for joining us this afternoon. I'm Michael Funk, one of the mid-cap software analysts at Bank of America. really happy to have Sonali here with us again, for the second year, I believe, at the Q Queen.
Yes, I was here last year.
Shortly after starting, on the job last year as CFO of RingCentral. Thank you again.
Thank you, I'm delighted to be here.
Yes, it is my second time at your conference, and I've just gone through my one-year anniversary at RingCentral.
As I was putting my questions together, I thought about that it's been a bit over a year since you stepped into the role. I was thinking back about that timing. You know, that time last year, we had the Russia-Ukraine conflict kicking off, right? Uncertainty created by that. You had the Fed raising interest rates, and you had the very beginning of enterprises pulling back on spending. I think also when you began to first see maybe some signs of pullback there as well. I mean, the obvious question, I think, is, you know, where are we now today, 12 months past all of those events? Is there more light? Is business more predictable than it was 12 months ago?
Yeah. Great question, and you're absolutely right. I literally joined as CFO just as the macro was starting to rear its ugly head. I joined May 9th, actually, it was announced May 9th. I started work officially at the 1st of June. We were starting to see a small impact in the business then, and then it progressively, you know, we saw more and more of that in Q3 and then even more so in Q4. What I would say today is, this is similar to what I said at our earnings in May, we are seeing a stabilization of the macro. What I mean by that is we're not seeing it get worse. We're also not seeing it improve, but it's stabilizing.
Within our customer base, the way we segment our customer base, SMB, so small and medium-sized businesses, are a relative bright spot. What I would say is on the enterprise side, we are still seeing, again, it's not getting worse, but we are still seeing the macro factors that we called out over the last several quarters, which is the elongation of the sales cycles returning to sort of the levels that we saw pre-COVID. Also additional layers of approval. We're seeing a lot of CFOs actually being brought into the final buying decision, and that just, again, elongates the actual closing of the deal. Whereas we don't really see that same trend, it's on the SMB side.
Then the smaller initial deployments as well, you know, we're continuing to see that, again, not getting worse, so really a stabilization. The other thing I called out at our May earnings, which I think is particularly impacting the enterprise side of things, is some weakness in upsell and on the downsell side. Let me tell you what I think is happening there. On the upsell side, what I would say is that, you know, companies, I believe, entered, you know, 2022 with a certain view in terms of how they were likely to grow, including us. Then many companies across various industries, you know, saw a bit of a slowdown or a decel in their revenues.
As a result of that, you know, the need to procure, and in our case, seats, and to, you know, upsell or to increase the footprint of seats, they're not quite seeing it come through the way they might have expected, which I think is natural in a slowing macro. On the downsell side, what we're seeing, it's really a result of headcount rationalization or optimization. You know, we are lucky in that we don't have large exposure to tech and the tech sector. Obviously, the tech sector has seen, you know, a big rationalization in headcount, particularly exaggerated in this part of the world, in Silicon Valley. But financial services has also been impacted, I think we're seeing a little bit of that.
Again, it's not outsized our exposure, but we do have some exposure, and I think that is playing out as well. Overall demand for our product, end user demand remains strong, and leads are actually up year-over-year. I think that's particularly interesting in the context of the fact that we actually cut back on our marketing spend in Q4 of last year. You probably have a question on our OpEx and margins. We're actually seeing, you know, higher quality leads, and importantly, leads are up year-over-year. You know, I think that's a testament to the fact that, you know, customers still need our product, want our product.
You know, where we are mission-critical or where it's mission-critical for customers to reach their customers by phone using voice, RingCentral is still the preferred solution. You know, we are seeing that both in UC and CC, and particularly, customers that are looking to save money, which I think is everyone these days, including us. You know, it's a really straightforward ROI decision to adopt cloud telephony to move from PBX, and we're seeing the positive signs of that, and that continues to be a very, very strong trend. We save UC customers, the ROI from switching is about 55% and less than 9-month payback period. For UC+CC, it's a 200% ROI, and the payback period is less than six months.
Yeah, it's all great color and good context where we are today. You're absolutely right. I do want to sales and marketing expense in general, 'cause something else you focused on in your first 12 months was, you know, you announced a expense initiative in October of 2022, right? You know, you did address that. You've also attacked the balance sheet, right? You've addressed some upcoming maturities, some of the converts coming due. Just kind of rewind, remind us the initiatives that you've undertaken and with opportunity to maybe address expenses incrementally or balance sheet.
Yeah, sure. You're absolutely right. I think I a year ago said that my number one priority was to drive efficient growth, and that's exactly what we are doing today. Our Op margins have gone from 10.2% when I arrived this year, we are guiding to exiting 2023 at Op margins of at least 20%. Very significant year-over-year improvement. For the full year, we are guiding to at least 18.5% in aggregate. Again, that's OP margin. Within that, we expect free cash flow to follow strongly as well. I think that's a really important point, and one that you saw in our last earnings.
We delivered $61 million of free cash flow, we very much expect the free cash flow trajectory to follow the OP margin trajectory. The reason that I call out cash flow is that you mentioned the balance sheet, you are again right, that we have been very proactive in terms of addressing our outstanding converts. We recently matured, took out $461 million of our $1 billion maturity that is due in March 2025. We did that with our delayed draw term loan A, as well as some of our own free cash flow. We were able to retire those converts at a discount at 92.5 cents on the dollar.
It was a deleveraging event and a very ROI positive outcome as well. We're really proud of that, and I think, you know, from my perspective, and I don't want to seem glib at all, but, you know, we now have a debt maturity ladder that is very manageable. When you think about the strong operating margin, free cash flow, and EBITDA profile we will be driving, we're currently driving, and that we will be generating over the next couple of years, it means that we have a lot of optionality around how we address the remaining maturities. I have said, and I said in our earnings, but I'm going to say it again: We will not allow any of those maturities to go current.
Again, we feel like in terms of servicing debt and servicing the quantum of debt that we have, we feel very, very comfortable given the strong cash flow profile that we're driving. Hopefully, you've seen us deliver on that certainly in the quarter and more goodness to come there. What's actually driving the operational or OpEx improvements, you mentioned some of the initiatives we took in October of 2022. We are by no means done. There is more to go for there. What is actually driving the savings on sales and marketing, which you also called out, we made some changes to our demand gen budget.
What we actually found is that by spending less money in more focused channels, we are actually able to drive higher quality pipeline, and again, better leads and more leads year-over-year with less spend. Part of that was branding. It was things like we were using TV adverts, as well as some outdoor, that we decided was not the best ROI, and we've since redeployed those dollars into more digital channels, and those are, you know, doing extremely well. We also have done a lot of automation. I called out something that we're doing on the finance side of the house. You know, this is really automating the procurement process.
When you're part of a company that's grown so quickly, you know, we're this $2.2 billion ARR company today, we grew very, very quickly, what you find is that sometimes the processes don't, keep up with the top line growth.
Didn't scale the same way.
They didn't scale.
Sure
... the same way. you know, those were big opportunities to go after, and they yield big savings.
Mm-hmm.
Just that one, automating procurement, actually the person who's running the project for me is sitting in the room right there in the front row, a star on my team. You know, just that alone is generating high single-digit million of annual savings. We have a huge procurement project, running across the entire business, and we are going through every single contract. That's just one example. There's more of that that will come through, and much more so in 2024. Because labor savings, in some ways, they're not easier, but they are, they hit the P&L more quickly. The program savings take time because it's contracted spend. You'll see more of that come through in 2024 when you ask about incremental.
There's also more we're going to be doing on the sales and marketing side. We called out on our earnings Project Ignite. That's something we're doing around go-to-market transformation and improving the economics with our channel partners. Channel today represents a significant portion of our overall go-to-market. It's about 40% of our sales today. You know, we saw opportunities to actually hand over more of the end-to-end sale process to our channel partners, and what we found was that that actually improved our overall customer acquisition cost and actually freed up our sellers to go out and hunt. You know, that is not yet coming through in our sales and marketing, but that is, you know, again, more goodness to come as we look forward.
Then, of course, there is the labor reduction that we announced at the end of last year, which was a difficult decision, but a needed. You know, we overhired, like most companies in the valley, in the second half of 2021 and probably early 2022, and, you know, you will continue to see, you know, OP margin improvement, and cash flow improvement as a result of that. The other thing I'll just call out is, you didn't ask about it, but, you know, stock-based comp, you've also seen. Hopefully, since I've arrived, you know, we brought that down by about 450 basis points year-over-year.
You'll see, you know, incremental improvement this year in 2023, and that's something that we, as a management team, are very, very focused on. You know, you should see it come down, not the same quantum, but, it will decrease again, and going forward.
If I understand correctly, so the sales and marketing, the reduction of spending there, it's mostly the advertising dollars. It's the change in the partner relationships, you know, it's more efficient spending. If I remember correctly, most of the headcount was focused outside of sales and marketing for the reduction in October, correct?
I would.
Yeah.
outside of sales, yes.
Yeah.
I wouldn't necessarily say outside of marketing, but we were very careful not to touch frontline sellers.
Mm-hmm.
It was a combination of marketing, parts of sales that were not touching the end customer, G&A, and some R&D. Again, R&D, there were two areas that we really wanted to protect. You know, I think last year you asked me, "Why did you join RingCentral?" You know, innovation is core to what we do, and, you know, our founder, Vlad Shmunis, is a product and technology guy. I think the reason we are who we are, and we have the growth margins we have and the ARPUs we have, is because we have the leading product that, you know, all our customers love. We felt it was really important that we continued investing in product and technology and R&D through this cycle, including through this macro.
We were very careful not to scale back on R&D too much, and innovation, and also on anything to do with frontline selling. There was some labor reduction in marketing, and then in other parts of the business as well.
Okay. you know, maybe just moving on from the expense reduction then, you know, for a moment.
Yeah
... has been a very important partner, historically, I think brought in a lot of the seats from the partner channel.
Yeah.
Just exited bankruptcy. What should we expect in the next 12 months from Avaya? Obviously, they're probably restructuring their own operations, but how did you change that relationship? How is the monetization different, any kind of payments going to Avaya, and how do you think about seat additions?
Yeah. Okay, great. Avaya continues to be a very important partner. They were, and they are today. We feel, actually, and I personally am very excited about our new agreement with Avaya, I believe it's new and improved, and there were some big wins for RingCentral, in terms of that renegotiated partnership agreement. First and foremost, we have preserved our exclusivity with Avaya. We are the natural destination for Avaya's PBX legacy customers. ACO is absolutely the natural destination, and we are set up to win those customers. Secondly, we have negotiated minimum commits in the revised contract. That is something that didn't exist in Avaya 1.0, you know, those were hard-fought and hard-won, and we feel like it was a big win for us.
We have included those minimum commitments in our guidance for this year. As you can imagine, Avaya has just reemerged from bankruptcy, and although you've probably been reading about it for a really long time, and it was a long, drawn-out process, the actual bankruptcy just took place a couple of weeks ago. There is a timing, like a ramp-up of, you know, Avaya reemerging and coming back to life. Those seats, as you think about them through the year, they will ramp as the year progresses, and that is fully baked into our guidance. One of the reasons that we talked about our bookings number and our ARR number, our ARR growth outpacing our overall subscription revenue growth, because those Avaya seats will likely be more back-end loaded.
You know, another really important factor is, no, there will not be payments to Avaya upfront. We make money when Avaya makes money, and vice versa. As they move seats over, they make money, and we make money. Both parties are aligned, and I don't think that we had that perfect alignment previously in Avaya 1.0, but we certainly do today, which is what makes us very upbeat about the opportunity ahead. Avaya does remain, you know, the largest holder of on-prem PBX seats today. You know, as far as we're concerned, it's not a question of if, it's not a question of, if, it's a question of when, and those seats will eventually move over, and we, again, are the best placed to take those seats.
That is still exclusive, correct, that agreement?
Still exclusive.
Okay.
Yeah.
Okay, great color on that as well. I think you were mentioning earlier that, you know, you're the only company to be top right quadrant in Gartner for both UC and CC, right? You have the NICE inContact relationship. How much is that combination of UC and CC driving that top-of-funnel growth that you were talking about earlier? You know, what percentage of that is a combination of the two products?
Yeah. We have a fantastic partnership with NICE inContact, as you mentioned, and that partnership dates from 2015. We have, you know, been in partnership together for a long time, and don't underestimate the power of that kind of long-term partnership, because it means that there's been a lot of integration between the two. I think there are some, you know, competitors out there that have since launched partnerships, but they don't have that history and those integrations. Again, it takes time to get, you know, the combined motion humming. We do feel very much like we have a right to win in contact center, as we do in UC, given the scale of our UC base.
What we find is, the UC/CC sales motion, is very much, you know, complementary, and most buyers want to purchase UC and CC from the same vendor. We really are the only choice if you want leading UCaaS and leading CCaaS. You know, over 60% of our enterprise deals come with a CC attach, so a contact center attach. Today, our contact center business is, you know, over $300 million of ARR, so, you know, larger than many standalone large-cap software companies, and it is outpacing the overall growth for the market, which means we are taking share. You know, it has been a, and continues to be a very important part of our overall growth.
We also have our own IP in terms of contact center, and that's our Engage product.
That is more downmarket, and it's a smaller part of that overall $300 million. We continue to invest there, and we see a lot of opportunity, to, you know, bring that, more and more, upmarket. For now, the NICE inContact sales motion is more upmarket and enterprise, and Engage Digital is more, downmarket and smaller customers.
Understanding. Can you remind me, what are the economics, that relationship with NICE, is there an eventual goal to have owner economics in that business, meaning to expand Engage capabilities or conserve more upmarket?
Yeah. We don't actually disclose. I mean, there's commercial sensitivity around disclosing the economics.
Understand. Even a broad brush, big picture.
Yeah. We don't disclose partner economics-
Yeah
... for any of our partnerships. Sorry, 'cause there is commercial sensitivity around it.
Yeah.
What I would say is that it's, you know, included in our subscription gross margins, which you can see are, you know, around 82% and industry leading. That incorporates the NICE inContact partnership as well.
In terms of, you know, do we like owner economics? We love owner economics. We would always want owner economics for everything. We are also really happy with the partnership with NICE inContact, and we feel that Engage is absolutely targeting a part of the market that we couldn't target with NICE inContact, so it's very complementary. That being said, you know, we are always evaluating and looking for opportunities to, you know, add adjacencies or, you know, find products that would be interesting and exciting to our massive install base of customers, sticky install base of customers. You know, I would never rule anything out completely, but we're really happy with how we're positioned today.
Actually, quick AI question here. I mean, does AI actually make the partnership more valuable with NICE, given their positioning with their, you know, 200 models and very deep data sets, arguably are the strongest positioning with AI in contact center? Does that make the relationship even more valuable versus building internally?
Yeah. I think it is extremely valuable, like, with or without AI. AI adds that, you know, new added dimension. What I would say, though, is that, you know, we feel like we're in a really strong position on UC as well.
in terms of AI. Actually, I would almost argue that, on the UC side of things, you know, we have billions and billions of minutes of voice data.
Sure, of course.
I actually think AI elevates voice. I sometimes think that voice is kind of a bit of an unsung hero. People actually use voice a ton, actually There's a survey that Salesforce did. We didn't even sanction this, or we didn't actually ask for the survey to be done, but the results were sent to us. You know, over 70% of companies prefer to use voice as the number 1 modality to go out to their customers and reach their customers. It far exceeds any other modality. Again, I think AI will elevate voice even further. We see huge engagement from our customers on voice. 96% of our customers are actively engaging in voice.
That's a higher number and higher engagement score than, you know, previously, so it's up year-over-year. The Salesforce data was also up year-over-year. Voice is actually becoming more and more prolific. I would argue that with voice, and you saw we announced RingSense, which is our one of our AI modules in our last earnings. I think, in fact, you know, you can take all of this data and turn it into, you know, much more structured and, you know, the kind of data that customers are able to derive insights from and will be willing to pay for.
I think that that could be something that's ARPU accretive and could be, and, you know, we believe will be a standalone product in its own right on our platform, but even beyond that, on other people's platforms, including CCaaS platforms. We think this could be another golden age of voice. You know, it's revolutionary. I'm gonna argue for the upside on the UCaaS side, just as much as the CCaaS side.
That was a good turn on that question. I like that. You know, you pulled for the expectation for, I think, $280 million.
Yeah
... in sorry, in unlevered free cash flow, right? Just the guidance, unlevered.
Correct.
Um, by-
Right
by 2024. How should I think about operating leverage in the business, though, and upside to that number if the macro does improve? I think your base case right now is kinda treading along sideways with the macro.
no material, you know, deterioration, no material improvement. If we do see improvement, how does operating leverage maybe add upside to that $280?
You're right. The numbers you quoted were right, but just let me be very specific. We had originally guided to a doubling of free cash flow by 2024, which was implied $280.
At the last earnings call, I said that we will be able to deliver that much earlier. 280, much earlier than the end of 2024. That is based on current assumptions, which is the macro staying exactly as it is, no deterioration, no improvement. Now, as you correctly point out, there is a lot of operating leverage in the model, particularly as we are at this level of scale. You know, as we go through $2 billion of ARR, $2.2 billion. As we scale up, you know, the operating leverage starts to shine through in the model, and more and more of that revenue growth hits not only operating margin, but also free cash flow.
You know, if the macro were to improve, I'm not gonna say that 100% of that improvement would go straight to OP and free cash flow, because there would also be opportunity to invest, and we are absolutely a growth company. You know, a company that believes in durable, sustainable, profitable growth. What I would say is that if we were to see an improvement in the macro, you would see more and more of that operating leverage come through, and you would see an even stronger free cash flow generation profile, but you would also see incremental investment in driving growth.
Actually, I have one last one here in the last minute. I think you also mentioned last quarter that you had seen some ARPU pricing pressure on the UCaaS side. Overall, ARPU was flat, which is consistent, but some pressure on the UCaaS side. Industry is still relatively fragmented. There are some competitors using pricing as a tool to gain market share. Do we have to see consolidation for market health to stabilize and, you know, allow the overall market to begin to grow again? Or do you believe that there can be market health and stability without consolidation?
I don't think consolidation is necessary at all. I think if you're a company like us, operating at scale, where we are today, and with our leading, you know, product leadership, and market leadership, we will continue to grow with or without consolidation. You see that in our guidance. I believe the market will continue to grow as well, the overall UCaaS market, because it's so underpenetrated today. That being said, it is a very fragmented market. There are fewer players today than there were a few years ago, but I think if you were to ask me if I had a crystal ball, you know, going forward, I think there'll be even fewer players going forward.
I think players that are subscale will find it more and more difficult to operate in the current environment. When I say subscale, I mean subscale in terms of revenue and subscale in terms of go-to-market reach and subscale in terms of being able to invest in innovation. None of that describes us, obviously. I think, you know, if you were to ask me, I feel that we and, you know, I clearly believe in our organic standalone plan. We will continue to be a leader, you know, as we are today, if you were to look out several years from now. I think overall, some players will ultimately drop out of the market because it's really tough to be subscale in the current environment.
In terms of competitive intensity, I don't think that we need consolidation in order to see a bit more discipline in terms of, you know, how even some of our competitors are behaving with the channel. I think in general, there has been a bit more discipline across the board, at least from what we've seen from our various competitors. You know, we feel like we're in a very, very good position in terms of being at scale, being highly profitable, becoming even more profitable, and then addressing our capital structure in a, you know, optimal way.
No, it's a great overview. Thank you.
Thanks.
Thank you, everyone. Certainly, thank you. I need 30 minutes.