Five9, Inc. 10-K

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report. Overview We are a pioneer and leading provider of intelligent cloud software for contact centers, facilitating more than nine billion call minutes between our more than 2,500 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 51 Table of Contents sizes transition from legacy on-premise contact center systems to our cloud solution. Our solution, comprised of our 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 APIs. Our VCC cloud platform matches each customer interaction with an appropriate agent resource and delivers relevant customer data to the agent in real-time through integrations with adjacent enterprise applications, such as CRM software, to optimize the customer experience and improve agent productivity. Unlike legacy on-premise contact center systems, our solution requires minimal up-front investment, 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 media, trade shows, industry events, telemarketing and out of home campaigns. We provide our solution through a 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 th e 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 telephony 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 reductions in the number of agent seats. Increases in the number of agent seats can be provisioned almost immediately. Our clients, therefore, are able to adjust the number of agent seats used to meet their changing contact center volume needs. 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 years ended December 31, 2021, 2020 and 2019, subscription and related usage fees accounted for 92% of our revenue for each of these years, respectively. The remainder was comprised of professional services revenue from the implementation and optimization of our solution. Termination of Proposed Merger with Zoom On July 16, 2021, we entered into an Agreement and Plan of Merger, or the Merger Agreement, by and among our company, Zoom, and Summer Merger Sub, Inc., a Delaware corporation and a direct, wholly owned subsidiary of Zoom, or Merger Sub. The Merger Agreement provided for the merger of Merger Sub with and into our company, or the Merger, with our company surviving the Merger and continuing as a wholly owned subsidiary of Zoom. On September 30, 2021 at a special meeting of our stockholders, a vote to approve the Merger was unsuccessful. As a result, immediately following the special meeting, on September 30, 2021, we and Zoom mutually agreed to terminate the Merger Agreement, effective immediately. Except as otherwise set forth in the Merger Agreement, none of our company, Zoom or Merger Sub shall have any further liability thereunder. We incurred approximately $7.6 million in transaction costs related to the Merger that was recorded in general and administrative expense in our consolidated statements of operations. Effects of COVID-19 In December 2019, a novel coronavirus disease known as COVID-19 was reported and on March 11, 2020, the WHO characterized COVID-19 as a pandemic. This pandemic has resulted in a widespread health crisis that has 52 Table of Contents significantly harmed the U.S. and global economies and caused significant fluctuation in financial markets, including those on which our common stock and our convertible senior notes trade, and may impact demand for our solution. In accordance with the various social distancing and other office closure orders and recommendations of applicable government agencies, all of our employees transitioned to work-from-home operations and we canceled all business travel by our employees except where necessary and properly authorized, which changed how we operated our business. Our clients and business partners have been, and continue to be subject to various and changing social distancing and office closure orders and recommendations and travel restrictions and prohibitions, which have changed the way we interact with our clients and business partners. Recently, we have re-opened our U.S. offices for employees to voluntarily return, subject to capacity restrictions and applicable government regulations. Appropriate measures are being taken to protect the health of employees who return to the office. We have also reinstated business travel on a voluntary basis and subject to prior approval. COVID-19 had a moderately positive impact on our 2020 and 2021 financial results due to the shift from brick-and-mortar to virtual. The severity and duration of the COVID-19 pandemic, and its impact on the U.S. and global economy remains uncertain, but we believe that there may be a continuing net benefit to us longer term. See Part I, Item 1A. Risk Factors, for further discussion of the impact of the COVID-19 pandemic on our business and operations. Key GAAP Operating Results Our revenue increased to $609.6 million for the year ended December 31, 2021, from $434.9 million and $328.0 million for the years ended December 31, 2020 and 2019, respectively. Revenue growth was primarily attributable to our larger clients, driven by an increase in our sales and marketing activities and our improved brand awareness. For each of the years ended December 31, 2021, 2020 and 2019, no single client accounted for more than 10% of our total revenue. As of December 31, 2021, we had over 2,500 clients across multiple industries. Our clients’ subscriptions generally range in size from fewer than 10 agent seats to approximately 11,000 agent seats. We had a net loss of $53.0 million, $42.1 million and $4.6 million for the years ended December 31, 2021, 2020 and 2019, respectively. 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 depend on many factors, including our ability to continue to expand our base of larger clients, grow revenue from our existing clients, innovate and expand internationally. While these areas represent significant opportunities for us, they also pose risks and challenges, including the impact of the COVID-19 pandemic, that we must successfully address in order to sustain the growth of our business and improve our operating results. Key Operating and Non-GAAP Financial Performance Metrics In addition to measures of financial performance presented in our 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. Annual Dollar-Based Retention Rate We believe that our Annual 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. Starting with the fourth quarter of 2020, we revised our Annual Dollar-Based Retention Rate calculation to be based on Net Revenue, rather than Net Invoicing. Our Annual Dollar-Based Retention Rate is calculated by dividing our Retained Net Revenue by our Retention Base Net Revenue on a monthly basis, which we then average using the rates for the trailing twelve months for the period presented. We define Retention Base Net Revenue as recurring net revenue from all clients in the comparable prior year period, and we define Retained Net Revenue as recurring net revenue from that same group of clients in the current period. We define recurring net revenue as net subscription and related usage revenue. The following table shows our Annual Dollar-Based Retention Rate based on Net Revenue for the periods presented: 53 Table of Contents Twelve Months Ended December 31, 2021 2020 Annual Dollar-Based Retention Rate 122% 117% Our Dollar-Based Retention Rate improved year-over-year primarily due to our larger clients increasing their number of agent seats. 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 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 expense, (4) other expense and interest income, (5) acquisition-related transaction costs and one-time integration costs, (6) COVID-19 relief bonuses for employees, (7) loss on early extinguishment of debt, (8) contingent consideration expense, (9) (benefit from) provision for income taxes, and (10) other 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): Year Ended December 31, 2021 2020 Net loss $ (53,000) $ (42,130) Non-GAAP adjustments: Depreciation and amortization (1) 38,732 25,087 Stock-based compensation (2) 108,805 64,747 Interest expense 8,027 28,348 Other expense and interest (income) 8 (3,034) Acquisition related transaction costs and one-time integration costs 13,576 6,335 COVID-19 relief bonuses for employees — 1,817 Loss on early extinguishment of debt — 6,964 Contingent consideration expense 5,640 — Benefit from income taxes (11,285) (2,453) Adjusted EBITDA $ 110,503 $ 85,681 (1) See ITEM 6 of this Form 10-K for depreciation and amortization expenses included in our results of operations for the periods presented. (2) See Note 7 to the consolidated financial statements for stock-based compensation expense included in our results of operations for the periods presented. 54 Table of Contents 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 revenue. 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 generally 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 reductions in the number of agent seats. Increases in the number of agent seats can be provisioned almost immediately. Our clients, therefore, are able to adjust the number of agent seats used to meet their changing contact center volume needs. Our larger clients typically choose annual contracts, which generally include an implementation and ramp period of several months. 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, which is 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 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 labor hours, provided all other criteria for revenue recognition are met. Cost of Revenue Our cost of revenue consists primarily of personnel costs, including stock-based compensation, fees that we pay to telecommunications providers for usage, USF costs which have been increasing, contributions and other regulatory costs, depreciation and related expenses of the servers and equipment, costs to build out and maintain co-location data centers, costs of public cloud-based data centers, 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 services, which investments will result in absolute dollar increases in cost of revenue but percentage of revenue declines in the long-term through economies of scale. In the near-term, however, we expect cost of revenue to increase both in absolute dollars and as a percentage of revenue, primarily due to increased investments in public cloud, cloud operations and professional services to support our growth initiatives. 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 our research and development expenses to increase in absolute dollars and as a percentage of revenue in the near term and to fluctuate in the longer term. Sales and Marketing . Sales and marketing expenses consist primarily of salaries and related expenses, including stock-based compensation, for personnel in sales and marketing, sales commissions, as well as advertising, 55 Table of Contents marketing, corporate communications, travel costs and allocated overhead. We believe it is important to continue investing in sales and marketing to continue to generate revenue growth, and we expect sales and marketing expenses to increase in absolute dollars over the long term and fluctuate as a percentage of revenue in the near and longer term as we continue to support our growth initiatives. 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 and as a percentage of revenue in the near term, but to increase in absolute dollars and decline as a percentage of revenue in the longer term. Results of Operations for the Years Ended December 31, 2021 and 2020 Based on the consolidated statements of operations and comprehensive loss set forth in this annual report, the following table sets forth our operating results as a percentage of revenue for the periods indicated: Year Ended December 31, 2021 2020 Revenue 100 % 100 % Cost of revenue 44 % 41 % Gross profit 56 % 59 % Operating expenses: Research and development 18 % 16 % Sales and marketing 32 % 30 % General and administrative 16 % 15 % Total operating expenses 66 % 61 % (Loss) income from operations (10) % (2) % Other (expense) income, net: Interest expense (1) % (7) % Loss on early extinguishment of debt — % (2) % Other (expense) and interest income — % 1 % Total other (expense) income, net (1) % (8) % Loss before income taxes (11) % (10) % Benefit from income taxes (2) % — % Net loss (9) % (10) % Year-to-year comparisons between 2020 and 2019 have been omitted from this Form 10-K but may be found in “Management's Discussion and Analysis of Financial Condition” in Part II, Item 7 of our Form 10-K for the fiscal year ended December 31, 2020, which specific discussion is incorporated herein by reference. Comparison of the Years Ended December 31, 2021 and 2020 Revenue Year Ended December 31, 2021 2020 $ Change % Change (in thousands, except percentages) Revenue $609,591 $434,908 $174,683 40% The increase in revenue for 2021 compared to 2020 was primarily attributable to our larger clients, driven by an increase in our sales and marketing activities and our improved brand awareness. 56 Table of Contents Cost of Revenue Year Ended December 31, 2021 2020 $ Change % Change (in thousands, except percentages) Cost of revenue $271,099 $180,284 $90,815 50% % of Revenue 44% 41% The increase in cost of revenue for 2021 compared to 2020 was primarily due to a $29.2 million increase in personnel costs, including stock-based compensation costs, driven mainly by increased headcount, higher salaries and a higher fair value of employee equity awards due primarily to our increased stock price, a $22.4 million increase in depreciation, data center and public cloud costs driven to support our growing capacity needs, an $18.5 million increase in third-party hosted software costs driven by increased client activities, a $5.7 million increase in USF contributions and other federal telecommunication service fees due primarily to increased client usage and an increase in the USF contribution rate, a $5.6 million increase in amortization expense due to the acquisitions of Virtual Observer in April 2020 and Inference in November 2020, and a $3.2 million increase in office, facilities and related costs. Gross Profit Year Ended December 31, 2021 2020 $ Change % Change (in thousands, except percentages) Gross profit $338,492 $254,624 $83,868 33% % of Revenue 56% 59% The increase in gross profit for 2021 compared to 2020 was primarily due to increases in subscription and related revenues. The decrease in gross margin for 2021 compared to 2020 was primarily due to the increase in personnel costs, driven by increased headcount, higher salaries and a higher fair value of employee equity awards primarily due to our increased stock price, the increase in depreciation, data center and public cloud costs to support our growing capacity needs, the increase in third-party hosted software costs driven by increased client activities, the increase in USF contributions and other federal telecommunication service fees due primarily to increased client usage and an increase in the USF contribution rate, the increase in amortization expense from the acquisition of certain intangible assets from Virtual Observer and Inference, and the increase in office, facilities and related costs. Due to increased investments in public cloud, cloud operations and professional services, we expect gross margin to decline slightly in the near term and increase in the long term. Operating Expenses Research and Development Year Ended December 31, 2021 2020 $ Change % Change (in thousands, except percentages) Research and development $106,897 $68,747 $38,150 55% % of Revenue 18% 16% The increase in research and development expenses for 2021 compared to 2020 was primarily due to a $33.6 million increase in personnel-related costs including stock-based compensation costs, driven mainly by increased headcount, higher salaries, higher fair value of employee equity awards due primarily to our increased stock price, and by incremental stock-based compensation costs due to the modification of certain stock-based awards of a former executive, and a $1.9 million increase in office, facilities and related costs. 57 Table of Contents Sales and Marketing Year Ended December 31, 2021 2020 $ Change % Change (in thousands, except percentages) Sales and marketing $193,929 $132,413 $61,516 46% % of Revenue 32% 30% The increase in sales and marketing expenses for 2021 compared to 2020 was primarily due to a $38.9 million increase in personnel-related costs, including stock-based compensation costs driven mainly by increased headcount, higher salaries and higher fair value of equity awards due primarily to our increased stock price, a $9.0 million increase in sales commission expenses driven by the growth in sales and bookings of our solution, and a $3.9 million increase in office, facilities and related costs. The remaining net increase in sales and marketing expenses was primarily due to the execution of our growth strategy to acquire new clients, increase the number of agent seats within our existing client base, and increased advertising and other marketing expenses to increase our brand awareness. General and Administrative Year Ended December 31, 2021 2020 $ Change % Change (in thousands, except percentages) General and administrative $93,916 $65,769 $28,147 43% % of Revenue 16% 15% The increase in general and administrative expenses for 2021 compared to 2020 was primarily due to a $14.6 million increase in personnel costs including stock-based compensation costs, driven mainly by increased headcount, higher salaries and a higher fair value of equity awards due primarily to our increased stock price, a $6.9 million increase in legal and other professional service costs mainly related to the proposed Merger that was terminated on September 30, 2021, and a $5.6 million increase in contingent consideration expense for the Inference acquisition. Other (Expense) Income, Net Year Ended December 31, 2021 2020 $ Change % Change (in thousands, except percentages) Interest expense $ (8,027) $ (28,348) $ 20,321 72 % Loss on early extinguishment of debt — (6,964) 6,964 (100) % Other (expense) and interest income (8) 3,034 (3,042) 100 % Total other (expense) income, net $ (8,035) $ (32,278) $ 24,243 75 % % of Revenue (1) % (8) % The decrease in interest expense for 2021 compared to 2020 was primarily due to our adoption of ASU 2020-06, which resulted in the elimination of the debt discounts that were amortized to interest expense over the contractual term of the convertible senior notes prior to January 1, 2021, and due to the 2023 Note Repurchase Transactions and other 2023 convertible senior note settlements in 2020, which resulted in the decrease in contractual interest expense due to the reduction in the aggregate outstanding principal amount of our 2023 convertible senior notes. The decrease in interest expense was offset in part by the increase in contractual interest expense due to the issuance of the 2025 convertible senior notes in May and June 2020. See Note 6 to the consolidated financial statements for further details. The 2023 Note Repurchase Transactions and other 2023 convertible senior note settlements in 2020 resulted in $7.0 million loss on early extinguishment of debt. The settlements that occurred in 2021 were subject to ASU 2020-06, with such settlements accounted for as contractual conversions and did not result in any gain or loss upon their settlement. 58 Table of Contents The decrease in other (expense) and interest income for 2021 compared to 2020 was primarily due to a decrease in interest income on our marketable investments resulting from lower investible balances and lower interest rates. Liquidity and Capital Resources To date, we have financed our operations, primarily through sales of our solution, net proceeds from our equity and debt financings, including the issuance of our 2025 convertible senior notes in May and June 2020 and of our 2023 convertible senior notes in May 2018, and lease facilities. As of December 31, 2021, we had $459.7 million in working capital, which included $90.9 million in cash and cash equivalents, $379.0 million in short-term marketable investments and $147.4 million in long-term marketable investments. We believe our existing cash and cash equivalents will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. We plan to continue to finance our operations in the future primarily through sales of our solution, net proceeds from equity and debt financings, and lease facilities. Our future capital requirements will depend on many factors including our growth rate, continuing market acceptance of our solution, client retention, our ability to gain new clients, the timing and extent of spending to support research and development efforts, the outcome of any pending or future litigation or other claims by third parties or governmental entities, the expansion of sales and marketing activities and personnel, the introduction of new and enhanced offerings, and the impact of the COVID-19 pandemic on these or other factors. We may also acquire or invest in complementary businesses, technologies and intellectual property rights, which may increase our use of cash and future capital requirements, both to pay acquisition costs and to support our combined operations. We may raise additional capital through equity or engage in debt financings at any time to fund these or other requirements. However, we may not be able to raise additional capital through equity or debt financings when needed on terms acceptable to us or at all, depending on our financial performance, market conditions, the trading price of our common stock, and other factors, including the length and severity of the impact of the COVID-19 pandemic on general economic conditions and potential future impacts on the financial markets. If we are unable to raise additional capital as needed, our business, operating results and financial condition could 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 also could be harmed. If we raise additional funds by issuing equity or equity-linked securities, the ownership of our existing stockholders would be diluted. If we raise additional funds through the incurrence of additional indebtedness, we will be subject to increased debt service obligations and could also be subject to restrictive covenants and other operating restrictions that could negatively impact our ability to operate our business. Cash Flows The following table summarizes our cash flows for the periods presented (in thousands): Year Ended December 31, 2021 2020 Net cash provided by operating activities $ 28,485 $ 67,302 Net cash used in investing activities (150,478) (382,330) Net cash (used in) provided by financing activities (7,501) 457,424 Net (decrease) increase in cash and cash equivalents $ (129,494) $ 142,396 Cash Flows from Operating Activities Cash provided by operating activities is primarily influenced by our personnel-related expenditures, data center and telecommunications carrier costs, office and facility related costs, USF contributions and other regulatory costs and the amount and timing of client payments. If we continue to improve our financial results, we expect net cash provided by operating activities to increase. 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. Net cash provided by operating activities was $28.5 million during the year ended December 31, 2021. Net cash provided by operating activities resulted from our net loss of $53.0 million adjusted for non-cash items of 59 Table of Contents $192.6 million, primarily consisting of $108.8 million of stock-based compensation, $38.7 million of depreciation and amortization, $26.1 million of amortization of commission costs, $5.6 million of contingent consideration expense and $4.0 million of amortization of issuance costs on our convertible senior notes, offset by use of cash for operating assets and liabilities of $111.1 million primarily due to the timing of cash payments to vendors and cash receipts from customers. Cash Flows from Investing Activities Net cash used in investing activities of $150.5 million in 2021 was comprised of $680.5 million related to purchases of marketable investments and $42.2 million in capital expenditures, offset in part by $572.2 million related to cash proceeds from sales and maturities of marketable investments. Cash Flows from Financing Activities Net cash used in financing activities of $7.5 million in 2021 related to $24.7 million of cash paid in connection with other 2023 convertible senior note settlements, $5.0 million in holdback payments related to acquisitions and $0.6 million of payments related to finance leases, partially offset by $15.4 million from the sale of common stock under our employee stock purchase plan and cash proceeds of $7.4 million from exercise of stock options. Contractual and Other Obligations Our material cash requirements include the following contractual and other obligations. Convertible Senior Notes In May and June 2020, we issued $747.5 million aggregate principal amount of our 2025 convertible senior notes in a private offering. The 2025 convertible senior notes mature on June 1, 2025 and are our senior unsecured obligations. The 2025 convertible senior notes bear interest at a fixed rate of 0.50% per annum, payable semiannually in arrears on June 1 and December 1 of each year, beginning December 1, 2020. In addition, under the terms of the 2025 convertible senior notes, we were obligated to pay additional interest on the 2025 convertible senior notes at a rate equal to 0.500% per annum for the period from June 13, 2021 through July 8, 2021, after which such additional interest is no longer payable. The total net proceeds from the offering, after deducting initial purchasers’ discounts and commissions and estimated debt issuance costs, were approximately $728.8 million. As of December 31, 2021, the aggregate principal amount outstanding of our 2025 convertible senior notes was $747.5 million. In May 2018, we issued $258.8 million aggregate principal amount of our 2023 convertible senior notes in a private offering. The 2023 convertible senior notes mature on May 1, 2023 and are our senior unsecured obligations. The 2023 convertible senior notes bear interest at a fixed rate of 0.125% per annum, payable semiannually in arrears on May 1 and November 1 of each year. The total net proceeds from the offering, after deducting the initial purchasers’ discounts and estimated debt issuance costs, were approximately $250.8 million. As of December 31, 2021, after giving effect to the 2023 Note Repurchase Transactions and other settlements upon conversion requests, approximately $34.2 million aggregate principal amount of 2023 convertible senior notes remained outstanding. For additional information regarding the convertible senior notes, see Note 6 to the consolidated financial statements included in this report. Leases We have leases for offices, data centers and computer and networking equipment that expire at various dates through 2031. Our leases have remaining terms of one to ten years. Some of the leases include an option to extend the leases for up to three to five years, and some of the leases include the option to terminate the leases upon 30-days notice. We had outstanding operating lease obligations of $64.0 million as of December 31, 2021, with $11.4 million payable within 12 months, $18.4 million payable within one to three years, $11.3 million payable within three to five years, and $22.9 million after five years. See Note 13 to the consolidated financial statements included in this report for further details. Cloud Services As of December 31, 2021, we had outstanding cloud service agreement commitments totaling $61.1 million, of which $21.8 million is expected to be paid in 2022 and the remaining $39.3 million in 2023. Hosting and Telecommunication Usage Services We have agreements with third parties to provide co-location hosting and telecommunication usage services. The agreements require payments per month for a fixed period of time in exchange for certain guarantees of network 60 Table of Contents and telecommunication availability. As of December 31, 2021, we had outstanding hosting and telecommunication usage services obligations of $18.6 million, with $8.5 million payable within 12 months, $9.8 million payable within one to three years, and $0.3 million payable within three to five years. Indemnification Agreements In the ordinary course of business, we enter into agreements of varying scope and terms pursuant to which we agree to indemnify 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 us or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors, officers and certain employees that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. There are no claims that we are aware of that could have a material effect on our consolidated balance sheet, consolidated statements of operations and comprehensive loss, or consolidated statements of cash flows. Contingencies — Legal and Regulatory We are subject to certain legal and regulatory proceedings, and from time to time may be involved in a variety of claims, lawsuits, investigations, and proceedings relating to contractual disputes, intellectual property rights, employment matters, regulatory compliance matters, and other litigation matters relating to various claims that arise in the normal course of business. We determine whether an estimated loss from a contingency should be accrued by assessing whether a loss is deemed probable and can be reasonably estimated. We assess our potential liability by analyzing specific litigation and regulatory matters using reasonably available information. We develop our views on estimated losses in consultation with inside and outside counsel, which involves a subjective analysis of potential results and outcomes, assuming various combinations of appropriate litigation and settlement strategies. Legal fees are expensed in the period in which they are incurred. See Note 10 to the consolidated financial statements for more details. Critical Accounting Policies and Estimates Our 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. We currently do not have any critical accounting estimates that involve a significant level of estimation uncertainty that could have a material impact on our consolidated financial statements. Our significant accounting policies are described in Note 1 to the consolidated financial statements. Revenue Recognition Revenue is recognized when control of the promised services is transferred to customers, in an amount that reflects the consideration that we expect to receive in exchange for those services. We generate all of our revenue from contracts with customers. In contracts with multiple performance obligations, we identify each performance obligation and evaluate whether the performance obligations are distinct within the context of the contract at contract inception. Performance obligations that are not distinct at contract inception are combined. We allocate the transaction price to each distinct performance obligation proportionately based on the estimated standalone selling price for each performance obligation. We then look to how services are transferred to the customer in order to determine the timing of revenue recognition. Most services provided under our agreements result in the transfer of control over time. Our revenue consists of subscription services and related usage as well as professional services. We charge clients subscription fees, usually billed on a monthly basis, for access to our VCC solution. The subscription fees are primarily based on the number of agent seats, as well as the specific VCC functionalities and applications deployed by the client. Agent seats are defined as the maximum number of named agents allowed to concurrently access the VCC cloud platform. Clients typically have more named agents than agent seats. Multiple named agents may use an agent seat, though not simultaneously. Substantially all of our clients purchase both subscriptions and related telephony usage. A small percentage of our clients subscribe to our platform but purchase telephony usage directly 61 Table of Contents from a wholesale telecommunications service provider. 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 used for inbound and outbound client interactions. Revenue generated from telephony usage is presented in revenue and cost of sales on a gross basis, as we are the party that controls the service and are responsible for fulfilling the promise to provide the call service by diverting the calls to selected carriers. We also offer bundled plans, generally for smaller deployments, whereby 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. Professional services revenue is derived primarily from VCC implementations, including application configuration, system integration, optimization, education and training services. Clients are not permitted to take possession of our software. We offer monthly, annual and multiple-year contracts to our clients, generally with 30 days’ notice required for reductions in the number of agent seats. Increases in the number of agent seats can be provisioned almost immediately. Our clients, therefore, are able to adjust the number of agent seats used to meet their changing contact center volume needs. 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. Support activities include technical assistance for our solution and upgrades and enhancements to our VCC cloud platform on a when-and-if-available basis, which are not billed separately. Professional services are primarily billed on a fixed-fee basis and are performed by us directly or, alternatively, clients may also choose to perform these services themselves or engage their own third-party service providers. Revenue for professional services is recognized over time, as services are performed. The estimation of variable consideration for each performance obligation requires us to make subjective judgments. In the early stages of our larger contracts, in order to allocate the overall transaction fee on a relative stand-alone selling price basis to our multiple performance obligations, we estimate variable consideration to be included in the transaction fee to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. When services are included in the contract with the customer and are not sold at their stand-alone selling price, we are required to estimate the number of seats the customer will use, especially during the initial ramp period of the contract, during which we bill under an ‘actual usage’ model for subscription-related services. The estimated variable consideration has had an immaterial impact on the allocation of transaction fees to multiple performance obligations in the past. We recognize revenue on fixed fee professional services performance obligations based on the proportion of labor hours expended compared to the total hours expected to complete the related performance obligation. The revenue recognition standards include guidance relating to any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, sales, use, value added and excise taxes. We record USF contributions and other regulatory costs on a gross basis in our consolidated statements of operations and comprehensive loss and record surcharges and sales, use and excise taxes billed to our clients on a net basis. The cost of gross USF contributions payable to the USAC and suppliers is presented as a cost of revenue in the consolidated statements of operations and comprehensive loss. Business Combinations, Goodwill, and Acquisition-Related Intangible Assets Accounting for business combinations requires us to make significant estimates and assumptions. We allocate the purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair value at the acquisition dates, with the excess recorded to goodwill. Critical estimates in valuing certain intangible assets and contingent consideration include, but are not limited to, future expected cash flows, expected asset lives, royalty rates, and discount rates. The amounts and useful lives assigned to acquisition-related intangible assets impact the amount and timing of future amortization expense. We use estimates, assumptions, and judgments when performing a goodwill impairment test or assessing the recoverability of acquisition-related finite-lived intangible assets. We test goodwill for impairment on an annual basis in the fourth quarter and more frequently if a significant event or circumstance indicates impairment, and assess the recoverability of acquisition-related intangible assets whenever events or circumstances indicate that the carrying amounts of such assets may not be recoverable. We also evaluate the estimated remaining useful lives of acquisition-related intangible assets for changes in circumstances that warrant a revision to the remaining periods of amortization. 62 Table of Contents Recent Accounting Pronouncements Refer to Note 1 in Item 8 of this Form 10-K for information related to recent accounting pronouncements.