optionality around that as I sit here today. So...

No, that was going to be the next target because you touched upon free cash flow, so how do you see that free cash flow expansion? And obviously, you don't want to pin yourself down to exactly what you're going to do, but any high-level thoughts around what some of the optionality and what some of the timing around when you would have to do something?

Sure. So on cash flow, you're right, we don't specifically guide on free cash flow. And I have my head of IR here who is definitely going to say don't guide. But what I did say on the call, well, in Q4, we gave some color around cash flow. And we said we expect cash flow to double 2022 to 2024. So it was implying about $180 million of free cash -- sorry, $280 million of free cash. And what I said on the last call was we will -- we expect for that to happen much earlier. So without being specific on when -- I think you understand the how because we went through some of the levers. If you think about the margin profile that we're driving. And if you think about the delta that we have because we're a SaaS business and you invest upfront in customer acquisition, there's always about a 5- or 6-point delta between operating margin and free cash flow. But if you think about the operating margin profile that I described and exiting the year at 20% plus, you can see using similar delta where the cash flow is going. So we will be generating significant cash flow over the next 3 years. Q1 was a record quarter. It was $61 million of free cash flow. And if you think about the levers that we have or the optionality we have around addressing the converts. So the first maturity is not until March 2025 and second maturity, March 2026. I've said we won't allow them to go current. But if you think about our financial profile and that margin profile and that cash flow profile, we will be able to use free cash flow that we generate. We will be able to use the term loan A delayed draw facility that we announced at Q4 of last year. So that's a $400 million facility and a $200 million revolver. We will also be able to access conventional debt markets if you think about the financial profile we're driving. We really do see a lot of optionality around addressing the converts and the profile we're driving allows us to really be in a position to see how the market is responding because, of course, it's always market-dependent. But what I said on the call and what I'll reiterate today is we feel confident about addressing the converts, and we will not allow them to go current and feel like the profile we're driving will be more than satisfactory to do that.

I love it. Sonalee, thank you for joining us. We really appreciate it.

Thank you, Sterling.