Bandwidth Inc. (BAND) Earnings Call Transcript & Summary

Great. I am Meta Marshall. I cover the communications, software and networking space at Morgan Stanley. We are pleased to have David Morken, CEO and, I guess, Founder as well…

Thank you.

Of Bandwidth with us here today. I'm going to read a very short disclosure on my part, and then we'll jump into things. So please note that for all important disclosures, including personal holding disclosures and Morgan Stanley disclosures, they appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk.

Great. So David, I appreciate you being here with us today. We're kind of kicking off all of the sessions, just with, like, an overview of coronavirus or question of just whether there's been any impact to your business? Or whether you foresee there being any impact to your business?

A different analyst wrote that we were a derivative, remote work hypothesis for this season. But I think it's too early to tell. The last thing we want is everybody to go get sick as fast as possible. But I think time will tell, but we've got phenomenal customers who do support voice, video, remote work. I'm just glad everybody who's here is here considering all those who stayed home. So thanks for coming out and supporting Morgan Stanley because they really need it.

We can take all the help we can get. All right. So maybe moving on. Bandwidth's value proposition is unique in the communication space. And how do you differentiate your opportunity and value proposition with strategic accounts versus your enterprise customers?

Strategic accounts, we consider customers who are using us really in their cost of goods sold within a customer experience or product. Enterprise customers are often using us in their SG&A, getting rid of Verizon, AT&T, CenturyLink inside the workplace. Both utilize the platform in similar ways. We serve very large enterprise with a software platform and network and very large strategics. And so it's easy for me to make the compare. But despite the fact that Internet giant customers of ours, strategics are using it to create a new experience for a customer or a Fortune 1000 doing a digital transformation is giving CenturyLink the boot, they're both using the same common platform. So the value prop is similar in that we really emphasize large customers when we go to market. And your question distinguishes 2 types, but they're both very large, and they take advantage of the platform and network in similar ways.

Okay. Got it. And so when it comes to the CPaaS market, people sometimes have trouble getting their arms around the use case. And whether it be two-factor authentication or just phone call, like how do you -- what do you think investors miss about the opportunity and how large it could be?

For enterprise CPaaS, imagine a world without Verizon, AT&T or CenturyLink. That's the opportunity. Imagine them gone, and product teams not having to ever call them back for any reason, or a CIO not having to work with them. That's the opportunity. The absence of Verizon, AT&T and CenturyLink is the fuel behind some of the reports showing a $5 billion TAM growing to 17% at a 39% CAGR over the next several years.

And is that just reprogrammable communications? Is that through -- like just help people think about why do you get to get rid of that carrier?

Because anything new being done for customers or employees is being done with software. And that's exactly what the carriers don't have, in simple terms.

Makes sense. So I'd make sure we put a fine point on that. You mentioned the next piece of your growth strategy is platform innovation. So what are the current needs of enterprise customers that the industry lacks that you plan to address? And what innovations require allowing customers to adapt? Like how are you helping them adapt to the dynamic environment?

We are in a season where it is well-known how to add value to an enterprise user or strategic with the platform. 80% of the revenue accrued at 20% of the API use cases. So if you go to dev.bandwidth.com, you'll see whether it's Java, PHP, Node, C#, Python, you can quickly activate a phone number, turn it on, turn it off, get 911, get an emergency responder specifically to a location in a building. You can do all those use cases, and those use cases really drive the vast majority of the opportunity, displacing Verizon, displacing AT&T, getting rid of CenturyLink. There are exciting edge use cases that have all kinds of interesting implications, but we focus on a really deep vertical set of APIs, specifically in the highest volume for large enterprise. That said, we do now have 10 people in R&D. We used to have 0. And we are excited about some of the new novel opportunities for our platform.

Okay. Got it. Anything you want to forecast?

Well, we've got -- yes. We've got WebRTC in an Alpha, and we have been in support of RCS and other things.

Okay. Got it. So messaging used to be a relatively small portion of your business when you went public. It grew 59% in 2019. It was your fastest-growing segment, now around 10% of revenue. What helps differentiate your messaging product? And how do you view the competitive landscape there?

We focused on toll-free messaging, which allows validation that the message was received as opposed to long code or short code. It also allows for 2-way conversations. So toll-free messaging was a big focus for us out of the gate, and that's been a real differentiator versus some of the folks who went forward with short code and regular long code messaging. And that's the primary difference for us. There's not a whole lot of difference in the infrastructure for anybody in messaging. It's pretty standard gateways we all have to use.

Okay. Got it. And staying on messaging again, how do you assess the kind of verified SMS opportunity going forward or the relationship you have with Google? And how does the RCS opportunity play within that landscape?

So the most powerful aspect of messaging is its ubiquity. It crosses all walled gardens. So if you're an Apple user, if you're a Google user, if you're stuck in a Facebook environment, SMS and MMS transit all those walled gardens. And so verified SMS add credibility attributes for an SMS message. So I know that Meta sent it. That's great. RCS adds images, so I can see a richer experience. Both though hang on the ubiquity, the standard of SMS and MMS being delivered. So if you're at point of sale, and you want to make sure the receipt goes to the customer, you know SMS or MMS are the method to deliver that payload. If you put verified attributes that it's coming from a particular -- your entity, that's great. But make no mistake about it, these things don't displace the value of SMS and MMS, they add to them.

Got it. Okay. Strategic accounts ramped much quicker than expected last quarter after maybe coming on a little bit slower in Q3. Can you just explain to us kind of how to think of some of these new strategic accounts you may be called out kind of midway through this year? And how they should be kind of ramping over the next year?

So this is -- it's really interesting. When we look back at our customers and understand when they joined us, they cluster in time with the Internet giants being the very first people to find our value. And indeed, we collaborated with some of them early. Then shortly thereafter, the UCaaS folks all arrived around the same time, conferencing customers thereafter. And most recently, last year, we saw service providers cluster on our calendar in our sales funnel and added several of them, one of which is very large with 10 million endpoints active. These service provider customers are different. Their business endpoints, which is terrific for the network effect of on-net calling which helps our gross margin, but the culture of the company is much different than we were used to working with. And the pace and cadence and process that they have was a lot longer than we were used to. And so we misforecast significantly a 90-day onboarding period, which turned out to be closer to 180. The relationship is great. We didn't have to write a new line of code, deploy any new hardware, augment the network. It was simply process, people and an execution challenge with a new cohort. We've learned our lesson as painful as it was. Factored that into guidance, and know this cohort well, and there's great value in serving them. And they are going through their own digital transformation, if you will, and we're excited to be a part of that.

So you mentioned kind of these 4 cohort of kind of strategic accounts, whether it be Internet giants, conferencing, UC and then kind of the service providers. Are there net incremental customers you think to bring on here? Or like how should we think about is that strategic accounts grow in mass or their use cases continue to grow as you think of strategic account growth?

Both. Short answer is both. So within a large strategic account, there are new product initiatives, new services constantly coming to market, some of which we collaborate and help them launch. Others that we hear about had launched because they're using a platform, and so we don't actually have to know. So expanding existing opportunity within these large accounts is extraordinary, and it's not uncommon for us to have 12 individual product leaders within a large strategic account using our platform with independent teams. There are, however, still opportunities to grow within these different segments, Gartner Magic Quadrant, although we have, I think, 7 out of 7 UCaaS, we only have 7 of 16 in the conferencing, and in the call center, I think, we have 9 of 16 or something. So we have room to add new, and we are consistently winning. But once you start working with them, it's fantastic to then grow significantly after you've begun the relationship.

Got it. And so you've made significant investments in salespeople to go after some of the opportunities with strategic accounts, also some just general enterprise accounts and grew customers 40% in 2019. Can you give us some context for how much the new sales reps contributed to this growth of the 40% that you saw in the last year and what they can kind of contribute going forward?

I think in '18, our sales team brought on $8.7 million new revenue from new logos. In '19, that was $11.7 million. As you said, we have got 40% that we've grown in '19. But as important as those growth numbers, how efficient we were in adding them, I think, is also important. So we've got a sales and marketing efficiency number that's 162% and a gross profit payback period against sales and marketing spend that's 14 months. And that's important to us because we're a team that's committed to returning to profitability throughout 2021. And we're staying true to that. And so we're spending the customer acquisition money efficiently as well as effectively. And I think both are important.

And so when we come to the more enterprise accounts, like has there been a particular pain point or entry point that's kind of helped you get into those customers that you've identified now with a number of customers under your belt?

These aren't sexy answers, but you're asking for pain points for enterprise like CIOs. So if I'm a CIO, and I have a Microsoft Teams, new implementation, and I want to do 911, that's Dynamic Location 911, so that the emergency responder doesn't just come to the front of the Palace Hotel, but knows to come to the Presidio Conference Room, you're going to use our API to assign Dynamic Location 911 to a phone number in here, and that's where someone is going to show up. That's a pain point for a CIO. How do I do 911 effectively and well with a product team where they have a software platform to use? That's all that they need. Another one is porting. So if you're doing a digital transformation of your communications, and you've got 20,000 phone numbers that need to move from Verizon to Bandwidth, porting is painful and unglamorous and vital to an enterprise decision maker. Your question is, what starts the conversation? What opens the door? You start talking nuts and bolts, and where the rubber meets the road with a decision-maker, and you talk about your platform's ability to do 911 in porting, and they want to talk more.

Yes. Okay. Definitely. You spent much of 2018 kind of analyzing the international opportunity and whether to expand beyond your U.S. routes, which have been very successful. And you build out kind of that capability in Western Europe in 2019. Are you looking towards more countries in 2020? Are there any investments that we should consider outstanding there? Or just how did you find kind of the enter -- close-ups into international markets?

We followed the demand of our existing customers. So our Internet giant shared with us how much they're spending outside the country on which services, and we prioritized our build-out after learning throughout '18, building in '19, generating revenue now in '20. The last part of your question, Meta, I'll take before I forget, which is are we building out new countries as we sit here and speak? No. We've got U.K., Switzerland and the EU countries, where we have a Frankfurt and a U.K. pop set up, and we have begun serving voice and messaging customers in both those areas. And our focus is now executing and generating revenue. We want to do that successfully. We've made the investment in CapEx. We've made the investment to have the capability and now we're scaling with our existing customers, primarily. There will be new customers. But the focus is on following demand, not creating it.

Okay. And so you've had an anchor tenant, which was kind of what got you comfortable making that initial investment. It sounds like now there is multiple customers. Is that something where there's enough that you can scale that to multiple customers? Or will it kind of be a capsule of customers you can serve in those markets for now?

We can scale. And importantly, something like 80% of the CapEx is for scaling, not fixed. And so we know how to successfully support the growth we see that's based on revenue from new customers and existing customers. And so it isn't a forklift. We've already invested for the platform and for the network to serve the customers we already have, and now we're growing with them.

Okay. You alluded to, in the answer, kind of a couple of questions back, about getting on the path of breakeven this year. And on the road towards profitability in 2021, what are those main levers that you think about kind of being able to get you there over that next year, 1.5 years?

G&A as a percent of revenue should come down. And Jeff, who's right here with us, who's our CFO. We've worked together 8 years and he has been instrumental in so much of our success. And that includes not just expanding gross margins seemingly inexorably year-over-year, but also on efficiently creating the headcount and teams that we need both in finance and guiding elsewhere as a percent of revenue. So we're levering that, and that should contribute. But there are also some other fundamentals like the product mix, as you mentioned, despite my best efforts to keep messaging from growing, it's still growing to now 10% of revenue. And so that's also good.

And on gross margin leverage, clearly messaging kind of helps that mix scale kind of helps that mix. Are there any -- I think over the course of last year, you guys made some investments to kind of raise, especially on kind of the conferencing piece to kind of help gross margins. So we think of the gross margin story here as now scale plus mix? Or are there other investments you could be making to improve gross margins?

Economies of scale are a foundational pillar we've always talked about. Network effects includes on-net calls between enterprise walled gardens of telephony reaching each other. Those are consistent and important. Product mix will continue to contribute. And those are really the fundamentals that we think at scale layer nicely under our fixed cost toward our terminal gross margin targets in the 60% range.

Okay. You guys obviously launched a convert last week, right? And I think...

Guess who let it? Morgan Stanley.

Yes. But I'm on the research side. I have no idea on these things. And so maybe kind of getting into, I think investors were wondering kind of use of funds. Just was it opportunistic? Just kind of what was the thinking and rationale behind kind of doing an offering -- in an offering upsize?

Opportunistic is a great word, but it was also something we did very well aware of the impact to equity investors. Because ultimately, even though if you do a cap call, you're eventually selling equity, essentially. But we are cognizant of what we were doing, but it's an important time. We think things are very fluid, fluid as to potential upside in our space, fluid as to mitigating downside. And so it was the right time, and we were very fortunate to be here with Morgan Stanley during the 2 days that represented the largest point drop since the financial crisis and successfully do a convert. But now we have capital, and the burden is on deploying it properly. And by properly, that means within the framework we've set for ourselves on profitability throughout 2021. And so we will not spend our way to that. It's something we will achieve organically. And if we approach an acquisition as part of the use of proceeds, it would be with that still very well front of mind as a principle that we've been pursuing and committed to since IPO.

Got it. And maybe on -- traditionally, you've been kind of a customer-led model as opposed to some other CPaaS models, which have been more developer-led. But I see in various things that you guys do your fair share of developer events as well. Like going forward, do you always see yourself being kind of customer or sales-led? Or do you -- how do you see that kind of developer-led channel developing?

I think we will remain committed to decision-makers and to the executives who have great product teams who are developers. But the enterprise scale that we support is something that's deliberate, and we have been successful now with 1,700 customers only. And I think we'll continue to focus on and serve. And if there is a distinction in the cloud between AWS and Azure, I think we're going to stay on the Azure side of enterprise focus when it comes to CPaaS.

Okay. And just as we think about, I think it's well understood kind of what you're serving the web giants with today, are there other services that you think you can be offering? Or you play this role of being kind of vendor agnostic? You don't care. You're not trying to go up the stack and compete with these guys. So where -- is that how you always see yourself? And is it just a customer growth game? Or what other services could you be thinking of offering?

Yes. We want to focus on being the platform or the gardener. And being the garden for lots of different crops is important, and we're not going to come up out of the ground and suddenly become one of those crops. We're going to pursue the difficult and challenging platform and network work. And we're excited about our customers depending upon us, relying on us, not just now here in the U.S., but worldwide. That's exciting. But there is so much to our mission to develop and deliver the power to communicate and to let creative teams in all kinds of specific verticals take advantage of our platform, and that includes the enterprise customer at scale who uses it in a different way. But it's vital for the CIO, making a decision. And again, the end game is life in business without incumbents, without Verizon, AT&T or CenturyLink. That's the plan.

How long do you think -- I mean, because I think CPaaS in general or -- and the way people think of CPaaS in general, is if you get to this vision of programmable communications where people don't need an AT&T, a Verizon or a CenturyLink. Where do you think we are on that journey? I mean, we're clearly at early stages, but do you think we're 5 years away, 10 years away from it being realistic that a new company starts up and just doesn't even think about having to go with AT&T?

It's happening every day. It's happening every day. 10 years ago, we had no phone numbers in production supporting any creative team. We now have 10% of all phone numbers, and that's against incumbents that had a 100-year head start. So in another 5 years, I think it's really important that those of us in CPaaS who deliver the value of the software platform do it without reselling the incumbents or else there will be a reckoning at some point in the future. But that's why we're vertically integrated.

Got it. I want to open it up to questions if there's any questions from the audience. All right. I will continue on. Looking forward to 20 -- oh, go ahead.

Can you talk about how you see the industry playing out? Is this going to consolidate, eventually, with CPaaS, UCaaS? Is it a few players owning all the stack? Or you see the way we have it right -- where do you see it going?

My most honest answer is, I don't know. I don't know. It's incredibly fluid. And one of the reasons we raised capital is we want to be able to take advantage of the fluidity before things coalesce around clear answers to that question. There will be layers of functionality vital for everybody to be able to build on it. And I think the winners in a platform strategy have broad appeal. And so if I go any farther than that, I'm just going to be demonstrating hubris. And so I just don't know.

Any other questions? All right. And so looking forward to 2021, are there any different -- are the growth drivers any different than they have been? Should we be thinking about the growth coming more from new customers? From strategic accounts? Just help us contextualize how you think about the next couple of years versus the last couple of years.

New logos with the records we've been setting is a contributor. The growth in new revenue from new logos, that's pillar #1. Pillar #2 is the existing customers and our dollar-based net retention that was most recently 113% and has the potential to grow from there and strengthen. Additionally, you have international. So there's new footprint in addressable market for existing customers, but also new. Virus or not, we're excited about that. And then last, product mix and platform innovation. That's an area where we expect to add spend based on what we provide. So those are the 4 that we're focused on for '21.

And so maybe ending on -- you have been a voice-centric company that has kind of always talked about the power of voice and the power of whether it be Alexa or Siri or kind of all these other voice being that main conduit. Yes, messaging has kind of become increasingly important. And so will you always see yourself as a voice-centric company and all these other things are ancillary? Or whether you see yourself as a platform company, kind of agnostic to whatever form of communication people want to use?

As far forward as I can see right now, the durable franchise we have will remain squarely centered on voice. The platform will reflect that, but you will have ancillary additional product mix. But the core should remain voice.

Okay. Got it. Thank you so much for being here, and I appreciate it. Thanks, everybody.

Thank you.