RingCentral Inc (RNG) 2014 Q1 法說會逐字稿

Greetings, and welcome to RingCentral's first quarter 2014 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Clyde Hosein, CFO and Executive Vice President for RingCentral. Thank you, Mr. Hosein. You may begin.

Thank you. Good afternoon, and welcome to RingCentral's first quarter of 2014 earnings conference call. I am Clyde Hosein, RingCentral's Chief Financial Officer. Joining me on today's call are Vlad Shmunis, Founder, Chairman and CEO, and David Berman, President.

Our format today will include prepared remarks by Vlad, David and I, 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 2014, our financial outlook for the second quarter, and an update for the full year 2014.

Some of our discussion and responses to your questions may contain forward-looking statements, including statements regarding our expected financial results for the second quarter and full year 2014. Our future plans, prospects and opportunities, trends in the business communication market, our expectations regarding our current and future strategic relationships, our growth strategies, future market position, expected growth, our estimates about the current and potential future markets in which we may compete, and our expectations about current and future service offerings.

The statements are subject to risk and uncertainties. Actual results may differ materially from our 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, and matters specific to our business, such as 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 10-K for the year ended December 31, 2013 and filed with the Securities and Exchange Commission, and is incorporated by reference into today's discussion.

Should any of these risks or uncertainties materialize, or should any of our assumptions as outlined in our earnings release and the documents referred to in that release prove to be incorrect, actual Company results could differ materially from these forward-looking statements. 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 first quarter 2014 earnings press release, 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.

Thanks, Clyde. Welcome, everyone, and thank you for joining us today for our first quarter 2014 earnings call. I am pleased to report that we had another strong quarter, with total revenues growing 36% year over year to a record $48.3 million. Most importantly, our flagship product, RingCentral Office, continued to lead the way, with annualized exit monthly recurring subscriptions up 64% year over year to about $126 million.

As Dave will outline for you in a moment, our growth initiatives continue to pay dividends. Our mobile first approach to this market is resonating with customers. We are continuing to disrupt the large business communications market. We believe that our mobile first approach is a key differentiator for our business.

As you may have seen yesterday, we released the latest updates to RingCentral Office, including a new version of our mobile app. This release includes improvements to the user interface, along with enhanced security and up-market administrative tools. The release also includes a new presence feature that shows on the mobile app the status of other employees, regardless of which device they are using.

This service enhances our value proposition of connecting users across devices and applications. We expect to continue to add functionality to the product and increase the value our customers receive from our leading platform.

Last quarter, as you know, we launched RingCentral Meetings as part of our enterprise edition, bringing to market the industry's first mobile-centric integrated cloud communications platform with HD video and web conferencing. The advanced functionality, integration, ease of use and attractive price point of RingCentral Meetings was well received by our customers and prospects. As a result of the successful introduction of RingCentral Meetings, we will be expanding its availability to the rest of our RingCentral Office additions.

Going forward, we will continue to push ahead on our strategic initiatives and invest in growth, given the strong results we are seeing. We continue to address the rapidly changing needs of modern workers through a full-function, mobile-centric solution that is easy to buy, use and manage. We believe that this value proposition is very difficult for our competition to match. The market for cloud-based business communications is very large and underpenetrated.

RingCentral remains the largest and fastest-growing pure-play cloud business communications player. You can see the trend continuing in our first-quarter results. I believe that we have just begun to capitalize on our market opportunity.

I'll now turn the call over to Dave to provide additional color on our growth strategy and some of our recent wins.

Thanks, Vlad. As we've discussed in past quarters, we have a three-pronged growth strategy. We're focused on continuing to move up-market to reach larger enterprises, we're adding additional distribution channels to scale our reach more quickly, and we're expanding globally through direct and indirect channels. We continue to make progress on all three fronts, as demonstrated by the strong results Vlad outlined. Let's dive into each one.

First, moving up-market. On our last earnings call, I mentioned that we were making changes to the sales organization to further drive our move up-market. Typically, the implementation of an up-market strategy would take multiple quarters to implement. I am pleased to report that this effort is substantially complete, and was accomplished while our business continued to grow rapidly.

We have made specific enhancements to our sales, marketing and support organization, to better focus on the needs of business customers of varying sizes, particularly larger customers. We targeted programs and marketing efforts aimed at each group. We are seeing meaningful proof points from these programs, as the bookings from enterprises with 50 users and above showed growth well above that of our overall Office bookings growth rate.

Second, distribution channels. We're making progress with our TELUS relationship and are continuing to work closely with them to bring our solutions to the Canadian market later this year. In addition, AT&T and our reseller network will remain a key focus for us going forward. Earlier this month, we participated in Ingram Micro Cloud Summit, the largest dedicated Cloud services event for the IT channel, where RingCentral was showcased as one of the leading partners before hundreds of value-added resellers who were in attendance.

Third, global expansion. Our efforts in the UK continue to gain traction. As we announced recently, we expanded our partnership with Ingram Micro to include the UK markets, as we look to replicate the success we've had with them in the US. In addition, we continue to add salespeople and infrastructure to support our growth plans going forward in both the UK and, eventually, the rest of Europe.

Let me share with you a few customer examples from the last quarter. Dycom Industries is a leading provider of specialty contracting services for the telecommunications industry, with greater than $1.6 billion in revenue in 2013. With more than 10,000 employees spread over 40 subsidiaries, and 320 locations Dycom had traditionally allowed each location to negotiate their own contracts. We have been working with them in recent periods to help centralize their phone systems, as our platform can scale across hundreds of locations with the same functionality.

In the past quarter, we added roughly 400 users. We now serve more than 900 employees throughout multiple offices across 16 of their subsidiaries. We will work with them as they continue to consolidate their systems, and hope to expand our footprint over time.

Ben Swanger Glass is a century-old glass manufacturer and retailer with more than 70 locations across 14 states. Similar to Dycom, Ben Swanger had a very expensive legacy system, consisting of multiple vendors and hardware across their locations that was proving difficult to manage. The company was attracted to our easy to use and managed solution, which they could deploy across several locations, along with the mobile functionality for their field-based workforce. We are more than 30% complete with a rollout that currently plans to add about 400 users.

iPass is a global wifi roaming provider for enterprises and telecom providers with more than $100 million in revenue for 2013. Faced with a set of aging and expensive hardware PBXs across multiple locations, iPass turned to us for help. They now have more than 200 users, including a large field sales team, live on our platform.

We are proud to be able to help these customers, and these are just a few examples from the past quarter. As you can see from both our reported results and improved guidance that Clyde will outline in a moment, we are executing well against our growth initiatives. The strength of our people and our platform puts us in an excellent position to continue to disrupt the large and growing business communications market. I will now turn the discussion over to Clyde to provide more details on the quarter and our guidance for the remainder of the year.

Thanks, Dave.

For the quarter, we posted revenues of $48.3 million, up 36% year over year and 6% sequentially from Q4. This result exceeded our earlier guidance of $46.5 million to $47.5 million. Within total revenues, service revenues grew 36% year over year to $43.9 million and 6% sequentially, while product revenues grew 36% year over year and 10% sequentially, to $4.4 million. Total Company annualized exit monthly recurring subscriptions grew to about $188 million, up 39% year over year and 8% sequentially.

Driving service revenue was a success of our flagship offer in RingCentral Office, which remains over 90% of our net new recurring subscription booking. Annualized exit monthly recurring subscriptions for office products grew to about $126 million, up 64% year over year and 12% sequentially. Our overall net monthly subscription dollar retention rate was consistent with the results in both Q4 and Q1 of last year, coming in at just over 99%.

Before I move further down the income statement, I want to remind you that my commentary will be focused on non-GAAP results. A reconciliation of our non-GAAP to GAAP results is provided with our earnings press release issued earlier today.

Service gross margins were 69.4% in the quarter, up more than two points from Q1 of last year, and slightly up from Q4. The underlying service gross margin demonstrated leverage, and improved quarter over quarter. However, consistent with what Dave discussed earlier, we are invested in several areas of the business, including the UK, enhanced customer support for larger customers and moving some of that support to Denver, closer to our main customer base in North America.

Consolidated gross margins, including phones, was 63.5%, up about two points from Q1 of last year and up about 1 point from Q4. This is the first time in a few years we were able to deliver a sequential increase in our gross margin for first quarter. This is a significant accomplishment, despite typical seasonality and the investments we are making to shift support for larger customers to the US.

Sales and marketing expenses were $23 million for the quarter, or 48% of revenues. This compares to $17 million, or 48% of revenues, in Q1 of last year, and $19.4 million, or 43% of revenues, in Q4. The sequential increase in sales and marketing spend is in part due to typical seasonality at the beginning of the calendar year, but also, as Dave mentioned, we expanded sales and support for larger customers.

We are expect to demonstrate the return on these investments from the acquisition of larger customers. As you know, the time to close these larger deals are typically longer.

We will continue to invest in sales and marketing, both here and abroad, as the payback on this spending remains strong. With each dollar of sales and marketing invested, contributed $8 of lifetime revenue, and $5 of lifetime contribution margin, over the projected eight-year life.

R&D expenses were $9 million in Q1, or 19% of revenues. This compares to $7.2 million, or 20% of revenues, in Q1 of last year, and $8.5 million, or 19% of revenues in Q4. We continue to invest in R&D to expand the functionality and the efficiency of the platform, and to serve larger customers.

G&A expenses were $7.7 million in Q1, or 16% of revenues. This compares to $6 million, or 17% of revenues in Q1 of last year, and $7.9 million, or 17% of revenues, in Q4. The year-over-year increase in G&A largely reflects the increased costs related to being a public company. However, going forward, we expect a more moderate growth versus our overall revenue growth rate.

We had an operating loss of $9.1 million, or an operating margin of negative 18.8%. This was at the midpoint of our earlier guidance of negative 18% to 20%. This compares to an operating loss of a $8.3 million, or an operating margin of negative 23.3%, in Q1 of last year, and an operating loss of $7.4 million in Q4, or in operating margin of negative 16.2%.

The sequential decline in our operating margins reflect typical seasonality in spending at the beginning of the calendar year, as well as increased investments to serve larger customers. Non-GAAP net loss was $9.7 million, compared to a loss of $9.1 million in Q1 of last year, and $8.5 million in Q4. Loss per share were $0.15, based on the share count of 63.8 million shares. This compares to our guidance of a loss of $0.14 to $0.16 per share.

On a GAAP basis, our net loss was $12.9 million, or $0.20 per share. The difference between our GAAP and non-GAAP results includes $3.2 million, or $0.05 per share, in stock-based compensation. We ended the quarter with cash and equivalents of about $167 million, compared to about $116 million at the end of the prior quarter. The increase includes about $57 million in net proceeds from our secondary offering, which was completed in early March. For the quarter, cash flow from operations was negative $2.5 million, compared to negative $9.5 million for Q1 of last year, and negative $3.2 million or Q4.

Now to our expectations for the second quarter and full year 2014. For the second quarter, we expect revenue of $50.5 million to $51.5 million, or growth of 34% to 37% year over year. We expect non-GAAP operating margin of negative 17% to negative 19%. This should lead to a non-GAAP EPS loss of $0.14 to $0.16 per share, based on 67 million weighted average shares outstanding.

For the full year fiscal 2014, we expect revenue of $207 million to $211 million, or growth of 29% to 31% year over year, an improvement compared to our prior guidance of revenue of $202 million to $208 million. This reflects our strong results in Q1, along with the continued momentum in the business.

Non-GAAP operating margin of negative 15% to negative 17%, consistent with our prior guidance. This will lead to non-GAAP EPS loss of $0.50 to $0.55 per share, based on 67 million weighted average shares outstanding, again consistent with our prior guidance.

In summary, our business showed strong growth once again in the quarter, as our traction with RingCentral Office and larger customers continues to grow. We have demonstrated tangible evidence of moving up-market to attract larger customers, both from a product and customer acquisition point of view.

We believe that our unique value proposition is successfully disrupting the very large market and, with the success of our growth initiatives, we will continue to invest accordingly. I will now turn the call over to the operator for Q&A.

(Operator Instructions)

Greg Dunham, Goldman Sachs

I think I want to start with the Office and the move up-market. Against, that exit monthly recurring revenue of north of 60%, despite the larger base -- and this is happening when you're making changes to the sales and support function within the organization. Can you remind us what changes you made, and the timing of those changes? And maybe, could you talk about, was this a significant headwind to the business? Because by the numbers, it doesn't look like there's a slowing down or any sort of disruption.

Greg, this is Dave. The changes we made first was, we aligned our sales marketing and support organizations around different customer tiers so that we could focus and have more accountability around those tiers. We also increased our investments up-market, and we've been doing this for some time. But the changes we made in Q1 were much more substantive. So we're comfortable that we're going to be continuing to grow that -- the up-market piece of the business.

Okay. And then a follow-up, maybe, for Vlad. You mentioned the recent release of Office, and having new up-market capabilities and administrative functionality. Can you maybe dig in a little bit? What is new in this release? And perhaps, where does this take you, from a profile of customers? You did mentioned that the growth in 50 user plus accounts was well over Office, but where can this take you? Thanks

Yes, Greg. Vlad here. So yes, very fair question. First, where it can take us. As we've been maintaining all along, we don't really see any type of a glass ceiling for this type of an approach that we are doing. We do believe that cloud communications -- cloud business communications is fundamentally able to address needs of businesses of any size, without limitation.

Now as far as our latest release is concerned, it's just one step in our continuing quest of making it easier and more -- easier for larger and larger customers to onboard, and to -- with RingCentral and to continue using our product and technology. In particular to the changes in our -- this particular release, the -- we did modify and enhance our up-market administrative capabilities. And fundamentally, at the high level, it has to do with making it easier for administrators, who are generally IT personnel working for these larger customers, to administer accounts with many users.

All right? So whereby our smaller customers, many times, you will have each individual administrating their own accounts, with larger companies, it's not the case. And as you know, our largest customers are now just shy of 1,000. So this is a pretty significant user basis and lists that need to be managed, and we just continue improving the product to make it easier for those situations to be handled. And additionally, as I think I also just mentioned, is, we did beef up some of the security characteristics of our product, which again, tend to be areas most of interest to larger customers.

Okay, great. One more for me, if you allow me to get one more in. And this is for Clyde. The growth margins, we see -- this is the biggest year-over-year growth and expansion we've seen in gross margins. How should we think about modeling gross margins, going forward? And that's it for me. Thanks

Thanks, Greg. We had a pretty good quarter. In terms of going forward, I think we have described, many times, our target margins, which is overall 70% to 75%. This demonstrates a continued track towards that. I wouldn't expect, every quarter, similar increases, but I think we are on track to hit our target margin of 70% to 75% and 75% to 80% for overall service So good leverage in the model. And as I described earlier, we did that in spite of increasing the support for larger customers out of Denver.

Kash Rangan, Bank of America Merrill Lynch

When I look at the business, a good quarter, obviously, in Office and software, really good start, showing pretty solid growth. Maybe it's just the law of big numbers, but I'm curious if you could talk about the exit office MRR growth rate? Seems to have been a little bit slower than the previous quarter. Are we just facing the tough comparisons, because it's software? A good start, but nonetheless tough comparison.

And also, if you could comment on growth versus leverage? SaaS stocks seem to have taken a bit of a beating, including yours. And I'm not sure if that has changed your mentality as to how you want to run the business for growth? Or do you want to steer a little bit more towards margin expansion? The expected growth. Thank you

I will take the first part as -- or the second part. I don't know about law of big numbers. Of course, it is law of big numbers. And as we get bigger, you've got to grow faster. But our overall revenue grew 36%. I think overall exit MRR grew 39%, and Office grew a whopping 64%. That's still significant numbers. I would remind you that that is about 3 times better than most of the competitors in the space from Office growth rate.

So it's fairly significant, and we're very proud of it. And as Dave mentioned, we are doing some very interesting things on the sales team to address bigger customers. As Vlad mentioned, we are enhancing the product. So I think on all fronts, we expect to improve from a product point of view, from a sales point of view, customer support point of view. The newest we delivered is enhancement in those areas. We are already the largest pure play player in the space, growing the fastest, so we intend to continue that. As to valuations, you're the bigger expert than that -- than I am.

But to your question, of course we're disappointed, but we understand. We understand it's a broader market. To the best of our knowledge, there's nothing Company-specific as to the trends in the last month. If there were, we'd be a lot more worried. I think most people we've talked to understand the business model and what we're trying to attract. So it hasn't changed what we're looking at. We have a big market we are addressing. We have a competitive environment we are comfortable with. So it doesn't change any of that.

We have very good unit economics. And so any combined very good unit economics with a large market, a good competitive position -- and a prudent person wouldn't change tactically, just based on one month's worth of trading. We believe - and my discussions with both buy sell and sell side, the model -- they still believe in the mode. It is still intact. We intend to continue to add. And as you can see on Q1 results, we are delivering those returns that people expect -- or better than, actually, people expected.

Terry Tillman, Raymond James

Nice job on the quarter. The first question, I'll just throw it out there, and then you all can decide who is best suited to answer it. But in terms of the enterprise edition with the meetings product, or the meetings functionality, could you give us any kind of quantification on how that's coming along, in terms of impacting new bookings?

Terry, it's still early. As you know, we announced it last quarter. And you, and many on this call, knows enterprise usually takes a little bit longer from a sales cycle time than -- certainly, our traditional, so it's still early. We are very happy with it. And I think Vlad mentioned some of the successes we saw in the large over-50 segment, is growing significantly faster than, certainly, the overall Office. So early results are very good. But it's still early to have meaningful numbers out there.

As it relates to the meetings functionality, if I wasn't mistaken, it sounded like there's going to be some new packaging, where it's going to be included in other SKUs -- other Office product SKUs. And if that's the case, are there pricing changes or pricing lift that's going to occur because of that added functionality?

Yes, Terry, Vlad here. So we are not planning on price adjustments at this point. We did -- we were very pleased with the way that enterprise edition, and meetings in particular, was received. And we simply see quite a good opportunity in making it available to a larger customer base.

Okay. And I guess with the move up-market, it's obviously one of the key growth pillars. And you talk a lot about 50 users and above, in terms of going after that market. Maybe just for my education, could -- I have a couple of sub questions to this topic. But typically, is that always a replacement of some sort of legacy PBX? Or is that also -- are you seeing greenfield opportunities for fast-growing businesses that have just outgrown nothing? And maybe, any kind of commentary about the sales cycles? And lastly, what's the profitability like on one of those bigger customers versus the average?

Yes, this is Dave. I will start out with the sales cycles. And we haven't seen anything meaningfully change in the sales cycles. We have very fast sales cycles, down below 50. Above 50, we do see a little bit longer sales cycle, but because of the unit economics and lifetime value, we see much, much larger deals as part of that.

Okay. And then I was also asking -- I don't know, Dave, if you could help me on this. But in the 50 user and above opportunities, is that always a replacement? Or is some of that even greenfield, because it's just a fast-growing small business that just hadn't had anything before. What is typically going on there, in terms of replacement or greenfield?

You know it's primarily replacement in the up-market. We're seeing these boxes that are depreciating over time. Our customers are really resonating to the strong value prop of the cloud, the mobile capabilities. And we also do get a bunch of greenfield opportunities, as well. So it's both.

Okay. And sorry for the multi-part question. It's hard to keep up with all my questions here. But I think I've asked about eight questions so far as part or two. But the last part of this just relates to -- and I don't know if, Clyde, this would be for you. But what about the average -- or the profitability on one of these bigger up-market opportunities, in relationship to -- let's call it 5 to 10 users or something that may have been more traditional for Office?

I think overall, our profitability should be consistent. Obviously, with larger customers, as they are buying more seats per, they get the benefit of pricing, but the support and sales to do it is less. So it comes down to those unit economics that I think you'll see, overall, for us. So we aren't -- we will see as we get there, but I wouldn't expect any differential change.

Okay. And just my last question, and this is a one-part question, so this will be a lot easier now. Just for the full year guide, it's good to see an increase. Obviously, you had some upside in the first quarter, so some of that is carry-through. And then I guess maybe some of the other growth initiatives just progressing a little bit faster than expected.

But you are maintaining the bottom line loss assumptions, so you're not really pulling through some of that revenue upside into smaller losses. And I guess, if you're piling the money back into investments, is one of these areas getting a greater share of the revenue upside for investment? Is it the international, or the channels, or maybe the move up-market? Or is it something else? Thank you

Thanks, Terry. Look, this is a typical SaaS model. You have got to invest, in terms of market and to generate customers. And the payback on this is about 12 to 18 months. So obviously, as we raise numbers, you have to raise the ceiling. The market then does exactly what you see here, in that case. I should remind everyone that our unit economics, as we reiterated earlier, is very compelling, with $1 of sales and marketing investments gets $8 of lifetime revenue and $5 of lifetime profit, which implies, over time, essentially the unit basis of about 30% or more margin. So I think that make sense for us to do that.

We are investing up-market, as you saw in our Q1 results. And obviously, that's going to continue throughout the year, which is part of that investment. I wouldn't exactly say, plow it back. I think we are being prudent about investing and demonstrating results associated with it. In terms of -- by channels, Dave described, I think, all channels are doing very well for us, both the direct channel, as well as the indirect channel. And within that, there are distributors like Ingram, and carriers are doing very well. And so we feel really good about where we invested and the returns in each one of those areas.

Bhavan Suri, William Blair

If we just go back to the sales approach for a second. When you look at the larger customers, is that generally a direct sale today? And then, do you envision the partners being able to execute some of these larger sales themselves? Or does that remain direct, at least for the foreseeable future?

Yes, Bhavan, this is Dave. We see both. We've got a substantial direct sales force that we've been ramping up nicely, and we're going to continue to grow that piece. We also have carrier partners such as AT&T and TELUS that we will be bringing online later this year. We've also got value-added resellers, and we are real pleased with the Ingram relationship that I mentioned in our opening remarks. So the answer is yes, we're seeing traction up-market with both channels.

Great. And then, as you look at what you did with the sales force, I'd love to know A, what is your natural attrition in the sales force? And then what is your forced attrition? Because there's a certain level of just making sure that the underperformers get weeded out. And so just some color around that would be great.

We manage our sales force to heavy metrics. We manage them very closely, and we look at the major metrics, and we do have performance, and we manage it very closely. We don't disclose those numbers.

Okay. And then just turning to the enterprise offering, you had the high-def video conferencing. And I just wanted to clarify, is that the meeting product? Or are those separate?

Yes, Vlad here. So enterprise edition includes a portion of it, which we call RingCentral meetings, which is comprised of video conferencing and web conferencing.

Great. And then obviously, it feels like you're -- at least, when we've talked, you're charging a little more for those capabilities of video and web conferencing. And so, maybe this is more for Clyde. But did you see some improvement in ASP through the period? And should we count on that? Or should we think of ASPs remaining roughly flat for -- at least over the rest of this period -- over the rest of this year?

No, for the rest of this year, we'll see how it goes. As Vlad indicated earlier, I think in the Q&A, that we hadn't planned on any meaningful price changes. But ASP has been -- obviously, as you add (multiple speakers), you will have the revenue per customer for those customers that engage it, obviously, would go up, if that's what you mean by ASP. But the average price itself wouldn't change. The revenue per customer for those that engage in that product, not that everybody does, obviously, the ARPU would increase.

Okay. And then one last one from me. When you are selling to the larger accounts, are they looking at the broader functionality on the initial deal? Or are they buying the subset today, and then that's part of the potential future up-sell?

Yes, let me address that. Vlad here. Look, we make it a point to really provide fully functional bundles. And this is actually a differentiated approach, we believe, in the industry. So we tend to not provide an a la carte menu, and let people just choose a feature at the time. Because frankly, it gets very confusing for everyone involved. And then -- we much prefer the situation to where we deliver a fully functional solution, people know exactly what they're paying for, there are no surprises month over month.

Now we do have a feature of each product, and I can't tell you that every customer uses every feature. What I can tell you is that our feature set currently, as well as the road map, is very heavily driven by actual customer demand. So we feel very comfortable in that we're delivering the right functionality, at the right price, to the target user base. And again, our growth speaks for itself. We tend to win. Frankly, a majority of the deals in this space tend to be going our way at this point, from what we can tell.

Yes, no. That's great. And we certainly are seeing, in the market, more vendors start to bundle as opposed to the Chinese menu of pricing. So I certainly think it's the right way. Thanks for taking my questions. Congratulations, guys. Good quarter

Brad Zelnick, Macquarie

Congratulations on a good start to the year. Listen, the metrics all seem to validate the success you're having up-market. It's great to hear the anecdotes that you've shared with us, or some of the wins, and the expanded relationships in your prepared remarks. But just looking at the flip side, and what you need to do to get there and continue moving further up. Can you maybe just talk about the obstacles in moving up-market.

And specifically, if you can just talk about the incumbents in the market? The Cisco's, the Avaya's, I can't imagine that they're willingly letting you come into their turf and take these relationships from them. And what are they doing, and what are you seeing competitively, from them in the field? Thanks

Yes, Vlad here. So a few things. One thing that we see them not doing, as opposed to doing, is we see them not coming out with a cloud-based mobile first approach, like we are. So we continue -- we believe we continue having a very strong edge, vis-a-vis being able to deliver a purely cloud-based solution to businesses of various sizes, and to be able to deploy our solution across multiple offices, fully embracing BYOD as we go.

This is differentiated positioning. It is not something that a traditional hardware manufacturers like Cisco or like -- or Avaya have historically been able to deliver, and we continue winning on those points.

Now having said that, we also see both of these suppliers really concentrate in what we would call the true enterprise segment. Not to say that there aren't exceptions, but fundamentally, their installations tend to be sales of lines -- and above, maybe 500 lines and above. And based on some published industry research, we believe that there is a huge opportunity, as well as for some database, I should say.

But we believe that there is continuously be a very meaningful opportunity in the sub-1,000 range. So we're still talking about hundreds of users on the platform per customer, but not necessarily thousands. And -- we just don't see them, Cisco or Avaya, playing in that space very effectively at this point.

Thanks Vlad. That's actually very helpful. And just one other from me. I appreciate hearing the update on TELUS, to hear that that's moving forward. But as we think about the broader opportunity with carriers, can you just give us maybe some sense of how much time you're spending on building that carrier pipeline? And can we -- a year from now, 18 months from now, can there be half a dozen such relationships like you have with AT&T and what you're developing with TELUS?

It's a two-part question, so let me take it one by one. So look, I think we've been consistent for -- really, from day one now, as a public company, that we consider a carrier channel and carrier relationships to be a strategic asset and a strategic differentiator. We continue to be the only pure-play cloud provider with a sizable direct user base -- as you know, over 300,000 business accounts -- as well as proven carrier traction.

So we think it's a very good position to be. We believe it helps us on both sides. It helps us on the indirect side to be able to bring all of the know-how of actually having to serve live customers, like we do. And there is the other side of course. Our customers feel much better about going with us, knowing that AT&T made the same choice.

So net/net is, we continue investing into both our existing relationships, namely AT&T and TELUS. We are -- absolutely don't see that these two will be the limit, as far as our ability to partner with other similar companies. I can't sit here today, now, and tell you that yes, what we will have, nine more in 12 months. It would be a good thing to have, but frankly, I think -- these are very, very long cycles.

But you've got to remember, there are only so many incumbents per country. And for now, we seem to be the ones winning what business is available from that, so we do feel good about the strategy.

Great. Thanks again for taking my questions, and nice job. Have a good one.

Mike Latimore, Northland Capital Markets

Congratulations on the quarter, and nice to see the service revenue growth rate improve a little bit versus last quarter. As you move up-market, one of the benefits, potentially, is improved retention rate. You already have a great retention rate, but maybe, can you talk a little bit about what kind of retention rates you would expect as you move up-market here, versus the historic rate?

Mike, typically, larger customers have a higher retention rate. They turn over less. If you recall, the biggest reason for churn in us is business mortality, what the business do, it's our feel, as opposed something company-specific or product-specific. As you move up-market to larger customers, and you can see that, as we demonstrated from our results, the churn rate on larger customers tend to be much better.

And then -- and obviously, the channel is doing well. Can you break out what percent of revenue comes from the channel at this point?

We do not break that out, Mike.

Okay. (multiple speakers) Yes, got it. And then, the growth rate, obviously you are landing a lot of new customers. Can you talk a little bit about what you're seeing from the current customer base? Is a fair amount of -- are you seeing a fair amount of growth, add-ons, or seat expansions from the current customer base? And how impactful that might be?

Yes, this is Dave. We're seeing nice growth from the base. Not only are they adding new locations and new lines, but we're pretty excited about the meetings capability and the ability to up-sell more into the base. So we've got 300,000 plus customers, and it's a very good opportunity for us to keep growing them.

And Vlad, you mentioned a little bit of seasonality in first quarter. Can you qualitatively or quantitatively describe what the effect of seasonality is on the first quarter?

Could you repeat the question, Mike?

You had just mentioned a little bit of seasonality in first quarter. Can you talk qualitatively or quantitatively what that affect is?

Sure. Typically, in Q1, in cost and expenses, you usually have an uptick, because you have got to reset payroll taxes and the like. And so pretty much every company deals with this. So that tends to hurt margins a little bit, although as you saw, our operating margin declined a little bit, primarily because of that. Our gross margin, however, improved, and that demonstrates leverage in the platform, as a model, in spite of that, and in spite of funding some new things.

So I won't describe it quantitatively, but qualitatively, that's probably the biggest impact. From a top line point of view, Q1 tends to be a little bit more subdued than Q4, coming off Q4 holidays. We also plowed through that. So net/net, we were able to manage through most of that, other than the OpEx increase. And a fair amount of that was adding people to move up-market.

Just a last question. You have a number of applications in your various suite of package -- suite of applications. Are there any that are of particular interest or growing interest, like SMS? Or you mentioned video. But any applications that are worth noting of high interest right now?

Yes, Vlad here. So again, we don't really view it as a basket of applications. It's really is an integrated product. So business SMS, for example, is -- happens to be a fairly unique differentiator for our offering versus competition. But it's not something that we make available on stand-alone basis.

It is [odd] that you get a single business number, phone number, that people can call and fax and text. And -- as well as now use for video and audio conferencing as well. So we do believe that the value -- it's -- so the total is much stronger than all of the individual components, to use it on a one-to-one basis, which is a big -- competitive point of differentiation for us.

But as far as what use is concerned, look, it's across the board. And we just told you that, for example, our latest offering, with video and web conferencing, was received so well that we decided to make it available to the entire user base. But albeit -- to be clear, we will have certain limitations so our higher-end customers will get slightly better capability than our lower-tier customers. But everyone will be able to experience this new functionality. And I think you can view this as our philosophy moving forward, as we execute on our road map.

Okay. If there are no more questions, then I would like to thank everyone for joining us today in our first-quarter earnings call. We are quite proud and pleased to have posted strong growth, and in our ability to meet our guidance, and to actually raise our guidance once again. We very much appreciate your interest in our Company, and we do look forward to providing you further updates in the future.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.