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Edited Transcript of RNG earnings conference call or presentation 11-Feb-19 10:00pm GMT

Q4 2018 RingCentral Inc Earnings Call

San Mateo Feb 13, 2019 (Thomson StreetEvents) -- Edited Transcript of RingCentral Inc earnings conference call or presentation Monday, February 11, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David D. Sipes

RingCentral, Inc. - COO

* Mitesh Dhruv

RingCentral, Inc. - CFO

* Ryan Goodman

RingCentral, Inc. - Director of IR

* Vladimir G. Shmunis

RingCentral, Inc. - Co-Founder, Chairman & CEO

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Conference Call Participants

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* Bhavanmit Singh Suri

William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications

* Brian Christopher Peterson

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Brian Jeffrey Schwartz

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* Dmitry G. Netis

Stephens Inc., Research Division - MD of Equity Capital Markets & Senior Research Analyst

* George Frederick Sutton

Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst

* Jonathan Allan Kees

Summit Insights Group, L.L.C - MD & Senior Analyst

* Kasthuri Gopalan Rangan

BofA Merrill Lynch, Research Division - MD and Head of Software

* Matthew David Van Vliet

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Meta A. Marshall

Morgan Stanley, Research Division - VP

* Michael James Latimore

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* Michael James Turrin

Deutsche Bank AG, Research Division - Research Analyst

* Nikolay Ivanov Beliov

BofA Merrill Lynch, Research Division - VP

* Samad Saleem Samana

Jefferies LLC, Research Division - Equity Analyst

* Sterling Auty

JP Morgan Chase & Co, Research Division - Senior Analyst

* Terrell Frederick Tillman

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* William Verity Power

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Zack Turcotte

Dougherty & Company LLC, Research Division - Anlayst

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Presentation

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Operator [1]

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Greetings, and welcome to RingCentral's Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ryan Goodman. Please proceed.

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Ryan Goodman, RingCentral, Inc. - Director of IR [2]

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Thank you. Good afternoon, and welcome to RingCentral's Fourth Quarter 2018 Earnings Conference Call. I am Ryan Goodman, RingCentral's Director of Investor Relations. Joining me today are Vlad Shmunis, Founder, Chairman and CEO; David Sipes, Chief Operating Officer; and Mitesh Dhruv, Chief Financial Officer. Our format today will include prepared remarks by Vlad, David and Mitesh, followed by Q&A.

Some of our discussions and responses to your questions will contain forward-looking statements. These statements are subject to risks and uncertainties. Actual results may differ materially from our forward-looking statements. A discussion of the risks and uncertainties related to our business is contained in our filings with the Securities and Exchange Commission and is incorporated by reference into today's discussion. RingCentral assumes no obligation and does not intend to update or comment on forward-looking statements made on this call. I encourage you to visit our Investor Relations website at ir.ringcentral.com to access our earnings release, slide deck, our non-GAAP to GAAP reconciliations, our periodic SEC reports, a webcast replay of today's call and to learn more about RingCentral.

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. We adopted ASC 606 as of January 1, 2018, under the full retrospective method. We have provided comparative numbers for the respective periods of 2017 in the slide deck and press 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.

With that, let me turn the call over to Vlad.

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Vladimir G. Shmunis, RingCentral, Inc. - Co-Founder, Chairman & CEO [3]

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Good afternoon, and thank you for joining our fourth quarter earnings conference call. Fourth quarter was an outstanding finish to a great year for RingCentral. We saw no slowdown in momentum, and we believe we further distanced ourselves from our competition.

Revenue, operating margin and non-GAAP EPS all exceeded the high end of our guidance. The performance in the quarter was driven by strong execution in the mid-market and enterprise business, combined with continued momentum with our channel partners. We closed a record number of 7-digit TCV deals in Q4, bringing the year's total to approximately 80 such deals.

I'm also excited to announce that we secured our first-ever 8-figure TCV deal in Q4. We are seeing enterprises of all sizes moving to the cloud.

Let me cover some of the key metrics for Q4. First, total revenue grew $289 million. This is 34% increase year-over-year and above the high end of our guidance range. Second, our core subscription revenue, normalized for the legacy AT&T base, grew 38% year-over-year, up from 36% in the same quarter last year. Third, mid-market and enterprise business continued to be a key driver of our outperformance. We define mid-market and enterprise as 50 seats or greater. This grew 73% year-over-year and is now a $309 million annualized business. Our enterprise business, defined as customers with $100,000 or more in annual recurring revenue, or ARR, nearly doubled year-over-year to $171 million. Fourth, our channel business grew over 80% year-over-year to over $180 million, with channel contributing a record number of 7-digit TCV deals for the quarter.

We're seeing the dollars are shifting towards cloud communication solutions from legacy vendors in this $50 billion market. This is consistent with the recent report published by Gartner titled Cloud-Based Unified Communications and Contact Center Momentum Is Refocusing our Magic Quadrant Research for 2019. It states that by 2022, 4 cloud-based UCaaS seat licenses will be sold for every premises-based UC license, driven by an expanding list of capabilities in UCaaS solutions. Workplace communications have become more mobile, distributed and global.

Cloud now surpasses legacy solutions across a broad range of parameters. It is clear that the cloud is winning and RingCentral is winning in the cloud.

As we look to service the broadening demands of the mid-market and enterprise customers, we continue to drive product innovation and portfolio expansion. At our user conference in November, we made 3 key announcements. One, we launched our new unified mobile app with integrated team messaging, voice and video seamlessly combined into a single application. This is well differentiated in the industry. Two, we launched RingCentral Engage, our digital customer engagement platform based on our acquisition of Dimelo. And three, we announced new artificial intelligence partnerships leveraging our open platform to enable real-time and post-call voice analytics.

To build on that momentum, last month, we announced the acquisition of Connect First, adding an important product to our customer engagement portfolio. It now includes RingCentral Contact Center for inbound communications and workforce optimization, RingCentral Engage for digital customer engagement and Connect First for outbound blended customer interactions. We believe our strong customer engagement portfolio provides customers with transformative and differentiated experiences and will accelerate customer transition to the cloud.

As we look ahead to 2019, our commitment to customer success is steadfast. We will continue to rapidly innovate and out-innovate our competition. Our industry-leading cloud communications and collaboration solutions, combined with our world-class customer support, create a widening gap and deepening moat between us and our competitors. We believe that we are well-positioned to achieve our goal of exceeding $1 billion in revenue in 2020.

Now for some color, I will turn the call over to our Chief Operating Officer, Dave Sipes.

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David D. Sipes, RingCentral, Inc. - COO [4]

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Thank you, Vlad. It was a great quarter, and we are pleased with the continued strength in our mid-market enterprise business. We attribute the strength to our efforts in expanding go-to-market capabilities, our rapid pace of product innovation and our success with land and expand. On the GTM front, we are focused on 3 key areas driving our success: one, expanding direct sales reach; two, growing the channel; and three, pushing ahead with our targeted verticals industry program.

First, throughout 2018, we further densified our direct enterprise sales force across major U.S., U.K. and Canada metro markets as well as expanding in France and Australia. An example of continued international momentum in the U.K. was our Q3 win with the Financial Times, which we have now followed in Q4 with a 7-figure-plus TCV win with a second major news and media organization. This new customer had a past experience with disruptive events shutting down their legacy on-premise system. Our highly fault-tolerant, distributed and mobile-first cloud architecture was critical in addressing their unique business continuity needs. Furthermore, our Global Office and open platform integrations with Google G Suite and other cloud applications were also key in securing this win.

Second, we increased our coverage in the channel with strong growth and new partners. Channel contributed more than 70% of our 7-figure wins in Q4. In addition, we announced reengagement with AT&T in late 2018. We have initiated enablement and training of their sales force. We are encouraged with our progress to date and look forward to growing this partnership in 2019.

Third, we increased our GTM focus on vertical industries, initially targeted at financial, health care and SLED. In fact, in Q4, we had several 7-figure wins in each of these verticals, comprising more than 30% of our 7-figure TCV deals.

An example of a win in SLED is our recent announcement of our largest deal ever, Columbia University. Columbia selected our cloud solutions to support 44,000 faculty, staff and students. We will deploy 14,000 seats of RingCentral Office for the faculty and staff, and we will roll out team messaging to 30,000 students. We're thrilled to be chosen by Columbia University as they modernize their communications infrastructure across the entire institution.

In terms of product innovation, key focus areas include high availability, mobility and collaboration, a differentiated open platform, Global Office and integrated contact center. Our high-availability platform and unified app, with integrated collaboration capabilities were critical in securing a win with the Golden State Warriors. RingCentral will power all of the Warriors' business communications, including the new Chase Center arena. RingCentral beat out a well-known legacy provider in the process. This is a clear example of the cloud winning and RingCentral winning in the cloud.

We continue to expand our open platform and Global Office capabilities. The number of registered developers on our platform is now close to 20,000, and we have approximately 2,000 certified app integrations. Last quarter, we added several countries to Global Office, bringing total count of Global Office countries to over 40.

A good example of an enterprise leveraging our platform and Global Office capabilities was our 3,000-seat win with Copart, a provider of online vehicle auctions. They will use our open APIs to create custom workflows that will allow them to improve efficiency in their yards. Our Global Office capabilities were paramount, as they need to deploy across locations in EMEA, Asia Pacific and Latin America. This customer was brought to us by one of our new enterprise-focused national channel partners.

We also continued our strong momentum with Contact Center, securing a 1,000-seat win with a large cloud software applications provider. Our strong omni-channel capabilities, integrations with multiple cloud enterprise applications and end-to-end QoS analytics were all key to winning.

Last but not least, our land-and-expand strategy is working. A good example is Heartland Dental, one of the nation's largest dental support organizations. After winning their business in late 2017, we had 4,000 seats deployed. In Q4, the customer expanded the deployment plan to 6,000 seats.

I also want to give a brief update on RingCentral Engage, a product based on our Dimelo acquisition that we are now beginning to integrate with our core platform. We're happy to see Dimelo expanding their relationship with SFR, a large telco in France. SFR was able to consolidate multiple digital channels into one integrated customer engagement platform with Dimelo. Dimelo also expanded its relationship with La Redoute, a large 180-year-old French apparel and hard goods retailer, helping them through their digital transformation. La Redoute began working with Dimelo in early 2018 and is now supporting 7 digital channels, including Apple Business Chat.

In summary, Q4 was a great quarter, with continued strength in our GTM and product portfolio capabilities, including our first 8-figure TCV customer deal and a 1,000-seat Contact Center win. With this momentum, we look forward to extending our market leadership in 2019.

Now for the financials, I will turn the call over to our Chief Financial Officer, Mitesh Dhruv.

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Mitesh Dhruv, RingCentral, Inc. - CFO [5]

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Thanks, Dave, and good afternoon, everyone. 2018 was another good year. We exited with a revenue run rate of over [$715 million]. Our growth rate was 34%, and our operating margin was approximately 9%. We are executing above the rule of 40, a combination of revenue growth and operating margin. We believe that the rule of 40 is a key metric to evaluate profitable growth across SaaS companies and is a high bar we will strive to sustain.

Our fourth quarter capped the year with strong performance on all key financial metrics. Total ARR grew to $726 million, up 33% year-over-year. And ARR for RingCentral Office grew to $644 million, up 38% year-over-year. Key drivers continue to be mid-market and enterprise, with strong contribution from channel partners. Mid-market and enterprise had another standout quarter, with ARR up 73% year-over-year to $309 million. Enterprise ARR nearly doubled again to $171 million.

We also secured a record number of 7-digit TCV deals, including one 8-figure deal. In fact, the average deal size of our million-dollar deals increased more than 40% year-over-year. This was a combination of both higher ARR and longer contracts. In other words, with our highest-value customers, we are seeing growth in the number of wins, the wins are getting larger and the contract durations are expanding.

This expansion in mid-market and enterprise has multiple positive impacts to our overall business. First, higher upsell. We yet again saw strong performance in new bookings from our existing customers. This represented over 40% of new business mix in the quarter.

Second, reduction in churn. In 2018, annualized office gross churn for the first time dipped below 10%. This was driven by a mix shift towards larger customers, as mid-market and enterprise churn is half of the small business churn.

In terms of mid-market and enterprise metrics, in 2018, we introduced the enterprise metric defined as customers with greater than $100,000 ARR. We are considering a similar dollar-based metric for mid-market. Dollar-based metrics provide more transparency to investors, as they better reflect our expanding product portfolio.

Moving on to the channel. In line with our philosophy of profitable growth, we are laser-focused on both the growth economics and the growth itself. To that end, we are happy to see strong growth in our channel business. As relates to channel economics, we see favorable dynamics versus direct. Channel's lower cost to book and lower churn more than offset longer-term residual costs. Faster time to breakeven is an extra benefit. Simply put, even after cost to book and residuals, channel delivers higher cumulative contribution profit.

Now I'll briefly go through the Q4 financials and then on to the 2019 outlook. Total revenue grew 34% to $189 million. Subscription revenue grew 32%, and core subscription revenue, which normalizes for the legacy AT&T base, grew 38%.

A bit of housekeeping on the AT&T metric. As we discussed last quarter, due to the terms in our revised AT&T agreement, going forward, we will only be able to provide overall subscription revenue. We will continue to provide color on AT&T as appropriate.

Subscription gross margin was 83.3%, up over 1 point year-over-year as we continue to achieve benefits of scale. Non-GAAP operating margin of 9.2% was also up over 1 point year-over-year and well ahead of our guidance, driven primarily by the revenue upside.

Now let's turn to our outlook. For 2019, we expect total revenue to be between $847 million and $859 million for an annual growth of 26% to 28%. We expect non-GAAP EPS of $0.69 to $0.73.

In summary, we finished 2018 with strong momentum across go-to-market execution, product innovation and financial metrics. Looking ahead, we are well-positioned to continue taking market share from legacy on-premise vendors as well as further extending our lead over cloud competitors. We expect channel and enterprise tailwinds to continue, bolstered by an expanding international footprint and our targeted vertical go-to-market programs. Longer term, we see incremental opportunities with our reestablished AT&T relationship and our expanded customer engagement product portfolio.

With that as a backdrop, we are confident we will achieve our goal of exceeding both the rule of 40 and $1 billion in revenue in 2020.

Now let me turn the call to the operator for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Nikolay Beliov with Bank of America Merrill Lynch.

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Nikolay Ivanov Beliov, BofA Merrill Lynch, Research Division - VP [2]

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I had a question for Mitesh first and a follow-up for Vlad and Dave. Mitesh, when you look at the 8-figure deal and new logos in general and when you think about upsell, how does it flow into ARR?

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Mitesh Dhruv, RingCentral, Inc. - CFO [3]

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Sure, Nikolay. So a 3-part question, the first one is on new logos, then what happened to land and expand or upsell and then how does it show up in ARR. So let's start with the first one, which is new logos. If you look at the 8 -- or the 7-digit TCV wins we announced, about 80% of those deals were new logos, which is very consistent with last quarter, which was a high watermark, so very solid performance in new logos. When it comes to upsell or land and expand, when we have -- when we deploy an initial customer, the initial deployment is usually a small subset of the overall potential. So that gives us a chance to go to the well multiple times. Dave, in his prepared remarks, gave an example of Heartland Dental, where we now have a commitment of 6,000 seats, up from 4,000 seats. But the best news is that the total potential for this customer is over 10,000 seats. So this is just one example of how several thousands -- hundreds of customers are upselling. So that's new logos and upsell. And the way it shows up in ARR, Nikolay, is that when we land a large deal, we only include in ARR the number of lines or users that are provisioned. So for example, for Columbia, in our Q4 ARR, only less than 5% of the deal value shows up. And so most of the committed opportunity is going to be showing up in ARR in the future.

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Nikolay Ivanov Beliov, BofA Merrill Lynch, Research Division - VP [4]

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Got it. And a quick question for you. When you look at the evolution of RingCentral, you started with small business. You moved to medium enterprise, large enterprise, and you've been highlighting Global 2000, G2K deals. If you can give us a sense of how many G2K customers you have at this point, how long are the sales cycles, who do you win against? Any color here will be helpful.

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David D. Sipes, RingCentral, Inc. - COO [5]

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Yes, this is Dave Sipes. As we move into the larger and mega large enterprise, we see -- I think the question was like sales cycles and how are we executing. Obviously, this was a record number of million-dollar deals in the quarter. We did 80 or so for the year. And sales cycles in that range average in the 9 to 12 months' time frame, and we're seeing good progression of our pipeline in that area.

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Operator [6]

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Our next question comes from the line of George Sutton with Craig-Hallum.

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George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst [7]

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Mitesh, I'm wondering on the enterprise side, I wanted to ask the last question a little differently. You gave some compelling metrics to begin, relative to enterprise. I wonder how can you -- or how do you plan to hit that accelerator on enterprise opportunities going forward? It would seem we're on just the early stages of this big move to the cloud for the larger companies. Help me understand sort of the trajectory there.

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Mitesh Dhruv, RingCentral, Inc. - CFO [8]

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Sure. Yes, sure, George. So just to recap, mid-market and enterprise -- or throughout the enterprise showed really strong strength. It's $170 million business, grew close to 100%. And it's actually 1/4 of our Office ARR. But if you look at a forward-looking indicator, it's more than -- or close to 40% of the bookings of Office is enterprise. So that's part 1. Part 2 is we did see a broad-based trend there and -- in the enterprise segment. And as Dave said, we did sign close to 80 deals over $1 million for the entire year. And if you double-click on this momentum, you see, overall, the deal value actually went up 40%, both because the customers are larger and the duration is getting extended. So that's sort of the backdrop for 2019. When you look at the drivers for 2019, there are really 3 key drivers how we plan to step on the gas here. One is the sales force, right? We will keep on densifying our enterprise sales force in the key regions. That's part #1. Part #2 is channel. If you look at the Gartner, they had a stat that by 2022, for every 1 seat deployed for on-premise, there will be 4 seats deployed for the cloud. So this now impacts the channel in a way that they are now going to be more behooved to work with players like RingCentral in the cloud. And the third one is our expanding portfolio. With RingCentral Engage, it's now -- right now, predominantly a play in just France and somewhat of EMEA with large brands. We now hope to cross-sell this in the future to large enterprises in the U.S., given the changing consumer behavior. So I think with the -- if you look at the overall deal wins, with larger enterprises going to the cloud and plus our doubling down efforts with the GTM and product portfolio, I think that's the way we think about 2019.

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George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst [9]

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Perfect. Just a quick follow-up on the contract duration extending. That's, I think, an impressive indication that there's more commitment on the part of the buyers. But could you give us some way to quantify that duration expansion, maybe a little bit more thinking behind it?

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Mitesh Dhruv, RingCentral, Inc. - CFO [10]

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Yes, it's been hovering around, call it, plus or minus, 2-ish years on an average. And we saw a slight uptick, not very meaningful, but it did go in the right direction with a slight uptick.

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Operator [11]

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Our next question comes from the line of Matt Stotler with William Blair.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [12]

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It's Bhavan here, obviously. I guess, maybe starting off again with you, Mitesh, and then I have a follow-up for Dave and Vlad. But just you had probably the biggest beat you've ever had in revenue, certainly on the top line, and certainly, guidance was ahead of expectations, at least the consensus. I guess, as you think about your philosophy and the team's philosophy of balancing growth with margin, and you've touched on rule of 40. You're certainly growing and potentially could grow just as fast in '19 as historically. And so how are you sort of balancing that between the growth rate and sort of the investment in sales and marketing to sort of drive some level of profitability? Just trying to understand if there's been any change in philosophy and how you guys are thinking about '19 and maybe even a little longer, about those 2 metrics.

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Mitesh Dhruv, RingCentral, Inc. - CFO [13]

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Sure, Bhavan. So let's talk about growth versus margin, our favorite topic in a SaaS business. So yes, thank you for acknowledging, we did have a strong quarter across the board. Most of the chips did fall our way for 2 reasons. One is the market itself is definitely coming to the cloud. And second is we, RingCentral did end up taking share from other cloud providers. So I think it was a double whammy there for us in a good way. And if you look at how we beat, so we beat The Street estimates by, call it, plus or minus, $8 million, and about 40% of that beat flowed through to the bottom line. Now think of that 40% as being our inherent levers in the model where you can look at this as the incremental revenue margins as a proxy for the installed base recurring margin. When you look at the SaaS model, there are 2 drivers, which drive this inherent leverage in the business model. First is churn, and second is upsell. So if you look at churn, our customers are definitely staying longer. And you saw our gross churn [port] down less than 10% for the first time. That's one. And second in upsell, we are seeing customers buy more from our platform, and we did report that about 40% of our new bookings came from existing customers. So with these growth and growth economics more so, I think the bias, Bhavan, is going to be toward dialing for growth, no change from the past. But that said, we will show some margin expansion, as we've been showing, and we are going to be committed to beating the rule of 40.

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Bhavanmit Singh Suri, William Blair & Company L.L.C., Research Division - Partner & Co-Group Head of Technology, Media and Communications [14]

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Got it. That's helpful. You touched on competition, Mitesh, so I'll turn this over to the other guys on the call. You have been taking share from other cloud providers, but ShoreTel kind of disappeared. David Sipes, you said before that sort of you're seeing more of an inflection and people are, as the ShoreTel comes up for renewal, moving over to you. I guess, just any sense of the competitive environment? Is the takeaway at the enterprise level, which feels like it, but you're sort of seeing the mid-market also being a fairly competitive takeaway? And is it still largely from on-premise players like the ShoreTel, Mitel equivalents? Or is it more from sort of your primary cloud competitor, who you keep leaving further and further behind? Just some color on the dynamics in both the mid-market, enterprise around the competitive environment.

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David D. Sipes, RingCentral, Inc. - COO [15]

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Yes, this is Dave Sipes. The vast majority of the market is obviously on-premise solutions that people are moving away from and looking to buy cloud solutions. And we see that point accelerating, and we see Gartner talking about that accelerating over the next few years. We see the largest replacements we're doing are typically the Cisco, the Avaya, the Mitel are the biggest ones in the market and the most common that we will replace. We also will compete -- well, our largest deals are million-dollar deals, it will typically be one of those key legacy providers that we're replacing. That dynamic has stayed true, and our win rates against those legacy solutions have sustained, very strong. Actually, saw an uptick against those players this quarter. So we see a greater momentum from the buyer and a stronger emphasis on cloud and cloud functionality that's helping us migrate the segment of the market over.

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Operator [16]

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Our next question comes from the line of Terry Tillman with SunTrust.

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Terrell Frederick Tillman, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [17]

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Looking forward to 1 day seeing maybe a 9-figure TCV deal. But anyway, specifically, my first question relates to -- and sorry for this bad cold I have and how I sound -- related to recent acquisitions, Dimelo and Connect First, maybe, Mitesh, could you talk about, I think initially, they were going to be immaterial to the model, but maybe as we look at the 2019 guidance, what kind of revenue contribution can you talk about from those 2 acquisitions specifically?

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Mitesh Dhruv, RingCentral, Inc. - CFO [18]

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Sure. Terry, your voice sounds fantastic, by the way.

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Vladimir G. Shmunis, RingCentral, Inc. - Co-Founder, Chairman & CEO [19]

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Compared to mine for sure.

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Mitesh Dhruv, RingCentral, Inc. - CFO [20]

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And the 9-figure deal, in due time. So to answer your question, look, both of these acquisitions, Dimelo and then Connect First, were really technology tuck-ins and was mainly to broaden or expand our product portfolio to crack open new addressable markets. So -- and the focus for 2019 for both these acquisitions is going to be on integrating both these products onto the RingCentral platform. So if you look at what contribution we have dialed in, it's very insignificant, especially after you consider the deferred revenue write-down. So -- but the hope long term, Terry, is that with our investments on integrating these products this year, long term, we hope to achieve more cross-sell synergies there to take both these products to our installed base longer term.

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Terrell Frederick Tillman, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [21]

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Okay. And I don't know if this is for Vlad or for Dave or for you, Mitesh, but my follow-up just relates to, at the user conference last year, talking about the unified mobile app, bringing it all together. What I'm curious about is, for some of your installed base, is there any kind of GTM efforts to really push them to move to the new app. And if so, could that be an incremental driver of cross-selling or upselling as we move into '19?

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David D. Sipes, RingCentral, Inc. - COO [22]

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Yes, this is Dave Sipes. So I think the question was with the new unified mobile app, if we're pushing the installed base. That's something that we're focused on over the next couple of quarters. We see a lot of advantages in the unified mobile app, a more unified experience, the ability to utilize both team messaging, video and telephony in one go and having a seamless experience across that. We think it's a huge advantage for the customers. We see very good adoption from our customers that have already moved over to that, and we do see that as becoming the permanent application of the future for RingCentral. It does create greater exposure to other products and services and allows greater adoption across the suite.

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Operator [23]

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Our next question comes from the line of Meta Marshall with Morgan Stanley.

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Meta A. Marshall, Morgan Stanley, Research Division - VP [24]

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First, a question on the Columbia deal. Can you just give a detail on how the students will use it? Like is it tied to kind of class threads? Or will it be used for talk between students? Just a little bit of detail there would be helpful, maybe to start.

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David D. Sipes, RingCentral, Inc. - COO [25]

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Yes, so we're rolling up team messaging collaboration across the student body. That's something focused on -- it'll start with different departments, different departments within the student body. And a key aspect is the learning management system integration that was core to the decision to move to RingCentral, and it was key that our platform supports these capabilities. So that's been an important aspect of that, so.

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Meta A. Marshall, Morgan Stanley, Research Division - VP [26]

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Okay, got it. And then maybe just on kind of direction of R&D. Last year, you guys talked a lot about it being used to expand international presence, with kind of 30 countries outfitted. Is the direction more contact center and integrating some of the Dimelo and Contact First integrations? Just if you could kind of give a direction of where that spend is going.

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David D. Sipes, RingCentral, Inc. - COO [27]

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Yes, so the -- on the product innovation side, a key aspect is, as we made these acquisitions, with RingCentral Engage is built upon the Dimelo product suite and Connect First is creating integrations and a unified platform between those products, as well as moving everybody over to the unified app. Our global capabilities continue to grow, as we're approximately 40 countries now on Global Office and we look to continue to expand there, as well as a big emphasis on our open platform development, which we've had a doubling of growth every year for several years, with over 1,800 certified apps.

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Operator [28]

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Our next question comes from the line of Brian Peterson with Raymond James.

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Brian Christopher Peterson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [29]

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So Mitesh, just wanted to expand on your channel comments a bit. Could you talk about how we should think about the growth and the margin implications of the channel expansion in 2019?

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Mitesh Dhruv, RingCentral, Inc. - CFO [30]

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Sure, Brian. So yes, let's talk about the channel performance in '18, and then we'll talk about the -- how we see '19 shaping up in terms of penetration and then what it means for margin and profit for the business model. So look, channel here has been a crown jewel. It's been a stellar performing vector for us, $180 million business, growing 80%, 1/4 of our business, so it's been amazing in that sense. And if you look at 2019 versus '18, we are still -- if you talk to channel partners, it's still in the very, very early stages, so -- at both internationally and in the U.S. So the playbook is going to be similar, where we are going to be adding some key channel partners in '19. And then that's A. And part B is also densifying our coverage within the channel partners we have, so sort of a two-pronged approach there, which has been serving us well. Now as it relates to profit and economics, as you know, Brian, for us, it's always profitable growth and not really growth at all costs. And we really look to that mantra there. So if you run the channel through the model -- channel economics through the model, the cumulative profit dollars for channel are accretive to the business and are higher than direct, for 3 reasons. One is that the payback is faster. There's no other incremental material sales and marketing dollars we have to spend. And the overall churn is lower in the channel. So these 3 vectors actually offset, more than offset the upfront costs we have to pay and the residual payments we have to pay for the channel. So -- and then again, cherry on top, it -- channel does free up extra investment dollars for us to invest those dollars in the direct sales and marketing, which then accelerates growth. So I think net-net, I think channel is here to stay and it's accretive to the business.

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Brian Christopher Peterson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [31]

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Got it. And just one more, just on the vertical opportunities you mentioned. Is there anything that you can share in terms of who you're displacing, deal sizes, ARPU? Or any unique value proposition that you're adding for the 3 verticals you mentioned?

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David D. Sipes, RingCentral, Inc. - COO [32]

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On the verticals, we continue -- we win several deals in each of our core verticals, so from financial services, health care, and state and local, education. We announced Columbia, but it wasn't our only higher education win. There were a couple other million-dollar TCV higher education in there, and that's a vertical we've had success with previously. Additionally, we've signed additional cooperative buying agreements with NASPO and TIPS that will help us add additional state and municipalities in the future. And on the health care, we've had many successes. We continue to have successes such as Heartland Dental, expansion there and continue to see success in the medical clinical areas within health care.

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Operator [33]

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Our next question comes from the line of Samad Samana with Jefferies.

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Samad Saleem Samana, Jefferies LLC, Research Division - Equity Analyst [34]

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Mitesh, one for you. Just looks like the strongest quarter-over-quarter change in net new ARR for a fourth quarter in the last few years. I was wondering if there's any change in seasonality for new large deals or if there's more and more seasonality favoring fourth quarter in terms of renewals. Just something to help us as we think about our models for ARR going forward. And then I have a follow-up question.

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Mitesh Dhruv, RingCentral, Inc. - CFO [35]

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Yes, if you look at the sequential trends, Samad, (inaudible) sequentially for Office, call it, between 8% to 9%. If you look at Q1 of this year, it was a little over 9%. This quarter, it was a little under 9%. So it's not that unusual. But that said, fourth quarter is sequentially pretty strong for us, and that's driving some of the strength there. So it was pretty broad-based.

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Samad Saleem Samana, Jefferies LLC, Research Division - Equity Analyst [36]

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Great. And then, Dave, I wanted to follow up on the government contract vehicles. I know the company put out a couple of press releases last week highlighting it. Could you remind us maybe what type of penetration the government -- or what percentage it represents in ARR? And then just remind us if you guys are FedRAMP certified already and how you see breaking into the federal opportunity, maybe going forward or how we should think about that opportunity ramping for RingCentral in maybe 2019 and going forward?

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David D. Sipes, RingCentral, Inc. - COO [37]

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Yes, these are still early opportunities for us on the state and local. We've obviously had a lot of success in education, both higher ed, even in K-12. We see this as opportunity to expand on that to get into state and local. Additionally, at a significant pace, we've increased our staffing in that area, focused on state and local within our sales team and have dedicated personnel in that area. So it's an opportunity there. As far as federal government, FedRAMP is something we're working on at this point. We don't have a time line yet that we're projecting, but that will be additional opportunity, I would say, that would follow as we see the success in education, state and local and then move to federal after that.

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Operator [38]

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Our next question comes from the line of Michael Turrin with Deutsche Bank.

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Michael James Turrin, Deutsche Bank AG, Research Division - Research Analyst [39]

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Wanted to talk a little bit about the Connect First acquisition. Could you spend a bit more time perhaps walking us through how this complements the Engage platform you've built on Dimelo and what you're now able to bring into the contact center market as well as how you're thinking about that opportunity set today?

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David D. Sipes, RingCentral, Inc. - COO [40]

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Yes, the -- we have, we think, are bringing best-in-class, world-class solutions to customers with the traditional RingCentral Contact Center inbound capability. Engage brought the ability for digital customer engagement that is allowing the way the new workforce and new consumers are communicating with businesses. And Connect First is a world-class outbound capability, outbound-blended capability, that starts penetrating a little more into sales and marketing lines of business outside of, let's say, customer support lines of business. So it adds to the breadth of the solutions as well as it gets us into additional buying organizations within the companies that we've already sold to or are prospecting with.

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Michael James Turrin, Deutsche Bank AG, Research Division - Research Analyst [41]

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And then maybe one for Mitesh. You've talked in the past around expectations for, call it, 75 to 100 basis points of margin expansion per year. You gave us more than that this year, and the initial guide for '19 maybe implies a touch less than that for next year. Is that just a result of the slight tilt towards growth, given you've been accelerating the top line? Or is there anything else you'd like us to take away there?

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Mitesh Dhruv, RingCentral, Inc. - CFO [42]

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No, nothing material for you to take away there, Michael. If you look at the starting of the guide from last year, if -- you probably would -- nothing too much to read there. I think the overarching theme, I think, what you need to keep in mind, at least the way we are driving the business, is toward the rule of 40. And I think growth plus operating margin, that's where we strive to achieve. So 50, 75 basis points is just noise there. But I think we will show operating margin expansion despite these 2 -- despite taking on some of the investments we have to make for these 2 acquisitions. And so I think that expansion is here to stay. But overall, I think it's the rule of 40, where we strive to achieve.

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Operator [43]

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Our next question comes from the line of Sterling Auty with JPMorgan.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [44]

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Back on the idea of competition and market share shift. I'm wondering from this perspective, you're you obviously winning in terms of the customer wins. Were you finding that you're further pushing out or displacing other vendors as the primary vendor in the channel? I remember the panel that you had at the Analyst Day and I think a couple of examples. I'm just wondering, are you seeing that as a growing trend, especially the resellers that are able to bring you into more of those upmarket opportunities?

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David D. Sipes, RingCentral, Inc. - COO [45]

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I think we've had a lot of success in the channel. We see it's continuing to grow, over -- around 80% year-over-year. We've built a strong reputation in the channel by supporting the channel, both in the selling activities and in the customer retention activities. And we've built a brand that we can deliver across some of these key new accounts as well as upselling into existing accounts. An example, Copart, which we mentioned on the call, was sourced by a new partner that we just secured last quarter, and this was the first deal they brought to us. So it's showing a willingness to partner with us on the largest deals and a confidence that exists in the channel. So we feel good about our position there and continue to work strongly with our partners in our go-to-market replacement of legacy solutions.

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Sterling Auty, JP Morgan Chase & Co, Research Division - Senior Analyst [46]

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All right, great. And then one follow-up would be now that we -- looking at the end of 2018 versus the end of 2017, can you quantitatively or at least qualitatively describe where we are in terms of the size of the go-to-market sales and marketing force? So how much did that headcount grow? And how much of that was geared specifically towards that mid-market enterprise versus traditional segments?

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Mitesh Dhruv, RingCentral, Inc. - CFO [47]

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Sure, Sterling. So I'll give you some data points, which would help frame the -- frame what you're asking. If you look at where the investment dollars went in terms of GTM, they all mostly went toward the mid-market and enterprise sales force. So that's sort of point #1. And if you look at the clip of growth of these investments for quota-carrying headcount, we -- the growth was lower in our overall ARR growth because we are seeing some improvements from these segments ramping and maturing overall. So more reps are ramped and are hitting quota. So that's the way to think about it, where we are growing our sales force shy of our overall ARR growth, given some of the efficiency we are seeing.

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Operator [48]

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Our next question comes from the line of Will Power with Robert W. Baird.

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William Verity Power, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [49]

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Yes, just a couple of questions. Let me maybe first start with Columbia, coming back to that win, which looked terrific. I'd love to get any kind of color you're able to provide on the RFP process. It sounds like you displaced an on-premise provider. Were there other cloud providers participating for that? It sounds like messaging was a key piece of the win. But I guess, as you step back, what were the other key attributes that really helped you stand out among the bidders there? And then the final piece there is -- maybe I missed this, but is Contact Center a part of that? And is that maybe still an opportunity?

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David D. Sipes, RingCentral, Inc. - COO [50]

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Sure. Yes, so Columbia, we've been in discussions with for a while, for probably a couple of years. So we've -- they've been a customer in their graduate school with Teachers College, Columbia, but the main campus was running a legacy solution, as you mentioned. We competed against probably the market-leading legacy solution and won against that. So it was kind of an on-prem versus cloud decision that they went through. And the scalability of our platform was critical. The integrations, as I mentioned earlier, about the LMS integration, but as well, integration with Google and ServiceNow were examples of helping win that. And there is a smaller component of Contact Center at this point, but that's additionally -- the bulk of it is the UCaaS opportunity at this point in time.

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William Verity Power, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [51]

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Okay, that's great. And then my second question, I just want to come back to international, too. I mean, you referenced another nice win in the U.K. Any other color you can provide on what the international growth looked like in the quarter, percent of revenue? Feels like you're making a nice headway across the board on that front.

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David D. Sipes, RingCentral, Inc. - COO [52]

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Yes, we continue to have success. We've seen it in million-dollar deals coming out of that market, and our team there has grown significantly. So we're having better recognition and better success. The percent of revenue is something that continues to grow, probably a little faster than overall. But we see both the U.K. We've had success in Australia, and now we're expanding into France. So we see additional expansion opportunity international going forward.

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Operator [53]

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(Operator Instructions) Our next question comes from the line of Dmitry Netis with Stephens Inc.

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Dmitry G. Netis, Stephens Inc., Research Division - MD of Equity Capital Markets & Senior Research Analyst [54]

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I guess, I'm just wondering about guidance for subscription revenue for Q1. So this is a recurring business. And if I roll your annualized monthly subscription run rate plus some of the net new business that you acquired, which was quite strong this quarter, right, plus the record-low churn, I come up with $179 million, $180 million for Q1 versus your guide of $177.5 million -- $175.5 million, $177.5 million. So I'm wondering if I'm missing something and why this growth decels to 28%, given your run rate growth rate in the last 4 quarters is 32%.

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Mitesh Dhruv, RingCentral, Inc. - CFO [55]

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Sure, Dmitry. Look, we -- it's a good start to the year, but we don't know what we don't know. We are cautiously optimistic for the year, and I think just one step at a time.

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Dmitry G. Netis, Stephens Inc., Research Division - MD of Equity Capital Markets & Senior Research Analyst [56]

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Anything to read on AT&T? Or is it just, it's not counting the AT&T business at all?

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Mitesh Dhruv, RingCentral, Inc. - CFO [57]

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We have not dialed in, Dmitry, much revenue from AT&T, because it's just the start of the relationship, and I think we just want to be cautiously optimistic there. Longer term, I think AT&T could be -- emerge as a good long-term vector for us or driver for us, given that the previous relationship was a $50 million business first. But we have not -- in '19, we have not dialed in much.

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Dmitry G. Netis, Stephens Inc., Research Division - MD of Equity Capital Markets & Senior Research Analyst [58]

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And if I may ask one other question, in your commercial bundle with Zoom and inContact, what percentage of your bookings include kind of the suite of all 3 products, meaning UCaaS, video and inContact? And when you do sell the entire bundle, what's the impact to the gross margins? And can you kind of tell us what the gross margin guidance will be? I know you're not guiding it, but can you give us a little calibration of what to look for on the gross margin line for '19?

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Mitesh Dhruv, RingCentral, Inc. - CFO [59]

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Sure. You packed in like 7 questions in 1, so that's -- so congrats on that. So I'll try. So we don't -- so unlike some of the other cloud vendors, we don't sell inContact or Contact Center along with our Office product. It's being bought separately. They are 2 separate bundles, so -- but we do integrate at a deep level with these 2 products. And in terms of gross margins, it's no secret that the Contact Center margins are, call it, plus or minus, 50-ish percent range, gross margins. And so if you blend the 2, our gross margins for Office with the Contact Center, I think I did allude to in the previous call, that the gross margin should be around 82%, plus or minus, range, which is what you put in your previous, so thanks for being ahead of that.

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Operator [60]

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Our next question comes from the line of Brian Schwartz with Oppenheimer.

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Brian Jeffrey Schwartz, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [61]

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Most of my questions have been answered today, but I thought maybe I would just ask one granular question for David out there. Just given the strength that you're seeing here now in the big deals and the upsell momentum that you're having in the installed base, I'm just curious if you're starting to face off with different buyer sets within the customer base, if there's new champions that are emerging for the company. The reason I ask is we've talked about this before, but one of the opportunities here is to expand the platform into more of an enterprise-scale business communications plus an engagement and collaboration platform. And I'm just kind of curious where you think you are on that journey, based on the customers and the buyers that you're speaking to today.

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David D. Sipes, RingCentral, Inc. - COO [62]

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Yes, so on customers and buyers, we're typically within the -- often in the CIO organization. We deal a little bit with procurement in some of these organizations. But as we've expanded the selling of Contact Center, the customer service line of business becomes important. And as we look to sell Engage and Connect, Engage, marketing gets more involved. And then with Connect First, we see a little more on the sales side. So we are broadening across the different buyers in the organizations. And as we talked about, we're working -- work those purchase decisions across all those buyers. And we've had a lot of success selling all of those, even upfront in some of the deals. And then other deals, we'll sell one product and then cross-sell over time into the other products.

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Operator [63]

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Our next question comes from the line of Mike Latimore with Northland Capital Markets.

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Michael James Latimore, Northland Capital Markets, Research Division - MD & Senior Research Analyst [64]

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Two quick ones here. What percent of your bookings is coming from international? And in terms of average revenue per seat, what's been the trend over the last year there?

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Mitesh Dhruv, RingCentral, Inc. - CFO [65]

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Sure, Mike. It's Mitesh. I'll take the second part first. So no quite -- no change to our pricing. It remains pretty stable. And then in terms of the bookings for international, we don't specifically break it out. International still remains a smaller piece of the overall pie, sub-10%. But the overall bookings growth was faster than the overall growth of the business, so it remains an emerging vector of growth for us.

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Operator [66]

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Our next question comes from the line of Matt Van Vliet with Stifel.

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Matthew David Van Vliet, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [67]

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Just curious where you guys stand on some of the vertical selling groups in terms of overall sales productivity. Are they a little bit earlier on the curve, since that's been a little bit more of a recent investment? And then how, just generally, has the headcount additions been specifically in those groups relative to the overall sort of quota-carrying headcount?

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David D. Sipes, RingCentral, Inc. - COO [68]

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Yes, this is Dave Sipes. So we've been investing in those verticals for a while, so it's not something that's new. But because of the success we're having, and I mentioned each of those verticals, financial services, health care and state and local education, had several million-dollar wins in the quarter. That's driving us to increase the size of those teams, but because we're seeing the productivity success from them.

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Operator [69]

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Our next question comes from the line of Zack Turcotte with Dougherty & Company.

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Zack Turcotte, Dougherty & Company LLC, Research Division - Anlayst [70]

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Zack on for Catharine Trebnick. So with the recent acquisitions to kind of round out your Contact Center and Customer Engagement platform, do you feel like your product portfolio is kind of complete at this point? And from a product and technology perspective, what's your focus right now? At your user conference last year and other conferences we've been to recently, it seems like there's a large focus on AI and analytics, particularly in relation to Contact Center.

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David D. Sipes, RingCentral, Inc. - COO [71]

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Look, we're always looking for additional technology solutions that can help with the overall portfolio. We believe in bringing world-class solutions to our customers in all areas. So I think there's still opportunities as we look across the communications suite, and we're continuing to look at opportunities. The -- probably the more important thing is, as we bring these organizations in, is to create that seamless user experience across the products. And so that's a big focus of our innovation, is to do that both from a user experience as well as from a platform HA capability, as we have a very high bar that customers expect from us. And as we bring in new innovative products, we also want them to meet that high bar of expectations. So those are key things that we'll be working on to further the strength of the product suite.

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Operator [72]

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Our next question comes from the line of Jon Kees from Summit Insights Group.

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Jonathan Allan Kees, Summit Insights Group, L.L.C - MD & Senior Analyst [73]

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I'll keep mine to one question. As you expand internationally, as you expand into adjacent markets, especially with your expanded portfolio into these adjacent as well as new markets, can you talk about your -- the efforts that you have to make in branding, on brand recognition? Especially in 2019, is that something you have to ramp up?

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David D. Sipes, RingCentral, Inc. - COO [74]

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It's Dave Sipes. The -- we continue to invest in our branding capabilities, both through traditional industry events as well as enterprise field marketing capabilities as well as some brand that you'll see in radio and across nationally. And we're focused, as we go into additional markets like the U.K., to make sure we go in with scale and make sure we build a strong reputation within those markets, both with the customers directly and also with the channel as we go to market. So those are things that we've continued to do, I would say, at the same kind of proportion that we've done in the past. And so as we grow the overall business, we'll continue to increase investments, but proportionally in those areas.

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Operator [75]

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Our final question comes from the line of Kash Rangan from Bank of America Merrill Lynch.

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Kasthuri Gopalan Rangan, BofA Merrill Lynch, Research Division - MD and Head of Software [76]

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I found your answers to be very insightful and analytical. I was just wondering if your CFO ever happened to be a Wall Street analyst in his past life. Of course, that's not the question. I know the answer to that question. But when you look at these mega deals that are happening for you guys, it's certainly an inflection point as you approach the million-dollar-plus level. Are you seeing more of these mega deals in your pipeline? And how do you think about the effect on your business, either from an expense investment standpoint or from the standpoint of lowering attrition and keep maintaining a growth profile?

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David D. Sipes, RingCentral, Inc. - COO [77]

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So this is Dave Sipes. We've had this progression as we moved into mid-market, had success in mid-market, then into smaller enterprise and now as we move into larger and mega enterprise. We're continuing the same playbook to have dedicated selling capabilities in those markets, bring the right mix of post-sell capabilities to the customers through professional services and customer success managers and do that in concert with our channel partners. So it's a playbook we've been running in the other segments. We're running that in the large segment. We're happy to be demonstrating success, and we see additional opportunities definitely in the pipeline of these coming down. But it's been a migration as we've done that, and we've continued to manage the rest of the business in a disciplined manner as we do advance into the upper ends of the market.

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Operator [78]

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We have reached the end of the question-and-answer session, and I will now turn the call back to management for closing remarks.

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Mitesh Dhruv, RingCentral, Inc. - CFO [79]

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Thank you all for dialing in. We'll see you next quarter. Thank you.

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Operator [80]

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This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.