Bandwidth Inc. (BAND) FY 2022 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

A global communications transformation is underway, and we believe Bandwidth is at the center. Our mission is to develop and deliver the power to communicate. We enable innovative organizations—from startup app developers to the world’s largest enterprises—to engage their end-users and deliver exceptional experiences everywhere people live, learn, work and play. Backed by the Bandwidth Communications Cloud, a global owned-and-operated network spanning more than 60 countries reaching over 90 percent of GDP, innovative enterprises use Bandwidth’s APIs to easily embed voice, messaging and emergency services capabilities into software and applications. Bandwidth was the first CPaaS provider to offer a robust selection of APIs built on our own cloud platform. Our award-winning support teams help businesses around the world solve complex communications challenges every day.

Bandwidth’s business benefits from multiple global megatrends, including the enterprise migration to the cloud, the adoption of Contact Center as a Service platforms, the need to be able to work from anywhere, the reinvention of customer experience and the growth in messaging applications to engage directly with consumers. We believe these megatrends, which have created sizable total addressable markets, are secular, long-lasting and still early in the adoption curve.

With the combination of our software APIs, our global Communications Cloud and our broad range of experience with global regulatory frameworks, we believe Bandwidth is one of the best-positioned providers in our space to deliver business-critical communications for global enterprises. In fact, Bandwidth already powers all the 2022 GartnerⓇ Magic Quadrant Leaders in the key cloud communications categories of UCaaS and CCaaS.

Our long-term vision is to continue strengthening this position as the key enabling platform for communications transformation. We will seek to do this in three ways: (1) by cross-selling and up-selling within our existing customers as they benefit from our global footprint and powerful APIs to automate and scale cloud communications; (2) by focusing on direct-to-enterprise growth to serve Global 2000 enterprises that come directly to Bandwidth to leverage our services to accelerate their digital transformations, and (3) by aiming to be the preferred provider for SaaS platforms that use conversational messaging to create digital engagements that enhance the customer experience. These three strategies are the foundation of the durable business we seek to build.

For the years ended December 31, 2022, 2021 and 2020, total revenue was $573 million, $491 million and $343 million, respectively, representing an increase of 17% in 2022 and 43% in 2021. Net income in 2022 was $20 million, and net loss in 2021 and 2020 was $27 million and $44 million, respectively. As of December 31, 2022, 2021 and 2020, the number of active customer accounts was 3,405, 3,300, and 2,879, respectively, representing a year-over-year increase of 3% in 2022 and 15% in 2021.

Segment Reporting Update and Cost Alignment

As a result of certain changes in our business during the quarter ended March 31, 2022, we re-evaluated our segment reporting and determined that one segment was appropriate, rather than the previously reported segments comprising “CPaaS” and “Other”. The primary drivers for this change were the strategic alignment of our operating departments and the sale of certain immaterial legacy businesses.

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Additionally, during the quarter ended March 31, 2022, we changed our presentation of certain costs to align with benchmarked definitions of cost of revenue, research and development, sales and marketing and general and administrative expenses. See Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information. For both matters, prior period information has been conformed to the current period presentation.

The following is a comparison of the change in costs to the prior period:

Adoption of Accounting Standards Update 2020-06

We adopted Accounting Standards Update 2020-06 (“ASU 2020-06”) on January 1, 2022 using the modified retrospective approach resulting in decreases in accumulated deficit of $9 million, additional paid in capital of $156 million, and deferred tax liability of $1 million. We also recorded an increase in the Convertible Notes balance of $148 million as a result of the reversal of the separation of the convertible debt between debt and equity. The adoption of this standard decreased the amount of non-cash interest expense to be recognized in current and future periods as a result of eliminating the discount associated with the equity component. For the year ended December 31, 2022, the combined interest expense of the 2026 Convertible Notes and 2028 Convertible Notes was $27 million lower upon the adoption of ASU 2020-06. The number of diluted shares increased as a result of transitioning from the treasury stock method to the as-if converted method, which impacted the earnings per share for the year ended December 31, 2022. The transition did not impact the years ended December 31, 2021 and 2020, as we incurred a net loss in both reporting periods. See Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.

Repurchase of 2026 Convertible Notes

During November 2022, we entered into separate, privately negotiated repurchase agreements with a limited number of holders of the 2026 Convertible Notes to repurchase (the “Repurchases”) approximately $160 million aggregate principal amount of the 2026 Convertible Notes for an aggregate cash price of approximately $117 million. The Repurchases closed on November 28, 2022. Following the Repurchases, approximately $240 million aggregate principal amount of the 2026 Convertible Notes remains outstanding. The difference between the consideration used to repurchase the 2026 Convertible Notes and the carrying value of the 2026 Convertible Notes resulted in a gain of $40 million recorded within other income (expense), net on our consolidated statements of operations included elsewhere in this Annual Report on Form 10-K.

COVID-19 Update

We believe COVID-19 has reduced to endemic levels globally however, while its persistent nature has diminished in the present period, it is possible it could potentially impact areas of the United States or the rest of the world to varying degrees in the future. During the COVID-19 pandemic, its adverse effects were prevalent in the locations where we, our customers, suppliers and third-party business partners conduct business. We acknowledge there may be additional impacts to the economy and our business going forward as a result of COVID-19 and that

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there is uncertainty regarding potentially broad or unknown implications of COVID-19 on our results of operations and overall financial performance remain uncertain. If the COVID-19 infection rate were to return to pandemic levels in the United States or in other global territories where we operate, we may experience curtailed customer demand that could materially adversely impact our business, results of operations and overall financial performance in future periods. Specifically, this could result in enterprises reducing usage of our services or delaying decisions to implement our services. See “Item 1A. Risk Factors” for further discussion of the possible impact of COVID-19 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 proven 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.

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) As a result of the change in revenue segment reporting, our KPIs of number of active customers and dollar-based net retention rates disclosed in previous SEC filings, press releases and presentations prior to reporting periods ending March 31, 2022, will not be directly comparable to our KPIs reported going forward. To facilitate comparison between the periods presented in the table above, number of active customers and dollar-based net retention rate have been conformed to the current period methodology.

Number of Active Customer Accounts

We define an active customer account at the end of any period as an individual account, as identified by a unique account identifier, for which we have recognized at least $100 of revenue in the last month of the period. We believe usage of our platform by an active 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 customer accounts if it has multiple unique account identifiers, each of which is treated as a separate active customer account. Customers who pay after using our platform and customers that have credit balances are included in the number of active customer accounts. For comparative purposes, the number of active customers presented in the table above has been updated to reflect the change in our reporting segments.

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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 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 revenue. To calculate the dollar-based net retention rate, we first identify the cohort of customers that generate revenue and that were customers in the same quarter of the prior year. The dollar-based net retention rate is obtained by dividing the revenue generated from that cohort in a quarter, by the revenue generated from that same cohort in the corresponding quarter in the prior year. The dollar-based net retention rate reported in a quarter is then obtained by averaging the result from that quarter, by the corresponding results from each of the prior three quarters. Customers of acquired businesses are included in the subsequent year’s calendar quarter of acquisition. 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 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 revenue in a quarterly reporting period) that has created a new customer, this new customer is tied to, and revenue from this new customer is included with, the original customer for the purposes of calculating this metric. For comparative purposes, the dollar-based net retention rate presented in the table above has been updated to reflect the change in our reporting segments.

Key Components of Statements of Operations

Revenue

Revenue is derived from (i) reoccurring sources such as per minute voice usage and voice calling, per text message usage and other usage services and fees, (ii) monthly recurring charges arising from phone number services, 911-enabled phone number services, messaging services and other services, and (iii) other various communications services and products, indirect revenue and messaging surcharge revenue.

For the years ended December 31, 2022, 2021 and 2020, we generated 78%, 75%, and 74%, respectively, of our revenue from reoccurring sources. The large bulk of our remaining revenue is generated from recurring monthly charges.

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 45%, 52%, and 50% of outstanding accounts receivable, net of allowance for doubtful accounts, as of December 31, 2022, 2021 and 2020, respectively.

Cost of Revenue and Gross Margin

Cost of revenue consists of fees paid to other network service providers, network operations costs, personnel costs, allocated costs of facilities and information technology, amortization of acquired technology intangibles and depreciation.

Fees paid to other network service providers arise when we purchase services such as minutes of use, phone numbers, messages, porting of customer numbers and network circuits.

Network operations costs are incurred for web services and cloud infrastructure, capacity planning and management, software licenses, hardware and software maintenance fees, customer support and network-related facility rents.

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Personnel costs (including non-cash stock-based compensation expenses) arise for employees who are responsible for the delivery of services and the operations and maintenance of the communications network.

Gross margin is calculated by subtracting cost of revenue from revenue, divided by 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.

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 driven by the growth in our business.

Research and Development

Research and development expenses consist of salaries and related personnel costs for the design, development, testing and enhancement of our cloud network and software products. Research and development expenses include depreciation and allocated costs of facilities and information technology utilized by our research and development staff.

Sales and Marketing

Sales and marketing expenses consist of salaries and related personnel costs, commissions, and costs related to advertising, marketing, brand awareness activities, sales support and professional services fees, and customer billing and collections functions. Sales and marketing expenses include depreciation, amortization of acquired customer relationship intangible assets, and allocated costs of facilities and information technology utilized by our sales and marketing staff.

General and Administrative

General and administrative expenses consist of salaries and related personnel costs for accounting, legal, human resources, corporate, and other administrative and compliance functions. General and administrative expenses include depreciation, expenditures for third party professional services, and allocated costs of facilities and information technology utilized by our corporate and administrative staff.

Income Taxes

For the years ended December 31, 2022, 2021 and 2020 our effective tax rate was (13.1)%, 12.3% and (51.8)%, respectively. The decrease in our effective tax rate is primarily due to the split of earnings and losses between jurisdictions. In 2022 we were in a pre-tax loss position in jurisdictions without valuation allowances and as such, recognized income tax benefit. However, as a result of income recognized in connection with our debt buy-back, we recognized pre-tax income in the U.S. The income resulted in nominal tax expense in the U.S. due to the utilization of tax attributes and the valuation allowance position.

Judgment is required in determining whether deferred tax assets will be realized in full or in part. Management assesses the available positive and negative evidence on a jurisdictional basis to estimate if deferred tax assets will be recognized and 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, 2022, we continue to maintain a valuation allowance for our 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.

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, 2022 and 2021

Revenue

In 2022, our total revenue increased by $82 million, or 17%, compared with the same period in 2021. This growth was the result of higher usage of our core messaging offering and additional A2P pass-through messaging surcharges imposed by certain carriers. Growth in our revenue other than from pass-through messaging surcharges, compared with the same period in 2021, was led by our core messaging offerings, which grew 46%, and phone number and 911-enabled phone number services, mostly offset by lower revenue from voice offerings. The growth in our core messaging offering was aided by higher messaging volumes from certain customers leading up to the U.S. midterm elections in November 2022. Compared with the same period last year, our voice offerings revenue in 2022 remained affected by lower usage arising from the 2021 DDoS incident as well as the absence of revenue from businesses divested earlier in 2022.

Active customer accounts increased 3% to 3,405 as of December 31, 2022, as compared with 3,300 active accounts as of December 31, 2021. Our dollar-based net retention rate as of December 31, 2022 was 112%.

Cost of Revenue and Gross Margin

In 2022, total cost of revenue increased $58 million, compared with the same period in 2021, driven by higher pass-through messaging surcharges of $56 million. In 2022, the combination of changes in total revenue and total cost of revenue yielded an increase in total gross profit of $25 million, or 11%, compared with the same period in 2021, driven by profit improvements from the combination of our revenue and cost of revenue derived other than from pass-through messaging surcharges.

Our total gross margin percentage of 42% in 2022 declined two percentage points, compared with the same period in 2021, as operating and product mix improvements were more than offset by the inclusion of higher pass-through messaging surcharges within total revenue.

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Operating Expenses

As a percentage of revenue, total operating expenses for the years ended December 31, 2022 and 2021 were 46% and 44%, respectively.

In 2022, research and development expenses increased by approximately $28 million, or 41%, compared with the same period in 2021. This increase was primarily due to increased personnel costs from greater numbers of employed staff of $22 million. The increase in headcount also contributed to higher allocated facilities and IT expenses of $7 million.

In 2022, sales and marketing expenses increased by $14 million, or 17%, compared with the same period in 2021, primarily due to an increase in sales personnel costs from a greater number of employed staff of $13 million.

In 2022, general and administrative expenses increased $4 million, or 6%, compared with the same period in 2021, primarily due to an increase in personnel costs of $5 million.

Interest Expense, Net

In 2022, interest expense, net of interest income, decreased by $26 million compared with the same period in 2021, due to a $24 million decrease in interest expense primarily related to the impact of the adoption of ASU 2020-06 on the Convertible Notes. See Note 8, “Debt,” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details.

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Income Tax Benefit

For the year ended December 31, 2022, we recognized an income tax benefit of $2 million, a decrease of $2 million compared with the same period in 2021. The resulting effective tax rate for the year ended December 31, 2022 was (13.1)% compared with 12.3% in 2021. For the year ended December 31, 2022, the favorable change to the effective tax rate was primarily due to the split of earnings and losses between jurisdictions. In 2022, we were in a pre-tax loss position in jurisdictions without valuation allowances and as such, recognized income tax benefit. However, as a result of income recognized in connection with our debt buy-back, we recognized pre-tax income in the U.S. This income resulted in nominal income tax expense in the U.S. due to the utilization of tax attributes and the valuation allowance position. For the years ended December 31, 2022 and 2021, the effective tax rates of (13.1)% and 12.3%, respectively, differed from the federal statutory rate of 21% in the U.S. primarily due to the valuation allowance recognized against federal and state deferred tax assets in the U.S.

Most of the permanent tax adjustments within our effective tax rate are offset by a valuation allowance. These adjustments include state taxes, federal research tax credits under Internal Revenue Code Section 41, equity compensation in the U.S. and other non-deductible expenditures in the U.S. Excluding the impact of the valuation allowance, we realize an estimated state effective tax rate of 4.3%. In addition, exclusive of the valuation allowance, we continue to generate income tax benefits in the current period related to income tax credits recognized for qualified research activities in the U.S. The applicable federal tax law and regulations define qualified research activities as research and development activities conducted in the U.S. that involve a process of experimentation designed to discover new information intended to develop a new or improved business component. Absent the valuation allowance, equity compensation also impacts the effective tax rate to the extent the income tax deduction exceeds or is below the related book expense, as required under ASC 718-740-35-2. Other U.S. non-deductible expenses that are offset by the valuation allowance consist primarily of non-deductible executive compensation under Internal Revenue Code 162(m).

Permanent tax adjustments within our effective tax rate that are not offset by the valuation allowance included minimum state taxes, foreign tax benefits and foreign rate differentials. As we continue to scale our international business, any changes to foreign business activity may impact our effective tax rate in the future.

We continue to expect recurring changes to the valuation allowance as deferred tax assets within the U.S. increase or decrease in subsequent periods. We will maintain a valuation allowance against all U.S. federal and state deferred tax assets until it becomes more likely than not that the benefit of our federal and state deferred tax assets will be realized.

Comparison of the Years Ended December 31, 2021 and 2020

Revenue

In 2021, our total revenue increased by $148 million, or 43%, compared with the same period in 2020. This growth was led by increases in our core voice, messaging and related surcharges, and phone number services of $71 million, $41 million, and $26 million, respectively. This growth was aided by a full year of revenue contribution from the acquisition of Voxbone in November 2020. 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 2021 DDoS Attack.

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Cost of Revenue and Gross Margin

In 2021, total cost of revenue increased $88 million, compared with the same period in 2020. This growth was driven by higher cost of revenue in our messaging business and related surcharges, network related costs, and core voice of $33 million, $24 million, and $23 million, respectively. This growth was aided by a full year of cost of revenue contribution from the acquisition of Voxbone in November 2020.

In 2021, the combination of changes in total revenue and total cost of revenue yielded an increase in total gross profit of $60 million, or 39%, compared with the same period in 2020, driven by higher revenue and improved operating leverage. For the year ended December 31, 2021, total gross margin was 44.0% compared with 45.0% for the year ended December 31, 2020 and was impacted by higher pass-through messaging surcharges within total revenue.

Operating Expenses

As a percentage of revenue, total operating expenses for the years ended December 31, 2021 and 2020, were 44% and 49%, respectively.

In 2021, research and development expenses increased by approximately $15 million, or 27%, compared with the same period in 2020. This increase was primarily due to increased personnel costs from greater numbers of employed staff of $10 million, which was driven by the acquisition of Voxbone in November 2020.

In 2021, sales and marketing expenses increased by $21 million, or 34%, compared with the same period in 2020, driven by the increase in sales personnel costs from a greater number of employed staff of $8 million from the acquisition of Voxbone in November 2020.

In 2021, general and administrative expenses increased by approximately $13 million, or 24%, compared with the same period in 2020, mainly from higher headcount costs of $14 million, driven by the acquisition of Voxbone in November 2020.

Interest Expense, Net

In 2021, interest expense, net of interest income increased by $15 million compared with the same period in 2020, due to a $12 million increase in interest expense related to the Convertible Notes and a $2 million decrease in interest income from the investment of follow-on equity offering proceeds. See Note 8, “Debt,” to the consolidated financial statements, for additional details.

Income Tax Benefit (Provision)

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In 2021, income tax expense decreased by $19 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.

Liquidity and Capital Resources

Our liquidity is provided by our cash flow from operations less expenditures for capital equipment, and supplemented by financing activities from time to time. Our cash flow from operations is driven by monthly payments from customers for communication services consumed during the period. Our primary uses of cash include operating costs, such as fees paid to other network service providers, network operations costs, personnel costs and facility expenses, as well as the purchase of property plant and equipment to support growth on our communications platform and the purchase of land for our new corporate headquarters.

On June 6, 2022, we entered into a credit agreement (the “Credit Agreement”) among us, as borrower, the lenders from time to time party thereto, and Silicon Valley Bank as administrative agent, issuing lender and swingline lender. The Credit Agreement provides for a $50 million revolving credit facility (the “Credit Facility”), including a $20 million sublimit for the issuance of letters of credit and a swingline subfacility of up to $5 million. The Credit Facility matures on June 6, 2025. As of December 31, 2022, there were no borrowings under the Credit Facility.

Additionally, in the last three years we have supplemented our liquidity with proceeds from our issuance of the 2026 Convertible Notes and the 2028 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 of Voxbone. On November 2, 2022, we repurchased $160 million of our 2026 Convertible Notes as further described in Note 8, “Debt,” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. We may, at any time and from time to time, seek to retire or purchase our 2026 Notes or 2028 Notes through cash purchases and/or exchanges for equity or debt, in open-market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

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.

Our principal future commitments consist of (i) an aggregate of $490 million in Convertible Notes (see Note 8, “Debt” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, for a discussion of the 2026 Convertible Notes and the 2028 Convertible Notes), (ii) a $496 million non-cancelable lease for our future office headquarters, which is anticipated to commence in mid-2023 and continue for an initial twenty (20) year term (the “Headquarters Lease”) (see Note 5, “Right-of-Use Asset and Lease Liabilities” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a discussion of our Headquarters Lease), (iii) $12 million in non-cancelable purchase obligations and future minimum payments under contracts to various service providers, and (iv) $17 million in future minimum rent payments for our current office space. See Note 12, “Commitments and Contingencies,” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for future lease commitments.

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Statement of Cash Flows

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

Cash Flows from Operating Activities

In 2022, net cash provided by operating activities was $35 million and was generated by our aggregate results of $40 million during the period, net of non-cash items comprising depreciation and amortization, non-cash reduction to the right-of-use asset, amortization of debt discount and issuance costs, stock-based compensation, deferred tax expense and other and net gain on extinguishment of debt and a $14 million cash inflow from increased operating liabilities, partially offset by a net cash outflow from operating assets aggregating $19 million. The net gain on extinguishment of debt was a result of the repurchase of $160 million aggregate principal amount of the 2026 Convertible Notes. Within operating liabilities, the net cash provided as a result of higher accounts payable of $17 million during 2022 was primarily related to the timing and amounts of purchases of both services and tangible goods and their related payment arrangements. The cash provided as a result of higher accrued expenses and other liabilities of $3 million during 2022 primarily related to higher accruals for lease incentives and higher advanced billings. This was partially offset by a cash outflow related to the operating right-of-use liability of $8 million. Within operating assets, cash used as a result of higher accounts receivable of $13 million during 2022 was driven by higher unbilled receivables balances of $2 million arising from higher usage amounts in the last month of 2022 and $11 million from timing of collection of invoiced amounts. The cash used as a result of higher prepaid expenses and other assets of $6 million during 2022 was driven by higher VAT receivables and the timing of advance payments for software and other services.

In 2021, net cash provided by operating activities was $41 million consisting of net loss of $27 million adjusted for non-cash items of $76 million and offset by cash used by changes in operating assets and liabilities of $8 million. Cash used in operating assets and liabilities included an increase in accounts receivable of $7 million, a decrease in operating right-of-use liability of $6 million, and an increase in prepaid expenses and other assets of $7 million. Offsetting these cash use items in assets and liabilities was an increase in accrued expenses and other liabilities of $10 million, and an increase in accounts payable of $2 million. The non-cash items included depreciation and amortization expense of $37 million, amortization of debt discount and issuance costs of $27 million, stock-based compensation expense of $15 million, right-of-use asset amortization of $6 million, and loss on disposal of property, plant and equipment of $1 million, offset by a deferred tax benefit of $8 million.

In 2020, net cash provided by operating activities was $5 million consisting of net loss of $44 million adjusted for non-cash items of $62 million and offset by cash used changes in operating assets and liabilities of $13 million. Cash generated in operating assets and liabilities included an increase in accrued expenses and other liabilities of $14 million. Offsetting these cash generating items in assets and liabilities were an increase in accounts receivable of $19 million, a decrease in operating right-of-use liability of $5 million, and an increase in prepaid expenses and other assets of $4 million. The non-cash items included depreciation and amortization expense of $17

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million, amortization of debt discount and issuance costs of $16 million, deferred tax expense of $14 million, stock-based compensation expenses of $10 million, and right-of-use amortization of $5 million.

Cash Flows from Investing Activities

In 2022, net cash used in investing activities was $133 million. Cash used in investing activities included the purchase of marketable securities of $180 million partially offset by proceeds from the sales and maturities of marketable securities of $109 million. Cash used for deposits for construction in progress and the purchase of property, plant and equipment, primarily for our Raleigh, NC headquarters, was $60 million.

In 2021, net cash provided by investing activities was $3 million. Cash provided by investing activities included proceeds from sales and maturities of other investments of $40 million, proceeds from the sale of land of $17 million, offset by the purchase of land of $30 million, purchase of property, plant and equipment of $21 million and capitalized internally developed software costs of $4 million.

In 2020, net cash used in investing activities was $455 million, mainly from the costs related to the Voxbone acquisition of $400 million, net of cash. In addition, cash used in investing activities was the purchase of other investments of $231 million, the purchase of property, plant and equipment of $12 million and capitalized internally developed software costs of $2 million, offset by the proceeds from sales and maturities of other investments of $191 million.

Cash Flows from Financing Activities

In 2022, net cash used in financing activities was $120 million, consisting primarily of $117 million net cash paid to repurchase $160 million aggregate principal amount of the 2026 Convertible Notes.

In 2021, net cash provided by financing activities was $207 million consisting primarily of $250 million in proceeds from the issuance of the 2028 Convertible Notes and $1 million in proceeds from the exercise of stock options, partially offset by $26 million in the purchase of the 2028 Capped Calls, $8 million in payments of debt issuance cost, $7 million in payment of holdback proceeds to former Voxbone shareholders, and $4 million in value of equity awards withheld for tax liabilities.

In 2020, net cash provided by financing activities was $347 million consisting primarily of $400 million in proceeds from the issuance of the 2026 Convertible Notes and $4 million in proceeds from the exercise of stock options, partially offset by $43 million in the purchase of the 2026 Capped Calls, $12 million in payments of debt issuances cost, and $2 million in value of equity awards withheld for tax liabilities.

Off-Balance Sheet Arrangements

With the acquisition of Voxbone, we have off-balance sheet agreements for short-term office leases in the amount of less than $1 million ending prior to December 31, 2023.

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Management’s Discussion and Analysis

Non-GAAP Financial Measures

We use Non-GAAP gross profit, Non-GAAP gross margin, Non-GAAP net 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 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

•stock-based compensation

We calculate Non-GAAP gross margin by dividing Non-GAAP gross profit by revenue less pass-through messaging surcharges, 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, stock-based compensation, pass-through messaging surcharges, and 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.

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(1) Calculated by dividing Non-GAAP gross profit by revenue less pass-through messaging surcharges of $99 million, $41 million, and $11 million in the years ended December 31, 2022, 2021 and 2020, respectively.

Non-GAAP Net Income

We define Non-GAAP net income as net income or loss adjusted for certain items affecting period-to-period comparability. Non-GAAP net 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;

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

•(gain) loss on sale of business;

•net (gain) loss on extinguishment of debt;

•non-recurring items not indicative of ongoing operations and other; and

•estimated tax impact of above adjustments, net of valuation allowances

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 by recalculating the tax provision on a Non-GAAP basis. 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 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. As a result of the adoption of ASU No. 2020-06 on January 1, 2022, we add back cash interest expense on the Convertible Notes, as if converted at the beginning of the period, if the impact is dilutive for the purposes of calculating diluted Non-GAAP net income or loss per Non-GAAP share.

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(1) Non-recurring items not indicative of ongoing operations and other include $0.9 million of foreign currency losses on the settlement of intercompany borrowings, which were repatriated in conjunction with the repurchase of a portion of the 2026 Convertible Notes and $0.6 million of nonrecurring litigation expense for the year ended December 31, 2022, and $0.5 million, $0.8 million, and $0.3 million of losses on disposals of property, plant and equipment during the years ended December 31, 2022, 2021 and 2020, respectively.

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(2) The estimated tax-effect of adjustments is determined by recalculating the tax provision on a Non-GAAP basis. The Non-GAAP effective income tax rate was 7.0%, 14.2%, and 5.0% for the years ended December 31, 2022, 2021 and 2020, respectively. For the year ended December 31, 2022, the Non-GAAP effective income tax rate differed from the federal statutory tax rate of 21% in the U.S. primarily due to research and development tax credits generated in 2022. For the years ended December 31, 2021 and 2020, these effective income tax rates differ from the federal statutory tax rate of 21% in the U.S. primarily due to the valuation allowance recognized against federal and state deferred tax assets in the U.S. We analyze the Non-GAAP valuation allowance position on a quarterly basis. In the fourth quarter of 2022, we removed the valuation allowance against all U.S. deferred tax assets for Non-GAAP purposes as a result of cumulative Non-GAAP U.S. income over the past three years and a significant depletion of net operating loss and tax credit carryforwards on a Non-GAAP basis. As of December 31, 2022, we have no valuation allowance against our remaining deferred tax assets for Non-GAAP purposes.

(3) Upon the adoption of ASU 2020-06, net income is increased for interest expense as part of the calculation for diluted Non-GAAP earnings per share. See Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details on the adoption of ASU 2020-06.

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 (benefit) provision;

•interest (income) expense, net;

•depreciation and amortization expense;

•acquisition related expenses;

•stock-based compensation expense;

•impairment of intangible assets, if any;

•(gain) loss on sale of business;

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

•net (gain) loss on extinguishment of debt; and

•non-recurring items not indicative of ongoing operations and other

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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.

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(1) Non-recurring items not indicative of ongoing operations and other include $0.9 million of foreign currency losses on the settlement of intercompany borrowings, which were repatriated in conjunction with the repurchase of a portion of the 2026 Convertible Notes and $0.6 million of nonrecurring litigation expense for the year ended December 31, 2022, and $0.5 million, $0.8 million, and $0.3 million of losses on disposals of property, plant and equipment during the years ended December 31, 2022, 2021 and 2020, 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, 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 to invest in our business. Free cash flow has certain limitations because it is subject to working capital timing, 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.

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

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

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

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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, 2022, 2021 and 2020 and no impairment charges were recorded. As of December 31, 2022 goodwill was $326 million.

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, 2022, intangible assets, net of accumulated amortization, were $177 million, which consists primarily of client relationships, client contracts and developed technology. No indicators of impairment were identified for the years ended December 31, 2022, 2021 and 2020.

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, 2022, software development costs, net of accumulated amortization, were $8 million.

Capitalized costs of platform and other software applications are included in property, plant 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

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

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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 $8 million and $11 million as of December 31, 2022 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.

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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