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 June 30, 2018

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 x	Accelerated filer o
Non-accelerated filer o	Smaller reporting company o
(Do not check if a smaller reporting company)	Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

As of July 31, 2018, 76,857,136 shares of the registrant’s Class A common stock and 20,589,110 shares of registrant’s Class B common stock were outstanding.

TWILIO INC.

Quarterly Report on Form 10-Q

For the Three Months Ended June 30, 2018

TABLE OF CONTENTS

		Page
	PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	4
	Condensed Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017	4
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017	5
	Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2018 and 2017	6
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.	Controls and Procedures	41
	PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	42
Item 1A.	Risk Factors	43
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	70
Item 3.	Defaults Upon Senior Securities	70
Item 4.	Mine Safety Disclosures	70
Item 5.	Other Information	70
Item 6.	Exhibits	71
	Signatures	72

1

Special Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), 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 service the interest on our convertible notes and repay such notes, to the extent required; and

·our ability to comply with modified or new laws and regulations applying to our business, including GDPR, the California Consumer Privacy Act of 2018 and other privacy regulations that may be implemented in the future.

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.

2

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 Part II, Item 1A, “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make.

3

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

TWILIO INC.

Condensed Consolidated Balance Sheets

(In thousands)

(Unaudited)

	As of June 30,			As of December 31,
	2018			2017
ASSETS
Current assets:
Cash and cash equivalents	$	493,510		$	115,286
Short-term marketable securities	301,136			175,587
Accounts receivable, net	67,572			43,113
Prepaid expenses and other current assets	21,812			19,279
Total current assets	884,030			353,265
Restricted cash	5,505			5,502
Property and equipment, net	56,721			50,541
Intangible assets, net	17,108			20,064
Goodwill	17,506			17,851
Other long-term assets	4,978			2,559
Total assets	$	985,848		$	449,782
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	23,765		$	11,116
Accrued expenses and other current liabilities	82,171			53,614
Customer deposits	7,843			—
Deferred revenue	9,056			13,797
Total current liabilities	122,835			78,527
Convertible senior notes, net	423,099			—
Other long-term liabilities	10,243			11,409
Total liabilities	556,177			89,936
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock	—			—
Class A and Class B common stock	96			94
Additional paid-in capital	725,073			608,165
Accumulated other comprehensive income	1,962			2,025
Accumulated deficit	(297,460		)	(250,438		)
Total stockholders’ equity	429,671			359,846
Total liabilities and stockholders’ equity	$	985,848		$	449,782

See accompanying notes to condensed consolidated financial statements.

4

TWILIO INC.

Condensed Consolidated Statements of Operations

(In thousands, except share and per share amounts)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Revenue	$	147,754		$	95,870		$	276,870		$	183,242
Cost of revenue	67,940			42,333			127,522			79,619
Gross profit	79,814			53,537			149,348			103,623
Operating expenses:
Research and development	39,811			29,714			77,387			56,236
Sales and marketing	37,749			26,153			70,571			47,269
General and administrative	24,212			4,740			47,605			21,943
Total operating expenses	101,772			60,607			195,563			125,448
Loss from operations	(21,958		)	(7,070		)	(46,215		)	(21,825		)
Other income (expenses), net	(1,898		)	471			(1,233		)	969
Loss before provision for income taxes	(23,856		)	(6,599		)	(47,448		)	(20,856		)
Provision for income taxes	(150		)	(510		)	(287		)	(480		)
Net loss attributable to common stockholders	$	(24,006	)	$	(7,109	)	$	(47,735	)	$	(21,336	)
Net loss per share attributable to common stockholders, basic and diluted	$	(0.25	)	$	(0.08	)	$	(0.50	)	$	(0.24	)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted	96,348,356			90,873,305			95,515,583			89,722,874

See accompanying notes to condensed consolidated financial statements.

5

TWILIO INC.

Condensed Consolidated Statements of Comprehensive Loss

(In thousands)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Net loss	$	(24,006	)	$	(7,109	)	$	(47,735	)	$	(21,336	)
Other comprehensive income (loss):
Unrealized gain (loss) on marketable securities	152			(106		)	(165		)	(194		)
Foreign currency translation	(629		)	1,583			102			1,481
Total other comprehensive income (loss)	(477		)	1,477			(63		)	1,287
Comprehensive loss attributable to common stockholders	$	(24,483	)	$	(5,632	)	$	(47,798	)	$	(20,049	)

See accompanying notes to condensed consolidated financial statements.

6

TWILIO INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Six Months Ended June 30,
	2018			2017
				As Adjusted
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(47,735	)	$	(21,336	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	11,392			8,480
Net amortization of investment premium and discount	(237		)	107
Amortization of debt issuance costs	211			—
Accretion of debt discount on convertible senior notes	2,484			—
Stock-based compensation	38,546			21,785
Amortization of deferred commissions	478			140
Provision for doubtful accounts	1,515			282
Write-off of internal-use software	515			96
Gain on lease termination	—			(295		)
Changes in operating assets and liabilities:
Accounts receivable	(26,048		)	(9,365		)
Prepaid expenses and other current assets	(2,847		)	1,933
Other long-term assets	(1,908		)	(932		)
Accounts payable	12,566			(1,282		)
Accrued expenses and other current liabilities	28,040			(6,311		)
Customer deposits	7,842			—
Deferred revenue	(4,542		)	2,353
Long-term liabilities	(1,047		)	296
Net cash provided by (used in) operating activities	19,225			(4,049		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities	(184,364		)	(220,914		)
Maturities of marketable securities	58,520			23,000
Capitalized software development costs	(9,958		)	(8,000		)
Purchases of property and equipment	(2,066		)	(6,772		)
Purchases of intangible assets	(249		)	(154		)
Acquisition, net of cash acquired	—			(22,621		)
Net cash used in investing activities	(138,117		)	(235,461		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible senior notes	550,000			—
Payment of debt issuance costs	(12,513		)	—
Purchase of capped call	(58,465		)	—
Payments of costs related to public offerings	—			(430		)
Proceeds from exercises of stock options	13,715			18,154
Proceeds from shares issued under ESPP	4,474			7,404
Value of equity awards withheld for tax liabilities	(910		)	(311		)
Net cash provided by financing activities	496,301			24,817
Effect of exchange rate changes on cash, cash equivalents and restricted cash	818			42
NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH	378,227			(214,651		)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH—Beginning of period	120,788			314,280
CASH, CASH EQUIVALENTS AND RESTRICTED CASH —End of period	$	499,015		$	99,629
Cash paid for income taxes	$	321		$	373
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Purchases of property, equipment and intangible assets, accrued but not paid	$	572		$	376
Stock-based compensation capitalized in software development costs	$	2,909		$	1,557
Debt offering costs, accrued but not paid	$	467		$	—

See accompanying notes to condensed consolidated financial statements.

7

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 (“API”). 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 States, 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 March 1, 2018 (“Annual Report”).

The condensed consolidated balance sheet as of December 31, 2017, included herein, was derived from the audited financial statements as of that date, but may not include all disclosures including certain notes required by U.S. GAAP on an annual reporting basis.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, comprehensive loss and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full year 2018 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 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; recoverability of long-lived and intangible assets; capitalization and useful life of the Company’s capitalized internal-use software development costs; 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.

8

(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, marketable securities and restricted cash with financial institutions that management believes are financially sound and have minimal credit risk exposure although the balances will exceed insured limits.

The Company sells its services to a wide variety of customers. If the financial condition or results of operations of any significant 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. During the three months ended June 30, 2018 and 2017, and six months ended June 30, 2018, there was no customer organization that accounted for more than 10% of the Company’s total revenue. During the six months ended June 30, 2017, one customer organization represented approximately 11% of the Company’s total revenue.

As of June 30, 2018 and December 31, 2017, no customer organization represented more than 10% of the Company’s gross accounts receivable.

(e)Significant Accounting Policies

Effective January 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) 606, “Revenue from Contracts with Customers”, which replaced the existing revenue recognition guidance, ASC 605, and outlines a single set of comprehensive principles for recognizing revenue under U.S. GAAP. Among other things, ASC 606 requires entities to assess the products or services promised in contracts with customers at contract inception to determine the appropriate unit at which to record revenue, which is referred to as a performance obligation. Revenue is recognized when control of the promised products or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those products or services.

The Company adopted ASC 606 using the modified retrospective method with cumulative catch-up adjustment to the opening retained earnings as of January 1, 2018. Results for reporting periods beginning after December 31, 2017 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historical accounting policies prior to adoption. In adopting the standard, the Company elected to apply the new guidance only to those contracts which were not completed as of the date of the adoption.

The impact of adopting the new standard on the Company’s consolidated financial statements was insignificant. The Company recorded a net cumulative catch-up adjustment to the beginning retained earnings as of January 1, 2018, of $0.7 million.

The primary impact relates to the deferral of incremental commission costs of obtaining new contracts. Under ASC 605, the Company deferred only direct and incremental commission costs to obtain a contract and amortized those costs on a straight-line basis over the term of the related subscription contract. Under the new standard, the Company defers all incremental commission costs to obtain the contract and amortizes these costs on a straight-line basis over the expected term of benefit of the underlying asset, which was determined to be five years.

The impact on the Company’s revenue recognition policies was insignificant. Prior to the adoption of ASC 606, the Company recognized the majority of its revenue according to the usage by its customers in the period in which that usage occurred. ASC 606 continues to support the recognition of revenue over time, and on a usage basis, for the majority of the Company’s contracts due to continuous transfer of control to the customer. The impact on the Company’s balance sheet presentation includes presenting customer refundable prepayments as customer deposit liabilities, whereas under ASC 605 these were included in deferred revenues.

There was not a significant tax impact to the Company’s consolidated statements of operations and consolidated balance sheet relating to the adoption of the new standard as there is a full valuation allowance due to the Company’s history of continued losses.

9

Revenue Recognition

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company enters into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for credits and any taxes collected from customers, which are subsequently remitted to governmental authorities.

The Company determines revenue recognition through the following steps:

·Identification of the contract, or contracts, with a customer;

·Identification of the performance obligations in the contract;

·Determination of the transaction price;

·Allocation of the transaction price to the performance obligations in the contract; and

·Recognition of revenue when, or as, the Company satisfies a performance obligation.

Nature of Products and Services

The Company’s revenue is primarily derived from usage-based fees earned from customers accessing the Company’s enterprise cloud computing services. Platform access is considered a monthly series comprising one performance obligation and usage-based fees are recognized as revenue in the period in which the usage occurs. In each of the three and six months ended June 30, 2018, the revenue from usage-based fees represented 84% of total revenue; and in each of the three and six months ended June 30, 2017, the revenue from usage-based fees represented 83% of total revenue.

Subscription-based fees are derived from certain term-based contracts, such as with the sales of telephone numbers, short codes and customer support. Term-based contracts revenue is recognized on a ratable basis over the contractual term of the arrangement beginning on the date that the service is made available to the customer. In the three and six months ended June 30, 2018, the revenue from term-based fees represented 16% of total revenue; and in the three and six months ended June 30, 2017, the revenue from term-based fees represented 17% of total revenue.

No significant judgments are required in determining whether products and services are considered distinct performance obligations and should be accounted for separately versus together, or to determine the stand-alone selling price (“SSP”).

Refer to Note 10, Revenue by Geographic Area, for additional disaggregation.

The Company’s arrangements do not contain general rights of return. However, credits may be issued on a case-by-case basis. The contracts do not provide customers with the right to take possession of the software supporting the applications. Amounts that have been invoiced are recorded in accounts receivable and in revenue or deferred revenue depending on whether the revenue recognition criteria have been met.

The reserve for sales credits is included in accounts receivable and is calculated based on historical trends and any specific risks identified in processing transactions. Changes in the reserve are recorded against revenue.

Deferred Revenue and Customer Deposits

Deferred revenue is recorded when cash payments are received in advance of future usage on non-cancellable contracts. Customer refundable prepayments are recorded as customer deposits. During the three and six months ended June 30, 2018, the Company recognized $3.6 million and $7.2 million of revenue, respectively, that was included in the deferred revenue balance, as adjusted for ASC 606 on January 1, 2018.

10

Deferred Sales Commissions

The Company records an asset for the incremental costs of obtaining a contract with a customer, for example, sales commissions that are earned upon execution of contracts. The Company uses the portfolio method to recognize the amortization expense related to these capitalized costs related to initial contracts, upsells and renewals, and such expense is recognized over the estimated period of benefit of the capitalized commissions, which is determined to be five years. Total net capitalized costs as of June 30, 2018 were $5.2 million and are included in prepaid expenses and other current and long-term assets in the accompanying condensed consolidated balance sheet. Amortization of these assets was $0.3 million and $0.5 million in the three and six months ended June 30, 2018, respectively, and is included in sales and marketing expense in the accompanying condensed consolidated statement of operations.

Other than adoption of ASC 606, there were no changes to our significant accounting policies as described in our Annual Report.

(f)Restricted Cash

In November 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-18, “Statement of Cash Flows (Topic 230) — Restricted Cash”. This standard provides guidance on the presentation of restricted cash and restricted cash equivalents in the statement of cash flows. Restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statements of cash flows. The amendments of this ASU should be applied using a retrospective transition method and are effective for reporting periods beginning after December 15, 2017. The Company adopted ASU 2016-18 in the first quarter of 2018 and applied the guidance retrospectively to the prior period’s condensed consolidated statement of cash flows with the following impact (in thousands):

	Six Months Ended June 30, 2017
	As Originally Reported			As Adjusted
Cash used in investing activities	$	(234,291	)	$	(235,461	)
Cash, cash equivalents and restricted cash — beginning of period	$	305,665		$	314,280
Cash, cash equivalents and restricted cash — end of period	$	92,184		$	99,629

Other than the revised statement of cash flows presentation of restricted cash, the adoption of ASU 2016-18 did not have an impact on the Company’s financial position and results of operations.

(g)Recently Issued Accounting Guidance, Not yet Adopted

In July 2018, the FASB issued ASU 2018-09, “Codification Improvements”, which does not prescribe any new accounting guidance, but instead makes minor improvements and clarifications of several different FASB Accounting Standards Codification areas based on comments and suggestions made by various stakeholders. Certain updates are applicable immediately while others provide for a transition period to adopt as part of the next fiscal year beginning after December 15, 2018. The Company is currently evaluating this guidance to determine the impact it may have on its statements of financial position, results of operations and cash flows.

In June 2018, the FASB issued ASU 2018-07, “Improvements to Nonemployee Share-Based Payment Accounting”, which aligns the measurement and classification for share-based payments to non-employees with the accounting guidance for share-based payments to employees. Among other requirements, the measurement of non-employee awards will now be fixed at the grant date, rather than remeasured at every reporting date. This guidance is effective for interim and annual reporting periods beginning after December 15, 2018, with early application permitted. The Company will adopt this guidance upon its effective date. The Company does not expect the adoption of this guidance to have a 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 a material impact on the Company’s financial position, results of operations or cash flows.

11

In June 2016, the FASB issued ASU 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 consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, “Leases”, which was further clarified by ASU 2018-10, “Codification Improvements to Topic 842, Leases”, and ASU 2018-11, “Leases - Targeted Improvements”, both issued in July 2018. ASU 2016-02 affects all entities that lease assets and will require lessees to recognize a lease liability and a right-of-use asset for all leases (except for short-term leases that have a duration of less than one year) as of the date on which the lessor makes the underlying asset available to the lessee. For lessors, accounting for leases is substantially the same as in prior periods. ASU 2018-10 clarifies or corrects unintended application of guidance related to ASU 2016-02. The amendments affects narrow aspects of ASU 2016-02 related to the implicit rate in the lease, impairment of the net investment in the lease, lessee reassessment of lease classification, lessor reassessment of lease term and purchase options, variable payments that depend on an index or rate and certain transition adjustments. ASU 2018-11 adds a transition option for all entities and a practical expedient only for lessors. The transition option allows entities to not apply the new leases standard in the comparative periods they present in their financial statements in the year of adoption. Under the transition option, entities can opt to continue to apply the legacy guidance in ASC 840, “Leases”, including its disclosure requirements, in the comparative periods presented in the year they adopt the new leases standard. Entities that elect this transition option will still be required to adopt the new leases standard using the modified retrospective transition method required by the standard, but they will recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption rather than in the earliest period presented. The practical expedient provides lessors with an option to not separate the non-lease components from the associated lease components when certain criteria are met and requires them to account for the combined component in accordance with the revenue recognition standard in ASC 606 if the associated non-lease components are the predominant components. The new standards are 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 these standards 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 consolidated financial statements and related disclosures.

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3. Fair Value Measurements

The following tables provide the financial assets measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017 (in thousands):

	Amortized Cost or Carrying		Gross Unrealized		Gross Unrealized Losses Less Than			Gross Unrealized Losses More Than			Fair Value Hierarchy as of June 30, 2018						Aggregate
	Value		Gains		12 Months			12 Months			Level 1		Level 2		Level 3		Fair Value
Financial Assets:
Cash and cash equivalents:
Money market funds	$	434,136	$	—	$	—		$	—		$	434,136	$	—	$	—	$	434,136
Commercial paper	29,905		—		—			—			—		29,905		—		29,905
Total included in cash and cash equivalents	464,041		—		—			—			434,136		29,905		—		464,041
Marketable securities:
U.S. Treasury securities	69,898		—		(59		)	(51		)	69,788		—		—		69,788
Corporate debt securities and commercial paper	232,001		—		(653		)	—			—		231,348		—		231,348
Total marketable securities	301,899		—		(712		)	(51		)	69,788		231,348		—		301,136
Total financial assets	$	765,940	$	—	$	(712	)	$	(51	)	$	503,924	$	261,253	$	—	$	765,177

	Amortized Cost or Carrying		Gross Unrealized		Gross Unrealized Losses Less Than			Gross Unrealized Losses More Than		Fair Value Hierarchy as of December 31, 2017						Aggregate
	Value		Gains		12 Months			12 Months		Level 1		Level 2		Level 3		Fair Value
Financial Assets:
Cash and cash equivalents:
Money market funds	$	95,432	$	—	$	—		$	—	$	95,432	$	—	$	—	$	95,432
Total included in cash and cash equivalents	95,432		—		—			—		95,432		—		—		95,432
Marketable securities:
U.S. Treasury securities	59,962		—		(216		)	—		59,746		—		—		59,746
Corporate debt securities and commercial paper	116,223		—		(382		)	—		—		115,841		—		115,841
Total marketable securities	176,185		—		(598		)	—		59,746		115,841		—		175,587
Total financial assets	$	271,617	$	—	$	(598	)	$	—	$	155,178	$	115,841	$	—	$	271,019

As of June 30, 2018, the fair value of the 0.25% convertible senior notes due 2023 (the “Notes”), as further described in Note 8 below, was approximately $571.6 million. The fair value was determined based on the closing price for the Notes on the last trading day of the reporting period and is considered as Level 2 in the fair value hierarchy.

As the Company views its marketable securities as available to support current operations, it has classified all available for sale securities as short-term. As of June 30, 2018, for fixed income securities that were in unrealized loss positions, the Company has determined that (i) it does not have the intent to sell any of these investments, and (ii) it is not more likely than not that it will be required to sell any of these investments before recovery of the entire amortized cost basis. In addition, as of June 30, 2018, the Company anticipates that it will recover the entire amortized cost basis of such fixed income securities and has determined that no other-than-temporary impairments associated with credit losses were required to be recognized during the three and six month ended June 30, 2018. Interest earned on marketable securities was $0.7 million and $1.4 million in the three and six months ended June 30, 2018, respectively; and $0.6 million and $1.1 million in the three and six months ended June 30, 2017, respectively.  The interest is recorded as other income (expense), net, in the accompanying condensed consolidated statements of operations.

The following table summarizes the contractual maturities of marketable securities as of June 30, 2018 and December 31, 2017 (in thousands):

	As of June 30, 2018				As of December 31, 2017
	Amortized Cost		Aggregate Fair Value		Amortized Cost		Aggregate Fair Value
Financial Assets:
Less than one year	$	280,947	$	280,339	$	108,584	$	108,360
One to two years	20,952		20,797		67,601		67,227
Total	$	301,899	$	301,136	$	176,185	$	175,587

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4. Property and Equipment

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

	As of June 30,			As of December 31,
	2018			2017
Capitalized internal-use software development costs	$	61,726		$	49,177
Leasehold improvements	14,495			14,246
Office equipment	11,119			9,652
Furniture and fixtures	2,201			1,976
Software	1,848			1,675
Total property and equipment	91,389			76,726
Less: accumulated depreciation and amortization	(34,668		)	(26,185		)
Total property and equipment, net	$	56,721		$	50,541

Depreciation and amortization expense was $4.3 million and $8.5 million for the three and six months ended June 30, 2018, respectively, and $3.1 million and $5.9 million for the three and six months ended June 30, 2017, respectively.

The Company capitalized $6.7 million and $13.1 million in internal-use software development costs in the three and six months ended June 30, 2018, respectively, and $5.2 million and $9.5 million in the three and six months ended June 30, 2017, respectively. Of this amount, stock-based compensation expense was $1.5 million and $2.9 million in the three and six months ended June 30, 2018, respectively, and $0.9 million and $1.6 million in the three and six months ended June 30, 2017, respectively.

Amortization of capitalized software development costs was $3.0 million and $5.7 million in the three and six months ended June 30, 2018, respectively, and $1.9 million and $3.7 million in the three and six months ended June 30, 2017, respectively.

5. Business Combinations

In February 2017, the Company completed its acquisition of Beepsend AB, 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 with a term of 18 months.

Additionally, the Company deposited $2.0 million into a separate escrow that was subject to future service conditions and was recorded ratably into the compensation expense as the services were rendered. As of June 30, 2018, the remaining balance in the escrow was $0.2 million.

The acquisition was accounted for as a business combination and the total purchase price was allocated to the net tangible and intangible assets and liabilities based on their fair values on the acquisition date and the excess was recorded as goodwill. The acquired entity’s results of operations have been included in the consolidated financial statements of the Company from the date of acquisition.

The following table presents the purchase price allocation, as adjusted, recorded in the Company’s condensed consolidated balance sheet as of March 31, 2017 (in thousands):

	Total
Net tangible liabilities	$	(3,575	)
Goodwill(1)	12,837
Intangible assets(2)	13,700
Total purchase price	$	22,962

(1)The goodwill 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. Goodwill is deductible for tax purposes.

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

	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 Company acquired a net deferred tax liability of $2.6 million in this business combination that is included in long-term liabilities in the accompanying condensed consolidated balance sheets.

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 the income approach to estimate the fair values of the identifiable intangible assets.

The Company incurred costs related to this acquisition of $0.7 million, of which $0.3 million and $0.4 million were incurred during 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 are not presented as the financial impact to the Company’s consolidated financial statements is immaterial.

6. Goodwill and Intangible Assets

Goodwill

Goodwill balance as of June 30, 2018 and December 31, 2017 was as follows (in thousands):

	Total
Balance as of December 31, 2017	$	17,851
Effect of exchange rate	(345		)
Balance as of June 30, 2018	$	17,506

Intangible assets

Intangible assets consisted of the following (in thousands):

	As of June 30, 2018
	Gross		Accumulated Amortization			Net
Amortizable intangible assets:
Developed technology	$	14,706	$	(7,412	)	$	7,294
Customer relationships	6,874		(1,384		)	5,490
Supplier relationships	2,759		(717		)	2,042
Trade name	60		(60		)	—
Patent	2,127		(140		)	1,987
Total amortizable intangible assets	26,526		(9,713		)	16,813
Non-amortizable intangible assets:
Domain names	32		—			32
Trademarks	263		—			263
Total	$	26,821	$	(9,713	)	$	17,108

	As of December 31, 2017
	Gross		Accumulated Amortization			Net
Amortizable intangible assets:
Developed technology	$	14,941	$	(5,476	)	$	9,465
Customer relationships	7,159		(1,006		)	6,153
Supplier relationships	2,881		(500		)	2,381
Trade name	60		(60		)	—
Patent	1,878		(108		)	1,770
Total amortizable intangible assets	26,919		(7,150		)	19,769
Non-amortizable intangible assets:
Domain names	32		—			32
Trademarks	263		—			263
Total	$	27,214	$	(7,150	)	$	20,064

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Amortization expense was $1.4 million and $2.8 million for the three and six months ended June 30, 2018, respectively, and $1.5 million and $2.7 million for the three and six months ended June 30, 2017, respectively

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

	As of June 30, 2018
2018 (remaining six months)	$	3,595
2019	5,092
2020	2,661
2021	1,529
2022	933
Thereafter	3,003
Total	$	16,813

7. Accrued Expenses and Other Liabilities

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

	As of June 30,		As of December 31,
	2018		2017
Accrued payroll and related	$	10,284	$	4,898
Accrued bonus and commission	6,479		4,777
Accrued cost of revenue	21,649		10,876
Sales and other taxes payable	21,945		20,877
ESPP contributions	1,814		1,338
Deferred rent	1,251		1,048
Accrued other expense	18,749		9,800
Total accrued expenses and other current liabilities	$	82,171	$	53,614

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

	As of June 30,		As of December 31,
	2018		2017
Deferred rent	$	7,886	$	8,480
Deferred tax liability, net	1,886		2,452
Accrued other expenses	471		477
Total other long-term liabilities	$	10,243	$	11,409

8. Convertible Senior Notes and Capped Call Transactions

In May 2018, the Company issued $550.0 million aggregate principal amount of 0.25% convertible senior notes due 2023 in a private placement, including $75.0 million aggregate principal amount of such Notes pursuant to the exercise in full of the over-allotment options of the initial purchasers (collectively, the “Notes”). The interest on the Notes is payable semi-annually in arrears on June 1 and December 1 of each year, beginning on December 1, 2018.

The Notes may bear special interest under specified circumstances relating to the Company’s failure to comply with its reporting obligations under the indenture relating to the issuance of Notes (the “indenture”) or if the Notes are not freely tradeable as required by the indenture. The Notes will mature on June 1, 2023, unless earlier repurchased or redeemed by the Company or converted pursuant to their terms. The total net proceeds from the debt offering, after deducting initial purchaser discounts and debt issuance costs, paid or payable by us, were approximately $537.0 million.

Each $1,000 principal amount of the Notes is initially convertible into 14.1040 shares of the Company’s Class A common stock par value $0.001, which is equivalent to an initial conversion price of approximately $70.90 per share. The conversion rate is subject to adjustment upon the occurrence of certain specified events but will not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a make-whole fundamental change, as defined in the indenture, the Company will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its Notes in connection with such make-whole fundamental change or during the relevant redemption period.

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Prior to the close of business on the business day immediately preceding March 1, 2023, the Notes may be convertible at the option of the holders only under the following circumstances:

(1) during any calendar quarter commencing after September 30, 2018, and only during such calendar quarter, if the last reported sale price of the Class A common stock for at least 20 trading days (whether or not consecutive) in a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is more than or equal to 130% of the conversion price on each applicable trading day;

(2) during the five business days period after any five consecutive trading day period in which, for each trading day of that period, the trading price per $1,000 principal amount of Notes for such trading day was less than 98% of the product of the last reported sale price of the Class A common stock and the conversion rate on each such trading day;

(3) upon the Company’s notice that it is redeeming any or all of the Notes; or

(4) upon the occurrence of specified corporate events.

On or after March 1, 2023, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders of the Notes may, at their option, convert all or a portion of their Notes regardless of the foregoing conditions.

Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of Class A common stock, or a combination of cash and shares of Class A Common Stock, at the Company’s election.  It is the Company’s current intent to settle the principal amount of the Notes with cash.

During the three months ended June 30, 2018, the conditions allowing holders of the Notes to convert were not met. The Company may redeem the Notes, in whole or in part, at its option, on or after June 1, 2021 but before the 35th scheduled trading day before the maturity date, at a cash redemption price equal to 100% of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest, if any, if the last reported sale price of the Class A Common Stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading days ending on, and including, the trading day immediately before the date the redemption notices were sent; and the trading day immediately before such notices were sent.

No sinking fund is provided for the Notes. Upon the occurrence of a fundamental change (as defined in the Indenture) prior to the maturity date, holders may require the Company to repurchase all or a portion of the Notes for cash at a price equal to 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

The Notes are senior unsecured obligations and will rank senior in right of payment to any of the Company’s indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment with the Company’s existing and future liabilities that are not so subordinated; effectively subordinated to any of the Company’s secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness and other liabilities (including trade payables) of current or future subsidiaries of the Company.

The foregoing description is qualified in its entirety by reference to the text of the indenture and the form of 0.25% convertible senior notes due 2023, which are attached as Exhibits 4.1 and 4.2 to this Quarterly Report on Form 10-Q and are incorporated herein by reference.

In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components.  The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was $119.4 million and was determined by deducting the fair value of the liability component from the par value of the Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the liability component over its carrying amount, or the debt discount, is amortized to interest expense at an effective interest rate over the contractual terms of the Notes.

In accounting for the transaction costs related to the Notes, the Company allocated the total amount incurred to the liability and equity components of the Notes based on the proportion of the proceeds allocated to the debt and equity components. Issuance costs attributable to the liability component were approximately $10.2 million,  were recorded as an additional debt discount and are

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amortized to interest expense using the effective interest method over the contractual terms of the Notes. Issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.

The net carrying amount of the liability component of the Notes was as follows (in thousands):

	As of June 30, 2018
Principal	$	550,000
Unamortized discount	(116,951		)
Unamortized issuance costs	(9,950		)
Net carrying amount	$	423,099

The net carrying amount of the equity component of the Notes was as follows (in thousands):

	As of June 30, 2018
Proceeds allocated to the conversion options (debt discount)	$	119,435
Issuance costs	(2,819		)
Net carrying amount	$	116,616

The following table sets forth the interest expense recognized related to the Notes (in thousands):

	Three Months Ended June 30, 2018
Contractual interest expense	$	164
Amortization of debt issuance costs	211
Amortization of debt discount	2,484
Total interest expense related to the Notes	$	2,859

In connection with the offering of the Notes, the Company entered into privately-negotiated capped call transactions with certain counterparties (the “capped calls”). The capped calls each have an initial strike price of approximately $70.90 per share, subject to certain adjustments, which corresponds to the initial conversion price of the Notes. The capped calls have initial cap prices of $105.04 per share, subject to certain adjustments. The capped calls cover, subject to anti-dilution adjustments, approximately 7,757,200 shares of Class A Common Stock. The capped calls are generally intended to reduce or offset the potential dilution to the Class A Common Stock upon any conversion of the Notes with such reduction or offset, as the case may be, subject to a cap based on the cap price. The capped calls expire on the earlier of (i) the last day on which any convertible securities remain outstanding and (ii) June 1, 2023, subject to earlier exercise. The capped calls are subject to either adjustment or termination upon the occurrence of specified extraordinary events affecting the Company, including a merger event, a tender offer, and a nationalization, insolvency or delisting involving the Company. In addition, the capped calls are subject to certain specified additional disruption events that may give rise to a termination of the capped calls, including changes in law, insolvency filings, and hedging disruptions. The capped call transactions are recorded in stockholders’ equity and are not accounted for as derivatives. The net cost of $58.5 million incurred to purchase the capped call transactions was recorded as a reduction to additional paid-in capital in the accompanying condensed consolidated balance sheet.

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9. Supplemental Balance Sheet Information

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

(a)Allowance for doubtful accounts:

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Balance, beginning of period	$	1,404		$	770		$	1,033		$	1,076
Additions	1,140			210			1,515			282
Write-offs	(8		)	(57		)	(12		)	(435		)
Balance, end of period	$	2,536		$	923		$	2,536		$	923

b)Sales credit reserve:

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Balance, beginning of period	$	1,702		$	818		$	1,761		$	544
Additions	1,544			421			2,651			972
Deductions against reserve	(621		)	(505		)	(1,787		)	(782		)
Balance, end of period	$	2,625		$	734		$	2,625		$	734

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10. 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 June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Revenue by geographic area:
United States	$	111,244		$	75,103		$	209,879		$	145,201
International	36,510			20,767			66,991			38,041
Total	$	147,754		$	95,870		$	276,870		$	183,242
Percentage of revenue by geographic area:
United States	75		%	78		%	76		%	79		%
International	25		%	22		%	24		%	21		%

Long-lived assets outside the United States were not significant.

11. Commitments and Contingencies

(a)Lease Commitments

The Company entered into various non-cancelable operating lease agreements for its facilities that expire over the next six 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 $4.2 million for the three and six months ended June 30, 2018, respectively, and $2.1 million and $4.0 million for the three and six months ended June 30, 2017, respectively.

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

Year Ending December 31:	As of June 30, 2018
2018 (remaining six months)	$	4,604
2019	8,070
2020	7,102
2021	7,033
2022	5,864
Thereafter	10,189
Total minimum lease payments	$	42,862

Additionally, in the three and six months ended June 30, 2018, the Company entered into several non-cancellable vendor agreements with a term from one to two years for total purchase commitments of $3.3 million and $7.8 million, respectively.

(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 Account Security products, its two-factor authentication use case and an API tool to find information about a phone number. The Company 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 PTO denied the Company’s petition for inter partes review of the ‘920 and ‘038 patents, and on June 26, 2017, it upheld the patentability of the ‘034 patent.

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,

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the PTO issued an order instituting the inter partes review for the ‘792 patent. On March 6, 2018, the PTO found all claims challenged by Twilio in the inter partes review unpatentable. On March 15, 2017, Twilio filed a motion to consolidate and stay related cases pending the conclusion of the ‘792 patent inter partes review, which the court granted. The Central District of California court lifted the stay on April 13, 2018. The court transferred the cases to the United States District Court, Northern District of California.  With respect to each of the patents asserted in the now-consolidated Telesign I and Telesign II cases (“TeleSign I/II”), the consolidated complaint seeks, among other things, to enjoin the Company from allegedly infringing the patents, along with damages for lost profits. The Telesign I/II litigation is currently ongoing.

On December 1, 2016, the Company filed a patent infringement lawsuit against Telesign in the United States District Court, Northern District of California (“Telesign III”), alleging indirect infringement of United States Patent No. 8,306,021 (“021”), United States Patent No. 8,837,465 (“465”), United States Patent No. 8,755,376 (“376”), United States Patent No. 8,736,051 (“051”), United States Patent No. 8,737,962 (“962”), United States Patent No. 9,270,833 (“833”), and United States Patent No. 9,226,217 (“217”). Telesign filed a motion to dismiss the complaint on January 25, 2017. In two orders, issued on March 31, 2017 and April 17, 2017, the Court granted Telesign’s motion to dismiss with respect to the ‘962, ‘833, ‘051 and ‘217 patents, but denied Telesign’s motion to dismiss as to the ‘021, ‘465 and ‘376 patents. On August 23, 2017, Telesign petitioned the U.S. Patent and Trademark Office (“U.S. PTO”) for inter partes review of the ‘021, ‘465, and ‘376 patents. On March 9, 2018, the PTO denied Telesign’s petition for inter partes review of the ‘021 patent and granted Telesign’s petitions for inter partes review of the ‘465 and ‘376 patents.  Telesign III is currently stayed pending resolution of the inter partes reviews of the ‘465 and ‘376 patents. The Company is seeking a judgment of infringement, a judgment of willful infringement, monetary and injunctive relief, enhanced damages, and an award of costs and expenses against Telesign.

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. Following a period of discovery, the plaintiff filed a motion for class certification on September 20, 2017. On January 2, 2018, the court issued an order granting in part and denying in part the plaintiff’s class certification motion. The court certified two classes of individuals who, during specified time periods, allegedly sent or received certain communications involving the accounts of three of the Company’s customers that were recorded. The court has not yet finalized a schedule for notice to potential class members, additional discovery, summary judgment motions, or trial.

The Company intends to vigorously defend itself against 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.

Legal fees and other costs related to litigation and other legal proceedings are expensed as incurred and are included in general and administrative expenses in the accompanying condensed consolidated statements of operations.

(c)Indemnification Agreements

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

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

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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 June 30, 2018 and December 31, 2017, 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 was both probable that a liability had been incurred and the amount of the exposure could be reasonably estimated. These estimates included several key assumptions including, but not limited to, the taxability of the Company’s services, the jurisdictions in which its management believed it has nexus, and the sourcing of revenues to those jurisdictions. Starting in March 2017, the Company began collecting these taxes from customers in certain jurisdictions, and since then has expanded the number of jurisdictions where these taxes are being collected. Effective January 2018, the Company began collecting taxes in one additional jurisdiction and accordingly, the Company is no longer recording a provision for its exposure in that jurisdiction. The Company expects to continue to expand the number of jurisdictions where these taxes will be collected in the future. 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 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 year ended December 31, 2017, the total impact of these changes on the net loss attributable to common stockholders was a reduction of $13.4 million. As of June 30, 2018 and December 31, 2017, the liability recorded for these taxes was $21.9 million and $20.9 million, respectively.

On June 21, 2018, the U.S. Supreme Court issued an opinion in South Dakota v. Wayfair permitting a state to require a seller to collect sales tax even if the seller has no physical presence in that state.  This opinion reversed a prior U.S. Supreme Court opinion requiring a physical presence by the seller.  We are evaluating the opinion as it applies to our facts and circumstances.

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

12. Stockholders’ Equity

(a)Preferred Stock

As of June 30, 2018 and December 31, 2017, the Company had authorized 100,000,000 shares of preferred stock, par value $0.001, of which no shares were issued and outstanding.

(b)Common Stock

As of June 30, 2018 and December 31, 2017, 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 June 30, 2018, 76,511,357 shares of Class A common stock and 20,828,123 shares of Class B common stock were issued and outstanding. As of December 31, 2017, 69,906,550 shares of Class A common stock and 24,063,246 shares of Class B common stock were issued and outstanding.

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

	As of June 30,	As of December 31,
	2018	2017
Stock options issued and outstanding	9,527,562	10,710,427
Nonvested restricted stock units issued and outstanding	7,705,589	5,665,459
Class A common stock reserved for Twilio.org	635,014	635,014
Stock-based awards available for grant under 2016 Plan	10,877,345	10,200,189
Stock-based awards available for grant under 2016 ESPP*	3,216,460	2,478,343
Class A common stock reserved for the convertible senior notes	10,472,165	—
Total	42,434,135	29,689,432

* Class A common stock committed for purchase under the 2016 ESPP was 131,581 shares and 235,372 shares as of June 30, 2018 and December 31, 2017, respectively.

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13. Stock-Based Compensation

2008 Stock Option Plan

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

2016 Stock Option Plan

The Company’s 2016 Stock Option and Incentive Plan (the “2016 Plan”) became effective on June 21, 2016. The 2016 Plan provides for the grant of ISOs, NSOs, restricted stock, RSUs, stock appreciation rights, unrestricted stock awards, performance share awards, dividend equivalent rights and cash-based awards to employees, directors and consultants of the Company. A total of 11,500,000 shares of the Company’s Class A common stock were initially reserved for issuance under the 2016 Plan. These available shares automatically increase each January 1, beginning on January 1, 2017, by 5% of the number of shares of the Company’s Class A and Class B common stock outstanding on the immediately preceding December 31, or such lesser number of shares as determined by the Company’s compensation committee. On January 1, 2018, the shares available for grant under the 2016 Plan were automatically increased by 4,698,490 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 will 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, 2018, the shares available for grant under the 2016 Plan were automatically increased by 939,698 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 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, 2018 and 2017, 201,581 and 580,705 shares of Class A common stock were purchased under the 2016 ESPP, respectively, and 131,581 shares are expected to be purchased in November 2018. As of June 30, 2018, total unrecognized compensation cost related to the 2016 ESPP was $1.4 million, which will be amortized over a weighted-average period of 0.4 years.

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Stock-based awards activity under the 2008 Plan and 2016 Plan 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, 2017	10,155,427		$	10.31	7.12	$	145,763
Granted	1,140,048		33.99
Exercised	(2,150,801	)	6.38
Forfeited and cancelled	(172,112	)	8.54
Outstanding options as of June 30, 2018	8,972,562		$	14.29	7.25	$	374,398
Options vested and exercisable as of June 30, 2018	4,825,743		$	8.60	6.35	$	228,834

Aggregate intrinsic value represents the difference between the fair value of the Company’s Class A common stock as reported on the New York Stock Exchange and the exercise price of outstanding “in-the-money” options. The aggregate intrinsic value of stock options exercised was $43.4 million and $74.5 million during the three and six months ended June 30, 2018, respectively, and $22.5 million and $100.7 million during the three and six months ended June 30, 2017, respectively.

The total estimated grant date fair value of options vested was $4.8 million and $12.8 million during the three and six months ended June 30, 2018, respectively, and $4.6 million and $8.7 million during the three and six months ended June 30, 2017, respectively.

The weighted-average grant-date fair value per share of options granted was $19.1 and $15.7 during the three and six months ended June 30, 2018, respectively, and $11.46 and $13.48 during the three and six months ended June 30, 2017, 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 performance condition for the first award was satisfied on March 31, 2018.

The stock options are amortized over a derived service period, as adjusted, of 3.1 years, 4.6 years and 5.4 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, 2017	555,000	$	31.72	6.0	$	—
Granted	—	—
Exercised	—	—
Forfeited and cancelled	—	—
Outstanding options as of June 30, 2018	555,000	$	31.72	5.9	$	13,487
Options vested and exercisable as of June 30, 2018	92,500	$	31.72	5.9	$	2,248

As of June 30, 2018, total unrecognized compensation cost related to nonvested stock options was $42.1 million, which will be amortized over a weighted-average period of 2.2 years.

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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, 2017	5,665,459		$	29.29	$	133,648
Granted	3,459,051		35.5
Vested	(1,041,782	)	28.8
Forfeited and cancelled	(377,139	)	28.9
Nonvested RSUs as of June 30, 2018	7,705,589		$	32.2	$	431,652

As of June 30, 2018, total unrecognized compensation cost related to nonvested RSUs was $229.7 million, which will be amortized over a weighted-average period of 3.2 years.

Valuation Assumptions

The fair value of employee stock options was estimated on the date of grant using the following assumptions in the Black-Scholes option pricing model:

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Employee Stock Options:
Fair value of common stock	$	41.22		$	24.77		$	33.01- $41.22		$	24.77 -$31.96
Expected term (in years)	6.08			6.08			6.08			6.08
Expected volatility	44.16		%	46.1		%	44.09%-44.16%			46.1%-47.6%
Risk-free interest rate	2.86		%	1.9		%	2.74%-2.86%			1.9%-2.1%
Dividend rate	0		%	0		%	0		%	0		%
Employee Stock Purchase Plan:
Expected term (in years)	0.5			0.5			0.5			0.5
Expected volatility	39.78		%	33.2		%	39.78		%	33.2		%
Risk-free interest rate	2.09		%	1.1		%	2.09		%	1.1		%
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

In May 2017, the FASB issued ASU 2017-09, “Compensation-Stock Compensation (Topic 718), Scope of Modification Accounting”, ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. ASU 2017-09 allows companies to make certain changes to awards, such as vesting conditions, without accounting for them as modifications. It does not change the accounting for modifications. ASU 2017-09 should be applied prospectively to awards modified on or after the adoption date. The Company adopted ASU 2017-09 in the first quarter of 2018. The adoption of this guidance did not have an impact on the Company’s financial position, results of operations or cash flows.

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Stock-Based Compensation Expense

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Cost of revenue	$	266	$	142	$	488	$	280
Research and development	9,749		5,710		17,621		10,194
Sales and marketing	5,049		2,363		8,908		4,358
General and administrative	5,942		4,185		11,529		6,953
Total	$	21,006	$	12,400	$	38,546	$	21,785

14. Net Loss Per Share Attributable to Common Stockholders

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

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

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

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Net loss attributable to common stockholders	$	(24,006	)	$	(7,109	)	$	(47,735	)	$	(21,336	)
Weighted-average shares used to compute net loss per share attributable to common stockholders, basic and diluted	96,348,356			90,873,305			95,515,583			89,722,874
Net loss per share attributable to common stockholders, basic and diluted	$	(0.25	)	$	(0.08	)	$	(0.50	)	$	(0.24	)

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

	As of June 30,
	2018	2017
Stock options issued and outstanding	9,527,562	12,491,714
Nonvested restricted stock units issued and outstanding	7,705,589	3,686,232
Class A common stock reserved for Twilio.org	635,014	680,397
Class A common stock committed under 2016 ESPP	131,581	227,462
Unvested shares subject to repurchase	334	27,844
Total	18,000,080	17,113,649

Since the Company expects to settle the principal amount of its outstanding convertible senior notes in cash and any excess in shares of the Company’s Class A common stock, the Company uses the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted net income per share, if applicable. The conversion spread will have a dilutive impact on diluted net income per share of Class A common stock when the average market price of the Company’s Class A common stock for a given period exceeds the conversion price of $70.90 per share for the Notes.

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15. Income Taxes

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. The Company adopted ASU 2016-16 in the first quarter 2018. Adoption of the ASU did not have any impact on the Company’s financial statements.

The Company determines its income tax provision or benefit for interim periods using an estimate of its annual effective tax rate, adjusted for discrete items occurring in the quarter. The primary difference between the Company’s 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.

The Company recorded a provision for income taxes of $0.2 million and $0.3 million for the three and six months ended June 30, 2018, respectively, and $0.5 million for both the three and the six months ended June 30, 2017.  The provision for income taxes consists primarily of income taxes and withholding taxes in foreign jurisdictions in which the Company conducts business. The Company’s U.S. operations have been in a loss position and the Company maintains a full valuation allowance against its U.S. deferred tax assets.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code including, but not limited to, (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) requiring a current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations; (5) eliminating the corporate alternative minimum tax (“AMT”) and changing how existing AMT credits can be realized; (6) creating the base erosion anti-abuse tax (“BEAT”), a new minimum tax; (7) creating a new limitation on deductible interest expense; and (8) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.

The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. The Company has not completed its accounting assessment for the effects of the Tax Act as of June 30, 2018; however, the final accounting assessment will occur no later than one year from the date the Tax Act was enacted.  The Company has also considered and estimated a number of provisions of the Tax Act effective January 1, 2018 and, based on the initial assessment, the Company has determined that the Tax Act did not have a material effect on its consolidated financial statements for the three and six months ended June 30, 2018.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed 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 are 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 Part II, Item 1A, “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 (“API”). 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 on the business challenges that a developer is looking to address, allowing our customers to more quickly and easily build better ways to engage with their customers throughout their journey. Our Programmable Communications Cloud software is a set of APIs that enables developers to embed voice, messaging and video capabilities into their applications. The Programmable Communications Cloud is designed to support almost all the fundamental ways humans communicate, unlocking innovators to address just about any communication market. The Super Network is our software layer that

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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 APIs that gives our customers access to more foundational components of our platform, like phone numbers.

As of June 30, 2018, our customers’ applications that are embedded with our products could reach users via voice, messaging and video in nearly every country in the world, and our platform offered customers local telephone numbers in over 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 supplement 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 augment this sales effort with the Twilio Enterprise Plan, which provides capabilities for advanced security, access management and granular administration, and is 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.

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 upfront 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 and customer deposits liability 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 whom 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 in 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

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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. In the three months ended June 30, 2018 and 2017, our revenue was $147.8 million and $95.9 million, respectively. In the three months ended June 30, 2018 and 2017, our 10 largest Active Customer Accounts generated an aggregate of 17% and 21% of our revenue, respectively. For each of the three months ended June 30, 2018 and 2017, among our 10 largest Active Customer Accounts we had three Variable Customer Accounts representing 8% of our revenue. For the three months ended June 30, 2018 and 2017, our Base Revenue was $135.0 million and $87.6 million, respectively. We incurred a net loss of $24.0 million and $7.1 million, for the three months ended June 30, 2018 and 2017, respectively. See the section titled “—Key Business Metrics—Base Revenue” below for a discussion of Base Revenue.

Key Business Metrics

	Three Months Ended June 30,
	2018			2017
Number of Active Customer Accounts (as of end date of period)	57,350			43,431
Base Revenue (in thousands)	$	135,004		$	87,583
Base Revenue Growth Rate	54		%	55		%
Dollar-Based Net Expansion Rate	137		%	131		%

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 June 30, 2018 and 2017, revenue from Active Customer Accounts represented over 99% of total revenue in each period.

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 each of the three months ended June 30, 2018 and 2017, we had six Variable Customer Accounts, which represented 9% of our total revenue.

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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 our 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.

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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 offerings, such as Programmable Voice, Programmable Messaging and Programmable Video. 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 Account Security products. In the three months ended June 30, 2018 and 2017, we generated 84% 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, short codes and customer support.

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

Amounts that have been charged via credit card or invoiced are recorded in accounts receivable and in revenue, deferred revenue or customer deposits, 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, increases or decreases in our network service provider and cloud infrastructure-related fees, the mix of U.S. usage compared to international usage, exchange rate fluctuations related to network service provider fees denominated in currencies other than the U.S. dollar, the mix of products that are less dependent on the traditional network service provider networks, 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, ad-hoc 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.

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

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

Our general and administrative expenses include a significant amount of sales and other taxes to which we are subject based on the manner we sell and deliver our products. Prior to March 2017, we did not collect such taxes from our customers and recorded such taxes as general and administrative expenses. Effective March 2017, we began collecting these taxes from customers in certain jurisdictions and added more jurisdictions throughout 2017 and in the first quarter of 2018 we began to collect these taxes in one additional jurisdiction. We continue expanding the number of jurisdictions where we will be collecting these taxes in the future. We expect that these expenses will decline in future years as we continue collecting these taxes from our customers in more jurisdictions, which would reduce our rate of ongoing accrual.

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.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code including, but not limited to, (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) requiring a current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations; (5) eliminating the corporate alternative minimum tax (“AMT”) and changing how existing AMT credits can be realized; (6) creating the base erosion anti-abuse tax (“BEAT”), a new minimum tax; (7) creating a new limitation on deductible interest expense; and (8) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.

We have not completed our accounting assessment for the effects of the Tax Act as of June 30, 2018; however, based on our initial assessment, we have determined that the Tax Act did not have a material effect on our condensed consolidated financial statements for the three months ended June 30, 2018.

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.

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	Three Months Ended June 30,
	2018			2017
	(In thousands)
Reconciliation:
Gross profit	$	79,814		$	53,537
Non-GAAP adjustments:
Stock-based compensation	266			142
Amortization of acquired intangibles	1,125			1,182
Non-GAAP gross profit	$	81,205		$	54,861
Non-GAAP gross margin	55		%	57		%

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, release of tax liability upon obligation settlement and payroll taxes related to stock-based compensation.

	Three Months Ended June 30,
	2018			2017
	(In thousands)
Reconciliation:
Operating expenses	$	101,772		$	60,607
Non-GAAP adjustments:
Stock-based compensation	(20,740		)	(12,258		)
Amortization of acquired intangibles	(226		)	(260		)
Acquisition-related expenses	—			(58		)
Release of tax liability upon obligation settlement	—			12,161
Payroll taxes related to stock-based compensation	(1,811		)	(604		)
Non-GAAP operating expenses	$	78,995		$	59,588

Non-GAAP Income (Loss) from Operations and Non-GAAP Operating Margin.  For the periods presented, we define non-GAAP income (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, release of tax liability upon obligation settlement and payroll taxes related to stock-based compensation.

	Three Months Ended June 30,
	2018			2017
	(In thousands)
Reconciliation:
Loss from operations	$	(21,958	)	$	(7,070	)
Non-GAAP adjustments:
Stock-based compensation	21,006			12,400
Amortization of acquired intangibles	1,351			1,442
Acquisition-related expenses	—			58
Release of tax liability upon obligation settlement	—			(12,161		)
Payroll taxes related to stock-based compensation	1,811			604
Non-GAAP income (loss) from operations	$	2,210		$	(4,727	)
Non-GAAP operating margin	1		%	(5		)%

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Results of Operations

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
	(In thousands)
Condensed Consolidated Statements of Operations Data:
Revenue	$	147,754		$	95,870		$	276,870		$	183,242
Cost of revenue(1) (2)	67,940			42,333			127,522			79,619
Gross profit	79,814			53,537			149,348			103,623
Operating expenses:
Research and development(1) (2)	39,811			29,714			77,387			56,236
Sales and marketing(1) (2)	37,749			26,153			70,571			47,269
General and administrative(1) (2)	24,212			4,740			47,605			21,943
Total operating expenses	101,772			60,607			195,563			125,448
Loss from operations	(21,958		)	(7,070		)	(46,215		)	(21,825