RingCentral, Inc. Q1 FY2022 Earnings Call

Good afternoon, and welcome to the RingCentral First Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Will Wong, Head of Investor Relations. Please go ahead.

Thank you. Good afternoon, and welcome to RingCentral's First Quarter 2022 Earnings Conference Call. I'm Will Wong, RingCentral's Head of Investor Relations. Joining me today are Vlad Shmunis, Founder, Chairman and CEO; Mo Katibeh, President and Chief Operating Officer; and Vaibhav Agarwal, Interim Chief Financial Officer. Our format today will include prepared remarks by Vlad, Mo and Vaibhav, followed by Q&A. We also have a slide presentation available on our investor relations website that will coincide with today’s call, which you can find under the Financial Results section at ir.ringcentral.com. Some of our discussions and responses to your questions will contain forward-looking statements, including our second quarter and full year 2022 financial outlook and our assumptions underlying that outlook. These statements are subject to risks and uncertainties. Actual results may differ materially from our forward-looking statements. 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. RingCentral assumes no obligation and does not intend to update or comment on forward-looking statements made on this call. Unless otherwise indicated, all measures that follow are non-GAAP with year-over-year comparisons. A reconciliation of all GAAP to non-GAAP results is provided with our earnings release and in the slide deck. Please visit our Investor Relations website to access our earnings release, slide deck, our GAAP to non-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 in the slide deck posted on our Investor Relations website. With that, I’ll turn the call over to Vlad.

Thanks, Will. Good afternoon, everyone, and thank you for joining our first quarter earnings conference call. I want to start today's call by first acknowledging the horrific events taking place in Ukraine. We're shocked to see the dreadful challenges facing the local people as the situation unfolds. As a company, we are proud to support local relief and humanitarian efforts. We are matching employee donations up to $1 million and we've already matched $850,000 to date. From a business perspective, we're enabling three phone calls to Ukraine for all customers using our RingCentral services. As you may know, this unspeakable humanitarian crisis is very close to my heart. We hope for a rapid end to this shocking disaster and we send our thoughts and prayers to the people affected. With that, I'd like to shift to our people and our business. First, I want to give a warm welcome to Sonalee Parekh, as our new Chief Financial Officer. Sonalee will be starting full time later this month. She joins us from HP Enterprise, where she was CFO of HPE's Communications Technology Group as well as Head of Corporate Development and Investor Relations for the entire company. Sonalee is a seasoned executive and brings over 25 years of experience in the global technology, media and telecommunications industries, including senior roles at Goldman Sachs, Barclays, Jefferies and others. I am also delighted to share that we are appointing our Chief Operating Officer, Mo Katibeh, to the position of President & Chief Operating Officer. Mo has had a meaningful impact since he joined RingCentral, including driving our strong Q1 performance. Mo brings outstanding executive leadership and a customer and people-first approach. In his new role, Mo’s responsibilities will be expanded to include human resources and corporate strategy, alongside product, sales, marketing, and customer experience. I would also like to sincerely thank Vaibhav Agarwal for his valuable contributions to our company as interim CFO. His selfless dedication and outstanding leadership ensured that we did not miss a beat during the transition period. Vaibhav will partner with Sonalee as we scale the company in the next stage of growth. Now turning to our Q1 results. We had a strong start to the year. We delivered solid revenue growth and significantly expanded both operating and free cash flow margins, clearly demonstrating the inherent benefits of our business model at scale. Top line growth was very robust, and we are well on track to achieve $2 billion in revenue this year. In Q1, total revenue grew 33% to $468 million, above the high end of our guidance of $455 million to $459 million. Subscriptions revenue increased 35% year-over-year to $440 million, up from 34% last year. Total exit ARR was $1.9 billion, up 35% year-over-year. Mid-market and Enterprise ARR, which includes customers generating $25,000 or more in ARR increased 46% year-over-year to over $1 billion. Notably, operating margins expanded 120 basis points to 10.4%, significantly above our guidance of 9.2%. This is a clear testament to the inherent profitability of our business, even as we continue to grow rapidly. We had a good Q1. So why are we winning? Let me give you a tip on the secret of our success. It's built on three factors: trust, innovation and partnerships, which comprise our core corporate values. First, trust, I am proud to announce that we have now achieved 15 consecutive quarters of five 9s uptime, which is a standard that most of our competitors can only aspire to. And underpinning everything we do is our dedication to security and data privacy. Simply put, we treat our customers' data like our own. We also embed state-of-the-art capabilities such as entering encryption into our portfolio. Our innovation strategy is focused on the customer. We invest heavily into making our products easy to set up, easy to use and easy to manage for businesses and partners alike, which is a key competitive advantage. As to new capabilities, in Q1, we introduced RingCentral Webinar Beta, arguably the simplest seamlessly integrated web and product available in the market today. Also new is our AI-based Meeting Insights and Summaries, a category-defining feature that helps people catch up on meetings with short-term summaries, video highlights and hot-linked keywords. Now on the partnerships. We're fortunate to count names such as AT&T, Avaya, BT, Deutsche Telekom, Mitel, Verizon, Vodafone and many others as part of our valued partners. And in Q1, we also added Frontier with more to come. Our partnerships are accretive to our growth and profitability. Mo and Vaibhav will go deeper on this. Looking forward, we see four global mega trends that give us confidence in the long-term prospects for our business. These are: one, the semantics of hybrid work in the post-COVID era, which in turn reinforces the need for cloud-based communications platforms; two, ongoing adoption of mobility by businesses worldwide that drives the need for solutions that enable work in any mode, on any device, from anywhere; three, Microsoft Teams in the enterprise, which creates a meaningful opportunity for well-integrated enterprise-grade UCaaS and CCaaS solutions; and four, continued preference from CIOs to evolve to cloud-based unified communications and contact center as an integrated solution from a single provider. Mo will expand on how each of these megatrends are a positive long-term growth driver for RingCentral. We have now delivered 35 straight quarters of strong performance, driven by focused execution and we're excited to start 2022 with solid momentum. With two seasoned leaders in Mo and Sonalee now at the helm, we have the right management team and skill sets to drive the next stage of our growth. The market opportunity ahead of us is large and our innovation and go-to-market strengths are a key differentiator. Looking ahead, we are firmly focused on durable revenue growth, sustainable profitability and stronger cash flows. With our leadership position in UCaaS, unique partnerships and most importantly, our great people, I am very optimistic about the future for RingCentral. With that, let me hand the call over to our President and Chief Operating Officer, Mo Katibeh.

Thank you, Vlad. First, I'd also like to welcome Sonalee. I know she's going to be an amazing partner as we execute on our strategy of delivering sustainable growth and profitability. With that, let me give you more detail on our strong results. As Vlad stated, we see four key megatrends that are long-term growth drivers for RingCentral: hybrid work, adoption of mobility, Microsoft Teams and CIO preference to evolve to cloud-based unified communications and contact center from a single provider. Let me go deeper on each of these items and the key capabilities that differentiate RingCentral and allow us to win. First, hybrid. It's clearly here to stay. A good example of RingCentral being a preferred solution for the hybrid world, as well as a testament to the traction of our strategic partnerships, is Suffolk County in New York State. Suffolk County selected Avaya Cloud Office to connect more than 6,000 employees across more than 200 locations and everywhere else that their employees happen to be on any given day. This digital transformation project consolidated numerous on-premise phone systems across police departments and social services and community buildings onto a modern platform. And it delivered significant ROI, with the cost being approximately half of their legacy solution. And more broadly, as people are complementing their legacy phones with personal computers and mobile devices, we are seeing that the use of RingCentral on both desktop and mobile devices is outpacing our overall growth in a meaningful way, a clear proof point that RingCentral is an enabler and a beneficiary of hybrid. Second, mobile. Across every vertical, we are seeing customers select RingCentral for their entire workforce. And why? The industry-leading capabilities that we provide across all modalities, including wireless devices, whether they're being used in the office or on the go. A great example of how increasing reliance on mobile phones is a growth driver for RingCentral is SCM Insurance Services, Canada's largest independent claims management firm. SCM needed a mobile-centric solution that let them replace a disjointed network of regional legacy systems with a modern cloud-based solution. The key differentiated capability that they required was the ability to quickly spin up local numbers for any region or area affected by a disaster. This allowed SCM's distributed workforce to reassure victims that they were getting help from someone close by. Also, SCM is using our native RingCentral Video service, both internally and to give their customers choice in how they want to communicate with SCM employees. Third, Microsoft Teams, which we see as a significant incremental growth opportunity for RingCentral. The large majority of Teams customers are on E1 or E3 licenses, which do not include any sort of phone or telephony service, a key part of any business identity. This creates an immediate opportunity to complete the cloud communication suite by adding a well-integrated UCaaS solution like RingCentral. And as to the minority of Teams customers who have an E5 license, well, first, they still require an incremental calling plan to make calls outside of their company. And even more importantly, they often need a richer feature set, five 9s reliability, integrated contact center options, larger geographical footprint, all things that RingCentral can offer. Let me give you two recent healthcare wins to illustrate this. The first is a large dental services organization, which purchased embedded dialer integration across their 350 locations. Our win was based on our ability to deliver key incremental features such as human-assisted call routing, multiline appearance on a single device and deep analytics, which allowed the customer to gauge employee productivity. The second is a large healthcare recruiting and staffing firm, who augmented Teams with RingCentral due to the importance of five 9s reliability and our enterprise-grade call queuing capabilities and integrated workforce management capabilities. The customer historically used a spreadsheet to track and dynamically manage their on-call agents. RingCentral was able to fully automate the process by creating custom call queues for each scheduling scenario in support of their nursing staff after hours. The net here is that our Teams revenue is up 500% year-over-year and with very healthy ARPUs. We are going to be hosting an event in the near future to provide deeper insights into our emerging Microsoft Teams practice. Please stay tuned for details. And last but not least, the fourth megatrend is integrated UCaaS and CCaaS. This integration matters because historically, at least 60% of existing on-prem UC and CC deployments were purchased from a single vendor. RingCentral is currently the only company offering a fully integrated solution, combining a market-leading UCaaS and a market-leading CCaaS on a single bill. Consequently, we are seeing continued growth in attach rates for contact center for our largest customers, with the average deal size increasing 34% year-over-year. A great proof point is Ryder Systems, a leading Fortune 500 logistics and transportation company. Ryder was an existing RingCentral MVP customer who recently expanded to add our contact center solution. By using our integrated platform and its unified directory, Ryder call center agents can easily transfer calls to non-contact center employees at any of their remote facilities with one click. This and other integrated capabilities allowed Ryder to significantly reduce costs and training times, as well as capture end-to-end performance metrics across their entire business. Now building on these megatrends, I also wanted to give an update on our partnerships and channel. First, we had outstanding pipeline generation in the quarter, up almost 50% quarter-over-quarter, including record sequential increases from our channel partners. Second, on our strategic partners, Mitel is ramping materially faster than originally expected, and this is even before the full enablement of the Mitel endpoints on RingCentral. Avaya was up 30% quarter-over-quarter and showed progress across all customer segments and regions with international leading the way. And international continues to be a meaningful opportunity for RingCentral, with only 10% of our revenues coming from outside of North America. In Q1, we launched the first RingCentral wholesale program for Europe to capitalize on this. In closing, my time at RingCentral has only increased my conviction and confidence in our market, our product portfolio and our team. We have a world-class product, a large underpenetrated market and a business model that is inherently profitable. We are now laser-focused on driving both growth and margin expansion with discipline and operational excellence. With that, I will now turn the call over to Vaibhav to cover the financials.

Thank you, Mo, and good afternoon. Q1 was a solid start to the year. All key metrics came in above the high end of guidance. Subscriptions revenue grew 35% year-over-year, up from 34% in Q1 of last year. Non-GAAP operating margin was 10.4%, an expansion of 120 basis points, putting us well above the Rule of 40. And we ended the quarter with $302 million of cash and generated non-GAAP free cash flow of $39 million. This represented a free cash flow margin of 8.2%, reflecting 170 basis points of margin increase year-over-year. To summarize, we delivered strong growth, higher profitability and a corresponding increase in free cash flow generation. We are committed to durable profitable growth as we capture this massive market opportunity. Now let me provide you with the key underlying drivers of growth. First, upmarket traction. Enterprise demand for our cloud-based communications platform remains strong. Enterprise customers, defined as customers with $100,000 or more of ARR, increased 53% year-over-year to $790 million. These customers account for over 40% of our business, up 5 points from a year ago. Second, contact center. Our unique offering of industry-leading UCaaS deeply integrated with industry-leading CCaaS continues to be a strong differentiator. We are seeing bundled wins with both new and existing customers. Contact center ARR is now over 10% of our business and is accretive to our growth. Third, our strategic partnerships. With Mitel still in very early innings, Avaya, Atos and Alcatel-Lucent Enterprise continue to ramp. While we do not expect this to be a metric we consistently share, we do note that we achieved a milestone of approximately 0.5 million seats across our strategic partnerships. This is already a positive ROI on a lifetime value basis relative to our initial investments into the first three relationships. As our strategic partnerships are ramping up, we are now seeing that in many cases, our partners are working with the channel to deliver our services to customers. In this spirit of better aligning our reported metrics with current market dynamics, we will be providing total ARR and segment metrics going forward. Now let's turn to ARPUs and profitability. Overall, ARPUs remained stable quarter-over-quarter and year-over-year at over $30. And of note, new customer acquisition ARPU also remained steady at over $30. This is driven by the value created by our industry-leading, seamlessly integrated enterprise-grade message, video and phone and CCaaS offerings, which is a competitive advantage that we expect to last well into the future. Subscription gross margins were stable at 82%. Operating margin expanded by 120 basis points to 10.4% as we drove efficiencies through a wide range of initiatives across the company. As demonstrated in Q1, the inherent leverage in our model allows us to invest in innovation and growth while delivering sustainable margin and free cash flow expansion as we scale. Further, as the mix from strategic partners increases, our profitability will continue to expand. The unit economics from these partners are better than the company average as we can leverage their highly experienced sales forces, marketing investments and installed customer bases. This drives lower customer acquisition costs. In addition, their upmarket focus and long-standing customer relationships result in lower churn and higher lifetime value. These factors result in a higher LTV to CAC ratio. Now turning to guidance for the full year 2022. We are raising our subscriptions revenue growth outlook to 28% at the midpoint versus our prior outlook for growth of 27%. We are maintaining total revenue growth of 25% to 26% year-over-year. This factors in an increasing demand for our mobile and softphone applications, while accounting for shifts in demand for legacy desk phones. We are raising our non-GAAP operating margin outlook to 11.5%, which represents 130 basis points of year-over-year growth. This represents a more than 3x increase from our prior outlook, and we are increasing our non-GAAP EPS outlook to $1.83 to $1.87, up from our prior outlook of $1.69 to $1.72. In summary, we had a strong quarter and are focused on durable profitable growth along with driving operating and free cash flow margin expansion. Looking ahead, we have multiple incremental growth drivers and margin levers, and we believe that we will scale to become a multibillion-dollar company with profitable growth. On a personal note, I would like to thank Vlad and the Board for the incredible opportunity to serve as interim CFO over the last 6 months. It has been an immensely fulfilling and rewarding experience, and I look forward to partnering with Mo and Sonalee to scale the company to the next level. With that, let's open the call for Q&A.

Our first question comes from Kash Rangan with Goldman Sachs.

Vlad and Mo, congratulations on a fantastic start to the year. Mo couldn't help but notice, but you talked about the megatrends and one of the trends was Microsoft. And I wanted to just get behind that a little bit more. Do you see this as a trend, whereby Microsoft customers that have purchased the E1 bundle are increasingly looking to a specialist provider like RingCentral to augment their capabilities? And I also wanted to understand, I think you've thrown an eye-popping number of 400% to 500% growth in your Microsoft practice. Can you just elaborate that a little bit? And besides that, it was great to see that the ARPU trends are very stable. I think there was a fear that is going south, but you certainly did a good job talking about the stability there. And one for Vlad, of course, you're not going to be forgotten. With the tremendous changes in the management team you've brought on board some really experienced executives from outside the company. How do you think it's all going to gel together from a go-to-market, finance, strategies, what are the changes we should be expecting or you should be expecting from your new management team?

I’ll take the second question since you directed it to me. It's difficult to predict the future, but so far, things look promising. We brought Mo on board in January, and there were several concerns related to the turbulence we faced in Q4. As you can see, we've had a fantastic quarter, largely thanks to Mo. The numbers reflect that, and his recent promotion to President is well deserved. Beyond the numbers, he's working diligently on developing the next layer of management and bringing in talented individuals. I can say, with a good level of confidence that we will emerge much stronger from last year's challenges, with a more experienced and better aligned management team. Both Mo and Sonalee add a great deal of discipline and create a culture focused on profitable growth. As a $2 billion company, we should be delivering tangible results, and you are seeing this reflected in our outcomes, our enhanced profitability outlook, and our record free cash flow generation. We believe this trend will continue. Regarding Sonalee, our new CFO, many of you may have already worked with her, especially from her time at Goldman. I'm excited about her joining us later this month. Our entire management team was deeply involved in the search and interview process, and Sonalee was our unanimous choice. It's a new beginning for RingCentral, which is currently a profitable $2 billion business with strong growth potential. Let me also address your Teams question briefly. Teams is a solid product and is gaining traction, particularly in the enterprise space. However, they lack a competitive cloud-based PBX component, which is a significant gap. Users have to pay extra for a subpar version, and it appears that they are reinstituting the name Microsoft Phone because it doesn't fulfill the requirements of a complete PBX solution. We're succeeding with E5 customers who recognize the limitations of Microsoft's offerings. Additionally, even disregarding the feature comparisons, the availability isn't up to par, with a maximum of 3.9x, which is not adequately supported by their SLA. Our geographical coverage is vastly superior, and we can look into the number of countries we operate in, which is twelve.

12 additional countries.

Okay. Which matters. If you happen to be in one of those 12 countries, then the thing is simply not viable. And also remember, even for E5, it's still mostly free you still need to have an underlying carrier, okay, which you need to pay for. Again, you don't get the countries in any case. But very importantly, you don't have a single throat to choke. PBX in the cloud or any enterprise communications, it's about reliability, and it's about no drama. So if you have a poor quality call, unless there is an end-to-end vendor like RingCentral, who you're going to complain to, is it Microsoft issue, is it Verizon or any other issues or somebody. So again, this is why we think that Teams, it's not a flow, it's a channel. I think we mentioned we've had tremendous growth. It's a meaningful size business even now. We will eventually be disclosing the number, but for competitive reasons, let's just say this is one of our stronger growth drivers at this point. And what we set out to do was simply to provide the world's best Teams integration, which, at this point, we already have between direct routing and embedded dialer, we really are the only sizable vendor to support both. That opens up a tremendous amount of opportunities for us. And some of our competitors have quoted their Teams penetration, I can tell you that we are at least towards that already, okay? So a lot of juice left there. Mo?

Vlad, I think you hit all of it. And Kash, if you have any follow-ups, I have to chat with you later. Why don't we move on to the next question?

The next question is from Terry Tillman with Truist.

Yes. Congrats from me as well. And Vlad, you certainly are on a roll. You crushed it with those answers there. And hi, Mo, and Vaibhav and congrats to Sonalee. Just two quick questions. I guess, first for you, Mo, you've had more time under your belt here at the company, and there's probably always going to be some low-hanging fruit areas on the go-to-market or operational excellence side that you can make an effect quickly. So anything you could touch on in terms of where you've been able to have an early impact? And then the second part of that question is the market has been rough obviously for software. But the shares are 3x sales on '23. And what do you think is most misunderstood about the story? And then I had just a quick follow-up for Vaibhav on Office ARR.

Very good, Terry. So let me jump in and say two things that I'm quite proud of relative to the first quarter. The first one, as we articulated, we saw a record increase in pipe from the channel. And anytime we're seeing it come in from the channel, it's illustrative of just the foundational power of the product that we're providing and customer demand being strong. And so you can imagine behind the scenes, there was a lot of really good operational work by our sales and channel teams to go drive that and really enjoy seeing that come to life. The second one is obviously the 120 basis points of margin expansion that we saw in the quarter and how we've raised our guidance for the year relative to that. And it really boiled down to the way we accomplished that was driving efficiencies across three key areas that are representative of the whole organization. One is how do we think about our people, our hiring, our headcount? The second one is how do we think about our program spend? And then the third one is how are we managing our supply chain and vendor ecosystem? And clearly, as we're lifting the guidance for the year, that should give you confidence about how we're thinking about the sustainability of this and really building on the points that Vlad made as well. And then I think you had a second question for Vaibhav?

Well, it was a tough question. It was just what do you think is most misunderstood, given the stock is where it's trading? So again, a tough question, but curious how you'd respond?

Part of today is getting your questions answered. I think what’s happening with Teams is a significant aspect of this. The key question is whether it represents a revenue opportunity for us or if it’s a product that will capture a lot of the legacy PBX seats we’re targeting. As Vlad mentioned, it clearly serves as a growth vector for us. We view it as a market pathway to engage with Teams customers, and the 500% growth we've experienced is a major contributor to that. Additionally, there's another crucial element that I believe the market has misunderstood, which is ARPU. Kash mentioned it earlier, and we included a slide in the presentation that Vaibhav highlighted. Currently, our ARPU is over $30, remaining stable across our customer base on a quarterly and yearly basis. Even more importantly, the ARPU for new customers acquired during the quarter is also above $30 and stable on a year-over-year and quarterly basis. These are the two main questions I frequently address, Terry, and that’s how I’d respond to them.

That's wonderful. And then just real quick here for Vaibhav. In terms of seasonality of office ARR for the rest of the year, anything we should think about the seasonality of this business at this point given all the things you have going on? Or should it ramp higher the net new ARR you add each quarter as we progress through the year?

Yes. Thanks, Terry, for the question. Look, we don't specifically guide to Office ARR. But what I would tell you is that we had a really good bookings quarter. We generated about $100 million of bookings. ARR is growing kind of in the mid-30s, which is very, very healthy. We did have some effects of the U.S. dollar strengthening during the quarter, about one point or two. But overall, demand environment looks good. Pipeline remains healthy as we get into Q2. So overall, feel very good about where we are and what we've guided in terms of revenue and operating margins.

Let me add a few thoughts here that I believe could be useful for everyone on the call. You raised an excellent question about misconceptions, and we've touched on some key points. At a high level, there are two main things that people may not fully understand, and they are interconnected. Firstly, when you look at competitors like Microsoft and Zoom, people might assume that your cloud-based phone services are inferior due to their larger size. They might think your pricing won't hold up. The misconception here is that competitors are not providing a complete package. When you compare the full offering to Zoom, the pricing is quite comparable, especially considering the extensive capabilities of your robust cloud PBX, which includes many integrations and use cases that others lack. This is why you continue to maintain strong growth figures without reducing your average revenue per user, as your prices are competitive when compared to larger firms. The second point, which is somewhat related, is that people often overlook that you are more than just message, video, and phone services; you are also a contact center provider. You have the unique advantage of being the only vendor offering a leading solution in both unified communications and contact center as a service on a single invoice. This level of integration is not found anywhere else. While your high-end contact center is developed in partnership with NICE inContact, there is a significant amount of intellectual property from both sides that has gone into this offering, making it difficult for competitors to replicate. There are no other companies that can come close to this integration. This solid intellectual property and longevity allow you to succeed in enterprises of all sizes, including large organizations, as you provide a differentiated, fully functional solution at reasonable prices. When you look at your blended average revenue per user, it remains over $30, consistent across all metrics, including your new customer acquisitions. With these additional insights, you hope to instill greater confidence in your ability to maintain this level of performance and continue growing without sacrificing profitability or margins.

The next question is from Brian Peterson with Raymond James.

So I wanted to follow up on Terry's question on ARR. And as you guys become enterprise focus, I know that's growing faster than the rest of the average. Does the bookings grow outpace ARR growth? And so like maybe we shouldn't look at those metrics as the same thing. Because I know not everything is implemented or an ARR to start. But I just wanted to make sure I understood kind of the difference between what bookings are and what ARR is trending during the quarter.

Yes. So thanks for the question, Brian. So ARR is growing in the mid-30s. And look, as we grow and mature as a company, ARR is a metric that we kind of look at internally. And we are continuing to add bookings quarter-on-quarter. So like I mentioned, we had a $100 million booking quarter, which was pretty strong. ARR growing in the mid-30s, and that's what's going to continue to layer on growth as we grow as a company. Mo, anything to add?

The only thing I'd add to that is, of course, I think all of us have hit on this is at the same time of delivering about $100 million of bookings, we had a very healthy margin we’re getting the scale. We're ensuring that we're balancing both our revenue and our profitability, which is why you're seeing us guide the way we're guiding on both.

The next question is from Samad Samana with Jefferies.

I wanted to ask about the subscription revenue guidance, Vaibhav. Considering the difference between the actual results and management's guidance, along with the revised guidance, it seems like not all of the positive results are reflected. Is there a change in the guidance approach, or is it simply a matter of being cautious due to broader economic uncertainty? How should we interpret this guidance?

Thank you, Samad, for the question. Regarding subscriptions, from a full-year guidance perspective, we did see a positive contribution from Q1 and the rates from Q2 on subscription revenue. However, the strengthening dollar has impacted us with some foreign exchange effects, which are reflected in the subscription revenue line, estimated between $5 million and $10 million. We have taken this into account in our guidance.

The next question is from Meta Marshall with Morgan Stanley.

Great. I wanted to dive into the kind of increase you noted on the channel partnerships, noting 30% quarter-on-quarter ramp in Avaya and 50% in channel. Do you think that, that is just maturing of those relationships? Or were there any kind of particular efforts over the last kind of six months to kind of drive that uptick?

Hello there, Meta. We have marketing and sales plans with our partners aimed at attracting customers who have issued RFPs, which we consider organic growth, as well as programs designed to actively present our message to customers who have not yet decided to transition to the cloud. As you mentioned, there has been a significant quarter-over-quarter increase with Avaya, and I am especially pleased with the progress we are seeing from Mitel. This confidence allows us to start sharing our current status regarding the number of seats from these partnerships. The main reasons for these partnerships are threefold: they collectively account for over 200 million legacy PBX seats, which represents a substantial market of potential customers in need of our products. Additionally, the structure of the deals enhances our overall company economics. Lastly, we can leverage our partners' experienced sales and marketing teams and their established relationships with these customers, which we know will continue to encourage adoption over time. We will provide periodic updates on the status of these partnerships and the number of seats they generate.

The next question is from Matt Stotler with William Blair.

I think I'll just ask a follow-up on Microsoft and maybe a little bit more pointed. We saw this morning that Avaya announced that they were expanding their relationship with Microsoft, their co-selling relationship to not just include contact center but also the entire OneCloud portfolio. So I wanted to see what you can share in terms of confirmation that, that includes co-selling relationship for Avaya Cloud Office? What that implies for that product, the opportunity there? And then any thoughts on the potential for an expanded go-to-market relationship with Microsoft in the future?

We certainly can't comment on other companies' announcements. We have to direct questions on that back to Avaya and Microsoft. What I will tell you is that, as we articulated a little bit earlier, we're continuing to see increases quarter-over-quarter in our own relationship with Avaya. That's on both a seat and a new revenue bookings basis. And at the heart of it, I think it boils down to. They've got a lot of legacy PBX customers that's outside of the CCaaS section of their business, which is, I think, where they focused on this morning that need a solution to move to the cloud, and that's where our partnership with Avaya is currently focused.

The next question, please go ahead.

No, I'm sorry, I was going to say, and obviously, I can't speculate on any future partnerships or other go-to-market or relationships with Microsoft either. But we're very excited about the MS Teams practice that we talked about quite a bit earlier, so I won't repeat myself.

The next question is from Matthew Niknam with Deutsche Bank.

Can you talk about how churn trended across cohorts between small, mid-sized businesses and enterprise?

Yes. So overall churn, Matt, trended in line and was stable quarter-over-quarter, year-over-year. And that was true across the segments as well. So no material kind of trends to kind of outline. I think from a net retention standpoint, when you look at the cohorts, every subsequent cohort has been better than the previous one. When we look at the 2021 cohort as an example, net retention is, call it, north of 150%. So healthy net retention trends there.

The next question is from George Sutton with Craig Hallum.

Using Frontier as a proxy, how many Frontiers, how many Mitels remain out there from your perspective with relatively untapped customer sets?

Thanks for the question. This is Mo. I'll take that one. What I'll tell you is, first, we're excited to welcome Frontier as our latest global service provider partner in the quarter. And broadly, we're seeing strong seat and revenue growth from our GSPs, those service providers. These are relationships that are going to continue to unlock new sales addressable markets for us for the foreseeable future. To get to the heart of your question, here's the way I'd have you think about it. Last year, we ended the year with 12 contracted relationships with GSPs, and of that 12, only 3 of them were producing meaningful revenue because of the cycle between when you do the contracts, you go and you actually build the product together, you integrate your products and then you enable your sellers and they go off into the market. So 12 contracted, 3 producing revenue. We're expecting at the end of this year that we're going to have about 18 contracted relationships. So 6 more. And of that, 9 are going to be producing meaningful revenue. The net here is that the new revenue-producing GSPs are going to continue to grow both this year as well as next year, and then we can talk about '24 at a later point in time.

The next question is from Taylor McGinnis with UBS.

I wanted to touch on operating margins and the guidance raise there. If you look at Q1, it looks like most of the leverage was coming from the R&D and G&A line in terms of leverage. So I guess when we think about the raise for the full year, and I know, Mo, you had some commentary earlier on that. Can you just talk about like where we should see most of that increase coming from and how to think about that in relation to the model?

Great question. Thank you for bringing it up. I can share that research and development, general and administrative, and sales and marketing all showed improvements this quarter in relation to our focus areas. In sales and marketing, we were able to use some of those savings to invest in increasing awareness of RingCentral in the market. Our win rates are strong in the industry, and as more businesses learn about RingCentral, we expect these win rates to lead to more organic revenue growth in the future. As we look to the rest of the year, the same overall dynamic applies. This isn't solely about focusing on one item in the profit and loss statement; it's about the three key areas we're concentrating on: maintaining discipline and operational excellence in our hiring and headcount, evaluating our program expenditures for efficiencies, and rationalizing our supply chain and vendor network to drive savings. Vaibhav, would you like to add anything?

No, I think you covered it.

The next question is from Peter Levine with Evercore.

Can you explain or provide details on the incremental margin contribution from a partner-led deal compared to a direct deal? As we consider the long-term profitability model, where do you see that leverage coming from?

Thank you for the question. To understand the different go-to-market strategies, consider this: when we secure a deal directly, the cost is highest because we invest in both lead generation and our sales team. In contrast, with channel partners, we only incur costs when we close a deal. As our strategic partner-led approach gains traction, it becomes more beneficial in two ways. First, we can utilize our partners' sales teams and marketing efforts, leading to reduced upfront booking costs. Second, these partners have established relationships with customers, which lowers churn and enhances customer lifetime value. Therefore, when we analyze everything, the lifetime value to customer acquisition cost ratios improve significantly for partner-led strategies compared to our overall business.

The next question is from Michael Turrin with Wells Fargo.

This is Austin Williams on for Michael Turrin. I just wanted to touch on the seat contributions from partners. How should we think about the mix of those 500,000 seats from Mitel versus the three A's? And as a follow-up, is there any color you can provide on how those GSP partners have added to the account in the context of those as well?

The seat count that Vaibhav mentioned earlier, Austin, actually does not include Mitel. It's solely based on the first three relationships, which answers your first question. Regarding the GSP side, we do not disclose the number of seats from those relationships. However, I want to emphasize what I appreciate about the GSP relationships: they are accumulating over time. As they become more active and start generating revenue, I see this as incremental growth that we can anticipate not only for the rest of this year but also reaching a minimum of 23%. Thank you for your question.

The last question will be from Alex Zukin with Wolfe Research.

I just want to get a better understanding. I'm calculating the ARR and trying to assess the net new ARR added, which appears to be down year-over-year compared to Q1 of last year. Is this due to delayed recognition, currency issues, or something else in the business that we should be aware of? Also, regarding gross margins, could you comment on the GAAP gross margins, which have decreased significantly sequentially? I'm interested in understanding where they might stabilize and what is driving the change.

Very good, Alex. I'll take the first half and then hand it off to Vaibhav. So I’ll come back to what I articulated a little bit ago, which is a good bookings quarter, about $100 million. If you look at the last x number of years of our business, Q1 is almost always the seasonally lowest quarter of the year. And really, as we think about how we're managing the business, it's about both driving that top line revenue growth and new bookings as well as ensuring that we're doing it in a very disciplined and profitable way. And that's where management's focus is right now. We want to drive both top line and bottom line. And that's why you're seeing us accelerating our margin guidance about 3x up for the rest of the year versus our prior guide last quarter. And then Vaibhav, if you want to talk about gross margin?

Yes. So on the gross margin side, when you look at the non-GAAP gross margins, there are multiple kind of good guys there. As we are upgrading to our native video product, we get efficiencies. And generally, with scale, we are spreading the costs, the fixed costs over a wider base, and we are getting scale. From a GAAP perspective, the two things that we exclude are stock-based compensation and intangibles amortization. And we acquired the CloudLink technology from Mitel last quarter. I think that the amortization of that technology is running through, we are getting the full impact of that in the quarter that's driving down GAAP gross margins.

This concludes our question-and-answer session, and the conference has now also concluded. Thank you for attending today's presentation. You may now disconnect.