FIVE9, INC. You should read the following discussion in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year endedDecember 31, 2019 . Overview We are a pioneer and leading provider of intelligent cloud software for contact centers, facilitating more than six billion call minutes between our more than 2,000 clients and their customers per year. We believe we achieved this leadership position through our expertise and technology, which has empowered us to help organizations of all sizes transition from legacy on-premise contact center systems to our cloud solution. Our solution, which is comprised of our Virtual Contact Center, or VCC, cloud platform and applications, allows simultaneous management and optimization of customer interactions across voice, chat, email, web, social media and mobile channels, either directly or through our application programming interfaces, or 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 customer relationship management, or 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 the maximum number of named agents allowed to concurrently access our solution. Our clients typically have more named agents than agent seats, and multiple named agents may use an agent seat, though not simultaneously. Substantially all of our clients purchase both subscriptions and related 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 three and six months endedJune 30, 2020 , subscription and related usage fees accounted for 92% and 91%, respectively, of our revenue. For each of the three and six months endedJune 30, 2019 , subscription and related usage fees accounted for 92% of our revenue. The remainder was comprised of professional services revenue from the implementation and optimization of our solution. Effects of COVID-19 30 -------------------------------------------------------------------------------- Table of Contents InDecember 2019 , a novel coronavirus disease known as COVID-19 was reported and onMarch 11, 2020 , theWorld Health Organization , orWHO , characterized COVID-19 as a pandemic. This pandemic has resulted in a widespread health crisis that has significantly harmed theU.S. and global economies and financial markets, including those on which our common stock and our convertible senior notes trade, and may impact demand for our solutions. In accordance with the various shelter-in-place and other social distancing orders and recommendations of applicable government agencies, all of our employees have transitioned to work-from-home operations and we have canceled all business travel by our employees, which have changed how we operate our business. Our clients and business partners are also subject to various and changing shelter-in-place and other social distancing orders and recommendations, which have changed the way we interact with our clients and business partners. Our financial results for the first half of 2020 were not materially impacted by COVID-19. The severity and duration of the COVID-19 pandemic is uncertain and such uncertainty will likely continue in the near term and we will continue to actively monitor the situation taking into account the impact to our employees, customers, partners and suppliers. While there is considerable uncertainty, we believe that certain parts of our business will benefit, particularly over the longer term, from the need to enable work from home agents and to enhance business continuity planning. On the other hand, our smaller clients with less financial resources will likely see their business decline or cease altogether, and clients in certain industry verticals, such as travel and leisure, and consumer discretionary may reduce their number of agent seats. In addition, our clients in general face uncertain and challenging macroeconomic conditions and may reduce the number of agent seats, delay purchasing decisions or payments, or experience an adverse impact on their ability to pay or may not be able to pay us. See Part II, 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$99.8 million and$194.9 million for the three and six months endedJune 30, 2020 , respectively, from$77.4 million and$152.0 million for the three and six months endedJune 30, 2019 , respectively. Revenue growth has primarily been driven by our larger clients. For each of the three and six months endedJune 30, 2020 and 2019, no single client accounted for more than 10% of our total revenue. As ofJune 30, 2020 , we had over 2,000 clients across multiple industries. Our clients' subscriptions generally range in size from fewer than 10 agent seats to approximately 6,000 agent seats. We had a net loss of$16.1 million and$23.5 million in the three and six months endedJune 30, 2020 , respectively, compared to a net loss of$1.9 million and$3.8 million in the three and six months endedJune 30, 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 client base, innovate and expand internationally. While these areas represent significant opportunities for us, they also pose risks and challenges that we must successfully address in order to sustain the growth of our business and improve our operating results, including the impact of the COVID-19 pandemic. Due to our continuing investments to grow our business, increase our sales and marketing efforts, pursue new opportunities, enhance our solution and build our technology, we expect our cost of revenue and operating expenses to increase in absolute dollars in future periods. However, we expect cost of revenue and certain operating expenses to fluctuate as a percentage of revenue in the near term taking into consideration the impact of COVID-19 and the macroeconomic environment. Key Operating and Non-GAAP Financial Performance Metrics In addition to measures of financial performance presented in our condensed consolidated financial statements, we monitor the key metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies. 31 -------------------------------------------------------------------------------- Table of Contents 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. Our Annual Dollar-Based Retention Rate is calculated by dividing our Retained Net Invoicing by our Retention Base Net Invoicing on a monthly basis, which we then average using the rates for the trailing twelve months for the period being presented. We define Retention Base Net Invoicing as recurring net invoicing from all clients in the comparable prior year period, and we define Retained Net Invoicing as recurring net invoicing from that same group of clients in the current period. We define recurring net invoicing as subscription and related usage revenue excluding the impact of service credits, reserves and deferrals. Historically, the difference between recurring net invoicing and our subscription and related usage revenue has been within 10%. The following table shows our Annual Dollar-Based Retention Rate for the periods presented: Twelve Months EndedJune 30, 2020 June 30, 2019
Annual Dollar-Based Retention Rate 105% 107%
Our Dollar-Based Retention Rate decreased year over year primarily due to fluctuations caused by our larger clients coming onto the platform at different times and ramping at different rates. 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 toU.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 withU.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 withU.S. GAAP and reconciliation of adjusted EBITDA to the most directly comparableU.S. GAAP measure, net loss. We calculate adjusted EBITDA as net loss before (1) depreciation and amortization, (2) stock-based compensation, (3) interest income, expense and other, (4) acquisition-related transaction costs and one-time integration costs, (5) COVID-19 relief bonus for employees, (6) provision for (benefit from) income taxes, and (7) other items that do not directly affect what we consider to be our core operating performance. 32 -------------------------------------------------------------------------------- Table of Contents The following table shows a reconciliation of net loss to adjusted EBITDA for the periods presented (in thousands): Three Months Ended Six Months Ended June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 Net loss$ (16,052) $
(1,860)
6,243 3,361 11,213 6,553
Stock-based compensation (2) 16,791 10,436 30,585 19,122
Interest expense 5,734 3,406 9,218 6,802
Interest income and other 4,965 (1,490) 3,893 (3,235)
Legal settlement - 420 - 420
Legal and indemnification fees related
to settlement (3) - 64 - 356
Acquisition-related transaction costs
and one-time integration costs 1,637 - 1,966 -
COVID-19 relief bonus for employees 1,817 - 1,817 -
Provision for (benefit from) income
taxes (2,876) 29 (2,807) (20)
Adjusted EBITDA $ 18,259 $ 14,366 $ 32,396 $ 26,214 (1)Depreciation and amortization expenses included in our results of operations are as follows (in thousands):
Three Months Ended Six Months Ended
June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019
Cost of revenue $ 5,120 $ 2,504 $ 9,060 $ 4,870
Research and development 497 450 963 890
Sales and marketing 2 1 3 2
General and administrative 624 406 1,187 791
Total depreciation and amortization
(2)See Note 7 to the condensed consolidated financial statements for stock-based compensation expense included in our results of operations for the periods presented. (3)Represents legal and indemnification fees related to the Melcher litigation. 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. 33 -------------------------------------------------------------------------------- Table of Contents 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 contributions and other regulatory costs, depreciation and related expenses of the servers and equipment, costs to build out and maintain co-location 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 service, resulting in absolute dollar increases in cost of revenue. As our business grows, we expect to realize economies of scale in network infrastructure, personnel and client support. Operating Expenses We classify our operating expenses as research and development, sales and marketing, and general and administrative expenses. Research and Development. Our research and development expenses consist primarily of salary and related expenses, including stock-based compensation, for personnel related to the development of improvements and expanded features for our services, as well as quality assurance, testing, product management and allocated overhead. We expense research and development expenses as they are incurred except for internal use software development costs that qualify for capitalization. We believe that continued investment in our solution is important for our future growth, and we expect our research and development expenses to increase in absolute dollars and as a percentage of revenue in the near 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, 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 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, due to among other things, the impact of COVID-19 and the resulting macroeconomic conditions, but to increase in absolute dollars and decline as a percentage of revenue over time. 34 -------------------------------------------------------------------------------- Table of Contents Results of Operations for the Three and Six Months EndedJune 30, 2020 and 2019 Based on the condensed consolidated statements of operations and comprehensive loss set forth in this Quarterly Report on Form 10-Q, the following table sets forth our operating results as a percentage of revenue for the periods indicated: Three Months Ended Six Months Ended June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 Revenue 100 % 100 % 100 % 100 % Cost of revenue 43 % 40 % 42 % 41 % Gross profit 57 % 60 % 58 % 59 % Operating expenses: Research and development 17 % 14 % 17 % 14 % Sales and marketing 32 % 30 % 32 % 29 % General and administrative 16 % 16 % 16 % 16 % Total operating expenses 65 % 60 % 65 % 59 % Income (loss) from operations (8) % - % (7) % - % Other income (expense), net: Interest expense (6) % (4) % (5) % (4) % Interest income and other (5) % 2 % (1) % 2 % Total other income (expense), net (11) % (2) % (6) % (2) % Loss before income taxes (19) % (2) % (13) % (2) % Provision for (benefit from) income taxes (3) % - % (1) % - % Net loss (16) % (2) % (12) % (2) % Revenue Three Months Ended Six Months Ended $ % $ % June 30, 2020 June 30, 2019 Change Change June 30, 2020 June 30, 2019 Change Change (in thousands, except percentages) Revenue$ 99,792 $ 77,436 $ 22,356 29 %$ 194,880 $ 151,974 $ 42,906 28 % The increase in revenue for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily attributable to our larger clients, driven by an increase in our sales and marketing activities and our improved brand awareness. Cost of Revenue Three Months Ended Six Months Ended $ % $ % June 30, 2020 June 30, 2019 Change Change June 30, 2020 June 30, 2019 Change Change (in thousands, except percentages) Cost of revenue$ 42,453 $ 31,248 $ 11,205 36 %$ 82,490 $ 62,099 $ 20,391 33 % % of Revenue 43 % 40 % 42% 41% The increase in cost of revenue for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily due to a$3.9 million and$6.4 million increase in personnel costs including stock-based compensation costs, driven mainly by increased headcount and a higher fair value of employee equity awards due primarily to our increased stock price, a$2.3 million and a$3.5 million increase in depreciation and data center costs driven by increased capital expenditures to support our growing capacity needs and continuing expansion of our existing data center facilities, a$1.7 million and a$2.7 million increase in amortization expense due to the acquisitions of certain intangible assets from Whendu inNovember 2019 andVirtual Observer inApril 2020 , a$1.1 million and a$2.6 million increase in third-party hosted software costs driven by increased client activities, a$1.0 million and$1.7 million increase in facilities and related costs, and a$0.9 million and$1.5 million increase in USF 35 -------------------------------------------------------------------------------- Table of Contents contributions and other federal telecommunication service fees due primarily to increased client usage and an increase in the USF contribution rate. Gross Profit Three Months Ended Six Months Ended $ % $ % June 30, 2020 June 30, 2019 Change Change June 30, 2020 June 30, 2019 Change Change (in thousands, except percentages)
Gross profit$ 57,339 $ 46,188 $ 11,151 24 %$112,390 $89,875 $22,515 25% % of Revenue 57 % 60 % 58% 59% The increase in gross profit for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily due to increases in subscription and usage revenues. The decrease in gross margin for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily due to the increase in amortization expense from the acquisition of certain intangible assets fromVirtual Observer and Whendu and from an increase in stock-based compensation costs, driven by increased headcount and a higher fair value of employee equity awards primarily due to our increased stock price. Operating Expenses Research and Development Three Months Ended Six Months Ended $ % $ % June 30, 2020 June 30, 2019 Change Change June 30, 2020 June 30, 2019 Change Change (in thousands, except percentages) Research and development$ 17,208 $ 10,811 $ 6,397 59 %$32,397 $21,357 $11,040 52% % of Revenue 17 % 14 % 17% 14% The increase in research and development expenses for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily due to a$5.3 million and a$9.3 million increase in personnel costs including stock-based compensation costs, driven mainly by increased headcount and a higher fair value of employee equity awards due primarily to our increased stock price. Sales and Marketing Three Months Ended Six Months Ended $ % $ % June 30, 2020 June 30, 2019 Change Change June 30, 2020 June 30, 2019 Change Change (in thousands, except percentages)
Sales and marketing$ 32,231 $ 23,250 $ 8,981 39 %$62,391 $44,951 $17,440 39% % of Revenue 32 % 30 % 32% 29% The increase in sales and marketing expenses for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily due to a$6.7 million and$12.9 million increase in personnel-related costs including stock-based compensation costs driven mainly by increased headcount and higher fair value equity awards due primarily to our increased stock price, and a$2.0 million and a$3.8 million increase in sales commission expenses driven by the growth in sales and bookings of our solution. General and Administrative Three Months Ended Six Months Ended $ % $ % June 30, 2020 June 30, 2019 Change Change June 30, 2020 June 30, 2019 Change Change (in thousands, except percentages)
General and administrative$ 16,129 $ 12,042 $ 4,087 34 %$30,787 $23,804 $6,983 29% % of Revenue 16 % 16 % 16% 16% 36
-------------------------------------------------------------------------------- Table of Contents The increase in general and administrative expenses for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily due to a$3.2 million and a$5.7 million increase in personnel costs including stock-based compensation costs, driven mainly by increased headcount and a higher fair value of equity awards primarily driven by our increased stock price, and a$1.0 million increase in legal and other professional services costs, which included$0.4 million in acquisition-related costs from the acquisition ofVirtual Observer . Other Income (Expense), Net Three Months Ended Six Months Ended $ % $ % June 30, 2020 June 30, 2019 Change Change June 30, 2020 June 30, 2019 Change Change (in thousands, except percentages) Interest expense$ (5,734) $ (3,406) $ (2,328) 68 %$ (9,218) $ (6,802) $ (2,416) 36 % Interest income and other (4,965) 1,490 (6,455) (433) % (3,893) 3,235 (7,128) (220) % Total other income (expense), net$ (10,699) $ (1,916) $ (8,783) 458 %$ (13,111) $ (3,567) $ (9,544) 268 % % of Revenue (11) % (2) % (6) % (3) % The increase in interest expense for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily due to an increase in interest expense under our 2025 convertible senior notes issued in May andJune 2020 , offset in part by the decrease in interest expense as a result of the 2023 Note Repurchase Transactions, which decreased the aggregate outstanding principal amount of our 2023 convertible senior notes. The unfavorable change of$(6.5) million and$(7.1) million in interest income and other for the three and six months endedJune 30, 2020 compared to the same periods of 2019 was primarily from a$5.8 million loss associated with the early extinguishment of our 2023 convertible senior notes and from lower interest income on our marketable investments. Liquidity and Capital Resources To date, we have financed our operations primarily through sales of our solution, lease facilities and net proceeds from our equity and debt financings, including the issuance of our 2025 convertible senior notes in May andJune 2020 and of our 2023 convertible senior notes inMay 2018 . As ofJune 30, 2020 , we had$675.5 million in working capital, which included$233.2 million in cash and cash equivalents and$452.7 million in short-term marketable investments. We also had$82.1 million in long-term marketable investments as ofJune 30, 2020 . In May andJune 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 onJune 1, 2025 and are our senior unsecured obligations. The 2025 convertible senior notes bear interest at a fixed rate of 0.500% per annum, payable semiannually in arrears onJune 1 andDecember 1 of each year, beginningDecember 1, 2020 . The total net proceeds from the offering, after deducting initial purchasers' discounts and commissions and estimated debt issuance costs, were approximately$728.8 million . InMay 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 onMay 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 onMay 1 andNovember 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 ofJune 30, 2020 , after giving effect to the 2023 Note Repurchase Transactions, approximately$77.7 million aggregate principal amount of 2023 convertible senior notes remained outstanding. For additional information regarding the convertible senior notes and related transactions, see Note 6 to the condensed consolidated financial statements included in this report. 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. 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 37 -------------------------------------------------------------------------------- Table of Contents or future litigation or other claims by third parties or governmental entities, the expansion of sales and marketing activities and personnel and the introduction of new and enhanced offerings, including 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 future capital requirements, either to pay acquisition costs or to support our combined operations. We may raise additional equity or engage in debt financings at any time to fund these or other requirements. However, we may not be able to raise additional equity or debt financing when needed on terms acceptable to us or at all, depending on market conditions 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, except percentages):
Six Months Ended
June 30, 2020 June 30, 2019 $ Change % Change
Net cash provided by operating activities
17,978 $ 7,181 40 %
Net cash (used in) provided by investing
activities (336,353) 6,037 (342,390) (5,672) %
Net cash provided by financing activities 466,453 4,542 461,911 10,170 %
Net increase in cash and cash equivalents
28,557 $ 126,702 444 %
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 $25.2 million during the six
months ended June 30, 2020 . Net cash provided by operating activities resulted
from our net loss of $23.5 million adjusted for non-cash items of $57.1 million ,
primarily consisting of $30.6 million of stock-based compensation, $11.2 million
of depreciation and amortization, $8.6 million of amortization of discount and
issuance costs on our convertible senior notes and $5.8 million of loss from the
early extinguishment of our 2023 convertible senior notes, offset by use of cash
for operating assets and liabilities of $8.5 million primarily due to the timing
of cash payments to vendors and cash receipts from customers.
Net cash provided by operating activities was $18.0 million during the six
months ended June 30, 2019 . Net cash provided by operating activities resulted
from our net loss of $3.8 million adjusted for non-cash items of $33.0 million ,
primarily consisting of $19.1 million of stock-based compensation, $6.6 million
of depreciation and amortization, and $6.2 million of amortization of discount
and issuance costs on our convertible senior notes, offset by use of cash for
operating assets and liabilities of $11.2 million primarily due to the time of
cash payments to vendors and cash receipts from customers.
Cash Flows from Investing Activities
Net cash used in investing activities of $336.4 million in the six months ended
June 30, 2020 was comprised of $460.9 million related to cash proceeds from
maturities of marketable investments, $28.3 million , net of cash acquired in
connection with the acquisition of Virtual Observer and $14.9 million in capital
expenditures, offset in part by $167.9 million related to purchases of
marketable investments.
38
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Net cash provided by investing activities of $6.0 million in the six months
ended June 30, 2019 was comprised of $165.4 million related to cash proceeds
from maturities of marketable investments and $0.2 million cash proceeds related
to gain from the sale of convertible notes held for investment, offset in part
by $151.3 million related to purchases of marketable investments and $8.2
million in capital expenditures.
Cash Flows from Financing Activities
Net cash provided by financing activities of $466.5 million in the six months
ended June 30, 2020 related to net cash proceeds of $728.8 million from the
issuance of the 2025 convertible senior notes, net of initial purchasers'
discounts and commissions and estimated debt issuance costs, cash proceeds of
$6.1 million from exercise of stock options and $5.7 million from the sale of
common stock under our employee stock purchase plan, partially offset by $181.5
million of cash paid in connection with the 2023 Note Repurchase Transactions,
$90.5 million of cash paid in connection with the 2025 Capped Call Transactions
and $2.2 million of payments related to finance leases.
Net cash provided by financing activities of $4.5 million in the six months
ended June 30, 2019 related to cash proceeds of $4.2 million from exercises of
stock options and $4.0 million from the sale of common stock under our ESPP,
partially offset by $3.7 million of payments related to finance leases.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with
U.S. GAAP. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue, expenses and related disclosures. On an ongoing basis, we
evaluate our estimates and assumptions. Our actual results may differ from these
estimates under different assumptions or conditions.
We believe our critical accounting policies involve the greatest degree of
judgment and complexity and have the greatest potential impact on our condensed
consolidated financial statements.
Revenue Recognition
Revenue is recognized when control of the promised services are 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 our 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 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
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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, this requires us 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.
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 condensed 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 condensed consolidated statements of operations and comprehensive
loss.
Recent Accounting Pronouncements
Refer to Note 1 of the notes to condensed consolidated financial statements
included in this report.
Off-Balance Sheet Arrangements
As of June 30, 2020 , we did not have any off-balance sheet arrangements, as
defined in Item 303(a)(4)(ii) of SEC Regulation S-K, such as the use of
unconsolidated subsidiaries, structured finance, special purpose entities or
variable interest entities.
Contractual Obligations
Our principal contractual obligations consist of future payment obligations
under our convertible senior notes, finance leases to finance data centers and
other computer and networking equipment, operating leases for office facilities,
and agreements with third parties to provide co-location hosting,
telecommunication usage and equipment maintenance services. These commitments as
of December 31, 2019 are disclosed in our Annual Report on Form 10-K for the
year ended December 31, 2019 , and did not change materially during the six
months ended June 30, 2020 except for certain hosting and telecommunications
agreements and the future payment obligations associated with the 2025
convertible senior notes, which were issued in May and June 2020 , offset in part
by the repurchase of a portion of the 2023 convertible senior notes in May 2020 .
As of June 30, 2020 , our commitments under various hosting and
telecommunications agreements for terms ranging up to 36 months totaled $7.4
million . These agreements require us to make monthly payments over the service
term in exchange for certain network services.
As of June 30, 2020 , $825.2 million of aggregate principal amount of our
convertible senior notes was outstanding. The 2023 convertible senior notes are
due May 1, 2023 and the 2025 convertible senior notes are due June 1, 2025 . For
additional information regarding the convertible senior notes, see Note 6 to the
condensed consolidated financial statements included in this report.
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