Business context and reporting period
RingCentral, Inc. filed this Form 10-K for the fiscal year ended December 31, 2018, with unaudited quarterly results for Q4 2018. The company provides cloud-based business communications, collaboration, contact-center and customer-engagement services, primarily through subscriptions. Subscription revenue represented 91% of 2018 revenue. Financial amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Total revenue | $673.6 million | $503.6 million |
| Software subscription revenue | $612.9 million | $465.3 million |
| Gross profit / gross margin | $516.5 million / 77% | $382.3 million / 76% |
| Operating loss | $(16.4) million | $(5.3) million |
| Net loss | $(26.2) million | $(4.2) million |
| Operating cash flow | $72.1 million | $41.2 million |
| Cash and cash equivalents at year-end | $566.3 million | $181.2 million |
| Working capital | $508.2 million | $139.6 million |
Q4 revenue was $188.6 million, versus $141.2 million in Q4 2017. Q4 gross profit was $144.5 million; operating loss was $3.4 million and net loss was $5.7 million (loss per share of $0.07), compared with a $0.2 million operating loss and $0.1 million net loss in Q4 2017.
At year-end, the company had $366.6 million carrying value of 0% convertible senior notes due 2023, with $460.0 million principal outstanding. Cash flow from investing activities was $(83.4) million, including capital expenditures and internal-use software, the Dimelo acquisition and the AT&T customer-base transaction. Financing activities provided $397.3 million, primarily from the notes issuance, partly offset by capped-call costs and share repurchases. Management said existing liquidity and operations were expected to meet cash requirements for at least 12 months.
Changes versus prior periods
- FY 2018 revenue grew 34% year over year; software subscriptions rose 32%. Management attributed growth to new customers, expansion within existing accounts, mid-market and enterprise sales, and channel partners.
- Operating expenses rose 37% to $532.9 million, led by sales and marketing expense (up 37%), R&D (up 34%) and general and administrative expense (up 42%). Increased staffing, marketing, product development and infrastructure investment contributed.
- Net loss widened to $26.2 million from $4.2 million. Interest expense increased to $16.1 million, mainly from amortization of the convertible notes’ discount and issuance costs.
- Subscription gross margin improved to 82% from 81%; total gross margin increased to 77% from 76%.
- AT&T resumed reselling RingCentral solutions under a revised August 2018 agreement. No customer accounted for more than 10% of 2018 revenue; AT&T had represented 11% in 2017.
Outlook, commentary, risks and unusual items
- The filing gives no specific numerical revenue or earnings guidance. Management expected gross margin to remain fairly consistent and R&D, sales and marketing, and general and administrative costs to increase in absolute dollars as the business expands.
- ARR, as defined by the company, was $725.8 million at December 31, 2018, up from $546.4 million a year earlier; Office ARR was $644.1 million versus $466.2 million. Net monthly subscription dollar retention exceeded 99% in each of the five reported quarters. Management cautions that these measures are not GAAP revenue.
- Dimelo was acquired in October 2018 for approximately $36.1 million, including contingent consideration. Connect First was acquired in January 2019 for consideration of up to $40 million. Integration, execution and acquisition-related costs and risks remain relevant.
- The notes were issued in March 2018 at 0% interest, with an initial conversion price of approximately $81.45 per share. The company spent $49.9 million on capped-call transactions intended to limit conversion dilution, subject to a cap, and repurchased $15.0 million of Class A shares in connection with the offering.
- Key risks include intense competition and pricing pressure; customer churn and longer enterprise sales cycles; reliance on carriers, resellers, network and hosting providers; service outages, cyberattacks and data-protection regulation; and telecommunications, tax and emergency-calling obligations. Most customers can terminate without penalty.
- Contingencies include a TCPA class action by Hurley that remained pending, and patent litigation by Uniloc that was stayed pending patent-review proceedings. The SPS TCPA case dismissal was affirmed on appeal and rehearing was denied. A former-employee wage-and-hour case had a proposed settlement subject to court approval; the company recorded an estimated accrual. The filing says losses for certain litigation matters could not be reasonably estimated.
- The company continued to report losses and had an accumulated deficit of $235.7 million. It also reported $428.7 million of federal and $344.8 million of state NOL carryforwards, whose use may be limited or expire unused.
- Revenue standard Topic 606 was adopted retrospectively in 2018; its impact on total revenue was not material, while capitalization and deferral of qualifying sales commissions was a significant accounting change. Management and the auditor concluded internal control over financial reporting was effective; the auditor excluded Dimelo from its internal-control assessment.
Important facts for investors to verify
- Whether subscription growth, retention above 99% and ARR growth translate into durable GAAP revenue and improving operating profitability.
- The extent to which higher sales, marketing, R&D and stock-based compensation costs can be absorbed as revenue scales.
- Convertible-note settlement, potential dilution and cash requirements at conversion, repurchase or maturity, as well as the terms and outcomes of capped calls.
- Execution and customer retention under the revised AT&T relationship, and the contribution and integration costs of Dimelo and Connect First.
- Developments in the pending Hurley and Uniloc matters, the employment settlement approval, and any changes to recorded legal or sales-tax contingencies.