Darren Yip - RingCentral, Inc. Vladimir G. Shmunis - RingCentral, Inc. Clyde R. Hosein - RingCentral, Inc..

Terry F. Tillman - Raymond James & Associates, Inc. Bhavan Singh Suri - William Blair & Co. LLC John DiFucci - Jefferies LLC Nikolay Beliov - Bank of America Merrill Lynch George Frederick Sutton - Craig-Hallum Capital Group LLC Meta A. Marshall - Morgan Stanley & Co. LLC Nicole Hayashi - Goldman Sachs & Co. Nick Altmann - Northland Securities Jackson E.

Ader - JPMorgan Securities LLC Barry McCarver - Stephens, Inc. Brian Schwartz - Oppenheimer & Co., Inc. (Broker) Jonathan Allan Kees - Summit Redstone Partners LLC Charles Erlikh - Robert W. Baird & Co., Inc. (Broker).

Greetings and welcome to the RingCentral's Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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 third 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 purpose of our call today is to provide you with information on our third quarter performance, as well as to provide our financial outlook for the fourth quarter and full year 2016. Some of our discussions and responses to your questions may contain forward-looking statements.

These will include statements on our expected financial results for the fourth quarter and full year 2016, and our expected annual revenues several years out.

In addition, these will include our future plans, prospects and opportunities, trends in the business communications market and our expectations regarding our expansion up-market and our success in the enterprise segment.

We'll also be making forward-looking statements about our competitive position, our relationships with our carriers, channel and strategic partners, the expected benefits of our investments in technology, our open platform and integrations, our products, including Glip and Contact Center and our Global Office solution, 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; success of 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 release and slide presentation, our non-GAAP to GAAP reconciliations, our periodic SEC reports, a webcast replay of today's call, and to learn more about RingCentral.

For certain forward-looking guidance, a reconciliation of the non-GAAP financial guidance to the corresponding GAAP measure is not available as discussed in detail on our Investor Relations website. With that, let me turn the call over to Vlad..

Thank you, Darren. I am pleased to report that Q3 was yet another solid quarter with strong top line growth and continue margin expansion. We grew overall revenues for the quarter to $97 million, driven by software subscription revenue growth of 31% year-over-year.

These solid results give us more wind in our sales as we continue our journey to $1 billion in annual revenues over the next four to five years. We're focused on balancing three things concurrently; continued industry leading growth, expanding margins and investing in enterprise. Q3 results demonstrate that this strategy is working.

One, we drove revenue growth at the high end of our guidance. Two, we expanded margins above our outlook. And three, we are now seeing meaningful traction in the enterprise segment.

As we've discussed before, participating in the small, mid and enterprise customer segments simultaneously allows us to go after an entire untapped market worth more than $50 billion globally. As a result, we continue to deliver industry-leading growth and scale that outpaces our competitors. Total RingCentral Office ARR grew 39% year-over-year.

Our up-market segment, all customers with over 50 seats doubled year-over-year and comprised over 40% of our total Office bookings. And since it was up last quarter, I would note that our mix of over $1,000 MRR in channel represented over 70% of Office bookings.

We're also pleased to report that about 75% of net new Office bookings are now under contract. This shows a longer-term commitment from our customers, particularly as we expand up-market. Office net retention remained over 100%. As I mentioned earlier, we are having meaningful success in our enterprise segment, which we define as over 1,000 seats.

We continue to see an increasing number of over $1 million contract value deals this year. In fact, our enterprise sales pipeline has nearly tripled since the beginning of the year. For instance, we closed a 1,700 Office user deal, along with 100 Contact Center seats at a private healthcare institution.

This was a takeaway from a direct cloud competitor. We won the deal because of our superior quality of service and our open API platform. Another example this quarter is our largest new customer win, a 5,000-user deal at a multi-billion-dollar restaurant chain with a total contract value over $3 million.

This is a replacement of the legacy Avaya system across multiple locations. This momentum has not gone unnoticed. We are pleased to be the recipient of two prestigious industry commission awards for our leadership in product innovation and execution.

First, RingCentral has been named a leader in the Gartner Magic Quadrant for the UCaaS segment worldwide for the second year in a row. In fact, we further extended our leading position versus our competitors from last year. This was due to our strong product innovation, ease of use and administration and overall customer satisfaction.

In addition, Frost & Sullivan just named RingCentral the 2016 UCaaS Company of the Year for North America. Again, our efforts in overall vision and product innovation were highlighted as key drivers. This award demonstrates our deep commitment to product innovation. We believe our higher R&D investments versus our direct competitors are paying off.

Our commitment to innovation has been the driving force behind RingCentral's success, and we now have over 100 issued patents. I want to take this opportunity to thank all of our employees for their commitment to innovation and excellence.

We believe RingCentral is increasing its lead as the largest and fastest-growing pure play cloud UCaaS provider worldwide. In the first three quarters of the year, we've already had four major releases of RingCentral Office focusing on enhancing our enterprise capabilities and expanding our global reach.

In addition, we rereleased RingCentral Glip as the native application for iOS and Android. This resulted in significantly enhanced performance and higher adoption. We also had eight major updates to our developer platform that further expanded our out-of-the-box integrations with other cloud solutions.

During the quarter, we also had the chance to showcase some of these innovations at our first user conference in San Francisco. Customer feedback reiterated our belief that modern enterprise communication is about much more than on-premise PBX replacement. Customers want a completely integrated open multi-modal business communication system.

They want a solution that empowers their workforce to work anywhere, anytime and on any device. We have built the only open cloud communications platform to meet their needs. We seamlessly integrate voice, video, conferencing, messaging team collaboration, custom workflow enablement and contact center.

We were particularly pleased by the customer excitement around our team messaging and collaboration solution. The boundaries between communication and collaboration are blurring. We anticipated this trend more than a year ago when we acquired Glip.

Our team messaging and collaboration has influenced more than a couple dozen up-market wins this past quarter alone. One of those wins was a leading specialty construction company with over 1,000 users across multiple locations. This was also a competitive takeaway from yet another cloud competitor.

Our open platform was also well-received by conference attendees. We joined forces with strategic partners such as Google, Salesforce, Dropbox and Okta to demonstrate the power of our open ecosystem. Customers want to integrate their communications platform with other cloud solutions and with their custom applications.

The integrations provide enhanced productivity for their employees and better experience for their customers. For instance, the 5,000-user multibillion-dollar restaurant chain mentioned earlier will leverage our open API to inform their customers of the status of their to-go orders. We've further strengthened our platform offering in Q3.

Our ISV partners added eight new out-of-the-box integrations, bringing the total to over 45. We saw over 80 new custom integrations, bringing the total number of custom-driven integrations to over 300. Open API integrations are critical for our enterprise customers and differentiate us from our competition.

We also continue seeing great progress with international enterprises based on our rapidly expanding Global Office capabilities. We added 11 countries to our offering and increased the number of customers by 50% quarter-over-quarter to nearly 400. For example, we won a 500-user account at SugarCRM.

SugarCRM was looking for a provider with a complete cloud communications and collaboration solution with global capabilities.

We replaced styles of multiple standalone communication applications including voice, video, web meeting and conferencing, and we were able to unify their eight offices around the globe, something their previous providers could not do. Our Contact Center business experienced a record quarter with an over 50% quarter-over-quarter increase in bookings.

We had multiple wins with over 100 Contact Center seats. For example, this quarter, we won a 100 Contact Center seat deployment at one of Florida's major news publications. This was along with 400 RingCentral Office seats replacing a legacy on-prem system. For another example, we expanded our presence at Wyndham Capital Mortgage.

There, we added 125 Contact Center seats to their preexisting 350 RingCentral Office seats. On the go-to-market front, our indirect channel performed really well, representing 25% of our total ARR. Our master agents and VARs had a record quarter of bookings.

They continue to bring us larger and larger deals, including the 5,000-seat deal I mentioned earlier. To continue the momentum, we recruited and activated nearly 400 new sub-agents and signed Intelisys, one of the key master agents in the U.S. Our partnership with Google, announced in late Q2, is also bearing fruit.

In Q3, we won a Google referral deal for an initial 300 users at G4S in the UK, one of the largest multinational security services companies in the world. Our integration with G Suite, formerly known as Google Apps, was key to the win.

We also expanded our Google Partner Network to include three strategic UK-based resellers, CTS, National Lead, and White Strates (13:38). On the carrier side, we saw some nice up-market wins as well. In particular, we had several important wins with our North American carrier partners.

This included a 250-user deal at a leading national fast food chain and a 325-user win at a well-known apparel retailer. In conclusion, we are very happy with the quarter.

We feel that momentum is in our side with our largest win ever, broad industry analyst recognition and strong customer demand for our open and complete cloud communication and collaboration solution across the board.

We believe we are well on our way to our $1 billion annual revenue target in four to five years, and I look forward to a strong finish to the year. Before I turn it over to Clyde for more color on the financial results, I'd like to remind everyone that we will be hosting our first Investor Day on November 16 in San Francisco.

Please join us, as we will be sharing insights and updates on our business strategy, product innovations, partnerships and vision for the future. 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. Q3 was yet another strong quarter for RingCentral.

We delivered revenue growth at the high-end of our guidance range along with improvements in operating margin and earnings per share. Q3 was underscored by 31% software subscription revenue growth year-over-year and non-GAAP software subscription gross margin of over 80%, amongst the best-in-class of SaaS companies.

Non-GAAP operating margin of 2.3% in the quarter represents a 40-basis point sequential increase over Q2. We also continue to see positive free cash flow generation in Q3 for the third consecutive quarter.

Overall, we saw solid results across the board as we continue to balance revenue growth, improving profitability and making investments in our expansive upmarket to increase penetration of enterprise-sized customers.

Total annualized exit monthly recurring subscriptions, or ARR, grew to approximately $390 million, up 31% year-over-year, and 7% sequentially. The ARR for RingCentral Office grew to approximately $317 million, up 39% year-over-year, and 9% sequentially.

Upsells continue to outpace churn in Q3, as RingCentral Office net monthly subscription dollar retention was once again over 100%, and overall net monthly subscription dollar retention also remained over 99%.

In Q3, over 40% of our new Office business came from existing customers, which we believe demonstrates satisfaction with the RingCentral platform along with tailwinds from land and expand with larger customers as we consistently move upmarket. Software subscription revenue in Q3 was $91.9 million, up 31% year-over-year and 7% sequentially.

The indirect channel contributed about 25% of revenues in Q3, with bookings relevantly consistent with Q2. As you may recall, Q2 was the strongest quarter ever for our channel new business. Other revenues were $5 million, bringing total revenue for the third quarter to $96.8 million.

As a reminder, in Q1 RingCentral transitioned direct phone sales to an agency model in which we received a commission for most of our phone sales instead of separately recognizing the full sales price and cost of the product.

On a comparative basis, adjusting prior periods to an apples-to-apples basis, as if the agency business model had been implemented last year, total revenues grew 30% year-over-year, and 5% sequentially. A full reconciliation is available on our earnings slide deck under IR website.

Before I move further down the income statement, I want to remind you that my commentary will be focused on non-GAP results and guidance. Unless otherwise indicated, all measures that follow are non-GAAP.

A reconciliation of all GAAP to non-GAAP 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 remained at 80% during Q3 and represents about a four-point improvement year-over-year.

Once again, demonstrating the leverage from our multi-tenant SaaS model. Gross margin from other revenues was 16% in the quarter. The other revenue line includes commissions under the agency model, professional services, and revenues from rental and carrier sales upfront.

Gross margins were down quarter-over-quarter from 28% in Q2, primarily due to the timing of revenue recognition of Pro services in some of our larger deals and a mix of revenues within the other revenue category. On a sustained basis, we expect other revenue gross margins to be 20%, plus or minus a few points.

Total gross margin was 77%, up about three points year-over-year and in line with Q2. Sales and marketing expenses were about $47 million for the quarter, or 49% of revenues. This was up from 44% in the third quarter a year ago, and from 47% last quarter, as we continue to invest in long-term growth.

These expenses include investments we are making in the enterprise segment, which remains a significant opportunity for us with meaningfully higher lifetime values. Our unit economics continue to be attractive.

For each $1 invested in sales and marketing, we continue to see $8 of revenue and about $6 of gross profit over the projected life of an Office customer. R&D expenses were $14 million in the third quarter, or 14% of revenues, down from 15% in Q3 a year ago, and from 16% last quarter.

As Vlad indicated, we continue to invest more than our competition, which has manifested in our industry-leading product, validated by multiple third parties, including Gartner and Frost & Sullivan.

This in turn is reflected in high customer retention and consistent high growth rate for Office ARR at around 40%, and organic revenue growth rate above 30%. G&A expenses were about $11 million in Q3, or 12% of revenues, down from 13% in the year-ago period and in line with Q2.

Netting it all out, our operating profit was $2.2 million for an operating margin of 2.3% above the high-end of our guidance range of 1% to 2%. This is an improvement of approximately 160 basis points from the third quarter a year ago, and up 40 basis points from last quarter.

Net income improved to $2 million, compared to $300,000 in Q3 of last year, and a $1.5 million profit last quarter. Earnings per share was $0.03, above our Q3 guidance range of breakeven to $0.02. Share count was 77 million fully diluted shares. On a GAAP basis, our Q3 net loss was $8 million, or a loss of $0.11 per share.

The difference between our GAAP and non-GAAP results was $10 million, or $0.14 per share. Of this, $0.11 was driven by stock-based compensation, while $0.03 was due to the combination of currency remeasurement of our intercompany balances in the UK, as well as amortization of intangibles and other items related to the Glip acquisition.

We ended Q3 with cash and short-term investments of $152 million, compared to $148 million at the end of Q2. Deferred revenue was $43 million as of September 30, an increase from $42 million in Q2 and $34 million a year ago.

For the quarter, cash flow from operations was $8 million compared to $10 million for Q2, and $2 million in the same period a year ago. Recall that Q2 benefited from improved working capital from the transition to the agency model and catch-up payments from our carrier partners.

Free cash flow was $4 million in Q3, marking our third consecutive quarter of positive free cash flow generation. Now, for our outlook for the fourth quarter and full year 2016. For the fourth quarter, we expect software subscription revenue of $98 million, plus or minus $0.5 million, which represents annual growth of 28%, plus or minus a point.

We expect total revenue of $102 million to $104 million which represents growth of 26% to 29% on a comparative basis with 2015 results adjusted to the agency model. We expect non-GAAP operating margin of 1.5% to 2.5%. We expect non-GAAP earnings per share of $0.02, plus or minus, $0.01, based on 79 million weighted average fully diluted shares.

The difference between our Q4 GAAP and non-GAAP EPS is expected to be approximately $0.12, including $0.11 of stock-based compensation, and $0.01 of acquisition-related intangibles. This excludes any effects from currency remeasurement, which is difficult to forecast.

For the full year 2016, we expect software subscription revenue of $356 million, plus or minus $0.5 million, which represents annual growth of 31%. We are raising our total revenue guidance to $376 million to $378 million, up about $4 million from our previous guidance of $370 million to $375 million.

Adjusting 2015 results to the agency model, this implies year-over-year growth of 31% to 32%. We are also raising our outlook for non-GAAP operating margin by approximately 20 basis points to a range of 1.8% to 2.1%, up from 1.5% to 2% we provided last quarter. We expect non-GAAP earnings per share of $0.07 to $0.09, up from $0.04 to $0.08 previously.

We expect weighted average fully diluted shares to be 77 million. We expect free cash flow for the year of approximately $11 million to $14 million, up from $9 million to $12 million previously. In summary, Q3 was another great quarter that puts us well on track to achieve our $1 billion annual revenue target in the next four years to five years.

As Vlad mentioned earlier, I want to invite you all to learn more about our business and our future strategies at our Investor Day on November 16 in San Francisco. For more information, please reach out to Darren, or check our investor relations website, as registration is required to attend.

With that, I'll turn the call over to the operator for Q&A..

Thank you. Ladies and gentlemen, at this time, we'll begin conducting a question-and-answer session. Our first question comes from the line of Terry Tillman with Raymond James. Please proceed with your question..

Hey, good afternoon, gentlemen, and first, congrats. My question is going to be around the enterprise business, and the follow-up is going to be on the Google relationship. First, on the enterprise business.

Could you guys talk about what kind of selling motion is involved in these bigger deals like a 5,000-seat deal? And compared to your upmarket and your SMB business, is it a dramatically different type of sales process? And how well is your sales team architected to handle those kinds of opportunities? This is my initial question..

Yes. Hi, Terry. Vlad here. Well, thank you very much for the congrats, we did have a good quarter. So, let me take it into order you gave.

So, as far as our enterprise situation is concerned, so we're seeing continued strong traction and expansion into the enterprise, and as we've just reported, and very grateful for that is, we have a 5,000-seat win, quite meaningful for us, over $3 million in TCV. So, these are really good sign.

And we've been on record I think for quite some time now saying that it's only a matter of time until we start getting multi-thousand seat wins, and we are now definitely seeing that. So, we do believe that there is more to come, as the entire market, including even sizable enterprises pivot more and more towards the cloud.

Now, as far as dynamics between enterprise and SMB and are concerned, that's actually a great question. So there are trade-offs and trade-offs are along the lines that we get faster return on our investment with smaller businesses, but we get meaningfully greater lifetime value, and in the end, it results in improved growth over time.

So, we get that from the enterprise. So, the balancing act that we are in at this point, and have been for some time, is really how to best balance our overall growth against operating margin expansion, and how to balance that with our strategic initiative of expanding into the enterprise channel.

And frankly, we feel very, very good about the choices we've been making so far. We've mentioned last quarter that – or actually I think two quarters ago, or for two quarters in a row, we've been saying that our midmarket segment is now our most profitable segment on the ROI basis.

And we expect to see similar improvements as we march upmarket, including multi-thousand person enterprises..

Okay. And if I could get in this follow-up question. It actually relates to Google. We've talked to Google resellers, and it does seem like there's growing interest from the reseller standpoint. But what's the motivation of Google working with you guys? And maybe their interest in the UC market? And how formal of a relationship is it? Thank you..

No, a great question. So, we feel very lucky and grateful for the fact that we were in the first batch of the solutions that Google chose to work with in their recommended for Google At Work program, and look, it's still early, but there is a very positive traction. So, we are working with Google directly.

We've had a customer conference, our first user conference was about a month ago, and Google participated and they presented it, sat on the panel which was quite helpful actually. We routinely participate in Google's events at the regional level, in their partner events.

And we are working directly with them in identifying joint account opportunities that we're jointly pursuing. Again, it's early, but we are seeing very nice wins from this relationship. So, some of the examples we've mentioned is Cardinal Financial, the G4S win. So, these were specific accounts brought to us by Google, or Google resellers.

As far as how strategic it is to Google, that's probably more of a question to Google, frankly, but what we see is that we very, very nicely complement the Google G Suite product they have, used to be Google Apps. In that we allow a business to go full cloud across all of their business productivity needs, with including business communications.

And that's a pretty powerful value proposition and frankly, as we sit here today, the only way that a business can truly go full cloud, 100%, no on-prem, across open utility functions is, really, if you consider the Google G Suite and RingCentral combination together. So, we like where we are with them..

Thanks a lot..

Thank you..

Our next question comes from the line of Bhavan Suri with William Blair. Please proceed with your question..

Hey, guys. Congrats, and thanks for taking my question. Two. Let's start off with the first one. Just on AT&T, and sort of that relationship, Vlad, it would be great to get an update on how that's progressed.

You know, you sort of gave the indirect channel, but it's great to see what AT&T contributed and sort of an update on that relationship would be helpful? And then I've got a second one, a quick follow up to Terry's..

Okay. Fantastic. Hi, Bhavan. So, as far as AT&T is concerned, well look, we continue seeing new business from all of our carrier partners and that includes AT&T. And we continue seeing record revenue, so revenue growth both quarter-over-quarter and year-over-year from all carrier partners, and that includes AT&T.

And by way of example, our North American carriers continued bringing in meaningful deals. And for example, just this past quarter, we had a 250-user win at a large fast food chain and we had another win over 300 seats at a well-known apparel retailer. And these were brought by North American carriers..

So Bhavan, if I may build on that, to your question. Carriers are part of our indirect channel. Indirect itself was about 25% of revenues in Q3, consistent with Q2, and up from about 20% a year ago. Within indirect, we are seeing VARs that are outpacing the carriers.

That's driven by our continued investments in the VAR channels and including new partners and better traction from existing partners. As you would expect, VARs are responding to customer demand for cloud-based solutions. So, it's end-user driven. It's more pull.

And just to reiterate one example we saw that Vlad mentioned in his prepared remarks is a 5,000-user win that came in from the channel. So, the channel continues to do really well for us, and I'd expect that to continue to do well..

Great. Great. And then, maybe just a quick follow-up. Enterprise is obviously doing really well. I'd love to get color on the enterprise pipeline. But typically, the beats you guys have are a little larger and this seemed a little less.

Is there a shift towards enterprise and the longer sales cycle that might be responsible? Is the velocity run rate business in the SMB market shifting? Have you guys changed any of that strategy at all, or is it still the same and is just sort of an anomaly? How should we think about that vis-à-vis the focus on the enterprise, the enterprise wins? But obviously, since being a public company you've typically beaten by more.

And so, I'm just trying to think about we and investors should think through that? Thanks, guys..

Sure. No, very fair question. Well, look, from what we can tell we are still the fastest growing pure-play in the segment, and we are able to do that while not only remaining profitable, but also growing our operating margins quarter-over-quarter. But again, just really to reiterate, it's a balancing act.

So, to make it very simple, we could grow a little faster if we were to not invest ahead of the curve, specifically into the enterprise channel.

So, it is a conscientious trade-off that we're making in investing for the long-term, while still keeping very respectable growth in business overall and in RingCentral Office, which is a $300 million business, recurrent revenue, growing at about 40%.

So these are not from our vantage point, these are not terrible numbers, but being able to do all of that and get these accounts, like for example this 5,000-user win we've mentioned already. Look, it's a $3 million, over $3 million TCV that will play itself out over a few years.

So that's kind of, you know, that will – that cannot, not help our growth down the line. And I just want to add that it's a song we've played before. We've had very similar dynamic a while ago, between small business and mid-sized market, and that one is now performing extremely well, and mid is now better, ROIs are small.

And again, we're just very confident that as we grow the sales force, and train them, and get our name better recognized in the enterprise segment, we should see improved performance and improved ROIs as well, which in turn should help our growth..

Got it. Thanks, guys. Appreciate it..

Thank you..

Our next question comes from the line of John DiFucci with Jefferies. Please proceed with your question..

Thanks. My question has to do with CloudConnect. I assume this is based on demand from large enterprises.

Is this something that a lot of enterprises have been asking for and waiting for? Guys, is this something that, should we perhaps because of this, expect to see perhaps more of those large deals in the near-term?.

Well, so, yeah, another good question here. So, the enterprises are definitely looking to shift towards the cloud. There is no doubt about that. We see that from enterprises directly. We also see this from our channel partners that are becoming more and more successful in the enterprise channel.

Now, it is just a matter of technology that the larger the company, and in particular, the larger an individual site is, vis-à-vis number of seats, the more likely it will be that they will want some type of a direct connect solution.

So, whether it'd be MPLS, or some other ways of achieving the same results, the fact is, if you want to provide quality of service for a multi-thousand seat installation, then in some cases, having a direct connection is, that makes sense.

And frankly, we've been hearing for some time that there were some confusion, let's say, in the space, as far as that, well, Ring will only go over-the-top; that's not true.

But what we were able to do recently is, make it very clear to the market, to the end customer, as well as to our channel partners that as a matter of fact, not only do we support direct connect installation, but we're able to productize it and call it out explicitly.

And that, you know, a lot of this was sort of a matter of perception, but at this point in time, I think those fears have been put to rest..

Got it. Okay. Thanks, Vlad. If I might, the follow-up, on another partnership, which has been talked about so far tonight, but a different one, Barracuda Networks just announced. I'm just trying to get an idea of what that opportunity is.

I think Barracuda, the CFO said that the end of life of their phone business, which I think was like $1 million to $2 million in revenue in this past quarter, is that the opportunity here? And I'm sorry, I don't know as much – I'll do some more work on Barracuda, but what is the opportunity with Barracuda with this new partnership?.

Well, we'll have to see. Barracuda is a company that we are working with, and you are right, I mean they did announce that they would like to get out of the communications business, of the voice part of the communications business, to be clear. So, they had an on-prem product that they chose to partner with us to migrate those customers to the cloud.

To be very, very clear, we have no interest, and are in no way involved in anything on-prem. So we're not taking that business on by any stretch. But we do have a migration agreement, let's say, that we negotiated with them which basically allows us to market to those customers and move them to our cloud.

And really, a big part of this is honestly not just even the installed base there, but our ability to work with our channel to leverage their channel relationships. And as Clyde mentioned, channels becoming more and more important for us. So, we're not becoming a Barracuda shop, if that's the question.

But certainly, it's yet another way for us to acquire customers on a cost-effective basis..

Great. Thanks, Vlad..

Thank you..

Our next question comes from the line of Nikolay Beliov with Bank of America. Please proceed with your question..

Hi. Thanks for taking my questions and congratulations on the results. Clyde, I wanted to pick your brain on, for like, the margin trajectory going forward that needs high level puts and takes. When I look at your business, gross margins are at long-term levels, the ones that you got during the IPO.

You're getting leverage from G&A and R&D and sales and marketing has been going up by 100 basis points a year as a percentage of revenue over the last three years.

Just wanted to like check on the commitment to margin expansion in the near-term in light of the investment in enterprise, because automatically at some point, G&A and R&D leverage is going to slow down and you have to start showing sales and marketing leverage.

And I'm just wondering how you think about that in both in the near and medium-term?.

Thank you, Nikolay. Happy to drill into that for you. If you look at, just to recap, our gross margin went through a very significant expansion over the last couple of years. We're running at about 80%, which is the high-end of our target range, and we continue to sustain that.

So, all new business that came in, in the last quarter, for example, last couple of quarters, came in at about 80% gross margin which is meaningfully, I think, 14 points improvement over a couple of years ago. We continue to see leverage in G&A and R&D, and we'll continue to do that. So that's point number one.

Point number two is, our unit economics, which I reiterated in our earlier remarks, continue to be great. Every $1 we invest in sales and marketing gets $8 of lifetime revenue, and $6 of lifetime gross profit. So very, very meaningful. Point number two. The marketing opportunity is still very large, very underpenetrated.

We've got a terrific product which yields those unit economics. So, we already did well in the small business and medium-sized business as we invested in that a couple years ago and those continue to do well.

The last frontier in this whole thing is enterprise, and as Vlad mentioned earlier, characteristics of enterprise you invest now, payback in aggregate is later down the line, so that obviously will put some headwinds on margin.

But we're seeing early successes, we announced a couple of thousand-plus enterprise class customers in this call today, and I think we also said our pipeline is about 3x what it was earlier this year. So we're very, very optimistic about that, that being the last frontier.

Having said all of that, so every quarter, I believe this year including the most recent quarter where we did 30 bps, 40 bps of operating margin improvement. So, in summary, we are committed to operating margin expansion. I think there are some dynamics in the market we are trying to manage while still delivering improvements in margin.

I think as you go to the medium-term, I think you'll continue to see us do that as enterprise that yielding better returns will allow us to do that, and we are still committed to a long-term target margins of 20%, 25%..

Got it. As a follow-up, Clyde, deferred revenue came in flattish quarter-over-quarter, and last year it was up sequentially.

Just wondering if there were – what the puts and takes were in the quarter in there?.

No, I don't think there's anything to read into that, Nikolay, it was up, meaning fully year-over-year I think like 20%, 30%. I wouldn't read too much into the trend quarter-over-quarter.

I think as time goes on, you will see improvement in deferred revenue, where I think we said about 75% of our new business, customers over two-thirds, 75% signed contracts, some of them prepay, which of course, create deferred revenue. So, I think the flattish nature quarter-over-quarter is not – I would not read much into that.

I think year-over-year is likely more indicative..

Got it. Thank you..

Thank you..

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

Thank you. Vlad, earlier in the call, you mentioned that the enterprise sales pipeline had tripled. I know a question was asked about this. But I don't think we went into some of the components of what is driving that.

And I wondered if you could also discuss any changes you're seeing in close rates relative to that kind of growth?.

Sure. So this goes back to our continual investment in the enterprise channel, which really – it really comes from two sides. So, there are two vectors to this growth. So, one is our direct sales force, and we are – it's fairly simple, we are rapidly building out our enterprise sales force. We are doing it in a judicious manner.

So, we are hiring people and on-boarding them at a pace that still allows us to stay profitable, and to still continue to grow overall. We're not interested in revenue at any cost. We're interested in good solid revenue with good ROI.

But having said that, we're just fortunate to be in the position where we are able to be on-boarding people across board and specifically in the enterprise direct segment. So, this is the first factor. The second factor is indirect, and as led by the VAR channel.

And there, you know, we're just seeing more and more VARs that we are adding to the family, as well as our existing VARs becoming more productive as they get better – familiar with the platform and also frankly, as demand and interest from enterprise increases. So these are both sustainable trends.

We are actually, as a matter of fact, quite optimistic that we will see both accelerated growth as well as improving ROI as this strategy evolves. Again, we've seen exactly the same thing in the mid-market. In enterprise, it will take a little bit longer, but the stakes are worth it. Those customers are extremely valuable.

And again, case in point, our 5,000 user deal did come from the channel, so we're quite hopeful that there will be more of those in the foreseeable future..

Let me ask you a quick follow-up relevant to the Contact Center side, so obviously tons of M&A in that space. I wonder how that M&A and the impact of that might have impacted some of your opportunities, and I would think in a positive way in your ability to deliver more directly. Thanks..

Sure. So we had a very good quarter for our Contact Center business. So by no means do we see any type of a slowdown, nor do we hear concerns about any of the competitive – from the competitive perspective with some of the players now having come through the M&A process. Look, there's very, very strong demand.

We are very confident and happy with our strategy of combining the best-in-class UCaaS solution. Ours was the best-in-class Contact Center – cloud-based Contact Center solution. And I know that's playing out well.

So we continue seeing strong execution and we don't see any reason why it would be slowing down in the immediate future, or in the foreseeable future, I should say..

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

Great. Thanks, guys, and congratulations on the quarter.

A couple questions just about the VAR business and just since Professional Services ticked down a little bit this quarter, it just brought to mind a question of would you expect the VARs to do more of the Professional Services in future deals as that line grows? Or would you guys still have the same Professional Services contribution? And then the second question, with the indirect channel being flat, I know we kind of talked about it, but is that mostly VARs doing larger deals with longer sales cycles perhaps? Or is it just the element that you already addressed of the carriers going just a little bit slower than the VAR channel? Thanks..

Thank you, Meta. Let's clarify a couple of thing. Indirect was flat as a percent of revenue, but it grew, so I don't want people to interpret that indirect was flat, and so that we are very excited about. There are two components to that. There's the carriers, which Vlad pointed out earlier, also grew as well.

But the bigger growth comes from VARs which we are very excited about. So, just to clarify that.

On the Prof Services business, that business grew, I think what you described is the gross margin, it had some near-term effects in Q2 where the – the way it works is, we incur cost and then the rev rec is recognized when the customer sign off on the services that we will contract them to perform and there was some timing issues with that that caused it, we think that recovers in subsequent quarters.

And then I think the side part of your question was whether the VARs will provide. I think that's potentially to come. I think our intention right now is to – at a level of comfort I think it's likely for us to do that. Today – and we've started developing our Prof Services just about a year ago and is doing really well.

It's helping us win a lot of business. So the team in our go-to-market group, they'll make the choice whether it makes sense based on the inputs of the customer to do that in-house or, as time emerges, whether we use the VARs to do that. So that's probably part of our toolkit going forward..

I'd like to actually add a little bit to that, to the last part that Clyde was saying. So, look, the indirect channel is – I think will be as low as 25% of our revenues overall. Again, to Clyde's point, it did not slow down at all. As a matter of fact, it very much kept pace with our overall growth. So we feel good about that.

And as far as Prof Service is concerned, so again, majority of our wins, including majority of our enterprise wins are direct. So wouldn't necessarily expect to transition that to VARs. But as VARs are growing, of course, we'll also expect them to be more and more self-reliant and to handle sort of their part of the equation.

But we do see Prof Services continuing being the line item for us, but relatively minor in comparison to our recurrent revenue business..

Our next question comes from the line of Heather Bellini with Goldman Sachs. Please proceed with your question..

Hi. Thanks. This is Nicole Hayashi in for Heather. I just had a higher level strategic question. Given Tulia's (56:25) growth and with Vonage having acquired in the space, I'd be interested in your view on whether participating in the software category a little further down the stack would make sense strategically for RingCentral..

Yes. No, no, no, very good question, Nicole. So, look, so we are participating. We're just doing it in a little bit different way.

So to remind everyone, all of the SaaS providers, not PaaS, not platform-as-a-service, but software-as-a-service providers in our space, we are the only ones with an open platform with hundreds of developers developing to our open APIs with dozens of applications already having been developed.

And we continue seeing innovative use cases and whereby customers will implement custom workflows. We have one example where a fast food chain customer is using our platform to notify their customers of status of their takeout orders. So that's – we're very much in that space.

We don't feel that we necessarily need to complete with Tulia (57:56) head to head, and take on their business model of transactional monetization, again to remind everyone, with the exception basically of Prof Services and with a tiny bit of remnant phone revenue.

All of our revenues is recurrent, and of new business, what, 75% is now under contract. So, we really like that position. That's, if you will, more of a Salesforce.com model versus Tulia's (58:35) model, but we think it's got legs..

Great. Thank you..

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

Hey, guys. This is Nick Altmann on for Mike. Thanks for taking my questions.

In terms of competition, can you guys give us any update on what you are seeing in terms of competition? And specifically, what you guys are seeing from Skype for Business and the Cloud PBX?.

Sure. So, Skype for Business, let's start with that. So, they continue not having a complete cloud solution. They do not really today offer anything that could be termed a Cloud PBX, simple case in point, there is not an order attendant that's available from Microsoft in the cloud.

And that is really what differentiates a very basic Cloud PBX, at least we still have that. So we don't see them directly. If anything, we hear of a link on-prem legacy customers being kind of interested in what Microsoft will eventually do with the cloud, but we don't see them today as direct competitors by any stretch.

Now having said that, another dynamic is that of course there are lots of Microsoft-based businesses out there, and we can serve them very well today with our Office365 and Outlook and Skype for Business integration, and those integrations are valued by customers, they have a following. These integrations are approved and well liked by Microsoft.

You may remember we had a joint press release several quarters ago. And we are quite happy to be able to complete the Microsoft Cloud Suite with our RingCentral Office offering..

Ladies and gentlemen, in the interest of time, if you could please limit yourself to one question. Thank you. Our next question comes from the line of Sterling Auty with JPMorgan. Please proceed with your question..

Hey, guys. This is Jackson Ader on for Sterling. I'll keep it to one.

Our question really is, in the indirect channel, has there been any kind of shake-up at all in terms of top partners and their contribution?.

Sure. Has there been any type of shake-up? Well, I mean, we keep on signing new partners.

You know, as I mentioned, our partners are contributing across the board, so there's always movement, you know? There's always movement and we already indicated that as a class, our VARs are on a relative basis out-performing carriers a little bit, but both are still contributing..

Our next question comes from the line of Barry McCarver from Stephens, Inc. Please proceed with your question..

Hey. Good afternoon, guys. Great quarter. I've got a question on M&A. A nice balance of cash on the balance sheet there.

Anything you might be looking at?.

We look. People give us ideas. No shortage of ideas from – certainly from the sell-side. But we are focused a lot on organic growth opportunities as least there as we discussed earlier. One M&A we did about a year ago was Glip and it was hugely successful and it's helping us quite a lot as it fill out our portfolio.

So I think it demonstrates we are willing to do it. We'll be very prudent and disciplined about doing it, so we don't reject those ideas, we listen to those ideas. But I think we'll be opportunistic – for the right opportunities, right valuations that would help accelerate our growth and our profitability.

That's where I think you will see us doing more..

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

Yeah. One question for Clyde. I don't know if you want to make the comment either qualitatively or quantitatively, but can you talk about the booking mix in the quarter and how much of the percentage of the new business that's coming in is coming from up-selling, the existing base versus new customer sign up? Thanks..

I think in either mine or Vlad's, I think it might have been mine, we said about 40% of our new bookings comes from existing customers, Brian.

So we put that specifically out there, so there's a lot of tailwinds from that, and you would expect that, right? For several years now we've been telling you that we've been going after larger customers, we've also been describing land and expand. And so this is the product and this is the metric of that success.

So it's quite meaningful that you would do it and it demonstrate the stickiness of the product where existing customers continue to buy more. And so if you look at a cohort basis, you will see that very clearly, and just to tease that out for you, we'll cover more of that at our upcoming Analyst Day..

Our next question comes from the line of Jonathan Kees with Summit Redstone. Please proceed with your question..

Great. Congratulations on the quarter and thanks for taking my question. Just real quick, I was curious about the commentary. During your prepared remarks, you talked about Google in the partnership there and the potential there and the fact that they even attended the user conference.

Just curious, it was not until a couple of questions ago that there was any discussion about Microsoft. Obviously, you're connected – you're a partner with them in terms of Office and you're integrated with them in terms of the Office and 365, and Outlook and stuff like that.

Do you still see as much potential there you would with Google or do you see more potential now with Google? Were they even at the user conference a month ago?.

So, yes – well, again, thanks for the congrats. Look, no, so Microsoft was not at our user conference, Google was. And to be clear, we have – as far as company to company, today, we have, I would say, a closer relationship with Google directly as opposed to with Microsoft directly.

Now, we still support both Google cloud or G Suite customers as well as Microsoft's Office365 customers and we do that via our integrations that we discussed. As far as potential is concerned, sure, I mean, we think that there is a lot of other potential on both sides.

Fact of the matter is t hat if you are a business that wants to move its IT to the cloud, which is now almost every business of any size, almost anywhere in the world, then as far as your productivity suite is concerned, there are two choices. There is Microsoft and Google.

Again, we're fortunate to have been one of the few chosen partners for Google, and specifically in this space we feel we're getting quite a bit of attention from them. We're hoping that there will be opportunities to work even closer with Microsoft as well..

We have time for one last question. Our last question comes from the line of Will Power with Robert W. Baird. Please proceed with your question..

Hey, this is actually Charlie Erlikh filling in for Will. Just wanted to ask about the competitive landscape in enterprise versus SMB, if you're seeing different competitors in each space and what specifically are you seeing? Thanks..

Yes. So, look, in the enterprise, most of the times, we see legacy providers. We see Cisco and Avaya and we're replacing tons of both, okay? And there's a lot to love there. It's a very, very large market that's dominated by legacy players whose solutions are no longer meeting the needs of modern businesses.

Now, we see legacy providers all the way down to mid and even sometimes smaller businesses because even if you have a 20, say, person shop, chances are you have a box of some kind, a PBX, smaller PBX or a key system. We're replacing those.

But if your question is about other cloud providers, we have the usual suspects, of the companies that are publicly held that might be on your radar. We see Vonage in the lower end of the market with smaller businesses. We see (01:08:42) in the mid-market.

We – our data suggest that we are winning meaningful portion of our deals and, very importantly, we're now beginning to see takeaways.

I think I mentioned some of them – some examples in the prepared remarks, to where customers who have already chosen the cloud provider are now moving – are now switching horses and going to RingCentral based on our quality of service, ease of use and just ability to support their needs globally.

I really do want to remind everyone, we've been consistently out-investing our direct competition on the product side and the innovation side, and we've been doing that for several years now. And these investments are definitely bearing fruit. So we expect to be winning more business.

Of course, most of the market is still greenfield, but we feel very, very confident from the competitive perspective. And, look, overall, numbers speak for themselves and you know what our growth has been, is.

We are confident that it will continue at a very healthy pace and we're confident that based on the extreme recent growth in our enterprise pipeline that this 5,000-user deal we've talked about a bit today, it's not an aberration. There will be more to come and even larger deal than that..

This does conclude the Q&A session. I'd like to hand the call back over to management for closing comments..

Thanks, Doug. Thanks to all of you for joining the call today and spending time to learn more about RingCentral. We certainly appreciate that, and we'll see you at the Analyst Day. Thank you..

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..