Freshworks Inc. (FRSH) FY 2021 MD&A

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this Annual Report on Form 10-K. As described in the section titled "Special Note Regarding Forward-Looking Statements," the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, particularly in “Risk Factors” and elsewhere in this Annual Report on Form 10-K.

Overview

Our mission is to make it fast and easy for businesses to delight their customers and employees.

We provide businesses of all sizes with modern SaaS products that are designed with the user in mind. Our primary product offerings include Freshdesk, our customer experience (CX) product; Freshservice, our IT service management (ITSM) product; and our customer relationship management (CRM) solution, which includes sales force and marketing automation. We currently have more than 56,000 businesses using our software to delight their customers and employees.

We generate revenue primarily from the sale of subscriptions for accessing our cloud-based software products over the contract term. Our subscription arrangements are available in monthly, quarterly, semi-annual, and annual plans, and we typically invoice for the full term in advance. We also sell professional services that include product configuration, data migration, systems integration, and training. Professional services revenue is recognized as services are performed.

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Our business has grown rapidly in recent periods as our customer base and operations have scaled. Our total revenue was $371.0 million, $249.7 million and $172.4 million in the years ended December 31, 2021, 2020 and 2019, respectively, representing year-over-year growth rates of 49% and 45%, respectively. We incurred operating losses of $204.8 million, $56.1 million and $29.7 million in the years ended December 31, 2021, 2020 and 2019, respectively, and our net losses were $192.0 million, $57.3 million and $31.1 million in the years ended December 31, 2021, 2020 and 2019, respectively.

Initial Public Offering

In September 2021, we completed our IPO, in which we issued and sold 31,350,000 shares of our newly authorized Class A common stock at $36.00 per share, which included 2,850,000 shares issued upon the exercise of the underwriters’ option to purchase additional shares. We received net proceeds of approximately $1.1 billion from our IPO, after deducting underwriters’ discounts.

Pursuant to our amended and restated certificate of incorporation in effect prior to our IPO, all shares of common stock then outstanding were reclassified as Class B common stock prior to our IPO. Upon completion of our IPO, the majority of shares of Class B common stock then outstanding was automatically converted into Class A common stock on a one-to-one basis, unless an option to remain as Class B common stock was elected by the holder. In addition, all shares of redeemable convertible preferred stock then outstanding were converted into 153,937,730 shares of common stock on a one-to-one basis and then reclassified into Class B common stock.

Impact of COVID-19

In response to the COVID-19 pandemic, we undertook decisive and comprehensive actions to lessen the impact of the pandemic on our business, including implementing a fully remote, work from home policy across all our global offices, enacting new policies and operating procedures, including restrictions on Freshworks-related business travel and reductions of in-person events.

Our customers were impacted by the pandemic throughout 2020, as conditions caused by the pandemic adversely affected spending by new customers and renewal and retention rates of existing customers. In 2020 we also experienced, and continued to experience through the year ended December 31, 2021, certain positive impacts on other aspects of our business. We believe that the pandemic has caused many of our customers and potential customers to accelerate their IT and digital investments benefiting businesses, like ours, that enable and enhance digital transformations. In addition, we have seen a temporary reduction in certain operating expenses related to reduced business travel, deferred hiring in certain areas, and the virtualization or postponement of in-person customer and employee events, in all periods presented.

Given our subscription-based business model, the effects of the COVID-19 pandemic may not be fully reflected in our revenue until future periods. The extent of the impact of COVID-19 on our future operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, related public health measures, and their impact on the macroeconomy, our current and prospective customers, employees, and vendors. The ultimate impact of the COVID-19 pandemic on our business and operations remains highly uncertain, and it is not possible for us to predict the duration and extent to which this will affect our business, including productivity of our employees in the United States and in India, where we have significant operations, future results of operations, and financial condition at this time. See the section titled “Risk Factors” for further discussion of the challenges and risks we have encountered and could encounter related to the COVID-19 pandemic.

Key Factors Affecting Our Performance

The growth and future success of our business depends on many factors. While each of these factors presents significant opportunities for our business, they also pose important challenges that we must successfully address in order to sustain our growth and improve our results of operations. For complete definitions of our key metrics, please refer to the section titled “Key Business Metrics” below.

Acquiring New Customers

We will continue to invest in acquiring new customers across all of our products. We believe that our focus on offering products that delight our users facilitates our go-to-market strategy, which is designed to be product-led and self-service in nature, reducing the friction new customers have to overcome to adopt our products within their organization. Our approach to acquiring new customers allows us to benefit from user-driven, organic adoption of our products across organizations of all sizes, as well as enable our customers to standardize on our products across the organization. As of December 31, 2021 and 2020, we had more than 56,000 and 48,500 paying customers, respectively.

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Recently, we have made significant investments in strengthening our outbound sales motion to enable adoption of department-specific and organization-wide use cases for mid-market and enterprise customers. We believe that larger businesses can benefit from implementing multiple Freshworks products, as once they are a customer they are able to expand their use of these products. We define annual recurring revenue (ARR) as the sum total of the subscription revenue we would contractually expect to recognize over the next 12 months from all customers at a point in time, assuming no increases, reductions, or cancellations in their subscriptions. For monthly subscriptions, we take the recurring revenue run-rate of such subscriptions for the last month of the period and multiply it by 12 to get to ARR. While monthly subscribers as a group have historically maintained or increased their subscriptions over time, there is no guarantee that any particular customer on a monthly subscription will renew its subscription in any given month, and therefore the calculation of ARR for these monthly subscriptions may not accurately reflect revenue to be received over a 12-month period from such customers. As of December 31, 2021 and 2020, 14,814 and 11,570 of our customers contributed more than $5,000 in ARR, respectively, demonstrating the broad appeal of our products to customers of all sizes and geographies. We believe that the number of customers that contribute more than $5,000 in ARR is an indicator of our success in expanding upmarket to larger businesses.

We also run focused programs to acquire startup and incubator customers. These programs include free credits to use our products, and webinars and events specifically tailored to highlight the benefits of our products for these types of customers. By encouraging startups and incubators to use our products early on in their company’s lifecycle, we believe we have the opportunity to convert these organizations to paying customers and grow with these customers as they grow their businesses.

Retaining and Expanding Within Existing Customers

Our business model relies on rapidly and efficiently landing new customers and expanding our relationships with them over time. We have experienced, and expect to continue to experience that, over time, a significant portion of our revenue growth will come from our existing customers expanding their usage of our products and buying additional products.

We measure the rate of expansion within our customer base using net dollar retention rate (as defined under Key Business Metrics), and we believe that our net dollar retention rate demonstrates a significant rate of expansion within our existing customer base. As of December 31, 2021 and 2020, our net dollar retention rate was 114% and 111%, respectively.

We have a significant opportunity to expand within our existing customer base and substantially increase the number of customers that purchase multiple Freshworks products. As of December 31, 2021, approximately 21% of our customers purchased two or more Freshworks products, which includes customers on our Freshdesk Omnichannel Suite and Freshsales Suite subscription plans counting as customers who purchased multiple products. These customers represented 47% of total ARR as of December 31, 2021, illustrating the large opportunity we have to sell additional products to our current customer base and drive growth.

We continue to increase the number of customers that have entered into larger subscriptions with us. We had 1,416 customers each contributing $50,000 or more in ARR as of December 31, 2021, representing an increase of 61% year-over-year from 881 customers as of December 31, 2020. As of December 31, 2021 and 2020, customers contributing more than $50,000 in ARR represented approximately 41% and 34% of total ARR, respectively. We believe that the number of customers contributing $50,000 or more in ARR indicates the strategic importance of our products for our customers and our ability to both initially land significant accounts or grow customers into significant accounts over time. No single customer accounted for more than 1% of ARR and our top 10 customers represented less than 5% of ARR as of December 31, 2021, and we have no significant concentration in a specific industry vertical or geography.

Investing in Our Growth

We believe that we are early in addressing our large market opportunity and we intend to continue to make investments to support the growth and expansion of our business. We have a track record of bringing new products to market and scaling these new products over time. As of December 31, 2021, we have two primary products with over $100 million in ARR, Freshdesk and Freshservice. We intend to invest in growing our research and development team to extend the functionality of our solutions and continue to bring new solutions to market. Our investments in our Neo platform have helped us accelerate the pace of innovation.

We believe that our market remains largely underserved. We intend to invest aggressively in our direct and indirect sales and marketing capabilities, including investments in our outbound sales motion. We have been global from our earliest product sales and our global footprint continues to expand, with customers in more than 120 countries. During the year ended December 31, 2021, 43%, 41%, and 16% of our revenue was derived from customers in North America; Europe, Middle East and Africa; and the rest of the world, respectively. We have a significant opportunity to further expand globally. We plan to support more languages, recruit partners, hire sales and customer experience personnel in additional countries as needed, and

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expand our presence in countries where we already operate. A critical part of our go-to-market strategy has been our broad and diverse set of partners that enrich our offerings, scale our geographic coverage, and help us reach a broader audience than we would be able to reach on our own, thus amplifying our go-to-market investments. We plan to continue to invest in growing our partner ecosystem to fuel additional customer acquisition and expand use cases within our existing customer base.

We are also focused on attracting new talent and retaining our employees. Our culture is a critical part of our success, and attracting and retaining the best available talent will help us make customer delight easy and continue our growth trajectory.

Key Business Metrics

We monitor and review a number of metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections, and make strategic decisions. We believe these key business metrics provide meaningful supplemental information for management and investors in assessing our operating performance.

Number of Customers Contributing More Than $5,000 in ARR

We define our total customers contributing more than $5,000 in ARR as of a particular date as the number of business entities or individuals, represented by a unique domain or a unique email address, with one or more paid subscriptions to one or more of our products that contributed more than $5,000 in ARR.

Net Dollar Retention Rate

Our net dollar retention rate measures our ability to increase revenue across our existing customer base through expansion of users and products associated with a customer as offset by our churn and contraction in the number of users and products associated with a customer. To calculate net dollar retention rate as of a particular date, we first determine "Entering ARR," which is ARR from the population of our customers as of 12 months prior to the end of the reporting period. We then calculate the "Ending ARR" from the same set of customers as of the end of the reporting period. We then divide the Ending ARR by the Entering ARR to arrive at our net dollar retention rate. Ending ARR includes upsells, cross-sells, and renewals during the measurement period and is net of any contraction or attrition over this period.

We expect our net dollar retention rate could fluctuate in future periods due to a number of factors, including our expected growth, the level of penetration within our customer base, our ability to upsell and cross-sell products to existing customers, and our ability to retain our customers.

Non-GAAP Financial Measures

In addition to our results determined in accordance with U.S. generally accepted accounting principles (GAAP), we believe the following non-GAAP financial measures are useful in evaluating our operating performance: non-GAAP loss from operations, non-GAAP net loss, and free cash flow. We use these non-GAAP financial measures to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe these non-GAAP financial measures may be helpful to investors because they provide consistency and comparability with past financial performance.

Non-GAAP financial measures have limitations in their usefulness to investors and should not be considered in isolation or as substitutes for financial information presented under GAAP. Non-GAAP financial measures have no standardized meaning prescribed by GAAP and are not prepared under any comprehensive set of accounting rules or principles. In addition, other companies, including companies in our industry, may calculate similarly titled non-GAAP financial measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. As a result, our non-GAAP financial measures are presented for supplemental informational purposes only.

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We exclude the following items from one or more of our non-GAAP financial measures, including the related income tax effect of these adjustments:

•Stock-based compensation expense. We exclude stock-based compensation, which is a non-cash expense, from certain of our non-GAAP financial measures because we believe that excluding this expense provides meaningful supplemental information regarding operational performance. In particular, stock-based compensation expense is not comparable across companies given the variety of valuation methodologies and assumptions.

•Employer payroll taxes on employee stock transactions. We exclude the amount of employer payroll taxes on equity awards from certain of our non-GAAP financial measures because they are dependent on our stock price at the time of vesting or exercise and other factors that are beyond our control and do not believe these expenses have a direct correlation to the operation of the business.

•Amortization of acquired intangibles. We exclude amortization of acquired intangibles, which is a non-cash expense, from certain of our non-GAAP financial measures. Our expenses for amortization of acquired intangibles are inconsistent in amount and frequency because they are significantly affected by the timing, size of acquisitions, and the allocation of purchase price. We exclude these amortization expenses because we do not believe these expenses have a direct correlation to the operation of our business.

•Acquisition-related expenses. We exclude transaction, integration, and retention expenses that are directly related to business combinations from certain of our non-GAAP financial measures because we believe that excluding these items provides meaningful supplemental information regarding operational performance and investors to make more meaningful comparisons between our operating results and those of other companies.

•Gain on sale of non-marketable equity investments. We exclude gains on the sale of non-marketable equity investments from certain of our non-GAAP financial measures because we believe they are unrelated to our ongoing operating performance and are not expected to recur in our continuing operating results.

Non-GAAP Loss From Operations and Non-GAAP Net Loss

We define non-GAAP loss from operations as GAAP loss from operations excluding stock-based compensation expense, employer payroll taxes on employee stock transactions, amortization of acquired intangibles, and acquisition-related expenses.

We define non-GAAP net loss as GAAP net loss, excluding stock-based compensation expense, employer payroll taxes on employee stock transactions, amortization of acquired intangibles, acquisition-related expenses, and gain on sale of non-marketable equity investments, net of their related tax effects.

The following tables present a reconciliation of our GAAP loss from operations to our non-GAAP loss from operations and our GAAP net loss to our non-GAAP net loss for each of the periods presented (in thousands):

Non-GAAP Loss from Operations

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Non-GAAP Net Loss

Free cash flow

We define free cash flow as net cash provided by (used in) operating activities, less purchases of property and equipment and capitalized internal-use software. We believe that free cash flow is a useful indicator of liquidity as it measures our ability to generate cash from our core operations after purchases of property and equipment. Free cash flow is a measure to determine, among other things, cash available for strategic initiatives, including further investments in our business and potential acquisitions of businesses.

The following table presents a reconciliation of free cash flow to net cash provided by (used in) operating activities, the most directly comparable measure calculated in accordance with GAAP for each of the periods presented:

Components of Our Results of Operations

Revenue

Substantially all of our revenue is derived from subscriptions, which comprises fees paid by customers for accessing our cloud-based software products during the term of the subscription. Subscription revenue is recognized ratably over the contract term beginning on the commencement date of each subscription, which is the date that the cloud-based software is made available to customers.

Professional services revenue comprises less than 5% of total revenue and includes fees charged for product configuration, data migration, systems integration, and training. Professional services revenue is recognized as services are performed.

Our subscription arrangements are available in monthly, quarterly, semi-annual, and annual plans, and we typically invoice for the full term in advance. Our payment terms generally require the customers to pay the invoiced amount in advance or within 30 days from the invoice date. Our professional services are generally billed in advance along with the related subscription arrangements.

Cost of Revenue

Cost of revenue consists primarily of personnel-related expenses (including salaries, related benefits, and stock-based compensation expense) for employees associated with our cloud-based infrastructure, payment gateway fees, voice, product support, and professional services organizations, as well as costs for hosting capabilities. Cost of revenue also includes third-

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party license fees, amortization of acquired technology intangibles, amortization of capitalized internal-use software, and allocation of general overhead costs such as facilities and information technology.

We expect our cost of revenue to continue to increase in dollar amount as we invest additional resources in our cloud-based infrastructure and customer support and professional services organizations. However, our gross profit and gross margin may fluctuate from period to period and due to the timing and extent of our investments in third-party hosting capacity, expansion of our cloud-based infrastructure, and customer support, and professional services organizations, as well as the amortization of costs associated with capitalized internal-use software.

Overhead Allocation

We allocate shared costs, such as facilities costs (including rent, utilities, and depreciation on capital expenditures related to facilities shared by multiple departments), information technology costs, and certain administrative personnel costs to all departments based on headcount and location. Allocated shared costs are reflected in each of the expense categories described below, in addition to cost of revenue as described above.

Operating Expenses

Research and Development. Research and development expense consists primarily of personnel-related costs, including salaries, related benefits, and stock-based compensation expense for engineering and product development employees, software license fees, rental of office premises, third-party product development services and consulting expenses, and depreciation expense for equipment used in research and development activities. We capitalize a portion of our research and development expenses that meet the criteria for capitalization of internal-use software. All other research and development costs are expensed as incurred.

We believe that continued investment in our products is important for our growth, and as such, we expect that our research and development expenses will continue to increase in dollar amount while varying as a percentage of revenue in the future.

Sales and Marketing. Sales and marketing expense consists primarily of personnel-related costs, including salaries, related benefits, and stock-based compensation expense for our sales personnel, sales commissions for our sales force and reseller commissions for our channel sales partners, as well as costs associated with marketing activities, travel and entertainment costs, software license fees, and rental of office premises. Sales commissions that are considered incremental costs incurred to obtain contracts with customers, are deferred and amortized over the expected benefit period of three years. Marketing activities include online lead generation, advertising, and promotional events.

We expect to continue to make significant investments as we expand our customer acquisition and retention efforts and return to in-person marketing events and normal business travel as the impact of COVID-19 subsides. As a result, we expect that our sales and marketing expenses will continue to increase in dollar amount while varying as a percentage of revenue in the future.

General and Administrative. General and administrative expense consists primarily of personnel-related costs, including salaries, related benefits, and stock-based compensation expense for general and administrative personnel, third-party professional services fees, including consulting, legal, audit, and accounting services, travel and entertainment costs, accounting, legal, human resources, and recruiting personnel, costs associated with acquisitions of businesses, software license fees, and rental of office premises.

As a publicly traded company, we expect increases in expenses associated with ongoing compliance and reporting obligations pursuant to the rules and regulations of the SEC, professional services fees and consulting expenses, costs to broaden our IT related infrastructure, as well as additional costs for accounting, insurance, and investor relations. Our general and administrative expenses are expected to continue to increase in dollar amount for the foreseeable future, however, we expect it to decline as a percentage of revenue over the longer term. This percentage may fluctuate from period to period depending upon the timing and amount of our general and administrative expenses.

Interest and Other Income, Net

Interest and other income, net primarily consists of interest income from our investment portfolios, amortization of premium or discount on marketable securities, and foreign currency gains and losses.

Provision for Income Taxes

Provision for income taxes consists primarily of income taxes related to U.S. states and foreign jurisdictions in which we conduct business. We maintain a full valuation allowance on our U.S. federal and state net deferred tax assets as we have

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concluded that it is not more likely than not that the deferred tax assets will be realized. Our effective tax rate is affected by tax rates in foreign jurisdictions and the relative amounts of income we earn in those jurisdictions, as well as non-deductible expenses, such as stock-based compensation, and changes in our valuation allowance.

Results of Operations

The following tables sets forth our consolidated statements of operations data for the periods presented (in thousands):

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(1)Includes stock-based compensation expense as follows:

Recognition of Stock-Based Compensation

Prior to the IPO, there was no stock-based compensation expense recognized from our equity awards as the liquidity event-related performance condition was not probable. The performance condition was satisfied upon the completion of the IPO in September 2021, and we began to recognize stock-based compensation expense. During the year ended December 31, 2021, stock-based compensation expense recognized included a cumulative charge associated with certain restricted stock units (RSUs) for which the service-based vesting condition had been satisfied upon the completion of the liquidity event.

During the year ended December 31, 2020, as described in Notes 10 and 11 to our consolidated financial statements included elsewhere in this report, we facilitated certain secondary equity transactions from which we recognized stock-based compensation expense for shares that were repurchased at excess value. We refer to these secondary transactions together as the "2020 Equity Transactions."

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The following table sets forth our consolidated statements of operations data for the periods presented, as a percentage of revenue:

Comparison of Fiscal Years Ended December 31, 2021 and 2020

Revenue

Revenue increased by $121.4 million, or 49%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. The total increase in revenue was primarily driven by increases in additional agents enabled by our customers under their account and sales of products to existing customers, as well as the addition of new customers. Our net dollar retention rate of 114% for the year ended December 31, 2021 reflects the expansion within existing customers and the sale of additional products to these customers.

Cost of Revenue and Gross Margin

Cost of revenue increased by $25.5 million, or 49%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. This increase was primarily due to increases of $5.6 million in stock-based compensation expense, $6.9 million in third-party hosting costs, $5.7 million in personnel-related costs due to annual compensation adjustments and higher headcount, $1.5 million in cloud voice service costs, $1.9 million in software license fees, $1.6 million increase in professional fees including legal costs, $1.4 million in payment gateway fees, and approximately $1.1 million in amortization of capitalized internal use software. Our gross margin remained consistent at 79% for the years ended December 31, 2021 and 2020. We expect our cost of revenue to continue to increase in dollar amount as we invest additional resources in our cloud-based infrastructure and customer experience and professional services organizations. However, our gross profit and gross margin may fluctuate from period to period as our revenue grows and the timing and extent of our investments in third-party hosting capacity, expansion of our cloud-based infrastructure, customer experience and professional services organizations.

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Operating Expenses

The increases in our operating expenses in the year ended December 31, 2021 compared to the year ended December 31, 2020 were headcount driven to support the growth of our business, as well as cumulative stock-based compensation recognized in connection with the IPO.

Research and Development

Research and development expense increased by $51.2 million, or 74%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. This increase was primarily due to increases of $29.3 million in stock-based compensation expense (which reflects the increase related to the cumulative stock-based compensation expense in connection with our IPO, net of the absence in the current period of stock-based compensation expense of $15.9 million recognized in connection with the 2020 Equity Transactions as described above), $20.2 million in personnel-related costs due to annual compensation adjustments and higher headcount, and $1.3 million in software license fees.

Sales and Marketing

Sales and marketing expense increased by $127.1 million, or 95%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. This increase was primarily due to increases of $53.2 million in stock-based compensation expense, $41.9 million in personnel-related costs due to annual compensation adjustments and higher headcount, $22.8 million in higher advertising, branding and event costs, $5.3 million in reseller commissions, and $4.3 million in software license fees.

General and Administrative

General and administrative expense increased by $66.2 million, or 130%, for the year ended December 31, 2021 compared to the year ended December 31, 2020. This increase was primarily due to increases of $42.1 million in stock-based compensation expense (which reflects the increase related to the cumulative stock-based compensation expense in connection with our IPO, net of the absence in the current period of stock-based compensation expense of $27.4 million recognized in connection with the 2020 Equity Transactions as described above), $11.9 million in personnel-related costs due to annual compensation adjustments and higher headcount, $4.5 million in professional services fees, comprised primarily of legal, accounting, and consulting fees, $3.9 million related to a legal settlement, $1.9 million in directors and officers insurance, $0.5 million in software license fees, $0.5 million in other taxes and licenses, and $0.7 million in other individually immaterial costs.

Interest and Other Income, Net

Interest and other income, net increased by $20.5 million, or 723%, primarily due to a $23.8 million gain from the sale of non-marketable equity investments and a $1.7 million benefit from the release of interest and penalties accrued for indirect taxes, offset by a $1.9 million decrease in interest income earned due to lower coupon rates and bond premium amortization, and $3.0 million in foreign exchange losses.

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Provision for Income Taxes

We are subject to federal and state income taxes in the United States and taxes in foreign jurisdictions. For the years ended December 31, 2021 and 2020, we recorded a provision for income taxes of $10.5 million, and $4.0 million on loss before taxes of $181.5 million and $53.3 million, respectively. The effective tax rates for the years ended December 31, 2021 and 2020 were (5.8)% and (7.6)% respectively. The effective tax rates differ from the statutory rate primarily due to maintaining a full valuation allowance on our U.S. federal and state net deferred tax assets as it was more likely than not that those deferred tax assets will not be realized. The $6.5 million increase in tax expense was due to a $3.7 million increase in foreign taxes due to higher pre-tax earnings and a $2.8 million increase in uncertain tax position for the year ended December 31, 2021.

Comparison of Fiscal Years Ended December 31, 2020 and 2019

Revenue

Revenue increased by $77.3 million, or 45%, for the year ended December 31, 2020 compared to the year ended December 31, 2019. The total increase in revenue was primarily driven by increases in additional agents enabled by our customers under their account and sales of products to existing customers, as well as the addition of new customers. Our net dollar retention rate of 111% for the year ended December 31, 2020 reflects the expansion within existing customers and the sale of additional products to these customers.

Cost of Revenue and Gross Margin

Cost of revenue increased by $16.0 million, or 44%, for the year ended December 31, 2020 compared to the year ended December 31, 2019. This increase was primarily due to increases of $5.5 million in third-party hosting costs, $2.8 million in personnel-related costs due to higher headcount, $2.7 million in amortization of costs associated with acquired technology intangibles, $1.5 million in cloud voice service costs, and $1.4 million in software license fees and $1.0 million increase in professional fees including legal costs. Our gross margin remained consistent at 79% for the years ended December 31, 2020 and 2019.

Operating Expenses

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The increases in our operating expenses in the year ended December 31, 2020 compared to the year ended December 31, 2019 were primarily headcount driven, as we substantially grew our business to 3,585 employees as of December 31, 2020 compared to 2,691 employees as of December 31, 2019.

Research and Development

Research and development expense increased by $30.7 million, or 79%, for the year ended December 31, 2020 compared to the year ended December 31, 2019. This increase was primarily due to a $15.9 million increase in stock-based compensation expense recognized in connection with the 2020 Equity Transactions described above, and increases of $12.8 million in personnel-related costs and $2.4 million in software license fees, offset by a decrease in other individually immaterial costs.

Sales and Marketing

Sales and marketing expense increased by $22.2 million, or 20%, for the year ended December 31, 2020 compared to the year ended December 31, 2019. This increase was primarily due to increases of $24.7 million in personnel-related costs, $3.3 million in reseller commissions, $1.9 million in rental of premises, $1.8 million in software license fees, and $1.3 million in other individually immaterial costs, partially offset by decreases of $6.2 million in marketing costs and $4.6 million in travel costs. The decrease in marketing costs and travel was a direct impact of the COVID-19 pandemic and curtailment of in-person marketing events and travel.

General and Administrative

General and administrative expense increased by $34.9 million, or 219%, for the year ended December 31, 2020 compared to the year ended December 31, 2019. This increase was primarily due to $27.4 million in stock-based compensation expense recognized in connection with the 2020 Equity Transactions and increases of $4.5 million in personnel-related costs, and $2.8 million in professional services fees, comprised primarily of legal, accounting, and consulting fees.

Interest and Other Income, Net

Interest income increased by $2.9 million, or 230%, primarily due to a full year of interest earned from higher balances of our investment portfolios during the year ended December 31, 2020, when compared to a partial year of interest earned during the year ended December 31, 2019. Other income (expense), net, decreased by $2.3 million, or 252%, for the year ended December 31, 2020 compared to the year ended December 31, 2019, primarily due to increases of $1.4 million in premiums amortized on marketable securities and other insignificant items.

Provision for Income Taxes

We are subject to federal and state income taxes in the United States and taxes in foreign jurisdictions. For the years ended December 31, 2020 and 2019, we recorded provision for income taxes of $4.0 million and $3.6 million on loss before taxes of $53.3 million and $27.5 million, respectively. The effective tax rate for the years ended December 31, 2020 and 2019 were (7.6)% and (13.2)% respectively. The effective tax rates differ from the statutory rate primarily as a result of providing no benefit on pre-tax losses incurred in the United States. We maintain a full valuation allowance on our U.S. federal and state net deferred tax assets as it was more likely than not that those deferred tax assets will not be realized. The $0.4 million increase in tax expense resulted primarily from an increase in pre-tax earnings in our foreign jurisdictions.

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Liquidity and Capital Resources

As of December 31, 2021, we had cash and cash equivalents of $747.9 million and marketable securities of $575.7 million. Since inception, we have funded our operations primarily with financing through the issuance of redeemable convertible preferred and common stock to investors, and in September 2021, we completed our IPO that generated net proceeds of approximately $1.1 billion. As of December 31, 2021, we had an accumulated deficit of $3.3 billion. Our operating activities provided cash flow of $11.5 million for the year ended December 31, 2021.

In February 2022, in connection with the expiration of the final lock-up period following the IPO, we issued an aggregate of 9.3 million shares of our common stock, net of shares withheld for taxes, as settlement of RSUs that had met the time-based service condition. We expect to pay $112.6 million in taxes on net share settlement of these RSUs.

Our other material cash requirements are related to the settlement of future contractual obligations associated with operating leases and other service subscription agreements (as described in Contractual Obligations below).

We believe our existing cash, cash equivalents and marketable securities, 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 the rate of our revenue growth, the timing and extent of spending on research and development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced product offerings, and other business initiatives and the continuing market adoption of our products. We may in the future enter into arrangements to acquire or invest in complementary businesses, services, and technologies, including intellectual property rights. We may be required to seek additional equity or debt financing in connection with such activities. If we raise additional funds through the incurrence of indebtedness, such indebtedness may have rights that are senior to holders of our equity securities and could contain covenants that restrict our operational flexibility. Any additional equity or convertible debt financing may be dilutive to stockholders. In the event that additional financing is required from outside sources, we may not be able to raise such financing on terms acceptable to us or at all.

Cash Flows

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

Operating Activities

Net cash provided by operating activities of $11.5 million for the year ended December 31, 2021 reflects our net loss of $192.0 million, adjusted for non-cash items such as stock-based compensation of $173.4 million, gain realized on sale of non-marketable equity investment of $23.8 million, depreciation and amortization of $13.3 million, amortization of deferred contract acquisition costs of $12.8 million, deferred income taxes of $1.9 million, premium amortization on marketable securities of $1.8 million, and net cash inflows of $28.0 million from changes in operating assets and liabilities. The net cash inflows from changes in operating assets and liabilities were due to increases of $56.0 million in deferred revenue, $17.7 million in accrued and other liabilities, and $2.0 million in accounts payable, offset by increases in assets of $24.2 million in deferred contract acquisition costs, $17.5 million in accounts receivable, and $5.9 million in prepaid expenses and other assets.

Net cash provided by operating activities of $32.5 million for the year ended December 31, 2020 reflects our net loss of $57.3 million, adjusted for non-cash items such as stock-based compensation of $43.3 million, depreciation and amortization of $11.2 million, amortization of deferred contract acquisition costs of $7.7 million, deferred income taxes of $2.4 million, and net cash inflows of $28.9 million from changes in operating assets and liabilities. The net cash inflows from changes in operating assets and liabilities were due to increases of $36.4 million in deferred revenue and $24.9 million in accrued and other liabilities, partially offset by increases in assets of $14.3 million in deferred contract acquisition costs, $9.9 million in accounts receivable, $8.2 million in prepaid expenses and other assets.

Net cash used in operating activities of $8.2 million for the year ended December 31, 2019, was comprised primarily of a net loss of $31.1 million, adjusted for non-cash items such as depreciation and amortization of $6.3 million, amortization of deferred contract acquisition costs of $4.0 million, deferred income taxes of $0.9 million and net cash inflows of $13.7 million from changes in operating assets and liabilities. The net cash inflows from changes in operating liabilities were due to increases

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of $27.4 million in deferred revenue, $13.9 million in accrued and other liabilities, and $2.7 million increase in accounts payable, offset by increases in assets of $11.3 million in prepaid expenses and other assets, $9.6 million in deferred contract acquisition costs, and $9.4 million in accounts receivable.

Investing Activities

Cash used in investing activities of $420.3 million for the year ended December 31, 2021 consisted of $435.8 million in purchases, net of maturities and sales, of marketable securities, $4.9 million in purchases, net of proceeds from sale of property and equipment, $3.6 million related to the capitalization of internal-use software, offset by $24.0 million in proceeds from sale of non-marketable equity investments.

Cash used in investing activities of $11.4 million for the year ended December 31, 2020 consisted of $5.1 million net payment for acquisitions, $4.6 million related to the capitalization of internal-use software, $4.4 million in purchases of property and equipment, and $1.8 million acquisition of intangibles, offset by $4.4 million in proceeds, net of purchases, from the maturities and sales of marketable securities.

Cash used in investing activities of $149.0 million for the year ended December 31, 2019 consisted of $128.2 million in purchases, net of maturities and sales of marketable securities, $11.5 million in purchases of property and equipment, $6.0 million net payment for acquisitions, and $3.3 million related to the capitalization of internal-use software.

Financing Activities

Cash provided by financing activities for the year ended December 31, 2021 consisted of approximately $1.1 billion in proceeds from our IPO, net of underwriting discounts, offset by $6.8 million in payments for deferred offering costs, $3.3 million in payment of withholding taxes on net share settlement of equity awards, and $0.9 million in payments for acquisition-related liabilities.

Cash used in financing activities of $1.9 million for the year ended December 31, 2020 consisted primarily of $2.1 million in payments for acquisition-related liabilities.

Cash provided by financing activities of $150.2 million for the year ended December 31, 2019 consisted primarily of net proceeds of $149.8 million from the issuance of Series H redeemable convertible preferred stock.

Remaining Performance Obligations on Customer Contracts

We generally enter into subscription agreements with our customers on monthly, annual, or multi-year terms and invoice customers in advance in either monthly or annual installments. A small portion of our annual contracts may have billing terms that are different from their subscription terms, and our multi-year contracts are invoiced annually. As of December 31, 2021, remaining performance obligations totaled $230.8 million, which comprised $160.2 million of deferred revenue and $70.6 million of unbilled amounts.

We expect that the value of the remaining performance obligations will change from one period to another for several reasons, including new contracts, timing of renewals, cancellations, contract modifications and foreign currency fluctuations. We believe that fluctuations in remaining performance obligations are not necessarily a reliable indicator of future revenue and we do not utilize it as a key management metric internally.

Contractual Obligations

Our principal commitments consist of operating lease obligations for office space and contractual obligations under third-party cloud infrastructure agreements and service subscription agreements.

As of December 31, 2021, our estimated future contractual obligations totaled $85.8 million, of which $34.2 million and $51.6 million were operating lease commitments and other contractual obligations, respectively. As disclosed in Note 9 to the consolidated financial statements included elsewhere in this report, our operating leases included short-term and long-term

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commitments of $7.0 million and $27.2 million, respectively. Our other contractual obligations included short-term and long-term commitments of $27.0 million and $24.6 million, respectively.

Our operating leases expire on varying dates through September 2028. Our other contractual obligations have commitments outstanding through December 2024.

Indemnification Agreements

In the ordinary course of business, we enter into agreements of varying scope and terms pursuant to which we agree to indemnify customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of the breach of such agreements, services to be provided by us, or from data breaches or intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain officers and employees that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers, or employees. No demands have been made upon us to provide indemnification under such agreements and there are no claims that we are aware of that could have a material effect on our consolidated balance sheets, consolidated statements of operations and comprehensive loss, or consolidated statements of cash flows.

Critical Accounting Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these consolidated financial statements requires our management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the applicable periods. We base our estimates, assumptions, and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our consolidated financial statements, which, in turn, could change the results from those reported. We evaluate our estimates, assumptions, and judgments on an ongoing basis.

Our significant accounting policies are discussed in additional detail in Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements included in Item 8 of Part II of this 10-K. The critical accounting estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements are described below.

Revenue Recognition

We derive revenue from subscription fees and related professional services. We sell subscriptions for our cloud-based solutions directly to customers and indirectly through channel partners through arrangements that are non-cancelable and non-refundable. Our subscription arrangements do not provide customers with the right to take possession of the software supporting the solutions and, as a result, are accounted for as service arrangements. We record revenue net of sales or value-added taxes.

Subscription Revenue

Subscription revenue is primarily comprised of fees paid by our customers for accessing our cloud-based software during the term of the arrangement. Our cloud-based services allow customers to use the multi-tenant software without requiring them to take possession of the software. Given that access to the cloud-based software represents a series of distinct services that comprise a single performance obligation that is satisfied over time, subscription revenue is recognized ratably over the contract term beginning on the commencement date of each contract, which is the date that the cloud-based software is made available to customers.

Professional Services Revenue

Professional services revenue is comprised of fees charged for services ranging from product configuration, data migration, systems integration and training. Professional services revenue is recognized as services are performed and represents less than 5% of total revenue.

Customers with Multiple Performance Obligations

Some of our contracts with customers contain both subscriptions and professional services. For these contracts, we account for individual performance obligations separately. The transaction price is allocated to the separate performance obligations on the basis of relative SSP. We determine SSP by taking into consideration historical selling price of these performance

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obligations in similar transactions, as well as current pricing practices and other observable inputs including, but not limited to, customer size and geography. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes to SSP.

Evaluating the terms and conditions of our customer contracts for appropriate revenue recognition and determining whether products and services are considered distinct performance obligations may require significant judgment. Judgment is also used to estimate the contract's transaction price and allocate it to each performance obligation.

Deferred Contract Acquisition Costs

Deferred contract acquisition costs are incremental costs that are associated with acquiring customer contracts and consist primarily of sales commissions and the associated payroll taxes and certain referral fees paid to independent third-parties. The costs incurred upon the execution of initial and expansion contracts are primarily deferred and amortized over an expected benefit period of three years. The Company considers the expected benefit period to exceed the initial contract term for certain costs because of anticipated renewals and because sales commission rates for renewal contracts are not commensurate with sales commissions for initial contracts. Significant judgement is used to determine the expected benefit period by taking into consideration the Company’s technology life cycle and an estimated customer relationship period, including expected contract renewals.

Stock-Based Compensation

We issue stock options and restricted stock units (RSUs) to employees, consultants, and directors, and stock purchase rights granted under the Employee Stock Purchase Plan (ESPP) to employees based on their estimated fair value on the date of the grant. For stock options and ESPP, the fair value is estimated using the Black-Scholes option-pricing model, and stock-based compensation is recognized in the consolidated statements of operations using the straight-line attribution method. The fair value of RSUs is based on the closing market price of our Class A common stock on the date of the grant. We recognize stock-based compensation expense over the requisite service period, which is the vesting period of the respective awards. Forfeitures are accounted for when they occur.

Prior to our IPO, the fair value of our common stock on the date of the grant was determined based on independent third-party valuations as there was no public market, and there was no stock-based compensation expense recognized from the RSUs as the liquidity event-related performance condition was not probable. Upon the completion of the IPO, the performance condition became probable, and we began to recognize stock-based compensation expense.

We also granted a performance-based award with both a service-based vesting condition and a market condition involving a certain range of stock price targets, and the fair value of such award was determined by using the Monte-Carlo simulation model. The associated stock-based compensation expense is recognized over the longer of the derived service period or the requisite service period, using the accelerated attribution method.

Changes in the assumptions, which are subjective and generally require significant analysis and judgement to develop, can materially affect the valuation of our equity awards and impact how much stock-based compensation expense is recognized.

Recent Accounting Pronouncements

See “Summary of Significant Accounting Policies” in Note 2 of the notes to our consolidated financial statements for more information.