RingCentral, Inc. (NYSE:RNG) Q1 2024 Earnings Call Transcript May 7, 2024
RingCentral, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by. This is the conference operator. Welcome to the RingCentral First Quarter 2024 Earnings Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After your presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Will Wong, Vice President, Investor Relations. Please go ahead.
Will Wong: Good afternoon. And welcome to RingCentral’s first quarter 2024 earnings conference call. Joining me today are Vlad Shmunis, Founder, Chairman and CEO; and Sonalee Parekh, CFO. Our format today will include prepared remarks by Vlad 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: Good afternoon and welcome to our first quarter conference call. We had a solid start to the year. In Q1, total revenue rose 9% to $584 million, above the high end of our outlook. ARR rose 10% to $2.4 billion, with Enterprise up 13% for the fourth consecutive quarter. Consistent with our strategy of driving profitable growth, we delivered a record quarter of profitability, with operating margin rising to approximately 21%, which was well above our outlook for Q1. I’m also proud of the material progress we have made on reducing stock-based compensation, as we have delivered another quarter of year-over-year improvement in SBC as a percent of revenue. Our execution in driving profitable growth has already resulted in an approximately 4x year-over-year increase in non-GAAP operating profit less SBC.
Improvements in SBC, combined with our share repurchase program is expected to result in our full year fully diluted share count declining year-over-year for the first time in our history. Speaking of making history, I’m excited to share that in Q1 we signed our largest UCaaS seat deal ever. We won a competitive RFP and sold 40,000 seats to a Fortune 500 retailer with over $20 billion in revenue. With RingCentral, this customer will be able to address their main pain points, which include dropped calls, long hold times, inadequate call reporting and lack of advanced voice features. In this mega deal win, RingCentral will be replacing their legacy solution, Skype for Business, demonstrating our ability to win against Teams Phone while operating within the Teams ecosystem.
In fact, the majority of our Enterprise customers have Teams, and in Q1, more than half of our large $1 million TCV deals were to customers that are utilizing our solutions integrated with and alongside Microsoft Teams. Importantly, this win was in one of our gold verticals, which include healthcare, financial and professional services, retail and public sector. We are mission critical in these verticals and we win given our unmatched reliability, ability to solve complex use cases, our integrated UCaaS and CCaaS platform and our thousands of available integrations. These verticals have been a key growth driver, especially in Enterprise, and we believe that there are at least 100 million seats in these verticals that we can convert over time.
Let me now give you more color on why we win, which is centered around our guiding principles of trust, innovation and partnerships or TIP, as we call it. First, trust, we achieved 5 9s uptime for the 23rd straight quarter. In fact, over the past year we’ve reached a new milestone of 6 9s. Our cloud platform is carrier grade, secure, standards compliant and battle tested, and continues to be a wide competitive moat and a key differentiator. Another core strength is our ability to solve complex use cases and integrate into customers commonly used horizontal and vertical-specific applications, especially in our gold verticals. We offer these customers a large breadth of business communication APIs as well as industry specific integrations, workflows and certifications.
For example, within the healthcare vertical, we integrate into patient data management applications such as Epic and Cerner, as well as meet HITRUST and HIPAA compliance requirements. These customers can create workflows based on the specific needs of their business. For example, healthcare providers can use RingCentral’s APIs to send prescriptions directly to the pharmacy’s system electronically and automatically trigger appointment reminders via SMS. Additionally, our market leading UCaaS solution integrated with a CCaaS platform that supports a wide variety of use cases and is also a vital differentiator. With RingCentral, companies have the ability to streamline workflows with our advanced tools and integrations. This was a key factor in why Sanitas, a Fortune 500 operator of medical centers in the U.S., selected RingCentral this quarter to power its communications platform.
With RingCentral, Sanitas will be able to provide their customers with a unified, seamless experience across interactions such as scheduling, billing and general inquiries. We believe this should drive increased revenue and patient retention from improved customer experiences, as well as lower costs from the increase in employee efficiency that our industry leading, integrated UCaaS and CCaaS platform provides. These are just two examples of our robust progress in new customer acquisition activity in Q1. But equally as important is our ability to retain existing customers and maximize customer lifetime value. On this point, our renewed focus on customer care is resulting in improved gross retention and better NPS scores. The combination of better gross retention, improving macro trends and the introduction of our new products should drive higher net retention going forward.
Now, on to innovation. This past quarter we announced a name change of our flagship, industry leading UCaaS solution from MVP to RingEX, which stands for RingCentral Employee Experience. With this change, we are signaling our commitment to continuous innovation based on emerging generative AI technologies. We started off on a high note with RingEX with RingSense AI, as we won the Overall Best of Enterprise Connect Award in March. One key reason we won is because of our differentiated, industry first, real-time AI for voice interactions. With this feature, users are able to capture key decisions and track action items in real time, enabling on-the-spot referencing and heightened accuracy. It is early days, but users are already seeing significant time savings.
For example, one customer highlighted that for an average 20-minute call, real time notes saves them 5 minutes post call, while also keeping all their notes attached to the contact to allow for easy referencing in future interactions. Voice-driven data historically has been largely inaccessible at scale as the data has been siloed. With RingSense AI now being an integral part of RingEX, we empower customers to take advantage of the billions of minutes of conversations that take place on our platform. Our customers will thus be able to automate manual tasks, unlock deeper insights and create more streamlined employee and customer workflows. Continuing on the theme of innovation, let me now share progress on our new products. First, RingCX, our AI-powered contact center, which is simple to use and easy to deploy, and which provides agents with all-in-one capabilities across 20 plus digital channels, automatic screen pops, contact matching in the CRM, case and ticket creation and interaction logging for all voice and digital interactions, all from an intuitive user interface.
We now have over 200 RingCX customers, almost double versus fourth quarter 2023. RingCX is now available in six countries, the U.S., Canada, the U.K., France, Germany and most recently Australia. In fact, one of our newest RingCX customers is from outside the U.S. Rotherham Metropolitan Borough Council in the United Kingdom. They purchased over 200 RingCX seats and over 3,000 RingEX licenses in Q1. Two key factors for our win; one, our unmatched reliability, as their prior cloud provider had consistent outages; and two, our fully integrated RingEX and RingCX solution. They will be using RingCX to provide a range of services for their almost 300,000 residents, including addressing incoming social care, planning, housing and business regulation and enforcement questions.
We are rapidly innovating with RingCX. We added over 300 features in Q1, bringing the total to over 1,000. Among the new features of RingCX are native integrations into Salesforce, HubSpot, ServiceNow, Zendesk and Microsoft Dynamics. We have also opened the RingCX platform to enable a growing ecosystem of partners such as Google, Dialogflow, Cognigy, Yellow.ai, Balto, and Calabrio. Our strength in voice, ease of deployment, use and maintenance and our attractive pricing and packaging give us confidence that we will continue to see positive results from RingCX going forward. We also continue to see good traction with RingSense for Sales, our first product in the RingSense portfolio. We have more than doubled our customer count sequentially in Q1 to over 600.
Many customers are benefiting from the automated interaction summaries, follow up notifications, call scoring, sentiment analysis and performance measure — management. This frees up salespeoples’ time, allowing them to focus on selling versus performing administrative tasks. For example, an insurance agency in the Midwest is using the AI-driven insights from RingSense for Sales to gain visibility into what’s working and not working in the agency’s sales and client-service practices. RingSense is able to monitor and glean insights from all their voice data, tone, word choice, energy, sentiment, helping the customer identify valuable insights they would not have caught by listening to a random selection of agent conversations. And within our own sales organization, we are seeing RingSense for Sales deliver both productivity and efficiency gains.
Our employees are now able to save at least 2 hours a week or about one full workday a month, from using RingSense’s automated note summary features. That is one extra day to speak with customers and potentially win more deals. Lastly, Events, which provides us with the opportunity to expand into new personas outside of our typical base, including line of business decision makers. RingCentral Events saw a roughly 25% sequential increase in new logos in the first quarter. New AI features for Events such as our AI writer and Q&A categorization further enhance the value that customers receive. These features also continue to differentiate RingCentral from the competition, and were important contributors to customers such as the Detroit Pistons, Vanderbilt University, a Fortune 50 technology company and one of the largest media companies in the world selecting RingCentral Events during the first quarter.
Last but not least, partnerships, which are key to continuing to scale our multi-product business. We have a diverse network of partners which includes over 15,000 channel partners, a number of large, strategic OEM partners, AWS and some of the largest global service providers, which include AT&T, BT, Charter Communications, Deutsche Telecom, Telus and Vodafone. We also continue to expand this network and announced our new partnership with Optus, Australia’s second largest provider of telecommunications services, during the first quarter. GSPs are a key growth driver for RingCentral, and are growing above our overall growth rate. We saw good traction with this cohort in Q1, including with Vodafone, where we won a 1,000 seat plus deal with a large European retailer.
Regarding Avaya, they continue to be the world’s largest holder of on-prem UC and CC seats. RingCentral continues to be Avaya’s exclusive UCaaS provider and in Q1 we extended the term of our multiyear agreement and enhanced our GTM and innovation collaboration model. We expect to work even more closely with Avaya to position, market and sell Avaya Cloud Office by RingCentral to the millions of existing Avaya on-prem users. Stay tuned for additional joint product announcements at the upcoming Avaya ENGAGE conference next week. We believe that as a whole our broad partner network will be an important contributor to our continued, profitable growth. In closing, Q1 was solid. We are executing on all our strategic priorities. Our core growth is stabilizing, our new products are demonstrating traction, our SBC is improving, and our free cash flow is expanding, demonstrating the strength of our business and its inherent profitability.
I am very excited about our future. With that, let me turn the call over to Sonalee.
Sonalee Parekh: Thanks Vlad. I’ll provide highlights from the first quarter and then discuss our business outlook for the second quarter and full year. In Q1, subscription revenue of $557 million was up 10% year-over-year, above the high end of our guidance range. ARR of $2.37 billion was up 10% versus last year. On a year-over-year basis, currency was neutral, while on a sequential basis, currency represented an almost $10 million headwind. Enterprise ARR continues to perform well, and rose 13% versus last year to $1.02 billion. We saw good traction with large customers, winning many $1 million plus TCV deals in our gold verticals. As Vlad highlighted, this includes a new Fortune 500 retailer that has committed to spending more than eight figures with us over the next few years.
Now moving to profitability. I’ll be referring to non-GAAP results unless otherwise noted. Subscription gross margin was 82%, consistent with prior quarters. Overall ARPU was again above $30. Our new product ARPUs are solidly higher than current overall ARPUs. Over time, we expect new products to become increasingly accretive to overall ARPU and retention. Operating margin rose 350 basis points versus last year to 20.7%, solidly above our guidance of 19.5%. The outperformance was driven by upside to our revenue guidance, as well as the timing of certain operating expenses. Importantly, we continue to remain disciplined in our spending, in particular within sales and marketing. Moving to free cash flow. We are now reporting and will guide to free cash flow defined as net cash provided by operating activities less capitalized expenditures.
This more closely reflects the cash flow generation of our business in a given period and includes cash paid for interest and other non-recurring items such as restructuring, which we will call out separately. In the first quarter of 2024, we generated free cash flow of $77 million. This is net of cash paid for interest of $23 million and non-recurring payments of $15 million, as well as $10 million of cash received from certain strategic partners. Excluding the impact of interest and these non-recurring items, free cash flow would have been $105 million, compared to $61 million in the first quarter of 2023, representing over 70% growth. Moving to stock-based compensation. As a percent of total revenue, stock-based compensation fell to 15.6%, down 340 bps versus last year.
We also remain disciplined on stock grants to both new and existing employees, and continue to expect new grants, net of forfeitures in 2024 to be about half of 2023 levels. Moving to our balance sheet. During the quarter, we repurchased 2.4 million shares for $80 million under the plans previously authorized by our Board of Directors. Recently our Board increased our repurchase authorization by an incremental $250 million. We currently have approximately $375 million remaining on our total authorization. Given our current valuation, strong and growing free cash flow and the significant progress we have made to bring down our leverage, we believe that share repurchase provides an attractive relative return. Moving to our converts. We had $161 million of our 2025 convertible notes outstanding on March 31st.
There is no change in our plan shared last quarter to utilize our existing liquidity sources and a portion of our free cash flow to retire the 2025 convert prior to its maturity date in March 2025. Our net leverage ratio, which declined year-over-year by over one turn to 2.5 times at the end of Q1 2024, continues to trend downwards as we expand our adjusted EBITDA and reduce gross debt. Our low and improving leverage ratio, strong BB credit rating, significant liquidity and strong free cash flow growth gives us flexibility and a range of alternatives for addressing our 2026 convertible notes. Now let me turn to guidance. Embedded in our guidance is the expectation that the macro environment and current business trends remain relatively stable, with no further material improvement or deterioration in conditions.
With that backdrop, for the second quarter of 2024, we expect subscription revenue growth of 9%; total revenue growth of 8% to 9%; non-GAAP operating margin of 20.7%, flat versus the first quarter of 2024; and non-GAAP EPS of $0.87 to $0.88. For the full year, we are raising our revenue outlook to reflect our Q1 revenue outperformance. We now expect subscription revenue of $2.267 billion to $2.287 billion, representing growth of 8% to 9%; and total revenue of $2.379 billion to $2.399 billion, representing annual growth of 8% to 9% We continue to expect non-GAAP operating margin of 21% and stock-based compensation as a percentage of total revenue of approximately 16%. We are raising our non-GAAP EPS to $3.59 to $3.67, up from $3.50 to $3.58, as we now expect 96 million to 97 million fully diluted shares outstanding in 2024, down from 98 million to 99 million shares previously.
Regarding free cash flow, under our updated definition, we expect free cash flow of $385 million to $390 million. Our outlook for $385 million to $390 million includes cash paid for interest of $60 million and cash paid for non-recurring restructuring and other items of $20 million, as well as $25 million of cash received from certain strategic partners. Excluding interest and these non-recurring items, we are raising our free cash flow outlook from $415 million to $420 million to $440 million to $445 million, up $25 million from our prior outlook. Our updated free cash flow guidance reflects the benefit we are seeing from better cash collections and lower commissions. We are also benefiting from a shift to annual, upfront billings for some contact center customers.
In summary, we had a strong start to the year and are raising our revenue and free cash flow outlook. Our leading, differentiated products and unique GTM, combined with our scale and laser focus on driving profitability and free cash flow position us well for creating long-term shareholder value. With that, let’s open up the call for questions.
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