Bandwidth Inc. (BAND) Q2 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the Bandwidth’s Second Quarter 2018 Earnings Results Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Marc Griffin.

Thank you, good afternoon, and welcome to Bandwidth's second quarter 2018 earnings call. Today, we'll be discussing the results announced in our press release issued after the market close. With me on the call this afternoon is David Morken, Bandwidth's, Chief Executive Officer; and Jeff Hoffman, Chief Financial Officer of Bandwidth. They will begin with prepared remarks and then we will open up 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 third quarter of 2018 and the full year of 2018, our plan is to execute on 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 views only as of today and should not be considered our views as of any subsequent date. 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 10-K filing on February 26, 2018, as updated by other SEC filings all of which are available on the Investor Relations 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 on the SEC's website at sec.gov. With that, let me turn the call over to David.

Thank you, Marc, and thanks to everyone for joining our second quarter earnings call. This quarter's results were outstanding. Our CPaaS revenue increased to 26% year-over-year, driving total revenue of $48.3 million. We achieved a 119% dollar-based net retention rate, demonstrating our continued success in expanding our existing enterprise relationships. Likewise, we continue to attract and serve new customers as our active CPaaS customers grew by 26% year-over-year. This gives us the confidence to increase our full year outlook. Our core differentiators provide the foundation for our ongoing success. This includes our highly scalable platform built for the enterprise with flexible and easy-to-use software APIs, our vertically integrated nationwide IP voice integrated nationwide IP voice network that we built and operate, which is one of the largest in the U.S., our one-of-a-kind CPaaS-based 911 network capabilities, our deep experience and expertise in voice and messaging, coupled with our growing long-term relationships with enterprises and, most importantly, our people, who continue to build, serve and inspire daily. These fundamentals deliver balanced revenue growth from a broad and diverse set of customers across all our services. Enterprise customers choose Bandwidth for the versatility of a cloud-based software platform coupled with the reliability of a network provider to address their complete communications requirements. Our focus on our enterprise customers is becoming more well-known among large and medium sized enterprises. For these teams, we often become their easy button for communications. Our innovation-rich culture produces some of the most agile and easy-to-use solutions in the entire CPaaS industry. Additionally, our people serve on dedicated customer support teams that partner with our enterprise customers to solve unique enterprise challenges. We empower enterprises to create, scale and operate voice or text communication services across any mobile application or connected device. We continue to believe it's still the very early days of the software-driven cloud communications revolution. The CPaaS multibillion-dollar market is large and rapidly growing. Enterprises need to leverage cloud-based software that enables superior communications, products and experiences to remain competitive. To date, enterprises across all verticals are enhancing their products and services by frequently and seamlessly communicating with their end users. Bandwidth provides enterprises the ability to engage with their end users by incorporating voice, messaging and 911 capabilities through our easy-to-use APIs. We continue to see enterprises choose Bandwidth to enable unique customer experiences critical to their mission. For example, in the second quarter, we began a new relationship with a leading online consumer mortgage and loan marketplace, which provides their customers an app with which they can connect with multiple lenders. The company was challenged to maintain customer privacy and satisfaction while connecting their customers with several lenders simultaneously. This well-known company is turning to Bandwidth to deliver a customer-centric approach by powering a new solution that will hide their customer's phone number from their third-party lenders while still allowing for controlled phone communication between the two. The new solution includes an advanced IVR system, which allows the customer to choose whether to accept, deny, block or send a voicemail before every call. In addition, customers will receive a text message with any voicemail messages for easy follow-up on the go. Bandwidth's communication platform allows us to empower enterprises to deliver connected experiences like this one, which are critical to a company's value proposition. Here another example. During the quarter, we entered into a new relationship with a very large e-commerce company with millions and millions of users, which is an early adopter of text messaging with existing customers for product promotions. Working together with Bandwidth, the company used Bandwidth's enterprise messaging services, which enables customers to click a number in the message to call a company back immediately. Additionally, the company will benefit from Bandwidth's owner economics, avoid surcharges and, in some cases, improve message deliverability. This is another example in which Bandwidth demonstrated our ability to enhance communication experiences and deliver scalable enterprise solutions. As I previously mentioned, Bandwidth is the only CPaaS provider with native software 911 capabilities, and we were greatly encouraged by the progress of our 911 API during the quarter. Our 911 API customer rapid SOS announced initiatives with both Apple and Uber. In addition, we further expanded our API to include dynamic location routing technology, which provides hyper-targeted in-depth emergency location information when routing 911 calls. Dynamic location routing technology enables enterprises with large campuses or office buildings to transmit conference room names, floor numbers and location-specific areas of an office in emergency calls. We believe dynamic location routing is an emerging standard for the 911 industry and are excited to include access to this technology in the form of an API on our platform. We continue to innovate with our platform and are investing in our R&D team to provide further value to our customers. Likewise, we are on track with our sales and marketing hiring plans and look forward to the impact of these teams in 2019. Also, as we have stated previously, we are exploring the development of our international offerings. We continue to learn more about the needs of our existing customers abroad, pathways to serving these customers and the regulatory environment that exists in various countries. We look forward to better understanding the international landscape during this year of discovery and are focused on delivering value to our customers in the same manner we do here in the U.S. Overall, we are executing our growth strategy for 2018 of expanding existing enterprise relationships and growing our enterprise customer base. Additionally, we continue to innovate with our platform and focus on enterprise customer satisfaction. A key component of growing our business is finding exceptional talent to join the best-in-class people already here at Bandwidth. Our extraordinary people services team continues to seek and find exceptional talent we are hiring across the company. I am most excited about all the new band mates that we are onboarding and look forward to the impact we will make together in the years ahead. With that, let me turn it over to Jeff to provide more details on our financials.

Thanks, David, and good afternoon everyone. On the call today, I will provide a more detailed overview of our second quarter financial performance and then provide our outlook for the third quarter and full year 2018. Following my remarks, we will open the call to your questions. Second quarter was an exceptional performance for Bandwidth, highlighted by accelerated CPaaS revenue growth and better than expected results across all guided metrics. We enjoyed strong ongoing demand as enterprises continue to embed voice, messaging and 911 into their products and services. Our growth was primarily driven by expanding our relationships with existing customers to increase usage levels across many offerings on our platform. Additionally, our results were bolstered by the continued momentum we are seeing from new customers. During the second quarter, our total revenue was $48.3 million, up 22% year-over-year and $2.7 million above the high-end of our guidance range. Within total revenue, CPaaS revenue was $39.8 million, up 26% year-over-year, and $0.8 million above the high-end of our guidance range. Other revenue contributed the remaining $8.5 million of total revenue and was slightly higher than the $8 million from the second quarter of 2017. While we continue to expect our legacy services to decline, this was partially offset by an increase in indirect revenue in the quarter. We ended the second quarter with 1,092 active CPaaS customers, up 26% year-over-year. In addition, our dollar-based net retention rate was 119% compared to 105% during the second quarter of 2017. 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 year 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 $22.8 million, yielding a gross margin of 47% for the second quarter of 2018, up from the $18.3 million and 46% gross margin we achieved in the second quarter of 2017. Second quarter adjusted EBITDA was $3.2 million compared to $5.8 million for the same period last year, which reflects our strong CPaaS performance, partially offset by an increase in operating expenses, primarily driven by higher personnel-related costs to support our growth. On a GAAP basis, we reported a net income of $10.5 million or $0.50 per share based on 20.9 million weighted average diluted shares outstanding during the second quarter of 2018. This includes approximately a $7.1 million income tax benefit from stock option exercises. Our non-GAAP net income in the second quarter was $4.1 million or $0.20 per share based on $20.9 million weighted average diluted shares outstanding. This is well above our guidance for the second quarter of a loss of $0.11 to $0.14. Non-GAAP net income excludes the $7.1 million income tax benefit from stock option exercises. The variance to our guidance was primarily due to better-than-expected gross profit and lower G&A expenses. During the second quarter, we generated $5.9 million in net cash from operations and $2.6 million in free cash flow, which includes purchases of property and equipment as well as capitalized software development costs for internal use. Now I'd like to finish with some thoughts regarding our financial outlook, beginning with the full year 2018. In terms of CPaaS revenue, we are increasing our full year guidance to $160.7 million to $161.7 million or growth of 23% at the midpoint of the range. We are increasing our total revenue for 2018 to be in the range of $198 million to $199 million. Non-GAAP earnings per share is expected to be in the range of approximately $0.04 to $0.09 per share. This outlook assumes weighted average diluted shares outstanding of approximately 20.9 million. Turning to our guidance for the third quarter of 2018. We expect CPaaS revenue to be in the range of $40 million to $40.5 million or up 21% year-over-year at the midpoint of the range. We expect total revenue to be in the range of $47.7 million to $48.2 million for the third quarter. Non-GAAP earnings per share is expected to be a loss in the range of $0.19 to $0.21 per share. This outlook assumes weighted average basis share outstanding of approximately $18.8 million. Overall, we're very pleased with our second quarter execution and look forward to capitalizing on our growing multibillion-dollar market opportunity. And with that, I will now hand the call back to the operator for the Q&A portion of the call.

At this time we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Richard Davis from Canaccord. Please proceed with your question.

Hey great. I'll let people ask a bunch of other questions, but I have a product question. So one of the things that we hear from marketers is that they would like kind of a better unification of kind of their messaging systems, and you guys recently introduced, I think, like an email to SMS integration using new guys and mail gun. So could you just talk at least broadly or specifically about how this feature fits into your strategies and what do you think about kind of unified messaging and those kind of things? Thanks.

Thanks, Richard. This is David. Messaging and email are two different modalities that we see enterprises using depending upon the use case, depending upon the frequency, the length of the content, the purpose, whether it's customer case or sales. And so that API that we announced is yet another tool in the tool belt of an enterprise product manager or general manager who are trying to perhaps do a nurture track with customers on a periodic basis, and they'll choose between an integration with SMS or email accordingly. So we don't see any inherent contradiction between the two. These are complementary modes of communicating with customers, and it does depend upon which particular use case is involved.

Got it. And so now that would match in with your – because you're working also with IBM Watson, right, I think, with their whatever text message tone analyzer, so it's just part of a – we should think of this as kind of a whole package. Is that – does that sound like the right way to think about it?

I think so. I think the whole point behind the word unified and unified messaging is these are all strands or threads that are woven together to have a stronger bond with your customer. And so you want to weave different threads, whether it's voice interactive responses as we talked in our one customer example with a mortgage lender or if it's messaging in the case of the e-commerce customer example we used. These are all common threads that are being woven to create a stronger bond between an enterprise and its most vital resource, and that's its customer.

Got it. Super helpful, thanks.

Our next question comes from the line of Meta Marshall from Morgan Stanley. Please proceed with your question.

Great, thanks. I was wondering if you could kind of expand upon the example you gave about the E911 customer and kind of, I guess, rapid SOS and their expansion of their relationship with Apple and Uber. And then maybe second, the guide for Q3, just trying to get a sense of is that a large increase in OpEx, so it's kind of leading into that net loss? Is there something different with the tax rate? Just kind of a big swing from Q2 to Q3, even taking out kind of the tax benefit or tax benefit that you received in Q2. Thanks.

Thank you, Meta. This is David. I'll answer the first part of the question and then turn to Jeff for the second part. Our E911 customer rapid SOS is a terrific relationship that we've had enjoyed for years and years, and we just applaud the announcement today made in the market, which are both early wins in the emerging space where we are as we often have found ourselves powering innovators. And in the case with rapid with Apple and Uber, similarly, and I'll let them speak for that solution in the public space. But for us, what we're most excited about is after lots of investment in our API for 911, we're excited to see in this last quarter really seminal announcements in the space. And so the three product highlights that we included for this last quarter were a voice customer example, a messaging example and, in the case of E911 with rapid and emergency servicing example.

Then I’ll take the second part, Meta. I'm sorry, go ahead. Did you have something else?

Yes no, no, I was just – you can go ahead.

Okay thanks. So in terms of the loss that we're projecting in third quarter that has to do with the ramp of our investments. It's mainly hiring, and you'll see that in our – that will occur in OpEx. So leading the way would be R&D and the hiring that we're doing there, followed by sales and marketing. We also, in third and fourth quarter, have a heavier dose of project expenses, things that we've talked about before with you. The rev rec 606 project we've been working on, our preparations for 404 A as well as some IT and security projects that we'll be executing in the second half of the year.

Okay, thanks.

Our next question comes from the line of Catharine Trebnick, Dougherty & Co. please proceed with your questions.

Thanks for taking my question. Could you give us a little bit of background on the competitive landscape on these three different wins? Were you the sole provider? Or was there anybody else involved or engaged? And how do you look at the competitive landscape? Thanks.

You bet Catharine. In these three examples, we defeated incumbents in two of the examples, and we're selected over a CPaaS provider – an alternative CPaaS provider into the third case. So it's a mixture. We find ourselves, though, seeing most of the time that we do compete and win against incumbents. And those are either incumbents, voice and messaging providers that you know well as AT&T, Verizon and others. Or in the case of E911, the incumbents include the established traditional 911 larger companies. And in that space, we're very much an innovator. So it is a mixture. It is a combination, but it does reflect our experience that the preponderance of the time, we are competing and winning against incumbents that are entrenched in the space.

Alright, thank you. And then just one quick follow-on. How many sales personnel did you hire during the quarter? I noticed your – you increased like – you had 64 new logo this quarter, and then how long does it take to get a new logo to actually generate revenue? What's the process in that?

So on the first part of your question, Catharine, we don't announce specific headcount numbers for any area of the company, but we are tracking to plan in 2018 as we've outlined, in the use of proceeds from the IPO. And we're very pleased with the recruiting and the training on the hunter sales team as well as the strategic sales team. And the second part of your question. The hunter team will onboard a customer, and we'll see that customer ramp between very quickly zero to 90 days to generate revenue. So it often is very quick. But depending upon the particulars of the integration, it can take longer, but zero to 90 days is a good rule of thumb.

Alright, thank you so much.

Our next question comes from the line of Will Power from Baird, please proceed with your question.

Alright great thanks Yes, congratulations on the results. I guess, David or Jeff, perhaps qualitatively, I'd love to kind of get your sense for the sources, the key sources of growth in the quarter. What I'm really trying to get at is the user space, voice space opportunities versus 911 and the subscription business within the model. Any change in trajectory within those? Or is it principally voice driven? And I guess within subscription piece with any ties to 911, you talked about the dynamic routing. Just to kind of come back to that, is that something that providers from outside is the current quarter or is there more of that to come?

Will, this is Jeff. I'll start and then David can maybe fill in on anything that I don't cover. The second quarter performance continues to have strong demand across the board. We're seeing revenue growth in all of our products, and it's spread across a diverse customer base. We will highlight, as we said in the prepared remarks, that most of our growth is coming from existing customers, and that was reflected in the dollar-based net retention rate. But we are pleased with the results, in Catharine's question, in the additions of 64 new active CPaaS customers in the quarter.

Okay, and then maybe, I just yes, go ahead.

Sorry, Will. This is David. I was just going to respond to the second part of your question. If you had a follow-up to Jeff, by all means, feel free.

No, no, I – you can go ahead, thank you.

I think the thrust of your question was how should you think about the timeliness of the E911 future revenue growth relative to the announcements that we made in the quarter. And I think what we're pointing to here is you're seeing the beginning of what is a very real disruptive improvement in emergency response, and we are in general availability in our API for 911. And you're seeing some of that in the marketplace with these kinds of announcements. So it is something for the future, but it's happening beginning right now, if that helps.

Okay. That's great. Okay. And then my second question was around the messaging opportunity, enterprise messaging, and you talked about this a little bit. Does that imply that SMS and messaging generally will become maybe a bigger focused? And does not require additional investments? How do we think about your focus on that particular area?

Historically, voice has been our dominant service in the 90% of overall revenue contribution, and we've talked about how we've grown messaging among our enterprise customers from 3% to 6%, and we're seeing that continue to grow. So I would remain consistent with our past commentary that enterprises are using messaging and voice in ways that are very creative, embedding it with devices and with applications in a way that we're finding ourselves very valuable to them as a single source both messaging and voice. And so we'll cross-sell it. We'll enter into a relationship leading with messaging and then add-on voice. So it's a very consistent observation that we have in terms of how we add value with both messaging and voice, and it has been growing.

Great, thank you.

Our next question Pat Walravens from JMP Securities, please proceed with your questions.

Well, great. Thank you. Congratulations guys on a great quarter. So I have two, and I'll just put them out upfront. The first is I'd love to hear just how is competition different internationally for you guys than it is here? And so how does that sort of play into how you think about entering? And then secondly, what are you finding are the characteristics of your new hires who are the most successful? Like, where do they come from and what are their backgrounds like?

This is David. Roger that. I'll take that question in reverse order, your two questions, if I could, Pat. So we are hiring from primarily research triangle park-based technology companies like Citrix, Share File, like Red Hat, places in the park like IBM, large private technology companies like SaaS. And I'm not the most popular CEO in the area right now to the extent that we've been hiring some terrific people away from existing teams, that's for sure, but these are folks who are highly qualified and outstanding. And I think being a public company has raised our profile, and I think we're able to attract and hopefully incent and retain folks that we otherwise would have had a harder time landing. So that's just an overview of the kind of psychographic profile background of who these folks are, and we're very pleased. I'm doing new hire breakfast orientations consistently, and I'm delighted and glad I joined the company before the quality of the folks that are coming onboard now or else I might not be able to join. With that said, the first part of your question regarding international competition and how it differs in different markets, we're finding regulatory authorities to be, in some cases, I would describe it as even more flexible than in the U.S. and in others not so much. And so we're being very deliberate about triaging our customer, our existing customer needs in particular jurisdictions where we know that investment is appropriate to enjoy the yield that should come from that investment from existing customer demand rather than delivering footprint and hoping that we can fill up capacity and have lots of API calls for a particular jurisdiction. And in that regard, there are key markets that we've looked at like the U.K. and the EU, and there are other markets on that list as we progress further. But we're doing a responsible, very deliberate job in pursuing these markets and following the customer demand that we have today.

Okay, that’s interesting, thank you.

Our next question comes from Brent Bracelin, KeyBanc Capital Markets, please proceed with your question.

Just hopping on the call here and apologize if this questions been asked, but we'll go ahead and ask a couple. One, I'm wondering if I could just get your thoughts here, David on the Google new G Suite. I think they announced last week plans to kind of add voice capabilities to that offering. Could you just kind of provide us an update on the implications there? And then two, could you touch base just on kind of industry pricing dynamics? Has there been any change in the last three months of note or not really? Thanks.

You bet, Brent. Thank you. And regarding Google's announcement very recently, Google suites and enterprise voice, congratulations to that team for that successful launch. I think it'll have a tremendous impact in the overall UCaaS space, and they are very creative and dynamic customers of ours attacking the incumbent stronghold of enterprise, desktop, phone, communications. And they're doing it in very creative ways. I think Google is just the most recent example of that. And our role as a CPaaS provider with the powerful API underneath is to really unlock the creativity of some of these teams, whether they be on the West Coast or elsewhere. And so just very, very happy with our team's ability to serve some of these most dynamic teams with what is an incredible opportunity to challenge a 100-year-old industry. Brent, the second part of your question, I think, was focused either around competition or pricing, if I recall correctly.

Just pricing in industry, has there been any sort of major shift one way or another?

In the most recent quarter, there's no new pricing dynamic that is a surprise to us whatsoever. So it's observing characteristics that are familiar to us.

Okay. Great. And then my last question here is really more around kind of the net dollar retention. The CPaaS business certainly looks really healthy, accelerating growth there again. It does look like at least this quarter, yes, it looks like there was acceleration in kind of the existing kind of customers expansion – existing kind of customers. What's driving the momentum at existing footprint today? Is it new use cases? Is it broader customer adoption on their part? Walk us through the improvement you saw in net retention rates and what that implies around kind of your existing installed base?

Hi Brent, this is Jeff. I'll take that one. We continue to see our customers mainly driven, as we said, by existing customers, but what we're seeing them is increase their usage on the platform. And as they succeed, we're succeeding as well. But it's very broad-based. We're seeing growth in voice, messaging as well as 911. So it's coming from a number of different sources.

So, there is like a customer concentration that's driving the bulk of that? It's pretty broad-based?

Yes, broad-based.

Okay, very helpful, that’s all I had, thank you.

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

Thank you very much, and I just want to say thanks to everyone for joining us on the call and to congratulate and thank our entire team at Bandwidth for a job well done and to great things in the future. Thank you all.

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