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 theSEC onFebruary 26, 2020 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). As discussed in the section entitled "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 these differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in the section entitled "Risk Factors" included under Part II, Item 1A below. Overview We are a leading provider of software-as-a-service ("SaaS") solutions that enable businesses to communicate, collaborate, and connect. 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 organizations across all their locations and employees, enabling them to be more productive and more responsive to their customers. Our cloud-based business communications and collaboration solutions are designed to be easy to use, providing a single user identity across multiple locations and devices, including smartphones, tablets, PCs and desk phones. Our solutions can be deployed rapidly and configured and managed easily. Through our platform, we enable third-party developers and customers to integrate our solution with leading business applications to customize their own business workflows. InApril 2020 , we announced RingCentral Video ("RCV"), which is another component offered as part of RingCentral Office. We have a portfolio of cloud-based offerings that are subscription based, made available at different rates varying by the specific functionalities, services, and number of users. We primarily generate revenues from the sale of subscriptions to our offerings. Our subscription plans have monthly, annual, or multi-year contractual terms. We believe that this flexibility in contract duration is important to meet the different needs of our customers. For each of the three months endedMarch 31, 2020 and 2019, subscriptions revenues accounted for 90% or more of our total revenues. The remainder of our revenues has historically been primarily comprised of product revenues from the sale of pre-configured phones and professional services. 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. We continue to invest 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 resellers who sell our solutions. We also sell our solutions through carriers including AT&T, Inc. ("AT&T"),TELUS Communications Company ("TELUS"), and BT Group plc ("BT"). InOctober 2019 , we entered into a strategic partnership with Avaya Holdings Corp. ("Avaya"), which includes the introduction of a new solutionAvaya Cloud Office byRingCentral ("ACO"), which will be marketed and sold by Avaya and its subsidiaries. InDecember 2019 , we entered into a strategic partnership with Atos SE ("Atos"), which includes the introduction of a co-brandedUnified Communications as a Service ("UCaaS") solution. 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 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. As ofMarch 31, 2020 , we had customers from a range of industries, including financial services, education, healthcare, legal services, real estate, retail, technology, insurance, construction, hospitality, and state and local government, among others. For each of the three months endedMarch 31, 2020 and 2019, the vast majority of our total revenues were generated in theU.S. andCanada , although we expect the percentage of our total revenues derived outside of theU.S. andCanada to grow as we continue to expand internationally. 26
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The growth of our business and our future success depend on many factors, including our ability to expand our customer base to larger customers, continue to innovate, grow revenues from our existing customer base, expand our distribution channels, and scale internationally. InDecember 2019 , a novel strain of Coronavirus disease ("COVID-19") was reported and inJanuary 2020 , theWorld Health Organization (the "WHO") declared the outbreak a "Public Health Emergency of International Concern." InFebruary 2020 , the WHO raised the COVID-19 threat level from high to very high at a global level and inMarch 2020 , the WHO characterized the COVID-19 as a pandemic. The worldwide spread of COVID-19 has resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. As of the filing date, the extent to which the COVID-19 pandemic may impact our financial condition or results of operations remains uncertain. While our revenues and earnings are relatively predictable as a result of our subscription-based business model, the effect of the COVID-19 pandemic, may not be fully reflected in our results of operations and overall financial performance until future periods. The COVID-19 pandemic has created a global slowdown of economic activity which has and will likely continue to decrease demand for a broad variety of goods and services, while also disrupting sales channels and marketing activities for an unknown period of time until the disease is contained. We are experiencing elevated churn in certain customer verticals, and customer requests for extension of payment terms. To address customer hardships, we are actively working with our customers to provide greater flexibility to manage challenges they are facing. Due to shelter in place, we are also observing reduction in demand for desktop phones. We may continue to experience curtailed customer demand due to reduced customer spends, shortened contract duration, higher churn, lengthened payment terms, credit cards declines, potential delays in professional services implementations, and reduction in demand for desktop phones, which could adversely impact our business, results of operations and overall financial performance in future periods. The extent of the impact of the COVID-19 pandemic on our operational and financial performance will also depend on certain developments, including the duration and spread of the outbreak, actions taken to contain the virus or its impact, impact on our partners, resellers and employees, impact on our customer, employee or industry events, and effect on our vendors, all of which are uncertain and cannot be predicted. For example, to support the health and well-being of our employees, customers, partners and communities in response to the COVID-19 pandemic, a vast majority of our employees are currently working remotely and we have shifted some of our customer events to virtual-only experiences, and we may deem it advisable to similarly alter, postpone or cancel entirely additional customer, employee or industry events in the future. At this point, the extent to which the COVID-19 may impact our financial condition or results of operations is uncertain, but changes we have implemented have not affected and are not expected to affect our ability to maintain operations, including financial reporting systems, internal control over financial reporting, and disclosure controls and procedures. Further discussion of the potential impacts of the COVID-19 pandemic on our business can be found in the section titled "Risk Factors" included in Part II, Item 1A below. Key Business Metrics In addition toUnited States generally accepted accounting principles ("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 and free cash flows 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 business, and we use these trends in order to formulate financial projections and make strategic business decisions. Our ARR equals our Monthly Recurring Subscriptions multiplied by 12. Our Monthly Recurring Subscriptions equals the monthly value of all customer recurring charges at the end of a given month. For example, our Monthly Recurring Subscriptions atMarch 31, 2020 was$85.8 million . As such, our ARR atMarch 31, 2020 was$1.0 billion . 27
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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 ARR, except that only customer subscriptions from RingCentral Office andRingCentral customer engagement solutions customers are included when determining Monthly Recurring Subscriptions for the purposes of calculating this key business metric. We believe that trends in revenue with respect to these products are important to the understanding of the overall health of our business, and we use these trends in order to formulate financial projections and make strategic business decisions. Our Office ARR atMarch 31, 2020 was$0.9 billion . 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 revenue, 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 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, all divided by (ii) 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$118 , divided by two. Our Net Monthly Subscription Dollar Retention Rate would then equal 99.4%, or approximately 99%, or one plus the quotient of the Dollar Net Change divided by the Average Monthly Recurring Subscriptions. Our key business metrics for the five quarterly periods endedMarch 31, 2020 were as follows (dollars in millions): March 31, 2020 December 31, 2019 September 30, 2019 June 30, 2019 March 31, 2019 Net Monthly Subscription Dollar Retention Rate >99% >99% >99% >99% >99% Annualized Exit Monthly Recurring Subscriptions$ 1,029.7 $ 960.1 $ 881.4 $ 830.8 $ 776.7 RingCentral Office Annualized Exit Monthly Recurring Subscriptions$ 943.3 $ 876.8 $ 800.3 $ 749.2 $ 694.0 28
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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): Three Months Ended March 31, 2020 2019 Revenues Subscriptions$ 243,104 $ 182,708 Other 24,408 18,781 Total revenues 267,512 201,489 Cost of revenues Subscriptions 52,433 35,334 Other 21,011 15,501 Total cost of revenues 73,444 50,835 Gross profit 194,068 150,654 Operating expenses Research and development 40,910 29,787 Sales and marketing 131,312 99,551 General and administrative 47,336 28,779 Total operating expenses 219,558 158,117 Loss from operations (25,490 ) (7,463 ) Other income (expense), net Interest expense (7,502 ) (5,032 ) Other (expense) income, net (27,517 ) 3,051 Other expense, net (35,019 ) (1,981 ) Loss before income taxes (60,509 ) (9,444 ) Provision for (benefit from) income taxes 212 (3,086 ) Net loss$ (60,721 ) $ (6,358 ) 29
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Percentage of Total Revenues *
Three Months Ended March 31, 2020 2019 Revenues Subscriptions 91 % 91 % Other 9 9 Total revenues 100 100 Cost of revenues Subscriptions 20 17 Other 8 8 Total cost of revenues 27 25 Gross profit 73 75 Operating expenses Research and development 15 15 Sales and marketing 49 49 General and administrative 18 14 Total operating expenses 82 78 Loss from operations (10 ) (4 ) Other income (expense), net Interest expense (3 ) (3 ) Other (expense) income, net (10 ) 2 Other expense, net (13 ) (1 ) Loss before income taxes (23 ) (5 ) Provision for (benefit from) income taxes - (2 ) Net loss (23 )% (3 )%
* Percentages may not add up due to rounding.
Comparison of the Three Months Ended
Three Months Ended March
31,
(in thousands, except percentages) 2020 2019 $ Change
% Change Revenues Subscriptions$ 243,104 $ 182,708 $ 60,396 33 % Other 24,408 18,781 5,627 30 % Total revenues$ 267,512 $ 201,489 $ 66,023 33 % Percentage of revenues Subscriptions 91 % 91 % Other 9 9 Total 100 % 100 % Subscriptions revenue. Subscriptions revenue increased by$60.4 million , or 33%, for the three months endedMarch 31, 2020 as compared to the respective prior year period. The increase was primarily a combination of the acquisition of new customers and upsells of seats and additional offerings to our existing customer base. This growth was primarily driven by an increase in sales to our mid-market and enterprise customers as we continue to move up market and increased sales through our channel partners. Although we expect to continue to add new customers and existing customers to increase their usage of our product, we will continue to monitor the COVID-19 pandemic carefully and its impact on customer demand, contract duration, churn, payment 30
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terms, and credit card declines. Fluctuations in foreign currency exchange rates and volatility in the market, including those resulting from the COVID-19 pandemic, could also cause variability in our revenue. Other revenues. Other revenues are primarily comprised of product revenue from the sale of pre-configured phones, phone rentals, and professional services. Other revenues increased by$5.6 million , or 30%, for the three months endedMarch 31, 2020 as compared to the respective prior year period, primarily due to the increase in product sales and professional services resulting from the overall growth in our business. Due to shelter in place, we may continue to see a reduction in demand for desktop phones. Also, the timing of professional services revenue could fluctuate due to dependency on onsite implementation for some customers. We will continue to monitor the COVID-19 pandemic carefully and its impact on phone and professional services revenue. Cost of Revenues and Gross Margin Three Months EndedMarch 31 ,
(in thousands, except percentages) 2020 2019 $ Change
% Change Cost of revenues Subscriptions$ 52,433 $ 35,334 $ 17,099 48 % Other 21,011 15,501 5,510 36 % Total cost of revenues$ 73,444 $ 50,835 $ 22,609 44 % Gross margins Subscriptions 78 % 81 % Other 14 % 17 % Total gross margin % 73 % 75 % Subscriptions cost revenues and gross margin. Cost of subscriptions revenues increased by$17.1 million , or 48%, for the three months endedMarch 31, 2020 as compared to the respective prior year period. The primary drivers of the increase were increases in infrastructure support costs of$9.5 million including amortization expense from acquired intangible assets, third-party costs to support our solution offerings of$5.4 million , and headcount and personnel and contractor-related costs of$2.2 million including share-based compensation expense. These factors resulted in a decrease in gross margin. The increase in headcount and other expense categories described herein was 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. We expect subscription gross margin to be within a relatively similar range in the future. However, we continue to monitor the COVID-19 pandemic carefully and its impact on our customers. Other cost of revenues and gross margin. Cost of other revenues increased by$5.5 million , or 36%, for the three months endedMarch 31, 2020 as compared to the respective prior year period. This was primarily due to an increase in cost of product sales of$2.6 million and personnel costs of$2.5 million including share-based compensation expense. Other revenues gross margin fluctuates based on timing of completion of professional services projects and transaction price of product sales. We continue to monitor the impact of COVID-19 on timing of professional services and transaction price of product sales. Research and Development Three Months Ended March 31,
(in thousands, except percentages) 2020 2019 $ Change
% Change Research and development$ 40,910 $ 29,787 $ 11,123 37 % Percentage of total revenues 15 % 15 %
Research and development expenses increased by
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The increases in research and development headcount and other expense categories were driven by continued investment in current and future software development projects for our applications. Given the continued emphasis and focus on product innovation, we expect research and development expenses to continue to increase in absolute dollars. Sales and Marketing Three Months EndedMarch 31 ,
(in thousands, except percentages) 2020 2019 $ Change
% Change Sales and marketing$ 131,312 $ 99,551 $ 31,761 32 % Percentage of total revenues 49 % 49 % Sales and marketing expenses increased by$31.8 million , or 32%, for the three months endedMarch 31, 2020 as compared to the respective prior year period, primarily due to increases in personnel and contractor costs of$14.2 million , third-party commissions of$9.2 million , advertising and marketing costs of$5.3 million , and amortization of deferred sales commission costs of$3.6 million . Of the total increase in personnel and contractor costs,$10.0 million was primarily due to headcount growth and approximately$3.7 million was due to higher share-based compensation expense. The increases in sales and marketing headcount and other expense categories were necessary to support our growth strategy to acquire new customers with a focus on larger customers, and to establish brand recognition to achieve greater penetration into theNorth America and international markets. Additionally, we expect sales and marketing expenses to continue to increase in absolute dollars as we continue to expand our presence inNorth America and international markets. General and Administrative Three Months Ended March 31,
(in thousands, except percentages) 2020 2019 $ Change
% Change General and administrative$ 47,336 $ 28,779 $ 18,557 64 % Percentage of total revenues 18 % 14 % General and administrative expenses increased by$18.6 million , or 64%, for the three months endedMarch 31, 2020 as compared to the respective prior year period, primarily due to increases in personnel and contractor costs of$13.9 million , including$9.2 million due to higher share-based compensation expense and a net increase of$4.7 million primarily driven by headcount growth, professional fees of$2.2 million , and increased allowance for doubtful accounts of$1.2 million , partly driven by customer collection concerns stemming from COVID-19. 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. Other Income (Expense), Net Three Months Ended March 31,
(in thousands, except percentages) 2020 2019 $ Change
% Change Interest expense$ (7,502 ) $ (5,032 ) $ (2,470 ) nm Other (expense) income, net (27,517 ) 3,051 (30,568 ) nm Other expense, net$ (35,019 ) $ (1,981 ) $ (33,038 ) nm nm - not meaningful Other expense, net increased by$33.0 million for the three months endedMarch 31, 2020 as compared to the respective prior year period, primarily due to a$23.2 million loss recognized on long-term investments,$7.3 million from the partial repurchase of our convertible senior notes, and$2.5 million increase in interest expense from the amortization of the debt discount and issuance costs due to the issuance of our new convertible notes. Interest income on our investments declined by$2.0 million as a result of reduction in Federal Funds rate in response to COVID-19. We expect interest income to further reduce in the future due to interest rate volatility in the current macroeconomic environment. 32
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Net loss Net loss increased by$54.4 million for the three months endedMarch 31, 2020 as compared to the respective prior year period, mainly due to non-cash items that include$20.1 million from our long-term investments,$17.2 million higher share-based compensation expense,$7.3 million from the partial repurchase of our convertible senior notes, and$6.7 million increase in amortization of acquired intangibles. Liquidity and Capital Resources Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. As ofMarch 31, 2020 andDecember 31, 2019 , we had cash and cash equivalents of$762.1 million and$343.6 million , respectively. We finance our operations primarily through sales to our customers and the majority of our customers are billed monthly. For customers with annual or multi-year contracts and those who opt for annual invoicing, we generally invoice only one annual period in advance. Revenue is deferred for such advanced billings. We also finance our operations from proceeds from issuance of convertible senior notes and proceeds from issuance of stock under our stock plans. We believe that our operations and existing liquidity sources as well as capital resources will satisfy our future cash requirements for at least the next 12 months. InMarch 2020 , we issued$1.0 billion aggregate principal of 0% convertible senior notes due 2025 (the "2025 Notes") in a private placement. As ofMarch 31, 2020 , the carrying value of our 2025 Notes totaled$796.9 million . Our 2025 Notes contain customary financial covenants. In connection with the offering of the 2025 Notes, we used part of the net proceeds from the offering to repurchase a portion of the 2023 Notes. For additional details, refer to Note 6, Convertible Senior Notes, to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. We are in compliance with all covenants under both the 2025 and 2023 Notes as ofMarch 31, 2020 . Our future capital requirements will depend on many factors, including revenue growth and costs incurred to support customer growth, acquisitions and expansions, sales and marketing, research and development, increased general and administrative expenses to support the anticipated growth in our operations, and capital equipment required to support our growing headcount and in support of our co-location data center facilities, as well as the extent of the COVID-19 pandemic and its effect on our business. Our capital expenditures in future periods are expected to grow in line with our business. We continually evaluate our capital needs and may decide to raise additional capital to fund the growth of our business for general corporate purposes through public or private equity offerings or through additional debt financing. We also may in the future make investments in or acquire businesses or technologies that could require us to seek additional equity or debt financing. Access to additional capital may not be available, or on favorable terms. The uncertainty created by the changing markets and economic conditions related to the COVID-19 pandemic may also impact our customers' ability to pay on a timely basis, which could negatively impact our operating cash flows. The table below, for the periods indicated, provides selected cash flow information (in thousands): Three Months Ended March 31, 2020 2019 Net cash provided by operating activities$ 13,069 $ 20,197 Net cash used in investing activities (14,250 ) (38,275 ) Net cash provided by financing activities 420,296 732 Effect of exchange rate changes (657 ) 47
Net increase (decrease) in cash and cash equivalents
Net Cash Provided by Operating Activities Cash provided by operating activities is influenced by our net loss, the timing of customer collections, as well as the amount and timing of disbursements to our vendors, the amount of cash we invest in personnel, marketing, and infrastructure costs to support the anticipated growth of our business, and the increase in the number of customers. Net cash provided by operating activities was$13.1 million for the three months endedMarch 31, 2020 . This was driven by a net loss of$60.7 million adjusted for impacts of non-cash adjustments of$106.2 million , partially offset by net cash used for 33
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working capital of$18.5 million and$13.9 million attributable to debt discount on a portion of the 2023 senior convertible notes that was repaid. The working capital changes were driven primarily by the timing of cash payments to vendors and cash receipts and prepayments from customers and carriers. The non-cash adjustments resulted primarily from$36.6 million of share-based compensation,$23.2 million for loss on investments,$16.5 million of depreciation and amortization,$14.7 million of amortization of debt discount and issuance costs related to our convertible notes along with the loss on early extinguishment of debt, and$9.8 million of amortization of deferred sales commission costs. Net cash provided by operating activities for the three months endedMarch 31, 2020 , decreased by$7.1 million as compared to the respective prior year period. This change reflects working capital impacts resulting from the timing of payments and collections and payment of a portion of the 2023 Notes related to interest.Net Cash Used in Investing Activities Our primary investing activities have consisted of our long-term investments, business acquisitions and purchase of intellectual properties, and capital expenditures and internal-use software. As our business grows, we expect our capital expenditures to continue to increase. Net cash used in investing activities was$14.3 million for the three months endedMarch 31, 2020 , primarily due to capital expenditures including personnel-related costs associated with development of internal-use software. Net cash used in investing activities for the three months endedMarch 31, 2020 decreased by$24.0 million as compared to the respective prior year period. The decrease was primarily due to cash used for business acquisitions in 2019 partially offset by higher capital expenditures. Net Cash Provided by Financing Activities Our primary financing activities have consisted of raising proceeds through the issuance of stock under our stock plans and issuance of our 2025 Notes, offset by partial repurchase of 2023 Notes. Net cash provided by financing activities was$420.3 million for the three months endedMarch 31, 2020 , primarily due from$986.5 million in proceeds from the issuance of our 2025 Notes, net of issuance costs, partially offset by cash paid for the partial repurchase for our 2023 Notes of$495.7 million ,$60.9 million payments for capped calls transactions and costs, and payments for taxes paid in connection with our stock plans of$10.4 million . Non-GAAP Free Cash Flow To supplement our statements of cash flows presented on a GAAP basis, we use non-GAAP measures of cash flows to analyze cash flow generated from our operations. We define free cash flow, a non-GAAP financial measure, as GAAP net cash provided by (used in) operating activities plus cash paid for repayments of convertible senior notes attributable to debt discount, reduced by purchases of property and equipment and capitalized internal-use software. We believe information regarding free cash flow provides useful information to management and investors in understanding the strength of liquidity and available cash. A limitation of the use of free cash flow is that it does not represent the total increase or decrease in our cash balance for the period. Free cash flow should not be considered in isolation or as an alternative to cash flows from operations, and should be considered alongside our other GAAP-based financial performance measures, such as net cash used in operating activities and our other GAAP financial results. The following table presents a reconciliation of free cash flow to net cash provided by operating activities, the most directly comparable GAAP measure, for each of the periods presented (in thousands): 34
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Table of Contents Three Months EndedMarch 31, 2020 2019 Net cash provided by operating activities 13,069
20,197
Purchases of property and equipment (6,861 ) (6,862 ) Capitalized internal-use software (7,389 ) (3,543 ) Repayment of convertible senior notes attributable to debt discount 13,894 - Non-GAAP free cash flow 12,713 9,792 Backlog We have generally signed new customers to contracts that vary in length, from month-to-month to multi-year terms for our subscriptions. The timing of invoicing to our customers is a negotiated term and thus varies among our subscription contracts. Payment terms are generally billed either monthly or on an annual basis. At any point in the contract term, there can be amounts that we have not yet been contractually able to invoice, which constitute backlog. Until such time as these amounts are invoiced, we do not recognize them as revenues, unearned revenues or elsewhere in our condensed consolidated financial statements. Given the variability in our contract length, we believe that backlog is not a reliable indicator of future revenues and we do not utilize backlog as a key management metric internally. Deferred Revenue Deferred revenue primarily consists of the unearned portion of invoiced fees for our subscriptions, which we recognize as revenue in accordance with our revenue recognition policy. Customers with annual or multi-year contracts may opt for annual invoicing. For these customers, we generally invoice only one annual subscription period in advance. Therefore, our deferred revenue balance does not capture the full contract value of such multi-year contracts. Accordingly, we believe that deferred revenue is not a reliable indicator of future revenues and we do not utilize deferred revenue as a key management metric internally. Contractual Obligations and Commitments Except as set forth below, and in Notes 6, 7 and 8 in the accompanying notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, there were no significant changes in our commitments under contractual obligations, as disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . Contingencies We are and may be in the future subject to certain legal proceedings and from time to time may be involved in a variety of claims, lawsuits, investigations, and proceedings relating to contractual disputes, intellectual property rights, employment matters, regulatory compliance matters, and other matters relating to various claims that arise in the normal course of business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and the amount can be reasonably estimated. Significant judgment is required to determine both probability and the estimated amount of loss. Such legal proceedings are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a significant impact on our results of operations, financial position, and cash flows. Off-balance Sheet Arrangements During the three months endedMarch 31, 2020 and 2019, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Item 3. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risk in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign currency exchange rates and interest rates. We do not hold or issue financial instruments for trading purposes. 35
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Foreign Currency Risk The majority of our sales and contracts are denominated inU.S. dollars, and therefore our net revenue is not currently subject to significant foreign currency risk. As part of our international operations, we charge customers in British Pounds,European Union ("EU") Euro, Canadian Dollars and Australian Dollars, among others. Fluctuations in foreign currency exchange rates and volatility in the market, including those resulting from the COVID-19 pandemic, will cause variability in our revenue. However, this impact has not been significant during the three months endedMarch 31, 2020 . Our operating expenses are generally denominated in the currencies of the countries in which our operations are located, which are primarily in theU.S. , and to a lesser extent inCanada ,Europe , andAsia-Pacific . The functional currency of our foreign subsidiaries is generally the local currency. Our consolidated results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign currency exchange rates. To date, we have not entered into any hedging arrangements with respect to foreign currency risk. During the three months endedMarch 31, 2020 , a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have had a material impact on our condensed consolidated financial statements. As our international operations continue to expand, risks associated with fluctuating foreign currency rates may increase. We will continue to reassess our approach to managing these risks. Interest Rate Risk As ofMarch 31, 2020 , we had cash and cash equivalents of$762.1 million . We hold our cash and cash equivalents for working capital purposes. Declines in interest rates would reduce future interest income. For the three months endedMarch 31, 2020 , a hypothetical 10% increase or decrease in overall interest rates would not have had a material on impact our interest income. The carrying amount of our cash equivalents reasonably approximates fair values. Due to the short-term nature of our money-market funds, we believe that exposure to changes in interest rates will not have a material impact on the fair value of our cash equivalents. We continue to observe lower interest income on our investments as a result of reduction in Federal Funds rate in response to COVID-19. We expect interest income to further reduce in the future due to interest rate volatility in the current macroeconomic environment. As ofMarch 31, 2020 , we had$245.1 million and$796.9 million outstanding from both the 2023 Notes and 2025 Notes (collectively the "Notes"), respectively. We carry the Notes at face value less unamortized discount on our balance sheet, and we present the fair value for required disclosure purposes only. The Notes have a zero percent fixed annual interest rate and, therefore, we have no economic exposure to changes in interest rates. The fair value of the Notes is exposed to interest rate risk. Generally, the fair value of our fixed interest rate Notes will increase as interest rates decline and decrease as interest rates increase. In addition, the fair values of the Notes are affected by our stock price. The fair value of the Notes will generally increase as our common stock price increases and will generally decrease as our common stock price decrease in value. Market Risk As ofMarch 31, 2020 , we had long-term investments in convertible and redeemable preferred stock of$109.9 million . These equity investments are subject to market related risks that could decrease or increase the fair value of our holdings. These equity investments are adjusted to fair value based on market inputs at the balance sheet date, which are subject to market-related risks that could decrease or increase the fair value of our holdings, including the potential impacts from COVID-19. A fluctuation in the investee's stock price, volatility or combination of both could have an adverse impact on the fair value of our investment. A hypothetical adverse stock price or volatility change of 10% could have resulted in a potential decrease of up to$8.1 million in the fair-value of our investment as ofMarch 31, 2020 . Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as ofMarch 31, 2020 . The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in theSEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions 36
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regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as ofMarch 31, 2020 , our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level. Changes in Internal Control over Financial Reporting There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has significantly affected, or is reasonably likely to significantly affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures In designing and evaluating our disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. 37
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