RingCentral, Inc. (RNG) Earnings Call Transcript
May 31, 2023
Earnings Call Speaker Segments
Good morning, everybody. So I'm just getting my ducks a little bit in a row here. Thank you all for joining us. With me up on stage we have Sonalee Parekh, the CFO of RingCentral. So Sonalee, first, thank you for joining us. We hope you're enjoying Newport Beach so far.
I definitely am and you can sign me up for this conference next year. It's a beautiful setting.
I love to hear that. I will give you $5 later for the pitch.
So look, Sonalee, it's the first time we met in person actually was this conference a year ago. And so I thought maybe we'd open up with -- the company has undergone a lot of changes. You've been there for a little bit over a year. Maybe it would be helpful just from a high level, what's changed from the company's perspective, maybe some of the key steps that you've taken over the time that you've been here as a CFO and maybe what you're thinking about where the company is today versus a year ago?
Yes. So firstly, thank you so much for hosting me. It is a wonderful conference, and we're really happy to be here. So you're right, I've just come up to my 1-year anniversary with RingCentral. And what has changed and what has stayed the same. So I think we -- when I first came on as the CFO a year ago, I said that my top priority was to drive efficient growth. And I feel like that is exactly what we are doing today. A lot of companies talk about sustainable, profitable growth, durable growth. We actually are executing on it. So we are still growing at a very healthy clip despite being a $2.2 billion ARR company. We are significantly more profitable today than we were a year ago. So when I joined the company, we had operating margins of about 10%. And by the way, I'm not taking full credit for this. It's the entire team. But today we're guiding to operating margins for fiscal year '23 of at least 18.5% and exiting Q4 of this year at least 20%. So that's significant, significant margin improvement. And how did we do that? How are we driving more efficient growth? We had a very, very hard look at our cost base, and how we were driving our growth. And we found a lot of opportunity in sales and marketing. And you can see that from our last earnings, we saw about a 400 basis point improvement in sales and marketing costs alone. And what we find is we're actually spending less in marketing and getting higher quality and better leads. So leads are actually up year-over-year despite spending significantly less. So I think we are on a very, very good path to continue driving durable growth. The other thing I will point out is I'm a big believer in free cash flow and free cash flow per share growth. I pray at that alter. I think we have done a really good job of converting that operating margin to free cash flow. You saw it in Q1. There's more goodness to come there. Last quarter -- at our last earnings, I guided to bringing forward our previous guidance on free cash flow of at least doubling by 2024. We -- I said that we would now achieve that much earlier. So we are also very, very focused on cash flow. And the other big milestone I want to talk to is our convertible debt. So we in Q4 -- just after Q4, actually, we announced a $400 million term loan A credit facility as well as a $200 million revolver. We drew down on that credit facility and retired a significant portion of our 2025 converts. So the remaining balance is very, very manageable. And if you think about the financial profile that we're driving today versus a year ago, it's -- the complexion of the company has changed significantly and dramatically. And when I think about that financial profile, I have a lot of confidence and conviction in terms of optionality around how we address the remaining balances of our convert, if you think about the deleveraging profile that we will drive. So how is that?
I think that's great. You hit on a lot of things that investors bring up with us. And I think it shows the steps towards value creation that the company has taken on its own over the last year plus and has been working towards for some time. So maybe let's shift a little bit to more near term. You mentioned recent earnings, it's now -- we're some time away from that. Everybody is focused on the demand environment. Maybe can you help us understand what you're hearing from customers as we think about the different pockets of the economy, some signal that there's still strength, some areas are showing some slowdown. What are you hearing from RingCentral customers? And how does demand look?
Sure. So yes, we are operating in a challenging macro environment, and this is something that we've called out in the last several quarters. Actually, I think the macro, it literally did start to weaken a year ago exactly as I was joining RingCentral. And we have called out certain trends that we've seen, particularly on the enterprise side. It's the elongated sales cycles, the lower initial deployments or smaller initial deployments. And where we've seen some weakness is around upsell and downsell. Churn has remained very, very constant and stable. It's something we manage very carefully and logo churn is very, very stable. But it's on the upsell and downsell and that is -- we're seeing a meaningful difference in terms of enterprise versus SMB. SMB, I describe in many ways as our Swiss watch. And SMB is actually showing a lot of resilience in the current climate. In terms of what we're seeing today relative to our earnings, we called out a stabilization in the macro environment and our earnings, and that is still very much what we're seeing. I think on the enterprise side, what we continue to see is sort of the additional layers of approval. But what I would say is that moving your communications from PBX to the cloud is an ROI-positive move. So in terms of -- and actually I'm getting called into some of the sales calls now and our head of procurement is as well, like people from my finance team are getting pulled into sales conversations because customers really care about how to save money. Just like I'm getting called into conversations with some of our suppliers. And I think what makes me feel really good is the product that we offer and the differentiation that we offer actually helps our customers do their jobs more efficiently and better. So there is still very, very strong end user demand. I said earlier, leads are up year-over-year. That is still the case. So we feel really good in terms of when this macro subsides that we will see this continued strong demand for our product. And the other thing I would say is we continued to innovate during this period. And when you asked earlier about what's changed. What hasn't changed is our commitment to innovation, to making really cool products that our customers love. And again, when we come out of this macro, I feel like that will really help on the upsell side. And just in Q1, we announced 4 new product intros, one of which was RingSense and I don't know if you're going to have a question on AI. It seems to be soup du jour, but we have our own proprietary AI solution that we believe will be monetizable and even stand-alone. So we continue to invest and delight our customers.
I'm legally required to ask an AI question to every company or else I can't be a sell-side analyst. But since you touched on it, I'll just -- I'll skip right over it. Maybe just a follow-up. You talked about the demand side. But as you think about competition in that context, are you seeing any changes in the competitive environment? And maybe specially on pricing as well as you think about what the competition is doing?
Yes, sure. So on the competitive side, I would say enterprise-wide, on the enterprise side, we do see Microsoft and Teams. What I would say there is we feel like we have a very differentiated solution. And we came out with our Microsoft for Teams -- RingCentral for Teams 2.0. And that is a super impressive and interesting product because it allows you to have the RingCentral phone on a single pane of glass embedded in your Microsoft Teams environment. And one of the large deals that we won in Q1 was a 5,000 UC and 5,000 CC deal in a Microsoft Teams environment of a Fortune 500 company. It was a health care company. We can't name them. But that just shows you that there are plenty of customers that are operating in Teams environment where if phone and reaching their customers is mission-critical to what they do, they went to use RingCentral. So yes, we are -- we see the competitors in terms of RFPs, but our win rates are strong and stable. The other thing I would say is on the pricing side, we are seeing a bit more discipline across the board. It's hard to call that a trend because that can be -- that can change quarter-to-quarter. But you've seen and read some of our peers and even outside of UCaaS are amending and changing their relationship with the channel. I think that is good overall for the industry. And we talked a bit about our IGNITE program at our earnings. But again, if you think about where the next leg of efficiency is going to come from on the sales and marketing side, we see a lot of opportunity to optimize there. And we're really focused on the customer acquisition cost. And that IGNITE program is -- plays very much into that. And bringing down the cost of customer acquisition is inherent in terms of seeing the operating leverage come through in the model that we're building.
That's helpful. You mentioned Microsoft Teams. So I want to maybe pull on that string a little bit. So you've given some data points recently, both on the product innovation side, on the deal side. Are you seeing that business accelerate? And maybe just help us understand how you're going to market and capturing the customers that want to work with RingCentral with Teams.
Yes. So we talked about 100% growth in the Teams practice, and that's been pretty consistent for the last several quarters. So it is a high-growth engine within our overall business. It's still small, like relative to our $2.2 billion of ARR, but it's a very fast and high-growing part of the business. And we believe the RingCentral for Teams 2.0 will be an accelerant. In terms of where we see this business going, we don't specifically guide by go-to-market channel. But what I would say is that we don't see any signs of it slowing down, and we are clearly investing in that part of the business. And there are very compelling reasons for our customers to want to adopt RingCentral in a Teams environment. And that is where they need the 99.999% reliability. And like what does that really mean? It means in a year, you have less than 5 minutes of downtime. The other thing is customers are willing to pay for and highly value our integration. We have over 10,000 integrations. If you want to integrate with Salesforce.com, RingCentral can do it. HubSpot, Zendesk, you name it, there's likely to be an integration. Again, customers that really need those integrations, and it's part of their daily workflows, they will absolutely adopt a RingCentral in a Teams environment. And what's so special about RingCentral for Teams 2.0 is it's single pane of glass. You don't have to open another app. You don't have to toggle. It is so straightforward and easy. So we see that as an exciting growth vector.
That's great. And I think there's a lot of investor confusion around maybe how the economics work for a company, just maybe how the structure works when there's direct rate going on. So can you just maybe broadly help us understand if somebody using Microsoft Teams and RingCentral? Did unit economics change? Or how should we think about that?
Yes. So if you think about -- like so Microsoft Teams has E1, E3 and E5 licenses. And if you look at sort of a Microsoft Teams' customer and what they'd be paying if they have the equivalent of MVP for RingCentral, which is Message Video Phone. If you compare those two, you actually are pretty kind of net neutral in terms of the extra amount that a Teams customer would have to pay for an E5 license, which is about $8, and then they'd have to pay extra for our calling plan. So if you take E1, E3 plus those additional charges and then compare that to what you would get from RingCentral MVP, you're about the same price point. But with MVP, you get all these additional features and functionality and geographic reach and reliability and security. And we also offer on top of that data and analytics. So when you talk about AI, I mean, we've actually been investing in AI for a couple of years. We have already -- we have AI embedded in certain of our products, median summaries, RingSense we were just talking about was one of the announcements we made in Q1, but RingSense is very much something that our customers, we believe, will potentially pay extra for. And it just adds more functionality and helps with the overall ARPU that we charge to those customers. Now what I would say is that where we compete with Teams, it does tend to be enterprise customers. So ARPUs on those customers are lower than for SMB. But if you look at Teams versus RingCentral for the same feature -- or actually, our features and functionality is richer, it's -- you're about net the same.
Understood. Maybe let's switch gears. Partners have been a really important part of the RingCentral story. You mentioned technology integrations, but maybe let's talk more on the distribution side. The company recently refreshed its partnership with Avaya. Can you help us understand maybe what changes were made and where there's still optimism around that partnership?
Yes. So as most people in the room here know, Avaya went through a fairly long and drawn out bankruptcy process and have recently re-emerged. And that's just a couple of weeks ago that they actually emerged from bankruptcy, although the bankruptcy, you've been reading about it for a long time. They literally have just emerged. So it's early days. But what I would say is that we are very excited about the amended partnership agreement or updated agreement. I can't go into all the details of it because, obviously, it's commercially sensitive, and we have other partnerships. But we felt like we had some really big wins relative to our former partnership, one of which is minimum commits that we have on a quarterly basis from Avaya. Secondly, we continue to be their exclusive provider of UCaaS. So we are the natural home for the on-prem base of Avaya, which depending on who you ask, it's anywhere between 100 million-ish seats. And those seats will ultimately move to the cloud. It's not a question of if, it's a question of when. And we are the natural home and we continue to be exclusive with Avaya. So we feel like those are 2 very, very big wins. The other thing is the economics today are much more aligned, so Avaya makes money when they transfer a seat over to RingCentral and RingCentral makes money. So everybody wins. And I think in any kind of partnership, you want it to be win-win and that is what we have today. In terms of what we've seen so far, it's early days. We expect that partnership and seats from that partnership to ramp in the second half, much more Q3, Q4. But as I said, we have minimum commits in any case. So we feel very strong -- or we feel like we're in a very strong position. And yes, we still are really upbeat about what can come from that partnership. And it will be an important driver as we continue to grow.
Great. Maybe just sticking on the partner side. There are a number of other important partners that you've announced with over the years. And I think those relationships have evolved in more recent quarters as well. So I'm just curious as you're thinking about the overall distribution that partners you're providing, is it more favorably structured? And is it kind of producing at the level as you guys would have thought? Just -- maybe help us understand how like an Atos or an Alcatel is also doing?
Yes. So overall partnerships like, of course, we always want more from our partners, and I hope they're listening. Yes, we want more. So specific to Atos and Alcatel, we did renegotiate those partnerships. That was one of the things when Mo, our COO -- President and COO, and I joined, one of the first things we did was take a hard look at all of our partnerships. And again, we want to optimize them. And as you think about driving profitable growth, that does sometimes require some renegotiation and things do change. So on Atos and ALE, they continue to be partners, but they are no longer on an exclusive basis. And one of the things that became clear to us on those partnerships and those are much smaller on a relative basis to say a buyer or Mitel in terms of their contribution to us. But they tend to be very Europe-focused. And the way they sell in Europe tends to be much more wholesale based. So there were some changes that we came to realize having been in the partnership for some time that we realized would improve the overall outcomes and, again, optimize it for both parties. So we did decide to change the nature of those partnerships. I can't really go into a lot more detail because, again, they're partnerships, so there's some commercial sensitivity, but they continue to be partners today. And one of them was responsible for bringing in one of our really big -- it was a French sports retailer, but a massive deal that we signed that we're really excited about. So still generating lots of good things.
Great. One of the real bright spots for the company has been the contact center business. And it's gotten to a pretty big scale than $300 million is the last data point the company gave, and it's been growing pretty rapidly. What's driving the success there given how crowded the overall contact center market is?
Yes. So that's a great question, and it has been a really, really bright point. So you're right. A quarter ago, we -- so what we said is we're going to update the market every other quarter on our contact center business. So a quarter ago, we said that it was about $300 million. So today, it's $300 million plus ARR. So a big proportion of our overall ARR and also growing well above overall contact center market. So we are taking share. And so why is that? From where we sit, we believe and what our customers tell us is they want to buy UC and CC from the same vendor. And we are the only communications platform that is Gartner, Magic Quadrant top right in both UC and CC. And of course, our partnership is with NICE inContact. It's a very good partnership. And I think we work really well together because in many ways, we target slightly different parts of the market. So we go to market together very, very strongly. And there was a survey that was done where -- it was a third-party survey, but 60% of respondents said that they want to buy UC and CC from the same vendor. Obviously, that plays very much to our strengths. And we're seeing that -- we're seeing 60%-plus adoption rate in our business are -- bundled right in our business. So it's very much in keeping with what we saw from that third-party survey. And we -- I don't think anyone else comes close. There are a few pretenders out there, but no one is doing it. And the other thing I would say is we have had that partnership for a really long time. And don't underestimate that. I think when I got to RingCentral, I underestimated that. I thought, "Well, couldn't someone else just replicate it?" No. there's a lot of behind-the-scene integration that happens and R&D dollars that went into that. And so it's a very hard thing to replicate at that scale as well.
NICE is here as well. So for those who would like to meet with them, that's also an opportunity to learn more. Maybe just in the interest of time, Sonalee, I'll jump ahead and just thinking -- you mentioned the -- what the company has done to take costs out, to drive leverage as you think about both from a headcount perspective and maybe overall cost measures. Where are we at on that journey? And how should we think about maybe the margin side of it going forward?
Yes. So I started off by saying we've gone from 10% to exiting Q4 at 20%. Don't expect that quantum a year from now, but I would say we're not done. Clearly, sales and marketing is an area that we're still focused on through all the comments I made around IGNITE, and I think that there's a lot more we can do there. But there's also the beauty of the operating leverage in the business and we continue to grow at a healthy rate. And we expect to be able to drive that leverage and have more of that revenue go straight to the bottom line and not to just bottom line but free cash flow and generating and driving free cash flow. We have incremental levers that we can pull and that we are pulling. But they're much more around efficiency in terms of customer acquisition, LTV to CAC, driving big procurement programs. You mentioned headcount, that is something an action we took in Q4 last year. But we see a lot of opportunity actually to just benefit from the inherent leverage in the model and continue to drive durable, profitable growth.
Awesome. We'll leave it there, Sonalee. Thank you so much for joining us. Great to hear from RingCentral. There's a lot going on, and we appreciate you joining us. Thank you.
Thank you. Thanks.
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