Bandwidth Inc. Q3 FY2024 Earnings Call

Thank you, Sarah. Welcome to Bandwidth's Q3 2024 earnings call. We're pleased to report solid momentum in Q3 carrying us into the end of the year with record revenue and profitability performance, strong conversion to free cash flow, and continued operating discipline. Given the overperformance in the quarter, we are raising our full-year outlook on both the top and bottom lines. These results are driven by the trust our customers place in us to deliver their business critical services, and I'm deeply grateful to our customers and our bandmates who make this possible. I also want to take a moment to thank God for the opportunities he has provided to us all. In September, we hosted Reverb24, our first-ever user conference at our campus in Raleigh, North Carolina. The event was a huge success as we engaged with over 100 customers and prospects in person and 1,400 more streaming globally. This was truly a milestone moment in our 25-year history and a strong proof point that the world's large enterprises rely on Bandwidth to transform their customer and employee experiences. As one customer told us afterwards, 'I have a much better understanding of Bandwidth, your capabilities and your culture. Kudos to your team for a great event and an amazing showcase.' Let's take a quick look at the takeaways from Reverb. At Reverb, we're proud to have announced our plan to develop an industry-first nomadic emergency services solution for markets outside the U.S. as well as progress on a new number reputation management solution for trusted calling and also a new centralized message registration center for faster and easier texting campaign registration. These innovations cross all three of our key customer categories, global communications plans, programmable services, and direct enterprise. In addition to being true technical milestones achieved by our talented team, they are also business critical solutions that will drive continued revenue growth and margin expansion. Our new next generation Bandwidth universal platform is the foundation of everything we do. At Reverb, we unveiled a number of powerful new capabilities to turbocharge the Bandwidth experience, including faster onboarding, automated workflow management, tailored regulatory frameworks, and deeper performance monitoring, all managed through convenient software APIs. Bottom line, these enhancements make Bandwidth faster to implement, easier to scale, and stickier for customer retention. Just listen to how Docusign's Vipin Kalra described it at Reverb. He consolidated nine different carriers in 15 geographies down to one with Bandwidth to power Docusign's contact-centered operations globally. The universal platform is also where we're building the next generation of our renowned emergency services. For years, we have been a leading innovator and provider of E-911 in the United States. Now we intend to make it global. We were excited to announce at Reverb our plans to develop the first-ever nomadic emergency services solution outside the U.S. We call it alternate location routing, and it promises to deliver similar life-saving potential for on-the-go workers globally as our 911 dynamic location routing services do in the United States. Our emergency services are frequently a door opener for larger customers to get to know us, and now we want to open that door to the entire world. So we've completely refreshed and upgraded the Bandwidth experience with our next gen universal platform. Turning now to the innovation pipeline for our enterprise business, we were excited to announce at Reverb that our award-winning Maestro platform now has the largest ecosystem of bring your own carrier integrations of any provider worldwide. That means enterprise IT teams have the flexibility to choose what works best for them to build custom tech stacks that enhance both customer and employee experiences. This freedom of choice and flexibility are powerful differentiators because our largest customers are now navigating multiple paths to the cloud. Some are embracing hybrid environments to maintain the best of both worlds on-prem and cloud, while others are reoptimizing their tech stacks by switching from cloud to cloud. And, of course, many are still moving 100% to the cloud for the first time. The power of Maestro is that it supports all three of these strategies, while reducing development time from months to hours and giving enterprises the control they need to adapt quickly in a constantly changing environment. With new enterprise deals closing every quarter, Maestro's flexibility and integration capabilities are driving steady business growth. The latest example is a large diversified credit union that needed rock solid reliability to modernize their on-prem contact center with a Webex CCaaS solution. They chose Maestro because they wanted maximum flexibility to build a modern tech stack to easily add new services they envision down the road. In addition, our all-IP solution made it easy to integrate the customers’ payment solution right into the call flow. Many of our customers are seeing significant operational efficiencies and cost savings by implementing Maestro. This creates additional upsell opportunities for advanced services such as conversational AI integrations. Our AIBridge product available with Maestro enables contact center operators to easily plug in best-in-class conversational AI providers like Google Dialogflow and Cognigy. At Reverb, we announced partnerships with two more leaders in the space, Kore.ai and Amelia, which will expand our AI ecosystem as enterprise adoption increases. Conversational AI enables enterprises to reduce operational costs by automating routine inquiries, which improves both the customer and the agent experience. The key financial benefit for Bandwidth is that AI interactions continue generating voice minutes on our network. Additionally, we can monetize the extra data streams needed to support AI integrations in the call flow. Customer experience works in two ways. Besides inbound communications, many of our customers also rely on outbound outreach, such as an in-home services provider scheduling an installation or a healthcare provider discussing test results. The challenge is that a rise in spam and fraudulent calls has eaten away at consumer trust, making it difficult for legitimate companies to connect with end users and get them to answer the phone. It's costing them a lot in wasted time and missed revenue. Bandwidth is now tackling this problem head-on with number reputation management, which is a new solution coming soon to help enterprises take back control and protect their outbound calling campaigns. As a cloud platform owner and operator, we have access to critical call data that can be analyzed to lead to remediation solutions. By ensuring that more calls are answered and fewer are mislabeled, we are enabling our customers to achieve higher conversion rates and maximize their revenue potential. This solution has already garnered significant interest with a waiting list of companies ready to come on board for our beta version. You've heard just some of the many ways we are elevating voice services with Maestro, AIBridge, and number reputation management. As customer experience evolves, more and more consumers want to be communicated with in their channel of choice. To that end, at Reverb, we announced a comprehensive vision for multichannel messaging with the announcement that we are now a directly connected aggregator. Bandwidth has enhanced our leadership position in the messaging market, improved our cloud owner economics, and strengthened our ability to deliver high volume mission critical messaging solutions. This not only boosts our margin profile, but it's the reason partners like Attentive Mobile, one of the largest conversational commerce platforms in the world, chose Bandwidth. Another key pillar of our messaging vision is RCS, or rich communications services. With Apple's support for RCS and mobile network operators now on board, we are among the first to develop a proof-of-concept for business-grade RCS, which is known as rich business messaging or RBM. This is a game changer for business messaging, and we're positioning ourselves to be the go-to partner for enterprises as they implement RBM across all our key markets just like we do with SMS. Navigating the global messaging landscape is highly complex, but Bandwidth is uniquely positioned to lead. With constantly evolving registration and verification requirements, our new Bandwidth registration center simplifies the process for our customers. This centralized hub streamlines compliance for high volume messaging, making it easier for enterprises to stay in line with industry regulations while meeting high standards for trust that are set by carriers. Registration centers should reduce friction and drive usage for high volume senders like a new patient engagement platform that shows bandwidth in Q3. This customer specializes in appointment verification for healthcare and dental providers as well. Knowing that missed appointments mean a loss of revenue for the provider, the customer came to us wanting a better way to verify messages were being delivered to patients. They also wanted better customer support after having deliverability issues with their previous provider. Bandwidth deployed a dedicated onboarding team to help them get up and running in just days, while our universal platform provides them with an unprecedented level of delivery insights to ensure timely patient communications. It is a great example of our messaging leadership in action. As we approach the end of 2024, we are excited by the momentum of our strong R&D roadmap and a clear focus on what the world's largest enterprises need and want. We're proud of the breakthrough innovations that we launched at Reverb which come from listening to our customers and anticipating the market. Our vendor-agnostic approach gives CIOs freedom of choice, helping us win their trust in long-term business. With continued leadership in Maestro, AI, and multichannel messaging, along with our next-gen universal platform, we are confident that we are well positioned to continue building our durable franchise as the most trusted provider in enterprise cloud communications. I'll now turn it over to Daryl to walk through the details of our financial results and our outlook.

Thank you, David, and thanks everyone for joining us today for this very special episode of Bandwidth's earnings announcement. Building on our overperformance for the first half of the year, Bandwidth delivered a record third quarter. Total revenue reached $194 million marking a 28% increase, and adjusted EBITDA grew to $24 million, representing a 74% increase year-over-year. Both metrics surpassed the upper range of our guidance. Drilling down into our third quarter results, again, total revenue rose to $194 million with cloud communications revenue of $139 million, up 15% from last year. Our cloud communications revenue benefited from growth across all our products and customer categories. And as a reminder, we go to market serving three customer categories within cloud communications revenue: direct enterprise customers, programmable customers, and global communications plans customers. We grew revenue 30% year-over-year in our direct enterprise customer category. The flexibility and control to build custom communications environments that enhance both customer and employee experiences using the Maestro platform continues to resonate with enterprises. Our programmable services category grew 55% year-over-year. We experienced strong demand for messaging, which represented 24% of cloud communications revenue and was driven by commercial customers in e-commerce, financial services, and healthcare as well as $8 million recognized from political campaign messaging. In fact, for the last 12 months ended September 30 compared to the same period last year, our commercial messaging revenue grew 32%, a very tangible demonstration of our ability to acquire new customers and take market share. For global communications plans, our Q3 revenue grew 5% year-over-year, slightly ahead of our expectations, reflecting stable momentum. In terms of operating metrics, our Q3 net retention rate was 117%, an increase of 6 percentage points from last quarter. Political campaign revenue contributed approximately 2 percentage points. Our ARPU climbed to a record $212,000 reflecting our success in attracting and serving large enterprises for their business critical communications and modest benefit from political campaigns. Adjusting for political campaign benefit, the Q3 ARPU grew to a record $201,000. Our third quarter non-GAAP gross margin was a record of 58%, up approximately 3 percentage points from the prior year's quarter as we continue to benefit from our four gross margin expansion pillars. We generated free cash flow of $14 million, showing strong flow through from adjusted EBITDA. We remain on track to achieve greater than $50 million free cash flow in 2024. Before I turn to the full year outlook, let me summarize our third quarter business model achievement. When compared to last year, revenue grew 28%. Within total revenue, cloud communications revenue grew 15%. The conversion to gross profit was very strong with gross profit growing 22% on our 15% cloud revenue growth, setting a record quarterly gross margin of 58%. Operating expenses grew 7% with half of that coming from increased investment in R&D innovation as David outlined from Reverb, all adding up to a remarkable profit growth of 74%. Now, turning to our outlook, we are raising our full-year guidance. We now expect revenue to be $742 million at the midpoint of our range, reflecting a $27 million raise to our previous guidance and year-over-year growth of 23%. We expect adjusted EBITDA to be $79 million at the midpoint, representing a 65% profitability growth over last year. Embedded in our updated full-year projections, we're now estimating a $25 million cloud communications revenue contribution from political campaign messaging customers, which notably represents less than 5% of cloud communications revenue. In closing, our priorities remain consistent: serving and delighting our customers, executing with precision, and staying committed to long-term profitable growth. These priorities were clearly reflected in the innovation on display at Reverb, a testament to the emerging market opportunities captured by the ingenuity and hard work of our Band Mates. We believe our culture of innovation will propel us forward to the next several years as leaders in the market.

Thank you, Darrell. And as he said, we will now move into the question-and-answer session. We'll be joined by our Chief Product Officer, John Bell, to provide additional insight on your innovation roadmap questions.

Well, I'm happy that I get to be the first one on this. Nice quarter, guys, especially even when normalizing everything and I appreciate all that color, Daryl. Maybe just to dive into on the RCS side of things, which is kind of a hot topic here in the space. Relatively kind of, I'll say not new, but a big sign up with Google here. I guess, what do you guys see playing out with RCS versus SMS volumes on the messaging side and how that could impact your gross margins moving forward?

Thanks, Jim and good to see you. I'm joined today by my Band Mate, John Bell, with whom I've had the pleasure of working for 13 years. He's our Chief Product Officer, and I'd like to ask him to handle your good question about RCS and what we've talked about today.

I'd say it's still early days for RCS and RBM, which use cases will work best for which technologies still early along with the economic impact of it. So we're still navigating it, but I think there's still a lot of uncertainty about how all the different channels will balance out over time as we move forward.

And then you guys talked about the driver or I'm sorry, voice coming in a little bit higher than you guys were expecting. Just trying to understand what was the cause of that?

We've had broad usage in voice across the different enterprise verticals and categories that we serve. Contact center certainly continues to be a focus for us both in that period and going forward. But very pleased both domestically and internationally with the usage of voice as a driver that we pointed out.

Our next question will be from Arjun Bhatia with William Blair. We don't hear you. Did you approve the use of your microphone? All right. Okay. We'll come back. We'll come back to you, Arjun. Our next question will be Will Power with Baird. Will, be sure to hit the green join button.

Maybe just come back universal platform. Great to hear some of the highlights. It sounds like a real success. And maybe for John who's on stage, I just love to kind of hear what kind of feedback you're getting from customers. And I guess, if you kind of break it down, I mean, David went through a lot. I mean, you've rolled out a lot at Reverb. Are there a couple of things that we should really be focused on as investors that could be bigger drivers over the next couple of years? And I guess, coupled with that again, what's kind of resonate with customers as you get feedback?

Thanks Will. John?

Yes. I think when you look at the totality of what we rolled out, it really represents Bandwidth's open approach toward the market. Our integrations to all the major UCaaS, CCaaS, AI platforms, really important, and then I'd also point out our programmable voice API that we've rolled out globally as well being really important. As we see more and more new entrants into our market, many of them are coming from different technical backgrounds. And so having that programmable voice platform helps us serve those new entrants with the technologies they're familiar with. And so, I think looking at the integrations and the technical breadth that we're taking globally is really important to us for the long term.

Could you provide any insights into the growth in messaging, excluding political factors, particularly regarding the key drivers and how those core trends compare to recent periods?

So in, one of the customer examples that we cited in the period, Will, we talked about how the use of our universal platform API for messaging was a key driver in winning them away from their incumbent. Deliverability and demonstrating that the messages sent, received on time and accurately is a huge insights product that we offer that differentiates us for the commercial customers. And I think that value will continue to resonate in the next year, as we think about messaging used through the universal platform. In terms of the financial contributions of messaging, let's pause and ask Daryl if you'd like to add to anything.

No, thank you, David. We're really pleased with the performance of our commercial messaging in the third quarter. It again performed off the second quarter very well. If we take commercial messaging ex surcharges, ex political it grew 18% in the third quarter off of 18% in the second quarter. We're really happy with that figure. That's more than double our nearest competitor in the space. And that nearest competitor includes surcharges. So we're happy with the growth there. And the healthcare company that David highlighted, the healthcare platform, where they had deliverability issues with that competitor and we were able to onboard as just a customer highlight, onboard them successfully in the third quarter. It's the attraction of the platform and our customer service and operations that seems to resonate really well with our commercial messaging customers.

Our next question will be from Eamon Coughlin with Barclays. Eamon, be sure to hit the green join button.

Congrats on a great quarter. We are hearing more interest from customers on generative AI use cases. Given the complexity and uptime requirements for these use cases, could Bandwidth have an edge for enterprises looking to activate around these voice AI use cases?

I'll begin and then invite John Bell to pile on. It's certainly the case being vertically integrated and having a universal footprint all our own that we have the ability to see quality to promise quality and to deliver it in vital media and signaling use cases for voice, handing it off, sending and receiving it across important jurisdictions and doing that in a regulatory compliant way. So, yes, if you're doing AI use cases, you want to work with a provider that is responsible for the entire tech stack. But let me pass it over to John.

Yes, I agree. And we're watching AI, a number of different AI models being used by enterprises. And so providing them the flexibility and the freedom of choice of which platforms they're choosing to use, making sure they can easily integrate into the communications stack is what's really important. And so we believe that the foundational investments we've made in the universal platform are really applicable to this future.

And then just trying to get a better understanding for political expectations for 4Q. Should we expect similar results to 3Q or a little more?

We recognized $8 million of political campaign revenue in cloud communications in the third quarter and inherent in our guide of around $25 million now after experiencing 338, the remainder of 11 we're expecting in the fourth quarter. So we are expecting a bit of a growth in terms of this last quarter.

And our last question will come from Meta Marshall at Morgan Stanley. Meta, be sure to hit the green join button.

So it certainly is a combination of existing and new customers with existing customers always out contributing just based upon the basic business we have with some stellar enterprise brands. Use cases always are evolving into creative and exciting new ways for end users. But there's nothing fundamentally different or unexpected about the way in which our customers are going to market with messaging, using our platform both domestically and now also internationally.

I want to reiterate David's comments. They are accurate, and I would like to emphasize our net retention rate. For the quarter, our net retention rate, excluding any political factors, is 115%, which we are extremely pleased with. This reflects both new revenue growth and significant growth among our existing customer base compared to last year. It's a broad improvement.

And Arjun did have one additional question. With the strong growth in global communications, are we already seeing AI drive more volume in voice or is that still to come?

It is already a launched, adopted, and growing part of our Maestro platform. Our AIBridge product now offers five partner integrations that are exciting. So, yes, it has begun.

And that – yes, I don't think we're going to be able to hear Meta. So sorry, Meta. We will talk to you very shortly. We have a call with you scheduled, so we'll follow-up there. And this concludes our question and answer session. Thank you all for joining today's presentation. You may now disconnect, and have a wonderful day.