Bandwidth Inc. Q2 FY2020 Earnings Call

Greetings, welcome to Bandwidth's Second Quarter 2020 Earnings Results Conference Call. Please note that this conference is being recorded. At this time, I'll turn the conference over to Sarah Walas. Ms. Walas, you may begin.

Thank you. Good afternoon, and welcome to Bandwidth's second quarter 2020 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 and full year of 2020. 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 various risks and uncertainties. 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 21, 2020, 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. 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 the market today. In these unprecedented times, we have estimated the revenue impact of COVID-19 for this quarter within our prepared remarks. Our methodology attributes significantly elevated platform usage to quantify current and estimate future financial impacts as a result of COVID-19. Accordingly, identifying any potential impacts in future periods may become challenging as any increased residual usage and the corresponding revenue impact will be inherent to our business and indistinguishable. Management makes no assurances that we will make further COVID-19 distinctions in the future. With that, let me turn the call over to David.

Thank you, Sarah, and thanks to everyone joining us on our call today. Bandwidth's purpose and the passion that drives us are both rooted in connection. We work to connect people, and now more than ever, it is time for us to connect with and support one another. My thoughts continue to be with the communities that have endured a multitude of tragedy and are in deep pain. We believe there is no place for discrimination anywhere in any form against any person. Bandwidth's culture remains committed to celebrating diversity, equality, and unity, which means a sincere love for one another and a celebration of the priceless differences that make us each unique. I continue to pray for all who have suffered great loss and sacrifice during this pandemic. I would like to extend my deepest sympathies to those who are sick or unemployed, and I'm grateful to all those serving during these challenging times, working to navigate a swift, safe return to our cherished livelihoods. At Bandwidth, we remain committed to keeping America connected. We are ensuring that healthcare systems, governments, businesses, and teachers can stay connected with those in need. We provide voice messaging and emergency service, delivering the greatest productivity experiences for workers who need to connect remotely. If you dial into most video conferences these days and use your phone for audio, you're likely using a Bandwidth number, and the call is probably delivered on our network. Our team is relentlessly focused on serving our customers' unprecedented demand for our services. As a result of our commitment to our mission and each other, we achieved our best year-over-year revenue growth performance ever. Our CPaaS revenue increased 40% year-over-year, driving total revenue in the quarter to $67.1 million. The fundamental strength of our business is driving broad-based growth across our customer base. The acceleration in our CPaaS revenue was clearly amplified in the second quarter by serving elevated demand from customers providing Meeting Solutions and UCaaS solutions that are keeping Americans connected. We also saw continued momentum from messaging, which grew 108% in Q2. While achieving record velocity on revenue growth, we also made progress toward our profitability goals, achieving more than $3 million of non-GAAP net income. We see three strong pillars supporting our success: our highly scalable platform of flexible APIs, our vertically integrated nationwide IP voice network that we build and operate, and our 911 capabilities that we believe are unique among CPaaS providers. Enterprises choose to build on these pillars because of their quality, cost benefits, and our amazing people who answer the call to serve our customers. Because of the strength of these pillars, we are able to significantly raise our annual CPaaS outlook, as Jeff will outline momentarily. Our vertically integrated approach to CPaaS and overall value proposition disproportionately attract and benefit large customers operating at scale. Many leading technology enterprises are long-standing Bandwidth customers, and our CPaaS revenue acceleration has been bolstered by their solutions being heavily utilized for remote connectivity in the current environment. At the onset of many more Americans working from home, our teams worked 24/7 to scale our platform and network to support the surge driven by our large enterprise customers who experienced explosive growth among their users. In this season, we have once again demonstrated our mission-critical value to the most innovative companies in the world. Our customer-centric approach has resulted in multifaceted, deep-seated, and expanding relationships with our enterprise customers. Because of our ability to serve, our largest customers extended their contracts, and we are pleased to announce that we signed a multiyear extension with one of our largest customers, retaining our position as their primary provider. We look forward to serving this customer for years to come in their quest to provide productivity tools and connect knowledge workers. In this season, we also completed a two-year extension of an originally executed five-year multimillion-dollar exclusive agreement with a Fortune 500 company that offers communications and technology solutions for residential, small businesses, and enterprises across the United States. We announced the original agreement this time last year. We are pleased by the early extension of this customer's commitment to the Bandwidth platform, and we are eager to continue to serve this customer exclusively. Now, I'd like to share a significant customer win from this quarter that marks an evolution of our engagement in serving enterprise customers migrating to the cloud. We announced a five-year multimillion-dollar agreement to provide CPaaS services to a Fortune 100 company, one of the nation's ten largest banks and among the largest issuers of Visa and Mastercard credit cards in the US. This customer will exclusively utilize Bandwidth's voice services and phone numbers to power their migration to a cloud contact center for their card services. Enterprises are increasingly migrating to the cloud but are challenged with managing complexity, ensuring operational continuity, and maintaining regulatory compliance. CIOs, as in the case of this customer, face challenges with thousands of employees moving from on-premise legacy solutions to the cloud. Unpredictable migration timelines can span days, cause telephony issues, and disrupt scheduled meetings. Additionally, migrating to a cloud provider often entails reliance on a mix of incumbent network providers and local operators, resulting in poor service quality. As a strategic partner to many leading UC collaboration and contact center providers, Bandwidth is ideally positioned to connect enterprise customers to cloud solutions. To do so requires agile software-driven tools capable of provisioning and porting numbers in a predictable process, where automation is the only viable solution at scale. These capabilities are encompassed in our software platform and, in the case of this customer, are critical to maintaining control and avoiding disruptions traditionally associated with migrating large employee bases from on-premise to cloud solutions. Equally important to this customer and large-scale customers alike is voice quality and reliability. Given that we operate our own All-IP nationwide voice network, we can predict, quickly detect, and resolve voice issues in real-time. Enterprises today need a migration partner that can connect them to the cloud and deliver an onboarding experience that allows them to continue to focus on their customers. I am proud that Bandwidth was able to deliver that experience to this customer. Likewise, we recently announced Duet for Microsoft Teams, a comprehensive solution for enterprises deploying Teams to accelerate their telephony migration while meeting complex 911 regulations through a single software-centric communications provider. Bandwidth is currently one of only two providers certified by Microsoft to provide dynamic E911 calling capabilities for direct routing, built on a reliable, software-powered network, which has long been the voice standard for leading UCaaS and CCaaS platforms. We engage with enterprises and connect them on their digital transformation journey. Internationally, we continue to make progress toward extending our world-class network into 13 European countries. In the second quarter, we provided new services to both existing and new customers. We continue pursuing our international mission and objectives consistent with our profitability principle as a key part of our long-term growth strategy. I want to end by thanking all our customers for the opportunity to serve and by thanking the Bandwidth team for your ongoing dedication to achieving our mission and to each other. With that, let me turn it over to Jeff.

Thank you, David, and good afternoon, everyone. Second quarter total revenue was $76.8 million, up 35% year-over-year. Within total revenue, CPaaS revenue was $67.1 million, up 40% year-over-year, a new record percentage growth for our business. Other revenue contributed the remaining $9.7 million, which is up 11% from the same period a year ago. Revenue growth at this scale is a testament to the power of our vertically integrated platform to serve the increasing communication needs of enterprise customers. Our stellar second quarter CPaaS revenue performance was driven by two key factors. First, ongoing and expected broad-based growth across our platform from enterprise customers who continue to scale usage in a predictable cadence with their plans to increasingly utilize cloud-based communication by embedding voice, messaging, and emergency services into their products. The second factor driving our outperformance was the increased usage driven by COVID-19-related remote work requirements, which peaked in April and thereafter dissipated throughout the quarter but remained at elevated levels compared to the pre-pandemic period. While it is becoming increasingly difficult to differentiate COVID-19-related usage from organic usage growth, we estimate the COVID-19 revenue impact in the second quarter to be in the range of $4.5 to $5 million. Regarding other revenue, the primary driver of our outperformance was due to higher A2P messaging surcharges, driven by continued strong customer demand for our messaging offering. Moving on to other key metrics, our dollar-based net retention rate was 133% in the quarter, another new record for our business and strong evidence of our ability to drive deeper and more meaningful relationships with our enterprise customers. We ended the second quarter with 1,900 active CPaaS customers, up 30% year-over-year. Gross margins came in at 48% for the quarter, as margins were negatively impacted by SMS surcharges, which we passed through to our customers, as well as heavier network investment within the cost of revenue in response to the surge demand created by the pandemic. This is expected to normalize over time, and we continue to believe that our gross margins will be in the high 40s for the year. Consistent with our commitment to balancing growth with profitability, our non-GAAP net income in the second quarter was $3.1 million or $0.13 per share, which is favorable to our breakeven guide due to gross profit overperformance as well as operating expense favorability. Now I'd like to expand our thoughts regarding our financial outlook. For the balance of 2020, we expect the estimated COVID-19-related usage to continue to dissipate, consistent with observable usage trends to date that show COVID-related usage declines from April's peak throughout the second quarter as work-from-home behavior evolves with the reopening of the economy. Despite less expected contribution from COVID-19 in the second half of the year, we are raising our annual 2020 CPaaS revenue guidance by more than $13 million based on the second quarter overperformance and our strong continuing business fundamentals. For CPaaS revenue, we have raised our full-year 2020 guidance to be in the range of $260.3 million to $261.8 million, or up 32% at the midpoint of the range. We expect total revenue for 2020 to be in the range of $296.8 million to $298.3 million, up 28% at the midpoint of the range. We're estimating our full-year non-GAAP earnings per share to be in the range of $0.05 to $0.11 per share, assuming 25.5 million weighted average diluted shares outstanding. Turning to our guidance for the third quarter of 2020, we expect CPaaS revenue to be in the range of $67.1 million to $67.6 million, or up 31% year-over-year at the midpoint of the range. This contributes to our total revenue guidance of $76 million to $76.5 million. Third quarter non-GAAP earnings per share is expected to be in the range of a loss of $0.03 to a loss of $0.01 per share, using 24.2 million weighted average shares outstanding. Finally, I want to thank all our Bandmates for their tremendous efforts that led to our exceptional performance this quarter. During these challenging times, I want to wish everyone strength, and hope you and your family remain safe and healthy. With that, let's open up the call for questions.

At this time, we'll now be conducting a question-and-answer session. Thank you. The first question is from the line of Bhavan Suri with William Blair. Please proceed with your question.

Hey guys, thanks for taking my questions and congratulations. Those are a great set of results there. I'd like to talk a little bit about the progression that you see in terms of platform usage and kind of deal flow from March-April into May-June, etc. Were there any notable behavioral changes over the last several months compared to what you saw early on in the pandemic lockdown that we've talked about in the past? Just want to understand how that played out? What you've seen as you talked to customers and obviously, the usage you see on the platform?

Glad to be here, Bhavan. In terms of the progression that we saw, I think you have to take it in two pieces. Let's first talk about the COVID impact. Obviously, we're doing our best to try to carve that out for you all. We saw a peak in April, which was higher than March. Then it began to decline in May, further declined in June, and we've seen that further decline even in July. Obviously, we're almost at the end of the month, and we've seen that as well. When we get to guidance, we expect this trend to continue. Our belief is that people have gone back to work to some degree, and we can clearly see that usage is down. We've seen other data points externally that have been similar to this. In terms of the organic business, meaning everything else other than COVID-related usage, we're seeing great fundamental strength in the business; we are, frankly, just clicking on a number of cylinders. The business is very strong, and we'll carry that with us into the second half of the year.

That's super helpful. Thanks for the transparency. You guys are always very clear about the puts and takes. I guess maybe a broader question: The messaging business is growing, but there are many messaging aggregators out there globally. Some of them are just aggregating messaging minutes, and some are discounting heavily with low gross margins. When you think about the competitive environment and your ability to maybe see pricing pressure or pricing power, how do you think about how that business trends over the next few quarters, but also over the next five years, both from a growth perspective and a pricing perspective? That would be really helpful.

Sure. I'd be glad to start. The messaging business is performing very well. You heard in David's remarks, we grew 108% year-over-year. A lot of what's driving that growth is toll-free messaging. Furthermore, messaging is actually accretive to our overall gross margins and so that's actually helping and additive to our margins right now. So I don't know if David has anything else to add, but that's where I would start.

Thank you, Jeff. Bhavan, I would add that 89% of our revenue remains voice, and we've got structural advantages in voice related to quality and costs. We believe this will remain stable and favorable over a five-year time horizon. Messaging has a different profile over that time horizon, but we are growing that business as well, though it remains a small minority.

Got it, that's helpful. Thanks for taking my questions, guys. Obviously, a very nice job. Thanks.

The next question is from the line of Will Power with Robert W. Baird. Please proceed with your question.

Okay, great. Thanks. That's a great quarter of results. Maybe to come back to the messaging strength, up over 100%, you called out a total of three messages. Any other drivers within that? How do we think about the sustainability of that, and what's in the pipeline ahead on that front?

Will, this is David. There are a broad set of use cases during the current season we are in, where engagement and communication remain vital where face-to-face contact is not allowed or impaired. Additionally, you have political activities and an election season that also contributes, so broad-based in terms of use cases, including the political aspect.

Okay. And I just want to come back to the Q3 guidance and think about the different puts and takes there. Last year, there was a nice increase sequentially into Q3. How do we think about the normal seasonality there? Presumably, as people return to work, there may be a slight decrease in meetings usage, but it seems the core UCaaS case, which is a significant part of your customer base, would continue to grow. Can you disaggregate the pieces related to the COVID impacts you've observed over the last couple of months?

Will, this is Jeff. I'll start, and if David would like to chime in, that would be great. As we enter the third quarter, you've got some balancing going on. The fundamental strength of the business is evident, and our value proposition is resonating in the market. COVID is declining, and we see that through July, which we expect to continue through the rest of the year. Normalizing for COVID, if you take our 40% CPaaS growth rate and deduct about 10% for COVID, that's around a 30% growth rate, which is right in line with our third-quarter guidance.

Okay, great. Thank you all.

Thank you. Our next question is from the line of Patrick Walravens with JMP. Please proceed with your question.

Great, thank you, and congratulations, Dave and Jeff. So many things to discuss. I think I'll start with the Fortune 500 company extension. Dave, can you remind us what stage 1 was for this company? And can you give us more details on what stage two entails?

You bet, Pat, great to hear your voice. This company engaged us years ago as a primary provider for all of their UCaaS and CCaaS needs. We have been effective in renewing that agreement several times. In this case, we've served them well during an extraordinary season, and we both came to terms on a two-year extension. This gives us continuity and visibility and is very favorable.

Can you remind us how you measure the impact of COVID? How do you benchmark it? How do you do that?

Sure. Let me start with how we did this in March, as it is the easiest to understand. In January and February, there was no COVID impact. We measured trends with our key customers, knowing if they were still growing, we would attribute some of that to organic growth from COVID. We applied the same principle in the second quarter. The reason we provided a range this time is there's interpretation involved. It’s getting harder to differentiate organic growth from COVID-driven growth without talking to the customer, and even then, they might say both. The business could be doing well, but COVID may have amplified their usage. We're doing our best to estimate and be as transparent as we can be.

Okay, great. Thank you very much and congratulations again.

Thanks, Pat.

Our next question comes from the line of Rich Valera with Needham & Company. Please proceed with your question.

Hey, it's Chad David on for Rich Valera. Just in terms of the Duet for Microsoft Teams. Can you discuss any early successes or additional color about that announcement?

The primary takeaway is that we are one of only two E911 certified providers with Microsoft, and Duet is a powerful solution provided by our platform that is extremely unique. The market opportunity is tremendous. There is great information on our site regarding the announcement. Additionally, we have not made further announcements about customer wins but look forward to doing so in the future.

Our next question comes from the line of Mark Murphy with JPMorgan. Please proceed with your question.

Hey again, I’ll add my congrats. David, are you seeing any signs of video fatigue where perhaps users don’t want to turn the camera on and are dialing in via telephone instead? Does this benefit you?

We are seeing that, Mark, particularly a use case I didn't anticipate: the ability to get up and walk around when dialing in. Users are utilizing their video on the screen but may dial in with their mobile phone, allowing for more mobility during the conference. This is a new power user use case that's favorable for us.

So returning to the extended agreements with your large strategic customers, it seemed like they extended even with some time left on their contract. Am I understanding that correctly? If so, what’s prompting this?

You are understanding that perfectly, Mark. What prompts that is the great work that both our customer teams and our own team have done during this extraordinary season. There are numerous opportunities to do great business together. Our performance has been perceived so well that the relationship is being extended early which gives us excellent continuity and visibility, driven by strong positive sentiment across both of these customer opportunities. The chemistry is at an all-time high.

With the recent trends in June and July, I heard your comments on the COVID impacts peaking in April, but we've also seen some re-openings being challenged. Are you wondering if remote work and learning will sustain?

We are, like you Mark, considering what behavior modifications will be ongoing after re-openings. Our forecasting is based on what we see on the platform, the trend, and our approach, which is to be conservative. You'll see us maintain that approach in forecasting going forward. If behaviors change permanently, that would be favorable. But for now, we are adjusting based on current observations.

I would add that I don’t think there's going back to the old normal. Work-from-home and remote work are likely here for the foreseeable future, possibly even becoming permanent. We're trying to find where that new level is, and we're confident it's higher than the old normal.

Well said, thank you very much.

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

Thanks. Can you provide an update on the gross margin investments you made for scalability in Q2? How should we think of those in terms of one time or over what time period they might be made? Additionally, any update on international progress or how the international business is ramping?

Meta, this is Jeff. In terms of sequentially, we did see a decline in our gross margin due to timing issues. In March, when the pandemic hit, we utilized our network excess capacity. This caused margins to pop a bit in Q1. In Q2, given the continued high level of COVID-related usage, we chose to invest more in our network. These costs are reflected in our cost of revenue. We aimed to regain headroom for future growth. Over time, we anticipate this will normalize and you'll see a bounce back in our margins. Other factors like A2P messaging surcharges also affected our gross margins. This was the main reason for the decline.

Meta, regarding your second question about our international progress, we are continuing to make good progress in selling new services to both new and existing customers per our go-to-market plan. The build-out continues, but we've faced some headwinds with decisions like Schrems II related to privacy. Nonetheless, things are proceeding according to plan.

Great, thanks.

Our next question is from the line of Mike Walkley with Canaccord. Please proceed with your question.

Thanks for taking my question. Hope everybody is healthy. Building on the slowing trend, do you think the summer season, with more vacations and schools out, will lead to benefits for your UCaaS and video conferencing customers due to distant learning as schools might adopt a hybrid approach in the fall?

We believe many use cases will persist that benefit us, including schools. Regardless of whether return to in-person classes occurs, this may certainly benefit us. As Jeff mentioned earlier, we're doing our best to estimate the new normal level on our platform. It’s fluid, and we hope for a quick return to normal. But there might be beneficial tailwinds for us this fall compared to the summer.

And my follow-up question is about the overall deal flow. Are you seeing an acceleration in closing deals as we move forward? Is it tougher to close some of these deals with everyone working remote? How do you see overall deal flow?

We see lead flow that is strong. We have mentioned in past periods that decision-makers were delaying during uncertainty. Things are relatively stable as relates to decision-making timeframes. While it is involved when you cannot meet in person, we're excited about the designations we've secured, such as with the Fortune 100 company. We are optimistic about the opportunities awaiting us. The digital transformation mindset among enterprise-level decision-makers is resolute; they are intent on migrating to the cloud, and that aggressive transition continues.

Great, well, congrats on your record revenue growth quarter and thanks for taking my questions.

Thank you.

Thank you. Our next question comes from the line of Alex Kurtz with KeyBanc. Please proceed with your question.

This is Steve Enders on for Alex. I just want to check on the CCaaS opportunity that you won in the quarter. What were the factors leading to the win against the incumbent voice providers you mentioned?

All the benefits of the Bandwidth platform include aspects of an API approach to communications that legacy providers have not possessed. As an enterprise CCaaS customer with a need for a flexible, scalable solution, you’re looking at Bandwidth's platform designed to help you migrate to the cloud at light speed, and to do so reliably. This is an aspect that the incumbent carriers have struggled to address. We don't anticipate a notable change in their behavior, and we foresee continuing our momentum with the largest enterprises in the country.

That's helpful. CCaaS seems to be emerging as a new opportunity for Bandwidth. What is the current state of that opportunity and your perspective on it?

We have discussed CCaaS in the past but have made our first material announcement regarding a significant customer. It represents a fantastic opportunity. We are active in supporting the CCaaS space with many good partners providing extraordinary solutions. We are excited about our role in the CCaaS ecosystem that assists the largest enterprises transition from legacy solutions.

Great, thank you.

Our next question comes from the line of Derek Soderberg with Colliers Securities. Please proceed with your question.

Hi, everyone. I’m sitting in for Catherine Trebnick. You discussed SMS surcharges. Verizon and AT&T have implemented surcharges on A2P text messaging. Is this creating a better competitive environment for Bandwidth? How do your surcharges compare to those of Verizon and AT&T?

There's no question that surcharges are an additional cost that is passed on to the customer for 10-digit long code SMS messages. Our messaging service is predominantly toll-free messages, but we anticipate that carriers will eventually apply similar fees to toll-free messaging. When that happens, we will likewise impose surcharges but pass those through to customers. In essence, this is an expanded cost for everyone involved, including Verizon and AT&T, regardless of who the provider may be. Currently, toll-free has an advantage without those charges, but we think that could very well change over time.

Can you also expand on the E911 business trends and growth drivers looking forward?

We were thrilled to announce that we are one of only two providers certified by Microsoft for E911 when we introduced our Duet solution, facilitating direct routing for Teams. That E911 solution is crucial for large companies shifting from legacy solutions to the cloud. We believe our leadership in the E911 space bodes well for our prospects given the large addressable market ahead.

Great, thanks.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. We thank you for your participation.