RingCentral, Inc. - Quarter Report: 2015 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2015

OR

For the transition period from                      to                     

Commission File Number: 001-36089

RingCentral, Inc.

(Exact Name of Registrant as Specified in its Charter)

20 Davis Drive

Belmont, California 94002

(Address of principal executive offices)

(650) 472-4100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x

As of November 1, 2015, there were 56,786,478 shares of Class A Common Stock issued and outstanding and 14,159,413 shares of Class B Common Stock outstanding.

TABLE OF CONTENTS

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in, but not limited to, the sections titled “Risk Factors”, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates”, “believes”, “could”, “seeks”, “estimates”, “expects”, “intends”, “may”, “plans”, “potential”, “predicts”, “projects”, “should”, “will”, “would” or similar expressions and the negatives of those terms. Forward-looking statements include, but are not limited to, statements about:

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Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be significantly different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss these risks in greater detail in the section entitled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be significantly different from what we expect.

Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ significantly from those anticipated in these forward looking statements, even if new information becomes available in the future.

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

RINGCENTRAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements

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RINGCENTRAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share data)

See accompanying notes to condensed consolidated financial statements

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RINGCENTRAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements

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RINGCENTRAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1. Description of Business and Summary of Significant Accounting Policies

Description of Business

RingCentral, Inc. (the “Company”) is a provider of software-as-a-service (“SaaS”) solutions for business communications. The Company was incorporated in California in 1999 and was reincorporated in Delaware on September 26, 2013.

Basis of Presentation and Consolidation

The unaudited condensed consolidated financial statements and accompanying notes of the Company reflect all adjustments (all of which are normal, recurring in nature and those discussed in these Notes) that are, in the opinion of management, are necessary for a fair presentation of the interim periods presented. All intercompany balances and transactions have been eliminated in consolidation. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending December 31, 2015. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted under the rules and regulations of the Securities and Exchange Commission (the “SEC”).

The unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the fiscal year ended December 31, 2014 included in the Company’s fiscal 2014 Annual Report on Form 10-K. There have been no changes in the Company’s significant accounting policies from those that were disclosed in the Company’s audited consolidated financial statements for the fiscal year ended December 31, 2014.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The significant estimates made by management affect revenues, accounts receivable, the allowance for doubtful accounts, inventory and inventory reserves, the allocation of the value of purchase consideration for business acquisitions, goodwill, intangible assets, share-based compensation, deferred revenue, return reserves, provision for income taxes, uncertain tax positions, loss contingencies, sales tax liabilities and accrued liabilities. Management periodically evaluates such estimates and they are adjusted prospectively based upon such periodic evaluation. Actual results could differ from these estimates, and such differences could affect the results of operations reported in future periods.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). This new guidance is a result of a joint project with the International Accounting Standards Board (the “IASB”) to clarify and converge the revenue recognition principles under U.S. GAAP and IFRS and to develop guidance that would streamline and enhance revenue recognition requirements. In April 2015, the FASB proposed a one-year deferral of the effective date for the new revenue reporting standard for entities reporting under U.S. GAAP. In accordance with the deferral, ASU 2014-09 will be effective for fiscal 2018, including interim periods within that reporting period. Entities have the option of applying retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. The Company is currently evaluating the impact that the standard will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. The new guidance simplifies the accounting for measurement-period adjustments in a business combination by requiring the acquirer to recognize adjustments to provisional amounts identified during the measurement period in the reporting period in which the adjustments are determined. The acquirer is also required to record in the reporting period in which the adjustments are determined, the effect on earnings of changes in depreciation, amortization, and other items resulting from the change to the provisional amounts. The new guidance is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. Therefore this guidance will impact future measurement period adjustments, if any, beginning in fiscal year 2016.

Note 2. Financial Statement Components

Cash and cash equivalents consisted of the following (in thousands):

Accounts receivable, net consisted of the following (in thousands):

Property and equipment, net consisted of the following (in thousands):

Accrued liabilities consisted of the following (in thousands):

Note 3. Fair Value of Financial Instruments

The Company carries certain financial assets consisting of money market funds, certificates of deposit, commercial paper and corporate debt securities at fair value on a recurring basis. Fair value is based on the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

The financial assets carried at fair value were determined using the following inputs (in thousands):

At September 30, 2015, all short-term investments were designated as available-for-sale and reported at fair value based either upon quoted prices in active markets, quoted prices in less active markets, or quoted market prices for similar investments, with unrealized gains and losses, net of related tax, if any, included in other comprehensive loss. The Company classifies all highly liquid instruments with an original maturity on the date of purchase of three months or less as cash and cash equivalents. The Company classifies available-for-sale securities that have a maturity date longer than three months as short-term investments, including those investments with a maturity date of longer than one year that are highly liquid These short-term investments may be sold at any time for use in current operations or for other purposes, such as consideration for business acquisitions, even if they have not yet reached maturity. As a result, all of our short-term investments held at September 30, 2015 were classified as current assets in the accompanying condensed consolidated balance sheet.

At September 30, 2015, available-for-sale securities consisted of the following (in thousands):

The Company does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of September 30, 2015. The Company expects to receive the full principal and interest on all of these short-term investments.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

The expected maturities of our short-term investments in available-for-sale securities at September 30, 2015 are shown below (in thousands):

The Company’s other financial instruments, including accounts receivable, accounts payable and other current liabilities, are carried at cost which approximates fair value due to the relatively short maturity of those instruments.

At December 31, 2014 and September 30, 2015, the Company estimated the fair value of its debt primarily using an expected present value technique, which is based on observable market inputs using interest rates currently available to companies of similar credit standing for similar terms and remaining maturities, and considering its own credit risk. The estimated fair value of the Company’s current and non-current debt obligations was $25,671,000 at December 31, 2014, compared to its carrying amount of $24,577,000 at that date. The estimated fair value of the Company’s current and non-current debt obligations was $20,012,000 at September 30, 2015, compared to its carrying amount of $19,528,000 at that date. If the debt was measured at fair value in the condensed consolidated balance sheets, the Company’s current and non-current debt would be classified in Level 2 of the fair value hierarchy.

Note 4. Business Combinations

On June 4, 2015, the Company acquired Glip, Inc. (“Glip”), a cloud messaging and collaboration company based in Boca Raton, Florida. Glip is a provider of team messaging services, integrated with project management, group calendars, notes, annotations, and file sharing. Glip also includes integrations with a number of third party business solutions. The objective of the acquisition is to extend our platform by adding team messaging and collaboration services such as calendar, project management, and document sharing. The consideration for this acquisition, net of cash acquired and including the fair value of contingent consideration payable in cash upon achievement of certain earn out milestones and the fair value of common stock issuable to the sellers, was $11,906,000. Under the terms of the acquisition, the Company may also pay up to $2,000,000 in payments at the end of a two-year period to certain Glip employees, who continue to be employees of the Company, which are accounted for as a post-combination expense.  

The consideration exchanged consisted of the following (in thousands):

The $3,447,000 fair value of the 223,190 unregistered common shares issued as part of the consideration paid for Glip ($3,830,000 before a $383,000 discount due to a 6-month restriction of resale as a result of SEC Rule 144 for issuance of unregistered shares) was determined on the basis of the five day weighted closing market price of the Company’s common shares preceding the acquisition date. We determined the initial fair value of the milestone based earn out liability of $2,289,000 using various estimates, including probabilities of success and discount rates. Based on the completion of milestones for the quarter ended September 30, 2015 and the estimated probability of completing of the remaining milestones, the estimated fair value of the milestone based earn out liability is $2,378,000 at September 30, 2015 and is classified as a current and non-current liability in the condensed consolidated balance sheet. At September 30, 2015, the contingent payment liability is $1,940,000 and classified as a non-current liability in the condensed consolidated balance sheet.

The following table summarizes the fair value of assets acquired as of the date of acquisition (in thousands):

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

The Company has included the financial results of Glip in the condensed consolidated statements of operations from the date of acquisition.

The following table sets forth the fair value components of identifiable acquired intangible assets (in thousands) and their estimated useful lives (in years) as of the date of acquisition:

The amount recorded for developed technology represents the estimated fair value of Glip’s cloud messaging and collaboration technology. The amount recorded for customer relationships represents the fair values of the underlying relationships with Glip customers. The goodwill balance is primarily attributed to the assembled workforce and expanded market opportunities when integrating Glip’s cloud messaging and collaboration technology with the Company’s other offerings. The goodwill balance is not deductible for U.S. income tax purposes.

The weighted-average amortization periods for customer relationships and developed technology are approximately 1.7 years and 4.7 years, respectively.

Acquired intangible assets as of September 30, 2015 were as follows (in thousands):

Amortization expense from acquired intangible assets for the three and nine months ended September 30, 2015 was $256,000 and $328,000, respectively. Amortization of developed technology is included in research and development expenses and amortization of customer relationships is included in sales and marketing expenses in the condensed consolidated statements of operations.

Estimated amortization expense for acquired intangible assets for the following five fiscal years and thereafter is as follows (in thousands):

Note 5. Debt

As of September 30, 2015, the Company’s debt is comprised of borrowings under the Third Amended and Restated Loan and Security Agreement dated March 30, 2015 (the “SVB Agreement”), as amended, with Silicon Valley Bank (“SVB”).

SVB Loan Agreement

Under the SVB Agreement, at September 30, 2015, the Company has one outstanding growth capital term loan (i.e., “the 2013 term loan”) and a revolving line of credit. The Company borrowed an additional growth capital loan in March 2012 (the “2012 term loan”) that matured in March 2015 and was repaid in full.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

The 2013 term loan was borrowed on December 31, 2013 with a principal amount of $15,000,000, which is being repaid in 48 equal monthly installments of principal, plus accrued and unpaid interest. Interest is due monthly and accrues at a floating rate based on the Company’s option of an annual rate of either the (i) prime rate plus a margin of 0.75% or 1.00% or (ii) adjusted LIBOR rate (based on one, two, three or six-month interest periods) plus a margin of 3.75% or 4.00%, in each case such margin being determined based on cash balances maintained with SVB. The Company elected the prime rate option and based on cash balances maintained with SVB at September 30, 2015, the current interest rate is 4.0%. As of September 30, 2015, the outstanding principal balance of the 2013 term loan was $8,750,000. $5,000,000 of the remaining principal balance is classified as non-current liabilities in the accompanying condensed consolidated balance sheet as this portion of the remaining principal balance is due beyond September 30, 2016.

The revolving line of credit provides for a maximum borrowing of up to $15,000,000 in principal amount, subject to limits based on recurring subscription revenue amounts as defined in the SVB Agreement. The recurring subscription revenue requirement is not expected to limit the amount of borrowings available under the line of credit. Under the line of credit, interest is paid monthly and accrues at a floating rate based on the Company’s option of an annual rate of either the (i) prime rate plus a margin of 0.25% or 0.50% or (ii) adjusted LIBOR rate (based on one, two, three or six-month interest periods) plus a margin of 3.25% or 3.50%, in each case such margin being determined based on cash balances maintained with SVB. The Company elected the prime rate option and based on cash balances maintained with SVB at September 30, 2015, the current interest rate is 3.5%. On August 11, 2015, the Company amended the terms of the SVB Agreement extending the maturity of the revolving line of credit from August 13, 2015 to August 14, 2017. The outstanding principal balance is classified as non-current liabilities in the condensed consolidated balance sheet as the principal balance is due beyond September 30, 2016. As of September 30, 2015, the outstanding principal balance and the available borrowing capacity of the line of credit were $10,778,000 and $4,222,000, respectively.

The Company has pledged substantially all of its assets, excluding intellectual property, as collateral to secure its obligations under the SVB Agreement. The SVB Agreement contains customary negative covenants that limit the Company’s ability to, among other things, incur additional indebtedness, grant liens, make investments, repurchase stock, pay dividends, transfer assets and merge or consolidate. The SVB Agreement, as amended, also contains customary affirmative covenants, as well as financial covenants that require the Company to (i) maintain minimum cash balances of $10,000,000, as defined in the agreement, and (ii) maintain minimum EBITDA levels, as determined in accordance with the agreement. On March 30, 2015, the Company adjusted certain financial covenants to expand its ability to invest in certain foreign subsidiaries and property and equipment. The Company was in compliance with all covenants under its credit agreement with SVB as of September 30, 2015.

Note 6. Commitments and Contingencies

Leases

The Company leases facilities for office space under non-cancelable operating leases for its U.S. and international locations and has entered into capital lease arrangements to obtain property and equipment for its operations. In addition, the Company leases space from third party datacenter hosting facilities under co-location agreements to support its cloud infrastructure. On September 25, 2014, the Company entered into a new lease for its headquarters in Belmont, California for a total lease commitment of $17,497,000 through 2021 and lease incentives totaling $1,486,000. The Company took full possession of the building in the first quarter of fiscal 2015.

On February 25, 2015, the Company signed an agreement that accelerated the termination date of the lease for its old headquarters office located in San Mateo, California from May 31, 2017 to April 30, 2015. The effectiveness of the early termination of the lease was contingent upon a third party entering into a lease agreement with the landlord for the San Mateo office space by February 28, 2015, and obtaining by March 30, 2015 the consent of the landlord’s lender to the early termination. The early termination of the lease was deemed effective on March 9, 2015 as both conditions were met. No additional lease payments were imposed by the early termination agreement and the Company’s future lease obligation ended on April 30, 2015. All office space lease agreements contain escalating monthly rental payments over the lease term, which are amortized to rent expense on a straight-line basis over the lease term.

Minimum Third Party Network Service Provider Commitments

On August 14, 2015, the Company amended its contract with a third-party network service provider containing a two year minimum commitment of approximately $170,000 a month. The commitment requires us to pay the higher of (i) our actual invoice or (ii) the monthly commitment amount.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Sales Tax Liability

During 2010 and 2011, the Company increased its sales and marketing activities in the U.S., which may be asserted by a number of states to create an obligation under nexus regulations to collect sales taxes on sales to customers in the state. Prior to 2012, the Company did not collect sales taxes from customers on sales in all states. In March 2012, the Company commenced collecting and remitting sales taxes on sales in all states so a loss contingency related to sales taxes exists for sales and marketing activities in 2010, 2011, and the first two months of 2012 ended February 29, 2012. As of September 30, 2015 and December 31, 2014, the Company had a balance for a long-term sales tax liability of $3,887,000 and $3,953,000, respectively, based on its best estimate of the probable liability for the loss contingency incurred as of those dates. The Company’s estimate of a probable outcome under the loss contingency is based on analysis of its sales and marketing activities, revenues subject to sales tax, and applicable regulations in each state in each period. No significant adjustments to the long-term sales tax liability have been recognized in the accompanying condensed consolidated financial statements for changes to the assumptions underlying the estimate. However, changes in management’s assumptions may occur in the future as the Company obtains new information which can result in adjustments to the recorded liability. Increases and decreases to the long-term sales tax liability are recorded as general and administrative expense.

A current sales tax liability for non-contingent amounts expected to be remitted in the next twelve months of $4,997,000 and $4,178,000, is included in accrued liabilities as of September 30, 2015 and December 31, 2014, respectively.

Legal Matters

The Company determines whether an estimated loss from a contingency should be accrued by assessing whether a loss is deemed probable and can be reasonably estimated. The Company assesses its potential liability by analyzing specific litigation and regulatory matters using reasonably available information. The Company develops its views on estimated losses in consultation with inside and outside counsel, which involves a subjective analysis of potential results and outcomes, assuming various combinations of appropriate litigation and settlement strategies. Except for the sales tax liability matter discussed above, the Company did not have any accrued liabilities recorded for such loss contingencies as of September 30, 2015 and December 31, 2014. Legal fees are expensed in the period in which they are incurred.

Note 7. Share-Based Compensation

A summary of share-based compensation expense recognized in the Company’s condensed consolidated statements of operations follows (in thousands):

A summary of share-based compensation expense by award type follows (in thousands):

As of September 30, 2015 and December 31, 2014, there was approximately $21,799,000 and $20,069,000 of unrecognized share-based compensation expense, net of estimated forfeitures, related to non-vested stock option grants, which will be recognized on a straight-line basis over the remaining weighted-average vesting periods of approximately 2.6 years and 2.4 years, respectively.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Equity Incentive Plans

As of September 30, 2015 a total of 7,997,000 shares remained available for grant under the 2013 Plan. A summary of option activity under all of the Company’s equity incentive plans at September 30, 2015 and changes during the period then ended is presented in the following table:

The weighted average grant date fair value of options granted and the total intrinsic value of options exercised were as follows (in thousands, except weighted average grant date fair value):

The Company estimated the fair values of each option awarded on the date of grant using the Black-Scholes-Merton option pricing model, which requires inputs including the fair value of common stock, expected term, expected volatility, risk-free interest rate and dividend yield. The weighted-average assumptions used in the option pricing models in the periods presented were as follows:

Employee Stock Purchase Plan

The ESPP allows eligible employees to purchase shares of the Class A common stock at a discount through payroll deductions of up to the lesser of 15% of their eligible compensation or the IRS allowable limit per calendar year, . A participant may purchase a maximum of 3,000 shares during an offering period. The offering period starts on the first trading day on or after May 11th and November 11th of each year. At the end of the offering period, the purchase price is set at the lower of: (i) 90% of the fair value of the Company’s common stock at the beginning of the six month offering period, and (ii) 90% of the fair value of the Company’s common stock at the end of the six month offering period. As of September 30, 2015, there was a total of $131,000 of unrecognized share-based compensation expense, net of estimated forfeitures, related to ESPP, which will be recognized on a straight-line basis over the remaining weighted-average vesting period of approximately 0.1 years. At September 30, 2015, a total of 2,024,000 shares were available for issuance under the ESPP.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Restricted Stock Units

For the nine months ended September 30, 2015, we issued 1,089,000 restricted stock units of Class A common stock under the 2013 Plan with a weighted average grant date fair value of $17.33 per share. As of September 30, 2015, there was a total of $90,883,000 of unrecognized share-based compensation expense, net of estimated forfeitures, related to restricted stock units, which will be recognized on a straight-line basis over the remaining weighted-average vesting period of approximately 3.1 years.

Note 8. Concentrations

Revenue by geographic location is based on the billing address of the customer. More than 90% of the Company’s revenue is from the United States during the three and nine months ended September 30, 2015 and 2014. Property and equipment by geographic location is based on the location of the legal entity that owns the asset. At September 30, 2015 and December 31, 2014, more than 86% and 87% of the Company’s property and equipment was located in the United States, with no single country outside the United States representing more than 10% of property and equipment.

Note 9. Income Taxes

The Provision (benefit) for income taxes for the three and nine months ended September 30, 2015 and 2014, was ($56,000), $19,000, ($1,342,000), and $184,000, respectively. The provision for income taxes during the three and nine months ended September 30, 2015 and 2014 consisted primarily of state minimum taxes, and foreign income taxes. Due to the Glip acquisition, a deferred tax liability was established for the book-tax basis difference related to identifiable acquired intangibles. The net deferred tax liability from acquisitions provided an additional source of income to support the realizability of our pre-existing deferred tax asset and as a result, we released a portion of the valuation allowance that was established in the previous year and recorded a one-time tax benefit of $1,411,000 for the three months ended June 30, 2015.

For the three and nine months ended September 30, 2015 and 2014, the provision for income taxes differed from the U.S federal statutory amount primarily due to state and foreign taxes currently payable, and the Company realized no benefit for current year losses due to maintaining a full valuation allowance against the U.S. and the majority of foreign net deferred tax assets.

The realization of tax benefits of net deferred tax assets is dependent upon future levels of taxable income, of an appropriate character, in the periods the items are expected to be deductible or taxable. Based on the available objective evidence, the Company does not believe it is more likely than not that the net deferred tax assets will be realizable. Accordingly, the Company has provided a full valuation allowance against the entire domestic and the majority of the foreign net deferred tax assets as of September 30, 2015 and December 31, 2014. The Company intends to maintain the full valuation allowance on the U.S. net deferred tax assets until sufficient positive evidence exists to support a reversal of, or decrease in, the valuation allowance.

During the three and nine months ended September 30, 2015, there have been no significant changes to the total amount of unrecognized tax benefits.

Note 10. Basic and Diluted Net Loss Per Share

Basic net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period, less the weighted-average unvested common stock subject to repurchase or forfeiture as they are not deemed to be issued for accounting purposes. Diluted net loss per share is computed by giving effect to all potential shares of common stock, stock options and restricted stock units, to the extent they are dilutive. For the three and nine months ended September 30, 2015 and 2014, all such common stock equivalents have been excluded from diluted net loss per share as the effect to net loss per share would be anti-dilutive.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

The following table sets forth the computation of the Company’s basic and diluted net loss per share of common stock (in thousands, except per share data):

The following table sets forth the potential shares of common stock that were excluded from diluted weighted-average common shares outstanding (in thousands):

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K filed on February 27, 2015 under the Securities Act of 1934, as amended (the “Securities Act”) with the SEC. As discussed in the section titled “Special Note Regarding Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ significantly from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included under Part II, Item 1A below.

Overview

We are a leading provider of software-as-a-service, or SaaS, solutions for the way employees communicate in business. We believe that our innovative, cloud-based approach disrupts the large market for business communications solutions by providing flexible and cost-effective services that support distributed workforces, mobile employees and the proliferation of “bring-your-own” communications devices. We enable convenient and effective communications for our customers, across all their locations, all their employees, all their devices, thus enabling a more productive and dynamic workforce.

We currently offer five products: RingCentral Office, RingCentral Professional, RingCentral Fax, RingCentral Contact Center, and Glip by RingCentral. RingCentral Office is our flagship product, which we sell in three editions: Standard, Premium and Enterprise. Our Standard Edition of RingCentral Office includes call management, mobile applications, voice, business SMS, business analytics and reporting, conferencing capabilities, and integration with other cloud-based business applications such as Box, Dropbox, Google for Work and Microsoft Office 365. Our Premium and Enterprise Editions include the Standard Edition functionality together with additional software integrations with other cloud-based business applications such as Salesforce CRM, Zendesk and Desk.com, high-definition voice, more advanced call routing for our larger customers, and automatic call recording. All editions are feature rich, but vary in the number of included toll-free minutes, number of concurrent conferencing meeting attendees, and by some of the various integrations with third-party business applications. We also offer RingCentral Professional, primarily an inbound call management tool for mobile professionals, and RingCentral Fax, an online fax subscription that permits sending and receiving faxes over the internet. In addition, we offer RingCentral Contact Center, a solution powered by inContact, which gives contact center agents the ability to engage their customers through multiple channels including voice, email, and chat along with easy administration and real-time reporting.  

In June 2015, RingCentral acquired Glip, a team messaging and collaboration company, which provides a solution for team messaging, task management, group calendars, notes, file sharing, and integrations with a number of third party business applications. We recently integrated Glip with RingCentral Office delivering an integrated cloud business communications and team collaboration solution. For example, employees can send a message, assign a task, schedule an event, share a file, collaborate on a project, and make a call or schedule a conference – from one easy to use mobile, web, or desktop app—versus toggling between multiple single-point applications to get work done.

We primarily generate revenues by selling subscriptions of our RingCentral Office, RingCentral Professional, RingCentral Fax, and RingCentral Contact Center offerings. RingCentral Office is offered at monthly subscription rates, varying by the specific functionalities and services and the number of users. RingCentral Office customers generally pay higher monthly subscription rates than customers of our other service offerings. RingCentral Professional is offered at monthly subscription rates that vary based on the desired amount of minutes usage and extensions allotted to the plan. RingCentral Fax is offered at monthly subscription rates that vary based on the desired number of pages and phone numbers allotted to the plan. In addition, RingCentral Contact Center is also offered as a monthly subscription based on three editions with varying features and capabilities.

Our subscription plans have historically had monthly or annual contractual terms, although we also have subscription plans with multi-year contractual terms, generally with larger customers. We believe that this flexibility in contract duration is important to meet the different needs of our customers. Generally, most of our fees for subscription plans have been billed in advance via credit card. However, as the number of larger RingCentral Office customers grows, we expect to bill more customers through commercial invoices with customary payment terms and, accordingly, our levels of accounts receivable may increase. We also expect our level of prepayments by larger customers to increase, accordingly our level of deferred revenue may increase. For the three and nine months ended September 30, 2015 and 2014, consistent with our recent prior periods, subscriptions revenues accounted for more than 90% of our total revenues. The remainder of our revenues is primarily comprised of product revenues from the sale of pre-configured office phones. We do not develop, manufacturer, or otherwise touch the delivery of physical phones and offer it as a convenience for a total solution to our customers in connection with subscriptions to our services. We rely on third-party providers to develop and manufacture these devices and fulfillment partners to successfully serve our customers. We are seeing a shift in customer behavior choosing to use our leading smart phone app versus the physical phones.

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We make significant upfront investments to acquire customers. Until 2010, we acquired most of our customer subscriptions through direct transactions on our website driven by online marketing channels. Beginning in 2010, in connection with our introduction of RingCentral Office, we established a direct, inside sales force. Since then, we have continued investing in our direct, inside sales force while also developing indirect sales channels to market our brand and our subscription offerings. Our indirect sales channel consists of a network of over 2,500 sales agents and resellers, including distributors such as Ingram Micro, Tech Data, Zones, and Jenne, as well as carrier partners including AT&T, TELUS, and BT, which we refer to collectively as resellers. We intend to continue to foster this network and to expand our network with other resellers. Beginning in 2011, we also began expanding into more traditional forms of media advertising, such as radio and billboard advertising.

Since its launch, our revenue growth has primarily been driven by our flagship RingCentral Office product offering, which has resulted in an increased number of customers, increased average subscription revenues per customer, and increased retention of our existing customer and user base. We define a “customer” as one individual billing relationship for the subscription to our services, which generally correlates to one company account per customer. We define a user as one person within a customer who has been granted a subscription license to use our services, such that the number of users per customer generally correlates closely to the number of employees within a customer account. As of September 30, 2015, we had customers from industries including advertising, finance, healthcare, legal services, non-profit organizations, real estate, retail and technology, and ranging in size from businesses with fewer than 10 to more than 1,500 RingCentral users. In October of 2013, we launched our United Kingdom operations, however for the three and nine months ended September 30, 2015 and 2014, 98% of our total revenues were generated in the U.S. and Canada, although we expect the percentage of our total revenues derived outside of the U.S. and Canada to grow as we expand internationally in the United Kingdom and beyond.  

The growth of our business and our future success depend on many factors, including our ability to expand our customer base to medium-sized and larger customers, continue to innovate, grow revenues from our existing customer base, expand our distribution channels and scale internationally. For example, as a result of our efforts to expand our customer base to target medium-sized and larger businesses, we expect to incur additional research and development and support and professional services costs and may experience longer sales cycles that may delay revenues associated with these costs. While these areas represent significant opportunities for us, they also pose risks and challenges that we must successfully address in order to sustain the growth of our business and improve our operating results.

We have experienced significant growth in recent periods, with total revenues of $114.5 million, $160.5 million and $219.9 million in 2012, 2013 and 2014, respectively, generating year-over-year increases of 40% and 37%, respectively. We have continued to make significant expenditures and investments, including those in research and development, infrastructure and operations and incurred net losses of $35.4 million, $46.1 million and $48.3 million, in 2012, 2013 and 2014, respectively. For the three months ended September 30, 2015 and 2014, our total revenues were $76.8 million and $56.9 million, respectively, representing a year-over-year increase of 35%. For the nine months ended September 30, 2015 and 2014, our total revenues were $212.8 million and $158.0 million, respectively, representing a year-over-year increase of 35%. For the three months ended September 30, 2015 and 2014, our net loss was $6.3 million and $12.0 million, respectively, and for the nine months ended September 30, 2015 and 2014, our net loss was $25.2 million and $38.2 million, respectively.

Key Business Metrics

In addition to generally accepted accounting principles, or U.S. GAAP, financial measures such as total revenues, gross margin and cash flows from operations, we regularly review a number of key business metrics to evaluate growth trends, measure our performance, and make strategic decisions. We discuss revenues and gross margin under “Results of Operations” and cash flow from operations under “Liquidity and Capital Resources.” Other key business metrics are discussed below.

Annualized Exit Monthly Recurring Subscriptions

We believe that our Annualized Exit Monthly Recurring Subscriptions (ARR) is a leading indicator of our anticipated subscriptions revenues. We believe that trends in revenue are important to understanding the overall health of our marketplace, and we use these trends in order to formulate financial projections and make strategic business decisions. Our Annualized Exit Monthly Recurring Subscriptions equals our Monthly Recurring Subscriptions multiplied by 12. Our Monthly Recurring Subscriptions equals the monthly value of all customer subscriptions in effect at the end of a given month. For example, our Monthly Recurring Subscriptions at September 30, 2015 were $24.8 million. As such, our Annualized Exit Monthly Recurring Subscriptions at September 30, 2015 were $297.5 million.

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RingCentral Office Annualized Exit Monthly Recurring Subscriptions

We calculate our RingCentral Office Annualized Exit Monthly Recurring Subscriptions (Office ARR) in the same manner as we calculate our Annualized Exit Monthly Recurring Subscriptions, except that only customer subscriptions from RingCentral Office customers are included when determining Monthly Recurring Subscriptions for the purposes of calculating this key business metric. RingCentral Office is our flagship product offering. We believe that trends in revenue with respect to RingCentral Office are also important to understanding the overall health of our marketplace, and we use these trends in order to formulate financial projections and make strategic business decisions. Our RingCentral Office Annualized Exit Monthly Recurring Subscriptions at September 30, 2015 were $227.7 million.

Net Monthly Subscription Dollar Retention Rate

We believe that our Net Monthly Subscription Dollar Retention Rate provides insight into our ability to retain and grow subscriptions revenues, as well as our customers’ potential long-term value to us. We believe that our ability to retain our customers and expand their use of our solutions over time is a leading indicator of the stability of our revenue base and we use these trends in order to formulate financial projections and make strategic business decisions. We define our Net Monthly Subscription Dollar Retention Rate as (i) one plus (ii) the quotient of Dollar Net Change divided by Average Dollar Monthly Recurring Subscriptions.

We define Dollar Net Change as the quotient of (i) the difference of our Monthly Recurring Subscriptions at the end of a period minus our Monthly Recurring Subscriptions at the beginning of a period minus our Monthly Recurring Subscriptions at the end of the period from new customers we added during the period, (ii) all divided by the number of months in the period. We define our Average Monthly Recurring Subscriptions as the average of the Monthly Recurring Subscriptions at the beginning and end of the measurement period.

As an illustrative example, if our Monthly Recurring Subscriptions were $118 at the end of a quarterly period and $100 at the beginning of the period, and $20 at the end of the period from new customers we added during the period, then the Dollar Net Change would be equal to ($0.67), or the amount equal to the difference of $118 minus $100 minus $20, all divided by three months. Our Average Monthly Recurring Subscriptions would equal $109, or the sum of $100 plus $118, divided by two. Our Net Monthly Subscription Dollar Retention Rate would then equal 99.4%, or approximately 99%, or one plus the quotient of the Dollar Net Change divided by the Average Monthly Recurring Subscriptions.

Our key business metrics for the five quarterly periods ended September 30, 2015 were as follows (dollars in millions):

Quarterly Revenue Trends

Our subscriptions revenues are primarily driven by recurring subscription services. Historically, we have acquired more new customers in the first and third quarters of our fiscal year. However, we have seen this trend become less pronounced as our business has grown, sales of RingCentral Office have accounted for a higher percentage of our total revenues, and as we move up-market to target and acquire larger customers.

Quarterly Operating Expenses Trends

Operating expenses are primarily driven by headcount and headcount-related expenses, including share-based compensation expenses, and by sales and marketing programs, and have been relatively consistent as a percentage of revenues. We experience some seasonality in spending on sales and marketing as we spend relatively less on marketing programs in the third and fourth quarters because of the summer and year-end vacation periods. However, we cannot assure you that this trend will continue.

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Results of Operations

The following tables set forth selected condensed consolidated statement of operations data and such data as a percentage of total revenues. The historical results presented below are not necessarily indicative of the results that may be expected for any future period (in thousands):

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Percentage of Total Revenues: