Bandwidth Inc. (BAND) Earnings Call Transcript & Summary

All right. So let's get started. Thanks for being here today at the Barclays TMT Conference. I'm Ryan MacWilliams, mid cap software analyst here at Barclays. It's my pleasure to have the Bandwidth team here. Guys, thanks for coming. With me today is David Morken, CEO; and CFO, Daryl Raiford. So we'll be taking questions directly from the room. But if you do have questions from the webcast, please e-mail me at [email protected], and we get those in. So we're talking beforehand about how you guys tripped down to Raleigh, North Carolina. And it's great that we're back in person and having you.

So I think at a high level before we get into like the nitty-gritty of voice API and different things on the Telco side and the messaging side, just for maybe those less familiar, can you just get a quick overview of Bandwidth and maybe some of the key differentiators versus your competition?

So great to be here, Ryan. Thanks for having us. We have a global software platform and network in order to differentiate and compete with incumbents. And that's often lost on folks who aren't used to our story. We compete against Verizon, AT&T, Lumen and then globally incumbents in each country. We have 63 countries where we provide full voice services, and we do text messaging as well. The way we compete and differentiate, Ryan, is through our software platform. Incumbents, as you might imagine, have not kept up with the software innovation over the last several decades. And so we're able to serve large enterprise customers with a software platform that enables voice and text messaging capabilities globally, and that's really our secret sauce.

And as a former contact center agent, I definitely understand how painful it is to try to move off numbers off a legacy platform or get different features. Is there anything that you can help with enterprise customers that maybe it's a little more difficult for those incumbents to provide?

We can. Uniquely, we've got so much coverage and footprint and expertise in a regulated space across so many different jurisdictions that through a single partner, you can go from, as we announced in the last quarter, you can go from working with 20 global incumbent vendors to just working with Bandwidth. And one of our large customer announcements in the period, that's exactly what they did. So they basically centralize functions reporting numbers, changing call flows into a contact center geographically all into a real-time interface, and incumbents just has not enabled their networks the way that we have. And so yes, we are finding great success against incumbents because of our software platform and the capability and as a contact center agent that's built in the contact center for lots of good reasons with flexibility, but also with enterprise customers more generically that are doing customer engagement and use cases of all kinds.

It's interesting. I talk to people who are switching firms or moving different roles within different organizations like yes, the hardest part for me was just moving my phone number over. They often just like, it's very difficult for some of those older providers. But as part making that switch, like your customers also get a pricing benefit or is there way to optimize like cost efficiencies?

When we're competing -- it's funny to say reporting a number. I had a conversation with a customer, it took them a year to move a number in Mexico from a provider to a new provider. And so it can be extraordinary, and we enable enterprises to move much more quickly and efficiently. In terms of owner economics of our network and platform, there are real advantages for us, which is why we've continued to grow gross margin quarter-over-quarter to the record level that we're at right now. It's precisely because we control our own assets that we can do the creative things that we can with capabilities, but also the economics are really favorable, and that's both economies of scale, but also on net calling. And so when 2 of our customers call each other, that stays on net, and that's highly accretive to gross margin and a wonderful benefit of having own infrastructure. I think the last thing to mention on our unique model of being vertically integrated is you would spend a decade plus, and you would spend a huge amount of capital to replicate the coverage and the regulatorily compliant nature of the service that we now have with the combination of Voxbone. You would move at the speed of government to add country after country. And indeed, they worked 15 years to get to that coverage. So that kind of a moat is why we uniquely have the position that we do with so many different countries globally.

Yes. And just moving to the government is a great way to put that because getting service coverage in Europe takes like $100,000 per country, it's like 3 to 6 months, 2 years to get coverage in Singapore. So not as easy as people might think. It's something you can't even just for money out either. As you said it's a longer process. Daryl, how nice is it as a part of owning your own network to kind of have more expense of your cost base? Like how does that help with projecting cost per customer and cost for Bandwidth by having that as unique asset?

It does. And thank you, Ryan, for hosting this really a top-class conference and top class research that we really do appreciate it. Owning our own platform with our soft layer on top is extremely important to us. We are cloud. We do not rent the cloud. So we have no variable costs through AWS or Azure, something if we think about typical cloud companies. Those owner economics really do drive the -- some of the important tenets of our improving gross margin. We have 4 very strong pillars around which we have been improving and will improve over the next several years, continue to drive our gross margin. The first one is around the fact that as we scale revenue, it's into a fixed cost platform and there may be some step costs, but there's -- it's a fixed cost platform on which every transaction is more and more accretive. We also benefit by -- as a second pillar, our improving product mix as we land and expand with our customers are -- we upsell and cross-sell across our premium products, which includes messaging and emergency services, and those are accretive to margin, and we're able to grow the -- we're able to grow the customer margin within each particular customer, and we enjoy that. The third one is, of course, we've spoken about this a number of times. We do sell -- as we grow our international operations disproportionately more to our U.S. base, we enjoy in the 60 countries a premium pricing environment because it is regulatorily difficult. And we do have this competitive moat that David was speaking about. So we've been able to really improve our overall aggregate company margins by growing internationally disproportionately. And finally, as a fourth item, operating for 20 years, operating our own platform with our software layer on top of it. Our network operations team is very good. We're experts in what we do. And over these last couple of years, we've been really good in driving cost out and becoming more efficient in terms of simply how we operate. And you see that in the record gross margin of this last quarter.

That's a great segue to my next question. David, operating for over 20 years, Founder CEO, we're looking at software macro. For us maybe for the first time in a while, but nothing you haven't really seen before, while leading Bandwidth. But from your point of view, I guess, what are some puts and takes of things that investor can get comfortable with about like the resiliency of Bandwidth software macro?

We've got extraordinary customers that stick with us even through things like the DDoS attack that we suffered last year. We didn't lose a single customer. We did have usage move away that we spent a year bringing back. But that's just an illustration of the extraordinary position that we have with our customers and the relationship I have lived through 2001, 2004, 2008. And during those times where we've had austerity or other kinds of economic impact, we've grown through each one of those seasons and done so responsibly, preserving our ability to persist, and that means focusing on your bottom line. So pre-IPO, we were bootstrapped for most of our 18 years at the time, I think, existence. So as we think about this period, we know that it is absolutely right to focus on operating margin and making sure that you are responsible for your obligations, in our case, the debt that we have coming due in '26 and '28. So growth is something that we've always thought about doing responsibly and have always been very cautious about customer payback periods and acquisition costs for customers. And so there's that DNA and operating discipline that I think is really important when you're about to cross both a capital desert and the uncertainty. So it really doesn't form a whole lot of how we think about every day at the company and how we develop our annual operating plan. And there's a hard one discipline that comes from having lived through multiple seasons. Now for us, uniquely, I think we benefit from being kind of an essential service. So you can't really avoid talking to your customers or engaging with your employees. And some of these use cases are absolutely vital. And so we're one of the last things that get shut off before the lights go out. So that's beneficial for us. But broadly speaking, we've always operated the company with a view toward bottom line, and that's no different today.

Yes, if you're pulling out your phone system, some things are going pretty bad. Absolutely. Look, just the question we get a lot about Bandwidth is we're seeing seat count reductions broadly, right? And you guys service some of the large UCaaS vendors that have big deployments throughout the globe. But with seat reductions, maybe starting in tech for now, have you seen any reductions in usage or any changes there that are worth calling out?

Sure. Our broad customer base continues to grow, either reflected by dollar-based net retention that we see or the average annual customer spend that we have. They certainly are asking their employees and others are as well to do more with less, but actual talk time and usage trends across different verticals in a macro downturn recessionary environment, they may be more under pressure than we've seen so far. But so far, so good, the engagement business that we support across global business has been healthy. And so we watch metrics carefully in both annual spend, average contract length, dollar-based net retention and the usage itself continues to support the business. Uniquely, we have some cyclicality in the political season that we've just come through that is buoyant for us and more and more of that political has other attributes that supports the business as well.

That's a great segue. I move over to Daryl on the political messaging. Perfect. I'm just going to owe you. Just really strong 3Q political messaging revenues, I think, more so than people expected. How should we think about that for 4Q? And are there any other attributes that you might not be thinking about this political election season?

We did benefit in the third quarter by -- through the campaign, political messaging, campaign messaging usage of $7 million. And we did expect as part of our fourth quarter guidance, we did expect to benefit again in the first 6 weeks of the fourth quarter up through the election cycle by more than that, more than the $7 million. Since then, the -- some of the campaigns have continued with runoffs and the like, and we have enjoyed that continuing business as well.

And just when it comes to that political traffic, any attributes that are worth calling out, like higher gross margin, mostly U.S.-based? Like how does that compare to the rest of your message business?

Margin for political messaging is at or maybe slightly less than the aggregate messaging business that we've enjoyed. The messaging business we've always disclosed has an aggregate margin of greater than the company's gross margin. So as we participate in messaging business, it is accretive to the gross margin of the company.

And just -- you talked about some puts and takes into the most recent year for Bandwidth right, like DDoS attack, you had some business lining down and then some customers issued pricing benefits. But stripping out things like that, along with the increase in carrier fees, you know, that if you call the space, we all know I love the APPCs. We've done a lot of work on here at Barclays. I guess, how do you think about like the organic growth rates of the voice business and the overall business for Bandwidth?

We had one customer this last year that we took a strategic pricing action on that we spoke about quite at length. Stripping away that -- we have -- and I should say, even including the effects of that this year, we've been reporting aggregate price of the company has been improving each quarter over more than the last 12 quarters. So we're very happy about that. Our ARR for our customer reached a record this last quarter. We may have pricing adjustments in terms of individual SKUs up or down as of the environment that we sell and dictate. But we've been very, very pleased overall with the pricing environment and how that's grown.

Yes. And actually, I want to touch about that, reading the transcript last night from last quarter, and you said pricing actually improved in 3Q. Can you just talk about some puts and takes of that? Is that a mix thing...

When we do a price volume and the analysis, yes, on aggregate, the pricing, like I said, for more than the last 12 quarters has improved each quarter. And that is based on a price volume analysis. It's the aggregate company -- again, SKUs may go up or down. But it is reflective of -- it's inherent in our ability to cross-sell and upsell because as we land and expand with clients, we're able to again sell more premium products. And in terms of an aggregate price, we're able to raise that per customer account price.

Excellent. And then just on the decision to buy back the converts, I thought that was a really interesting move and definitely one that shareholders rewarded when it was announced in the earnings. I guess like how do you feel about your current capital structure? And I guess what does that move alike from like a flexibility standpoint?

Sure. So we did. We did announce as part of our earnings that we had entered into a repurchase transaction to purchase $160 million space value of our $400 million convertible notes that are due in 2026 at nearly 30% discount. And that transaction did close on November 28 after the VWAP period had transpired. We feel really -- we obviously feel really good about the discount. We feel really good about the transaction itself, and we feel really good about the future in the sense that we believe it gives us optionality. It gives us optionality to -- in the first instance with our slightly over $200 million of remaining cash on hand and the $240 million of notes due in 2026 with the cash on hand and free cash flow that we expect to generate over the next several years, it gives us the option to retire those notes in full if we so choose. We believe that the free cash flow generation of the company allows us to add our option, if we so choose in the future, refinance a partial amount of those notes or our free cash flow generation to enter into a regular way term loan if we chose to do so. We think that our capital structure is very well balanced right now with a lot of optionality, and we're happy about that outcome.

Investors, some years can focus on top line, some years focus on the bottom line. I think we all know where people are focused right now. But just given that outstanding converts, like how do you feel about the potential for margin efficiency here going into the tough macro? Like are there opportunities to drive more cost savings through balance?

Yes. Our model is -- we do believe that there is. We believe that we will become as our business scales and revenue continues to grow, we believe that we will become more -- we will generate more operating leverage in terms of the bottom line and in terms of free cash flow. Our long-term model is to grow our gross -- our non-GAAP gross margin is greater than 60%. We enjoy operating expenses at roughly around 40% of revenue right now. We don't believe that operating expenses will grow proportionate with revenue or need to grow and will become much more efficient in terms of the fall through. That's going to generate adjusted EBITDA targets, in our minds, over the next several -- approaching over the next several years in the 20% range, which at a 5% CapEx load would imply a 15% free cash flow target over, say, 3 years.

And just from a high level, I mean, I think -- the Street has you still around like double-digit growth for next year. But I guess, where are you more focused on? Like is it more important to kind of hit that revenue number or max on the top line side or really drive operating efficiencies.

Yes. Bottom line focus is where we are oriented. There's certainly a relationship between top and bottom line, obviously. And the high-calorie revenue that you pursue is informed by that bottom line focus, and that's always been part of the other is more important than ever.

And just on the number of customers. I mean I know we talked about it a lot, which is -- that's not a great representation though of your business given how large some of your UCaaS and CCaaS customers are. But I was surprised to see that pick up last quarter. But how should we think about Bandwidth strategy to kind of like really focus on those big enterprise deals at this point?

Yes. Sandy Preizler is on board to focus and organize the sales team on the Global 5000 enterprise customers, where a lot of the opportunity and growth is. It's also an area where we solve complexity so well that we're able to command contribution to our gross margin target in those engagements as well. And we will have a power law associated with those customer ads as they disproportionately contribute if they're a very large customer. We have legacy smaller customers that are organically trading out of the business, and that's by design. We aren't focused long tail on small companies. We're really focused on the Global 5000. And part of the reason is, again, our footprint. So when you serve so well in 63 countries, every conversation is a global conversation. You're much more unique globally when you have jurisdictions that are far flung and rarely served to a single partner. And so it's just complementary to pursue the global business customers that we are. And some of the smaller customers we've had historically leaving contributed to our average annual customer spend continuing to get to record levels and the average contract length going from 17 to 21 months, again, climbing into record territory. And I think those attributes will continue, and they're all favorable for the model and the assets that we've got to offer those customers.

And we're now a few years out from the Voxbone acquisition, which is the first big deal for Bandwidth, really excited to bring the U.S. capabilities in the international service coverage together. I guess, like where do you see where that acquisition is now and like how it's going to help you quite often internationally?

I think 2023 is the last time we'll talk about the integration and moving to a single pane of glass. Devesh Agarwal is on board leading software development strategy and his mission includes wrapping up all aspects of the customer experience to a single network, single pane of glass by the end of '23. And so to your point, in terms of going on offense, having a single global customer experience across the jurisdiction is that we offer and the owner economics that come with that, let us compete against the BT or Telefonica or Colt or Tata in ways that are pretty powerful. You do that with capability and experience, not dollar for dollar on a pricing battle, and we like that a lot. What it unlocks for the enterprise customer, we announced a few examples of in this most recent period. Again, not just the 20 global carriers that consolidated down into a single relationship with Bandwidth for 1 customer, but 2 others that also including the premium cruise line based in Europe, got rid of 5 different global relationships to use our platform. And so we'll continue to march around the world and I think have wins because we've invested in the software platform layer on top of the network in a way that incumbents just to have it.

And I was really excited to see the Voxbone acquisition, just given they had really strong relationships with contact center vendors globally.

They do.

And what's the advent or the next step? You announced a further partnership with Five9, but what's the next step for Bandwidth in the context on our own?

Genesys, we announced a relationship. And in the opportunity with Genesys that was international in nature and with Five9 we announced in the quarter, messaging adding to voice. And so in both cases, we've deepened and broadened the relationship with those 2 contact center leaders. And they're very focused on both what we've done domestically with messaging and voice, but internationally with the footprint that we offer. It just -- it eliminates a huge pain point for them to have to manage multiple global incumbent providers in ways that are not efficient. They're still at times faxing change requests or working for months to months support, thousands and thousands of numbers when we programmatically address that in our platform.

Yes. That's a key piece of the Bandwidth value proposition because as you go to like a cloud complex center vendor, right, you can diagram your calls through -- or put your call through a third party, someone else, Bandwidth, a little difficult to do that with classic telco.

This is -- you make a great point. In the contact center right now, there is a Cambrian explosion of third-party apps that are incredibly powerful, whether they're AI-driven sentiment or authentication for identity. They route calls in real time from a rep through a really intelligent filter that adds value and then back perhaps to a different rep. Our platform uniquely allows those kinds of orchestrated calls to third-party solutions to happen in very complex ways that an incumbent has no hope. So we're displacing Verizon and contact centers all over the place as a result of the creativity that's happening in the contact center. But frankly, we don't have anything to do with that layer, but supporting it as communications infrastructure is vital.

And the one nice thing about Bandwidth is people call me to say who's going to win? Is it NICE, is it Genesys, is it Five9? I'm like, "Oh, he's on the Bandwidth side, I don't really need to make a call there. Before I go too far and I guess, the things that I'm very interested in, just on the gross margins on the messaging side. With the recent implementation, APPCs, like there's been some changes in that -- from that aspect. But do you think there's any way from a secular standpoint that we could see improvement in messaging gross margins over time or like opportunities for Bandwidth there?

From a new investor standpoint, I want to make sure that I begin with the distinction between domestic and international messaging. So international messaging has very low gross margins, domestic messaging, not so much. We have grown up focused on majoring in domestic messaging. And so when we say it's accretive to our overall gross margin, often people don't -- can't figure out why that's the case. To your question on structurally, is there opportunity going forward to do something in messaging that we've been able to achieve in voice, which is owner economics. There certainly is, right now, an opportunity in the ecosystem to be creative, not just on scale, which would represent volume and pricing related to volume. But I think that being a trusted partner in the ecosystem right now is really important and vital and we've grown up being trustworthy to the largest incumbents that we have the right to work with on the voice side. And I think in messaging, there's opportunity there, to play a role that's vital and trusted, certainly in the political season that we've just come through, we've been responsible for enforcing and maintaining different policies for campaign registration on A2P and political. There is a level of messaging going on right now that is beyond just political elections. That's what we call civic engagement and civic engagement messaging are around nonelection cycle topics of all kinds. And the volumes that are coming from that, I think, are more buoyant than just election season. But again, I do think that there is an opportunity over time to play a role in the messaging ecosystem that's different than that which exists today. And I think that there would be gross margin improvement that comes with that.

That's component. Yes. I mean volume gets volume and more relationships. From your point of view, I mean, it's something we talk about a lot with the CPaaS space where it's like international lower gross margin, but higher gross profit, right, and source of area for growth. Like how do you think about the trade-off between those 2 things?

Well, for us, our international business is our voice platform as opposed to messaging. So that is -- we enjoy the, I guess, the coupling of higher gross profit and higher gross margin. So that dynamic is kind of virtuous for us in terms of that. And we are very much focused on taking our U.S. customers international into that -- into those 60 countries and supporting them. They want to be on Bandwidth. They want to grow with Bandwidth. They want to consolidate their service providers that they have in the international markets and they want to reduce their telecomplexity that comes with that. And so we're excited about doing that to grow with our customers and to be able to provide them that capability. And that will yield more gross profit dollars and gross margin.

Perfect. So we're wrapping up towards the end, so we can ask it now. I get this question a lot. I think the pricing change that the 1 customer had earlier this year was kind of an isolated case, but people bring up a lot going on tougher macro, could you see more pressure from customers there? I guess, how do you think about that like engaging those conversations? And maybe like how can we talk about how Bandwidth differentiated offering like supports, your side there?

I think the most important answer is that there hasn't been a similar conversation or reduction since. So we've almost come full year and it hasn't happened. And we didn't think it would. It was a very unique relationship when we were happy with. It hasn't happened again. We don't expect it to -- the current pricing environment, as Daryl spoke to for 12 quarters has improved. When things are off there, a couple of things happen. Your competitors don't expand in the new footprint. They don't spend the money to come after you in different countries, if they're not the incumbents. And the incumbents are very sensitive to debt loads. And so their pricing, we think the pricing environment is going to be healthy.

And I mean, just as a corollary, during 2020, you didn't exactly see that pressure from both customers. I mean the workloads are going higher, but?

Yes. We think that our ability to serve well and grow our terminal -- toward our terminal gross margin targets are intact, if not helped during the season as we get towards 60% and beyond.

So if I can just ask my one nerdy Cloud Com question. Can you just talk about like the different dynamics between handling inbound calls and outbound calls? Maybe how those workloads and like pricing and demand different.

It's wholly nerdy.

Sorry, but I had to get one.

You can have multiple providers for an outbound call. You can multisource. You can have 5, 6 vendor partners and they can bid different rates for outbound cool. If you're the nation's largest credit card issuer, you have a consumer 800 number for tens of millions of customers to use that single number is routed by -- provided by a single provider for 100% of the volume. And the vulnerability there is intense if there's an outage. And so inbound calls for us to a contact center are high stakes, high impact, high consequence and we have a product we announced called Call Assure that's patented and very, very cool that improves our already industry-leading solution to include a solution for an inbound number like I just described, that continues to work even if Bandwidth gets nuked off of planet, your inbound toll free will still work. And it's pretty cool and customers value that highly. But that nerdy question is lost on a lot of folks, outbound terminations what it's called. Usage can flow across multiple partners inbound to a dedicated number is a single relationship that's got to be a very trusted partner for an enterprise.

And that's when we speak to the durable nature of the contact center business in the global enterprise because that 1-800 number serving millions and millions of calls is very durable and sticky. It's integrated, not only in the Comstock that Bandwidth is providing, is integrated within the cloud CCaaS offering that our partner is providing and/or other partners for the configurations of sentiment analysis and artificial intelligence and things like that. So once the CIO at one of our global enterprises, whether you're a cruise line in Europe, whether you're a large pharmaceutical -- retail pharmaceutical concern in the United States. Once you're a CIO and you have that -- those capabilities in place, you -- the nature of the capability that we provide becomes very durable and sticky and is not very changeable.

And that inbound use case, that's not something you're going to hold the monthly pricing auction for...

No.

I'm trying to switch around. No, thanks. Well, guys, thanks for bearing with me how to get one for those questions in. But at this time, I'd like to thank Bandwidth being here today, and hopefully I'll see you guys in Raleigh.

Thank you. Appreciate it.

Okay.

Thank you.