RingCentral, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Financial statements are unaudited; amounts below are in millions unless stated otherwise. RingCentral provides cloud-based business communications and collaboration services, principally through software subscriptions.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $96.8 | $76.8 | $275.2 | $212.8 |
| Software subscription revenue | $91.9 | $70.3 | $257.9 | $194.7 |
| Gross profit / margin | $73.4 / 76% | $54.4 / 71% | $207.7 / 75% | $148.4 / 70% |
| Operating loss | $(7.1) | $(5.8) | $(19.3) | $(24.9) |
| Net loss | $(8.0) | $(6.3) | $(22.4) | $(25.2) |
| Net loss per share, basic and diluted | $(0.11) | $(0.09) | $(0.31) | $(0.36) |
- Q3 revenue grew 26% year over year; subscription revenue grew 31%. For the nine-month period, total revenue increased 29% and subscription revenue increased 32%. Subscription revenue represented 95% of Q3 revenue and 94% of nine-month revenue.
- Q3 gross margin expanded to 76%, primarily from improved subscription margins and infrastructure economies of scale. Nine-month gross margin was 75%, also benefiting from the phone-sales agency transition.
- Operating expenses rose to $80.4 million in Q3 from $60.3 million, including sales and marketing of $50.3 million, up 44%. Nine-month operating expenses rose 31% to $227.0 million. Nine-month operating loss narrowed, but Q3 operating and net losses widened year over year.
- Operating cash flow was $22.4 million for the first nine months, versus $2.2 million a year earlier. The filing attributes the increase to noncash adjustments and working-capital timing; share-based compensation of $22.6 million was a substantial noncash adjustment.
- Investing activities used $11.1 million, mainly for property and equipment and internal-use software. Financing activities provided $3.6 million. Cash and cash equivalents increased by $14.8 million to $152.4 million.
- At September 30, cash was $152.4 million; total debt was $15.8 million, comprising a $5.0 million term loan and $10.8 million drawn on a $15.0 million revolving facility, leaving $4.2 million available. The drawn revolver is due in August 2017. The company reported compliance with credit covenants.
- Current assets were $192.7 million and current liabilities $108.5 million. Deferred revenue rose to $42.7 million from $36.7 million at year-end 2015.
Material changes and operating metrics
- Monthly recurring subscriptions at September 30 implied annualized recurring subscriptions (ARR) of $389.5 million; RingCentral Office ARR was $316.8 million. Net monthly subscription dollar retention remained above 99% in each of the five quarters presented.
- Under its Westcon agency arrangement, RingCentral shifted most direct phone sales to a distributor that sells and delivers phones to customers. This changes phone sales from primarily gross product revenue to commission revenue and reduces both reported other revenue and related costs. Other revenue declined 23% in Q3 and 4% for the nine-month period. The company completed the transition during Q2 2016; carrier-partner phone sales remain outside the agency model.
- Sales and marketing investment increased materially to support customer acquisition and expansion into larger accounts and additional markets. Management said research and development, sales and marketing, and general and administrative expenses are expected to continue increasing in absolute dollars.
- Other expense for the nine-month period increased to $2.9 million from $1.6 million, principally reflecting foreign-exchange losses associated with the decline in the British pound.
Outlook, risks, and contingencies
- The filing provides no specific numerical revenue or earnings guidance. Management said existing liquidity, operations, and available borrowing capacity should meet cash requirements for at least the next 12 months; future capital needs depend on growth, investment, litigation, and other factors.
- The company expects continued investment in product development, infrastructure, customer acquisition, and international expansion, and disclosed that it expects losses to continue for the foreseeable future. Results remain subject to seasonality and variability in customer acquisition, expansion, and spending.
- A putative class action alleges violations of the Telephone Consumer Protection Act and conversion relating to fax cover sheets sent using the company’s system. The court dismissed the initial complaint on October 7, 2016, with leave to amend; the plaintiff filed an amended complaint on October 27. RingCentral intends to defend the case, but said it could not estimate a possible loss or range of loss. No loss-contingency accrual was recorded.
- The company recorded a $3.5 million long-term sales-tax liability and $4.7 million of current sales-tax liability. Estimates may change as tax rules and nexus assessments evolve.
- Key disclosed risks include intense competition and pricing pressure; customer turnover and dependence on reseller channels; reliance on third-party networks, data centers, and service providers; service interruptions, cyberattacks, and fraud; telecommunications, privacy, and tax regulation; foreign-exchange and Brexit-related uncertainty; and execution risks in expansion to larger customers and international markets.
- Substantially all assets other than intellectual property secure the SVB facility. Its covenants restrict certain activities, including additional debt, liens, investments, and asset transfers. A hypothetical 10% foreign-exchange-rate change was estimated to affect the financial statements by approximately $2.6 million.
Important facts for investors to verify
- Whether subscription growth and retention above 99% continue, and whether growth translates into improving operating profitability.
- Whether higher sales and marketing and development spending produces customer growth efficiently, particularly among larger customers.
- How the Westcon agency model affects reported revenue, margins, phone availability, and customer experience; reported revenue comparisons are affected by the gross-to-net presentation change.
- Cash generation quality, including the contribution of share-based compensation and working-capital timing; debt maturities, available revolver capacity, and covenant compliance.
- Developments in the TCPA litigation and sales-tax exposure, neither of which has a clear final cost in the filing.
- Potential dilution and governance implications: the filing reports a dual-class share structure and approximately 68% of voting power held collectively by Class B holders and other pre-IPO holders.