RingCentral, Inc. (NYSE:RNG) Q4 2023 Earnings Call Transcript
RingCentral, Inc. (NYSE:RNG) Q4 2023 Earnings Call Transcript February 20, 2024
RingCentral, Inc. beats earnings expectations. Reported EPS is $0.86, expectations were $0.83. 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: Good afternoon and welcome to the RingCentral Fourth Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Will Wong, Vice President of Investor Relations. Please go ahead.
Will Wong: Thank you. Good afternoon and welcome to RingCentral's fourth quarter 2023 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 now turn the call over to Tarek.
Vlad Shmunis: Good afternoon and welcome to our fourth quarter 2023 earnings call. First, I'd like to welcome two new Board members, Ned Segal and Prat Bhatt, to the RingCentral family. Ned is a seasoned executive with more than 25 years of technology, finance, and capital markets experience including at Twitter, Intuit, and Goldman Sachs. Prat is an accomplished technology industry veteran and financial expert, having served as the Chief Accounting Officer at Cisco Systems for over twenty years. I look forward to working with them both. I also want to warmly thank Allan Thygesen for his nine years of service on our Board, as he will be transitioning off the Board in Q2. Now, moving to our results. We ended the year on a strong note.
In Q4, total revenue rose 9%, above the midpoint of our guidance. ARR rose 11% to $2.3 billion. We also achieved record profitability, with quarterly operating margin of 20.5% and free cash flow of nearly $100 million, well above our outlook. Our strong finish to 2023 positions us well to execute on our strategy in 2024 and beyond. I returned as CEO to deliver on our strategy of; one, delivering durable growth and value from our core; two, expanding our TAM by turning RingCentral into a multi-product, AI-first communications leader. To that end, we have recently added three new products to our portfolio; RingCX, our native, AI-first contact center, RingSense for Sales, our conversation intelligence platform for sales professionals, and RingCentral Events, our new virtual, hybrid, and onsite events platform.
And three, driving continued robust free cash flow generation, while materially reducing SBC, and maximizing free cash flow per share growth over the long-term. Our right to win is rooted in our industry leading, reliable, global, fully-featured business communication platform that now includes cloud PBX, cloud contact center, and Video meetings, Webinars and Events, all infused with state-of-the-art AI capabilities. As a testament to our industry leadership, in November 2023, RingCentral was named a Leader in the Gartner Magic Quadrant for Unified Communications as a Service Worldwide Report for the ninth consecutive year. And we are excited to report that Aragon Research, an independent third-party research firm, just named RingCX as a leader in the Intelligent Contact Center for SMB.
We believe this is a testament to RingCentral's ability to continue delivering a superior, differentiated solution in a competitive market. We are proud to have built a $2.3 billion recurring revenue business that is growing, profitable and serves over 400,000 customers across Enterprise, mid-market, and SMB. Within Enterprise, which we define as customers that generate $100,000 in ARR or more, I am particularly proud to report that this segment has just achieved $1 billion of ARR. This is a major milestone for our company. In fact, in this post-COVID world, Enterprise continues to be a strong growth driver for us. Today, we count almost 20% of Fortune 1000 companies as our Enterprise customers. Amongst these are two of the world's three largest hotel brands, one of the world's largest car rental companies, and many leading Fortune 500 financial services companies.
Notably, the majority of our Enterprise customers utilize our solutions integrated with and alongside Microsoft Teams. This strong presence with large customers and within the Microsoft Teams environment is a testament to the trust our Enterprise customers have in our products and our ability to add value to the Teams environment. Our new, advanced integration with Microsoft Teams is a key reason enterprise customers select RingCentral. This includes customers such as Republic Airways, one of the largest regional airlines in the US. Overall, Enterprise continues to be a growth driver for RingCentral, with a positive long-term outlook. Let me now share some additional highlights of why customers large and small continue to choose RingCentral to power their communications.
Broadly speaking, customers have historically picked us because of our 99.999% reliability, which we achieved for the 22nd straight quarter, robust feature set, regulatory compliance, and depth and breadth of our integrations. Here are some examples of key large wins and expansions for this quarter. One, a Fortune 100 insurance provider that purchased 20,000 UCaaS seats to connect its distributed broker network made up of thousands of field offices. Another one is a Global 500 retailer that purchased 18,000 UCaaS seats to power communications across its more than 2,000 stores. And finally, a Fortune 500 global healthcare solutions company that added millions of dollars to their existing contract. One of the key integrations for this customer is our reliable and powerful calling capabilities embedded in Microsoft Teams, which they have already deployed to their employees.
Their additional spend is a testament to their confidence in our ability to deliver a full communications platform, and add value to the Teams environment. Leveraging our core strengths, we are now expanding into adjacencies such as CCaaS, hybrid, and virtual events, and conversational intelligence for sales. These categories have addressable markets that more than double our current opportunity to over $70 billion, providing multiple vectors for us to drive long-term, profitable growth. Industry analysts and customers alike are already recognizing our ability to deliver in one of our key adjacencies, namely CCaaS. In their latest report, Aragon Research praised RingCX's ability to deliver powerful AI functionality, which includes automated quality management, coaching, and conversation analytics, while being easy to deploy, easy to use, and easy to maintain, and all at a disruptive price point.
Regarding customers, we now have over 100 paying RingCX accounts, up from about 50 when we launched in November. These accounts include two Fortune 1000 enterprises who each purchased over 1,000 seats. We also now have hundreds of paying RingSense for Sales customers after having just launched in the second half of 2023. Lastly, approximately six months ago we acquired Hopin's Events business. We are happy with this acquisition and view it as a key addition to our portfolio. Since re-launching as RingCentral Events, hundreds of customers have hosted virtual and hybrid events on this platform in the past few months. This includes many large Fortune 500 companies and well-known businesses such as Spotify, Reddit and HubSpot. We continue to see strong demand for our Events platform.
With recent improvements in packaging and pricing and the addition of AI-powered features for Events, we expect to significantly scale this business over time. Notably, we recently won Harvard University over a well-known video-first competitor. Harvard chose us because of our advanced branding capabilities, level of production, and superior attendee user experience. While it is still early for our new products, given the level of traction we are already seeing, we believe we can achieve at least $100 million in ARR from RingCX, RingSense, and RingCentral Events, collectively, by the end of 2025. We expect these new products to be meaningful contributors to our strategy of delivering long-term, profitable growth. Importantly, going forward, our multi-product strategy will be augmented by taking an AI-first approach to everything we do.
AI is revolutionizing the way the world works and communicates. The pace of AI innovation in our industry is accelerating. We have a robust roadmap of new AI-based features that should help differentiate our core and new products from the competition. Over the course of this year, we are planning to announce many more AI rooted innovations that will enhance both employee and customer experiences. Stay tuned for some exciting product and innovation announcements at Enterprise Connect at the end of March. We will leverage our broad go-to-market capabilities as we execute on our AI-first, multi-product, strategy. In that vein, I am pleased to welcome Brightspeed, formerly known as CenturyLink, who will join other valuable members of our global service provider family that now includes AT&T, BT, Charter Communications, Telus, and Vodafone, amongst others.
Speaking of Vodafone. We started with Vodafone UK and Germany, and in 2023, we expanded with Vodafone into Italy, Portugal, and Spain. And we are super excited about a recent Enterprise win with Vodafone, landing a 15,000-seat deal at Ikea, Germany. And last but certainly not least, profitability. We have greatly expanded our profitability, with operating margins improving from 12% in 2022 to over 20% exiting 2023. We also more than doubled our adjusted, unlevered free cash flow to $325 million for the year. We continue to expect to drive further margin expansion and robust free cash flow generation in 2024 and beyond. Another important factor in creating shareholder value is minimizing SBC. I, and our entire senior management team and the Board, are laser-focused and committed to delivering meaningful improvement in 2024 and beyond.
Sonalee will provide more color shortly. In closing, we exited 2023 as a stronger, leaner, more profitable business, and we're well on our way to becoming an AI-first, multi-product portfolio company. Our opportunity is large, our strategy is clear, and we are heads down executing. I am optimistic about our future and am happy to be back at the helm leading RingCentral's next chapter. With that, thank you and let me turn the call over to Sonalee.
Sonalee Parekh: Thanks Vlad. I'll now provide highlights from the fourth quarter and full year 2023, and then discuss our guidance for 2024. In Q4, subscription revenue of $547 million was up 9% year-over-year, above the midpoint of our guidance range. ARR of $2.33 billion was up 11% versus last year. Our Enterprise ARR grew 13% versus last year to $1 billion. We saw good traction in our $1 million plus TCV deals. We finished with a seasonally strong Q4, resulting in over 100 large deals for the year. Within SMB, ARR rose 9% versus last year, and mid-market ARR grew 10%, and we believe the demand environment has begun to stabilize. Moving to CCaaS. Once again, we saw more than 60% of our large, million dollar plus TCV deals include both UCaaS and CCaaS.
CCaaS ARR now represents over $350 million of our total ARR base. 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. Additionally, we are seeing good traction with our new products. We have already sold thousands of RingCX and RingSense for Sales seats at ARPUs that are higher than our corporate average, and expect new products to be accretive to ARPU and retention over time. Operating margin of 20.5%, above our guidance for 20.0%, rose 650 basis points versus last year. Our focus on increased efficiency and productivity and the significant operating leverage in our business continues to drive the meaningful increase in our profitability.
Importantly, we generated quarterly adjusted, unlevered free cash flow of $97 million, a quarterly record. Moving to our balance sheet. In December, we repurchased $253 million nominal value of our 2025 convertible notes for approximately $240 million. During the quarter, we also repurchased 2.1 million shares at an average price of approximately $31. Now, turning to the full year, let me share a few key takeaways. First, we delivered growth that was above the market. Second, we meaningfully transformed our profitability and free cash flow generation profile. Third, we executed against our capital allocation policy that includes debt reduction, share repurchase, and investing in innovation, both organically and inorganically. Now, let me provide some more detail about each.
First, regarding growth. Total revenue of $2.2 billion was up 11%. We began to see stabilization of demand in the second half of 2023. Second, profitability. We added over $210 million of incremental subscription revenue in 2023, while keeping our operating expenses roughly flat. This was driven primarily by the reduction in sales and marketing expense, which as a percentage of total revenue declined 370 basis points versus last year, as we optimized our marketing spend, increased the productivity of our sales teams, and continued to be disciplined in compensating partners based on the value they create. This resulted in operating margins rising 670 basis points versus last year to 19.1%, and adjusted, unlevered free cash flow margins increasing from 5.2% to 14.8%.
Regarding free cash flow, we generated $325 million of adjusted, unlevered free cash flow for the year, which exceeded the mid-point of our guidance by roughly $30 million. The significant increase in our free cash flow reflects our increasing profitability, as well as efforts we have undertaken to optimize upfront channel commissions and improve our working capital efficiency. Lastly, we executed against our capital allocation policy that we had previously shared. In 2023, we strengthened our balance sheet as we repurchased $839 million of our 2025 convertible notes and $41 million of our 2026 convertible notes at a meaningful discount, and we were able to reduce our gross debt by over $90 million. We exited the year at 2.6 times net debt to adjusted EBITDA, down almost two turns compared to 2022.
We also repurchased roughly 10 million shares for $315 million, or approximately $31.50 per share. Our Board increased our repurchase authorization by $150 million, and we currently have $200 million remaining on our total authorization. Lastly, we acquired an Events platform from Hopin, while continuing to invest in the development and launch of many new products. We accomplished a lot on the financial front in 2023. In 2024, our priorities are to one, invest in the business to drive growth. Two, expand profitability by remaining disciplined in our spend and focused on increasing efficiency and productivity. Three, significantly reducing SBC expense and net share dilution; and four, continue to deploy a capital allocation approach centered around deleveraging, share repurchase, and both organic and inorganic investments.
Let me now expand on each of these priorities. First, investing in our business to drive growth. Growth in our core business remains stable, as the UCaaS market is large and continues to expand. Additionally, as Vlad noted, we expect new products to meaningfully increase our TAM and contribute at least $100 million of ARR by the end of 2025. Second, expanding profitability. Going forward, in 2024 and beyond, we believe we can continue to grow revenue faster than operating expenses. We will continue to focus on increasing sales and marketing efficiency. This includes increased discipline with commissions paid to sellers and channel partners and reallocating resources to where we see the highest ROI. Third, and very importantly, SBC. As Vlad noted, the senior management team and the Board are laser-focused on reducing stock-based compensation and dilution.
We expect to reduce net new grants in 2024 by over 50% from 2023 levels. This results in total stock-based compensation coming down by approximately 350 basis points in 2024. We expect further meaningful improvement in 2025 and beyond. Finally, executing against our capital allocation priorities. Addressing our 2025 and 2026 converts is a key priority. $161 million of the 2025 converts remains outstanding at December 31st, 2023. We plan to utilize a portion of our free cash flow to retire the 2025 convert by its maturity date in March 2025. Based on our 2024 guidance and deleveraging post paydown, our net leverage ratio will trend closer to 2 times. Our low and improving leverage ratio, strong BB credit rating, and strong free cash flow growth gives us numerous options for fully addressing our 2026 converts prior to maturity.
Beyond addressing our converts, we will allocate our free cash flow to investments with the highest return. This includes organic and inorganic investments and share repurchases, where we see an opportunity to take advantage of the dislocation between how the market currently values us and the inherent strength of our business. We expect all these actions will drive significant growth in our adjusted, unlevered free cash flow per share of approximately 25% in 2024 and to allow us to reduce share count in the intermediate term. Now, let me turn to guidance. Embedded in our guidance is the expectation that the macro environment and current business trends remain stable, with no further improvement or deterioration in conditions. For the first quarter of 2024, we expect subscriptions revenue growth of 8% to 9%; total revenue growth of 8% to 9%; non-GAAP operating margin of 19.5%; non-GAAP EPS of $0.79 to $0.80.
We also expect to incur restructuring charges of roughly $5 million to $7 million in Q1 in connection with the reallocation of resources to our new products such as RingCX and RingSense. For the full year 2024, we expect subscriptions revenue growth of 8% to 9%; total revenue growth of 8% to 9%; non-GAAP operating margin of 21%. This is up 190 bps versus 2023. Stock-based compensation as a percentage of revenue is expected to be approximately 16% at the midpoint in 2024, and down from approximately 20% in 2023. We are also targeting a further meaningful improvement in stock-based compensation as a percentage of revenue in 2025 and beyond. Non-GAAP EPS of $3.50 to $3.58. Lastly, we expect an adjusted, unlevered free cash flow margin of 17.5%, or $415 to $420 million.
This represents a roughly 300 bps increase versus 2023. In summary, 2023 was a year in which we delivered above-market topline growth, while achieving record profitability and free cash flow. Building on the significant margin improvement we achieved in 2023, we expect operating margins and free cash flow to continue to expand, all while reducing stock-based compensation. This is reflected in the over 600 basis points combined improvement in SBC as a percentage of revenue and free cash flow margin that we have shared in our guidance. We have put in place a strong financial foundation, and I believe we are set up well to deliver on our strategy of multi-product growth and expanding margins in 2024 and beyond. With that, let's open the call for questions.
Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question today is from Meta Marshall with Morgan Stanley. Please go ahead.
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