Bandwidth Inc. (BAND) Earnings Call Transcript & Summary

Good afternoon, everybody. It's Mike Walkley. I'm the analyst here at Canaccord Genuity. I cover communications, IoT and security. Really excited to have Jeff Hoffman, he's the CFO of Bandwidth, joining us today. And I have to say Jeff wins the award, and we appreciate him putting the Canaccord Genuity background behind him there. So the format of the conversation today. It's a fireside chat or a Q&A session. We will take questions from the audience, so for all those dialed in, please feel free to throw questions. Type them in and I will try to include them in the process. So with that, Jeff, I hope you and your families are well and healthy, and I really appreciate you joining us today.

Historically, Canaccord Genuity, at our conference in Boston, we have a lot of portfolio managers in general who are looking for new stock ideas, so I thought, before we got into the specifics, it might be helpful just if you could share what -- how long you've been with Bandwidth and just the markets your technologies address.

Sure. I'd be glad [ to. It's good to be with you ], Mike, virtually. And we're doing well here in Raleigh, North Carolina, and hope the same for you. So taking the question sort of in that order. I've been with Bandwidth since 2011, so I got to experience a lot of the growth. And we've done a lot of fun things along the way. It will be 9 years, I guess, for me this coming October, but I've been in TMT for over 20 years. Sort of for your more market generalists or investor generalists: Bandwidth's mission is to develop and deliver the power to communicate. And what you see in there in that mission is develop as in software and deliver as in network. That's a vertically integrated approach that we use to attack the enterprise segment of communications. Specifically, Bandwidth provides voice messaging and 911. Today, we have about 1,900 enterprise customers. Lots of great customers in there, but some that I would highlight for you: Microsoft, Zoom and Google, just to name a few.

Great. Just as you look at COVID-19 and the pandemic, I think it's permanently shifting the way a lot of people around the world are going to work. A lot more remote work going on, driving a lot of these high usage rates for your customers, which has to be, hopefully, driving your business. Can you just talk about how, one, your network performed to meet this surge in demand; and two, just any kind of usage rates you can share with us in terms of how your business has picked up with a lot of these remote meeting products?

Yes. Thanks, Mike. So our business is performing very well. We just recently had our second quarter call and produced some of our best results ever. We do -- we are enjoying a number of tailwinds, including the work-from-home dynamic that's related to the pandemic. It's certainly been very rewarding for our team to see people connected during this time of social distancing, but in terms of demand, we saw an onslaught in March when everyone sort of [ slothed ] home. And we saw a 30% increase in concurrent calls on our network almost overnight and we've never seen anything like that before. Blissfully, we're prudent operators and we always have some extra room in there for unforeseen things, but this really sort of tested us. Very proud of our engineering team and our software developers that met the demand. We saw the surge most notably in UCaaS and meeting solution customer segments and never really missed a beat with it. And so very, very proud of that. And obviously, 5 months in, we're all still sort of dealing with this pandemic and what's going on, but I think we've adjusted to sort of this new normal.

Great. And just speaking of the new normal: You've done a good job, I think, on the earnings calls trying to help investors understand maybe temporary shifts because of this demand surge from UCaaS customers, but can you kind of help us think about longer-term growth drivers versus what you broke out? And how do you even try to break that out? Because it's just so hard to know what a new normal is going to be like. I think these UCaaS customers can be big customers for quite a long time.

I think [ that's right ]. And like everyone, we're doing our best and we're learning along the way. I think in terms of how we've tried to break out the COVID-19 impact, I think the best way I can do that for you is talk about -- we'll start with like March as an example, when the pandemic hit. What we did in our forecasting -- we knew January and February and we knew obviously the months previous to that, but we kind of extrapolated what we thought would happen in March based on that trend. So it was growing. 1, 2, 3, 4. We probably would have assumed 5. And in March, when the surged demand hit, instead of seeing 5, we saw like a 10 in the analogy that I'm using here. And so anything above what we were expecting, we attributed to COVID. I think it's good because we then slice it by product, and again that's where we discovered most of this was coming from the UCaaS and meeting solutions segment. Admittedly, as I said, now 5 months into this, it's becoming harder to determine, well, what's just organic growth or part of the new normal? And what is COVID? And what is that definition? And so in the second quarter, we provided a range of what we thought it was, knowing that it was less precise. We also added to our guidance in the second half of the year some COVID impact, but what we're seeing is that COVID impact peaked in April. And you've probably heard some other companies talk about this. I've seen in the news similarly. And it's stepped down since then. And so that's kind of what we use as a guide to forecast, but in terms of longer-term growth, we're certainly proud of the results we just have, but we know they've been amplified by COVID. And I think there will be some permanence to COVID. I don't think there's going back to what we used to know as normal, but how David and I have always talked about our business is that we want to grow profitably. And we see this as a consistent 20% to 25% grower, and we want to do that for 20 or 25 years. And we prefer that path over growing at 40% for 4 years. So that's how I would characterize our long-term growth. I think we still have a long way to go and scaling, and once we do, we can achieve our terminal gross margin targets of 60% and operating margins north of 20%.

That's helpful. And just thinking about maybe seasonality trends. I can see the dip here in the pandemic in the summer months, but we have an election season coming up that should put some more traffic on your network. You have people returning from vacations, back to school, so how should we maybe think about seasonality of your business? And do you think you'll -- you could see a re-uptick maybe of those high surge levels?

Well, I think it's possible. There's a lot more people vacationing in the summer even if it's a staycation during the pandemic, but I think they're taking time off from work. And so that can certainly be usage related. If you put COVID sort of aside, we don't have a lot of seasonality in our business. The only thing that I can highlight is in fourth quarter is there's less effective business days, when you factor in the holidays in and around Thanksgiving, Christmas and the like. And so that's the one time that we would do it. The other thing that I would point to is we're in a presidential election year, and so we're certainly experiencing -- and part of the benefit that we've had on the messaging side has been in politically driven messaging. We'll expect that to continue into the middle of the fourth quarter. And then once that election happens, we'll expect that to sort of go away. So those are some of the seasonal factors, but we're a pretty resilient, consistent business. People need communications. That drives the usage and [ not entirely on ] seasonality overall.

Great. That's helpful. Maybe just stepping back to help some of the investors. You've been winning some of these huge customers you highlighted, like Zoom and Google and RingCentral. Can you talk about why they're choosing you relative to maybe some of the incumbents and how this is driving your business growth?

Yes. I think we win again because we're a vertically integrated software and network platform. It's just flat-out better to serve the enterprise than just a network or software only. The customers can enjoy more command and control. They can earn owner economics that we enjoy through increasing their volumes on our platforms, but each of these relationships are a little bit different in terms of common themes. I will say close collaboration and a real spirit of partnership. Many of the companies that you've listed here, we've done business for well over 10 years, not all of them but most of them. And so we view it as a real partnership. And most of the time, we're winning away from incumbent providers that don't have software, and we win because of our software and our stellar customer support.

Great. One thing I've been getting a lot of questions on recently is just the importance of 911. You've just -- you announced this deal for Duet for Microsoft Teams. Can you just talk about the E911 capabilities that Bandwidth can offer to its customers and how this is a growth driver for your company also?

Yes. Just to review for maybe some of the people new to the story: The only significant M&A activity that Bandwidth has ever done is we bought a 911 company in 2011 called Dash. It's been a great business for us, a real differentiator. And if you talk to our sales team, they would tell you it's definitely a door opener. Even if they don't ultimately sell 911, it's something that CIOs, product leaders, the enterprises are interested in talking about. What I think you're referencing there is our relationship with Microsoft which is -- continues to expand and deepen. Duet is the latest example of this partnership. And Duet is sort of our name for Microsoft and Bandwidth, but it's also known or what Microsoft Teams would call as direct routing or, if you prefer, bring your own carrier. And so CIOs increasingly are choosing to go a direct routing path where they can pick their own carrier, Bandwidth in this case. And it's sort of to simplify and accelerate the process of migrating their telecom to Microsoft usually from an incumbent provider. And as you mentioned, Bandwidth is 1 of 2 E911 emergency service providers for Microsoft Teams. So very excited about this announcement and this relationship, and I think there's a lot of growth to come from this in the future.

Great. No, that's helpful. And maybe just switching gears a little bit, I think you guys have a focus on Europe and kind of building out 13 countries over there. Can you just update us maybe about capital expenditures and how that's going given some of the difficult travel in the short term?

Sure. As just a quick review again for those that might be new with us: [ Historically ], Bandwidth has been focused on serving the U.S. market. After our IPO, we made a conscious intention to raise capital to expand our geographies our customers have been asking us for a while. So in 2018, we spent a lot of time collaborating with our key customers as well as international regulators. We then did a build-out in 2019, adding points of presence in Frankfurt, Germany and London, U.K. To catch you up to today, 2020, this is our first real year of international revenue and we're tracking to plan. To your good point, Mike, it would be better if the world was open and plane rides were available and we could meet with some of these regulators and other partners face to face, but we're doing what the rest of the world is and we're making the best of it and doing virtual meetings like this. And things overall are going well. We're very excited about this opportunity and I think it's a way that we can further serve our customers, and we're excited about that. Many of our customers have told us that they spend more on communications in these 13 jurisdictions that we'll cover with these new points of presence than they do in the U.S. So I think on a long-term basis you should see a lot of expansion here as well.

Great. That's helpful. And then maybe just building off that in terms of closing deals. How are some of the larger enterprise complex deals going in this environment? Clearly there's a need for your services. How are those interactions going and the pipeline coming together?

Yes. So very proud of our sales team and sort of fought through all the pandemic has given us, and they continue from home to remain very productive. Our gross adds are as high as I ever recall. And so we are still able to engage with customers and we are able to -- still to close deals. In terms of large and complex deals, the thing that comes to mind to me is a recent win we have with a banking institution that we announced on our second quarter earnings call. It's a top 10 bank and one of the major providers of credit cards. And this is also a CCaaS opportunity. So call center, winning this business once again away from incumbent providers and won it in the second quarter, have already started migration. And it's already starting to produce usage and in turn revenue. So I think it's a great example of where -- new markets that Bandwidth can continue to attack, whether it's CCaaS or financial institutions. And hopefully, we'll do what we've always done on new verticals, is find more opportunities within there to serve.

Great. We've covered somewhat the UCaaS and CCaaS opportunities, but I also get questions about the CPaaS opportunity. Can you talk about how important is owning your own network, how you win deals? And do you even compete much with some of those companies like a Nexmo or Twilio?

Yes. So 85% of the time, we're competing with those incumbent providers. To put names on it, think about AT&T, Verizon, CenturyLink. Those are the ones that we're doing. We normally win because of software and, frankly, better customer support and helping folks through migrations. About 15% of the time, we will run into other CPaaS providers. We have such an advantage on voice. Where we usually see these other CPaaS providers is on messaging engagement. Obviously, we're doing well there. You've seen, in the last couple of quarters, we've had year-over-year growth rates at over 100%. What I'd highlight there is what I mentioned earlier. Some political messaging is helping us, but I think, longer term, toll-free messaging has been a real winner for us. It offers 2-way communication capabilities, and it gets around some of the newly implemented A2P SMS surcharges. So that seems to have really resonated with our enterprise customers.

Great. And Jeff, I get a lot of questions. Just you pulled in profitability by a year, which was great to see. Not a lot of companies are raising guidance or pulling in profitability metrics in this environment. Can you help investors, one, understand gross margin trends? That's a question I get a lot. And then two, just longer-term margin targets for you. What led to deploying it in this year? And how should investors think about longer-term growth with also all the investments you want to put into the business to support that 20%-plus top line growth.

Yes. I appreciate the question. We always spend a lot of time talking about revenue and some other things with it. Bandwidth is a team that's always had a healthy tension between top line growth and profitability. And I think it goes back to pre IPO, when we were growing out of our own cash flow and it was a necessity. In terms of pulling in profitability by a year, it's really just been the success of the business. It's mainly been top line growth with some good gross margin performance. Of course, some of that is us managing expenses. And I think the icing on that cake has been the net beneficiary from the work-from-home dynamic. And so that allowed it, to pull it in, but profitability is very important to us. Today, we're in and around 50% gross margins, a little bit lower in this last quarter due to some timing events, but we've grown and expanded gross margin over the years. We expect that we'll be able to continue to do so. And our terminal gross margin target is 60%, and our guidance in this latest quarter is that we'll do at midpoint $2 million of non-GAAP net income. So we're very proud of that. And we'll continue to invest in the business but do it on the right side of profitability to both achieve top line growth and remain profitable.

Great. And can you help us out, just think about different products that you have or services you provide, how that impacts gross margin mix on a quarterly basis and what you need to see happen over time maybe to get closer to that 60% terminal value?

Yes. So I think product mix is one thing. Today, almost 90% of our CPaaS revenues are voice. So basically our margins today are a proxy for what voice margins are. I can tell you messaging is accretive to our overall margins as well as phone numbers and 911 are also accretive as well. How we get to the 60% gross margins is through scale, and what we'll be able to enjoy as we get [ bigger there are ] economies of scale in a couple different flavors. We can certainly get some volume discounting from some partners, but we'll also be spreading out our fixed COGS over a larger revenue base, so driving more operating leverage there. In addition, as a network owner, and you can only do this if you do own the network, we can benefit from on-net calling. So that -- one of our customers calls another one of our customers. We keep all the money and don't have to share that with anyone else, and those are very high margins. I think the other thing that we can do is, as we grow, we can interconnect and peer with other network providers. And there's still headroom for us to grow and do that. And when we do that, not only does it save us money and costs, but it also saves our counterparty [ in doing its rounds ]. So it's mutually beneficial. So those are really the 3 big things, again economies of scale; network effects, as in on-net calling; and peering, that as we get more scale will drive us to that 60% gross margins.

That's helpful. And our business couldn't function without your services. Just kind of an interesting question because I -- this is more my one data point dealing with a lot of investors, but we do these virtual meetings all day long and I'm finding -- we have to do it today, but there's this something I call Zoom fatigue or video fatigue. So I'm finding more and more of my client interactions that I -- keeps our business going daily. People are dialing in, which has to be driving good revenue for you. Is there any way you guys can track that in terms of your end customers, how much they're dialing in versus just using a pure computer interface or the Internet?

Yes. So we can all appreciate the video fatigue things, especially on days like today when you're on it all day. And it's a different feeling at the end of the day than if those were dial-in calls, but we have sort of a numerator in that we know how many calls are going on. We know the usage, the duration of those calls. There's a lot of things that we've been good at. What we don't necessarily know that many of our customers -- using Zoom as an example since you gave that one and since we're on that modality now. We don't know the denominator of how many video things are. I can tell you that I do watch it since we're in the business. We've done -- over the last few quarters since this all work-from-home dynamic, I've seen anywhere -- and this is more anecdotal, so don't take this as -- I'm reminded of my statistics professor that would tell me my findings are not a large-enough sample, but we've seen anywhere from 20% to 50% of the people that are dialing in -- and there's reasons for it. One is people are finding a superior audio quality, and that makes sense to me. We're also finding the people -- I'm standing right now because I just can't sit any longer, but people want to get up and stretch or grab something to drink or just move and maybe pace a little bit while they're on a call. If they're on a dial-in, you can step away the screen from -- do that. And then something that I've had a few people tell me about is they choose to do both or their company mandates we do both video and dial-in. Some of it is for audio quality, but it's some of it's a blend of those other reasons. And so I think this is a good driver for us and is a nice tailwind, among others, that should help our business going forward.

Great. I know we're running low on time. Just a question I get sometimes too that you can probably help me out with is some of the smart speakers like Alexa. What are some of the hurdles for making that a bigger area for people to use for voice? And how might that be able to drive your business, particularly as it seems like that could be a 911 service too?

Yes. So smart speakers, I think, are a big opportunity. Today, not all but most, you can call out from your smart speaker. And so you could say -- and Bandwidth powers all of the ones that do this. But so if I said call Mike Walkley on his cellphone, I can do that. What we can't do is the reverse of that today. Technologically, very simple, we could implement that and do that today. I think the reason you haven't seen people go forward with that is manufacturers of the smart speakers and service providers is -- I think it's a business model question because, once you have 2-way communication, not only do you have [ that in actual sense ] but you also need a phone number for that device to come into. And then because there is 2-way communication, the FCC would mandate 911 service. So what's exciting about us -- for us in this is we could go from 1 stream of revenue to 4 streams of revenue, but it's really up to these customers, if they want to move forward with it. I think customer demand is there. I think customer expectation is there. I think the business model sort of needs to catch up. And they need to figure out how to monetize or not or what the value is, but to have true home phone replacement, I think you have to be able to call in and out and you have to have 911 service. So it's something I would have thought would have happened a long time ago based on a number of theories. It hasn't. I'm done predicting when it will happen, but I think it's a when, not an if.

Great. Well, Jeff, I know we're running low on time, so I want to throw it back to you. Any concluding thoughts, anything you think investors might be missing about the long-term investment story or any just final pitch on the long-term investment opportunity for Bandwidth?

Thank you. Well, again, pleasure to be with you. Appreciate the interest and the support. The conference has gone great. I think the virtual setup is really interesting. I think I heard more people say, "I like it." I mean it's been great staying out of airports and hotels, so maybe this will become a blended mix of what we do. But in terms of your question. What do the people sort of misunderstand about Bandwidth or whatever? I think we covered these, but just to get on: There's 2 that sort of come to mind. One is people undervalue the power of a vertically integrated platform and why it serves the enterprise communication market so well. It -- long term, it will dominate other industries. Vertical integration has already won. And then finally, something that we cleared up earlier that we're constantly reminding investors is we're not in a cage match with other CPaaS providers. We're actually more in a all-boats-rise environment where we're taking from share donators like the incumbent legacy providers and CPaaS is winning. So those are probably the 2 things I'd remind investors of.

Great. Well, Jeff, I really appreciate you participating in our conference. I hope you have a great set of remaining one-on-one meetings. And best wishes to you and your employees for everybody to stay healthy.

Thank you, Mike. Thank you.

Thanks...