RingCentral, Inc. - Quarter Report: 2017 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2017

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  ☒    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  ☒    No  ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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   ☒

As of May 2, 2017, there were 62,299,595 shares of Class A Common Stock issued and outstanding and 12,866,564 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 and collaboration. 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, 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, 2017. Certain information and note disclosures normally included in annual consolidated 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 (SEC).

The unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. The significant estimates made by management affect revenues, the allowance for doubtful accounts, goodwill, share-based compensation, capitalization of internally developed software, return reserves, provision for income taxes, uncertain tax positions, loss contingencies, sales tax liabilities, and accrued liabilities. Management periodically evaluates these estimates and will make adjustments prospectively based upon the results of such periodic evaluations. Actual results could differ from these estimates.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), which will replace numerous requirements in U.S. GAAP and provide companies with a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. In July 2015, the FASB approved the deferral of the new standard's effective date by one year. The new standard is effective for annual reporting periods beginning after December 15, 2017. The FASB will permit companies to adopt the new standard early, but not before the original effective date of annual reporting periods beginning after December 15, 2016.

The Company is currently evaluating the potential changes from adopting the new standard on its financial statements and disclosures. The Company is in the process of implementing appropriate changes to its business processes, systems and controls to support revenue recognition and disclosures under the new standard. Based on this evaluation, the Company will adopt the requirements of the new standard in the first quarter of 2018 and anticipates using the modified retrospective transition method.  Additionally, as the Company continues to assess the new standard along with industry trends and internal progress, the Company may adjust its implementation plan and methodology to use the full retrospective method accordingly.

Under the new standard, the Company expects in some cases to recognize revenue earlier for subscription plans with free periods and products sold at discounts. The impact of adopting the new standard on the Company’s total revenues is not expected to be material. The Company anticipates the most significant impact of adopting the new standard primarily relates to the deferral of

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

sales commissions due to capitalization of certain sales commissions, which previously were expensed as incurred and to the incremental disclosure requirements. Under the new standard, certain commissions will be capitalized and amortized over the expected period of benefit.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires that lessees recognize a right-of-use asset and a lease liability on the balance sheet for all leases with the exception of short-term leases. Both capital and operating leases will need to be recognized on the balance sheet.  The standard is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted.  The standard must be adopted using a modified retrospective approach for all leases that existed or are entered into after the beginning of the earliest comparative period in the financial statements.  The Company is currently evaluating the timing of adoption and the impact that the standard will have on its consolidated financial statements and related disclosures.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, which clarifies the presentation and classification in the statement of cash flows.  The guidance addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice for certain cash receipts and cash payments.  The standard is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted.  The adoption of this amendment is not expected to have a material impact on the Company’s consolidated financial statements or disclosures.

In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, which requires entities to recognize at the transaction date the income tax effects for intra-entity transfers of assets other than inventory.  The standard is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted.  The Company is currently in the process of evaluating the impact of the adoption on its consolidated financial statements and related disclosures.  

In November 2016, the FASB issued ASU 2016-18, Restricted Cash, which clarifies the presentation of restricted cash and restricted cash equivalents in the statements of cash flows. The standard requires restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts presented on the statements of cash flows. The standard is effective for interim and annual reporting periods beginning after December 15, 2017 using a retrospective adoption method, with early adoption permitted.  The adoption of this amendment is not expected to have a material impact on the Company’s consolidated financial statements or disclosures.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which modifies the goodwill impairment test and requires an entity to write down the carrying value of goodwill up to the amount by which the carrying amount of a reporting unit exceeds its fair value. The standard is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted.  The adoption of this amendment is not expected to have a material impact on the Company’s consolidated financial statements or disclosures.

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting (Topic 718), which simplifies the accounting for stock-based compensation related to the accounting for forfeitures, employer tax withholding, excess tax benefits related to awards and cash flow presentation. The Company adopted the new standard in the first quarter of 2017. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements or related disclosures.  

Reclassification

Certain immaterial items previously reported have been reclassified to conform to the current year’s reporting presentation.

Note 2. Agency Agreement with Westcon Group

In January 2016, the Company entered into a sales agency agreement with Westcon Group, Inc. (Westcon), a global distributor of communications devices, to provide the phones purchased by customers. Under this agreement, the Company was an agent of Westcon and received a commission for its services, which primarily included referring phone sales to Westcon. Westcon provided phones directly to the Company’s customers instead of the Company purchasing phones from third-party vendors and reselling the phones to the Company’s customers. Commission revenues from the arrangement were recorded as the Company was the agent for these sales. The Company completed its transition of direct phone sales to Westcon during the three months ended June 30, 2016, which excluded carriers’ phone sales. The Company did not transition the carrier partners to the agency model as the billing relationships to these customers are through the carriers.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

The Company’s sales of phones that are provided free or significantly discounted to customers were not part of the sales agency agreement with Westcon. The Company recognizes revenue and costs from these sales as the Company is the primary obligor and has latitude in determining pricing.

In December 2016, the Company terminated the Westcon sales agency agreement and entered into a reseller (direct sale) agreement with Westcon. Effective January 1, 2017, the Company switched from the agency model to the direct sale model whereby the Company will no longer serve as an agent for referring phone sales to Westcon and will no longer receive commissions for its services. Under the reseller agreement, the Company will purchase phones directly from Westcon for resale to its customers and will recognize revenues and costs for phone sales based on the following criteria:

Note 3. Other Revenue and Cost of Revenue

For the three months ended March 31, 2017 and 2016, the majority of other revenues consisted of product revenues from sales of phones.  Product revenues were $6.1 million and $4.6 million for the three months ended March 31, 2017 and 2016, respectively. Product cost of revenues were $5.9 million and $4.5 million for the three months ended March 31, 2017 and 2016, respectively.     

Note 4. Financial Statement Components

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

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

Prepaid expenses and other current assets consisted of the following (in thousands):

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Accrued liabilities consisted of the following (in thousands):

Note 5. Fair Value of Financial Instruments

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.  The Company measures and reports certain cash equivalents, including money market funds and certificates of deposit, at fair value in accordance with the provisions of the authoritative accounting guidance that addresses fair value measurements.  This guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  The hierarchy is broken down into three levels based on the reliability of the inputs as follows:

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

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

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.

On February 10, 2017, the Company paid off its debt in full, which was held by Silicon Valley Bank. 

At December 31, 2016, the Company estimated the fair value of its debt 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. The estimated fair value of the Company’s current and non-current debt obligations was $14.9 million at December 31, 2016, compared to its carrying amount of $14.8 million 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 6. Business Combinations      

In June 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. The consideration for the acquisition, net of cash acquired, which also included the fair value of contingent consideration payable upon achievement of certain earn out milestones and the fair value of common stock issuable to the sellers, was $11.9 million.  Of this total consideration, $1.5 million of cash was held back by the Company upon closing as security for certain indemnification obligations of such sellers. In June 2016, the Company paid the $1.5 million in full.  

The initial fair value of the milestone based earn out liability was determined to be $2.3 million using various estimates, including probabilities of achievement and discount rates.  During the year ended December 31, 2016, the Company issued 45,893 shares of the Company’s Class A common stock to settle certain milestones achieved.  Based on the completion of milestones for the three months ended March 31, 2017 and the estimated probability of completing the remaining milestones, the estimated fair value of the milestones based earn out liability was $1.9 million at March 31, 2017 and December 31, 2016, which is classified as a current liability in the condensed consolidated balance sheets.

Additionally, under the terms of the acquisition, the Company may also pay up to $2.0 million 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. At March 31, 2017 and December 31, 2016, the contingent payment liability was $1.4 million, respectively, and is classified as a current liability in the condensed consolidated balance sheets as settlement will occur in 2017.

The carrying values of intangible assets are as follows (in thousands):

Amortization expense from acquired intangible assets for the three months ended March 31, 2017 and 2016 was $0.3 million in both periods. Amortization of developed technology is included in cost of revenues and amortization of customer relationships is included in sales and marketing expenses in the condensed consolidated statements of operations.  At March 31, 2017, the weighted average amortization periods for customer relationships and developed technology approximate 0.2 years and 3.2 years, respectively.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

Note 7. Debt

As of December 31, 2016, the Company’s debt was comprised of borrowings under the Third Amended and Restated Loan and Security Agreement dated March 30, 2015 (SVB Agreement), as amended, with Silicon Valley Bank (SVB).  Under the SVB Agreement, the Company had one outstanding growth capital term loan (2013 Term Loan) and a revolving line of credit. On February 10, 2017, the Company paid off its 2013 Term Loan and revolving line of credit balances of $14.8 million to SVB.  Upon repayment, the SVB Agreement was terminated.

The 2013 Term Loan was borrowed on December 31, 2013 with a principal amount of $15.0 million, which was being repaid in 48 equal monthly installments of principal, plus accrued and unpaid interest. Interest was due monthly and accrued 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 was determined based on cash balances maintained with SVB. The Company elected the prime rate option.  In May 2016, the terms of the SVB Agreement were amended to reduce the margin on the annual rate of the 2013 Term Loan to either (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%, which resulted in an interest rate of 4.00% at December 31, 2016, based on the prime rate option and cash balance maintained with SVB. As of December 31, 2016, the outstanding principal balance of the 2013 Term Loan was $4.0 million, of which $0.3 million was payable subsequent to December 31, 2017 and was classified as a non-current liability in the accompanying condensed consolidated balance sheet.   

The revolving line of credit provided for a maximum borrowing of up to $15.0 million in principal amount, subject to limits based on recurring software subscription revenue amounts as defined in the SVB Agreement. The recurring software subscription revenue requirement did not limit the amount of borrowings available under the line of credit. Under the line of credit, interest was paid monthly and accrued 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 was determined based on cash balances maintained with SVB. The Company elected the prime rate option.  In August 2015, the terms of the SVB Agreement were amended to extend the maturity of the revolving line of credit from August 13, 2015 to August 14, 2017.  In May 2016, the terms of the SVB Agreement were amended to reduce the margin on the annual rate of the revolving line of credit to either the (i) prime rate plus a margin of 0% or 0.25% or (ii) adjusted LIBOR rate (based on one, two, three, or six-month interest periods) plus a margin of 3.00% to 3.25%, resulting in an interest rate of 3.75% at December 31, 2016, based on the prime rate option and cash balance maintained with SVB. As of December 31, 2016, the outstanding principal balance and the available borrowing capacity of the line of credit were $10.8 million and $4.2 million, respectively. The outstanding principal balance was classified as a current liability in the condensed consolidated balance sheet as the principal balance was due in August 2017.   

The Company had pledged substantially all of its assets, excluding intellectual property, as collateral to secure its obligations under the SVB Agreement. The SVB Agreement contained customary negative covenants that limited 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 contained customary affirmative covenants, as well as financial covenants that required the Company to (i) maintain minimum cash balances of $10.0 million, as defined in the SVB Agreement, and (ii) maintain minimum EBITDA levels, as determined in accordance with the SVB Agreement. In March 2016, the Company adjusted certain financial covenants thresholds 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 December 31, 2016. With the repayment of the debt, the lien on the assets has been removed.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 8. 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.  The Company leases space for its corporate headquarters in Belmont, California through July 2021.

Sales Tax Liability

The Company regularly increases its sales and marketing activities in various states within the U.S., which may create nexus in those states to collect sales taxes on sales to customers.  Although the Company is diligent in collecting and remitting such taxes, there is uncertainty as to what constitutes sufficient in-state presence for a state to levy taxes, fees, and surcharges for sales made over the Internet.  As of March 31, 2017 and December 31, 2016, the Company had a long-term sales tax liability of $3.1 million at both period ends, 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.

The Company recorded a current sales tax liability for non-contingent amounts expected to be remitted in the next twelve months of $5.8 million and $6.0 million as of March 31, 2017 and December 31, 2016, respectively, which is included in accrued liabilities in the condensed consolidated balance sheets.

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.  Legal fees are expensed in the period in which they are incurred.

TCPA Matter

          On April 21, 2016, Supply Pro Sorbents, LLC (SPS) filed a putative class action against the Company in the United States District Court for the Northern District of California (Court), alleging common law conversion and violations of the federal Telephone Consumer Protection Act (TCPA) arising from fax cover sheets used by the Company’s customers when sending facsimile transmissions over the Company’s system (Lawsuit).  SPS seeks statutory damages, costs, attorneys’ fees and an injunction in connection with its TCPA claim, and unspecified damages and punitive damages in connection with its conversion claim.  On July 6, 2016, the Company filed a Petition for Expedited Declaratory Ruling before the Federal Communications Commission (FCC), requesting that the FCC issue a ruling clarifying certain portions of its regulations promulgated under TCPA at issue in the Lawsuit (Petition).  The Petition remains pending.  On July 8, 2016, the Company filed a motion to dismiss the Lawsuit in its entirety, along with a collateral motion to dismiss or stay the Lawsuit pending a ruling by the FCC on the Company’s Petition.  On October 7, 2016, the Court granted the Company’s motion to dismiss and gave SPS 20 days to amend its complaint.  The Court concurrently dismissed the Company’s motion to dismiss or stay as moot.  SPS filed its amended complaint on October 27, 2016, alleging the same theories and claims.  On November 21, 2016, the Company filed a motion to dismiss the amended complaint, along with a renewed motion to dismiss or stay the case pending resolution of the FCC Petition.  The motions to dismiss and to stay the Lawsuit are fully briefed and under submission to the Court.  Discovery has not yet commenced.  The Company intends to vigorously defend itself in the Lawsuit.  Litigation is inherently uncertain, however, and it is too early in this proceeding to predict the outcome of this Lawsuit.  Based on the information known by the Company as of the date of this filing and the rules and regulations applicable to the preparation of the Company’s consolidated financial statements, it is not possible to provide an estimated amount of any such loss or range of loss that may occur.

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

Patent Infringement Matter

On April 25, 2017, Uniloc USA, Inc. and Uniloc Luxembourg, S.A. filed in the U.S. District Court for the Eastern District of Texas two actions against the Company alleging infringement of U.S. Patent Nos. 7,804,948; 7,853,000; and 8,571,194 by RingCentral’s Glip unified communications application.  The Company has not yet been served with the lawsuits.  The plaintiffs seek a declaration that the Company has infringed the patents, damages according to proof, injunctive relief, as well as their costs, attorney’s fees, expenses and interest. This litigation is still in its earliest stages and the Company is unable to estimate any reasonably possible loss, or range of loss, with respect to this matter. The Company intends to vigorously defend against this lawsuit. 

Note 9. Share-Based Compensation

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

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

Equity Incentive Plans

As of March 31, 2017, a total of 7,557,532 shares remained available for grant under the 2013 Equity Incentive Plan (2013 Plan). A summary of option activity under all of the Company’s equity incentive plans at March 31, 2017 and changes during the period then ended is presented in the following table:

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

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 model in the periods presented were as follows:

As of March 31, 2017, there was approximately $9.3 million 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 period of approximately 1.9 years.  

Employee Stock Purchase Plan

The 2013 Employee Stock Purchase Plan (ESPP) allows eligible employees to purchase shares of the Class A common stock at a discounted price, 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 periods start on the first trading day on or after May 11th and November 11th of each year. At the end of the offering period, the discounted purchase price is set at the lower of: (i) 90% of the fair value of the Company’s Class A common stock at the beginning of the six month offering period and (ii) 90% of the fair value of the Company’s Class A common stock at the end of the six month offering period.

As of March 31, 2017, there was a total of $0.2 million 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 March 31, 2017, a total of 2,291,580 shares were available for issuance under the ESPP.

Restricted Stock Units

The 2013 Plan provides for the issuance of restricted stock units (RSUs) to employees, directors, and consultants.  RSUs issued under the 2013 Plan generally vest over four years.  A summary of activity of RSUs under the 2013 Plan at March 31, 2017 and changes during the period then ended is presented in the following table:

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RINGCENTRAL, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

As of March 31, 2017, there was a total of $62.8 million 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 3.0 years.

Note 10. Segment Reporting

The Company has determined the chief executive officer is the chief operating decision maker. The Company’s chief executive officer reviews financial information presented on a consolidated basis for purposes of assessing performance and making decisions on how to allocate resources. Accordingly, the Company has determined that it operates in a single reporting segment.

Concentrations

Revenue by geographic location is based on the billing address of the customer. More than 90% of the Company’s revenues were derived from the U.S. during the three months ended March 31, 2017 and 2016.  

Generally, 75% of the Company’s total billings are collected through credit card payments, resulting in a minimal accounts receivable balance.  The Company’s accounts receivable balance of $31.3 million as of March 31, 2017, primarily consists of receivables due from larger customers and carriers who are billed on invoices at customary payment terms.  As the Company moves up-market and acquires larger customers, the Company expects the accounts receivable balance to increase.  At March 31, 2017 and December 31, 2016, one of the Company’s carriers accounted for 28% and 30% of the Company’s total accounts receivable, respectively.  

Long-lived assets by geographic location is based on the location of the legal entity that owns the asset. At March 31, 2017 and December 31, 2016, more than 87% of the Company’s consolidated long-lived assets were located in the U.S. with no single country outside of the U. S. representing more than 10% of the Company’s consolidated long-lived assets.

Note 11. Income Taxes

The provision for income taxes for the three months ended March 31, 2017 and 2016, was $50,953 and $50,005, respectively, and consisted primarily of state minimum taxes and foreign income taxes. For the three months ended March 31, 2017 and 2016, the provision for income taxes differed from the U.S federal statutory rate primarily due to state and foreign taxes currently payable.  Additionally, the Company realized no benefit for current year losses due to a full valuation allowance against the U.S. and the 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 March 31, 2017 and December 31, 2016. 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 months ended March 31, 2017, there have been no significant changes to the total amount of unrecognized tax benefits.

Note 12. 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 shares of 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, restricted stock units, and ESPP to the extent they are dilutive. For the three months ended March 31, 2017 and 2016, 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 summarizes the potentially dilutive common shares that were excluded from diluted weighted-average common shares outstanding because including them would have had an anti-dilutive effect (in thousands):

Note 13. Related Party Transactions

In the ordinary course of business, the Company made purchases from Google Inc. at which one of the Company’s directors serves as President, Americas. Total payables to Google Inc. at March 31, 2017 and December 31, 2016 were $1.6 million and $1.0 million, respectively. Total expenses incurred from Google Inc. were $4.0 million and $2.9 million in the three months ended March 31, 2017 and 2016, respectively.  

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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 with the SEC on February 28, 2017 under the Securities Act of 1934, as amended (the Securities Act). 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 and collaborate in business. We believe that our innovative, cloud-based approach disrupts the large market for business communications and collaboration by providing flexible and cost-effective solutions that support distributed workforces, mobile employees, and the proliferation of smart phones and tablets. We enable convenient and effective communications for our customers, across all their locations, all their employees, all the time, thus enabling a more productive and dynamic workforce.

We primarily generate revenues by selling software subscriptions of our RingCentral Office, RingCentral Professional, RingCentral Fax, RingCentral Contact Center, and RingCentral Glip offerings. RingCentral Office, which offers an integrated communications and collaboration solution, is offered at monthly subscription rates, varying by the specific functionalities and services and the number of users. To support multinational enterprise customers, we introduced RingCentral Global Office (Global Office) as an expansion of RingCentral Office. Global Office, offered on a monthly subscription, connects workforces across multiple countries, while reducing complexity and high costs of maintaining multiple, legacy on-premise PBX systems with a single cloud solution. RingCentral Professional is inbound call management for mobile professionals 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. RingCentral Contact Center is a multi-channel hosted contact center solution that integrates with RingCentral Office, offered at a monthly subscription based on three editions with varying features and capabilities.  RingCentral Glip is a team messaging and collaboration feature made available to all RingCentral Office customers, and as a stand-alone freemium offering to non-RingCentral users. Seamlessly integrated with RingCentral Office, RingCentral Glip enables a collaborative communications experience, which delivers great work productivity and better team efficiency.  RingCentral CloudConnect is a service that allows enterprises to leverage their dedicated and private connections to exchange data directly with the RingCentral cloud. Customers use their preferred network service provider to connect to the RingCentral cloud through a private data exchange enabling lower latency, greater network reliability and availability, and added security. Recently, RingCentral introduced Rooms and Rooms Connector to bring a cloud web conferencing solution to meeting rooms for a monthly per license add-on fee. We also offer RingCentral Connect Platform, which is an open platform supported by Application Program Interfaces (APIs) and Software Development Kits (SDKs) that allows developers to integrate our solution with leading business applications or to customize within their own business workflows.  

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 are billed in advance via credit card or through commercial invoices with customary payment terms. We expect to bill more customers through commercial invoices, thus our level of accounts receivable may increase. As we increase the number of larger customers, we expect our level of prepayments for customers with annual or multi-year contracts to increase and, accordingly, our level of deferred revenue may increase. For the three months ended March 31, 2017 and 2016, software subscriptions revenues accounted for more than 90% of our total revenues. The remainder of our revenues has historically been primarily comprised of product revenues from the sale of pre-configured office phones. We do not develop, manufacture, 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.  

In January 2016, we entered into a sales agency agreement with Westcon, a global distributor of communications devices, to provide the phones purchased by customers. Under this agreement, we were an agent and received a commission for our services, which primarily included referring sales to Westcon. Westcon provided phones directly to our customers instead of us purchasing phones from third-party vendors and reselling the phones to our customers. We recorded commission revenues for this arrangement because we were the agent for these sales.  During the three months ended June 30, 2016, we completed our transition of direct phone sales to Westcon, which excluded our carriers’ phone sales. In addition, we had sales in which we provided free or significantly discounted phones to our customers for promotional reasons. As our agency arrangement did not allow for these significant discounts,

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we were the seller to these customers and recognized the related revenues and costs from the sale.  In addition, our carrier partners did not move to the agency model as they wanted to maintain the customer relationship. This resulted in a mixed hardware engagement model and administrative burden to manage the two models.  In December 2016, we terminated the Westcon sales agency agreement and entered into a reseller (direct sale) agreement with Westcon. Effective January 1, 2017, we switched from the agency model to the direct sale model whereby we are no longer serving as an agent for referring phone sales to Westcon and we no longer receive commissions for our services.  Under the direct sale model, we purchase phones directly from Westcon for resale to our customers. Under this model, we recognize revenues and costs for phone sales as we are the primary obligor for order fulfillment, have latitude in determining pricing, and assume general inventory risk. The shift to the direct sale model resulted in increases in our other revenues and the corresponding costs of other revenues, resulting in decreased gross margin.

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 sales force. Since then, we have continued investing in our direct 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 4,200 sales agents and resellers who are active in selling our solutions and with whom we have direct relationships, including distributors such as CDW Corporation, Ingram Micro Inc., Tech Data Corporation, and Jenne Inc., as well as carrier partners including AT&T Inc., TELUS Communications Company, and BT Group plc, which we refer to collectively as resellers. Our network of resellers includes master agents who manage other sales agents and resellers, resulting in an even larger reseller network.  We intend to continue to foster this network and expand our network with other resellers. We also participate in 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 software subscription revenue 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. In the case of our carrier partners, who resell our product to multiple companies, we consider each reseller to be a single customer. We define a user as one person within a customer who has been granted a subscription license to use our services. As of March 31, 2017, we had customers from a range of industries, including advertising, financial services, healthcare, legal services, non-profit organizations, real estate, retail, technology, insurance, education, waste management, construction, security services, restaurant, software, solar, automotive dealership, managed care, hospitality, and publishing. In October of 2013, we launched our United Kingdom (U.K.) operations; however, for the three months ended March 31, 2017 and 2016, the vast majority 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 March 2017, we announced the expansion of RingCentral Office in 13 European countries including Austria, Belgium, Denmark, France, Ireland, Italy, Luxembourg, Netherlands, Portugal, Norway, Spain, Sweden, and Switzerland.

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, who have higher life-time value and lower attrition, continue to innovate, grow revenues from our existing customer base, expand our distribution channels, and scale internationally.

While these areas represent significant opportunities for us, they also pose risks and challenges that we must 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 $379.7 million, $296.2 million, and $219.9 million in the years ended December 31, 2016, 2015 and 2014, respectively, generating year-over-year increases of 28% and 35%, respectively.  For the three months ended March 31, 2017 and 2016, our total revenues were $111.8 million and $86.5 million, respectively. We have continued to make significant expenditures and investments, including those in sales and marketing, research and development, infrastructure and operations and incurred net losses of $29.3 million, $32.1 million, and $48.3 million in the years ended December 31, 2016, 2015 and 2014, respectively.  For the three months ended March 31, 2017 and 2016, our net loss was $7.3 million and $6.6 million, respectively.

Key Business Metrics

In addition to generally accepted accounting principles, or U.S. GAAP, and 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.

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Annualized Exit Monthly Recurring Subscriptions

We believe that our Annualized Exit Monthly Recurring Subscriptions (ARR) is a leading indicator of our anticipated software subscriptions revenues. We believe that trends in revenue are important to understanding the overall health of our business, and we use these trends 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 contracted at the end of a given month. For example, our Monthly Recurring Subscriptions at March 31, 2017 was $37.6 million. As such, our Annualized Exit Monthly Recurring Subscriptions at March 31, 2017 was $450.8 million.

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 business, and we use these trends to formulate financial projections and make strategic business decisions. Our RingCentral Office Annualized Exit Monthly Recurring Subscriptions at March 31, 2017 was $373.0 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 software 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 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.

For 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 March 31, 2017 were as follows (dollars in millions):

Quarterly Revenue Trends

Our software subscriptions revenue is primarily driven by recurring subscription services. Historically, we have acquired more new customers in the first and third quarters of a 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. 

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Quarterly Operating Expenses Trends

Operating expenses are primarily driven by employee-related 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 a percentage of revenue as we spend relatively less on marketing programs in the third and fourth quarters due to the summer and year-end vacation periods and November and December holidays. However, this trend may not continue as we acquire larger customers.

Results of Operations

The following tables set forth selected condensed consolidated statements 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

Comparison of the three months ended March 31, 2017 and 2016

Revenues

Software subscriptions revenues.  Software subscriptions revenues increased by $23.7 million, or 30%, for the three months ended March 31, 2017 as compared to the respective period of the prior year primarily due to the acquisition of new customers and upsells of additional offerings to our existing customer base. In addition, our software subscriptions revenues mix contained a higher proportion of RingCentral Office customers for the three months ended March 31, 2017 as compared to the respective period of the prior year, which generally carry a higher monthly subscription rate versus our other product offerings. While the acquisition of new customers and upsells of additional offerings and seats into our existing customer base were the primary reasons for the increase, the short-term trends for user and customer acquisition have varied from period to period as some customers made a small initial user subscription followed by a larger additional user subscription, while other customers purchased a large initial user subscription followed by a smaller additional user subscription. In addition, the period of time between a customer’s initial subscription and the purchase of additional subscriptions varies significantly, ranging from one month to a few years. The overall growth in our customer base was primarily due to our investment in sales and marketing personnel, which resulted in our sales and marketing expenditures increasing by 41% for the three months ended March 31, 2017 as compared to the respective period of the prior year, which include advertising and sales personnel expenditures that helped facilitate the increase in customer acceptance of our products.

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Other revenues.  Other revenues are primarily comprised of product revenue from the sale of pre-configured phones, phone rentals and professional services. On January 1, 2017, we switched from an agency model to a direct phone sale model under which we are recognizing the full sales price and cost of the product instead of receiving a commission for phone sales.

Other revenues increased by $1.5 million, or 24%, for the three months ended March 31, 2017, as compared to the respective period of the prior year primarily due to the shift to the direct sale model.

Total revenues.  Total revenues were $111.8 million for the first quarter of 2017, up from $86.5 million in the first quarter of 2016, representing 29% growth. Adjusting for the new direct sale model, on a comparable basis, total revenues grew 27% year over year.

Cost of Revenues and Gross Margin

 Cost of software subscriptions revenues.  Cost of software subscriptions revenues increased by $3.5 million, or 21%, for the three months ended March 31, 2017 as compared to the respective period of the prior year primarily due to increases in personnel costs of $1.1 million, third-party costs to support our products of $0.8 million, overhead costs to support our products of $1.2 million, and professional fees of $0.2 million. The increase in personnel costs was driven by an increase of 14% in average headcount and higher share-based compensation expense of $0.1 million.

The increase in headcount and other expense categories described herein were driven primarily by investments in our infrastructure and capacity to improve the availability of our subscription offerings, while also supporting the growth in new customers and increased usage of our subscriptions by our existing customer base.

Cost of other revenues. Cost of other revenues increased by $2.0 million or 40% for the three months ended March 31, 2017 as compared to the respective period of the prior year. This was primarily due to increases in the cost of product sales of $1.4 million, which was driven primarily by the shift to the direct phone sale model in 2017, and the cost of professional services of $0.6 million.  The increase in the cost of professional services was due to an increase in revenues for implementation services.

Gross margin.  Our gross margin was 76% and 75% for the three months ended March 31, 2017 and 2016, respectively, which was primarily due to an improvement in gross margin for software subscriptions revenues. The improvement in gross margin for software subscriptions revenues was primarily due to economies of scale obtained in our infrastructure, which includes transport costs and customer support expenses. The gross margin for other revenues was 13% and 24% for the three months ended March 31, 2017 and 2016, respectively. The decrease in gross margin for other revenues was due primarily to the transition from the agency model to direct sale model for phones. Adjusting for the new direct model, on a comparable basis, gross margin would have been 1.9% higher year over year.

We expect our software subscription revenues gross margin to remain relatively consistent.  We expect a decrease in other revenues gross margin due to transitioning from the agency model to the direct sale model effective January 2017, which resulted in a move from a net to a gross presentation of other revenue and associated costs. 

Research and Development

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 Research and development expenses increased by $2.2 million, or 14%, for the three months ended March 31, 2017 as compared to the respective period of the prior year primarily due to increases in personnel costs of $1.2 million, cost recovery during the three months ended March 31, 2016 of $0.7 million, professional fees of $0.1 million, and overhead costs to support our research and development efforts of $0.1 million. The increase in personnel cost was primarily due to an increase in average headcount of 24% and higher share-based compensation expense of $0.2 million.  

The increases for the three months ended March 31, 2017 in research and development headcount and other expense categories were driven by continued investment in current and future software development projects for our cloud-based and mobile applications.  We expect research and development expenses to continue to increase in absolute dollars as we continue to invest in such development.

Sales and Marketing

         Sales and marketing expenses increased by $17.1 million, or 41%, for the three months ended March 31, 2017 as compared to the respective period of the prior year primarily due to increases in personnel costs of $9.2 million, indirect channel commissions of $2.9 million, advertising and marketing costs of $2.5 million, training and travel costs of $1.2 million, and overhead costs to support our marketing efforts of $1.4 million, partially offset by a decrease in professional fees of $0.1 million. The increase in personnel cost was primarily due to an increase in average headcount of 36% and higher share-based compensation expense of $1.3 million.  

The increases for the three months ended March 31, 2017 in sales and marketing headcount and other expense categories were necessary to support our growth strategy to acquire new and larger customers and establish brand recognition to achieve greater penetration into the North American and European markets. Additionally, we expect sales and marketing expenses to continue to increase in absolute dollars as we continue to expand our presence in North America, Europe, and other markets.

General and Administrative

        General and administrative expenses increased by $1.8 million, or 13%, for the three months ended March 31, 2017 as compared to the respective period of the prior year primarily due to increases in personnel costs of $2.1 million and outsource center costs of $0.2 million, partially offset by a decrease in professional fees of $0.5 million. The increase in personnel cost was primarily due to an increase in average headcount of 8% and higher share-based compensation expense of $0.5 million.

We expect general and administrative expenses to continue to increase in absolute dollars as we continue to make additional investments in processes, systems and personnel to support our anticipated revenue growth and to comply with our public company reporting obligations.

Other Income and Expense, net

        Other income (expense), net increased by $0.6 million for the three months ended March 31, 2017 as compared to the respective period of the prior year primarily due to lower interest expense of $0.1 million due to the repayment of our debt in February 2017, and

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foreign currency gain in the first quarter of 2017 compared to a foreign exchange loss experienced on the British pound during the prior year comparable period.

Liquidity and Capital Resources

As of March 31, 2017 and December 31, 2016, we had $149.7 million and $160.4 million, respectively, of cash and cash equivalents. Since our initial public offering in 2013 and our follow-on offering in early 2014, we have financed our operations primarily through sales to our customers, proceeds from issuance of stock under our stock plans, and proceeds from issuance of debt. We believe that our operations along with existing liquidity sources will satisfy our cash requirements for at least the next 12 months.

Generally, 75% of our total billings are collected through credit card payments received at the beginning of each subscription period, which is monthly for the majority of our customers.  As we continue to move up market, the number and size of customers with annual or multi-year contracts is increasing and those who opt for annual invoicing is also increasing.  For these customers, we generally invoice only one annual period in advance and all invoicing occurs at the start of the respective subscription period.  Therefore, a source of our cash provided by operating activities is our deferred revenue, which is included within our condensed consolidated balance sheet as a liability.  Deferred revenue consists of the unearned portion of invoiced fees for our software subscriptions, which we recognize as revenue ratably over the term of agreement.  As of March 31, 2017 and December 31, 2016, we had deferred revenue of $49.4 million and $45.2 million, respectively.

As of December 31, 2016, the carrying value of our debt totaled $14.8 million, which was paid in full in February 2017 as discussed in Note 7 of the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.  

Our future capital requirements will depend on many factors, including revenue growth and costs incurred to support customer growth, international expansion, sales and marketing, research and development, litigation, increased general and administrative expenses to support the anticipated growth in our operations, and capital equipment required to support our growing headcount and in support of our co-location data center facilities. Our capital expenditures in future periods are expected to grow in line with our business. To the extent that existing cash and cash equivalents are not sufficient to fund our future operations, we may need to raise additional funds through public or private equity offerings or through additional debt financing. Although we currently are not a party to any agreement and do not have any understanding with any third parties with respect to potential investments in, or acquisitions of, businesses or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional financing sources may not be available on terms favorable to us or at all.

The table below, for the periods indicated, provides selected cash flow information (in thousands):