All right, perfect. Welcome everybody. Meta Marshall, I cover the communications software names here at Morgan Stanley. I'll read the disclosures while we get Vlad up on stage. For important research disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. We are delighted to have RingCentral here with us today. We have Vlad Shmunis, CEO and Founder, Mo Katibeh, President and COO, and Sonalee Parekh, CFO. Thanks so much for being here today. You know, Vlad, maybe starting with you. You know, there are a lot of areas for RingCentral to be excited about, namely kind of the 20% operating profit target exiting 2023.
Before we start in on that conversation, you know, there's obviously kind of these bearish concerns that have weighed on the name. Over the past year, there's just been questions about differentiation within UCaaS, with Teams becoming a more visible overlayer. Just what do you think that more bearish view of investors misses?
Yeah. Well, first, thank you for having us.
Yeah.
More than happy to talk more about the positive.
Yeah.
To your question, I think that what many folks are missing are two things.
Mm-hmm.
One is that UCaaS, voice-centric UCaaS, is still a gigantic, ginormous market.
Yeah.
People have been questioning the $450 million legacy seat number.
Mm-hmm.
I do believe there is some truth to that, the actual addressable market, which continues to stay voice-centric, is still easily in the hundreds of millions of seats, and those are the seats that are... If you think about B2B2C. Okay? When consumers reach their providers, reach their brands by phone. It excludes many of the knowledge workers. That is a true statement.
Right.
It includes your stalwart industries such as healthcare, retail, financial sector, flat. If you think any type of an interaction, if you're calling your dentist, your realtor, if you are in a university environment, certainly anytime you're calling a retail store, these communications are still by phone.
Mm-hmm.
Very large market. Which brings us to the second leg of the stool, which is RingCentral continues to be the best cloud PBX in the world. Why are we the best cloud PBX in the world? We're the only ones with five nines reliability for over four years and counting. Knock on wood. Two, we have the widest geographical coverage with regulatory compliance. Other people will try to confuse that issue and tell you, "Well, we got as many countries or maybe three more countries." Yes, with BYOC, bring your own carrier. As far as being able to provide an end-to-end-
Mm-hmm.
-turnkey solution without the BYOC, which is where most of the real business is, that is still with Central. Why? You know, we had an earlier start, if nothing else.
Yeah.
We continue investing in that area. There come integrations. We have the deepest, longest list of integrations in the industry. We continue adding to that. What are these integrations? All kinds of CRM systems. Yes, everybody's got Salesforce. Salesforce has like 40% market share, but what about the other 60%?
Mm-hmm.
Everybody wants to integrate with RingCentral. Okay? We have this App Store, App Gallery with many hundreds of titles on it. We've talked about over years how we have tens of thousands, at this point, something like 50,000 developers that have written code to our APIs.
Mm-hmm.
That is a defensible moat right there. Then there is the feature set. We simply have more features.
Mm-hmm.
Okay? Some of them are pretty esoteric. They have to do with things like, you know, call control and whisper and call monitoring, et cetera. Some of the even Contact Center-like functions that are all well embedded in our product. There is analytics. Our analytics is way beyond simply quality of service analytics. It is a bit of a WFO, workforce optimization, workforce management in its own right.
Mm-hmm.
All of this combined allows us to win better than 50% of all RFPs, even when we're going against larger companies, and there are only two larger companies in this space really at this point.
Right.
which is Microsoft and Zoom.
Mm-hmm.
When somebody needs a phone solution, phone-centric solution, RingCentral is the way to go. Market understands that.
Got it. Sometimes there's also just confusion about some of the counts that are kind of out there. You have, you know, you just said there can be some debate about kind of the $400 million install base, but there's a big number there. There's kind of the $20 million you guys have talked about maybe being the market that's moved towards the cloud. You have a lot of numbers that are kind of thrown out about as others on PSTN connections and elsewhere. Like, where should we consider cloud, the cloud transition? Like, what should we consider as the status of that transition, and what metrics should we be looking at for that?
Right. Again, let's look at the addressable market.
Right.
We are not claiming that there is $400 million to transition. We are claiming that there is maybe about half of that to transition. If you use the $20 million number, and that's going between the big three, Microsoft, you know, Microsoft and Zoom.
Yeah.
Okay, that's your 10% penetration. That still leaves 90% out there. We are doing well in that segment.
Mm-hmm.
We haven't yet talked about our differentiated GTM. It is well-differentiated with especially very recent successes we've had with global service providers. We have our old partners such as AT&T doing extremely well. Some of the new ones are ramping up. Vodafone is coming up internationally. We have high hopes for that. It's very early. Charter Communications we've announced last quarter. I can tell you they're doing ahead of plan and meaningfully ahead of plan. As always, we have numerous other conversations and opportunities in place. We're definitely doing well in that market. The other differentiated GTM has been our strategic partnerships led by Avaya. Avaya has underperformed expectations.
Mm-hmm.
Obviously our own expectations as well. However, we did get, in rough numbers, 400,000-500,000 seats from that relationship. On lifetime value basis, okay, let's say we did.
Yeah.
Okay, not great, not terrible. Very importantly, moving forward, Avaya is still a growing concern. They will emerge out of bankruptcy. A modified version of our agreement will survive that bankruptcy. Under this new construct, every seat that moves, Avaya actually gets paid real cash. That was not the case before because there was a prepay, which we needed to write down, so that's unfortunate. Moving forward, incentives are aligned. Guess what? Avaya is still the largest incumbent on Earth, both for UC, and we are their exclusive UCaaS provider, so UC to UCaaS migration. We are their exclusive destination for those seats. They're also the largest CC provider in the world. What we know is that historically, they sold most of their seats as their UC and their CC together.
We are, call it optimistic, that with a renewed focus on CCaaS and coming up with their own CCaaS, that integrating with our UCaaS will be a winning motion. We're actually super excited about that. Hopefully, bankruptcy proceedings will terminate sometimes within the next 30 to 60 days, and it will be not business as usual, but business better than usual.
Got it. Maybe kind of the last of the difficult questions is just, you know, investors were maybe surprised with the level of deceleration in growth in 2023, particularly given the exit ARR. Just where are you seeing the most weakness today? Is it in renewals, either in seat counts or ARPU, new customer pricing, or just new customer adds? Are there any patterns worth noting there?
I'll give you my short answer.
Yeah.
Mo will add. Short answer, it's the macro. Okay?
Yep.
Our acquisitions are doing strong, but we are seeing our customers, they're staying within RingCentral, but as they are going through their downturns, that does create a headwind for us. We expect it to subside and then hopefully rebound back once the economy starts expanding. Maybe Mo can provide a little bit more details.
Yeah. Thanks, Vlad. We've been talking about this for the last two, three quarters, and really what we saw throughout 2022 was that the demand side of the equation remained strong. In terms of opportunities, leads, if you will, coming into the funnel, continued strength there. There's really two key dynamics that have played out. One is something that you've been hearing, I think, from a lot of different companies, is the continued increase in the time that it's taking for that lead to actually close and become a closed sale. That sequentially continued to climb throughout 2022 and very clearly now back to pre-COVID levels. The second dynamic was the size of the opportunity as they were closing, got smaller, especially upmarket throughout 2022. When you put those two dynamics together, especially factoring in that ARPU has remained stable, strong-
Mm-hmm.
Throughout this time period, that is what's led to the guidance that we've provided for 2023.
Yeah. The only other thing I'd add there, I think you'll probably dig deeper on guidance overall. When we guided, we guided based on the trends we were seeing in the market at the time, which was two weeks ago. Within that guidance, we are baking a relatively conservative view on down-sell and churn given the current macro. When you think about churn even being stable, it's stable on a base that grew 25% last year.
Right.
The actual dollar number of churn is, you know, significantly higher if you think of absolute terms. I think that's something that people need to incorporate in the overall contextualizing of the guidance.
Got it. I mean, maybe part of the cost discipline that you guys were bringing into RingCentral was, you know, less marketing, maybe less generous commissions, but largely keeping frontline sales counts similar. Just how do you discern the move, you know, versus macro, like basically keeping that end person sales count similar when maybe your opportunity set is slightly elongated this year?
Very good. Yeah. Two key ways of thinking about that. We've said, look, one, we're going to get our sales and marketing machine to be significantly more efficient. Part of the labor actions that we've taken is in service of that goal, and at the same time we said, "Look, but we're investing in our frontline. We're actually looking to expand." This really goes back to what Sonalee just articulated a little bit ago, which is that as you think about an ever larger base and even reasonably constant churn and down sell within it, you need more and more bookings.
Factoring in the demand environment, factoring in cycle times, factoring in the opportunity size, you can imagine that we've done the math on right sizing our sales team, and even frontline, vis-a-vis that and factoring in the churn and down sell, which again, together leads us to the guidance for the year.
You mentioned kind of the lead generation is still quite healthy even though it's just kind of taking longer to get through that. You know, how are you positioning salespeople to say, "Hey, I know it's gonna take you a little bit longer to kind of get to that commission," or just what is that communication like with salespeople of, "I still need you to harvest as much but it just might take a little longer to close"?
Well, the way I think about that is, and it's interesting 'cause we actually represent this dynamic as well, the sales motion and the way we're selling the value proposition, everything that Vlad already articulated, but also that in many cases when a customer is moving from a prem-based solution to a cloud-based solution, there's real TCO savings for that customer. The cost of the solution, the embedded telco, the human surround, as you factor it in, we know we can save our customers money.
The dynamic that's played out is, call it the sheer level of approval, where historically we knew that we could, you know, whether it was the senior director or the VP, the IT buyer, the line of business buyer, now it's the CFO, the CEO, in some cases even the board is having to weigh in, which inherently adds cycles to the time. Within RingCentral, we've done the same thing. You know, part of our own cost discipline is we've changed the authority level for a given purchase order where something where an AVP might have historically been able to approve, Sonalee and I are approving as well. That is the dynamic we're seeing play through.
You know, we focus our sales people on managing their pipeline and new leads that are coming in, knowing that, look, even if it takes a little bit longer, that should stabilize at a given point in time, and then it's managing the pipeline and closing deals.
Got it. Maybe, Vlad, turning back to you just on the partnerships, you know, that has always been a really differentiated part of the RingCentral story and, you know, you've continued to grow those. Now, you have learned a lot over the last four, five years of kind of all of those partnerships of what works, what doesn't work, you know, and you've continued to add to that. Just maybe what are your learnings from that, and how has it changed your kind of partnership approach going forward?
Oh, great question. I continue believing that partnerships are a feature and not a bug.
Mm-hmm.
They're a good thing.
Yep.
It's great to have AT&Ts, Vodafones, Charters, Salesforces sell RingCentral.
Mm-hmm.
Just simply a good thing. Okay? We want to do more of those. It was, and again, we'll rebound, to have Avaya Salesforce now. Yes, diminished.
Yeah
... for their own internal reasons, but still, whatever number of hundreds of salespeople they have left to still have this, us as a core part of the portfolio. Those are positive learnings. Negative learnings, which are probably, you know, maybe even more valuable is, look, we, you know, pre-paid a bunch of commissions to people.
Mm-hmm.
That was not a good thing to do. We will never do it again. Every new deal moving forward, starting with this renewed Avaya arrangement, is people get paid as they go.
Okay.
We think that that aligns incentives and we're also very careful not that we did, but some of the partners fell into this ASC 606 trap towards their recognizing revenue ahead of cash and, you know, that's fool's gold.
Yeah.
Okay? That's kind of what got them into trouble to begin with.
Yeah.
moving forward, we believe that everybody's very clear that what really counts is cash, free cash flow, and again, aligns incentives is the short answer, is the learning.
how does maybe the AWS partnership that you guys just announced as well, how does that like or dislike some of the partnerships that you've had in the past?
It's very different because we've never had an AWS, right?
Yeah.
That's a mega scaler. Look, it's very early, but we know the company well. They know us well. It's a two-way street partnership, they also have been selecting us.
Yeah.
You know, we are seeing good early deal flow. Clearly they're extremely well penetrated into, you know, Fortune 1000s, G2Ks, et cetera, where we, you know, absolutely could use some help. We'll have to see. Look, AWS is a major technology provider and, obviously OpenAI and ChatGPT is on everyone's mind and, but you know, they have competitive technologies too. We'll just have to see what happens there. They also have a portfolio that we're quite complimentary to. For example, their contact center product is, you know, they do not have a UCaaS solution, who knows? You know, maybe there will be some integrations along that way. They have a video product, again complementary to UCaaS. We think that there are deep strategic alignments and again, so far, so good.
Mo, maybe in the past you've been pretty positive on the... just given your background, positive on the service provider kind of pieces of the partnerships and just, you know, why is that an area where you think, like, they're really incentivized to sell RingCentral?
Great question. Building on, again, on what Vlad said earlier, the global service provider partnerships and ecosystem in general is an area that we remain excited about. We continue to see stable growth from those partners. Each one of them opens up new addressable market for us. As you think about growth with each new partnership, whether that's a new segment, whether it's a new country, a new segment within a new country, each one of them becomes the opportunity to stack on the existing ones that we have and contribute meaningful new growth for us, without meaningful upfront investment, especially as you think about the geographic landscape.
To the second half of your question, the motion that we see with the global service providers is they're generally selling some sort of other solution, whether it's a cable, fiber, mobility products.
Mm-hmm.
We know the business customers, whether they've had a legacy PBX solution or not, are looking for a lot of the feature functionality that comes along with multi-tenant UCaaS sitting on top of that fiber cable or mobility. Whether it's creating a business persona on top of a personal cell device, all the way up to, you know, multi-location businesses that simply want one unified system replacing, you know, aging legacy solutions. By the way, many of the GSP sold the legacy PBX solutions as well and are actively looking for a way to migrate those customers to an alternate solution without the capital investment that's required to build a world-class UCaaS. This is why we're continuing to see strength from those partnerships.
Got it. Sonalee, maybe turning to you. You know, you guys meaningfully raised your fiscal 2023 profitability targets, exiting the year at 20% and kind of expanding upon that 350 basis point plus upward rating leverage expansion target you had the quarter before. You know, where are you finding the most opportunities for leverage?
Yeah, thanks for the question, Meta. A couple of points I would make. One is that you're absolutely right. We are guiding to a minimum of 18% Op margin for the current year. That's a 560 basis point year-over-year improvement. We've also said that we will exit at at least 20% Op margin. In terms of where we're finding the savings and the additional leverage, you'll all be aware that we announced a RIF at the end of last year, and that would account for about 300 basis points of that overall improvement year-over-year. The remainder, I would say, is mainly coming from, and this has been a huge area of focus for Mo and I since we've arrived, is around sales and marketing.
You can see where our sales and marketing as a percentage of revenue was when we ended the year in 2022, and you should expect to see a meaningful improvement there. What we've done is really about getting our sales force to be more productive. We actually haven't impacted the frontline sellers, as Mo alluded to earlier. We've just attacked things like spans and layers, sales surround, areas where actually there was some duplication. Then on top of that, we've also, looked at every single program across the board within marketing and made some significant, rationalization there. What we found is that our leads and, lead gen engine is actually stronger than ever, even after having made those, rationalization.
The other thing I would say is, you know, this is the beginning of the journey. I mean, we have made some progress, but there will be more to go. You know, we're excited about the fact that this macro is not gonna last forever, right? Everyone knows, everyone in this room knows markets are cyclical, and we wanna make sure that as we come out of this macro, as it subsides, that we are stronger and more profitable when we do continue to drive that growth.
Maybe you could just address quickly, or not quickly, whatever. Maybe you can just address the difference between kind of free cash flow margins versus EBITDA margins, and particularly, you know, now that we're past some of these prepayments and things like that.
Yeah.
How they should convert.
We do have a differential between our Op margins and our free cash flow, which we've called out. You know, last year we ended with about a 600 basis point differential. We've said for the current year to expect, you know, similar. The reason for that is, in our business, we do make upfront investments in the form of commissions to our sellers and to our partners. However, we believe that those commissions are very much an investment in the future because the LTV we derive from those customers is very significant.
Mm-hmm.
Although our growth this year has decelerated, we are still making very, very significant investments in new acquisition. Mo talked to that earlier. We are still adding many new logos. That, of course, has the upfront impact on the cash flow, and then the revenues come over time. Many of our customers pay actually monthly, so that's why you see that timing difference. We do also intend to drive free cash flow growth this year, and I just wanna take a moment to clarify something from our earnings call. We said that we would double our free cash flow, at least double our free cash flow, 2024 over 2022. We ended 2022 with a 4% free cash flow margin, but that was depressed by some one-time restructuring charges we had.
Actually, our underlying free cash flow was closer to $140 million, and that is the number, and that is the baseline from which we will more than double. We feel really excited about that ability to continue expanding and growing. The other point I would make, and this is slightly touching on something you covered with Mo earlier, but some of those cost actions we took actually allow us to make investments in new areas. One of the areas that we're significantly investing in this year is on renewals and customer renewals and customer success. That is one of the great things about being able to optimize investments. Part of the cost savings is going to the bottom line, but part is also being reinvested to ensure that we emerge even stronger.
Got it. Maybe, I know we're at time, but Vlad, just the last question for you of just where... You know, you have been with this business for a long time. You're clearly going through like a macro digestion. You have been through cycles before. Just what gets you most excited, whether it's contact center, whether it's just reinvigorating some of these partnerships, whether it's just a more disciplined company, like what gets you most excited about the company kind of going forward?
We're solving a real mission-critical need for, millions and millions and millions of people. That's a general answer.
Yes.
More specific answer is that there is a new mega trend, coming, which is, which is Conversational AI. This will probably dwarf the two mega trends we were founded on.
Mm-hmm
Which was mobility and globalization. This is a game changer. We've acquired the company three years ago, called DeepAffects, a small company, purely technical. We already have been introducing the technology into our portfolio, such as transcriptions, sentiment analysis, meeting summaries. We are stay tuned for Enterprise Connect. We'll be making additional announcements there. Things will change, if you think about, you know, what's, you know, everybody's been talking about lately is ChatGPT.
Yeah.
What's ChatGPT? You know, it is conversing with a bot.
Yeah.
Well, you converse by voice. Who is strongest in voice? RingCentral.
Yeah.
We believe that we can in partnerships with people, clearly, nobody's going to compete with OpenAI directly. Maybe Amazon will. Okay? From our perspective, this type of technology is right to be incorporated specifically into UCaaS and CCaaS. People have been talking more about CCaaS integration. Not too many people have been talking about UCaaS integrations. We think that our strengths there, super exciting.
Perfect. All right. Well, Mo, Sonalee, Vlad, thank you so much for being here today.
Thank you so much.
Thanks, Meta.