UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________

FORM 10-Q

______________________________________________

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

For the quarterly period ended June 30, 2018

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

Commission File Number: 001-38285

Bandwidth Inc.

(Exact name of registrant as specified in its charter)

______________________________________________

Delaware	56-2242657
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

900 Main Campus Drive

Raleigh, NC 27606

(Address of principal executive offices) (Zip Code)

(800) 808-5150

(Registrant’s telephone number, including area code)

______________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yesx Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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

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

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

As of July 31, 2018, 11,793,127 shares of the registrant’s Class A common stock and 7,040,405 shares of registrant’s Class B common stock were outstanding, respectively.

BANDWIDTH INC.

Quarterly Report on Form 10-Q

For the Three Months Ended June 30, 2018

TABLE OF CONTENTS

		Page
Special Note Regarding Forward Looking Statement		2
PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of December 31, 2017 and June 30, 2018	5
	Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income for the Three and Six Months Ended June 30, 2017 and 2018	6
	Unaudited Condensed Consolidated Statements of Cash Flows for the Six months ended June 30, 2017 and 2018	7
	Notes to Unaudited Condensed Consolidated Financial Statements	8
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43
Item 4.	Controls and Procedures	44
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	44
Item 1A.	Risk Factors	45
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	74
Item 6.	Exhibits	75
	Signatures	77

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

• our ability to attract and retain customers, including large enterprises;

• our approach to identifying, attracting and keeping new and existing customers, as well as our expectations regarding customer turnover;

• our beliefs regarding network traffic growth and other trends related to the usage of our products and services;

• our expectations regarding revenue, costs, expenses, gross margin, dollar based net retention rate, adjusted EBITDA, Non-GAAP net income and capital expenditures;

• our beliefs regarding the growth of our business and how that impacts our liquidity and capital resources requirements;

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

• our ability to attract, train, and retain qualified employees and key personnel;

• our beliefs regarding the expense and productivity of and competition for our sales force;

• our expectations regarding headcount;

• our ability to maintain and benefit from our corporate culture;

• our plans to further invest in and grow our business, and our ability to effectively manage our growth and associated investments;

• our ability to introduce new products and services and enhance existing products and services;

• our ability to compete successfully against current and future competitors;

• the evolution of technology affecting our products, services and markets;

• the impact of certain new accounting standards and guidance as well as the time and cost of continued compliance with existing rules and standards;

• our beliefs regarding the use of non-generally accepted accounting principles (“GAAP”) financial measures;

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

• our expectations regarding litigation and other pending or potential disputes;

• our ability to comply with modified or new laws and regulations; and

• the increased expenses associated with being a public company.

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

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

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

3

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

4

BANDWIDTH INC.

Condensed Consolidated Balance Sheets

(In thousands)

(Unaudited)

	December 31, 2017			June 30, 2018
Assets
Current assets:
Cash and cash equivalents	$	37,627		$	45,806
Marketable securities	—			10,992
Accounts receivable, net of allowance for doubtful accounts	21,225			23,001
Prepaid expenses and other current assets	6,400			7,395
Total current assets	65,252			87,194
Property and equipment, net	14,946			19,331
Intangible assets, net	7,643			7,348
Deferred costs, non-current	2,068			1,811
Other long-term assets	1,192			798
Goodwill	6,867			6,867
Deferred tax asset	6,526			13,204
Total assets	$	104,494		$	136,553
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	3,025		$	1,786
Accrued expenses and other current liabilities	15,725			18,531
Current portion of deferred revenue and advanced billings	5,768			5,607
Total current liabilities	24,518			25,924
Other liabilities	716			2,392
Deferred revenue, net of current portion	2,549			6,851
Total liabilities	27,783			35,167
Stockholders’ equity:
Class A and Class B common stock	17			19
Additional paid-in capital	102,465			110,437
Accumulated deficit	(25,771		)	(9,068		)
Accumulated other comprehensive loss	—			(2		)
Total stockholders’ equity	76,711			101,386
Total liabilities and stockholders’ equity	$	104,494		$	136,553

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

5

BANDWIDTH INC.

Condensed Consolidated Statements of Operations and Comprehensive Income

(In thousands, except share and per share amounts)

(Unaudited)

	Three months ended June 30,					Six months ended June 30,
	2017			2018		2017			2018
Revenue	$	39,526		$	48,304	$	79,151		$	101,316
Cost of revenue	22,294			26,566		43,860			51,930
Gross profit	17,232			21,738		35,291			49,386
Operating expenses:
Research and development	2,409			4,435		5,091			8,216
Sales and marketing	2,413			4,654		4,971			9,176
General and administrative	8,257			11,490		15,894			22,059
Total operating expenses	13,079			20,579		25,956			39,451
Operating income	4,153			1,159		9,335			9,935
Other (expense) income, net	(991		)	90		(1,412		)	139
Income before taxes	3,162			1,249		7,923			10,074
Income tax (provision) benefit	(1,215		)	9,263		(2,987		)	6,629
Net income	$	1,947		$	10,512	$	4,936		$	16,703
Other comprehensive income (loss)
Unrealized gain (loss) on marketable securities, net of income tax benefit	$	—		$	4	$	—		$	(2	)
Total comprehensive income	$	1,947		$	10,516	$	4,936		$	16,701
Earnings per share:
Net income	$	1,947		$	10,512	$	4,936		$	16,703
Less: net income allocated to participating securities	254			—		645			—
Net income attributable to common stockholders	$	1,693		$	10,512	$	4,291		$	16,703
Net income per share:
Basic	$	0.14		$	0.58	$	0.36		$	0.93
Diluted	$	0.13		$	0.50	$	0.33		$	0.80
Weighted average number of common shares outstanding:
Basic	11,814,584			18,154,964		11,806,619			17,908,159
Diluted	12,889,334			20,893,653		12,977,606			20,866,777

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

6

BANDWIDTH INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Six months ended June 30,
	2017			2018
Operating activities
Net income	$	4,936		$	16,703
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	2,821			2,683
Accretion of bond discount	—			(26		)
Amortization of debt issuance costs	64			32
Stock-based compensation	490			1,255
Change in fair value of shareholders’ anti-dilutive arrangement	553			—
Deferred taxes	2,456			(6,677		)
Loss on disposal of property and equipment	9			10
Changes in operating assets and liabilities:
Accounts receivable	(130		)	(1,776		)
Prepaid expenses and other assets	(1,180		)	(620		)
Deferred costs	(598		)	225
Accounts payable	(2,997		)	(2,375		)
Accrued expenses and other liabilities	(2,229		)	3,542
Deferred revenue and advanced billings	811			4,141
Net cash provided by operating activities	5,006			17,117
Investing activities
Purchase of property and equipment	(1,123		)	(3,113		)
Capitalized software development costs	(1,598		)	(1,547		)
Proceeds from sale of property and equipment	3			3
Purchase of marketable securities	—			(13,995		)
Maturities of marketable securities	—			3,000
Net cash used in investing activities	(2,718		)	(15,652		)
Financing activities
Borrowings on line of credit	4,000			—
Repayments on line of credit	(6,500		)	—
Payments on capital leases	(23		)	(50		)
Repayments on term loan	(1,000		)	—
Payment of costs related to the initial public offering	—			(285		)
Proceeds from issuances of common stock	109			7,004
Net cash (used in) provided by financing activities	(3,414		)	6,669
Net (decrease) increase in cash, cash equivalents, and restricted cash	(1,126		)	8,134
Cash, cash equivalents, and restricted cash, beginning of period	7,028			37,870
Cash, cash equivalents, and restricted cash, end of period	$	5,902		$	46,004
Supplemental disclosure of cash flow information
Cash paid during the year for interest	$	965		$	45
Cash paid for taxes	$	484		$	155
Supplemental disclosure of noncash investing and financing activities
Purchase of property and equipment, accrued but not paid	$	74		$	2,126

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

7

BANDWIDTH INC.

Notes to Condensed Consolidated Financial Statements

(In thousands except share and per share amounts)

(Unaudited)

1. Organization and Description of Business

Bandwidth Inc. (together with its subsidiaries, “Bandwidth” or the “Company”) was founded in July 2000 and incorporated in Delaware on March 29, 2001. The Company’s headquarters are located in Raleigh, North Carolina. The Company is a cloud-based, software-powered communications platform-as-a-service (“CPaaS”) provider that enables enterprises to create, scale and operate voice or text communications services across any mobile application or connected device.

The Company has two operating and reportable segments, CPaaS and Other. CPaaS revenue is derived from usage and monthly services fees charged for usage of Voice, Messaging, 911 and Phone Numbers solutions through the Company’s proprietary CPaaS software application programming interfaces. Other revenue consists of fees charged for services provided such as: SIP trunking, data resale, and a hosted Voice-over Internet Protocol (“VoIP”). The Other segment also includes revenue from traffic generated by other carriers, SMS registration fees and other miscellaneous product lines.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and applicable rules and regulations of the SEC regarding interim financial reporting. Certain information and disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K filed with the SEC on February 26, 2018.

The condensed consolidated balance sheet as of December 31, 2017, included herein, was derived from the audited financial statements as of that date, but does not include all disclosures including certain notes required by GAAP on an annual reporting basis. Additionally, certain items in the prior period financial statements have been reclassified to conform with the current year presentation.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, comprehensive income and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full year 2018 or any future period.

Principles of Consolidation

The consolidated financial statements include the accounts of Bandwidth Inc. and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

8

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Use of Estimates

The preparation of the Company’s consolidated financial statements in conformity with U.S. GAAP requires the Company to make estimates and judgments that affect the amounts reported in these financial statements and accompanying notes. Although the Company believes that the estimates it uses are reasonable, due to the inherent uncertainty involved in making these estimates, actual results reported in future periods could differ from those estimates. These estimates in the consolidated financial statements include, but are not limited to, allowance for doubtful accounts, recoverability of long lived and intangible assets, customer relationship period, valuation allowances on tax assets, certain accrued expenses, and contingencies.

Cash and Cash Equivalents

The Company classifies all highly liquid investments with stated maturities of three months or less from date of purchase as cash equivalents and all highly liquid investments with stated maturities of greater than three months from the date of purchase as current marketable securities. The Company has a policy of making investments only with commercial institutions that have at least an investment grade credit rating. The Company invests its cash primarily in government securities and obligations, corporate debt securities, money market funds and reverse repurchase agreements (RRAs). RRAs are collateralized by deposits in the form of Government Securities and Obligations for an amount not less than 102% of their value. The Company does not record an asset or liability as the Company is not permitted to sell or repledge the associated collateral. The Company has a policy that the collateral has at least an "A" (or equivalent) credit rating. The Company utilizes a third party custodian to manage the exchange of funds and ensure that collateral received is maintained at 102% of the value of the RRAs on a daily basis. RRAs with stated maturities of greater than three months from the date of purchase are classified as marketable securities.

Restricted Cash

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same such amounts shown in the condensed consolidated statements of cash flows:

For the six months endedJune 30, 2018:

	December 31, 2017		June 30, 2018
Cash and cash equivalents	$	37,627	$	45,806
Restricted cash	243		198
Total cash, cash equivalents, and restricted cash shown in the statements of cash flows	$	37,870	$	46,004

For the six months endedJune 30, 2017:

	December 31, 2016		June 30, 2017
Cash and cash equivalents	$	6,788	$	5,679
Restricted cash	240		223
Total cash, cash equivalents, and restricted cash shown in the statements of cash flows	$	7,028	$	5,902

Restricted cash is for Automated Clearing House (“ACH”) availability, customer deposits and for credit card security. The Company has classified this asset as a long-term asset in order to match the expected period of restriction and is included in Other long-term assets in the condensed consolidated balance sheets.

9

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Concentration of Credit Risk

Financial instruments that are exposed to concentration of credit risk consist primarily of cash and cash equivalents, marketable securities and trade accounts receivable. Cash deposits may be in excess of insured limits. The Company believes that the financial institutions that hold its cash deposits are financially sound and, accordingly, minimal credit risk exists with respect to these balances.

With regard to customers, credit evaluation and account monitoring procedures are used to minimize the risk of loss. The Company believes that no additional credit risk beyond amounts provided for by the allowance for doubtful accounts are inherent in accounts receivable. As of December 31, 2017, one customer represented approximately 13% of the Company’s accounts receivable, net of allowance for doubtful accounts. As of June 30, 2018, no individual customer represented more than 10% of the Company’s accounts receivable, net of allowance for doubtful accounts.

For the three and six months ended June 30, 2017 and 2018, no individual customer represented more than 10% of the Company’s total revenue.

Recently Adopted Accounting Standards

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09, Compensation-Stock Compensation (Topic 718), Scope of Modification Accounting, which amends the scope of modification accounting for share-based payment arrangements. The ASU provides guidance on the types of changes to terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718, Compensation-Stock Compensation. ASU 2017-09 was effective for fiscal years and interim periods within those years beginning after December 15, 2017. The adoption of this standard did not have a material impact on the Company’s financial statements.

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

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

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

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments, which clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. ASU2016-15 was effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company adopted this standard retrospectively and it had no material impact on the Company’s financial statements.

10

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Recent Accounting Pronouncements Not Yet Adopted

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

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

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

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” This new guidance will replace most existing GAAP guidance on this topic. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14 “Revenue from Contracts with Customers: Deferral of the effective date,” which deferred by one year the effective date for the new revenue reporting standard for entities reporting under GAAP. In accordance with the deferral, this guidance will be effective for the Company beginning in the year ended December 31, 2019. This guidance can be applied either retrospectively to each period presented or as a cumulative effect adjustment as of the date of adoption. In December 2016, the FASB issued ASU 2016-20, “Revenue from Contracts with Customers, Technical Corrections andImprovements to Topic 606,” which made 12 additional technical corrections and improvements to the new revenue standard. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers, Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” clarifying the implementation guidance on principal versus agent considerations. Specifically, an entity is required to determine whether the nature of a promise is toprovide the specified good or service itself (that is, the entity is a principal) or to arrange for the good or service to be provided to the customer by the other party (that is, the entity is an agent). The determination influences the timing and amount of revenue recognition. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers, Identifying Performance Obligations and Licensing”, clarifying the implementation guidance on identifying

11

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

performance obligations and licensing. Specifically, the amendments reduce the cost and complexity of identifying promised goods or services and improve the guidance for determining whether promises are separately identifiable. The amendments also provide implementation guidance on accounting for an entity’s promise to grant a license. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers, Narrow-Scope Improvements and Practical Expedients,” clarifying guidance on assessingcollectability, presentation of sales taxes, noncash consideration, completed contracts andcontract modifications.The effective date and transition requirements for ASU 2016-20, ASU 2016-08 and ASU 2016-10 are the same as the effective date and transition requirements for ASU 2014-09, which will be effective for the Company beginning January 1, 2019.

The Company is in the process of completing its evaluation of the potential impacts of the new standard on its consolidated financial statements and has selected a modified retrospective transition method with cumulative effect adjustment. Additionally, the Company has engaged a third-party service provider to assist in the design of a new technology solution to comply with the requirements of ASU 2014-09. While the Company has not yet completed the full analysis of the impact of the new standard, based on the evaluation to date, the Company does not expect the adoption of the guidance to have a material impact on its financial results. The Company will continue to monitor and assess the impact of the changes of the new standard and the related interpretations of its application as they become available.

3. Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, marketable securities, accounts receivable, accounts payable and accrued expenses approximate fair value as of December 31, 2017 and June 30, 2018 because of the relatively short duration of these instruments. Marketable securities consist of U.S. treasury securities not otherwise classified as cash equivalents. All marketable securities are considered to be available-for-sale and are recorded at their estimated fair values. Unrealized gains and losses for available-for-sale securities are recorded in other comprehensive income (loss).

The Company evaluated its financial assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level in which to classify them for each reporting period. The following table summarizes the assets measured at fair value as of December 31, 2017 and June 30, 2018:

	Fair value measurements on a recurring basis December 31, 2017
	Level 1		Level 2		Level 3		Total
Financial assets:
Money market account (included in cash and cash equivalents	$	28,015	$	—	$	—	$	28,015
Total financial assets	$	28,015	$	—	$	—	$	28,015

There were no marketable securities as of December 31, 2017.

12

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

	Amortized cost or carrying value		Unrealized gains		Unrealized losses			Fair value measurements on a recurring basis June 30, 2018
								Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents:
Money market account	$	15,177	$	—	$	—		$	15,177	$	—	$	—	$	15,177
U.S. Reverse repurchase agreements	17,000		—		—			—		17,000		—		17,000
Total included in cash and cash equivalents	32,177		—		—			15,177		17,000		—		32,177
Marketable securities:
U.S. treasury securities	10,995		—		(3		)	—		10,992		—		10,992
Total marketable securities	10,995		—		(3		)	—		10,992		—		10,992
Total financial assets	$	43,172	$	—	$	(3	)	$	15,177	$	27,992	$	—	$	43,169

The Company classifies its marketable securities as current assets as they are available for current operating needs. The following table summarizes the contractual maturities of marketable securities as of June 30, 2018:

	Amortized cost		Aggregate fair value
Financial assets:
Less than one year	$	10,995	$	10,992
Total	$	10,995	$	10,992

For fixed income securities that had unrealized losses as of June 30, 2018, the Company determined that no other-than-temporary impairment existed. As of June 30, 2018, all securities in an unrealized loss position have been in an unrealized loss position for less than one year. During the three and six months ended June 30, 2018, there were $3,000 in maturities of marketable securities. Interest earned on marketable securities in the three and six months ended June 30, 2018 was $32 and $48, respectively, and is recorded as other (expense) income, net, in the accompanying condensed consolidated statements of operations and comprehensive income.

4. Financial Statement Components

Accounts receivable, net of allowance for doubtful accounts consist of the following:

	December 31,			June 30,
	2017			2018
Trade accounts receivable	$	44,692		$	13,375
Unbilled accounts receivable	8,653			10,791
Allowance for doubtful accounts	(32,463		)	(1,473		)
Other accounts receivable	343			308
Total accounts receivable, net	$	21,225		$	23,001

13

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Components of allowance for doubtful accounts are as follows:

	Three months ended June 30,						Six months ended June 30,
Allowance for doubtful accounts:	2017			2018			2017			2018
Balance, beginning of period	$	88		$	142		$	255		$	189
Charged to bad debt expense	55			209			12			210
Deductions (1)	(31		)	(209		)	(155		)	(257		)
Balance, end of period	$	112		$	142		$	112		$	142

________________________

(1) Write off of uncollectible accounts after all collection efforts have been exhausted.

	Three months ended June 30,					Six months ended June 30,
Allowance for CABS revenue:	2017			2018		2017			2018
Balance, beginning of period	$	24,736		$	1,148	$	22,316		$	32,274
Write-off of previously outstanding and fully reserved billings related to settlement	—			—		—			(24,968		)
Billings deemed not probable of collection (1)	2,706			183		5,169			301
Revenue recognized from outstanding billings previously deemed uncollectible related to settlement	—			—		—			(6,268		)
Deductions (2)	(41		)	—		(84		)	(8		)
Balance, end of period	$	27,401		$	1,331	$	27,401		$	1,331

________________________

(1) Represents amounts billed in the period but where collectibility is not probable based on customers collection experience. Amounts were charged to a contra-revenue account.

(2) Write off of uncollectible accounts after all collection efforts have been exhausted.

	Three months ended June 30,				Six months ended June 30,
CABS revenue:	2017		2018		2017		2018
Billed	$	4,939	$	3,129	$	9,550	$	7,208
Revenue recognized from current billings (2)	2,233		2,946		4,381		6,907
Billings deemed not probable of collection (1)	$	2,706	$	183	$	5,169	$	301

________________________

(1) Represents amounts billed in the period but where collectibility is not probable based on customers collection experience. Amounts were charged to a contra-revenue account.

(2) Does not include $6,268 in revenue recognized as a result of a settlement agreement related to previously billed and outstanding and uncollectible invoices.

On January 29, 2018, the Company and Verizon entered into a settlement agreement to resolve an ongoing dispute and litigation with Verizon, which is a CABS customer of the Company. The settlement agreement also resolved Verizon’s counter-claims against the Company. Pursuant to the settlement agreement, Verizon made a lump sum payment to the Company on February 8, 2018 of $4,400, which was recognized as revenue during the three months ended March 31, 2018. Immediately following receipt of the $4,400 payment, the Company issued to Verizon bill credits with respect to other CABS amounts previously billed and reserved to Verizon of $24,968. The amount credited to Verizon comprised the majority of the allowance for CABS revenue as of December 31, 2017. During the three months ended March 31, 2018, the Company recognized as revenue $6,268, including the $4,400 payment made on February 8, 2018 and the remaining outstanding receivables which had been previously reserved as uncollectible, but for which collection was no longer in doubt as a result of the settlement. The settlement agreement also specifies certain terms for the Company’s CABS billings to Verizon prospectively.

14

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Accrued expenses and other current liabilities consisted of the following:

	December 31,		June 30,
	2017		2018
Accrued expense	$	6,851	$	9,955
Accrued compensation and benefits	5,237		4,121
Accrued sales, use, and telecom related taxes	3,030		3,525
Other accrued expenses	607		930
Total accrued expenses and other current liabilities	$	15,725	$	18,531

5. Property and Equipment

Property and equipment, net consisted of the following:

	December 31,			June 30,
	2017			2018
Furniture and fixtures	$	863		$	872
Computer and office equipment	7,545			7,028
Telecommunications equipment	19,985			22,758
Leasehold improvements	453			2,374
Software development costs	15,517			17,172
Automobile	10			10
Total cost	44,373			50,214
Less—accumulated depreciation	(29,427		)	(30,883		)
Total property and equipment, net	$	14,946		$	19,331

The Company capitalized $921 and $1,598 of software development costs in the three and six months ended June 30, 2017, respectively, and $1,106 and $1,547 in the three and six months ended June 30, 2018, respectively.

Amortization expense related to capitalized software development costs were $556 and $1,136 in the three and six months ended June 30, 2017, respectively, and $425 and $873 in the three and six months ended June 30, 2018, respectively.

The Company recognized depreciation expense, which includes amortization of capitalized software development costs, as follows:

	Three months ended June 30,				Six months ended June 30,
	2017		2018		2017		2018
Cost of revenue	$	1,036	$	1,015	$	2,083	$	2,078
Research and development	13		31		23		61
Sales and marketing	6		12		13		22
General and administrative	180		108		282		227
Total depreciation expense	$	1,235	$	1,166	$	2,401	$	2,388

15

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

6. Intangible Assets

Intangible assets consisted of the following as of December 31, 2017:

	Gross amount		Accumulated amortization			Net carrying value		Amortization period
								(Years)
Customer relationships	$	10,396	$	(3,552	)	$	6,844	20
Domain name and related trademarks	2,678		(2,643		)	35		3–7
Licenses, amortizable	341		(341		)	—		2
Non-compete agreements	139		(139		)	—		2–5
Developed technology	775		(775		)	—		3
Licenses, indefinite lived	764		—			764		Indefinite
Total intangible assets, net	$	15,093	$	(7,450	)	$	7,643

Intangible assets consisted of the following as of June 30, 2018:

	Gross amount		Accumulated amortization			Net carrying value		Amortization period
								(Years)
Customer relationships	$	10,396	$	(3,812	)	$	6,584	20
Domain name and related trademarks	2,678		(2,678		)	—		3–7
Licenses, amortizable	341		(341		)	—		2
Non-compete agreements	139		(139		)	—		2–5
Developed technology	775		(775		)	—		3
Licenses, indefinite lived	764		—			764		Indefinite
Total intangible assets, net	$	15,093	$	(7,745	)	$	7,348

Amortization expense for definite lived intangible assets was $210 and $420 in the three and six months ended June 30, 2017, respectively, and $130 and $295 in the three and six months ended June 30, 2018, respectively.

Future estimated amortization expense for definite lived intangible assets subsequent to June 30, 2018 is as follows:

	Amount
2018 (remaining)	$	260
2019	520
2020	520
2021	520
2022	520
Thereafter	4,244
	$	6,584

7. Debt

Revolving Loan

16

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

As of December 31, 2017 and June 30, 2018, the Company had $0 outstanding on the revolving loan and was in compliance with all financial and non-financial covenants for all periods presented. The available borrowing capacity under the revolving loan was $25,000 as of June 30, 2018.

As of December 31, 2017 and June 30, 2018, the outstanding unamortized loan fees associated with the availability of the revolving loan were $175 and $143, respectively, and are included in other long-term assets.

Capital Leases

The Company leases various equipment under leases accounted for as capital leases with expiration dates ranging from October 2018 through December 2018. As of December 31, 2017, cost and accumulated depreciation of the assets under capital leases recorded by the Company were $1,951 and $1,832, respectively. As of June 30, 2018, cost and accumulated depreciation of the assets under capital leases recorded by the Company were $1,951 and $1,871, respectively.

Remaining payments due on the Company’s capital lease obligations as of June 30, 2018, are as follows:

	Amount
2018 (remaining)	$	42
Less amount representing interest	—
Current portion of long-term capital lease obligation (1)	42
Less current maturities	42
Long-term capital lease obligation	$	—

______________________

(1) Included in accrued expenses and other current liabilities on the condensed consolidated balance sheets.

8. Segment and Geographic Information

The Company has two reportable segments, CPaaS and Other. Segments are primarily evaluated based on revenue and gross profit. The Company does not allocate operating expenses, interest expense or income tax expense to its segments. Accordingly, the Company does not report such information. Additionally, the Chief Operating Decision Maker does not evaluate the Company’s operating segments using discrete asset information. The segments share the majority of the Company’s assets. Therefore, no segment asset information is reported.

	Three months ended June 30,				Six months ended June 30,
	2017		2018		2017		2018
CPaaS
Revenue	$	31,547	$	39,833	$	63,194	$	78,730
Cost of revenue	18,919		23,137		37,147		45,042
Gross profit	$	12,628	$	16,696	$	26,047	$	33,688
Other
Revenue	$	7,979	$	8,471	$	15,957	$	22,586
Cost of revenue	3,375		3,429		6,713		6,888
Gross profit	$	4,604	$	5,042	$	9,244	$	15,698
Consolidated
Revenue	$	39,526	$	48,304	$	79,151	$	101,316
Cost of revenue	22,294		26,566		43,860		51,930
Gross profit	$	17,232	$	21,738	$	35,291	$	49,386

17

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

All assets were held in the United States as of December 31, 2017 and June 30, 2018.

The Company generates its revenue primarily in the United States. Revenue by geographical area is detailed in the table below (which is determined based on the customer billing address):

	Three months ended June 30,				Six months ended June 30,
	2017		2018		2017		2018
United States	$	39,385	$	48,154	$	78,903	$	100,978
International	141		150		248		338
Total	$	39,526	$	48,304	$	79,151	$	101,316

9. Stockholders’ Equity

Preferred Stock

As of December 31, 2017 and June 30, 2018, the Company had authorized 10,000,000 shares of undesignated preferred stock, par value $0.001, of which no shares were issued and outstanding.

Common Stock

As of December 31, 2017and June 30, 2018, the Company had authorized 100,000,000shares of Class A common stock with one vote per share and 20,000,000 shares of Class B common stock with ten votes per share, each par value $0.001. As of December 31, 2017, 4,197,831 and 13,440,724 shares of Class A and B common stock, respectively, were issued and outstanding. As of    June 30, 2018, 11,375,229 and 7,436,718 shares of Class A and B common stock, respectively, were issued and outstanding.

Shares of Class B common stock are convertible into shares of Class A common stock upon the stockholder’s voluntary written notice to the Company’s transfer agent or a transfer by the stockholder, subject to limited exceptions for transfers for estate planning purposes.

The Company had reserved shares of common stock for issuance under stock-based award agreements as follows:

	December 31,	June 30,
	2017	2018
Stock options issued and outstanding	3,659,791	2,545,717
Nonvested restricted stock units issued and outstanding	—	314,728
Stock purchase warrants issued and outstanding	51,350	—
Stock-based awards available for grant under the 2017 Plan	1,050,000	917,284
	4,761,141	3,777,729

10. Stock Based Compensation

2001 and 2010 Stock Option Plans

During 2001, the Company adopted the Bandwidth Inc. Stock Option Plan (the “2001 Plan”).As of July 26, 2010, the Company adopted the 2010 Equity Compensation Plan (the “2010 Plan”).

18

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Following the effectiveness of the 2010 Plan, the Company did not make any further grants under the 2001 Plan. However, the 2001 Plan continues to govern the terms and conditions of the outstanding awards granted under it. On November 9, 2017, the 2010 Plan was terminated in connection with the Company’s IPO. Accordingly, no shares are available for future issuance under the 2010 Plan. However, the 2010 Plan continues to govern the terms and conditions of the outstanding awards granted thereunder.

2017 Incentive Award Plan

The Company’s 2017 Incentive Award Plan (the “2017 Plan”) became effective on November 9, 2017. The 2017 Plan provides for the grant of stock options, including incentive stock options and non-qualified stock options, stock appreciation rights, restricted stock, dividend equivalents, restricted stock units, and other stock or cash based awards to employees, consultants and directors of the Company. A total of 1,050,000 shares of the Company’s Class A common stock were originally reserved for issuance under the 2017 Plan. These available shares automatically increase each January 1, beginning on January 1, 2018, by 5% of the number of shares of the Company’s Class A common stock outstanding on the final day of the immediately preceding calendar year. On January 1, 2018, the shares available for grant under the 2017 Plan were automatically increased by 200,000 shares.

The terms of the stock option grants are determined by the Company’s Board of Directors. The Company’s stock options vest based on terms of the stock option agreements, which is generally over four years. The stock options have a contractual life of ten years.

RSUs granted under the 2017 Plan are subject to a time-based vesting condition. The compensation expense related to these awards is based on the grant date fair value of the RSUs and is recognized on a ratable basis over the applicable service period. The Company granted restricted stock units to its non-employee Board of Directors, some of which vested immediately while others vest 25% as of each calendar quarter immediately following the grant date. Other RSUs awarded to executives and employees are earned over a service period of four years.

19

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Stock options

The fair value of options granted is estimated on the date of grant using the Black-Scholes option pricing model based on the assumptions in the table below:

	Three months ended June 30,		Six months ended June 30,
	2017	2018	2017	2018
Expected dividend yield	0%	N/A	0%	0%
Expected stock price volatility	47%	N/A	47%	47%
Average risk-free interest rate	1.9%	N/A	1.9%-2.3%	2.5%
Expected life	6.2 years	N/A	6.2 years	6.2 years
Fair value of common stock	$9.60	N/A	$9.60	$22.81

________________________

No options were granted in the three months ended June 30, 2018.

The following summarizes the stock option activity for the six months ended June 30, 2018:

	Number of options outstanding		Weighted- average exercise price (per share)		Weighted- average remaining contract life (in years)	Aggregate intrinsic value (in thousands)
Outstanding as of December 31, 2017	3,659,791		$	6.88	4.38	$	59,436
Granted	17,988		22.81
Exercised	(1,117,646	)	6.23			33,525
Forfeited or cancelled	(14,416	)	12.07
Outstanding as of June 30, 2018	2,545,717		$	7.25	4.35	$	78,239
Options vested and exercisable at June 30, 2018	2,197,792		$	6.46	3.74	$	69,275

Aggregate intrinsic value represents the total pre-tax intrinsic value, which is computed based on the difference between the option exercise price and the estimated fair value of the Company’s common stock. Prior to the IPO, the fair value of the Company’s common stock was estimated by the Company’s board of directors. After the IPO, the fair value of the Company’s common stock is the Company’s Class A common stock price as reported on the NASDAQ Global Select Market.

The weighted average grant-date fair value of stock options granted was $4.30 and $4.34 for the three and six months ended June 30, 2017, respectively, and $11.10 for the six months ended June 30, 2018. No options were granted during the three months ended June 30, 2018.

The total estimated grant date fair value of options vested was $510 and $627 for the three and six months ended June 30, 2017, respectively, and $360 and $471 for the three and six months ended June 30, 2018, respectively.

As of June 30, 2018, total unrecognized compensation cost related to all non-vested stock options was $1,618, which will be amortized over a weighted-average period of 2.40 years.

20

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Restricted Stock Units

The following summarizes the restricted stock unit activity for the periods presented:

	Number of awards outstanding		Weighted-average grant date fair value (per share)
Nonvested RSUs as of December 31, 2017	—		$	—
Granted	325,730		26.01
Vested	(6,512	)	22.81
Forfeited or cancelled	(4,490	)	28.89
Nonvested RSUs as of June 30, 2018	314,728		$	26.03

As of June 30, 2018, total unrecognized compensation cost related to non-vested RSUs was $7,573, which will be amortized over a weighted-average period of 3.63 years.

Stock-Based Compensation Expense

The Company recognized total stock-based compensation expense in continuing operations as follows:

	Three months ended June 30,				Six months ended June 30,
	2017		2018		2017		2018
Cost of revenue	$	21	$	32	$	41	$	49
Research and development	30		129		62		203
Sales and marketing	43		140		70		218
General and administrative	150		461		317		785
Total	$	244	$	762	$	490	$	1,255

11. Commitments and Contingencies

Operating Leases

The Company leases approximately 178,000 square feet of office space under operating lease agreements that expire at various dates beginning in 2021 and extend through 2025 in several locations within the United States including its headquarters, which is located in Raleigh, NC. On January 12, 2018, the Company entered into an 84-month operating lease agreement to provide 40,035 square feet of additional office space. This new lease is expected to be occupied in September 2018. On March 27, 2018, the Company entered into a 60-month operating lease agreement to provide 5,930 square feet of additional office space, which commenced in June 2018. The leases contain escalation clauses and various landlord concessions including tenant improvement allowances. The Company recognizes the total minimum lease payments on a straight-line basis over the term of the lease.

21

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

Future minimum lease payments required under operating leases as of June 30, 2018 are as follows:

	Amount
2018 (remaining)	$	2,262
2019	5,004
2020	5,180
2021	5,254
2022	3,438
Thereafter	3,717
	$	24,855

The Company incurred rent expense of $868 and $1,380 for the three and six months ended June 30, 2017, respectively, and $1,022 and $1,955 for the three and six months ended June 30, 2018, respectively, which is included in general and administrative expenses in the condensed consolidated statements of operations and comprehensive income.

On April 20, 2015, the Company created a wholly owned subsidiary, Republic Wireless, Inc. (“Republic”), which was incorporated in Delaware. On November 30, 2016, the Company completed a pro-rata distribution of the common stock of Republic to its stockholders of record as of the close of business (the “Spin-Off”).

In conjunction with the Spin-Off, the Company signed a Facilities Service Agreement with Republic in which the Company agreed to sub-lease 40,657 square feet of office space to Republic. The sub-lease is non-cancellable and extends to May 2022. The Company recorded a reduction of rent expense of $217 and $446 for the three and six months ended June 30, 2017, respectively, and $251 and $502 for the three and six months ended June 30, 2018, respectively, which is included in general and administrative expenses in the condensed consolidated statements of operations and comprehensive income.

Future minimum sub-lease receipts required under the non-cancellable lease as of June 30, 2018 are as follows:

	Amount
2018 (remaining)	$	513
2019	1,042
2020	1,065
2021	1,089
2022	594
Thereafter	$	4,303

Contractual Obligations

On October 25, 2015, the Company entered into an agreement with a telecommunications service provider. The service agreement requires the Company to pay a monthly recurring charge beginning on January 1, 2016 associated with the services received. The service agreement is non-cancellable and contains annual minimum commitments of $1,200 to be fulfilled over five years or for as long as the Company continues to receive services from this vendor. In addition, as of June 30, 2018 the Company has $4,590 in other non-cancellable purchase obligations, consisting of primarily network equipment maintenance and software license contracts.

Legal Matters

22

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

The Company is involved as a defendant in various lawsuits alleging that the Company failed to bill, collect and remit certain taxes and surcharges associated with the provision of 911 services pursuant to applicable laws in various jurisdictions. In August 2016, the Company received a Civil Investigative Demand from the Consumer Protection Division of the North Carolina Department of Justice, though no formal complaint has been filed in connection with that investigation. The North Carolina Department of Justice is investigating the billing, collection and remission of certain taxes and surcharges associated with 911 service pursuant to applicable laws of the State of North Carolina.

While the results of these legal proceedings cannot be predicted with certainty, in the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the Company’s financial position or results of operations.

12. Employee Benefit Plan

The Company sponsors a defined contribution 401(k) plan which allows eligible employees to defer a portion of their compensation. The Company, at its discretion, may make matching contributions. The Company made matching contributions of $64 and $415 for the three and six months ended June 30, 2017, respectively, and $259 and $546 for the three and six months ended June 30, 2018, respectively.

13. Income Taxes

At the end of each interim reporting period, the Company determines the income tax provision by using an estimate of the annual effective tax rate, adjusted for discrete items occurring in the quarter. The effective income tax rate reflects the effect of federal and state income taxes, the benefit associated with research and development income tax credits and certain non-deductible items.

The Company’s effective tax rate was 38.4% and 37.7% for the three and six months ended June 30, 2017, respectively, and (741.6)% and (65.8)% for the three and six months ended June 30, 2018, respectively. The change in tax rate is primarily due to the decrease in the federal statutory tax rate under the Tax Cuts and Jobs Act from 35% to 21%, prior and current year research and development tax credits, as well as the impact of stock compensation tax deductions as a result of exercises, which occurred during the three months ended June 30, 2018.

The Company’s effective tax rate for the three and six months ended June 30, 2018, respectively, is lower than the U.S. federal statutory rate of 21.0% primarily due to the impact of stock compensation tax deductions.

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

14. Related Parties

In connection with the Spin-Off on November 30, 2016, the Company and Republic entered into certain agreements in order to govern the ongoing relationships between the two companies after the Spin-Off and to provide for an orderly transition. The agreements include a Transition Services Agreement, Facilities Sharing Agreement, Tax Sharing Agreement, and Master Services Agreement. The equity holders of Bandwidth pre-IPO are comprised of substantially the same individuals and entities that are the equity owners of Republic. The Company has determined the equity owners of Republic are related parties of Bandwidth. The Company has certain involvement with Republic via ongoing services arrangements, with these ongoing services arrangements creating a variable interest in Republic. The Company assessed the relationship with Republic under guidance for variable interest entities. Because investors in Republic have disproportionate voting rights, the Company concluded that Republic is a VIE, but Bandwidth is not a primary beneficiary. The Company’s maximum exposure to loss relating to this variable interest entity is limited to amounts due under the service agreements between the Company and Republic.

23

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

The Company received net compensation under the Transition Services Agreement of $160 and $511 for the three and six months ended June 30, 2017, respectively, and $22 and $50 for the three and six months ended June 30, 2018, respectively, which is included in general and administrative expenses in the condensed consolidated statements of operations and comprehensive income. In addition, there was approximately $15 and $6 due from Republic as of December 31, 2017 and June 30, 2018, respectively, which was recorded within accounts receivable in the accompanying condensed consolidated balance sheets.

The Company received rental payments under the Facilities Sharing Agreement of $216 and $446 for the three and six months ended June 30, 2017, respectively, and $251 and $502 for the three and six months ended June 30, 2018, respectively, which is included in general and administrative expenses in the condensed consolidated statements of operations and comprehensive income. No amounts were due to the Company under the Facilities Sharing Agreement as of December 31, 2017 and June 30, 2018.

The Tax Sharing Agreement governs rights and obligations after the Spin-Off regarding income taxes and other taxes, including tax liabilities and benefits, attributes, returns and contests. There are no amounts outstanding or payable under this agreement as of December 31, 2017 and June 30, 2018.

The Master Services Agreement specifies certain wholesale telecommunications services to be provided by the Company. The agreement is cancellable at any time by either party. The Company provided telecommunication services to Republic of $540 and $1,073 for the three and six months ended June 30, 2017, respectively, and $1,005 and $1,991 for the three and six months ended June 30, 2018, respectively. The Company recognized such amounts as revenue in the accompanying condensed consolidated statements of operations and comprehensive income. As of December 31, 2017 and June 30, 2018, the Company had a receivable of $311 and $343, respectively, under the Master Services Agreement.

Subsequent to the expiration of the 180-day blackout window on May 9, 2018, Republic employees that held Bandwidth stock options began exercising their options. Upon exercise, Bandwidth withholds the employee tax amounts due from the proceeds. For the three months ended June 30, 2018, Bandwidth had collected on behalf of and remitted withholding tax to Republic of $6,475 and had a related payable of $0 as of June 30, 2018.

15. Basic and Diluted Income per Common Share

As of December 31, 2017, the Company used the two-class method to compute net income per common share, because it had issued securities, other than common stock, that contractually entitled the holders to participate in dividends and earnings. These participating securities included the Company’s redeemable convertible preferred stock which had non-forfeitable rights to participate in any dividends declared on the Company’s common stock. The two-class method requires earnings for the period to be allocated between common stock and participating securities based upon their respective rights to receive distributed and undistributed earnings.

Under the two-class method, for periods with net income, basic net income per common share is computed by dividing the net income attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Net income attributable to common stockholders is computed by subtracting from net income the portion of current period earnings that the participating securities would have been entitled to receive pursuant to their dividend rights had all of the period’s earnings been distributed. No such adjustment to earnings is made during periods with a net loss, as the holders of the participating securities have no obligation to fund losses.

Diluted net income per common share is computed under the two-class method by using the weighted average number of shares of common stock outstanding, plus, for periods with net income attributable to common stockholders, the potential dilutive effects of stock options and warrants. The Company analyzed the potential dilutive effect of any outstanding dilutive securities under the “if-converted” method and treasury-stock method when calculating diluted earnings per share, in which it is assumed that the outstanding participating securities convert into common stock at

24

Notes to Condensed Consolidated Financial Statements (continued)

(In thousands except share and per share amounts)

the beginning of the period or date of issuance, if later. The Company reports the more dilutive of the approaches (two-class or “if-converted”) as its diluted net income per share during the period.

As of January 1, 2018, the Company no longer had outstanding securities other than common stock, which required holders’ participation in dividends and earnings; therefore, the Company no longer was required to calculate EPS under the two-class method. Basic net income per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted net income per share is computed by giving effect to all potential shares of common stock, including stock options, stock related to unvested restricted stock awards, and outstanding warrants to the extent dilutive.

The components of basic and diluted earnings per share, or EPS, are as follows:

	Three months ended June 30,				Six months ended June 30,
	2017		2018		2017		2018
Earnings per share
Net income	$	1,947	$	10,512	$	4,936	$	16,703
Less: net income allocated to participating securities	254		—		645		—
Net income attributable to common stockholders	$	1,693	$	10,512	$	4,291	$	16,703
Net income per share:
Basic	$	0.14	$	0.58	$	0.36	$	0.93
Diluted	$	0.13	$	0.50	$	0.33	$	0.80
Weighted Average Number of Common Shares Outstanding
Basic	11,814,584		18,154,964		11,806,619		17,908,159
Dilutive effect of stock options, restricted stock units, and warrants	1,074,750		2,738,689		1,170,987		2,958,618
Diluted	12,889,334		20,893,653		12,977,606		20,866,777

The following common share equivalents have been excluded from the calculation of weighted-average common shares outstanding, because the effect is anti-dilutive for the periods presented:

	Three months ended June 30,		Six months ended June 30,
	2017	2018	2017	2018
Anti-dilutive Disclosure
Series A redeemable convertible preferred stock outstanding	1,775,000	—	1,775,000	—
Stock options issued and outstanding	747,581	—	648,788	15,603

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

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

25

Management’s Discussion and Analysis

Overview

We are a leading cloud-based communications platform for enterprises in the United States. Our solutions include a broad range of software application programming interfaces (“APIs”) for voice and text functionality and our owned and managed, purpose-built internet protocol (“IP”) voice network, one of the largest in the nation. Our sophisticated and easy-to-use software APIs allow enterprises to enhance their products and services by incorporating advanced voice and text capabilities. Companies use our platform to more frequently and seamlessly connect with their end users, add voice calling capabilities to residential Internet of Things (“IoT”) devices, offer end users new mobile application experiences and improve employee productivity, among other use cases. By owning and operating a capital-efficient, purpose-built IP voice network, we are able to offer advanced monitoring, reporting and analytics, superior customer service, dedicated operating teams, personalized support, and flexible cost structures. Over the last ten years, we have pioneered the communications platform-as-a-service (“CPaaS”) space through our innovation-rich culture and focus on empowering enterprises with end-to-end communications solutions.

Our voice software APIs allow enterprises to make and receive phone calls and create advanced voice experiences. Integration with our purpose-built IP voice network ensures enterprise-grade functionality and secure, high-quality connections. Our messaging software APIs provide enterprises with advanced tools to connect with end users via messaging. Our customers also use our solutions to enable 911 response capabilities, real-time provisioning and activation of phone numbers and toll-free number messaging.

We are the only CPaaS provider in the industry with our own nationwide IP voice network, which we have purpose-built for our platform. Our network is capital-efficient and custom-built to support the applications and experiences that make a difference in the way enterprises communicate. Since a communications platform is only as strong as the network that backs it, we believe our network provides a significant competitive advantage in the control, quality, pricing power and scalability of our offering. We are able to control the quality and provide the support our customers expect, as well as efficiently meet scalability and cost requirements.

For the three months ended June 30, 2017 and 2018, total revenue was $39.5 million and $48.3 million, respectively. CPaaS revenue for the three months ended June 30, 2017 and 2018 was $31.5 million and $39.8 million, respectively, representing an increase of 26%. Net income for the three months ended June 30, 2017 and 2018 was $1.9 million and $10.5 million, respectively. The number of active CPaaS customer accounts increased from 865 as of June 30, 2017, to 1,092 as of June 30, 2018, or 26%.

Key Performance Indicators

We monitor the following key performance indicators (“KPIs”) to help us evaluate our business, identify trends affecting our business, formulate business plans, and make strategic decisions. We believe the following KPIs are useful in evaluating our business:

	Three months ended June 30,						Six months ended June 30,
	2017			2018			2017			2018
	(Dollars in thousands)
Number of active CPaaS customers (as of period end)	865			1,092			865			1,092
Dollar-based net retention rate	105		%	119		%	107		%	117		%
Adjusted EBITDA	$	5,842		$	3,218		$	12,655		$	13,883
Free cash flow	$	4,061		$	2,616		$	2,285		$	12,457

Number of Active CPaaS Customer Accounts

26

Management’s Discussion and Analysis

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

For the three and six months ended June 2017 and 2018, revenue from active CPaaS customer accounts represented approximately 99% of total CPaaS revenue.

Dollar-Based Net Retention Rate

Our ability to drive growth and generate incremental revenue depends, in part, on our ability to maintain and grow our relationships with our existing customers that generate CPaaS revenue and seek to increase their use of our platform. We track our performance in this area by measuring the dollar-based net retention rate for our customers who generate CPaaS revenue. Our dollar-based net retention rate compares the CPaaS revenue from customers in a quarter to the same quarter in the prior year. To calculate the dollar-based net retention rate, we first identify the cohort of customers that generate CPaaS revenue and that were customers in the same quarter of the prior year. The dollar-based net retention rate is obtained by dividing the CPaaS revenue generated from that cohort in a quarter, by the CPaaS revenue generated from that same cohort in the corresponding quarter in the prior year. When we calculate dollar-based net retention rate for periods longer than one quarter, we use the average of the quarterly dollar-based net retention rates for the quarters in such period. Our dollar-based net retention rate increases when such customers increase usage of a product, extend usage of a product to new applications or adopt a new product. Our dollar-based net retention rate decreases when such customers cease or reduce usage of a product or when we lower prices on our solutions.

As our customers grow their business and extend the use of our platform, they sometimes create multiple customer accounts with us for operational or other reasons. As such, when we identify a significant customer organization (defined as a single customer organization generating more than 1% of CPaaS revenue in a quarterly reporting period) that has created a new CPaaS customer, this new customer is tied to, and CPaaS revenue from this new customer is included with, the original CPaaS customer for the purposes of calculating this metric.

Key Components of Statements of Operations

Revenue

We generate a majority of our revenue from our CPaaS segment. CPaaS revenue is derived from voice usage, phone number services, 911-enabled phone number services, messaging services and other services. We generate a portion of our CPaaS revenue from usage-based fees which include voice calling and messaging services. For the three months ended June 30, 2017 and 2018, we generated 57% and 64% of our CPaaS revenue, respectively, from usage-based fees. We also earn monthly fees from services such as phone number services and 911 access service. For the three months ended June 30, 2017 and 2018, we generated 41% and 34% of our CPaaS revenue in each period from monthly per unit fees.

27

Management’s Discussion and Analysis

For the six months ended June 30, 2017 and 2018, we generated 57% and 64% of our CPaaS revenue, respectively, from usage-based fees. We also earn monthly fees from services such as phone number services and 911 access service. For the six months ended June 30, 2017 and 2018, we generated 41% and 35% of our CPaaS revenue in each period from monthly per unit fees.

The remainder of our revenue is generated by our Other segment. Other revenue is composed of revenue earned from our legacy services and indirect revenue. Other revenue as a percentage of total revenue is expected to continue to decline over time.

We recognize accounts receivable at the time the customer is invoiced. Additionally, we record a receivable and revenue for unbilled revenue if the services have been delivered and are billable in subsequent periods. Unbilled revenue made up 46% and 47% of outstanding accounts receivable, net of allowance for doubtful accounts as of June 30, 2017 and 2018, respectively.

Cost of Revenue and Gross Margin

CPaaS cost of revenue consists primarily of fees paid to other network service providers from whom we buy services such as minutes of use, phone numbers, messages, porting of customer numbers and network circuits. Cost of revenue also contains costs related to support of our IP voice network, web services, cloud infrastructure, capacity planning and management, rent for network facilities, software licenses, hardware and software maintenance fees and network engineering services. Personnel costs (including non-cash stock-based compensation expenses) associated with personnel who are responsible for the delivery of services, operation and maintenance of our communications network, and customer support, as well as, third-party support agreements and depreciation of network equipment, amortization of internally developed software and gain (loss) on disposal of property and equipment are also included in cost of revenue.

Other cost of revenue consists of costs supporting non-CPaaS services including leased circuit costs paid to third party providers, internet connectivity expenses, minutes of use, direct operations, contractors, regulatory fees, surcharges and other pass-through costs and software and hardware maintenance fees.

Gross margin is calculated by subtracting cost of revenue from revenue, divided by total revenue, expressed as a percentage. Our cost of revenue and gross margin have been, and will continue to be, affected by several factors, including the timing and extent of our investments in our network, our ability to manage off-network minutes of use and messaging costs, the product mix of revenue, the timing of amortization of capitalized software development costs and the extent to which we periodically choose to pass on any cost savings to our customers in the form of lower usage prices.

Operating Expenses

The most significant components of operating expenses are personnel costs, which consist of salaries, benefits, bonuses, and stock-based compensation expenses. We also incur other non-personnel costs related to our general overhead expenses, including facility expenses, software licenses, web services, depreciation and amortization of assets unrelated to delivery of our services. We expect that our operating expenses will increase in absolute dollars.

Research and Development

Research and development (“R&D”) consist primarily of personnel costs (including non-cash stock-based compensation expenses), outsourced software development and engineering service and cloud infrastructure fees for staging and development of outsourced engineering services. We capitalize the portion of our software development costs in instances where we invest resources to develop software for internal use. We plan to continue to invest in R&D to enhance current product offerings and develop new services.

28

Management’s Discussion and Analysis

Sales and Marketing

Sales and marketing expenses consist primarily of personnel costs, including commissions for our sales employees and non-cash stock-based compensation expenses. Sales and marketing expenses also include expenditures related to advertising, marketing, our brand awareness activities, sales support and professional services fees.

We focus our sales and marketing efforts on creating sales leads and establishing and promoting our brand. We plan to continue to invest in sales and marketing in order to expand our CPaaS customer base by growing headcount, driving our go-to-market strategies, building brand awareness, advertising and sponsoring additional marketing events.

General and Administrative

General and administrative expenses consist primarily of personnel costs, including stock-based compensation, for our accounting, finance, legal, human resources and administrative support personnel and executives. General and administrative expenses also include costs related to product management and reporting, customer billing and collection functions, information services, professional services fees, credit card processing fees, rent associated with our headquarters in Raleigh, North Carolina and our other offices, and depreciation and amortization. We expect that we will incur increased costs associated with supporting the growth of our business and to meet the increased compliance requirements associated with our transition to, and operation as, a public company.

Income Taxes

For the three months ended June 30, 2017 and 2018, our effective tax rate was 38.4% and (741.6)%, respectively. The decrease in our effective tax rate is primarily due to the impact of stock compensation tax deductions from stock option exercises, as well as the decrease in the federal statutory tax rate under the Tax Cuts and Jobs Act (the “Act”).

For the six months ended June 30, 2017 and 2018, our effective tax rate was 37.7% and (65.8)%, respectively. The decrease in our effective tax rate is primarily due to the impact of stock compensation tax deductions from stock option exercises, as well as, the decrease in the federal statutory tax rate under the Act.

Non-GAAP Financial Measures

We use Non-GAAP gross profit, Non-GAAP gross margin, Adjusted EBITDA, Non-GAAP net income and free cash flow for financial and operational decision making and to evaluate period-to-period differences in our performance. Non-GAAP gross profit, Non-GAAP gross margin, Adjusted EBITDA, Non-GAAP net income and free cash flow are non-GAAP financial measures, which we believe are useful for investors in evaluating our overall financial performance. We believe these measures provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to key performance indicators used by management in its financial and operational decision making. For a reconciliation of each of the non-GAAP financial measures described below, see below.

Non-GAAP Gross Profit and Non-GAAP Gross Margin

GAAP defines gross profit as revenue less cost of revenue. Cost of revenue includes all expenses associated with our various service offerings as more fully described under the caption “Key Components of Statement of Operations-Cost of Revenue and Gross Margin.” We define Non-GAAP gross profit as gross profit after adding back the following items:

• depreciation; and

• stock-based compensation.

29

Management’s Discussion and Analysis

We add back depreciation and stock-based compensation because they are non-cash items. We eliminate the impact of these non-cash items because we do not consider them indicative of our core operating performance. Their exclusion facilitates comparisons of our operating performance on a period-to-period basis. Therefore, we believe that showing gross margin, as Non-GAAP to remove the impact of these non-cash expenses, such as depreciation, amortization and stock-based compensation, is helpful to investors in assessing our gross profit and gross margin performance in a way that is similar to how management assesses our performance.

We calculate Non-GAAP gross margin by dividing Non-GAAP gross profit by revenue, expressed as a percentage of revenue.

Management uses Non-GAAP gross profit and Non-GAAP gross margin to evaluate operating performance and to determine resource allocation among our various service offerings. We believe that Non-GAAP gross profit and Non-GAAP gross margin provide useful information to investors and others to understand and evaluate our operating results in the same manner as our management and board of directors and allows for better comparison of financial results among our competitors. Non-GAAP gross profit and Non-GAAP gross margin may not be comparable to similarly titled measures of other companies because other companies may not calculate Non-GAAP gross profit and Non-GAAP gross margin or similarly titled measures in the same manner as we do.

Consolidated

	Three months ended June 30,						Six months ended June 30,
	2017			2018			2017			2018
	(In thousands)
Consolidated Gross Profit	$	17,232		$	21,738		$	35,291		$	49,386
Depreciation	1,036			1,015			2,083			2,078
Stock-based compensation	21			32			41			49
Non-GAAP Gross Profit	$	18,289		$	22,785		$	37,415		$	51,513
Non-GAAP Gross Margin %	46		%	47		%	47		%	51		%

By Segment

CPaaS

	Three months ended June 30,						Six months ended June 30,
	2017			2018			2017			2018
	(In thousands)
CPaaS Gross Profit	$	12,628		$	16,696		$	26,047		$	33,688
Depreciation	1,036			1,015			2,083			2,078
Stock-based compensation	21			32			41			49
Non-GAAP Gross Profit	$	13,685		$	17,743		$	28,171		$	35,815
Non-GAAP CPaaS Gross Margin %	43		%	45		%	45		%	45		%

Other

There are no Non-GAAP adjustments to gross profit for the Other segment.

Adjusted EBITDA

We define Adjusted EBITDA as net income adjusted to reflect the addition or elimination of certain income statement items including, but not limited to:

30

Management’s Discussion and Analysis

• income tax provision (benefit);

• interest expense (income), net;

• depreciation and amortization expense;

• stock-based compensation expense;

• impairment of intangible assets, if any;

• loss on disposal of property and equipment; and

• change in fair value of financial instruments, including any change in shareholders’ anti-dilutive arrangements.

Adjusted EBITDA is a key measure used by management to understand and evaluate our core operating performance and trends, to generate future operating plans and to make strategic decisions regarding the allocation of capital. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates comparisons of our operating performance on a period-to-period basis.

	Three months ended June 30,					Six months ended June 30,
	2017		2018			2017		2018
	(In thousands)
Net income	$	1,947	$	10,512		$	4,936	$	16,703
Income tax provision (benefit) (2)	1,215		(9,263		)	2,987		(6,629		)
Interest expense (income), net	438		(90		)	859		(139		)
Depreciation	1,235		1,166			2,401		2,388
Amortization	210		130			420		295
Stock-based compensation	244		762			490		1,255
Loss on disposal of property and equipment	—		1			9		10
Change in fair value of shareholders' anti-dilutive arrangement (1)	553		—			553		—
Adjusted EBITDA	$	5,842	$	3,218		$	12,655	$	13,883

________________________

(1) Relates to an anti-dilutive agreement which allows certain principal non-founder shareholders the ability to purchase additional common shares. See Note 4, Fair Value of Financial Instruments, in the Annual Report on Form 10-K for further explanation.

(2) Includes $7,052 of excess tax benefits associated with the exercise of stock options in the three and six months ended June 30, 2018.

Non-GAAP Net Income

We define Non-GAAP net income as net income adjusted for certain items affecting period-to-period comparability. Non-GAAP net income excludes:

• stock-based compensation;

• change in fair value of shareholders’ antidilutive arrangement;

• amortization of acquired intangible assets related to the acquisition of Dash Carrier Services, LLC;

• impairment charges of intangibles assets, if any;

• loss on disposal of property and equipment;

• estimated tax impact of above adjustments;

• income tax benefit resulting from excess tax benefits associated with the exercise of stock options;

31

Management’s Discussion and Analysis

• benefit resulting from the release of the valuation allowance on our deferred tax assets (“DTA”); and

• impact on remeasurement of DTA as a result of 2017 tax reform.

We calculate Non-GAAP basic and diluted shares by adding the weighted average of outstanding Series A redeemable convertible preferred stock, if any, to the weighted average number of outstanding basic and diluted shares, respectively.

We believe Non-GAAP net income is a meaningful measure because by removing certain non-cash and other expenses we are able to evaluate our operating results in a manner we believe is more indicative of the current period’s performance. We believe the use of Non-GAAP net income may be helpful to investors because it provides consistency and comparability with past financial performance, facilitates period-to-period comparisons of results of operations and assists in comparisons with other companies, many of which may use similar non-GAAP financial information to supplement their GAAP results.

	Three months ended June 30,						Six months ended June 30,
	2017			2018			2017			2018
	(In thousands)
Net income	$	1,947		$	10,512		$	4,936		$	16,703
Stock-based compensation	244			762			490			1,255
Change in fair value of shareholders' anti-dilutive arrangement (1)	553			—			553			—
Amortization related to acquisitions	130			130			260			260
Loss on disposal of property and equipment	—			1			9			10
Estimated tax effects of adjustments	(355		)	(229		)	(501		)	(391		)
Income tax benefit of option exercises	—			(7,052		)	—			(7,052		)
Non-GAAP net income	$	2,519		$	4,124		$	5,747		$	10,785
Non-GAAP net income per Non-GAAP share
Basic	$	0.19		$	0.23		$	0.42		$	0.60
Diluted	$	0.17		$	0.20		$	0.39		$	0.52
Non-GAAP Weighted Average Number of Shares outstanding
Basic	11,814,584			18,154,964			11,806,619			17,908,159
Series A redeemable convertible preferred stock outstanding	1,775,000			—			1,775,000			—
Non-GAAP Basic Shares	13,589,584			18,154,964			13,581,619			17,908,159
Diluted	12,889,334			20,893,653			12,977,606			20,866,777
Series A redeemable convertible preferred stock outstanding	1,775,000			—			1,775,000			—
Non-GAAP Diluted Shares	14,664,334			20,893,653			14,752,606			20,866,777

________________________

(1) Relates to an anti-dilutive agreement which allowed certain principal non-founder shareholders the ability to purchase additional common shares. See Note 4, Fair Value of Financial Instruments, in the Annual Report on Form 10-K for further explanation.

32

Management’s Discussion and Analysis

Free Cash Flow

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

	Three months ended June 30,						Six months ended June 30,
	2017			2018			2017			2018
	(In thousands)
Net cash provided by operating activities	$	5,975		$	5,874		$	5,006		$	17,117
Net cash used in investing in capital assets (1)	(1,914		)	(3,258		)	(2,721		)	(4,660		)
Free cash flow	$	4,061		$	2,616		$	2,285		$	12,457

________________________

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

33

Management’s Discussion and Analysis

Results of Operations

Consolidated Results of Operations

The following table sets forth the consolidated statements of operations for the periods indicated.

	Three months ended June 30,				Six months ended June 30,
	2017		2018		2017		2018
	(In thousands)
Revenue:
CPaaS revenue	$	31,547	$	39,833	$	63,194	$	78,730
Other revenue	7,979		8,471		15,957		22,586
Total revenue	39,526		48,304		79,151		101,316
Cost of revenue:
CPaaS cost of revenue	18,919		23,137		37,147		45,042
Other cost of revenue	3,375		3,429		6,713		6,888
Total cost of revenue	22,294		26,566		43,860		51,930
Gross profit:
CPaaS	12,628		16,696		26,047		33,688
Other	4,604		5,042		9,244		15,698
Total gross profit	17,232		21,738		35,291		49,386
Operating expenses:
Research and development	2,409		4,435		5,091		8,216
Sales and marketing	2,413		4,654		4,971		9,176
General and administrative	8,257