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

Description of Business

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

Principles of Consolidation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and include the consolidated accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

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

Foreign Currency

The functional currency of the Company’s foreign subsidiaries is generally the local currency. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are recorded as part of a separate component of stockholders’ equity and reported in the statements of comprehensive loss. Foreign currency transaction gains and losses are included in net loss for the period. All assets and liabilities denominated in a foreign currency are translated into U.S. dollars at the exchange rate on the balance sheet date. Revenues and expenses are translated at the average exchange rate during the period. Equity transactions are translated using historical exchange rates.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at fair value.

Allowance for Doubtful Accounts

For the years ended December 31, 2017 and 2016, a significant portion of revenues were realized from credit card transactions while the remaining revenues generated accounts receivable. The portion of revenues billed to customers through invoices with payment terms has increased year over year as we continue to move up market. The Company determines provisions based on historical loss patterns, the number of days that billings are past due, and an evaluation of the potential risk of loss associated with delinquent accounts.

Below is a summary of the changes in allowance for doubtful accounts for the years ended December 31, 2017, 2016 and 2015 (in thousands):

	Balance at beginning of year		Provision, net of recoveries		Write-offs		Balance at end of year
Year ended December 31, 2017
Allowance for doubtful accounts	$	434	$	1,674	$	1,396	$	712
Year ended December 31, 2016
Allowance for doubtful accounts	$	377	$	648	$	591	$	434
Year ended December 31, 2015
Allowance for doubtful accounts	$	125	$	411	$	159	$	377

Inventory

The Company’s inventory consists primarily of phones held at third parties. Inventory is stated at the lower of cost computed on a first-in, first-out basis, or market value. Inventory write-downs are recorded when the cost of inventory exceeds its net realizable value and establishes a new cost basis for the inventory. On a quarterly and annual basis, the Company analyzes inventory on a part by part basis in comparison to forecasted demand to identify potential excess and obsolescence issues, and adjusts carrying amounts to estimated net realizable value accordingly.

Internal-Use Software Development Costs

The Company capitalizes qualifying internal-use software development costs that are incurred during the application development stage, provided that management with the relevant authority authorizes and commits to the funding of the project, it is probable the project will be completed, and the software will be used to perform the function intended. Costs related to preliminary project activities and post implementation activities are expensed as incurred. Capitalized internal-use software development costs are included in property and equipment and are amortized on a straight-line basis over their estimated useful lives.

For the years ended December 31, 2017 and 2016, the Company capitalized $8.3 million and $2.5 million, net of impairment, of internal-use software development costs, respectively. The carrying value of internal-use software development costs was $11.9 million and $4.4 million at December 31, 2017 and 2016, respectively.

Property and Equipment, net

Property and equipment, net is stated at cost, less accumulated depreciation and amortization. Depreciation and amortization is calculated on a straight-line basis over the estimated useful lives of those assets as follows:

Computer hardware and software	3 to 5 years
Internal-use software development costs	3 to 4 years
Furniture and fixtures	1 to 5 years
Leasehold improvements	Shorter of the estimated lease term or useful life

The Company evaluates the recoverability of property and equipment for possible impairment whenever events or circumstances indicate that the carrying amount of such assets or asset groups may not be recoverable. Recoverability of these assets or asset groups is measured by comparing the carrying amounts of such assets or asset groups to the future undiscounted cash flows that such assets or asset groups are expected to generate. If this evaluation indicates that the carrying amount of the assets or asset groups is not recoverable, the carrying amount of such assets or asset groups is reduced to its estimated fair value.

Maintenance and repairs are charged to expense as incurred.

Concentrations of Credit Risk and Significant Customers

Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. Although the Company deposits its cash with multiple financial institutions, its deposits, at times, may exceed federally insured limits. The Company’s accounts receivable are primarily derived from sales by resellers and to larger direct customers. The Company performs ongoing credit evaluations of its resellers and does not require collateral on accounts receivable. The Company maintains an allowance for doubtful accounts for estimated potential credit losses. At December 31, 2017 and 2016, AT&T, one of our resellers, accounted for 18% and 30% of the Company’s total accounts receivable, respectively. For the years ended December 31, 2017, 2016, and 2015, AT&T accounted for 11%, 14%, and 13% of the Company’s total revenues and 12%, 13%, and 12% of the Company’s software subscription revenues, respectively. In January 2018, the Company closed a transaction with AT&T to allow it to transition the existing customer base of RingCentral Office@Hand solution, for which AT&T acted as a reseller, directly to the Company, and AT&T is no longer selling new subscriptions for the Company’s service. Refer to Note 17 for further discussion.

During the years ended December 31, 2017, 2016 and 2015, the Company contracted a significant portion of its software development efforts from third-party vendors located in Russia and Ukraine. A cessation of services provided by these vendors could result in a disruption to the Company’s research and development efforts.

Revenue Recognition

The Company’s revenues consist primarily of software subscriptions and other revenues. The Company’s software subscriptions revenue includes all fees billed in connection with subscriptions to the Company’s RingCentral Office, RingCentral Professional, RingCentral Fax, RingCentral Contact Center, and RingCentral Glip products. These software subscription fees include recurring fixed plan subscription fees, variable usage-based fees for usage in excess of plan limits, recurring administrative cost recovery fees, one-time fees, and other recurring fees related to our subscriptions. The Company provides its subscriptions pursuant to contractual arrangements that typically range in duration from one month to three years. The Company’s subscription fees are generally billed in advance directly to customer credit cards or via invoices issued to larger customers. The Company’s other revenues consist of product revenues from sales of phones, phone sales to carrier partners, phone rentals, and professional implementation services, and commission revenues.

The Company recognizes revenue when the following criteria are met:

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there is persuasive evidence of an arrangement;

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the subscription is being provided to the customer or the product has been delivered;

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the amount of fees to be paid by the customer is fixed or determinable; and

•

the collection of the fees is reasonably assured.

Revenue under subscription plans are recognized as follows:

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fixed plan subscription and administrative cost recovery fees are recognized on a straight-line basis over their respective contractual subscription terms;

•

fees for additional minutes of usage in excess of plan limits are recognized over the estimated usage period in a manner that approximates actual usage; and

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one-time upfront fees are initially deferred and recognized on a straight-line basis over the estimated average customer life.

Product revenue is billed at the time the order is received and recognized when the phone has been delivered to the customer. Professional service revenue is generally recognized upon completion of performance.

The Company enters into arrangements with multiple-elements that generally include services to be provided under the subscription plan and the sale of products used in connection with the Company’s subscriptions. The Company allocates the consideration to each deliverable in a multiple-deliverable arrangement based upon its relative selling prices. The Company determines the selling price using vendor-specific objective evidence (“VSOE”) for its subscription plans and best estimated selling price (“BESP”) for its product offerings. Consideration allocated to each deliverable, limited to the amount not contingent on future performance, is then recognized to revenue when the basic revenue recognition criteria are met for the respective deliverable.

The Company determines VSOE based on historical standalone sales to customers. In determining VSOE, the Company requires that a substantial majority of the selling prices fall within a reasonably narrow pricing range. VSOE exists for all of the Company’s subscription plans. The Company uses BESP as the selling price for its product offerings as the Company is not able to determine VSOE of fair value from standalone sales or third-party evidence of selling price (“TPE”). The Company estimates BESP for a product by considering company-specific factors such as pricing objectives, direct product and other costs, bundling and discounting practices, and contractually stated prices.

A portion of the Company’s software subscriptions and product revenues are generated through sales by resellers. When the Company assumes a majority of the business risks associated with performance of the contractual obligations, it records these revenues at the gross amount paid by the customer with amounts retained by the resellers recognized as sales and marketing expense. The Company’s assumption of such business risks is evidenced when, among other things, it takes responsibility for delivery of the product or subscription, is involved in establishing pricing of the arrangement, assumes credit and inventory risk, and is the primary obligor in the arrangement. When a reseller assumes the majority of the business risks associated with the performance of the contractual obligations, the Company records the associated revenue at the net amount received from the reseller. The Company recognizes revenue from resellers when the following criteria are met:

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persuasive evidence of an arrangement exists through a contract with the customer;

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the subscription is being provided to the customer or the product has been delivered;

•

the amount of fees to be paid by the customer is fixed or determinable; and

•

the collection of the fees is reasonably assured.

The Company’s deliverables sold through its reseller agreements consist of the Company’s software subscriptions and products. Subscriptions sold through resellers are recognized on a straight-line basis over the period the subscriptions are provided to the end customer. Phones sold through resellers are shipped directly to the end customer and are recognized when title transfers to the end customer. Revenue from resellers has predominantly been recorded on a gross basis for all periods presented.

The Company records reductions to revenue for estimated sales returns and customer credits at the time the related revenue is recognized. Sales returns and customer credits are estimated based on historical experience, current trends, and expectations regarding future experience.

Customer billings related to taxes imposed by and remitted to governmental authorities on revenue-producing transactions are reported on a net basis. When such remitted taxes exceed the amount billed to customers, the cost is included in general and administrative expenses.

Amounts billed in excess of revenue recognized for the period are reported as deferred revenue on the consolidated balance sheet. The Company’s deferred revenue consists primarily of unearned revenue on annual and monthly subscription plans.

Cost of Revenues

Cost of software subscriptions revenue primarily consists of costs of network capacity purchased from third-party telecommunications providers, network operations, costs to build out and maintain data centers, including co-location fees for the right to place the Company’s servers in data centers owned by third-parties, depreciation of the servers and equipment, along with related utilities and maintenance costs, personnel costs associated with customer care and support of the functionality of the Company’s platform and data center operations, including share-based compensation expenses, and allocated costs of facilities and information technology. Cost of software subscriptions revenue is expensed as incurred.

Cost of other revenue is comprised primarily of the cost associated with purchased phones, shipping costs, costs of professional services, and allocated costs of facilities and information technology related to the procurement, management and shipment of phones. Cost of other revenue is expensed in the period product is delivered to the customer.

Share-Based Compensation

Share-based compensation expense resulting from options, restricted stock units (“RSUs”), and employee stock purchase plan (“ESPP”) rights granted is measured as the grant date fair value of the award and is recognized using the straight-line attribution method over the requisite service period of the award, which is generally the vesting period. The Company estimates the fair value of stock options and ESPP rights using the Black-Scholes-Merton option-pricing model. The Company estimates the fair value of RSUs as the closing market value of its Class A Common Stock on the grant date. Compensation expense for stock options and RSUs granted to non-employees is revalued, or marked to market, as of each reporting date until the stock options and RSUs are vested. Compensation expense is recognized net of estimated forfeiture activity, which is based on historical forfeiture rates.

Research and Development

Research and development expenses consist primarily of third-party contractor costs, personnel costs, technology license expenses, and depreciation associated with research and development equipment. Research and development costs are expensed as incurred.

Advertising Costs

Advertising costs, which include various forms of e-commerce such as search engine marketing, search engine optimization and online display advertising, as well as more traditional forms of media advertising such as radio and billboards, are expensed as incurred and were $42.4 million, $41.6 million, and $34.3 million for the years ended December 31, 2017, 2016 and 2015, respectively.

Commissions

Commissions consist of variable compensation earned by sales personnel and third-party resellers. Sales commissions associated with the acquisition of a new customer contract are recognized as sales and marketing expense at the time the customer has entered into a binding agreement.

Income Taxes

The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date. The Company records a valuation allowance to reduce its deferred tax assets to the amount of future tax benefit that is more likely than not to be realized. As of December 31, 2017, except for deferred tax assets associated with its subsidiaries in the Netherlands and China, the Company recorded a full valuation allowance against all other net deferred tax assets due to its history of operating losses. The Company classifies interest and penalties on unrecognized tax benefits as income tax expense.

Segment Information

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

Indemnification

Certain of the Company’s agreements with resellers and customers include provisions for indemnification against liabilities if its subscriptions infringe upon a third-party’s intellectual property rights. At least quarterly, the Company assesses the status of any significant matters and its potential financial statement exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount or the range of loss can be estimated, the Company accrues a liability for the estimated loss. The Company has not incurred any material costs as a result of such indemnification provisions and the Company has not accrued any liabilities related to such obligations in the consolidated financial statements as of December 31, 2017 or 2016.

Recent Accounting Pronouncements

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

The Company evaluated the potential changes from the adoption of the new standard on its financial statements and disclosures, and is in the process of implementing appropriate changes to its business processes, systems and controls to support revenue recognition and disclosures under the new standard. Based on this evaluation, the Company will adopt the requirements of the new standard in the first quarter of 2018, using the full retrospective transition method.

Under the new standard, the Company expects in some cases to recognize revenue earlier for subscription plans when the customer receives services for no consideration during the initial months (i.e., initial period is discounted) as a result of elimination of contingent revenue guidance (i.e., under today’s accounting, amounts allocated to delivered items are limited to amounts that are not contingent on the provision of future services) in the new standard. The impact of adopting the new standard on the Company’s total revenues is not significant.

The more significant impact of adoption the new standard primarily relates to the deferral of incremental commission costs of obtaining subscription contracts, which previously were expensed as incurred. Under the new standard, the Company will defer all incremental commission costs to obtain the contract and amortize them over the expected period of benefit, which is estimated to be five years. The amortization cost will be charged to sales and marketing costs on the consolidated statements of operations. The Company expects to add approximately $53.3 million and $33.4 million in deferred costs relating to the capitalized component of sales commission to the balance sheet as of December 31, 2017 and December 31, 2016.

There will not be any significant tax impact to the Company’s consolidated statements of operations and consolidated balance sheet relating to the adoption of the new standard as there will be a full valuation allowance due to the Company’s history of continued losses.

Select consolidated statements of operations line items, which reflect the adoption of the new standard are as follows (in thousands):

	Year ended December 31,
	2017			2016
Revenues
Software subscriptions		465,254			356,562
Other		38,363			23,874
Total revenues		503,617			380,436
Gross profit		382,346			288,225
Operating expenses
Sales and marketing		240,223			180,125
Operating loss		(5,338	)		(12,868	)
Net loss		(4,204	)		(16,225	)
Weighted-average number of shares used in computing net loss per share		76,281			72,994
Basic and diluted	$	(0.06	)	$	(0.22	)

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires that lessees recognize a right-of-use asset and a lease liability on the balance sheet for all leases with the exception of short-term leases. Both capital and operating leases will need to be recognized on the balance sheet. The standard is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The standard must be adopted using a modified retrospective approach for all leases that existed or are entered into after the beginning of the earliest comparative period in the financial statements. The Company expects to adopt the standard in the first quarter of 2019. The Company is currently evaluating the impact that the standard will have on its consolidated financial statements and related disclosures. The Company expects the impact of adoption of the new standard on the Company’s statements of operations not to be material. The Company anticipates the most significant impact of adopting the new standard will primarily be the establishment of a right-of-use asset and a corresponding lease liability in its consolidated balance sheets.

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting (Topic 718), which simplifies the accounting for stock-based compensation related to the accounting for forfeitures, employer tax withholding, excess tax benefits related to awards and cash flow presentations. The standard is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company adopted this standard in the first quarter of 2017. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

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

In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, which requires entities to recognize at the transaction date the income tax effects for intra-entity transfers of assets other than inventory. The standard is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. The adoption of this amendment is not expected to have a material impact on the Company’s consolidated financial statements or disclosures.

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

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which provides guidance to evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. If substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single asset or a group of similar assets, the assets acquired (or disposed of) are not considered a business. The guidance is effective for annual periods beginning after December 15, 2017, including interim period within those periods, with early adoption permitted in two scenarios as defined in the standard. The Company will adopt this guidance in the first quarter of 2018. The adoption of the standard is not expected to have a material impact on the Company’s consolidated financial statements or disclosures.

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

In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting, which amends the scope of modification accounting for share-based payment arrangements. The amendments in the update provide guidance on the types of changes to the terms or conditions of share-based payment awards that would require application of modification accounting under ASC 718, Compensation-Stock Compensation. The standard is effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted. The adoption of this amendment is not expected to have a material impact on the Company’s consolidated financial statements or disclosures.

Reclassification

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