Bandwidth Inc. (BAND) Q2 2019 Earnings Report, Transcript and Summary

Greetings and welcome to Bandwidth Inc's Second Quarter 2019 Earnings Results Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Mr. Marc Griffin, Investor Relations. Thank you, Marc. You may begin.

Thank you, good afternoon and welcome to Bandwidth's second quarter 2019 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 fiscal quarter of 2019 and the full year of 2019, our plans 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 15, 2019, as updated by our 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. Reconciliation of GAAP to non-GAAP measures is included in our press release issued after the close of the 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 thank you to everyone joining us on our second quarter earnings call. I am very pleased to report that our second quarter results exceeded our expectations on both the top and bottom lines. Our CPaaS revenue increased 20% year-over-year driving total revenue in the quarter of $56.8 million. The investments we have made in our sales and marketing teams continue to produce early indicators of success. We achieved a new best in the second quarter growing our active CPaaS customers 34% year-over-year. Additionally, we continue to deepen our relationships with existing customers as demonstrated by our 113% dollar base net retention rate. These results demonstrate the tremendous opportunity to capture an increased share of a growing $10.9 billion CPaaS market opportunity. We are excited to be serving some of the most innovative companies here are a few of the most notable customer success stories. We are pleased to announce a five-year multimillion dollar agreement in principal to provide CPaaS services for a Fortune 500 company that offers communications and technology solutions for residential small business and enterprises across the U.S. Under the terms of the agreement, this existing customer will use Bandwidth CPaaS platform and nationwide voice network to expand the engagement and collaboration services offered to its enterprise customers. Combining Bandwidth’s robust API platform with the company's existing network creates a powerful combination that supports the digital transformation efforts of the company’s large enterprise customers. The Company’s customers can now leverage the power of Bandwidth’s enterprise grade voice messaging, and 911 APIs as they adopt cloud-based [UCaaS and CPaaS] applications. We look forward to beginning a deeper relationship with this customer who will contribute meaningfully to our fourth quarter growth and will be among the largest customers of Bandwidth in 2020. Bandwidth has a track record of delivering comprehensive solutions that address the unique and complex needs of the large enterprise customers we serve. As a result, these enterprises have continued to innovate and grow with our platform over extended timeframes. In the case of this customer example, our relationship began six years ago in 2013. Our relationship with large enterprise customers often expands across different product suites, divisions and use cases over time. 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. In this case, our customer now utilizes our full voice product suite including our 911 services. We also entered into a new customer relationship with one of the largest operators of mobile and Internet services in Europe and Africa. The company is also a leading provider of global IT and telecommunication services solutions across 160 countries and territories. The company will rely on Bandwidth’s platform and suite of voice products to power their U.S.-based voice needs. The company serves large, multinational enterprises and was seeking a provider that could deliver a superior customer experience with cost benefits at scale. This customer chose Bandwidth for our capability to meet the critical communications needs of enterprise customers. Our all IP voice network that we own and operate provides enterprise grade functionality with secure, high quality connections and offers economic benefits at scale. Additionally, our dedicated and personalized customer support teams demonstrate our commitment to customer satisfaction. We are accustomed to developing deep multifaceted relationships with organizations of this size and look forward to the opportunity to do so with this customer in the future. This quarter we entered into a new relationship with a mobile app that connects more than 1.5 million users with next-generation emergency services. Our customers’ mobile app connect subscribers in distress with public safety and delivers critical location information to first responders for fast and reliable emergency response. This customer chose Bandwidth's new Emergency Calling API to embed these 911 capabilities into their application. Our new API automatically routes emergency calls to the appropriate public safety answering point based on an address provided by our customers’ app, simplifying complex call flows, back office dispatch systems and virtual call center processes used in the past. Additionally, Bandwidth’s new Emergency Calling API replaces solutions that rely on non-emergency phone numbers for police, fire and medical response, which are acknowledged with a lower priority than emergency calls. Bandwidth’s Emergency Calling API is a unique solution that allows personal safety platforms, Internet of Things and connected device manufacturers, as well as do-it-yourself residential and enterprise security companies to embed emergency calling functionality into their platforms without the need for a sophisticated and costly Voice over IP network infrastructure. We believe that this API’s ability to make true emergency calls without VoIP infrastructure will make emergency calling capabilities accessible to a large number of apps where it may not have been technically or financially feasible to do so in the past. We are excited to introduce another innovative solution for 911 services. In addition to our Emergency Calling API, our product team deployed an initial release of its notification engine. We began by launching email notifications for 911, so when a 911 call takes place within a large enterprise, an email notification can be simultaneously sent to onsite security personnel. In subsequent releases, we plan to extend this feature with API notifications to allow enterprises to integrate our 911 service with their applications along with SMS notifications and traditional voice recording notifications. We continue to plan to support Kari’s Law, which requires all multiline telephone systems, onsite notifications simultaneously with 911 calls by February, 2020. We are in the beginning of the era of the 911 of things. And with our emergency calling API and 911 notifications, we are able to connect more users with public safety using the devices, apps and tools we interact with daily. In addition to 911, we strive for continuous improvement to our platform to meet our customers' needs. During the second quarter, we introduced upgrades to our platform to deliver an improved porting experience for enterprise customers. We have automated populating inputs to facilitate porting orders and also increased our single porting session capacity by 20-fold to over 20,000 numbers in a single request significantly reducing execution efforts of our customers. Last, we are pleased with the progress we are making to expand our platform internationally. Bandwidth is now supporting one of our largest enterprise customers in the United Kingdom with their recent product launch. We continue to deploy infrastructure in the UK to support our platform expansion and are on track to complete the build out of our network infrastructure and not just in the UK but throughout the EU by the end of the year. In summary, I am pleased to see strong demand from enterprises that choose to build on Bandwidth’s three pillars. Our highly scalable platform of easy-to-use APIs, our vertically integrated IP voice network that offers unmatched quality and costs and our 911 capabilities that we believe are unique among CPaaS providers. Our team remains focused on executing on our mission and delivering best-in-class service to our enterprise customers. With that, let me turn the call over to Jeff.

Thanks David and good afternoon everyone. As David mentioned, our strong second quarter performance exceeded the high end of our guidance for both top and bottom lines. Our business continues to benefit from ongoing demand from enterprises across many different industries who are seeking to embed voice, messaging and 911 into their products and services. During the second quarter, our total revenue was $56.8 million, up 18% year-over-year and $1.5 million above the high-end of our guidance range. Within total revenue, CPaaS revenue was $48 million, up 20% year-over-year and $0.7 million above the high-end of our guidance range. Other revenue contributed the remaining $8.8 million of total revenue, which was $0.8 million above our implied guidance. As a comparison, other revenue was $8.5 million in the same period last year. Here are some key metrics in the second quarter that drove these results. Our expanded sales and marketing teams are attracting more new customers to our platform. We ended the second quarter with 1,467 active CPaaS customers, up 34% year-over-year, a record percentage increase for our business. Consistent with previous cohorts, we expect these newly onboarded customers to scale their usage over future periods as they become increasingly familiar with our platform, network and customer support. Our dollar-based net retention rate was 113% in the second quarter of 2019 as compared to 119% a year-ago and 111% in the first quarter of 2019. Before moving on to profitability metrics, I would like to call 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 second quarter 2019 non-GAAP gross profit, which excludes stock-based compensation and depreciation, was $28.2 million, yielding a gross margin of 50%. This compares favorably to the $22.8 million and the 47% gross margin we achieved in the second quarter of 2018. Second quarter 2019 adjusted EBITDA was slightly above breakeven as compared to $3.2 million of adjusted EBITDA for the same period last year. This again reflects the increased investment we are making in sales and marketing as well as research and development to support the expansion of our platform. On a GAAP basis, we reported net income of $3.5 million or $0.14 per share based on $24.4 million weighted average diluted shares outstanding, during second quarter 2019. Our non-GAAP net loss in the second quarter was $0.9 million or a loss of $0.04 per share based on $23.1 million weighted average shares outstanding. This is favorable to our guidance for the second quarter of a net loss of $0.17 to $0.19 per share. The favorable non-GAAP net loss variance as compared to our guidance was driven by outperformance in gross profit and operating expense. During the second quarter, net cash from operating activities, produced $2.4 million and we utilized $4.1 million in free cash flow, which includes $6.5 million of 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. For the third quarter 2019, we expect CPaaS revenue to be in the range of $50.4 million to $50.9 million or up 22% year-over-year at the midpoint of the range at $50.7 million. This contributes to our total revenue guidance for the quarter of $58.4 million to $58.9 million. For the full year 2019, we expect CPaaS revenue to be in the range of $201.8 million to $202.8 million or up 23% at the midpoint of the range. I want to call out that our implied fourth quarter guidance for CPaaS revenues in the range of $58.4 million to $58.9 million or up 33% at the midpoint year-over-year. The sequential uptick in our fourth quarter implied guidance is informed by three factors. First, we expect an improving dollar based net retention rate, as we continue to collaborate with our existing customers and maintain good visibility into their go-forward usage plan on existing products, as well as opportunities to support new use cases. Second, as David referenced earlier, we are pleased with the five year multi-million dollar opportunity with an existing customer that is expected to further amplify our fourth quarter CPaaS revenue growth. Third and finally, we have significantly invested in our go-to-market team and our larger sales team is attracting more customers as the new customer scale on our platform, we expect an increased contribution to our fourth quarter revenue growth. It is the culmination of these drivers that informs our guidance for the remainder of the year and in particular the implied CPaaS revenue growth acceleration in the fourth quarter. Finishing our thoughts on our outlook, we expect 2019 total annual revenue to be in the range of $234.8 million to $235.8 million, up 15% at the midpoint of the range. Turning to the third quarter profitability, non-GAAP earnings per share is expected to be a loss in the range of $0.14 to $0.16 per share. This outlook assumes weighted average shares outstanding of approximately $23.4 million. Non-GAAP earnings per share for 2019 is expected to be in the range of approximately a loss of $0.43 to $0.48 per share. This outlook assumes weighted average shares outstanding of approximately $22.6 million. In summary, we’re pleased with our results to date and are looking forward to a strong finish for the second half of 2019. With that, let’s open it up for questions.

Thank you. [Operator Instructions] The first question comes from Mark Murphy with JPMorgan. Please go ahead.

So great. Hi, gentlemen, this is Benjamin on behalf of Mark. Congrats on the quarter, seems like a pretty good one. I want to double-click on the large deal that you talked about. Could you maybe talk about how competitive was that deal? Who did you compete with? And what was the main reason behind choosing them versus some of the competitors? And is there any way to understand the scale of the time agreement in dollar terms. I mean, can it be a top 3 logo 2020?

Benjamin, thank you for joining. I appreciate your question. In regard to this opportunity that we have, you wouldn’t be surprise to understand that the competition we faced were the three large incumbent providers and we have one out based upon our platform and network combination, which is so unique. In addition to our extraordinary team that supports large enterprise. Most of the time when we’re engaging in the marketplace, we’re winning opportunities relative to the incumbents Verizon, AT&T, CenturyLink. And this is no different, this is simply an opportunity that we have with a very large enterprise with whom we’ve been working since 2013, and that’s also very consistent for us. We develop and grow with our customers. And this is another example, where we are reaching an inflection point with this customer, where we will be doing significantly more for them. And to answer your question, it remains to be seen, but they certainly could be within our top customers here in the near term.

Understood. Okay. So well, on a high level, just to follow up, as you add these large kind of logos, seems like you talked about two here. And we are seeing some good gross margin expansion as well. As you think about growing the company over the next few years. I mean, do you think it is possible to see a period, where your revenue accelerates any of the new reps later on the international kicks in and while gross margin expansion continues, maybe driven by the largest scale as well as more in network calls as a percentage of the mix increases? I mean, can – is it possible to see that kind of a period in the near term?

We certainly believe that it’s not only possible, but we expect to achieve both increase top line revenue as well as the continued margin expansion. And we’ve been successful at that throughout our history and we believe that that will remain possible going forward.

Awesome. And one last question for Jeff. It seems like the revenue guide kind of implies the revenue ramp incrementally more towards Q4. Maybe than what The Street was expecting. Was that mainly functional, when this deal closed – this large deal closed? Or is there anything to read from the linearity of the productivity ramp for the new reps, et cetera? Anything to know there?

Yes. Sure. Thanks, Benjamin. There were a lot of puts and takes as there are each quarter when we update our guidance. This deal was certainly one of them. And we always just endeavor to give you our best view and best forecast, and it is a little bit more back weighted to the fourth quarter.

Understood. Thank you, guys.

Thank you. Your next question comes from Brent Bracelin with KeyBanc. Please go ahead.

Hi, guys. this is Parker Snook on for Brent Bracelin. Once again, you guys have added a lot of customers this quarter. I was wondering you could provide some color on the profile of these new wins. Is it a mix of voice and messaging or how’s that with you?

The mix of customers is consistent with our recent past weighted heavily toward our voice business, and the platform and network combination that we support. And that’s in terms of revenue approximately 93%, 94% of our overall revenue, and the new customers continue to come to us for the voice platform in the emergency services platform with messaging being an area that is growing, but the vast majority remains voice.

Thank you.

Thank you. The next question comes from Richard Davis with Canaccord Genuity. Please go ahead.

Hey, thanks very much. You guys have been a lot of success at the high end, but obviously, not every company needs an enterprise grade CPaaS. As an outsider, how should I think about the demarcation kind of between, I don’t know, hobbyist is not a negative, but people that don’t need enterprise class CPaaS and organizations that need enterprise grade CPaaS, because I’m just kind of thinking about the addressable market and who you can hit and stuff like that? Thanks.

You bet, Richard. Many of our great customers start small. I’m thinking of folks, who have fewer headcounts than you might imagine relative to the top-line revenue. But as they scale, enterprise CPaaS becomes essential to them for two primary reasons. One, economies of scale so that they can continue to deploy their capital, where they should to grow their business, not on exorbitantly-priced communications platform and network. And so as a function of top-line revenue scale that’s often what drives people to us in Raleigh, North Carolina to join our platform and network. Our second one however, is reliability and quality. Because we own and operate the underlying voice network, we are able to deliver visibility into that network. So, if you are an enterprise business communications application or user experience, our quality and reliability become essential. And then last, Richard, I would just add if you are doing an emergency response service, the 911 of things, think smart doorbells or thermostats or otherwise, it goes without saying that the reliability and quality of enterprise, CPaaS is critical. And since we are also in command and control of those elements underneath our platform, enterprises that rely on those functions, we appeal to them very greatly.

Great. Okay. Thank you so much.

Thank you. The next question comes from Charlie Erlikh with Baird. Please go ahead.

Great. Thanks for taking the question and congrats on a solid quarter. it’s really interesting to hear about these new 911 APIs and capabilities. Would you mind giving us a little bit more detail on what those APIs do and maybe what the expectations are for the 911 business in general? Could that actually grow as a percent of the CPaaS revenue?

It certainly is an area we intend to grow as a percentage of our CPaaS revenue and the appeal and value that the API provide are directly related to the creativity of folks developing apps that pull data from your handset that are more granular than simply your street address fixed to a handset that is on a traditional phone in the living room. They’re pulling information from your mobile handset that has to do with your actual location in the real time. And our API are able to support some of these really creative apps and teams that are frankly providing a better set of data for emergency responders. And so the appeal to them is really using next generation 911 and all of its functionality, but doing so by just coding to our API. And that’s a very rich area for innovation and we’re supporting it and I’m really proud of what the team launched in this last period.

That really sounds great. And then I just wanted to ask another question about the Q4 ramp. As part of the reason why we’re expecting that ramp, because we had such a strong customer ad quarter – this quarter and just in terms of the timing of when those actually start to hit revenue, I mean, I guess the question is when do these new customers actually start to hit the revenue? Is it on a three to six-month delay as you get deployed or how does that timing work?

Hi, Charlie. this is Jeff. yes is the short answer to that. And then I’ll elaborate that, when we have customer ads, usually in quarter, there’s not typically a lot of revenue. They start small as David had said, but as we get into the second and third quarter of them onboarding customer, you usually see a pretty significant ramp there, where they’re starting to add a meaningful revenue contribution. So certainly, the last couple of quarters we’ve had an uptick in net customer ads and now we’re starting to see the revenue follow as expected in the second half of 2019.

Great, that makes sense. Thanks guys.

Thank you. The next question comes from Meta Marshall with Morgan Stanley. Please go ahead.

Hi guys. It's Jonathan Lee on for Meta. Thanks for taking my question. On international build out, can you give us a sense of any hurdles that you may be facing that are different than those in the U.S? And how does that impact your thinking on expanding to other region?

You bet. The European and UK opportunity that we're executing in the ends right now is certainly a higher hurdle than what we're used to in the United States. My son is a steeplechaser, and I think that's an apt analogy. These are hurdles that we know how to get over and there may be water hazards beyond there, but we know how to navigate that and has learned. In particular in these two areas this year, how do we get in front of the appropriate regulators to be able to do business or provide service in each of these countries. And so while they are hurdles, they are not insurmountable, they're navigable, and team is doing an excellent job launching and supporting our current customer base use cases already in the UK and we anticipate that we'll continue to launch and support services in both the EU and UK throughout the rest of this year. But to your point, it is a learning curve and we have spent adequate time learning and now this year building and we anticipate significant revenue contribution won't come until 2020 and beyond. But this has been a great building year so far.

Understood. And separately, can you articulate the steps you're currently taking it to prevent robocalling. Is there are any enhancements that you see as necessary as their potential for regulation picture.

We are active with the FCC as one of the pioneers in the vanguard of stir shaking and the establishment of those standards to present robocalling, for years, we have traced and trapped and removed from our network offenders. We have cooperated with law enforcement and we are extremely aggressive in cutting out anyone who happens to get access to our network who does robocalling. So we're proud of the leadership position, we've had historically, both with the FCC and with the industry leading the charge, really as an early warning participant to what we are seeing now. And we are hopeful that we will continue to lead and be effective in getting rid of robocalling in the years to come. But if I had to describe our posture in leadership role relative to others in the space, it’s clearly as a leader.

Got it. And one more, if I could. So dollar based net retention improved after a slight deceleration last quarter. Are there any active initiatives that you’re taking a circle back with existing customers or what do you attribute the increase to?

So we consistently engage with our customers to understand what their business plans are for current products as well as new product needs. And that’s part of our normal daily business to better serve those customers. And that’s really what drives this business to dollar based net retention.

Got it. Thanks guys.

Thank you. [Operator Instructions] The next question comes from Jacob Barrie with Dougherty & Company. Please go ahead.

Hi. This is Jacob. I’m actually online for Catharine Trebnick. One question I have kind of follow up on the international scale that you guys have been doing. Catharine wants to know if, well I guess you hinted at some infrastructure being built over in Europe, is that correct? And can you confirm where that’s at?

Hey Jacob, certainly that is in London and Frankfurt to support the UK and the broader EU and that infrastructure – the physical infrastructure, the servers, the hardware is in place, the software is configured, the routing is live. We are ahead of or on schedule in every regard in terms of the build out for that theater, and I'm pretty excited about it.

That's awesome. If you can just confirm, I know you've probably – you've hinted at it as well, but are you – are you planning on continuing with more infrastructure in the EU and or Africa?

We have a list of jurisdictions we've prioritized based upon our current customer partners and where they do service and business today. And so we're pursuing that path of following demand where it leads us. And so the short answer is, yes. It is part and parcel our international plans to deploy behind the demand that already exists in countries from our existing customer base.

Awesome. Thank you. Thank you for that. Another question I have is – so Catharine actually explained to me that you recently did a fairly large hiring of sales force and she's curious to know if they are at full capacity and from what I've heard, it sounds like they probably are based on the new customers that you've – that you've brought in this quarter?

We have definitely grown the sales teams significantly, Jacob. And as those sales teams are hired, they go through orientation and training and on boarding and then they have a ramp to full quota carrying capacity. And depending upon the cohort, full capacity is either reached or not based upon a period of time to get up to full quota carrying capacity. And that depends upon the length of time for a junior salesperson or more senior or even a strategic salesperson. There's different length of ramps. So to specifically answer your question, you're never at a 100% capacity because you always have people who are still coming up to speed and that's certainly the case with us right now as we're in the middle of this year and we've hired so significantly looking back over the last six, nine, and 12 months.

Awesome. Thank you for that. One other question I have is we're kind of – we're trying to get a better understanding of the competitive landscape, and wanting to know really with these new customers that you're gaining, you know if you're pulling some customers over from current – from direct competitors of yours. And if so, do you know which company they are mostly coming from?

We are winning customers that currently do business with folks like Verizon, AT&T and CenturyLink and that is who we primarily win business from. So yes, we're aware of that, but we also support and serve emerging technology teams that are just getting to market where enterprise CPaaS is important to them. Does that answer your question?

Yes. Thank you very much. I believe that is all the questions that I have. So thank you very much for that.

Thank you, Jacob.

Thank you. There are no further questions at this time. This concludes today’s teleconference. You may now disconnect your lines. Thank you for your participation.