Bandwidth Inc. (BAND) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that are included elsewhere in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K. Our fiscal year ends on December 31.

Overview

We are a leading global enterprise cloud communications company. Our solutions include a broad range of software Application Programming Interfaces (“APIs”) for voice, messaging and emergency services. Our sophisticated and easy-to-use software APIs allow enterprises to enhance their products and services by incorporating advanced, global connectivity for voice, messaging and emergency services communications capabilities. Companies use our platform to more frequently and seamlessly connect with their end users, add voice calling capabilities to applications and devices, transition from on-premise to cloud-based communication tools and applications, integrate messaging capabilities into applications or software, build interactive voice response systems for contact centers, and offer end users new mobile application experiences including emergency services and improve employee productivity, among other use cases. We have established a reputation as a leader in the Communications Platform-as-a-Service (“CPaaS”) space through our innovation-rich culture and focus on empowering enterprises with end-to-end communications solutions.

We are the only CPaaS provider in the industry that owns and operates a nationwide IP voice network in the United States. In 2020, we acquired Voxbone, a leading European-based communications platform with its own IP voice network assembled by building relationships with local carriers around the globe. Our deep U.S. presence and global platform extending across more than 60 countries serves enterprises in countries representing more than 90% of global gross domestic product. We believe that our current and future customers will benefit from using a unified software platform, network and team to serve people around the world.

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 believe our network is capital-efficient and supports 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, while meeting regulatory, scalability and cost requirements more efficiently.

For the years ended December 31, 2019, 2020 and 2021, total revenue was $232.6 million, $343.1 million, and $490.9 million, respectively. For the years ended December 31, 2019, 2020 and 2021, our CPaaS segment revenue was $197.9 million, $298.1 million, and $413.9 million, respectively, representing an increase of 51% in 2020 and 39% in 2021. Net income in 2019 was $2.5 million, and net loss in 2020 and 2021 was $44.0 million and $27.4 million, respectively. As of December 31, 2019, 2020 and 2021, the number of active CPaaS customer accounts was 1,728, 2,848, and 3,228, respectively, representing a year-over-year increase of 40% in 2019, 65% in 2020 and 13% in 2021.

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Acquisition of Voxbone

On November 2, 2020, we acquired all of the A Ordinary Shares, B Ordinary Shares and C Ordinary Shares of Voice Topco Limited (“Voice Topco”) through a Share Purchase Agreement (the “Share Purchase Agreement” and such purchase, the “Share Purchase”) (the “Acquisition”). Voice Topco directly or indirectly holds all of the issued and outstanding shares of Voxbone S.A., which (with its subsidiaries) is the operating subsidiary of Voice Topco. The Acquisition was valued at €446 million. As consideration for the Share Purchase, we (i) paid the Sellers (as defined in the Share Purchase Agreement) approximately $400 million (or approximately €338 million based on prevailing exchange rates at the close of business on October 9, 2020) at the Closing (as disclosed in the Share Purchase Agreement) and (ii) issued to the Sellers at the Closing shares of our Class A common stock, with an aggregate value of approximately €108 million (or approximately $128 million based on prevailing exchange rates at the close of business on October 9, 2020).

COVID-19 Update

The novel coronavirus (“COVID-19”) pandemic persisted throughout 2021 and remains an issue today, impacting areas of the United States and the rest of the world to varying degrees. The broader implications of COVID-19 on our results of operations and overall financial performance remain uncertain. The COVID-19 pandemic and its adverse effects have been prevalent in the locations where we, our customers, suppliers and third-party business partners conduct business. During the year ended December 31, 2021, we experienced stable or increased usage by our customers that had been most impacted by COVID-19, including large enterprise customers that offer unified communications as a service (“UCaaS”), meeting solutions, travel, hospitality and ridesharing services, among others. We acknowledge there may be additional impacts to the economy and our business going forward as a result of COVID-19, and we expect there may be some volatility in customer demand and buying habits as the pandemic continues. Our U.S. offices have remained open to employees, subject to applicable government regulations. Appropriate measures are being taken to protect the health of our employees who return to the office. We have also reinstated business travel, subject to applicable government regulations. As the COVID-19 pandemic abates, we may experience curtailed customer demand that could materially adversely impact our business, results of operations and overall financial performance in future periods. Specifically, we may experience impact from enterprises reducing usage of our services or delaying decisions to implement our services. As a result, the effect of the COVID-19 pandemic will not be reflected fully in our results of operations and overall financial performance until future periods. See “Item 1A. Risk Factors” for further discussion of the possible impact of the COVID-19 pandemic on our business.

DDoS Attack

Beginning on September 25, 2021, our communications network was subjected to a distributed denial of service attack (the “DDoS Attack”) initially causing intermittent communications services disruptions affecting certain of our markets and customers. A DDoS attack is a malicious attempt to disrupt the normal traffic of a targeted server, service or network by overwhelming the target or its surrounding infrastructure with a flood of unwanted internet traffic from multiple sources, resulting in the slowdown or blockage of legitimate traffic. Our mitigation efforts, in conjunction with our partners from leading cybersecurity firms, have proved successful. Our network has been largely stable and operating at normal service levels since the evening of September 29, 2021, although there have been some continued intermittent disruptions. We estimate that the impact from lost transaction volume and customer credits attributable to the DDoS Attack reduced CPaaS revenue for the full year 2021 by approximately $10.0 million.

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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:

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(1) See “Non-GAAP Financial Measures”, discussed elsewhere in Management’s Discussion and Analysis.

Number of Active CPaaS Customer Accounts

We believe 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 usage of our platform by an active CPaaS customer at or above the $100 per month threshold is a stronger indicator of potential future engagement than trial usage 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.

In the years ended December 31, 2019, 2020 and 2021, 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. Customers of acquired businesses are included in the subsequent year’s calendar quarter of acquisition. 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.

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As our customers grow their businesses and increase usage 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 reoccurring sources such as per minute voice usage and voice calling, per text message usage and other usage services and fees, and from monthly recurring charges arising from phone number services, 911-enabled phone number services, messaging services and other services.

For the years ended December 31, 2019, 2020 and 2021, we generated 66%, 74% and 72%, respectively of our CPaaS revenue from reoccurring sources. The large bulk of our remaining CPaaS revenue is generated from recurring monthly charges.

The remainder of our revenue not classified in our CPaaS segment is generated by our Other segment. Other segment revenue is composed of revenue earned from various communications services and products, indirect revenue and messaging surcharge revenue.

We recognize accounts receivable at the time the customer is invoiced. Additionally, we record a receivable for unbilled revenue if services have been delivered and are billable in subsequent periods. Unbilled revenue made up 54%, 50% and 52% of outstanding accounts receivable, net of allowance for doubtful accounts, as of December 31, 2019, 2020 and 2021, 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, changes to the mix or amount of personnel-related costs included in our cost of revenue, the product mix of revenue, the timing of amortization of capitalized software development costs and fluctuations in the price we charge our customers for services.

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

Sales and Marketing

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

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 industry 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 and other facilities costs associated with our headquarters in Raleigh, North Carolina and our other offices, and depreciation and amortization.

Income Taxes

For the years ended December 31, 2019, 2020 and 2021, our effective tax rate was 116.4%, (51.8)%, and 12.3%, respectively. The increase in our effective tax rate is primarily due to a change in the valuation allowance related to certain deferred tax assets.

Judgment is required in a determination as to whether deferred tax assets will be realized in full or in part. Management assesses available positive and negative evidence on a jurisdictional basis to estimate if deferred tax assets will be recognized, or when it is more likely than not that all or some deferred tax assets will not be realized and a valuation allowance must be established. As of December 31, 2021, the Company continues to maintain a valuation allowance for its U.S. federal and state net deferred tax assets.

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Results of Operations

Consolidated Results of Operations

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

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The following table sets forth our results of operations as a percentage of our total revenue for the periods presented. *

(*) Columns may not foot due to rounding.

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Comparison of the Years Ended December 31, 2020 and 2021

Revenue

In 2021, total revenue increased by $147.8 million, or 43%, and CPaaS revenue increased by $115.9 million, or 39%, compared with the same period in 2020. As a percentage of total revenue, CPaaS revenue was 84% in 2021 compared with 87% in 2020.

Revenue earned on our international platform contributed $81.5 million of this increase to total revenue and $78.8 million to CPaaS revenue. Excluding the higher amounts attributable to our international platform, revenue from all of our CPaaS offerings increased from the same period in 2020 led by growth in our voice and messaging offerings of $20.4 million, and phone number services and 911-enabled phone number services of $16.7 million. We believe our revenue results were lowered by approximately $10.0 million in 2021 from lost transaction volume and customer credits due to the previously disclosed DDoS Attack. These increases in usage volume period-over-period, including the negative impact of approximately $10.0 million from lower transaction volume, yielded our dollar-based net retention rate of 110%.

Active CPaaS customer accounts increased 13% to 3,228 as of December 31, 2021, as compared with 2,848 as of December 31, 2020 active accounts as of December 31, 2020.

Other revenue increased by $31.9 million, or 71%, in 2021 primarily due to higher indirect revenue, which increased by $30.6 million due to an increase in messaging surcharges and indirect voice revenue, and $2.7 million due to reoccurring revenue earned from our international platform.

Cost of Revenue and Gross Margin

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In 2021, total gross profit increased by $60.7 million, or 38%, compared with the same period in 2020, driven by higher revenue and improved operating leverage offset by unfavorable segment mix, which resulted in total gross margin of 45% for the year ended December 31, 2021 compared with 46% for the year ended December 31, 2020.

As a component of total gross margin, our CPaaS gross margin grew from 46% to 47% for the years ended December 31, 2020 and 2021, respectively. Higher CPaaS gross margins arose from higher revenue, improved operating leverage and product mix. Our higher revenue drove correspondingly higher CPaaS cost of revenue for the year ended December 31, 2021 of $56.7 million, or 35%, compared with the same period in 2020. CPaaS cost of revenue increased due to an increase in network costs of $22.8 million due to both network expansions and amortization expense, partially related to our international platform, voice usage costs of $22.5 million, costs of phone numbers and 911 of $8.7 million, and cost of messaging of $2.7 million from increased cost per message and higher messaging sales volumes.

Excluding depreciation, amortization and stock-based compensation of $20.8 million for the year ended December 31, 2021 and $11.2 million for the year ended December 31, 2020, CPaaS Non-GAAP gross margins increased to 53%, compared with 50% for the year ended December 31, 2020, and total Non-GAAP gross margins were 49% and 49%, respectively, for the years ended December 31, 2020 and 2021. Higher CPaaS Non-GAAP gross margins were driven by revenue growth, improved operating leverage, improved product mix and the inclusion of higher margin sales from our international platform. See “Non-GAAP Financial Measures”, discussed elsewhere in Management’s Discussion and Analysis.

In 2021, other cost of revenue increased by $30.4 million compared with the same period in 2020. This was primarily due to increased indirect revenue and costs related to messaging surcharges, resulting in decreased Other gross margin from 45% to 29%.

Operating Expenses

As a percentage of revenue, total operating expenses for the years ended December 31, 2020 and 2021 decreased from 50% to 45%, respectively, as revenue growth exceeded corresponding growth in operating expenditures in 2021.

In 2021, R&D expenses increased by $13.1 million, or 31%, compared with the same period in 2020. This increase was due to increased personnel costs of $10.0 million including the impact of growth in headcount as a result of the Acquisition, and an increase in non-headcount costs of $3.1 million.

In 2021, sales and marketing expenses increased by $11.3 million, or 28%, compared with the same period in 2020, primarily due to an increase in sales personnel costs of $7.8 million, which included the impact of growth in headcount as a result of the Acquisition, and an increase in non-headcount costs of $3.5 million.

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In 2021, general and administrative expenses increased by $25.0 million, or 28%, compared with the same period in 2020. This increase was primarily due to higher personnel costs of $13.9 million resulting from the impact of growth in headcount as a result of the Acquisition, depreciation and amortization costs of $10.0 million, facilities costs of $3.2 million, and other costs of $2.2 million, offset by a decrease in professional costs of $4.3 million.

Interest Income (Expense), Net

In 2021, interest expense, net of interest income, increased by $15.1 million compared with the same period in 2020, due to a $12.4 million increase in interest expense related to the Convertible Notes and a $2.5 million decrease in interest income from the investment of follow-on equity offering proceeds. See Note 9, “Debt” to the consolidated financial statements, for additional details.

Income Tax Benefit

In 2021, income tax expense decreased by $18.8 million compared with the same period in 2020. The effective tax rate for the year ended December 31, 2021, was 12.3% compared with (51.8)% in the same period in 2020. The increase in our effective tax rate is primarily due to a change in the valuation allowance related to certain deferred tax assets.

Comparison of the Years Ended December 31, 2019 and 2020

Revenue

In 2020, total revenue increased by $110.5 million, or 48%, compared to the same period in 2019, and CPaaS revenue increased by $100.1 million, or 51%, compared to the same period in 2019. The increase in CPaaS revenue was primarily attributable to an increase in the usage of all our service offerings, particularly our voice and messaging usage, which accounted for $58.6 million of the increase in CPaaS revenue. Messaging usage increased in the year due to higher volumes of messages related to political campaigns for the U.S. elections in November. The situation caused by COVID-19 also caused increased usage in the year because of more reliance on our offerings to connect people during a time of physical distancing and work from home environment. Increased usage was mostly driven by large enterprise customers that offer UCaaS services and meeting solutions and our phone number services. Our phone number services and 911-enabled phone number services accounted for $13.2 million of the increase in CPaaS revenue. In 2020, CPaaS revenue also increased by $11.8 million from higher usage pricing due to a shift in product mix to products with a higher rate compared to the same period in 2019. In addition, $16.6 million of growth was attributable to the acquisition of Voxbone for the period from November 1, 2020 through December 31, 2020. The changes in usage and price in 2020 compared to the same period in 2019 were reflected in our dollar-based net retention rate of 131%. In addition, revenue from new CPaaS customers contributed $22.9 million, or 11%, to CPaaS revenue for 2020 compared to $11.7 million, or 7%, in the same period in 2019.

The increase in usage was also attributable to a 65% increase in the number of active CPaaS customer accounts, from 1,728 as of December 31, 2019 to 2,848 as of December 31, 2020. As a percentage of total revenue, CPaaS revenue increased from 85% in 2019 to 87% in the same period in 2020.

Other revenue increased by $10.4 million, or 30%, in 2020 due to higher indirect revenue, which increased by $12.7 million primarily due to an increase in messaging surcharges and indirect voice revenue, offset by the expected decline of legacy revenue, which decreased by $2.3 million, compared to the same period in 2019.

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Cost of Revenue and Gross Margin

In 2020, total gross profit increased by $50.2 million, or 47%, compared to the same period in 2019. Total gross margin was 46% for both years. In 2020, CPaaS cost of revenue increased by $50.4 million, or 46%, compared to the same period in 2019. CPaaS cost of revenue increased due to an increase in voice usage costs of $25.0 million due to growth in minutes used by customers. Cost of messaging increased by $10.3 million due to growth in messages used by customers, including an increase related to political campaigns and increased cost per message. Network costs also increased $13.0 million due to network expansions and depreciation expense. Cost of phone numbers and 911 increased by $2.1 million. COVID-19 and the increased usage resulting from the work at home environment generated increased voice usage costs and network expansions. CPaaS gross margin increased from 44% in 2019 to 46% in 2020. Excluding depreciation and stock-based compensation of $6.8 million in 2019 and $9.7 million in 2020, CPaaS Non-GAAP gross margin was 48% and 50%, respectively, and total Non-GAAP gross margin was 49% for both years

In 2020, other cost of revenue increased by $9.9 million compared to the same period in 2019, primarily due to a $10.8 million increase in cost of indirect revenue related to messaging surcharges offset by a $0.9 million decrease in costs as a result of the expected churn in legacy services.

Operating Expenses

In 2020, R&D expenses related to the expansion of our product offerings increased by $10.6 million, or 34%, compared to the same period in 2019. This increase was primarily due to increased personnel costs of $10.1 million including the impact of growth in headcount as a result of the Acquisition and an increase in non-headcount costs of $0.5 million.

In 2020, sales and marketing expenses increased by $5.5 million, or 16%, compared to the same period in 2019, primarily due to an overall increase in sales personnel costs of $6.6 million including the impact of growth in headcount as a result of the Acquisition offset by a decrease in non-headcount costs of $1.1 million.

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In 2020, general and administrative expenses increased by $29.9 million, or 51%, compared to the same period in 2019. This increase was due to $12.7 million in costs which consist of mainly fees for financial and legal services, due diligence services and success fees related to the acquisition of Voxbone, higher personnel costs of $11.9 million due to the impact of growth in headcount as a result of the Acquisition, depreciation and amortization costs of $3.1 million, facilities costs of $1.4 million, bank charges and license costs of $1.1 million, professional costs of $0.6 million, and expensed IT charges of $0.6 million, offset by lower other non-headcount costs of $0.9 million and travel and entertainment expenses of $0.6 million, which contributed to the overall increase in general and administrative expenses.

As a percentage of revenue, total operating expenses for the years ended December 31, 2018, 2019 and 2020 increased from 43% to 53% and 50%, respectively, as operating expenditures growth exceeded corresponding growth in revenue in 2019 and 2020.

Interest Expense, Net

In 2020, interest expense, net increased by $16.1 million compared to the same period in 2019, due to a $0.1 million decrease in interest income from the investment of follow-on equity offering proceeds and a $16.2 million increase in interest expense related to the Convertible Notes. See Note 9, “Debt” to the consolidated financial statements, for additional details.

Income Tax Provision

In 2020, income tax benefit decreased by $32.7 million compared to the same period in 2019 The effective tax rate for the twelve months ended December 31, 2020 was (51.8)% compared to 116.4% in the same period in 2019. The decrease in our effective tax rate is primarily due to the change in judgment related to the realizability of certain deferred tax assets and the resulting valuation allowance.

Liquidity and Capital Resources

Our liquidity for the year ended December 31, 2021 was provided by positive free cash flow, derived from our cash flow from operations of $40.8 million less expenditures for capital equipment. In the last three years, we have also supplemented our liquidity with proceeds from our issuance of the Convertible Notes in February 2020 and March 2021, respectively. We used a majority of the proceeds from the issuance of our 2026 Convertible Notes to consummate the Acquisition. We believe that our cash and cash equivalents balances and the cash flows generated by our operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, our belief may prove to be incorrect, and we could utilize our available financial resources sooner than we currently expect. Our future capital requirements and the adequacy of available funds will depend on many factors, including those set forth in the section titled “Risk Factors.” We may be required to seek additional equity or debt financing in order to meet these future capital requirements. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, or at all. If we are unable to raise additional capital when desired, our business, results of operations and financial condition would be adversely affected.

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Our principal future commitments consist of (i) an aggregate of $650.0 million in Convertible Notes (see Note 9, “Debt” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for a discussion of our 2026 Convertible Notes and our 2028 Convertible Notes), (ii) a $495.7 million non-cancelable lease for our future office headquarters, which is anticipated to commence in May of 2023 (the “Headquarters Lease”), (iii) a $3.6 million non-cancelable lease for our London office, (iv) $18.1 million in non-cancelable purchase obligations and future minimum payments under contracts to various service providers, and (v) $15.8 million in future minimum rent payments for our current office space. The initial base rent for the Headquarters Lease will be $38.79 per square foot, or approximately $20.7 million per annum, and will increase by 1.85% on each anniversary of the commencement date. In addition, we are required to deposit an amount equal to the final “Cost of the Work” (as defined in the lease agreement) minus the amount of allowance for certain tenant improvements (the “Excess Costs”) with USEF Edwards Mill Owner, LLC and Chicago Title Insurance Company when such amount has been determined. The final calculation of Excess Costs for the Headquarters Lease is expected to be approximately $12.6 million to occur in March 2022. See Note 13, “Commitments and Contingencies” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for future lease commitments.

Statement of Cash Flows

The following table summarizes our cash flows for the periods indicated:

Cash Flows from Operating Activities

In 2021, net cash provided by operating activities was $40.8 million, consisting of net loss of $27.4 million adjusted for non-cash items of $76.2 million, and offset by cash used by changes in operating assets and liabilities of $8.0 million.

Cash used in operating assets and liabilities included an increase in accounts receivable of $6.7 million, a decrease in operating right-of-use liability of $6.2 million, and an increase in prepaid expenses and other assets of $6.8 million. Offsetting these cash use items in assets and liabilities was an increase in accrued expenses and other liabilities of $9.7 million, and an increase in accounts payable of $2.0 million.

The non-cash items included depreciation and amortization expense of $36.7 million, amortization of debt discount and issuance costs of $26.8 million, stock-based compensation expenses of $14.5 million, right-of-use asset amortization of $5.7 million, and loss on disposal of property and equipment of $0.8 million, offset by a deferred tax benefit of $8.3 million.

In 2020, net cash provided by operating activities was $4.5 million, consisting of net loss of $44.0 million adjusted for non-cash items of $61.8 million and offset by cash used by changes in operating assets and liabilities of $13.3 million.

Cash generated in operating assets and liabilities included an increase in accrued expenses and other liabilities of $14.4 million, and an increase in accounts payable of $0.3 million. Offsetting these cash generating

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items in assets and liabilities were an increase in accounts receivable of $18.8 million, a decrease in operating right-of-use liability of $5.3 million, and an increase in prepaid expenses and other assets of $3.8 million.

The non-cash items included depreciation and amortization expense of $16.8 million, amortization of debt discount and issuance costs of $15.6 million, deferred tax expense of $14.3 million, stock-based compensation expenses of $9.9 million, right-of-use asset amortization of $4.8 million, and loss on disposal of property and equipment of $0.3 million.

In 2019, cash used in operating activities was $1.3 million, consisting of net income of $2.5 million adjusted for non-cash items. These non-cash items included depreciation and amortization expense of $9.6 million, stock-based compensation expenses of $6.6 million, right-of-use asset amortization of $4.3 million, loss on disposal of property and equipment of $0.5 million, offset by deferred tax benefit of $17.5 million, cash used by changes in operating assets and liabilities of $6.6 million, and accretion of bond discount of $0.7 million. Cash generated from operating assets and liabilities included an increase in accrued expenses and other liabilities of $5.5 million, an increase in accounts payable of $1.1 million, and an increase in deferred revenue and advanced billings of $0.6 million. Offsetting these cash generating items in assets and liabilities were an increase in accounts receivable of $6.2 million, an increase in prepaid expenses and other assets of $4.2 million, and a decrease in operating right-of-use liability of $3.4 million.

Cash Flows from Investing Activities

In 2021, net cash provided by investing activities was $2.8 million. Cash provided by investing activities included proceeds from sales and maturities of other investments of $40.0 million, proceeds from the sale of land of $17.5 million, offset by the purchase of land of $30.0 million, purchase of property and equipment of $20.7 million and capitalized internally developed software costs of $3.9 million.

In 2020, cash used in investing activities was $455.1 million mainly from the costs related to the Acquisition of $400.5 million, net of cash. In addition, cash used in investing activities was the purchase of other investments of $230.8 million, the purchase of property and equipment of $12.3 million and capitalized internally developed software costs of $2.3 million, offset by the proceeds from sales and maturities of other investments of $190.8 million.

In 2019, cash used in investing activities was $7.7 million from the proceeds from the sales and maturities of marketable securities of $86.4 million, offset by the investment in marketable securities of $68.4 million, the purchase of property and equipment of $22.2 million and capitalized internally developed software costs of $3.5 million.

Cash Flows from Financing Activities

In 2021, net cash provided by financing activities was $207.0 million consisting primarily of $250.0 million in proceeds from the issuance of the 2028 Convertible Notes and $0.9 million in proceeds from the issuance of stock options, partially offset by $25.5 million in the purchase of the 2028 Capped Calls, $7.5 million in payments of debt issuance cost, $6.7 million in payment of holdback proceeds to former Voxbone shareholders, $4.0 million in value of equity awards withheld for tax liabilities, and $0.2 million in payments on finance leases.

In 2020, cash provided by financing activities was $346.9 million consisting primarily of $400.0 million in proceeds from the issuance of the Convertible Notes and $4.1 million in proceeds from the issuance of stock options, partially offset by $43.3 million in the purchase of the 2026 Capped Calls, $12.0 million in payments of debt issuance cost, and $1.9 million in value of equity awards withheld for tax liabilities.

In 2019, cash provided by financing activities was $152.4 million consisting primarily of $147.4 million in proceeds from the follow-on public offering, $7.4 million in proceeds from the issuance of stock options, partially offset by $1.4 million in value of equity awards withheld for tax liabilities, $0.8 million in payments related to the cost of the follow-on public offering and $0.2 million in payments of debt issuance cost.

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Debt

On May 25, 2021, we terminated the Credit and Security Agreement, dated as of November 4, 2016, as amended and restated as of March 1, 2019, among the Company, KeyBank National Association, and KeyBanc Capital Markets Inc. (the “Credit Agreement”). The Credit Agreement provided for a secured $25.0 million revolving credit facility. As of May 25, 2021, no borrowings were outstanding under the Credit Agreement. As of December 31, 2021, we had no outstanding unamortized loan fees for the Credit Agreement.

On March 16, 2021, we issued $250.0 million aggregate principal amount of the 2028 Convertible Notes in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act. The interest on the 2028 Convertible Notes is payable semi-annually in arrears on April 1 and October 1 of each year, beginning on October 1, 2021. The 2028 Convertible Notes may bear special interest under specified circumstances relating to our failure to comply with our reporting obligations under the indenture governing the 2028 Convertible Notes (the “2028 Indenture”) or if the 2028 Convertible Notes are not freely tradeable as required by the 2028 Indenture. The 2028 Convertible Notes will mature on April 1, 2028, unless earlier repurchased, redeemed by us, or converted pursuant to their terms. The total net proceeds from the 2028 Convertible Notes, after deducting initial purchaser discounts, costs related to the 2028 Capped Calls, and debt issuance costs, paid or payable by us, were approximately $217.0 million.

On February 28, 2020, we issued $400.0 million aggregate principal amount of the Convertible Notes in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act, including $50.0 million aggregate principal amount of such Convertible Notes pursuant to the exercise in full of the initial purchasers’ over-allotment option. The interest on the Convertible Notes is payable semi-annually in arrears on March 1 and September 1 of each year, beginning on September 1, 2020. The 2026 Convertible Notes may bear special interest under specified circumstances relating to our failure to comply with our reporting obligations under the indenture governing the 2026 Convertible Notes (the “2026 Indenture”) or if the 2026 Convertible Notes are not freely tradeable as required by the 2026 Indenture. The 2026 Convertible Notes will mature on March 1, 2026, unless earlier repurchased, redeemed by us, or converted pursuant to their terms. The total net proceeds from the Convertible Notes, after deducting initial purchaser discounts, costs related to the Capped Calls, and debt issuance costs, paid or payable by us, were approximately $344.7 million.

Non-GAAP Financial Measures

We use Non-GAAP gross profit, Non-GAAP gross margin, Non-GAAP net (loss) income, Adjusted EBITDA 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, Non-GAAP net (loss) income, Adjusted EBITDA 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. See below for a reconciliation of each of the non-GAAP financial measures described 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 Statements of Operations-Cost of Revenue and Gross Margin.” We define Non-GAAP gross profit as gross profit after adding back the following items:

•depreciation and amortization;

•amortization of acquired intangible assets related to acquisitions; and

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•stock-based compensation.

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

In our calculation of Non-GAAP gross profit and Non-GAAP gross margin, we eliminate the impact of depreciation and amortization, amortization of acquired intangible assets related to acquisitions, and stock-based compensation, all non-cash items, because we do not consider them indicative of our core operating performance. The exclusion of these items facilitates comparisons of our operating performance on a period-to-period basis. 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 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 we do.

Consolidated

By Segment

CPaaS

Other

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

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Non-GAAP Net (Loss) Income

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

•stock-based compensation;

•amortization of acquired intangible assets related to acquisitions;

•amortization of debt discount and issuance costs for convertible debt;

•acquisition related expenses;

•impairment charges of intangibles assets, if any;

•loss (gain) on disposal of property and equipment;

•net cost associated with early lease terminations and leases without economic benefit

•estimated tax impact of above adjustments;

•income tax benefit resulting from excess tax benefits associated with the exercise of stock options, vesting of restricted stock units and equity compensation; and

•expense resulting from recording the valuation allowance on our deferred tax assets.

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. The tax-effect of Non-GAAP adjustments is determined using a blended rate of statutory tax rates in the jurisdictions where we have tax filings. When we have a valuation allowance recorded and no tax benefits will be recognized, the rate is considered to be zero.

We believe Non-GAAP net (loss) 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 (loss) 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.

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________________________

(1) The Non-GAAP tax-effect adjustments are calculated based on statutory tax rates in the jurisdictions where we have has tax filings. When we have a valuation allowance recorded and no tax benefits will be recognized, the rate in that jurisdiction is considered to be zero. The rate was 25.2%, 1.8%, 13.2% for the years ended December 31, 2019, 2020 and 2021, respectively.

(2) The Company recognized a tax expense of $0.0 million, $15.0 million, and $9.6 million to record a valuation allowance on U.S. deferred tax assets in the years ended December 31, 2019, 2020 and 2021, respectively.

Adjusted EBITDA

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

•income tax provision (benefit);

•interest (income) expense, net;

•depreciation and amortization expense;

•acquisition related expenses;

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•stock-based compensation expense;

•impairment of intangible assets, if any;

•loss (gain) on disposal of property and equipment, if any; and

•net cost associated with early lease terminations and leases without economic benefit

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.

________________________

(1) Includes $0.0 million, $15.0 million, and $9.6 million of tax expense to record a valuation allowance on U.S. deferred tax assets for the years ended December 31, 2019, 2020 and 2021, respectively.

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 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 to invest in our business. Free cash flow has certain limitations because 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 residual cash flows available for discretionary expenditures. Therefore, it is important to evaluate free cash flow along with our consolidated statements of cash flows.

________________________

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

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(2) Includes the net cash used from the purchase of land of $(30.0) million offset by the proceeds from sale of land of $17.5 million from investing activities of the consolidated statement of cash flows for the year ended December 31, 2021.

Critical Accounting Policies and Significant Judgments and Estimates

Our consolidated financial statements are prepared in accordance with GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs, and expenses and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these judgments and estimates under different assumptions or conditions, and any such differences may be material.

We believe the accounting policies discussed below are critical to the process of making significant judgments and estimates in the preparation of our financial statements, and to understanding our historical and future performance.

Revenue Recognition and Deferred Revenue

We generate revenue primarily from the sale of communications services to enterprise customers. Revenue recognition commences upon transfer of control of promised goods or services to customers in an amount that we expect to receive in exchange for those goods or services.

The majority of our revenue is generated from usage-based fees earned from customers accessing our communications platform. Access to the communications platform is considered a series of distinct services, with continuous transfer of control to the customer, comprising one performance obligation. Usage-based fees are recognized in revenue in the period the traffic traverses our network.

Revenue from service-based fees, such as the provision and management of phone numbers and emergency services access, is recognized on a ratable basis as the service is provided, which is typically one month.

We enter into arrangements with customers that are typically 2 to 3 years in length with an auto-renewal feature. When required as part of providing service, revenues and associated expenses related to nonrefundable, upfront service activation and setup fees are deferred and recognized over the longer of the associated service contract period or estimated period of benefit.

Our arrangements do not contain general rights of return or provide customers with the right to take possession of the software supporting the applications. Amounts that have been invoiced are recorded in accounts receivable and in revenue or deferred revenue depending on whether the revenue recognition criteria have been met.

We maintain a reserve for sales credits. Credits are accounted for as variable consideration and are estimated based on several inputs including historical experience, contractual obligations and current trends of credit issuances. Adjustments to the reserve are recorded against revenue.

Business Combinations

We use the acquisition method of accounting for business combinations which requires the tangible and intangible assets acquired and liabilities assumed to be recorded at their respective fair market value as of the acquisition date. Goodwill represents the excess of the consideration transferred over the fair value of the net assets acquired. The fair values of the assets acquired and liabilities assumed are determined based upon management's valuation and involves making significant estimates and assumptions based on facts and circumstances that existed as of the acquisition date. We use a measurement period following the acquisition date to gather information that existed as of the acquisition date that is needed to determine the fair value of the assets acquired and liabilities

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assumed. The measurement period ends once all information is obtained, but no later than one year from the acquisition date.

Goodwill and Intangible Assets

Goodwill

Goodwill represents the excess of the aggregate fair value of consideration transferred in a business combination, over the fair value of assets acquired, net of liabilities assumed. Goodwill is not amortized, but is subject to an annual impairment test. We test goodwill for impairment annually on December 31 of each calendar year or more frequently if events or changes in business circumstances indicate the asset might be impaired. Goodwill is tested for impairment at the reporting unit level. In evaluating the recoverability of goodwill, we perform a qualitative analysis to determine whether events and circumstances exist that indicate that it is more likely than not that goodwill is impaired. The qualitative factors we consider include but are not limited to, macroeconomic conditions, industry and market conditions, company-specific events and changes in circumstances. We completed our annual goodwill impairment analysis in each of the years ended December 31, 2019, 2020 and 2021 and no impairment charges were recorded. As of December 31, 2021 goodwill was $344.4 million which has been assigned to the CPaaS segment.

Long-Lived Assets

Long-lived assets, including intangible assets with definite lives, are amortized over their estimated useful lives and are reviewed for impairment if indicators of impairment arise.

We evaluate the recoverability of our long-lived assets for impairment whenever events or circumstances indicate that the carrying amount of the assets may not be recoverable. Recoverability of long-lived assets are measured by comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. As of December 31, 2021, intangible assets, net of accumulated amortization, were $211.2 million, which consists primarily of client relationships, client contracts and developed technology. No indicators of impairment were identified for the years ended December 31, 2019, 2020 and 2021.

Internal-Use Software Development Costs

Internal-use software includes software that has been acquired, internally developed, or modified exclusively to meet the Company's needs. We capitalize qualifying internal-use software development costs that are incurred during the application development stage. Capitalization of costs begins when two criteria are met: (i) the preliminary project stage is completed and (ii) it is probable that the software will be completed and used for its intended function. Capitalization ceases when the software is substantially complete and ready for its intended use, including the completion of all significant testing. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality and expense costs incurred for maintenance and minor upgrades and enhancements. Costs related to preliminary project activities and post-implementation operating activities are expensed as incurred. As of December 31, 2021, software development costs, net of accumulated amortization, were $7.5 million.

Capitalized costs of platform and other software applications are included in property and equipment. These costs are amortized over the estimated useful life of the software on a straight-line basis over three years, which is recorded in cost of revenue in the statement of operations. We evaluate the useful life of these assets on an annual basis and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets.

Income Taxes

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We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that are included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

We reduce the measurement of a deferred tax asset, if necessary, by a valuation allowance if it is more likely than not that we will not realize some or all the deferred tax asset. Quarterly, we review the deferred tax assets for recoverability based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences, the implementation of prudent and feasible tax planning strategies, and results of recent operations. The evaluation of the recoverability of deferred tax assets requires judgment in assessing future profitability. Should there be a change in the ability to recover deferred tax assets, our income tax provision would increase or decrease in the period in which the assessment is changed.

We account for uncertain tax positions by recognizing the financial statement effects of a tax position only when, based upon technical merits, it is more likely than not that the position will be sustained upon examination. The tax benefit recognized is measured as the largest amount of benefit determined on a cumulative probability basis that we believe is more likely than not to be realized upon ultimate settlement of the position. We recognize potential accrued interest and penalties associated with unrecognized tax positions in income tax expense.

Other Contingencies

We are subject to legal proceedings and litigation arising in the ordinary course of business. Periodically, we evaluate the status of each legal matter and assess our potential financial exposure. If the potential loss from any legal proceeding or litigation is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is involved in the determination of the probability of a loss and whether the amount of the loss is reasonably estimable. The outcome of any proceeding is not determinable in advance. As a result, the assessment of a potential liability and the amount of any accruals recorded are based only on the information available to us at the time. As additional information becomes available, we reassess the potential liability related to the legal proceeding or litigation, and may revise our estimates. Any revisions could have a material effect on our results of operations.

We conduct operations in many tax jurisdictions throughout the United States and globally. In many of these jurisdictions, non-income-based taxes and fees, such as sales and use taxes, Value Added Taxes (“VAT”), telecommunications taxes, and regulatory fees including those associated with (or potentially associated with) VoIP telephony services or 911 services, are assessed or may be assessed on our operations. We are subject to indirect taxes, and may be subject to certain other taxes and surcharges in some of these jurisdictions. We generally bill and collect from our customers these taxes and surcharges. We record a liability for tax collected from customers but not yet paid to the appropriate jurisdiction. In addition, we record a provision for non-income based taxes and fees in jurisdictions where it is both probable that liability has been incurred and the amount of the exposure can be reasonably estimated. As a result, we have recorded a liability of $5.4 million, $9.1 million and $11.0 million as of December 31, 2019, 2020 and 2021, respectively, included in accrued expenses and other current liabilities. These estimates are based on several key assumptions, including the taxability of our services, the jurisdictions in which we believe we have nexus and the sourcing of revenue to those jurisdictions. In the event these jurisdictions challenge our assumptions and analysis, our actual exposure could differ materially from our current estimates.

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Recently Issued Accounting Guidance

See Note 2, “Summary of Significant Accounting Policies” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for a summary of recently adopted accounting standards and recent accounting pronouncements not yet adopted.

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