10-Q 1 a17-20572_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 September 30, 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 October 31, 2017, 68,822,548 shares of the registrant’s Class A common stock and 24,207,167 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 September 30, 2017

 

TABLE OF CONTENTS

 

 

 

Page

 

PART I — FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (unaudited)

4

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016

4

 

 

 

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 2017 and 2016

5

 

 

 

 

Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended
September 30, 2017 and 2016

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 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

24

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

35

 

 

 

Item 4.

Controls and Procedures

36

 

 

 

 

PART II — OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

37

 

 

 

Item 1A.

Risk Factors

38

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

64

 

 

 

Item 6.

Exhibits

65

 

 

 

 

Signatures

67

 

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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 larger customers;

 

·                  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.

 

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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.

 

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 September 30,
2017

 

As of December 31,
2016

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

91,906

 

$

305,665

 

Short-term marketable securities

 

192,031

 

 

Accounts receivable, net

 

37,258

 

26,203

 

Prepaid expenses and other current assets

 

26,420

 

21,512

 

Total current assets

 

347,615

 

353,380

 

Restricted cash

 

7,450

 

7,445

 

Property and equipment, net

 

47,718

 

37,552

 

Intangible assets, net

 

21,274

 

10,268

 

Goodwill

 

17,407

 

3,565

 

Other long-term assets

 

2,084

 

484

 

Total assets

 

$

443,548

 

$

412,694

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

7,117

 

$

4,174

 

Accrued expenses and other current liabilities

 

55,283

 

59,308

 

Deferred revenue

 

13,599

 

10,222

 

Total current liabilities

 

75,999

 

73,704

 

Long-term liabilities

 

12,549

 

9,543

 

Total liabilities

 

88,548

 

83,247

 

Commitments and contingencies (Note 10)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A and Class B common stock

 

93

 

87

 

Additional paid-in capital

 

584,390

 

516,090

 

Accumulated deficit

 

(231,519

)

(186,730

)

Accumulated other comprehensive income

 

2,036

 

 

Total stockholders’ equity

 

355,000

 

329,447

 

Total liabilities and stockholders’ equity

 

$

443,548

 

$

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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

Revenue

 

$

100,542

 

$

71,533

 

$

283,784

 

$

195,383

 

Cost of revenue

 

48,254

 

31,285

 

127,873

 

86,315

 

Gross profit

 

52,288

 

40,248

 

155,911

 

109,068

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

31,674

 

21,106

 

87,910

 

53,339

 

Sales and marketing

 

25,778

 

15,873

 

73,047

 

47,451

 

General and administrative

 

18,867

 

14,545

 

40,810

 

36,773

 

Total operating expenses

 

76,319

 

51,524

 

201,767

 

137,563

 

Loss from operations

 

(24,031

)

(11,276

)

(45,856

)

(28,495

)

Other income, net

 

1,000

 

138

 

1,969

 

92

 

Loss before provision for income taxes

 

(23,031

)

(11,138

)

(43,887

)

(28,403

)

Provision for income taxes

 

(422

)

(116

)

(902

)

(313

)

Net loss attributable to common stockholders

 

$

(23,453

)

$

(11,254

)

(44,789

)

$

(28,716

)

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

 

$

(0.25

)

$

(0.13

)

$

(0.49

)

$

(0.68

)

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

 

92,156,768

 

83,887,901

 

90,543,087

 

42,030,989

 

 

See accompanying notes to condensed consolidated financial statements.

 

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TWILIO INC.

 

Condensed Consolidated Statements of Comprehensive Loss

 

(In thousands)

 

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

Net loss

 

$

(23,453

)

$

(11,254

)

$

(44,789

)

$

(28,716

)

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Unrealized loss on marketable securities

 

(44

)

 

(238

)

 

Foreign currency translation

 

793

 

 

2,274

 

 

Total other comprehensive income

 

749

 

 

2,036

 

 

Comprehensive loss attributable to common stockholders

 

$

(22,704

)

$

(11,254

)

$

(42,753

)

$

(28,716

)

 

See accompanying notes to condensed consolidated financial statements.

 

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TWILIO INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

 

$

(44,789

)

$

(28,716

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

13,406

 

5,292

 

Amortization of bond premium

 

153

 

 

Stock-based compensation

 

35,973

 

15,649

 

Provision for doubtful accounts

 

407

 

1,017

 

Gain on lease termination

 

(295

)

 

Write-off of internally developed software

 

96

 

188

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(9,173

)

(11,275

)

Prepaid expenses and other current assets

 

(4,947

)

(11,561

)

Other long-term assets

 

(1,512

)

(59

)

Accounts payable

 

1,411

 

2,317

 

Accrued expenses and other current liabilities

 

(1,454

)

18,625

 

Deferred revenue

 

3,364

 

3,346

 

Long-term liabilities

 

306

 

9,596

 

Net cash provided by (used in) operating activities

 

(7,054

)

4,419

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

(Increase) decrease in restricted cash

 

1,170

 

(7,439

)

Purchases of marketable securities

 

(280,569

)

 

Maturities of marketable securities

 

87,325

 

 

Capitalized software development costs

 

(12,281

)

(8,447

)

Purchases of property and equipment

 

(8,613

)

(5,282

)

Purchases of intangible assets

 

(206

)

(646

)

Acquisition, net of cash acquired

 

(22,621

)

 

Net cash used in investing activities

 

(235,795

)

(21,814

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from initial public offering, net of underwriting discounts

 

 

160,426

 

Payments of costs related to public offerings

 

(430

)

(3,936

)

Proceeds from exercises of stock options

 

22,504

 

4,751

 

Proceeds from shares issued in ESPP

 

7,404

 

 

Tax benefit related to stock-based compensation

 

 

62

 

Value of equity awards withheld for tax liabilities

 

(476

)

(518

)

Net cash provided by financing activities

 

29,002

 

160,785

 

Effect of exchange rate changes on cash and cash equivalents

 

88

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

(213,759

)

143,390

 

CASH AND CASH EQUIVALENTS—Beginning of period

 

305,665

 

108,835

 

CASH AND CASH EQUIVALENTS—End of period

 

$

91,906

 

$

252,225

 

Cash paid for income taxes

 

$

489

 

$

153

 

NON-CASH INVESTING AND FINANCING ACTIVITIES:

 

 

 

 

 

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

 

$

124

 

$

2,373

 

Stock-based compensation capitalized in software development costs

 

$

2,712

 

$

1,068

 

Vesting of early exercised options

 

$

315

 

$

512

 

Costs related to the public offerings, accrued but not paid

 

$

 

$

368

 

 

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 is the leader in the Cloud Communications Platform category and enables developers to build, scale and operate real-time communications within their software applications via simple-to-use Application Programming Interfaces, or APIs. The power, flexibility, and reliability offered by the Company’s software building blocks empower entities of virtually every shape and size to build world-class engagement into their customer experience.

 

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 fourth quarter of 2016, the Company adopted the guidance of Accounting Standard Update (“ASU”) No. 2016-09, “Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting”, which simplified several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, statutory tax withholding requirements and classification in the statement of cash flows. The Company adopted all provisions on either prospective or modified retrospective basis. The impact from any of the adopted provisions was immaterial to the Company’s financial position, results of operations and cash flows. Hence, prior periods were not adjusted.

 

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 September 30, 2017, one customer organization represented approximately 11% 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 and nine months ended September 30, 2017, no customers represented more than 10% of the Company’s total revenue. In the three months ended September 30, 2016, one customer organization represented 15% of the Company’s total revenue, and in the nine months ended September 30, 2016, two customer organizations represented 10% and 13% 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 May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Updates (“ASU”) 2017-09, “Compensation-Stock Compensation (Topic 718), Scope of Modification Accounting”, which clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. The guidance is effective prospectively for interim and annual periods beginning after December 15, 2017 and early adoption is permitted. The Company will adopt this guidance upon its effective date. The Company does not expect the adoption of this guidance to have any material impact on the Company’s financial position, results of operations or cash flows.

 

In January 2017, the FASB issued 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 prospectively for interim and annual reporting periods beginning after December 15, 2019. The Company will adopt this guidance upon its effective date. The Company does not expect the adoption of this guidance to have any material 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 will adopt this guidance upon its effective date.  The restricted cash balances as of September 30, 2017 and December 31, 2016 were $7.4 million and $8.6 million, respectively.

 

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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 will adopt this guidance upon its effective date. The Company does not expect the adoption of this guidance to have any material impact on the Company’s financial position, results of operations or cash flows.

 

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.

 

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.  In September 2017, the FASB issued ASU 2017-13, “Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842)”. These amendments provide additional clarification and implementation guidance on the previously issued ASUs. These amendments do not change the core principles of the guidance stated in ASU 2014-09, instead they are intended to clarify and improve operability of certain topics included within the revenue standard. 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. While the Company has not yet completed the full analysis, based on the evaluation to date, the Company does not expect the adoption of this guidance to have a material impact on its financial position, results of operations or cash flows.

 

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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, 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 and 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. 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.

 

The following tables summarize the Company’s financial assets as of September 30, 2017 and December 31, 2016 by type (in thousands):

 

 

 

Amortized Cost
or Carrying

 

Net
Unrealized

 

Fair Value Hierarchy as of September 30, 2017

 

Aggregate Fair

 

 

 

Value

 

Losses

 

Level 1

 

Level 2

 

Level 3

 

Value

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

90,144

 

$

 

$

90,144

 

$

 

$

 

$

90,144

 

Total included in cash and cash equivalents

 

90,144

 

 

90,144

 

 

 

90,144

 

Marketable securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

59,951

 

(125

)

59,826

 

 

 

59,826

 

Corporate debt securities

 

132,318

 

(113

)

 

132,205

 

 

132,205

 

Total marketable securities

 

192,269

 

(238

)

59,826

 

132,205

 

 

192,031

 

Total financial assets

 

$

282,413

 

$

(238

)

$

149,970

 

$

132,205

 

$

 

$

282,175

 

 

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 September 30, 2017 (in thousands):

 

 

 

Amortized

 

Aggregate Fair

 

 

 

Cost

 

Value

 

Financial Assets:

 

 

 

 

 

Less than one year

 

$

121,215

 

$

121,130

 

One to two years

 

71,054

 

70,901

 

Total

 

$

192,269

 

$

192,031

 

 

For fixed income securities that had unrealized losses as of September 30, 2017, the Company has determined that no other-than-temporary impairment existed. As of September 30, 2017, all securities in an unrealized loss position have been in an unrealized loss position for less than one year.  Interest earned on marketable securities in the three and nine months ended September 30, 2017 was $0.7 million and $1.8 million, respectively, and is recorded as other income (expense), net, in the accompanying condensed consolidated statements of operations.

 

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4. Property and Equipment

 

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

 

 

 

As of
September 30,
2017

 

As of
December 31,
2016

 

 

 

 

 

 

 

Capitalized software development costs

 

$

43,571

 

$

28,661

 

Leasehold improvements

 

14,208

 

14,063

 

Office equipment

 

9,263

 

5,729

 

Furniture and fixtures

 

1,902

 

1,576

 

Software

 

1,500

 

968

 

Total property and equipment

 

70,444

 

50,997

 

Less: accumulated depreciation and amortization

 

(22,726

)

(13,445

)

Total property and equipment, net

 

$

47,718

 

$

37,552

 

 

Depreciation and amortization expense was $3.4 million and $9.3 million for the three and nine months ended September 30, 2017, respectively, and $1.9 million and $4.9 million for the three and nine months ended September 30, 2016, respectively.

 

The Company capitalized $5.5 million and $15.0 million of software development costs in the three and nine months ended September 30, 2017, respectively, and $3.4 million and $9.5 million in the three and nine months ended September 30, 2016, respectively. Of this amount, the stock-based compensation expense was $1.2 million and $2.8 million in the three and nine months ended September 30, 2017, respectively, and $0.4 million and $1.1 million in the three and nine months ended September 30, 2016, respectively.

 

Amortization of capitalized software development costs was $2.2 million and $5.9 million in the three and nine months ended September 30, 2017, respectively, and $1.4 million and $3.7 million in the three and nine months ended September 30, 2016, respectively.

 

5. Recent Acquisition

 

On February 6, 2017, the Company completed its acquisition of a messaging provider based in Sweden 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.

 

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The following table presents the preliminary purchase price allocation recorded in the Company’s condensed consolidated balance sheet on the acquisition date, and as subsequently adjusted during the three months ended June 30, 2017 (in thousands):

 

 

 

Total

 

Net tangible liabilities

 

$

(3,326

)

Goodwill(1)

 

12,588

 

Intangible assets(2)

 

13,700

 

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.

 

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

 

 

 

Total

 

Estimated
life
(in years)

 

Developed technology

 

$

5,000

 

4

 

Customer relationships

 

6,100

 

7-8

 

Supplier relationships

 

2,600

 

5

 

Total intangible assets acquired

 

$

13,700

 

 

 

 

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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 $0.7 million, of which $0.3 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 is immaterial.

 

6. Intangible Assets

 

Goodwill

 

Goodwill balance as of September 30, 2017 and December 31, 2016 was as follows:

 

 

 

Total

 

Balance as of December 31, 2016

 

$

3,565

 

Goodwill recorded in connection with the recent acquisition

 

12,688

 

Measurement period adjustment

 

(100

)

Effect of exchange rate

 

1,254

 

Balance as of September 30, 2017

 

$

17,407

 

 

Intangible assets

 

Intangible assets consisted of the following (in thousands):

 

 

 

As of September 30, 2017

 

 

 

Gross

 

Accumulated
Amortization

 

Net

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Developed technology

 

$

14,888

 

$

(4,365

)

$

10,523

 

Customer relationships

 

7,096

 

(774

)

6,322

 

Supplier relationships

 

2,854

 

(364

)

2,490

 

Trade name

 

60

 

(60

)

 

Patent

 

1,737

 

(93

)

1,644

 

Total amortizable intangible assets

 

26,635

 

(5,656

)

20,979

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Domain names

 

32

 

 

32

 

Trademarks

 

263

 

 

263

 

Total

 

$

26,930

 

$

(5,656

)

$

21,274

 

 

 

 

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

 

 

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Amortization expense was $1.5 million and $4.2 million for the three and nine months ended September 30, 2017, respectively, and $0.1 million and $0.4 million for the three and nine months ended September 30, 2016, respectively.

 

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

 

 

 

As of
September 30,
2017

 

2017 (remaining 3 months)

 

$

2,659

 

2018

 

5,483

 

2019

 

5,081

 

2020

 

2,651

 

2021

 

1,518

 

Thereafter

 

3,587

 

Total

 

$

20,979

 

 

7. Accrued Expenses and Other Liabilities

 

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

 

 

 

As of
September 30,

 

As of
December 31,

 

 

 

2017

 

2016

 

Accrued payroll and related

 

$

5,408

 

$

3,133

 

Accrued bonus and commission

 

3,204

 

2,251

 

Accrued cost of revenue

 

11,553

 

8,741

 

Sales and other taxes payable

 

19,394

 

28,795

 

ESPP contributions

 

3,574

 

4,364

 

Deferred rent

 

668

 

1,250

 

Accrued other expense

 

11,482

 

10,774

 

Total accrued expenses and other current liabilities

 

$

55,283

 

$

59,308

 

 

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

 

 

 

As of
September 30,

 

As of
December 31,

 

 

 

2017

 

2016

 

Deferred rent

 

$

9,335

 

$

9,387

 

Deferred tax liability

 

2,780

 

 

Accrued other expense

 

434

 

156

 

Total other long-term liabilities

 

$

12,549

 

$

9,543

 

 

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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

Balance, beginning of period

 

$

923

 

$

795

 

$

1,076

 

$

486

 

Additions

 

125

 

170

 

407

 

1,017

 

Write-offs

 

 

(16

)

(435

)

(554

)

Balance, end of period

 

$

1,048

 

$

949

 

$

1,048

 

$

949

 

 

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(b)  Sales credit reserve (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

Balance, beginning of period

 

$

734

 

$

652

 

$

544

 

$

714

 

Additions

 

104

 

169

 

1,076

 

1,012

 

Deductions against reserve

 

(238

)

(337

)

(1,020

)

(1,242

)

Balance, end of period

 

$

600

 

$

484

 

$

600

 

$

484

 

 

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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

Revenue by geographic area:

 

 

 

 

 

 

 

 

 

United States

 

$

76,713

 

$

60,535

 

$

221,914

 

$

165,528

 

International

 

23,829

 

10,998

 

61,870

 

29,855

 

Total

 

$

100,542

 

$

71,533

 

$

283,784

 

$

195,383

 

Percentage of revenue by geographic  area:

 

 

 

 

 

 

 

 

 

United States

 

76

%

85

%

78

%

85

%

International

 

24

%

15

%

22

%

15

%

 

10. Commitments and Contingencies

 

(a)                                 Lease Commitments

 

The Company entered into various non-cancelable operating lease agreements for its facilities over the next seven 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 $2.1 million and $6.1 million for the three and nine months ended September 30, 2017, respectively, and $2.1 million and $5.1 million for the three and nine months ended September 30, 2016, respectively.

 

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

 

Year Ending December 31:

 

As of September 30,
2017

 

2017 (remaining three months)

 

$

1,958

 

2018

 

7,326

 

2019

 

7,375

 

2020

 

7,068

 

2021

 

7,033

 

Thereafter

 

16,052

 

Total minimum lease payments

 

$

46,812

 

 

(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 July 8, 2016, the U.S. PTO denied the Company’s petition for inter partes review of the ‘920 and ‘038 patents. After the U.S. PTO held its hearing on the ‘034 patent inter partes review, on June 26, 2017, it upheld the patentability of the ‘034 patent, adopting Telesign’s narrow construction of its patent.

 

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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. On March 8, 2017, in response to a petition by the Company,  the U.S. PTO issued an order instituting the inter partes review for the ‘792 patent. A final written decision is expected by March 2018.  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. On May 16, 2017, the court issued an order to consolidate the Telesign I and Telesign II matters and stay the consolidated case until the completion of the inter partes review of the ‘792 patent. 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 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. This litigation is currently ongoing.

 

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 a hearing on the class certification motion is set for December 2017.

 

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.

 

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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 September 30, 2017 and December 31, 2016, no amounts were 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. Prior to March 2017, the Company had not billed nor collected these taxes from its customers and, in accordance with U.S. GAAP, 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. Effective March 2017, the Company began collecting these taxes from customers in certain jurisdictions and intends to collect in other jurisdictions in the near term. 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. Simultaneously, the Company was and continues to be in discussions with certain states regarding its prior state sales and other taxes, if any, that the Company may owe.

 

During the three months ended June 30, 2017, the Company revised its estimates of its tax exposure based on settlements reached with various states indicating that certain revisions to the key assumptions including, but not limited to, the sourcing of revenue and the taxability of the Company’s services were appropriate in the current period. In the nine months ended September 30, 2017, total impact of these changes on the net loss attributable to common stockholders was a reduction of $13.1 million, or $0.14 per share. As of September 30, 2017, the total liability related to these taxes was $19.4 million.

 

In the event other jurisdictions challenge management’s assumptions and analysis, the actual exposure could differ materially from the current estimates.

 

11. Stockholders’ Equity

 

(a)                                 Preferred Stock

 

As of September 30, 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 September 30, 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 September 30, 2017, 68,671,207 shares of Class A common stock and 24,248,777 shares of Class B common stock were issued and outstanding. As of December 31, 2016, 49,996,410 shares of Class A common stock and 37,252,138 shares of Class B common stock were issued and outstanding.

 

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

 

 

 

As of
September 30,

 

As of
December 31,

 

 

 

2017

 

2016

 

Stock options issued and outstanding

 

11,380,189

 

14,649,276

 

Nonvested restricted stock units issued and outstanding

 

4,384,898

 

2,034,217

 

Class A common stock reserved for Twilio.org

 

680,397

 

680,397

 

Stock-based awards available for grant under 2016 Plan

 

11,601,980

 

10,143,743

 

Class A common stock reserved for issuance under 2016 ESPP

 

224,126

 

597,038

 

Total

 

28,271,590

 

28,104,671

 

 

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12. 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 new-hire 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. In July 2017, the Company began granting restricted stock units to existing employees that vest in equal quarterly installments over a four year service period.

 

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.

 

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 Class A common stock on the purchase date.

 

In the three months ended June 30, 2017, 580,705 shares of the Company’s Class A common stock were purchased under the 2016 ESPP and 224,126 shares are expected to be purchased in the fourth quarter of 2017.

 

As of September 30, 2017, total unrecognized compensation cost related to the 2016 ESPP was $0.3 million, which will be amortized over a weighted-average period of 0.13 years.

 

Stock option activity under the 2008 Plan and the 2016 Plan during the nine months ended September 30, 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

 

1,443,335

 

31.06

 

 

 

 

 

Exercised

 

(4,615,225

)

4.88

 

 

 

 

 

Forfeited and cancelled

 

(652,197

)

7.93

 

 

 

 

 

Outstanding options as of September 30, 2017

 

10,825,189

 

$

9.89

 

7.37

 

$

218,574

 

Options vested and exercisable as of September 30, 2017

 

5,166,349

 

$

5.30

 

6.54

 

$

126,828

 

 

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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 $18.6 million and $119.3 million for the three and nine months ended September 30, 2017, respectively, and $4.4 million and $15.7 million for the three and nine months ended September 30, 2016, respectively.

 

The total estimated grant date fair value of options vested was $3.0 million and $12.2 million for the three and nine months ended September 30, 2017, respectively, and $4.9 million and $11.4 million for the three and nine months ended September 30, 2016, respectively. No options were granted in the three months ended September 30, 2017 and 2016. The weighted-average grant-date fair value of options granted in the nine months ended September 30, 2017 and 2016 was $13.48 and $5.52, 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 September 30, 2017

 

555,000

 

$

31.72

 

6.41

 

$

 

Options vested and exercisable as of September 30, 2017

 

 

$

 

 

$

 

 

As of September 30, 2017, total unrecognized compensation cost related to all non-vested stock options was $38.6 million, which will be amortized over a weighted-average period of 2.2 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

 

3,093,326

 

 

 

 

 

Vested

 

(492,757

)

 

 

 

 

Forfeited and cancelled

 

(249,888

)

 

 

 

 

Nonvested RSUs as of September 30, 2017

 

4,384,898

 

$

30.86

 

$

130,818

 

 

As of September 30, 2017, total unrecognized compensation cost related to nonvested RSUs was $121.1 million, which will be amortized over a weighted-average period of 3.26 years.

 

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Table of Contents

 

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. The stock-based compensation expense recorded for this award during the three and nine months ended September 30, 2017 was $0.1 million and $0.3 million, respectively.

 

As of September 30, 2017, there were no nonemployee awards outstanding.

 

Early Exercises of Nonvested Options

 

As of September 30, 2017 and December 31, 2016, the Company recorded a liability of $0.1 million and $0.3 million for 16,033 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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

Employee Stock Options:

 

 

 

 

 

 

 

 

 

Fair value of common stock

 

*

 

*

 

$24.77 -$31.96

 

$10.09-$15.00

 

Expected term (in years)

 

*

 

*

 

6.08

 

6.08

 

Expected volatility

 

*

 

*

 

46.1%-47.6%

 

51.4%-53.0%

 

Risk-free interest rate

 

*

 

*

 

1.9%-2.1%

 

1.3%-1.5%

 

Dividend rate

 

*

 

*

 

0%

 

0%

 

 


*No stock options were granted in the period.

 

Employee Stock Purchase Plan:

 

 

 

 

 

 

 

 

 

Expected term (in years)

 

0.5

 

0.9

 

0.5

 

0.9

 

Expected volatility

 

33.2

%

52

%

33.2

%

52

%

Risk-free interest rate

 

1.1

%

0.6

%

1.1

%

0.6

%

Dividend rate

 

0

%

0

%

0

%

0

%

 

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 total stock-based compensation expense as follows (in thousands):

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

Cost of revenue

 

$

180

 

$

84

 

$

460

 

$

135

 

Research and development

 

6,493

 

3,741

 

16,687

 

7,636

 

Sales and marketing

 

2,603

 

1,432

 

6,961

 

3,282

 

General and administrative

 

4,912

 

2,391

 

11,865

 

4,596

 

Total

 

$

14,188

 

$

7,648

 

$

35,973

 

$

15,649

 

 

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Table of Contents

 

13. 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.

 

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Table of Contents

 

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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

Net loss attributable to common stockholders

 

$

(23,453

)

$

(11,254

)

$

(44,789

)

$

(28,716

)

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

 

92,156,768

 

83,887,901

 

90,543,087

 

42,030,989

 

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

 

$

(0.25

)

$

(0.13

)

$

(0.49

)

$

(0.68

)

 

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 September 30,

 

 

 

2017

 

2016

 

 

 

 

 

 

 

Issued and outstanding options

 

11,380,189

 

16,476,973

 

Nonvested RSUs issued and outstanding

 

4,384,898

 

1,639,378

 

Common stock reserved for Twilio.org

 

680,397

 

780,397

 

Shares committed under 2016 ESPP

 

224,126

 

604,865

 

Unvested shares subject to repurchase

 

16,033

 

74,451

 

Total

 

16,685,643

 

19,576,064

 

 

14. 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 1.9% and 1.0%, respectively, of the Company’s outstanding common stock as of September 30, 2017, and 2.0% and 1.0%, respectively, of the Company’s outstanding common stock as of December 31, 2016. The amount of software services the Company purchased from the first vendor was $5.3 million and $14.7 million for the three and nine months ended September 30, 2017, respectively, and $3.7 million and $10.3 million during the three and nine months ended September 30, 2016, respectively. The net amount due to this vendor as of September 30, 2017 was $1.9 million.  The amounts due to or from this vendor as of December 31, 2016 were insignificant.

 

The amount of services the Company purchased from the second vendor was $0.2 million and $0.6 million for the three and nine months ended September 30, 2017, respectively, and $0.1 million and $0.3 million for the three and nine months ended September 30, 2016, respectively. The net amounts due from this vendor as of September 30, 2017 and December 31, 2016 were insignificant.

 

15. Employee Benefit Plan

 

The Company sponsors a 401(k) defined contribution plan covering all employees. The employer contribution to the plan was $0.3 million and $1.6 million in the three and nine months ended September 30, 2017, respectively, and $0.2 million and $0.9 million in the three and nine months ended September 30, 2016, respectively

 

* * * * * *

 

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Table of Contents

 

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 their software applications via our simple-to-use Application Programming Interfaces, or APIs. The power, flexibility, and reliability offered by our software building blocks empowers companies of virtually every shape and size to build world-class engagement into their customer experience.

 

Our platform consists of three layers: our Engagement Cloud, Programmable Communications Cloud and Super Network. Our Engagement Cloud software is a set of APIs that handles the higher-level communication logic needed for nearly every type of customer engagement. These APIs are focused more on what a developer is looking to accomplish, rather than how to do it, thereby allowing our customers to more quickly and easily build better ways to engage with their customers. Our Programmable Communications Cloud software is a set of APIs that enables developers to embed voice, messaging and video capabilities into their applications. 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. The Super Network also contains a set of API’s giving our customers access to more foundational components of our platform, like phone numbers.

 

As of September 30, 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 telephone numbers in over 100 countries and text-to-speech functionality in 26 languages. We support our global business through 27 cloud data centers in nine 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 software developers, who we believe are becoming increasingly influential in technology decisions in a wide variety of companies. We call this approach our Business Model for Innovators, which empowers developers by reducing friction and upfront costs, encouraging experimentation, and enabling developers to grow as customers as their ideas succeed. 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-adopt 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 executives 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, sales force automation and marketing automation that they sell to other businesses.

 

We are supplementing our self-service model with a sales effort aimed at engaging larger potential customers, strategic leads and existing customers through a direct sales approach. We have supplemented this sales effort with the Twilio Enterprise Plan, which provides capabilities for advanced security, access management and granular administration targeted at the needs of enterprise scale customers. Our sales organization works with 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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Table of Contents

 

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 September 30, 2017 and 2016, our revenue was $100.5 million and $71.5 million, respectively. In the three months ended September 30, 2017 and 2016, our 10 largest Active Customer Accounts generated an aggregate of 17% and 31% of our revenue, respectively. For the three months ended September 30, 2017 and 2016, among our 10 largest Active Customer Accounts we had four and three Variable Customer Accounts in each period representing 8% and 10% of our revenue, respectively. For the three months ended September 30, 2017 and 2016, our Base Revenue was $92.0 million and $64.1 million, respectively. We incurred a net loss of $23.5 million and $11.3 million for the three months ended September 30, 2017 and 2016, respectively. See the section titled “—Key Business Metrics—Base Revenue” for a discussion of Base Revenue. As we previously disclosed, revenue from Uber, our largest Base Customer Account, decreased on a sequential basis in the last three quarters. This was due to a combination of product usage decreases and certain price adjustments that were made by us as a result of Uber’s high volume growth. Accordingly, we expect the year-over-year decline in our revenue from Uber to continue to negatively impact our revenue growth rates and our Dollar-Based Net Expansion Rate for upcoming periods.

 

Key Business Metrics

 

 

 

Three Months
Ended
September 30,

 

 

 

2017

 

2016

 

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

 

46,489

 

34,457

 

Base Revenue (in thousands)

 

$

91,965

 

$

64,099

 

Base Revenue Growth Rate

 

43

%

75

%

Dollar-Based Net Expansion Rate

 

122

%

155

%

 

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 September 30, 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 September 30, 2017 and 2016, we had six and eight Variable Customer Accounts, which represented 9% and 10%, 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 Engagement Cloud and 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 September 30, 2017 and 2016, we generated 82% and 83% 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.

 

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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, which 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.

 

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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. Prior to March 2017, we did not collect such taxes from our customers and have therefore recorded such taxes as general and administrative expenses. Effective March 2017, we began collecting these taxes from customers in certain jurisdictions and intend to collect in other jurisdictions in the near term. We expect that these expenses will decline in future years as we continue collecting these taxes from our customers.

 

Provision for Income Taxes.  Our income tax provision or benefit for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items occurring in the quarter. The primary difference between our effective tax rate and the federal statutory rate relates to the net operating losses in jurisdictions with a valuation allowance or a zero tax rate.

 

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.  For the periods presented, 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
September 30,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Reconciliation:

 

 

 

 

 

Gross profit

 

$

52,288

 

$

40,248

 

Non-GAAP adjustments:

 

 

 

 

 

Stock-based compensation

 

180

 

84

 

Amortization of acquired intangibles

 

1,250

 

70

 

Non-GAAP gross profit

 

$

53,718

 

$

40,402

 

Non-GAAP gross margin

 

53

%

56

%

 

Non-GAAP Operating Expenses.  For the periods presented, 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, acquisition-related expenses and payroll taxes related to stock-based compensation.

 

 

 

Three Months Ended
September 30,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Reconciliation:

 

 

 

 

 

Operating expenses

 

$

76,319

 

$

51,524

 

Non-GAAP adjustments:

 

 

 

 

 

Stock-based compensation

 

(14,008

)

(7,564

)

Amortization of acquired intangibles

 

(265

)

(66

)

Acquisition related expenses

 

(35

)

(137

)

Payroll taxes related to stock-based compensation

 

(595

)

 

Non-GAAP operating expenses

 

$

61,416

 

$

43,757

 

 

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Non-GAAP Loss from Operations and Non-GAAP Operating Margin.  For the periods presented, we define non-GAAP loss from operations and non-GAAP operating margin as GAAP loss from operations and GAAP operating margin, respectively, adjusted to exclude stock-based compensation, amortization of acquired intangibles, acquisition-related expenses and payroll taxes related to stock-based compensation.

 

 

 

Three Months Ended
September 30,

 

 

 

2017

 

2016

 

 

 

(In thousands)

 

Reconciliation:

 

 

 

 

 

Loss from operations

 

$

(24,031

)

$

(11,276

)

Non-GAAP adjustments:

 

 

 

 

 

Stock-based compensation

 

14,188

 

7,648

 

Amortization of acquired intangibles

 

1,515

 

136

 

Acquisition related expenses

 

35

 

137

 

Payroll taxes related to stock-based compensation

 

595

 

 

Non-GAAP loss from operations

 

$

(7,698

)

$

(3,355

)

Non-GAAP operating margin

 

(8

)%

(5

)%

 

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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

 

 

(In thousands)

 

Revenue

 

$

100,542

 

$

71,533

 

$

283,784

 

$

195,383

 

Cost of revenue(1) (2) 

 

48,254

 

31,285

 

127,873

 

86,315

 

Gross profit

 

52,288

 

40,248

 

155,911

 

109,068

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development(1) (2) 

 

31,674

 

21,106

 

87,910

 

53,339

 

Sales and marketing(1) (2) 

 

25,778

 

15,873

 

73,047

 

47,451

 

General and administrative(1) (2)

 

18,867

 

14,545

 

40,810

 

36,773

 

Total operating expenses

 

76,319

 

51,524

 

201,767

 

137,563

 

Loss from operations

 

(24,031

)

(11,276

)

(45,856

)

(28,495

)

Other income, net

 

1,000

 

138

 

1,969

 

92

 

Loss before provision for income taxes

 

(23,031

)

(11,138

)

(43,887

)

(28,403

)

Provision for income taxes

 

(422

)

(116

)

(902

)

(313

)

Net loss attributable to common stockholders

 

$

(23,453

)

$

(11,254

)

$

(44,789

)

$

(28,716

)

 


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

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

 

 

(In thousands)

 

Cost of revenue

 

$

180

 

$

84

 

$

460

 

$

135

 

Research and development

 

6,493

 

3,741

 

16,687

 

7,636

 

Sales and marketing

 

2,603

 

1,432

 

6,961

 

3,282

 

General and administrative

 

4,912

 

2,391

 

11,865

 

4,596

 

Total

 

$

14,188

 

$

7,648

 

$

35,973

 

$

15,649

 

 

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

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

 

 

(In thousands)

 

Cost of revenue

 

$

1,250

 

$

70

 

$

3,429

 

$

210

 

Research and development

 

25

 

38

 

101

 

114

 

Sales and marketing

 

220

 

 

539

 

 

General and administrative

 

20

 

28

 

64

 

83

 

Total

 

$

1,515

 

$

136

 

$

4,133

 

$

407

 

 

 

 

Three Months
Ended
September 30,

 

Nine Months
Ended
September 30,

 

 

 

2017

 

2016

 

2017

 

2016

 

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

 

 

 

 

 

 

 

 

 

Revenue

 

100

%

100

%

100

%

100

%

Cost of revenue

 

48

 

44

 

45

 

44

 

Gross profit

 

52

 

56

 

55

 

56

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

32

 

30

 

31

 

27

 

Sales and marketing

 

26

 

22

 

26

 

24

 

General and administrative

 

19

 

20

 

14

 

19

 

Total operating expenses

 

76

 

72

 

71

 

70

 

Loss from operations

 

(24

)

(16

)

(16

)

(15

)

Other income, net

 

1

 

*

 

1

 

*

 

Loss before provision for income taxes

 

(23

)

(16

)

(15

)

(15

)

Provision for income taxes

 

*

 

*

 

*

 

*

 

Net loss attributable to common stockholders

 

(23

)%

(16

)%

(15

)%

(15

)%

 


*                                         Less than 0.5% of revenue.

 

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

 

Comparison of the Three Months Ended September 30, 2017 and 2016

 

Revenue

 

 

 

Three Months Ended September 30,

 

 

 

 

 

 

 

2017

 

2016

 

Change

 

 

 

(Dollars in thousands)

 

Base Revenue

 

$

91,965

 

$

64,099

 

$

27,866

 

43

%

Variable Revenue

 

8,577

 

7,434

 

1,143

 

15

%

Total revenue

 

$

100,542

 

$

71,533

 

$

29,009

 

41

%

 

In the three months ended September 30, 2017, Base Revenue increased by $27.9 million, or 43%, compared to the same period last year, and represented 91% and 90% of total revenue in the three months ended September 30, 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 122% for the three months ended September 30, 2017. The increase in usage was also attributable to a 35% increase in the number of Active Customer Accounts, from 34,457 as of September 30, 2016 to 46,489 as of September 30, 2017. As we previously disclosed, revenue from Uber, our largest Base Customer Account, decreased this quarter. This was due to a combination of product usage decreases and certain price adjustments that were made by us as a result of Uber’s high volume growth. Accordingly, we expect the year-over-year decline in our revenue from Uber to continue to negatively impact our revenue growth rates and our Dollar-Based Net Expansion Rate for upcoming periods.

 

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In the three months ended September 30, 2017, Variable Revenue increased by $1.1 million, or 15%, compared to the same period last year, and represented 9% and 10% of total revenue in the three months ended September 30, 2017 and 2016, respectively. This increase 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 $76.7 million, or 76%, and $23.8 million, or 24%, respectively, of total revenue in the three months ended September 30, 2017, compared to $60.5 million, or 85%, and $11.0 million, or 15%, respectively, of total revenue in the three months ended September 30, 2016. This increase in international revenue is attributable to the growth in usage of our products, particularly our Programmable Messaging and Programmable Voice products, by our existing international Active Customer Accounts; a 41% increase in the number of international Active Customer Accounts, excluding the recent acquisition, driven in part by our focus on expanding our sales to customers outside of the United States; and our recent acquisition. We opened two offices outside of the United States between September 30, 2016 and September 30, 2017.

 

Cost of Revenue and Gross Margin

 

 

 

Three Months Ended September 30,

 

 

 

 

 

 

 

2017

 

2016

 

Change

 

 

 

(Dollars in thousands)

 

Cost of revenue

 

$

48,254

 

$

31,285

 

$

16,969

 

54

%

Gross margin

 

52

%

56

%

 

 

 

 

 

In the three months ended September 30, 2017, cost of revenue increased by $17.0 million, or 54%, compared to the same period last year. The increase in cost of revenue was primarily attributable to a $14.0 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 $1.6 million increase in amortization expense related to our internal-use software and acquired intangible assets.

 

Operating Expenses

 

 

 

Three Months Ended September 30,

 

 

 

 

 

 

 

2017

 

2016

 

Change

 

 

 

(Dollars in thousands)

 

Research and development

 

$

31,674

 

$

21,106

 

$

10,568

 

50

%

Sales and marketing

 

25,778

 

15,873

 

9,905

 

62

%

General and administrative

 

18,867

 

14,545

 

4,322

 

30

%

Total operating expenses

 

$

76,319

 

$

51,524

 

$

24,795

 

48

%

 

In the three months ended September 30, 2017, research and development expenses increased by $10.6 million, or 50%, compared to the same period last year. The increase was primarily attributable to an $8.0 million increase in personnel costs, net of a $2.1 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 $0.5 million increase in outsourced engineering services, a $0.5 million increase in cloud infrastructure fees to support the staging and development of our products, a $0.5 million increase in depreciation and amortization expenses and a $0.2 million increase in other professional fees.

 

In the three months ended September 30, 2017, sales and marketing expenses increased by $9.9 million, or 62%, compared to the same period last year. The increase was primarily attributable to a $6.6 million increase in personnel costs, largely as a result of a 45% average increase in sales and marketing headcount as we continued to expand our sales efforts in the United States and internationally, a $0.6 million increase in marketing and advertising costs, a $0.5 million increase in credit card processing fees due to increased volume, a $0.4 million increase in depreciation and amortization, a $0.4 million increase in employee travel, a $0.3 million increase related to our brand awareness programs and events and a $0.2 million increase in professional fees.

 

In the three months ended September 30, 2017, general and administrative expenses increased by $4.3 million, or 30%, compared to the same period last year. The increase was primarily attributable to a $3.8 million increase in personnel costs, largely as a result of a 28% average increase in headcount to support the growth of our business, a $0.5 million increase in depreciation expense and a $1.0 million increase in professional services fees. These increases were partially offset by a $1.3 million decrease in sales and other taxes as we settled the outstanding liabilities in certain jurisdictions and a