Greetings. Welcome to the Bandwidth Incorporated Fourth Quarter and Full-Year 2019 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] Please note, this conference is being recorded. I will now turn the conference over to your host, Sarah Walas, Vice President of Investor Relations. Ms. Walas, you may begin.

Thank you. Good afternoon, and welcome to Bandwidth's fourth 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 first fiscal quarter of 2020 and the full-year of 2020, and to the extent provided future periods, 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 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, Sarah, and thank you to everyone joining us on the call. I would like to begin by saying a few short thank yous for an amazing 2019. First, thank you to our incredible enterprise customers for trusting us to help you succeed. We are looking forward to achieving more great things together in 2020. Thank you to all our BAND mates. Your commitment to serve each other and our customers is unrivaled. Your honesty, intelligence, and overcoming spirit were essential to us executing our mission to develop and deliver the power to communicate. To our investors, thank you for your faith and confidence in our flexible software APIs, owner-operated, all-IP nationwide voice network, and our team. And most importantly, I want to thank God for his faithfulness during each and every one of the last 20 years at Bandwidth. Now let's talk about our results. I am incredibly proud of our team for finishing out 2019 on a strong note with a solid quarter. Our CPaaS revenue increased 21% year-over-year, driving total revenue in the quarter of $62 million. In the fourth quarter, we grew our active CPaaS customers a record 40% year-over-year. During the quarter, our broad-based growth drove strong revenue results, which were amplified by the strategic customer relationships we discussed on our last call. I would like to share a few highlights that demonstrate the depth of our relationship with our customers. We previously announced a relationship with one of the pioneers of modern and mobile point-of-sale solutions for small and medium businesses. In the last 12 months, this global company processed approximately $100 billion of gross payments and they use Bandwidth's enterprise-grade toll-free messaging solution to deliver digital receipts, loyalty rewards, promotions, appointment reminders, payroll and customer support from businesses to customers. We are…

Thank you, David, and good afternoon to everyone joining us on the call. I am proud of our team who delivered another strong performance in the fourth quarter. During the fourth quarter, our total revenue was $62 million, up 18% year-over-year and $3.1 million above the high-end of our guidance range. Within total revenue, CPaaS revenue was $53.4 million, up 21% year-over-year and $2.6 million above the high-end of our guidance range. Other revenue contributed the remaining $8.6 million of total revenue, which was $0.5 million above our implied other revenue guidance and up slightly from the same period last year. The overperformance in CPaaS revenue continues to be driven by broad-based growth across voice, messaging and 911. The majority of the $2.6 million CPaaS revenue overperformance above the high-end of our guidance range is attributable to the group of strategic customers that we highlighted on last quarter's earnings call. Our onboarding teams are adept at adapting to the pace of our customers testing and integration efforts, and in collaboration with our customers, we exceeded our onboarding expectations in the fourth quarter. Now let's move on to other key metrics that drove the solid fourth quarter results. Our expanded go-to-market team continues to attract new customers to our platform. We ended the fourth quarter with 1,728 active CPaaS customers, up 40% year-over-year, once again setting a new record percentage increase. We achieved 113% dollar-based net retention rate in the fourth quarter of 2019 as compared to 121% a year-ago. You will recall that in the fourth quarter of 2018, we had the benefit of mid-term election related usage as well as the large customer testing a new offering that drove higher usage in that quarter. Before moving on to profitability metrics, I would like to call out that I will…

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Richard Davis, Canaccord Genuity. Please proceed with your question.

Hey. Thanks, guys. It's actually DJ on the line for Richard. Congrats on the strong results.

Thanks, DJ.

Yes. Good to talk to you. So it sounds like you guys have already onboarded at least a portion of the Fortune 500 service provider business that we've been talking about. So you've probably seen some of the usage patterns, right? At scale, it's going to be a ton of new business lines. I think you said about $10 million. So how should we think about the impact there to on-net calling? And I guess more specifically, I'm interested in gross margins, right? You saw some nice improvement in Q4. Is it possible that we see another step-up in gross margins as volumes for those new users start to ramp?

It certainly is possible, and we're watching it closely. The characteristics of calling patterns for business customers are favorable in terms of their contribution to the network effect you're talking about. So certainly it’s possible, but we aren't getting granular on projecting that. And let me just ask Jeff if he wants to add to that.

Yes. Hi, DJ. It's certainly going to be a favorable impact for us. And as you know, we've talked a lot about the power of economies of scale and network effects, but I think those things take time to distill within our platform. Just also reminding, there's a lot of other factors that go into gross margins, whether it be the level of investment that we're doing at any given time, product mix, geography, et cetera. And so just don't want to kind of over pivot on gross margin accelerating at a faster pace than it is.

Sure. So being measured, but trends are going in the right direction. And then maybe I can move on to international. So any comment on how many customers you have ramping volumes internationally today? Are all of your Internet giant customers there today? And then, I guess, this is a little bit of a harder question, but how should we think about revenue contribution or call volume mix in 2020? Are there any metrics that you plan to share next year to help us kind of track progress there?

On the first part of your question, DJ, we did announce last year one of our Internet giant customers who had launched with us internationally. We do have more than one, but haven't announced anything else. And won't be breaking international out as a separate segment. There are some ways that you can look at international in our SEC filings, but it's early. We're growing this year after learning and building and don't have anything else to announce right now.

Very good. Thanks for the color guys.

Thank you.

Our next question is from Will Power, Robert W. Baird & Company. Please proceed with your question.

Great. Thanks. Yes, apologize for any background noise. Quick question on the 2020 revenue guidance, it looks to be modestly above, I think, previous expectations. And that's kind of despite, as I understand, maybe pulling forward a little bit of revenue from the strategic customers into Q4 given that was a source of upside. So maybe just speak to kind of the – I don't know the upside drivers that's giving you more confidence and kind of the revenue growth outlook for the full-year?

Hi, Will. This is Jeff. So I think it starts with our strong execution in the fourth quarter and we're fired up about capitalizing on opportunities ahead of us in 2020. There's a lot of great things going on within our business and that strength is what gave us the confidence to increase the CPaaS guide from our last call.

Okay, great. And if I could just maybe sneak one other in just quickly. Great to see all the progress in traffic, in use cases on the SMS side. Given you were initially just on voice, I know that's still the far and wide, biggest part of the business. Are there investments you need to make there? Either additional, I don't know SMS gateways or other infrastructure to kind of support that growth?

The investments in the platform are software, and so we have a developer team dedicated to scaling the platform and rolling out new use cases and that's the primary investment into that growth.

Okay. So nothing significant that you'd call out there, okay.

No.

Thank you.

Thanks Will.

Our next question is from Pat Walravens, JMP Securities. Please proceed with your question.

Hi. This is Joe on for Pat. Thank you so much for taking our question. Congrats on the quarter. Just back on the messaging, how do you differentiate in that market competitively?

Hi. There are a number of different flavors of messaging to include person-to-person messaging, application-to-person messaging, long code phone number-originated messaging, short code messaging. And then what we have had great success in providing the enterprise customers like we talked about at the outset of the call, toll-free messaging, and the advantage of toll-free messaging includes being able to verify the delivery of that message and to be able to troubleshoot and diagnose issues with upstream mobile providers. And that has proved very valuable to the enterprise customers that we serve and the use cases that they have with their customers.

Great. Thank you. And then just a follow-up there, I believe that component of the CPaaS revenue is around high-single digits, if I remember correctly at some point. But can you give us a sense of maybe how you guys think about how big of a piece of the CPaaS that could ultimately grow to in terms of percentage of that revenue line?

You bet. When we went public at the end of 2017, messaging represented 6% of our revenue and we just announced that it has grown to now 10% of our revenue.

I would just add. I think voice – we’ll always be voice-centric and skewed that way. Although, I think there's a lot of room to grow on the messaging side as well.

Thank you.

Our next question is from Mark Murphy, JPMorgan. Please proceed with your question.

Hey, guys. Thank you. This is Pinjalim. Congrats on the quarter. Thanks for taking our questions. Jeff, one question on the guidance. Could you help us understand maybe the assumption about onboarding times for the 2020 revenue guidance? Are you expecting that to be similar to what we saw in Q3? Or is it more what you saw this quarter?

Hi, Pinjalim. I think what I'd start with and I think what you're getting at is this new strategic cohort that we’re talking about yesterday. And just as a reminder for some folks on the call, they're engaging with us in a deeper partnership way that encompasses exclusivity as well as long-term commitments to multiple products and services all up front with significant usage volumes. And what we saw last quarter, just as a reminder, was some extended onboarding times. And it makes a lot of sense. This is mission-critical for these organizations that want to test, integrate properly before they move volumes. And so we progress through that with a number of these customers, most notably the Fortune 500 that's been highlighted. And we have a much better understanding of how these things are going, are taking those lessons learned and have incorporated that into our forecast and feel good about it. But there's no real new learnings to highlight other than we progressed up that learning curve.

Okay. So in terms of just the assumptions, I mean would you say those are pretty much similar to how you guided maybe the initial guidance for 2019?

No. The lessons learned towards the end of 2019 as Jeff just mentioned, have now been applied to this year's set of numbers and guidance.

Specifically, Pinjalim, historically, what we've done is seen anywhere on average from 60 to 90 days for an average customer, but they're usually just adding one or two products and they're ramping over time in a very measured way. What we saw in this new cohort is extended times up to 180 days, but they're bringing more products at once, high volume, bigger commitments and so they're just taking rightly so, a little bit longer time.

Understood. Okay. And David, on the messaging thing, it seems like it's growing pretty rapidly. I wanted to ask you about the relationship with verified SMS with Google. How significant is that with respect to overall opportunity set? And what happens when RCS becomes more prevalent? How difficult is it to – is it going to switch to RCS once RCS becomes more prevalent? Or is that complete? Or am I just confusing both of them?

I like your question and I will try to answer it. The verified SMS opportunity is very promising because it augments and adds to and provides more credibility around the sending entity of an SMS message. So it leverages the existing ubiquity of SMS by adding new information fields. So as to your question, how does that look for the future? It looks it's early, but it's promising and it's the right direction for SMS to continue to add the kind of value that it does with the content of a message being understood to be from a particular individual. The second part of your question on RCS. RCS and supporting RCS, we don't think in any way impairs the potential for SMS and MMS to continue to federate across walled gardens in an effective fashion that's valuable. So the ubiquity of SMS and MMS we think continues to be really a winning strategy, but both verified SMS and RCS are important developments that we are keeping up with.

Understood. Thank you very much.

Our next question is from Meta Marshall, Morgan Stanley. Please proceed with your question.

Hi. This is Eric on for Meta. Thanks for taking our question. Maybe just kind of touching on the international rollout, where are you on the investments that need to be made and maybe more specifically, are there further countries you're planning to invest in, in 2020?

Eric, we built out significantly in 2019 and incurred significant expense for UK and our Frankfurt data centers and the connectivity required to provide service. We do have additional countries that we are targeting, but we will follow demand and build where we have existing customers that we support with traffic in those areas. And so we've baked the cost of continuing to expand international within our annual guidance. There's work to be done, but we're excited about the progress we made building in 2019 and we are focused on growing revenue in 2020.

Thank you. And then maybe just – I know you touched on before the gross margin uptick, and that things were starting to trend in the right direction, but just for modeling purposes as we're looking at putting our numbers together, should we think of the level in Q4 is sustainable? Could there be offsets that would push that back down or is it mostly upward trajectory?

Hi, Eric. This is Jeff. We're very excited to see not only the fourth quarter revenue where we achieved 50% gross margins, but we saw that earlier this year as well. And so we're certainly bouncing around that area. How I would think about our gross margins on a non-GAAP basis for 2020 is in the high 40s. And what it's going to matter is that some of the things I was talking about earlier in terms of the level of investment that we make throughout the year and the timing of that. That can impact the overall gross margin, and how network effects, like we were talking about DJ with, product mix, geography, et cetera, now more so, foreign exchange, how all these things will inform the margin and that sort of how we're getting to the high 40s, like we ended up this year.

Got it. Thank you.

Our next question is from Rich Valera, Needham & Company. Please proceed with your question.

Thank you. You guys have seen some very nice growth of active CPaaS customer accounts, and I think you actually noted that you saw record growth there 41%. And that's been going on for several quarters. So just wondering how we should think of that as potentially a leading indicator of your business since you're kind of growing customer accounts at roughly 2x the rate of your revenue growth right now? How should we think about that eventually bridging or not and just as a leading indicator?

Hi, Rich. This is Jeff. It is a good leading indicator, so you're absolutely on the right track. What we always caution folks about is in our business, as a usage-based revenue business. We don't see a lot of intra-quarter revenue because customers are once again testing, getting familiar with our platform and before they integrate with the APIs and then began consuming services. And so it takes time for that to do that. We're very pleased with the results and I think it speaks favorably for our business to set another new record and we're a little bit of a broken record on this, in that we've set multiple records here. And again, a lot of that is due to the surge effort that we undertook in 2018 and maturing the business in 2019 that we're setting these new records. So I think it's a good way to inform it. In terms of modeling, what we've always stressed with great analysts like yourselves is that we think dollar-based net retention and new logo revenue growth are probably more useful measures to do your modeling.

Fair enough. And then it sounds like you've got pretty good visibility to nice sequential bump ups in Q1 and Q2 as you onboard the strategic cohort that we've been talking about. I'm thinking as you get into the second half that they're more or less onboarded and you would need some new perhaps strategic accounts or some other business to drive that second half ramp that's embedded in guidance. Can you talk about sort of what drives that second half ramp? Do you need to have new strategic wins? Are those in the forecast in the pipeline? Just any color on that would be helpful.

Hey, Rich, this is David. We are continuing to onboard, as you mentioned, this cohort throughout the first half of the year. And as Jeff mentioned earlier, these companies are engaging our platform very broadly and very deeply. After onboarding, there's a scaling season as well, and so they will continue to grow with us, not just for the six months during which we onboard. When onboarding happens, there's a period where they're continuing to grow with us. In addition, the growth is more broad-based than just this cohort, the sales funnel and the opportunity pipeline includes new customers that we have added or are adding in our projections that support the guidance that Jeff provided earlier.

Fair enough. That's helpful. Thank you, gentlemen.

Our next question is from Alex Kurtz, KeyBanc Capital Markets. Please proceed with your question.

Hey, guys. Good afternoon. Thanks for taking the question. I just want to rewind a bit to what happened 90 days ago and what we're hearing today. It sounds like there was a real change and improved visibility with these strategic accounts. And I was just kind of wondering if you could kind of double click on what happened over the last three months here to give you this better visibility, which is great for the model and great for 2020. But I'm just trying to – you alluded to it earlier, but I just want to know if there's any bit more behind it?

You bet. This is David. As we talked about for the Q4 period, we had learned that it was taking longer to onboard. It is a tremendous credit to the operating teams here at Bandwidth and at our customers that we have been able to accelerate and grow faster than we thought we were going to. And it's really quite that simple. The words that I have from our customers in this cohort for the work that we've done on our side for our team include adjectives like awesome, excellent, top-notch, friendly, and so we have just outperformed beyond our expectations and that's what's led to the improvement.

Okay. And that's helpful. And then on messaging, just given the growth that you're seeing here and how it may impact 2020 margin levels. I was just wondering if that giving you any confidence on how that might trend during the year as the mix grows with messaging.

Sure. Alex, this is Jeff. I'll take that one. So messaging – gross margins are accretive to our overall gross margins. There's obviously many flavors as David talked about in one of the other questions or responses to a question. But overall it is accretive and so that's one of the healthy factors to our gross margin that offset things like further investment.

Thank you.

Our next question is from David Wallace, Dougherty & Company. Please proceed with your question.

Yes. Hi, guys. This is David. I'm calling in for Catharine Trebnick. I guess my question is, you mentioned earlier on, some operating leverage that you would expect throughout the year. You mentioned specifically that most of it would come from G&A. I wonder if you could just talk a little bit about how we should be thinking about R&D and sales and marketing margins going into the future.

Hi, David. This is Jeff. I will do my best to answer your question. So you're correct and heard correctly that where we think we're going to see the most pronounced operating leverage during 2020 will be in our G&A expenses as a percent of revenue. You should see that go down. Conversely, we continue to invest in R&D and sales and marketing, our go-to-market team. And we – although we've had a surge in the past, where there was really large amounts of additions, both nominally and percentage, this year it will grow more in line with the revenue growth. And so you should end up with roughly similar percentage of revenues that you saw in 2019 and in 2020.

Great. Thank you.

We have reached the end of the question-and-answer session, and this does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.