Five9
Five9, Inc. (Form: 10-Q, Received: 05/03/2017 16:39:40)
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission File Number: 001-36383
 
Five9, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
 
94- 3394123
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
Bishop Ranch 8
4000 Executive Parkway, Suite 400
San Ramon, CA 94583
(Address of Principal Executive Offices) (Zip Code)
(925) 201-2000
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes:  x     No:   o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes:   x     No:   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company . See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
o
 
 
Accelerated Filer
x
Non-accelerated filer
o
(Do not check if a smaller reporting Company)
 
Smaller Reporting Company
o
 
 
 
 
Emerging Growth Company
x
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    Yes:  x     No:   o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes:   o   No:   x


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As of April 26, 2017 , there were 54,448,680 shares of the Registrant’s common stock, par value $0.001 per share, outstanding.


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FIVE9, INC.
FORM 10-Q
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which involve substantial risks and uncertainties. These statements reflect the current views of our senior management with respect to future events and our financial performance. These forward-looking statements include statements with respect to our business, expenses, strategies, losses, growth plans, product and client initiatives, market growth projections, and our industry. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.
Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. These factors include the information set forth under the caption “Risk Factors” and elsewhere in this report, including the following:
our quarterly and annual results may fluctuate significantly, may not fully reflect the underlying performance of our business and may result in decreases in the price of our common stock;
if we are unable to attract new clients or sell additional services and functionality to our existing clients, our revenue and revenue growth will be harmed;
our recent rapid growth may not be indicative of our future growth, and even if we continue to grow rapidly, we may fail to manage our growth effectively;
failure to adequately expand our sales force could impede our growth;
if we fail to manage our technical operations infrastructure, our existing clients may experience service outages, our new clients may experience delays in the deployment of our solution and we could be subject to, among other things, claims for credits or damages;
security breaches and improper access to or disclosure of our data or our clients’ data or other cyber attacks on our systems, could result in litigation and regulatory risk, harm our reputation and adversely affect our business;
the markets in which we participate are highly competitive, and if we do not compete effectively, our operating results could be harmed;
if our existing clients terminate their subscriptions or reduce their subscriptions and related usage, our revenues and gross margins will be harmed and we will be required to spend more money to grow our client base;
our growth depends in part on the success of our strategic relationships with third parties and our failure to successfully grow and manage these relationships could harm our business;
we are establishing a network of master agents and resellers to sell our solution; our failure to effectively develop, manage, and maintain this network could materially harm our revenues;
we sell our solution to larger organizations that require longer sales and implementation cycles and often demand more configuration and integration services or customized features and functions that we may not offer, any of which could delay or prevent these sales and harm our growth rates, business and operating results;
because a significant percentage of our revenue is derived from existing clients, downturns or upturns in new sales will not be immediately reflected in our operating results and may be difficult to discern;
we rely on third-party telecommunications and internet service providers to provide our clients and their customers with telecommunication services and connectivity to our cloud contact center software and any failure by these service providers to provide reliable services could subject us to, among other things, claims for credits or damages;
we have a history of losses and we may be unable to achieve or sustain profitability;
we may not be able to secure additional financing on favorable terms, or at all, to meet our future capital needs; and
failure to comply with laws and regulations could harm our business and our reputation.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may differ materially from what we anticipate. You should not place undue reliance on our forward-looking statements. Any forward-looking statements you read in this report reflect our views only as of the date of this report with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. We undertake no obligation to update any forward-looking statements made in this report to reflect events or circumstances after the date of this report or to reflect new information or the occurrence of unanticipated events, except as required by law.

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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIVE9, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
 
March 31, 2017
 
December 31, 2016
 
 
(Unaudited)
 
 
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
56,452

 
$
58,122

Accounts receivable, net
 
15,453

 
13,881

Prepaid expenses and other current assets
 
5,117

 
3,008

Total current assets
 
77,022

 
75,011

Property and equipment, net
 
15,830

 
14,688

Intangible assets, net
 
1,422

 
1,539

Goodwill
 
11,798

 
11,798

Other assets
 
2,276

 
2,203

Total assets
 
$
108,348

 
$
105,239

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
3,394

 
$
3,366

Accrued and other current liabilities
 
13,028

 
9,604

Accrued federal fees
 
3,018

 
2,742

Sales tax liability
 
1,138

 
1,347

Notes payable
 
643

 
742

Capital leases
 
6,009

 
6,230

Deferred revenue
 
10,920

 
10,047

Total current liabilities
 
38,150

 
34,078

Revolving line of credit
 
32,594

 
32,594

Sales tax liability — less current portion
 
1,399

 
1,476

Notes payable — less current portion
 
162

 
318

Capital leases — less current portion
 
6,468

 
5,915

Other long-term liabilities
 
590

 
530

Total liabilities
 
79,363

 
74,911

Commitments and contingencies (Note 9)
 

 

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.001 par value; 5,000 shares authorized, no shares issued and outstanding at March 31, 2017 and December 31, 2016
 

 

Common stock, $0.001 par value; 450,000 shares authorized, 54,444 shares and 53,363 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively
 
54

 
53

Additional paid-in capital
 
200,637

 
196,555

Accumulated deficit
 
(171,706
)
 
(166,280
)
Total stockholders’ equity
 
28,985

 
30,328

Total liabilities and stockholders’ equity
 
$
108,348

 
$
105,239

See accompanying notes to condensed consolidated financial statements.

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FIVE9, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited, in thousands, except per share data)

 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
Revenue
 
$
47,014

 
$
38,015

Cost of revenue
 
19,971

 
16,610

Gross profit
 
27,043

 
21,405

Operating expenses:
 
 
 
 
Research and development
 
6,847

 
5,802

Sales and marketing
 
15,778

 
12,706

General and administrative
 
8,860

 
6,536

Total operating expenses
 
31,485

 
25,044

Loss from operations
 
(4,442
)
 
(3,639
)
Other income (expense), net:
 
 
 
 
Interest expense
 
(882
)
 
(1,199
)
Interest income and other
 
118

 
(45
)
Total other income (expense), net
 
(764
)
 
(1,244
)
Loss before income taxes
 
(5,206
)
 
(4,883
)
Provision for income taxes
 
49

 
28

Net loss
 
$
(5,255
)
 
$
(4,911
)
Net loss per share:
 
 
 
 
Basic and diluted
 
$
(0.10
)
 
$
(0.10
)
Shares used in computing net loss per share:
 
 
 
 
Basic and diluted
 
53,688

 
51,377

Comprehensive Loss:
 
 
 
 
Net loss and comprehensive loss
 
$
(5,255
)
 
$
(4,911
)
See accompanying notes to condensed consolidated financial statements.

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FIVE9, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(5,255
)
 
$
(4,911
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
 
Depreciation and amortization
 
2,095

 
2,103

Provision for doubtful accounts
 
24

 
25

Stock-based compensation
 
3,129

 
1,994

Loss on disposal of property and equipment
 
3

 
1

Non-cash adjustment on investment
 
(103
)
 

Amortization of debt discount and issuance costs
 
20

 
91

Accretion of interest
 
5

 

Others
 
(11
)
 
(4
)
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
(1,595
)
 
(1,990
)
Prepaid expenses and other current assets
 
(2,129
)
 
(1,715
)
Other assets
 
30

 
(30
)
Accounts payable
 
(95
)
 
825

Accrued and other current liabilities
 
3,119

 
1,935

Accrued federal fees and sales tax liability
 
(11
)
 
93

Deferred revenue
 
909

 
1,659

Other liabilities
 
24

 
(24
)
Net cash provided by operating activities
 
159

 
52

Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(514
)
 
(252
)
Net cash used in investing activities
 
(514
)
 
(252
)
Cash flows from financing activities:
 
 
 
 
Proceeds from exercise of common stock options
 
793

 
2,397

Repayments of notes payable
 
(258
)
 
(1,608
)
Payments of capital leases
 
(1,850
)
 
(1,306
)
Net cash used in financing activities
 
(1,315
)
 
(517
)
Net decrease in cash and cash equivalents
 
(1,670
)
 
(717
)
Cash and cash equivalents:
 
 
 
 
Beginning of period
 
58,122

 
58,484

End of period
 
$
56,452

 
$
57,767

Non-cash investing and financing activities:
 
 
 
 
Equipment obtained under capital lease
 
$
2,603

 
$
1,307

Equipment purchased and unpaid at period-end
 
159

 
137

See accompanying notes to the condensed consolidated financial statements.

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FIVE9, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Description of Business and Summary of Significant Accounting Policies
Five9, Inc. and its wholly-owned subsidiaries (the “Company”) is a provider of cloud software for contact centers. The Company was incorporated in Delaware in 2001 and is headquartered in San Ramon, California. The Company has offices in Europe and Asia, which primarily provide research, development, sales, marketing, and client support services.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 . All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The significant estimates made by management affect revenue, the allowance for doubtful accounts, intangible assets, goodwill, loss contingencies, including the Company’s accrual for federal fees and sales tax liability, accrued liabilities, stock-based compensation, provision for income taxes and uncertain tax positions. Management periodically evaluates such estimates and they are adjusted prospectively based upon such periodic evaluation. Actual results could differ from those estimates.
Significant Accounting Policies
The Company’s significant accounting policies are disclosed in its Annual Report on Form 10-K for the year ended December 31, 2016 . During the three months ended March 31, 2017 , there were no changes to the Company's significant accounting policies.
Recently Adopted Accounting Pronouncements
In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting . This ASU simplifies several aspects of the accounting for share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The guidance is effective for the Company beginning in the first quarter of 2017, with early application permitted. Beginning in Q1 2017, the Company is accounting for forfeitures as they occur, rather than by estimating expected forfeitures. The net effect of this change was recognized as a $0.2 million reduction to accumulated deficit in the condensed consolidated financial statements. Upon adoption of the new standard, all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) are recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards are treated as discrete items in the reporting period in which they occur. The Company also recognizes excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. The Company has applied the modified retrospective adoption approach beginning in Fiscal Year 2017 and prior periods have not been adjusted. As a result, the Company will establish a net operating loss deferred tax asset of $5.3 million to account for prior period excess tax benefits through retained earnings, however an offsetting valuation allowance of $5.3 million will also be established through retained earnings because it is not more likely than not that the deferred tax asset will be realized due to historical and expected future losses, such that there is no impact on the Company’s condensed consolidated financial statements.

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In April 2015, the FASB issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement . The ASU provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The ASU does not change the accounting for a customer’s accounting for service contracts. A company can elect to adopt the ASU either prospectively or retrospectively. The Company adopted this guidance prospectively beginning in the first quarter of 2016 and the adoption did not have a material effect on its condensed consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs . The ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this ASU. In August 2015, the FASB issued ASU No. 2015-15, Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements , which clarifies that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The Company adopted this guidance retrospectively beginning in the first quarter of 2016 and the adoption did not have a material effect on its condensed consolidated financial statements for the prior periods or the current period reported.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern . The new guidance requires management of public and private companies to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and, if so, disclose that fact. Management will also be required to evaluate and disclose whether its plans alleviate that doubt. The standard is effective for the Company's annual period ended December 31, 2016 and interim and annual periods thereafter. Early adoption is permitted. The Company adopted this guidance prospectively beginning in the fourth quarter of 2016 and the adoption did not have a material effect on its consolidated financial statements.
Recent Accounting Pronouncements Not Yet Effective
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , which requires measurement and recognition of expected credit losses for certain types of financial assets held. ASU 2016-13 is effective for the Company in its first quarter of 2020, and earlier adoption is permitted beginning in the first quarter of 2019. The Company is currently evaluating the impact of ASU 2016-13 on its consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) . Under the new guidance, a lessee will be required to recognize assets and liabilities for both finance, or capital, and operating leases with lease terms of more than 12 months. The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. Lessor accounting will remain largely unchanged from current GAAP. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach that includes a number of optional practical expedients that entities may elect to apply. This guidance is effective for the Company beginning in the first quarter of 2019. Early adoption is permitted. The Company is currently assessing the effect the guidance will have on its consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606 and issued subsequent amendments to the initial guidance in August 2015, March 2016, April 2016 and May 2016 within ASU 2015-04, ASU 2016-08, ASU 2016-10 and ASU 2016-12, respectively (ASU 2014-09, ASU 2015-04, ASU 2016-08, ASU 2016-10 and ASU 2016-12 collectively, Topic 606). Topic 606 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers and will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. Topic 606 defines a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP. Topic 606 is effective for the Company's annual and interim reporting periods beginning January 1, 2018 using either a retrospective or a

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cumulative effect transition method. The Company has developed an implementation plan to adopt this new guidance. As part of this plan, the Company is currently assessing the impact of the new guidance on its results of operations. Based on procedures performed to date, nothing has come to the Company's attention that would indicate that the adoption of Topic 606 will have a material impact on its financial statements, however, the Company will continue to evaluate this assessment in 2017. The Company intends to adopt Topic 606 on January 1, 2018. The Company has not yet selected a transition method, but expects to do so in the third quarter of 2017 upon completion of further analysis.
2 . Fair Value Measurements
The Company carries cash equivalents consisting of money market funds at fair value on a recurring basis. Fair value is based on the price that would be received from selling an asset in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1  — Observable inputs which include unadjusted quoted prices in active markets for identical assets.
Level 2  — Observable inputs other than Level 1 inputs, such as quoted prices for similar assets, quoted prices for identical or similar assets in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset.
Level 3  — Unobservable inputs that are supported by little or no market activity and that are based on management’s assumptions, including fair value measurements determined by using pricing models, discounted cash flow methodologies or similar techniques.
The fair value of assets carried at fair value was determined using the following inputs (in thousands):
 
 
March 31, 2017
 
 
Total
 
Level 1
Level 3
Assets
 
 
 
 
 
Cash equivalents
 
 
 
 
 
Money market funds
 
$
20,081

 
$
20,081

$

Other Assets
 
 
 
 
 
Embedded conversion option held for investment
 
$
903

 
$

$
903

 
 
 
 
 
 
 
 
December 31, 2016
 
 
Total
 
Level 1
Level 3
Assets
 
 
 
 
 
Cash equivalents
 
 
 
 
 
Money market funds
 
$
20,069

 
$
20,069

$

Other Assets
 
 
 
 
 
Embedded conversion option held for investment
 
$
873

 
$

$
873


Fair Value Measured and Recorded Using Significant Unobservable Inputs (Level 3) (in thousands):
 
March 31, 2017
Beginning balance
$
873

Total gains (losses) included in earnings
30

Ending balance
$
903

The valuation of an embedded conversion option held for investment with a convertible note was performed using a Black-Scholes option-pricing model which relies primarily on estimates of expected term, volatility, risk-free rate, and dividends related to our investment in a privately-held company, or the investee. The most significant unobservable inputs used in the determination of estimated fair value of the option are the estimates of share price

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and volatility, driven by the investee's ability to meet financial targets, and which directly correlates to the fair value recognized in other non-current assets within the condensed consolidated balance sheets.
The fair value of this asset is estimated quarterly by management based on inputs received from the investee's management using the excess earnings method under the income approach. Potential valuation adjustments are made as the progress toward achieving financial targets becomes determinable, with the impact of such adjustments being recorded to 'Interest income and other' in our condensed consolidated statements of operations and comprehensive loss.
During the three months ended March 31, 2017 , there were no transfers in or out of Level 3 from other levels in the fair value hierarchy.
There were no assets or liabilities measured at fair value on a non-recurring basis as of March 31, 2017 .
3 . Financial Statement Components
Cash and cash equivalents consisted of the following (in thousands):
 
 
March 31,
2017
 
December 31,
2016
Cash
 
$
36,371

 
$
38,053

Money market funds
 
20,081

 
20,069

Cash and cash equivalents
 
$
56,452

 
$
58,122

Accounts receivable, net consisted of the following (in thousands):
 
 
March 31,
2017
 
December 31,
2016
Trade accounts receivable
 
$
14,268

 
$
12,640

Unbilled trade accounts receivable, net of advance client deposits
 
1,209

 
1,253

Allowance for doubtful accounts
 
(24
)
 
(12
)
Accounts receivable, net
 
$
15,453

 
$
13,881

Prepaid expenses and other current assets consisted of the following (in thousands):
 
 
March 31,
2017
 
December 31,
2016
Prepaid expenses
 
$
3,905

 
$
2,199

Other current assets
 
1,212

 
809

Prepaid expenses and other current assets
 
$
5,117

 
$
3,008

Property and equipment, net consisted of the following (in thousands):
 
 
March 31,
2017
 
December 31,
2016
Computer and network equipment
 
$
39,746

 
$
37,664

Computer software
 
5,954

 
5,133

Internal-use software development costs
 
500

 
475

Furniture and fixtures
 
1,201

 
1,130

Leasehold improvements
 
629

 
624

Property and equipment
 
48,030

 
45,026

Accumulated depreciation and amortization
 
(32,200
)
 
(30,338
)
Property and equipment, net
 
$
15,830

 
$
14,688

Depreciation and amortization expense associated with property and equipment was $2.0 million for each of the three months ended March 31, 2017 and 2016 .

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Property and equipment capitalized under capital lease obligations consist primarily of computer and network equipment and were as follows (in thousands):
 
 
March 31,
2017
 
December 31,
2016
Gross
 
$
40,214

 
$
35,504

Less: accumulated depreciation and amortization
 
(26,521
)
 
(23,128
)
Total
 
$
13,693

 
$
12,376

Accrued and other current liabilities consisted of the following (in thousands):
 
 
March 31,
2017
 
December 31,
2016
Accrued compensation and benefits
 
$
8,840

 
$
7,456

Accrued legal expenses (1)
 
1,995

 
193

Accrued expenses
 
2,193

 
1,955

Accrued and other current liabilities
 
$
13,028

 
$
9,604

(1) The March 31, 2017 balance includes an accrual of the settlement amount, and the legal and indemnification fees related the Melcher litigation. See Part II, Item I “Legal Proceedings."
4 . Intangible Assets
The components of intangible assets were as follows (in thousands):
 
 
March 31, 2017
 
December 31, 2016
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Developed technology
 
$
2,460

 
$
(1,214
)
 
$
1,246

 
$
2,460

 
$
(1,126
)
 
$
1,334

Customer relationships
 
520

 
(359
)
 
161

 
520

 
(333
)
 
187

Domain names
 
50

 
(35
)
 
15

 
50

 
(32
)
 
18

Non-compete agreements
 
140

 
(140
)
 

 
140

 
(140
)
 

Total
 
$
3,170

 
$
(1,748
)
 
$
1,422

 
$
3,170

 
$
(1,631
)
 
$
1,539

Amortization expense related to intangible assets was $0.1 million for each of the three months ended March 31, 2017 and 2016 .
As of March 31, 2017 , the expected future amortization expense for intangible assets was as follows (in thousands):
Period
 
Expected Future Amortization Expense
Remainder of 2017
 
$
349

2018
 
442

2019
 
351

2020
 
280

Total
 
$
1,422

5 . Debt
2016 Loan and Security Agreement
On August 1, 2016 , or the Effective Date, the Company entered into a loan and security agreement, or the 2016 Loan and Security Agreement , with the lenders party thereto and City National Bank, as agent for such lenders. The 2016 Loan and Security Agreement provides for a revolving line of credit, or the New Revolving Credit Facility , of up to $50.0 million and matures on August 1, 2019 . On the Effective Date, the Company borrowed $32.6 million under the 2016 Loan and Security Agreement. The proceeds were used to extinguish existing indebtedness

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under all prior Loan and Security Agreements and will be used for working capital and other general corporate purposes.
Loans under the 2016 Loan and Security Agreement bear a variable annual interest rate of the prime rate plus 0.50% , subject to a 0.25% increase if our adjusted EBITDA is negative at the end of any fiscal quarter. The Company has agreed to pay a fee of 0.25% per annum on the unused portion of the revolving credit facility as well as an anniversary fee of $31,250 on each of the first and second anniversaries of the Effective Date. The Company is accreting the total estimation of unused fees and anniversary fees evenly over the full term of the 2016 Loan and Security Agreement. Under the terms of the 2016 Loan and Security Agreement , the outstanding balance cannot exceed the Company’s trailing four months of MRR (monthly recurring revenue including subscription and usage) multiplied by the average trailing 12 month dollar based retention rate (calculated on the same basis as in the Company’s periodic reports filed with the Securities and Exchange Commission). As of March 31, 2017 , the outstanding principal balance under the 2016 Loan and Security Agreement was $32.6 million , which is included in 'Revolving line of credit' in the condensed consolidated balance sheets. As of March 31, 2017 , the amount available for additional borrowings was $17.4 million .
The Company incurred approximately $0.2 million in fees that were directly attributable to the issuance of this credit facility. These costs are deferred and included within 'Prepaid expenses and other current assets' and 'Other assets' in the Company's condensed consolidated balance sheets and being amortized to interest expense on a straight-line basis over three years starting from the Effective Date of the New Revolving Credit Facility .
The obligations of the Company under the 2016 Loan and Security Agreement are guaranteed by the Company’s subsidiary, Five9 Acquisition. The Company’s obligations under the 2016 Loan and Security Agreement and Five9 Acquisition’s obligations under its guaranty are secured by a first priority perfected security interest in and lien on substantially all of the Company’s and Five9 Acquisition's assets. The 2016 Loan and Security Agreement contains certain customary covenants, including the requirement that the Company maintain $25.0 million of unrestricted cash deposited with the lenders for the term of the agreement, a minimum liquidity ratio of unrestricted cash and accounts receivable to the outstanding amounts under the 2016 Loan and Security Agreement , as well as customary events of default. Under the 2016 Loan and Security Agreement, the Company is also prohibited from declaring dividends or making other distributions on capital stock. The Company was in compliance with these covenants as of March 31, 2017 .
The Company recorded a $1.0 million loss on extinguishment of debt in the third quarter of 2016 under the 2013 Loan and Security Agreement and the 2014 Loan and Security Agreement. The loss was comprised of $0.4 million in prepayment penalties , a $0.4 million write-off of unamortized debt discounts , and a $0.2 million write-off of unamortized debt issuance costs .
2013 Loan and Security Agreement
Prior to entering into the 2016 Loan and Security Agreement on August 1, 2016 , the Company had a revolving line of credit of up to  $20.0 million , or Prior Revolving Credit Facility, under a loan and security agreement with a lender, which was entered into in March 2013 and last amended in December 2014, or 2013 Loan and Security Agreement. The Prior Revolving Credit Facility carried a variable annual interest rate of the prime rate plus  0.50%  and would have matured on December 1, 2016 .
The 2013 Loan and Security Agreement was collateralized by substantially all the assets of the Company. The balance outstanding could not exceed the lesser of (i)  $20.0 million  or (ii) an amount equal to the Company’s monthly recurring revenue for the three months prior multiplied by the average Dollar-Based Retention Rate over the prior twelve months, less the amount accrued for the Company’s Universal Service Fund (“USF”) obligation (accrued federal fees). As of August 1, 2016 , the Company had canceled and paid back all amounts due under the Prior Revolving Credit Facility.
In connection with its acquisition of SoCoCare in October 2013, the Company also borrowed  $5.0 million  under a term loan, or the Term Loan, under the 2013 Loan and Security Agreement in October 2013. Monthly interest-only payments were due on the advance at the prime rate plus  1.50%  through September 2014. Principal and interest payments were due in equal monthly installments from October 2014 through the maturity of the Term Loan in March 2017. As of August 1, 2016 , the Company had canceled and paid back all amounts due under the Term Loan.
The 2013 Loan and Security Agreement contained certain covenants, including the requirement that the Company maintain  $7.5 million  of cash deposited with the lender for the term of the 2013 Loan and Security Agreement. The Company was in compliance with these covenants through the cancellation date of August 1, 2016 .

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The 2013 Loan and Security Agreement remained senior to other debt, including the debt issued under the 2014 Loan and Security Agreement discussed below.
2014 Loan and Security Agreement
Prior to entering into the 2016 Loan and Security Agreement on August 1, 2016 , the Company had a term loan facility of  $30.0 million  with a syndicate of  two  lenders, or Lenders, which was entered into in February 2014 and amended in December 2014 and February 2015, or the 2014 Loan and Security Agreement. The term loan facility was available to the Company in tranches. The first tranche for  $20.0 million  was advanced upon entering into the agreement. The remaining  $10.0 million  was available for drawdown by the Company until February 20, 2016 in  $1.0 million  increments, which expired on February 20, 2016. The Company incurred  $0.4 million  in debt costs in connection with borrowing the first tranche in February 2014. The term loan bore interest at a variable per annum rate equal to the greater of  10%  or LIBOR plus  9% . Interest was due and payable on the last business day of each month during the term of the loan commencing in February 2014. Monthly principal payments were due beginning in February 2016 based on 1/60th of the outstanding balance at that time and would continue until all remaining principal outstanding under the term loan became due and payable in February 2019. As of August 1, 2016 , the Company had canceled and paid back all borrowings under the 2014 Loan and Security Agreement.
The term loan was secured by substantially all the assets of the Company and was subordinate to the 2013 Loan and Security Agreement. The 2014 Loan and Security Agreement contained certain covenants and included the occurrence of a material adverse event, as defined in the agreement and determined by the Lenders, as an event of default. The Company was in compliance with these covenants through the effective cancellation date of August 1, 2016 .
In connection with entering into the 2014 Loan and Security Agreement, the Company issued to the Lenders warrants to purchase  177,865  shares of common stock at  $10.12  per share, which vest and become exercisable over a  ten  year term from the date of issuance, based on amounts drawn under the  $30.0 million  term loan facility. Based on the drawdown of  $20.0 million  in February 2014,  118,577  shares of common stock issuable under the warrants vested and are exercisable by the Lenders. The fair value of these vested warrants of  $1.0 million  was recorded as a discount against the debt proceeds and was being recognized as additional interest expense over the term of the loan. The remaining  59,288  shares of common stock issuable under the warrants pertaining to the undrawn  $10.0 million  did not vest and were no longer exercisable on February 20, 2016 when the $10.0 million was no longer available for borrowing.
Promissory Note
In July 2013, the Company issued a promissory note to the Universal Service Administrative Company, or USAC, for $4.1 million in principal amount as a financing arrangement for that amount of accrued federal fees. The promissory note carried a fixed annual interest rate of 12.75% and was repayable in 42 equal monthly installments of principal and interest beginning in August 2013. As of December 31, 2016 , approximately $0.1 million of this promissory note was outstanding and is included as notes payable in the accompanying condensed consolidated balance sheets. As of March 31, 2017 , the promissory note was fully paid.
FCC Civil Penalty
In June 2015, the Company entered into a consent decree with the Federal Communications Commission or FCC, Enforcement Bureau (Note  9 ), in which the Company agreed to pay a civil penalty of  $2.0 million  to the U.S. Treasury in twelve equal quarterly installments starting in July 2015 without interest. As a result, the Company discounted the  $2.0 million  liability, which was accrued in the third quarter of 2014 for the then tentative civil penalty, to its present value of  $1.7 million  at an annual interest rate of  12.75%  to reflect the imputed interest and reclassified this discounted liability from 'Accrued federal fees' to 'Notes payable.' The  $0.3 million discount was recorded as a reduction to general and administrative expense in the three months ended June 30, 2015 and is being recognized as interest expense over the payment term of the civil penalty. As of March 31, 2017 and December 31, 2016 , the outstanding civil penalty payable was $0.8 million and $1.0 million , respectively, of which the net carrying value was  $0.8 million  and $0.9 million , respectively, and is included as 'Notes payable' in the accompanying condensed consolidated balance sheets.

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As of March 31, 2017 and December 31, 2016 , the Company’s outstanding debt is summarized as follows (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Promissory note to USAC
 

 
120

FCC civil penalty
 
833

 
1,000

Total notes payable, gross
 
833

 
1,120

Less: discount
 
(54
)
 
(79
)
Total notes payable, net carrying value
 
779

 
1,041

Revolving line of credit
 
32,594

 
32,594

Interest accretion under 2016 line of credit
 
$
26

 
$
19

Total debt, net carrying value
 
$
33,399

 
$
33,654

Less: current portion of debt *
 
(643
)
 
(742
)
Total debt, less current portion **
 
32,756

 
32,912

 
 
 
 
 
 
 
 
 
 
* Included in ‘Notes payable’ in the condensed consolidated balance sheets.
** Included in ‘Notes payable - less current portion’ and 'Revolving line of credit — less current portion' in the condensed consolidated balance sheets.
Maturities of the Company’s outstanding debt as of March 31, 2017 are as follows (in thousands):
Period
 
Amount to Mature
2017
 
500

2018
 
333

2019
 
32,594

Total
 
$
33,427

6 . Stockholders’ Equity
Capital Structure
The Company is authorized to issue 450,000,000 shares of common stock with a par value of $0.001 per share. As of March 31, 2017 and December 31, 2016 , the Company had 54,443,729 shares and 53,363,013 shares of common stock issued and outstanding, respectively.
The Company is also authorized to designate and issue up to  5,000,000  shares of preferred stock with a par value of $0.001 per share in one or more series without stockholder approval and to fix the rights, preferences, privileges and restrictions thereof. As of March 31, 2017 and December 31, 2016 , the Company had no shares of preferred stock issued and outstanding.
Warrants
As of March 31, 2017 and December 31, 2016 , the Company had outstanding warrants to purchase 13,017 and 131,597 shares of common stock, respectively, with a weighted-average exercise price of $6.93 per share and $9.80 per share, respectively. Most of these warrants expire on October 18, 2023 .

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Common Stock Reserved for Future Issuance
Shares of common stock reserved for future issuance related to outstanding equity awards, common stock warrants, and employee equity incentive plans were as follows (in thousands):
 
 
March 31, 2017
Stock options outstanding
 
5,127

Restricted stock units outstanding
 
2,607

Shares available for future grant under 2014 Plan
 
7,569

Shares available for future issuance under ESPP
 
1,636

Common stock warrants outstanding
 
13

Total shares of common stock reserved
 
16,952

Equity Incentive Plans  
Prior to its initial public offering (“IPO”), the Company granted stock options under its Amended and Restated 2004 Equity Incentive Plan, as amended (the “2004 Plan”).
In March 2014, the Company’s board of directors and stockholders approved the 2014 Equity Incentive Plan (“2014 Plan”) and 5,300,000 shares of common stock were reserved for issuance under the 2014 Plan. In addition, on the first day of each year beginning in 2015 and ending in 2024, the 2014 Plan provides for an annual automatic increase to the shares reserved for issuance in an amount equal to 5% of the total number of shares outstanding on December 31st of the preceding calendar year or a lesser number as determined by the Company’s board of directors. Pursuant to the automatic annual increase,  2,668,150  and 2,558,231  additional shares were reserved under the 2014 Plan on January 1, 2017 and 2016 , respectively.
No further grants were made under the 2004 Plan once the 2014 Plan became effective on April 3, 2014. Upon the effectiveness of the 2014 Plan, all shares reserved for future issuance under the 2004 Plan became available for issuance under the 2014 Plan. After the IPO, any forfeited or expired shares that would have otherwise returned to the 2004 Plan instead return to the 2014 Plan. As of March 31, 2017 , 7,568,651 shares of common stock were available for future grant under the 2014 Plan.
The 2004 Plan and the 2014 Plan are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 .
Stock Options
A summary of the Company’s stock option activity during the three months ended March 31, 2017 is as follows (in thousands, except years and per share data):
 
 
Number of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life
(Years)
 
Aggregate
Intrinsic
Value
Outstanding as of December 31, 2016
 
5,556

 
$
5.23

 
 
 
 
Options granted (weighted average grant date fair value of $7.86 per share)
 
449

 
16.21

 
 
 
 
Options exercised
 
(858
)
 
0.92

 
 
 
 
Options forfeited or expired
 
(20
)
 
12.23

 
 
 
 
Outstanding as of March 31, 2017
 
5,127

 
$
6.88

 
6.7
 
$
49,171

The Company has computed the aggregate intrinsic value amounts disclosed in the above table based on the difference between the exercise price of the options and the closing market price of the Company’s common stock of $16.46 per share as of March 31, 2017 for all in-the-money options outstanding.

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Restricted Stock Units
A summary of the Company's restricted stock unit, or RSU, activity during the three months ended March 31, 2017 is as follows (in thousands, except per share data):
 
 
Number of Shares
 
Weighted Average Grant Date Fair Value Per Share
Outstanding as of December 31, 2016
 
2,019

 
$
7.65

RSUs granted
 
792

 
16.26

RSUs vested and released
 
(177
)
 
6.71

RSUs forfeited
 
(27
)
 
7.67

Outstanding as of March 31, 2017
 
2,607

 
$
10.30

Employee Stock Purchase Plan
The Company's 2014 Employee Stock Purchase Plan, or ESPP, became effective on April 3, 2014 and is described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 . The number of shares of common stock originally reserved for issuance under the ESPP was 880,000 shares, which will increase automatically each year, beginning on January 1, 2015 and continuing through January 1, 2024, by the lesser of (i)  1% of the total number of shares of the Company’s common stock outstanding on December 31 of the preceding calendar year; (ii)  1,000,000 shares of common stock (subject to adjustment to reflect any split or combination of the Company’s common stock); or (iii) such lesser number as determined by the Company’s board of directors. Pursuant to the automatic annual increase, 533,630 and 511,646 additional shares were reserved under the ESPP on January 1, 2017 and 2016 , respectively. As of March 31, 2017 , 1,635,854 shares of common stock were available for future grants under the ESPP.
During the three months ended March 31, 2017 , no shares were purchased under the ESPP.
Stock-Based Compensation
Stock-based compensation expenses for the three months ended March 31, 2017 and 2016 were as follows (in thousands):
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
Cost of revenue
 
$
434

 
$
265

Research and development
 
637

 
435

Sales and marketing
 
928

 
434

General and administrative
 
1,130

 
860

Total stock-based compensation
 
$
3,129

 
$
1,994

As of March 31, 2017 , unrecognized stock-based compensation expenses by award type and their expected weighted-average recognition periods are summarized in the following table (in thousands, except years).
 
 
Stock Option
 
RSU
 
ESPP
Unrecognized stock-based compensation expense
 
$
8,426

 
$
24,752

 
$
132

Weighted-average amortization period
 
2.9 years

 
3.3 years

 
0.1 years

The Company recognizes stock-based compensation expense that is calculated based upon awards that have vested, reduced for actual forfeitures. All stock-based compensation for equity awards granted to employees and non-employee directors is measured based on the grant date fair value of the award.

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The Company values RSUs at the closing market price of its common stock on the date of grant. The Company estimates the fair value of each stock option and purchase rights under the ESPP granted to employees on the date of grant using the Black-Scholes option-pricing model and using the assumptions noted in the below table. The weighted-average assumptions used to value stock options granted during the three months ended March 31, 2017 and 2016 were as follows:
Stock Options
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
Expected term (years)
 
6.0
 
6.0
Volatility
 
49%
 
48%
Risk-free interest rate
 
2.0%
 
1.5%
Dividend yield
 
 
7 . Net Loss Per Share
Basic net loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period, and excludes any dilutive effects of employee stock-based awards and warrants. Diluted net income per share is computed giving effect to all potentially dilutive common shares, including common stock issuable upon exercise of stock options and warrants and vesting of restricted stock. As the Company had net losses for the three months ended March 31, 2017 and 2016 , all potentially issuable common shares were determined to be anti-dilutive.
The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data).
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
Net loss
 
$
(5,255
)
 
$
(4,911
)
Weighted-average shares used in computing basic and diluted net loss per share
 
53,688

 
51,377

Basic and diluted net loss per share
 
$
(0.10
)
 
$
(0.10
)
The following securities were excluded from the calculation of diluted net loss per share attributable to common stockholders because their effect would have been anti-dilutive for the periods presented (in thousands).
 
 
March 31, 2017
 
March 31, 2016
Stock options
 
5,127

 
5,980

Restricted stock units
 
2,607

 
2,459

ESPP
 

 
162

Common stock warrants
 
13

 
132

Total
 
7,747

 
8,733

8 . Income Taxes
The provision for income taxes for the three months ended March 31, 2017 and 2016 was approximately $49 thousand and $28 thousand , respectively. The provision for income taxes consisted primarily of foreign income taxes.
For the three months ended March 31, 2017 and 2016 , the provision for income taxes differed from the statutory amount primarily due to the Company realizing no benefit for current year losses due to maintaining a full valuation allowance against its domestic net deferred tax assets.
The realization of tax benefits of deferred tax assets is dependent upon future levels of taxable income, of an appropriate character, in the periods the items are expected to be deductible or taxable. Based on the available objective evidence, the Company does not believe it is more likely than not that the net deferred tax assets will be realizable. Accordingly, the Company has provided a full valuation allowance against the domestic net deferred tax assets as of March 31, 2017 and December 31, 2016 . The Company intends to maintain the remaining valuation allowance until sufficient positive evidence exists to support a reversal of, or decrease in, the valuation allowance. During the three months ended March 31, 2017 , there were no material changes to the total amount of unrecognized tax benefits. 

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9 . Commitments and Contingencies
Commitments
The Company’s principal commitments consist of future payment obligations under capital leases to finance data centers and other computer and networking equipment purchases, operating lease agreements for office space, research and development, and sales and marketing facilities, and agreements with third parties to provide co-location hosting, telecommunication usage and equipment maintenance services. These commitments as of December 31, 2016 are disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 , and did not change materially during the  three  months ended  March 31, 2017  except for the acquisition of certain additional data center and network equipment and software under multiple capital leases, and certain hosting and telecommunications agreements. As of  March 31, 2017 , the total minimum future payment commitments under these capital leases added during the three months ended March 31, 2017 were approximately $2.6 million , of which  $0.6 million  is due in 2017, with the remainder of $2.0 million due over approximately  28 months . The Company entered into various hosting and telecommunications agreements for terms of 24 months to 36 months commencing on various dates in the first and second quarters of 2017. These agreements require the Company to make monthly payments over the service term in exchange for certain network services. The Company's total minimum future payment commitments under these agreements are $1.0 million .
Universal Services Fund Liability
During the third quarter of 2012, the Company determined that based on its business activities, it is classified as a telecommunications service provider for regulatory purposes and it should make direct contributions to the federal USF and related funds based on revenues it receives from the resale of interstate and international telecommunications services. In order to comply with the obligation to make direct contributions, the Company made a voluntary self-disclosure to the FCC Enforcement Bureau and registered with the USAC, which is charged by the FCC with administering the USF. The Company filed exemption certificates with its wholesale telecommunications service providers in order to eliminate its obligation to reimburse such wholesale telecommunications service providers for their USF contributions calculated on services sold to the Company. In April 2013, the Company began remitting required contributions on a prospective basis directly to USAC.
The Company’s registration with USAC subjects it to assessments for unpaid USF contributions, as well as interest thereon and civil penalties, due to its late registration and past failure to recognize its obligation as a USF contributor and as an international carrier. The Company will be required to pay assessments for periods prior to the Company’s registration. As of December 31, 2012, the total past due USF contribution being imposed by USAC and accrued by the Company for the period from 2003 through 2012 was  $8.1 million , of which  $4.7 million  was undisputed and  $3.4 million , including  $0.8 million  that pertains to 2003 through 2007, was disputed. The Company has submitted two separate Requests for Review (a form of appeal) to the FCC's Wireline Bureau challenging the application of FCC rules to the assessments of USF fees for 2003 to 2007, and from 2008 to 2012. In January 2017, the FCC Wireline Bureau ruled in favor of the Company regarding the principal for the 2008 to 2012 assessments, but not the related interest or penalties, resulting in a reversal of $3.1 million to cost of revenue. The Company has filed a third Request for Review disputing the interest and penalties on the back assessments for the period of 2008 through 2012. The FCC has not yet resolved the Company’s Requests for Review challenging assessments for 2003 to 2007 or its Request for Review on the interest and penalties. If the pending disputes are not resolved in the Company’s favor, it is still possible that the Company will be required to pay back assessments for one or both of those periods.
In July 2013, the Company and USAC agreed to a financing arrangement for  $4.1 million  of the undisputed  $4.7 million  of the unpaid USF contributions whereby the Company issued to USAC a promissory note payable in the principal amount of the  $4.1 million  and paid off the remaining undisputed  $0.6 million . The repayment terms of the promissory note payable are disclosed in Note 5 . As of December 31, 2016 , approximately $0.1 million of this promissory note was outstanding and is included as notes payable in the accompanying condensed consolidated balance sheets. As of March 31, 2017 , the promissory note was fully paid. In addition to the promissory note payable, as of  March 31, 2017  and December 31, 2016 , the Company had an accrued liability for the disputed portion of the unpaid USF contributions and estimated interest and penalties of  $2.7 million and $2.5 million , respectively, included in accrued federal fees on the condensed consolidated balance sheets. For each of the  three months ended  March 31, 2017 and 2016 , the Company recorded interest and penalty expenses of  $0.1 million as a charge to general and administrative expense, which were related to its disputed unpaid USF obligations.

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On June 12, 2015, in connection with the Company’s disclosure to the FCC, the Company entered into a consent decree with the FCC Enforcement Bureau. In the consent decree, the Company agreed to pay a civil penalty of $2.0 million to the U.S. Treasury in twelve equal quarterly installments starting in July 2015 without interest (Note 5 ). In the third quarter of 2014, the Company accrued a $2.0 million liability for the then tentative civil penalty. The consent decree also requires the Company to adopt certain internal regulatory compliance monitoring and training requirements, and to report on the status of those compliance efforts to the FCC’s Enforcement Bureau for three years. The Company’s implementation of the internal regulatory compliance monitoring and training requirements were completed in August 2015, and its annual compliance reporting to the FCC will continue until June 2018.
State and Local Taxes and Surcharges
In April 2012, the Company commenced collecting and remitting sales taxes on sales of subscription services in all the U.S. states in which it determined it was obligated to do so. During the first quarter of 2015, the Company conducted an updated sales tax review of the taxability of sales of its subscription services. As a result, the Company determined that it may be obligated to collect and remit sales taxes on such sales in four additional states. Based on its best estimate of the probable sales tax liability in those four states relating to its sales of subscription services during the period 2011 through 2014, during the three months ended March 31, 2015, the Company recorded a general and administrative expense of  $0.6 million  as an immaterial out of period adjustment to accrue for such taxes.
During 2013, the Company analyzed its activities and determined it may be obligated to collect and remit various state and local taxes and surcharges on its usage-based fees. The Company had not remitted state and local taxes on usage-based fees in any of the periods prior to 2014 and therefore accrued a sales tax liability for this contingency. In January 2014, the Company commenced paying such taxes and surcharges to certain state     authorities. In June 2014, the Company commenced collecting state and local taxes or surcharges on usage-based fees from its clients on a current basis and remitting such taxes to the applicable U.S. state taxing authorities.
During the three months ended March 31, 2017, the Company made no payments for its contingent sales taxes on either usage-based fees or sales of subscription services. During the three months ended March 31, 2016, the Company remitted $0.2 million for its contingent sales taxes on both usage-based fees and sales of subscription services. For the three months ended March 31, 2017, the Company recognized a $0.1 million gain as an offset to general and administrative expense related to its estimated sales tax liability on both usage-based fees and sales of subscription services in the U.S. and Canada. For the three months ended March 31, 2016, the Company recognized $6 thousand as general and administrative expense related to its estimated sales tax liability on both usage-based fees and sales of subscription services in the U.S. and Canada, which was not being collected from its clients.
As of March 31, 2017 and December 31, 2016 , the Company had total accrued liabilities of $1.9 million and $2.1 million , respectively, for such contingent sales taxes and surcharges that were not being collected from its clients but may be imposed by various taxing authorities, of which $0.5 million and  $0.6 million were included in current “Sales tax liability” on the condensed consolidated balance sheets, respectively, and the remaining were included in non-current “Sales tax liability” on the condensed consolidated balance sheets. The Company’s estimate of the probable loss incurred under this contingency is based on its analysis of the source location of its usage-based fees and the regulations and rules in each tax jurisdiction.
Legal Matters
The Company is involved in various legal and regulatory matters arising in the normal course of business. In management’s opinion, resolution of these matters is not expected to have a material impact on the Company’s consolidated results of operations, cash flows, or its financial position. However, due to the uncertain nature of legal matters, an unfavorable resolution of a matter could materially affect the Company’s future consolidated results of operations, cash flows or financial position in a particular period. The Company expenses legal fees as incurred.
The Company is currently involved in the following lawsuits as a defendant.
Melcher Litigation
On September 28, 2016, a complaint was filed in the United States District Court for the Southern District of California against Five9, Inc., or Five9, as the successor in interest to Face It, Corp., or Face It, and Lance Fried, a former Five9 employee who was the former Chief Executive Officer of Face It. The action, captioned Melcher, et al. v. Five9, Inc., et al., No. 16-cv-02440, or the Federal Lawsuit, was filed as a direct action by Carl Melcher, or

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Melcher, a purported former stockholder of Face It, and his related investment entity Melcher Family Limited Partnership, or MFLP.
In the complaint, the plaintiffs allege that Face It repurchased the plaintiffs’ stock in September 2013 before Five9 acquired Face It, and that in connection with the repurchase, Fried made material misstatements or omissions to Melcher, by failing to disclose that Face It allegedly was in concurrent discussions about a potential sale of the company to Five9. The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, as well as various claims under state law and common law. The complaint seeks to set aside Face It’s September 2013 stock repurchase from the plaintiffs, as well as an unspecified amount of damages and an award of attorney’s fees and costs, in addition to other relief.
On November 8, 2016, the court entered an order staying the Federal Lawsuit and ordered the parties to proceed to arbitration of the dispute before the American Arbitration Association, or AAA. On November 16, 2016, Melcher and MFLP submitted a Demand for Arbitration to AAA against Five9, asserting claims identical to those alleged in the Federal Lawsuit.
On March 31, 2017, Five9 reached a settlement with the plaintiffs that fully resolves the plaintiffs’ claims against Five9 and provides for mutual releases between the parties in exchange for a one-time payment by Five9 to the plaintiffs of $1.7 million . The settlement amount is included in 'accrued and other current liabilities' in the condensed consolidated balance sheets and 'general and administrative' expense in the statements of operations and comprehensive loss.
Five9 believes that it has indemnification rights against the former stockholders of Face It for losses it incurred in connection with the defense and resolution of this matter.
NobelBiz Litigation
On August 5, 2011, NobelBiz sent a letter to the Company asserting infringement of a patent related to virtual call centers. On April 3, 2012, NobelBiz filed a patent infringement lawsuit against the Company in the United States District Court for the Eastern District of Texas. The patent asserted in the complaint is different, but related, to the patent asserted in the original letter. The lawsuit, NobelBiz Inc. v. Five9, Inc., Case No. 6:12-cv-00243-LED, alleges that the Company’s local caller ID management service infringes United States Patent No. 8,135,122, or the ‘122 patent. The ‘122 patent, titled “System and Method for Modifying Communication Information (MCI),” issued on March 13, 2012, and according to the complaint is alleged to relate to “a system for processing a telephone call from a call originator (also referred to as a calling party) to a call target (also referred to as a receiving party), where the system accesses a database storing outgoing telephone numbers, selects a replacement telephone number from the outgoing telephone numbers based on the telephone number of the call target, and originates an outbound call to the call target with a modified outgoing caller identification (‘caller ID’).” NobelBiz seeks damages in the form of lost profits as well as injunctive relief. The lawsuit is one of several lawsuits filed by NobelBiz against various companies including TCN Inc., LiveVox, Inc. and Global Connect LLC. On March 28, 2013, the court granted the Company’s motion to transfer the case to the United States District Court for the Northern District of California. Subsequently, NobelBiz amended its complaint to add claims related to U.S. Patent No. 8,565,399, or the ‘399 patent, which is a continuation in the same family as the ‘122 patent and addresses the same technology. The Company responded to the complaint and amended complaint by asserting noninfringement and invalidity of the ‘122 and ‘399 patents. On January 16, 2015, the court issued an order regarding claim construction of the two patents-in-suit. On March 7, 2016, the court stayed the case pending an appeal in lawsuits involving NobelBiz, Global Connect and TCN that also involve the ‘122 and ‘399 patents. The appeal for those cases is likely to last until later this year, after which time the lawsuit between NobelBiz and Five9 will resume and a new schedule will be entered by the Court.
The Company has investigated the claims alleged in the complaint and believes that it has good defenses to the claims. While the Company does not believe that it is probable that a loss has been incurred, the ultimate resolution of the matter could potentially result in a loss. Management’s best estimate of the low end of the range of the potential loss is zero. At this time, it is not possible to reasonably estimate the high end of the range of the potential loss, which could be material to the Company’s results of operations. Accordingly, the Company has not accrued a loss related to this matter.
Indemnification Agreements
In the ordinary course of business, the Company enters into agreements of varying scope and terms pursuant to which it agrees to indemnify clients, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, services to be provided by the

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Company or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with directors and certain officers and employees that will require it, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. Other than as described below, no demands have been made upon the Company to provide indemnification under such agreements and there are no claims that it is aware of that could have a material effect on the consolidated balance sheet, consolidated statement of operations and comprehensive loss, or consolidated statements of cash flows. On October 27, 2016, the Company received notice from Lance Fried, a former officer and director of Face It, of his claim for indemnification by the Company (as successor in interest to Face It), and for advancement of all legal fees and expenses he incurs in connection with the defense of the Melcher litigation. See PART I, ITEM3 of this Form 10-K. As of March 31, 2017 , the Company had incurred or advanced Mr. Fried $62 thousand in connection with this claim. To the extent that it is ultimately determined that Mr. Fried is not entitled to indemnification, Mr. Fried has undertaken to reimburse the Company for all amounts advanced to him. In addition, the Company believes that it has indemnification rights against the former stockholders of Face It for all losses that are incurred in connection with the Melcher litigation, including without limitation, amounts incurred to indemnify or advance the legal fees and expenses of Mr. Fried pursuant to his indemnification claim against the Company.
10 . Geographical Information
The following table is a summary of revenues by geographic region based on client billing address and has been estimated based on the amounts billed to clients during the periods (in thousands).
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
United States
 
$
44,358

 
$
35,593

International
 
2,656

 
2,422

Total revenue
 
$
47,014

 
$
38,015

The following table summarizes total property and equipment, net, in the respective locations (in thousands).
 
 
March 31, 2017
 
December 31, 2016
United States
 
$
14,430

 
$
13,025

International
 
1,400

 
1,663

Property and equipment, net
 
$
15,830

 
$
14,688

    
11 . Subsequent Events
In April 2017, the Company was notified that third parties are suspected of having unlawfully acquired some of its clients’ information. The Company believes this acquisition was the result of a vulnerability that has now been remediated. Clients determined to have been impacted have been notified. The Company is working closely with law enforcement authorities and conducting its own ongoing internal investigation with the assistance of outside counsel and technical experts.
Expenses incurred to date related to this incident have not been material. The Company will incur additional expenses and may incur losses in connection with this incident, however, at this time it is unable to reasonably estimate any such additional expenses or losses. Five9 has insurance that is likely to apply to this incident.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2016 .
Overview
We are a pioneer and leading provider of cloud software for contact centers, facilitating more than three billion interactions between our more than  2,000  clients and their customers per year. We believe we achieved this leadership position through our expertise and technology, which has empowered us to help organizations of all sizes transition from legacy on-premise contact center systems to our cloud solution. Our solution, which is comprised of our Virtual Contact Center, 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 routes each customer interaction to an appropriate agent resource, and delivers relevant customer data to the agent in real-time to optimize the customer experience. Unlike legacy on-premise contact center systems, our solution requires minimal up-front investment and can be rapidly deployed and adjusted depending on our client’s requirements.
Since founding our business in 2001, we have focused exclusively on delivering cloud contact center software. We initially targeted smaller contact center opportunities with our telesales team and, over time, invested in expanding the breadth and depth of the functionality of our cloud platform to meet the evolving requirements of our clients. In 2009, we made a strategic decision to expand our market opportunity to include larger contact centers. This decision drove further investments in research and development and the establishment of our field sales team to meet the requirements of these larger contact centers. We believe this shift has helped us diversify our client base while significantly enhancing our opportunity for future revenue growth. To complement these efforts, we have also focused on building client awareness and driving adoption of our solution through marketing activities, which include internet advertising, digital marketing campaigns, social marketing, trade shows, industry events and telemarketing.

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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 both inbound and outbound interactions. 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 changes in the number of agent seats. Our clients can use this notice period to rapidly adjust the number of agent seats used to meet their changing contact center volume needs, including to reduce the number of agent seats to zero. As a general matter, this means that a client can effectively terminate its agreement with us upon 30 days’ notice. Our larger clients typically choose annual contracts, which generally include an implementation and ramp period of several months. Fixed subscription fees, including bundled plans, are generally billed monthly in advance, while related usage fees are billed in arrears. For the three months ended March 31, 2017 and 2016 , subscription and related usage fees accounted for 94% and 95% of our revenue, respectively. The remainder was comprised of professional services revenue from the implementation and optimization of our solution.
Our revenue increased to $47.0 million for the three months ended March 31, 2017 from $38.0 million for the three months ended March 31, 2016 . Revenue growth has primarily been driven by our larger clients. For each of the three months ended March 31, 2017 and 2016 , no single client accounted for more than 10% of our total revenue. As of March 31, 2017 , we had over 2,000 clients across multiple industries. Our clients' subscriptions generally range in size from fewer than 10 agent seats to approximately 1,000 agent seats.
We have continued to make significant expenditures and investments, including in sales and marketing, research and development and infrastructure. We primarily evaluate the success of our business based on revenue growth, adjusted EBITDA 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 client base, particularly in larger opportunities, grow revenue from our existing client base, develop innovative products and features, and expand internationally. While these areas represent significant opportunities for us, they also pose risks and challenges that we must successfully address in order to sustain the growth of our business and improve our operating results. In order to pursue these opportunities, we anticipate that we will continue to expand our operations and headcount in the near term.
Due to our continuing investments to grow our business, increase our sales and marketing efforts, pursue new opportunities, enhance our solution and build our technology, we expect our cost of revenue and operating expenses to increase in absolute dollars in future periods. However, we expect these expenses to decrease as a percentage of revenue as we grow our revenue and gain economies of scale by increasing our client base without direct incremental development costs and by utilizing more of the capacity of our data centers.
Key Operating and Financial Performance Metrics
In addition to measures of financial performance presented in our condensed consolidated financial statements, we monitor the key metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies.
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

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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 Ended
 
 
March 31, 2017
 
March 31, 2016
Annual Dollar-Based Retention Rate
 
99%
 
98%
The increase in our Annual Dollar-Based Retention Rate from March 31, 2016 to March 31, 2017 was primarily due to our larger clients increasing the number of agent seats.
Adjusted EBITDA
We monitor adjusted EBITDA, a non-GAAP financial measure, to analyze our financial results and believe that it is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance. We believe that adjusted EBITDA helps illustrate underlying trends in our business that could otherwise be masked by the effect of the income or expenses that we exclude from adjusted EBITDA. Furthermore, we use this measure to establish budgets and operational goals for managing our business and evaluating our performance. We also believe that adjusted EBITDA provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods with other companies in our industry.
Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP and our calculation of adjusted EBITDA may differ from that of other companies in our industry. We compensate for the inherent limitations associated with using adjusted EBITDA through disclosure of these limitations, presentation of our financial statements in accordance with U.S. GAAP and reconciliation of adjusted EBITDA to the most directly comparable U.S. GAAP measure, net loss. We calculate adjusted EBITDA as net loss before (1) depreciation and amortization, (2) stock-based compensation, (3) interest income, expense and other, (4) provision for income taxes, and (5) other unusual items that do not directly affect what we consider to be our core operating performance.
The following table shows a reconciliation from net loss to Adjusted EBITDA for the periods presented (in thousands):
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
Net loss
 
$
(5,255
)
 
$
(4,911
)
Non-GAAP adjustments:
 
 
 
 
Depreciation and amortization (1)
 
2,095

 
2,103

Stock-based compensation (2)
 
3,129

 
1,994

Interest expense
 
882

 
1,199

Interest income and other
 
(118
)
 
45

Legal settlement (3)
 
1,700

 

Legal and indemnification fees related to settlement (3)
 
135

 

Provision for  income taxes
 
49

 
28

Adjusted EBITDA
 
$
2,617

 
$
458

 
 
 
 
 

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(1) Depreciation and amortization expenses included in our results of operations are as follows (in thousands):
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
Cost of revenue
 
$
1,576

 
$
1,680

Research and development
 
206

 
148

Sales and marketing
 
30

 
53

General and administrative
 
283

 
222

Total depreciation and amortization
 
$
2,095

 
$
2,103

(2) See Note 6 of the notes to the condensed consolidated financial statements for stock-based compensation expense included in our results of operations for the periods presented.
(3) Represents settlement amount, legal and indemnification fees related to the settlement of the Melcher litigation. See Part II, Item I “Legal Proceedings."
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 based on the volume of minutes for inbound and outbound client interactions. We also offer bundled plans, generally for smaller deployments, where the client is charged a single monthly fixed fee per agent seat that includes both subscription and unlimited usage in the contiguous 48 states and, in some cases, Canada. We offer monthly, annual and multiple-year contracts for our clients, generally with 30 days’ notice required for changes in the number of agent seats. Our clients can use this notice period to rapidly adjust the number of agent seats used to meet their changing contact center volume needs, including to reduce the number of agent seats to zero. As a general matter, this means that a client can effectively terminate its agreement with us upon 30 days’ notice.
Fixed subscription fees, including plans with bundled usage, are generally billed monthly in advance, while variable usage fees are billed in arrears. Fixed subscription fees are recognized on a straight-line basis over the applicable term, predominantly the monthly contractual billing period. Support activities include technical assistance for our solution and upgrades and enhancements on a when and if available basis, which are not billed separately. Variable subscription related usage fees for non-bundled plans are billed in arrears based on client-specific per minute rate plans and are recognized as actual usage occurs. We generally require advance deposits from clients based on estimated usage. All fees, except usage deposits, are non-refundable.
In addition, we generate professional services revenue from assisting clients in implementing our solution and optimizing use. These services include application configuration, system integration and education and training services. Professional services are primarily billed on a fixed-fee basis and are typically performed by us directly. In limited cases, our clients 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, and allocated office and facility costs and amortization of acquired technology. Cost of revenue can fluctuate based on a number of factors, including the fees we pay to telecommunications providers, which vary depending on our clients’ usage of our VCC cloud platform, the timing of capital expenditures and related depreciation charges and changes in headcount. We expect to continue investing in our network infrastructure and operations and client support function to maintain high quality and availability of service. As our business grows, we expect to realize economies of scale in network infrastructure, personnel and client support.
Operating Expenses
We classify our operating expenses as research and development, sales and marketing, and general and administrative expenses.
Research and Development .    Our research and development expenses consist primarily of salary and related expenses (including stock-based compensation) for personnel related to the development of improvements and expanded features for our services, as well as quality assurance, testing, product management and allocated overhead. We expense research and development expenses as they are incurred except for internal-use software development costs that qualify for capitalization. We believe that continued investment in our solution is important for our future growth, and we expect research and development expenses to increase in absolute dollars in the foreseeable future, although these expenses as a percentage of our revenue are expected to decrease over time.
Sales and Marketing .    Sales and marketing expenses consist primarily of salaries and related expenses (including stock-based compensation) for employees in sales and marketing, sales commissions, as well as advertising, marketing, corporate communications, travel costs and allocated overhead. We expense sales commissions associated with the acquisition or renewal of client contracts as incurred in the period the contract is acquired or the renewal occurs. We believe it is important to continue investing in sales and marketing to continue to generate revenue growth. Accordingly, we expect sales and marketing expenses to increase in absolute dollars 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 from period to period, but decline as a percentage of revenue over time.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest expense associated with our debt and capital leases. We expect interest expense for our outstanding debt to decrease due to a lower interest rate for our New Revolving Credit Facility compared to the 2014 Loan and Security Agreement and the 2013 Loan and Security Agreement (see Note 5 of the notes to condensed consolidated financial statements included in this Form 10-Q). We expect interest expense for our capital leases to increase as a result of our continued capital spending funded by capital leases.
Provision for Income Taxes
Our provision for income taxes consists primarily of corporate income taxes resulting from profits generated in foreign jurisdictions by our wholly-owned subsidiaries, along with state income taxes payable in the United States.

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Results of Operations for the Three Months Ended March 31, 2017 and 2016
Based on the condensed consolidated statements of operations and comprehensive loss set forth in this quarterly report, the following table sets forth our operating results as a percentage of revenue for the periods indicated:
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
Revenue
 
100
 %
 
100
 %
Cost of revenue
 
42
 %
 
44
 %
Gross profit
 
58
 %
 
56
 %
Operating expenses:
 
 
 
 
Research and development
 
15
 %
 
15
 %
Sales and marketing
 
34
 %
 
33
 %
General and administrative
 
18
 %
 
18
 %
Total operating expenses
 
67
 %
 
66
 %
Loss from operations
 
(9
)%
 
(10
)%
Other income (expense), net:
 
 
 
 
Interest expense
 
(2
)%
 
(3
)%
Interest income and other
 
 %
 
 %
Total other income (expense), net
 
(2
)%
 
(3
)%
Loss before income taxes
 
(11
)%
 
(13
)%
Provision for income taxes
 
 %
 
 %
Net loss
 
(11
)%
 
(13
)%
Revenue
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Revenue
 
$47,014
 
$38,015
 
$8,999
 
24%
The increase in revenue for the three months ended March 31, 2017 compared to the same period of 2016 was primarily attributable to our larger clients, driven by an increase in our sales and marketing activities and our improved brand awareness. For the three months ended March 31, 2017 and 2016 , the majority of our revenues and revenue growth has been from our larger clients as we move to larger average deals sizes and maintain strong customer retention rates.
Cost of Revenue
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Cost of revenue
 
$19,971
 
$16,610
 
$3,361
 
20%
% of Revenue
 
42%
 
44%
 
 
 
 
The increase in cost of revenue for the three months ended March 31, 2017 compared to the same period of 2016 was primarily due to a $1.5 million increase in cash-based personnel costs driven by increased headcount, a $0.8 million increase in USF contributions and other federal telecommunication service fees primarily due to increased client usage, a $0.4 million increase in third party hosted software costs due to increased client activities,

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and a $0.4 million increase in facility-related costs. The remainder of the increase was primarily due to our business growth and system implementations.
Gross Profit
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Gross profit
 
$27,043
 
$21,405
 
$5,638
 
26%
% of Revenue
 
58%
 
56%
 
 
 
 
The increase in gross profit and gross margin for the three months ended March 31, 2017 compared to the same period of 2016 was primarily due to economies of scale for subscription, improved efficiencies in usage, and higher amounts charged for, and better efficiencies in, professional services.
Operating Expenses
Research and Development
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Research and development
 
$6,847
 
$5,802
 
$1,045
 
18%
% of Revenue
 
15%
 
15%
 
 
 
 
The increase in research and development expenses for the three months ended March 31, 2017 compared to the same period of 2016 was primarily due to a $0.4 million increase in cash-based personnel-related costs resulting from increased headcount, a $0.2 million increase in consulting costs, a $0.2 million increase in stock-based compensation costs, and a $0.1 million increase in facilities and allocated overhead costs.
Sales and Marketing
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Sales and marketing
 
$15,778
 
$12,706
 
$3,072
 
24%
% of Revenue
 
34%
 
33%
 
 
 
 
The increase in sales and marketing expenses for the three months ended March 31, 2017 compared to the same period of 2016 was primarily due to a $1.3 million increase in cash-based personnel-related costs, a $0.7 million increase in commissions paid to sales personnel driven by the growth in sales and bookings of our solution, a $0.5 million increase in stock-based compensation costs, a $0.2 million increase in discretionary and other marketing-related expenses, and a $0.2 million increase in business travel and related expenses. These increases were primarily due to the execution of our growth strategy to acquire new clients, increase the number of agent seats within our existing client base and establish brand awareness.
General and Administrative
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
General and administrative
 
$8,860
 
$6,536
 
$2,324
 
36%
% of Revenue
 
18%
 
18%
 
 
 
 

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The increase in general and administrative expenses for the three months ended March 31, 2017 compared to the same period of 2016 was primarily due to $1.8 million in accrued settlement and legal costs incurred in the first quarter of 2017, a $0.9 million increase in cash-based personnel-related costs, and a $0.3 million increase in stock-based compensation costs. Partially offsetting these increases was a decrease of $0.3 million in facilities and allocated overhead costs and a $0.2 million decrease in consulting and audit costs.
Other Income (Expense), Net
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Interest expense
 
$
(882
)
 
$
(1,199
)
 
$
317

 
(26
)%
Interest income and other
 
118

 
(45
)
 
163

 
(362
)%
Total other income (expense), net
 
$
(764
)
 
$
(1,244
)
 
$
480

 
(39
)%
% of Revenue
 
(2
)%
 
(3
)%
 
 
 
 
The decrease in other income (expense), net for the three months ended March 31, 2017 compared to the same period of 2016 was primarily due lower interest expense related to lower interest rates under the 2016 Loan and Security Agreement compared to the 2014 Loan and Security Agreement and the 2013 Loan and Security Agreement.
Liquidity and Capital Resources
To date, we have financed our operations primarily through sales of our solution, lease facilities and net proceeds from our equity and debt financings. As of March 31, 2017 , we had cash and cash equivalents totaling $56.5 million .
As of March 31, 2017 , we had a total of $32.6 million in principal amount outstanding under a revolving credit facility governed by our 2016 Loan and Security Agreement . On August 1, 2016 , we entered into the 2016 Loan and Security Agreement with two lenders for the New Revolving Credit Facility of up to  $50.0 million . The New Revolving Credit Facility matures in August 1, 2019 . Under the terms of the New Revolving Credit Facility , the balance outstanding cannot exceed our trailing four months of MRR (monthly recurring revenue including subscription and usage) multiplied by the average trailing 12 month dollar based retention rate (calculated on the same basis as set forth in Item 2 of this report, see "Annual Dollar-Based Retention Rate"). The New Revolving Credit Facility carries a variable annual interest rate of the prime rate plus 0.50% , subject to a 0.25% increase if our adjusted EBITDA is negative at the end of any fiscal quarter. Upon the effectiveness of the 2016 Loan and Security Agreement , we immediately drew down $32.6 million and terminated the 2013 Loan and Security Agreement and the 2014 Loan and Security Agreement by repaying the aggregate outstanding principal, accrued interest and prepayment penalty balances thereunder of $32.4 million along with $0.2 million in administrative fees.
In addition, as of March 31, 2017 , we had a $0.8 million FCC civil penalty payable to the U.S. Treasury (see Note 5 of the notes to condensed consolidated financial statements included in this Form 10-Q).
We believe our existing cash and cash equivalents and the amount available for borrowing under our New Revolving Credit Facility (or any refinancing of the facility) will be sufficient to meet our working capital and capital expenditure needs at least through March 31, 2018. 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 development efforts, the outcome of any pending or future litigation or other claims by third parties or governmental entities, including the matter described in Note 11 . “Subsequent Events” to our financial statement footnotes included herein, the expansion of sales and marketing activities and the introduction of new and enhanced offerings. We may also acquire or invest in complementary businesses, technologies and intellectual property rights, which may increase our future capital requirements, both to pay acquisition costs and to support our combined operations. We may raise additional equity or debt financing at any time. We may not be able to raise additional equity or debt financing on terms acceptable to us or at all. If we are unable to raise additional capital when desired or required, our business, operating results, and financial condition would be harmed. In addition, if our operating performance during the next twelve months is below our expectations, our liquidity and ability to operate our business could be harmed.

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If we raise additional funds by issuing equity or equity-linked securities, the ownership of our existing stockholders will be diluted. If we raise additional funds through the incurrence of additional indebtedness, we will be subject to increased debt service obligations and could also be subject to new or additional restrictive covenants and other operating restrictions that could harm our ability to conduct our business.
Cash Flows
The following table summarizes our cash flows for the periods presented (in thousands, except percentages):
 
 
Three Months Ended
 
 
March 31, 2017
 
March 31, 2016
 
$ Change
 
% Change
Net cash provided by operating activities
 
$
159

 
$
52

 
$
107

 
206
%
Net cash used in investing activities
 
(514
)
 
(252
)
 
(262
)
 
104
%
Net cash used in financing activities
 
(1,315
)
 
(517
)
 
(798
)
 
154
%
Net decrease in cash and cash equivalents
 
$
(1,670
)
 
$
(717
)
 
$
(953
)
 
133
%
Cash Flows from Operating Activities
Cash provided by or used in operating activities is primarily influenced by our personnel-related expenditures, datacenters 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.
During the three months ended March 31, 2017 , net cash provided by operating activities was $0.2 million as compared to net cash provided by operating activities of $0.1 million for the same period of 2016 . The improvement was primarily due to a $0.6 million decrease in net loss after adjusting for non-cash expenses and a $0.5 million favorable change in net cash flows resulting from changes in operating assets and liabilities.
During the three months ended March 31, 2017 , cash inflows from changes in operating assets and liabilities included a $0.9 million increase in deferred revenue primarily attributable to increased billings, and a $3.1 million increase in accrued and other liabilities primarily for the $1.8 million accrual of settlement, legal and indemnification fees related to the Melcher litigation, ESPP withholdings for employees for the purchase period that commenced in November 2016, and additional employee paid-time-off liability due to timing of usage. Cash outflows from changes in operating assets and liabilities included primarily a $2.1 million increase in prepaid expenses and other current assets primarily related to long-term maintenance contracts and annual subscription fees on third-party licensed technology and insurance policies, and a $1.6 million increase in accounts receivable due to increased sales.
During the three months ended March 31, 2016, cash inflows from changes in operating assets and liabilities included a $1.9 million increase in accrued and other liabilities primarily for ESPP withholdings for employees for the purchase period that commenced in November 2015, additional employee paid-time-off liability due to timing of usage and sales commissions driven by the growth in sales and bookings of our solution, a $1.7 million increase in deferred revenue primarily attributable to increased billings, and a $0.8 million increase in accounts payable related to timing of liabilities and payments. Cash outflows from changes in operating assets and liabilities included primarily a $2.0 million increase in accounts receivable due to increased sales, and a $1.7 million increase in prepaid expenses and other current assets primarily related to long-term maintenance contracts and annual subscription fees on third-party licensed technology and insurance policies.
Cash Flows from Investing Activities
Net cash used in investing activities of $0.5 million in the three months ended March 31, 2017 and 2016 was primarily for purchase of property and equipment.

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Cash Flows from Financing Activities
During the three months ended March 31, 2017 , cash used in financing activities of $1.3 million was primarily related to $1.9 million in payments under our capital lease obligations and $0.3 million in repayments of notes payable. Cash outflows were offset in part by cash received from stock option exercises of $0.8 million .
During the three months ended March 31, 2016, cash used in financing activities of $0.5 million was primarily for repayments of $2.9 million on our capital lease and notes payable obligations, offset in part by cash received from stock option exercises of $2.4 million.
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. Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016 . During the three months ended March 31, 2017 , our critical accounting policies did not materially change. Please see Note 1 of Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.

Off Balance Sheet Arrangements
As of  March 31, 2017 , we did not have any off balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K, such as the use of unconsolidated subsidiaries, structured finance, special purpose entities or variable interest entities.
Contractual Obligations
Our principal contractual obligations consist of future payment obligations under debt, capital leases to finance data centers and other computer and networking equipment, operating leases for office space, research and development, and sales and marketing facilities, and agreements with third parties to provide co-location hosting, telecommunication usage and equipment maintenance services. These commitments as of December 31, 2016 are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016 , and did not change during the three months ended March 31, 2017 except for the acquisition of certain additional data center and network equipment and software under multiple capital leases. As of March 31, 2017 , total minimum future payment commitments under these capital leases added during the three months ended March 31, 2017 were approximately $2.6 million , of which  $0.6 million  is due in 2017, with the remainder due over approximately  28 months thereafter.
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk
We are exposed to market risk in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.
Interest Rate Sensitivity
As of March 31, 2017 , we had cash and cash equivalents of $56.5 million that were held primarily in cash or money-market funds. We hold our cash and cash equivalents for working capital purposes. Declines in interest rates would reduce future interest income. For the three months ended March 31, 2017 , the effect of a hypothetical 10% increase or decrease in overall interest rates would not have had a material impact on our interest income. The carrying amount of our cash equivalents reasonably approximates fair value. We do not enter into investments for trading or speculative purposes. Due to the short-term nature of our money-market funds, we believe that we do not

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have any material exposure to changes in the fair value of our cash equivalents as a result of changes in interest rates. 
As of March 31, 2017 , we had a total of $32.6 million in outstanding borrowings under our variable interest rate debt or financing agreements. See Note 5 of the notes to condensed consolidated financial statements of this Form 10-Q for a detailed discussion of our indebtedness. For the three months ended March 31, 2017 , a hypothetical 10% increase in the interest rates under these agreements would have increased our interest expense by approximately $35 thousand .
Foreign Currency Risk
The functional currency of our foreign subsidiaries is the U.S. dollar. Substantially all of our sales are denominated in U.S. dollars, and therefore our revenue is not currently subject to material direct foreign currency risk. However, if the U.S. dollar strengthens relative to other currencies, such strengthening could have an indirect effect on our sales to the extent it raises the cost of our solution to non-U.S. clients and thereby could reduce demand. A weaker U.S. dollar could have the opposite effect. The precise indirect effect of currency fluctuations is difficult to measure or predict because our sales are influenced by many factors in addition to the impact of such currency fluctuations.
Our operating expenses are primarily denominated in the currencies of the countries in which our operations are located, which are primarily the U.S., the Philippines, Russia, and the U.K. Our consolidated results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign currency exchange rates. To date, we have not entered into any hedging arrangements with respect to foreign currency risk or other derivative financial instruments. During the three months ended March 31, 2017 , the effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would have had a maximum impact of approximately $0.2 million on our operating results.
ITEM 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of  March 31, 2017 .
Based on management’s evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of  March 31, 2017 , our disclosure controls and procedures were designed, and were effective, to provide assurance at a reasonable level that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosures.
In designing and evaluating our disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Changes in Internal Control over Financial Reporting
During the three months ended March 31, 2017 , there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
We are subject to certain legal and regulatory proceedings described below, and from time to time may be involved in a variety of claims, lawsuits, investigations and proceedings relating to contractual disputes, intellectual property rights, employment matters, regulatory compliance matters and other litigation matters.
Melcher Litigation
On September 28, 2016, a complaint was filed in the United States District Court for the Southern District of California against Five9, Inc., or Five9, as the successor in interest to Face It, Corp., or Face It, and Lance Fried, a former Five9 employee who was the former Chief Executive Officer of Face It. The action, captioned Melcher, et al. v. Five9, Inc., et al., No. 16-cv-02440, or the Federal Lawsuit, was filed as a direct action by Carl Melcher, or Melcher, a purported former stockholder of Face It, and his related investment entity Melcher Family Limited Partnership, or MFLP.
In the complaint, the plaintiffs allege that Face It repurchased the plaintiffs’ stock in September 2013 before Five9 acquired Face It, and that in connection with the repurchase, Fried made material misstatements or omissions to Melcher, by failing to disclose that Face It allegedly was in concurrent discussions about a potential sale of the company to Five9. The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, as well as various claims under state law and common law. The complaint seeks to set aside Face It’s September 2013 stock repurchase from the plaintiffs, as well as an unspecified amount of damages and an award of attorney’s fees and costs, in addition to other relief.
On November 8, 2016, the court entered an order staying the Federal Lawsuit and ordered the parties to proceed to arbitration of the dispute before the American Arbitration Association, or AAA. On November 16, 2016, Melcher and MFLP submitted a Demand for Arbitration to AAA against Five9, asserting claims identical to those alleged in the Federal Lawsuit.
On March 31, 2017, we reached a settlement with the plaintiffs that fully resolves the plaintiffs’ claims against us and provides for mutual releases between the parties in exchange for a one-time payment by us to the plaintiffs of $1.7 million . The settlement amount is included in 'accrued and other current liabilities' in the condensed consolidated balance sheets and 'general and administrative' expense in the statements of operations and comprehensive loss.
We believe that we have indemnification rights against the former stockholders of Face It for losses incurred in connection with the defense and resolution of this matter.
NobelBiz Litigation
On August 5, 2011, NobelBiz sent a letter to us asserting infringement of a patent related to virtual call centers. On April 3, 2012, NobelBiz filed a patent infringement lawsuit against us in the United States District Court for the Eastern District of Texas. The patent asserted in the complaint is different, but related, to the patent asserted in the original letter. The lawsuit, NobelBiz Inc. v. Five9, Inc., Case No. 6:12-cv-00243-LED, alleges that our local caller ID management service infringes United States Patent No. 8,135,122, or the ‘122 patent. The ‘122 patent, titled “System and Method for Modifying Communication Information (MCI),” issued on March 13, 2012, and according to the complaint is alleged to relate to “a system for processing a telephone call from a call originator (also referred to as a calling party) to a call target (also referred to as a receiving party), where the system accesses a database storing outgoing telephone numbers, selects a replacement telephone number from the outgoing telephone numbers based on the telephone number of the call target, and originates an outbound call to the call target with a modified outgoing caller identification (‘caller ID’).” NobelBiz seeks damages in the form of lost profits as well as injunctive relief. The lawsuit is one of several lawsuits filed by NobelBiz against various companies including TCN Inc., LiveVox, Inc. and Global Connect LLC. On March 28, 2013, the court granted our motion to transfer the case to the United States District Court for the Northern District of California. Subsequently, NobelBiz amended its complaint to add claims related to U.S. Patent No. 8,565,399, or the ‘399 patent, which is a continuation in the same family as the ‘122 patent and addresses the same technology. We responded to the complaint and amended complaint by asserting noninfringement and invalidity of the ‘122 and ‘399 patents. On January 16, 2015, the court issued an order regarding claim construction of the two patents-in-suit. On March 7, 2016, the court stayed the case pending an appeal in lawsuits involving NobelBiz, Global Connect and TCN that also involve the ‘122 and ‘399 patents. The appeal for those cases is likely to last until later this year, after which time the lawsuit between NobelBiz and Five9 will resume and a new schedule will be entered by the Court.

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The outcome of litigation and regulatory claims cannot be predicted with certainty, may be expensive and cause distraction to our management, even if we are ultimately successful, and could harm our future results of operations, cash flows and financial condition.
ITEM 1A. Risk Factors
Our operations and financial results are subject to various risks and uncertainties. You should consider carefully the risks and uncertainties described below, together with all of the other information in this report. If any of the following risks or other risks actually occur, our business, financial condition, results of operations, and future prospects could be materially harmed, and the price of our common stock could decline.
The following description of the risk factors associated with our business includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 .
Risks Related to Our Business and Industry
Our quarterly and annual results may fluctuate significantly, may not fully reflect the underlying performance of our business and may result in decreases in the price of our common stock.
Our quarterly and annual results of operations, including our revenues, profitability and cash flow have varied, and may vary significantly in the future, and period-to-period comparisons of our operating results may not be meaningful. Accordingly, the results of any one quarter or period should not be relied upon as an indication of future performance. Our quarterly and annual financial results may fluctuate as a result of a variety of factors, many of which are outside our control and, as a result, may not fully reflect the underlying performance of our business. Fluctuation in quarterly and annual results may harm the value of our common stock. Factors that may cause fluctuations in our quarterly and annual results include, without limitation:
market acceptance of our solution;
our ability to attract new clients and grow our business with existing clients;
client renewal rates;
our ability to adequately expand our sales and service team;
our ability to acquire and maintain strategic and client relationships;
the amount and timing of costs and expenses related to the maintenance and expansion of our business, operations and infrastructure;
the timing and success of new product and feature introductions by us or our competitors or any other change in the competitive dynamics of our industry, including consolidation among competitors, clients or strategic partners;
network outages or security incidents, including the matter described in Note 11 . “Subsequent Events” to our financial statement footnotes included herein, which may result in additional expenses or losses, the loss of clients, the provision of client credits, and harm to our reputation;
seasonal factors that may cause our revenues in the first half of a year to be relatively lower than our revenues in the second half of a year;
inaccessibility or failure of our cloud contact center software due to failures in the products or services provided by third parties;
our ability to expand, and effectively utilize our network of master agents and resellers;
the timing of recognition of revenues under current and future GAAP;    
changes in our pricing policies or those of our competitors;
the level of professional services and support we provide our clients;
the components of our revenue;
the addition or loss of key clients, including through acquisitions or consolidations;
general economic, industry and market conditions;
the timing of costs and expenses related to the development or acquisition of technologies or businesses and potential future charges for impairment of goodwill from acquired companies;
compliance with, or changes in, the current and future domestic and international regulatory environment;

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the hiring, training and retention of key employees;
litigation or other claims against us;
the ability to expand internationally, and to do so profitability;
our ability to obtain additional financing;
advances and trends in new technologies and industry standards; and
increases or decreases in the costs to provide our solution or pricing changes upon any renewals of client agreements.
If we are unable to attract new clients or sell additional services and functionality to our existing clients, our revenue and revenue growth will be harmed.
To increase our revenue, we must add new clients, add additional agent seats and sell additional functionality to existing clients, and encourage existing clients to renew their subscriptions on terms favorable to us. As our industry matures, as our clients experience seasonal trends in their business, or as competitors introduce lower cost and/or differentiated products or services that are perceived to compete favorably with ours, our ability to add new clients and renew, maintain or sell additional services to existing clients based on pricing, cost of ownership, technology and functionality could be harmed. As a result, our existing clients may not renew our agreements, and we may be unable to attract new clients or grow or maintain our business with existing clients, which could harm our revenue and growth.
Furthermore, a portion of our revenue is generated by acquiring domestic and international telecommunications minutes from wholesale telecommunication service providers and reselling those minutes to our clients. As a result, if telecommunications rates decrease, we must resell more minutes to maintain our level of usage revenue.
Our recent rapid growth may not be indicative of our future growth, and if we continue to grow rapidly, we may fail to manage our growth effectively.
For the three months ended March 31, 2017 , our revenue was  $47.0 million , which increased by  $9.0 million , or  24% , from  $38.0 million  for the same period of 2016 . For the years ended December 31, 2016, 2015 and 2014, our revenues were $162.1 million, $128.9 million and $103.1 million, respectively, representing year-over-year growth of 26% and 25%, respectively. In the future, as our revenue increases, our annual revenue growth rate may decline. We believe growth of our revenue depends on a number of factors, including our ability to:
compete with other vendors of cloud-based enterprise contact center systems to capture market share from providers of legacy on-premise systems;
increase our existing clients’ use of our solution and further develop our partner ecosystem;
strengthen and improve our solution through significant investments in research and development and the introduction of new and enhanced solutions;
introduce our solution to new markets outside of the United States and increase global awareness of our brand; and
selectively pursue acquisitions.
If we are not successful in achieving these objectives, our revenue may be harmed. In addition, we plan to continue to invest in future growth, including expending substantial financial and other resources on:
sales and marketing, including a significant expansion of our sales and professional services organization;
our technology infrastructure, including systems architecture, management tools, scalability, availability, performance and security, as well as disaster recovery measures;
solution development, including investments in our solution development team and the development of new solutions, as well as new applications and features for existing solutions;
international expansion; and
general administration, including legal, regulatory compliance and accounting expenses. 
Moreover, we continue to expand our headcount and operations. We grew from 692 employees as of December 31, 2015 to 807 employees as of March 31, 2017 . We anticipate that we will continue to expand our operations and headcount in the near term. This growth has placed, and future growth will place, a significant strain on our management, administrative, operational and financial resources and infrastructure. Our success will depend

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in part on our ability to manage this growth effectively. To manage the expected growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. Failure to effectively manage growth could result in difficulty or delays in adding new clients, declines in quality or client satisfaction, increases in costs, system failures, difficulties in introducing new features or solutions, the need for more capital than we anticipate or other operational difficulties, and any of these difficulties could harm our business performance and results of operations.
The expected addition of new employees and the capital investments that we anticipate will be necessary to manage our anticipated growth will make it more difficult for us to generate earnings or offset any future revenue shortfalls by reducing costs and expenses in the short term. If we fail to manage our anticipated growth, we will be unable to execute our business plan successfully.
Failure to adequately expand our direct sales force will impede our growth.
We will need to continue to expand and optimize our sales infrastructure in order to grow our client base and business. We plan to continue to expand our direct sales force, both domestically and internationally. Identifying and recruiting qualified personnel and training them in the use and sale of our solution requires significant time, expense and attention. It can take several months before our sales representatives are fully trained and productive. Our business may be harmed if our efforts to expand and train our direct sales force do not generate a corresponding increase in revenues. In particular, if we are unable to hire, develop and retain talented sales personnel or if new sales personnel are unable to achieve desired productivity levels in a reasonable period of time, we may not be able to realize the expected benefits of this investment or increase our revenues.
If we fail to manage our technical operations infrastructure, our existing clients may experience service outages, our new clients may experience delays in the deployment of our solution and we could be subject to, among other things, claims for credits or damages.
Our success depends in large part upon the capacity, stability and performance of our operations infrastructure. From time to time, we have experienced interruptions in service, and may experience such interruptions in the future. These service interruptions may be caused by a variety of factors, including infrastructure changes, human or software errors, viruses, security attacks, fraud, spikes in client usage and denial of service issues. In some instances, we may not be able to identify the cause or causes of these performance problems within an acceptable period of time. Our failure to achieve or maintain expected performance levels, stability and security could harm our relationships with our clients, result in claims for credits or damages, damage our reputation and significantly reduce client demand for our solution and harm our business.
Any future service interruptions could:
cause our clients to seek credits or damages for losses incurred;
cause existing clients to cancel their contracts and move to a competitor;
affect our reputation as a reliable service provider;
make it more difficult for us to attract new clients or expand our business with existing clients; or
require us to replace existing equipment.
We have experienced significant growth in the number of agents and interactions that our infrastructure supports. As the number of agent seats within our client base grows and our clients' use of our service increases, we will need to continue to make additional investments in our capacity to maintain adequate stability and performance, the availability of which may be limited or the cost of which may be prohibitive. In addition, we need to properly manage our operations infrastructure in order to support version control, changes in hardware and software parameters and the evolution of our solution. If we do not accurately predict or improve our infrastructure requirements to keep pace with growth in our business, our business could be harmed.
Security breaches and improper access to or disclosure of our data or our clients’ data, or other cyber attacks on our systems, could result in litigation and regulatory risk, harm our reputation and adversely affect our business.
Our solution involves the storage and transmission of our clients’ information, including information about our clients’ customers or other information treated by our clients as confidential. Unauthorized access, security breaches or other cyber attacks could result in the loss of confidentiality, integrity and availability of such information, or unauthorized use of our systems, leading to litigation, indemnity obligations, increased expense, and other liability. Such incidents could also cause interruptions to the solution we provide, degrade the user experience,

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or cause clients to lose confidence in our solution. In April 2017, we were notified that third parties are suspected of having unlawfully acquired some of our clients’ information. We believe this acquisition was the result of a vulnerability that has now been remediated. Clients determined to have been impacted have been notified. We are working closely with law enforcement authorities and conducting our own ongoing internal investigation with the assistance of outside counsel and technical experts. Expenses incurred to date related to this incident have not been material. We will incur additional expenses and may incur losses in connection with this incident, however, at this time we are unable to reasonably estimate any such additional expenses or losses.
While we have security measures in place to protect client information and minimize the probability of security breaches and other cyber attacks, if these measures fail as a result of a cyber-attack, other third-party action, employee error, malfeasance or otherwise, and someone obtains unauthorized access to our clients’ information, our reputation could be damaged, our business may suffer and we could incur significant liability. Because the techniques used to obtain unauthorized access or sabotage systems change frequently and generally are not identified until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Moreover, any failure on the part of third parties, including our clients, to achieve or maintain security measures for their own systems could harm our relationships with our clients, result in claims against us for credits or damages, damage our reputation and significantly reduce client demand for our solution. Any or all of these issues could harm our ability to attract new clients, cause existing clients to cancel, reduce or not renew their subscriptions, result in reputational damage or subject us to third-party lawsuits, regulatory fines or other action or liability, including orders or consent decrees forcing us to modify our business practices, all of which could have a material and adverse effect on our business, reputation or financial results.
The markets in which we participate are highly competitive, and if we do not compete effectively, our operating results could be harmed.
The market for contact center solutions is highly competitive. Generally, we do not have long-term contracts with our clients and our clients can terminate our service and switch to competitors’ offerings on short notice.
We currently compete with large legacy technology vendors that offer on-premise enterprise telephony and contact center systems, such as Avaya and Cisco, and legacy on-premise software companies that come from a computer-telephony integration, or CTI, heritage, such as Aspect, and Genesys (including through its recent acquisition of Interactive Intelligence). These companies are supplementing their traditional on-premise contact center systems with cloud offerings, either through acquisition or in-house development. Additionally, we compete with vendors that historically provided other contact center services and technologies and expanded to offer cloud contact center software. These companies include inContact (recently acquired by NICE Ltd.) and LiveOps, now named Seranova. We also face competition from smaller contact center service providers with specialized contact center software offerings. Our actual and potential competitors may enjoy competitive advantages over us, including greater name recognition, longer operating histories and larger marketing budgets, as well as greater financial or technical resources. With the introduction of new technologies and market entrants, we expect competition to intensify in the future.
Some of our competitors can devote significantly greater resources than we can to the development, promotion and sale of their products and services and many have the ability to initiate or withstand substantial price competition. Current or potential competitors may also be acquired by third parties with significantly greater resources, such as NICE Ltd.'s acquisition of inContact and Genesys’ acquisition of Interactive Intelligence. In addition, many of our competitors have stronger name recognition, longer operating histories, established relationships with clients, more comprehensive product offerings, larger installed bases and major distribution agreements with consultants, system integrators and resellers. Our competitors may also establish cooperative relationships among themselves or with third parties that may further enhance their product offerings or resources and ability to compete. If our competitors’ products, services or technologies become more accepted than our solution, if they are successful in bringing their products or services to market earlier than ours, or if their products or services are less expensive or more technologically capable than ours, our revenues could be harmed. Pricing pressures and increased competition could result in reduced sales and revenues, reduced margins and loss of, or a failure to maintain or improve, our competitive market position, any of which could harm our business.

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If our existing clients terminate their subscriptions or reduce their subscriptions and related usage, our revenues and gross margins will be harmed and we will be required to spend more money to grow our client base.
We expect to continue to derive a significant portion of our revenues from existing clients. As a result, retaining our existing clients is critical to our future operating results. We offer monthly, annual and multiple-year contracts to our clients, with 30 days’ notice generally required for changes in the number of agent seats or termination of their contracts. Subscriptions and related usage by our existing clients may decrease if:
clients are not satisfied with our services, prices or the functionality of our solution;
the stability, performance or security of our hosting infrastructure and hosting services are not satisfactory;
our clients’ business declines due to industry cycles, seasonality, business difficulties or other reasons;
competition increases from other contact center providers;
the attach rate of voice traffic purchased through us decreases;
alternative technologies, products or features emerge that we do not provide;
our clients or potential clients experience financial difficulties; or
the U.S. or global economy declines.
If our existing clients’ subscriptions and related usage decrease or are terminated, we will need to spend more money to acquire new clients to maintain our existing level of revenues. We incur significant costs and expenses, including sales and marketing expenses, to acquire new clients, and those costs and expenses are an important factor in determining our net profitability. There can be no assurance that our efforts to acquire new clients will be successful.
Our growth depends in part on the success of our strategic relationships with third parties and our failure to successfully grow and manage these relationships could harm our business.
We leverage strategic relationships with third parties, such as CRM providers, Workforce Optimization, or WFO, providers, other technology providers, system integrators, and telephony providers. For example, our CRM and system integrator relationships provide significant lead generation for new client opportunities. As we grow our business, we will continue to depend on both existing and new strategic relationships. Our competitors may be more successful than we are in establishing or expanding relationships with third parties or may provide incentives to third parties to favor their products over our solution. These strategic partners may cease to recommend our solution to prospective clients due to actual or perceived lack of features, technological or security issues or failures, reputational concerns, economic incentives, or other factors, which would harm our business, financial condition and operations. Furthermore, there has and continues to be a significant amount of consolidation in our industry and adjacent industries, and if our partners are acquired, fail to work effectively with us or go out of business, they may no longer support or promote our solution, or may be less effective in doing so, which could harm our business, financial condition and operations. If we are unsuccessful in establishing or maintaining our strategic relationships with third parties, or these partners fail to recommend our solution, our ability to compete in the marketplace or to grow our revenues could be impaired and our operating results may suffer. Even if we are successful, we cannot assure you that these relationships will result in increased client usage of our solution or increased revenue.
In addition, identifying new partners, and negotiating and documenting relationships with them, requires significant time and resources. As the complexity of our solution and our third-party relationships increases, the management of those relationships and the negotiation of contractual terms sufficient to protect our rights and limit our potential liabilities will become more complicated. We also license technology from certain third parties, including through OEM relationships. Certain of these agreements permit either party to terminate all or a portion of the relationship without cause at any time and for any reason. If one of these agreements is terminated by the other party, we would have to find an alternative source or develop new technology ourselves, either of which could cause delays in our ability to offer our solution or certain product features to our to clients, result in increased expense and harm our business. Our inability to successfully manage and maintain these complex relationships or negotiate sufficient contractual terms could harm our business.

We are establishing a network of master agents and resellers to sell our solution; our failure to effectively develop, manage, and maintain this network could materially harm our revenues.
We are establishing a network of master sales agents, which provide sales leads, and resellers, which sell our solution to new and existing clients. We expect that this network will enable us to attract additional clients. We expect our resellers will also assist us in expanding internationally. These master agents and resellers sell, or may in

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the future decide to sell, solutions for our competitors. Our competitors may be able to cause our current or potential resellers to favor their services over ours, either through financial incentives, technological innovation, by offering a broader array of services to these service providers or otherwise, which could reduce the effectiveness of our use of these third parties. If we fail to maintain relationships with current master agents and resellers, fail to develop relationships with new master agents and resellers in new and existing markets, if we fail to manage, train, or provide appropriate incentives to our existing master agents and resellers, or if our master agents and resellers are not successful in their sales efforts, sales of our subscriptions may decrease or not grow at an appropriate rate and our operating results could be harmed.
In addition, identifying new resellers, and negotiating and documenting relationships with them, requires significant time and resources. As the complexity of our solution and our reseller relationships increases, the management of those relationships and the negotiation of contractual terms sufficient to protect our rights and limit our potential liabilities will become more complicated. Our inability to successfully manage these complex relationships or negotiate sufficient contractual terms could harm our business.
The loss of one or more of our key clients, or a failure to renew our subscription agreements with one or more of our key clients, could harm our ability to market our solution.
We rely on our reputation and recommendations from key clients in order to market and sell our solution. The loss of any of our key clients, or a failure of some of them to renew or to continue to recommend our solution, could have a significant impact on our revenues, reputation and our ability to obtain new clients. In addition, acquisitions of our clients could lead to cancellation of our contracts with those clients, thereby reducing the number of our existing and potential clients.
Our clients may fail to comply with the terms of their agreements, necessitating action by us to collect payment, or may terminate their subscriptions for our solution.
If clients fail to pay us under the terms of our agreements or fail to comply with the terms of our agreements, including compliance with regulatory requirements, we may terminate clients, lose revenue, be unable to collect amounts due to us, be subject to legal or regulatory action and incur costs in enforcing the terms of our contracts, including litigation. Some of our clients may seek bankruptcy protection or other similar relief and fail to pay amounts due to us, seek reimbursement for amounts already paid, or pay those amounts more slowly, either of which could harm our operating results, financial position and cash flow.
We sell our solution to larger organizations that require longer sales and implementation cycles and often demand more configuration and integration services or customized features and functions that we may not offer, any of which could delay or prevent these sales and harm our growth rates, business and operating results.
As we continue to target our sales efforts at larger organizations, we face greater costs, longer sales and implementation cycles and less predictability in completing our sales. These larger organizations typically require more configuration and integration services, which increases our upfront investment in sales and deployment efforts, with no guarantee that these clients will subscribe to our solution or increase the scope of their subscription. Furthermore, with larger organizations, we must provide greater levels of education regarding the use and benefits of our solution to a broader group of people. As a result of these factors, we must devote a significant amount of sales support and professional services resources to individual clients and prospective clients, thereby increasing the cost and time required to complete sales. Our typical sales cycle for larger organizations is four to six months , but can be significantly longer, and we expect that our average sales cycle may increase as sales to larger organizations continue to grow as a percentage of our business. Longer sales cycles could cause our operating and financial results to be less predictable and to fluctuate from period to period. In addition, many of our clients that are larger organizations initially deploy our solution to support only a portion of their contact center agents. Our success depends on our ability to increase the number of agent seats and the number of applications utilized by larger organizations over time. There is no guarantee that these clients will increase their subscriptions for our solution. If we do not expand our initial relationships with larger organizations, the return on our investments in sales and deployment efforts for these clients will decrease and our business may suffer.
Furthermore, we may not be able to provide the configuration and integration services that larger organizations typically require. For example, our solution does not currently permit clients to modify our software code, but instead requires them to use our set of application programming interfaces, or APIs. If prospective clients require customized features or functions that we do not offer, and that would be difficult for them to deploy

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themselves, they will need to use our services or third-party service providers or we may lose sales opportunities with larger organizations and our business could suffer.
Because a significant percentage of our revenue is derived from existing clients, downturns or upturns in new sales will not be immediately reflected in our operating results and may be difficult to discern.
We generally recognize subscription revenue from clients monthly as services are delivered. As a result, a significant percentage of the subscription revenue we report in each quarter is derived from existing clients. Consequently, a decline in new subscriptions in any single quarter will likely have only a small impact on our revenue results for that quarter. However, the cumulative impact of such declines could harm our revenues in future quarters. Accordingly, the effect of significant downturns in sales and market acceptance of our solution, and potential changes in our pricing policies or renewal rates, will typically not be reflected in our results of operations until future periods. We also may be unable to adjust our cost structure to reflect the changes in revenue, resulting in lower margins and earnings. In addition, our subscription model makes it difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new clients will be recognized over time as services are delivered. For example, many of our clients initially deploy our solution to support only a portion of their contact center agents. Any increase to our revenue and the value of these existing client relationships will only be reflected in our results of operations if and when these clients increase the number of agent seats and the number of components of our solution over time.
We rely on third-party telecommunications and internet service providers to provide our clients and their customers with telecommunication services and connectivity to our cloud contact center software and any failure by these service providers to provide reliable services could subject us to, among other things, claims for credits or damages.
We rely on third-party telecommunication service providers to provide our clients and their customers with telecommunication services. These telephony services include the public switched telephone network, or PSTN, telephone numbers, call termination and origination services, and local number portability for our clients. In addition, we depend on our internet bandwidth suppliers to provide uninterrupted and error-free service through their telecommunications networks. We exercise little control over these third-party providers, which increases our vulnerability to problems with the services they provide. If any of these service providers fail to provide reliable services, or terminate or increase the cost of the services that we and our clients depend on, we may be required to switch to another service provider. Delays caused by switching our technology to another service provider, if available, and qualifying this new service provider could materially harm our client relationships, business, financial condition and operating results.
Due to our reliance on these service providers, when problems occur, it may be difficult to identify the source of the problem. Service disruption or outages, whether caused by our service, the products or services of our third-party service providers, or our clients’ or their customers’ equipment and systems, may result in loss of market acceptance of our solution and any necessary repairs or other remedial actions may force us to incur significant costs and expenses. Any failure on the part of third-party service providers to achieve or maintain expected performance levels, stability and security could harm our relationships with our clients, result in claims for credits or damages, damage our reputation, significantly reduce client demand for our solution and seriously harm our financial condition and operating results.
We depend on data centers operated by third parties and any disruption in the operation of these facilities could harm our business.
We host our solution at data centers located in Santa Clara, California; Atlanta, Georgia; Slough, England and Amsterdam, The Netherlands. Any failure or downtime in one of our data center facilities could affect a significant percentage of our clients. While we control and have access to our servers and all of the components of our network that are located in our external data centers, we do not control the operation of these facilities. The owners of our data center facilities have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, or if one of our data center operators is acquired, closes, suffers financial difficulty or is unable to meet our growing capacity needs, we may be required to transfer our servers and other infrastructure to new data center facilities, and we may incur significant costs and service interruptions in connection with doing so.
Our data centers are subject to various points of failure. Problems with cooling equipment, generators, uninterruptible power supply, routers, switches, or other equipment, whether or not within our control, could result

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in service interruptions for our clients as well as equipment damage. Our data centers are subject to disasters such as earthquakes, floods, fires, hurricanes, acts of terrorism, sabotage, break-ins, acts of vandalism and other events, which could cause service interruptions or the operators of these data centers to close their facilities for an extended period of time or permanently. The destruction or impairment of any of our data center facilities could result in significant downtime for our solution and the loss of client data. Because our ability to attract and retain clients depends on our providing clients with highly reliable service, even minor interruptions in our service could harm our business, revenues and reputation. Additionally, in connection with the continuing expansion of our existing data center facilities, there is an increased risk that service interruptions may occur as a result of server addition, relocation or other issues.
Our data centers are also subject to increased power costs. We may not be able to pass on any increase in power costs to our clients, which could reduce our operating margins.
Shifts over time or from quarter-to-quarter in the mix of sizes or types of organizations that purchase our solution or changes in the components of our solution purchased by our clients could affect our gross margins and operating results.
Our strategy is to sell our solution to both smaller and larger organizations. Our gross margins can vary depending on numerous factors related to the implementation and use of our solution, including the features and number of agent seats purchased by our clients and the level of usage and professional services and support required by our clients. For example, our larger clients typically require more professional services and because our professional services offerings typically have negative margins, any increase in sales of professional services could harm our gross margins and operating results. We also have lower margins on our usage revenues. Sales to larger organizations may also entail longer sales cycles and more significant selling efforts. Selling to smaller clients may involve smaller contract sizes, fewer opportunities to sell additional services, a higher likelihood of contract terminations, fewer potential agent seats and greater credit risk and uncertainty. If the mix of organizations that purchase our solution, or the mix of solution components purchased by our clients, changes unfavorably, our revenues and gross margins could decrease and our operating results could be harmed.

We are in the process of expanding our international operations, which exposes us to significant risks.
To date, we have not generated significant revenues from outside of the U.S., Canada and the U.K. However, we already have significant operations outside these countries and we expect to grow our international presence in the future. The future success of our business will depend, in part, on our ability to expand our operations and customer base worldwide. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic, and political risks that are different from those in the U.S. Due to our limited experience with international operations and developing and managing sales and distribution channels in international markets, our international expansion efforts may not be successful.
We have a history of losses and we may be unable to achieve or sustain profitability.
We have incurred significant losses in each period since our inception in 2001. We incurred net losses of  $5.3 million  and  $4.9 million  in the three months ended March 31, 2017  and 2016 , respectively, and a net loss of $11.9 million in the year ended December 31, 2016 . As of March 31, 2017 , we had an accumulated deficit of $171.7 million . These losses and our accumulated deficit reflect the substantial investments we have made to develop our solution and acquire new clients. We expect the dollar amount of our costs and expenses to increase in the future as revenue increases, although at a slower rate. We expect our losses to continue for the foreseeable future as we continue to develop and expand our business. Furthermore, to the extent we are successful in increasing our client base, we may also incur increased losses because costs associated with acquiring clients are generally incurred up front, while revenues are recognized over the course of the client relationship. We also have negative gross margins on our professional services, which are expected to continue in the medium term. In addition, as a public company, we incur significant legal, accounting and other expenses. Our historical or recent growth in revenues is not necessarily indicative of our future performance. Accordingly, we cannot assure you that we will achieve profitability in the future nor that, if we do become profitable, we will sustain profitability.
If the market for cloud contact center software solutions develops more slowly than we expect or declines, our business could be harmed.
The cloud contact center software market is not as mature as the market for legacy on-premise contact center systems, and it is uncertain whether cloud contact center solutions will achieve and sustain high levels of client

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demand and market acceptance. Our success will depend to a substantial extent on the widespread adoption of cloud contact center software solutions as a replacement for legacy on-premise systems. Many larger organizations have invested substantial technical, personnel and financial resources to integrate legacy on-premise contact center systems into their businesses and, therefore, may be reluctant or unwilling to migrate to cloud contact center solutions such as ours. It is difficult to predict client adoption rates and demand for our solution, the future growth rate and size of the cloud contact center software market, or the entry of competitive products and services. The expansion of the cloud contact center software market depends on a number of factors, including the refresh rate for legacy on-premise systems, cost, performance and perceived value associated with cloud contact center software solutions, as well as the ability of providers of cloud contact center software solutions to address security, stability and privacy concerns. If we or other cloud contact center solution providers experience security incidents, loss of client data, disruptions in service or other problems, the market for cloud contact center software products, solutions and services as a whole, including our solution, may be harmed. If cloud contact center software solutions do not achieve widespread adoption, or there is a reduction in demand for such solutions caused by a lack of client acceptance, enhanced product offerings from on-premise providers, technological challenges, weakening economic conditions, security or privacy concerns, competing technologies and products, decreases in corporate spending or otherwise, it could result in decreased revenues and our business could be harmed.
Our recent growth makes it difficult to evaluate and predict our current business and future prospects.
While we have been in existence since 2001, much of our growth has occurred in recent years. Our recent growth may make it difficult for investors to evaluate our current business and our future prospects. We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries, including increasing and unforeseen expenses as we continue to grow our business.
Our ability to forecast our future operating results is limited and subject to a number of uncertainties, including our ability to predict revenue levels, and plan for and model future growth. We have encountered and will continue to encounter risks and uncertainties frequently experienced by growing companies in rapidly changing industries, such as the risks and uncertainties described in this report. If our assumptions regarding these risks and uncertainties, which we use to plan our business, are incorrect or change due to adjustments in our markets or our competitors and their product offerings, or if we do not address these risks successfully, our operating and financial results could differ materially from our expectations and our business could suffer.
If our solution fails, or is perceived to fail, to perform properly or if it contains technical defects, our reputation could be harmed, our market share may decline and we could be subject to product liability claims.
Our solution may contain undetected errors or defects that may result in failures or otherwise cause our solution to fail to perform in accordance with client expectations. Moreover, our clients could incorrectly implement or inadvertently misuse our products, which could result in client dissatisfaction and harm the perceived utility of our products and our brand. Because our clients use our solution for mission-critical aspects of their business, any real or perceived errors or defects in, or other performance problems with, our solution may damage our clients’ businesses and could significantly harm our reputation. If that occurs, we could lose future sales, or our existing clients could elect to cancel our solution, seek payment credits, seek damages against us, or delay or withhold payment to us, which could result in reduced revenues, an increase in our provision for uncollectible accounts and service credits, an increase in collection cycles for accounts receivable, and harm our financial results. In addition, since telecommunications billing is inherently complex and requires highly sophisticated information systems to administer, our billing system may experience errors or we may improperly operate the system, which could result in the system incorrectly calculating the fees owed by our clients or related taxes and administrative fees. Clients also may make indemnification or warranty claims against us, which could result in significant expense and risk of litigation. Product performance problems could result in loss of market share, failure to achieve market acceptance and the diversion of development resources.
Any product liability, intellectual property, warranty or other claims against us could damage our reputation and relationships with our clients, and could require us to spend significant time and money in litigation or pay significant settlements or damages. Although we maintain general liability insurance, including coverage for errors and omissions, this coverage may not be sufficient to cover liabilities resulting from such claims. Also, our insurers may disclaim coverage. Our liability insurance also may not continue to be available to us on reasonable terms, in sufficient amounts, or at all. Any contract or product liability claims successfully brought against us would harm our business.

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We are subject to many hazards and operational risks that can disrupt our business, some of which may not be insured or fully covered by insurance.
Our operations are subject to many hazards inherent in the cloud contact center software business, including:
damage to third-party and our infrastructure and data centers, related equipment and surrounding properties caused by earthquakes, hurricanes, tornadoes, floods, fires and other natural disasters, explosions and acts of terrorism;
security breaches resulting in loss or disclosure of confidential client and customer data and potential liability to clients and non-client third parties for such disclosures;
inadvertent damage from third parties; and
other hazards that could also result in suspension of operations, personal injury and even loss of life. 
These risks could result in substantial losses and the curtailment or suspension of our operations. For example, in the event of a major earthquake along the West Coast of the United States (where our corporate headquarters and one of our data centers are located), hurricane or tropical storm in the southeastern United States (where our other U.S. data center is located) or catastrophic events such as fire, power loss, telecommunications failure, cyber-attack, war or terrorist attack, we may be unable to continue our operations and may endure system and service interruptions, reputational harm, delays in product development, breaches of data security and loss of critical data, any of which could harm our business and operating results.
We are not insured against all claims, events or accidents that might occur. If a significant accident or event occurs that is not fully insured, if we fail to recover all anticipated insurance proceeds for significant accidents or events for which we are insured, or if we or our data center providers fail to reopen facilities damaged by such accidents or events, our operations and financial condition could be harmed. In addition to being denied coverage under existing insurance policies, we may not be able to maintain or obtain insurance of the type and amount we desire at reasonable rates.
The contact center software solutions market is subject to rapid technological change, and we must develop and sell incremental and new products in order to maintain and grow our business.
The contact center software solutions market is characterized by rapid changes in client requirements, frequent introductions of new and enhanced products and features and continuing and rapid technological advancement. To compete successfully, we must continue to design, develop, manufacture and sell new and enhanced contact center products, applications and features that provide increasingly higher capabilities, performance and stability at lower cost. If we are unable to develop or acquire new features for our existing solution or new applications that achieve market acceptance or that keep pace with technological developments, our business would be harmed. For example, we are focused on enhancing the reliability, features and functionality of our contact center solution to enhance its utility to our clients, particularly larger clients with complex, dynamic and global operations. The success of these enhancements depends on many factors, including timely development, introduction and market acceptance, as well as our ability to transition our existing clients to these new products, applications and features. Failure in this regard may significantly impair our revenue growth. In addition, because our solution is designed to operate on a variety of systems, we will need to continuously modify and enhance our solution to keep pace with changes in hardware, operating systems, the increasing trend toward multi-channel communications and other changes to software technologies. We may not be successful in developing or acquiring these modifications and enhancements or bringing them to market in a timely fashion. Furthermore, uncertainties about the timing and nature of new network platforms or technologies, or modifications to existing platforms or technologies, could delay introduction of our solution and increase our research and development expenses. Any failure of our solution to operate effectively with future network platforms and technologies could reduce the demand for our solution, result in client dissatisfaction and harm our business.
Our ability to continue to enhance our solution is dependent on adequate research and development resources. If we are not able to adequately fund our research and development efforts, we may not be able to compete effectively and our business and operating results may be harmed.
In order to remain competitive, we must continue to develop new solution offerings and enhancements to our existing cloud contact center software. Maintaining adequate research and development personnel and resources to meet the demands of the market is essential. If we are unable to develop products, applications or features internally due to constraints, such as high employee turnover, insufficient cash, inability to hire sufficient research and development personnel or a lack of other research and development resources, we may miss market opportunities.

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Furthermore, many of our competitors expend considerably greater amounts on their research and development programs than we do, and those that do not may be acquired by larger companies that would allocate greater resources to our competitors’ research and development programs. Our failure to devote adequate research and development resources or compete effectively with the research and development programs of our competitors could harm our business.
If we are unable to maintain the compatibility of our software with other products and technologies, our business would be harmed.
Our clients often integrate our solution with their business applications, particularly third-party CRM solutions. These third-party providers or their partners could alter their products so that our solution no longer integrates well with them, or they could delay or deny our access to technology releases that allow us to adapt our solution to integrate with their products in a timely fashion. If we cannot adapt our solution to changes in complementary technology deployed by our clients, it may significantly impair our ability to compete effectively.
Our business could be harmed if our clients are not satisfied with the professional services and technical support provided by us or our partners.
Our business depends on our ability to satisfy our clients, not only with respect to our solution, but also with the professional services and technical support that are required for our clients to implement and use our solution to address their business needs. Professional services and technical support may be performed by our own staff or, in a select subset of cases, by third parties. We will need to continue to expand and optimize our professional services and technical support in order to keep up with new client installations and ongoing service, which will take time and expense to implement. Identifying and recruiting qualified service personnel and training them in our solution is difficult and competitive and requires significant time, expense and attention. We may be unable to respond quickly enough to accommodate short-term increases in client demand for support services. We also may be unable to modify the format of our support services or change our pricing to compete with changes in support services provided by our competitors. Increased client demand for these services, without corresponding revenues, could increase our costs and harm our operating results. If a client is not satisfied with the deployment and ongoing services performed by us or a third party, then we could lose clients, miss opportunities to expand our business with these clients, incur additional costs, or lose, or suffer reduced margins on, our service revenue, any of which could damage our ability to grow our business. In addition, negative publicity related to our professional services and technical support, regardless of its accuracy, may damage our business by affecting our ability to compete for new business with current and prospective clients.
Sales to clients outside the United States or with international operations and our international sales efforts and operations support expose us to risks inherent in international sales and operations.
A key element of our growth strategy is to expand our international sales efforts and develop a worldwide client base. Because of our limited experience with international sales, our international expansion may not be successful and may not produce the return on investment we expect. To date, we have realized only a small portion of our revenues from clients outside the United States.
Our international employees are primarily located in the Philippines, where technical support, training and other professional services are performed, and Russia, where software development services are performed. We have also started to increase our sales, marketing and support personnel in the U.K. to maintain and support our European data centers and to provide service and support to clients in the European Union. Operating in international markets requires significant resources and management attention and subjects us to intellectual property, regulatory, economic and political risks that are different from those in the United States. As we increase our international sales efforts and continue our other international operations, we will face risks in doing business internationally that could harm our business, including:
the need to establish and protect our brand in international markets;
the need to localize and adapt our solution for specific countries, including translation into foreign languages and associated costs and expenses;
difficulties in staffing and managing foreign operations, particularly hiring and training qualified sales and service personnel;
the need to make implementations, and offer customer care, in various native languages;
different pricing environments, longer sales and accounts receivable payment cycles and collections issues;

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weaker protection for intellectual property and other legal rights than in the U.S. and practical difficulties in enforcing intellectual property and other rights outside of the U.S.;
increased risk of piracy, counterfeiting and other misappropriation of our intellectual property in our locations outside the U.S.;
new and different sources of competition;
general economic conditions in international markets;
fluctuations in the value of the U.S. dollar and foreign currencies, which may make our solution more expensive in other countries or may increase our costs, impacting our operating results when translated into U.S. dollars;
compliance with customs duties, tariffs and other international trade complexities;
compliance challenges related to the complexity of multiple, conflicting and changing governmental laws and regulations, including employment, tax, telecommunications and telemarketing laws and regulations;
privacy and data protection laws and regulations that are complex, expensive to comply with and may require that client data be stored and processed in a designated territory;
increased risk of international telecom fraud;
laws and business practices favoring local competitors;
compliance with U.S. laws and regulations for foreign operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act, import and export control laws, tariffs, trade barriers, economic sanctions and regulatory or contractual limitations on our ability to sell our solution in certain foreign markets, and the risks and costs of non-compliance;
increased financial accounting and reporting burdens and complexities;
restrictions on the transfer of funds;
adverse tax consequences; and
unstable economic and political conditions. 
 These risks could harm our international operations, increase our operating costs and hinder our ability to grow our international business and, consequently, our overall business and results of operations. In addition, if the political and military situation in Russia and the Ukraine significantly worsens, or if either Russia or the United States imposes significant new economic sanctions or restrictions, and we are restricted or precluded from continuing our software development operations in Russia, our costs could increase, and our product development efforts, business and results of operations could be significantly harmed.
In addition, compliance with laws and regulations applicable to our international operations increases our cost of doing business outside the United States. We may be unable to keep current with changes in foreign government requirements and laws as they change from time to time. Failure to comply with these regulations could harm our business. In many countries outside the United States it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. regulations applicable to us. Although we have implemented policies and procedures designed to ensure compliance with these laws and policies, there can be no assurance that all of our employees, contractors, strategic partners and agents will comply with these laws and policies. Violations of laws or key control policies by our employees, contractors, strategic partners or agents could result in delays in revenue recognition, financial reporting misstatements, fines, penalties, or prohibitions on selling our solution, any of which could harm our business.
We depend on our senior management team and the loss of one or more key employees or an inability to attract and retain highly skilled employees could harm our business and results of operations.
Our success largely depends upon the continued services of our key executive officers. We also rely on our leadership team in the areas of research and development, marketing, sales, services and general and administrative functions, and on mission-critical individual contributors. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business. The loss of one or more of our executive officers or key employees could seriously harm our business. We currently do not maintain key person life insurance policies on any of our employees.
To execute our growth plan, we must attract and retain highly qualified personnel and we may incur significant costs to do so. Competition for these personnel is intense, especially for engineers highly experienced in designing and developing cloud software and for senior sales executives. We have, from time to time, experienced,

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and we expect to continue to experience, difficulty in hiring and retaining employees with appropriate qualifications. We invest significant time and expense in training our employees, which increases their value to competitors who may seek to recruit them and increases our costs. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects would be harmed. Many of the companies with which we compete for experienced personnel have greater resources than we have. If we hire employees from competitors or other companies, their former employers may attempt to assert that these employees or we have breached legal obligations, resulting in a diversion of our time and resources and, potentially, damages.
Volatility or lack of performance in the trading price of our common stock may also affect our ability to attract and retain qualified personnel because job candidates and existing employees often emphasize the value of the stock awards they receive in connection with their employment when considering whether to accept or continue employment. If the perceived value of our stock awards is low or declines, it may harm our ability to recruit and retain highly skilled employees.
If we fail to grow our marketing capabilities and develop widespread brand awareness cost effectively, our business may suffer.
Our ability to increase our client base and achieve broader market acceptance of our cloud contact center software solution will depend to a significant extent on our ability to expand our marketing operations. We plan to continue to dedicate significant resources to our marketing programs, including internet advertising, digital marketing campaigns, social marketing, trade shows, industry events, co-marketing with strategic partners and telemarketing. The effectiveness of our online advertising has varied over time and may vary in the future due to competition for key search terms, changes in search engine use and changes in the search algorithms used by major search engines. All of these efforts will continue to require us to invest significant financial and other resources in our marketing efforts. Our business will be seriously harmed if our efforts and expenditures do not generate a proportionate increase in revenue.
In addition, we believe that developing and maintaining widespread awareness of our brand in a cost-effective manner, both in the United States and internationally, is critical to achieving widespread acceptance of our solution and attracting new clients. Brand promotion activities may not generate client awareness or increase revenues, and even if they do, any increase in revenues may not offset the costs and expenses we incur in building our brand. If we fail to successfully promote, maintain and protect our brand, or incur substantial costs and expenses, we may fail to attract or retain clients necessary to realize a sufficient return on our brand-building efforts, or to achieve the widespread brand awareness that is critical for broad client adoption of our solution.
We may not be able to secure additional financing on favorable terms, or at all, to meet our future capital needs.
To date, we have financed our operations, primarily through sales of our solution, lease facilities and net proceeds from our equity and debt financings. We do not know when or if our operations will generate sufficient cash to fund our ongoing operations. In the future, we may require additional capital to respond to business opportunities, challenges, acquisitions, a decline in sales, increased regulatory obligations or unforeseen circumstances and may engage in equity or debt financings or enter into credit facilities.
We have a substantial amount of debt. As of March 31, 2017 , we had approximately $32.6 million in principal amount outstanding under our New Revolving Credit Facility entered into on August 1, 2016 and a $0.8 million FCC civil penalty payable to the U.S. Treasury. See Note 5 of the notes to condensed consolidated financial statements.
Our New Revolving Credit Facility is collateralized by substantially all of our assets and contains a number of covenants that limit our ability to, among other things, sell assets, make acquisitions or investments, incur debt, grant liens, pay dividends, enter into transactions with our affiliates and use all of our available cash on hand and may prevent us from engaging in acts that may be in our best long-term interests. The amount of our current total debt and the collateral pledged under the New Revolving Credit Facility and the covenants to which we are bound may prevent us from being able to timely secure additional debt or equity financing on favorable terms, or at all, or to pursue business opportunities, including potential acquisitions. Any debt financing obtained by us in the future would cause us to incur additional debt service expenses and could include additional restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and pursue business opportunities. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new equity securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms

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satisfactory to us when we require it, our ability to continue to grow and support our business and to respond to business challenges could be significantly limited.
Adverse economic conditions may harm our business.
Our business depends on the overall demand for cloud contact center software solutions and on the economic health of our current and prospective clients. In general, worldwide economic conditions remain unstable. In addition to the United States, we plan to market and sell our solution in Europe, Asia and other international markets. If economic conditions, including currency exchange rates, in these areas and other key potential markets for our solution continue to remain uncertain or deteriorate further, clients may delay or reduce their contact center and overall information technology spending. If our clients experience economic hardship, this could reduce the demand for our solution, delay and lengthen sales cycles, lower prices for our solution, and lead to slower growth or even a decline in our revenues, operating results and cash flows.
We may acquire other companies or technologies or be the target of strategic transactions, which could divert our management’s attention, result in additional dilution to our stockholders and otherwise disrupt our operations and harm our operating results.
We may acquire or invest in businesses, applications or technologies that we believe could complement or expand our solution, enhance our technical capabilities or otherwise offer growth opportunities. The pursuit of potential acquisitions may divert the attention of management, and cause us to incur various costs and expenses in identifying, investigating and pursuing acquisitions, whether or not they are consummated. We may not be able to identify desirable acquisition targets or be successful in entering into an agreement with any particular target.
To date, the growth in our business has been primarily organic, and we have limited experience in acquiring other businesses, having only completed one small acquisition. In any future acquisitions, we may not be able to successfully integrate acquired personnel, operations and technologies, or effectively manage the combined business following the acquisition. We also may not achieve the anticipated benefits from our future acquired businesses due to a number of factors, including:
inability to integrate or benefit from acquisitions in a profitable manner;
unanticipated costs or liabilities associated with the acquisition, including legal claims arising from the activities of companies we acquire;
incurrence of acquisition-related costs;
difficulty converting the clients of the acquired business to our solution and contract terms, including disparities in the revenues, licensing, support or professional services model of the acquired company;
difficulty integrating the accounting systems, operations and personnel of the acquired business;
difficulties and additional costs and expenses associated with supporting legacy products and hosting infrastructure of the acquired business;
diversion of management’s attention from other business concerns;
harm to our existing relationships with our partners and clients as a result of the acquisition;
the loss of our or the acquired business’s key employees;
diversion of resources that could have been more effectively deployed in other parts of our business; and
use of substantial portions of our available cash to consummate the acquisition. 
In addition, a significant portion of the purchase price of companies we acquire may be allocated to acquired goodwill and other intangible assets, which must be assessed for impairment at least annually. In the future, if our acquisitions do not yield expected returns, we may be required to take charges to our operating results based on this impairment assessment process, which could harm our results of operations.
Acquisitions could also result in dilutive issuances of equity securities, the use of our available cash, or the incurrence of debt, which could harm our operating results. In addition, if an acquired business fails to meet our expectations, our operating results, business and financial condition may suffer.
In addition, we may receive inquiries relating to potential strategic transactions, including from third parties who may seek to acquire us. We will continue to consider and discuss such transactions as we deem appropriate. Such potential transactions may divert the attention of management, and cause us to incur various costs and expenses in investigating and evaluating such transactions, whether or not they are consummated.

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If we are unable to maintain and further develop effective internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock may decrease.
As a public company, we are required to maintain internal control over financial reporting and to report any material weaknesses in such internal controls. Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, requires that we evaluate and determine the effectiveness of our internal control over financial reporting and provide a management report on our internal control over financial reporting. However, our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 until we are no longer an “emerging growth company,” as defined by The Jumpstart Our Businesses Act of 2012, or The JOBS Act, which could occur for reporting periods after December 31, 2016.
In the future, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
If we have material weaknesses in our internal control over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. If we identify material weaknesses in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 in a timely manner, if we are unable to assert that our internal control over financial reporting is effective or if our independent registered public accounting firm is unable to attest that our internal control over financial reporting is effective, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could decrease. We could also become subject to stockholder or other third-party litigation as well as investigations by the stock exchange on which our securities are listed, the SEC or other regulatory authorities, which could require additional financial and management resources and could result in fines, trading suspensions or other remedies.
Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported operating results.
U.S. GAAP is subject to interpretation by the FASB, the SEC and various bodies formed to promulgate and interpret appropriate accounting principles. A change in accounting standards or practices can have a significant effect on our reported results and may even affect our financial statements completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and will occur in the future. Changes to existing rules or the questioning of current practices may harm our reported financial results or the way we account for or conduct our business.
For example, we recognize revenue in accordance with ASU 2009-13, Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements — a Consensus of the Emerging Issues Task Force (formerly known as EITF 08-01). In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers , a new standard on the recognition of revenue from contracts with customers, which includes a single set of rules and criteria for revenue recognition to be used across all industries. Companies may use either a full retrospective or a modified retrospective approach to adopt ASU 2014-09. The new standard is effective for our annual and interim reporting periods beginning January 1, 2018. As a result of future interpretations or applications of existing and new accounting standards, including ASU 2014-09 and ASU 2009-13, the timing of our revenue and commission expense recognition will change, which will cause fluctuations in our operating results.
In addition, certain factors have in the past and may in the future cause us to defer recognition of revenues. For example, the inclusion in our client contracts of material non-standard terms, such as acceptance criteria, could require the deferral of revenue. To the extent that such contracts become more prevalent in the future our revenue may be harmed.
Because of these factors and other specific requirements under U.S. GAAP for revenue recognition, we must have precise terms and conditions in our arrangements in order to recognize revenue when we deliver our solution or perform our professional services. Negotiation of mutually acceptable terms and conditions can extend our sales cycle, and we may accept terms and conditions that do not permit revenue recognition at the time of delivery.
The results of the United Kingdom’s referendum on withdrawal from the European Union may have a negative effect on global economic conditions, financial markets and our business.

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In June 2016, a majority of voters in the United Kingdom elected to withdraw from the European Union in a national referendum, referred to as Brexit. The referendum was advisory, and the terms of any withdrawal are subject to a negotiation period that could last at least two years after the government of the United Kingdom formally initiated the withdrawal process on March 29, 2017. Such withdrawal has created significant