Earnings Call Transcript - BAND Q1 2023

Operator, Operator

Good day and welcome to the Bandwidth Inc. First Quarter 2023 Earnings Conference Call. Please note that this event is being recorded today. I will now hand the conference over to Sarah Walas, Vice President of Investor Relations. Please proceed.

Sarah Walas, Vice President of Investor Relations

Thank you. Good afternoon, and welcome to Bandwidth's first quarter 2023 earnings call. Today, we'll discuss the results announced in our press release issued after the market close. The press release and an earnings presentation with historical financial highlights can be found on the Investor Relations page at investors.bandwidth.com. With me on the call this afternoon is David Morken, our CEO; and Daryl Raiford, our CFO. 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 second quarter and full year of 2023. We caution you not to put undue reliance on these forward-looking statements as they may involve risks and uncertainties that may cause actual results to vary materially from any future results or outcomes expressed or implied by the forward-looking statements. Any forward-looking statements made on this call and in the presentation slides reflect our analysis as of today, and we have no plans or obligation to update them. For a discussion of material risks and other important factors that could affect our actual results, please refer to those contained in our latest 10-K filing 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 as well as in the earnings presentation, which are located on our website at investors.bandwidth.com. With that, let me turn the call over to David.

David Morken, CEO

Thank you, Sarah, and thanks to everyone for joining us. 2023 is off to a good start. We are making solid progress adding direct to enterprise customers, developing innovative, award-winning products, and advancing our strategic initiatives while focusing on profitability. During the first quarter of the year, we exceeded our revenue guidance and are on target to meet our goal of growing profitability by 30% this year. I want to thank our customers for continuing to trust us with their mission-critical communications. Thank you as well to all our Bandwidth team members around the world for supporting our customers and each other in selfless dedication to our mission, and I thank God for blessing us with a 24th year of extraordinary opportunities. We serve three distinct customer categories: Global communications plans, programmable services, and direct-to-enterprise. This quarter, we highlight our growing momentum in the direct-to-enterprise market, where we power cloud contact centers and new developments in our software platform. In direct-to-enterprise, we won several Global 2000 financial services leaders that chose Bandwidth as the voice provider for their contact centers during the quarter. Notably, each one deployed a different CCaaS platform while choosing our Bandwidth Communications Cloud to power their communication stack. This shows how we're leveraging our strong relationships with all the Gartner leaders in cloud contact centers, and the breadth and depth of our expansion in the enterprise contact center space. Among existing customers, we expanded our long-term relationship with the largest issuer of Visa and MasterCard in the United States. Using the Bandwidth Communications Cloud, we helped this customer scale up its contact center capacity due to a recent acquisition. Additionally, this customer needed new international coverage to connect with employees in the Asia Pacific region. Because we seamlessly connected this customer across global geographies, we were awarded this new business. As these examples show, we're seeing measurable results by directly serving enterprise customers. We've grown over tenfold the number of enterprise contact centers utilizing the Bandwidth Communications Cloud just in the last three years. Our significant expertise across numerous industry verticals comes from providing scalability, redundancy, pre-integrated conversational AI, and native fraud scoring technology and is driving the largest enterprises to come directly to Bandwidth to help build their cloud contact centers. A successful enterprise communication strategy is dynamic, and our strong culture of innovation keeps us ahead of and shapes the curve. For example, we integrated AI into our communications cloud over a year ago. That's because we've prioritized R&D from our very earliest days. For the last 24 years, in fact, innovation has been the foundation for all our growth and profitability. Bandwidth Maestro is the latest example, born from our close connection with enterprise CIOs who now must connect their entire organizations to create better customer experiences while streamlining operations. Maestro integrates the best-in-class platforms and capabilities that CIOs need across UCaaS, CCaaS and AI. It's truly a next-generation capability and customer experience, and it saves months of integration work. So enterprises can achieve faster time to revenue. Unlike the proprietary lock-in of other providers, Maestro maintains our platform-agnostic approach, providing flexibility to CIOs. We believe the value proposition and ROI of Maestro is unique in the CPaaS space, with full availability slated for later this year, the early market reaction to Maestro has been encouraging in recognition of its excellence in technology advancement, innovation, and business impact, Maestro won Best of Show at Enterprise Connect. This is a substantial achievement, and it is already proving to energize conversations with both existing customers and prospects. Maestro joins other award-winning innovations we've launched recently like our native text messaging app for Microsoft Teams called Send-To, which recently won the Internet Telephony Product of the Year Award, and our backup solution for toll-free calling named Call Assure, which was a finalist in the prestigious CX awards this past quarter. These are just a few examples of how our innovation engine and breadth of solutions are shaping the future of cloud communications for both new and existing enterprise customers. We're still in the early stage of a long-term secular trend of digital transformation that's becoming more and more dynamic by the day with emerging AI technologies, converging platforms, and exciting new use cases. We're focused on maximizing our direct-to-enterprise momentum, capitalizing on new innovations like Maestro, increasing product penetration across all three customer categories, and exploiting the competitive advantage of being the only CPaaS provider with our own global network, all while serving our customers and executing with discipline to grow profitably. I'll now turn it over to Daryl to walk through the details of our financial results.

Daryl Raiford, CFO

Thank you, David, and good afternoon, everyone. We started the year with a solid first quarter, achieving revenue of $138 million and adjusted EBITDA of $5 million. Both results position us well to deliver our full year outlook. Revenue compared with last year benefited from monthly recurring charges for phone numbers and emergency services, which combined were up 6% year-over-year, and higher messaging revenue, up 8%, representing 15% of total revenue, excluding surcharges. Our commercial messaging growth was driven by solid demand across a variety of use cases, including health care, retail and e-commerce shopping, fintech, and civic engagement. On a sequential basis, excluding surcharges, overall, first quarter messaging was lower than in 4Q '22 as we had expected. But adjusting for the positive effects of political campaign messaging recognized in last fourth quarter, we achieved sequential growth of 16% in our commercial messaging from higher demand in those same verticals. Pass-through surcharges associated with messaging were $23 million in the first quarter. The combination of these products power the offers that we provide to our three target customer markets. In terms of our market results in our most established market, global communications plans, we met our expectations for revenue that was essentially flat year-over-year due to softness primarily in UCaaS customers. In our programmable services and direct-to-enterprise customer categories, our quarterly growth from messaging and monthly recurring charges is evident as these two customer categories grew 8% and 27%, respectively, year-over-year. Programmable services continue to strengthen from a secular movement to messaging engagement. And although the direct-to-enterprise category is a small base of revenue for us today, the undeniable market dynamics, customer wins David highlighted, and strong pipeline give us confidence this market will be a key driver in achieving our long-term financial targets. Rounding out our first quarter results, non-GAAP gross margin was 54%, up 1 percentage point from the prior year's quarter. We continue to benefit from economies of scale, a rich mix of higher-margin products, global coverage, and operating improvements. In terms of our operating metrics, our first quarter net dollar retention rate was 109%. For customers greater than $100,000 annual revenue, our net dollar retention hit 111%, 2 percentage points higher than the total customer metric and clearly demonstrating the benefits from focusing on large customers and direct-to-enterprise opportunities. Active customer count was 3,361, although the customer count metric has diminished in relevance over time as we focus on larger and more profitable customers. Average annual revenue per customer, which continued to rise, reached $172,000 in the first quarter, another demonstrable result from larger customer opportunities. In the first quarter, we further strengthened our balance sheet with another repurchase of 2026 convertible notes, resulting in a reduction of $65 million of convertible debt for approximately $51 million cash or an approximate 22% discount to par value. This latest opportunistic repurchase, combined with the $160 million repurchased in November 22, lowered the outstanding 2026 notes by $225 million or 55% of the original principal balance, utilizing only $168 million of cash, effectively erasing $57 million of our net debt obligation. The remaining balance of our convertible debt maturity in 2026 is now $175 million. We continuously evaluate our options for the best use of our balance sheet to stay opportunistic in the current capital market environment. With our resolute focus on profitable growth, we create the option to fully repay our remaining convertible note obligations in full upon their respective maturities with our earnings and available cash if that is the choice we wish to make. We ended the quarter with a cash and securities balance of $124 million, a more than sufficient amount to meet our business needs and sustain a great deal of financial flexibility. Turning to our outlook, we are on track to achieving our full-year guidance provided at the start of the year of $576 million to $584 million in revenue, and $43 million to $47 million adjusted EBITDA. Our outlook for the full year is unchanged despite a challenging macro environment. In summary, our financial and operating performance in the first quarter represents a solid start to the year. We'll continue to focus on what we can control, serving and delighting our customers every day, growing our margin, being disciplined with our costs, and becoming more profitable. Now, I'll turn the call back over to the operator for questions.

Operator, Operator

Our first question will come from Mike Walkley with Canaccord Genuity.

Mike Walkley, Analyst

Nice to see the solid start to the year, and the updated guidance. I guess, David, for you, just a question on maybe the linearity of the quarter and just post Silicon Valley Bank and some of the macro issues, have you seen anything slowing in the March, April time frame? Or is business really trending as you expected for the year?

David Morken, CEO

Thank you, Mike. Very proud of the team for what we achieved in the first quarter. And we certainly, like everyone, are watching things like the issues with banks. But we're executing as expected and guiding forward as you've come to know us well in a way that we believe is accurate and reflects both macro and things that we do see internally. Nothing to call out in particular that would further answer your question on conditions. But again, executing the plan that we set for ourselves for the year, really delighted that we've started off the year with the performance in the first quarter as expected and believe that we will continue to execute throughout the remainder of this year toward the objectives that we have defined for ourselves.

Mike Walkley, Analyst

And just for my follow-up question, Daryl, good job paying down the debt. It certainly seems like you guys have the balance sheet in a good position now given your profitable growth history. Just in terms of the Q2 guidance on the slightly higher revenue, but similar adjusted EBITDA. Is there any kind of change in mix or gross margins? Or you kind of just expected Q2 similar to Q1?

Daryl Raiford, CFO

We're expecting Q2 on the revenue line to grow just modestly over Q1. We're also expecting our EBITDA to be as we've guided at $5 million. We believe that we have some real operating flexibility there. Clearly, the macroeconomic conditions that we even witnessed today would give some in the market pause, but we're pretty happy that we have derisked our guide for the second quarter and are comfortable with it.

Operator, Operator

And our next question will come from Meta Marshall with Morgan Stanley.

Meta Marshall, Analyst

I noticed the success you had in APAC. Do you feel that you have covered all the necessary regions at this stage? Are there still regions that might be more important as you look to expand globally? Additionally, regarding the Maestro product, it was impressive to see at Enterprise Connect. When do you anticipate it will start making a significant impact on revenue? Will it be meaningful in 2024, or will it take longer for it to gain traction?

David Morken, CEO

Regarding your first question related to geographies and markets that we opened, we celebrated opening Turkey and did so really behind a strong business case from an existing customer. And that's the way we've historically built instead of trying to build it and they will come, we follow demand. And so we've got a very good relationship with some of our most aggressive international customers who identify for us markets that are favorable for lots of different user experiences, and we'll invest and build in those geographies responsibly. Sometimes, we'll begin by partnering, but then our unique value proposition that you've followed for a while, Meta, is to have an owned and operated network beneath our software platform, and we'll continue to execute against that strategy globally following our customers around the world. In regard to Maestro, so excited that the product has been received the way that it has winning the Best of Show at Enterprise Connect. The team continues to have very encouraging and exciting conversations with enterprise customers about the product. And we believe that it will continue to pick up steam and momentum throughout the rest of this year, but your question, the essence of which is when will the revenue arrive for Maestro, we think that it is going to be exciting to see throughout '24 and beyond as we head toward our long-term growth targets for direct-to-enterprise business that Maestro is going to really drive a lot of that growth. That's the reaction we have from the early responses and conversations coming out of the award-winning quarter that we've just left. And we may not call out directly related Maestro revenue, but it is the leading car on this train that we're on towards the future with direct-to-enterprise.

Operator, Operator

And our next question will come from James Fish with Piper Sandler.

James Fish, Analyst

David, in your prepared remarks, I think it was you, noted some softness with the UCaaS side of the business. I guess, can you elaborate on that in terms of what you guys are seeing? And also what you're seeing with also your largest customers in that part of the market, as well as on the contact center side where it sounds like things are going pretty well?

David Morken, CEO

Yes. I'll start in reverse. The CCaaS momentum with the direct enterprise wins has been fantastic and as expected. Lots of high interest in the bring-your-own-carrier model for consuming CCaaS. Every single deal win that we highlighted on this call was related to contact centers in the enterprise and bringing your own carriers. So that's exciting. We think regarding UCaaS, that it's purely a function of the macro and fewer seats that may result from the macro. Usage patterns for UCaaS are largely attributable to the economic conditions; are you adding heads? Usage was healthy and growing prior to the pandemic. And so we think that the return to the office is not the primary factor. And again, I think it's most important to recognize that within the overall guide and results, the conditions in UCaaS haven't changed either our expectation or our results for the quarter. So it's something that we've easily accounted for in the period, and don't think that it takes us off track at all for the remainder of the year.

James Fish, Analyst

Helpful. And then on the customer count, I know you guys are focused in on larger and higher-quality customers. But it was another quarter where it was down sequentially again and somebody's got to ask it here. How much of this was kind of continued rationalization versus, I think in the past year where you've given what the gross additions were this quarter? Can you help us kind of bridge the rationalization versus kind of gross additions? Or is this kind of a clean customer count to think of going forward?

David Morken, CEO

We are continuing to streamline our customer base by letting go of small unprofitable customers. On average, these customers generate $2,000 a year, while our average customer revenue is $172,000 a year. Therefore, the total customer count isn't as relevant for predicting future revenues. Our focus remains on achieving profitable growth from larger enterprise customers. This quarter, our average customer revenue rose to $172,000, compared to $158,000 a year ago. The increase in our average annual customer spend is a positive sign and aligns with our goals. Consequently, we aren't worried about the overall customer count.

Operator, Operator

And our next question will come from Ryan Koontz with Needham & Company.

Ryan Koontz, Analyst

There has been nice progress in messaging, and it's encouraging to see that business developing. On the voice side, you noted a softening in UCaaS and strength in CCaaS, which is a familiar pattern. Could you provide insights on the pricing environment for both segments and how we should consider its impact relative to seat counts and usage in those areas?

Daryl Raiford, CFO

Ryan, this is Daryl. Pricing had a favorable impact in the first quarter; it was driven by a richer mix of higher-priced products like messaging and phone numbers. When we look at pricing and volume, pricing did increase again as it has been for many quarters. It wasn't necessarily a SKU by SKU price increase, but we have enjoyed improved aggregate pricing.

Operator, Operator

Our next question will come from Patrick Walravens with JMP Securities.

Patrick Walravens, Analyst

Great. So David, let's discuss ChatGPT for a moment. Studies indicate that customer service representatives are at the highest risk of job elimination. What does this mean for the total number of positions in call centers? How will this affect your company? Because you don't really charge based on the number of seats, right? It's more about consumption.

David Morken, CEO

That's exactly right, Pat. We're usage-based, and we're excited about providing high fidelity, reliable audio for conversational AI customer support in all its robust parameters. ChatGPT is understood and experienced today as a text-based prompt. We were present at the dawn of products like Alexa, which were voice-driven conversations and believe that conversational AI will migrate rapidly to voice and that we have an incredible role to play, orchestrating those very intelligent and effective conversations among reps that are really empowered by AI tools, as well as potentially stand-alone reps as well. Our role is usage-based in our model, and so we're excited about the dawn of this new era.

Patrick Walravens, Analyst

Okay. But the pressure on seats is going to happen, right?

David Morken, CEO

If I am uncertain, I will not speculate. Although I cannot forecast what lies ahead, I am optimistic about the remarkable teams we collaborate with in the CCaaS sector. They know how to adapt, overcome challenges, and make use of some of the most advanced AI tools available. While their business models may evolve, I believe the value they contribute to the contact center environment will persist. The specifics of how this will unfold remain uncertain, which is why your question is very pertinent. Nevertheless, the teams leading the charge in the digital transformation of contact centers are fully engaged with this.

Patrick Walravens, Analyst

Okay. And one more, just I think as a reminder for myself and everyone else. So I mean 5% growth this quarter, down from 24% next year, but there's this bizarre dynamic about elections, right? So how do you guys feel about next year in terms of what growth you can do and has that changed?

David Morken, CEO

We firmly believe that the long-term trajectory that we put out on our Investor Day is well within reach, having finished one quarter since we talked about that, and we're on track and on plan and reiterating our guidance for the rest of this year; everything about executing in the last 90 days supports the longer-term thesis that we socialized on Investor Day.

Operator, Operator

This concludes our question-and-answer session and also concludes the call. Thank you very much for attending today's presentation. You may now disconnect your lines.