Bandwidth Inc. (BAND) Earnings Call Transcript & Summary

Thanks, everyone, for joining us. We're really excited to have David Morken, CEO of Bandwidth with us for about 25 minutes. Dave, really appreciate you taking time out of the day. Before we kick it off, Alex Kurtz here with KeyBanc Equity Research. I appreciate everyone joining. We have a pretty good Q&A function on the webcasting website. So if you have some questions, early or often, just start putting them in there, and I can see them real-time and integrate them into our discussion. And then if we have some time, we can kind of go through those at the end of the 25 minutes or so. So Dave, thanks for coming and joining us today. Thank you.

My pleasure, Alex, great to be here.

So a lot has happened in 6 months. Your business has just really seen an interesting adoption curve. And what's been your -- before we get into our prepared questions, like what's your biggest takeaway so far going through March and June, right? I mean all of a sudden, you saw this worldwide adoption of UCaaS, and obviously, that's beneficial. So what's been your high-level takeaways?

Highest level takeaways have to do with customers and our own employees. Culture is super important to us, Alex. And so with all of the different social and health-related issues going on, our focus was on culture and our team and then also on customers. And so we saw certain cohorts with explosive growth, and we rallied in real-time around the clock to support them. And then we also needed to focus on our own team and how, as an entire family of folks, we're moving forward together through a season that's really unprecedented.

Yes. It's a recurring question I've been asking all of our executives over the last 2 days, is just what's been like to operate the business remotely, right? I mean I know we talk about your end customers using their platform, but what's it been like inside of Bandwidth?

People are amazingly productive and amazingly efficient. However, it comes at a cost. We are withdrawing relationship capital that we have deposited with each other, in many cases, for years. I'm really grateful that we have invested in so much to do with the vibrant culture because we're making withdrawals right in the left right now. And morale, I would describe, it's really -- this is super unique. You can be productively efficient, doing more work than you've ever done and still be at, perhaps the lowest ebb in terms of morale because you're not together, because as you're separated, you're isolated, you're anxious, you've got concerns. Your kids can't go back to school, you can't go to church. You can't -- your sports teams get canceled, your college kids get sent home, but you may be closing more deals than you ever have. In fact, you may be working with customers around fire. So there's this crazy dynamic.

Interesting. Yes. We've heard a lot about that, the fatigue of all this, right? We had a company yesterday that said, we had so much productivity that we had to shut down people once a week because otherwise, they were just spending the whole time in front of the computer, and it doesn't work longer term.

We gave a whole day off to the team for that reason. We also established a new benefit called a [ Go-Do Day ], which annually, you have a paid day off to go volunteer or protest or pick a cause and go for it. So's we found unique ways to also address what can be an all-consuming reality of working remote behind a screen nonstop.

Right. Spent all day talking about this. So let's dive into Bandwidth. I think just to level set with some of the newer investors that are on the call, and we have really great numbers here, are watching this right now. What would you say are the top 3 drivers for the CPaaS market over the next 5 years? And then in conjunction with that question, how does COVID change the adoption curve?

So I'll start with the CPaaS market. IDC estimates it will grow from $5 billion to $17 billion by 2023. The 3 greatest drivers within the CPaaS market have everything to do with the incumbent, dominant players from whom we take share. We're talking about Verizon, AT&T, CenturyLink, that's who we compete with most of the time. And the 3 drivers are relative to what they have in the enterprise space. And what's going on is a 10-year technology shift from premise-based legacy analog solutions for communications to the cloud. And that overarching shift is well underway in voice and messaging. And the biggest drivers are companies who recently, through this season, have even accelerated, realizing they have to go to the cloud to support remote work. They must take advantage of both the efficiency and the economy of getting rid of legacy providers and analog hardware. So #1 is just a general technology trend of digital transformation. That's a huge driver. #2, how do you do it? And the answer is a software platform and a network. The biggest driver for us is the fact that we can go into a call center like the Fortune 100 bank we announced on our last call, and displace AT&T and Verizon because we have a software platform and they don't. So because they have largely invested in other areas, there's an amazing opportunity for CPaaS to serve enterprise customers in a way that the incumbents simply can't. And then last, messaging. So messaging is something that we have watched grow since our IPO pretty extraordinarily from 6% to now 11% of our revenue. And again, it's based upon having a software application that can really easily allow an enterprise to message-enable their communications. The carriers, again, largely have ignored or even tried in some cases with surcharges to suppress the proliferation of this new and vital engagement channel. So overall, the space is large. The incumbents are pretty passive and the software and network combination and the extraordinary journey transformation, 10-year shift in technology.

Yes. I think one area of your company that I don't think gets enough explanation by the street, and I think you need to do a better job is explaining what your software really does and how it allows this customization inside these enterprises and UCaaS providers. What is -- I know we spent a lot of time on UCaaS side, but what has COVID-19 done to accelerating the enterprise side of the business, right? So people are making big investments in their communication platforms internally. So what have you seen on the enterprise side, which is the majority, right, outside of UCAAS? I mean that's a big part of your business.

It is. What we've seen, most importantly, is an acceleration in the decision-making mindset of the enterprise CIO, General Manager, SVP, they realize it's not a question of if, any longer, but when they need to move away from premise-based equipment and incumbent providers to the cloud for all their communications. It's a foregone conclusion. As a result, largely, of the season that we've just come through. It used to be, Alex, we'd have to have a first principle's question about why Alcatel loosened or why Avaya or why Verizon or why AT&T were not the right solution or partner? Now it's not even a question. Simply when, how, what are the challenges around porting 20,000 numbers from Verizon to Bandwidth through the platform, how can I do E911 through your platform instead of the incumbent, those decision cycles, I think, are compressed.

Right. So on that topic, bring-your-own-carrier concept. I think investors are still trying to understand what's driving that. And what bandwidth brings to that discussion. So maybe let's cover that for a few minutes.

Microsoft's SKU in the grand scheme of things can be purchased by a very small company or a very large enterprise. Very large enterprises, however, have real motivation to bring their own provider and still use Teams instead of getting the dial tone and number through the SKU. And what Microsoft, to their credit, have done is recognized large enterprise should be able to bring their own provider, select their own 911 provider and still engage with Teams. And so the Duet announcement, which we're really stoked about, Alex, was an announcement that Microsoft has certified 2 providers, of which we are 1 to do E911 with Teams for large enterprise that is bringing their own provider to the table. Reasons for the large enterprise to do this can include everything from massive call volumes and capacity to very custom and extraordinarily complex routing to simply a desire to control their own destiny within their communications in a unique way. We are fired up about being certified by Microsoft as an E911 provider. We're the only CPaaS solution out there in the platform that can configure an endpoint -- a Team's endpoint so that an emergency responder doesn't just come to the receptionist. The emergency responder gets dispatched to the conference room on the fifth floor. And that's a huge difference for CIO to move to the cloud and to know that the emergency services migration he's doing also gets him into the modern era. So we're excited about it. It's a great path. We win in both cases. In other words, we're already working with Microsoft if the business gets serviced from the SKU. But now we're also, in bringing-your-own-provider, able to win as well.

Yes. Your advanced E911 capabilities allow you to play in both the UCaaS side as well as the enterprise side. So for the investors on the call here, they hear E911 and I know that we're in the leads on with you about all the regulations that are going to place and why it matters. But maybe just a fly-by about what's happened, why these new capabilities have come to the market? And who do you compete with on that?

I'll take them in reverse order, the incumbent is Intrado. And the reason we win against an incumbent like Intrado is because our software platform is vertically integrated with the network. And in this case, Alex, that network is something we acquired back in 2011. The only acquisition we've done in our history, we acquired a facilities-based 911 provider. And since then, we've expanded the endpoints we serve from 2 million to now 10 million. We've interconnected with the 7,000-plus public safety access points. All that complexity, all the interconnection and routing that's geo-spatial, the whole point is for an emergency responder to get to the right person at the office. In the old world, if you had a corporate campus, the ambulance would show up, and it was work to try to figure out where in the world they're supposed to go if an office line called 911. With E911, the way our platform provides it, we can, again, direct the emergency responder specifically based on the technology that we've built and acquired to an exact location. And that is so much of an improvement on the quality and the timeliness of care that can be dispatched. And it's way overdue in an office environment to know that an emergency responder can go to the right place. So it's a fantastic conversation starter from the new enterprise that we're talking to. And it's often understood to be a huge decision criteria that our platform supports it in real-time and the enterprise doesn't have to have any knowledge of the underlying complexity, they just need to know when you get E911 from Bandwidth's platform, you get the modern version that is specific as to sending people to the right place.

Got it. I wanted to -- by the way, for those who are dialed in, please, if you have some questions up, please go ahead and start filling out those. I can look -- I can see those real-time over here. So let's transition into messaging, which has been growing at a good clip the last couple of quarters. It was over 10% the last couple of quarters. So we often get the question how you align with the 2 larger vendors in the marketplace, Nexmo and Twilio. And it's obviously -- that part of the market is big, right? There's a lot of movement, and there's a lot of new application development that requires these capabilities. So it's an expanding marketplace. But where does Bandwidth messaging strategy fit it into the broader marketplace opportunities? I mean you guys are going after specific types of outcomes or you going after everything?

Messaging has been growing over 100% the last couple of quarters, 108% plus, and is now 11% of our revenue. And is part of our platform strategy and important to our enterprise customers to have for us as a single source. It is an engagement channel that's vital. And in this current season that we're in, what we have seen are congregations in the faith-based community that cannot meet together, school classes that cannot convene, teams that have had to be disbanded. These kinds of communities are finding messaging to be vital. We're also in an election season where we have really high volume, important political speech going on. We've supported a broad set of use cases to fuel that 100-plus percent messaging growth to now be at 11% of total. That said, we're cautious. It's accretive to gross margins, but there aren't the structural advantages that we enjoy in voice. And so when we compete against the incumbents like Verizon, AT&T and CenturyLink, it's 85% of the time, and it's regarding voice. When we do bump into another CPaaS competitor, it's often in the messaging space, downmarket in terms of the size of the opportunity, but it's only 15% of the time. We win against the incumbents, obviously, because we have a software platform and a voice network. On the messaging side, it's an asynchronous service. And so it's hard to differentiate based upon quality because if a message is delayed, face it. If it's delayed 5 seconds, nobody cares. But if voice communications are delayed 30 milliseconds, everybody hangs up. We have our own network and platform combination that makes a huge difference in voice. In messaging, long term, while gross margins are accretive right now to our total, we think price discovery is going to compress that, things like surcharges are challenging because you pass those through. So those are headwinds to your gross margin target. Having said all of that, we've supported it, we've scaled it because our customers have asked us to, and we've grown with them, but we will remain a voice-focused CPaaS company.

Okay. You briefly mentioned it, Dave, the interesting dynamic about your on-network calling and what it means for margins, right? We've talked about that. Actually, I think I was on stage with you back in March, probably at the last investor conference of 2020, and I asked you this question. So why did -- just take us through why that's structured? And then -- and why it's margin accretive? Because it would seem that from the outside looking in as more of your UCaaS customers interact with each other, right? There's kind of a flywheel effect on the margin, right? More minutes on network between your different platforms that you work with, it should be accretive. So just take us through how that works.

You bet. Each of these UCaaS environments we consider to be walled gardens. What I mean by that is within Teams, a Teams' subscriber calling another Teams' subscriber. If it's over-the-top of our IP, that's a closed loop. There's no third-party termination costs, but there's no need for a phone number either. The value of a phone number and the public switch telephone network is that it federates all of these emerging walled gardens. And I can list the CCaaS customers we have, we have all of Gartner's Magic Quadrant CCaaS, UCaaS customers. So each time a RingCentral customer calls a Teams customer, for us, Alex, that stays on net gross margins are as high as any SaaS margins you've seen. There's no third-party termination cost, that's very different than a Google Suites user calling someone's Verizon handset where there's a third-party cost to that for us. So as a function -- it's a true network effect in that each additional endpoint that joins us from each new walled garden, a dialpad that's still private. I can go on and on. Each time someone new joins, it adds to our gross margin profile, and it's simply a function of scale for us to continue to improve gross margins. There are also economies of scale as the fixed costs of our network are subscribed by a greater user base. But we're excited about having grown gross margin every year that Jeff and I have worked together, now 8 or 9 years, and it's a function of the business model.

Right. Yes. The drivers of the long-term gross margin, it's a question we get a lot from the investors, the economies of scale that you and Jeff have talked about, is obviously the big focus point, right, to drive future leverage.

It is network effects from on-net calling, economies of scale and that terminal gross margin target of 60% or even higher is a function of growing. There does not need to be some superhuman trick for us to achieve it. It's just growth.

Right. So a question just come in here. So I'm going to ask you a question then kind of filter through this. So this has been obviously a very unique year as far as first half versus second half, right? So I remember on the March call, you said we expect work from home to stop July 1. And now there is some implied assumptions on that continuing a bit into the second half. So you raised the year, so what are your assumptions currently around the work-from-home impact to the top line?

We've done the best we can to break out COVID impact in the first 2 quarters. We raised -- at the midpoint of our range, we raised our guidance $13.5 million. So from 25% to 32% year-over-year. And $5 million of that is due to the strength that we had in the second quarter. The remaining $8.5 million is a broad set of contributors. Our fundamental assumption that you articulated, Alex, was that we would all be back as of July 1. And obviously, it hasn't happened and it's heartbreaking for those of us with kids headed to school or college now coming back from college. For the business, it means that we are likely doing the best we can to forecast. But there is potential for us to do better than that. We could also certainly find reasons that we do worse. But our operating assumption that schools, churches, offices would be back to normal July 1, that's out the window.

Okay. And so that obviously got updated in your new guidance for calendar '20?

It did. We did -- it did, and we're doing the best we can, and it's not easy. What we saw specifically in April was the high point. And then by quarter end of Q2, you're about half of that and then linear declining, we've been assuming the best we can. We factored that into the forecast already. So no change there. But we had hoped that we would all be back by July 1.

Right. So this question is really focused on -- I think it's going to be tough for you to answer because I think it pertains to '21 and beyond. But you have a group of customers that have onboarded record number of users, right? And that was something that you didn't see coming at the end of calendar '19. I guess you kind of have to see how it plays out, but you're going to head into '21 with a lot more people on your platform than you assumed at the beginning of the year, right, Dave?

Yes. We are.

Okay. And I guess we'll just have to see how the usage tracks, and I'm sure you'll provide additional commentary in Q3 about what that looks like.

Well said. We're all trying to figure out the new normal and how things normalize remains to be seen.

Right. Any other questions before we let Dave hop here? I'm just going to give you guys a second. Yes, I just want to finish the carrier surcharges and impact to your model. It's obviously been -- it's a very important dynamic, not just for you, but all the platforms in the CPaaS market. How do you try to understand what that's going to look like quarter-to-quarter, year-to-year? And how to figure it as far as a cost of the business and maybe a demand headwind at time? So it's sort of outside of your control, but it obviously impacts the industry.

We expect all the carriers to apply surcharges. This is how they behave. And long code -- 10-digit long code messaging, all of the carriers will apply surcharges. We have focused on toll-free messaging as a huge value add for business for a couple of reasons. But we fully expect surcharges to come to toll-free over time as well. And it's -- because this is a nonregulated area. And so what some might perceive is bad behavior by providers, there's no recourse. And so this is one of the reasons why structurally, we biased heavily toward voice, where we have a structural advantage. We have, by law, oversight from the FCC. Messaging is really tough to understand directionally how painful the surcharges could get. But you've got to assume all providers will assess them now that the largest move, and that will be across both 10-digit long code, it will be passed through. It will destroy some business models. It won't do to others and it will certainly impact gross margins because it's faster.

One last question here that just came in. CapEx needs on incremental network capacity investments. How do you plan for that as usage spikes on the platform?

So we've got a good handle on the ratio of CapEx to revenue and usage, and there will be no significant change to that. We know how to scale it efficiently. So our historicals are pretty accurate.

Okay. Great. Well, listen, we're in a -- we're going to keep you on time and get you out to the rest of your investor discussions with us today. Really appreciate, Dave, taking time with us. Thank you very much.

Alex. Thank you, Sir.

All right. We'll speak soon. Thank you, Sir. Bye-bye.

Bye.