Bandwidth Inc. (BAND) Earnings Call Transcript & Summary

I'm going to start with a brief disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. For those who don't know me, I'm Meta Marshall, I cover the communication software space here at Morgan Stanley. We're delighted today to have Bandwidth with us here today; and David Morken, CEO and Co-Founder of Bandwidth.

Thank you, Meta.

All right. So Bandwidth has been able to utilize the same network to service a growing set of use cases and customer types over the years. Can you just give investors a sense of kind of the core differentiation and core ethos of bandwidth?

You bet. It's important to understand who we're differentiated from and that would be our top competitors. In the U.S., that's Verizon, AT&T, Lumen. Internationally, Tata, Colt. And the core differentiation has a lot to do with 2 fundamental differences. One, global footprint. We have network in 60-plus countries that we own and operate. And then two, we have a software platform on top of that network where our customers integrate with us for global service. If you're an incumbent, you don't have a software platform. You also don't have in the U.S., territories outside the U.S. where you're native. So those 2 facts differentiate us considerably from those we compete with most of the time and actually represent the primary drivers for customers finding us and using us.

Got it. When it comes to your UCaaS and CCaaS customers, there's kind of been this trajectory or kind of pattern that you guys have repeated breaking into one customer with the use case and then repeating it with kind of subsequent sales to the ecosystem. This is applied to kind of video conferencing customers or video conferencing use cases, phone numbers, E911, direct routing. Just how does that expansion happen? And how do you kind of identify one opportunity and then broaden it out from there?

We've had waves of customers come on board Bandwidth. In the early days, the Internet giants like Google, like Amazon, like Microsoft found us and worked with our platform. After the initial wave of Internet giants, we have the UCaaS providers, whether that's Microsoft Teams, RingCentral, Dialpad, UCaaS and then more recently, CCaaS, Five9's Genesys. So these waves have crashed successfully onto our platform and scaled in a wonderful way. And most recently, global enterprise, the Global 2000 enterprise customers are utilizing us because of the international footprint, because of the ease of use, because of the enterprise support, we're able to help them migrate to the cloud, change their contact center, in many cases, away from an incumbent that's inflexible. So it's been really interesting to think back over the last 24 years now and identify periods of time when, to your point, Meta, word-of-mouth, where we haven't had a global sales force of any serious significance or size back then, it was word-of-mouth reputation, delivering on what you promised to do that caused entire cohorts to come on board.

Okay. And I mean, just -- is it now like word-of-mouth is what used to be the case, but is it still word-of-mouth plus like somebody realizes, Oh, they're using Bandwidth, we should be using that too? And it is met by an eager salesperson? Or just like what is that kind of land and expand almost within customer type?

We were probably hyperbolic in our IPO video when we said all roads lead to Raleigh, where we're headquartered. It's not entirely true. All customers don't find us natively. We have a really good enterprise-focused sales motion, staffed, trained, feet on the ground, traveling based in Raleigh, but also often based in major metros. And so we have graduated to the point now where we do a successful customer acquisition in the Global 2000, outbound, direct. Interestingly, we haven't utilized the channel until very recently. So we've been into direct sales motion, but word-of-mouth has been important.

When you got a slide in your investor deck where you were kind of walking through the progression of Google over time as a customer and the different use cases and products that they had used. You have an extensive logo page of customers. So just like where do you think you are on kind of scaling some of those relationships?

We have been very blessed to support, work with, partner with all of the Gartner Magic Quadrant leaders in both UCaaS and CCaaS, and have grown significantly with them in different ways. Sometimes they're adopting new product that we have on the platform. Other times, they're going into new jurisdictions like, for example, taking some of them to Turkey most recently. The growth that they are enjoying with us like that page in our investor deck has a lot to do with what their strategy is at any one point in time. So for Microsoft, you mentioned Google, and we've worked with them now for 15 years. But at Microsoft, we are their primary partner for Teams. If you take the SKU direct from Microsoft, we are their primary partner for Azure Communication Services, if you engage with that CPaaS platform that they've offered. We're collaborating with them. We're talking to them about the road map. We're supporting them in where they want to go. And often, they help us innovate as well by telling us what they'd like us to do.

That kind of leads into the next question. Thanks for the setup. Clearly, at the time of the IPO, those customers wanted you to go international, and Voxbone was part of kind of getting that international coverage. Just how -- what is that kind of road map that your customers are asking you to go on today?

Today, it is the large enterprise that is driving most of our collaboration and innovation. And it's in ways that are important to them whether it's changing their contact centers around the world by replacing -- in the case of the largest electronic signature company in the world, they had 15 different contact centers globally, and 9 underlying incumbent in-country providers that did all the voice services for them. They got rid of 9 relationships and integrated with our platform. Doing that with them was really -- it was awesome for both of us for what we delivered, but what we also learned. Similarly, in the United States, the nation's largest credit card issuer had an incumbent powering their massive contact centers and needed a flexible platform and innovated with us to do extraordinary new call flows for them. So yes, for a company like Microsoft or Google, historically, we've innovated well and gone into far flung jurisdictions through the Voxbone acquisition or Turkey most recently. But now it's large enterprise who are migrating to the cloud, who are coming to us and saying, we want to do customer engagement different. We actually have gone -- we're going to choose our own UCaaS solution, but we want to bring our own partnership with you to power it. And those enterprise conversations are exciting.

Got it. Messaging has been another area of huge growth for you guys over the past couple of years. Maybe you could just like lay out where your inherent advantage is here because at least on one side of that, you don't have a network advantage?

Enterprise messaging is very different than enterprise voice. We grew up in messaging powering commercial use cases, whether it's a point-of-sale confirmation for a customer like Block or in a health care, it's an authentication or identification use case. The enterprise level of support and the regulatory expertise that we have has lent itself really significantly to campaign messaging, civic engagement, political discourse Where it's highly regulated, we're great at support, we're great at holding hands to be regulatorily compliant. But to your good point, the infrastructure in messaging is very even playing field for everybody involved. You can't differentiate the way that you can with voice owning and operating a platform, but you can do an awful lot of enterprise-grade support and importantly, high-volume capacity. The open rates that we're able to deliver to our customers are industry-leading, and that's allowed us to grow messaging very significantly.

Got it. On -- I guess we still kind of struggle on this kind of direct enterprise solutions. Can you just give us a definition of what some of these services would be versus kind of that global communications plan?

Yes. So a global communications customer like a Microsoft, like a Google, like a RingCentral, Dialpad, Zoom, they'll consume services on the same platform that we extend to an enterprise customer direct. So a large bank, for example. But it's how they consume the platform that is very, very different. You may have Zoom multisource and use our platform, but then also use others. Global enterprise and the Global 2000, they want 1 partner. And they want 1 partner for EMEA, they want 1 partner for the world, and they aren't interested in multiple integrations. That's fantastic for us. So while we might have a global communications plans, customer multi-sourcing, asking for a different kind of support level, global enterprise are margin accretive to us, consume us exclusively as a partner, get rid of incumbent relationships that are myriad around the world to consolidate with us and allow us to help them with new engagement use cases. And it's same underlying infrastructure and technology, they consume it differently.

Okay. Got it. I mean just on that international footprint and kind of that one- they want one person to kind of work with across that. Obviously, Voxbone kind of expanded that international coverage that you had. You just mentioned Turkey as an addition. Are there any like regions that still need to be worked on to kind of give back?

Give that, yes. We've got customers that want us to take us -- take them to North Korea, probably aren't going to do that. Cuba, trying to figure that out. There are always markets opening where we have demand that wants to go there. And instead of build it and they will come, we've really focused on remaining profitable by following demand into jurisdictions where we know it exists, where we can displace an incumbent. And so we do have good footprint prioritization for new jurisdictions that we're investing in.

Okay. Definitely North Korea is not going to [Indiscernible]

North Korea [Indiscernible]. No.

All right. So you've targeted -- since the time of the IPO, you've kind of talked about this Global 2000 customer base. And so what is it that changes that opportunity set over the next couple of years to kind of being similar customers that you've targeted but broader set of offerings to them?

These enterprises don't think about moving to the cloud for their engagement strategies as being optional. It's mandatory. They must compete and whether that's changing the way their contact center works, changing their UCaaS solution for their own employees, doing messaging, bidirectional messaging for different use cases, global enterprise have only begun to move all of their communications to the cloud. Our direct enterprise business is going to grow to 20% of our overall business here in the next several years and is growing at 2 to 3x the industry average. Our TAM is a TAM that is allowing us to double the opportunity over the next several years. Fortunately for us, we have grown up cutting our teeth for our GCP customers, whether it's enterprise levels of support or the underlying capacity and reliability and [Indiscernible] support that we offer them. So the enterprise gets to benefit from the high-volume Internet giants that we've served historically. But the decision criteria for these senior executives at these Global 2000 companies are embracing the cost savings in this current climate associated with getting rid of AT&T, Verizon, Lumen, Telefonica, British Telecom, I could go on and on. The incumbent solutions are not only inflexible, they're also expensive.

Got it. Maybe just jumping into kind of where we are today. You forecasted for 1% growth at the midpoint for 2023 or 8% ex political. This is below kind of your midterm growth target. So just what are the macro impacts that you're seeing right now? Is it new sales? Is it certain verticals? Just where is that kind of the headwinds, the greatest?

We've factored in the macro headwinds as we think about 2023, as you said, net of political messaging revenue, we would be growing at 8% this year. And the hedge or the macro headwind that we've quantified is about a 5% revenue headwind that we think is responsible when we listen to all of our UCaaS and CCaaS customers and how they're telling the world what their business is going to do and what they share with us. So we think that, that's an appropriate and modest hedge, if you will, in '23.

So it's largely from kind of those UCaaS, CCaaS customers, not necessarily enterprises pulling back on usage or new customer pipeline and kind of that...

It's impossible to ignore when the Gartner Magic Quadrant leaders, all of them in UCaaS and CCaaS are dialing that growth the way they are projecting.

I haven't noticed that at all. All right. Given growth over the past couple of years, kind of ex political and acquisitions, like I guess the bigger question is you laid out this kind of 15% to 20% CAGR. But yes, that's not necessarily a CAGR that you guys have accomplished over the past couple of years. So just -- what gave you confidence in those targets, particularly given you're at a much larger scale, so that means adding much more kind of net incremental dollars?

So we held our first Investor Day in our 5 years as being a public company, largely because for the first time, our business has become predictably cyclical. And if we only talk about the next 12 months, the world is going to miss the significant business that is political messaging. That business is growing very rapidly, and in '22, represented $37 million of revenue, including surcharges, and it's gone in '23. It comes back with a vengeance heading into '24. It will be historic, the levels of spend compared to the past. E-mail as an outlet for free speech-driven political campaigns is being replaced by messaging. Civic engagement is at an all-time high. And '24 is going to be a banner year and will represent for us in political about half of our projected mid-teens growth for that season. The other half comes from the commercial examples that we're talking about. But we did Investor Day largely because we have a predictably cyclical business that is going to go through a trough in '23 and then come back to a crest in '24. And then fortunately, the entire tide of our commercial global business rises so that it isn't as dramatic set of crests and troughs. But for the first time in our history, we have a periodic surge in business every other year.

Okay. Got it. Your non-GAAP gross margins have been a standout over the past couple of years, particularly versus the CPaaS space. Is the accretion that you saw and kind of expect to see a result of mix? Or what kind of scale benefits have you gotten from voice in the market?

Thank you for calling that out. And to put numbers on it, over the last 3 years, we've grown gross margin 7 points. And over the next 3 years, we're going to grow it another 5 points. So we're averaging about 2 points of gross margin improvement every year and have projected terminal gross margins at or about 60% or greater at about $750 million of revenue. There is a good product mix contribution, but we have a different model in our CPaaS business, which is an owned and operated global network under a software platform. So we have economies of scale where we are spreading more and more revenue over a fixed cost base, and that yields significant gross margin improvement in and of itself. There are also network effects from RingCentral customers calling Microsoft Teams customers and those calls remaining on net with no third-party termination costs. Those are important -- domestic messaging is actually accretive to gross margin for us. The enterprise direct business is gross margin accretive for us, but the operating efficiency of our business model overall is what has yielded this 12 percentage points of gross margin improvement, which we're really proud of. I asked an analyst at one point, Meta, "Hey, does anybody else have -- does anyone else growing gross margin during this period?" and they couldn't come up with the name, so I was feeling pretty good about our team.

All right. You laid out kind of a meaningful pickup in EBITDA margins as well. This is impressive not only because you have lower SBC than customers, but you're just starting to put you into an attractive kind of GAAP profitability, free cash flow position. Just where is that additional lever? You've mentioned a lot of areas that you want to invest in, a lot of businesses that you want to grow. Just where are you kind of looking to get that OpEx leverage?

We are improving EBITDA 30% by $10 million to $45 million in 2023. About half of that $10 million comes from the increased revenue and the amount of the gross margin that falls through to the bottom. The other half is about 3% operating efficiency on our total OpEx line, which is very reasonable. And keep in mind, this is $45 million of profitability that's 30% more without doing layoffs. So I think we're the only company achieving this level of profitability, not by doing it through layoffs. And that's something that's attribute to not having higher like a profligate over the last 2 years and being responsible and kind of focused on profitability before it was cool, but it's not unnatural acts, it's efficient operating and it's gross profit contribution to the bottom line.

Got it. You've hired more software talent over the past couple of years. Just where are you finding those resources being invested most? And if you could spend more, where would you spend more?

The customer experience for the direct enterprise customer and moving their numbers elegantly away from an incumbent in a domestic or international context and allowing the administration of voice and messaging services to be a wonderful experience instead of like going to the dentist. We're investing in places that yield delighting our customers in addition to new jurisdictions. We have tremendous new software development leadership in Devesh Agarwal, who Anthony Bartolo, our Chief Operating Officer, brought on Board. And so we're investing behind that talent and that leadership and focused on doing it globally in both voice and messaging. Those are some examples.

Got it. Maybe circling back real quick to the kind of growth CAGR point and understanding kind of the political -- the even years, lumpiness kind of -- that there's going to be to the business. Just as you think about like time of some of these initiatives, I guess, the question is really that kind of 2025 year and what gives you confidence about kind of some of the initiatives that you're taking today, so we can all think about kind of this huge spike we're going to see in 2024. But what gives you that confidence on 2025?

So our global plans business, about $360 million, growing at the industry rate of about 8%. Our programmable services growing at 21%, about a $90 million messaging business. Our direct enterprise $24 million, so starting at a smaller number, but it's growing at 2 to 3x the industry rate. So it's got velocity where we project forward the combination of the political cyclicality and the enterprise growth across those 3 market offers, and you land at a really good place in terms of both getting to the growth objectives we have, but doing it in a way that is both profitable and free cash flow yielding to be responsible for our debt, which I'm excited about.

And just on sales cycles of that, what is the sales cycle for a typical enterprise customer? And is it something where all that traffic kind of comes on immediately or it kind of takes 6 to 12 months to kind of ramp those customers?

So 6 to 9 months is a good bearing point for a deal cycle. And getting to the terminal growth rate or share of wallet opportunity takes about another 18 months after they onboard.

Okay. Got it. Voxbone, obviously, has been a very successful transaction in order to kind of bring you that international footprint. Are there synergies largely complete there? Or are there still opportunities for kind of further revenue cost synergies there?

We finished the integration with Voxbone in the third quarter of 2021 and the organization of the 2 teams is unified under leadership now. There are wonderful upside opportunities for growth. But in terms of synergies, in terms of like cost synergies, that's been done.

Largely done and behind you. Okay. How do you view -- international is, obviously, something that you looked at kind of build versus buy over time. As you look at other capabilities to kind of expand your platform, what is that kind of build buy or given maybe a more attractive M&A market than there has been in the past?

The most attractive target for us in M&A has been our own debt. The dislocation in the market and the discount has represented an extraordinary opportunity, and we've basically found $58 million free on the ground. However, if there was an opportunity for us to pick up an asset that was doing free cash flow at a really attractive price, that would contribute to our capital strategy of retiring the debt, which is within our control to do. But yes, we've got 2 acquisitions that we've now been successful with integrating to great advantage. But right now, we're really focused on our own knitting, but the attributes that would be attractive, Meta, are contributing to free cash flow.

Got it. I have more questions, but are there any questions from the audience? All right. Perfect. Maybe you can just kind of refresh us on some of the actions that you've taken to kind of get the balance sheet in a healthier place and just that kind of process to kind of that being less of an overhang in the next couple of years?

You bet. We had 26 notes that totaled $400 million that we have engaged in 2 repurchase transactions to bring down to $175 million. And we did so at a 30% discount for the first one in November. And then this week, wired $50 million to retire, another $65 million. So again, $58 million free cash as a result. And we will be able to pay off the remaining $175 million on the 26 note with current cash on hand and the free cash flow we generate. And then over the next few years, what we also have left on hand and generate, we'll take care of the 28 note, if we so choose. But it's been an extraordinary opportunity.

Yes. Perfect. AI is kind of the topic du jour. Is there any way that you can incorporate AI into your service offerings or just that you're utilizing even within the business to kind of gain efficiency?

So everyone knows about ChatGPT and the way to engage with ChatGPT is via text. What we are experiencing in the contact center makes us believe that the primary interface for engaging with generative AI for new content or other conversational AI, those conversations are going to largely end up being vocal, verbal. And being a company that specializes in both the transport and signaling, the media and the signaling around voice, the fidelity of audio has a direct bearing on the efficacy of AI. But we also have an enormous amount of metadata or signaling data around conversations that we can inject into an algorithm for purposes of improving the dialogue, the case resolution in the contact center. We have all kinds of information that heretofore hasn't seemed valuable because nobody could use it or grok it and add value to conversations. But where we sit today, we realize that if you're texting into an AI interface, you have the substance, but we use emojis to try to capture tone and tenor and volume and pace and accent and dialect and emphasis. I can do it right here on stage and drive you guys crazy. But we can layer -- you can layer from an audio stream into an AI interface sentiment and all kinds of logical inferences about the speaker to add intelligence to a response in a way that's compelling, but most important is a data set that hasn't yet been adopted by most AI approaches. So look out, I think voice ends up being both the interface, where fidelity of audio and the metadata around signaling both have an incredible bearing on improving what should be an intelligent conversation.

Okay. Got it. I mean maybe just last question for me. Obviously, you founded Bandwidth. Maybe what are you most excited about Bandwidth today versus where you were maybe 5, 10 years ago?

It's the same thing, but different. What gets me most excited about is our team and those that are now on our team, confronting historic challenges and overcoming them and yielding value in a way they never dreamed possible. I still -- that's what gets me up in the morning, serving customers and delighting them. Technologically, there have always been seasons of amazing change, and we're in another one right now. But it's the human component of teams, loving each other, loving the customer, teeing up wind mills successfully at times. We're moving into our headquarters in August. We're super excited about that. We're in-person culture. If -- we're 5 days a week in-person mandatory, and we love it that way and have a campus to support the dynamism of a team that loves being together.

Great. Perfect. Well, with that, David, we appreciate having you here and hearing more about the Bandwidth story.

Thank you, Meta.

Thanks.