I'm Ana Goshko, and I cover technology and telecom credits for B of A. We're thrilled to have RingCentral with us today at our 2023 Leveraged Finance Conference. This morning, we have with us Aziz Megji, who's the company's Senior Vice President of Finance and Treasurer. So, Aziz, thank you so much for being with us.
Thanks for having us.
Good. Good. So, any opening comments before we jump into questions?
No, let it rip.
Okay, great. Okay, so RingCentral has been an issuer in the convertibles market, but it issued its first non-convertible bond, not too long ago, so that was in August. It was the $400 million, 8.5% notes. So just in case there's anyone in our audience that's new to the story, it may be good to start with just a few minute overview of the company to sort of set the stage and level set.
Yeah, absolutely. Good to be with you all. So RingCentral, we've been around for about 20 years, and a public company for the last 10 years, and we are the leader in unified collaboration as a service, so UCaaS. So our flagship product is a platform that enables small, medium, and large-sized companies to communicate across voice, chat, video, in the cloud. So we basically—the heritage of the company was bringing on-premise PBX phone systems to the cloud, and over the past 20 years, we've established a number one market share position, in terms of revenue in the UCaaS space. And have used our strength in voice to enter new markets such as contact center, events, and now AI.
We're defining our whole company around AI and establishing ourselves as a leader in AI for communications, infusing that technology into our voice, video, chat, contact center, functionalities from a horizontal perspective, and also creating, vertical specific use cases targeted at certain personas, such as, customer support personas and sales personas to-
Drive better outcomes, for those, for those individuals. So that's who we are. We're a $2.3 billion ARR business. We'll expect to generate between $290 million and $300 million in levered free cash flow this year. We've done a tremendous job evolving our financial profile to what we call healthy, profitable growth. We expect this year to grow double digits for our guidance and generate 19% operating margin and exit the year at 20% operating margin. So that, at those levels, that's about a 660 basis point improvement year-over-year and nearly doubling free cash flow. So, a lot of long-term growth vectors for us. The market we're in is still very underpenetrated.
We estimate about 400 million unified collaboration UCaaS seats are still on-prem, and we are really the ripe destination for those seats as they move to the cloud. Just given our strength in UCaaS, not only are we the leader, but we believe our platform is highly differentiated from our competitors from a reliability standpoint. So one thing that we're very, very proud of is that we have what we call five nines reliability. So in a year, our platform only experiences less than 5 minutes of downtime, and that's unmatched in the industry.
We have the most robust set of features and capabilities on our UCaaS platform, as well as the deepest breadth and depth of integrations with other third-party software applications, which is really important as our product really fits into an enterprise and SMB workflow. So with those product attributes, our partner network, we have 15,000 VAR partners who are trained and enabled to sell RingCentral. That's over 50,000 people feet on the street who are selling RingCentral every day through our partner network. Through our exclusive relationships with Avaya and Mitel, we have access to some of the largest holders of some of those on-prem seats.
And then the continued investment in innovation and strengthening the platform, we believe, will be long-term drivers of durable, profitable growth and continued market share expansion.
Okay, great. Thanks. So, to dive deeper on the recent earnings call, your, you know, recent statements, you have a new CEO. Recently, Tarek Robbiati joined and set a sort of five-pillar strategy, and I think it's a good roadmap for our discussion. So, the first one was to continue to innovate and build a multi-product business, and I want to touch back on the AI opportunity. But, before we get to that, so net retention, you cited about 100%, but you have a goal to do better than that by expanding your footprint with existing customers. Can you talk about how you're planning to achieve that?
Yeah, absolutely. So one thing that's unique about us is, you know, we built this $2.3 billion ARR base really on the back of one platform, our core message, video, and phone platform. So as we think about near-term drivers of growth, it's really evolving into a multi-product company. So we recently announced a proprietary native contact center as a service offering called RingCX. So this is really predicated on a simple use case, easy to use, easy to deploy, AI first, targeted primarily at downmarket customers. However, it has the scalability and the robustness of the platform to handle the largest of contact centers. But simple, easy to use is really the premise, and we're really excited about that product and the ability to cross-sell to our UC base.
What we've found is that UC plus CC, that use case, is really strong in driving significant ROI for our customers. Because the synergy is there. Being able to connect the front of the house with the call center in a seamless way is really important as customers transform not only their contact center into customer experience excellence centers, but the whole company into a customer experience-oriented ethos. So we're excited about that product. That's a significant innovation. We also now have a full video stack, so from meetings to webinar, events, and room, that was completed with our acquisition of the events assets from Hopin a couple months ago. So we're excited about that full video stack. Now we can address every use case that customers have across the video continuum.
And then AI. AI infused into everything, AI with our RingSense platform for AI into phone, video, contact center, and for certain customer personas. So we believe those new products really present the next wave of growth as we drive cross-sell and upsell to our base. So historically, it's just with our upsell component of our net retention, it's been about more lines or more features. Now the story's about more lines, more features, and more products. More products drive higher upsell. They'll drive greater customer retention, so lower churn, that equation of the net retention, and we believe will be key drivers of expanding the net retention over time.
Okay, so has most of the hard work been done on the development of the video platform as well as the RingSense AI, or is there still a product roadmap that you're working on? Are you really just, like, in cross-sell mode, or are you-
Yeah.
Still working to develop?
Yeah, so on the development front, we're fairly advanced. So, you know, the RingCX contact center product is not something that just was born overnight. It's actually a... We acquired two companies, about five years ago. One was very strong in outbound, communications from the contact center. The other was very strong in omni-channel. We've integrated those two and put a whole bunch of technology around that and features and capabilities. That's RingCX. So it's been many years in the making, and it's fairly advanced at this point. Robust roadmap, a lot of investment in going into it going forward, but we're really ready to take share and drive growth now.
Events is a fairly mature product that we acquired from Hopin, and it's one of the leading events products, really differentiated by the personalization, the customization, the robustness of features. You know, they're hosting events, 50,000-plus user conferences for leading brands. You know, you pick the name. You know, they're a customer of Hopin and now RingCentral. So these are fairly advanced products. And then the AI, you know, AI is now kind of the buzz in generative AI and... But we've been infusing AI into our products for many years, right? We've had transcriptions. We've had meeting summaries. We bought a company in 2018, DeepAffects, which is now kind of the basis for our RingSense platform in 2018.
You know, we've been developing these technologies for many years, and now it's really about just operationalizing our company to be a multiproduct company and to drive adoption of these products through our customer base.
Okay, great. So moving on to the next goal, so that's to focus more deeply on customer segments and key verticals. So, I think where you've highlighted opportunity is in the SMB market. So what's the opportunity there, and how do you size that?
Yeah, absolutely. So, you know, think about the segmentation of our business. About 40% is SMB, 20% is mid-market, and 40% is enterprise. So, you know, we are a very large SMB provider. That's actually where our heritage had been, and we've moved upmarket over time. In SMB, you know, our SMBs truly value the product and use the robustness of the features. I mean, they're using the product as a mini contact center, as a mini CRM. It's really core to their operations. So if you think about voice, I mean, voice continues to be the preferred modality of communication for business. And in the SMB, it's the vast majority of the communication. You know, your local hairdresser is not communicating with their customers via video or chat. So it's a significant opportunity for us.
We see really strong KPIs there. As we think about our AI platform and RingSense, our AI platform and RingCX, and the ability to cross-sell those offerings into the SMB market, it's a significant opportunity. You know, we see that as a strong growth driver going forward, and we're uniquely positioned to be, to take share there.
Okay, and then what about industry verticals? Where do you see the most opportunity there?
Across segments, we see the verticals where voice is the mission-critical to communicating with customers, a place that we have extremely high win rates and drive differentiation. So that tends to be in healthcare, distributed retail, distributed financial services, public sector. And of the 400 million on-premise seats in UC, we estimate about 100 million are in those verticals. So it's a significant opportunity, and we have very deep integrations with vertical-specific enterprise applications that allow our core UC product to integrate into those workflows. That's really important. So in healthcare, it's Epic and Cerner, one example, of how we integrate and really become part of that enterprise workflow.
So we're excited about those opportunities, developing additional partnerships to go to market in vertical-specific areas, and then continuing to invest in the roadmap, to deepen our integrations and features that are focused on vertical-specific customers.
Okay, great. The third goal was to expand partnerships. So maybe if you could just recap who are your most important partnerships to date, and, you know, how do you work with them? What's that relationship like?
Yeah, the partnerships is a key element of our story and how we've been successful. So, as we think about partners, it really breaks down into a few different buckets. So it's one, it's our value-added reseller community, so over 15,000 resellers, 50,000 people, trained and enabled on RingCentral. So that's one big piece. The second is our strategic partners. So we're unique in the sense that we have exclusive relationships with some of the largest on-prem OEMs. So we've been an exclusive partner with Avaya since 2019. We've been an exclusive partner with Mitel since 2020. And between the two of them, they hold a significant portion of those 400 million on-prem seats.
And so as those on-prem seats move to the cloud, those Avaya and Mitel on-prem seats, we are the natural destination, to migrate those seats towards. So we're excited about those partnerships. And then we have some new emerging partnerships. We have a partnership with AWS that we announced in Q4 of 2022. It's early, but we're seeing promising signs of traction there. And another part of our growth will be developing new partners. So, you know, Tarek talked about this on the call, but new ISV partners, industry-specific partners, service provider partners. We've been very focused on VARs and these strategic partners. That next wave of growth will also benefit from new partner relationships that will help and strengthen our presence, especially as it relates to vertical-specific and SMB-
Okay.
And international.
Okay, and then, the fourth pillar was to grow internationally. So first of all, how big is your international revenue now?
It's about 10%.
Okay, and then what is the goal and over what time to grow that?
Yeah. So, you know, it's been 10% for a couple of years, so it's a significant growth opportunity and one that we've not unlocked fully to date. And couple of the ways that we're going to unlock that is, one, is new go-to-market motions and partners, so establishing new relationships internationally with players who can broaden our reach, so those are ongoing conversations we're having. Second is new go-to-market motions. So wholesale is a real successful motion in Europe. So we are developing wholesale relationships with new partners. Part of our Avaya relationship now is to unlock a wholesale motion through Avaya, which should open up some opportunity to migrate more seats.
We see that as a significant opportunity, and it's really about operationalizing our go-to-market to go capture that, and that's one of Tarek's key focuses.
Okay. And then, you know, by region, you mentioned Europe. Is that where you plan to expand, or are there other regions of the world?
Yeah. So Europe is a key expansion opportunity. We're strong in U.K., but Western Europe is a continued focus. We just got licensed in India, so that's a focus. Some new countries like Portugal and Italy are also a key focus. And some of the partners we've established through our G SP channel, so we have a robust set of telco and cable relationships across the world, including in Europe with Deutsche Telekom and Vodafone. Some of those are newer partnerships, and so as those mature and ramp, we see a significant opportunity in ramping them in Europe, especially with Vodafone.
Okay. Then, the final goal was to increase operational productivity. Is this a cost-cutting program, or, you know, how are you going to become more productive?
Yeah. So, you know, thus far this year, we've done a tremendous job in driving operating margin expansion, so 660 basis points based on our guidance versus where we landed in 2022 for the year. And going forward, it's really gonna be, you know, three parts. One is operating leverage. So we have a $2.3 billion ARR base. As that renews, that will renew at a very high margin, which will drive operating leverage. Second is continued efficiency. You know, we grew to $2.3 billion very, very fast, and some of our processes didn't scale in the same way. So this continued focus on efficiencies, as it relates to some of our non-headcount spend, headcount spend, as well as on the go-to-market side.
So improving our sales and marketing as a percentage of revenue is a key focus, right? Driving more efficiency there, lowering cost of customer acquisition, improving channel spend. Those are all key focuses. And as we ramp these new product motions and cross-sell motions, that should help because those come at a much higher contribution margin than acquiring new customers just outright. So those are really the vectors of continued focused on productivity, efficiency, which will lead to higher margins and free cash flow over time. Probably not at the same rate as 660 basis points, as we'll reinvest some of kind of that margin expansion operating leverage back into growth and have to balance growth and profitability. But there's certainly more margin expansion to come in the story.
Okay, and then, the company's stock compensation has been very high. I think it's been as high as 20% of revenue. Management has talked about an intention to reduce it. So does that mean more cash compensation, and is this going to be dilutive to either adjusted EBITDA or free cash flow?
Yeah, so we have a few different levers on how we'll look to address stock-based compensation. We brought it down from about 24% to, based on our guide, around 20% this year. That's still not good enough, and there's been some headwinds as it relates to stock-based compensation. You know, we've issued shares in the past at much higher share prices, which is still playing through the stock-based compensation. You know, we're having to retain and refresh employees at what we view are relatively low stock prices, which has an impact as well. So going forward, there's a few different levers. With, you know, our guidance of $295 million of unlevered free cash flow at the midpoint, that does give us more flexibility to shift some of the stock-based compensation to cash.
So we will employ that as a lever going forward. Second, we'll be more disciplined in how we issue stock-based compensation, you know, and how wide we go with it versus cash compensation. And then third, as we think about our employee and headcount mix and where it's located in the seniority mix, optimizing that a bit to put less pressure on how much stock we issue to employees versus cash compensation. So we think the mix of those three levers, as well as some of those headwinds coming off, will materially drive down stock-based compensation, both on the GAAP measure on the expense side as well as the dilution. So, you know, SBC and Tarek and Vlad have said this on calls, is a key focus of ours.
And it's something that to get to benchmark is probably not going to be a one-year type journey, but it... You know, three years is too much, right? So, you know, we're looking over the next 18-24 months to drive more closely to benchmark, and we feel we have the levers in place to get us there, and there will be a meaningful move downwards on that journey in 2024.
Okay, so the company's described macroeconomic headwinds, so elongated sales cycle, a tough environment for upsells. So, has there been any change in that? And then also, how is that impacting contract renewals? Are you seeing any downsizing as companies, as contracts come up for renewal?
Yeah. So we haven't seen a further deterioration in what we've seen over the past couple quarters. It's kind of stabilized from where we've seen in Q1, Q2. So not gotten better, but not gotten worse. And in our business, where the macro really impacts the most is in sales cycles and size of customer deployments. We've seen sales cycles elongate and the size of customer deployments come down. And then when you couple that with the customers are more cautious about buying decisions, so that's impacted our upsell, right? So as customers look to buy more seats, they're taking longer to make those decisions, pushing them off, which has impacted our upsell and our net retention as a result.
From the churns and the downsell part of the equation, our churn has been relatively stable, so we've, we've not seen any deterioration or material change in our ability to retain the logos. We have seen some downsell pressure. So as customers, you know, reduce their headcount, you know, they're naturally coming to say, "You know, let's reduce our footprint because we have less people." So that has been a pressure. So we hope as the macro subsides and that downsells pressure alleviates, as customers buy more lines or more seats, as the new products take hold, that will all have be key drivers in that retention expansion. But in terms of the macro, we're not seeing anything materially change from an improvement or from a further degradation versus what we've seen over the past couple of quarters.
Okay, great. So let's shift to capital structure. So, as, as we highlighted when we started out, the company recently issued the 8.5 notes, the $400 million, and that was used to help repay convertible notes. You have $414 million, my last count of converts due in March 2025, then you've got another $609 due in March 2026. What is the plan to address those?
Yeah, so we've, you know, on the 2025 converts, and we started the year with about $1 billion in the 2025 converts, and so we've done, you know, a great job in delevering, diversifying, and de-risking the balance sheet. So we've, you know, we've raised a $400 million term loan A with the help of Bank of America, and then subsequently, a $400 million unsecured high-yield note. And so with the proceeds of those, we reduced that bond to $414 million. We have about another $240 million on the balance sheet of remaining high-yield proceeds that we'll use to further reduce the 2025 note over time.
So when you kind of pro forma the $414 million for the $240 million, that leaves about $174 million remaining to address. So we have an additional $75 million that we can draw on our term loan A through a new banking relationship, and then free cash flow. You know, we expect to generate $295 million of unlevered this year. You can—we'll look to grow free cash flow in excess of revenue. In 2024, we're not guiding yet, but you know, the principle is to continue to grow that, and grow that with operating leverage.
So you can just imagine, with that type of free cash flow profile, the liquidity from the term loan A, additional liquidity we have on the revolver, we have ample coverage of that remaining about $175 million of our 2025 convert. So we feel very good about our ability to address that with our liquidity position, and free cash flow profile.
Okay. Do you have a leverage target or a credit rating target?
So, you know, an important milestone for us was driving under 3x net leverage. This past quarter, we were just on top of that, and, you know, with our guidance for Q4, we'll be materially below that. So, you know, that's an important milestone to driving below that 3x, and we're there. Going forward, we'd like to drive below 2x, and we believe with our EBITDA profile, with our revenue growth profile, we'll be able to do that in the near to intermediate term. You know, we're currently BB at the corporate level across all three agencies, and the goal is to be an investment-grade company.
And so, we think with our profile of durable, profitable growth, free cash flow generation, driving down our SBC, that that's an intermediate-term goal, to be an investment-grade company and, and drive down, materially below 2x net leverage.
Okay, great. Any questions from the audience? Okay.
There's one in the-
Oh, there's one.
If you go in your sales quote in your platform, yeah. And what, what do you see?
Yeah, absolutely.
So let me repeat the question, and that actually was the question I had in reserve. So it's, it's on the competitive landscape. So as you're kind of selling to customers, who are your key competitors? How are you differentiated versus the competitors, basically?
Yeah.
Yeah.
Absolutely. So, you know, as we think about the landscape, and it really breaks down into modalities as well. So, you know, in UCaaS, there's three modalities. There's phone, there's video, and there's messaging. And so when customers look for a solution, you know, there's a long tail of competitors, but the three we see most are Microsoft Teams, Zoom, and 8x8. And so from a customer decision-making and buying process, if you're looking for differentiated phone capabilities, integration, reliability, which means that phone is a key modality of how you communicate, of how you reach your customers, which tends to be SMBs, a lot of them is mid-market, those verticals I highlighted, where reaching your end consumer is a key business activity. RingCentral is the de facto choice, right? We win in those situations.
If your preference is video for communications, which tends to be in knowledge worker segments, technology, professional services, you know, Zoom and Teams tend to do well. If messaging is your core way of internal communication, Teams tends to do very well. So that's how the landscape breaks down. And where we see opportunity is not only in those phone-centric use cases, SMB and those verticals I highlighted, but also in knowledge workers, where customers say, "Well, I want to standardize on Teams." We have a Teams application for phone that we can embed in the Teams environment in a seamless way, single pane of glass, at a price point that's similar to buying a Teams phone plan, calling plan, and the Teams phone license.
And we see strong adoption there, in the Teams environment with that product in the knowledge worker segment. So that's how we see the competitive landscape. It's really about modality and how you're communicating. We continue to be the leader in cloud phone, based on reliability, based on features, based on integrations. And then the other key thing is around contact center. You know, Microsoft Teams doesn't offer a contact center product, so we see a strong adoption of our contact center offerings, whether it be our partnership with NICE at the high end or our proprietary native RingCX for simple use cases within Teams environments. And we see a lot of strong win rates with those products within Zoom environments.
So, you know, it's really about phone, SMB mid-market in those key verticals, knowledge workers, we can penetrate the teams base and then contact center throughout. And that's really the strategy and why we win, and we see our win rates continue to be very strong against all those competitors.
Um,
Yeah, so we've you know, we disclose our average ARPU. It's been relatively stable with no above $30. You know, and pricing is different in different segments and based on how you value the product. You know, we see still very strong pricing and be able to hold our ARPU in those modalities where phone is the use case, right? And so you can imagine SMBs, how core and critical our platform is to their business. And they're willing to pay for the features, for the differentiation, for the reliability, for the integrations. In the largest of enterprises, where people are just communicating internally, that's typically where you see the pricing pressure. That's not a place where we participate. That's not our core market. We'll compete, and we'll win there. That's not the core of what we do.
Well, the core of what we do is SMB mid-market, and those verticals where phone matters, phone is mission-critical. And those features, the reliability, are key to how those customers run their business, and they're willing to pay the premium for those features because they're they're mission-critical to their business. So, that's how we see it, and in the larger enterprises, there is ARPU compression and competition, and that's mainly because they don't value the features as much for their business.
Okay, great. Great, well, with that, we're out of time. So, Aziz, thank you so much for being with us-
Thanks for having us.
And attending the conference.
We appreciate it, yeah.
And spending time with investors today.
Absolutely.
Okay.
Thank you.
Thank you.
Appreciate it.