UPWORK, INC 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis of our financial condition and results of operations together with the sections titled “Business,” “Risk Factors,” and “Selected Consolidated Financial Data,” and the consolidated financial statements and related notes included elsewhere in this Annual Report. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, as well as assumptions that may never materialize or that may be proven incorrect. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed in the sections titled “Special Note Regarding Forward-Looking Statements” and “Risk Factors” and in other parts of this Annual Report. Overview Business Independent talent is an increasingly sought-after, critical, and expanding segment of the global workforce. We operate the world’s largest work marketplace that connects businesses with independent talent, as measured by GSV. GSV represents the total amount that clients spend on both our marketplace offerings and our managed services offering as well as additional fees we charge to both clients and freelancers for other services. We define freelancers as users that advertise and provide services to clients through our work marketplace, and we define clients as users that work with freelancers through our work marketplace. Freelancers on our work marketplace include independent professionals and agencies of varying sizes. The clients on our work marketplace range in size from small businesses to Fortune 100 companies. With users in over 180 countries, our work marketplace enabled $2.5 billion of GSV for the year ended December 31, 2020. For purposes of determining countries where we enable GSV, we include both the countries in which the clients that paid for the applicable services are located, as well as the countries in which the freelancers that provided those services are located. As a global work marketplace that connects freelancers and clients regardless of their location, our GSV originates from around the world. Of the $2.5 billion of GSV enabled on our work marketplace in 2020, approximately 25% was generated from U.S. freelancers, our largest freelancer geography, as measured by GSV, in each of 2020, 2019, and 2018, while freelancers in India and the Philippines remained our next largest freelancer geographies in all three years. Of the $2.1 billion and $1.8 billion of GSV enabled on our work marketplace in 2019 and 2018, respectively, approximately 27% and 23%, respectively, was generated from freelancers in the United States. Approximately 67% of our GSV in 2020 was generated from U.S. clients, compared to approximately 68% and 66% of GSV in 2019 and 2018, respectively, with clients in no other country representing more than 10% of our GSV in any year. We generate revenue from both freelancers and clients, with a majority of our revenue generated from service fees charged to freelancers. We also generate revenue from fees charged to both clients and freelancers for other services, such as for transacting payments through our work marketplace, premium offerings, purchases of Connects, foreign currency exchange, and our Upwork Payroll offering. In addition, we provide a managed services offering where we engage freelancers to complete projects, directly invoice the client, and assume responsibility for work performed. On December 31, 2019, we adopted Topic 606 effective as of January 1, 2019 using the modified retrospective method. As a result, revenue results for the years ended December 31, 2020 and 2019 are presented in accordance with this new revenue recognition standard while historical revenue results for reporting periods prior to 2019 are presented in conformity with amounts previously disclosed under the prior revenue recognition standard, Topic 605. Financial Highlights for 2020 In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a pandemic, which continues to spread throughout the United States and the world, and has resulted in governmental authorities implementing numerous measures to contain the virus, including travel bans and restrictions, shelter-in-place orders, and business limitations and shutdowns. The COVID-19 pandemic and the resulting restrictions intended to prevent its spread have accelerated the secular shift toward remote and independent work, and, with our unique, remote-based business model, the COVID-19 pandemic has not impacted our clients’ access to highly-skilled freelancers to complete short- and long-term projects on our work marketplace. In 2020, we continued to identify opportunities to prioritize our advertising and marketing efforts in order to reach those new and existing clients seeking to engage with independent talent due to the COVID-19 pandemic, as well as companies that have already embraced a remote work model. As a result of these efforts, our 2020 results were fueled by both existing and new clients, who used our work marketplace to address their changing business needs. We began to see the impact of the pandemic on our results at the end of the first quarter, when we experienced a temporary reduction in the growth rates of GSV and revenue. This trend continued into the beginning of the second quarter, driven by spend contraction by many of our clients, as the COVID-19 pandemic continued to disrupt their businesses. These trends stabilized in the second half of the second quarter, and improved thereafter, contributing to an overall increase in the growth 55 rates of GSV and revenue in 2020. Also, beginning in the second half of the second quarter of 2020, we began to see an increase in client acquisition driven by the acceleration in the shift toward remote work, due in part to the COVID-19 pandemic and the execution of our strategic initiatives. This increase in client acquisition continued to accelerate in the second half of 2020 and drove an increase in freelancer billings, which, in turn, drove an increase in marketplace revenue. As a result, our work marketplace enabled $2.5 billion of GSV in 2020, $2.1 billion in 2019, and $1.8 billion in 2018, representing year-over-year increases of 21% in 2020 and 19% in 2019. We generated revenue of $373.6 million in 2020, $300.6 million in 2019, and $253.4 million in 2018, representing year-over-year increases of 24% in 2020 and 19% in 2019. While we have not incurred significant disruptions to our business thus far from the COVID-19 pandemic, at this time, we are unable to fully assess the aggregate impact it will have on our business due to various uncertainties, which include, but are not limited to, the duration of the pandemic, its effect on the economy, its impact to the businesses of our clients, actions that may be taken by governmental authorities related to the pandemic, and other factors identified in Part I, Item 1A “Risk Factors” in this Annual Report, including the risk factor titled “Our business experienced, and may again experience, an adverse impact from the ongoing COVID-19 pandemic. In addition, users may reduce their use of our work marketplace following the COVID-19 pandemic.” Additionally, while we have made significant investments to grow our business, including investments in sales and marketing to acquire new clients and drive brand awareness, in the fourth quarter of 2020, we decided that it was no longer cost-effective for our sales team to sell our Upwork Business offering. We do not expect this decision to have a material impact on our marketplace revenue, as we will service those clients that we had previously targeted with our Upwork Business offering with our other marketplace offerings, such as Upwork Basic and Plus. In 2020, we also made significant investments in research and development to build new product features and launch new offerings and in operations and personnel, and we intend to continue to focus on these efforts. As a result, we generated a net loss of $22.9 million in 2020 compared to a net loss of $16.7 million in 2019. Our adjusted EBITDA was $14.0 million in 2020, an increase of 89% from 2019. Adjusted EBITDA is a financial measure that is not prepared in accordance with, and is not an alternative to, financial measures prepared in accordance with U.S. GAAP. See the section titled “Selected Consolidated Financial Data—Non-GAAP Financial Measures” for a definition of adjusted EBITDA and information regarding our use of adjusted EBITDA and a reconciliation of net loss to adjusted EBITDA. Key Financial and Operational Metrics We monitor the following key financial and operational metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions. On December 31, 2019, we adopted Topic 606 effective as of January 1, 2019 using the modified retrospective method. Financial results for the years ended December 31, 2020 and 2019 are presented in accordance with this new revenue recognition standard. Historical financial results for the year ended December 31, 2018 are presented in conformity with amounts previously disclosed under the prior revenue recognition standard, Topic 605. Our key metrics were as follows as of or for the periods presented (in thousands, except percentages): As of or for the Year Ended December 31, 2020 2019 2018 GSV $ 2,523,649 $ 2,087,055 $ 1,756,289 Marketplace revenue $ 338,152 $ 268,284 $ 223,831 Marketplace take rate 13.6 % 13.1 % 13.0 % Core clients 145.4 124.4 105.5 Client spend retention 102 % 102 % 108 % Net loss $ (22,867) $ (16,659) $ (19,907) Adjusted EBITDA (1) $ 14,022 $ 7,438 $ 3,824 (1) Adjusted EBITDA is not prepared in accordance with, and is not an alternative to, financial measures prepared in accordance with U.S. GAAP. See “Selected Consolidated Financial Data—Non-GAAP Financial Measures” above for a definition of adjusted EBITDA and for information regarding our use of adjusted EBITDA and a reconciliation of adjusted EBITDA to net loss, the most directly comparable financial measure prepared under U.S. GAAP. As discussed below with respect to each key metric, we believe these key financial and operational metrics are useful to evaluate period-over-period comparisons of our business and in understanding our operating results, and management uses these metrics to track our performance. For a discussion of limitations in the measurement of our key financial and operational metrics, see “Risk Factors—We track certain performance metrics with internal tools and do not independently verify such metrics. Certain of our performance metrics may not accurately reflect certain details of our business, are subject to inherent challenges in measurement, and real or perceived inaccuracies in such metrics may harm our reputation and negatively affect 56 our business.” GSV represents the total amount that clients spend on our marketplace offerings and our managed services offering as well as additional fees we charge to both clients and freelancers for other services. We believe that GSV is an important metric, as it represents the overall amount of business transacted through our work marketplace, which in turn is a key driver of our financial results. We believe our marketplace revenue, which represents a majority of our revenue, will grow as GSV grows, although they could grow at different rates. We evaluate the correlation between marketplace revenue and GSV by measuring marketplace take rate, which is calculated as marketplace revenue divided by marketplace GSV. We use the number of core clients to track the number of clients that we consider are actively using our work marketplace, and this metric in any given period drives both GSV and client spend retention. Similarly, client spend retention impacts the growth rate of GSV. For information on how we define core clients and how we calculate client spend retention and marketplace take rate, see “—Core Clients,” “—Client Spend Retention,” and “—Marketplace Take Rate,” respectively, below. Gross Services Volume (GSV) GSV includes both client spend and additional fees charged for other services. Client spend, which we define as the total amount that clients spend on both our marketplace offerings and our managed services offering, is the primary component of GSV. GSV also includes additional fees charged to both clients and freelancers for other services and offerings, such as for transacting payments through our work marketplace, user memberships, purchases of Connects, and foreign currency exchange. GSV is an important metric because it represents the amount of business transacted through our work marketplace. Our marketplace revenue is primarily comprised of the service fees paid by freelancers as a percentage of the total amount freelancers charge clients for services accessed through our work marketplace. Therefore, marketplace revenue is correlated to GSV, and we believe that our marketplace revenue will grow as GSV grows, although they could grow at different rates. For a discussion of how we measure and evaluate the correlation between marketplace revenue and GSV, see “—Marketplace Take Rate” below. Growth in the number of core clients and increased client spend retention are the primary drivers of GSV growth, and we expect the client spend retention trends discussed in “—Client Spend Retention,” below, to affect the rate at which GSV grows. We derive a substantial portion of our GSV and revenue from small- and medium-sized businesses. In 2020, we continued to identify opportunities to prioritize our advertising and marketing efforts in order to reach those new and existing clients seeking to engage with independent talent. As a result, of these efforts, coupled with the secular shift towards remote work caused by the COVID-19 pandemic and the resulting restrictions intended to prevent its spread, our work marketplace enabled $2.5 billion of GSV in 2020, representing a year-over-year increase of 21%. We expect our GSV to fluctuate between periods due to a number of factors, including the current COVID-19 pandemic and its impact on our clients’ businesses; the number of Sundays (i.e., the day we bill and recognize revenue for the majority of our freelancer service fees each week) or the number of Mondays (i.e., the day we bill and recognize revenue for a substantial portion of our client fees each week) in any given quarter; and the volume of projects that are posted by clients on our work marketplace, the characteristics of those projects, such as size, duration, and pricing, and the availability and qualifications of freelancers to complete those projects. Marketplace Revenue Marketplace revenue, which represents the majority of our revenue, consists of revenue derived from our Upwork Basic, Plus, and Enterprise and other premium offerings. We generate marketplace revenue from both freelancers and clients. Our marketplace revenue is primarily comprised of service fees paid by freelancers as a percentage of the total amount freelancers charge clients for services accessed through our work marketplace, and to a lesser extent, payment processing and administration fees charged to clients. We also generate marketplace revenue from fees for premium offerings, freelancer memberships, purchases of Connects, and other services, such as foreign currency exchange and our Upwork Payroll offering. Marketplace revenue is an important metric because it is the primary driver of our business, and we believe it provides greater comparability to other online marketplaces. The growth rate of marketplace revenue fluctuates in relation to the growth rate of GSV. Therefore, marketplace revenue is correlated to GSV, and we believe that our marketplace revenue will grow as GSV grows, although they could grow at different rates. The COVID-19 pandemic and execution of our strategic initiatives resulted in an increase in client acquisition in the second half of 2020. This increase in client acquisitions drove an increase in freelancer billings, and, in turn, drove an increase in marketplace revenue. We expect our marketplace revenue growth rates to continue to vary from period to period due to a variety of other factors such as the impact of the COVID-19 pandemic and any resulting macroeconomic impact on the businesses and spending behavior of our current and prospective clients; the number of Sundays (i.e., the day we bill and recognize revenue for the majority of our freelancer service fees each week) or the number of Mondays (i.e., the day we bill and recognize revenue for a substantial portion of our client fees each week) in any given quarter; the lapping of significant launches of new products, pricing changes, and other monetization efforts; the performance of client spend retention; and the ability of the recent and continued investment in our enterprise sales team to accelerate the acquisition of, and achieve increased spend from, Upwork Enterprise clients, and the timing of those results. 57 Marketplace Take Rate Marketplace take rate measures the correlation between marketplace revenue and GSV and is calculated by dividing marketplace revenue by marketplace GSV. Marketplace take rate is an important metric because it is the key indicator of how well we monetize spend on our work marketplace from our Upwork Basic, Plus, and Enterprise and other premium offerings. During the year ended December 31, 2020, our marketplace take rate increased primarily as a result of an acceleration in the shift toward remote work, due in part to the COVID-19 pandemic and the execution of our strategic initiatives that resulted in an influx of new clients, which caused freelancers to bill at higher rates of our tiered service fee structure, as well as increased client payment processing fees, and other monetization efforts. We expect our marketplace take rate to vary from period to period as marketplace revenue and GSV vary as a result of a variety of factors, such as the number of Sundays (i.e., the day we bill and recognize revenue for the majority of our freelancer service fees each week) or the number of Mondays (i.e., the day we bill and recognize revenue for a substantial portion of our client fees each week) in any given quarter; pricing changes; the ability of the recent and continued investment in our enterprise sales team to accelerate the acquisition of, and achieve increased spend from, our Upwork Enterprise clients and the timing of those results; and ongoing efforts to improve processes on our work marketplace, including project proposals and purchases of Connects, among others. Core Clients We believe that the number of core clients is an indicator of our growth and the overall health of our business because core clients are a primary driver of GSV and, therefore, marketplace revenue. We define a core client as a client that has spent in the aggregate at least $5,000 since it began using our work marketplace and also had spend-activity on our work marketplace during the 12 months preceding the date of measurement. We believe that aggregate spend of at least $5,000 indicates that the client is actively using our work marketplace. Historically, these core clients have been more likely to continue using our work marketplace, although we saw a contraction in spend from many core clients during the first half of the second quarter that we believe was a result of the COVID-19 pandemic’s impact on the businesses of these clients. This trend stabilized in the second half of the second quarter of 2020, and then improved throughout the remainder of 2020, as spend from clients increased due to a greater need for remote work resulting from the COVID-19 pandemic. Additionally, we saw an increase in core client acquisitions, as we have seen new clients come to our work marketplace due in part to the increase in remote work resulting from the COVID-19 pandemic and the execution of our strategic initiatives. We continue to see businesses of all sizes use our work marketplace in a recurring way for larger, more complex projects, and we expect the number of core clients to continue to increase over time but could vary quarter by quarter depending, in part, on the extent to which the COVID-19 pandemic and any resulting macroeconomic downturn impacts our business, the businesses of our clients, and other factors identified in the section titled “Risk Factors” included elsewhere in this Annual Report, including the risk factor titled “Our business experienced, and may again experience, an adverse impact from the ongoing COVID-19 pandemic. In addition, users may reduce their use of our work marketplace following the COVID-19 pandemic.” Client Spend Retention We calculate client spend retention by dividing our recurring client spend by our base client spend. We define base client spend as the aggregate client spend from all clients during the four quarters ended one year prior to the date of measurement. We define our recurring client spend as the aggregate client spend during the four quarters ended on the date of measurement from the same clients included in our measure of base client spend. Our business is recurring in nature even though clients are not contractually required to spend on a recurring basis. We believe that client spend retention is an indicator of the value of our work marketplace and the overall health of our business because it impacts the growth rate of GSV, and, therefore, marketplace revenue. Long-term and recurring use by freelancers and clients are the primary drivers of growth in our marketplace and give us increased revenue visibility. While continued use of our work marketplace by freelancers is a factor that impacts our ability to attract and retain clients, we currently have a significant surplus of freelancers in relation to the number of clients actively engaging freelancers for most categories of services on our work marketplace. As a result of this surplus, we primarily focus our efforts on retaining client spend and acquiring new clients, as opposed to acquiring new freelancers and retaining existing freelancers. Moreover, we generate revenue when clients engage and pay freelancers, and therefore, our key metrics and operating results are directly impacted by client spend. Additionally, the number of freelancers retained between periods is merely one of many factors that may impact client spend in a particular period and is not a primary driver of our key metrics and operating results. As of December 31, 2020 and 2019, client spend retention was 102%. Although the COVID-19 pandemic did not have a material adverse impact on our financial results for the year ended December 31, 2020, we believe the COVID-19 pandemic’s disruption of the business of many of our clients resulted in a temporary reduction in spend from some of those affected clients in the second quarter. Client spend stabilized in the second half of the second quarter, and then improved throughout the remainder of 2020, due to the increased adoption of remote work resulting from the COVID-19 pandemic and execution against our strategic initiatives. This temporary reduction in spend in the second quarter, combined with the acceleration of client spend from existing clients in the second half of 2020, resulted in client spend retention remaining unchanged from 2019. 58 Additionally, client spend retention has declined—from its historically highest levels in 2018 and the first quarter of 2019—following an acceleration in client spend retention that occurred subsequent to the launch of our U.S.-to-U.S. domestic marketplace offering in the second half of 2017, which initiated a substantial increase in the average hourly earnings rate of freelancers. These hourly rates stabilized over the course of 2019, causing the reduction in retention rate. As we acquire more large enterprise, global account, and mid-market clients in current and future periods, we expect them to continue to make positive contributions to our client spend retention in future years. Client spend retention will continue to vary from period to period due to client size and spending behavior, among other factors, including the impact of the ongoing COVID-19 pandemic, the related restrictions intended to prevent its spread, and the resulting macroeconomic downturn on the businesses and spending behavior of our clients. Adjusted EBITDA We define adjusted EBITDA as net income (loss) adjusted for stock-based compensation expense, depreciation and amortization, interest expense, other (income) expense, net, income tax (benefit) provision, and, if applicable, other non-cash transactions. In 2020, we made significant investments to grow our business, acquire new clients, and drive brand awareness. As a result, our adjusted EBITDA was $14.0 million in 2020, representing an increase of 89% from 2019. Adjusted EBITDA is not prepared in accordance with, and is not an alternative to, financial measures prepared in accordance with U.S. GAAP. See the section titled “Selected Consolidated Financial Data—Non-GAAP Financial Measures” above for information on our use of adjusted EBITDA and a reconciliation of net loss to adjusted EBITDA. Components of Our Results of Operations Revenue Marketplace Revenue. Marketplace revenue is generated from our Upwork Basic, Plus, and Enterprise and other premium offerings. Under these marketplace offerings, we generate revenue from both freelancers and clients. Marketplace revenue, which represents the majority of our total revenue, is primarily comprised of the service fees paid by freelancers as a percentage of the total amount that freelancers charge clients for services accessed through our work marketplace and, to a lesser extent, payment processing and administration fees paid by clients. In the fourth quarter of 2020, we decided that it was no longer cost-effective for our sales team to sell our Upwork Business offering. We do not expect this decision to have a material impact on our marketplace revenue, as we will service those clients that we had previously targeted with our Upwork Business offering with our other marketplace offerings, such as Upwork Basic and Plus. Our Upwork Basic and Plus offerings provide clients with access to freelancers with verified work history and client feedback on our work marketplace, the ability to instantly match with the right freelancers, and built-in collaboration features. For freelancers working with clients that are on our Upwork Basic and Plus offerings, we have a tiered freelancer service fee schedule based on cumulative lifetime billings by the freelancer to each client. Freelancers typically pay us 20% of the first $500, 10% for the next $9,500, and then 5% for any amount over $10,000 they bill to each client through our work marketplace. We recognize revenue on Sunday for the majority of our tiered freelancer service fees each week. To a lesser extent, we also generate revenue from freelancers through membership fees, purchases of Connects, and withdrawal and other fees. In addition, we generate marketplace revenue from our Upwork Basic and Plus offerings by charging clients a payment processing and administration fee. Clients using our Upwork Basic offering pay a fee equal to 3% of their client spend. We recognize revenue on Monday for a substantial portion of our client fees each week. Clients using our Upwork Plus offering pay a flat fee of approximately $50 per month for additional features and pay a fee equal to 3% of their client spend unless they pay via ACH (in which case, provided all eligibility criteria are met, the fee is waived). To a lesser extent, we also generate revenue from clients through foreign currency exchange fees when clients choose to pay in currencies other than the U.S. Dollar. Our Upwork Enterprise and other premium offerings, which are designed for larger clients, include access to additional product features, premium access to top freelancers, professional services, custom reporting, and flexible payment terms. For our Upwork Enterprise offering, we charge clients a monthly or annual subscription fee and a service fee calculated as a percentage of the client’s spend on freelancer services, in addition to the service fees paid by freelancers. Additionally, Upwork Enterprise clients can also subscribe to a compliance offering that includes worker classification services for an additional fee and may also choose to use our work marketplace to engage freelancers that were not originally sourced through our work marketplace for a lower fee percentage. One of our premium offerings, Upwork Payroll, is available to clients when freelancers are classified as employees for engagements on our work marketplace. The client enters into an Upwork Payroll agreement with us, and we separately contract 59 with unrelated third-party staffing providers that provide employment services to such clients. Revenue from Upwork Payroll is currently immaterial. The COVID-19 pandemic and the resulting restrictions intended to prevent its spread have accelerated the secular shift toward remote and independent work. In 2020, we continued to identify opportunities to prioritize our advertising and marketing efforts in order to reach those new and existing clients seeking to engage with independent talent due to the COVID-19 pandemic, as well as companies that have already embraced a remote work model. As a result of these efforts, coupled with our execution against strategic initiatives, our 2020 results were fueled by both existing and new clients, who used our work marketplace to address their changing business needs and drove an increase in freelancer billings, which, in turn, drove an increase in marketplace revenue. Although the COVID-19 pandemic did not have a material adverse impact on our financial results for the year ended December 31, 2020, we are continuously evaluating the nature of and extent to which the COVID-19 pandemic will impact our business, operating results, and financial condition. Managed Services Revenue. Through our managed services offering, we are responsible for providing services and engaging freelancers directly or as employees of third-party staffing providers to perform services for clients on our behalf. The freelancers providing services in connection with our managed services include independent talent and agencies of varying sizes. Under U.S. GAAP, we are deemed to be the principal in these managed services arrangements and therefore recognize the entire GSV of managed services projects as managed services revenue, as compared to recognizing only the percentage of the client spend that we receive, as we do with our marketplace offerings. Managed services revenue grew at a slower rate than our marketplace revenue in 2020 compared to 2019, and we anticipate this trend to continue, as we primarily focus on increasing client usage of and spend on our marketplace offerings. Cost of Revenue and Gross Profit Cost of Revenue. Cost of revenue consists primarily of the cost of payment processing fees, amounts paid to freelancers to deliver services for clients under our managed services offering, personnel-related costs for our services and support personnel, third-party hosting fees for our use of AWS, and the amortization expense associated with capitalized internal-use software and platform development costs. We define personnel-related costs as salaries, bonuses, benefits, travel and entertainment, and stock-based compensation costs for employees and the costs related to other service providers we engage. We expect cost of revenue to increase in absolute dollars in future periods due to higher payment processing fees, third-party hosting fees, and personnel-related costs in order to support growth on our work marketplace. We expect third-party hosting fees to increase in 2021 as we complete our migration from the AWS data centers in California to the AWS data center in Oregon because we will need to use both AWS facilities during the migration period. We plan to complete this migration in the first quarter of 2021. Additionally, we are implementing disaster-relief protocols that will increase third-party hosting costs in future periods. Amounts paid to freelancers in connection with our managed services offering are tied to the volume of managed services used by our clients. The level and timing of all of these items could fluctuate and affect our cost of revenue in the future. Gross Profit and Gross Margin. Our gross profit and gross margin may fluctuate from period to period. Such fluctuations may be influenced by our revenue, the mix of payment methods that our clients choose, the timing and amount of investments to expand hosting capacity, our continued investments in our services and support teams, the timing and amounts paid to freelancers in connection with our managed services offering, and the amortization expense associated with capitalized internal-use software and platform development costs. In addition, gross margin will be impacted by fluctuations in our revenue mix between marketplace revenue and managed services revenue. For example, our managed services revenue grew at a slower rate than our marketplace revenue in 2020 compared to 2019, and we anticipate this trend to continue, as we primarily focus on increasing client usage of and spend on our marketplace offerings. As a result, we expect gross profit to increase in absolute dollars in future periods, although gross margin, expressed as a percentage of total revenue, may vary from period to period. Operating Expenses Research and Development. Research and development expense primarily consists of personnel-related costs and third-party hosting costs related to development. Research and development costs are expensed as incurred, except to the extent that such costs are associated with internal-use software and platform development that qualifies for capitalization. In 2020, we made significant investments in research and development to build new product features and launch new offerings, and we believe continued investments in research and development are important to attain our strategic objectives. As a result, we expect research and development expense to increase in absolute dollars in future periods, although this expense, expressed as a percentage of total revenue, may vary from period to period. Sales and Marketing. Sales and marketing expense consists primarily of expenses related to personnel-related costs, including sales commissions, which we expense as they are incurred, and advertising and marketing activities. In 2020, we made significant investments to grow our business, including investments in sales and marketing to acquire new clients and drive 60 brand awareness. However, in the fourth quarter of 2020, we decided that it was no longer cost-effective for our sales team to sell our Upwork Business offering. We do not expect this decision to have a material impact on our marketplace revenue, as we will service those clients that we had previously targeted with our Upwork Business offering with our other marketplace offerings, such as Upwork Basic and Plus. In light of the COVID-19 pandemic and the global macroeconomic downturn and their effect on client spend on our work marketplace, we continue to identify opportunities to prioritize our advertising and marketing efforts in order to reach those new and existing clients seeking to engage with independent talent due to the COVID-19 pandemic, as well as companies that have already embraced a remote work model. As a result, we expect this expense to increase in absolute dollars in future periods, although this expense expressed as a percentage of total revenue may vary from period to period. General and Administrative. General and administrative expense consists primarily of personnel-related costs for our executive, finance, legal, human resources, corporate development, and operations functions; outside consulting, legal, and accounting services; and insurance. We expect to continue to invest in corporate infrastructure and to incur additional expenses associated with operating as a public company, including increased stock-based compensation expense related to executive compensation arrangements, legal and accounting costs, investor relations costs, insurance premiums, and compliance costs. Additionally, in light of the COVID-19 pandemic and the restrictions intended to prevent its spread, we are evaluating our needs for our current office space, and any reductions to our office space may impact the recoverability of our operating lease asset, which could result in impairment charges being recognized in general and administrative expense. As a result, we expect general and administrative expense to increase in absolute dollars in future periods, although this expense, expressed as a percentage of total revenue, may vary from period to period. Provision for Transaction Losses. Provision for transaction losses consists primarily of losses resulting from fraud and bad debt expense associated with our trade and client receivables balance and transaction losses associated with chargebacks. Provisions for these items represent estimates of losses based on our actual historical incurred losses and other factors. We expect provisions for transaction losses to increase proportionally as GSV grows. As a result, we expect provision for transaction losses to increase in absolute dollars in future periods, although expressed as a percentage of total revenue, this expense may vary from period to period. Interest Expense Interest expense consists of interest on our outstanding borrowings. Other (Income) Expense, Net Other (income) expense, net consists primarily of gains and losses from foreign currency exchange transactions, interest income that we earn from our deposits in money market funds and investments in marketable securities, and, prior to October 2018, expenses resulting from the revaluation of our redeemable convertible preferred stock warrant liability. Our redeemable convertible preferred stock warrant was converted to a common stock warrant exercisable for the same number of shares, and our redeemable convertible preferred stock warrant liability was reclassified to additional paid-in capital upon the completion of our IPO in October 2018. Income Tax Benefit (Provision) We account for income taxes in accordance with the liability method. Under the liability method, deferred assets and liabilities are recognized based upon anticipated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax bases. The provision for income taxes is comprised of the current tax liability and the change in deferred tax assets and liabilities. We establish a valuation allowance to the extent that it is more likely than not that deferred tax assets will not be recoverable against future taxable income. Deferred tax assets and liabilities are measured using the enacted tax rates that will be in effect for the years in which those tax assets are expected to be realized or settled. We regularly assess the likelihood that deferred tax assets will be realized from recoverable income taxes or recovered from future taxable income based on the realization criteria set forth in the relevant authoritative guidance. To the extent that we believe any amounts are less likely than not to be realized, we record a valuation allowance to reduce our deferred tax assets. The realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. If we subsequently realize deferred tax assets that were previously determined to be unrealizable, the respective valuation allowance would be reversed, resulting in an adjustment to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize potential liabilities based on an estimate of whether, and the extent to which, additional taxes will be due. We account for uncertain tax positions in accordance with the relevant guidance, which prescribes a recognition threshold and measurement approach for uncertain tax positions taken or expected to be taken in our income tax return, and also provides guidance on recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The 61 guidance utilizes a two-step approach for evaluation of uncertain tax positions. The first step is to determine if the weight of available evidence indicates a tax position is more likely than not to be sustained upon audit. The second step is to measure the tax benefit as the largest amount that is more likely than not to be realized on ultimate settlement. A liability is reported for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. Any interest and penalties related to unrecognized tax benefits are recorded as income tax expense. 62 Results of Operations The following table sets forth our consolidated results of operations for the years ended December 31, 2020, 2019, and 2018 (in thousands): 2020 2019 2018 Revenue: Marketplace $ 338,152 $ 268,284 $ 223,831 Managed services 35,476 32,278 29,523 Total revenue 373,628 300,562 253,354 Cost of revenue (1) 104,267 88,144 81,458 Gross profit 269,361 212,418 171,896 Operating expenses Research and development (1) 83,471 64,027 55,488 Sales and marketing (1) 133,225 95,891 72,963 General and administrative (1) 71,518 67,327 49,336 Provision for transaction losses 3,555 3,905 5,821 Total operating expenses 291,769 231,150 183,608 Loss from operations (22,408) (18,732) (11,712) Interest expense 778 1,306 2,038 Other (income) expense, net (469) (3,407) 6,142 Loss before income taxes (22,717) (16,631) (19,892) Income tax provision (150) (28) (15) Net loss $ (22,867) $ (16,659) $ (19,907) (1) Includes stock-based compensation expense as follows (in thousands): Cost of revenue $ 779 $ 456 $ 282 Research and development 9,783 6,471 3,258 Sales and marketing 4,440 2,609 1,637 General and administrative 10,506 9,262 5,184 Total $ 25,508 $ 18,798 $ 10,361 Comparison of the Years Ended December 31, 2020 and 2019 Revenue (in thousands, except percentages) Year Ended December 31, Change 2020 2019 $ % Marketplace $ 338,152 $ 268,284 69,868 26 % Percentage of total revenue 91 % 89 % Managed services $ 35,476 $ 32,278 3,198 10 % Percentage of total revenue 9 % 11 % Total revenue $ 373,628 $ 300,562 $ 73,066 24 % For the year ended December 31, 2020, total revenue was $373.6 million, an increase of $73.1 million, or 24%, as compared to 2019. Marketplace revenue represented 91% of total revenue and increased by $69.9 million, or 26%, compared to 2019. Marketplace revenue increased primarily due to an increase in GSV, which grew by 21% in 2020 as compared to 2019, and a 17% increase in the number of core clients as of December 31, 2020 compared to December 31, 2019. We believe these increases in marketplace revenue, GSV, and core clients were primarily due to investments in sales and marketing to accelerate the 63 acquisition of new clients and drive brand awareness, the launch of new offerings such as Upwork Plus, the recent changes made in the pricing and packaging of Connects purchases in 2019, and investments in research and development to build new product features. Additionally, marketplace revenue also increased as a result of an increase in client acquisition that was driven by an acceleration in the shift toward remote work, due in part to the COVID-19 pandemic and execution of our strategic initiatives. This increase in client acquisition, which began in the second quarter of 2020 and accelerated throughout the remainder of the year, continued to drive an increase in freelancer billings, which, in turn, drove an increase in marketplace revenue. Freelancer service fees generated $199.3 million and $168.8 million of marketplace revenue during the years ended December 31, 2020 and 2019, respectively. Client payment processing and administration fees generated $55.2 million and $43.9 million of marketplace revenue during the years ended December 31, 2020 and 2019, respectively. Managed services revenue represented 9% and 11% of total revenue for the years ended December 31, 2020 and 2019, respectively. Managed services revenue increased by $3.2 million, or 10%, for the year ended December 31, 2020 compared to 2019. Cost of Revenue and Gross Margin (in thousands, except percentages) Year Ended December 31, Change 2020 2019 $ % Cost of revenue $ 104,267 $ 88,144 $ 16,123 18 % Components of cost of revenue: Costs of freelancer services to deliver managed services 28,703 26,763 1,940 7 % Other components of cost of revenue 75,564 61,381 14,183 23 % Total gross margin 72 % 71 % For the year ended December 31, 2020, cost of revenue increased by $16.1 million, or 18%, compared to 2019. The increase was primarily due to a $14.2 million, or 23%, increase in other components of cost of revenue, which was driven by an increase of $7.5 million in payment processing fees due to an increase in client spend on our work marketplace, $2.9 million in third-party hosting costs due to our AWS data center migration and implementation of disaster-relief protocols, $2.0 million in amortization of capitalized platform development costs, and $1.8 million in customer support, software, and other costs. Research and Development (in thousands, except percentages) Year Ended December 31, Change 2020 2019 $ % Research and development $ 83,471 $ 64,027 $ 19,444 30 % Percentage of total revenue 22 % 21 % For the year ended December 31, 2020, research and development expense increased by $19.4 million, or 30%, as compared to 2019. The increase was primarily due to increases in personnel-related costs of $18.6 million, which resulted from investments made to increase the size of our workforce in connection with the execution of our strategic initiatives, and licensed software and other costs of $2.1 million, partially offset by the capitalization of $1.3 million of additional internal-use software and platform development costs. Sales and Marketing (in thousands, except percentages) Year Ended December 31, Change 2020 2019 $ % Sales and marketing $ 133,225 $ 95,891 $ 37,334 39 % Percentage of total revenue 36 % 32 % For the year ended December 31, 2020, sales and marketing expense increased by $37.3 million, or 39%, as compared to 2019. This increase was primarily due to year-over-year increases of $20.3 million in personnel-related costs to expand our enterprise sales team, including sales commissions that we expense as incurred, $15.7 million in marketing and advertising costs due to our efforts to accelerate our acquisition of Upwork Enterprise clients and our ongoing focus on increasing brand awareness, and $1.3 million in amortization of licensed software and facilities-related and other costs resulting from ongoing business growth. 64 General and Administrative (in thousands, except percentages) Year Ended December 31, Change 2020 2019 $ % General and administrative $ 71,518 $ 67,327 $ 4,191 6 % Percentage of total revenue 19 % 22 % For the year ended December 31, 2020, general and administrative expense increased by $4.2 million, or 6%, as compared to 2019. This increase was primarily due to increases of $5.2 million in personnel-related costs and $0.7 million in outside consulting and other costs, partially offset by reductions in facilities-related and other expenses of $1.7 million. Provision for Transaction Losses (in thousands, except percentages) Year Ended December 31, Change 2020 2019 $ % Provision for transaction losses $ 3,555 $ 3,905 $ (350) (9) % Percentage of total revenue 1 % 1 % For the year ended December 31, 2020, provision for transaction losses decreased by $0.4 million, or 9%, as compared to 2019, and represented approximately 1% of revenue for each period. Interest Expense and Other (Income) Expense, Net (in thousands, except percentages) Year Ended December 31, Change 2020 2019 $ % Interest expense $ 778 $ 1,306 $ (528) (40) % Other income, net (469) (3,407) 2,938 (86) % For the year ended December 31, 2020, interest expense decreased by $0.5 million, as compared to 2019. This resulted from lower balances outstanding on the Term Loans. See “Note 7—Debt” of the notes to our consolidated financial statements included elsewhere in this Annual Report. For the year ended December 31, 2020, other income, net was $0.5 million, as compared to $3.4 million in 2019, which was primarily driven by lower investment income received from marketable securities of $1.5 million, as well as additional foreign currency exchange losses of $1.4 million from higher volumes of foreign currency transactions resulting from additional foreign currencies added in the second quarter of 2019. Comparison of the Years Ended December 31, 2019 and 2018 Revenue (in thousands, except percentages) Year Ended December 31, Change 2019 2018 $ % Marketplace $ 268,284 $ 223,831 44,453 20 % Percentage of total revenue 89 % 88 % Managed services $ 32,278 $ 29,523 2,755 9 % Percentage of total revenue 11 % 12 % Total revenue $ 300,562 $ 253,354 $ 47,208 19 % For the year ended December 31, 2019, total revenue was $300.6 million, an increase of $47.2 million, or 19%, as compared to 2018. Marketplace revenue represented 89% of total revenue for 2019, an increase of $44.5 million, or 20%, compared to 2018. Marketplace revenue increased primarily due to an increase in GSV, which grew by 19% in 2019 as compared to 2018. GSV grew primarily driven by an 18% increase in the number of core clients as of December 31, 2019 compared to December 31, 65 2018. We believe these increases in marketplace revenue, GSV, and core clients were primarily due to investments in sales and marketing to acquire new clients and drive brand awareness, the launch of new offerings such as Upwork Plus and Upwork Business, the recent changes made in the pricing and packaging of Connects purchases in 2019, and investments in research and development to build new product features. Freelancer service fees generated $168.8 million and $149.9 million of marketplace revenue during the years ended December 31, 2019 and 2018, respectively. Client payment processing and administration fees generated $43.9 million and $35.5 million of marketplace revenue during the years ended December 31, 2019 and 2018, respectively. Managed services revenue represented 11% and 12% of total revenue for the year ended December 31, 2019 and 2018, respectively. Managed services revenue increased by $2.8 million, or 9%, for the year ended December 31, 2019 compared to 2018, primarily due to an increase in client demand for our managed services offering and a resulting increase in the amount of freelancer services used to deliver our managed services offering. Cost of Revenue and Gross Margin (in thousands, except percentages) Year Ended December 31, Change 2019 2018 $ % Cost of revenue $ 88,144 $ 81,458 $ 6,686 8 % Components of cost of revenue: Costs of freelancer services to deliver managed services 26,763 24,490 2,273 9 % Other components of cost of revenue 61,381 56,968 4,413 8 % Total gross margin 71 % 68 % For the year ended December 31, 2019, cost of revenue increased by $6.7 million, or 8%, compared to 2018. The increase was partially due to a $2.3 million, or 9%, increase in cost of freelancer services to deliver managed services, which was driven by a corresponding increase of $2.8 million in managed services revenue for the year ended December 31, 2019 compared to 2018. In general, the cost of freelancer services to deliver managed services is directly correlated to our managed services revenue. Other components of cost of revenue increased by $4.4 million, which included an increase of $5.8 million in payment processing fees due to an increase in client spend on our work marketplace and $0.9 million in amortization of capitalized platform development costs, partially offset by a $1.7 million reduction in third-party hosting costs due to our migration to AWS and a $0.6 million reduction in personnel-related costs, amortization of licensed software, and other costs. Research and Development (in thousands, except percentages) Year Ended December 31, Change 2019 2018 $ % Research and development $ 64,027 $ 55,488 $ 8,539 15 % Percentage of total revenue 21 % 22 % For the year ended December 31, 2019, research and development expense increased by $8.5 million, or 15%, as compared to 2018. The increase was primarily due to an increase in personnel-related costs of $8.8 million and an increase of $1.7 million in amortization of licensed software, partially offset by the capitalization of $1.3 million of additional internal-use software and platform development costs and a $0.7 million reduction in third-party services and other costs during 2019. Sales and Marketing (in thousands, except percentages) Year Ended December 31, Change 2019 2018 $ % Sales and marketing $ 95,891 $ 72,963 $ 22,928 31 % Percentage of total revenue 32 % 29 % For the year ended December 31, 2019, sales and marketing expense increased by $22.9 million, or 31%, as compared to 2018. This increase was primarily due to year-over-year increases of $13.9 million in marketing and advertising costs due to our ongoing digital marketing and advertising programs and our TV and radio ad campaign that commenced in the second quarter of 2019, $6.1 million in personnel-related costs to build out our enterprise sales team, including sales commissions that we 66 expense as incurred, and $2.9 million in amortization of licensed software, and facilities-related and other costs resulting from ongoing business growth. General and Administrative (in thousands, except percentages) Year Ended December 31, Change 2019 2018 $ % General and administrative $ 67,327 $ 49,336 $ 17,991 36 % Percentage of total revenue 22 % 19 % For the year ended December 31, 2019, general and administrative expense increased by $18.0 million, or 36%, as compared to 2018. This increase was primarily due to increases of $11.3 million in personnel-related costs, which included adding additional personnel primarily within our finance and accounting organization to support our being a public company, $3.0 million in other professional services expenses (including audit, compliance, and legal services), $1.9 million related to increased rent, insurance, and other costs associated with our new office leases, $1.1 million in non-income taxes, and $0.7 million of expense related to our Tides Foundation common stock warrant. Provision for Transaction Losses (in thousands, except percentages) Year Ended December 31, Change 2019 2018 $ % Provision for transaction losses $ 3,905 $ 5,821 $ (1,916) (33) % Percentage of total revenue 1 % 2 % For the year ended December 31, 2019, provision for transaction losses decreased by $1.9 million, or 33%, as compared to 2018. These decreases were mainly due to improved payment collection processes and reducing fraudulent activity on our work marketplace. For the year ended December 31, 2019, provision for transaction losses represented approximately 1% of revenue for the same period. Interest Expense and Other (Income) Expense, Net (in thousands, except percentages) Year Ended December 31, Change 2019 2018 $ % Interest expense $ 1,306 $ 2,038 $ (732) (36) % Other (income) expense, net (3,407) 6,142 (9,549) (155) % For the year ended December 31, 2019, interest expense decreased by $0.7 million, as compared to 2018. This resulted from a reduction in the interest rate on our Second Term Loan (as defined below), which was the prime rate plus 5.25% per annum for most of 2018 and was reduced to the prime rate plus 0.25% per annum in October 2018 as a result of our IPO, resulting in a corresponding reduction in interest expense. See “Note 7—Debt” of the notes to our consolidated financial statements included elsewhere in this Annual Report. For the year ended December 31, 2019, other income, net was $3.4 million, as compared to other expense, net of $6.1 million for the year ended December 31, 2018. During 2019, we received interest income from our cash equivalents and marketable securities of $2.5 million, as compared to $6.1 million of expense we incurred in 2018 related to the revaluation of our redeemable convertible preferred stock warrant liability. Our redeemable convertible preferred stock warrant converted to a common stock warrant exercisable for the same number of shares, and our redeemable convertible preferred stock warrant liability was reclassified to additional paid-in capital upon completion of our IPO. Accordingly, we did not incur this expense during the year ended December 31, 2019, nor will this expense recur in future periods. 67 Quarterly Results of Operations The following tables summarize our selected unaudited quarterly consolidated statements of operations data for each of the eight quarters in the period ended December 31, 2020. The information for each of these quarters has been prepared on a basis consistent with our audited financial statements included elsewhere in this Annual Report and, in the opinion of management, includes all adjustments of a normal, recurring nature that are necessary for the fair statement of the results of operations for these periods in accordance with U.S. GAAP. The data should be read in conjunction with our audited financial statements and notes thereto included elsewhere in this Annual Report. Our historical quarterly results are not necessarily indicative of the results that may be expected for a full year or in any future period. Three Months Ended March 31, 2019 June 30, 2019 September 30, 2019 December 31, 2019 March 31, 2020 June 30, 2020 September 30, 2020 December 31, 2020 (in thousands) Revenue Marketplace $ 60,455 $ 65,728 $ 69,912 $ 72,189 $ 74,782 $ 78,464 $ 88,040 $ 96,866 Managed services 8,021 8,055 8,103 8,099 8,414 9,067 8,708 9,287 Total revenue 68,476 73,783 78,015 80,288 83,196 87,531 96,748 106,153 Cost of revenue (1) 21,125 21,588 22,494 22,937 23,485 25,408 26,596 28,778 Gross profit 47,351 52,195 55,521 57,351 59,711 62,123 70,152 77,375 Operating expenses Research and development (1) 15,800 15,696 16,209 16,322 19,348 20,547 20,833 22,743 Sales and marketing (1) 20,518 24,479 25,322 25,572 30,678 34,440 33,577 34,530 General and administrative (1) 15,661 14,064 16,468 21,134 17,824 17,102 18,047 18,545 Provision for transaction losses 637 855 1,214 1,199 912 1,018 724 901 Total operating expenses 52,616 55,094 59,213 64,227 68,762 73,107 73,181 76,719 Income (loss) from operations (5,265) (2,899) (3,692) (6,876) (9,051) (10,984) (3,029) 656 Interest expense 373 357 317 259 230 258 152 138 Other (income) expense, net (479) (832) (462) (1,634) 731 (248) (452) (500) Income (loss) before income taxes (5,159) (2,424) (3,547) (5,501) (10,012) (10,994) (2,729) 1,018 Income tax provision (1) (27) — — (9) (30) (18) (93) Net income (loss) $ (5,160) $ (2,451) $ (3,547) $ (5,501) $ (10,021) $ (11,024) $ (2,747) $ 925 Net income (loss) per share, basic and diluted $ (0.05) $ (0.02) $ (0.03) $ (0.05) $ (0.09) $ (0.09) $ (0.02) $ 0.01 Weighted-average shares used to compute net income (loss) per share, basic and diluted 106,639 108,683 111,163 112,690 114,119 116,524 120,681 123,398 (1) Includes stock-based compensation expense as follows (in thousands): Cost of revenue $ 144 $ 73 $ 109 $ 130 $ 174 $ 202 $ 203 $ 200 Research and development 1,380 1,686 1,503 1,902 1,950 2,769 2,567 2,497 Sales and marketing 642 583 635 749 928 1,312 1,212 988 General and administrative 2,129 289 1,685 5,159 2,485 2,851 2,874 2,296 Total $ 4,295 $ 2,631 $ 3,932 $ 7,940 $ 5,537 $ 7,134 $ 6,856 $ 5,981 68 The following table sets forth our unaudited quarterly consolidated results of operations data for each of the periods indicated as a percentage of total revenue: Three Months Ended March 31, 2019 June 30, 2019 September 30, 2019 December 31, 2019 March 31, 2020 June 30, 2020 September 30, 2020 December 31, 2020 Revenue Marketplace 88 % 89 % 90 % 90 % 90 % 90 % 91 % 91 % Managed services 12 11 10 10 10 10 9 9 Total revenue 100 100 100 100 100 100 100 100 Cost of revenue 31 29 29 29 28 29 27 27 Gross profit 69 71 71 71 72 71 73 73 Operating expenses Research and development 23 21 21 20 23 23 22 21 Sales and marketing 30 33 32 32 37 39 35 33 General and administrative 23 19 21 26 21 20 19 17 Provision for transaction losses 1 1 2 1 1 1 1 1 Total operating expenses 77 75 76 80 83 84 76 72 Income (loss) from operations (8) (4) (5) (9) (11) (13) (3) 1 Interest expense 1 — — — — — — — Other (income) expense, net (1) (1) (1) (2) 1 — — — Income (loss) before income tax (8) (3) (5) (7) (12) (13) (3) 1 Income tax — — — — — — — — Net income (loss) (8) % (3) % (5) % (7) % (12) % (13) % (3) % 1 % Liquidity and Capital Resources Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and amounts available for borrowing under the Loan Agreement referred to below under “—Term and Revolving Loans.” In August 2020, we entered into an amendment to the Loan Agreement that, among other things, extended the maturity date of the revolving line of credit from September 2020 to September 2022 and eliminated a formula-based restriction that prohibited us from borrowing funds under the revolving line of credit in an amount that exceeded a specified percentage of eligible trade and client accounts receivable. Our cash equivalents and marketable securities primarily consist of commercial paper, treasury bills, and U.S. government securities. As of December 31, 2020 and 2019, we had $94.1 million and $48.4 million in cash and cash equivalents, respectively. As of December 31, 2020 and 2019, we had $75.6 million and $85.5 million in marketable securities, respectively. We believe our existing cash and cash equivalents, marketable securities, cash flow from operations (in periods in which we generate cash flow from operations), and amounts available for borrowing under the Loan Agreement will be sufficient to meet our working capital requirements for at least the next 12 months. To the extent existing cash and cash equivalents, cash from marketable securities, cash from operations (in periods in which we generate cash flow from operations), and amounts available for borrowing under the Loan Agreement are insufficient to fund our working capital requirements, or should we require additional cash for other purposes, we will need to raise additional funds. In the future, we may attempt to raise additional capital through the sale of equity securities or through equity-linked or debt financing arrangements. If we raise additional funds by issuing equity or equity-linked securities, the ownership and economic interests of our existing stockholders will be diluted. If we raise additional financing by incurring additional indebtedness, we will be subject to additional debt service requirements and could also be subject to additional restrictive covenants, such as limitations on our ability to incur additional debt, and other operating restrictions that could adversely impact our ability to conduct our business. Any future indebtedness we incur may result in terms that could also be unfavorable to our equity investors. There can be no assurances that we will be able to raise additional capital on terms we deem acceptable, or at all. The inability to raise additional capital as and when required would have an adverse effect, which could be material, on our results of operations, financial condition, and ability to achieve our business objectives. We also believe that our principal sources of liquidity will allow us to manage the impact of the COVID-19 pandemic on our business operations for the foreseeable future, which could include reductions in revenue and delays in payments from users, as 69 further described above in “Risk Factors—Our business experienced, and may again experience, an adverse impact from the ongoing COVID-19 pandemic. In addition, users may reduce their use of our work marketplace following the COVID-19 pandemic.” The challenges posed by the COVID-19 pandemic on our business are expected to continue to evolve. Consequently, we will continue to evaluate our financial position in light of future developments, particularly those relating to the COVID-19 pandemic. Escrow Funding Requirements As a licensed internet escrow agent, we offer escrow services to users of our work marketplace and, as such, we are required to hold our users’ escrowed cash and in-transit cash in trust as an asset and record a corresponding liability for escrow funds held on behalf of freelancers and clients on our balance sheet. We expect the balances of our funds held in escrow, including funds held in transit, and the related liability to grow as GSV grows and may vary from period to period. Escrow regulations require us to fund the trust with our operating cash to cover shortages due to the timing of cash receipts from clients for completed hourly billings. Freelancers submit their billings for hourly contracts to their clients on a weekly basis every Sunday, and the aggregate amount of such billings is added to escrow funds payable to freelancers on the same day. As of Sunday each week, we have not yet collected funds for hourly billings from clients as these funds are in transit. Therefore, in order to satisfy escrow funding requirements, every Sunday we fund the shortage of cash in trust with our own operating cash and typically collect this cash shortage from clients within the next several days. As a result, we expect our total cash and cash flows from operating activities to be impacted when a quarter ends on a Sunday. As of December 31, 2020 and 2019, funds held in escrow, including funds in transit, were $135.0 million and $108.7 million, respectively. To the extent we have not yet collected funds for hourly billings from clients which are in transit due to timing differences in receipt of cash from clients and payments of cash to freelancers, we may, from time to time, utilize the revolving line of credit under our Loan Agreement to satisfy escrow funding requirements. We drew down $25.0 million under the revolving line of credit for such purpose in each of March and June 2019, which we subsequently repaid in April and July 2019, respectively. We drew down $15.0 million under the revolving line of credit for the same purpose in September 2018, which we subsequently repaid in October 2018. Term and Revolving Loans Under our Loan Agreement, the aggregate amount of the facility is up to $49.0 million, consisting of a term loan in the original principal amount of $15.0 million, which we refer to as the First Term Loan, a term loan in the original principal amount of $9.0 million, which we refer to as the Second Term Loan and, together with the First Term Loan, the Term Loans, and a revolving line of credit, which permits borrowings of up to $25.0 million subject to customary conditions. The First Term Loan matures in March 2022, and the Second Term Loan and revolving line of credit mature in September 2022. All borrowings under the Loan Agreement bear interest at floating rates, and, therefore, our borrowing costs are affected by changes in market interest rates. Specifically, the First Term Loan bears interest at the prime rate plus 0.25% per annum and has a repayment term of 18 months of interest-only payments that ended in March 2019, followed by equal monthly installments of principal plus interest until the maturity in March 2022. Accordingly, we commenced repayment of the First Term Loan in April 2019. For the years ended December 31, 2020 and 2019, we repaid $5.0 million and $3.8 million of principal of the First Term Loan, respectively. In September 2018, we entered into a second amendment to the Loan Agreement, which, among other changes, provided for a reduction in the interest rate for the Second Term Loan, from the prime rate plus 5.25% per annum to the prime rate plus 0.25% per annum, from and after the occurrence of an initial public offering by us with net proceeds of more than $50.0 million. This reduction became effective following the completion of our IPO in October 2018. The Second Term Loan has a repayment term of 17 months of interest-only payments that ended in March 2019, followed by equal monthly installments of principal plus interest until the maturity in September 2022. Accordingly, we commenced repayment of the Second Term Loan in April 2019. For the years ended December 31, 2020 and 2019, we repaid $2.6 million and $1.9 million of principal of the Second Term Loan, respectively. In March 2019, we entered into the third amendment to the Loan Agreement, which, among other changes, (i) amended the adjusted quick ratio financial covenant to provide that we will maintain an adjusted quick ratio of 1.75 to 1.00 (previously 1.30 to 1.00), (ii) reduced the frequency with which we are required to provide certain financial information to the lender during periods in which we maintain an adjusted quick ratio of 2.50 to 1.00, and (iii) eliminated the minimum EBITDA covenant with which we were required to comply. In August 2020, we entered into the fourth amendment to the Loan Agreement, which, among other things, extended the maturity date of the revolving line of credit from September 2020 to September 2022 and eliminated a formula-based restriction that prohibited us from borrowing funds under the revolving line of credit in an amount that exceeded a specified percentage of eligible trade and client accounts receivable. The revolving line of credit bears interest at the prime rate with accrued interest due monthly. As a result of the uncertainty caused by the COVID-19 pandemic, we drew down $15.0 million and $3.0 million under the revolving line of credit in March and April 2020, respectively, both of which we subsequently repaid in full in May 70 2020. Additionally, as described above under “—Escrow Funding Requirements,” to the extent we have not yet collected funds for hourly billings from clients that are in-transit due to timing differences in receipt of cash from clients, we may utilize the revolving line of credit to satisfy escrow funding requirements. In each of March and June 2019, we drew down $25.0 million under the revolving line of credit for such purpose, which we subsequently repaid in April and July 2019, respectively. We drew down $15.0 million under the revolving line of credit for such purpose in September 2018, which we subsequently repaid in October 2018. For further information, see “Note 7—Debt” in the notes to our consolidated financial statements included elsewhere in this Annual Report. Our obligations under the Loan Agreement are secured by first priority liens on substantially all of our assets excluding our intellectual property (but including proceeds therefrom) and the funds and assets held by our subsidiary Upwork Escrow Inc. The Loan Agreement prohibits us from pledging our intellectual property. The Loan Agreement also includes a restriction on dividend payments, other than dividends payable solely in common stock. The Loan Agreement contains affirmative covenants, including a covenant requiring that we maintain an adjusted quick ratio, and also contains certain non-financial covenants. We were in compliance with our covenants under the Loan Agreement as of December 31, 2020 and 2019. As of December 31, 2020, we had $10.8 million outstanding pursuant to the Term Loans and no borrowings outstanding under the revolving line of credit. As of December 31, 2019, we had $18.3 million outstanding pursuant to the Term Loans and no borrowings outstanding under the revolving line of credit. Cash Flows The following table summarizes our cash flows for the years ended December 31, 2020, 2019, and 2018 (in thousands): 2020 2019 2018 Net cash provided by operating activities $ 22,365 $ 1,058 $ 13,744 Net cash used in investing activities (4,146) (100,924) (6,841) Net cash provided by financing activities 54,641 29,402 112,065 Net increase (decrease) in cash, cash equivalents, and restricted cash $ 72,860 $ (70,464) $ 118,968 Operating Activities Our largest source of cash from operating activities is revenue generated from our work marketplace. Our primary uses of cash from operating activities are for personnel-related expenditures, marketing activities, including advertising, payment processing fees, amounts paid to freelancers to deliver services for clients under our managed services offering, and third-party hosting costs. In addition, because we are licensed as an internet escrow agent, our total cash and cash provided by operating activities may be impacted by the timing of the end of our fiscal quarter as discussed in the section titled “—Liquidity and Capital Resources—Escrow Funding Requirements.” Net cash provided by operating activities during 2020 was $22.4 million, which resulted from non-cash charges of $43.0 million and net cash inflows of $2.2 million from changes in operating assets and liabilities, offset by a net loss of $22.9 million. The change in operating assets and liabilities primarily resulted from changes in trade and client receivables, accrued expenses, and other current and long-term liabilities. Due to fluctuations in revenue and the number of transactions on our work marketplace, coupled with fluctuations in the timing of cash receipts and payments, our operating assets and liabilities will likely continue to fluctuate in the future. Net cash provided by operating activities during 2019 was $1.1 million, which resulted from non-cash charges of $32.2 million, offset by a net loss of $16.7 million and net cash outflows of $14.4 million from changes in operating assets and liabilities. The change in operating assets and liabilities primarily resulted from the increase in trade and client receivables of $10.9 million. Net cash provided by operating activities during 2018 was $13.7 million, which resulted from a net loss of $19.9 million, offset by non-cash charges of $10.4 million for stock-based compensation, $4.9 million for depreciation and amortization, $6.1 million and $0.2 million related to the change in fair value of our redeemable convertible preferred stock warrant liability and expense related to our Tides Foundation common stock warrant, respectively, $5.1 million for provision for transaction losses, $0.2 million for amortization of debt issuance costs and loss on disposal of fixed assets, and net cash inflows of $6.7 million from changes in operating assets and liabilities. The changes in operating assets and liabilities included cash inflows of $3.5 million resulting from a decrease in trade and client receivables due to the timing of collections year-over-year. Additionally, changes in accounts payable and accrued expenses and other liabilities generated cash inflows of $1.6 million and $2.9 million, respectively. These cash inflows were partially offset by $1.3 million related to cash spent on prepaid expenses and other assets. 71 Investing Activities Net cash used in investing activities during 2020 was $4.1 million, which was primarily a result of investing $107.3 million in various marketable securities during 2020, as well as $8.0 million of internal-use software and platform development costs that we paid during the period and purchases of property and equipment of $6.3 million primarily for leasehold improvements and furniture related to our office lease in Chicago, Illinois. These uses of cash were partially offset by proceeds from maturities of marketable securities of $117.5 million. Net cash used in investing activities during 2019 was $100.9 million, which was primarily a result of investing $168.8 million in various marketable securities during 2019, as well as $5.9 million of internal-use software and platform development costs that we paid during the period and purchases of property and equipment of $10.8 million primarily for leasehold improvements and furniture related to our new office leases in Santa Clara, California and Chicago, Illinois. These uses of cash were partially offset by proceeds from maturities of marketable securities of $84.5 million. Net cash used in investing activities during 2018 was $6.8 million, which resulted from capitalized internal-use software and platform development costs of $3.8 million and purchases of property and equipment of $3.0 million primarily for leasehold improvements and furniture. Financing Activities Net cash provided by financing activities during 2020 was $54.6 million, which resulted primarily from cash received from stock option exercises of $31.0 million, proceeds from our employee stock purchase program of $4.9 million, and an increase in escrow funds payable of $26.3 million, partially offset by net repayments of debt of $7.6 million. Net cash provided by financing activities during 2019 was $29.4 million, which resulted primarily from cash received from stock option exercises of $18.2 million, proceeds from our employee stock purchase program of $6.4 million, and an increase in escrow funds payable of $10.5 million, partially offset by net repayments of debt of $5.7 million. Net cash provided by financing activities during 2018 was $112.1 million, which was primarily due to proceeds received from our IPO, net of underwriting discounts and commissions, of $109.4 million, cash received from the exercise of stock options and common stock warrants of $8.2 million, and an increase in escrow funds payable of $10.9 million, partially offset by net repayments of debt of $10.0 million, payments of taxes related to net share settlements of $0.2 million, and the payment of costs related to our IPO of $6.2 million. Obligations and Other Commitments Our principal commitments consist of obligations under our non-cancellable operating leases for office space and the Loan Agreement. The following table summarizes our contractual obligations as of December 31, 2020 (in thousands): Total Less than 1 Year 1 - 3 Years 3 - 5 Years More Than 5 Years Leases (1) $ 32,906 $ 6,405 $ 13,365 $ 8,199 $ 4,937 Debt principal 10,750 7,571 3,179 — — Total contractual obligations $ 43,656 $ 13,976 $ 16,544 $ 8,199 $ 4,937 (1) Represents minimum operating lease payments under operating leases for office facilities, excluding potential lease renewals and tenant improvement allowances. In the ordinary course of business, we enter into contracts and agreements that contain a variety of representations and warranties and provide for indemnification. In addition, we have entered into indemnification agreements with our directors and executive officers and certain key employees that require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as our directors, executive officers, or employees. The terms of such obligations may vary. To date, we have not paid any material claims or been required to defend any actions related to our indemnification obligations. As of December 31, 2020 and 2019, we had accrued liabilities related to uncertain non-income tax positions based on management’s best estimate of its liability, which are reflected on our consolidated balance sheet. We could be subject to examination in various jurisdictions related to income and non-income tax matters. The resolution of these types of matters, giving recognition to the recorded reserve, could have an adverse impact on our business. Additionally, in light of the COVID-19 pandemic and the restrictions intended to prevent its spread, we are evaluating our needs for our current office space. We may determine to either close or sublease certain of our offices, either of which may impact the recoverability of our operating lease asset, which could result in impairment charges being recognized in general and administrative expense. 72 Off-Balance Sheet Arrangements As of December 31, 2020, we did not have any relationships with other entities or financial partnerships such as entities often referred to as structured finance or special purpose entities that have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis using historical experience and other factors and adjust those estimates and assumptions when facts and circumstances dictate. Actual results could materially differ from these estimates and assumptions. Certain of our accounting policies require higher degrees of judgement than others in their application. These include certain aspects of accounting for revenue recognition, goodwill, internal-use software and platform development costs, stock-based compensation, and income taxes. Revenue Recognition We primarily generate revenue from freelancers and clients from marketplace and managed service offerings. We account for revenue in accordance with Topic 606, which we adopted on December 31, 2019 effective as of January 1, 2019 using the modified retrospective method. Revenue is recognized upon transfer of control of promised services to users in an amount that reflects the consideration we expect to receive in exchange for those services. Determining the method and amount of revenue to recognize requires management to make judgments and estimates. Other judgements include determining whether to present revenue gross, as a principal, or net, as an agent, and certain aspects of applying Topic 606 to our arrangements with freelancers subject to tiered service fees. We apply judgement in the application of the portfolio approach practical expedient to our arrangements with freelancers subject to tiered service fees, which includes estimating the standalone selling price of the material rights and the period of time over which to defer and recognize the consideration allocated to the material rights. Specifically, management applies judgement in assessing the continued appropriateness for the estimates, which include assessing the continued appropriateness of the methodology and relevant data inputs to estimate the likelihood and the period of time over which to defer and recognize the consideration allocated to the material rights. We utilize historical user transaction data in developing these estimates. We recognize revenue related to the material rights based on our estimate of when the material rights are exercised, and adjust revenue for changes in estimates in the period of change on a cumulative catch-up basis. Goodwill Goodwill is not amortized, but is assessed for impairment at least annually, or more frequently if events or changes in circumstances indicate the goodwill may be impaired. For purposes of performing the impairment tests, we identify reporting units in accordance with U.S. GAAP. The identification of reporting units requires management judgment. We conduct our annual assessment during the fourth quarter of each calendar year based on a single reporting unit structure. We have the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then additional impairment testing is not required. However, if we conclude otherwise, then we are required to perform a quantitative test. We compare the carrying value of the reporting unit to its estimated fair value, and if the fair value is determined to be less than the carrying value, we recognize an impairment loss for the difference. For 2020, 2019, and 2018, we conducted our goodwill impairment testing by performing the quantitative test of the impairment model. The fair value was determined by us using quoted market prices of our common stock. We determined that the fair value of our reporting unit exceeded the net book value of our reporting unit, and as such, we concluded that there was no impairment of goodwill at the impairment testing date. Internal-Use Software and Platform Development Costs We capitalize certain internal-use software and platform development costs associated with creating and enhancing internal-use software related to our software platform and technology infrastructure. Once a project is substantially complete and the software and technologies are ready for their intended purpose, capitalization ends and amortization commences. Internal-use software and platform development costs are amortized using a straight-line method over the estimated useful life, and the determination of the estimated useful life requires management judgment. 73 Stock-Based Compensation We measure and recognize compensation expense for all stock-based awards granted to service providers, including stock options, RSUs, and purchase rights granted under our 2018 Employee Stock Purchase Plan, which we refer to as the 2018 ESPP, based on the estimated fair value of the award on the grant date. We calculate the estimated fair value of stock options and purchase rights granted under the 2018 ESPP on the date of grant using the Black-Scholes option pricing model, which is impacted by the fair value of our common stock, as well as changes in assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected dividend yield, the expected term of the awards, the risk-free interest rates, and the expected common stock price volatility over the term of the option awards. Prior to our IPO, the estimated fair value of our common stock was determined by our board of directors, and had been based in part upon contemporaneous valuations performed at periodic intervals by unrelated third-party specialists. Because there had been no public market for our common stock, our board of directors considered this independent valuation and other factors, including, but not limited to, our actual operating and financial performance, the current status of the technical and commercial success of our operations, our financial condition, the stage of development, and competition to establish the fair value of our common stock at the time of grant of stock options. Following our IPO, we use the quoted market price of our common stock as reported on The Nasdaq Global Select Market for the fair value of RSUs and stock options and purchase rights under our 2018 ESPP. We generally recognize the fair value of stock options and RSUs on a straight-line basis over the period during which a service provider is required to provide services in exchange for the award (generally the vesting period). We recognize the fair value of purchase rights granted under the 2018 ESPP as an expense on a straight-line basis over the offering period and account for forfeitures as they occur. Income Taxes We utilize the asset and liability method under which deferred tax assets and liabilities arise from the temporary differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements, as well as from net operating loss and tax credit carryforwards. Deferred tax amounts are determined by using the tax rates expected to be in effect when the taxes will actually be paid or refunds received, as provided for under current tax law. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. We regularly review our tax positions and benefits to be realized. We recognize tax liabilities based upon our estimate of whether, and the extent to which, additional taxes will be due when such estimates are more likely than not to be sustained. An uncertain income tax position will be recognized only if it is more likely than not to be sustained. We recognize interest and penalties related to income tax matters as income tax expense. Recent Accounting Pronouncements See “Note 2—Basis of Presentation and Summary of Significant Accounting Policies” of the notes to our consolidated financial statements included elsewhere in this Annual Report for recently issued accounting pronouncements not yet adopted as of the date of this Annual Report.