Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
______________________________________________
FORM 10-Q
______________________________________________

 
x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT 1934
 
For the quarterly period ended March 31, 2018
 
o        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 001-38285
 
Bandwidth Inc.
(Exact name of registrant as specified in its charter)
 ______________________________________________
 
Delaware
 
56-2242657
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
900 Main Campus Drive
Raleigh, NC 27606
(Address of principal executive offices) (Zip Code)
 
(800) 808-5150
(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 the 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
o

Non-accelerated filer
x

Smaller reporting company
o

(Do not check if a smaller reporting company)

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.    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

As of April 30, 2018, 4,207,908 shares of the registrant’s Class A common stock and 13,508,378 shares of registrant’s Class B common stock were outstanding, respectively.
 


Table of Contents


BANDWIDTH INC.
Quarterly Report on Form 10-Q

For the Three Months Ended March 31, 2018
TABLE OF CONTENTS
 
 
Page
 

 
 
 
 
 
 
 
 
 


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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, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements contained in this Quarterly Report on Form 10-Q, other than statements of historical fact, are forward-looking statements. Forward-looking statements generally can be identified by the words “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” "would," "project," "plan," “estimate,” or “continue,” or the negative of these words or other similar terms or expressions that concern our expectations strategy, plans or intentions. Forward looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

our ability to attract and retain customers, including large enterprises;
our approach to identifying, attracting and keeping new and existing customers, as well as our expectations regarding customer turnover;
our beliefs regarding network traffic growth and other trends related to the usage of our products and services;
our expectations regarding revenue, costs, expenses, gross margin, dollar based net retention rate, adjusted EBITDA and capital expenditures;
our beliefs regarding the growth of our business and how that impacts our liquidity and capital resources requirements;
the sufficiency of our cash and cash equivalents to meet our liquidity needs;
our ability to attract, train, and retain qualified employees and key personnel;
our beliefs regarding the expense and productivity of and competition for our sales force;
our expectations regarding headcount;
our ability to maintain and benefit from our corporate culture;
our plans to further invest in and grow our business, and our ability to effectively manage our growth and associated investments;
our ability to introduce new products and services and enhance existing products and services;
our ability to compete successfully against current and future competitors;
the evolution of technology affecting our products, services and markets;
the impact of certain new accounting standards and guidance as well as the time and cost of continued compliance with existing rules and standards;
our beliefs regarding the use of non-generally accepted accounting principles ("GAAP") financial measures;
our ability to maintain, protect and enhance our intellectual property;
our expectations regarding litigation and other pending or potential disputes;
our ability to comply with modified or new laws and regulations; and
the increased expenses associated with being a public company.

We caution you that the foregoing list may not contain all the forward-looking statements made in this Quarterly Report on Form 10-Q.
You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations and prospects. The outcome of the events described in these forward-looking

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statements is subject to risks, uncertainties and other factors described in the section titled "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.
The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.


3

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements


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BANDWIDTH INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
(Unaudited)


 
December 31,
2017
 
March 31,
2018
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
37,627

 
$
38,773

Marketable securities

 
8,492

Accounts receivable, net of allowance for doubtful accounts
21,225

 
24,404

Prepaid expenses and other current assets
6,400

 
6,953

Total current assets
65,252

 
78,622

Property and equipment, net
14,946

 
15,902

Intangible assets, net
7,643

 
7,478

Deferred costs, non-current
2,068

 
1,933

Other long-term assets
1,192

 
1,047

Goodwill
6,867

 
6,867

Deferred tax asset
6,526

 
3,915

Total assets
$
104,494

 
$
115,764

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
3,025

 
$
3,154

Accrued expenses and other current liabilities
15,633

 
14,471

Current portion of deferred revenue and advanced billings
5,768

 
7,080

Current portion of long-term debt and capital lease obligations
92

 
67

Total current liabilities
24,518

 
24,772

Other liabilities
716

 
704

Deferred revenue, net of current portion
2,549

 
7,113

Total liabilities
27,783

 
32,589

Stockholders' equity:
 
 
 
Class A and Class B common stock
17

 
18

Additional paid-in capital
102,465

 
102,743

Accumulated deficit
(25,771
)
 
(19,580
)
Accumulated other comprehensive loss

 
(6
)
Total stockholders’ equity
76,711

 
83,175

Total liabilities and stockholders’ equity
$
104,494

 
$
115,764

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


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Table of Contents
BANDWIDTH INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In Thousands, Except Share And Per Share Amounts)
(Unaudited)


 
Three Months Ended
March 31,
 
2017
 
2018
Revenue
$
39,625

 
$
53,012

Cost of revenue
21,566

 
25,364

Gross profit
18,059

 
27,648

Operating expenses:
 
 
 
Research and development
2,682

 
3,781

Sales and marketing
2,558

 
4,522

General and administrative
7,637

 
10,569

Total operating expenses
12,877

 
18,872

Operating income
5,182

 
8,776

Other (expense) income, net
(421
)
 
49

Income before income taxes
4,761

 
8,825

Income tax provision
(1,772
)
 
(2,634
)
Net income
$
2,989

 
$
6,191

Other comprehensive loss:
 
 
 
Change in unrealized net loss on marketable securities, net of income tax benefit of $0 and $2, respectively
$

 
$
(6
)
Total comprehensive income
$
2,989

 
$
6,185

Earnings per share:
 
 
 
Net income
$
2,989

 
$
6,191

Less: net income allocated to participating securities
391

 

Net income attributable to common stockholders
$
2,598

 
$
6,191

Net income per share:
 
 
 
Basic
$
0.22

 
$
0.35

Diluted
$
0.20

 
$
0.30

Weighted average number of common shares outstanding:
 
 
 
Basic
11,798,565

 
17,658,611

Diluted
12,972,609

 
20,484,753

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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BANDWIDTH INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)


 
Three Months Ended
March 31,
 
2017
 
2018
Operating activities
 
 
 
Net income
$
2,989

 
$
6,191

Adjustments to reconcile net income to net cash (used in) provided by operating activities:
 
 
 
Depreciation and amortization
1,376

 
1,387

Accretion of bond discount

 
(6
)
Amortization of debt issuance costs
32

 
16

Stock-based compensation
246

 
493

Deferred taxes
1,562

 
2,611

Loss on disposal of property and equipment
9

 
9

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(166
)
 
(3,179
)
Prepaid expenses and other assets
(1,232
)
 
(471
)
Deferred costs
(401
)
 
146

Accounts payable
(1,663
)
 
(656
)
Accrued expenses and other liabilities
(3,943
)
 
(1,174
)
Deferred revenue and advanced billings
222

 
5,876

Net cash (used in) provided by operating activities
(969
)
 
11,243

Investing activities
 
 
 
Purchase of property and equipment
(130
)
 
(961
)
Capitalized software development costs
(677
)
 
(441
)
Purchase of marketable securities

 
(8,498
)
Net cash used in investing activities
(807
)
 
(9,900
)
Financing activities
 
 
 
Borrowings on line of credit
4,000

 

Repayments on line of credit
(3,000
)
 

Payments on capital leases
(15
)
 
(25
)
Repayments on term loan
(500
)
 

Payment of costs related to the initial public offering

 
(285
)
Proceeds from issuances of common stock

 
70

Proceeds from sale of fixed assets
3

 

Net cash provided by (used in) financing activities
488

 
(240
)
Net (decrease) increase in cash, cash equivalents, and restricted cash
(1,288
)
 
1,103

Cash, cash equivalents, and restricted cash, beginning of period
7,028

 
37,870

Cash, cash equivalents, and restricted cash, end of period
$
5,740

 
$
38,973

Supplemental disclosure of cash flow information
 
 
 
Cash paid during the year for interest
$
549

 
$
19

Cash (refunded) paid for taxes
$
(33
)
 
$
90

Supplemental disclosure of noncash financing activities
 
 
 
Purchase of property and equipment, accrued but not paid
$
247

 
$
785

Unrealized loss on marketable securities, accrued but not realized
$

 
$
6

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

7


BANDWIDTH INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands Except Share And Per Share Amounts)
(Unaudited)
1. Organization and Description of Business
Bandwidth Inc. (together with its subsidiaries, “Bandwidth” or the “Company”) was founded in July 2000 and incorporated in Delaware on March 29, 2001. The Company’s headquarters are located in Raleigh, North Carolina. The Company is a cloud-based, software-powered communications platform-as-a-service (“CPaaS”) provider that enables enterprises to create, scale and operate voice or text communications services across any mobile application or connected device.
The Company has two operating and reportable segments, CPaaS and Other. CPaaS revenue is derived from usage and monthly services fees charged for usage of Voice, Messaging, 911 and Phone Numbers solutions through the Company’s proprietary CPaaS software application programming interfaces. Other revenue consists of fees charged for services provided such as: SIP trunking, data resale, and a hosted Voice-over Internet Protocol (“VoIP”). The Other segment also includes revenue from traffic generated by other carriers, SMS registration fees and other miscellaneous product lines.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and applicable rules and regulations of the SEC regarding interim financial reporting. Certain information and disclosures normally included in the 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 Annual Report on Form 10-K filed with the SEC on February 26, 2018.
The condensed consolidated balance sheet as of December 31, 2017, included herein, was derived from the audited financial statements as of that date, but does not include all disclosures including certain notes required by GAAP on an annual reporting basis.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, comprehensive income and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full year 2018 or any future period.
Principles of Consolidation
The consolidated financial statements include the accounts of Bandwidth Inc. and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

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Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with U.S. GAAP requires the Company to make estimates and judgments that affect the amounts reported in these financial statements and accompanying notes. Although the Company believes that the estimates it uses are reasonable, due to the inherent uncertainty involved in making these estimates, actual results reported in future periods could differ from those estimates. These estimates in the consolidated financial statements include, but are not limited to, allowance for doubtful accounts, recoverability of long lived and intangible assets, customer relationship period, valuation allowances on tax assets, certain accrued expenses, and contingencies.
Cash and Cash Equivalents
The Company classifies all highly liquid investments with stated maturities of three months or less from date of purchase as cash equivalents and all highly liquid investments with stated maturities of greater than three months from the date of purchase as current marketable securities. The Company has a policy of making investments only with commercial institutions that have at least an investment grade credit rating. The Company invests its cash primarily in government securities and obligations, corporate debt securities, money market funds and reverse repurchase agreements (RRAs). RRAs are collateralized by deposits in the form of Government Securities and Obligations for an amount not less than 102% of their value. The Company does not record an asset or liability as the Company is not permitted to sell or repledge the associated collateral. The Company has a policy that the collateral has at least an "A" (or equivalent) credit rating. The Company utilizes a third party custodian to manage the exchange of funds and ensure that collateral received is maintained at 102% of the value of the RRAs on a daily basis. RRAs with stated maturities of greater than three months from the date of purchase are classified as marketable securities.

Restricted Cash
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same such amounts shown in the condensed consolidated statements of cash flows:
 
December 31,
 
March 31,
 
2017
 
2018
Cash and cash equivalents
$
37,627

 
$
38,773

Restricted cash
243

 
200

Total cash, cash equivalents, and restricted cash shown in the statements of cash flows
$
37,870

 
$
38,973

Restricted cash is for Automated Clearing House availability, customer deposits and for credit card security. The Company has classified this asset as a long-term asset in order to match the expected period of restriction and is included in Other long-term assets in the condensed consolidated balance sheets.
Concentration of Credit Risk
Financial instruments that are exposed to concentration of credit risk consist primarily of cash and cash equivalents, marketable securities and trade accounts receivable. Cash deposits may be in excess of insured limits. The Company believes that the financial institutions that hold its cash deposits are financially sound and, accordingly, minimal credit risk exists with respect to these balances.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


With regard to customers, credit evaluation and account monitoring procedures are used to minimize the risk of loss. The Company believes that no additional credit risk beyond amounts provided for by the allowance for doubtful accounts are inherent in accounts receivable. As of December 31, 2017, one customer represented approximately 13% of the Company's accounts receivable, net of allowance for doubtful accounts. As of March 31, 2018, one customer represented approximately 10% of the Company's accounts receivable, net of allowance for doubtful accounts.
For the three months ended March 31, 2017 and 2018, no individual customer represented more than 10% of the Company’s total revenue.
Recently Adopted Accounting Standards
In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09, Compensation-Stock Compensation (Topic 718), Scope of Modification Accounting, which amends the scope of modification accounting for share-based payment arrangements. The ASU provides guidance on the types of changes to terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718, Compensation-Stock Compensation. ASU 2017-09 is effective for fiscal years and interim periods within those years beginning after December 15, 2017. The adoption of this standard did not have a material impact on the Company's financial statements.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805) Clarifying the Definition of a Business, which amends the guidance of FASB Accounting Standards Codification Topic 805, “Business Combinations”, adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. This guidance is effective for annual and interim periods beginning after December 15, 2017, and early adoption is permitted under certain circumstances. The impact from the adoption of this standard is dependent upon future transactions.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash, which requires a statement of cash flows to explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash and restricted cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017. The adoption of this standard did not have a material impact on the Company's financial statements. 

In November 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory. ASU 2016-16 requires companies to account for the income tax effects of intercompany transfers of assets other than inventory (e.g., intangible assets) when the transfer occurs. This guidance is effective for fiscal years beginning after December 15, 2017. The adoption of this standard did not have a material impact on the Company's financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments, which clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


those fiscal years, and early adoption is permitted. The Company adopted this standard retrospectively and it had no material impact on the Company's financial statements.

Recent Accounting Pronouncements Not Yet Adopted
In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which addresses the income tax effects of items in accumulated other comprehensive income which were originally recognized in other comprehensive income, rather than in income from continuing operations. Specifically, it permits a reclassification from AOCI to retained earnings for the adjustment of deferred taxes due to the reduction of the historical corporate income tax rate to the newly enacted corporate income tax rate resulting from the U.S. tax law changes enacted in December 2017. This ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The new guidance must be applied either on a prospective basis in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the U.S. tax law changes are recognized. The Company is evaluating the effect of adopting this new accounting guidance, but does not expect adoption will have a material impact on the Company’s financial statements.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairment. The ASU requires impairment charges to be based on the first step in today’s two-step impairment test. ASU 2017-04 is effective for annual and interim impairment tests performed in periods beginning after December 15, 2021, and early adoption is permitted. Management does not expect the adoption of this guidance to have a significant impact on the Company's financial position, results of operations, or cash flows.

In February 2016, the FASB issued ASU 2016-02, Leases. The standard will affect all entities that lease assets and will require lessees to recognize a lease liability and a right-of-use asset for all leases (except for short- term leases that have a duration of less than one year) as of the date on which the lessor makes the underlying asset available to the lessee. For lessors, accounting for leases is substantially the same as in prior periods. ASU 2016-02 is effective for fiscal years beginning after December 15, 2019, and interim periods within annual periods beginning after December 15, 2020, and early adoption is permitted. For leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, lessees and lessors must apply a modified retrospective transition approach. While the Company expects the adoption of this standard to result in an increase to the reported assets and liabilities, it has not yet determined the full impact the adoption of this standard will have on its financial statements and related disclosures.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” This new guidance will replace most existing GAAP guidance on this topic. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14 “Revenue from Contracts with Customers: Deferral of the effective date,” which deferred by one year the effective date for the new revenue reporting standard for entities reporting under GAAP. In accordance with the deferral, this guidance will be effective for the Company beginning in the year ended December 31, 2019. This guidance can be applied either retrospectively to each period presented or as a cumulative effect adjustment as of the date of adoption. In

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


December 2016, the FASB issued ASU 2016-20, “Revenue from Contracts with Customers, Technical Corrections and Improvements to Topic 606,” which made 12 additional technical corrections and improvements to the new revenue standard. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers, Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” clarifying the implementation guidance on principal versus agent considerations. Specifically, an entity is required to determine whether the nature of a promise is to provide the specified good or service itself (that is, the entity is a principal) or to arrange for the good or service to be provided to the customer by the other party (that is, the entity is an agent). The determination influences the timing and amount of revenue recognition. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers, Identifying Performance Obligations and Licensing”, clarifying the implementation guidance on identifying performance obligations and licensing. Specifically, the amendments reduce the cost and complexity of identifying promised goods or services and improve the guidance for determining whether promises are separately identifiable. The amendments also provide implementation guidance on accounting for an entity’s promise to grant a license. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers, Narrow-Scope Improvements and Practical Expedients,” clarifying guidance on assessing collectability, presentation of sales taxes, noncash consideration, completed contracts and contract modifications. The effective date and transition requirements for ASU 2016-20, ASU 2016-08 and ASU 2016-10 are the same as the effective date and transition requirements for ASU 2014-09, which will be effective for the Company beginning January 1, 2019.
The Company is still assessing all potential impacts of the new standard on its consolidated financial statements. Given the comprehensive nature of the standard, the Company has already taken steps to identify the impact on its consolidated financial results. The Company has completed a diagnostic which highlighted potential differences between current accounting policies and the new standard. Additionally, the Company has engaged a third-party service provider to assist in its evaluation of customer contracts to identify the attributes that could result in a different accounting treatment under ASU 2014-09. From an information technology perspective, the Company identified the preliminary business requirements and functionality of a new technology solution and has selected a software provider. The Company has not yet reached a conclusion as to whether the quantitative effect of the adoption of the new standard on its revenue will be material. The Company will continue to monitor and assess the impact of the changes of the new standard and the related interpretations of its application as they become available.
3. Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, marketable securities, accounts receivable, accounts payable and accrued expenses approximate fair value as of December 31, 2017 and March 31, 2018 because of the relatively short duration of these instruments. Marketable securities consist of U.S. treasury securities not otherwise classified as cash equivalents. All marketable securities are considered to be available-for-sale and are recorded at their estimated fair values. Unrealized gains and losses for available-for-sale securities are recorded in other comprehensive income (loss).
The Company evaluated its financial assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level in which to classify them for each reporting period. The following table summarizes the assets measured at fair value as of December 31, 2017 and March 31, 2018:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


 
Fair Value Measurements on a Recurring Basis
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
 
 
 
 
 
 
 
Money market account (included in cash and cash equivalents
$
28,015

 
$

 
$

 
$
28,015

Total financial assets
$
28,015

 
$

 
$

 
$
28,015

There were no marketable securities as of December 31, 2017.
 
Amortized Cost or Carrying Value
 
Net Unrealized Losses
 
Fair Value Measurements on a Recurring Basis
March 31, 2018
Level 1
 
Level 2
 
Level 3
 
Total
Financial Assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
Money market account
$
15,541

 
$

 
$
15,541

 
$

 
$

 
$
15,541

U.S. Reverse repurchase agreements
14,000

 

 

 
14,000

 

 
14,000

Total included in cash and cash equivalents
29,541

 

 
15,541

 
14,000

 

 
29,541

Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. treasury securities
8,500

 
(8
)
 

 
8,492

 

 
8,492

Total marketable securities
8,500

 
(8
)
 

 
8,492

 

 
8,492

Total financial assets
$
38,041

 
$
(8
)
 
$
15,541

 
$
22,492

 
$

 
$
38,033

The Company classifies its marketable securities as current assets as they are available for current operating needs. The following table summarizes the contractual maturities of marketable securities as of March 31, 2018:
 
Amortized Cost
 
Aggregate Fair Value
Financial Assets:
 
 
 
Less than one year
$
8,500

 
$
8,492

Total
$
8,500

 
$
8,492

For fixed income securities that had unrealized losses as of March 31, 2018, the Company determined that no other-than-temporary impairment existed. As of March 31, 2018, all securities in an unrealized loss position have been in an unrealized loss position for less than one year. During the three months ended March 31, 2018, there were no sales of marketable securities. Interest earned on marketable securities in the three months ended March 31, 2018 was $16 and is recorded as other (expense) income, net, in the accompanying condensed consolidated statements of operations and comprehensive income.
4. Financial Statement Components

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


Accounts receivable, net of allowance for doubtful accounts consist of the following:
 
December 31,
 
March 31,
 
2017
 
2018
Trade accounts receivable
$
44,692

 
$
15,002

Unbilled accounts receivable
8,653

 
10,335

Allowance for doubtful accounts
(32,463
)
 
(1,290
)
Other accounts receivable
343

 
357

Total accounts receivable, net
$
21,225

 
$
24,404

Components of allowance for doubtful accounts are as follows:
 
Three Months Ended
March 31,
Allowance for doubtful accounts:
2017
 
2018
Balance, beginning of period
$
255

 
$
189

Charged to bad debt expense
(43
)
 
1

Deductions (1)
(124
)
 
(48
)
Balance, end of period
$
88

 
$
142

________________________
(1) Write off of uncollectible accounts after all collection efforts have been exhausted.
 
Three Months Ended
March 31,
Allowance for CABS revenue:
2017
 
2018
Balance, beginning of period
$
22,316

 
$
32,274

Write-off of previously outstanding and fully reserved billings related to settlement

 
(24,968
)
Billings deemed not probable of collection (1)
2,463

 
118

Revenue recognized from outstanding billings previously deemed uncollectible related to settlement

 
(6,268
)
Deductions (2)
(43
)
 
(8
)
Balance, end of period
$
24,736

 
$
1,148

________________________
(1) Represents amounts billed in the period but where collectibility is not probable based on customers collection experience. Amounts were charged to a contra-revenue account.
(2) Write off of uncollectible accounts after all collection efforts have been exhausted.
 
Three Months Ended
March 31,
CABS revenue:
2017
 
2018
Billed
$
4,611

 
$
4,079

Revenue recognized from current billings (2)
2,148

 
3,961

Billings deemed not probable of collection (1)
$
2,463

 
$
118

________________________
(1) Represents amounts billed in the period but where collectibility is not probable based on customers collection experience. Amounts were charged to a contra-revenue account.
(2) Does not include $6,268 in revenue recognized as a result of a settlement agreement related to previously billed and outstanding and uncollectible invoices.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


On January 29, 2018, the Company and Verizon entered into a settlement agreement to resolve an ongoing dispute and litigation with Verizon, which is a CABS customer of the Company. The settlement agreement also resolved Verizon’s counter-claims against the Company. Pursuant to the settlement agreement, Verizon made a lump sum payment to the Company on February 8, 2018 of $4,400, which was recognized as revenue during the three months ended March 31, 2018. Following receipt of the $4,400 payment, the Company issued to Verizon bill credits with respect to other CABS amounts previously billed to Verizon of $24,968, which were previously reserved and comprised the majority of the allowance for CABS revenue as of year-end. As of the three months ended March 31, 2018, the Company recognized as revenue $6,268, including the $4,400 payment made on February 8, 2018, in accounts receivable previously reserved for which collection is no longer in doubt. The settlement agreement also specifies certain terms for the Company's CABS billings to Verizon prospectively. The Company will continue to assess collectability of its outstanding CABS accounts receivable.

Accrued expenses and other current liabilities consisted of the following:
 
December 31,
 
March 31,
 
2017
 
2018
Accrued expense
$
6,851

 
$
7,878

Accrued compensation and benefits
5,237

 
2,809

Accrued sales, use, and telecom related taxes
3,030

 
3,146

Other accrued expenses
515

 
638

Total accrued expenses
$
15,633

 
$
14,471



5. Property and Equipment
Property and equipment, net consisted of the following:    
 
December 31,
 
March 31,
 
2017
 
2018
Furniture and fixtures
$
863

 
$
872

Computer and office equipment
7,545

 
7,450

Telecommunications equipment
19,985

 
21,490

Leasehold improvements
453

 
453

Software development costs
15,517

 
16,073

Automobile
10

 
10

Total cost
44,373

 
46,348

Less—accumulated depreciation
(29,427
)
 
(30,446
)
Total property and equipment, net
$
14,946

 
$
15,902

The Company capitalized $677 and $441 of software development costs during the three months ended March 31, 2017 and 2018, respectively.

Amortization expense related to capitalized software development costs were $580 and $448 for the three months ended March 31, 2017 and 2018, respectively.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


The Company recognized depreciation expense, which includes amortization of capitalized software development costs, as follows:
 
Three Months Ended
March 31,
 
2017
 
2018
Cost of revenue
$
1,047

 
$
1,064

Research and development
10

 
29

Sales and marketing
7

 
10

General and administrative
102

 
119

Total depreciation expense
$
1,166

 
$
1,222

6. Intangible Assets
Intangible assets consisted of the following as of December 31, 2017:
 
Gross
Amount
 
Accumulated
Amortization
 
Net Carrying
Value
 
Amortization
Period
 
 
 
 
 
 
 
(Years)
Customer relationships
$
10,396

 
$
(3,552
)
 
$
6,844

 
20
Domain name and related trademarks
2,678

 
(2,643
)
 
35

 
3–7
Licenses, amortizable
341

 
(341
)
 

 
2
Non-compete agreements
139

 
(139
)
 

 
2–5
Developed technology
775

 
(775
)
 

 
3
Licenses, indefinite lived
764

 

 
764

 
Indefinite
Total intangible assets, net
$
15,093

 
$
(7,450
)
 
$
7,643

 
 
Intangible assets consisted of the following as of March 31, 2018:
 
Gross
Amount
 
Accumulated
Amortization
 
Net Carrying
Value
 
Amortization
Period
 
 
 
 
 
 
 
(Years)
Customer relationships
$
10,396

 
$
(3,682
)
 
$
6,714

 
20
Domain name and related trademarks
2,678

 
(2,678
)
 

 
3–7
Licenses, amortizable
341

 
(341
)
 

 
2
Non-compete agreements
139

 
(139
)
 

 
2–5
Developed technology
775

 
(775
)
 

 
3
Licenses, indefinite lived
764

 

 
764

 
Indefinite
Total intangible assets, net
$
15,093

 
$
(7,615
)
 
$
7,478

 
 
Amortization expense for definite lived intangible assets was $210 and $165 for the three months ended March 31, 2017 and 2018, respectively. The weighted average amortization period for all definite lived intangible assets is 19 years.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


Future estimated amortization expense for definite lived intangible assets subsequent to March 31, 2018 is as follows:
 
Amount
2018 (remaining)
$
390

2019
520

2020
520

2021
520

2022
520

Thereafter
4,244

 
$
6,714

7. Debt
Revolving Loan

As of December 31, 2017 and March 31, 2018, the Company had $0 outstanding on the revolving loan and was in compliance with all financial and non-financial covenants for all periods presented. The available borrowing capacity under the revolving loan was $25,000 as of March 31, 2018.

As of December 31, 2017 and March 31, 2018, the outstanding unamortized loan fees for the revolving loan were $175 and $159, respectively, and are included in other long-term assets.

Capital Leases

The Company leases various equipment under leases accounted for as capital leases with expiration dates ranging from October 2018 through December 2018. As of December 31, 2017, cost and accumulated depreciation of the assets under capital leases recorded by the Company were $1,951 and $1,821, respectively. As of March 31, 2018, cost and accumulated depreciation of the assets under capital leases recorded by the Company were $1,951 and $1,863, respectively.

Remaining payments due on the Company’s capital lease obligations as of March 31, 2018, are as follows:
 
Amount
2018 (remaining)
$
67

Less amount representing interest

 
67

Less current maturities
67

 
$


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


8. Segment and Geographic Information
The Company has two reportable segments, CPaaS and Other. Segments are primarily evaluated based on revenue and gross profit. The Company does not allocate operating expenses, interest expense or income tax expense to its segments. Accordingly, the Company does not report such information. Additionally, the CODM does not evaluate the Company’s operating segments using discrete asset information. The segments share the majority of the Company’s assets. Therefore, no segment asset information is reported.
 
Three Months Ended
March 31,
 
2017
 
2018
CPaaS
 
 
 
Revenue
$
31,647

 
$
38,897

Cost of revenue
18,228

 
21,905

Gross profit
$
13,419

 
$
16,992

Other
 
 
 
Revenue
$
7,978

 
$
14,115

Cost of revenue
3,338

 
3,459

Gross profit
$
4,640

 
$
10,656

Consolidated
 
 
 
Revenue
$
39,625

 
$
53,012

Cost of revenue
21,566

 
25,364

Gross profit
$
18,059

 
$
27,648

All assets were held in the United States as of December 31, 2017 and March 31, 2018.

The Company generates its revenue primarily in the United States. Revenue by geographical area is detailed in the table below (which is determined based on the customer billing address):
 
Three Months Ended
March 31,
 
2017
 
2018
United States
$
39,518

 
$
52,824

International
107

 
188

Total
$
39,625

 
$
53,012

9. Stockholders’ Equity
Preferred Stock
As of December 31, 2017 and March 31, 2018, the Company had authorized 10,000,000 shares of undesignated preferred stock, par value $0.001, of which no shares were issued and outstanding.

Common Stock
As of December 31, 2017 and March 31, 2018, the Company had authorized 100,000,000 shares of Class A common stock with one vote per share and 20,000,000 shares of Class B common stock with ten

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands Except Share and per Share Amounts)

votes per share, each par value $0.001. As of December 31, 2017, 4,197,831 and 13,440,724 shares of Class A and B common stock, respectively, were issued and outstanding. As of    March 31, 2018, 4,202,831 and 13,489,628 shares of Class A and B common stock, respectively, were issued and outstanding.
Shares of Class B common stock are convertible into shares of Class A common stock upon the stockholder's voluntary written notice to the Company's transfer agent or a transfer by the stockholder, subject to limited exceptions for transfers for estate planning purposes.

The Company had reserved shares of common stock for issuance as follows:
 
December 31,
 
March 31,
 
2017
 
2018
Stock options issued and outstanding
3,659,791

 
3,658,999

Nonvested restricted stock units issued and outstanding

 
312,277

Stock purchase warrants issued and outstanding
51,350

 

Stock-based awards available for grant under the 2017 Plan
1,050,000

 
919,735

 
4,761,141

 
4,891,011


10. Stock Based Compensation
2001 and 2010 Stock Option Plans
During 2001, the Company adopted the Bandwidth Inc. Stock Option Plan (the "2001 Plan"). As of July 26, 2010, the Company adopted the 2010 Equity Compensation Plan (the "2010 Plan").
Following the effectiveness of the 2010 Plan, the Company did not make any further grants under the 2001 Plan. However, the 2001 Plan continues to govern the terms and conditions of the outstanding awards granted under it. On November 9, 2017, the 2010 Plan was terminated in connection with the Company's IPO. Accordingly, no shares are available for future issuance under the 2010 Plan. However, the 2010 Plan continues to govern the terms and conditions of the outstanding awards granted thereunder.
2017 Incentive Award Plan
The Company's 2017 Incentive Award Plan (the "2017 Plan") became effective on November 9, 2017. The 2017 Plan provides for the grant of stock options, including incentive stock options and non-qualified stock options, stock appreciation rights, restricted stock, dividend equivalents, restricted stock units, and other stock or cash based awards to employees, consultants and directors of the Company. A total of 1,050,000 shares of the Company's Class A common stock were originally reserved for issuance under the 2017 Plan. These available shares automatically increase each January 1, beginning on January 1, 2018, by 5% of the number of shares of the Company's Class A common stock outstanding on the final day of the immediately preceding calendar year. On January 1, 2018, the shares available for grant under the 2017 Plan were automatically increased by 200,000 shares.
The terms of the stock option grants are determined by the Company’s Board of Directors. The Company’s stock options vest based on terms of the stock option agreements, which is generally over four years. The stock options have a contractual life of ten years.
RSUs granted under the 2017 Plan are subject to a time-based vesting condition. The compensation expense related to these awards is based on the grant date fair value of the RSUs and is recognized on a

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


ratable basis over the applicable service period. The Company granted restricted stock units to its non-employee Board of Directors, some of which vested immediately while others vest 25% as of each calendar quarter immediately following the grant date. Other RSUs awarded to executives and employees are earned over a service period of four years.
Stock options
The fair value of options granted is estimated on the date of grant using the Black-Scholes option pricing model based on the assumptions in the table below:
 
Three Months Ended
March 31,
 
2017
 
2018
Expected dividend yield
0%
 
0%
Expected stock price volatility
44%
 
47%
Average risk-free interest rate
2.0%-2.3%
 
2.5%
Expected life
6.2 years
 
6.2 years
Fair value of common stock
$9.60
 
$22.81
The following summarizes the stock option activity for the periods presented:
 
Number of
Options
Outstanding
 
Weighted-
Average
Exercise Price
(per share)
 
Weighted-
Average
Remaining
Contract Life
(in years)
 
Aggregate
Intrinsic
Value (in
thousands)
Outstanding as of December 31, 2017
3,659,791

 
$
6.88

 
4.38
 
$
59,436

Granted
17,988

 
22.81

 

 

Exercised
(5,000
)
 
6.74

 

 
$
111

Forfeited or cancelled
(13,780
)
 
12.19

 

 

Outstanding as of March 31, 2018
3,658,999

 
$
6.94

 
4.14
 
$
94,116

 
 
 
 
 
 
 
 
Options vested and exercisable at March 31, 2018
3,227,445

 
$
6.30

 
3.60
 
$
85,078

 
 
 
 
 
 
 
 
Options vested and expected to vest as of March 31, 2018
3,647,576

 
$
6.92

 
4.13
 
$
93,891

Aggregate intrinsic value represents the total pre-tax intrinsic value, which is computed based on the difference between the option exercise price and the estimated fair value of the Company’s common stock. Prior to the IPO, the fair value of the Company's common stock was estimated by the Company's board of directors. After the IPO, the fair value of the Company's common stock is the Company's Class A common stock price as reported on the NASDAQ Global Select Market.
The weighted average grant-date fair value of stock options granted was $4.34 and $11.10 for the three months ended March 31, 2017 and 2018, respectively.
The total estimated grant date fair value of options vested was $117 and $111 for the three months ended March 31, 2017 and 2018, respectively.
As of March 31, 2018, total unrecognized compensation cost related to all non-vested stock options was $1,869, which will be amortized over a weighted-average period of 2.55 years.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


Restricted Stock Units
The following summarizes the restricted stock unit activity for the periods presented:
 
Number of Awards Outstanding
 
Weighted-Average Grant Date Fair Value (per share)
 
Aggregate
Intrinsic
Value (in
thousands)
Nonvested RSUs as of December 31, 2017

 
$

 
$

Granted
316,643

 
25.69

 
 
Vested
(4,046
)
 
22.81

 
 
Forfeited or cancelled
(320
)
 
28.58

 
 
Nonvested RSUs as of March 31, 2018
312,277

 
$
25.72

 
$
2,167

As of March 31, 2018, total unrecognized compensation cost related to non-vested RSUs was $7,874, which will be amortized over a weighted-average period of 3.85 years.
Stock-Based Compensation Expense

The Company recognized total stock-based compensation expense in continuing operations as follows:
 
Three Months Ended
March 31,
 
2017
 
2018
Cost of revenue
$
20

 
$
18

Research and development
31

 
74

Sales and marketing
27

 
78

General and administrative
168

 
323

Total
$
246

 
$
493


11. Commitments and Contingencies
Operating Leases
The Company leases office space under operating lease agreements that expire at various dates beginning in 2021 and extend through 2025 in several locations within the United States including its headquarters, which is located in Raleigh, NC. On January 12, 2018, the Company entered into an 84 month operating lease agreement to provide 40,035 square feet of additional office space. This new lease is expected to commence in September 2018. On March 27, 2018, the Company entered into a 60 month operating lease agreement to provide 5,930 square feet of additional office space. This new lease is expected to commence in June 2018. The leases contain escalation clauses and various landlord concessions including a tenant improvement allowance. The Company recognizes the total minimum lease payments on a straight-line basis over the term of the lease.
Future minimum lease payments required under operating leases as of March 31, 2018 are as follows:

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(In Thousands Except Share And Per Share Amounts)


 
Amount
2018 (remaining)
$
3,145

2019
5,004

2020
5,180

2021
5,254

2022
3,438

Thereafter
3,742

 
$
25,763

The Company incurred rent expense of $513 and $933 for the three months ended March 31, 2017 and 2018, respectively, which is included in general and administrative expenses in the condensed consolidated statements of operations and comprehensive income.
On April 20, 2015, the Company created a wholly owned subsidiary, Republic Wireless, Inc. (“Republic”), which was incorporated in Delaware. On November 30, 2016, the Company completed a pro-rata distribution of the common stock of Republic to its stockholders of record as of the close of business (the “Spin-Off”).
In conjunction with the Spin-Off, the Company signed a Facilities Service Agreement with Republic in which the Company agreed to sub-lease 40,657 square feet of office space to Republic. The sub-lease is non-cancellable and extends to May 2022. The Company recorded a reduction of rent expense of $230 and $251 for the three months ended March 31, 2017 and 2018, respectively, which is included in general and administrative expenses in the condensed consolidated statements of operations and comprehensive income.
Future minimum sub-lease receipts required under the non-cancellable lease as of March 31, 2018 are as follows:
 
Amount
2018 (remaining)
$
769

2019
1,042

2020
1,065

2021
1,089

2022
594

Thereafter
$
4,559

Contractual Obligations
On October 25, 2015, the Company entered into an agreement with a telecommunications service provider. The service agreement requires the Company to pay a monthly recurring charge beginning on January 1, 2016 associated with the services received. The service agreement is non-cancellable and contains annual minimum commitments of $1,200 to be fulfilled over five years or for as long as the Company continues to receive services from this vendor. In addition, the Company has other non-cancellable purchase obligations totaling $6,112 as of March 31, 2018, which consists primarily of non-cancellable or in-transit network equipment, which is expected to be received in less than one year.

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(In Thousands Except Share And Per Share Amounts)


Legal Matters
The Company is involved as a defendant in various lawsuits alleging that the Company failed to bill, collect and remit certain taxes and surcharges associated with the provision of 911 services pursuant to applicable laws in various jurisdictions. In August 2016, the Company received a Civil Investigative Demand from the Consumer Protection Division of the North Carolina Department of Justice, though no formal complaint has been filed in connection with that investigation. The North Carolina Department of Justice is investigating the billing, collection and remission of certain taxes and surcharges associated with 911 service pursuant to applicable laws of the State of North Carolina.
While the results of these legal proceedings cannot be predicted with certainty, in the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the Company’s financial position or results of operations.
On January 29, 2018, the Company and Verizon entered into a settlement agreement to resolve an ongoing dispute and litigation with Verizon, which is a CABS customer of the Company. The settlement agreement also resolved Verizon’s counter-claims against the Company. Pursuant to the settlement agreement, Verizon made a lump sum payment to the Company on February 8, 2018 of $4,400. Following receipt of the $4,400 payment, the Company issued to Verizon bill credits with respect to other CABS amounts previously billed to Verizon, which were previously reserved and comprised the majority of the allowance for CABS revenue as of year-end. The settlement agreement also specifies certain term for the Company's CABS billings to Verizon prospectively. The Company will continue to assess collectability of its outstanding CABS accounts receivable, including amounts due under this settlement agreement.
    
12. Employee Benefit Plan
The Company sponsors a defined contribution 401(k) plan which allows eligible employees to defer a portion of their compensation. The Company, at its discretion, may make matching contributions. The Company made matching contributions of $351 and $287 for the three months ended March 31, 2017 and 2018, respectively.
13. Income Taxes
At the end of each interim reporting period, the Company determines the income tax provision by using an estimate of the annual effective tax rate, adjusted for discrete items occurring in the quarter. The Company’s effective tax rate was 37.2% and 29.8% for the three months ended March 31, 2017 and 2018, respectively. The change in tax rate is primarily due to the decrease in the federal statutory tax rate under the Tax Cuts and Jobs Act. The effective income tax rate reflects the effect of federal and state income taxes and the permanent impacts of differences in book and tax accounting.

The Company’s effective tax rate for the three months ended March 31, 2018 differs from the U.S. federal statutory rate of 21.0% primarily due to state taxes, credits and other permanent differences.

There has been no material change to the Company's SAB 118 assertion.

14. Related Parties

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


In connection with the Spin-Off on November 30, 2016, the Company and Republic entered into certain agreements in order to govern the ongoing relationships between the two companies after the Spin-Off and to provide for an orderly transition. The agreements include a Transition Services Agreement, Facilities Sharing Agreement, Tax Sharing Agreement, and Master Services Agreement. The equity holders of Bandwidth pre-IPO are comprised of substantially the same individuals and entities that are the equity owners of Republic. The Company has determined the equity owners of Republic are related parties of Bandwidth. The Company has certain involvement with Republic via ongoing services arrangements, with these ongoing services arrangements creating a variable interest in Republic. The Company assessed the relationship with Republic under guidance for variable interest entities. Because investors in Republic have disproportionate voting rights, the Company concluded that Republic is a VIE, but Bandwidth is not a primary beneficiary. The Company’s maximum exposure to loss relating to this variable interest entity is limited to amounts due under the service agreements between the Company and Republic.
For the three months ended March 31, 2017 and 2018, the Company received compensation of $351 and $28, respectively, which is included in general and administrative expenses in the condensed consolidated statements of operations and comprehensive income. In addition, there was approximately $15 and $11 due from Republic as of December 31, 2017 and March 31, 2018, respectively, which was recorded within accounts receivable in the accompanying condensed consolidated balance sheets.
For the three months ended March 31, 2017 and 2018, the Company received rental payments under the Facilities Sharing Agreement of $230 and $251, respectively, which is included in general and administrative expenses in the condensed consolidated statements of operations and comprehensive income. No amounts were due to the Company under the Facilities Sharing Agreement as of December 31, 2017 and March 31, 2018.
The Tax Sharing Agreement governs rights and obligations after the Spin-Off regarding income taxes and other taxes, including tax liabilities and benefits, attributes, returns and contests. There are no amounts outstanding or payable under this agreement as of December 31, 2017 and March 31, 2018.
The Master Services Agreement specifies certain wholesale telecommunications services to be provided by the Company. The agreement is cancellable at any time by either party. During the three months ended March 31, 2017 and 2018, the Company provided telecommunication services to Republic of $534 and $986, respectively. The Company recognized such amounts as revenue in the accompanying condensed consolidated statements of operations and comprehensive income. As of December 31, 2017 and March 31, 2018, the Company had a receivable of $311 and $310, respectively, under the Master Services Agreement.
15. Basic and Diluted Income per Common Share
As of December 31, 2017, the Company used the two-class method to compute net income per common share, because it had issued securities, other than common stock, that contractually entitled the holders to participate in dividends and earnings. These participating securities included the Company’s redeemable convertible preferred stock which had non-forfeitable rights to participate in any dividends declared on the Company’s common stock. The two-class method requires earnings for the period to be allocated between common stock and participating securities based upon their respective rights to receive distributed and undistributed earnings.

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(In Thousands Except Share And Per Share Amounts)


Under the two-class method, for periods with net income, basic net income per common share is computed by dividing the net income attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Net income attributable to common stockholders is computed by subtracting from net income the portion of current period earnings that the participating securities would have been entitled to receive pursuant to their dividend rights had all of the period’s earnings been distributed. No such adjustment to earnings is made during periods with a net loss, as the holders of the participating securities have no obligation to fund losses.
Diluted net income per common share is computed under the two-class method by using the weighted average number of shares of common stock outstanding, plus, for periods with net income attributable to common stockholders, the potential dilutive effects of stock options and warrants. The Company analyzed the potential dilutive effect of any outstanding dilutive securities under the “if-converted” method and treasury-stock method when calculating diluted earnings per share, in which it is assumed that the outstanding participating securities convert into common stock at the beginning of the period or date of issuance, if later. The Company reports the more dilutive of the approaches (two-class or “if-converted”) as its diluted net income per share during the period.
As of January 1, 2018, the Company no longer had outstanding securities other than common stock, which required holders' participation in dividends and earnings; therefore the Company no longer was required to calculate EPS under the two-class method. Basic net income per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted net income per share is computed by giving effect to all potential shares of common stock, including stock options, stock related to unvested restricted stock awards, and outstanding warrants to the extent dilutive.
The components of basic and diluted earnings per share, or EPS, are as follows:
 
Three Months Ended
March 31,
 
2017
 
2018
Earnings per share
 
 
 
Net income
$
2,989

 
$
6,191

Less: net income allocated to participating securities
391

 

Net income attributable to common stockholders
$
2,598

 
$
6,191

Net income per share:
 
 
 
Basic
$
0.22

 
$
0.35

Diluted
$
0.20

 
$
0.30

Weighted Average Number of Common Shares Outstanding
 
 
 
Basic
11,798,565

 
17,658,611

Dilutive effect of stock options, restricted stock units, and warrants
1,174,044

 
2,826,142

Diluted
12,972,609

 
20,484,753


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Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands Except Share And Per Share Amounts)


The following common share equivalents have been excluded from the calculation of weighted-average common shares outstanding, because the effect is anti-dilutive for the periods presented:
 
Three Months Ended
March 31,
 
2017
 
2018
Anti-dilutive Disclosure
 
 
 
Series A redeemable convertible preferred stock outstanding
1,775,000

 

Stock options issued and outstanding
588,365

 
94,126

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes that are included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements based upon current plans, expectations and beliefs that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” in this Quarterly Report on Form 10-Q. Our fiscal year ends on December 31.
Overview

We are a leading cloud-based communications platform for enterprises in the United States. Our solutions include a broad range of software application programming interfaces ("APIs") for voice and text functionality and our owned and managed, purpose-built internet protocol ("IP") voice network, one of the largest in the nation. Our sophisticated and easy-to-use software APIs allow enterprises to enhance their products and services by incorporating advanced voice and text capabilities. Companies use our platform to more frequently and seamlessly connect with their end users, add voice calling capabilities to residential Internet of Things ("IoT") devices, offer end users new mobile application experiences and improve employee productivity, among other use cases. By owning and operating a capital-efficient, purpose-built IP voice network, we are able to offer advanced monitoring, reporting and analytics, superior customer service, dedicated operating teams, personalized support, and flexible cost structures. Over the last ten years, we have pioneered the communications platform-as-a-service ("CPaaS") space through our innovation-rich culture and focus on empowering enterprises with end-to-end communications solutions.
Our voice software APIs allow enterprises to make and receive phone calls and create advanced voice experiences. Integration with our purpose-built IP voice network ensures enterprise-grade functionality and secure, high-quality connections. Our messaging software APIs provide enterprises with advanced tools to connect with end users via messaging. Our customers also use our solutions to enable 911 response capabilities, real-time provisioning and activation of phone numbers and toll-free number messaging.

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Table of Contents
Management's Discussion and Analysis

We are the only CPaaS provider in the industry with our own nationwide IP voice network, which we have purpose-built for our platform. Our network is capital-efficient and custom-built to support the applications and experiences that make a difference in the way enterprises communicate. Since a communications platform is only as strong as the network that backs it, we believe our network provides a significant competitive advantage in the control, quality, pricing power and scalability of our offering. We are able to control the quality and provide the support our customers expect, as well as efficiently meet scalability and cost requirements.
For the three months ended March 31, 2017 and 2018, total revenue was $39.6 million and $53.0 million, respectively. CPaaS revenue for the three months ended March 31, 2017 and 2018 was $31.6 million and $38.9 million, respectively, representing an increase of 23%. Net income for the three months ended March 31, 2017 and 2018 was $3.0 million and $6.2 million, respectively. The number of active CPaaS customer accounts increased from 819 as of March 31, 2017, to 1,028 as of March 31, 2018, or 26%.
Key Performance Indicators
We monitor the following key performance indicators ("KPIs") to help us evaluate our business, identify trends affecting our business, formulate business plans, and make strategic decisions. We believe the following KPIs are useful in evaluating our business:
 
Three Months Ended
March 31,
 
2017

2018
 
(Dollars in thousands)
Number of active CPaaS customers (as of period end)
819


1,028

Dollar-based net retention rate
109
%

115
%
Adjusted EBITDA
$
6,813


$
10,665

Free cash flow
$
(1,776
)

$
9,841

Number of Active CPaaS Customer Accounts
We believe that the number of active CPaaS customer accounts is an important indicator of the growth of our business, the market acceptance of our platform and our future revenue trends. We define an active CPaaS customer account at the end of any period as an individual account, as identified by a unique account identifier, for which we have recognized at least $100 of revenue in the last month of the period. We believe that the use of our platform by active CPaaS customer accounts at or above the $100 per month threshold is a stronger indicator of potential future engagement than trial usage of our platform at levels below $100 per month. A single organization may constitute multiple unique active CPaaS customer accounts if it has multiple unique account identifiers, each of which is treated as a separate active CPaaS customer account. Customers who pay after using our platform and customers that have credit balances are included in the number of active CPaaS customer accounts. Customers from our Other segment are excluded in the number of active CPaaS customer accounts, unless they are also CPaaS customers.
For the three months ended March 31, 2017 and 2018, revenue from active CPaaS customer accounts represented approximately 99% of total CPaaS revenue.

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Table of Contents
Management's Discussion and Analysis

Dollar-Based Net Retention Rate
Our ability to drive growth and generate incremental revenue depends, in part, on our ability to maintain and grow our relationships with our existing customers that generate CPaaS revenue and seek to increase their use of our platform. We track our performance in this area by measuring the dollar-based net retention rate for our customers who generate CPaaS revenue. Our dollar-based net retention rate compares the CPaaS revenue from customers in a quarter to the same quarter in the prior year. To calculate the dollar-based net retention rate, we first identify the cohort of customers that generate CPaaS revenue and that were customers in the same quarter of the prior year. The dollar-based net retention rate is obtained by dividing the CPaaS revenue generated from that cohort in a quarter, by the CPaaS revenue generated from that same cohort in the corresponding quarter in the prior year. When we calculate dollar-based net retention rate for periods longer than one quarter, we use the average of the quarterly dollar-based net retention rates for the quarters in such period.
Our dollar-based net retention rate increases when such customers increase usage of a product, extend usage of a product to new applications or adopt a new product. Our dollar-based net retention rate decreases when such customers cease or reduce usage of a product or when we lower prices on our solutions. As our customers grow their business and extend the use of our platform, they sometimes create multiple customer accounts with us for operational or other reasons. As such, when we identify a significant customer organization (defined as a single customer organization generating more than 1% of CPaaS revenue in a quarterly reporting period) that has created a new CPaaS customer, this new customer is tied to, and CPaaS revenue from this new customer is included with, the original CPaaS customer for the purposes of calculating this metric.
Key Components of Statements of Operations
Revenue
We generate a majority of our revenue from our CPaaS segment. CPaaS revenue is derived from voice usage, phone number services, 911-enabled phone number services, messaging services and other services. We generate a portion of our CPaaS revenue from usage-based fees which include voice calling and messaging services. For the three months ended March 31, 2017 and 2018, we generated 57% and 63% of our CPaaS revenue, respectively, from usage-based fees. We also earn monthly fees from services such as phone number services and 911 access service. For the three months ended March 31, 2017 and 2018, we generated 40% and 35% of our CPaaS revenue in each period from monthly per unit fees.
The remainder of our revenue is generated by our Other segment. Other revenue is composed of revenue earned from our legacy services and indirect revenue. Other revenue as a percentage of total revenue is expected to continue to decline over time.
We recognize accounts receivable at the time the customer is invoiced. Additionally, we record a receivable and revenue for unbilled revenue if the services have been delivered and are billable in subsequent periods. Unbilled revenue made up 45% and 42% of outstanding accounts receivable, net of allowance for doubtful accounts as of March 31, 2017 and 2018, respectively.

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Management's Discussion and Analysis

Cost of Revenue and Gross Margin
CPaaS cost of revenue consists primarily of fees paid to other network service providers from whom we buy services such as minutes of use, phone numbers, messages, porting of customer numbers and network circuits. Cost of revenue also contains costs related to support of our IP voice network, web services, cloud infrastructure, capacity planning and management, rent for network facilities, software licenses, hardware and software maintenance fees and network engineering services. Personnel costs (including non-cash stock-based compensation expenses) associated with personnel who are responsible for the delivery of services, operation and maintenance of our communications network, and customer support as well as, third-party support agreements and depreciation of network equipment, amortization of internally developed software and gain (loss) on disposal of property and equipment are also included in cost of revenue.
Other cost of revenue consists of costs supporting non-CPaaS services including leased circuit costs paid to third party providers, internet connectivity expenses, minutes of use, direct operations, contractors, regulatory fees, surcharges and other pass-through costs and software and hardware maintenance fees.
Gross margin is calculated by subtracting cost of revenue from revenue, divided by total revenue, expressed as a percentage. Our cost of revenue and gross margin have been, and will continue to be, affected by several factors, including the timing and extent of our investments in our network, our ability to manage off-network minutes of use and messaging costs, the product mix of revenue, the timing of amortization of capitalized software development costs and the extent to which we periodically choose to pass on any cost savings to our customers in the form of lower usage prices.
Operating Expenses
The most significant components of operating expenses are personnel costs, which consist of salaries, benefits, bonuses, and stock-based compensation expenses. We also incur other non-personnel costs related to our general overhead expenses, including facility expenses, software licenses, web services, depreciation and amortization of assets unrelated to delivery of our services. We expect that our operating expenses will increase in absolute dollars.
Research and Development
Research and development ("R&D") consist primarily of personnel costs (including non-cash stock-based compensation expenses), outsourced software development and engineering service and cloud infrastructure fees for staging and development of outsourced engineering services. We capitalize the portion of our software development costs in instances where we invest resources to develop software for internal use. We plan to continue to invest in R&D to enhance current product offerings and develop new services.
Sales and Marketing
Sales and marketing expenses consist primarily of personnel costs, including commissions for our sales employees and non-cash stock-based compensation expenses. Sales and marketing expenses also include expenditures related to advertising, marketing, our brand awareness activities, sales support and professional services fees.

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Management's Discussion and Analysis

We focus our sales and marketing efforts on creating sales leads and establishing and promoting our brand. We plan to continue to invest in sales and marketing in order to expand our CPaaS customer base by growing headcount, driving our go-to-market strategies, building brand awareness, advertising and sponsoring additional marketing events.
General and Administrative
General and administrative expenses consist primarily of personnel costs, including stock-based compensation, for our accounting, finance, legal, human resources and administrative support personnel and executives. General and administrative expenses also include costs related to product management and reporting, customer billing and collection functions, information services, professional services fees, credit card processing fees, rent associated with our headquarters in Raleigh, North Carolina and our other offices, and depreciation and amortization. We expect that we will incur increased costs associated with supporting the growth of our business and to meet the increased compliance requirements associated with our transition to, and operation as, a public company.
Income Taxes
For the three months ended March 31, 2017 and 2018, our effective tax rate was 37.2% and 29.8%, respectively. The decrease in our effective tax rate is primarily due to the decrease in the federal statutory tax rate under the Tax Cuts and Jobs Act (the "Act").
Non-GAAP Financial Measures
We use Non-GAAP gross profit, Non-GAAP gross margin, Adjusted EBITDA, Non-GAAP net income and free cash flow for financial and operational decision making and to evaluate period-to-period differences in our performance. Non-GAAP gross profit, Non-GAAP gross margin, Adjusted EBITDA, Non-GAAP net income and free cash flow are non-GAAP financial measures, which we believe are useful for investors in evaluating our overall financial performance. We believe these measures provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to key performance indicators used by management in its financial and operational decision making. For a reconciliation of each of the non-GAAP financial measures described below, see “Reconciliation of Non-GAAP Financial Measures.”
Non-GAAP Gross Profit and Non-GAAP Gross Margin
GAAP defines gross profit as revenue less cost of revenue. Cost of revenue includes all expenses associated with our various service offerings as more fully described under the caption “Key Components of Statement of Operations-Cost of Revenue and Gross Margin.” We define Non-GAAP gross profit as gross profit after adding back the following items:
depreciation and amortization; and
stock-based compensation.


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Management's Discussion and Analysis

We add back depreciation and amortization and stock-based compensation because they are non-cash items. We eliminate the impact of these non-cash items because we do not consider them indicative of our core operating performance. Their exclusion facilitates comparisons of our operating performance on a period-to-period basis. Therefore, we believe that showing gross margin, as Non-GAAP to remove the impact of these non-cash expenses, such as depreciation, amortization and stock-based compensation, is helpful to investors in assessing our gross profit and gross margin performance in a way that is similar to how management assesses our performance.
We calculate Non-GAAP gross margin by dividing Non-GAAP gross profit by revenue, expressed as a percentage of revenue.
Management uses Non-GAAP gross profit and Non-GAAP gross margin to evaluate operating performance and to determine resource allocation among our various service offerings. We believe that Non-GAAP gross profit and Non-GAAP gross margin provide useful information to investors and others to understand and evaluate our operating results in the same manner as our management and board of directors and allows for better comparison of financial results among our competitors. Non-GAAP gross profit and Non-GAAP gross margin may not be comparable to similarly titled measures of other companies because other companies may not calculate Non-GAAP gross profit and Non-GAAP gross margin or similarly titled measures in the same manner as we do.
Consolidated
 
Three Months Ended
March 31,
 
2017
 
2018
 
(In thousands)
Consolidated Gross Profit
$
18,059

 
$
27,648

Depreciation
1,047

 
1,064

Stock-based compensation
20

 
18

Non-GAAP Gross Profit
$
19,126

 
$
28,730

Non-GAAP Gross Margin %
48
%
 
54
%
By Segment
CPaaS
 
Three Months Ended
March 31,
 
2017
 
2018
 
(In thousands)
CPaaS Gross Profit
$
13,419

 
$
16,992

Depreciation
1,047

 
1,064

Stock-based compensation
20

 
18

Non-GAAP Gross Profit
$
14,486

 
$
18,074

Non-GAAP Gross CPaaS Margin %
46
%
 
46
%
Other
There are no Non-GAAP adjustments to gross profit for the Other segment.

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Management's Discussion and Analysis

Adjusted EBITDA
We define Adjusted EBITDA as net income adjusted to reflect the addition or elimination of certain income statement items including, but not limited to:
income tax provision (benefit);
interest expense, net;
depreciation and amortization expense;
stock-based compensation expense;
impairment of intangible assets, if any; and
loss (gain) on disposal of property and equipment.

Adjusted EBITDA is a key measure used by management to understand and evaluate our core operating performance and trends, to generate future operating plans and to make strategic decisions regarding the allocation of capital. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates comparisons of our operating performance on a period-to-period basis.
 
Three Months Ended
March 31,
 
2017
 
2018
 
 
 
 
Net income
$
2,989

 
$
6,191

Income tax provision
1,772

 
2,634

Interest expense (income), net
421

 
(49
)
Depreciation
1,166

 
1,222

Amortization
210

 
165

Stock-based compensation
246

 
493

Loss on disposal of property and equipment
9

 
9

Adjusted EBITDA
$
6,813

 
$
10,665


Non-GAAP Net Income
We define Non-GAAP net income as net income adjusted for certain items affecting period-to-period comparability. Non-GAAP net income excludes:
stock-based compensation;
amortization of acquired intangible assets related to the acquisition of Dash Carrier Services, LLC;
impairment charges of intangibles assets, if any;
loss (gain) on disposal of property and equipment;
estimated tax impact of above adjustments;
benefit resulting from the release of the valuation allowance on our deferred tax assets ("DTA"); and
impact on remeasurement of DTA as a result of 2017 tax reform.


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Management's Discussion and Analysis

We calculate Non-GAAP basic and diluted shares by adding the weighted average of outstanding Series A redeemable convertible preferred stock to the weighted average number of outstanding basic and diluted shares, respectively.
We believe Non-GAAP net income is a meaningful measure because by removing certain non-cash and other expenses we are able to evaluate our operating results in a manner we believe is more indicative of the current period's performance. We believe the use of Non-GAAP net income may be helpful to investors because it provides consistency and comparability with past financial performance, facilitates period-to-period comparisons of results of operations and assists in comparisons with other companies, many of which may use similar non-GAAP financial information to supplement their GAAP results.
 
Three Months Ended
March 31,
 
2017
 
2018
 
(In thousands)
Net income
$
2,989

 
$
6,191

Stock-based compensation
246

 
493

Amortization related to acquisitions
130

 
130

Loss on disposal of property and equipment
9

 
9

Estimated tax effects of adjustments
(146
)
 
(160
)
Non-GAAP net income
$
3,228

 
$
6,663

Non-GAAP net income per Non-GAAP share
 
 
 
Basic
$
0.24

 
$
0.38

Diluted
$
0.22

 
$
0.33

 
 
 
 
Non-GAAP Weighted Average Number of Shares outstanding
 
 
 
Basic
11,798,565

 
17,658,611

Series A redeemable convertible preferred stock outstanding
1,775,000

 

Non-GAAP Basic Shares
13,573,565

 
17,658,611

 
 
 
 
Diluted
12,972,609

 
20,484,753

Series A redeemable convertible preferred stock outstanding
1,775,000

 

Non-GAAP Diluted Shares
14,747,609

 
20,484,753


Free Cash Flow
Free cash flow represents net cash provided by or used in operating activities less net cash used in the acquisition of property, plant and equipment and capitalized development costs of software for internal use. We believe free cash flow is a useful indicator of liquidity and provides information to management and investors about the amount of cash generated from our core operations that can be used for investing in our business. Free cash flow has certain limitations in that it does not represent the total increase or decrease in the cash balance for the period, it does not take into consideration investment in long-term securities, nor does it represent the residual cash flows available for discretionary expenditures. Therefore, it is important to evaluate free cash flow along with our condensed consolidated statements of cash flows.

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Table of Contents
Management's Discussion and Analysis

 
Three Months Ended
March 31,
 
2017
 
2018
 
(In thousands)
Net cash (used in) provided by operating activities
$
(969
)
 
$
11,243

Net cash used in investing in capital assets (1)
(807
)
 
(1,402
)
Free cash flow
$
(1,776
)
 
$
9,841

________________________
(1) Represents the acquisition cost of property, equipment and capitalized development costs for software for internal use.

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Management's Discussion and Analysis


Results of Operations
Consolidated Results of Operations
The following table sets forth the consolidated statements of operations for the periods indicated.
 
Three Months Ended
March 31,
 
2017
 
2018
 
(In thousands)
Revenue:
 
 
 
CPaaS revenue
$
31,647

 
$
38,897

Other revenue
7,978

 
14,115

Total revenue
39,625

 
53,012

Cost of revenue:
 
 
 
CPaaS cost of revenue
18,228

 
21,905

Other cost of revenue
3,338

 
3,459

Total cost of revenue
21,566

 
25,364

Gross profit:
 
 
 
CPaaS
13,419

 
16,992

Other
4,640

 
10,656

Total gross profit
18,059

 
27,648

Operating expenses:
 
 
 
Research and development
2,682

 
3,781

Sales and marketing
2,558

 
4,522

General and administrative
7,637

 
10,569

Total operating expenses
12,877

 
18,872

Operating income
5,182

 
8,776

Other expense:
 
 
 
Interest (expense) income, net
(421
)
 
49

Income before income taxes
4,761

 
8,825

Income tax provision
(1,772
)
 
(2,634
)
Net income
$
2,989

 
$
6,191


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Table of Contents
Management's Discussion and Analysis

The following table sets forth our results of operations as a percentage of our total revenue for the periods presented. *
 
Three Months Ended
March 31,
 
2017
 
2018
Revenue:
 
 
 
CPaaS revenue
80
 %
 
73
 %
Other revenue
20
 %
 
27
 %
Total revenue
100
 %
 
100
 %
Cost of revenue:
 
 
 
CPaaS cost of revenue
46
 %
 
41
 %
Other cost of revenue
8
 %
 
7
 %
Total cost of revenue
54
 %
 
48
 %
Gross profit:
 
 
 
CPaaS
34
 %
 
32
 %
Other
12
 %
 
20
 %
Total gross profit
46
 %
 
52
 %
Operating expenses:
 
 
 
Research and development
7
 %
 
7
 %
Sales and marketing
6
 %
 
9
 %
General and administrative
19
 %
 
20
 %
Total operating expenses
32
 %
 
36
 %
Operating income
13
 %
 
17
 %
Other expense:
 
 
 
Interest (expense) income, net
(1
)%
 
 %
Income before income taxes
11
 %
 
6
 %
Income tax provision
(4
)%
 
(5
)%
Net income
8
 %
 
12
 %
(*) Columns may not foot due to rounding.



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Management's Discussion and Analysis


Comparison of the Three Months Ended March 31, 2017 and 2018
Revenue
 
Three Months Ended
March 31,
 
 
 
 
 
2017
 
2018
 
Change
 
(In thousands)
 
 
 
 
CPaaS revenue
$
31,647

 
$
38,897

 
$
7,250

 
23
%
Other revenue
7,978

 
14,115

 
6,137

 
77
%
Total revenue
$
39,625

 
$
53,012

 
$
13,387

 
34
%
For the three months ended March 31, 2018, total revenue increased by $13.4 million, or 34%, compared to the same period in 2017, and CPaaS revenue increased by $7.3 million, or 23%, compared to the same period in 2017. The increase in CPaaS revenue was primarily attributable to an increase in the usage of all our service offerings, particularly our voice and messaging usage, which accounted for $10.1 million of the increase in CPaaS revenue, and our phone number services and 911-enabled phone number services, which accounted for $1.3 million of the increase in CPaaS revenue. This overall increase in CPaaS revenue was partially offset by $4.2 million related to pricing decreases that we have implemented over time with our customers in the form of lower usage prices to increase the reach and scale of our platform. The changes in usage and price in the three months ended March 31, 2018 compared to the same period in 2017 were reflected in our dollar-based net retention rate of 115%. The increase in usage was also attributable to a 26% increase in the number of active CPaaS customer accounts, from 819 as of March 31, 2017 to 1,028 as of March 31, 2018. In addition, revenue from new CPaaS customers contributed $2.6 million, or 8%, to CPaaS revenue for the three months ended March 31, 2018 compared to $1.4 million, or 5% to CPaaS revenue in the same period in 2017. As a percentage of total revenue, CPaaS revenue decreased from 80% to 73% from the three months ended March 31, 2017 to the same period in 2018. Other revenue increased by $6.1 million, or 77%, due to an increase in indirect revenue of $6.9 million, from the settlement of a dispute, and expected declines in our legacy services of $0.8 million.
Cost of Revenue and Gross Margin
 
Three Months Ended
March 31,
 
 
 
 
 
2017
 
2018
 
Change
 
(In thousands)
 
 
 
 
Cost of revenue:
 
 
 
 
 
 
 
CPaaS cost of revenue
$
18,228

 
$
21,905

 
$
3,677

 
20
%
Other cost of revenue
3,338

 
3,459

 
121

 
4
%
Total cost of revenue
21,566

 
25,364

 
3,798

 
18
%
Gross profit
$
18,059

 
$
27,648

 
$
9,589

 
53
%
Gross margin:
 
 
 
 
 
 
 
CPaaS
42
%
 
44
%
 
 
 
 
Other
58
%
 
75
%
 
 
 
 
Total gross margin
46
%
 
52
%
 
 
 
 

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Table of Contents
Management's Discussion and Analysis

For the three months ended March 31, 2018, total gross profit increased by $9.6 million, or 53%, compared to the same period in 2017. Total gross margin increased from 46% to 52% during the same period. In 2018, CPaaS cost of revenue increased by $3.7 million, or 20% compared to the same period in 2017. CPaaS cost of revenue increased primarily due to an increase in voice usage costs of $3.0 million due to growth in minutes used by customers, partially offset by a decrease in the cost per minute from vendors. Cost of phone numbers increased by $0.1 million due to an increase in phone numbers used by customers. Network costs also increased $0.5 million. For the three months ended March 31, 2018, CPaaS gross margin increased from 42% to 44% compared to the same period in 2017. Excluding depreciation and stock-based compensation of $1.1 million and $1.1 million for the three months ended March 31, 2017 and 2018, respectively, CPaaS Non-GAAP gross margin would have been 46% and 46% for the three months ended March 31, 2017 and 2018, respectively, and total Non-GAAP gross margin would have been 48% and 54% for the same periods.
Other cost of revenue increased by $0.1 million, which was due to a $0.4 million increase in cost of indirect revenue related to cost of carrier access revenue, partially offset by a $0.3 million decrease as a result of churn in legacy services.
Operating Expenses
 
Three Months Ended
March 31,
 
 
 
 
 
2017
 
2018
 
Change
 
(In thousands)
 
 
 
 
Research and development
$
2,682

 
$
3,781

 
$
1,099

 
41
%
Sales and marketing
2,558

 
4,522

 
1,964

 
77
%
General and administrative
7,637

 
10,569

 
2,932

 
38
%
Total operating expenses
$
12,877

 
$
18,872

 
$
5,995

 
47
%
For the three months ended March 31, 2018, research and development expenses increased by $1.1 million, or 41%, compared to the same period in 2017. This increase was primarily due to increased personnel costs of $1.0 million.
For the three months ended March 31, 2018, sales and marketing expenses increased by $2.0 million, or 77%, compared to the same period in 2017 primarily due to an overall increase in sales personnel costs of $1.5 million and other non-headcount costs of $0.5 million.
General and administrative expenses increased by $2.9 million for the three months ended March 31, 2018, or 38%, compared to the same period in 2017. This increase was due to higher personnel cost of $1.3 million. Facilities expense of $0.5 million, hosted software costs of $0.3 million and professional expenses of $0.7 million also contributed the overall general and administrative expenses.
Interest Expense, Net
For the three months ended March 31, 2018, interest expense decreased by $0.5 million compared to the same period in 2017, due to repayment of all outstanding debt in 2017 with the proceeds from the IPO and increased interest income from investments in marketable securities.
Income Tax Expense
For the three months ended March 31, 2018, income tax expense increased by $0.9 million compared to the same period in 2017. The effective tax rate for the three months ended March 31, 2018 was 29.8% compared to 37.2% in the same period in 2017. The change in tax rate is primarily due to the decrease in the federal statutory tax rate under the Act.

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Table of Contents
Management's Discussion and Analysis


Liquidity and Capital Resources

To date, our principal sources of liquidity have been the proceeds of $74.4 million, net of underwriting discounts and commissions, from our initial public offering in November 2017, in addition to free cash flow driven by payments received from customers using our services, as well as borrowings under our senior secured credit facility. We believe that our cash and cash equivalents balances, our marketable securities portfolio, our credit facility and the cash flows generated by our operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, our belief may prove to be incorrect, and we could utilize our available financial resources sooner than we currently expect. Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth in the section titled “Risk Factors.” We may be required to seek additional equity or debt financing in order to meet these future capital requirements. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, or at all. If we are unable to raise additional capital when desired, our business, results of operations and financial condition would be adversely affected.

Statement of Cash Flows

The following table summarizes our cash flows for the periods indicated:
 
Three Months Ended
March 31,
 
2017
 
2018
 
(In thousands)
Net cash (used in) provided by operating activities
$
(969
)
 
$
11,243

Net cash used in investing activities
(807
)
 
(9,900
)
Net cash provided by (used in) financing activities
488

 
(240
)
Net increase in cash and cash equivalents
$
(1,288
)
 
$
1,103

Cash Flows from Operating Activities
For the three months ended March 31, 2018, cash provided by operating activities was $11.2 million, consisting of net income of $6.2 million adjusted for non-cash items. These non-cash items included depreciation and amortization expense of $1.4 million, stock-based compensation expenses of $0.5 million, deferred tax expense of $2.6 million and cash provided by changes in operating assets and liabilities of $0.5 million. Cash generated from operating assets and liabilities included an increase in deferred revenue of $5.9 million and a decrease in deferred costs of $0.1 million. Offsetting these cash generating items in assets and liabilities were increases in accounts receivable and prepaid expenses of $3.2 million and $0.5 million, respectively, and decreases in accrued expenses and accounts payable of $1.2 million and $0.7 million, respectively.

For the three months ended March 31, 2017, cash used in operating activities was $1.0 million, consisting of net income of $3.0 million adjusted for non-cash items. These non-cash items included depreciation and amortization expense of $1.4 million, stock-based compensation expenses of $0.2 million, deferred tax expense of $1.6 million and cash used in changes in operating assets and liabilities of $7.2 million. Cash outflows from operating assets and liabilities included increases in accounts receivable of $0.2 million, prepaid expenses and other assets of $1.2 million, deferred costs of $0.4 million along with decreases

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Management's Discussion and Analysis

in accounts payable of $1.7 million and accrued expenses of $3.9 million. Offsetting these cash outflow items in assets and liabilities was an increase in deferred revenue and advance billings of $0.2 million.

Cash Flows from Investing Activities
For the three months ended March 31, 2018, cash used in investing activities from continuing operations was $9.9 million from the investment in marketable securities of $8.5 million, the purchase of property, plant and equipment of $1.0 million and capitalized internally developed software costs of $0.4 million.
For the three months ended March 31, 2017, cash used in investing activities from continuing operations was $0.8 million from the purchase of property, plant and equipment of $0.1 million and capitalized internally developed software costs of $0.7 million.
Cash Flows from Financing Activities
For the three months ended March 31, 2018, cash used in financing activities from continuing operations was $0.2 million consisting primarily of $0.3 million in costs from the initial public offering, partially offset by $0.1 million in proceeds from the issuances of common stock.
For the three months ended March 31, 2017, cash provided by financing activities from continuing operations was $0.5 million consisting primarily of $1.0 million in net borrowings on our line of credit, partially offset by $0.5 million in repayments on our term loan.
Debt
As of December 31, 2017 and March 31, 2018, the Company had $0 outstanding on the revolving loan and was in compliance with all financial and non-financial covenants for all periods presented. The available borrowing capacity under our revolving credit facility loan was $25,000 as of March 31, 2018.

As of December 31, 2017 and March 31, 2018, the outstanding unamortized loan fees for the revolving loan were $175 and $159, respectively, and were included in other long-term assets.
Contractual Obligations and Other Commitments
The following table summarizes our non-cancellable contractual obligations as of March 31, 2018:
 
Total
 
Less
Than 1
Year
 
1 to 2
Years
 
3 to 5
Years
 
More
than 5
years
As of March 31, 2018:
 
 
 
 
 
 
 
 
 
Operating leases (1)
$
25,763

 
$
4,379

 
$
10,261

 
$
9,126

 
$
1,997

Capital leases
67

 
67

 

 

 

Purchase obligations (2)
9,412

 
5,513

 
3,467

 
432

 

Total
$
35,242

 
$
9,959

 
$
13,728

 
$
9,558

 
$
1,997

________________________
(1) Operating leases represent total future minimum rent payments under non-cancellable operating lease agreements. $8.7M increase in operating leases due to two new leases extending through 2025 (see Note 11, "Commitments and Contingencies," in our condensed consolidated financial statements).
(2) Purchase obligations represent total future minimum payments under contracts to various service providers. Purchase obligations exclude agreements that are cancellable without penalty.

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Management's Discussion and Analysis

Off-Balance Sheet Arrangements
We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.
Critical Accounting Policies and Significant Judgments and Estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs, and expenses and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these judgments and estimates under different assumptions or conditions and any such differences may be material.
We believe that the assumptions and estimates associated with revenue recognition and deferred revenue, stock-based compensation, the valuation of goodwill and intangible assets, internal-use software development costs, income taxes and other contingencies have the greatest potential impact on our condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates.
There have been no material changes to our critical accounting policies and significant judgments and estimates as compared to the critical accounting policies and significant judgments and estimates disclosed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on February 26, 2018.

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Management's Discussion and Analysis

Recently Issued Accounting Guidance
See Note 2, "Summary of Significant Accounting Policies," to the unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, for a summary of recently adopted accounting standards and recent accounting pronouncements not yet adopted.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to certain market risks 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 the result of fluctuations in interest rates and, to a lesser extent, inflation.
Interest Rate Risk
Our primary exposure to market risk relates to interest rate changes. We had cash and cash equivalents totaling $39.0 million as of March 31, 2018, which were held for working capital purposes. Our cash and cash equivalents are comprised primarily of interest bearing checking accounts and money market accounts. Marketable securities consist of U.S. treasury securities not otherwise classified as cash equivalents.
Such interest-earning instruments carry a degree of interest rate risk. To date, fluctuations in interest income have not been significant. The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. Due to the short-term nature of our investments, we have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates.
Our debt is comprised of a revolving line of credit account, which had no amount outstanding as of March 31, 2018. The revolving line of credit has an interest rate based on the 1-month LIBOR rate plus 225 basis points as of March 31, 2018. A one-eighth percentage point increase or decrease in the applicable rate for our credit facility (assuming the revolving portion of the credit facility is fully drawn) would have an annual impact of less than $0.1 million on cash interest expense.
Foreign Currency Risk
Our customers consume our services primarily in the United States. Our revenue and expenses are denominated in U.S. dollars and as a result we have no foreign currency risk.
Inflation
We do not believe inflation has had a material effect on our business, financial condition or results of operations. We continue to monitor the impact of inflation in order to minimize its effects through pricing strategies, productivity improvements and cost reductions. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

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Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, have evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that 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 SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent limitation on the effectiveness of internal control
The effectiveness of any system of internal control over financial reporting, including ours, is subject to inherent limitations, including the exercise of judgment in designing, implementing, operating, and evaluating the controls and procedures, and the inability to eliminate misconduct completely. Accordingly, any system of internal control over financial reporting, including ours, no matter how well designed and operated, can only provide reasonable, not absolute assurances. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We intend to continue to monitor and upgrade our internal controls as necessary or appropriate for our business, but cannot assure you that such improvements will be sufficient to provide us with effective internal control over financial reporting.

PART II — OTHER INFORMATION
Item 1. Legal Proceedings
In April 2014, Phone Recovery Services, LLC (“Phone Recovery Services”) filed a complaint against us in the Superior Court of the District of Columbia. The complaint alleges that we failed to bill, collect and remit certain taxes and surcharges associated with the provision of 911 services pursuant to applicable laws of the District of Columbia. In November 2015, the Superior Court of the District of Columbia dismissed Phone Recovery Services’ complaint with prejudice. Phone Recovery Services subsequently appealed, and we are currently awaiting a decision regarding Phone Recovery Services’ appeal.

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Phone Recovery Services, acting or purporting to act on behalf of applicable jurisdictions, or the applicable county or city itself, has filed similar lawsuits against us and/or one of our subsidiaries in the Superior Court of the State of Rhode Island, the Court of Common Pleas of Allegheny County, Pennsylvania and the District Court of Ramsey County, Minnesota that are currently in various stages of litigation. The case in Ramsey County, Minnesota was dismissed in November 2016; in August 2017, the Minnesota Court of Appeals affirmed that dismissal. On September 5, 2017, Phone Recovery Services filed a notice of appeal to the Minnesota Supreme Court. To date, we have not received any material adverse decision in connection with those matters.
We face similar lawsuits brought directly by various state and local governments alleging underpayment of 911 taxes and surcharges, although we understand that Phone Recovery Services may be working in conjunction with each state or local government as a consultant on a contingency basis. The following county or municipal governments have named us in lawsuits associated with the collection and remittance of 911 taxes and surcharges: Birmingham Emergency Communications District, Alabama; Clayton County, Cobb County, DeKalb County, Fulton County, Gwinnett County, Macon-Bibb County, Georgia and Columbus Consolidated Government, Georgia (collectively, the “Georgia Cases”); Cook County and Kane County Illinois; City of Chicago, Illinois; the State of Illinois (collectively, the “Illinois Case”); Beaver County, Berks County, Bucks County, Butler County, Chester Co., Clarion County, Cumberland County, Dauphin County, Delaware County, Lancaster County, Lebanon County, Mercer County, Somerset County, Washington County, Westmoreland County, and York County, Pennsylvania (collectively, the “Pennsylvania Cases”); and Charleston County, South Carolina. The complaints allege that we failed to bill, collect and remit certain taxes and surcharges associated with 911 service pursuant to applicable laws. The Georgia Cases have been closed administratively during the appeal of a related case in the Georgia courts; the Georgia Cases may be reopened. We understand that Augusta-Richmond County, Bartow County, Chatham County, Cherokee County, City of Atlanta, City of Savannah, Forsyth County, Houston County and Spalding County, Georgia each intends to initiate legal proceedings against us with allegations substantially similar to those in the Georgia Cases. The Pennsylvania Case in Butler County, Pennsylvania was dismissed in August 2016 and that dismissal is currently pending appeal; the remaining Pennsylvania Cases have been stayed until the appeal of the dismissal of the Butler County, Pennsylvania Case is resolved. The Illinois Case was dismissed in December 2016; Phone Recovery Services timely filed a notice of appeal and the appeal is underway.
We intend to vigorously defend these lawsuits and believe we have meritorious defenses to each. However, litigation is inherently uncertain, and any judgment or injunctive relief entered against us or any adverse settlement could negatively affect our business, results of operations and financial condition.
In August 2016, we received a Civil Investigative Demand from the Consumer Protection Division of the North Carolina Department of Justice, though no formal complaint has been filed in connection with that investigation. The North Carolina Department of Justice is investigating the billing, collection and remission of certain taxes and surcharges associated with 911 service pursuant to applicable laws of the State of North Carolina.
On January 29, 2018, we entered into a settlement agreement with MCI Communications Services, Inc. d/b/a Verizon Business and Verizon Select Services, Inc. (collectively, "Verizon") to resolve an ongoing dispute and litigation with Verizon, which is a carrier access billing ("CABS") customer of ours. The settlement agreement also resolved Verizon’s counter-claims against us. Pursuant to the settlement agreement, Verizon made a lump sum payment to us on February 8, 2018 of $4,400. Following receipt of the $4,400 payment, we issued Verizon bill credits with respect to other CABS amounts previously billed to Verizon, which were previously reserved and comprised the majority of the allowance for CABS revenue as of year-end. The settlement agreement also specifies certain term for our CABS billings to Verizon prospectively.

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In addition to the litigation discussed above, from time to time, we may be subject to legal actions and claims in the ordinary course of business. We have received, and may in the future continue to receive, claims from third parties asserting, among other things, infringement of their intellectual property rights. Future litigation may be necessary to defend ourselves, our partners and our customers by determining the scope, enforceability and validity of third-party proprietary rights, or to establish our proprietary rights. The results of any current or future litigation cannot be predicted with certainty, and regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.

Item 1A. Risk Factors
A description of the risks and uncertainties associated with our business is set forth below. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Quarterly Report on Form 10-Q, including the section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The risks and uncertainties described below may not be the only ones we face. If any of the risks actually occur, our business, financial condition, results of operations and prospects could be materially and adversely affected. In that event, the market price of our Class A common stock could decline.
Risks Related to Our Business
The success of our growth and expansion plans depends on a number of factors that are beyond our control.
We have grown our business considerably over the last several years. We cannot guarantee that we will be able to maintain our growth or that we will choose to target the same pace of growth in the future. Our success in achieving continued growth depends upon several factors including:
the availability and retention of qualified and effective personnel with the expertise required to sell and operate effectively or successfully;
the overall economic health of new and existing markets;
the number and effectiveness of competitors;
the pricing structure under which we will be able to purchase services required to serve our customers;
the availability to us of technologies needed to remain competitive; and
federal and state and regulatory conditions, including the maintenance of state regulation that protects us from unfair business practices by traditional network service providers or others with greater market power who have relationships with us as both competitors and suppliers.
The market in which we participate is highly competitive, and if we do not compete effectively, our business, results of operations and financial condition could be harmed.
The market for cloud communications is rapidly evolving, significantly fragmented and highly competitive, with relatively low barriers to entry in some segments. The principal competitive factors in our market include completeness of offering, credibility with developers, global reach, ease of integration and programmability, product features, platform scalability, reliability, security and performance, brand awareness

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and reputation, the strength of sales and marketing efforts, customer support, as well as the cost of deploying and using our services. Our competitors fall into two primary categories:
CPaaS companies that offer a narrower set of software APIs, less robust customer support and fewer other features while relying on third-party networks and physical infrastructure; and
network service providers that offer limited developer functionality on top of their own networks and physical infrastructure, such as AT&T, Level 3 and Verizon.
Some of our competitors and potential competitors are larger and have greater name recognition, longer operating histories, more established customer relationships, a larger global reach, larger budgets and significantly greater resources than we do. In addition, they have the operating flexibility to bundle competing products and services at little or no incremental cost, including offering them at a lower price as part of a larger sales transaction. As a result, our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. In addition, some competitors may offer services that address one or a limited number of functions at lower prices, with greater depth than our services or in different geographies. Our current and potential competitors may develop and market new services with comparable functionality to our services, and this could lead to us having to decrease prices in order to remain competitive. In addition, some of our competitors have lower list prices than us, which may be attractive to certain customers even if those services have different or lesser functionality. If we are unable to maintain our current pricing due to the competitive pressures, our margins will be reduced and our business, results of operations and financial condition would be adversely affected. Customers utilize our services in many ways, and use varying levels of functionality that our services offer or are capable of supporting or enabling within their applications. Customers that use many of the features of our services or use our services to support or enable core functionality for their applications may have difficulty or find it impractical to replace our services with a competitor’s services, while customers that use only limited functionality may be able to more easily replace our services with competitive offerings.
With the introduction of new services and new market entrants, we expect competition to intensify in the future. In addition, some of our customers choose to use our services and our competitors’ services at the same time. Moreover, as we expand the scope of our services, we may face additional competition. Further, customers and consumers may choose to adopt other forms of electronic communications or alternative communication platforms, including developing necessary networks and platforms in-house.
Furthermore, if our competitors were to merge such that the combined entity would be able to compete fully with our service offering, then our business, results of operations and financial condition may be adversely effected. If one or more of our competitors were to merge or partner with another of our competitors, the change in the competitive landscape could also adversely affect our ability to compete effectively. In addition, pricing pressures and increased competition generally could result in reduced revenue, reduced margins, increased losses or the failure of our services to achieve or maintain widespread market acceptance, any of which could harm our business, results of operations and financial condition.
We presently operate in the United States and provide certain limited services in Canada. Our IP voice network, which is at the core of our product offerings, is located in the United States. Our current and potential competitors have developed and may develop in the future product solutions that are available internationally as well as domestically. To the extent that customers seek product solutions that include support and scaling internationally, they may choose to use other service providers to fill their communication service needs. Furthermore, while we believe the U.S. market is sufficiently large and expanding to allow us to continue to grow our business, we may face slower growth due to our relative lack of exposure to international markets. Each of these factors could lead to reduced revenue, slower growth and lower brand name recognition amongst

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our industry competitors, any or all of which could harm our business, results of operations and financial condition.
If we are unable to attract new customers in a cost-effective manner, then our business, results of operations and financial condition would be adversely affected.
In order to grow our business, we must continue to attract new customers in a cost-effective manner. We use a variety of marketing channels to promote our services, our Bandwidth Communications Platform, and we periodically adjust the mix of our marketing programs. If the costs of the marketing channels we use increase dramatically, then we may choose to use alternative and less expensive channels, which may not be as effective as the channels we currently use. As we add to or change the mix of our marketing strategies, we may need to expand into more expensive channels than those we are currently in, which could adversely affect our business, results of operations and financial condition. We will incur marketing expenses before we are able to recognize any revenue that the marketing initiatives may generate, and these expenses may not result in increased revenue or brand awareness. We have made in the past, and may make in the future, significant expenditures and investments in new marketing campaigns. We cannot assure you that any new investments in sales and marketing, including any increased focus on enterprise sales efforts, will lead to the cost-effective acquisition of additional customers or increased sales or that our sales and marketing efficiency will be consistent with prior periods. If we are unable to maintain effective marketing programs, then our ability to attract new customers could be materially and adversely affected, our advertising and marketing expenses could increase substantially and our results of operations may suffer.
The market for some of our services and platform is new and unproven, may decline or experience limited growth and is dependent in part on enterprises and developers continuing to adopt our platform and use our services.
We have been developing and providing a cloud-based platform that enables developers and organizations to integrate voice and messaging communications capabilities into their software applications. This market is relatively new and unproven and is subject to a number of risks and uncertainties. We believe that our future success will depend in large part on the growth, if any, of this market. For example, the utilization of software APIs by developers and organizations to build communications functionality into their applications is still relatively new, and developers and organizations may not recognize the need for, or benefits of, our services and platform. Moreover, if they do not recognize the need for and benefits of our services and platform, they may decide to adopt alternative services and/or develop the necessary services in-house to satisfy their business needs. In order to grow our business and expand our market position, we intend to focus on educating enterprise customers about the benefits of our services and platform, expanding the functionality of our services and bringing new technologies to market to increase market acceptance and use of our platform. Our ability to expand the market that our services and platform address depends upon a number of factors, including the cost, performance and perceived value associated with such services and platform. The market for our services and platform could fail to grow significantly or there could be a reduction in demand for our services and platform as a result of a lack of customer acceptance, technological changes or challenges, competing services, platforms and services, decreases in spending by current and prospective customers, weakening economic conditions and other causes. If our market does not experience significant growth or demand for our services and platform decreases, then our business, results of operations and financial condition could be adversely affected.
We must increase the network traffic and resulting revenue from the services that we offer to realize our targets for anticipated revenue growth, cash flow and operating performance.

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We must increase the network traffic and resulting revenue from our inbound and outbound voice calling, text messaging, emergency voice functions, telephone numbers and related services at acceptable margins to realize our targets for anticipated revenue growth, cash flow and operating performance. If:
we do not maintain or improve our current relationships with existing key customers;
we are not able to expand the available capacity on our network to meet our customers’ demands in a timely manner;
we do not develop new large wholesale and enterprise customers; or
our customers determine to obtain these services from either their own network or from one of our competitors,
then we may be unable to increase or maintain our revenue at acceptable margins.
Our business depends on customers increasing their use of our services and any loss of customers or decline in their use of our services could materially and adversely affect our business, results of operations and financial condition.
Our ability to grow and generate incremental revenue depends, in part, on our ability to maintain and grow our relationships with existing customers and to have them increase their usage of our Bandwidth Communications Platform. If our customers do not increase their use of our services, then our revenue may decline and our results of operations may be harmed. Customers generally are charged based on the usage of our services. Most of our customers do not have long-term contractual financial commitments to us and, therefore, most of our customers may reduce or cease their use of our services at any time without penalty or termination charges. We cannot accurately predict customers’ usage levels and the loss of customers or reductions in their usage levels of our services may each have a negative impact on our business, results of operations and financial condition. If a significant number of customers cease using, or reduce their usage of, our services, then we may be required to spend significantly more on sales and marketing than we currently plan to spend in order to maintain or increase revenue from customers. Such additional sales and marketing expenditures could adversely affect our business, results of operations and financial condition.
If we are unable to increase the revenue that we derive from enterprises, our business, results of operations and financial condition may be adversely affected.
We currently generate all of our revenue from enterprise customers. Our ability to expand our sales to enterprise customers will depend, in part, on our ability to effectively organize, focus and train our sales and marketing personnel and to attract and retain sales personnel with experience selling to enterprises. We believe that there is significant competition for experienced sales professionals with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth in the future will depend, in part, on our ability to recruit, train and retain a sufficient number of experienced sales professionals, particularly those with experience selling to enterprises. In addition, even if we are successful in hiring qualified sales personnel, new hires require significant training and experience before they achieve full productivity, particularly for sales efforts targeted at enterprises and new territories. Our recent hires and planned hires may not become as productive as quickly as we expect and we may be unable to hire or retain sufficient numbers of qualified individuals in the future in the markets where we do business.
With respect to enterprise customers, the decision to adopt our services may require the approval of multiple technical and business decision makers, including security, compliance, procurement, operations and IT. In addition, while enterprise customers may quickly deploy our services on a limited basis, before

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they will commit to deploying our services at scale, they often require extensive education about our services and significant customer support time, engage in protracted pricing negotiations and seek to secure readily available development resources. In addition, sales cycles for enterprises are inherently complex, and some enterprise customers may not generate revenue that justifies the cost to obtain such customers. In addition, these complex and resource-intensive sales efforts could place additional strain on our limited product and engineering resources. Further, enterprises, including some of our customers, may choose to develop their own solutions that do not include our services. They also may demand reductions in pricing as their usage of our services increases, which could have an adverse impact on our gross margin. Our efforts to sell to these potential customers may not be successful. If we are unable to increase the revenue that we derive from enterprises, then our business, results of operations and financial condition may be adversely affected.
If we do not develop enhancements to our services and introduce new services that achieve market acceptance, our business, results of operations and financial condition could be adversely affected.
Our ability to attract new customers and increase revenue from existing customers depends in part on our ability to enhance and improve our existing services, increase adoption and usage of our services and introduce new services. The success of any enhancements or new services depends on several factors, including timely completion, adequate quality testing, actual performance quality, market-accepted pricing levels and overall market acceptance. Enhancements and new services that we develop may not be introduced in a timely or cost-effective manner, may contain errors or defects, may have interoperability difficulties with our Bandwidth Communications Platform or other services or may not achieve the broad market acceptance necessary to generate significant revenue. In certain instances, the introduction of new services requires the successful development of new technology. To the extent that upgrades of existing technology are required for the introduction of new services, the success of these upgrades may be dependent on reaching mutually acceptable terms with vendors and on vendors meeting their obligations in a timely manner.
Furthermore, our ability to increase the usage of our services depends, in part, on the development of new use cases for our services, which may be outside of our control. Our ability to generate usage of additional services by our customers may also require increasingly sophisticated and more costly sales efforts and result in a longer sales cycle. If we are unable to successfully enhance our existing services to meet evolving customer requirements, increase adoption and usage of our services or develop new services, or if our efforts to increase the usage of our services are more expensive than we expect, then our business, results of operations and financial condition would be adversely affected.
We have experienced rapid growth and expect our growth to continue, and if we fail to effectively manage our growth, then our business, results of operations and financial condition could be adversely affected.
We have experienced substantial growth in our business since inception, which has placed and may continue to place significant demands on our corporate culture, operational infrastructure and management. We believe that our corporate culture has been a critical component of our success. We have invested substantial time and resources in building our team and nurturing our culture. As we expand our business and mature as a public company, we may find it difficult to maintain our corporate culture while managing this growth. Any failure to manage our anticipated growth and organizational changes in a manner that preserves the key aspects of our culture could hurt our chance for future success, including our ability to recruit and retain personnel, and effectively focus on and pursue our corporate objectives. This, in turn, could adversely affect our business, results of operations and financial condition.
In addition, in order to successfully manage our rapid growth, our organizational structure has become more complex. In order to manage these increasing complexities, we will need to continue to scale and adapt our operational, financial and management controls, as well as our reporting systems and procedures. The

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expansion of our systems and infrastructure will require us to commit substantial financial, operational and management resources before our revenue increases and without any assurances that our revenue will increase.
Finally, continued growth could strain our ability to maintain reliable service levels for our customers. If we fail to achieve the necessary level of efficiency in our organization as we grow, then our business, results of operations and financial condition could be adversely affected.
Our pricing and billing systems are complex and errors could adversely affect our revenue and profits.
Our pricing and billing efforts are complex to develop and challenging to implement. To be profitable, we must have accurate and complete information about the costs associated with voice and text communications, and properly incorporate such information into our pricing model. Our pricing model must also reflect accurate and current information about the market for our services, including the pricing of competitive alternatives for our services, as well as reliable forecasts of traffic volume. We may determine pricing for our services based on data that is outdated or otherwise flawed. Even if we have complete and accurate market information, we may not set prices to optimize both revenue and profitability. If we price our services too high, the amount of traffic that our customers may route to our network may decrease and accordingly our revenue may decline. If we price our services too low, our margins may be adversely affected, which will reduce our ability to achieve and maintain profitability.
Additionally, we rely heavily on third parties to provide us with key software and services for our billing. If these third parties cease to provide those services to us for any reason, or fail to perform billing services accurately and completely, we may not be able to deliver accurate invoices promptly. Delays in invoicing can lead to de