Bandwidth Inc. Q3 FY2020 Earnings Call

Thank you for standing by. This is the conference operator. Welcome to the Bandwidth Inc. Third Quarter 2020 Earnings Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I’d now like to hand the conference over to Sarah Walas, Vice President of Investor Relations at Bandwidth. Please go ahead.

Thank you. Good afternoon, and welcome to Bandwidth's third 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 fourth fiscal quarter and full year of 2020, and to the extent provided future periods, statements regarding the expected timing of the closing of the proposed Voxbone transaction and the expected benefits of the proposed transaction and our expectations around the impact of the COVID-19 pandemic on our business. 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 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 market today, which is located on our website at investors.bandwidth.com. With that, let me turn the call over to David.

Thank you, Sarah. Welcome, everyone. With so much good news to share, I need to begin by thanking God for the strength to seize the opportunities He has provided us. Together, our team delivered record results in the quarter. We are raising our annual revenue guidance substantially and we are acquiring Voxbone, expanding into over 60 countries worldwide. To my Bandmates, thank you for your stamina and resilience during the season when enterprise communication is more vital than ever before. To our soon-to-be Bandmates at Voxbone, welcome aboard, we are ecstatic that you are joining us on our mission to develop and deliver the power to communicate now around the globe. During this quarter, enterprise demand for our software platform and network was higher than ever before. Our CPaaS revenue increased a record 43% year-over-year. This accelerating growth was driven by a diverse cross-section of customers expanding their usage of all our services. Our unique combination of software platform, network, and enterprise customer support resonates with enterprises operating at scale. Our extraordinary growth was also driven by messaging, which grew 164% year-over-year. This increase was powered by an unprecedented amount of political messaging traffic in the run-up to next week's U.S. presidential election. We proved to be an ideal choice for this group of customers to achieve industry-sanctioned high volume deliverability. Our messaging results were also bolstered by an expanding relationship from an innovative customer well known for point-of-sale solutions. This customer's fast-growing division, which gives users the ability to send, spend, and store money, is driving increased messaging usage on our platform. The company utilizes our enterprise-grade toll-free messaging solution for application-to-person use cases requiring high-volume delivery of customer receipts and mobile delivery confirmation. In addition to expanding existing relationships, we continue to attract new enterprise customers to our platform. This quarter, we surpassed another milestone as we now serve more than 2,000 CPaaS customers, an increase of 25% year-over-year. Our sales and marketing teams have executed well, onboarding 115 net new customers in the quarter. While achieving record revenue growth and attracting new customers to our platform, we also continued to exceed our profitability goals. For more than two decades, Bandwidth has transformed enterprise communications across the United States. Last year, we started serving customers in Europe using our software-powered voice network. Earlier this month, we shared that we will soon be serving our customers around the globe with international cloud communications leader Voxbone joining our Band. We believe that this combination of two CPaaS leaders accelerates our international expansion by at least several years. Together, we will serve global enterprises across 60 plus countries representing 93% of the world's GDP. The two companies complement each other brilliantly. We share the same values and can now describe them in different languages. We are mission-first while committed to serving others. Our shared set of values and an incredible chemistry between the teams is the basis of the strong cultural fit we will harness to serve customers worldwide. We both offer cloud communications platforms powered by a modern network, giving customers quality, control, and scale. Over the past 15 years, Voxbone has consistently added country coverage and prided itself on a compliance-first infrastructure strategy to serve a large and innovative customer base. Both teams are excited for the opportunity to deliver the same experiences our customers have enjoyed in expanding footprints. Our customers will benefit from a unified software platform and network for the rapid launch, and hyperscale of communications, applications, and experiences. We will offer enterprise-grade global connectivity for cloud platforms, mobile applications, and Fortune 1000 enterprises. The reaction from customers and team members on the acquisition announcement has given us total conviction that Bandwidth will be more uniquely positioned than ever before. This quarter, our team delivered greater results than ever before in our history. While we are acquiring one of the most impressive teams and businesses in and around the world, I am proud of all my amazing Bandmates, who with me remain humbled and grateful for the many opportunities afforded us during this season. With that, I will turn it over to Jeff.

Thank you, David. And thanks to everyone for joining us on this call, including our friends at Voxbone. We had an exceptional quarter which drove both top and bottom-line results, far exceeding our expectations. Third quarter total revenue was $84.8 million, up 40% year-over-year. Within total revenue, CPaaS revenue was $73.8 million, up 43% year-over-year, which is another new record percentage growth for our business. Other revenue contributed the remaining $11 million of total revenue in the period, which is up 22% from the same period a year ago. The majority of our revenue growth continues to come from the core drivers of the business. However, we did have two factors that amplified our results in the quarter. First, we experienced elevated usage in messaging driven by the upcoming U.S. elections. Second, we continue to benefit from the work-from-anywhere dynamic caused by the ongoing pandemic. And as we have previewed, this COVID impact continues to decline quarter-over-quarter. Combined, these two factors added approximately 12% to our third quarter year-over-year CPaaS revenue growth, with 7% coming from political messaging volumes and 5% from COVID-related usage. In addition, I want to highlight our strong new logo growth contribution in the quarter. We continue to expand our existing customer relationships, as evidenced by our solid dollar-based net retention rate of 131% in the quarter, compared to 116% a year ago. The primary driver of our other revenue outperformance was higher A2P messaging surcharges associated with serving strong messaging demand. On September 1st, carriers implemented an additional toll-free messaging surcharge, and accordingly, we expect these fees to continue going forward. Despite these increasing messaging surcharge factors, our non-GAAP gross margins came in at 49% for the quarter, and we remain on track to achieve gross margins in the high 40s for full year 2020. We continue to balance strong top-line growth with profitability as evidenced by our non-GAAP net income in the third quarter, $6.5 million or $0.24 per share. This result is favorable to our guide and driven by gross profit over-performance, as well as operating expense favorability. Now I'd like to share our thoughts regarding our financial outlook. We are raising our annual 2020 total revenue guidance by more than $29 million to reflect: one, the over-performance in the third quarter; two, the continued strong demand for services; as well as; three, the expected contribution from the pending Voxbone acquisition. The fundamental strength in our standalone business accounts for more than $15 million of the raise, with $8.5 million coming from our third quarter over-performance and approximately $7 million from the increase in our fourth quarter total revenue guide. The Voxbone acquisition is on track to close on October 31st, and we anticipate receiving two months of contribution from Voxbone in the fourth quarter of 2020. This equates to approximately $14 million of anticipated total revenue contribution from Voxbone to our fourth quarter and annual guidance, of which $13 million will be CPaaS revenues, and the remaining $1 million of revenue will be included in our Other segment. This contribution assumes current business conditions and current foreign currency exchange rates. In terms of CPaaS revenue, we have raised our full year 2020 guidance to be in the range of $284.3 million to $284.8 million. We expect total revenue for 2020 to be in the range of $326.6 million to $327.1 million. We're estimating our full year non-GAAP earnings per share to be in the range of $0.44 to $0.46 per share, assuming 25.8 million weighted average diluted shares outstanding. I want to highlight that the share count includes adjustments for convertible debt conversions and shares to be issued related to the pending Voxbone acquisition. Turning to our guidance for the fourth quarter of 2020. We expect CPaaS revenue to be in the range of $84.3 million to $84.8 million. This contributes to our total revenue guidance of $96.5 million to $97 million. Fourth quarter non-GAAP earnings per share is expected to be in the range of $0.03 to $0.05 per share using 27.5 million weighted average diluted shares outstanding. In summary, our third quarter was an outstanding quarter for our business. And we look forward to driving this positive momentum into the fourth quarter and beyond. With that, let me turn the call back to the operator for Q&A.

Thank you. We will now begin the question-and-answer session. Your first question comes from Mark Murphy with JPMorgan.

Yes. Thank you and congratulations on a very nice quarter. First of all, I'm wondering, does the flare-up in COVID cases and the reinstatement of lockdowns in Europe affect your thinking at all that April was the peak of the usage spike or does that kind of remain your thought process?

Hey, Mark, this is David. It currently remains our conclusion that April was the peak. We'll keep watching it. But that's how we think right now.

Okay, David, as a follow-up, do you have any thoughts on the announcement of Microsoft Azure Communication Services? We also noticed RingCentral's announcement of a bulk SMS API. I'm asking because I'm curious about how you view those offerings in relation to our Bandwidth customers. Do you think the industry will benefit from them, and could Bandwidth benefit as well?

We do cheer both Microsoft and RingCentral for those announcements, big fans of both for their customers, and think that it does bode well for Bandwidth.

Okay. The final question is, Jeff or David, could you explain where Voxbone is focusing its international efforts? Specifically, what are the locations of the data centers and where is the voice traffic coming from? Is there anything surprising about that?

I don't think anything will be counterintuitive. You can think about the largest country contribution coming demographically from the largest GDP countries. The networks are complementary in the protocols and the stack that each use. The data centers are located where you find important carrier meeting points and where there's good aggregation of traffic. So I think intuitively, their architecture has made great sense to our team as we've diligenced the company, and we're very excited about finishing the transaction, closing, and really growing the business together.

Your next question comes from Bhavan Suri with William Blair.

I guess I just want to follow up on that question a little bit, David, just your thought process, strategically. So, let's say you now get embedded, and you've been sort of the arms dealer to all these guys, RingCentral, Microsoft, et cetera. How do you think about drawing a line about where you start to provide more value? Do you think about moving up the stack and providing some sort of more application-like technology that's built in the core of the platform that Bandwidth has today? Or do you think at least for the foreseeable future, you remain sort of the underlying infrastructure provider, and guys sort of leverage that technology, so again, you don't want to get too competitive? But there's got to be a gap that you see in the space that you could fill with an application, very specific application, maybe a political messaging application or something that would make sense, love to just know how you think about that philosophically, strategically with the team?

We are focusing more on horizontal expansion rather than vertical. Sixty percent of the total addressable market in CPaaS lies outside of our home market in North America. The Voxbone acquisition allows us to access 93% of the world's GDP across more than 60 countries. Therefore, our main goal with the excellent Voxbone team is to reach the full market for many of the customers we currently serve in North America. Our priority is to effectively address the entire market with our capabilities. There will be opportunities in the future to enhance our value as a CPaaS provider, which acts as a vital component for our enterprise customers. However, at this moment, our customers are urging us to replicate the successful services we've provided for them globally.

To do so well. And then I have a quick follow up here. You’re obviously very bullish I appreciate it. But one of the things you've given us color in the past is sort of the pipeline of some of these new types of customers, some of these large communication service providers. Just how is that pipeline going? How do you see it developing forward? And has COVID had any impact on the cadence of those, either acceleration, deceleration? Or how should we think about the cadence of these very, very large, kind of platform-class type deals you've talked about in the past? Thank you.

You bet. The cohort that we onboarded really toward the end of last year has progressed very nicely this year in turning up service as we expected. As you'll recall, we caught up and accelerated that cohort of customers onto our network. And nothing new to report there regarding COVID impact on that projected group of service provider customers utilizing the platform broadly. We've, in fact, been happy about outperforming our own internal estimates of those customers coming onboard. And going forward, I don't think that COVID is a negative regarding the value that we offer to that type of customer. So the pipeline, we think, is as we expected at the beginning of the year.

Your next question comes from Will Power with Baird.

Okay. Great. Yes, a couple of questions. Thanks for the color on the political messaging contribution and work for anywhere contribution, I guess, for Q3. Any way to get some flavor for what you're assuming on those fronts in the Q4 guidance? I'm sorry if I missed that. I'll start with that, then I have a second question.

Will, this is Jeff. I'd be glad to take that question. So in terms of political messaging, we continue at the beginning of the fourth quarter to see strong volumes from political messaging. We expect that to carry through next week in the election, but thereafter dissipate materially as they've done in previous election cycles. On the COVID front, each quarter, we've seen that elevated demand tick down, and we expect that to continue in the fourth quarter compared to the third quarter.

Okay. Just to clarify, have you observed this trend continuing through the third quarter and into the early part of the fourth quarter? The reason I ask is that, with lockdowns being reinstated, does that lead to any changes in your perspective, or is it not yet at this stage?

We did see it come down in the third quarter. That's as far as we're going to go on the comments related to COVID at this point. And so that's what we can tell you.

Okay. And then I guess, as you look at the broader kind of core strength in Q3, I guess I'd just be interested in kind of the breadth of that strength. You've got your unified communications cohort, meetings, UCaaS providers, which we know have been strong. Maybe trying to help us qualitatively understand the growth there versus your other broader set of enterprise customers where based on the customer growth you probably continue to see contraction.

This is David. The growth outside of the political factors and the COVID tailwind was indeed diverse and came from a range of solid enterprise customers. We highlighted a point-of-sale customer that was scaling well. Additionally, one of the service provider groups that onboarded is doing well, as is a financial services company. Overall, the performance is broad, not limited to UCaaS and CCaaS, but really from the wider customer base that is performing well and is diversified.

Your next question comes from Rich Valera with Needham & Company.

Jeff, as we approach 2021, I know people are starting to refine their models. Can you share any insights on 2021 at this stage? Specifically, how much of the 220 baseline do you believe was non-recurring due to factors like COVID, political influences, or the $14 million from Voxbone? Any preliminary thoughts you have on 2021 would be appreciated.

Yes. Rich, obviously, we'll have a lot more to say on our next call and detail the 2021 outlook. But I think for now, the things that I would consider and think about: one, just the underlying strong business fundamentals, but also thinking about some of the macroeconomic uncertainty that's out there. And then you should think about some of the things that we may and likely will encounter in terms of the hard comps of political messaging and COVID as those tail off. So that's kind of what I'd have you think about.

Fair enough. Can you share any expectations regarding the growth of Voxbone at this time? I believe you mentioned an annualized figure of $85 million for 2020. What are your thoughts on how we should view the growth in that area?

Yes. Nothing to share for 2021, but you're right. In 2020, we said that we expect them to achieve at least $85 million in 2020 for total revenue, and that would represent 25% or more growth. So at this point, we're focused on closing the transaction, beginning integration. And again, we'll have more to say on the next call.

Your next question comes from Pat Walravens with JMP Securities.

So Dave, what do you have planned to ensure that Voxbone operates as smoothly as possible?

The Hippocratic Oath comes first, Pat. That's the first operating principle as we plan the integration. The second is really creating a one Bandwidth experience for the customer and for how we lead the team. Both teams on either side are excited about how complementary our services are, and how the combination value of the customer base is so accretive. There's very familiar technology on both sides. But the leadership that we're excited about working with at Voxbone are very impressive. Our obligation is to do no harm first and then create a one Bandwidth customer experience.

Great. And then if I can add a separate one. Can you just quickly remind us of the history with Microsoft and then provide a little more color around this latest evolution in the relationship in terms of Azure Communication Services?

In reverse order, Pat, the Azure Communication Services announcement included that the same high-quality experience that Microsoft customers of Microsoft Teams enjoy will be available through their platform. We are delighted to be a long-term Microsoft and Microsoft Teams’ primary partner. So we believe that we've got a really important role. And we're proud and excited about continuing to work together with them.

Our next question comes from Alex Kurtz with KeyBanc Capital Markets.

This is actually George in for Alex. Going back to the Voxbone acquisition, what do you expect this will mean for longer-term gross margin outlook? Do you expect to increase for all network traffic to have any effects?

George, this is Jeff. So in terms of long-term gross margin, we expect the Voxbone acquisition to be accretive, and that will be right out of the gates. Additionally, having a larger business, we expect to continue to benefit from economies of scale as well as network effects.

Your next question comes from Mike Walkley with Canaccord Genuity.

Just another follow-up question on Voxbone. Now that the deal has been announced and you've gone back and forth with some larger customers, can you maybe share some customer feedback for the one experience and if it's leading to any cross-sell or upsell opportunities to create more of a global footprint for some of your North American customers?

This is David. Enthusiasm, anecdotally, some of the comments, 'What took you so long?' Just overall excitement about the two teams coming together to provide a unified offering around the world. The customer response universally has been positive. That's really been encouraging to us. You always hope and expect you'll be embraced by your customers for doing new things for them. And certainly, that's been the case in our experience so far. In terms of cross-sell and upsell, we think there's tremendous opportunity as we begin to look forward.

And just my follow-up question, with the over 130% dollar-based net retention, were there any special large deals closed in the quarter or any customers reviewing deals early like you talked about last quarter?

No, nothing special to call out, again, very broad-based, driven by higher usage, both on the voice and messaging side. We also found favorable contribution from pricing as well as on our monthly recurring charges. So across the board, just a great performance.

Your next question comes from Meta Marshall with Morgan Stanley.

On your new customer adds, that was an uptick that we've seen kind of from some of the slowdown earlier in the year. Just wanted to get a sense of what you're seeing as far as sales processes for bringing on enterprise customers? Are your sales reps traveling yet or people getting used to kind of the new normal of selling virtually? Just any color there would be helpful.

We only travel where the customer welcomes us to do so and have done some and continue to really be proud of the sales team for their execution, getting over 2,000 total customers is a great milestone. It's just been a really rewarding year to watch sales leadership really fight through the friction of not being able to do business at shows and with enterprise connections. Important in-person often couldn't be prouder of the marketing team for the demand generation, the sales team for their morale, their camaraderie, and the results are really showing that and show through. So appreciate your kind words.

And then just in terms of on Voxbone, clearly, a good opportunity or great opportunity there for to expand some of your relationships more globally. Just in terms of timing of when you could start utilizing or expanding some of your contracts more globally and utilizing Voxbone's network?

We're excited about closing the transaction on time and in full and really believe that the complementary nature of the networks will yield both quality for customers worldwide. But also, as Jeff mentioned, the bedrock of the gross margin progress that we've inexorably and unequivocally made period-over-period, we'll continue with this addition as we march around the world together. Network effects and economies of scale just compound. And so we're really excited.

Your next question comes from Andrew King with Collier Securities.

First off, I just wanted to get a deeper dive into your channel strategy on COVID. Are you seeing a bigger uptick in your digital event and digital marketing? How do you change that strategy? And then just second for Jeff, going forward with the acquisition of Voxbone, can you give us any insight into the medium to long-term operating margin trend?

The marketing team, as I was just mentioning, has rallied and pivoted away from going to shows like Enterprise Connect and hosting events and introducing who we are at Bandwidth to enterprise prospects to really engaging digitally and sometimes arranging for contemporaneous physical world deliveries of whether it's wine and cheese for a conference call or a seminar or webinar. They've been so creative in continuing to drive great pipeline contribution to the sales team. It takes a lot of creativity and energy in this kind of a season, and the flexibility that they've demonstrated has contributed significantly to our great performance in this latest quarter.

And this is Jeff. As far as the acquisition, we not only think that Voxbone will be accretive to our gross margins, but also to our non-GAAP net income. They've been a profitable business throughout their history. In addition to the strategic merits, the financial profile was one of the things that was really attractive to us in acquiring the company.

This concludes the question-and-answer session. This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.