RingCentral Inc (RNG) 2016 Q1 法說會逐字稿

Welcome to RingCentral's first-quarter 2016 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, Darren Yip, Director of Investor Relations for RingCentral. Thank you, Mr. Yip, you may begin.

Thank you. Good afternoon, and welcome to RingCentral's first-quarter 2016 earnings conference call. I'm Darren Yip, RingCentral's Director of Investor Relations.

Joining me today are Vlad Shmunis, Founder, Chairman and CEO; and Clyde Hosein, Chief Financial Officer. Our format today will include prepared remarks by Vlad and Clyde, followed by Q&A. The primary purpose of today's call, is to provide you with information regarding our performance for the first quarter of 2016, along with our financial outlooks for our second quarter and full year 2016.

Some of our discussions and responses to your questions may contain forward-looking statements, including statements regarding our expected financial results for the second quarter and full year of 2016. Our future plans, prospects and opportunities, trends in the business communications market, our expectations regarding our expansion internationally and upmarket, our partner relationships with our indirect channel, including carriers and VARs, the expected benefits of our integrated partnerships, open platform, the Glip and contact center products, and our global office solution, our new phone distribution model and our growth strategies, current and future market position and expected growth.

These statements are subject to risks and uncertainties. Actual results may differ materially from our forward-looking statements and projections for a variety of reasons, including but not limited to, general economic and market conditions, the effects of competition and technological change, the success of our marketing, sales and retention efforts, and customer demand for, and acceptance of, our products and services. 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. We disclaim any obligation to update information contained in our forward-looking statements, whether as a result of new information, future events, or otherwise.

I encourage you to visit our Investor Relations website at IR.RingCentral.com to access our earnings press release and slide presentation, our non-GAAP to GAAP reconciliation, our periodic SEC reports, a webcast replay of today's call, and to learn more about RingCentral. With that, let me turn the call over to Vlad.

Thank you, Darren. The first quarter was a great start to 2016 for RingCentral. We delivered strong top line growth, combined with continued margin expansion.

Exit ARR for RingCentral Office grew 45% year-over-year. RingCentral Office is about a $270 million recurring revenue business, and represents over 95% of our net new business. Underpinning the growth of Office was three key drivers.

First, we're successfully executing in the mid-market. Second, we had the strongest quarter in our indirect channel, and third, we are beginning to see initial traction in multi-national enterprises with our global office initiative. The cloud communications market has reached a tipping point.

After several years of the gradual shift to the cloud, we believe the debate between on-premise and cloud is finally over. We see evidence that the balance has tipped to the cloud. on-prem legacy vendors are finally acknowledging the shift. They are trying to pivot their business models to accommodate the cloud.

As the legacy vendors begin to talk more about the cloud, curiosity and interest from enterprise customers continues to rise. Our legacy competitors can only talk about the future that is two to three years away. RingCentral is already here with a platform that is market-ready and proven. We saw this reflected in our mid-markets.

It hit an inflection point for RingCentral since last year, with sales cycle times contracting meaningfully. For the past few quarters, our mid-market ROI has exceeded that of small business. In other words, it now is more cost efficient for us long-term to acquire customers with over 50 employees than those who are smaller.

This is a momentous shift, and we expect similar improvements with our 1,000-plus enterprise accounts down the line. On the indirect side, VARs are adapting to the new business model, by adding cloud solutions to their portfolios. This validates the tipping point that I mentioned earlier.

We have had an outstanding quarter with VARs generating significant new business in Q1. The overall total addressable markets remains a huge, underpenetrated opportunity. Gartner estimates that $50 billion was spent on on-premise-based telephony over the last four years. On-premise solutions are primarily voice-centric. The TAM for the markets we serve is much larger. It includes other areas of unified communications, including messaging, team collaboration, contact center, and video and other capabilities.

Additionally, our unique open platform enables integrations through custom work flows and other best of breed software. Underpinned by our unwavering commitment to technology leadership, the other three main growth drivers have not changed. These are -- one, expansion of markets. Two, international reach, and three, strong execution with our channel partners. In the first quarter, we continued to see good progress in all of these areas.

First, the progress upmarket. As I mentioned, expansion upmarket continued to show great progress in Q1. In the 50-plus user market segments, the successful expansion into larger enterprises has driven the average new deal size to well over 100 users.

This segment now accounts for about 35% of RingCentral Office bookings, up from about 30% last year. Also, I am proud to announce that we now have several customers with over seven-figure contract values.

All of this combined led to ARR growth for the segment to be over 100% year-over-year for the eighth consecutive quarter, and this on a much larger base. ROI for customers, with 50 to 1,000 employees is the best across all our direct selling segments. This is allowing us to continue expanding upmarket, resulting in higher quality revenues with attractive returns. This also gives us extra confidence in our enterprise segment, namely with customers with over 1,000 users.

We believe this segment will follow a similar path, and we're positioning ourselves accordingly. In Q1, our sales team had its best ever upsell quarter, selling into existing customers. For example, New Relic has used RingCentral for a few years. We are now expanding our footprint there to include our global office capabilities, as well as our cloud contact center.

The install base continues to grow, and provides an insulated, more predictable revenue stream, a revenue growth stream. More than a third of the bookings came from existing customers. We expect the land-and-expand opportunities to continue to increase as we see further upmarket adoption.

We also continue to sign longer-term contracts. Great than two-thirds of our net new office business comes from customers opting for annual or multi-year agreements. As a result, more than half of our office installed base is now under contract.

Second, expanding our international reach. During Q1, we announced an expanded international footprint with our global office products. This is a very important growth driver, and key differentiator in the enterprise segment.

Connecting multiple on-premise PBX systems compounded by multiple geographies is very complex and expensive. This also results in poor user and administrative experience. RingCenter Global Office solves these pain points. It provides employees abroad a local in-country experience, while being globally connected together on a single cloud communications solution. This has helped us gain good momentum with our push into multi-national enterprises.

In a short period of just three months since rolling out our global office product, we already signed over 100 multinational customers on Global Office. One such example is Hortonworks, a leading provider of enterprise-ready open data platforms. Hortonworks was looking for a solution to quickly expand its presence in different geographies, while not over-burdening its IT staff.

We won the deal by providing their employees abroad a local in-country experience while being globally connected together. In addition, we also displaced their existing contact center provider with our cloud solution that is closely integrated with RingCentral Office.

Similarly, we recently won a 2,000 user deployment with ARC Document Solutions. ARC is a global technology company focused on document and information management. With over 180 locations around the world, ARC was looking for a single reliable global solution to cover their needs.

The third growth driver I referenced was our strong partner relationships with indirect channel, that includes carriers and VARs. Leveraging partners to provide more feet on the street, the indirect channel contributed approximately 25% of revenues in Q1, up from 20% a year ago. With AT&T, BT and TELUS, we remain the only pure play SaaS business communications company with multiple major carriers reselling our solutions.

In the first quarter, we continued to see strong results from our carrier partners. In spite of Q1 being typically a seasonally slow quarter for carriers, we saw a sequential increase in our carrier business. It was a great start to the year.

One example of a win with a carrier partner was a 1,000 user customer. This customer is a reseller of communication services across hundreds of locations. The key to this win was our unique mobile service solution to enhance their employee productivity.

VARs had a great bookings quarter as well, as our partners adapt to customers' requests to move to the cloud. In fact, several of the biggest deals came from VAR partners.

For example, one of the VAR partners worked with our overlay teams to deliver a more than 1,000 user win with the ADF Companies. ADF is a world-class franchise restaurant operator with over 300 restaurants. RingCentral helped replace their multiple-legacy PBXs.

Quality of service and time to implement were key factors in the win. RingCentral rose to the occasion by signing and deploying all the users within the quarter.

In addition, a VAR channel partner closed a 600 seat deal with the Dwyer Group, a multi-national company spread around the world. It is a holding company for recognizable franchises, such as Mr. Rooter and Molly Maids. Dwyer Group is utilizing Global Office to fulfill needs abroad, in the UK, and Germany.

On the technology front, we continue to innovate a rapid pace. RingCentral has the first-mover advantage as a pure play cloud solution to capture the seismic shift in communications and team collaboration to the cloud. We have been and remain solidly the largest and fastest-growing scaled up provider in the space.

We have consistently invested over 15% of revenue back into R&D to maintain and accelerate our lead. We believe a focus on rapid innovation has been and will continue to be a significant differentiator to drive growth. Our release cycles are measured in weeks, not months or years.

We are well ahead of the competition in terms of investments, in innovation, platform integrations, and product portfolio. We are able to do this, because we combine go-to market, ops and core technology, all under one roof. It drives faster development and deployment cycles and stands for better customer satisfaction, overall.

This is a big advantage in addressing the needs of the customer, when compared to legacy on-premise solutions. To that end, we are making good progress in our quest to tightly integrate communications and collaboration in the cloud. We recently unveiled a new capability that enables users to seamlessly transition from a Glip messaging conversation to a voice call with a single click of a button.

This is an industry-first integration of the enterprise cloud PBX capabilities with a team collaboration tool. This creates a more streamlined and convenient experience for all our users. For the 2,000 user ARC Document Solutions I mentioned earlier, our Glip Enterprise messaging and collaboration capabilities were a key differentiator in winning this deal.

On the platform front, in Q1, we also continue to extend the open platform to further enable integration. Last quarter, we achieved a significant milestone of over 1 million third-party API requests per day to the platform, up 40% sequentially. Additionally, we saw more than 50 new software integrations in the quarter, taking the total to over 175.

This integration provides productivity benefits for our customers, while creating product stickiness for RingCentral. In Q1, one example of a win that was driven by our unique RingCentral Connect platform capabilities was a 400-user customer at one of the nation's largest solar electric companies. The seamless integration of Google for Work and salesforce.com were critical for this win. Integration into new verticals are also part of our enterprise growth strategy to create compelling solutions for our customers.

Earlier, we introduced our integration with Sikka software in the healthcare vertical. Now, when a patient calls, it automatically enables medical office workers to see a 360-degree view of a patient's medical, financial, and insurance profiles. We are now working on a similar integration for the wellness industry with MINDBODY.

As you may recall, MINDBODY became a customer of RingCentral last year with over 1,000 users. Expanding this customer relationship, into an integrated partnership, gives you a peek into our ecosystem expansion strategy. These industry vertical integrations provides yet another differentiator for RingCentral Office to expand upmarket. Our cloud contact center offerings further unlocks meaningful new opportunities for RingCentral.

In Q1, we won over 700 office and contact center users at Hill Country Holdings. It is one of the largest independent owners of Ashley Furniture Home Stores. Our ability to provide one solution for all of their communications needs was key to this win.

Our expanded product portfolio with the RingCentral cloud contact center offerings is also increasing our TAM. It allows us to offer multi-channel capabilities, we previously could not provide to the customers.

This is allowing us to cross-sell to the strong base, and expand our deployments in other areas. Overall, the market is playing out as we expected. Multiple vectors of growth alongside the huge opportunity created by business communications shifting to the cloud, puts us in a great position.

We are well ahead of the competition in terms of investments in innovation, partnerships, and integrations. The cloud communications market penetration is in early stages. We are still in very early earnings with a long runway ahead.

We could more than double the size of the Company in the next few years, and still be well under 10% share of the overall market. These are early earnings, indeed, and the best is yet to come. And with that, I will turn the call over to Clyde.

Thank you, Vlad, and good afternoon, everyone. Before I begin, I want to ask that you refer to the slide deck on our investor relations website, which will help summarize the key points in our call today, as well as provide some supplemental information.

Q1 was a great start to the year, highlighted by another quarter of over 30% subscription revenue growth, record software subscription gross margins of 80%, and the third consecutive quarter of positive non-GAAP operating margin. Relative to our guidance, we once again met or exceeded the high end of our outlook for revenue, gross and operating margin and EPS. Total annualized exit monthly recurring subscriptions or ARR, grew to approximately $340 million, up 34% year-over-year, and 7% sequentially.

The ARR for RingCentral Office grew to approximately $269 million, up 45% year-over-year and 9% sequentially. Customer satisfaction continued to be strong in Q1, with overall net monthly subscription dollar retention over 99%. Office net monthly subscription dollar retention was once again over 100%, as it is common for customers to adopt RingCentral Office in part of their organization, and increase their footprint over time.

Software subscription revenue was $80 million, up 33% year-over-year and 5% sequentially. This was driven by a strong performance at office, especially in upmarket, along with a very strong quarter in our indirect channel. Total revenue for the first quarter was $86.5 million.

This was above our guidance of $79.5 million to $82.5 million. Compared to the midpoint of guidance, this was an overachievement of $5.5 million. I would note that this $5.5 million overachievement includes about $2.6 million as a result of the transition to the new agency model for our phone fulfillment, as we were conservative in our initial forecast, given this was the first quarter of implementation for the new model.

As a reminder, in the first quarter of 2016 we began to transition direct phone sales to an agency model, where phones are sold to our customers by a third-party distributor. Under the new agency model, RingCentral receives a commission for phone sales, instead of recognizing the full sale price. In order to provide transparency to investors, we are providing supplemental information on a pro forma basis to provide a clear comparison of the Company's results with prior periods under the new agency model.

The pro forma information reflects the results, as if the Company had fully transitioned to the new agency model for the first quarter of 2016, and for all periods in 2015. This supplemental information is provided in today's press release, and on our IR website. Adjusted for the new agency model on a comparative basis by removing the $2.6 million additional revenue from the transition I mentioned earlier, pro forma total revenue was $83.9 million and grew 34% year-over-year.

This was up from $62.7 million in the first quarter of 2015. There is no change to software subscription revenues under this model. Before I move further down the income statement, I want to remind you that my commentary will be focused on pro forma results and guidance.

A reconciliation of all GAAP to pro forma results is provided with our earnings press release issued earlier today, and in the slide deck on our IR website. Our software subscription gross margin was a record 80% in Q1. This represents a 590 basis point improvement year-over-year and a 140-basis point improvement sequentially.

Our continued margin expansion further demonstrates the leverage from our multi-tenant SaaS model. This 80% gross margin achievement places us amongst the best-in-class SaaS peers. Pro forma gross margin from our other revenue line was 39% in the first quarter.

Other revenue includes commissions under the agency model, professional services, and revenues from phone rentals. Pro forma total gross margin was 78%. Sales and marketing expenses were about $40 million for the quarter, or 47% of revenues.

This was up from 46% last quarter, and down from 48% in the first quarter a year ago, as we continued to invest in growth, given our model's attractive unit economics. As Vlad noted, we are seeing mid-market sales and marketing ROIs surpass those of the small business segment. You may recall that we discussed investing into the mid-market ahead of the curve, and we are starting to see that payoff.

These efficiencies give us the capability to further invest in the mid-market and enterprise market segments, which should result in higher quality and stickier revenues to the Company. As a testament to our business model, combined with the efficiencies I mentioned above, we continue to see attractive unit economics with each dollar invested in sales and marketing contributing $8 of revenue and $5 of contribution margin over the projected life of an office customer. R&D expenses were $13 million in the first quarter, or 16% of revenues, down from about 17% last quarter, and Q1 a year ago.

G&A expenses were about $12 million in Q1 or 14% of revenues, up 1 point from 13% last quarter, and down from 15% we reported in the first quarter of 2015. We had an operating profit of $1.3 million for an operating margin of 1.5%, which is above our guidance of breakeven to 0.5%. This is an improvement of 9 points from the first quarter a year ago, and about 0.5 point from last quarter.

Net income improved to $1 million, compared to a net loss of $5.3 million in Q1 of last year, and $0.5 million profit last quarter. Net income per share was $0.01 at the high end of our Q1 guidance range of breakeven, plus or minus $0.01 per share.

Share count was 75 million fully diluted shares. On a GAAP basis, our Q1 net loss was $6.6 million or a loss of $0.09 per share. The difference between our GAAP and pro forma results includes $7.6 million or $0.10 per share.

Of that amount, $0.09 per share were in stock-based compensation, and about $0.01 from the combination of amortization of intangibles, and other items related to the Glip acquisition, and from currency remeasurement of our balance sheet, all of which were excluded from our pro forma results. We ended Q1 with cash and short-term investments of $139 million, compared to $138 million at the end of Q4. The deferred revenue was $39 million as of March 31, an increase of 6% sequentially and 38% year-over-year.

Deferred revenue grew faster than revenues year-over-year, due primarily to the addition of larger customers, who are more receptive to annual invoicing. For the quarter, cash flow from operations was positive $4.8 million, compared to negative $700,000 for Q1 of last year, and positive $2.9 million last quarter. This is the fourth consecutive quarter of positive operating cash flow results.

Moving to our outlook for the second quarter and full-year 2016. We have historically provided guidance to total revenue. Today, we will also be providing guidance for subscription revenue for additional clarity. For the second quarter, we expect software subscription revenues of $83 million to $84 million, or growth of about 29% to 30% year-over-year.

We expect total revenue of $86.5 million to $88.5 million, which on a pro forma basis would imply year-over-year growth of 27% to 30%. We expect non-GAAP operating margin of 1% to 2%. This should lead to a non-GAAP earnings per share of breakeven to $0.02, based on 76 million weighted average fully-diluted shares.

For the full-year 2016, we are raising our software subscription revenue guidance to $344 million to $350 million, or growth of 27% to 29%, and up from our previous guidance of $337 million to $345 million. We are raising our total revenue guidance to $359 million to $367 million, up from our previous guidance of $347 million to $357 million. On a pro forma basis, this would imply a year-over-year growth of 26% to 29%.

We are also raising our outlook for pro forma operating margin to a range of 1% to 2%, up from 1% to 1.5% we provided last quarter. This should lead to pro forma earnings per share of $0.03 to $0.07, up from $0.01 to $0.05 previously. We expect weighted average fully-diluted shares to be 77 million.

In summary, we started 2016 with great momentum across multiple growth vectors, which bodes well for our future success throughout the year. We're going after a huge underpenetrated market opportunity.

We believe our first-mover advantage and investments in innovation, channel partners, and expanding our addressable market will continue to differentiate RingCentral as the industry leader. With that, I will turn the call over to the operator for Q&A.

Ladies and gentlemen at this time we will be conducting a question-and-answer session.

(Operator Instructions)

Our first question comes from the line of Bhavan Suri with William Blair.

(Operator Instructions)

Hi, Vlad and Clyde, can you hear me okay? Hi Vlad, congrats on a great quarter, you guys. Nice set of numbers and nice guidance.

Vlad, despite your obviously being a little under the weather, I hope you feel a little better. Just to dive into the question, the biggest question, I think, that investors are wrestling with, is around your relationship with AT&T and sort of the concerns of the rollout, what could be viewed as a potential competitive offer.

We'd like to get an update on how the relationship is progressing, and how you view what might play out there over time. And then I have a followup after that. Thank you.

Sure, Bhavan. Clyde, I'll take this one. So, firstly, yes, a little bit under the weather, unfortunately and also dialing in from London, and I had a very full day of meetings here. But I am here for a good cause; but I think I will be fine.

Look, as far as AT&T, I think it is the same answer, we will be fine. AT&T has been a long-term valued channel partner of ours. We have coexisted with other service providers and other vendors within the AT&T ecosystem.

We have competed within and survived within the environment very effectively. To be clear, our relationship with AT&T actually postdates that of most of their other service providers in this area. And, you know, there were and continue to be still very good reasons to continue doing business together.

So, in a nutshell, we continue thinking that this is a healthy relationship. We are filling a need in their portfolio, their own pronouncements lately have indicated that they will continue offering the best solution for the [use case], so we're pretty optimistic that this relationship will continue and will continue performing.

Great, that's really helpful. One quick follow-up if I may, you have talked about the value in moving upmarket and we have obviously seen that in terms of the deferred billings.

A quick question on investments, do you think it is going to need, you know, you shift the sales force and you added a midmarket and enterprise sales force, do you need to continue increasing investment as you move up midmarket, or do you think that for at least this year, you have got those investments built into guidance and numbers to continue a line of penetrating upmarket?

Yes. Let me take a stab at it. So, first, to be very clear, we are a growing company.

You can see our growth, it speaks for itself. Of course, we are planning to continue our investments, but every investment, we are planning to do is of course built into the guidance. So, no, of course we would not be projecting a negative surprise, and as you know this has not been our history from day one with the public. We have been fairly conservative in the way that we project. With respect to midmarket in particular, it is actually a very interesting point. I just referred to it in my prepared comments, but I want to reiterate. It is really a momentous occasion for us that now our midmarket ROI is actually better than that of what we get with small businesses.

So, what this really means, and this used to not be the case, because it was a more of a new endeavor for us, so as we were scaling up things were not as efficient. But we are now finally in a situation to where it is actually on ROI basis makes better business sense for us to invest midmarket than even in smaller businesses where we started from a number of years ago. So, yes, we will continue these investments.

Very importantly, given these learnings, we are extremely optimistic and we actually have very solid data,[attached] at this point, this same success should also transfer over into enterprise accounts, and we define midmarket at up to 1000 seats, and enterprise 1000-plus. So, yes, continual investments, continual growth. And we are confident that this will continue in ROI. Clyde, I don't know if you want to add to this.

No, Vlad, I think you covered it. The key is in midmarket distributor rate, the efficiency that we see in, which makes it a lot more easy and more efficient to grow revenues in that midmarket spread, so I think you did a great job.

Next question Terry Tillman with Raymond James.

Hi, gentlemen, can you hear me okay?

Yes.

Hi. I would like to provide a commentary, great job, great numbers. The first question is a broader competitive question in terms of the cast of characters you see in the SMB market, or the small business market, midmarket, enterprise, are you seeing any changes in terms of who you are seeing, and if you'll remind us, is there one common thread on how or why you went across those segments?

Sure. Let me take this in reverse order, maybe.

Why do we win? We win because we fundamentally have a better product, better usable product.

We continue meaningfully outpacing all of our direct competition in our investments in R&D. We own our own platform, we are not a reseller of anybody else's stack, as some of our competitors are. Very importantly, we invest very heavily into user experience, both vis-a-vis the product itself, but also in the entire provisioning bordering -- onboarding -- I didn't say it right, and lifecycle management.

So, frankly, you get what you pay for, and we are very, very serious about delivering the best possible product in this category. And I think as all of you know, we have third-party validation in us -- the big, the absolute magic quarters leader for (inaudible) this year. So that is as far as why we win. And by the way, we'll continue this investments, and yes, they are also baked into the guidance, and we believe that we are well poised to continue this record of out-performance and excellence on the technology side.

As far as the competitors that we see, we see larger companies, Cisco and Microsoft raising their heads and saying that they also want to be this cloud communications [newcast] segment, this is great, that just means that there is finally broad market acceptance. From that perspective, it actually make their jobs easier, we no longer need to convince perspective customers that cloud is a viable solution for communications for businesses of any size, because, of course, larger companies are also [basic holders]. Frankly, what we see and what we hear from Gartner, and just what we see in the field, we believe we have a sizable advantage that is measured in years versus both Cisco and Microsoft. So, while they talk a good game we play a good game, that's the point. So, we're comfortable with that.

My followup just relates to -- it is good to see the milestones around the upmarket business, could you remind us -- you obviously you had the [better-off] Denver operation, and I am assuming that you continue to invest in that, but how is the Charlotte operation going, and should we expect more regional sales offices in 2016, or is it going to be more about the deepening the bench in each of those offices? Thank you.

We will probably see more of deepening the bench, but understand, we have -- the locations that you have mentioned, which is Denver, Charlotte, and of course, don't forget our headquarters in Belmont, in Silicon Valley, these are our major centers. But we do have people throughout, and we are effectively covering the entire footprint of the United States.

Having said this, Charlotte is our newest office, but we have a very well-established playbook. So, we know how to onboard people, how to get them to be productive, and is following in exactly the same path as we have anticipated. It is still the same company.

Next question is from Nikolay Beliov from Bank of America.

Hi. Thanks for taking my questions. Congratulations on the great quarter and the guidance.

Hi, Clyde, I had a question for you. At the point of the IPO you've provided long-term guidance of subscription for revenue gross margins of 75% to 80%, you hit 80% in Q1, and you provided long-term gross margin guidance of 70% to 75%, and you hit 76% increase Q1, which is about the high end of the long-term guide.

You are already there. At this point, should we expect those two metrics to level off, or there's more room for improvement here going forward? And how that out-performance on the gross margin line might impact the overall EBIT goal of 20% to 25% in the long-term?

Thank you, Nikolay. The team has done a terrific job in executing. We have a terrific team from sales, all the way down to operations that got us to 80% on our subscription gross margin a couple of years out after IPO. So a big shout out to all of them, and I think it demonstrates the quality of the product and acceptance of customers.

I think it's still a little early, we just hit it, to look at extended ranges, that might be something for the future. As you noted earlier, we shifted a model and that shift in the model, by farming out the direct phone sales is going to help margins, that's what you saw, the total gross margin improving. So, we will go implement that.

And without, right now, today, change in that. As to the bottom line, one of the things Vlad mentioned earlier, a couple of things to recap for you, is it's still a very large market, underpenetrated; we are winning very well in that space, but consistent with a SAS model requires upfront investment in product and in sales and marketing, and we intend to continue to do that while generating 30%-plus of revenue growth.

So, our bottom line is improving, I think it's third consecutive quarter of improvement, obviously not close to our target yet, but the target is much further along, and probably does not reflect 30% growth. So, for now, in summary, we are very comfortable where we are. I think you might see some modest improvement on total gross margin, and we'll continue to invest in sales and marketing product to continue to drive the top line.

Thank you.

Mike Latimore from Northland Capital Markets.

Hi, thanks a lot. In this year's first quarter, you had (inaudible) growth, which is about the same as in the prior quarter, whereas in the last year you saw a little bit of slowdown in the first quarter. Is it fair that the indirect channel, the midmarket is keeping the growth rate a little more sustainable?

We had a good quarter on indirect, I think that Vlad mentioned it was a very good, it was a record quarter for indirect, particularly VARs. And we have invested in that area, Mike, as you know, for quite a while. That, combined with the inflection in the midmarket is beginning to yield a good return for us.

Not surprises, I would caution you guys not to get too hung up about absolute year over year. There will still be some volatility in those year-over-year book exchange. But as we still, the market is still emerging, and then we are mixing up to go to larger customers, hopefully you will start to see more and more 1000-plus customers.

I would not get too hung up on any given quarter, but you are right we had a very good first quarter, partly driven by some of the growth factors we have at indirect VARs. Indirect in general, and VARs in particular, did well for us.

Vlad, you mentioned that Cisco and Microsoft were raising their heads. Clearly, you had a very strong first quarter, but I guess qualitatively, are you seeing customers take a little bit longer time to evaluate those options now, or no real change in sales cycle?

Actually, as I actually mentioned is we see sales cycles in the midmarket actually contracting a little bit, and that usually leads to better ROI overall. I think that one of the dynamics that we are seeing is that, firstly, customers no longer need to be convinced of the fact that cloud is the solution of choice, so definitely we see a tipping point there. As you know, we just mentioned we now have several customers with million-dollar commitments on our books that used to not be the case up until very recently.

What we see is customers now saying, okay, well, you know what? We're going to go cloud (inaudible) anyway, who is the business leader, who is the segments leader? I don't know, whatever due diligence they do, but the fact remains neither Cisco nor Microsoft today have a true cloud offering that is anything close to what we have. The shortcomings Cisco is offering it's really a bunch of switches strung together, and Microsoft seems to be a couple of years behind, according to cloud adjustment features. So, it actually has been helpful to us for these giants to acknowledge that cloud is the way to go.

Next question is from John DiFucci from Jefferies.

Thanks for taking my question. Vlad and Clyde, I want to come back to a question that keeps being asked, and your results your guide sort of speak for themselves, you obviously continued to see a lot of traction in the market, and all the data in the field evidence we see points to a secular move that you are talking about, Vlad, as businesses move to cloud-based solutions in this market.

But, with AT&T, and we talk to investors about this all the time, they call in, and I'm sure you guys have probably talked about it over the last month, too, because it was about a month ago or so it was announced. I mean, they are a material part of your revenue, and that is why they are such a focus here. It has not been that long ago that this was announced, but have you seen any change in your business coming in through AT&T, and you have had enough time now to speak to AT&T about it.

How do you think this is going to move going forward, realizing you have a lot of other partnerships, too, and they can make up for things, especially if there's a secular move here. But just to get a better feel for us, and as we think about this going forward, how do you think -- have you seen any changes in that relationship as far as the business coming from it, and do you anticipate that happening going forward?

Yes, Vlad again. So, look, short answer is no. We continue seeing very strong performance.

Once we analyze those numbers, they speak for themselves. We are, as I mentioned, we are very optimistic that the strength of our products will continue carrying the day, and of course it is good that AT&T last year was 11% of our revenues, and we have many other channels and a very large user base of our own. But we are by no means throwing in the towel on AT&T, and as a matter of fact, as far as what we see on the ground, today, it is only strengths.

Really, what I really urge you and everyone else concerned with this, is refer to their own announcement of some of the new product, they were very explicit in the position they are taking, that they will continue dealing and offering multiple platforms. All we can ask for is a level playing field, we know that our product, technology and go-to markets will carry [the day].

That's great, Vlad. Thank you very much, that is very clear.

My followup, it's probably a question for Clyde, it's nice to see the run rate profitability, Clyde, it's also nice to see that you guys are doing what you say you're going to do, consist here in this regard. And in this case, too, I don't think it was mentioned, you are free cash flow positive this quarter, too, so that is really nice to see. But assuming this growth opportunity continues here, and it almost feels like now, especially given some of what we are seeing out there and some of what you have talked about and what Vlad talked about in the prepared remarks, that the world is ready now.

Does it make sense for you to potentially increase your investment and your go-to market efforts at this point? Obviously, that could have an effect on margin, it doesn't, but if you are growing you could still potentially profit, and how do you think about that given the opportunity today?

John, thank you very much, the Company has done and the team has done a great job. You mentioned free cash flow positive, we were last quarter.

In a meaningful way, well over $2 million, but let me add to that, as we are going to invest, that is clearly within the management team to keep investing, so we will continue that. We agree with all of the points that the market is ready, the market inflection point, you've heard us use that for several quarters, that's data adoption rate is increasing, so why not increase investments?

We will do it in a very intelligent way, as we have in the past, but we will increase our investment in that space. So, speaking back to cash flow to make that point, reason being highlighted [as much is], next quarter more likely than not you will see us making some CapEx investments to expand our footprint globally, to increase our presence in some of the countries that we probably don't speak to their geographies we don't probably speak to today, so that is one quarter where you might see a negative, but I think inconsistent free cash flow basis is in our near to medium-term future.

The point is there as we continue to invest both in sales and marketing and product and in CapEx, to take advantage of the inflection point that we have, so while top line will continue to grow and grow healthy, the inherent SAS model where you've got to invest upfront for sales and marketing and you get your return over a period of time will tamper down, and the rate and pace of increase of your margin improvement, but you will see that increase.

That is baked into our guidance, so guidance is a full guidance with revenue and profit, so there is no additional risk involved in there. The short answer is we're going to build on the success we've built. We are going to keep investing as we have in the past, intelligently and delivering results to you as an investment community, as we have in the past.

I really want to iterate, John, is every investment, and we will continue investing aggressively, but to the best of our knowledge and ability, every planned investment has been baked in.

Next question, Heather Bellini from Goldman Sachs.

Hi, this is Jack [Logalin] filling in for Heather. A couple of questions.

One, on the international expansion, it looks like the Global Office product is being rolled out in more than 20 countries soon versus just availability in 10 today. I guess one of the hurdles involved there, and I know you've talked about CapEx investment, any other barriers? Then, secondly, what [Geo] has sustained the uptake for that product so far?

Hi. Couple of things. Firstly, as we are rolling out and we are Global Offices today already available, in well over 10, it has been not so much a matter of count, because obviously there are much larger countries and there are much smaller ones, we cover some of the major ones already.

Of course, US, UK, Germany, France, some of the larger economies in the Western Hemisphere are already covered, and that's really where we see the demand. As far as CapEx is concerned, I also want to be very careful here. We have the infrastructure in place already all paid up for to cover all of North America, as well as all of Western Europe. Okay?

So, it really is more of a matter of rolling out products across those geographies. Which have a lot to do with satisfying various local regulations, legal requirements, sometimes you have to get appropriate licenses to operate, frankly none of this is rocket science, but it just takes time and perseverance. We are very comfortable with our international expansion road map.

Again, just to reiterate, the numbers speak for themselves. Three months, over 100 global enterprises using RingCentral Global Office, so it's a pretty big accomplishment. Again, more to come.

Next question, Brian Schwartz with Oppenheimer & Company.

Hi, guys this is Daniel Greenfield, dialing in for Brian. Congrats on the quarter. Just one question from me surrounding the contact center actually.

How did the contact center, and I understand it is relatively new, how did that help you grow this quarter, and are you beginning to actually come into any deals where you actually start with the contact center, or are you participating in a lot of RFPs where the customer is asking for both, contact center and PBX replacement?

Yes. We have never positioned our cloud contact center as a standalone solution. Even though it would do just fine at that level, but, really the value add is in very close integration between [viewcast] and the cloud contact center.

And that's where we excel. The way that we look at it is having this product does, really, two things. Firstly, it unlocks new opportunities for us, where customers essentially won't have a single vendor, a single bill, and single (audible), and now having both products under one roof satisfies that.

And the second one, of course, is contact center pricing is generally higher than that for viewcast. That does have a positive effect on our ARPA, okay, as well as longer-term margins. It is a very important arrow quiver, but it is not something we're (inaudible).

Great. Thanks.

Next question, Sterling Auty from JPMorgan.

Thanks. Hi, guys. One question, in your prepared remarks you gave a lot of examples of technology customers, just wondering if in the new customers you brought on in the quarter was there industry concentration towards technology or any one or two industries?

Sure, go ahead.

The short answer is technology, guys, we had some very good successes, probably because they are early adopters, but we had many examples of successes outside of the tech industry. Early, we announced that, we had an announcement early this quarter, with an engineering company, obviously not in the tech space that deployed a very large deployment, as an example.

There are more examples out there in our press release of this. We have retail, a number of stores, restaurants, Pizza Hut for example, a franchise deployed out on the East Coast.

So, the deployment is not industry-specific. It is very broad, as you would expect it to be. Maybe there's a slight edge to technology companies that may be early adopters, but that is de minimis. I think this is being adopted across all industries.

Thank you.

Next question, Jonathan Kees from Summit Research.

Great. Thanks for taking my question, and I would like to add the congrats for the quarter.

I just wanted to talk about your indirect revenues, obviously there's been a lot of questions in terms of AT&T; wondering if you could provide some more elaboration in terms of the other two carriers. AT&T being obviously a 10% customer and being a good part of that indirect revenues, but there were expectations of, at least with BT, it's not with Teles to become in the near future somewhat close to being a 10% customer. Certainly you have mentioned in the past that the growth rate has been better than AT&T has performed in the past, just some additional color on that. And I also have an additional question, a follow-up question. Thanks.

Sure. Let me take that. Of course we would like every sized relationship to become a 10% customer, but I want to caution that it took AT&T over five years to get there. AT&T is a larger company and (inaudible).

So, it's a matter of time, and really want to just remind everyone, we are a [pure-play] cloud services provider, and what that means is that while growth can be fairly rapid, but we get paid by [receipt], by the month. So, it takes some time to build to a meaningful revenue base, but the good news is that once you do, if you keep your[churn under control, and our churn, as you know our net churn continues to do negative, so we continue to seek more revenue from customer cohorts year over year. So, as long as that trend continues, we will feel very good about Teles and BT and any of those channels.

But, really, it is going to be some time. Also, of course, do not forget, that we are investing quite heavily on the direct side as well and we never want to lose that, because in there that puts us in control of our destiny, it allows us, really, the most secure way of controlling and delighting our customer, so it's going to be a horse race. Hopefully, it will continue growing very strongly across all of our channels, and also, as Clyde mentioned, not just direct and carrier service providers but also through traditional VARs, which have been doing very, very well for us.

Okay, great, and if I could ask about those VARs, it's still part of the indirect, I guess ex-carriers, that's a smaller part of the indirect revenues -- you've recently added a new chief for that division and looking to expand your partnerships there and master agents. I guess I wanted to see what -- if you could elaborate some more in terms of what you are looking to do there. There are a lot of companies out there that have added and increased towards VARs and VADs and still not gotten the attraction that they had hoped for. I'm wondering what you are doing, hopefully, what you are doing differently?

So, as I just mentioned, while we have not yet broken out our VAR general numbers publicly, but just to iterate, we are seeing very good performance from the channel, as you know, we are seeing healthy growth in our overall business, we are seeing very healthy growth in the mid to high 40s, for RingCentral Office, and that is approximately $270 million, $280 million business.

So, things are well. Having said that, VARs are doing even better than those averages. As far as will other companies are investing in this channel and not seeing the results? I can only speak for ourselves.

We tend to balance our investments in the product and technology with our investments in the channel. We strongly believe that we need to have both. Sometimes what we see people do is overinvest in the channel at the expense of the product, and the product needs to carry itself, too.

We think that as long as we continue leading the category in technology and as long as we continue our focus and our investments. And hire the best people out there that we can find, and we can find very good people, given our performance lately we should be fine. Again, we are very, very excited about our indirect channel and within that, specifically, VAR.

Next question comes from the line of James Fawcett with Morgan Stanley.

Hi, this is Eugene Anderson on for James. Thanks for taking my question.

Just a little more on the gross margin outperformance. Aside from the change to the phone model, are there any other drivers that you could perhaps shed some more color on, perhaps you're seeing better pricing or maybe lower transport costs. Thank you very much.

If you look at the subscription margin, which is totally independent of the model that also improves almost two points quarter over quarter, and six points year over year, so that's the true value of our software subscription of having a multitenant model. You see that leverage in there. But as we get bigger we get better economies upscale particularly like on transport costs, for example.

So, there is a fair amount on the cost side. On the other side of costs, as we've described in previous calls, our churn has been improving, last time we reported about 20% year over year, each of the last two years, that also helps. Then, as we move up to larger customers, you're getting a lot more -- that contributes to the same thing, that a churn long-term a lot more stickiness, so, all of those contribute to what eventually was last quarter 80% subscription margin on subscription. So it is not just the business model, the fundamental software is generating a significant amount of gross margin.

Thanks so much.

Next question from Kash Rangan from BOA Merrill Lynch.

Hi, guys, can you hear me okay? Okay, wonderful.

Somebody had to hit me over the head to remind me that you guys have seven-figure deals. So, can you talk a little more about your seven-figure deals. What is -- my rough math suggests it's about 3000 users per at least seven-figure customer, how did we get to this point and how were you able to convince these customers that you are for real in the enterprise center (inaudible).

Are we potentially looking at a good chunk of the Fortune 500 recipe [500] using RingCentral over the next few years, because I think this is an important landmark. And secondly, I know we all like to study Microsoft and we wouldn't like to dismiss Microsoft, they have this packaging E5, which includes the Skype functionality coupled in Office, all delivered in the cloud-based service, previously you had to install a server; and I know that several of your management team members had been at other companies with computers of Microsoft. How are you viewing Microsoft, and how -- and I understand your technology is two years ahead of Microsoft, but let's say we're two years down the line, what is RingCentral going to look like that can give us the confidence that you have a gameplan to continue to stay abreast of Microsoft? Maybe you'll define a new market segment, or there's something else going on in your mind, just wanted to get your thoughts [frankly]. Thank you.

Thank you, Kash. Let's take it in the order that you asked it.

First, as far as seven-figure deals, yes, it is very, very exciting. Look, it is really another testament to the fact of viewcast acceptance being a specific point across the board, and in particular with larger customers with multiple thousands of users that they need to satisfy.

So, we have been on record, (inaudible) are [ideal], and every call we've had saying that we do not see a glass ceiling out there, and on the road show, Kash, as you may remember, we were getting information like, well, are you guys ever going to get a 500-seat customer, a 1000-seat customer? We don't hear these questions anymore. And I am as convinced that we will eventually be announcing a 10,000-seat customer and, hopefully, beyond that. Also, just want to iterate one more point, that even though, for, in this call for some time, we have been talking about our quote-unquote upmarket customers as being over 50 seats, but in reality, the average seat count for those customers is well over 100.

So, we are absolutely well into midmarket, and as you can see by some of these early indicators with our seven-figure deals, we are now beginning the early stages of penetrating true enterprises with thousands of employees. Frankly, a lot of this success is (inaudible), again, in our absolute commitment to technology innovation and preparation of excellence, and in particular, the fact that our Global Office (inaudible) already, the fact that our Global Office products in just a short three months we got over a 100 multinational [use it gets], that just goes to show how much appetite there is out there. Again, you remember that our overall market penetration, not just us, but for the entire viewcast would think using single digits versus established legacy long-term vendors.

And the writing's on the wall, viewcast cloud will take over, we're leading in the segment, and we expect to continue this leadership. Which, frankly, leads me to the second part of your question -- so what about Microsoft? Of course, nobody would ever be dismissive of them, they are very strong company, with a very strong channel, but over and over people are well-focused, well-funded and are really aimed at executing one particular strategy in the particular field, over and over those people have been able to stand up.

As you know, we have quite a few polls from WebEx have done extremely well when Microsoft bought a direct competitor of theirs. Of course, you have other examples, you have people like [Intuit] owning 60% of the market base, forcing Microsoft out of the field. Look, it is a very large market.

We just don't see anybody monopolizing it, even Microsoft. There is quite the road map that we have ahead of us, and we know we can execute, we believe it will be able to keep up and continue delivering better value, better functionality, better customer service and continue seeing (inaudible). The old-fashioned way.

There are no further questions in the queue at this time. This does conclude today's teleconference.

Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.