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

Welcome, everybody. I'm Meta Marshall. I cover the communications software space here at Morgan Stanley. I'm delighted to have RingCentral here with us today. For any important disclosures, please see the Morgan Stanley disclosure website at morganstanley.com/researchdisclosures. If you have any questions, reach out to Morgan Stanley sales representative. Again, let's move on to the more exciting parts than disclosures. Vlad Shmunis, Sonalee Parekh, we have the CEO, Co-Founder and -- or founder and then Sonalee Parekh, CFO, with us here today.

Maybe let's kick off. Vlad, you stepped back into the CEO role at RingCentral. What do you think are the most important things or tenants to the RingCentral strategy that investors should understand?

Yes. Fair enough. So thanks for having us. Look, it's a few things. So one is we're turning into a multiproduct company. That's a big change. Maybe a bit overdue, I don't know. But when I was, for a few months, I was not the CEO or Chair, I was running tech for the company, I was the Executive Chairman. We've had 2 significant introductions, which is one was RingCX, our own cloud contact center. The other one is RingCentral Events, which is a highly competitive [indiscernible] product based on the technology we acquired from Hopin, a little bit earlier in the year. And these two new products plus our RingSense AI platform is really our foray into enabling our fairly large and important sales force, both internal as well as our channel network of over 60,000 partners. So enabling them with multiple products. So we think it will do great for us as far as TAM expansion, SAM expansion, upsell, ARPU expansion, so just total goodness there. So this is one area of focus. And the other one is, I think, there was, maybe, a bit of, I don't know, what you call it and then you get something I'm not aligned with, that was said, which is, "Hey, SMB is going to -- RingCentral is going to retrench it to SMB. So that is very far from my strategy. Enterprise is a $1 billion business for us. 20% of Fortune 1000 are meaningful customers, meaningful, meaning over $100,000 ARR, and it is a growth driver for us. And especially nowadays, when teams is taking strong growth in the enterprise our teams integration, which is industry's best at this point, is really playing well and will continue to be a growth driver for us. So that is going to be an area of focus for me as well is to reestablish ourselves as an enterprise leader.

Okay. Perfect. I mean you just introduced that there was mentioning teams. Just how has the market opportunity you see changed over the last 5 years as teams, AI, video usage have kind of meaningfully changed the UC landscape?

Yes. Look, sure, there was much less teams, maybe no teams 5 years ago, but a different set of competitive dynamics. Also about 4 years ago, COVID hit. So many things that we shuffled. But as far as what we see now is we absolutely see continued traction in the enterprise. The play at this point is not so much about the entire collab stack because in the enterprise, at least U.S. enterprise. Clearly, the teams dominate. But it is about a peaceful coexistence with teams and the ability to add value there, and we're extremely well positioned. We don't overlap with them that much. We're known as a voice-first provider and not as a video-first provider to have for a video-first provider to coexist with teams. So just more overlap there and more competitive. But then also don't forget that Teams is in the end, mostly enterprise and mostly North America in much less so in Europe, for example. And that leaves out rest of the world that leaves out SMB, which is also a [indiscernible] business for us. So plenty of room to growth.

Okay. So I mean maybe the overarching question I get from investors sometimes is we've largely thought of this market over time as this $400 million fee opportunity, somewhere between a $20 and $30 monthly ARPU. However, that no longer seems appropriate just given [indiscernible] or channel checks as far as kind of what the voice ARPU is. Is there a better framework that we should be working with particularly as you expand out the product portfolio?

Yes. Well, yes, things obviously have changed over time. And there are new technologies, there are new players, COVID and work partners are changing. So look, 450 million seats is what incumbent legacy providers, PBX providers, have cumulatively shipped over time. So that's where that number came from. Now, if every one of those lines going to migrate to the cloud, probably not, okay? I think your own research shows 80 million lines that are -- that would be migrating and specifically migrating into mission-critical applications, which is, for example, not where Microsoft is particularly strong, okay? So there is still a gigantic opportunity out there. On the ARPU side, look, there are -- yes, there is absolutely pricing pressure as more people have voice or good voice. But the flip side of it is that we're also not standing still. So with our new product introductions with RingCX, which is priced at $65 and this -- a pricing disruptor in the segment at this point with residential events, where we have also just reimagined the way that, that product needs to be sold. And I can tell you that we've been getting super strong reaction to the new packaging and pricing there, including this one recent win that we've announced with Harvard University, which was a direct competitive situation against the variable known provider that we won, okay? So both of those products, while disruptively priced, are still a huge tailwind to our ARPU as a whole. So again, there is puts and takes. But if you look at the number of seats that we have and the revenue that we have, you'll see that, overall, we are holding steady, [indiscernible] 20 to 30 range along with that ratio.

Okay. So maybe a smaller seat, but a bigger ARPU kind of number at the end of the day. All right, consistently over the years, one of your largest advantages has been your channel partnerships and your channel -- and the partnerships you've had with legacy vendors. Do any of the changes that we've talked about just in terms of expanding out that portfolio or just the impact of teams, change that partnership or channel strategy? And is there a part of that market where that channel and partnership strategy still gives you the greatest advantage?

It's still a very strong asset that we have 16,000 channel relationships, a number of leading global service providers, GSPs, starting with AT&T and British Telecom and Vodafone, Charter Communications, some of the more notable ones that we have. So look, it's a very large opportunity. We're talking about business communications worldwide. There are only so many providers, and you can count them on one hand, probably that can even do this, they can address the footprint. We're definitely one of them. We're still in a very good position from the leadership perspective, for voice-centric applications, and that's the major strength of us -- of ours. And channel recognizes that. So absolutely, it's an asset that we have and we continue to nurture.

Got it. You've changed incentives for the channel and the structure of some of these partnerships, a fair amount over the last couple of years. Where have you seen success with those changes? And where have you kind of revised some of the changes that you've made?

Yes. Look, it's about optimization. Generally, we're a known commodity from the channel perspective. Now that it works, now it's sticky. They know that if you have -- if a customer has a voice-centric mission-critical application, we should be at the table and if we are at the table, we tend to win more than not win. So again, all of that is still there. And again, like I said, we're nurturing those relationships. What the tweaks are being made is in getting them to do a little bit more heavy lifting from the channel partner side, trying to optimize our spend. Very importantly, with our multiproduct strategy that's emerging now. We are very much interested in incentivizing the channel as well as our own sales force in not just relying on the well-proven RingCentral PBX, but in expanding those efforts. So we are specifically incentivizing people to be selling multiple products, and that's how they get accelerators. And look, it's early. But so far, we're more than pleased with both our RingCX introduction and RingCentral Events.

Got it. You noted that the partnerships, particularly the GSP partnerships have been performing to expectations as of late. Where are you seeing kind of the most traction? And just how should investors judge you on this? I think this is a question we've gotten over the years, should it be a percentage of installed base? Should it be a percentage of revenue coming from new partnership. Is it something to kind of benchmark for investors what your progress is here?

Look, firstly -- actually, you'll have your own different models and so forth. Look, I think it's fairly simple from my perspective. It's combination of growth and profitability and I'm trying to hit that sweet spot. It's definitely not growth at all costs like it used to be. We've made substantial improvements into rationalizing our spend. I think still Sonalee is on there, but obviously, major improvements in profitability, in free cash flow, major re-rationalization of SBC. So we're talking about not just profitability, but per EPS not the earnings, but the earnings per share. Sonalee will address all of that. And then there is growth and stickiness of the user base. And look, as we sit here today, yes, we're not growing like we used to. But out of the public competitors, so the words [indiscernible] there is also that.

Sorry, Meta, just on the partner question. The one thing I would add is Vlad talked about the 16,000 channel partners that we have, then we have our strategic partners and then global service providers, which we're adding, you mentioned Charter, but that partnership has gone exceptionally well. But we aren't over-indexed to any one partner. And I think that's an important point. And partnerships have been a significant part of our growth, and they will continue to be a significant contributor to our growth going forward.

Is there an internal benchmark? Or do you -- what kind of metrics internally, even if we don't know exactly what those metrics are, are you using internally to kind of judge the success of those partnerships?

Yes, exactly because we don't disclose kind of seat numbers by partner. And you can imagine with all these different partnerships and commercial agreements, like there is commercial sensitivity there, which is partly why we can't be specific. But of course, we judge, I mean, we don't look just at seats because not all seats are created equally, and I think we've made that point a couple of times. But we look at the overall, not just revenue and ARR and ARPU that we get from a specific partnership, but also the unit economics around that. And that's really important. And what Vlad was saying earlier about working with the channel and ensuring that we're optimizing the economics for us. And hopefully, you saw some goodness in our sales and marketing line over the past year, but there's going to be more to go for there. And part of it is really looking at those unit economics. And direct selling versus selling through the channel versus GSPs. And we are a portfolio, and we absolutely manage the business as a portfolio, but we want to optimize each one those go-to-market motions.

Okay. Perfect. So let's switch gears to CCaaS. As you noted, you've been seeing impressive early traction with RingCX. How are you managing some of the conflicts between RingCX and then your products with NICE? And just how does the go-to-market or kind of customer segmentation differ between the two?

It's actually not that complicated. They are both CCaaS products granted, but one is an enterprise-grade product, which is the one that is NICE based for complicated use cases, for larger contact centers, for way more involved workflows, many more integrations, very, very strong WFO basically, obviously, which is where they are coming from to begin with. So it bifurcates fairly easy for smaller contact centers, for simpler use cases. CX is a clear winner because of its pricing, because of its packaging and we can [indiscernible] model that's what differentiated.

Okay. Got it. So on the latest earnings call, you outlined kind of expectations for the combination of RingCX, RingSense and events to reach $100 million of ARR by 2025. Just how should investors think about this ramp? And is this a metric that you would hope to kind of report as we go throughout 2024?

So absolutely, at least $100 million of ARR from those three new products by 2025. So clearly, 2024 is a ramp year. When you think about when these products actually went live second half of 2023 and even Q4 of 2023. So expect it to be more back-end loaded in 2024 and certainly the line share in 2025. Will we update you? Absolutely. We haven't quite discussed the cadence or the right cadence or the right metrics or we haven't firmed up on that. But what we will do and commit to do is update you by the end of this year on where we are.

Okay. Great. And just how should we think about the gross margins as these products ramp either because of additional professional services or just additional compute resources that these products might need?

Yes. So great question. And as you know, we have leading gross margins today, 82% subscription gross margins, 82% plus. We don't expect any meaningful impact from the ramp-up in the new products. Now of course, we are investing in new products on the R&D side, clearly, on the sales and marketing side, clearly. But in terms of gross margin, there's actually a lot of our infrastructure that we can leverage, so you won't see any down drift there. And then on the professional services side, if you look at RingCX, RingSense and RingSense Events, they're not heavy lift in terms of professional services. They're easy to deploy, easy to use, easy to maintain. So again, you wouldn't really need to model in any impact there on gross margin.

Okay. Got it. Vlad, just in early days of kind of having some of these products out, just where do you feel like AI adoption is strongest in UC and CC? Or kind of what feature sets are customers reacting most positively to?

Super early. Super, super early, okay? We just recently had an industry Analyst Day to where we exposed some new innovations. We did it under embargo. So I should probably not be breaking it myself. But we will have presence at Enterprise Connect in Orlando later this month. So please, please come by. We will have a few things to say. But I can tell you that amount of interest is through the roof. And again, it's very, very early and people are just trying to -- just beginning to understand the realm of possibility here.

And maybe we'll hear more about it at Enterprise Connect, but just how should we think about what does RingCentral think that they can be differentiated with some of these new AI capabilities versus kind of what is going to be best provided by either partners or others?

AI is an enabling technology, it does not stand on its own, maybe ChatGPT, but even that is more of a curiosity at that point, right? So the business applications are, I believe, going to be industry-specific, use-case-specific. Value of RingCentral AI, it's not in the AI, it's an application of that AI to our use cases, which is mission-critical business communications, historically, voice first. But over time, clearly expanding into other modalities, such as video or contact center, which is omnichannel to begin with. And even, for example, there are absolutely great implications for AI. So we view ourselves as an open platform. And what it means is that: a, we are using our own AI and we did make an acquisition in that space a few years ago. So yes, we do have our own models, but we're also working with open AI, we're working with Google. We're working with Amazon, all of the usual suspects, okay? And there are ways to -- some are more appropriate for certain use cases and others, given current state of tech, okay? And our own AI technology, we also intend to make it available outside of the RingCentral suite itself. So it's dynamic, but again, huge opportunity to disrupt and we should be on the beneficiary side of that.

Okay. I wanted to circle back to something that you said earlier just about one of the things that you stepping back into the role, I wanted to make clear was just RingCentral's role upmarket with enterprise. Just how do you see kind of the needs of the enterprise? Is it that they will adopt more products whereas kind of SMBs may have more differentiated voice needs? Just what do you feel like is the difference in needs between maybe an enterprise and an SMB customer today?

Yes. Great question. Look, enterprises tend to be a little more complicated. They tend to be a little more global. They tend to be a lot more sensitive to various regulatory obligations, right? SMBs tend to be much more interested in usability, ease of deployment. In many cases, it's going to be -- for very small enterprises, it will be the proprietary himself or herself that would be responsible, okay? And where RingCentral fits in is we really are trying to provide the best user experience and engagement, and we are known for that in this space. And it's not an easy area to simplify. We have been at this for many years. And so we're trying to do to empower small businesses with all the features and enterprise yield, and we are also trying to make enterprises usability as simple and intuitive for a small business.

Okay. Okay. Perfect. Last year at Enterprise Connect, you guys were talking a lot about the opportunity with frontline workers, potentially adding to the market opportunity for RingCentral. Just how has this part of the strategy developed?

I mean we're seeing good traction in all of those initiatives. There are different ways to define frontline workers of course. But we are -- we have our golden verticals, what we call them, and frontline workers is one of them, okay? But RingCentral, we're not planning to retrench into a frontline worker application.

Okay. Okay. Perfect. Sonalee, maybe moving on to you for a little bit. RingCentral's margin expansion in '23 was particularly impressive after multiple years of this as you drove a 600 basis points of operating margin expansion, something you expect to have another 200 basis points in 2024. Just how are you balancing investment versus cost savings, particularly as you guys expand the portfolio?

Yes. No, it's a really good question. And thank you. Yes, we're really proud of the work we've done over the last 2 years on margin, but not just margin, free cash flow as well. And of course, we think about the balance between growth and profitability. And as you see, the way we guided this year, it's a 200 basis point operating margin improvement as opposed to 600. However, a couple of things to call out. One is that we made a very deliberate decision to switch some of our stock-based comp into cash-based comp this year, and that was about a 100 basis point headwind for 2024. So without that, we would have been guiding to a 300 basis point improvement in operating margin. So about half of what you saw last year. And then also, your point about investing in new products and in growth, we see a very big opportunity ahead of us. And these products from what we've seen the early days in terms of customer traction, it's been very, very strong, but it does require investment and not just investment in sales, but also in pipeline because the pipe generation for those products for some of these products is actually different from our core business. So that requires investment as well. So if you take those two things into account, it's about 200 basis point of headwind. So ex that, the margins would have improved 400-plus basis points. As we look ahead, it's really important to balance growth and profitability. But as you can see from the guidance we've given on NPI, new product introduction, we are definitely going after the growth. And if you were to ask me, if I had to decide which end of the seesaw to push on, we clearly want to go after growth, but sustainably and profitably and we think we can deliver both.

Okay. Got it. You've also made a lot of progress towards balance sheet cleanup. Just how are you thinking about cash flow and capital allocation over the next couple of years?

Yes, a really good question. So in terms of balance sheet, yes, we've made a lot of progress on -- certainly on our convert. So we had -- as we looked -- as we enter 2023, we had a $1 billion maturity in March 2025 and then a $650 million maturity in March 2026. We basically dealt with the '25. We have $161 million remaining on the '25, but we clearly have sufficient liquidity and you see we've guided on free cash flow for this year, so about $420 million at the midpoint. So we could easily cover that with our own cash flow. So you heard me when I first actually joined RingCentral, I had said we won't allow our convertibles to go current. But given the financial profile that we're driving today, we actually are comfortable with certain portions of it going current because we've demonstrated we have lots of capacity and optionality to deal with those maturities. Also for the 2026, they currently yield 0%. And you saw in 2025, `we were opportunistic at certain times where we were able to buy back the verticals at significant discounts, and it allowed us to deleverage. And if you look at our leverage today, we ended the year 2023 at about 2.5x where -- if you look at 2024 and the way we guided, what's been implied there is that we'll be just above 2x. So we're very, very comfortable with where we are in terms of leverage. So when you think about uses of cash and capital allocation, which obviously, as a management team, we discussed and debate heavily, clearly, investment, organic investment in new products will continue to be very, very important. And you continue to see us investing in R&D. But we also feel that using our cash to buy back our shares, given the price of the trade out, particularly price on a free cash flow basis, we see a lot of value in that. And you saw at earnings, we announced a $200 million authorization, which -- and you saw the amount we did in 2023. Share buybacks will continue to be a part of our capital allocation. And then we will also continue to delever a bit with our own free cash flow. And finally, Vlad mentioned the Hopin transaction -- the Hopin deal earlier, but if we find suitable and interesting and assets like Hopin, we will continue to do those. And as we become a more free cash flow generative company, obviously, that gives us more firepower to be able to do those types of deals. And what we love so much about Hopin is, one, it really elevated our video offering. But two, it brought with it such amazing tech and talent. And those are the kind of deals that we want to do. So we really think about our capital allocation policy very, very dynamically. And you'll see us move on all four of those levers that I outlined.

Got it. And we did spend a lot of time talking about macro, but just as you thought about putting together kind of your 2024 forecast, just either in terms of impacted downsells, impact of what you're seeing just a far as deal sizes in terms of what you're seeing this as far as deal cycle elongation, can you just kind of contextualize what you're kind of incorporating for macro?

Sure. Absolutely. So we did see a stabilization in those trends, exactly those ones you called out. So the sales cycle elongation that has now stabilized. The initial deal deployment being was getting smaller and smaller, it's now stabilized. Levels of approval, we're not getting as many layers and actually we're -- again, this feeds into the kind of deal cycle. Where we continue to see some challenges are on the upsell side of the house whilst new logo acquisition and new acquisition remains strong. And what we're doing there to address that is clearly the new products. And we think that, that will go a long way to addressing any weakness that may persist there. In terms of how we've guided, we made a deliberate decision not to assume any improvement in the macro. We've seen a stabilization in this last -- say, last two quarters, but I think it's too early to call a trend. I read all the same newspapers that you all read and listen to the news, and I think there's a wide range of outcomes that are possible as we look ahead in 2024. And one of -- you specifically asked about churn and downsell as well. We've assumed stable churn and downsell trends. But of course, stable on a larger base is a larger dollar amount that exits the business. So it makes that acquisition and upsell bogey that much higher. So if we were able to improve that and there are initiatives that we're driving internally and that has been an area of investment for us around customer success and customer care, if we do see an improvement there, then that should be beneficial to -- relative to where we guided.

Got it. Are there any questions from the audience? So maybe ending with our last couple of minutes Vlad. Just clearly, steps back into this role. You've been in this -- you founded this company. Just what do you think is kind of misunderstood about the RingCentral story today?

How mission-critical we are. How sustainable revenue stream is, how much opportunity is still ahead of us, how little overlap and inversely how much room to operate there exists still between us and Microsoft. So yes, all of the [indiscernible] cases are, seeing people looking at the glass half empty or mostly empty when in reality, maybe if not awful, but certainly more than helpful.

All right. Well, perfect. Vlad, Sonalee, thank you so much for being here today. I appreciate it.

Thanks, Meta.