RingCentral, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Financial amounts below are in U.S. dollars; income statement and cash flow figures are in millions unless stated otherwise. Prior-year comparisons reflect the company’s retrospective adoption of ASC 606.
Business context
RingCentral provides cloud-based business communications and collaboration software, with subscription services accounting for 91% of revenue in Q2. RingCentral Office is its flagship offering. Management cited customer additions, expansion sales to existing customers, growth in mid-market and enterprise customers, and channel sales as drivers of subscription growth. The company is transitioning AT&T Office@Hand customers to RingCentral, with the transition expected to be completed by January 2019.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $160.8 | $119.9 | $311.2 | $232.2 |
| Software subscription revenue | $146.0 | $110.9 | $282.9 | $215.0 |
| Gross profit / margin | $122.8 / 76% | $90.4 / 75% | $237.4 / 76% | $175.3 / 76% |
| Operating loss | $(4.7) | $(2.6) | $(6.0) | $(4.9) |
| Net loss | $(8.3) | $(2.1) | $(11.0) | $(4.4) |
| Basic and diluted loss per share | $(0.10) | $(0.03) | $(0.14) | $(0.06) |
- Revenue rose 34% year over year in both Q2 and the first half; subscription revenue grew 32% in both periods. Other revenue increased 65%, mainly from phone sales and professional services.
- Q2 gross margin improved one percentage point to 76%. Subscription gross margin increased to 82% from 80%; management attributed this to infrastructure economies of scale. Management expects overall gross margin to remain fairly consistent.
- Operating expenses increased 37% in Q2 to $127.4 million; sales and marketing grew 40%, research and development 33%, and general and administrative 31%. Management expects these expense categories, in absolute dollars, to continue increasing.
- Net loss widened year over year, partly reflecting $4.8 million of Q2 interest expense from amortization of the convertible notes’ discount and issuance costs. The notes bear no regular cash interest.
- Operating cash flow was $28.9 million in the first half, versus $17.5 million a year earlier. Investing activities used $35.7 million, including $18.5 million for the AT&T customer-base acquisition. Financing activities provided $392.5 million, principally from the notes offering.
- Cash and cash equivalents were $567.3 million at June 30, up from $181.2 million at year-end. Current assets were $678.1 million and current liabilities $156.9 million. Management said available liquidity should meet cash requirements for at least 12 months.
- The company issued $460 million principal amount of 0% convertible senior notes due 2023. Their net carrying amount was $356.8 million after unamortized discount and issuance costs; disclosed fair value was approximately $492.2 million. The company also spent $49.9 million on capped calls and repurchased $15 million of common stock.
Key changes, outlook and risks
- Annualized exit monthly recurring subscriptions (ARR), a company-defined metric, reached $629.6 million, compared with $478.0 million a year earlier; Office ARR was $548.0 million versus $398.9 million. Net monthly subscription dollar retention exceeded 99% in each of the five quarters shown.
- Remaining performance obligations were $495 million, excluding contracts with an original expected term under one year; RingCentral expected to recognize $303 million over the next 12 months and $192 million thereafter.
- Management reported no formal numerical revenue or earnings guidance in the supplied filing text. It expects research and development, sales and marketing, and general and administrative expenses to rise in absolute dollars, while overall gross margin is expected to remain fairly consistent.
- ASC 606 was adopted January 1, 2018 using full retrospective application. It chiefly resulted in capitalizing and amortizing incremental sales commissions; prior-year figures were adjusted. Management said the effect on total revenue was not material.
- Key exposures include continued operating losses, intense competition, dependence on third-party networks, data centers and service providers, service reliability and cybersecurity, customer retention, and the cost and execution risks of moving up-market and expanding internationally. The filing also discusses uncertainty around regulatory and privacy requirements, including GDPR and changes to U.S. broadband rules.
- Three disclosed legal matters remain unresolved: an appeal in the SPS TCPA case, a pending motion to dismiss in the Hurley TCPA case, and patent litigation brought by Uniloc that is stayed pending patent-review proceedings. The company said it could not estimate potential losses; it reported no accrued liabilities for these loss contingencies.
- The company recorded a $1.9 million long-term sales-tax liability and $11.0 million in current sales-tax liabilities. Management noted that future changes in assumptions or tax requirements could affect the estimates.
Important facts for investors to verify
- Whether subscription growth, retention above 99%, and ARR growth continue, and how these non-GAAP operating metrics are defined and calculated.
- Progress and customer retention through the AT&T customer transition expected to finish by January 2019.
- The effect of rising sales and marketing and other operating costs on losses, margins, and operating cash flow; first-half operating cash flow included substantial non-cash share-based compensation and debt-discount amortization.
- The notes’ conversion, cash-settlement, repurchase, and maturity obligations, as well as the capped calls’ limits on potential dilution.
- Developments in the TCPA and Uniloc cases, sales-tax exposure, and the company’s reliance on third-party infrastructure and providers.
- Comparability of reported results after retrospective ASC 606 adjustments, particularly deferred sales commissions and the resulting balance-sheet effects.