Edgar Filing: Five9, Inc.

10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-36383

Five9, Inc.

(Exact Name of Registrant as Specified in Its Charter)



Delaware		94- 3394123
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

Bishop Ranch 8

4000 Executive Parkway, Suite 400

San Ramon, CA 94583

(Address of Principal Executive Offices) (Zip Code)

(925) 201-2000

(Registrant’s Telephone Number, Including Area Code)

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

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

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



Large Accelerated Filer	o		Accelerated Filer	o

Non-accelerated filer	x	(Do not check if a smaller reporting Company)	Smaller Reporting Company	o

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

As of October 23, 2015, there were 50,504,265 shares of the Registrant’s common stock, par value $0.001 per share, outstanding.

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FIVE9, INC.

FORM 10-Q

TABLE OF CONTENTS



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS		3

PART I. FINANCIAL INFORMATION		4
ITEM 1. Financial Statements		4
Condensed Consolidated Balance Sheets (Unaudited)		4
Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)		5
Condensed Consolidated Statements of Cash Flows (Unaudited)		6
Notes to Condensed Consolidated Financial Statements (Unaudited)		7
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Overview		19
Key Operating and Financial Performance Metrics		20
Key Components of Our Results of Operations		22
Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014		24
Liquidity and Capital Resources		27
Critical Accounting Policies and Estimates		28
Off Balance Sheet Arrangements		29
Contractual Obligations		29
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk		30
ITEM 4. Controls and Procedures		31

PART II. OTHER INFORMATION		32
ITEM 1. Legal Proceedings		32
ITEM 1A. Risk Factors		33
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds		57
ITEM 3. Defaults Upon Senior Securities		57
ITEM 4. Mine Safety Disclosures		57
ITEM 5. Other Information		57
ITEM 6. Exhibits		58

SIGNATURES		59

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which involve substantial risks and uncertainties. These statements reflect the current views of our senior management with respect to future events and our financial performance. These forward-looking statements include statements with respect to our business, expenses, strategies, losses, growth plans, product and customer initiatives, market growth projections, and our industry. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.

Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. These factors include the information set forth under the caption “Risk Factors” and elsewhere in this report, including the following:


•	our quarterly and annual results may fluctuate significantly, may not fully reflect the underlying performance of our business and may result in decreases in the price of our common stock;


•	if we are unable to attract new clients or sell additional services and functionality to our existing clients, our revenue and revenue growth will be harmed;


•	our recent rapid growth may not be indicative of our future growth, and even if we continue to grow rapidly, we may fail to manage our growth effectively;


•	the markets in which we participate are highly competitive, and if we do not compete effectively, our operating results could be harmed;


•	if we fail to manage our technical operations infrastructure, our existing clients may experience service outages, our new clients may experience delays in the deployment of our solution and we could be subject to, among other things, claims for credits or damages;


•	if our existing clients terminate their subscriptions or reduce their subscriptions and related usage, our revenues and gross margins will be harmed and we will be required to spend more money to grow our client base;


•	we sell our solution to larger organizations that require longer sales and implementation cycles and often demand more configuration and integration services or customized features and functions that we may not offer, any of which could delay or prevent these sales and harm our growth rates, business and operating results;


•	because a significant percentage of our revenue is derived from existing clients, downturns or upturns in new sales will not be immediately reflected in our operating results and may be difficult to discern;


•	we rely on third-party telecommunications and internet service providers to provide our clients and their customers with telecommunication services and connectivity to our cloud contact center software and any failure by these service providers to provide reliable services could subject us to, among other things, claims for credits or damages;


•	we have a history of losses and we may be unable to achieve or sustain profitability;


•	we may not be able to secure additional financing on favorable terms, or at all, to meet our future capital needs; and


•	failure to comply with laws and regulations could harm our business and our reputation.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may differ materially from what we anticipate. You should not place undue reliance on our forward-looking statements. Any forward-looking statements you read in this report reflect our views only as of the date of this report with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. We undertake no obligation to update any forward-looking statements made in this report to reflect events or circumstances after the date of this report or to reflect new information or the occurrence of unanticipated events, except as required by law.

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

FIVE9, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share data)



	September 30, 2015			December 31, 2014
ASSETS
Current assets:
Cash and cash equivalents	$	59,501		$	58,289
Short-term investments	—			20,000
Accounts receivable, net	9,309			8,335
Prepaid expenses and other current assets	2,917			1,960
Total current assets	71,727			88,584
Property and equipment, net	12,376			12,571
Intangible assets, net	2,169			2,553
Goodwill	11,798			11,798
Other assets	800			1,428
Total assets	$	98,870		$	116,934

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,865		$	4,179
Accrued and other current liabilities	8,053			7,318
Accrued federal fees	5,595			7,215
Sales tax liability	1,036			297
Notes payable	6,045			3,146
Capital leases	4,313			4,849
Deferred revenue	5,562			5,346
Total current liabilities	33,469			32,350
Revolving line of credit	12,500			12,500
Sales tax liability — less current portion	1,949			2,582
Notes payable — less current portion	19,232			22,778
Capital leases — less current portion	4,538			4,423
Other long-term liabilities	640			548
Total liabilities	72,328			75,181
Commitments and contingencies (Note 9)
Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000 shares authorized, no shares issued and outstanding at September 30, 2015 and December 31, 2014	—			—
Common stock, $0.001 par value; 450,000 shares authorized, 50,499 shares and 49,322 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively	51			49
Additional paid-in capital	177,393			170,286
Accumulated deficit	(150,902		)	(128,582		)
Total stockholders’ equity	26,542			41,753
Total liabilities and stockholders’ equity	$	98,870		$	116,934

See accompanying notes to condensed consolidated financial statements.

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FIVE9, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited, in thousands, except per share data)



	Three Months Ended						Nine Months Ended
	September 30, 2015			September 30, 2014			September 30, 2015			September 30, 2014
Revenue	$	32,287		$	25,869		$	92,835		$	74,828
Cost of revenue	14,812			13,504			43,860			40,121
Gross profit	17,475			12,365			48,975			34,707
Operating expenses:
Research and development	5,473			5,503			17,079			16,282
Sales and marketing	10,797			9,296			31,322			27,992
General and administrative	6,087			7,967			19,389			17,653
Total operating expenses	22,357			22,766			67,790			61,927
Loss from operations	(4,882		)	(10,401		)	(18,815		)	(27,220		)
Other income (expense), net:
Interest expense	(1,235		)	(1,116		)	(3,529		)	(2,986		)
Interest income and other	119			95			72			99
Change in fair value of convertible preferred and common stock warrant liabilities	—			—			—			1,745
Total other income (expense), net	(1,116		)	(1,021		)	(3,457		)	(1,142		)
Loss before provision for income taxes	(5,998		)	(11,422		)	(22,272		)	(28,362		)
Provision for income taxes	50			13			48			52
Net loss	$	(6,048	)	$	(11,435	)	$	(22,320	)	$	(28,414	)
Net loss per share:
Basic and diluted	$	(0.12	)	$	(0.24	)	$	(0.45	)	$	(0.84	)
Shares used in computing net loss per share:
Basic and diluted	50,369			48,310			49,931			33,762
Comprehensive Loss:
Net loss	$	(6,048	)	$	(11,435	)	$	(22,320	)	$	(28,414	)
Other comprehensive loss:
Change in unrealized gain/loss on short-term investments, net of tax	—			1			—			1
Comprehensive loss	$	(6,048	)	$	(11,434	)	$	(22,320	)	$	(28,413	)

See accompanying notes to condensed consolidated financial statements.

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FIVE9, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)



	Nine Months Ended
	September 30, 2015			September 30, 2014
Cash flows from operating activities:
Net loss	$	(22,320	)	$	(28,414	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	5,525			4,858
Provision for doubtful accounts	157			43
Stock-based compensation	6,010			4,796
Loss on the disposal of property and equipment	10			1
Non-cash interest expense	260			210
Changes in fair value of convertible preferred and common stock warrant liabilities	—			(1,745		)
Others	40			(5		)
Changes in operating assets and liabilities:
Accounts receivable	(1,149		)	(744		)
Prepaid expenses and other current assets	(957		)	(981		)
Other assets	(178		)	(39		)
Accounts payable	(1,329		)	(1,018		)
Accrued and other current liabilities	788			2,558
Accrued federal fees and sales tax liability	161			(787		)
Deferred revenue	192			666
Other liabilities	(83		)	(158		)
Net cash used in operating activities	(12,873		)	(20,759		)
Cash flows from investing activities:
Purchases of property and equipment	(689		)	(478		)
Decrease (increase) in restricted cash	806			(25		)
Purchase of short-term investments	(20,000		)	(29,993		)
Proceeds from maturity of short-term investments	40,000			—
Net cash provided by (used in) investing activities	20,117			(30,496		)
Cash flows from financing activities:
Net proceeds from initial public offering, net of payments for offering costs	—			71,459
Proceeds from exercise of common stock options and warrants	419			767
Proceeds from sale of common stock under ESPP	680			—
Proceeds from notes payable	—			19,561
Repayments of notes payable	(2,622		)	(783		)
Payments of capital leases	(4,509		)	(4,008		)
Net cash provided by (used in) financing activities	(6,032		)	86,996
Net increase in cash and cash equivalents	1,212			35,741
Cash and cash equivalents:
Beginning of period	58,289			17,748
End of period	$	59,501		$	53,489
Non-cash investing and financing activities:
Equipment obtained under capital lease	$	4,193		$	4,512
Equipment purchased and unpaid at period-end	84			3
Reclass of deferred initial public offering costs to additional paid-in capital	—			2,179
Net cashless exercise of preferred stock warrants to Series A-2 convertible preferred stock	—			509
Vesting of early exercised stock options	—			185
Reclass of warrants liabilities to additional paid-in capital upon initial public offering	—			2,647
Conversion of convertible preferred stock to common stock upon initial public offering	—			54,244

See accompanying notes to the condensed consolidated financial statements.

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FIVE9, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Description of Business and Summary of Significant Accounting Policies

Five9, Inc. (together with its wholly-owned subsidiaries, the “Company”) is a provider of cloud contact center software. The Company was incorporated in Delaware in 2001 and is headquartered in San Ramon, California. In addition, the Company has offices in Europe and Asia, which primarily provide research, development and client support services.

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. All intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The significant estimates made by management affect revenue, the allowance for doubtful accounts, intangible assets, goodwill, loss contingencies, including the Company’s accrual for federal fees and sales tax liability, accrued liabilities, stock-based compensation, fair value calculations of the convertible preferred and common stock warrant liabilities, provision for income taxes and uncertain tax positions. Management periodically evaluates such estimates and they are adjusted prospectively based upon such periodic evaluation. Actual results could differ from those estimates.

Significant Accounting Policies

The Company’s significant accounting policies are disclosed in its Annual Report on Form 10-K for the year ended December 31, 2014. During the nine months ended September 30, 2015, there were no changes to the Company's significant accounting policies.

Recent Accounting Pronouncements

In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. The ASU provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The ASU does not change the accounting for a customer’s accounting for service contracts. A company can elect to adopt the ASU either prospectively or retrospectively. This guidance is effective for the Company beginning in the first quarter of 2016. Early adoption is permitted. The Company does not expect this guidance to have a material effect on its consolidated financial statements.

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issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. Early adoption is permitted. This guidance is effective for the Company on a retrospective basis beginning in the first quarter of 2016 and is not expected to have a material effect on the Company's consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The new guidance requires management of public and private companies to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and, if so, disclose that fact. Management will also be required to evaluate and disclose whether its plans alleviate that doubt. The standard will be effective for the Company's annual period ending December 31, 2016 and interim and annual periods thereafter. Early adoption is permitted. The Company does not expect that the requirement will have an impact on its financial position, results of operations or cash flows.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The ASU No. 2014-09 is originally effective for the Company's annual and interim reporting periods beginning January 1, 2017. The standard permits the use of either the retrospective or cumulative effect transition method. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 for all entities by one year while providing an option to early adopt the standard on the original effective date. Accordingly, the new revenue standard is effective for the Company's annual and interim reporting periods beginning January 1, 2018. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

2. Fair Value Measurements

The Company carries cash equivalents and short-term investments consisting of money market funds and marketable securities at fair value on a recurring basis. Fair value is based on the price that would be received from selling an asset in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

Level 1 — Observable inputs which include unadjusted quoted prices in active markets for identical assets.

Level 2 — Observable inputs other than Level 1 inputs, such as quoted prices for similar assets, quoted prices for identical or similar assets in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are based on management’s assumptions, including fair value measurements determined by using pricing models, discounted cash flow methodologies or similar techniques.

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



	September 30, 2015
	Total		Level 1
Assets
Cash equivalents:
Money market funds	$	20,005	$	20,005

	December 31, 2014
	Total		Level 1
Assets
Short-term investments:
U.S. Treasury bills	$	20,000	$	20,000

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3. Financial Statement Components

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



	September 30, 2015		December 31, 2014
Cash	$	39,496	$	58,289
Money market funds	20,005		—
Cash and cash equivalents	$	59,501	$	58,289

Restricted Cash

As of September 30, 2015, the Company's restricted cash balance was not material. As of December 31, 2014, the Company had restricted cash of $0.8 million that included $0.7 million related to a letter of credit issued to the Company’s landlord with respect to its lease obligation and $0.1 million under letters of credit primarily related to an insurance policy. These letters of credit had been released during the first half of 2015. Restricted cash is included in 'Other assets' on the accompanying condensed consolidated balance sheets.

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



	September 30, 2015			December 31, 2014
Trade accounts receivable	$	8,488		$	7,482
Unbilled trade accounts receivable, net of advance client deposits	839			918
Allowance for doubtful accounts	(18		)	(65		)
Accounts receivable, net	$	9,309		$	8,335

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



	September 30, 2015			December 31, 2014
Computer and network equipment	$	28,412		$	24,292
Computer software	2,961			2,264
Internal-use software development costs	74			—
Furniture and fixtures	1,061			1,030
Leasehold improvements	611			611
Property and equipment	33,119			28,197
Accumulated depreciation and amortization	(20,743		)	(15,626		)
Property and equipment, net	$	12,376		$	12,571

Depreciation and amortization expense associated with property and equipment was $1.7 million and $5.1 million for the three and nine months ended September 30, 2015, respectively, and $1.5 million and $4.5 million for the three and nine months ended September 30, 2014, respectively.

Property and equipment capitalized under capital lease obligations consist primarily of computer and network equipment and were as follows (in thousands):



	September 30, 2015			December 31, 2014
Gross	$	25,211		$	21,025
Less: accumulated depreciation and amortization	(14,086		)	(10,609		)
Total	$	11,125		$	10,416

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Accrued and other current liabilities consisted of the following (in thousands):



	September 30, 2015		December 31, 2014
Accrued compensation and benefits	$	6,025	$	5,078
Accrued expenses	2,028		2,240
Accrued and other current liabilities	$	8,053	$	7,318

4. Intangible Assets

The components of intangible assets, which were acquired in connection with the Company’s acquisition of Face It, Corp., which the Company refers to as SoCoCare, a social engagement and mobile customer care solution provider, in October 2013, were as follows (in thousands):



	September 30, 2015							December 31, 2014
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Developed technology	$	2,460	$	(687	)	$	1,773	$	2,460	$	(423	)	$	2,037
Customer relationships	520		(203		)	317		520		(125		)	395
Domain names	50		(20		)	30		50		(12		)	38
Non-compete agreements	140		(91		)	49		140		(57		)	83
Total	$	3,170	$	(1,001	)	$	2,169	$	3,170	$	(617	)	$	2,553

Amortization expense related to intangible assets was $0.1 million and $0.4 million for the three and nine months ended September 30, 2015, respectively, and $0.1 million and $0.4 million for the three and nine months ended September 30, 2014, respectively.

As of September 30, 2015, the expected future amortization expense for intangible assets was as follows (in thousands):



Period	Expected Future Amortization Expense
Remainder of 2015	$	128
2016	503
2017	465
2018	442
2019	351
2020	280
Total	$	2,169

5. Long-Term Debt

2013 Loan and Security Agreement

The Company has a revolving line of credit of up to $20.0 million ("Revolving Credit Facility") under a loan and security agreement with a lender, which was entered into in March 2013 and last amended in December 2014 (“2013 Loan and Security Agreement”). The Revolving Credit Facility carries a variable annual interest rate of the prime rate plus 0.50% and matures on December 1, 2016.

The 2013 Loan and Security Agreement is collateralized by substantially all the assets of the Company. The balance outstanding cannot exceed the lesser of (i) $20.0 million or (ii) an amount equal to the Company’s monthly recurring revenue for the three months prior multiplied by the average Dollar-Based Retention Rate over the prior twelve months, less the amount accrued for the Company’s Universal Service Fund ("USF") obligation (accrued federal fees). As of September 30, 2015, the outstanding principal balance under the Revolving Credit Facility was $12.5 million, which has been disclosed as a non-current liability, and the amount available for additional borrowings was $7.5 million.

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In connection with its acquisition of SoCoCare, the Company also borrowed $5.0 million under a term loan (the “Term Loan”) under the 2013 Loan and Security Agreement in October 2013. Monthly interest-only payments were due on the advance at the prime rate plus 1.50% through September 2014. Principal and interest payments are due in equal monthly installments from October 2014 through the maturity of the Term Loan in March 2017. As of September 30, 2015 and December 31, 2014, approximately $3.0 million and $4.5 million, respectively, of this Term Loan was outstanding and is included as notes payable in the condensed consolidated balance sheets.

The 2013 Loan and Security Agreement contains certain covenants, including the requirement that the Company maintain $7.5 million of cash deposited with the lender for the term of the 2013 Loan and Security Agreement. The Company was in compliance with these covenants as of September 30, 2015. The 2013 Loan and Security Agreement remains senior to other debts, including the debt issued under the 2014 Loan and Security Agreement discussed below.

2014 Loan and Security Agreement

The Company has a term loan facility of $30.0 million with a syndicate of two lenders ("Lenders"), which was entered into in February 2014 and amended in December 2014 and February 2015 (the “2014 Loan and Security Agreement”). The term loan facility is available to the Company in tranches; the first tranche for $20.0 million was advanced upon the closing of the agreement and the remaining $10.0 million is available for drawdown by the Company until February 2016 in $1.0 million increments. The Company incurred $0.4 million in debt issuance costs in connection with borrowing the first tranche in February 2014. The term loan bears interest at a variable per annum rate equal to the greater of 10% or LIBOR plus 9%. Interest is due and payable on the last business day of each month during the term of the loan commencing in February 2014. Monthly principal payments are due beginning in February 2016 based on 1/60th of the outstanding balance at that time and will continue until all remaining principal outstanding under the term loan becomes due and payable in February 2019. All amounts outstanding under this loan facility have been disclosed as part of 'Notes payable - less current portion' in the condensed consolidated balance sheet as of September 30, 2015.

The term loan is secured by substantially all the assets of the Company and is subordinate to the 2013 Loan and Security Agreement. The 2014 Loan and Security Agreement contains certain covenants and includes the occurrence of a material adverse event, as defined in the agreement and determined by the Lenders, as an event of default. As of September 30, 2015, the Company was in compliance with these covenants.

In connection with entering into the 2014 Loan and Security Agreement, the Company issued to the Lenders warrants to purchase 177,865 shares of common stock at $10.12 per share, which vest and become exercisable over a ten year term from the date of issuance, based on amounts drawn under the $30.0 million term loan facility. Based on the drawdown of $20.0 million in February 2014, 118,577 shares of common stock issuable under the warrants vested and are exercisable by the Lenders. As of September 30, 2015, 59,288 shares of common stock issuable under the warrants pertaining to the undrawn $10.0 million were unvested.

Promissory Note

In July 2013, the Company issued a promissory note to the Universal Service Administrative Company ("USAC") for $4.1 million in principal amount as a financing arrangement for that amount of accrued federal fees. The promissory note carries a fixed annual interest rate of 12.75% and is repayable in 42 equal monthly installments of principal and interest beginning in August 2013. As of September 30, 2015 and December 31, 2014, approximately $1.7 million and $2.6 million in principal amount, respectively, of this promissory note was outstanding and is included as notes payable in the accompanying condensed consolidated balance sheets.

FCC Civil Penalty

In June 2015, the Company entered into a consent decree with the Federal Communications Commission (“FCC”) Enforcement Bureau (Note 9), in which the Company agreed to pay a civil penalty of $2.0 million to the U.S. Treasury in twelve equal quarterly installments starting in July 2015 without interest. As a result, the Company discounted the $2.0 million liability, which was accrued in the third quarter of 2014 for the then tentative civil penalty, to its present value of $1.7 million to reflect the imputed interest and reclassified this discounted liability from 'Accrued federal fees' to 'Notes payable.' The $0.3 million discount was recorded as a reduction to general and administrative expense in the three months ended June 30, 2015 and is being recognized as interest expense over the payment term of the civil penalty. As of September 30, 2015, the outstanding civil penalty payable was $1.8 million, of which the net carrying value was $1.6 million and is included as 'Notes payable' in the accompanying condensed consolidated balance sheets.

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As of September 30, 2015 and December 31, 2014, the Company’s outstanding debt is summarized as follows (in thousands):



	September 30, 2015			December 31, 2014
Term loan under 2014 Loan and Security Agreement	$	20,000		$	20,000
Term loan under 2013 Loan and Security Agreement	3,000			4,500
Promissory note to USAC	1,667			2,640
FCC civil penalty	1,833			—
Total notes payable, gross	26,500			27,140
Less: discount	(1,223		)	(1,216		)
Total notes payable, net carrying value	25,277			25,924
Revolving line of credit, non-current	12,500			12,500
Total debt, net carrying value	$	37,777		$	38,424
Less: current portion of debt	(6,045		)	(3,146		)
Total debt, less current portion *	31,732			35,278

* Included in ‘Revolving line of credit’ and ‘Notes payable - less current portion’ in the condensed consolidated balance sheets.

Maturities of the Company’s outstanding debt as of September 30, 2015 are as follows (in thousands):



Period	Amount to Mature
Remainder of 2015	$	874
2016	20,173
2017	5,286
2018	4,334
2019	8,333
Total	$	39,000

6. Stockholders’ Equity

Capital Structure

The Company is authorized to issue 450,000,000 shares of common stock with a par value of $0.001 per share. As of September 30, 2015, the Company had 50,498,973 shares of common stock issued and outstanding.

The Company is also authorized to designate and issue up to 5,000,000 shares of preferred stock with a par value of $0.001 per share in one or more series without stockholder approval and to fix the rights, preferences, privileges and restrictions thereof. As of September 30, 2015, the Company had no shares of preferred stock issued and outstanding.

Common Stock Subject to Forfeiture

In connection with employment and service agreements entered into in connection with the Company’s acquisition of SoCoCare in October 2013 ("Acquisition Date"), the Company issued 118,577 shares of unvested restricted common stock, the vesting of which was contingent upon continuing employment or services and subject to forfeiture. These shares were valued at $8.48 per share based on the Acquisition Date fair value of the Company’s common stock. This amount was recorded as stock-based compensation on a straight-line basis over the requisite service periods. During October 2014, 50% of such shares vested. During the three months ended March 31, 2015, in accordance with the applicable stock issuance agreement, the vesting on 37,905 shares accelerated in connection with the termination of employment of a shareholder. During the three months ended June 30, 2015, the remaining 21,384 unvested shares were forfeited as a result of terminations of employment of the remaining employee-shareholders. As of December 31, 2014, the 59,289 shares that were subject to forfeiture were included in issued and outstanding shares of common stock.

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Warrants

As of September 30, 2015 and December 31, 2014, the Company had outstanding warrants to purchase 359,596 shares of common stock with a weighted-average exercise price of $5.59 per share, which expire on various dates between February 2020 and February 2024.

Common Stock Reserved for Future Issuance

As of September 30, 2015, shares of common stock reserved for future issuance related to outstanding equity awards, common stock warrants, and employee equity incentive plans were as follows (in thousands):



		September 30, 2015
Stock options outstanding		6,553
Restricted stock units outstanding		1,606
Shares available for future grant under 2014 Plan		5,197
Shares available for future issuance under ESPP		1,058
Common stock warrants outstanding		360
Total shares of common stock reserved		14,774

Equity Incentive Plans

Prior to the Initial Public Offering ("IPO"), the Company granted stock options under its Amended and Restated 2004 Equity Incentive Plan, as amended (the “2004 Plan”).

In March 2014, the Company’s board of directors and stockholders approved the 2014 Equity Incentive Plan (“2014 Plan”) and 5,300,000 shares of common stock were reserved for issuance under the 2014 Plan. In addition, on the first day of each year beginning in 2015 and ending in 2024, the 2014 Plan provides for an annual automatic increase to the shares reserved for issuance in an amount equal to 5% of the total number of shares outstanding on December 31st of the preceding calendar year or a lesser number as determined by the Company’s board of directors. Pursuant to the automatic annual increase, 2,466,124 additional shares were reserved under the 2014 Plan on January 1, 2015.

Upon the effectiveness of the 2014 Plan on April 3, 2014, no future grants will be made under the 2004 Plan. All shares reserved under the 2004 Plan became available for grant under the 2014 Plan. Any forfeited or expired shares that would otherwise return to the 2004 Plan after the IPO instead return to the 2014 Plan. As of September 30, 2015, 5,196,762 shares of common stock were available for future grant under the 2014 Plan.

The 2004 Plan and the 2014 Plan are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Stock Options

A summary of the Company’s stock option activities during the nine months ended September 30, 2015 is as follows (in thousands, except years and per share data):



	Number of Shares Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value
Outstanding as of December 31, 2014	7,164		$	4.34
Options granted (weighted average grant date fair value of $2.40 per share)	234		5.02
Options exercised	(565	)	0.75
Options forfeited or expired	(280	)	7.20
Outstanding as of September 30, 2015	6,553		$	4.56	6.8	$	7,478

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The Company has computed the aggregate intrinsic value amounts disclosed in the above table based on the difference between the original exercise price of the options and the fair market value of the Company’s common stock of $3.70 as of September 30, 2015 for all in-the-money options outstanding.

Restricted Stock Units

A summary of the Company's restricted stock units ("RSU") activities during the nine months ended September 30, 2015 is as follows (in thousands, except per share data):



	Number of Shares		Weighted Average Grant Date Fair Value Per Share
Outstanding as of December 31, 2014	1,370		$	5.21
RSUs granted	839		4.82
RSUs vested and released	(475	)	5.91
RSUs forfeited	(128	)	5.17
Outstanding as of September 30, 2015	1,606		$	4.81

Employee Stock Purchase Plan

The Company's 2014 Employee Stock Purchase Plan ("ESPP") became effective on April 3, 2014 and is described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. The number of shares of common stock originally reserved for issuance under the ESPP was 880,000 shares, which will increase automatically each year, beginning on January 1, 2015 and continuing through January 1, 2024, by the lesser of (i) 1% of the total number of shares of the Company’s common stock outstanding on December 31 of the preceding calendar year; (ii) 1,000,000 shares of common stock (subject to adjustment to reflect any split or combination of the Company’s common stock); or (iii) such lesser number as determined by the Company’s board of directors. Pursuant to the automatic annual increase, 493,224 additional shares were reserved under the ESPP on January 1, 2015. As of September 30, 2015, 1,058,251 shares of common stock were available for future issuance under the ESPP.

During the three months ended September 30, 2015, no shares were purchased under the ESPP. During the nine months ended September 30, 2015, 158,842 shares were purchased on May 15, 2015 at a weighted-average price of $4.28 per share under the ESPP.

Stock-Based Compensation

Stock-based compensation expenses for the three and nine months ended September 30, 2015 and 2014 are as follows (in thousands):



	Three Months Ended				Nine Months Ended
	September 30, 2015		September 30, 2014		September 30, 2015		September 30, 2014
Cost of revenue	$	233	$	158	$	639	$	366
Research and development	475		583		1,389		1,404
Sales and marketing	448		361		1,430		1,055
General and administrative	789		775		2,552		1,971
Total stock-based compensation	$	1,945	$	1,877	$	6,010	$	4,796

As of September 30, 2015, unrecognized stock-based compensation expenses by award type, net of estimated forfeitures, and their expected weighted-average recognition periods are summarized in the following table (in thousands, except years).



	Stock Option		RSU		ESPP
Unrecognized stock-based compensation expense	$	7,906	$	6,316	$	63
Weighted-average amortization period	2.3 years		2.9 years		0.1 years

The Company recognizes stock-based compensation expense that is calculated based upon awards ultimately expected to vest and, thus, stock-based compensation expense is reduced for estimated forfeitures. Forfeitures are

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estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. All stock-based compensation for equity awards granted to employees and non-employee directors is measured based on the grant date fair value of the award.

The Company values RSUs at the closing market price of its common stock on the date of grant. The Company estimates the fair value of each stock option and purchase right under the ESPP granted to employees on the date of grant using the Black-Scholes option-pricing model and using the assumptions noted in the below table. The weighted-average assumptions used to value stock options granted during the three and nine months ended September 30, 2015 and 2014 were as follows:



Stock Options	Three Months Ended		Nine Months Ended
	September 30, 2015	September 30, 2014	September 30, 2015	September 30, 2014
Expected term (years)	6.1	6.1	6.1	6.1
Volatility	48%	55%	49%	56%
Risk-free interest rate	1.6%	1.8%	1.5%	1.8%
Dividend yield	—	—	—	—

7. Net Loss Per Share

Basic net loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period, and excludes any dilutive effects of employee stock-based awards and warrants. Diluted net income per share is computed giving effect to all potentially dilutive common shares, including common stock issuable upon exercise of stock options and warrants and vesting of restricted stock. As the Company had net losses for the three and nine months ended September 30, 2015 and 2014, all potentially issuable common shares were determined to be anti-dilutive.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data).



	Three Months Ended						Nine Months Ended
	September 30, 2015			September 30, 2014			September 30, 2015			September 30, 2014
Net loss	$	(6,048	)	$	(11,435	)	$	(22,320	)	$	(28,414	)
Weighted-average shares used in computing basic and diluted net loss per share	50,369			48,310			49,931			33,762
Basic and diluted net loss per share	$	(0.12	)	$	(0.24	)	$	(0.45	)	$	(0.84	)

The following securities were excluded from the calculation of diluted net loss per share because their effect would have been anti-dilutive for the periods presented (in thousands).



	September 30, 2015	September 30, 2014
Stock options	6,553	6,968
Restricted stock units	1,606	545
ESPP	189	383
Common stock warrants	360	360
Common stock subject to repurchase or forfeiture	—	120
Total	8,708	8,376

8. Income Taxes

The provision for income taxes for the three and nine months ended September 30, 2015 was approximately $50 thousand and $48 thousand, respectively. The provision for income taxes for the three and nine months ended September 30, 2014 was approximately $13 thousand and $52 thousand, respectively. The provision for income taxes consisted primarily of foreign income taxes.

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For the three and nine months ended September 30, 2015 and 2014, the provision for income taxes differed from the statutory amount primarily because the Company did not realize a tax benefit for current year losses as it maintained a full valuation allowance against its domestic and foreign net deferred tax assets.

The realization of tax benefits of deferred tax assets is dependent upon future levels of taxable income, of an appropriate character, in the periods the items are expected to be deductible or taxable. Based on the available objective evidence, the Company does not believe it is more likely than not that the net deferred tax assets will be realizable. Accordingly, the Company has provided a full valuation allowance against the domestic and foreign net deferred tax assets as of September 30, 2015 and December 31, 2014. The Company intends to maintain the valuation allowance until sufficient positive evidence exists to support a reversal of, or decrease in, the valuation allowance. During the three and nine months ended September 30, 2015, there were no material changes to the total amount of unrecognized tax benefits.

9. Commitments and Contingencies

Commitments

The Company’s principal commitments consist of obligations under operating lease agreements for offices, research and development, and sales and marketing facilities, capital leases to finance data centers and other computer and networking equipment purchases and agreements with third parties to provide co-location hosting and telecommunication usage services. These commitments as of December 31, 2014 are disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2014, and did not change materially during the nine months ended September 30, 2015 except for the acquisition of certain additional data center and network equipment and software under multiple capital leases. As of September 30, 2015, the total minimum future payment commitments under these capital leases were approximately $4.4 million, of which $0.4 million is due in 2015, with the remainder due over approximately 2.9 years thereafter.

Universal Services Fund Liability

During the third quarter of 2012, the Company determined that based on its business activities, it is classified as a telecommunications service provider for regulatory purposes and it should make direct contributions to the federal USF and related funds based on revenues it receives from the resale of interstate and international telecommunications services. Previously, the Company had believed that the telecommunications services were an integral part of an information service that the Company provides via its software and had instead made indirect USF contributions via payments to its wholesale telecommunications service providers. In order to comply with the obligation to make direct contributions, the Company made a voluntary self-disclosure to the FCC Enforcement Bureau and has registered with the USAC, which is charged by the FCC with administering the USF. The Company has filed exemption certificates with its wholesale telecommunications service providers in order to eliminate its obligation to reimburse such wholesale telecommunications service providers for their USF contributions calculated on services sold to the Company.

The Company’s registration with USAC subjects it to assessments for unpaid USF contributions, as well as interest thereon and civil penalties, due to its late registration and past failure to recognize its obligation as a USF contributor and as an international carrier. The Company will be required to pay assessments for periods prior to the Company’s registration. As of December 31, 2012, the total past due USF contribution being imposed by USAC and accrued by the Company for the period from 2003 through 2012 was $8.1 million, of which $4.7 million was undisputed and $3.4 million, including $0.8 million that pertains to 2003 through 2007, was disputed. While the Company is in administrative proceedings before the FCC to limit such back assessments to the period 2008 through 2012, it is possible that it will be required to pay back assessments for the period from 2003 through 2007. In 2013, the Company began remitting required contributions on a prospective basis directly to USAC.

In July 2013, the Company and USAC agreed to a financing arrangement for $4.1 million of the undisputed $4.7 million of the unpaid USF contributions whereby the Company issued to USAC a promissory note payable in the principal amount of the $4.1 million and paid off the remaining undisputed $0.6 million. The repayment terms of the promissory note payable are disclosed in Note 5. As of September 30, 2015 and December 31, 2014, the principal balance of the promissory note payable was $1.7 million and $2.6 million, respectively, and is included in the notes payable amounts on the condensed consolidated balance sheets. In addition to the promissory note payable, as of September 30, 2015 and December 31, 2014, the Company had an accrued liability for the disputed portion of the unpaid USF contributions and estimated interest and penalties of $4.5 million and $4.2 million, respectively, included in accrued federal fees on the condensed consolidated balance sheets. For the three and nine months ended

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September 30, 2015, the Company recorded interest and penalty expenses of $0.1 million and $0.4 million, respectively, as a charge to general and administrative expense, which were related to its disputed unpaid USF obligations.

In June 2015, in connection with the Company's late registration with the USAC and past failure to recognize its obligation as a USF contributor and as an international carrier from 2003 to 2012, the Company entered into a consent decree with the FCC Enforcement Bureau. In the consent decree, the Company agreed to pay a civil penalty of $2.0 million to the U.S. Treasury in twelve equal quarterly installments starting in July 2015 without interest (Note 5). In the third quarter of 2014, the Company had accrued a $2.0 million liability for the then tentative civil penalty. The consent decree also requires the Company to adopt certain internal regulatory compliance monitoring and training requirements, and to report on the status of those compliance efforts to the FCC’s Enforcement Bureau during a period of three years.

State and Local Taxes and Surcharges

In April 2012, the Company commenced collecting and remitting sales taxes on sales of subscription services in all the U.S. states in which it determined it was obligated to do so. During the first quarter of 2015, the Company conducted an updated sales tax review of the taxability of sales of its subscription services. As a result, the Company determined that it may be obligated to collect and remit sales taxes on such sales in four additional states. Based on its best estimate of the probable sales tax liability in those four states relating to its sales of subscription services during the period 2011 through 2014, for the three months ended March 31, 2015, the Company recorded a general and administrative expense of $0.6 million as an immaterial out of period adjustment to accrue for such taxes.

During 2013, the Company analyzed its activities and determined it may be obligated to collect and remit various state and local taxes and surcharges on its usage-based fees. The Company had not remitted state and local taxes on usage-based fees in any of the periods prior to 2014 and therefore accrued a sales tax liability for this contingency. In January 2014, the Company commenced paying such taxes and surcharges to certain state authorities. In June 2014, the Company commenced collecting state and local taxes or surcharges on usage-based fees from its clients on a current basis and remitting such taxes to the applicable U.S. state taxing authorities.

During the three and nine months ended September 30, 2015, the Company has remitted $0.1 million and $1.0 million for its contingent sales taxes on both usage-based fees and sales of subscription services. For the three and nine months ended September 30, 2015, the Company recognized $17 thousand and $1.0 million, respectively, as general and administrative expense related to its estimated sales tax liability on both usage-based fees and sales of subscription services in the U.S. and Canada, which was not being collected from its clients. During 2015, the Company expects to commence collecting such sales taxes from its clients on a current basis and remitting such taxes to the applicable taxing authorities.

As of September 30, 2015, the Company had total accrued liabilities of $2.6 million for such contingent sales taxes and surcharges that were not being collected from its clients but may be imposed by various taxing authorities, of which $0.7 million and $1.9 million was included in current and non-current "Sales tax liability" on the condensed consolidated balance sheets, respectively. As of December 31, 2014, the Company had total accrued liabilities of $2.6 million for such contingent sales taxes and surcharges, which was included in non-current "Sales tax liability" on the condensed consolidated balance sheets. The Company’s estimate of the probable loss incurred under this contingency is based on its analysis of the source location of its usage-based fees and the regulations and rules in each tax jurisdiction.

Legal Matters

The Company is involved in various legal and regulatory matters arising in the normal course of business. In management’s opinion, resolution of these matters is not expected to have a material impact on the Company’s consolidated results of operations, cash flows, or its financial position. However, depending on the nature and timing of any such dispute, an unfavorable resolution of a matter could materially affect the Company’s future consolidated results of operations, cash flows or financial position in a particular period.

The Company is currently involved in the following lawsuit as a defendant.

NobelBiz Litigation

In April 2012, NobelBiz, Inc., a telecommunication solutions company, brought a patent infringement lawsuit in the U.S. District Court for the Eastern District of Texas against the Company seeking a permanent injunction,

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damages and attorneys' fees. The Company responded to the complaint and preliminary injunction request by asserting non-infringement and invalidity of the patent.

In March 2013, the court granted the Company's motion to transfer the case to the U.S. District Court for the Northern District of California subsequent to which the complainant amended its claim to include another related patent. The Company has responded to this amended claim by continuing to assert non-infringement and invalidity of the patents. During December 2013, the court in California held a status conference and subsequently held a claim construction hearing regarding the patents on August 22, 2014. On January 16, 2015, the court issued an order regarding claim construction of the two patents-in-suit. A trial date of June 20, 2016 has been set in the event that the case is not resolved by summary judgment motions. The deadline for filing summary judgment motions is March 4, 2016. The Company has investigated the claims alleged in the complaint and believes that it has good defenses to the claims. Accordingly, the Company has not accrued a loss related to this matter as the Company does not believe that it is probable that a loss will be incurred.

The Company recognizes general and administrative expense for legal fees in the period the services are provided.

Indemnification Agreements

In the ordinary course of business, the Company indemnifies various clients, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, services to be provided by the Company or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with its directors, officers and certain employees that require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. No demands have been made upon the Company to provide indemnification under such agreements and thus there are no claims that the Company is aware of that would have a material effect on the Company’s condensed consolidated balance sheets, condensed consolidated statements of operations and comprehensive loss, or condensed consolidated statements of cash flows.

10. Geographical Information

The following table is a summary of revenues by geographic region based on client billing address and has been estimated based on the amounts billed to clients during the periods (in thousands).



	Three Months Ended				Nine Months Ended
	September 30, 2015		September 30, 2014		September 30, 2015		September 30, 2014
United States	$	29,987	$	23,879	$	86,353	$	69,130
International	2,300		1,990		6,482		5,698
Total revenue	$	32,287	$	25,869	$	92,835	$	74,828

The following table summarizes total property and equipment, net in the respective locations (in thousands).



	September 30, 2015		December 31, 2014
United States	$	10,408	$	10,625
International	1,968		1,946
Property and equipment, net	$	12,376	$	12,571

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

You should read the following discussion in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this report and our Annual Report on Form 10-K for the year ended December 31, 2014. In addition to historical information, this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that involve risks and uncertainties that could cause our actual results to differ materially from our expectations. Factors that could cause such differences include, but are not limited to, those described in the section titled “Risk Factors” and elsewhere in this report.

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Overview

We are a pioneer and leading provider of cloud software for contact centers, facilitating over three billion interactions between our more than 2,000 clients and their customers per year. We believe we achieved this leadership position through our expertise and technology, which has empowered us to help organizations of all sizes transition from legacy on-premise contact center systems to our cloud solution. Our solution, which is comprised of our Virtual Contact Center ("VCC") cloud platform and applications, allows simultaneous management and optimization of customer interactions across voice, chat, email, web, social media and mobile channels, either directly or through our application programming interfaces. Our VCC cloud platform routes each customer interaction to an appropriate agent resource, and delivers relevant customer data to the agent in real-time to optimize the customer experience. Unlike legacy on-premise contact center systems, our solution requires minimal up-front investment and can be rapidly deployed and adjusted depending on our client’s requirements.

Since founding our business in 2001, we have focused exclusively on delivering cloud contact center software. We initially targeted smaller contact center opportunities with our telesales team and, over time, invested in expanding the breadth and depth of the functionality of our cloud platform to meet the evolving requirements of our clients. In 2009, we made a strategic decision to expand our market opportunity to include larger contact centers. This decision drove further investments in research and development and the establishment of our field sales team to meet the requirements of these larger contact centers. We believe this shift has helped us diversify our client base while significantly enhancing our opportunity for future revenue growth. To complement these efforts, we have also focused on building client awareness and driving adoption of our solution through marketing activities, which include internet advertising, digital marketing campaigns, social marketing, trade shows, industry events and telemarketing.

We provide our solution through a Software as a Service ("SaaS") business model with recurring subscriptions. We offer a comprehensive suite of applications delivered on our VCC cloud platform that are designed to enable our clients to manage and optimize interactions across inbound and outbound contact centers. We primarily generate revenue by selling subscriptions and related usage of our VCC cloud platform. We charge our clients monthly subscription fees for access to our solution, primarily based on the number of agent seats, as well as the specific functionalities and applications our clients deploy. We define agent seats as the maximum number of named agents allowed to concurrently access our solution. Our clients typically have more named agents than agent seats, and multiple named agents may use an agent seat, though not simultaneously. Substantially all of our clients purchase both subscriptions and related usage from us. A small percentage of our clients subscribe to our platform but purchase telephony usage directly from wholesale telecommunications service providers. We do not sell telephony usage on a stand-alone basis to any client. The related usage fees are based on the volume of minutes for inbound and outbound interactions. We also offer bundled plans, generally for smaller deployments, where the client is charged a single monthly fixed fee per agent seat that includes both subscription and unlimited usage in the contiguous 48 states and, in some cases, Canada. We offer monthly, annual and multiple-year contracts to our clients, generally with 30 days’ notice required for changes in the number of agent seats. Our clients can use this notice period to rapidly adjust the number of agent seats used to meet their changing contact center volume needs, including to reduce the number of agent seats to zero. As a general matter, this means that a client can effectively terminate its agreement with us upon 30 days’ notice. Our larger clients typically choose annual contracts, which generally include an implementation and ramp period of several months. Fixed subscription fees, including bundled plans, are generally billed monthly in advance, while related usage fees are billed in arrears. For the three and nine months ended September 30, 2015, subscription and related usage fees accounted for 96% and 97% of our revenue, respectively. For the three and nine months ended September 30, 2014, subscription and related usage fees accounted for 97% of our revenue. The remainder was comprised of professional services revenue from the implementation and optimization of our solution.

Our revenue increased to $32.3 million and $92.8 million for the three and nine months ended September 30, 2015 from $25.9 million and $74.8 million for the three and nine months ended September 30, 2014. Revenue growth has primarily been driven by new clients choosing to use our solution and to a lesser extent, existing clients gradually increasing the number of agent seats under subscription. For each of the three and nine months ended September 30, 2015 and 2014, no single client accounted for more than 10% of our total revenue. As of September 30, 2015, we had over 2,000 clients across multiple industries. Our clients' subscriptions generally range in size from fewer than 10 agent seats to approximately 1,000 agent seats.

We have continued to make significant expenditures and investments, including in sales and marketing, research and development and infrastructure. We primarily evaluate the success of our business based on revenue growth and the efficiency and effectiveness of our investments. The growth of our business and our future success

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depend on many factors, including our ability to continue to expand our client base to include larger opportunities, grow revenue from our existing client base, innovate and expand internationally. While these areas represent significant opportunities for us, they also pose risks and challenges that we must successfully address in order to sustain the growth of our business and improve our operating results.

In order to pursue these opportunities, we anticipate that we will continue to expand our operations and headcount in the near term. The expected addition of new employees and the investments that we anticipate will be necessary to manage our anticipated growth will make it more difficult for us to generate earnings.

Due to our continuing investments to grow our business, increase our sales and marketing efforts, pursue new opportunities, enhance our solution and build our technology, we expect our cost of revenue and operating expenses to increase in absolute dollars in future periods. However, we expect these expenses as a percentage of revenue to decrease as we grow our revenue and gain economies of scale by increasing our client base without direct incremental development costs and by utilizing more of the capacity of our data centers.

Key Operating and Financial Performance Metrics

In addition to measures of financial performance presented in our condensed consolidated financial statements, we monitor the key metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies.

Dollar-Based Retention Rate

We believe that our Dollar-Based Retention Rate provides insight into our ability to retain and grow revenue from our clients, and is a measure of the long-term value of our client relationships. Our Dollar-Based Retention Rate is calculated by dividing our Retained Net Invoicing by our Retention Base Net Invoicing on a monthly basis, which we then average using the rates for the trailing twelve months for the period being presented. We define Retention Base Net Invoicing as recurring net invoicing from all clients in the comparable prior year period, and we define Retained Net Invoicing as recurring net invoicing from that same group of clients in the current period. We define recurring net invoicing as subscription and related usage revenue excluding the impact of service credits, reserves and deferrals. Historically, the difference between recurring net invoicing and our subscription and related usage revenue has been within 10%.

The following table shows our Dollar-Based Retention Rate for the periods presented:



	Twelve Months Ended
	September 30, 2015	September 30, 2014
Dollar-Based Retention Rate	95%	97%

The year-over-year decline in our Dollar-Based Retention Rate was primarily due to several clients who provide support for Affordable Care Act (“ACA”) enrollment. Our recurring net invoicing to these clients increased significantly in the twelve months ended September 30, 2014 compared to the twelve months ended September 30, 2013 due to intense and extended activity during the initial roll out of the ACA. In the twelve months ended September 30, 2015, we did not experience the same growth rate in the recurring net invoicing from ACA clients as we had in the twelve months ended September 30, 2014, because enrollees were more familiar with the process, requiring less support, and, unlike the prior year, the enrollment deadline was not extended. As a result, our Dollar-Based Retention Rate declined from September 30, 2014 to September 30, 2015.

Adjusted EBITDA

We monitor Adjusted EBITDA, a non-GAAP financial measure, to analyze our financial results and believe that it is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance. We believe that Adjusted EBITDA helps illustrate underlying trends in our business that could otherwise be masked by the effect of the income or expenses that we exclude from Adjusted EBITDA. Furthermore, we use this measure to establish budgets and operational goals for managing our business and evaluating our performance. We also believe that Adjusted EBITDA provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods with other companies in our industry.

Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP and our calculation of Adjusted EBITDA may differ from that of other

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companies in our industry. We compensate for the inherent limitations associated with using Adjusted EBITDA through disclosure of these limitations, presentation of our financial statements in accordance with U.S. GAAP and reconciliation of Adjusted EBITDA to the most directly comparable U.S. GAAP measure, net loss. We calculate Adjusted EBITDA as net loss before (1) depreciation and amortization, (2) stock-based compensation, (3) Interest income, expense and other, (4) provision for income taxes, and (5) other unusual items that do not directly affect what we consider to be our core operating performance.

The following table shows a reconciliation of net loss to Adjusted EBITDA for the periods presented (in thousands):



	Three Months Ended						Nine Months Ended
	September 30, 2015			September 30, 2014			September 30, 2015			September 30, 2014
Net loss	$	(6,048	)	$	(11,435	)	$	(22,320	)	$	(28,414	)
Non-GAAP adjustments:
Depreciation and amortization ⁽¹⁾	1,840			1,567			5,525			4,858
Stock-based compensation ⁽²⁾	1,945			1,877			6,010			4,796
Interest expense	1,235			1,116			3,529			2,986
Interest income and other	(119		)	(95		)	(72		)	(99		)
Provision for income taxes	50			13			48			52
Change in fair value of convertible preferred and common stock warrant liabilities	—			—			—			(1,745		)
Reversal of contingent sales tax liability ⁽³⁾	—			—			—			(2,766		)
Accrued FCC charge ⁽⁴⁾	—			2,000			—			2,000
Out of period adjustment for sales tax liability ⁽⁵⁾	—			—			765			—
Adjusted EBITDA	$	(1,097	)	$	(4,957	)	$	(6,515	)	$	(18,332	)

(1) Depreciation and amortization expenses included in our results of operations are as follows (in thousands):



	Three Months Ended				Nine Months Ended
	September 30, 2015		September 30, 2014		September 30, 2015		September 30, 2014
Cost of revenue	$	1,470	$	1,272	$	4,467	$	3,847
Research and development	126		58		315		154
Sales and marketing	52		50		152		146
General and administrative	192		187		591		711
Total depreciation and amortization	$	1,840	$	1,567	$	5,525	$	4,858

(2) See Note 6 of the notes to the condensed consolidated financial statements for stock-based compensation expense included in our results of operations for the periods presented.

(3) Included in general and administrative expense. This amount represents a credit recorded in the second quarter of 2014 following a favorable ruling from a state's revenue authority.

(4) Included in general and administrative expense. The expense was recorded in the third quarter of 2014 for an accrued liability for the then tentative FCC civil penalty. See Note 9 of the notes to the condensed consolidated financial statements.

(5) Included in general and administrative expense. The amount represents immaterial out of period adjustments recorded in the first two quarters of 2015 for 2011 through 2014.

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Key Components of Our Results of Operations

Revenue

Our revenue consists of subscription and related usage as well as professional services. We consider our subscription and related usage to be recurring. This recurring revenue includes fixed subscription fees for the delivery and support of our VCC cloud platform, as well as related usage fees. The related usage fees are based on the volume of minutes for inbound and outbound client interactions. We also offer bundled plans, generally for smaller deployments, where the client is charged a single monthly fixed fee per agent seat that includes both subscription and unlimited usage in the contiguous 48 states and, in some cases, Canada. We offer monthly, annual and multiple-year contracts for our clients, generally with 30 days’ notice required for changes in the number of agent seats. Our clients can use this notice period to rapidly adjust the number of agent seats used to meet their changing contact center volume needs, including to reduce the number of agent seats to zero. As a general matter, this means that a client can effectively terminate its agreement with us upon 30 days’ notice.

Fixed subscription fees, including plans with bundled usage, are generally billed monthly in advance, while variable usage fees are billed in arrears. Fixed subscription fees are recognized on a straight-line basis over the applicable term, predominantly the monthly contractual billing period. Support activities include technical assistance for our solution and upgrades and enhancements on a when and if available basis, which are not billed separately. Variable subscription related usage fees for non-bundled plans are billed in arrears based on client-specific per minute rate plans and are recognized as actual usage occurs. We generally require advance deposits from clients based on estimated usage. All fees, except usage deposits, are non-refundable.

In addition, we generate professional services revenue from assisting clients in implementing our solution and optimizing use. These services include application configuration, system integration and education and training services. Professional services are primarily billed on a fixed-fee basis and are typically performed by us directly. In limited cases, our clients may choose to perform these services themselves or engage their own third-party service providers to perform such services. Professional services are recognized as the services are performed using the proportional performance method, with performance measured based on hours of work performed, provided all other criteria for revenue recognition are met.

Cost of Revenue

Our cost of revenue consists primarily of fees that we pay to telecommunications providers for usage, personnel costs (including stock-based compensation), costs to build out and maintain co-location data centers, depreciation and related expenses of the servers and equipment, USF contributions and other regulatory costs, allocated office and facility costs and amortization of acquired technology. Cost of revenue can fluctuate based on a number of factors, including the fees we pay to telecommunications providers, which vary depending on our clients’ usage of our VCC cloud platform, the timing of capital expenditures and related depreciation charges and changes in headcount. We expect to continue investing in our network infrastructure and operations and client support function to maintain high quality and availability of service. As our business grows, we expect to realize economies of scale in network infrastructure, personnel and client support.

Operating Expenses

We classify our operating expenses as research and development, sales and marketing and general and administrative expenses.

Research and Development. Our research and development expenses consist primarily of salary and related expenses (including stock-based compensation) for personnel related to the development of improvements and expanded features for our services, as well as quality assurance, testing, product management and allocated overhead. We expense research and development expenses as they are incurred except for internal use software development costs that qualify for capitalization. We believe that continued investment in our solution is important for our future growth, and we expect research and development expenses to increase in absolute dollars in the foreseeable future, although these expenses as a percentage of our revenue are expected to decrease over time.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries and related expenses (including stock-based compensation) for employees in sales and marketing, including commissions and bonuses, as well as advertising, marketing, corporate communications, travel costs and allocated overhead. We expense the costs of sales commissions associated with the acquisition or renewal of client contracts as incurred in the period the contract is acquired or the renewal occurs. We believe it is important to continue investing in sales and marketing to continue to generate revenue growth. Accordingly, we expect sales and marketing expenses to increase in absolute

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dollars as we continue to support our growth initiatives, although these expenses as a percentage of our revenue are expected to decrease over time.

General and Administrative. General and administrative expenses consist primarily of salary and related expenses (including stock-based compensation) for management, finance and accounting, legal, information systems and human resources personnel, professional fees, compliance costs, other corporate expenses and allocated overhead. We expect that general and administrative expenses will fluctuate in absolute dollars from period to period but decline as a percentage of revenue over time.

Other Income (Expense), Net

Other income (expense), net consists primarily of interest expense associated with our debt and capital leases and, prior to our IPO, was also impacted by the change in fair value of our convertible preferred and common stock warrant liabilities. As a result of a $2.0 million FCC civil penalty that is payable in twelve equal quarterly installments starting in July 2015, our $20.0 million term loan borrowed in February 2014 (see Note 5 of the notes to condensed consolidated financial statements of this Form 10-Q) and our continued capital spending funded by capital leases, we expect interest expense to increase in absolute dollars.

Change in Fair Value of Convertible Preferred and Common Stock Warrant Liabilities. Prior to our IPO, we had outstanding warrants to purchase shares of our convertible preferred stock and common stock which were classified as liabilities. These warrants were subject to re-measurement at each balance sheet date, and any change in fair value was recognized as a component of other income (expense), net. In connection with our IPO in April 2014, these liability-classified warrants became equity-classified and accordingly the associated liability was reclassified to additional paid-in capital. After the IPO, we are no longer required to re-measure the fair value of the warrant liability, therefore, beginning with the three months ended June 30, 2014, no further charges or credits related to such warrants have been or will be made to other income (expense), net.

Provision for Income Taxes

Our provision for income taxes consists primarily of corporate income taxes resulting from profits generated in foreign jurisdictions by our wholly-owned subsidiaries, along with state income taxes payable in the United States.

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Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014

Based on the condensed consolidated statements of operations and comprehensive loss set forth in this quarterly report, the following table sets forth our operating results as a percentage of revenue for the periods indicated:



	Three Months Ended				Nine Months Ended
	September 30, 2015		September 30, 2014		September 30, 2015		September 30, 2014
Revenue	100	%	100	%	100	%	100	%
Cost of revenue	46	%	52	%	47	%	54	%
Gross profit	54	%	48	%	53	%	46	%
Operating expenses:
Research and development	17	%	21	%	18	%	22	%
Sales and marketing	33	%	36	%	34	%	37	%
General and administrative	19	%	31	%	21	%	23	%
Total operating expenses	69	%	88	%	73	%	82	%
Loss from operations	(15	)%	(40	)%	(20	)%	(36	)%
Other income (expense), net:
Interest expense	(4	)%	(5	)%	(4	)%	(4	)%
Interest income and other	—	%	1	%	—	%	—	%
Change in fair value of convertible preferred and common stock warrant liabilities	—	%	—	%	—	%	2	%
Total other income (expense), net	(4	)%	(4	)%	(4	)%	(2	)%
Loss before provision for income taxes	(19	)%	(44	)%	(24	)%	(38	)%
Provision for income taxes	—	%	—	%	—	%	—	%
Net loss	(19	)%	(44	)%	(24	)%	(38	)%

Revenue



	Three Months Ended								Nine Months Ended
	September 30, 2015		September 30, 2014		$ Change		% Change		September 30, 2015		September 30, 2014		$ Change		% Change

	(in thousands, except percentages)
Revenue	$	32,287	$	25,869	$	6,418	25	%	$	92,835	$	74,828	$	18,007	24	%

The increase in revenue for the three and nine months ended September 30, 2015 compared to the same periods of 2014 was primarily attributable to revenue from new clients acquired, which was primarily driven by an increase in sales and marketing activities. Our average pricing remained relatively consistent between these periods.

Cost of Revenue



	Three Months Ended								Nine Months Ended
	September 30, 2015		September 30, 2014		$ Change		% Change		September 30, 2015		September 30, 2014		$ Change		% Change

	(in thousands, except percentages)
Cost of revenue	$	14,812	$	13,504	$	1,308	10	%	$	43,860	$	40,121	$	3,739	9	%
% of Revenue	46%		52%						47%		54%

The increase in cost of revenue for the three and nine months ended September 30, 2015 compared to the same periods of 2014 was primarily due to a $1.0 million and a $2.9 million increase in personnel costs driven by increased headcount, a $0.5 million and a $1.1 million increase in USF contributions and other federal telecommunication service fees primarily due to increased client usage, a $0.4 million and a $0.9 million increase in third party hosted software costs due to increased client activities, a $0.2 million and a $0.6 million increase in depreciation expenses due to additional investments in equipment to support current and expected future client

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growth, and a $0.2 million and a $0.6 million increase in facility-related costs. These increases were offset in part by a $1.0 million and a $2.7 million decrease in telecommunication carrier costs relating to our clients' long distance call usage due to improved usage efficiencies.

Gross Profit



	Three Months Ended								Nine Months Ended
	September 30, 2015		September 30, 2014		$ Change		% Change		September 30, 2015		September 30, 2014		$ Change		% Change

	(in thousands, except percentages)
Gross profit	$	17,475	$	12,365	$	5,110	41	%	$	48,975	$	34,707	$	14,268	41	%
% of Revenue	54%		48%						53%		46%

For the three and nine months ended September 30, 2015, the increase in gross margin was primarily due to improved usage efficiencies and continued benefit from economies of scale.

Operating Expenses

Research and Development



	Three Months Ended									Nine Months Ended
	September 30, 2015		September 30, 2014		$ Change			% Change		September 30, 2015		September 30, 2014		$ Change		% Change

	(in thousands, except percentages)
Research and development	$	5,473	$	5,503	$	(30	)	(1	)%	$	17,079	$	16,282	$	797	5	%
% of Revenue	17%		21%							18%		22%

The increase in research and development expenses for the nine months ended September 30, 2015 compared to the same period of 2014 was primarily due to a $0.7 million increase in personnel-related costs driven primarily by increased headcount.

Sales and Marketing



	Three Months Ended								Nine Months Ended
	September 30, 2015		September 30, 2014		$ Change		% Change		September 30, 2015		September 30, 2014		$ Change		% Change

	(in thousands, except percentages)
Sales and marketing	$	10,797	$	9,296	$	1,501	16	%	$	31,322	$	27,992	$	3,330	12	%
% of Revenue	33%		36%						34%		37%

The increase in sales and marketing expenses for the three months ended September 30, 2015 compared to the same period of 2014 was primarily due to a $0.6 million increase in personnel costs and a $0.6 million increase in discretionary and other marketing-related expenses. The increase in sales and marketing expenses for the nine months ended September 30, 2015 compared to the same period of 2014 was primarily due to a $1.4 million increase in personnel costs, a $0.5 million increase in commissions paid to sales personnel, and a $0.4 million increase in stock-based compensation expense.

These increases as well as the remainder of the increases were primarily due to increased headcount, the growth in sales of our solution and increased marketing activities, which supported our growth strategy to acquire new clients and increase the number of agent seats within our existing client base and establish brand awareness. The increase in stock-based compensation expense was also due to an increase in the fair value of employee equity awards.

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General and Administrative



	Three Months Ended									Nine Months Ended
	September 30, 2015		September 30, 2014		$ Change			% Change		September 30, 2015		September 30, 2014		$ Change		% Change

	(in thousands, except percentages)
General and administrative	$	6,087	$	7,967	$	(1,880	)	(24	)%	$	19,389	$	17,653	$	1,736	10	%
% of Revenue	19%		31%							21%		23%

The decrease in general and administrative expenses for the three months ended September 30, 2015 compared to the same period of 2014 was primarily due to a $2.0 million decrease in federal fees, which was offset in part by a $0.4 million increase in outside professional services fees primarily due to increased consulting costs as we prepare for Section 404 compliance, as well as higher auditors fees. The increase in general and administrative expenses for the nine months ended September 30, 2015 compared to the same period of 2014 was primarily due to a $2.9 million increase in contingent state and local taxes and surcharges, a $0.6 million increase in stock-based compensation expense, and a $0.2 million increase in office and facility related costs, partially offset by a $2.3 million decrease in federal fees.

The decrease in federal fees for the three and nine months ended September 30, 2015 resulted from a $2.0 million one-time charge recorded in the third quarter of 2014 for a then tentative FCC civil penalty and a $0.3 million credit recorded in the second quarter of 2015 to discount the final FCC civil penalty of $2.0 million to its present value (see Note 5 and Note 9 of the notes to our condensed consolidated financial statements).

The increase in contingent state and local taxes and surcharges for the nine months ended September 30, 2015 was primarily due to a one-time $2.8 million credit recorded in the second quarter of 2014 to release a contingent state tax liability that was accrued progressively on a quarterly basis from 2011 through the first quarter of 2014 for a specific state following a favorable ruling from that state's revenue authority, a $0.6 million and a $0.2 million immaterial out of period adjustment recorded in the first and the second quarter of 2015, respectively, for additional sales taxes for certain revenue earned during the period 2011 through the first quarter of 2015, partially offset by a $0.7 million decrease in sales taxes primarily for our usage-based fees as we commenced collecting state and local taxes and surcharges from our clients for applicable states in June 2014.

The increases in stock-based compensation costs and office related costs were primarily due to headcount additions, increased business insurance required to operate as a public company since our IPO in April 2014 and an increase in the fair value of employee equity awards.

Other Income (Expense), Net



	Three Months Ended											Nine Months Ended
	September 30, 2015			September 30, 2014			$ Change			% Change		September 30, 2015			September 30, 2014			$ Change			% Change

	(in thousands, except percentages)
Interest expense	$	(1,235	)	$	(1,116	)	$	(119	)	11	%	$	(3,529	)	$	(2,986	)	$	(543	)	18	%
Interest income and other	119			95			24			25	%	72			99			(27		)	(27	)%
Change in fair value of convertible preferred and common stock warrant liabilities	—			—			—			—	%	—			1,745			(1,745		)	(100	)%
Total other income (expense), net	$	(1,116	)	$	(1,021	)	$	(95	)	9	%	$	(3,457	)	$	(1,142	)	$	(2,315	)	203	%
% of Revenue	(4)%			(4)%								(4)%			(2)%

For the three and nine months ended September 30, 2015, interest expense increased as a result of a higher average balance of outstanding debt. In February 2014, we borrowed a $20.0 million term loan under a loan and security agreement. In June 2015, we agreed to pay an FCC civil penalty of $2.0 million to the U.S. Treasury in twelve equal quarterly installments starting in July 2015 without interest. The imputed interest of this civil penalty was $0.3 million and is being recognized as interest expense over the payment term of the civil penalty. See Note 5 of the notes to our condensed consolidated financial statements.

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Liquidity and Capital Resources

To date, we have financed our operations, primarily through sales of our solution, lease facilities and net proceeds from our equity and debt financings. As of September 30, 2015, we had cash and cash equivalents totaling $59.5 million.

In April 2014, we consummated our IPO and received aggregate proceeds of $74.9 million after deducting underwriters’ discounts and commissions of $5.6 million, but before deduction of offering expenses of approximately $4.2 million, of which $0.8 million was paid by us prior to 2014 and the remaining $3.4 million was paid in the first two quarters of 2014.

We maintain a revolving line of credit of $20.0 million with a bank under our 2013 Loan and Security Agreement (see Note 5 of the notes to condensed consolidated financial statements included in this Form 10-Q). As of September 30, 2015, we had borrowed $12.5 million under this facility and the amount available for additional borrowings was $7.5 million. The 2013 Loan and Security Agreement contains certain covenants, including the requirement that we maintain $7.5 million of cash deposited with the lender for the term of the agreement and includes the occurrence of a material adverse effect, as defined in the agreement and determined by the lender, as an event of default. As of September 30, 2015, we were in compliance with these covenants.

We also have a term loan facility of $30.0 million under our 2014 Loan and Security Agreement (see Note 5 of the notes to condensed consolidated financial statements included in this Form 10-Q). At closing in February 2014, we borrowed $20.0 million from the term loan facility with the remaining $10.0 million available to be borrowed until February 2016. The 2014 Loan and Security Agreement contains certain covenants and includes the occurrence of a material adverse event, as defined in the agreement and determined by the Lenders, as an event of default. As of September 30, 2015, we were in compliance with these covenants.

We believe our existing cash, cash equivalents and the amounts available for borrowing under our term loan facility and our revolving line of credit will be sufficient to meet our working capital and capital expenditure needs at least through September 30, 2016. Our future capital requirements will depend on many factors including our growth rate, continuing market acceptance of our solution, client retention, ability to gain new clients, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities and the introduction of new and enhanced offerings. We may also acquire or invest in complementary businesses, technologies and intellectual property rights, which may increase our future capital requirements, both to pay acquisition costs and to support our combined operations. We may be required to seek additional equity or debt financing. In the event that additional financing is required, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition would be harmed. In addition, if our operating performance during the next twelve months is below our expectations, our liquidity and ability to operate our business could be harmed.

If we raise additional funds by issuing equity or equity-linked securities, the ownership of our existing stockholders will be diluted. If we raise additional funds through the incurrence of indebtedness, we will be subject to increased debt service obligations and could also be subject to restrictive covenants, such as limitations on our ability to incur additional debt, and other operating restrictions that could harm our ability to conduct our business.

Cash Flows

The following table summarizes our cash flows for the periods presented (in thousands, except percentages):



	Nine Months Ended
	September 30, 2015			September 30, 2014			$ Change			% Change
Net cash used in operating activities	$	(12,873	)	$	(20,759	)	$	7,886		(38	)%
Net cash provided by (used in) investing activities	20,117			(30,496		)	50,613			(166	)%
Net cash provided by (used in) financing activities	(6,032		)	86,996			(93,028		)	(107	)%
Net increase in cash and cash equivalents	$	1,212		$	35,741		$	(34,529	)	(97	)%

Cash Flows from Operating Activities

Cash used in operating activities is significantly influenced by the amount of cash we invest in personnel and infrastructure to support the anticipated growth of our business and the amount and timing of client payments. As we continue to invest in personnel and infrastructure to support the anticipated growth of our business, we expect net

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uses of cash by operations to continue. Our largest source of operating cash inflows is cash collections from our clients for subscription and related usage services. Payments from clients for these services are typically received monthly. For the three months ended September 30, 2015 and 2014, our days-sales-outstanding were 24 and 25 days.

During the nine months ended September 30, 2015, net cash used in operating activities decreased by $7.9 million compared to the same period of 2014 primarily due to a $10.0 million decrease in net loss after adjusting for non-cash expenses, offset in part by a $2.1 million increase in net cash outflows resulting from changes in operating assets and liabilities.

During the nine months ended September 30, 2015, cash outflows from changes in operating assets and liabilities included primarily a $1.3 million decrease in accounts payable related to timing of liabilities and payments, a $1.1 million increase in accounts receivable due to increased sales, and a $1.0 million increase in prepaid expenses and other current assets primarily related to long-term maintenance contracts and annual subscription fees for third-party SaaS services. Cash inflows from changes in operating assets and liabilities was primarily due to a $0.8 million increase in accrued and other liabilities primarily for ESPP withholdings for employees due to timing of ESPP purchase, for accrued bonus and commission driven by our improved sales and financial performance, and for personnel costs due to increase in employee headcount.

During the nine months ended September 30, 2014, cash outflows from changes in operating assets and liabilities included primarily a $1.0 million increase in prepaid expenses and other current assets primarily related to long-term maintenance contracts and annual subscription fees on third-party licensed technology and insurance policies, a $1.0 million decrease in accounts payable related to timing of liabilities and payments, a $0.7 million increase in accounts receivable due to increased sales, and a $0.8 million decrease in accrued federal fees and sales tax liability primarily due to releasing a contingent state tax liability of $2.8 million in the second quarter of 2014 as a result of a favorable ruling from a specific state's revenue authority, which was offset by a $2.0 million accrual for a then tentative settlement with the FCC Enforcement Bureau. Cash inflows from changes in operating assets and liabilities included a $2.6 million increase in accrued and other liabilities primarily for ESPP withholdings for employees which started in April 2014, personnel costs due to increase in employee headcount and commissions paid to sales personnel driven by the growth in sales of our solution, and a $0.7 million increase in deferred revenue primarily attributable to increased billings.

Cash Flows from Investing Activities

Net cash provided by investing activities of $20.1 million in the nine months ended September 30, 2015 was primarily from proceeds of $40.0 million from maturity of short-term investments and a $0.8 million decrease in restricted cash due to the release of two letters of credit related to our office lease obligation and an insurance policy, offset in part by purchase of short-term investments of $20.0 million and purchase of property and equipment of $0.7 million.

Net cash used in investing activities in the nine months ended September 30, 2014 was primarily for purchase of short-term investments of $30.0 million and purchase of property and equipment of $0.5 million.

Cash Flows from Financing Activities

During the nine months ended September 30, 2015, cash used in financing activities of $6.0 million was primarily for repayments of $7.1 million on our capital lease and notes payable obligations, offset in part by cash received from stock option exercises of $0.4 million and proceeds of $0.7 million from the sale of common stock under our employee stock purchase plan.

During the nine months ended September 30, 2014, cash provided by financing activities of $87.0 million was attributable to proceeds of $71.5 million from the IPO net of $3.4 million of payments for offering costs made in the first two quarters of 2014, net proceeds of $19.6 million from a term loan under our 2014 Loan and Security Agreement, and cash received from stock option and warrants exercises of $0.8 million. These cash inflows were partially offset by $4.8 million in repayments on our capital lease and notes payable obligations.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

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We believe our critical accounting policies involve the greatest degree of judgment and complexity and have the greatest potential impact on our consolidated financial statements. Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014. During the nine months ended September 30, 2015, our critical accounting policies did not materially change.

Recent Accounting Pronouncements

In April 2015, the FASB issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. The ASU provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The ASU does not change the accounting for a customer’s accounting for service contracts. A company can elect to adopt the ASU either prospectively or retrospectively. This guidance is effective for us beginning in the first quarter of 2016. Early adoption is permitted. We do not expect this guidance to have a material effect on our consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this ASU. In August 2015, the FASB issued ASU No. 2015-15, Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, which clarifies that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. Early adoption is permitted. This guidance is effective for us on a retrospective basis beginning in the first quarter of 2016 and is not expected to have a material effect on our consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The new guidance requires management of public and private companies to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and, if so, disclose that fact. Management will also be required to evaluate and disclose whether its plans alleviate that doubt. The standard will be effective for our annual period ending December 31, 2016 and interim and annual periods thereafter. Early adoption is permitted. We do not expect that the requirement will have an impact on our financial position, results of operations or cash flows.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The ASU No. 2014-09 is originally effective for our annual and interim reporting periods beginning January 1, 2017. The standard permits the use of either the retrospective or cumulative effect transition method. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 for all entities by one year while providing an option to early adopt the standard on the original effective date. Accordingly, the new revenue standard is effective for our annual and interim reporting periods beginning January 1, 2018. We have not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

Off Balance Sheet Arrangements

As of September 30, 2015, we did not have any off balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K, such as the use of unconsolidated subsidiaries, structured finance, special purpose entities or variable interest entities.

Contractual Obligations

Our principal contractual obligations consist of future payment obligations under debt, capital leases to finance data centers and other computer and networking equipment purchases, operating leases for office space, research and development, and sales and marketing facilities, and agreements with third parties to provide co-

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location hosting and telecommunication usage services. These contractual obligations as of December 31, 2014 are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014, and did not change during the nine months ended September 30, 2015 except for the following agreements entered into in 2015.

In June 2015, the Company entered into a consent decree with the FCC Enforcement Bureau, in which the Company agreed to pay a civil penalty of $2.0 million to the U.S. Treasury in twelve equal quarterly installments starting in July 2015 without interest (see Note 5 of the notes to condensed consolidated financial statements included in this Form 10-Q). As of September 30, 2015, outstanding civil penalty payable was $1.8 million.

During the nine months ended September 30, 2015, we purchased certain additional data center and network equipment and software under multiple capital leases. As of September 30, 2015, total minimum future payment commitments under these capital leases were approximately $4.4 million, of which $0.4 million is due in 2015, with the remainder due over approximately 2.9 years thereafter.

ITEM 3. Quantitative and Qualitative Disclosure 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 interest rates, and to a lesser extent, foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.

Interest Rate Sensitivity

As of September 30, 2015, we had cash and cash equivalents of $59.5 million that were held primarily in cash or money market funds. We hold our cash and cash equivalents for working capital purposes. Declines in interest rates would reduce future interest income. For the three and nine months ended September 30, 2015, the effect of 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 value. We do not enter into investments for trading or speculative purposes. Due to the short-term nature of these money-market funds, we believe that we do not have any material exposure to changes in the fair value of our cash equivalents as a result of changes in interest rates.

As of September 30, 2015, we had a total of $35.5 million outstanding under our variable interest rate debt or financing agreements. See Note 5 of the notes to our condensed consolidated financial statements for a detailed discussion of our indebtedness. For the three and nine months ended September 30, 2015, a hypothetical 10% increase in the interest rates under these agreements would have increased our interest expense by approximately $0.1 million and $0.2 million.

Foreign Currency Risk

The functional currency of our foreign subsidiaries is the U.S. dollar. Our sales are primarily denominated in U.S. dollars, and therefore our net revenue is not directly subject to foreign currency risk. However, we are indirectly exposed to foreign currency risk. A stronger U.S. dollar could make our solution more expensive in other countries and therefore reduce demand. A weaker U.S. dollar could have the opposite effect. Such economic exposure to currency fluctuations is difficult to measure or predict because our sales are influenced by many factors in addition to the impact of such currency fluctuations.

Our operating expenses are generally denominated in the currencies of the countries in which our operations are located except for Russia. Compensation of our employees in Russia is primarily denominated in the U.S. dollar. 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 exchange rates. To date, we have not entered into any hedging arrangements with respect to foreign currency risk or other derivative financial instruments. During the three and nine months ended September 30, 2015, the effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would have had a maximum impact of approximately $0.1 million and $0.4 million on our operating results.

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ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of September 30, 2015.

Based on management’s evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2015, our disclosure controls and procedures were designed, and were effective, to provide assurance at a reasonable level that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosures.

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.

Changes in Internal Control over Financial Reporting

During the three months ended September 30, 2015, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

We are subject to certain legal and regulatory proceedings described below, 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 litigation matters.

Universal Services Fund Liability

During the third quarter of 2012, we determined that based on our business activities, we are classified as a telecommunications service provider for regulatory purposes and we are required to make direct contributions to the USF based on revenue we receive from the resale of interstate and international telecommunications services. Previously, we had been advised that the telecommunications services were an integral part of an information service and accordingly made indirect USF contributions as an end user through payments to our wholesale telecommunications service providers. In order to comply with the obligation to make direct contributions, in November 2012, we made a voluntary self-disclosure to the FCC Enforcement Bureau and have registered with USAC, which is charged by the FCC with administering the USF. We have accrued for past due contributions dating back to 2003 and, in April 2013, began remitting required contributions on a current basis directly to USAC. See Note 9 of the notes to our condensed consolidated financial statements for a discussion.

Our registration with USAC subjects us to assessments for unpaid USF contributions, as well as interest thereon and civil penalties, due to our late registration and past failure to recognize our obligation as a USF contributor and as an international carrier.

In 2012, we also determined that we were a provider of international telecommunications services and therefore we were required to secure from the FCC a section 214 international carrier authorization permitting such international telecommunications. We applied with the FCC for international carrier authority, which was granted on June 9, 2015.

In October 2014, the FCC Enforcement Bureau began to negotiate with us a consent decree and a civil penalty to conclude its investigation into our USF contribution and international carrier authorization compliance since 2003. In June 2015, we entered into a consent decree with the FCC Enforcement Bureau, in which we agreed to pay a civil penalty of $2.0 million to the U.S. Treasury in twelve equal quarterly installments starting in July 2015 without interest. In the third quarter of 2014, the Company had accrued a $2.0 million liability for the then tentative civil penalty. The consent decree also requires us to adopt certain internal regulatory compliance monitoring and training requirements, and to report on the status of those complia