Bandwidth Inc. (BAND) Q3 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the Bandwidth third quarter 2017 earnings results conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] I would now like to turn the conference over to your host, Seth Potter, Investor Relations.

Thank you and good afternoon and welcome to Bandwidth’s third quarter 2017 earnings call. Today, we’ll be discussing the results announced in our press release issued after the market closed. With me on the call this afternoon is David Morken, Bandwidth’s Chief Executive Officer and Jeff Hoffman, the Chief Financial Officer of Bandwidth. They'll begin with prepared remarks and then open the call for Q&A. During the call, we will make statements related to our business that may be considered forward-looking, including statements concerning our financial guidance for the fourth quarter of 2017 and full year 2017, our plan to execute our growth strategy, our ability to maintain existing and acquire new customers and other statements regarding our plans and prospects. Forward-looking statements may often be identified with words such as, we expect, we anticipate, or upcoming. These statements reflect our view only as of today and should not be considered our views as any substitute subsequent to this day. We undertake no obligation to update or revise these forward-looking statements. Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties that could cause the actual results to differ materially from our expectations. For a discussion of material risks and other important factors that could affect our actual results, please refer to those contained in our financial prospectus filed pursuant to Rule 424(b) on November 13, 2017 as updated by our other SEC filings, all of which are available on the Investors section of our website at bandwidth.com and on the SEC’s website at sec.gov. Finally, during the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our press release issued after the close of market today, which is located on our website at bandwidth.com and the SEC’s website at sec.gov. With that, let me turn the call over to David.

Thanks, Seth and thank you to everyone joining us today on our first call as a public company. Our IPO was an exciting milestone and Jeff and I would like to start by thanking our enterprise customers and our amazing Bandwidth teammates who've made our success possible. Given that this is our first earnings call, we thought it would be helpful to provide a brief overview of Bandwidth. I’ll then summarize the operating results for the third quarter and discuss our strategic growth initiatives before turning it over to Jeff Hoffman, our CFO. Enterprise customers use our software platform and our all IP network to provide voice calls, text messages and 911 services to end users of their applications and devices. You might use Bandwidth today if you use Google Voice, Microsoft Office 365, Skype for Business, RingCentral or smartphone apps like Pinger, Grubhub and ZipRecruiter. We believe we are entering a golden age of communications heralded by a new voice user interface, natural language processing and always on intelligent devices. We are honored to serve many of the leading companies who are ushering in this new era. Our software platform, nationwide network and amazing team give our customers the powerful tools they need to deliver the highest quality voice, messaging and emergency services for any application, website or device. Our software platform is uniquely positioned to meet the end-to-end needs of our enterprise customers. At the heart of our communications platform as a service or CPaaS solution is a robust set of application programming interfaces known as APIs that allow our enterprise customers to seamlessly integrate voice and messaging directly into their products, services and applications. The APIs are built to top, our nationwide all IP network that we own and control, which allows us to offer the kind of reliability and quality that an enterprise customer demands. In terms of the market opportunity, according to IDC, the overall CPaaS market is expected to reach $8.2 billion by 2021. We believe this market is being driven by a number of factors, including enterprise demand to embed communications into their applications. In today's mobile world, collaboration is more important than ever and the reason why enterprises are working to make communicating on the go easier and more accessible by incorporating voice and messaging into the applications we use every day, where we live, work and play. Over the last decade, voice calling has migrated toward unified communications as well as integrated solutions within enterprise applications, such as Google Suites and Office from Microsoft 365. Enterprise users communicate and collaborate using these applications, which use software powered communications platforms such as Bandwidths to carry out the calling and messaging functions. Another trend driving CPaaS growth is the shift to a voice driven interface from text. Voice first user interfaces built on natural language processing and AI technology are becoming a natural extension of existing voice enabled devices such as mobile phones. According to Gartner, by 2018, more than 2 billion people will use conversational AI to interact with virtual personal assistants known as VPAs, virtual customer assistants and other AI enabled smartphones and connected devices on a regular basis. By 2020, more than 50% of cloud interactions will be in homes with VPA speakers. Looking forward, we expect the rise of voice as an interface to further expand our opportunities. Amazon's Alexa, Google Assistant, Apple's Siri, Microsoft's Cortana and Facebook M are all examples of voice as the first new user interface since the mouse and touchscreen. Bandwidth is well positioned to benefit from all these trends as well as power the next wave of communication innovators providing services and devices for our connected homes, cars and workplaces. In regard to our differentiation in the market, we are the only CPaaS provider that combines both our API platform and our all IP network, which allows us the ability to offer enterprise customers the control and visibility they demand, so they can offer a high quality experience for their end user customers. Voice quality is critical for an enterprise since a delay could result in a dropped call or losing important parts of the conversation. In addition, we are the only CPaaS provider that offers our own 911 emergency network capabilities, allowing us to provide enterprise customers secure state-of-the-art 911 provisioning and a real time geospatial routing platform. Our third quarter results are evidence that our strategy is working. Total revenue came in at 41.3 million, driven by a 10% year-over-year increase in CPaaS revenue. In the third quarter, our active CPaaS customers increased 18% year-over-year to 918 customers. We're very proud to have achieved solid revenue growth with limited sales and marketing investment, given our bootstrapped history and believe our growth inflection point is ahead of us. Looking forward, our focus will be to accelerate our growth by adding new enterprise customers across a broad range of industries, which need enterprise grade voice and messaging services. We plan to use a portion of the IPO proceeds to ramp our sales and marketing efforts, given the demand we are seeing in the market. We expect our existing enterprise relationships to drive growth with not only increased usage of our platform, but often customers initiate with one of our services and subsequently add other solutions. Additionally, we frequently benefit from the opportunity to provide our services to different lines of business within existing customer organizations, particularly with larger enterprises where we engage with multiple product leaders across various lines of business. We also continue to build innovative product capabilities to meet our customer's needs. We intend to invest in the continued development of our platform and product features to support new use cases and help our enterprise customers succeed, as communications technologies evolve. Finally, given that some of our enterprise customers operate globally or have plans to do so, we plan to explore the development and growth of our international offerings. Today, our international business is immaterial and while we do not have specific expansion plans to announce today, we are actively exploring opportunities including those where we might have a cost or quality advantage in serving our customers. So in summary, we were very pleased with the strong execution in the third quarter. We remain excited about our future and our ability to grow our CPaaS customer base, expand with existing enterprise customers and further leverage our unique combination of our API platform and our all IP network. With that, let me hand it over to Jeff Hoffman, our CFO to walk through the financials in more detail. Jeff?

Thanks, David. I will provide a more detailed overview of our third quarter financial performance and then provide our outlook for the fourth quarter and full year 2017. Following my remarks, we will open up the call to your questions, but given that this is our first call as a public company, I wanted to provide some additional color on our business model. Our CPaaS segment is our focus and represents the majority of our revenue. CPaaS is a usage based revenue model, meaning, we charge our customers per voice minute, per phone number, per text message and per 911 enabled phone number. Voice usage from our enterprise customers is driven by voice communication, which consists of inbound, outbound and toll free voice minutes, while monthly service fees include the provisioning management of phone numbers and 911 enabled phone numbers. Messaging services are driven by the number of messages that go across our platform and network. Our other segment includes our legacy services such as SIP trunking data resale and hosted voice-over-IP as well as revenue generated from carriers, SMS registration fees and other miscellaneous products and services. This segment represents a smaller portion of our revenue and going forward is expected to continue to decline as a percentage of our total revenue. We monitor key metrics that we plan to share each quarter that collectively help us evaluate our business. We believe that the number of active CPaaS customer accounts is an important indicator of the growth of our business, the market acceptance of our platform and our future revenue trends. We define an active CPaaS customer account at the end of any period as an individual account for which we have recognized at least $100 of revenue in the last month of the period. Dollar based net retention rate is another key metric we track to measure our ability to maintain and grow our relationships with our existing customers. Dollar based net retention rate compares to the CPaaS revenue from customers in a quarter to the same quarter in the prior period. Now, let me turn to our third quarter results. We are pleased with our third quarter performance, which was driven by ongoing enterprise demand as enterprises continued to embed voice and messaging into software applications. Our results were consistent with the high end of the range provided in the recent development section of our prospectus. Our total revenue was 41.3 million in the third quarter, up 7% year-over-year. And within total revenue, CPaaS revenue was 33.4 million, up 10% year-over-year. Other revenue contributed the remaining 7.9 million of total revenue, down from 8.4 million in the third quarter 2016 due to the expected continued decline in legacy services. We ended the third quarter with 918 active CPaaS customer accounts, up 18% year-over-year. In addition, our dollar based net retention rate was 105% compared to 112% during the third quarter of 2016, which primarily reflects our decision to curtail services to a competitive CPaaS provider, which we expect to only impact the fourth quarter going forward. Before moving on to profitability metrics, I would like to point out that I will be discussing non-GAAP results going forward. Our GAAP financial results along with the full reconciliation between GAAP and non-GAAP results can be found in our earnings release. Our non-GAAP gross profit, which excludes stock-based compensation and depreciation, was 19.9 million, yielding a gross margin of 48% for the third quarter, an increase from 18.3 million and 47% respectively for the same period last year. The improvement was driven by our CPaaS segment where we realized an increase in CPaaS revenue and the declining unit costs for 911 phone numbers and voice services. Third quarter adjusted EBITDA was 5.2 million compared to 6.2 million for the same period last year, which reflects an increase in operating expenses, primarily driven by headcount related costs. As David had mentioned earlier, we are very pleased with Bandwidth’s ability to achieve solid revenue growth with limited sales and marketing investment throughout our self funded history. Given the successful IPO, we plan to expand our investments in sales and marketing in order to accelerate our growth going forward. Non-GAAP net income in the third quarter was 2.2 million or $0.15 per share based on 15 million weighted average diluted shares outstanding. On a GAAP basis, net income from continuing operations attributable to common stockholders for the third quarter of 2017 was 1.4 million or $0.11 per share based on 13.3 million weighted average diluted shares outstanding. During the third quarter, we generated 4.8 million in net cash from continuing operations and 2.7 million in free cash flow, which includes CapEx and capitalized software development costs for internal use of 2.1 million. Turning to the balance sheet, as of September 30, 2017, Bandwidth had cash and cash equivalents of 5.4 million and 38.5 million in debt. Subsequent to the end of the third quarter, Bandwidth closed its initial public offering of Class A common stock on November 14, 2017, which generated proceeds, net of underwriting discounts and commissions to the company of approximately 74.4 million, a portion of which was used to pay down all amounts outstanding under our term loan facility. Now, I'd like to finish with some thoughts regarding our financial outlook for 2017, starting with the fourth quarter. We expect fourth quarter CPaaS revenue to be in the range of 34.2 million to 34.7 million. We expect fourth quarter total revenue to be in the range of 41.4 million to 41.9 million, which reflects our CPaaS revenue guidance as well as the expected ongoing decrease in other revenue. Non-GAAP EPS is expected to be in the range of $0.00 to $0.01 per diluted share. This outlook assumes weighted average diluted shares outstanding of approximately 17.8 million, which includes the shares of Class A common stock issued by the company in the initial public offering as well as the conversion of the company's convertible preferred stock into shares of common stock. From a full year 2017 perspective, we expect CPaaS revenue to be in the range of 130.8 million to 131.3 million. We expect total revenue to be in the range of 161.9 million to 162.4 million. Non-GAAP EPS is expected to be in the range of $0.50 to $0.51 per diluted share. This outlook assumes weighted average diluted shares of approximately 16.1 million. So in summary, we're very pleased with our third quarter execution and remain excited about our ability to accelerate growth and leverage our software platform and all IP network. Bandwidth is addressing a large and growing marketplace and we believe we have an opportunity to build a very large business as voice continues to become the new user interface. With that, I will now hand the call back to the operator for the Q&A session.

[Operator Instructions] Our first question is from Meta Marshall, Morgan Stanley. Please proceed with your question.

Great. Thanks, guys. Congratulations on the quarter. I wanted to get a sense of now being public and trying to ramp your OpEx line items, what you're seeing as far as hiring? Are you able to onboard those people as quickly as possible? Is there any kind of slowdown ahead for the holiday season? And then just in kind of early reads since the IPO and targeting kind of customers you'd like to go after, are you seeing any difference in sales cycles or conversations before and after being public? Thanks.

Thank you, Meta. This is David and thanks very much for your question. In regard to hiring, this morning, I spent the bulk of my time interviewing and our team is hitting all cylinders, as you can imagine, deploying our proceeds as we outlined toward our growth going forward and that involves a focus in marketing and sales and other areas. We aren't providing specific guidance or numbers around key teams, but to answer your question, we're seeing our people services group execute the way that we've been proud of for quite a while and we anticipate that we'll continue to work hard to get the right folks in the right seats to execute our plan in ’18 and beyond. To the second part of your question and I think there are two parts to the second part of your question. We have identified target prospects that we're excited about approaching with both our existing strategic account representatives and our Hunter team and while there is a holiday fast approaching, historically, we haven't seen a whole lot of seasonality in our business. And so we’ll continue to sell through the holiday with an appropriate period, so it reflects the culture that we have at the company, but we're an aggressive team and focused on growth. Does that answer your question?

I guess I just wanted to get a sense of conversations with prospective customers. Have they changed any now that you've gone through -- now that they have seen a little bit more publicity from you guys or a little bit more marketing, has the conversation changed with prospective customers?

Our customers are, as you know, enterprise customers that do pay attention to the capital markets and to your stat as a private versus a public company and we've enjoyed inbound interest in our offering from enterprise customers that we don't think historically may have been able to find us, given our bootstrapped approach to marketing historically. So I would describe the public offering as a tailwind in terms of PR and that's reflected by activity on the sales desk.

Our next question is from Brent Bracelin, KeyBanc. Please proceed with your question.

This is Clarke Jeffries on the line for Brent. I just had a question around the announcements made at AWS re:Invent. They talked about [indiscernible] and one of the partners mentioned with RingCentral. I was just kind of curious whether your partnerships with those communication providers, does the relationship pull through to a service like that. I know there are many choices of conferencing providers in that service and so when RingCentral is the chosen provider to you, get economics from that relationship.

Thanks, Clarke. Well, we do have customers such as RingCentral. We don't -- we respect our enterprise customers and so I want to make sure that I'm careful in my answer. When we provide our platform and our network as a service to our customers, often, they'll have far end users that are using that service and we will benefit. But without answering the particular customer names of your question, that's a common experience we see across our customer base.

Okay. So it would be unfair to say that if RingCentral was plugged into a larger platform, it could be possible that the end user you would see benefit from them choosing that provider?

It could be possible.

And then I guess my second question would be around pricing, specifically within voice. Just looking at the providers, how often does pricing come in specifically what voice, just volume discounting among the major providers, is that a common occurrence or is voice something where network quality is sufficiently important so that prices is not part of that conversation.

Quality and cost are both important in every conversation with an enterprise customer and our enterprise customers come to us and sign multi-year contracts. And as they grow their business and increase volumes, we will share the benefit of that with them in a pricing context, but the baseline, most important characteristic of our service for enterprise customers is the quality of the underlying platform and network that we own and operate. That's our secret sauce, that's our advantage for the enterprise customers that we serve, but as customers scale, they should get some of the benefit of that scale as they grow with us and historically we have had long, long term relationships with our enterprises as they've grown.

Our next question is from Richard Davis, Canaccord. Please proceed with your question.

Just on the new business generation side of the house, where do you see -- I know it's a big opportunity and things like that. Where are we in this market in terms of, when you're signing deals at these competitive displacements, as it feels like there's a bunch of Greenfield, is it 50-50, 60-40, those kind of things. Thanks.

Thanks, Richard. So we most often find ourselves in the large enterprise space, displacing an incumbent provider. That's the reality we face when we're selling into the enterprise. I can't give you a numeric split in terms of Greenfield versus existing, but in the large enterprise, they usually have existing service that they provide. When there is a new product, when there is a new device or a voice driven experience, then there is a greenfield opportunity. If it's a new application that is being launched, then there's often a brand new experience within perhaps a different product team in the customer we already serve, but the way we think about the opportunity right now in voice is that it is very early across the board as we see creative and dynamic product teams at large enterprise engaging with their customers or engaging with other constituencies, using AI and always connected devices. So we're excited about the value of our platform and network in the context of enterprises that are embedding voice and messaging as well as voice as an interface.

Our next question is from Pat Walravens, JMP Securities.

Oh, great, thank you and congratulations to you guys on your IPO. So my first question is pretty big picture. Dave, why do you have confidence that you can accelerate the growth of this business?

Thank you, Pat and appreciate your congratulations very much. We are confident and I am particularly confident because we've been able to grow this business with cash that we've generated historically out of our own business model and that cash has supported a very small sales force. Our use of proceeds with this public offering is directed at scaling the product and service that we have been able to sell into large enterprise over the course of our history and we're focused on simply reaching more of those folks within the Fortune 1000 and beyond with an expanded sales force. So we've stuck to our knitting, we know how to train and make sales people productive at a small scale and with this capital, we should easily be able to continue to do what we do quite well.

Thank you. And then secondly just to help us sort of fit the right pieces into place, because this is a really big market, right. Who do you compete against the most often? Is it more traditional carriers or is it more like the Twilio and Nexmos of the world? And where do you feel like you’re best suited and where are situations where maybe you're not as well suited?

Our average CPaaS customer is spending over $150,000 annually with us, which is orders of magnitude higher 10, 20 times more than other CPaaS average customer revenues. So most of the time, when we're talking about enterprises spending that much money with us, numerically to answer your question, most of the time, our scorecard is measured against the incumbent Verizon, AT&Ts, CenturyLinks of the world. That's the business that we're winning away when we are winning new accounts most of the time. As we come down market to smaller newer teams that we're serving, we will encounter other CPaaS providers, but the lion's share of our new business going forward is squarely focused on winning against the incumbents.

Our next question is from Will Power, Baird.

And again I guess I would echo the previous comments, congratulations on nice results, Dave and Jeff out of the gate here. I guess a couple of questions. David, you referenced the opportunity with voice first devices and of course you look at some of the early holiday sales results, the speaker of voice first devices have been hot sellers, I wondered if there are any early anecdote you’re able to see with respect to what you’re either seeing with respect to calling trends from those devices, usage generally and any thoughts with respect to maybe a pickup in marketing around some of those communications capabilities from those types of devices.

If we were still a private company, well, I would love to share some of that detail and color and anecdote, but I'm learning as fast as I can and I can simply say that, generally speaking, we're excited about voice as an interface and what it means to be able to call through devices and applications that allow you to just speak to an ambient microphone in your living room or in your office, but can't share anything specifically.

Okay. And then I want to follow-up on the comments with respect to looking at potential international expansion. I wonder if there's any other color you could provide with respect to looking at organic opportunities, is that something you could do from your own investments, is that something that would require M&A and just trying to get a sense for geographies too, because it certainly seemed like a bigger push in Canada in particular could make sense and probably would be more limited investment versus Europe or AsiaPac. So any color there would be great.

Fair question, Will. So, pardon me, as I said in my opening remarks, international is a growth opportunity for us. Our business right now is a material in the international space, so it's early days, but our D&A and our history has consistently reflected a focus on having a structural advantage where we're disciplined about capital allocation. That's how we've grown our business and so we will be opportunistic and believe just philosophically that it's important to follow demand into a new country rather than to try to create it. So you should expect us to reflect the same discipline that we've had historically growing the company but where we have both demand from an existing customer and a favorable environment to add value and quality and cost advantage, you should expect us to exploit that opportunity readily.

Maybe if I could just give one question to deal for Jeff to bring him in, looking at the CPaaS gross margins, nice to see some improvement there year over year, and I think you’ve referenced some of the cost improvements, maybe just give us a sense for how we should think about the cadence of additional cost improvements and expansion opportunities in that CPaaS gross margin line moving forward?

Sure. Thanks, Will. Appreciate the question and the interest in Bandwidth. So as you sort of pointed out, our gross margins have continued to grow and that's something we're excited about and I think shows the health of the business. Historically, we've grown the business at the rate that we can being self funded and most of our gross margin expansion has come from either a favorable revenue mix and/or opportunities to take cost out of the business. As we invest more in sales and marketing, we think we will be able to demonstrate more operating leverage by spreading the fixed cost of our own IP network over that larger revenue base and we'll see additional pickup in margin there as well and again this is one of the big advantages of having an own network there and so we're excited about that opportunity as well.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to David Morken for closing remarks.

Thank you, Ulmer and thank you to everyone on the call today, for following us and to all our investors who might be listening in, welcome to the BAND and we look forward to talking to you again in the future. And that concludes our first earnings call as a public company. Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.