Bandwidth Inc. (BAND) Earnings Call Transcript & Summary

Okay. Good morning, everyone. I am Mark Murphy, software analyst with JPMorgan. And we are very pleased to be hosting Bandwidth's CEO, David Morken; and CFO, Jeff Hoffman. Gentlemen, thank you so much for being with us. It means a lot. What -- the way this is going to work is, I am going to kick it off with a handful of questions. We are also able to take questions from the audience. [Operator Instructions] And you can do that anonymously so in a way that only the panelists will see the question, and then I can read that out for David and Jeff. So again, David and Jeff, welcome to the conference and thank you for joining us. Maybe we could start with just a very brief introduction of yourselves and the company and the types of problems that you're solving. And David, I want to mention you're still muted.

At our company, when you talk on mute, you owe everybody $1. So I hope nobody is attending this call right now. Sorry about that, Mark. In all seriousness, my name is David Morken, Co-Founder, CEO and Chairman of Bandwidth, 21 years running Bandwidth. And very excited to be here with me, my colleague, Jeff Hoffman, our Chief Financial Officer with whom I've worked now 8 years. Our company is a communications platform as a service company, and we're uniquely focused on the enterprise, providing primarily voice services for a software platform and an integrated network, focused right now on just the United States, but we've embarked upon international expansion into the EU and Europe. And that's just a basic elevator overview of who we are. Jeff, do you want to quickly comment about yourself?

Yes. I think you covered it well, Dave. Mark, great being with you and everyone else and always happy to talk about the company. So I think we should just roll right into questions you have, if that's all right.

Excellent. I wanted to mention, I should congratulate you as well on your technical savvy for figuring out how to get the JPMorgan virtual background. We've got all 3 of us with that. I think that's a first here, so. Thank you for that...

[ Nice building. ]

Yes. We'll work on the mute button. But yes, you got the [indiscernible].

That's right.

Okay. David, maybe we can talk a little about the evolution of the industry. I think we've heard you talk about injecting software into telecom, providing the tools you need to build the future of communications. Can you walk us through just why that kind of change is necessary and how you see this industry evolving to require the types of technologies that you offer?

Certainly, Mark, and it really goes all the way back to our anchor customer for us, which was Google. We collaborated with Google back in 2007, 2008. And their challenge was we have product teams trying to create experiences like Google Voice at the time. We know how to code. We know nothing about communications infrastructure, we know nothing about any of that. So can you get us a layer? And oh, by the way, can you be our partner that rolls out a scaled network underneath it so our teams can simply code to create an experience for our users that is voice initially and then evolve from there? That customer collaboration was the genesis, was the beginning of now, 13 years later, our entire platform and network here in the U.S.

Okay. Now you've got this very intriguing customer base and some interesting exposures. It includes Microsoft. You just mentioned Google, I believe. It includes Amazon. You have Zoom. It crosses my mind that we're using Zoom right here, and you're heavily involved in that. RingCentral and many others. So it's this impressive list of companies that we think are pretty savvy about the technologies that they're choosing. Could you walk us through some of those use cases because we do get these questions. Well, which Microsoft products, which Google products, how -- and I don't even know how much of that you're able to share, but how is Zoom -- how exactly is Zoom using Bandwidth? So maybe we could just get a better feel of how it's -- we're all kind of relying on Bandwidth in our daily lives?

Certainly, Mark. If anyone out there has dialed into -- not using video, but using a phone dialed into this conference over a regular phone, chances are you're generating revenue for Bandwidth. We displaced Verizon in the very beginning, who was serving Zoom at the very earliest days. And Zoom used our platform and our network to go to market with conferencing. And more recently, Mark, their Zoom phone product launched entirely on the Bandwidth platform and network. So both UCaaS and conferencing, if you're using a regular phone, not the video, not IP to IP, you're using Bandwidth. In the case of Microsoft Teams, if you're using a conference number in Teams or you're assigned a direct dial individual number, that's Bandwidth entirely. At Google now for almost 15 years, we have powered everything from Google Voice to 1-800-GOOG-411 to 911 service for Google Fiber to advertising tracking numbers and, most recently, G Suites and CallJoy. So we're the -- we've -- we're really good partners with Google. And we're their easy button for almost every use case at other opportunities like Amazon, RingCentral, Cisco Webex and others. In fact, we serve 12 out of 12 of the Gartner Magic Quadrant in UCaaS. And by serve, Mark, I think it's important that everybody understand, the use cases include getting rid of your desktop phone, getting rid of your premise-based phone system. And we can be exclusive to one of these entities. We can also be in a multi-sourced environment where we're one of several platforms that they support. Fortunately for us, focusing on the enterprise, historically we have enjoyed a primary position in most of these relationships, but I want to make sure I touched on that.

Okay. Now you're talking about UCaaS. The term CPaaS comes up a lot as well. And when we think about that term, Twilio is one that comes to mind. They're doing well as it's been with -- people may have also heard of Nexmo. They may have heard of Plivo. Can you help us understand how Bandwidth is differing from the other CPaaS providers, that's a question that we get pretty frequently. And then as well, the traditional telecom carriers, such as AT&T and Verizon, which we understand you displaced one of those through Zoom. Can you help us understand, compare and contrast those assets a little bit?

You bet. I'll take that question in reverse order, if I could, Mark. Most of the time, we're competing against the incumbents who have a 100-year head start with premise-based equipment and analog technology. AT&T, Verizon, CenturyLink, we compete with them the vast majority of the time when we focus on enterprise customers. And here's where we win, we have a software platform. That software platform offers robust API or SDK for mobile where a customer can engage, code their use case to us. Verizon, CenturyLink, AT&T simply do not invest in this area. They do not have the DNA. They do not have the vision. That's why we win because we have a software platform. Now to your good question, what about CPaaS? When we compete against CPaaS, and it's probably 15% of the time and it's usually involving text messaging, we win because we have a platform like Twilio or like Nexmo or like Plivo, but we also have an underlying network. So for voice, we win against CPaaS because we have both platform and network, and I'll explain in a moment why the network matters. But we're very different than the other CPaaS providers for 3 main reasons: number one, voice. 89% of our revenue is voice, not messaging. Number two, enterprise focus. Our average customer is spending $150,000 a year approximately with us, 10x some of the other names in CPaaS. And then third, we own the underlying networks beneath the platform that are responsible for delivering the actual quality of the voice call and also benefit from the economics of keeping calls on net. So that ownership of the network, it translates -- for the largest enterprise teams that you're talking about, it translates into quality and economics. And so if we're head-to-head in CPaaS providers for a voice engagement at scale with a large enterprise, we're doing analytics that are predictive for these NOCs with these large customers and helping them understand the deliverability of their calls, the quality of their calls and at an economic value prop that someone who doesn't own the asset can compete with.

Okay. So voice, enterprise, the network. One of the questions, David, that we'll get pretty commonly is for us to help explain and describe the moat or what is it that is kind of making this business defensible as it appears to be? And is it stemming from -- is it the network itself? Is it the software layer, the APIs that you built? Is it your -- the support capability that you have? I should say, the service and support, something that's unique. Is there a cultural barrier, a cultural moat or some different kind of business model moat? What would be -- if someone were trying to mimic what you have, what do you think they would struggle with?

It depends on who they are. An incumbent would have to buy Twilio because our moat relative to Verizon, AT&T and CenturyLink is the software layer, the API and the focus on supporting the next generation of creatives for the use cases we support. That's the moat. And I do not see AT&T, I do not see CenturyLink or Verizon anytime soon crossing that moat. They haven't historically. I don't see that happening anytime soon. What about among the CPaaS companies? What is the moat? It's 175,000 plus IP circuits interconnected at 5 points of presence, all interconnected with the incumbent carrier's bylaw under the Telecom Act. You're going to need to spend, probably by now, 4 to 5 years building, standing tall in front of 50 state public utility commissions to get phone numbers. You're going to have to spend an enormous amount of money. And since building this network underneath our software platform beginning in 2007, we've seen exactly nobody try. And so I like to describe the moat as being filled with oil and set on fire.

Okay. I like that, maybe with some alligators in there. Okay. Now you talk, David, sometimes about the command and control of the network. I was wondering if you can click a bit deeper on that. I think the question we'll get on that sometimes is, well, how does that manifest, right? So if I'm the end user, is there something that I'm experiencing because you command and control the network? Is it the call -- is there a faster speed of the network and they're blessed -- is it call consistency? Is it the handoffs? Is it the audio quality? Or is it -- is that a benefit that's kind of accruing to me as the end user? Or is it accruing to Zoom or Microsoft or Google?

Ultimately, it has to accrue to the end user of our customers, and it has to be experienced in ways like low post dial delay, when a call gets completed quickly instead of taking forever. While you're on a phone call, the fidelity of the audio, those are command and control elements. What about scaling? If you have a work from home, overnight dynamic like happened recently, do we scale infinitely with the infrastructure and the software platform? Those benefits have to accrue to the end user for us to be valuable to the enterprises we serve. But we also are able to interface with their network operation centers and convey to them, here's how you're performing. Here's your average call duration, which is an indicator of quality or here are issues an enterprise customer of yours is having on a Monday morning relative to prior Monday mornings, something is wrong. So the analytics and the visibility we have end-to-end is radically different than if you just resell a carrier.

Okay. And then just to double-click on that, the ability to infinitely scale is -- you're able to do that because what, the network has that much capacity?

I wish I could simply say yes, but I can't. There are aspects to scaling that are not infinite. And so let me pull back that term because it's too hyperbolic. It is massively scalable. There are components in the network that we stay ahead of that are hardware related. And recently, we've proved that through this surge without having any issues and within our CapEx budget. But we also have daily stand-ups with the networks we connect with to make sure all of us are carrying appropriately headroom on the network to support the growth. So it's massively scalable. It's high-quality and the analytics that we have are valuable to enterprise teams, especially for business users that you're doing a conference call and revenues riding on it, that's different than a different kind of phone call.

Okay, understood. Now maybe we can go back and just touch on some elements of your recently reported Q1. You had revenue growth of 29%, and so that accelerated pretty noticeably. It had been high teens in some of the prior quarters. You did raise guidance for the year. And there -- that's interesting. I think many software companies have been kind of withdrawing guidance for the year. Maybe you could walk us through a bit just some of the tailwinds you experienced in Q1. And what was it that might have -- something surprised you positively, right, relative to the guidance. So can you explain to us what that was?

I'll ask Jeff to start by maybe enumerating how we attributed the lockdown benefit in Q1 and Q2, and then we'll go from there.

Sounds good. Thanks, David. So I think starting with sort of what surprised us, I think the size and speed of the surge in demand was something we had never experienced before. I think this goes back to what David was talking about, the combination of assets, network that we own and the software layer helped us serve our customers very well during that time. We're very proud of our team who [indiscernible] what our customers needed during that time. To put some color on that, we saw a surge in concurrent calls on the network, people all calling at once, of 30% in March. That's pretty rapid. And due to some of the headroom we had on the capacity and the agility of our team, we were able to meet that demand. In terms of enumerating the COVID benefit, we have been really clear in trying to follow where the SEC had guided us. And so we were very specific and had estimated the benefit in the quarter at $1.8 million within the quarter to that over-the-top end of our guidance. But one of the things I want to make sure that isn't lost is the strong fundamentals of the business with or without COVID. What was amazing with or without COVID is it was an all-time high for not only top line growth but also for gross margins and also for non-GAAP net income as -- profitability is one of the things that we're trying to do. And so there were many tailwinds across the business, and I'll leave it there.

Now Jeff, you mentioned -- I wanted to touch on this. You said a surge in concurrent calls. Can you help us understand -- are you talking about calls coming from anywhere? Or do you mean what you call, I think, in-net or on-net, right, like someone calling from Ring to Zoom and they're -- and both those calls are running through your network?

Yes. I think there's a couple of things that are there. So when we talk about concurrent calls, that's what puts the most stress on our network and tests it. So what happens in the U.S. is when all time zones are up and working, think of 11:00 a.m. Eastern and 2:00 p.m. Eastern, those are the times where you're getting the most call volume. And that's what our team needs to make sure that we have capacity to deliver, not only across the network, but in each place that our customers do need that. The other point that I think you're making, Mark, is there's different flavors of calling that are on there. And so today, our business has a little over 1,800 customers. And as you point out, a good example, imagine a UCaaS customer of ours who calls into a -- we'll use a Zoom conference, since that's what we're on, that would be considered all on-net for Bandwidth. And what that means is we carry the call from start to finish, we don't share any economics with any other provider. And you should think of those margins on those calls as the highest SaaS margins you've probably ever seen. And so that's accretive and a growing thing. As we continue to grow our customer base from 1,800 to 3,600 and so forth, we expect to have a greater degree of on-net calling, and that will work in our favor and help us to achieve our terminal gross margins.

Okay, very helpful. And we're starting to get a question or 2 coming into the Q&A. I want to make sure that I get to that in about 5 minutes. But let me ask you this. We hear you loud and clear, there was strength sort of relating to the global situation, and there was kind of other strength in the core business. If we look at what happened with the remote spending wave, I'm curious -- and David, maybe you can help us as well on this. Are there elements there that you think will be enduring in nature, right, as opposed to kind of a temporary surge? So I think we're interested in trying to understand and project forward, where is there going to be a structural change that, if something changed, we're going to take it with us as people kind of slowly begin to return to the office?

The shape of the demand curve, Mark, if I showed you the graphs that we can look at real-time here on our platform, would reveal a very serious spike above sustained previous levels late in March, followed by a nominal decline and a very steady chart forward. That's what it would look like for March through April now into May. We're prevented from taking any of that forward after June because up to 40 million people in America aren't going to work at all. There's no way we can plan appropriately that any tailwind continues when confronting that kind of structural impediment. I don't -- we just can't.

Okay. And so -- and that's where you're kind of getting into -- there's a change in how people are working, but there's a change in the economy. They're offsetting, and that's why you -- I think what you're trying to say is you're trying to not get over your [ skis ] in terms of how that nets out in the back half of the year. Is that correct?

That's correct. We've been a team that's been bootstrapped forever. Profitability is important to us. We reconcile growth with bottom line profitability. And it's too uncertain to take these tailwinds farther than the first half of the year until people, up to 40 million, actually start working at all.

Yes, okay. Let me take a couple from the audience here. There's a question saying, what percentage of revenue is contractual versus usage based? Is that anything you've disclosed?

So all of our revenue is contractual, meaning we have customers under contract. We're not month-to-month. In fact, our average customer contract length is 2 years. However, I think what the heart of the question is, is it committed revenue? Is it seats that you can bank on? No, it's variable. There are minimum commitments, and there are volume tiers that we hope our customers hit. But they can vary month to month, and that's very different for SaaS to have a usage-based model. So that's an excellent question.

Okay. The next one from the audience. Since you own the underlying network, how should we think about CapEx intensity over time?

We're very efficient, but let me ask Jeff to enumerate specifically for us.

Yes. So I think you should think about it, and we guided on this when we initially gave our 2020 guidance after our fourth quarter call and things remain the same. You should think of us in an 8% to 9% of revenue in terms of growth. And so today, that range will get you in sort of a $23 million to $25 million CapEx. Going forward, we would assume similar percent of revenue going forward. One caveat to that, if we continue to expand globally, there could be some onetime costs just like in this past year where we made investments in the EU and the U.K. to expand our footprint that could increase it on a onetime basis. And I should say, most of that growth is -- or excuse me, most of that CapEx is driven by growth. So it's success-based in that, if we don't grow, the CapEx won't be spent. And that's like 7 of the 8, or 8 of the 9 with the balance being for maintenance.

Okay. Understood, very clear. Now I wanted to touch on as well this sales hiring surge. You -- this kind of goes back to 2018 when you started to very dramatically ramp sales head count. So now it's a couple of years later. When you look back on it, where would you say that, that surge in sales hiring succeeded? Where do you see room for improvement? And I think it also crosses my mind, that was a bit of an unusual move for Bandwidth as a company. Was that -- do you look back at that and say, that is kind of a onetime experiment? Or is that a hiring surge that you could contemplate again in maybe several years out in the future if the right opportunity presented itself?

It's more onetime. We quadrupled the sales team in a matter of months. '18 was a mad dash appropriately for the opportunity. But Mark, if we did that again from the current numbers and granted those are kind of law of small numbers. As we got started, as you know, our strategic reps were like 2. But we quadrupled the hunter team, and I don't anticipate we'll ever do anything like that again. What we are doing is continuing to invest in sales on a good drumbeat to address the opportunities in front of us. The team has been efficient and the SEC has continued to ask us to be really clear in this season. And so I'll share with you a KPI we don't normally about 2020 sales effectiveness, which really kind of relates to hiring done in '18, ramping during '19 and now what are we at right now in terms of top end of the funnel. Yes, we're efficient in terms of sales and marketing percent, gross profit payback periods of 14 months. But in January, we did 45 new logos, new contracts signed. Then we did 53 in February. We did 61 in March. We did 83 in April, a record. And so the team continues to produce effectively. But that surge you mentioned, you're absolutely right, Mark, that was a onetime catch-up from being bootstrapped to raising capital and putting it to work more than out of your own cash flow.

Okay. Understood. Let me take another one that's coming in from the audience Q&A, and it says, could you please ask about E911, the current demand environment and longer term opportunity?

Current demand environment. I'll use Microsoft Teams as an example. If you are migrating away from a relationship with a hardware vendor for your phone system and you're migrating away from a relationship with a traditional carrier and you're a CIO and you want Microsoft Teams, you got to answer the question on 911. And specifically, location-based 911 for a conference room on the third floor in the northwest corner, the opportunity right now as everyone moves to the cloud is tremendous for 911. And we have an API that allows dynamic location routing. So an emergency responder shows up at the front desk and knows what floor, what corner, what conference room. CIOs value that as part of a Teams integration as part of a move away from Verizon and premise-based gear. So the -- and this environment we're in right now since March has accelerated this focus on getting away from premise-based, getting to the cloud. So 911 opens more and more doors. So C-level conversation is about migrating away from traditional solutions when it comes to 911, and we do think it's a longer-term opportunity. We think 911 will be cloud-based. We have an API that uniquely allows you to activate an endpoint for emergency responders in real time. But more than that, Mark, we own the underlying infrastructure beneath that API. So we can do it more cost effectively than anybody.

Okay. Did not realize the kind of tailwind that that piece of your business would have had right now. So I'm glad that we have that question from the audience. There is another one in here. It is saying -- I guess the spirit of this is, it's the concept of could one of your customers do a direct connect with someone else? And I don't think I understand technically exactly what that means, with the Zoom to RingCentral or something like that. Does that make sense to you?

There are 2 different ways I understand the question. One is could they do a direct connect with an incumbent instead of using our platform and network? And the answer there is none of our enterprise customers want to do an analog hardware-based direct connect with an incumbent. The other potential interpretation of the question that I think you're alluding to is the walled gardens, Google, Apple, Amazon, others, Ring and Dialpad, are they going to federate? And the short answer is most of them hate each other, compete with each other for users and environments that they're trying to be all-inclusive. We federate like Switzerland across walled gardens really beautifully.

Okay. In the time that we have left, which may not be a lot, I want to ask about 1 or 2 more topics, one being profitability. So Jeff, maybe just a good one for you. You pulled forward the profitability outlook by about a year. And so now we're expecting you to be profitable on a non-GAAP basis this year for 2020. And maybe you can help us understand what you've done to accelerate that and where would we see most of that leverage in the P&L.

Sure. I'd be glad to address that, Mark. Let me quickly kind of go back to the time of the IPO. What we shared with investors is that we believe we can hold 2 thoughts in our mind at the same time. One is to deliver robust top line growth but, at the same time, we'll try and do it profitably. And so we're just following our mission. Clearly, right after IPO, 2018 and 2019 were investment years. Now 2020, we're starting to get closer to profitability. And to your good point, we've accelerated from 2021 what we were saying into 2020. How we did that was twofold. One was the benefit that we received from this work from home environment, particularly in UCaaS and Meeting Solutions, we've taken that and a good chunk of that is falling to the bottom line, which helped us do that. And the other half is really due to us rationalizing our investments I'm looking at. What I can share with you there is we've left sales and marketing and R&D spend intact, but we have looked at some things on the G&A side in response to the macroeconomic uncertainty, and we pulled it in. And so it was those 2 prongs that sort of allowed us to pull profitability in, which we're defining as at least $1 of non-GAAP net income in 2020. And that's where we really want to go -- going in the future, is to stay on the right side of profitability but still attack this large and growing market opportunity on the right side of profitability.

Okay. So anything less than $1 is not going to suffice this year?

$0.75 is not going to cut it.

Okay. There's another question coming in now in the Q&A. And actually, I think I wanted to follow-up on this. Anyway, could you talk about how Bandwidth achieves highest SaaS margins for delivering Zoom goals? That was an intriguing comment that you made. I think you had -- because I think, Jeff, you had said that when it's on network, that it's -- those gross margins are extremely high. And can you talk about how it would compare with the gross margin of the rest of the -- I guess, of the rest of the business?

Sure. So our margins today are at 51% in our latest quarter, and those are up since the time of IPO as we continue to benefit from economies of scale. What we're talking about are network effects. And the specific term that I used was on-net calling. And so when we have one customer call another customer, and Bandwidth on its own can handle that call from start to finish, there are very little costs involved with that call. And so it's great when we have UCaaS providers calling into Meeting Solutions. And that's one of the levers that's helping us to drive our expanding gross margin profile. Let me contrast that with, let's say, I call from a UCaaS provider, but I call Mark into your mobile phone and we'll make up that it's Verizon wireless. We would have to share some of those economics with Verizon wireless to help us terminate that call. And so those margins would be more in line with our overall average. So we've estimated our on-net calling at this point in the middle teens as a percentage of revenue. And again, that's only with 1,800 customers. As we grow our customer base, that should be one of the things that will be a tailwind for us as our customers interact more and more. So I hope that helps.

Okay. Very helpful. Now, David, I think we have about 1 minute left. So maybe we'll try to do this very quickly. The current environment, has it done anything to change the trajectory of the messaging business? And we realize you're way heavier on voice, but is there any change in the behavior or any change in the voice versus messaging mix?

Our messaging graphs look remarkably like our voice graphs, and we have new segments. So community groups that are no longer able to meet together, faith-based organizations that aren't having service, we've had whole segments show up and clamor for messaging solutions. Existing messaging customers are doing all kinds of different use cases to fill the gaps from not being in person. So great question, Mark. Messaging has done similar surge and then steady since the lockdowns.

Okay. Very helpful. Great note to end on. I want to thank you, David and Jeff, very kindly for taking the time to be with us at our virtual conference. And it means the world to us and really appreciate the insights. And I think we'll call it a day there.

God bless, Mark. Thank you.

Thanks, Mark. Enjoyed it.