10-Q 1 a17-8813_110q.htm 10-Q

Table of Contents

 

 

 

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, 2017

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 001-37806

 

Twilio Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

26-2574840

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

375 Beale Street, Suite 300

San Francisco, California 94105

(Address of principal executive offices) (Zip Code)

 

(415) 390-2337

(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.    x

 

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, 2017, 61,729,168 shares of the registrant’s Class A common stock and 28,752,691 shares of registrant’s Class B common stock were outstanding.

 

 

 



Table of Contents

 

TWILIO INC.

 

Quarterly Report on Form 10-Q

 

For the Three Months Ended March 31, 2017

 

TABLE OF CONTENTS

 

 

 

Page

 

PART I — FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (unaudited)

4

 

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016

4

 

 

 

 

Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2017 and 2016

5

 

 

 

 

Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2017 and 2016

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2017 and 2016

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

33

 

 

 

Item 4.

Controls and Procedures

34

 

 

 

 

PART II — OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

35

 

 

 

Item 1A.

Risk Factors

36

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

60

 

 

 

Item 6.

Exhibits

61

 

 

 

 

Signatures

62

 

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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, and Section 21E of the Securities Exchange Act of 1934, as amended, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” 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 future financial performance, including our revenue, cost of revenue, gross margin and operating expenses, ability to generate positive cash flow and ability to achieve and sustain profitability;

 

·                  the impact and expected results from changes in our relationship with our largest customer;

 

·                  the sufficiency of our cash and cash equivalents to meet our liquidity needs;

 

·                  anticipated technology trends, such as the use of and demand for cloud communications;

 

·                  our ability to continue to build and maintain credibility with the global software developer community;

 

·                  our ability to attract and retain customers to use our products;

 

·                  our ability to attract and retain enterprises and international organizations as customers for our products;

 

·                  our ability to form and expand partnerships with independent software vendors and system integrators;

 

·                  the evolution of technology affecting our products and markets;

 

·                  our ability to introduce new products and enhance existing products;

 

·                  our ability to optimize our network service provider coverage and connectivity;

 

·                  our ability to pass on our savings associated with our platform optimization efforts to our customers;

 

·                  our ability to successfully enter into new markets and manage our international expansion;

 

·                  the attraction and retention of qualified employees and key personnel;

 

·                  our ability to effectively manage our growth and future expenses and maintain our corporate culture;

 

·                  our anticipated investments in sales and marketing and research and development;

 

·                  our ability to maintain, protect and enhance our intellectual property;

 

·                  our ability to successfully defend litigation brought against us;

 

·                  our ability to comply with modified or new laws and regulations applying to our business; and

 

·                  the increased expenses associated with being a public company.

 

We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.

 

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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 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.

 

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PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

TWILIO INC.

 

Condensed Consolidated Balance Sheets

 

(In thousands)

 

(Unaudited)

 

 

 

As of March 31,
2017

 

As of December 31,
2016

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

118,440

 

$

305,665

 

Short-term marketable securities

 

170,086

 

 

Accounts receivable, net

 

29,959

 

26,203

 

Prepaid expenses and other current assets

 

23,229

 

21,512

 

Total current assets

 

341,714

 

353,380

 

Restricted cash

 

7,447

 

7,445

 

Property and equipment, net

 

40,931

 

37,552

 

Intangible assets, net

 

22,756

 

10,268

 

Goodwill

 

16,183

 

3,565

 

Other long-term assets

 

735

 

484

 

Total assets

 

$

429,766

 

$

412,694

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

6,233

 

$

4,174

 

Accrued expenses and other current liabilities

 

62,259

 

59,308

 

Deferred revenue

 

11,108

 

10,222

 

Total current liabilities

 

79,600

 

73,704

 

Other long-term liabilities

 

12,306

 

9,543

 

Total liabilities

 

91,906

 

83,247

 

Commitments and contingencies (Note 11)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A and Class B common stock

 

90

 

87

 

Additional paid-in capital

 

538,917

 

516,090

 

Accumulated deficit

 

(200,957

)

(186,730

)

Accumulated other comprehensive loss

 

(190

)

 

Total stockholders’ equity

 

337,860

 

329,447

 

Total liabilities and stockholders’ equity

 

$

429,766

 

$

412,694

 

 

See accompanying notes to condensed consolidated financial statements.

 

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TWILIO INC.

 

Condensed Consolidated Statements of Operations

 

(In thousands, except share and per share amounts)

 

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

Revenue

 

$

87,372

 

$

59,340

 

Cost of revenue

 

37,286

 

26,827

 

Gross profit

 

50,086

 

32,513

 

Operating expenses:

 

 

 

 

 

Research and development

 

26,522

 

14,864

 

Sales and marketing

 

21,116

 

13,422

 

General and administrative

 

17,203

 

10,593

 

Total operating expenses

 

64,841

 

38,879

 

Loss from operations

 

(14,755

)

(6,366

)

Other income (expenses), net

 

498

 

(18

)

Loss before (provision) benefit for income taxes

 

(14,257

)

(6,384

)

(Provision) benefit for income taxes

 

30

 

(84

)

Net loss attributable to common stockholders

 

$

(14,227

)

$

(6,468

)

Net loss per share attributable to common stockholders, basic and diluted

 

$

(0.16

)

$

(0.37

)

Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted

 

88,612,804

 

17,483,198

 

 

See accompanying notes to condensed consolidated financial statements.

 

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TWILIO INC.

 

Condensed Consolidated Statements of Comprehensive Loss

 

(In thousands, except share and per share amounts)

 

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

Net loss

 

$

(14,227

)

$

(6,468

)

Other comprehensive loss:

 

 

 

 

 

Foreign currency translation

 

(102

)

 

Change in unrealized net loss on marketable securities

 

(88

)

 

Total other comprehensive loss

 

(190

)

 

Comprehensive loss attributable to common stockholders

 

$

(14,417

)

$

(6,468

)

 

See accompanying notes to condensed consolidated financial statements.

 

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TWILIO INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

 

$

(14,227

)

$

(6,468

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

3,955

 

1,580

 

Amortization of bond premium

 

63

 

 

Stock-based compensation

 

9,385

 

3,025

 

Provision for doubtful accounts

 

72

 

303

 

Gain on lease termination

 

(295

)

 

Write-off of internally developed software

 

26

 

85

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(1,950

)

(2,406

)

Prepaid expenses and other current assets

 

(972

)

(2,048

)

Other long-term assets

 

(178

)

15

 

Accounts payable

 

149

 

7,349

 

Accrued expenses and other current liabilities

 

5,221

 

3,893

 

Deferred revenue

 

885

 

745

 

Other long-term liabilities

 

306

 

(51

)

Net cash provided by operating activities

 

2,440

 

6,022

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Increase in restricted cash

 

 

(7,439

)

Purchases of marketable securities

 

(170,769

)

 

Capitalized software development costs

 

(3,649

)

(2,493

)

Purchases of property and equipment

 

(4,971

)

(782

)

Purchases of intangible assets

 

(8

)

(144

)

Acquisition, net of cash acquired

 

(22,621

)

 

Net cash used in investing activities

 

(202,018

)

(10,858

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Payments of costs related to public offerings

 

(238

)

(1,434

)

Proceeds from exercises of stock options

 

12,735

 

755

 

Value of equity awards withheld for tax liabilities

 

(155

)

 

Net cash provided by (used in) financing activities

 

12,342

 

(679

)

Effect of exchange rate changes on cash and cash equivalents

 

11

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

(187,225

)

(5,515

)

CASH AND CASH EQUIVALENTS—Beginning of period

 

305,665

 

108,835

 

CASH AND CASH EQUIVALENTS—End of period

 

$

118,440

 

$

103,320

 

Cash paid for income taxes

 

$

42

 

$

31

 

NON-CASH INVESTING AND FINANCING ACTIVITIES:

 

 

 

 

 

Purchases of property, equipment and intangible assets, accrued but not paid

 

$

1,184

 

$

878

 

Stock-based compensation capitalized in software development costs

 

$

709

 

$

316

 

Vesting of early exercised options

 

$

155

 

$

112

 

Costs related to the public offerings, accrued but not paid

 

$

192

 

$

716

 

 

See accompanying notes to condensed consolidated financial statements.

 

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TWILIO INC.

 

Notes to Condensed Consolidated Financial Statements

 

(Unaudited)

 

1. Organization and Description of Business

 

Twilio Inc. (the “Company”) was incorporated in the state of Delaware on March 13, 2008. The Company provides a Cloud Communications Platform that enables developers to build, scale and operate communications within software applications through the cloud primarily as a pay-as-you-go service. The Company’s product offerings fit three basic categories: Programmable Voice, Programmable Messaging and Programmable Video. The Company also provides use case products, such as a two-factor authentication solution.

 

The Company’s headquarters are located in San Francisco, California and the Company has subsidiaries in the United Kingdom, Estonia, Ireland, Colombia, Germany, Hong Kong, Singapore, Bermuda, Spain, Sweden and Australia.

 

2. Summary of Significant Accounting Policies

 

(a)                                 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 (“U.S. GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with U.S. 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 our Annual Report on Form 10-K filed with the SEC on February 21, 2017 (“Annual Report”).

 

The condensed consolidated balance sheet as of December 31, 2016, included herein, was derived from the audited financial statements as of that date, but may not include all disclosures including certain notes required by U.S. 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 loss and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full year 2017 or any future period.

 

(b)                                 Principles of Consolidation

 

The condensed consolidated financial statements include the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

 

(c)          Use of Estimates

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates are used for, but not limited to, revenue allowances and returns; valuation of the Company’s stock and stock-based awards; recoverability of long-lived and intangible assets; capitalization and useful life of the Company’s capitalized internal-use software; fair value of acquired intangible assets and goodwill; accruals and contingencies. Estimates are based on historical experience and on various assumptions that the Company believes are reasonable under current circumstances. However, future events are subject to change and best estimates and judgments may require further adjustments; therefore, actual results could differ materially from those estimates. Management periodically evaluates such estimates and they are adjusted prospectively based upon such periodic evaluation.

 

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(d)          Concentration of Credit Risk

 

Financial instruments that potentially expose the Company to a concentration of credit risk consist primarily of cash, cash equivalents, marketable securities, restricted cash and accounts receivable. The Company maintains cash, cash equivalents, restricted cash and marketable securities with financial institutions that management believes are financially sound and have minimal credit risk exposure.

 

The Company sells its services to a wide variety of customers. If the financial condition or results of operations of any one of the large customers deteriorate substantially, operating results could be adversely affected. To reduce credit risk, management performs ongoing credit evaluations of the financial condition of significant customers. The Company does not require collateral from its credit customers and maintains reserves for estimated credit losses on customer accounts when considered necessary. Actual credit losses may differ from the Company’s estimates. As of March 31, 2017, one customer organization represented approximately 14% of the Company’s gross accounts receivable. As of December 31, 2016, one customer organization represented approximately 16% of the Company’s gross accounts receivable.

 

In the three months ended March 31, 2017, one customer organization represented 12% of the Company’s total revenue and in the three months ended March 31, 2016 two customer organizations represented 15% and 11% of the Company’s total revenue.

 

(e)           Significant Accounting Policies

 

There have been no changes to our significant accounting policies described in our Annual Report.

 

(f)                                    Recently Issued Accounting Guidance, Not yet Adopted

 

In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Updates (“ASU”) 2017-04, “Simplifying the Test for Goodwill Impairment”, which removes the second step of the goodwill impairment test that requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This guidance is effective for interim and annual reporting periods beginning after December 15, 2019 and will be applied prospectively. Management does not expect the adoption of this guidance to have any impact on the Company’s financial position, results of operations or cash flows.

 

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 Company will evaluate the impact of this guidance on its financial statements and related disclosures next time there is a potential business combination.

 

In November 2016, the FASB issued ASU 2016-18, “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. This guidance is effective for annual and interim periods beginning after December 15, 2017, and early adoption is permitted. The Company is evaluating the impact of this guidance on its consolidated financial statements and related disclosures.

 

In October 2016, the FASB issued ASU 2016-16, “Intra-Entity Transfers Other Than Inventory”, which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This guidance is effective for annual and interim periods beginning after December 15, 2017, and early adoption is permitted. The Company is evaluating the impact of this guidance on its consolidated financial statements and related disclosures.

 

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments”, which changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which will generally result in earlier recognition of allowances for losses. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for annual and interim periods beginning after December 15, 2018. The Company is evaluating the impact of this guidance on its condensed consolidated financial statements and related disclosures.

 

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In February 2016, the FASB issued ASU No. 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. For public companies, the new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. 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, the Company has not yet determined the full impact that the adoption of this standard will have on its condensed consolidated 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 U.S. 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 which deferred, by one year, the effective date for the new revenue reporting standard for entities reporting under U.S. GAAP. In accordance with the deferral, this guidance will be effective for the Company beginning January 1, 2018 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. Early adoption is permitted beginning January 1, 2017. 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 determining whether an entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which is satisfied over time). In May 2016, the FASB issued ASU 2016-12 “Revenue from Contracts with Customers (Topic 606), Narrow-Scope Improvements and Practical Expedients,” which amends the guidance on transition, collectability, noncash consideration and the presentation of sales and other similar taxes. ASU 2016-12 clarifies that, for a contract to be considered completed at transition, all (or substantially all) of the revenue must have been recognized under legacy GAAP. In addition, ASU 2016-12 clarifies how an entity should evaluate the collectability threshold and when an entity can recognize nonrefundable consideration received as revenue if an arrangement does not meet the standard’s contract criteria. The effective date and transition requirements for ASU 2016-08, ASU 2016-10 and ASU 2016-12 are the same as the effective date and transition requirements for ASU 2014-09. The Company performed its preliminary evaluation and selected a modified retrospective transition method with cumulative effect adjustment as of the standard’s effective date.

 

3. Fair Value Measurements

 

The Company records certain of its financial assets at fair value on a recurring basis. The Company’s financial instruments, which include cash, cash equivalents, money market funds, accounts receivable and accounts payable are recorded at their carrying amounts, which approximate their fair values due to their short-term nature. Restricted cash is short-term and long-term in nature. Restricted cash consists of cash in a savings account, hence its carrying amount approximates its fair value. Marketable securities consist of U.S. treasury securities and high credit quality corporate debt 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).

 

Impairments are considered to be other than temporary if they are related to deterioration in credit risk or if it is likely that the security will be sold before the recovery of its cost basis. Realized gains and losses and declines in value deemed to be other than temporary are determined based on the specific identification method and are reported in other income (expense), net.

 

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The following tables summarize the Company’s financial assets as of March 31, 2017 and December 31, 2016 by type (in thousands):

 

 

 

Amortized Cost
or Carrying

 

Net
Unrealized

 

Fair Value Hierarchy as of March 31, 2017

 

Aggregate Fair

 

 

 

Value

 

Losses

 

Level 1

 

Level 2

 

Level 3

 

Value

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

95,925

 

$

 

$

95,925

 

$

 

$

 

$

95,925

 

Corporate debt securities

 

5,999

 

 

5,999

 

 

 

5,999

 

Total included in cash and cash equivalents

 

101,924

 

 

101,924

 

 

 

101,924

 

Marketable securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury securities

 

59,928

 

(51

)

59,877

 

 

 

59,877

 

Corporate debt securities

 

110,246

 

(37

)

 

110,209

 

 

110,209

 

Total marketable securities

 

170,174

 

(88

)

59,877

 

110,209

 

 

170,086

 

Total financial assets

 

$

272,098

 

$

(88

)

$

161,801

 

$

110,209

 

$

 

$

272,010

 

 

There were no marketable securities as of December 31, 2016.

 

 

 

Carrying

 

Fair Value Hierarchy as of December 31, 2016

 

Aggregate Fair

 

 

 

Value

 

Level 1

 

Level 2

 

Level 3

 

Value Total

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

Money market funds (included in cash and cash equivalents)

 

$

274,135

 

$

274,135

 

$

 

$

 

$

274,135

 

Total financial assets

 

$

274,135

 

$

274,135

 

$

 

$

 

$

274,135

 

 

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, 2017 (in thousands):

 

 

 

Amortized

 

Aggregate Fair

 

 

 

Cost

 

Value

 

Financial Assets:

 

 

 

 

 

Less than one year

 

$

94,844

 

$

94,805

 

One to two years

 

75,330

 

75,281

 

Total

 

$

170,174

 

$

170,086

 

 

For fixed income securities that had unrealized losses as of March 31, 2017, the Company has determined that no other-than-temporary impairment existed. As of March 31, 2017, 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, 2017, there were no sales of marketable securities. Interest earned on marketable securities in the three months ended March 31, 2017 was $0.5 million and is recorded as other income (expense), net, in the accompanying condensed consolidated statement of operations.

 

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4. Property and Equipment

 

Property and equipment consisted of the following (in thousands):

 

 

 

As of
March 31,
2017

 

As of
December 31,
2016

 

 

 

 

 

 

 

Capitalized software development costs

 

$

32,984

 

$

28,661

 

Leasehold improvements

 

13,931

 

14,063

 

Office equipment

 

7,128

 

5,729

 

Furniture and fixtures

 

1,730

 

1,576

 

Software

 

1,381

 

968

 

Total property and equipment

 

57,154

 

50,997

 

Less: accumulated depreciation and amortization

 

(16,223

)

(13,445

)

Total property and equipment, net

 

$

40,931

 

$

37,552

 

 

Depreciation and amortization expense was $2.8 million and $1.4 million for the three months ended March 31, 2017 and 2016, respectively.

 

The Company capitalized $4.3 million and $2.9 million of software development costs in the three months ended March 31, 2017 and 2016, respectively, of which $0.7 million and $0.3 million, respectively, was stock-based compensation expense.  Amortization of capitalized software development costs was $1.8 million and $1.1 million in the three months ended March 31, 2017 and 2016, respectively.

 

5. Recent Acquisition

 

On February 6, 2017, the Company completed its acquisition of a Swedish mobile operator specializing in messaging and SMS solutions, for a total purchase price of $23.0 million, paid in cash, of which $5.0 million was held in escrow.  The escrow will continue for 18 months after the transaction closing date and may be extended under certain circumstances.

 

Additionally, the Company deposited $2.0 million into a separate escrow account that will be released to certain employees on the first and second anniversaries of the closing date, provided the underlying service conditions are met. This amount is recorded as prepaid compensation in the accompanying condensed consolidated balance sheet and is amortized into expense as the services are rendered.

 

The acquisition was accounted for as a business combination and, accordingly, the total purchase price was allocated to the preliminary net tangible and intangible assets and liabilities based on their preliminary fair values on the acquisition date. The prepaid compensation subject to service conditions is accounted for as a post-acquisition compensation expense and recorded as research and development expense in the accompanying condensed consolidated statement of operations. We expect to continue to obtain information to assist us in determining the fair values of the net assets acquired on the acquisition date during the measurement period.

 

The acquired entity’s results of operations have been included in the condensed consolidated financial statements of the Company from the date of acquisition.

 

The following table presents the preliminary purchase price allocation recorded in the Company’s condensed consolidated balance sheet on the acquisition date (in thousands):

 

 

 

Total

 

Net tangible liabilities

 

$

(3,326

)

Goodwill(1)

 

12,688

 

Intangible assets(2)

 

13,600

 

Total purchase price

 

$

22,962

 

 

The Company acquired a net deferred tax liability of $2.6 million in this business combination.

 


(1)                                     Goodwill represents the excess of purchase price over the fair value of identifiable tangible and intangible assets acquired and liabilities assumed. The goodwill in this transaction is primarily attributable to the future cash flows to be realized from the acquired technology platform, existing customer and supplier relationships as well as operational synergies.

 

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(2)                                     Identifiable finite-lived intangible assets were comprised of the following:

 

 

 

Total

 

Estimated
life
(in years)

 

Developed technology

 

$

4,900

 

4

 

Customer relationships

 

6,100

 

7-8

 

Supplier relationships

 

2,600

 

5

 

Total intangible assets acquired

 

$

13,600

 

 

 

 

The estimated fair value of the intangible assets acquired was determined by the Company, and the Company considered or relied in part upon a valuation report of a third-party expert. The Company used income approaches to estimate the fair values of the identifiable intangible assets.  Specifically, the developed technology asset class was valued using the-relief-from royalty method, while the customer relationships asset class was valued using a multi-period excess earnings method and the supplier relationships asset class was valued using an incremental cash flow method.

 

The Company incurred costs related to this acquisition of $0.6 million, of which $0.2 million and $0.4 million were incurred during the fiscal years 2017 and 2016, respectively. All acquisition related costs were expensed as incurred and have been recorded in general and administrative expenses in the accompanying condensed consolidated statements of operations.

 

Pro forma results of operations for this acquisition have not been presented as the financial impact to the Company’s condensed consolidated financial statements would be immaterial.

 

6. Intangible Assets

 

Goodwill

 

Goodwill balance as of March 31, 2017 and December 31, 2016 was as follows:

 

Balance as of December 31, 2016

 

$

3,565

 

Goodwill recorded in connection with the acquisition

 

12,688

 

Effect of exchange rate changes

 

(70

)

Balance as of March 31, 2017

 

$

16,183

 

 

Intangible assets

 

Intangible assets consisted of the following (in thousands):

 

 

 

As of March 31, 2017

 

 

 

Gross

 

Accumulated
Amortization

 

Net

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Developed technology*

 

$

14,273

 

$

(2,102

)

$

12,171

 

Customer relationships*

 

6,464

 

(283

)

6,181

 

Supplier relationships*

 

2,585

 

(75

)

2,510

 

Trade name

 

60

 

(60

)

 

Patent

 

1,664

 

(65

)

1,599

 

Total amortizable intangible assets

 

25,046

 

(2,585

)

22,461

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Domain names

 

32

 

 

32

 

Trademarks

 

263

 

 

263

 

Total

 

$

25,341

 

$

(2,585

)

$

22,756

 

 


*The balances include the effect of the exchange rate changes.

 

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Table of Contents

 

 

 

As of December 31, 2016

 

 

 

Gross

 

Accumulated
Amortization

 

Net

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Developed technology

 

$

9,400

 

$

(1,140

)

$

8,260

 

Customer relationships

 

400

 

(148

)

252

 

Trade name

 

60

 

(56

)

4

 

Patent

 

1,512

 

(55

)

1,457

 

Total amortizable intangible assets

 

11,372

 

(1,399

)

9,973

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Domain names

 

32

 

 

32

 

Trademarks

 

263

 

 

263

 

Total

 

$

11,667

 

$

(1,399

)

$

10,268

 

 

Amortization expense was $1.2 million and $0.1 million for the three months ended March 31, 2017 and 2016, respectively.

 

Total estimated future amortization expense was as follows (in thousands):

 

 

 

As of
March 31,
2017

 

2017 (remaining 9 months)

 

$

4,291

 

2018

 

5,450

 

2019

 

5,049

 

2020

 

2,618

 

2021

 

1,509

 

Thereafter

 

3,544

 

Total

 

$

22,461

 

 

7. Accrued Expenses and Other Liabilities

 

Accrued expenses and other current liabilities consisted of the following (in thousands):

 

 

 

As of
March 31,

 

As of
December 31,

 

 

 

2017

 

2016

 

Accrued payroll and related

 

$

10,571

 

$

7,497

 

Accrued bonus and commission

 

1,622

 

2,251

 

Accrued cost of revenue

 

9,902

 

8,741

 

Sales and other taxes payable

 

28,988

 

28,795

 

Deferred rent

 

542

 

1,250

 

Accrued other expense

 

10,634

 

10,774

 

Total accrued expenses and other current liabilities

 

$

62,259

 

$

59,308

 

 

Other long-term liabilities consisted of the following (in thousands):

 

 

 

As of
March 31,

 

As of
December 31,

 

 

 

2017

 

2016

 

Deferred rent

 

$

9,625

 

$

9,387

 

Deferred tax liability

 

2,537

 

 

Accrued other expense

 

144

 

156

 

Total other long-term liabilities

 

$

12,306

 

$

9,543

 

 

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Table of Contents

 

8. Supplemental Balance Sheet Information

 

A roll-forward of the Company’s reserves is as follows (in thousands):

 

(a) Allowance for doubtful accounts (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

Balance, beginning of period

 

$

1,076

 

$

486

 

Additions

 

72

 

303

 

Write-offs

 

(378

)

(138

)

Balance, end of period

 

$

770

 

$

651

 

 

(b)  Sales credit reserve (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

Balance, beginning of period

 

$

544

 

$

714

 

Additions

 

551

 

486

 

Deductions against reserve

 

(277

)

(551

)

Balance, end of period

 

$

818

 

$

649

 

 

9. Revenue by Geographic Area

 

Revenue by geographic area is based on the IP address at the time of registration. The following table sets forth revenue by geographic area (dollars in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

Revenue by geographic area:

 

 

 

 

 

United States

 

$

70,098

 

$

50,508

 

International

 

17,274

 

8,832

 

Total

 

$

87,372

 

$

59,340

 

 

 

 

 

 

 

Percentage of revenue by geographic area:

 

 

 

 

 

United States

 

80

%

85

%

International

 

20

%

15

%

 

10. Credit Facility

 

Effective January 2015, the Company entered into a $15.0 million revolving credit agreement. The credit facility expired in March 2017 and was not renewed. The Company had no outstanding balance on this credit facility in either period presented.

 

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11. Commitments and Contingencies

 

(a)                                 Lease Commitments

 

The Company entered into various non-cancelable operating lease agreements for its facilities over the next eight years. Certain operating leases contain provisions under which monthly rent escalates over time. When lease agreements contain escalating rent clauses or free rent periods, the Company recognizes rent expense on a straight-line basis over the term of the lease.

 

Rent expense was $1.9 million and $1.1 million for the three months ended March 31, 2017 and 2016, respectively.

 

Future minimum lease payments under non-cancelable operating leases were as follows (in thousands):

 

Year Ending December 31:

 

As of
March 31,
2017

 

2017 (remaining nine months)

 

$

5,888

 

2018

 

7,146

 

2019

 

7,319

 

2020

 

7,059

 

2021

 

7,033

 

Thereafter

 

16,052

 

Total minimum lease payments

 

$

50,497

 

 

(b)                                 Legal Matters

 

On April 30, 2015, Telesign Corporation, or Telesign, filed a lawsuit against the Company in the United States District Court, Central District of California (“Telesign I”). Telesign alleges that the Company is infringing three U.S. patents that it holds: U.S. Patent No. 8,462,920 (“‘920”), U.S. Patent No. 8,687,038 (“‘038”) and U.S. Patent No. 7,945,034 (“‘034”). The patent infringement allegations in the lawsuit relate to the Company’s Programmable Authentication products, its two-factor authentication use case and an API tool to find information about a phone number. The Company has petitioned the U.S. Patent and Trademark Office (“U.S. PTO”) for inter partes review of the patents at issue. On March 9, 2016, the District Court stayed the court case pending the resolution of those proceedings. On June 28, 2016, the U.S. PTO instituted the inter partes review of the ‘034 patent, briefing on which has now begun, including Telesign’s contingent motion to amend the ‘034 patent. On July 8, 2016, the U.S. PTO denied the Company’s petition for inter partes review of the ‘920 and ‘038 patents. The Company subsequently petitioned for rehearing on this decision, and the request for rehearing was fully briefed by both parties on October 11, 2016. On July 20, 2016, Telesign applied to the court to lift the stay on Telesign I. The Company opposed the request, and on September 15, 2016, the court denied the request to lift the stay on Telesign I. On November 15, 2016, the U.S. PTO denied the Company’s request for rehearing on the denied petitions for inter partes review. On December 20, 2016, the Company filed a reply to Telesign’s opposition to the ‘034 inter partes review and simultaneously filed an opposition to Telesign’s motion to amend the ‘034 patent. On January 23, 2017 Telesign filed its reply to the Company’s opposition to the motion to amend. On March 27, 2017, the U.S. PTO held its hearing on the ‘034 patent inter partes review. A ruling is expected in June 2017.

 

On March 28, 2016, Telesign filed a second lawsuit against the Company in the United States District Court, Central District of California (“Telesign II”), alleging infringement of U.S. Patent No. 9,300,792 (“‘792”) held by Telesign. The ‘792 patent is in the same patent family as the ‘920 and ‘038 patents asserted in Telesign I, and the infringement allegations in Telesign II relate to the Company’s Programmable Authentication products and its two-factor authentication use case. On May 23, 2016, the Company moved to dismiss the complaint in Telesign II. On August 3, 2016, the United States District Court, Central District of California, issued an order granting Twilio’s motion to dismiss Telesign’s complaint with leave to amend. Telesign filed an amended complaint on September 2, 2016 and the Company moved to dismiss the amended complaint on September 16, 2016. On November 7, 2016, the Company’s motion to dismiss was denied, and the Company filed its answer to the first amended complaint on November 21, 2016. On February 27, 2017, Twilio’s petition for review of the Covered Business Method of the ‘792 patent was denied.  On March 8, 2017 the U.S. PTO issued an order instituting the inter partes review for the ‘792 patent.  On March 15, 2017, Twilio filed a motion to consolidate and stay related cases pending the conclusion of the now instituted ‘792 patent inter partes review. The hearing on this motion is scheduled for May 22, 2017. With respect to each of the patents asserted in Telesign I and Telesign II, the complaints seek, among other things, to enjoin the Company from allegedly infringing the patents, along with damages for lost profits.

 

On December 1, 2016, the Company filed a patent infringement lawsuit against Telesign in the United States District Court, Northern District of California, alleging indirect infringement of United States Patent No. 8,306,021, United States Patent No. 8,837,465, United States Patent No. 8,755,376, United States Patent No. 8,736,051, United States Patent No. 8,737,962, United

 

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Table of Contents

 

States Patent No. 9,270,833, and United States Patent No. 9,226,217. Telesign filed a motion to dismiss the complaint on January 25, 2017.  In two orders, issued on March 31, 2017 and April 17, 2017, the Court granted Telesign’s motion to dismiss with respect to the ‘962, ‘833, ‘051 and ‘217 patents, but denied Telesign’s motion to dismiss as to the ‘021, ‘465 and ‘376 patents.

 

On February 18, 2016, a putative class action complaint was filed in the Alameda County Superior Court in California, entitled Angela Flowers v. Twilio Inc. The complaint alleges that the Company’s products permit the interception, recording and disclosure of communications at a customer’s request and are in violation of the California Invasion of Privacy Act. The complaint seeks injunctive relief as well as monetary damages. On May 27, 2016, the Company filed a demurrer to the complaint. On August 2, 2016, the court issued an order denying the demurrer in part and granted it in part, with leave to amend by August 18, 2016 to address any claims under California’s Unfair Competition Law. The plaintiff opted not to amend the complaint. Discovery has already begun, and will continue until August 2017, when the plaintiff must file its motion for class certification.

 

The Company intends to vigorously defend these lawsuits and believes it has meritorious defenses to each matter in which it is a defendant. It is too early in these matters to reasonably predict the probability of the outcomes or to estimate ranges of possible losses.

 

In addition to the litigation matters discussed above, from time to time, the Company is a party to legal action and subject to claims that arise in the ordinary course of business. The claims are investigated as they arise and loss estimates are accrued, when probable and reasonably estimable. While it is not feasible to predict or determine the ultimate outcome of these matters, the Company believes that these legal proceedings will not have a material adverse effect on its financial position or results of operations.

 

(c)                                  Indemnification Agreements

 

The Company has signed indemnification agreements with all of its board members and executive officers. The agreements indemnify the board members and executive officers from claims and expenses on actions brought against the individuals separately or jointly with the Company for certain indemnifiable events. Indemnifiable Events generally mean any event or occurrence related to the fact that the board member or the executive officer was or is acting in his or her capacity as a board member or an executive officer for the Company or was or is acting or representing the interests of the Company.

 

In the ordinary course of business, the Company enters into contractual arrangements under which it agrees to provide indemnification of varying scope and terms to business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the breach of such agreements, intellectual property infringement claims made by third parties and other liabilities relating to or arising from the Company’s various products, or its acts or omissions. In these circumstances, payment may be conditional on the other party making a claim pursuant to the procedures specified in the particular contract. Further, the Company’s obligations under these agreements may be limited in terms of time and/or amount, and in some instances, the Company may have recourse against third parties for certain payments. The terms of such obligations may vary.

 

As of March 31, 2017 and December 31, 2016, no amounts had been accrued.

 

(d)                                 Other taxes

 

The Company conducts operations in many tax jurisdictions throughout the United States. In many of these jurisdictions, non-income-based taxes, such as sales and use and telecommunications taxes are assessed on the Company’s operations. Historically, the Company has not billed or collected these taxes and, in accordance with U.S. GAAP, has recorded a provision for its tax exposure in these jurisdictions when it is both probable that a liability has been incurred and the amount of the exposure can be reasonably estimated. As a result, the Company recorded a liability of $29.0 million and $28.8 million as of March 31, 2017 and December 31, 2016, respectively. These estimates include several key assumptions including, but not limited to, the taxability of the Company’s services, the jurisdictions in which its management believes it has nexus, and the sourcing of revenues to those jurisdictions. In the event these jurisdictions challenge management’s assumptions and analysis, the actual exposure could differ materially from the current estimates.

 

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Table of Contents

 

12. Stockholders’ Equity

 

(a)                                 Preferred Stock

 

As of March 31, 2017, the Company had authorized 100,000,000 shares of preferred stock, par value $0.001, of which no shares were issued and outstanding.

 

(b)                                 Common Stock

 

As of March 31, 2017 and December 31, 2016, the Company had authorized 1,000,000,000 shares of Class A common stock and 100,000,000 shares of Class B common stock, each par value $0.001 per share.  As of March 31, 2017, 61,549,597 shares and 28,658,032 shares of Class A and Class B common stock, respectively, were issued and outstanding. As of December 31, 2016, 49,996,410 shares and 37,252,138 shares of Class A and Class B common stock, respectively, were issued and outstanding.

 

The Company had reserved shares of common stock for issuance as follows:

 

 

 

As of
March 31,

 

As of
December 31,

 

 

 

2017

 

2016

 

Stock options issued and outstanding

 

13,545,334

 

14,649,276

 

Nonvested restricted stock units issued and outstanding

 

2,692,636

 

2,034,217

 

Common stock reserved for Twilio.org

 

680,397

 

680,397

 

Stock-based awards available for grant under 2016 Plan

 

13,238,750

 

10,143,743

 

Common stock reserved for issuance under 2016 ESPP

 

594,218

 

597,038

 

Total

 

30,751,335

 

28,104,671

 

 

13. Stock-Based Compensation

 

2008 Stock Option Plan

 

The Company granted options under its 2008 Stock Option Plan (the “2008 Plan”), as amended and restated, until June 22, 2016, when the plan was terminated in connection with the Company’s IPO. Accordingly, no shares are available for future issuance under the 2008 Plan.  The 2008 Plan continues to govern outstanding equity awards granted thereunder.

 

2016 Stock Option Plan

 

The Company’s 2016 Stock Option and Incentive Plan (the “2016 Plan”) became effective on June 21, 2016. The 2016 Plan provides for the grant of ISOs, NSOs, restricted stock, RSUs, stock appreciation rights, unrestricted stock awards, performance share awards, dividend equivalent rights and cash-based awards to employees, directors and consultants of the Company. A total of 11,500,000 shares of the Company’s Class A common stock were initially reserved for issuance under the 2016 Plan. These available shares automatically increase each January 1, beginning on January 1, 2017, by 5% of the number of shares of the Company’s Class A and Class B common stock outstanding on the immediately preceding December 31, or such lesser number of shares as determined by the Company’s compensation committee. On January 1, 2017, the shares available for grant under the 2016 Plan were automatically increased by 4,362,427 shares.

 

Under the 2016 Plan, the stock options are granted at a price per share not less than 100% of the fair market value per share of the underlying common stock on the date of grant. Under both plans, stock options generally expire 10 years from the date of grant and vest over periods determined by the board of directors. The vesting period for options and restricted stock units is generally a four-year term from the date of grant, at a rate of 25% after one year, then monthly or quarterly, respectively, on a straight-line basis thereafter.

 

2016 Employee Stock Purchase Plan

 

The Company’s Employee Stock Purchase Plan (“2016 ESPP”) became effective on June 21, 2016. A total of 2,400,000 shares of the Company’s Class A common stock were initially reserved for issuance under the 2016 ESPP. These available shares automatically increase each January 1, beginning on January 1, 2017, by the lesser of 1,800,000 shares of the common stock, 1% of the number of shares of the Company’s Class A and Class B common stock outstanding on the immediately preceding December 31 or such lesser number of shares as determined by the Company’s compensation committee. On January 1, 2017, the shares available for grant under the 2016 Plan were automatically increased by 872,485 shares.

 

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The 2016 ESPP allows eligible employees to purchase shares of the Company’s Class A common stock at a discount of up to 15% through payroll deductions of their eligible compensation, subject to any plan limitations. Except for the initial offering period, the 2016 ESPP provides for separate six-month offering periods beginning in May and November of each fiscal year, starting in May 2017.

 

On each purchase date, eligible employees will purchase the Company’s stock at a price per share equal to 85% of the lesser of (i) the fair market value of the Company’s Class A common stock on the offering date or (ii) the fair market value of the Company’s common stock on the purchase date.

 

As of March 31, 2017, no shares of Class A common stock were purchased under the 2016 ESPP and 594,218 shares are expected to be purchased at the end of the initial offering period. As of March 31, 2017, total unrecognized compensation cost related to the 2016 ESPP was $0.4 million, which will be amortized over a weighted-average period of 0.1 years.

 

Stock option activity under the 2008 Plan and the 2016 Plan during the three months ended March 31, 2017 was as follows:

 

Stock Options

 

 

 

Number of
options
outstanding

 

Weighted-
average
exercise
price
(per
share)

 

Weighted-
average
remaining
contractual
term
(in years)

 

Aggregate
intrinsic
value
(in
thousands)

 

Outstanding options as of December 31, 2016

 

14,649,276

 

$

6.14

 

7.52

 

$

332,716

 

Granted

 

1,293,335

 

31.79

 

 

 

 

 

Exercised

 

(2,860,321

)

4.49

 

 

 

 

 

Forfeited and cancelled

 

(91,956

)

8.29

 

 

 

 

 

Outstanding options as of March 31, 2017

 

12,990,334

 

$

9.04

 

7.65

 

$

261,375

 

Options vested and exercisable as of March 31, 2017

 

5,189,267

 

$

4.69

 

6.48

 

$

125,491

 

 

Aggregate intrinsic value represents the difference between the fair value of the Company’s common stock and the exercise price of outstanding “in-the-money” options. 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 New York Stock Exchange. The aggregate intrinsic value of stock options exercised was $78.2 million and $3.0 million for the three months ended March 31, 2017 and 2016, respectively.

 

The total estimated grant date fair value of options vested was $4.1 million and $3.0 million for the three months ended March 31, 2017 and 2016, respectively. The weighted-average grant-date fair value of options granted was $13.72 and $5.17 for the three months ended March 31, 2017 and 2016, respectively.

 

On February 28, 2017, the Company granted a total of 555,000 shares of performance-based stock options in three distinct awards to an employee with grant date fair values of $13.48, $10.26 and $8.41 per share for a total grant value of $5.9 million.  The first half of each award vests upon satisfaction of a performance condition and the remainder vests thereafter in equal monthly installments over a 24-month period.  The achievement window expires after 4.3 years from the date of grant and the stock options expire seven years after the date of grant.  The stock options are amortized over a derived service period of three years, 4.25 years and 4.75 years, respectively.  The stock options value and the derived service period were estimated using the Monte-Carlo simulation model.  The following table summarizes the details of the performance options:

 

 

 

Number of
options
outstanding

 

Weighted-
average
exercise
price
(per
share)

 

Weighted-
average
remaining
contractual
term
(in years)

 

Aggregate
intrinsic
value
(in
thousands)

 

Outstanding options as of December 31, 2016

 

 

$

 

 

$

 

Granted

 

555,000

 

31.72

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited and cancelled

 

 

 

 

 

 

 

Outstanding options as of March 31, 2017

 

555,000

 

$

31.72

 

6.91

 

$

 

Options vested and exercisable as of March 31, 2017

 

 

$

 

 

$

 

 

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As of March 31, 2017, total unrecognized compensation cost related to all non-vested stock options was $48.9 million, which will be amortized over a weighted-average period of 2.45 years.

 

Restricted Stock Units

 

 

 

Number of
awards
outstanding

 

Weighted-
average
grant date
fair value
(per
share)

 

Aggregate
intrinsic
value
(in
thousands)

 

Nonvested RSUs as of December 31, 2016

 

2,034,217

 

$

32.66

 

$

58,687

 

Granted

 

794,792

 

31.39

 

 

 

Vested

 

(104,288

)

11.90

 

 

 

Forfeited and cancelled

 

(32,085

)

41.30

 

 

 

Nonvested RSUs as of March 31, 2017

 

2,692,636

 

$

32.97

 

$

77,667

 

 

As of March 31, 2017, total unrecognized compensation cost related to nonvested RSUs was $78.7 million, which will be amortized over a weighted-average period of 3.37 years.

 

Equity Awards Granted to Nonemployees

 

In September 2016, the Company granted 30,255 restricted stock units to a nonemployee. The award is vested upon the satisfaction of a service condition over two years starting in August 2015 and the stock-based compensation expense recorded for this award during the three months ended March 31, 2017 was $0.1 million.

 

In December 2015, the Company granted a stock option to purchase 30,000 shares to another nonemployee. On January 1, 2017 due to the employee status change, the grant was converted into a standard award and no further changes in fair value will occur.

 

As of March 31, 2017, total unrecognized compensation cost related to the nonvested nonemployee award was $0.3 million, which will be amortized over a weighted average period of 0.4 years.

 

Early Exercises of Nonvested Options

 

As of March 31, 2017 and December 31, 2016, the Company recorded a liability of $0.2 million and $0.3 million for 38,886 and 49,580 unvested shares, respectively, that were early exercised by employees and were subject to repurchase at the respective period end. These amounts are reflected in current and non-current liabilities on the Company’s consolidated balance sheets.

 

Valuation Assumptions

 

The fair value of employee stock options under our equity incentive plans and purchase rights under the ESPP was estimated on the date of grant using the following assumptions in the Black-Scholes option pricing model:

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

Employee Stock Options:

 

 

 

 

 

Fair value of common stock

 

 

$31.72 - $31.96

 

$10.09 - $10.30

 

Expected term (in years)

 

6.08

 

6.08

 

Expected volatility

 

47.56

%

52.4% - 53.0%

 

Risk-free interest rate

 

2.07

%

1.4% - 1.5%

 

Dividend rate

 

0

%

0

%

 

 

 

 

 

 

Employee Stock Purchase Plan:

 

 

 

 

 

Expected term (in years)

 

0.9

 

0.9

 

Expected volatility

 

52

%

52

%

Risk-free interest rate

 

0.6

%

0.6

%

Dividend rate

 

0

%

0

%

 

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The following assumptions were used in the Monte Carlo simulation model to estimate the fair value and the derived service period of the performance options:

 

Asset volatility

 

40

%

Equity volatility

 

45

%

Discount rate

 

14

%

Stock price at grant date

 

$

31.72

 

 

Stock-Based Compensation Expense

 

The Company recorded the total stock-based compensation expense as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

Cost of revenue

 

$

138

 

$

23

 

Research and development

 

4,484

 

1,516

 

Sales and marketing

 

1,995

 

734

 

General and administrative

 

2,768

 

752

 

Total

 

$

9,385

 

$

3,025

 

 

14. Net Loss per Share Attributable to Common Stockholders

 

Basic and diluted net loss per common share is presented in conformity with the two-class method required for participating securities.

 

Class A and Class B common stock are the only outstanding equity in the Company. The rights of the holders of Class A and Class B common stock are identical, except with respect to voting and conversion. Each share of Class A common stock is entitled to one vote per share and each share of Class B common stock is entitled to ten votes per share. Shares of Class B common stock may be converted into Class A common stock at any time at the option of the stockholder, and are automatically converted into Class A common stock upon sale or transfer, subject to certain limited exceptions.

 

Basic net loss per share attributable to common stockholders is computed using the weighted-average number of common shares outstanding during the period. Diluted net loss per share attributable to common stockholders is computed using the weighted-average number of common shares and, if dilutive, potential common shares outstanding during the period. The dilutive effect of these potential common shares is reflected in diluted earnings per share by application of the treasury stock method.

 

The following table sets forth the calculation of basic and diluted net loss per share attributable to common stockholders during the periods presented (in thousands, except share and per share data):

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

Net loss attributable to common stockholders

 

$

(14,227

)

$

(6,468

)

Weighted-average shares used to compute net loss per share attributable to common stockholders, basic and diluted

 

88,612,804

 

17,483,198

 

Net loss per share attributable to common stockholders, basic and diluted

 

$

(0.16

)

$

(0.37

)

 

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The following outstanding shares of common stock equivalents were excluded from the calculation of diluted net loss per share attributable to common stockholders because their effect would have been anti-dilutive:

 

 

 

As of March 31,

 

 

 

2017

 

2016

 

Conversion of convertible preferred stock outstanding

 

 

54,508,441

(1)

Issued and outstanding options

 

13,545,334

 

16,704,752

 

Nonvested RSUs issued and outstanding

 

2,692,636

 

573,800

 

Common stock reserved for Twilio.org

 

680,397

 

888,022

 

Shares committed under 2016 ESPP

 

594,218

 

 

Unvested shares subject to repurchase

 

38,886

 

35,528

 

Total

 

17,551,471

 

72,710,543

 

 


(1)                                 Includes 687,885 shares of Series T convertible preferred stock related to the Authy acquisition held in escrow.

 

15. Transactions with Investors

 

In 2015, two of the Company’s vendors participated in the Company’s Series E convertible preferred stock financing and owned approximately 1.96% and 0.98%, respectively, of the Company’s outstanding capital stock as of March 31, 2017, and 2.0% and 1.0% respectively, of the Company’s capital stock as of December 31, 2016. During the three months ended March 31, 2017 and 2016, the amount of software services the Company purchased from the first vendor was $4.6 million and $3.1 million, respectively. The amounts due to this vendor that were accrued as of March 31, 2017 were $2.0 million.  As of December 31, 2016, the amounts due to this vendor were insignificant.

 

The amount of services the Company purchased from the second vendor was $0.2 million and $0.1 million for the three months ended March 31, 2017 and 2016, respectively. The amounts due to this vendor as of March 31, 2017 and December 31, 2016 were insignificant.

 

16. Employee Benefit Plan

 

The Company sponsors a 401(k) defined contribution plan covering all employees. The employer contribution to the plan was $0.9 million and $0.5 million in the three months ended March 31, 2017 and 2016, respectively.

 

* * * * * *

 

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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 consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. In addition to historical financial information, the following discussion contains forward-looking statements that is 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 the leader in the Cloud Communications Platform category. We enable developers to build, scale and operate real-time communications within software applications.

 

Our developer-first platform approach consists of three things: our Programmable Communications Cloud, Super Network and Business Model for Innovators. Our Programmable Communications Cloud software enables developers to embed voice, messaging, video and authentication capabilities into their applications via our simple-to-use Application Programming Interfaces, or APIs. We do not aim to provide complete business solutions, rather our Programmable Communications Cloud offers flexible building blocks that enable our customers to build what they need. The Super Network is our software layer that allows our customers’ software to communicate with connected devices globally. It interconnects with communications networks around the world and continually analyzes data to optimize the quality and cost of communications that flow through our platform. Our Business Model for Innovators empowers developers by reducing friction and upfront costs, encouraging experimentation, and enabling developers to grow as customers as their ideas succeed.

 

As of March 31, 2017, our customers’ applications that are embedded with our products could reach users via voice, messaging and video in nearly every country in the world, and our platform offered customers local telephone numbers in over 60 countries and text-to-speech functionality in 26 languages. We support our global business through 26 cloud data centers in eight regions around the world and have developed contractual relationships with network service providers globally.

 

Our business model is primarily focused on reaching and serving the needs of developers. We established and maintain our leadership position by engaging directly with, and cultivating, our developer community, which has led to the rapid adoption of our platform. We reach developers through community events and conferences, including our SIGNAL developer conferences, to demonstrate how every developer can create differentiated applications incorporating communications using our products.

 

Once developers are introduced to our platform, we provide them with a low-friction trial experience. By accessing our easy-to-configure APIs, extensive self-service documentation and customer support team, developers build our products into their applications and then test such applications through free trials. Once they have decided to use our products beyond the initial free trial period, customers provide their credit card information and only pay for the actual usage of our products. Historically, we have acquired the substantial majority of our customers through this self-service model. As customers expand their usage of our platform, our relationships with them often evolve to include business leaders within their organizations. Once our customers reach a certain spending level with us, we support them with account managers or customer success advocates within our sales organization to ensure their satisfaction and expand their usage of our products.

 

When potential customers do not have the available developer resources to build their own applications, we refer them to our network of Solution Partners, who embed our products in their solutions, such as software for contact centers and sales force and marketing automation that they sell to other businesses.

 

We recently began to supplement our self-service model with a sales effort aimed at engaging larger potential customers, strategic leads and existing customers through an enterprise sales approach. We have supplemented this sales effort with a new product launch, Twilio Enterprise Plan, which provides new capabilities for advanced security, access management and granular administration. Our sales organization targets technical and business leaders who are seeking to leverage software to drive competitive differentiation. As we educate these leaders on the benefits of developing applications that incorporate our products to differentiate their business, they often consult with their developers regarding implementation. We believe that developers are often advocates for our products as a result of our developer-focused approach. Our sales organization includes sales development, inside sales, field sales, sales engineering and customer success personnel.

 

 

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We generate the substantial majority of our revenue from customers based on their usage of our software products that they have incorporated into their applications. In addition, customers typically purchase one or more telephone numbers from us, for which we charge a monthly flat fee per number. Some customers also choose to purchase various levels of premium customer support for a monthly fee. Customers that register in our self-service model typically pay up-front via credit card and draw down their balance as they purchase or use our products. Most of our customers draw down their balance in the same month they pay up front and, as a result, our deferred revenue at any particular time is not a meaningful indicator of future revenue. As our customers’ usage grows, some of our customers enter into contracts and are invoiced monthly in arrears. Many of these customer contracts have terms of 12 months and typically include some level of minimum revenue commitment. Most customers with minimum revenue commitment contracts generate a significant amount of revenue in excess of their minimum revenue commitment in any period. Historically, the aggregate minimum commitment revenue from customers with which we have contracts has constituted a minority of our revenue in any period, and we expect this to continue in the future.

 

Our developer-focused products are delivered to customers and users through our Super Network, which uses software to optimize communications on our platform. We interconnect with communications networks globally to deliver our products, and therefore we have arrangements with network service providers in many regions throughout the world. Historically, a substantial majority of our cost of revenue has been network service provider fees. We continue to optimize our network service provider coverage and connectivity through continuous improvements in routing and sourcing in order to lower the usage expenses we incur for network service provider fees. As we benefit from our platform optimization efforts, we sometimes pass these savings on to customers in the form of lower usage prices on our products in an effort to drive increased usage and expand the reach and scale of our platform. In the near term, we intend to operate our business to expand the reach and scale of our platform and to grow our revenue, rather than to maximize our gross margins.

 

We have achieved significant growth in recent periods. For the three months ended March 31, 2017 and 2016, our revenue was $87.4 million and $59.3 million, respectively. In the three months ended March 31, 2017 and 2016, our 10 largest Active Customer Accounts generated an aggregate of 25% and 32% of our revenue, respectively. For both the three months ended March 31, 2017 and 2016, among our 10 largest Active Customer Accounts we had three Variable Customer Accounts, respectively, representing 7% and 16% of our revenue, respectively. For the three months ended March 31, 2017 and 2016, our Base Revenue was $80.6 million and $49.8 million, respectively. We incurred a net loss of $14.2 million and $6.5 million for the three months ended March 31, 2017 and 2016, respectively. See the section titled “—Key Business Metrics—Base Revenue” for a discussion of Base Revenue.

 

Key Business Metrics

 

 

 

Three Months
Ended
March 31,

 

 

 

2017

 

2016

 

Number of Active Customer Accounts (as of end date of period)

 

40,696

 

28,648

 

Base Revenue (in thousands)

 

$

80,643

 

$

49,834

 

Base Revenue Growth Rate

 

62

%

92

%

Dollar-Based Net Expansion Rate

 

141

%

170

%

 

Number of Active Customer Accounts.  We believe that the number of our Active Customer Accounts is an important indicator of the growth of our business, the market acceptance of our platform and future revenue trends. We define an Active 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 $5 of revenue in the last month of the period. We believe that the use of our platform by our customers at or above the $5 per month threshold is a stronger indicator of potential future engagement than trial usage of our platform or usage at levels below $5 per month. A single organization may constitute multiple unique Active Customer Accounts if it has multiple account identifiers, each of which is treated as a separate Active Customer Account.

 

In the three months ended March 31, 2017 and 2016, revenue from Active Customer Accounts represented over 99% of total revenue in each period.

 

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Table of Contents

 

Base Revenue.  We monitor Base Revenue as one of the more reliable indicators of future revenue trends. Base Revenue consists of all revenue other than revenue from large Active Customer Accounts that have never entered into 12-month minimum revenue commitment contracts with us, which we refer to as Variable Customer Accounts. While almost all of our customer accounts exhibit some level of variability in the usage of our products, based on our experience, we believe that Variable Customer Accounts are more likely to have significant fluctuations in usage of our products from period to period, and therefore that revenue from Variable Customer Accounts may also fluctuate significantly from period to period. This behavior is best evidenced by the decision of such customers not to enter into contracts with us that contain minimum revenue commitments, even though they may spend significant amounts on the use of our products and they may be foregoing more favorable terms often available to customers that enter into committed contracts with us. This variability adversely affects our ability to rely upon revenue from Variable Customer Accounts when analyzing expected trends in future revenue.

 

For historical periods through March 31, 2016, we defined a Variable Customer Account as an Active Customer Account that (i) had never signed a minimum revenue commitment contract with us for a term of at least 12 months and (ii) had met or exceeded 1% of our revenue in any quarter in the periods presented through March 31, 2016. To allow for consistent period-to-period comparisons, in the event a customer account qualified as a Variable Customer Account as of March 31, 2016, or a previously Variable Customer Account ceased to be an Active Customer Account as of such date, we included such customer account as a Variable Customer Account in all periods presented. For reporting periods starting with the three months ended June 30, 2016, we define a Variable Customer Account as a customer account that (a) has been categorized as a Variable Customer Account in any prior quarter, as well as (b) any new customer account that (i) is with a customer that has never signed a minimum revenue commitment contract with us for a term of at least 12 months and (ii) meets or exceeds 1% of our revenue in a quarter. Once a customer account is deemed to be a Variable Customer Account in any period, it remains a Variable Customer Account in subsequent periods unless such customer enters into a minimum revenue commitment contract with us for a term of at least 12 months.

 

In the three months ended March 31, 2017 and 2016, we had seven and nine Variable Customer Accounts, which represented 8% and 16%, respectively, of our total revenue.

 

Dollar-Based Net Expansion Rate.  Our ability to drive growth and generate incremental revenue depends, in part, on our ability to maintain and grow our relationships with existing Active Customer Accounts and to increase their use of the platform. An important way in which we track our performance in this area is by measuring the Dollar-Based Net Expansion Rate for our Active Customer Accounts, other than our Variable Customer Accounts. Our Dollar-Based Net Expansion Rate increases when such Active Customer Accounts increase usage of a product, extend usage of a product to new applications or adopt a new product. Our Dollar-Based Net Expansion Rate decreases when such Active Customer Accounts cease or reduce usage of a product or when we lower usage prices on a product. As our customers grow their businesses and extend the use of our platform, they sometimes create multiple customer accounts with us for operational or other reasons. As such, for reporting periods starting with the three months ended December 31, 2016, when we identify a significant customer organization (defined as a single customer organization generating more than 1% of revenue in a quarterly reporting period) that has created a new Active Customer Account, this new Active Customer Account is tied to, and revenue from this new Active Customer Account is included with, the original Active Customer Account for the purposes of calculating this metric. We believe measuring our Dollar-Based Net Expansion Rate on revenue generated from our Active Customer Accounts, other than our Variable Customer Accounts, provides a more meaningful indication of the performance of our efforts to increase revenue from existing customers.

 

Our Dollar-Based Net Expansion Rate compares the revenue from Active Customer Accounts, other than Variable Customer Accounts, in a quarter to the same quarter in the prior year. To calculate the Dollar-Based Net Expansion Rate, we first identify the cohort of Active Customer Accounts, other than Variable Customer Accounts, that were Active Customer Accounts in the same quarter of the prior year. The Dollar-Based Net Expansion Rate is the quotient obtained by dividing the revenue generated from that cohort in a quarter, by the revenue generated from that same cohort in the corresponding quarter in the prior year. When we calculate Dollar-Based Net Expansion Rate for periods longer than one quarter, we use the average of the applicable quarterly Dollar-Based Net Expansion Rates for each of the quarters in such period.

 

Key Components of Statements of Operations

 

Revenue.  We derive our revenue primarily from usage-based fees earned from customers using the software products within our Programmable Communications Cloud. These usage-based software products include our Programmable Voice, Programmable Messaging and Programmable Video products. Some examples of the usage-based fees for which we charge include minutes of call duration activity for our Programmable Voice products, number of text messages sent or received using our Programmable Messaging products and number of authentications for our Programmable Authentication product. In the three months ended March 31, 2017 and 2016, we generated 83% and 82% of our revenue, respectively, from usage-based fees. We also earn monthly flat fees from certain fee-based products, such as telephone numbers and customer support. We do not generate any revenue directly from our Super Network or Business Model for Innovators.

 

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Table of Contents

 

Customers typically pay up-front via credit card in monthly prepaid amounts and draw down their balances as they purchase or use our products. As customers grow their usage of our products they automatically receive tiered usage discounts. Our larger customers often enter into contracts, for at least 12 months, that contain minimum revenue commitments, which may contain more favorable pricing. Customers on such contracts typically are invoiced monthly in arrears for products used.

 

Amounts that have been charged via credit card or invoiced are recorded in accounts receivable and in revenue or deferred revenue, depending on whether the revenue recognition criteria have been met. Given that our credit card prepayment amounts tend to be approximately equal to our credit card consumption amounts in each period, and that we do not have many invoiced customers on pre-payment contract terms, our deferred revenue at any particular time is not a meaningful indicator of future revenue.

 

We define U.S. revenue as revenue from customers with IP addresses at the time of registration in the United States, and we define international revenue as revenue from customers with IP addresses at the time of registration outside of the United States.

 

Cost of Revenue and Gross Margin.  Cost of revenue consists primarily of fees paid to network service providers. Cost of revenue also includes cloud infrastructure fees, personnel costs, such as salaries and stock-based compensation for our customer support employees, and non-personnel costs, such as amortization of capitalized internal-use software development costs. Our arrangements with network service providers require us to pay fees based on the volume of phone calls initiated or text messages sent, as well as the number of telephone numbers acquired by us to service our customers. Our arrangements with our cloud infrastructure provider require us to pay fees based on our server capacity consumption.

 

Our gross margin has been and will continue to be affected by a number of factors, including the timing and extent of our investments in our operations, our ability to manage our network service provider and cloud infrastructure-related fees, the mix of U.S. revenue compared to international revenue, the timing of amortization of capitalized software development costs and the extent to which we periodically choose to pass on our cost savings from platform optimization efforts 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, stock-based compensation and compensation expenses related to stock repurchases from employees. We also incur other non-personnel costs related to our general overhead expenses. We expect that our operating costs will increase in absolute dollars.

 

Research and Development.  Research and development expenses consist primarily of personnel costs, outsourced engineering services, cloud infrastructure fees for staging and development, amortization of capitalized internal-use software development costs and an allocation of our general overhead expenses. We capitalize the portion of our software development costs that meets the criteria for capitalization.

 

We continue to focus our research and development efforts on adding new features and products including new use cases, improving our platform and increasing the functionality of our existing products.

 

Sales and Marketing.  Sales and marketing expenses consist primarily of personnel costs, including commissions for our sales employees. Sales and marketing expenses also include expenditures related to advertising, marketing, our brand awareness activities and developer evangelism, costs related to our SIGNAL developer conferences, credit card processing fees, professional services fees and an allocation of our general overhead expenses.

 

We focus our sales and marketing efforts on generating awareness of our company, platform and products through our developer evangelist team and self-service model, creating sales leads and establishing and promoting our brand, both domestically and internationally. We plan to continue investing in sales and marketing by increasing our sales and marketing headcount, supplementing our self-service model with an enterprise sales approach, expanding our sales channels, driving our go-to-market strategies, building our brand awareness and sponsoring additional marketing events.

 

General and Administrative.  General and administrative expenses consist primarily of personnel costs for our accounting, finance, legal, human resources and administrative support personnel and executives. General and administrative expenses also include costs related to business acquisitions, legal and other professional services fees, sales and other taxes, depreciation and amortization and an allocation of our general overhead expenses. We expect that we will incur costs associated with supporting the growth of our business and to meet the increased compliance requirements associated with both our international expansion and our transition to, and operation as, a public company.

 

Our general and administrative expenses include a significant amount of sales and other taxes to which we are subject based on the manner we sell and deliver our products. Historically, we have not collected such taxes from our customers and have therefore

 

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Table of Contents

 

recorded such taxes as general and administrative expenses. We expect that these expenses will decline in future years as we continue to implement our sales tax collection mechanisms and start collecting these taxes from our customers.

 

Provision for Income Taxes.  Our provision for income taxes historically has not been significant to our business, as we have incurred operating losses to date. Our provision for income taxes consists primarily of income taxes in certain foreign jurisdictions in which we conduct business.

 

Non-GAAP Financial Measures

 

We use the following non-GAAP financial information, collectively, to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively, 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 use similar non-GAAP financial information to supplement their GAAP results. Non-GAAP financial information is presented for supplemental informational purposes only, and should not be considered a substitute for financial information presented in accordance with generally accepted accounting principles, and may be different from similarly-titled non-GAAP measures used by other companies. Whenever we use a non-GAAP financial measure, a reconciliation is provided to the most closely applicable financial measure stated in accordance with generally accepted accounting principles. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures.

 

Non-GAAP Gross Profit and Non-GAAP Gross Margin.  We define non-GAAP gross profit and non-GAAP gross margin as GAAP gross profit and GAAP gross margin, respectively, adjusted to exclude stock-based compensation and amortization of acquired intangibles.

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Reconciliation:

 

 

 

 

 

Gross profit

 

$

50,086

 

$

32,513

 

Non-GAAP adjustments:

 

 

 

 

 

Stock-based compensation

 

138

 

23

 

Amortization of acquired intangible assets

 

997

 

70

 

Non-GAAP gross profit

 

$

51,221

 

$

32,606

 

Non-GAAP gross margin

 

59

%

55

%

 

Non-GAAP Operating Expenses.  We define non-GAAP operating expenses (including categories of operating expenses) as GAAP operating expenses (and categories of operating expenses) adjusted to exclude, as applicable, stock-based compensation, amortization of acquired intangibles, expenses related to stock repurchases, acquisition-related expenses, release of tax liability upon obligation settlement, charitable contribution, gains or losses on lease termination and payroll taxes related to stock-based compensation.

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Reconciliation:

 

 

 

 

 

Operating expenses

 

$

64,841

 

$

38,879

 

Non-GAAP adjustments:

 

 

 

 

 

Stock-based compensation

 

(9,247

)

(3,002

)

Amortization of acquired intangible assets

 

(179

)

(65

)

Acquisition-related expenses

 

(217

)

 

Release of tax liability upon obligation settlement

 

920

 

 

Gain on lease termination

 

295

 

 

 

Payroll taxes related to stock-based compensation

 

(1,450

)

 

Non-GAAP operating expenses

 

$

54,963

 

$

35,812

 

 

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Non-GAAP Operating Loss and Non-GAAP Operating Margin.  We define non-GAAP operating loss and non-GAAP operating margin as GAAP operating loss and GAAP operating margin, respectively, adjusted to exclude stock-based compensation, amortization of acquired intangibles, expenses related to stock repurchases, acquisition-related expenses, release of tax liability upon obligation settlement, charitable contribution, gains or losses on lease termination and payroll taxes related to stock-based compensation.

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Reconciliation:

 

 

 

 

 

Loss from operations

 

$

(14,755

)

$

(6,366

)

Non-GAAP adjustments:

 

 

 

 

 

Stock-based compensation

 

9,385

 

3,025

 

Amortization of acquired intangible assets

 

1,176

 

135

 

Acquisition-related expenses

 

217

 

 

Release of tax liability upon obligation settlement

 

(920

)

 

Gain on lease termination

 

(295

)

 

 

Payroll taxes related to stock-based compensation

 

1,450

 

 

Non-GAAP loss from operations

 

$

(3,742

)

$

(3,206

)

Non-GAAP operating margin

 

(4

)%

(5

)%

 

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Results of Operations

 

The following tables set forth our results of operations for the periods presented and as a percentage of our total revenue for those periods. The period-to-period comparison of our historical results are not necessarily indicative of the results that may be expected in the future.

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Revenue

 

$

87,372

 

$

59,340

 

Cost of revenue(1) (2)

 

37,286

 

26,827

 

Gross profit

 

50,086

 

32,513

 

Operating expenses:

 

 

 

 

 

Research and development(1) (2)

 

26,522

 

14,864

 

Sales and marketing(1)

 

21,116

 

13,422

 

General and administrative(1) (2)

 

17,203

 

10,593

 

Total operating expenses

 

64,841

 

38,879

 

Loss from operations

 

(14,755

)

(6,366

)

Other income (expenses), net

 

498

 

(18

)

Loss before (provision) benefit for income taxes

 

(14,257

)

(6,384

)

(Provision) benefit for income taxes

 

30

 

(84

)

Net loss attributable to common stockholders

 

$

(14,227

)

$

(6,468

)

 


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

 

 

 

Three Months Ended
March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Cost of revenue

 

$

138

 

$

23

 

Research and development

 

4,484

 

1,516

 

Sales and marketing

 

1,995

 

734

 

General and administrative

 

2,768

 

752

 

Total

 

$

9,385

 

$

3,025

 

 

(2)                                 Includes amortization of acquired intangible assets as follows:

 

 

 

Three Months
Ended
March 31,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Cost of revenue

 

$

997

 

$

70

 

Research and development

 

38

 

38

 

Sales and marketing

 

117

 

 

General and administrative

 

24

 

27

 

Total

 

$

1,176

 

$

135

 

 

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Table of Contents

 

 

 

Three Months
Ended
March 31,

 

 

 

2017

 

2016

 

Consolidated Statements of Operations, as a percentage of revenue:**

 

 

 

 

 

Revenue

 

100

%

100

%

Cost of revenue

 

43

 

45

 

Gross profit

 

57

 

55

 

Operating expenses:

 

 

 

 

 

Research and development

 

30

 

25

 

Sales and marketing

 

24

 

23

 

General and administrative

 

20

 

18

 

Total operating expenses

 

74

 

66

 

Loss from operations

 

(17

)

(11

)

Other income (expenses), net

 

1

 

*

 

Loss before (provision) benefit for income taxes

 

(16

)

(11

)

(Provision) benefit for income taxes

 

*

 

*

 

Net loss

 

(16

)

(11

)

Net loss attributable to common stockholders

 

(16

)%

(11

)%

 


*            Less than 0.5% of revenue.

 

**         Columns may not add up to 100% due to rounding.

 

Comparison of the Three Months Ended March 31, 2017 and 2016

 

Revenue

 

 

 

Three Months
Ended
March 31,

 

 

 

 

 

 

 

2017

 

2016

 

Change

 

 

 

(Dollars in thousands)

 

Base Revenue

 

$

80,643

 

$

49,834

 

$

30,809

 

62

%

Variable Revenue

 

6,729

 

9,506

 

(2,777

)

(29

)%

Total revenue

 

$

87,372

 

$

59,340

 

$

28,032

 

47

%

 

In the three months ended March 31, 2017, Base Revenue increased by $30.8 million, or 62%, compared to the same period last year, and represented 92% and 84% of total revenue in the three months ended March 31, 2017 and 2016, respectively. This increase was primarily attributable to an increase in the usage of all our products, particularly our Programmable Messaging products and Programmable Voice products, and the adoption of additional products by our existing customers. This increase was partially offset by pricing decreases that we have implemented over time for our customers in the form of lower usage prices in an effort to increase the reach and scale of our platform. The changes in usage and price were reflected in our Dollar-Based Net Expansion Rate of 141%. The increase in usage was also attributable to a 42% increase in the number of Active Customer Accounts, from 28,648 as of March 31, 2016 to 40,696 as of March 31, 2017. Uber, our largest Base Customer Account, has notified us that they may decrease their usage of our products in upcoming periods, which could negatively impact our revenue growth rates and our Dollar-Based Net Expansion Rate for upcoming periods.

 

In the three months ended March 31, 2017, Variable Revenue decreased by $2.8 million, or 29%, compared to the same period last year, and represented 8% and 16% of total revenue in the three months ended March 31, 2017 and 2016, respectively. This decrease was primarily attributable to the fluctuating nature of our Variable Customer Accounts. As these customers increase or decrease their usage of our products, Variable Revenue also varies from period to period.

 

U.S. revenue and international revenue represented $70.1 million, or 80%, and $17.3 million, or 20%, respectively, of total revenue in the three months ended March 31, 2017, compared to $50.5 million, or 85%, and $8.8 million, or 15%, respectively, of

 

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total revenue in the three months ended March 31, 2016. Of the total $8.5 million increase in international revenue in absolute dollars $3.4 million was attributable to our acquisition of a Swedish mobile operator in February 2017. The remaining increase was attributable to the growth in usage of our products, particularly our Programmable Messaging products and Programmable Voice products, by our existing international Active Customer Accounts and to a 58% increase in the number of international Active Customer Accounts, driven in part by our focus on expanding our sales to customers outside of the United States. We opened two offices outside of the United States between March 31, 2016 and March 31, 2017.

 

Cost of Revenue and Gross Margin

 

 

 

Three Months
Ended
March 31,

 

 

 

 

 

 

 

2017

 

2016

 

Change

 

 

 

(Dollars in thousands)

 

Cost of revenue

 

$

37,286

 

$

26,827

 

$

10,459

 

39

%

Gross margin

 

57

%

55

%

 

 

 

 

 

In the three months ended March 31, 2017, cost of revenue increased by $10.5 million, or 39%, compared to the same period last year. The increase in cost of revenue was primarily attributable to a $7.6 million increase in network service providers’ fees, a $1.2 million increase in cloud infrastructure fees to support the growth in usage of our products and a $1.3 million increase in amortization expense related to our internal-use software and acquired intangible assets.

 

Operating Expenses

 

 

 

Three Months
Ended
March 31,

 

 

 

 

 

 

 

2017

 

2016

 

Change

 

 

 

(Dollars in thousands)

 

Research and development

 

$

26,522

 

$

14,864

 

$

11,658

 

78

%

Sales and marketing

 

21,116

 

13,422

 

7,694

 

57

%

General and administrative

 

17,203

 

10,593

 

6,610

 

62

%

Total operating expenses

 

$

64,841

 

$

38,879

 

$

25,962

 

67

%

 

In the three months ended March 31, 2017, research and development expenses increased by $11.7 million, or 78%, compared to the same period last year. The increase was primarily attributable to an $8.5 million increase in personnel costs, net of a $1.6 million increase in capitalized software development costs, largely as a result of a 44% average increase in our research and development headcount due to our continued focus on product development and enhancement. The increase was also due in part to a $0.9 million increase in cloud infrastructure fees to support the staging and development of our products, $0.6 million increase in facilities expenses to accommodate our headcount growth, a $0.3 million increase in amortization expense related to our internal-use software and acquired intangible assets and a $0.3 million increase related to employee travel.

 

In the three months ended March 31, 2017, sales and marketing expenses increased by $7.7 million, or 57%, compared to the same period last year. The increase was primarily attributable to a $5.7 million increase in personnel costs, largely as a result of a 33% average increase in sales and marketing headcount as we continued to expand our sales efforts in the United States and internationally, a $0.9 million increase in marketing and advertising costs, a $0.4 million increase in credit card processing fees due to increased volume, a $0.3 increase in professional fees, a $0.2 million increase in facilities expenses to accommodate our headcount growth and a $0.2 million increase related to our SIGNAL conference.

 

In the three months ended March 31, 2017, general and administrative expenses increased by $6.6 million, or 62%, compared to the same period last year. The increase was primarily attributable to a $3.9 million increase in personnel costs, largely as a result of a 24% average increase in headcount to support the growth of our business, a $0.5 million increase in sales and other taxes, a $0.5 million increase in facilities and related expenses, a $0.6 million increase in professional services fees and a $0.2 million increase in business acquisition related costs.

 

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Liquidity and Capital Resources

 

To date, our principal sources of liquidity have been the net proceeds of $155.5 million and $64.4 million, after deducting underwriting discounts and offering expenses paid or payable by us, from our initial public offering in June 2016 and our follow-on public offering in October 2016, respectively; the net proceeds we received through private sales of equity securities, as well as the payments received from customers using our products. From our inception through March 31, 2016, we completed several rounds of equity financing through the sale of our convertible preferred stock for total net proceeds of $237.1 million.  Our $15.0 million revolving credit agreement expired in March 2017, and we did not renew it. We believe that our cash and cash equivalents balances, our marketable securities portfolio 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.

 

Cash Flows

 

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

 

 

 

Three Months
Ended March 31,

 

 

 

2017

 

2016

 

 

 

 

 

 

 

Cash provided by operating activities

 

$

2,440

 

$

6,022

 

Cash used in investing activities

 

(202,018

)

(10,858

)

Cash provided by financing activities

 

12,342

 

(679

)

Effect of exchange rate changes on cash and cash equivalents

 

11

 

 

Net decrease in cash and cash equivalents

 

$

(187,225

)

$

(5,515

)

 

Cash Flows from Operating Activities

 

In the three months ended March 31, 2017, cash provided by operating activities consisted primarily of our net loss of $14.2 million adjusted for non-cash items, including $9.4 million of stock-based compensation expense, $4.0 million of depreciation and amortization expense and $3.5 million of cumulative changes in operating assets and liabilities. With respect to changes in operating assets and liabilities, accounts payable and other liabilities increased $5.4 million and deferred revenue increased $0.9 million, primarily due to increases in transaction volumes and additional accruals of sales and other taxes. These increases were partially offset by an increase in accounts receivable and prepaid expenses of $2.9 million, which resulted primarily from the timing of cash receipts from certain of our larger customers, pre-payments for cloud infrastructure fees and certain operating expenses.

 

Cash Flows from Investing Activities

 

In the three months ended March 31, 2017, cash used in investing activities was $202.0 million, primarily consisting of $170.8 million of investments in marketable securities, a $22.6 million payment for our most recent acquisition, net of cash acquired, a $5.0 million increase in purchases of capital assets primarily related to the leasehold improvements under our new office lease, and a $3.6 million of payments for capitalized software development as we continued to build new products and enhance our existing products.

 

Cash Flows from Financing Activities

 

In the three months ended March 31, 2017, cash provided by financing activities was $12.3 million, primarily consisting of proceeds from stock options exercises by our employees.

 

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Table of Contents

 

Critical Accounting Policies and Estimates

 

Our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

 

We believe that the assumptions and estimates associated with revenue recognition, stock-based compensation, the valuation of goodwill and intangible assets, internal-use software development costs, accruals and legal 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 estimates as compared to the critical accounting policies and estimates disclosed in our Annual Report on Form 10-K.

 

Recently Issued Accounting Guidance

 

See Note 2 of the notes to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for a summary of recently issued and adopted accounting pronouncements.

 

Contractual Obligations and Other Commitments

 

Our principal commitments consist of obligations under our operating leases for office space and contractual commitments to our cloud infrastructure and network service providers. There have been no material changes to our principle commitments described in our most recent Annual Report on Form 10-K.

 

Off-Balance Sheet Arrangements

 

We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.

 

Item 3.         Quantitative and Qualitative Disclosures about Market Risk

 

Quantitative and Qualitative Disclosures about Market Risk

 

We are exposed to certain market risks in the ordinary course of our business. These risks primarily include interest rate sensitivities as follows:

 

Interest Rate Risk

 

We had cash and cash equivalents of $118.4 million and marketable securities of $170.1 million as of March 31, 2017.  Cash and cash equivalents consist of bank deposits, money market funds and investments in debt securities with maturities of three months or less from the date of purchase. Marketable securities consist of U.S. treasury securities and high credit quality corporate debt securities not otherwise classified as cash equivalents. The cash and cash equivalents and marketable securities are held for working capital purposes. 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. A hypothetical 10% change in interest rates during any of the periods presented would not have had a material impact on our consolidated financial statements.

 

Currency Exchange Risks

 

The functional currency of our foreign subsidiaries is the U.S. dollar. Therefore, we are exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries into U.S. dollars. The local currencies of our foreign subsidiaries are the British pound, the euro, the Colombian peso, the Singapore dollar, the Hong Kong dollar and the Swedish Krona. Our subsidiaries remeasure monetary assets and liabilities at period-end exchange rates, while non-monetary items are remeasured at historical rates. Revenue and expense accounts are remeasured at the average exchange rate in effect during the fiscal year. If there is a

 

33



Table of Contents

 

change in foreign currency exchange rates, the conversion of our foreign subsidiaries’ financial statements into U.S. dollars would result in a realized gain or loss which is recorded in our consolidated statements of operations. We do not currently engage in any hedging activity to reduce our potential exposure to currency fluctuations, although we may choose to do so in the future. A hypothetical 10% change in foreign exchange rates during any of the periods presented would not have had a material impact on our consolidated financial statements.

 

Item 4.         Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our principal executive officer and principal financial officer have concluded that as of such date, our disclosure controls and procedures were effective.

 

Changes in Internal Control

 

There were no changes in our internal control over financial reporting in connection with the evaluation required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act that occurred 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 Limitations on Effectiveness of Controls

 

Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

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Table of Contents

 

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

On April 30, 2015, Telesign Corporation, or Telesign, filed a lawsuit against us in the United States District Court, Central District of California (“Telesign I”). Telesign alleges that we are infringing three U.S. patents that it holds: U.S. Patent No. 8,462,920 (“‘920”), U.S. Patent No. 8,687,038 (“‘038”) and U.S. Patent No. 7,945,034 (“‘034”). The patent infringement allegations in the lawsuit relate to our Programmable Authentication products, our two-factor authentication use case and an API tool to find information about a phone number. We have petitioned the U.S. Patent and Trademark Office for inter partes review of the patents at issue. On March 9, 2016, the District Court stayed the court case pending the resolution of those proceedings. On June 28, 2016, the Patent and Trademark Office instituted the inter partes review of the ‘034 patent, briefing on which has now begun, including Telesign’s contingent motion to amend the ‘034 patent. On July 8, 2016, the U.S. PTO denied our petition for inter partes review of the ‘920 and ‘038 patents. We subsequently petitioned for rehearing on this decision, and the request for rehearing was fully briefed by both parties on October 11, 2016. On July 20, 2016, Telesign applied to the court to lift the stay on Telesign I. We opposed the request, and on September 15, 2016, the court denied the request to lift the stay on Telesign I. On November 15, 2016, the U.S. PTO denied our request for rehearing on the denied petitions for inter partes review. On December 20, 2016, we filed a reply to Telesign’s opposition to the ‘034 inter partes review and simultaneously filed an opposition to Telesign’s motion to amend the ‘034 patent. On January 23, 2017, Telesign filed its reply to our opposition to the motion to amend. On March 27, 2017, the U.S. PTO held its hearing on the ‘034 patent inter partes review. A ruling is expected in June 2017.

 

On March 28, 2016, Telesign filed a second lawsuit against us in the United States District Court, Central District of California (“Telesign II”), alleging infringement of U.S. Patent No. 9,300,792 (“‘792”) held by Telesign. The ‘792 patent is in the same patent family as the ‘920 and ‘038 patents asserted in Telesign I, and the infringement allegations in Telesign II relate to our Programmable Authentication products and our two-factor authentication use case. On May 23, 2016, we moved to dismiss the complaint in Telesign II. On August 3, 2016, the United States District Court, Central District of California, issued an order granting Twilio’s motion to dismiss Telesign’s complaint with leave to amend. Telesign filed an amended complaint on September 2, 2016 and we moved to dismiss the amended complaint on September 16, 2016. On November 7, 2016, our motion to dismiss was denied, and we filed our answer to the first amended complaint on November 21, 2016. On February 27, 2017, Twilio’s petition for review of the Covered Business Method of the ‘792 patent was denied.  On March 8, 2017, the U.S. PTO issued an order instituting the inter partes review for the ‘792 patent.  On March 15, 2017, Twilio filed a motion to consolidate and stay related cases pending the conclusion of the now instituted ‘792 patent inter partes review.  The hearing on this motion is scheduled for May 22, 2017. With respect to each of the patents asserted in Telesign I and Telesign II, the complaints seek, among other things, to enjoin us from allegedly infringing the patents along with damages for lost profits.

 

On December 1, 2016, we filed a patent infringement lawsuit against Telesign in the United States District Court, Northern District of California, alleging indirect infringement of United States Patent No. 8,306,021, United States Patent No. 8,837,465, United States Patent No. 8,755,376, United States Patent No. 8,736,051, United States Patent No. 8,737,962, United States Patent No. 9,270,833, and United States Patent No. 9,226,217. Telesign filed a motion to dismiss the complaint on January 25, 2017. In two orders, issued on March 31, 2017 and April 17, 2017, the Court granted Telesign’s motion to dismiss with respect to the ‘962, ‘833, ‘051 and ‘217 patents, but denied Telesign’s motion to dismiss as to the ‘021, ‘465 and ‘376 patents.

 

On February 18, 2016, a putative class action complaint was filed in the Alameda County Superior Court in California, entitled Angela Flowers v. Twilio Inc. The complaint alleges that our products permit the interception, recording and disclosure of communications at a customer’s request and are in violation of the California Invasion of Privacy Act. The complaint seeks injunctive relief as well as monetary damages. On May 27, 2016, we filed a demurrer to the complaint. On August 2, 2016, the court issued an order denying the demurrer in part and granted it in part, with leave to amend by August 18, 2016 to address any claims under California’s Unfair Competition Law. The plaintiff opted not to amend the complaint. Discovery has already begun, and will continue until August 2017, when the plaintiff must file its motion for class certification.

 

We intend to vigorously defend these lawsuits and believe we have meritorious defenses to each matter in which we are a defendant. 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 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.

 

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Table of Contents

 

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 and Our Industry

 

The market for our products and platform is new and unproven, may decline or experience limited growth and is dependent in part on developers continuing to adopt our platform and use our products.

 

We were founded in 2008, and have been developing and providing a cloud-based platform that enables developers and organizations to integrate voice, messaging and video 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 revenue currently constitutes a significant portion of the total revenue in this market, and therefore, we believe that our future success will depend in large part on the growth, if any, of this market. The utilization of 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 products and platform. Moreover, if they do not recognize the need for and benefits of our products and platform, they may decide to adopt alternative products and services to satisfy some portion of their business needs. In order to grow our business and extend our market position, we intend to focus on educating developers and other potential customers about the benefits of our products and platform, expanding the functionality of our products and bringing new technologies to market to increase market acceptance and use of our platform. Our ability to expand the market that our products and platform address depends upon a number of factors, including the cost, performance and perceived value associated with such products and platform. The market for our products and platform could fail to grow significantly or there could be a reduction in demand for our products as a result of a lack of developer acceptance, technological challenges, competing products 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 products decreases, then our business, results of operations and financial condition could be adversely affected.

 

We have a history of losses and we are uncertain about our future profitability.

 

We have incurred net losses in each year since our inception, including net losses of $41.3 million, $35.5 million, $26.8 million and $14.2 million in 2016, 2015, 2014 and the three months ended March 31, 2017, respectively. We had an accumulated deficit of $201.0 million as of March 31, 2017. We expect to continue to expend substantial financial and other resources on, among other things:

 

·                  investments in our engineering team, the development of new products, features and functionality and enhancements to our platform;

 

·                  sales and marketing, including expanding our direct sales organization and marketing programs, especially for enterprises and for organizations outside of the United States, and expanding our programs directed at increasing our brand awareness among current and new developers;

 

·                  expansion of our operations and infrastructure, both domestically and internationally; and

 

·                  general administration, including legal, accounting and other expenses related to being a public company.

 

These investments may not result in increased revenue or growth of our business. We also expect that our revenue growth rate will decline over time. Accordingly, we may not be able to generate sufficient revenue to offset our expected cost increases and achieve and sustain profitability. If we fail to achieve and sustain profitability, then our business, results of operations and financial condition would be adversely affected.

 

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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. For example, our headcount has grown from 567 employees on March 31, 2016 to 829 employees on March 31, 2017. In addition, we are rapidly expanding our international operations. Our international headcount grew from 78 employees as of March 31, 2016 to 172 employees as of March 31, 2017, and we established operations in two new countries within that same period. We expect to continue to expand our international operations in the future. We have also experienced significant growth in the number of customers, usage and amount of data that our platform and associated infrastructure support. This growth 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 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 quarterly results may fluctuate, and if we fail to meet securities analysts’ and investors’ expectations, then the trading price of our Class A common stock and the value of your investment could decline substantially.

 

Our results of operations, including the levels of our revenue, cost of revenue, gross margin and operating expenses, have fluctuated from quarter to quarter in the past and may continue to vary significantly in the future. These fluctuations are a result of a variety of factors, many of which are outside of our control, may be difficult to predict and may or may not fully reflect the underlying performance of our business. If our quarterly results of operations fall below the expectations of investors or securities analysts, then the trading price of our Class A common stock could decline substantially. Some of the important factors that may cause our results of operations to fluctuate from quarter to quarter include:

 

·                  our ability to retain and increase revenue from existing customers and attract new customers;

 

·                  fluctuations in the amount of revenue from our Variable Customer Accounts and our larger Base Customer Accounts;

 

·                  our ability to attract and retain enterprises and international organizations as customers;

 

·                  our ability to introduce new products and enhance existing products;

 

·                  competition and the actions of our competitors, including pricing changes and the introduction of new products, services and geographies;

 

·                  the number of new employees;

 

·                  changes in network service provider fees that we pay in connection with the delivery of communications on our platform;

 

·                  changes in cloud infrastructure fees that we pay in connection with the operation of our platform;

 

·                  changes in our pricing as a result of our optimization efforts or otherwise;

 

·                  reductions in pricing as a result of negotiations with our larger customers;

 

·                  the rate of expansion and productivity of our sales force, including our enterprise sales force, which has been a focus of our recent expansion efforts;

 

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·                  change in the mix of products that our customers use;

 

·                  change in the revenue mix of U.S. and international products;

 

·                  changes in laws, regulations or regulatory enforcement, in the United States or internationally, that impact our ability to market, sell or deliver our products;

 

·                  the amount and timing of operating costs and capital expenditures related to the operations and expansion of our business, including investments in our international expansion;

 

·                  significant security breaches of, technical difficulties with, or interruptions to, the delivery and use of our products on our platform;

 

·                  the timing of customer payments and any difficulty in collecting accounts receivable from customers;

 

·                  general economic conditions that may adversely affect a prospective customer’s ability or willingness to adopt our products, delay a prospective customer’s adoption decision, reduce the revenue that we generate from the use of our products or affect customer retention;

 

·                  changes in foreign currency exchange rates;

 

·                  extraordinary expenses such as litigation or other dispute-related settlement payments;

 

·                  sales tax and other tax determinations by authorities in the jurisdictions in which we conduct business;

 

·                  the impact of new accounting pronouncements;

 

·                  expenses in connection with mergers, acquisitions or other strategic transactions; and

 

·                  fluctuations in stock-based compensation expense.

 

The occurrence of one or more of the foregoing and other factors may cause our results of operations to vary significantly. As such, we believe that quarter-to-quarter comparisons of our results of operations may not be meaningful and should not be relied upon as an indication of future performance. In addition, a significant percentage of our operating expenses is fixed in nature and is based on forecasted revenue trends. Accordingly, in the event of a revenue shortfall, we may not be able to mitigate the negative impact on our income (loss) and margins in the short term. If we fail to meet or exceed the expectations of investors or securities analysts, then the trading price of our Class A common stock could fall substantially, and we could face costly lawsuits, including securities class action suits.

 

Additionally, certain large scale events, such as major elections and sporting events, can significantly impact usage levels on our platform, which could cause fluctuations in our results of operations. We expect that significantly increased usage of all communications platforms, including ours, during certain seasonal and one-time events could impact delivery and quality of our products during those events. We also experienced increased expenses in the second quarter of 2016 due to our developer conference, SIGNAL, which we plan to host again in the second quarter of 2017 and plan to host annually. Such annual and one-time events may cause fluctuations in our results of operations and may impact both our revenue and operating expenses.

 

If we are not able to maintain and enhance our brand and increase market awareness of our company and products, then our business, results of operations and financial condition may be adversely affected.

 

We believe that maintaining and enhancing the “Twilio” brand identity and increasing market awareness of our company and products, particularly among developers, is critical to achieving widespread acceptance of our platform, to strengthen our relationships with our existing customers and to our ability to attract new customers. The successful promotion of our brand will depend largely on our continued marketing efforts, our ability to continue to offer high quality products, our ability to be thought leaders in the cloud communications market and our ability to successfully differentiate our products and platform from competing products and services. Our brand promotion and thought leadership activities may not be successful or yield increased revenue. In addition, independent industry analysts often provide reviews of our products and competing products and services, which may significantly influence the perception of our products in the marketplace. If these reviews are negative or not as strong as reviews of our competitors’ products and services, then our brand may be harmed.

 

From time to time, our customers have complained about our products, such as complaints about our pricing and customer support. If we do not handle customer complaints effectively, then our brand and reputation may suffer, our customers may lose

 

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confidence in us and they may reduce or cease their use of our products. In addition, many of our customers post and discuss on social media about Internet-based products and services, including our products and platform. Our success depends, in part, on our ability to generate positive customer feedback and minimize negative feedback on social media channels where existing and potential customers seek and share information. If actions we take or changes we make to our products or platform upset these customers, then their online commentary could negatively affect our brand and reputation. Complaints or negative publicity about us, our products or our platform could materially and adversely impact our ability to attract and retain customers, our business, results of operations and financial condition.

 

The promotion of our brand also requires us to make substantial expenditures, and we anticipate that these expenditures will increase as our market becomes more competitive and as we expand into new markets. To the extent that these activities increase revenue, this revenue still may not be enough to offset the increased expenses we incur. If we do not successfully maintain and enhance our brand, then our business may not grow, we may see our pricing power reduced relative to competitors and we may lose customers, all of which would adversely affect our business, results of operations and financial condition.

 

Our business depends on customers increasing their use of our products and any loss of customers or decline in their use of our products 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 platform. If our customers do not increase their use of our products, then our revenue may decline and our results of operations may be harmed. For example, Uber, our largest Base Customer Account, has notified us that they may decrease their usage of our products in upcoming periods, which could lead to decreased revenue from this customer versus recent historical periods. Customers are charged based on the usage of our products. 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 products 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 products may each have a negative impact on our business, results of operations and financial condition. Reductions in usage from existing customers and the loss of customers could cause our Dollar-Based Net Expansion Rate to decline in the future if customers are not satisfied with our products, the value proposition of our products or our ability to otherwise meet their needs and expectations. If a significant number of customers cease using, or reduce their usage of our products, 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 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 products and platform, such as developer events and evangelism, as well as search engine marketing and optimization. We periodically adjust the mix of our other marketing programs such as regional customer events, email campaigns, billboard advertising and public relations initiatives. 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, and we cannot assure you that any such investments will lead to the cost-effective acquisition of additional customers. 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.

 

If we do not develop enhancements to our products and introduce new products 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 products, increase adoption and usage of our products and introduce new products. The success of any enhancements or new products depends on several factors, including timely completion, adequate quality testing, actual performance quality, market-accepted pricing levels and overall market acceptance. Enhancements and new products 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 platform or other products or may not achieve the broad market acceptance necessary to generate significant revenue. Furthermore, our ability to increase the usage of our products depends, in part, on the development of new use cases for our products, which is typically driven

 

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by our developer community and may be outside of our control. We also have invested, and may continue to invest, in the acquisition of complementary businesses, technologies, services, products and other assets that expand the products that we can offer our customers. We may make these investments without being certain that they will result in products or enhancements that will be accepted by existing or prospective customers. Our ability to generate usage of additional products 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 products to meet evolving customer requirements, increase adoption and usage of our products, develop new products, or if our efforts to increase the usage of our products are more expensive than we expect, then our business, results of operations and financial condition would be adversely affected.

 

If we are unable to increase adoption of our products by enterprises, our business, results of operations and financial condition may be adversely affected.

 

Historically, we have relied on the adoption of our products by software developers through our self-service model for a significant majority of our revenue, and we currently generate only a small portion of our revenue from enterprise customers. Our ability to increase our customer base, especially among enterprises, and achieve broader market acceptance of our products will depend, in part, on our ability to effectively organize, focus and train our sales and marketing personnel. We have limited experience selling to enterprises and only recently established an enterprise-focused sales force.

 

Our ability to convince enterprises to adopt our products will depend, in part, on our ability 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. Because we do not have a long history of targeting our sales efforts at enterprises, we cannot predict whether, or to what extent, our sales will increase as we organize and train our sales force or how long it will take for sales personnel to become productive.

 

As we seek to increase the adoption of our products by enterprises, we expect to incur higher costs and longer sales cycles. In this market segment, the decision to adopt our products 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 products on a limited basis, before they will commit to deploying our products at scale, they often require extensive education about our products 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 more complex and less predictable than the sales through our self-service model, and some enterprise customers may not use our products enough to 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 products. They also may demand reductions in pricing as their usage of our products increases, which could have an adverse impact on our gross margin. As a result of our limited experience selling and marketing to enterprises, 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 are unable to expand our relationships with existing Solution Partner customers and add new Solution Partner customers, our business, results of operations and financial condition could be adversely affected.

 

We believe that the continued growth of our business depends in part upon developing and expanding strategic relationships with Solution Partner customers. Solution Partner customers embed our software products in their solutions, such as software applications for contact centers and sales force and marketing automation, and then sell such solutions to other businesses. When potential customers do not have the available developer resources to build their own applications, we refer them to our network of Solution Partner customers.

 

As part of our growth strategy, we intend to expand our relationships with existing Solution Partner customers and add new Solution Partner customers. If we fail to expand our relationships with existing Solution Partner customers or establish relationships with new Solution Partner customers, in a timely and cost-effective manner, or at all, then our business, results of operations and financial condition could be adversely affected. Additionally, even if we are successful at building these relationships but there are problems or issues with integrating our products into the solutions of these customers, our reputation and ability to grow our business may be harmed.

 

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We rely upon Amazon Web Services to operate our platform and any disruption of or interference with our use of Amazon Web Services would adversely affect our business, results of operations and financial condition.

 

We outsource substantially all of our cloud infrastructure to Amazon Web Services, or AWS, which hosts our products and platform. Customers of our products need to be able to access our platform at any time, without interruption or degradation of performance. AWS runs its own platform that we access, and we are, therefore, vulnerable to service interruptions at AWS. We have experienced, and expect that in the future we may experience interruptions, delays and outages in service and availability from time to time due to a variety of factors, including infrastructure changes, human or software errors, website hosting disruptions and capacity constraints. Capacity constraints could be due to a number of potential causes including technical failures, natural disasters, fraud or security attacks. For instance, in September 2015, AWS suffered a significant outage that had a widespread impact on the ability of our customers to use several of our products. In addition, if our security, or that of AWS, is compromised, our products or platform are unavailable or our users are unable to use our products within a reasonable amount of time or at all, then our business, results of operations and financial condition could be adversely affected. In some instances, we may not be able to identify the cause or causes of these performance problems within a period of time acceptable to our customers. It may become increasingly difficult to maintain and improve our platform performance, especially during peak usage times, as our products become more complex and the usage of our products increases. To the extent that we do not effectively address capacity constraints, either through AWS or alternative providers of cloud infrastructure, our business, results of operations and financial condition may be adversely affected. In addition, any changes in service levels from AWS may adversely affect our ability to meet our customers’ requirements.

 

The substantial majority of the services we use from AWS are for cloud-based server capacity and, to a lesser extent, storage and other optimization offerings. AWS enables us to order and reserve server capacity in varying amounts and sizes distributed across multiple regions. We access AWS infrastructure through standard IP connectivity. AWS provides us with computing and storage capacity pursuant to an agreement that continues until terminated by either party. AWS may terminate the agreement by providing 30 days prior written notice, and may in some cases terminate the agreement immediately for cause upon notice. Although we expect that we could receive similar services from other third parties, if any of our arrangements with AWS are terminated, we could experience interruptions on our platform and in our ability to make our products available to customers, as well as delays and additional expenses in arranging alternative cloud infrastructure services.

 

Any of the above circumstances or events may harm our reputation, cause customers to stop using our products, impair our ability to increase revenue from existing customers, impair our ability to grow our customer base, subject us to financial penalties and liabilities under our service level agreements and otherwise harm our business, results of operations and financial condition.

 

To deliver our products, we rely on network service providers for our network service.

 

We currently interconnect with network service providers around the world to enable the use by our customers of our products over their networks. We expect that we will continue to rely heavily on network service providers for these services going forward. Our reliance on network service providers has reduced our operating flexibility, ability to make timely service changes and control quality of service. In addition, the fees that we are charged by network service providers may change daily or weekly, while we do not typically change our customers’ pricing as rapidly. Furthermore, many of these network service providers do not have long-term committed contracts with us and may terminate their agreements with us without notice or restriction. If a significant portion of our network service providers stop providing us with access to their infrastructure, fail to provide these services to us on a cost-effective basis, cease operations, or otherwise terminate these services, the delay caused by qualifying and switching to other network service providers could be time consuming and costly and could adversely affect our business, results of operations and financial condition.

 

Further, if problems occur with our network service providers, it may cause errors or poor quality communications with our products, and we could encounter difficulty identifying the source of the problem. The occurrence of errors or poor quality communications on our products, whether caused by our platform or a network service provider, may result in the loss of our existing customers or the delay of adoption of our products by potential customers and may adversely affect our business, results of operations and financial condition.

 

Our future success depends in part on our ability to drive the adoption of our products by international customers.

 

In 2016, 2015, 2014 and the three months ended March 31, 2017, we derived 16%, 14%, 12% and 20% of our revenue, respectively, from customer accounts located outside the United States. The future success of our business will depend, in part, on our ability to expand our customer base worldwide. While we have been rapidly expanding our sales efforts internationally, our experience in selling our products outside of the United States is limited. Furthermore, our developer-first business model may not be successful or have the same traction outside the United States. As a result, our investment in marketing our products to these potential customers may not be successful. If we are unable to increase the revenue that we derive from international customers, then our business, results of operations and financial condition may be adversely affected.

 

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We are in the process of expanding our international operations, which exposes us to significant risks.

 

We are continuing to expand our international operations to increase our revenue from customers outside of the United States as part of our growth strategy. Between March 31, 2016 and March 31, 2017, our international headcount grew from 78 employees to 172 employees, and we opened two new offices outside of the United States. We expect, in the future, to open additional foreign offices and hire employees to work at these offices in order to reach new customers and gain access to additional technical talent. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic and political risks in addition to those we already face in the United States. Because of our limited experience with international operations as well as developing and managing sales in international markets, our international expansion efforts may not be successful.

 

In addition, we will face risks in doing business internationally that could adversely affect our business, including:

 

·                  exposure to political developments in the United Kingdom (U.K.), including the outcome of the U.K. referendum on membership in the European Union (EU), which has created an uncertain political and economic environment, instability for businesses and volatility in global financial markets;

 

·                  the difficulty of managing and staffing international operations and the increased operations, travel, infrastructure and legal compliance costs associated with numerous international locations;

 

·                  our ability to effectively price our products in competitive international markets;

 

·                  new and different sources of competition;

 

·                  potentially greater difficulty collecting accounts receivable and longer payment cycles;

 

·                  higher or more variable network service provider fees outside of the United States;

 

·                  the need to adapt and localize our products for specific countries;

 

·                  the need to offer customer support in various languages;

 

·                  difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions;

 

·                  difficulties with differing technical and environmental standards, data privacy and telecommunications regulations and certification requirements outside the United States, which could prevent customers from deploying our products or limit their usage;

 

·                  export controls and economic sanctions administered by the Department of Commerce Bureau of Industry and Security and the Treasury Department’s Office of Foreign Assets Control;

 

·                  compliance with various anti-bribery and anti-corruption laws such as the Foreign Corrupt Practices Act and United Kingdom Bribery Act of 2010;

 

·                  tariffs and other non-tariff barriers, such as quotas and local content rules;

 

·                  more limited protection for intellectual property rights in some countries;

 

·                  adverse tax consequences;

 

·                  fluctuations in currency exchange rates, which could increase the price of our products outside of the United States, increase the expenses of our international operations and expose us to foreign currency exchange rate risk;

 

·                  currency control regulations, which might restrict or prohibit our conversion of other currencies into U.S. dollars;

 

·                  restrictions on the transfer of funds;

 

·                  deterioration of political relations between the United States and other countries; and

 

·                  political or social unrest or economic instability in a specific country or region in which we operate, which could have an adverse impact on our operations in that location.

 

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Also, due to costs from our international expansion efforts and network service provider fees outside of the United States that are generally higher than domestic rates, our gross margin for international customers is typically lower than our gross margin for domestic customers. As a result, our gross margin may be impacted and fluctuate as we expand our operations and customer base worldwide.

 

Our failure to manage any of these risks successfully could harm our international operations, and adversely affect our business, results of operations and financial condition.

 

We currently generate significant revenue from our largest customers, and the loss or decline in revenue from any of these customers could harm our business, results of operations and financial condition.

 

In 2016, 2015, 2014 and the three months ended March 31, 2017 our 10 largest Active Customer Accounts generated an aggregate of 30%, 32%, 28% and 25% of our revenue, respectively. In addition, a significant portion of our revenue comes from two customers, one of which is a Variable Customer Account.

 

In 2016, 2015, 2014 and the three months ended March 31, 2017, WhatsApp, a Variable Customer Account, accounted for 9%, 17%, 13%  and 5% of our revenue, respectively. WhatsApp uses our Programmable Voice products and Programmable Messaging products in its applications to verify new and existing users on its service. Our Variable Customer Accounts, including WhatsApp, do not have long-term contracts with us and may reduce or fully terminate their usage of our products at any time without notice, penalty or termination charges. In addition, the usage of our products by WhatsApp and other Variable Customer Accounts may change significantly between periods.

 

A second customer, Uber, a Base Customer Account, accounted for more than 10% of our revenue in 2016 and the three months ended March 31, 2017, and accounted for less than 10% of our revenue in each of 2015 and 2014. Uber uses our Programmable Messaging products and Programmable Voice products. Although Uber has entered into a minimum commitment contract with us, its usage historically has significantly exceeded the minimum revenue commitment in its contract, and it could significantly reduce its usage of our products without notice or penalty. Recently, Uber’s usage with us has fluctuated and they have notified us that they may decrease usage in the future.

 

In the event that our large customers do not continue to use our products, use fewer of our products, or use our products in a more limited capacity, or not at all, our business, results of operations and financial condition could be adversely affected.