RINGCENTRAL, INC. 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 theSecurities and Exchange Commission (the "SEC") 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 and nine months endedSeptember 30, 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 and rental 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 resellerswho 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 is marketed and sold by Avaya and its subsidiaries. InDecember 2019 , we entered into a strategic partnership with Atos SE ("Atos") and its subsidiary,Unify Software andSolutions GmbH & CO. KG ("Unify"), which includes the introduction of a newUnified Communications as a Service ("UCaaS") solution called Unify Office byRingCentral ("UO"), which is marketed and sold as the exclusive UCaaS offering for the Atos Unify product family installed base. InJuly 2020 , we entered into a strategic partnership with Alcatel-Lucent Enterprise ("ALE"), which includes the introduction of a new co-branded solution which will be marketed and sold as the exclusive UCaaS solution offering of ALE. We intend to continue to foster this network and expand our network with resellers and other channel partners. 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 ofSeptember 30, 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 and nine 31 -------------------------------------------------------------------------------- Table of Contents months endedSeptember 30, 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. 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 ("COVID-19") was reported and inJanuary 2020 , theWorld Health Organization (the "WHO") declared the outbreak a "Public Health Emergency of International Concern." InFebruary 2020 , theWHO raised the COVID-19 threat level from high to very high at a global level and inMarch 2020 , theWHO 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. During the three months endedSeptember 30, 2020 , we noted contributions from new bookings as more businesses transition toRingCentral in the current work-from-anywhere environment. In the first and early part of the second quarter, we experienced higher churn rate mainly with small business customers in certain verticals. Since then we have seen stabilization in churn levels. Due to the shelter-in-place, we continue to see more customers opting for theRingCentral apps on laptops and mobile devices over traditional desktop phones which has impacted demand for physical phone devices. We also observed customer requests for extension in payment terms. To address customer hardships, we continue to engage with these customers providing them greater flexibility to manage challenges they are facing. 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 may experience curtailed customer demand due to reduced customer spend, shortened contract duration, higher churn, lengthened payment terms, credit card 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. We may in the future continue to experience elevated churn in certain customer verticals and customer requests for extension of payment terms. 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 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 pandemic 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. 32 -------------------------------------------------------------------------------- Table of Contents 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 atSeptember 30, 2020 was$98.3 million . As such, our ARR atSeptember 30, 2020 was$1.2 billion . 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 primarily 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 atSeptember 30, 2020 was$1.1 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$118 , divided by two. Our Net Monthly Subscription Dollar Retention Rate would then equal 99.4%, or approximately 99%, or one plus the quotient of the Dollar Net Change divided by the Average Monthly Recurring Subscriptions. Our key business metrics for the five quarterly periods endedSeptember 30, 2020 were as follows (dollars in millions): September 30, December 31, September 30, 2020 June 30, 2020 March 31, 2020 2019 2019 Net Monthly Subscription Dollar Retention Rate >99% >99% >99% >99% >99% Annualized Exit Monthly Recurring Subscriptions$ 1,179.0 $ 1,106.5 $ 1,029.7 $ 960.1 $ 881.4 RingCentral Office Annualized Exit Monthly Recurring Subscriptions$ 1,091.6 $ 1,018.3 $ 943.3$ 876.8 $ 800.3 33
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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
2020 2019 2020 2019
Revenues
Subscriptions $ 279,639 $ 210,906 $ 779,781 $ 588,406
Other 23,985 22,446 69,340 61,587
Total revenues 303,624 233,352 849,121 649,993
Cost of revenues
Subscriptions 60,531 40,930 169,685 114,343
Other 21,783 18,775 62,710 49,827
Total cost of revenues 82,314 59,705 232,395 164,170
Gross profit 221,310 173,647 616,726 485,823
Operating expenses
Research and development 48,481 35,286 132,910 97,705
Sales and marketing 152,986 109,882 421,931 313,023
General and administrative 49,513 39,142 146,381 100,401
Total operating expenses 250,980 184,310 701,222 511,129
Loss from operations (29,670) (10,663) (84,496) (25,306)
Other income (expense), net
Interest expense (12,680) (5,160) (32,780) (15,280)
Other income, net 21,824 2,926 36,910 9,118
Other income (expense), net 9,144 (2,234) 4,130 (6,162)
Loss before income taxes (20,526) (12,897) (80,366) (31,468)
Provision for (benefit from) income taxes 431 (148) 803 (3,118)
Net loss $ (20,957) $ (12,749) $ (81,169) $ (28,350)
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Percentage of Total Revenues *
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Revenues
Subscriptions 92 % 90 % 92 % 91 %
Other 8 10 8 9
Total revenues 100 100 100 100
Cost of revenues
Subscriptions 20 18 20 18
Other 7 8 7 8
Total cost of revenues 27 26 27 25
Gross profit 73 74 73 75
Operating expenses
Research and development 16 15 16 15
Sales and marketing 50 47 50 48
General and administrative 16 17 17 15
Total operating expenses 83 79 83 79
Loss from operations (10) (5) (10) (4)
Other income (expense), net
Interest expense (4) (2) (4) (2)
Other income, net 7 1 4 1
Other income (expense), net 3 (1) - (1)
Loss before income taxes (7) (6) (9) (5)
Provision for (benefit from) income taxes - - - -
Net loss (7) % (5) % (10) % (4) %
* Percentages may not add up due to rounding.
Comparison of the Three and Nine Months Ended
Three Months Ended September 30, Nine Months Ended September 30,
(in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change
Revenues
Subscriptions $ 279,639 $ 210,906 $ 68,733 33 % $ 779,781 $ 588,406 $ 191,375 33 %
Other 23,985 22,446 1,539 7 % 69,340 61,587 7,753 13 %
Total revenues $ 303,624 $ 233,352 $ 70,272 30 % $ 849,121 $ 649,993 $ 199,128 31 %
Percentage of revenues
Subscriptions 92 % 90 % 92 % 91 %
Other 8 10 8 % 9 %
Total 100 % 100 % 100 % 100 %
Subscriptions revenue. Subscriptions revenue increased by $68.7 million , or 33%,
for the three months ended September 30, 2020 , and $191.4 million , or 33%, for
the nine months ended September 30, 2020 , as compared to the respective prior
year periods. 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 terms, and
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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 $1.5 million , or 7%, for the three months ended
September 30, 2020 , and $7.8 million , or 13% for the nine months ended
September 30, 2020 , as compared to the respective prior year periods, 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 continued to see
a shift towards using RingCentral apps on laptops and mobile devices over
traditional desktop phones and timing of professional services projects. We may
see a reduction in demand for desktop phones and slower implementation services.
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 Ended September 30, Nine Months Ended September 30,
(in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change
Cost of revenues
Subscriptions $ 60,531 $ 40,930 $ 19,601 48 % $ 169,685 $ 114,343 $ 55,342 48 %
Other 21,783 18,775 3,008 16 % 62,710 49,827 12,883 26 %
Total cost of revenues $ 82,314 $ 59,705 $ 22,609 38 % $ 232,395 $ 164,170 $ 68,225 42 %
Gross margins
Subscriptions 78 % 81 % 78 % 81 %
Other 9 % 16 % 10 % 19 %
Total gross margin % 73 % 74 % 73 % 75 %
Subscriptions cost revenues and gross margin. Cost of subscriptions revenues
increased by $19.6 million , or 48%, for the three months ended September 30,
2020 as compared to the respective prior year period. The primary drivers of the
increase were increases in infrastructure support costs including amortization
of acquired intangible of $10.8 million , third-party costs to support our
solution offerings of $6.9 million , and personnel and contractor-related costs
including share-based compensation expenses of $3.0 million . The decrease in
gross margin was mainly driven by higher amortization of acquired intangible
assets of $6.2 million mainly due to acquisition of certain intellectual
property rights and share-based compensation expense of $1.1 million .
Cost of subscriptions revenues increased by $55.3 million , or 48%, for the nine
months ended September 30, 2020 , as compared to the respective prior year
period. The primary drivers of the increase were increases in infrastructure
support costs including amortization of acquired intangibles of $29.4 million ,
third-party costs to support our solution offerings of $19.3 million , and
personnel and contractor-related costs including share-based compensation
expense of $8.2 million . The decrease in gross margin was mainly driven by
higher amortization of acquired intangible assets of $19.3 million and higher
share-based compensation expense of $2.8 million .
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
$3.0 million , or 16%, for the three months ended September 30, 2020 as compared
to the respective prior year period. This was primarily due to an increase in
personnel costs of $2.5 million including share-based compensation expense.
Other revenue gross margin fluctuated based on timing of completion of
professional services projects and transaction price for product sales.
Cost of other revenues increased by $12.9 million , or 26%, for the nine months
ended September 30, 2020 , as compared to the respective prior year period. This
was primarily due to an increase in personnel costs of $8.0 million including
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share-based compensation expense, and cost of product sales of $4.3 million .
Other revenue gross margin fluctuated based on timing of completion of
professional services projects and transaction price for 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 September 30, Nine Months Ended September 30,
(in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change
Research and development $ 48,481 $ 35,286 $ 13,195 37 % $ 132,910 $ 97,705 $ 35,205 36 %
Percentage of total revenues 16 % 15 % 16 % 15 %
Research and development expenses increased by $13.2 million , or 37%, for the
three months ended September 30, 2020 as compared to the respective prior year
period, primarily driven by increases in personnel and contractor costs due to
higher headcount growth of $6.4 million , higher share-based compensation expense
of $4.4 million , and increase in professional fees of $2.8 million .
Research and development expenses increased by $35.2 million , or 36%, for the
nine months ended September 30, 2020 , as compared to the respective prior year
period, primarily driven by $32.1 million increase in personnel and contractor
costs and increase in professional fees of $4.7 million . The increase in
personnel and contractor costs was mainly driven by approximately $19.3 million
relating to headcount growth and $11.9 million share-based compensation expense.
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 Ended September 30, Nine Months Ended September 30,
(in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change
Sales and marketing $ 152,986 $ 109,882 $ 43,104 39 % $ 421,931 $ 313,023 $ 108,908 35 %
Percentage of total revenues 50 % 47 % 50 % 48 %
Sales and marketing expenses increased by $43.1 million , or 39%, for the three
months ended September 30, 2020 as compared to the respective prior year period,
primarily due to increases in personnel and contractor costs of $20.7 million ,
advertising and marketing costs of $14.0 million , third-party commissions of
$6.5 million , and amortization of deferred sales commission costs of $4.4
million , partially offset by $3.3 million decrease in travel costs resulting
from the impact of COVID-19. Of the total increase in personnel and contractor
costs, $12.7 million was primarily due to headcount growth and approximately
$7.4 million was due to higher share-based compensation expense.
Sales and marketing expenses increased by $108.9 million , or 35%, for the nine
months ended September 30, 2020 , as compared to the respective prior year
period, primarily due to increases in personnel and contractor costs of $51.9
million , advertising and marketing costs of $28.1 million , third-party
commissions of $22.5 million , and amortization of deferred sales commission
costs of $11.9 million , partially offset by a $6.2 million decrease in travel
costs resulting from the impact of COVID-19. Of the total increase in personnel
and contractor costs, $33.6 million was primarily due to headcount growth
and approximately $17.6 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 the North 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 in North America and international
markets.
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General and Administrative
Three Months Ended September 30, Nine Months Ended September 30,
(in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change
General and administrative $ 49,513 $ 39,142 $ 10,371 26 % $ 146,381 $ 100,401 $ 45,980 46 %
Percentage of total revenues 16 % 17 % 17 % 15 %
General and administrative expenses increased by $10.4 million , or 26%, for the
three months ended September 30, 2020 as compared to the respective prior year
period, primarily due to increases in personnel and contractor costs of $11.6
million including $10.9 million due to higher share-based compensation expense,
business fees and taxes of $1.7 million , and overhead costs of $1.3 million ,
partially offset by cost savings of $3.1 million including credits and decreased
travel costs.
General and administrative expenses increased by $46.0 million , or 46%, for the
nine months ended September 30, 2020 , as compared to the respective prior year
period, primarily due to increases in personnel and contractor costs of $40.1
million including $31.9 million due to higher share-based compensation expense,
business fees and taxes of $4.4 million , professional fees of $3.3 million ,
overhead costs of $2.6 million , and increased allowance for doubtful accounts of
$1.6 million partly driven by customer collection concerns stemming from
COVID-19, partially offset by cost savings of $6.3 million including credits and
decreased travel costs.
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 September 30, Nine Months Ended September 30,
(in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change
Interest expense $ (12,680) $ (5,160) $ (7,520) nm $ (32,780) $ (15,280) $ (17,500) nm
Other income, net 21,824 2,926 18,898 nm 36,910 9,118 27,792 nm
Other income (expense), net $ 9,144 $ (2,234) $ 11,378 nm $ 4,130 $ (6,162) $ 10,292 nm
nm - not meaningful
Other income, net increased by $11.4 million for the three months ended
September 30, 2020 , as compared to the respective prior year period. This was
primarily due to an increase of $18.9 million of other income, net, comprised of
$26.4 million unrealized gain recognized on our long-term investments in the
third quarter of 2020, partially offset by $5.1 million from loss on partial
repurchase of our convertible senior notes, and a decline in interest income on
our investments of $2.8 million mainly as a result of reduction in Federal Funds
rate in response to COVID-19. Interest expense was higher by $7.5 million due to
increase in the amortization of debt discount and issuance costs from our 2025
and 2026 convertible senior notes issued in the first and third quarters of
2020, respectively.
Other income, net increased by $10.3 million for the nine months ended
September 30, 2020 , as compared to the respective prior year period. Other
income, net was higher by $27.8 million , primarily due to $47.8 million net
unrealized gain recognized on our long-term investments, partially offset by
$12.3 million from the loss on partial repurchase of our convertible senior
notes, and decrease in interest income on our investments by $7.4 million .
Interest expense was higher by $17.5 million due to increase in the amortization
of debt discount and issuance costs from our 2025 and 2026 convertible senior
notes issued in the first and third quarters of 2020, respectively.
We expect interest income to further reduce in the future due to interest rate
volatility in the current macroeconomic environment.
Net loss
Net loss increased by $8.2 million for the three months ended September 30,
2020 , as compared to the respective prior year period, mainly due to non-cash
items including $24.2 million higher share-based compensation expense, $7.5
million increase in interest expense from the amortization of debt discount and
issuance costs from our convertible senior notes, and
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$6.3 million increase in amortization of acquired intangibles, partially offset
by $26.4 million unrealized gain from our long-term investments, and $2.3
million decrease in acquisition-related expenses.
Net loss increased by $52.8 million for the nine months ended September 30,
2020 , as compared to the respective prior year period, mainly due to non-cash
items including $65.7 million higher share-based compensation expense, $19.3
million increase in amortization of acquired intangibles, and $17.5
million increase in interest expense from the amortization of debt discount and
issuance costs from our convertible senior notes, partially offset by $47.8
million net unrealized gain recognized from our long-term investments, and $3.0
million decrease in acquisition-related expenses.
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 of September 30, 2020 and December 31, 2019 , we had cash and cash equivalents
of $745.6 million and $343.6 million , respectively. We finance our operations
primarily through sales to our customers, which could be billed either on a
monthly or annually one year in advance. 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.
In March 2020 , we issued $1.0 billion aggregate principal of 0% convertible
senior notes due 2025 (the "2025 Notes") in a private placement. As of
September 30, 2020 , the carrying value of our 2025 Notes totaled $815.5 million .
In September 2020 , we issued $650.0 million aggregate principal of 0%
convertible senior notes due 2026 (the "2026 Notes") in a private placement. As
of September 30, 2020 , the carrying value of our 2026 Notes totaled $504.4
million . Our 2025 Notes and 2026 Notes contain customary financial covenants. In
connection with both these offering, out of total net proceeds of $1.6 billion ,
we used approximately $1.0 billion from both offerings to repurchase a portion
of the 2023 Notes.
During the nine months ending September 30, 2020 , we received conversion
requests on the principal amount of the 2023 Notes totaling approximately $69.2
million , out of which $16.1 million were outstanding as of September 30, 2020 .
We received additional conversion requests of $5.5 million subsequent to
September 30, 2020 . The remaining outstanding principal balance of the 2023
Notes is $80.2 million as of the filing date. We intend to settle this
outstanding principal amount out of our cash and cash equivalents outstanding
balance. 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 the 2026, 2025 and 2023 Notes as of September 30, 2020 .
During the three months ended September 30, 2020 , we entered into a strategic
partnership agreement with ALE under which we paid $100.0 million .
During the nine months ended September 30, 2020 , we financed approximately $4.7
million of property, equipment, and software licenses through vendor financing
arrangements.
We believe that our operations, existing liquidity sources as well as capital
resources and ability to raise cash through additional financing will satisfy
our future cash requirements and obligations for at least the next 12 months.
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.
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The table below provides selected cash flow information (in thousands):
Nine
Months Ended
2020 2019
Net cash (used in) provided by operating activities $ (32,707) $ 71,008
Net cash used in investing activities (62,041) (60,697)
Net cash provided by financing activities 496,363 6,403
Effect of exchange rate changes 337 (380)
Net increase (decrease) in cash and cash equivalents $
401,952
Net Cash (Used in) Provided by Operating Activities Cash used in or provided by operating activities is driven 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 payments under strategic arrangements. Net cash used in operating activities was$32.7 million for the nine months endedSeptember 30, 2020 . This was driven by$100.0 million paid under strategic agreement and$32.6 million attributable to debt discount on a portion of the 2023 convertible senior notes that was repaid. These were offset by$99.9 million in cash flow from operating activities during the nine months endedSeptember 30, 2020 . The cash flow from operating activities was driven by timing of cash receipts and prepayments from customers and carriers and cash payments for personnel related costs and to vendors. Net cash provided by operating activities for the nine months endedSeptember 30, 2020 , decreased by$103.7 million as compared to the respective prior year period. This change was driven by payments under the strategic arrangement and debt discount for a portion of the 2023 senior convertible notes that was repaid, offset with the additional cash generated from operating activities.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$62.0 million for the nine months endedSeptember 30, 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 nine months endedSeptember 30, 2020 increased by$1.3 million as compared to the respective prior year period. The increase was primarily due to increased investment in capital expenditures and internal-use software development in 2020, partially offset by cash used for business acquisitions in 2019. Net Cash Provided by Financing Activities Our primary financing activities have consisted of raising proceeds through the issuance of our 2025 Notes and 2026 Notes in the first and third quarters of 2020, respectively, and stock under our stock plans, offset by partial repurchase and conversion requests of our 2023 Notes. Net cash provided by financing activities was$496.4 million for the nine months endedSeptember 30, 2020 , primarily due to$1.6 billion proceeds from the issuance of our 2025 Notes and 2026 Notes, net of issuance costs, partially offset by cash of$1.0 billion paid for the partial repurchase and conversion requests for our 2023 Notes and$102.7 million payments for capped calls transactions and costs. We also had proceeds from issuance of stock in connection with stock plans of$24.1 million , which was offset with payments for taxes paid in connection with our stock plans of$27.7 million . Net cash provided by financing activities for the nine months endedSeptember 30, 2020 increased by$490.0 million primarily due to both the 2026 Notes and 2025 Notes issued in 2020, partially offset by the partial settlement of the 2023 Notes. Refer to Note 6, Convertible Senior Notes, in the accompanying notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. 40 -------------------------------------------------------------------------------- Table of Contents 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 strategic partnerships and 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 liquidity 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 (used in) operating activities, the most directly comparable GAAP measure, for each of the periods presented (in thousands): Nine
Months Ended
2020 2019
Net cash (used in) provided by operating activities $ (32,707) $ 71,008
Strategic partnerships 100,000 -
Repayment of convertible senior notes attributable to debt discount
32,640 -
Non-GAAP net cash provided by operating activities 99,933 71,008
Purchases of property and equipment (33,992) (21,355)
Capitalized internal-use software (28,049) (11,472)
Non-GAAP free cash flow $ 37,892 $ 38,181
Backlog
We have generally signed new customers to contracts that vary in length, from
month-to-month to multi-year terms for our subscriptions. At any point in the
contract term, there can be amounts allocated to services that we have not yet
contractually performed, which constitute backlog. Until such time, we do not
recognize them as revenues 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 3, 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 ended December 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
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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 nine months ended September 30, 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.
Foreign Currency Risk
The majority of our sales and contracts are denominated in U.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 and nine months ended September 30, 2020 . Our
operating expenses are generally denominated in the currencies of the countries
in which our operations are located, which are primarily in the U.S. , and to a
lesser extent in Canada , Europe , and Asia-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 and nine months ended September 30, 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 of September 30, 2020 , we had cash and cash equivalents of $745.6 million . We
invest our cash and cash equivalents in short-term money market funds. We have
experienced a decline in the interest rates associated with money market funds
over the last several quarters. Declines in interest rates would reduce future
interest income. For the three and nine months ended September 30, 2020 , a
hypothetical 10% increase or decrease in overall interest rates would not have
had a material impact on 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
expect interest income to further reduce in the future due to interest rate
volatility in the current macroeconomic environment.
As of September 30, 2020 , we had $89.2 million , $815.5 million , and $504.4
million outstanding from the 2023 Notes, 2025 Notes, and 2026 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 of September 30, 2020 , we had long-term investments in convertible and
redeemable preferred stock of $173.6 million . These equity investments are
subject to market related risks that could decrease or increase the fair value
of our
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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 $12.2 million in the
fair-value of our investment as of September 30, 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 of September 30, 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 the SEC'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 regarding required disclosure. Based on the evaluation of our
disclosure controls and procedures as of September 30, 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.
We have not experienced any material impact to our internal controls over
financial reporting although since March 2020 most of our employees and extended
workforce are now working remotely due to the COVID-19 pandemic. We are
continually monitoring and assessing the COVID-19 situation on our internal
controls to address impacts to their design, implementation and operating
effectiveness.
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.
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