RingCentral, Inc. (NYSE:RNG) Q4 2022 Earnings Call Transcript

RingCentral, Inc. (NYSE:RNG) Q4 2022 Earnings Call Transcript February 15, 2023

Operator: Good afternoon, and welcome to the RingCentral Fourth Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Will Wong. Please go ahead.

Will Wong: Thank you. Good afternoon, and welcome to RingCentral’s fourth quarter and full year 2022 earnings conference call. I’m Will Wong, VP of Investor Relations. Joining me today are Vlad Shmunis, Founder, Chairman and CEO; Mo Katibeh, President and Chief Operating Officer; and Sonalee Parekh, Chief Financial Officer. Our format today will include prepared remarks by Vlad, Mo and Sonalee, followed by Q&A. We also have a slide presentation available on our Investor Relations website that will coincide with today’s call, which you can find under the Financial Results section at ir.ringcentral.com. Some of our discussion and responses to your questions will contain forward-looking statements regarding the company’s business operations, financial performance and outlook.

These statements are subject to risks and uncertainties, some of which are beyond our control and are not guarantees of future performance. Actual results may differ materially from our forward€looking statements and we undertake no obligation to update these statements after this call. For a complete discussion of the risks and uncertainties related to our business, please refer to the information contained in our filings with the Securities and Exchange Commission, as well as today’s earnings release. Unless otherwise indicated, all measures that follow are non€GAAP with year-over-year comparisons. A reconciliation of all GAAP to non€GAAP results is provided with our earnings release and in the slide deck. For certain forward€looking guidance, a reconciliation of the non€GAAP financial guidance to the corresponding GAAP measure is not available as discussed in detail in the slide deck posted on our Investor Relations website.

With that, I’ll turn the call over to Vlad.

Vlad Shmunis: Thanks Will. Good afternoon and thank you for joining our fourth quarter earnings conference call. 2022 was a milestone year for RingCentral. I am very proud of what our team has achieved against a challenging macroeconomic backdrop. The strength and resilience of our business model and stickiness of our customer base allowed us to once again deliver on our guidance. Let me give you a few facts regarding 2022. One, we finished the year with $2.1 billion of annual recurring revenue. We are now one of only ten pure-play SaaS companies with over $2 billion of recurring revenue and greater than 80% subscription gross margins. Two, we exited the year with a record operating margin of 14%, which is up over 300 basis points versus last year.

Three, contact center is now approximately a $300 million ARR business, which we believe makes us a top 5 global CCaaS provider. And four, most importantly, we still invested over a $0.25 billion in product and technology, further cementing our market leadership position. And going from strength to strength, in 2022, RingCentral received over 30 workplace and employer brand awards. We were honored to be included among the best companies for diversity, women, and company culture. This allowed us to build a world-class team, as we attracted top notch senior executive talent from companies such as Google, Adobe, AWS, NVIDIA and Five9. Building on this solid foundation, we expect continued growth and improving customer acquisition costs, resulting in strong operating margin expansion.

We have also made significant progress driving down SBC as a percent of revenue by almost 400 basis points in 2022 and we expect continued improvement in this area going forward. All this puts us on a path to significantly stronger free cash flow, which, combined with our new credit facility, puts us well on our way towards addressing our outstanding converts. Mo and Sonalee will provide more detail about our results and outlook shortly. But before they do, let me remind you of the main drivers of our success. It comes down to our corporate values: trust, innovation and partnerships. First, Trust. Q4 marked the 18th consecutive quarter of 99.999% uptime. Reliability is often the single most important factor for customers, as our service is mission critical to them.

They select RingCentral because we can be trusted to connect them with anyone, anywhere and at any time. This continues to be a positive differentiator for us in our industry. And we see it in our base, with over 95% of our customers actively using RingCentral for both internal and external communications and with billions of API calls each month. Trust also means data privacy and security. This quarter, we expanded end€to€end encryption beyond support for video. It now includes messaging and phone, giving customers the ability to keep critical information safe. Privacy and security are top priorities, and we will continue to invest to maintain our leadership in this important area given its criticality our customers. Second, innovation.

RingCentral was built on the dual megatrends of mobility and distributed workforces, which we leveraged to improve the effectiveness of communications for enterprises worldwide. And now there is a new megatrend emerging that is potentially even more disruptive, namely AI. While the power of large language model AI has recently captured the imagination of the broader public, we are proud to have been one of the first in our industry to deploy these types of solutions. We are leveraging AI to make real time communications more intelligent, seamless, and effective. Noise reduction, echo cancellation, virtual backgrounds, meeting transcriptions, summaries and highlights are just a few examples of how we use AI to further enhance our users’ experiences and productivity.

Moving forward, we will continue to invest in AI across our portfolio. You will see us launching new products that leverage AI to improve efficiency of collaboration for knowledge workers, improve the efficacy of our Contact Center for Agents and Supervisors, and improve the productivity for front-line workers. We expect these investments will further cement our leadership position in the age of AI. Stay tuned for exciting new product announcements throughout 2023. Outside of AI, we’ve added hundreds of features to our platform in 2022. This includes delivering on our advanced EU data privacy requirements, Ray BAUM’S Act compliance, browser support for Firefox, enablement of GSP partners like Vodafone and Charter, the introduction of device-as-a-service, new unique integrations for RingCentral Contact Center, a revamped resource center, 60-plus new integrations into key third-party tools to simplify customer workflows, and expansion to additional digital customer engagement channels like LinkedIn for example.

And finally, partnerships. We are committed to our strategy of partnering with the world’s most recognizable brands to create additional value for businesses and enterprises worldwide. Our partnerships with companies like AT&T, BT, Vodafone and a number of others are unique and have been a meaningful driver of our success. Partnerships remain an important part of our strategy. Mo will double click, but let me share couple recent highlights. First, we are launching a new partnership with AWS. This announcement marks the beginning of an important new relationship, whereby we will work together with AWS to deliver technologies and innovations that improve business communications for today’s hybrid workforce. Under this new multi-year strategic agreement, RingCentral and AWS will directly sell our product, and customers will be able to directly purchase RingCentral MVP and Contact Center solutions from the AWS Marketplace.

In addition, RingCentral and AWS will work together to develop and deliver vertical solutions for businesses in core industries such as healthcare, financial services, retail, education and public sector, as well as invest in joint marketing, lead generation and promotion activities together. We are extremely excited about this new strategic relationship and cannot wait to get started. Also, yesterday we announced an extended and expanded agreement to our strategic partnership with Avaya, with significantly improved terms. Avaya Cloud Office by RingCentral remains Avaya’s exclusive multi-tenanted UCaaS solution to Avaya customers. Avaya continues to hold the world’s largest base of Unified Communications on-prem users, and we remain best positioned to migrate this base to the cloud.

Looking ahead, there are hundreds of millions of on-prem seats that are still to be migrated and where we have the right to win every day. There is tremendous product market fit, and we have the product, partnerships and most importantly, people to capture this large, untapped opportunity that is still in front of us. With that, let me turn the call over to Mo to discuss in more detail what we are seeing in the market today.

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Mo Katibeh: Thanks Vlad. We continue to execute well and delivered solid results in the current environment. Upmarket new logo acquisition was robust. Also, our net retention rate in Q4 was again over 100%, demonstrating our ability to both land and expand, and driven in part by continued strength within our contact center, which grew above the company average. Our contact center brings together the world’s leading UC and CC. In the latest 2022 Gartner Critical Capabilities for Unified Communications as a Service Worldwide report, RingCentral ranked first in the UC with integrated contact center use case ahead of 11 other vendors. And the reason why is tightly integrated functionality that benefits customers of all sizes with unique, differentiated experiences.

First, for agents, our integrated solution offers seamless access to other non-contact center employees across the business and the ability to share simple context for the interaction, and two, for supervisors, our Performance Management solution, Contact Center Pulse, provides real time alerts on agent performance KPIs using our messaging technology. This allows supervisors to react to changing interaction volumes and agent performance instantly. Our customers also get an end-to-end experience with seamless billing, faster implementation, and integrated support. As Vlad mentioned, there are hundreds of millions of seats in the verticals and geographies that we are actively selling in today. We are mission critical to industries such as healthcare, financial services, retail, education and professional services, where real-time customer interaction is essential to the ability to operate.

For example, Aspen Dental, one of the largest dental service organizations in the U.S., Community Health Plan of Washington and Viva Health were all $1 million plus TCV healthcare wins this quarter. They selected RingCentral because we address key priorities for them such as HIPAA compliance, increasing staff efficiency and patient engagement, and of course, reducing care coordination friction. Our differentiation is clearly a driving factor in helping us win not just in healthcare, but also within the Teams ecosystem. We are successful with Teams users because of our unmatched and mission critical capabilities. First, we offer 99.999% of uptime, native PSTN to over 45 countries, and out of the box analytics and reporting. Second, we also have numerous, deep integrations into both our contact center solution as well as leading technology applications such as Google, Salesforce and ServiceNow.

And third, we enable native SMS and vertical specific capabilities and integrations that many of our core customers need to do their job. This has resulted in triple digit growth in the fourth quarter and increasing penetration of the Teams base. We continue to see this as an opportunity for future growth. Now, moving to partnerships. On Avaya, we are pleased with the new extended and expanded agreement, which now includes minimum seat commitments and a better aligned incentive structure intended to drive accelerated migration to Avaya Cloud Office. We expect to see renewed focus in selling ACO after Avaya finalizes their recapitalization. We expect Avaya will emerge stronger and better positioned to migrate the world’s largest on-premises installed based to Avaya Cloud Office by RingCentral, the best UCaaS destination for every Avaya Unified Communications customer.

Regarding Mitel, we continue to see strong traction since we entered into our strategic partnership in November 2021, with sequential growth in new seat sales every quarter of 2022. In addition to our strategic partners, our channel and GSP partners continue to be integral to our success, providing us with broad distribution and helping us expand our addressable customer base. Leads generated by our channel partners increased over 30% year-over-year in Q4. Channel partners continue to pick RingCentral because of our leading product and ease of working with us. Our GSP partners continue to drive stable growth, and we look forward to the continued ramp of new partners such as Charter and Vodafone. On International, we continue to gain traction with almost triple the number of $1 million plus TCV deals in Q4 versus the prior year.

Now turning to what we are seeing in the field. Our Q4 pipeline was up versus last year, and our win rates continue to be steady and strong. However, the conversion of these opportunities continues to be impacted by the current macro environment. Cycles times remain elongated versus last year, with initial deployment sizes down both year-over-year and versus Q3. Customers continue to understand how we are able to save them money while also enhancing their communications channels, but in this environment timing and deal size remain headwinds. What we can control is being more efficient in our go-to-market activities. Sales and marketing expense as a percent of revenue demonstrated solid year-over-year improvement in Q4. And there is more to come, as the impact of the efficiency actions we took in 2022 will be fully realized this year.

We have also executed on additional actions to make our go-to-market more efficient going forward. This includes: one, evolving our partnerships to improve overall economics for all parties; two, reducing support functions in sales while investing in front line sales capacity; three, lowering upfront commissions costs across our partners and direct sellers while also allowing top performers to earn more; and four, continuing to be disciplined on marketing spend, which thus far has yielded better leads, with improved conversion rates, and at a lower cost. In summary, we continue to execute well in the current environment. Our ability to help customers save money while increasing their efficiency has not changed. We are continuing to look at all aspects of our go-to-market to ensure we are as efficient as possible for when macro conditions improve, setting us up well for more profitable growth going forward.

Now I’ll pass it over to Sonalee to discuss our financials and business outlook.

Sonalee Parekh: Thanks, Mo. Before I discuss our performance and 2023 outlook, I wanted to reflect on what we achieved in 2022. As Vlad said, we are among a select group of SaaS companies with over $2 billion in ARR and subscription gross margins of over 80%. We clearly demonstrated the power of our business model at scale as we solidly exceeded our profitability goals in 2022 against a dynamic and challenging macro backdrop. We are a significantly more profitable company as we enter 2023. Now, turning to our Q4 performance. Subscriptions revenue of $502 million was up 19% year-over-year and in line with our guidance range. On a constant currency basis, subscriptions revenue rose 21% year-over-year. ARPU was once again stable across both UCaaS and CCaaS, with overall and new acquisition ARPU holding steady above $30.

Importantly, new customer ARPU is being generated at more attractive unit economics as customer acquisition cost improves. Moving to profitability. Our non-GAAP operating margin of 14% set another quarterly record and was up over 300 basis points year-over-year, driven by efficiencies generated across the business, most notably in sales and marketing. Now, moving to full year 2022. Subscriptions revenue of $1.89 billion was up 27% year-over-year. On a constant currency basis, subscriptions revenue rose 29% year-over-year. Total revenue of $1.99 billion was up 25% year-over-year. On a constant currency basis, total revenue rose 26%. Our ability to deliver a clearly differentiated product that is highly valued by our sticky customer base continues to generate industry-leading subscription gross margins, which came in at 82.4% in 2022.

Moving to ARR. We delivered $2.1 billion of ARR, up 17% year-over-year and 19% on a constant currency basis. Our CCaaS business now represents approximately $300 million of ARR. Going forward, we will provide updates on our CCaaS ARR on a semi-annual basis, with the next update in Q223. We have also set the foundation for expanding profitability. In 2022, our operating profit dollars rose over 50% year-over-year, which resulted in an operating profit margin of 12.4%, up 220 basis points year-over-year, with more to come. Now turning to our balance sheet. We ended 2022 with cash of $270 million. This is inclusive of $55 million of shares repurchased in Q4, bringing the full year total to approximately $100 million. Today we are announcing a new, board approved, share repurchase authorization for $175 million through December 31, 2023.

Moving to free cash flow. As is typical in our industry, timing differences between commissions and customer payments result in a delta between operating margin and free cash flow margin. Thus our free cash flow margin over a 12-month period typically trails our non-GAAP operating margin by five points to six points. These upfront commissions are investments, that result in very attractive ROI over the life of the customer. For the full year 2022, we generated free cash flow of $75 million, or a margin of 4%. This includes a roughly three point impact from items related to restructuring, third-party relocation costs, renegotiating terms with vendors and the linearity of vendor payments. Our disciplined approach to driving productivity and efficiency across the business will result in meaningful free cash flow expansion in 2023 and beyond.

We are targeting robust free cash flow growth in 2023 with normalized, unlevered free cash flow doubling over the next two years, 2022 to 2024. The free cash flow growth we project provides us with the flexibility to invest for growth, address our converts and return capital to our shareholders. On this point, I’m excited to announce that we have entered into a five year, $600 million credit facility consisting of a $400 million Delayed Draw Term Loan A and a $200 million revolver with Bank of America and JPMorgan acting as joint lead arrangers and bookrunners and Wells Fargo as joint bookrunner. Use of proceeds from the revolver and Term Loan A are for general corporate purposes, including the retiring of convertible debt. If market conditions present an attractive opportunity to do so, Term Loan A may be drawn at any time over the next nine months.

We saw very strong demand for the facility and had strong participation from leading financial institutions, which is a testament to our strengthening financial profile, strategy of driving efficient growth, robust free cash flow generation, and focus on disciplined capital management. Now turning to guidance. This outlook is reflective of what we see in the market today. It does not assume any improvement to current macro conditions. Taking this into account for the first quarter of 2023, we expect subscriptions revenue growth of 14% to 15%. Total revenue growth of 12% to 13%, non-GAAP operating margin of 16.5% and non-GAAP EPS of $0.69 to $0.70. For the full year 2023, we expect subscriptions revenue growth of 10% to 11%. Total revenue growth of 10% to 11%.

Non-GAAP operating profit margin of at least 18%, up at least 560 basis points versus last year. Based on the midpoint of our revenue guidance, we expect operating profit dollars to grow at least 60% and non-GAAP EPS of $3.04 to $3.10. As we look forward, we will be disciplined in protecting our ARPU while managing our cost structure as we drive durable growth and expanding operating profit margins. Our operating margin improvement will be driven by four main factors. One, operating leverage as we continue to scale above $2 billion in recurring revenues. Two, more efficient labor spend and improving the productivity of our workforce. This includes stock-based compensation, which we expect to further improve as a percentage of revenue by more than 100 basis points year-over-year in 2023.

Following an almost 400 basis point improvement in 2022, we believe this trend will continue beyond 2023 given: one, our discipline on labor also applies to stock-based compensation, and two, the impact of issuing shares at historical prices. We are committed to driving SBC as a percentage of revenue meaningfully lower over the next two years. Three, a multiyear go-to-market transformation to further improve sales and marketing productivity and partner economics, which will lower the cost of acquiring new customers. Four, vendor rationalization which will drive meaningful procurement savings. These levers are key as we drive towards continued significant margin expansion and growing free cash flow. In summary, 2022 was a year of solid execution despite a difficult macro backdrop.

In 2023, we will deliver healthy growth and drive greater efficiency within the business. Two quarters ago, we reiterated our commitment to achieving at least a 20% operating margin. Since then, we have hit major milestones in the path to achieving this goal. To this end, we are proud to announce that we expect to exit 2023 with at least a 20% operating profit margin. We have built a strong foundation and we remain laser-focused on delivering value to our stakeholders. With that, let’s open the call for questions.

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Q&A Session

Operator: Our first question comes from Samad Samana with Jefferies. Please go ahead.

Samad Samana: Hey, good evening and thanks for taking my questions. I guess maybe first one, Sonalee only for you. I appreciate, the enhanced disclosures and all the detail around, the leverage. I guess just when I think about capital management strategy overall, now that you have the facility to take care of the converts, how should we think about between the buyback and other ways of using the free cash flow? How should we think about using that over the next 12 months and then redeploying that and is there room for that free cash flow conversion to improve. Now that some of the prepaid commissions that you previously have a better structure with your partnerships?

Sonalee Parekh: Yes, thanks for the question, Samad. And yes, we are very, very excited about the credit facility that we announced today. So that’s a $200 million term loan and $400 million €“ $200 million revolver and $400 million Term Loan A. And what I would say is our revenue and profitability profile that we outlined for you really allows us to consider accessing all forms of financing, so not just convertible debt markets. And we believe that the Term Loan A really provides us the best option to retire a portion of our convertible debt and reduce those maturities, if market conditions present an attractive opportunity for us to do so. And I would say the terms were very attractive and demand for that transaction was very strong.

We have no immediate plan to retire the converts, but we’ll be watching the market closely and make a decision on whether to draw on that Term Loan A or not over the next nine months or so. But within that, we plan to grow EBITDA significantly over the next few years. And that will drive down our leverage multiple significantly and again, presents us with a lot of optionality in terms of how we refinance convertibles? How we decide to invest in our own organic growth? And then as you say share buybacks. So, I really view our capital allocation policy as dynamic. It will take all three forms, but at the moment we are, as very firmly focused on driving margin improvement and also free cash flow. And in terms of the relationship between the two, you heard of my prepared remarks, we’re expecting free cash flow to double over the period 2022 to 2024.

However, you still will see about a five point delta between OP margin and free cash flow as is the case and as typical with many SaaS businesses. In terms of the renegotiation of the partnership, that is helpful in terms of driving margin, but it wouldn’t make a significant enough difference in terms of really narrowing that delta. So for now, I would say for modeling purposes, expect that delta to continue between OP margin and free cash flow. Hopefully that answers your question?

Samad Samana: It does. And then I have a follow-up. And this could really be for any of you all, but just as I think about where ARR ended and then the guidance for 2023 for, it kind of suggests that subscription revenue in 2023 will end up being about where ARR ended in 2022. I’m just curious, how should we think about that? Is there an expected uptick and churn in the base or is there a combination of maybe expected churn versus some offset and slower new business? Just how do we reconcile, where the business ended in the fourth quarter and then that forward subscription revenue? And it doesn’t have to be on the math itself, but just maybe how is the company thinking about the business between those two different things?

Sonalee Parekh: Yes, so why don’t I start and then I may hand over to Mo for some comments around the business. We don’t typically guide to ARR, but let me provide some color given your question. So, we are adding net new bookings at a healthy rate and we will in 2023. We’ve shown you a revenue guide of 10% to 11% for 2023, and that does factor in new bookings. And what I would say directionally is, we would expect ARR growth for 2023 to be above where we guided for total revenue growth in 2023. And some of the puts and takes there are, as we are now growing more upmarket and also given the current macro, we’ve assumed more back-end-loaded bookings, and we’re being more conservative in terms of what we’re forecasting on churn and downsell in the current environment, as is prudent.

And as our base gets larger, obviously that churn number, even if it’s stable as a percentage, it gets larger as well. But I think the most important thing from your perspective is that ARR growth, we would expect it directionally to be above total revenue growth for the year.

Samad Samana: Really helpful. I’ll hop back in the queue, but great to see all the progress on the margin expansion. Thanks guys.

Sonalee Parekh: Thanks, Samad.

Operator: The next question is from Sterling Auty with SVB. Please go ahead.