Bandwidth Inc. (BAND) Earnings Call Transcript & Summary

[Audio Gap] to the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Welcome, everybody. I'm Meta Marshall. I head up communications software here at Morgan Stanley. We're delighted to have Bandwidth here with us today: David Morken, CEO; Daryl Raiford, CFO. We're to the point where I start butchering last names. So it was good, I'm good.

So David, obviously, delighted to have you back here. The Bandwidth portfolio has evolved pretty meaningfully over the last couple of years. And so just how has the portfolio and the mix of the business changed maybe since we had you here for the IPO many years ago?

Many years ago. And thank you, Meta, for having us back and to Morgan Stanley for putting on this awesome conference. 5 years ago, our revenue mix, our product portfolio was primarily voice, followed by messaging in an emergency service. And back then, messaging was about 10% of our total. Fast forward to today, and it's almost 20%. So that's the first portfolio change that is really important to understand about us. The second is Maestro. Maestro is an orchestration layer that our enterprise customers can plug our global owned and operated network into it and then select their favorite UCaaS, CCaaS or emerging AI or machine learning solution into it and very easily and elegantly add to their call flows virtual assistance, identification, authorization, all kinds of emerging use cases for the contact center and other UCaaS applications. That Maestro platform was added in the last year and is vital to understanding our success in the enterprise. So those are the 2 biggest changes that I see to our product portfolio: messaging and Maestro.

Okay. Got it. The comm software space has faced a few challenges, particularly on the UCaaS side, and so -- who used to be kind of a good portion of your customer base. The enterprise piece of the business has become a more critical driver of growth going forward. Just what are the needs of these customers that you're kind of uniquely able to address? And what tends to be the entry point with those customers?

They are vital for us. And their entry point focuses on simplifying their communication stack. And the reason they're trying to simplify it and unify voice and messaging and emergency service into a single platform is because they need to adapt to the emerging AI conversational solutions that seem to come out every week. So first thing first, in the cloud, they have to unify on a single platform voice, messaging and emergency services. We do that for them with the Maestro platform. We also do that for them globally. So simplify, move to the cloud, do it globally and then plug in emerging solutions. And we're agnostic. We're not trying to lock them into a walled garden. We believe that the best of breed in the use cases have yet to really be established. And so instead of lock in, Maestro lets them be agnostic and try before they buy in some cases where we have pre-integration. So whether it's AIBridge or Maestro, we have had real success with these large enterprises globally who need to unify, simplify and integrate new solutions rapidly. And that's what Maestro and our global owned and operated network give them.

Okay. And so you think increasingly, kind of Maestro will be that first entree into a customer versus kind of traditionally what you've done in the past with kind of the unified communications?

Yes. The network and the platform are essential. The Maestro orchestration layer is what is driving our enterprise growth to be 21% in this last year and doubling our share of our revenue with enterprises from 5%, doubling it to 10% by '26. Maestro is the inflection that allows enterprises to adopt our global network and also future-proof it to adjust to AI opportunities that are emerging, again, almost every week.

Okay. Perfect. So when -- is it the -- basically, back to Maestro and what would kind of draw a customer to Maestro first. Is it conversational AI and just all of the different solutions that are being bombarded with right now and just trying to figure out how to organize that? Like what is that catalyst that draws the customer towards Maestro?

So conversational AI is a dialogue between an intelligent agent and a customer or a constituent. And we support the media and the signaling between those 2 vital parties in a conversational AI dialogue. Maestro, as an orchestration layer, allows our customers to adjust and add to their call flow or to their message flow new attributes. You can send a call for sentiment. You can send a call for identification. You can inject a virtual agent into the conversation and resolve an issue 90% faster, 10x faster. So for us, every single AI endpoint represents a new user of our voice network or of our messaging solution. So you've got an exponential increase in the number of endpoints that we're going to facilitate over the next decade. And the amount of intelligence in those conversations means for our enterprise customers lower costs and increase joy, where in the contact center it hasn't existed before because they know you, they know things about you, and they're able in the middle of that conversation to add value.

Okay. And so maybe sticking with Maestro, just I know that you've been kind of building in additional integrations into that. Just where are we in terms of kind of what are the next priority in terms of integration pipeline?

The one that immediately comes to mind is in the contact center and the need to have beyond what we've already done with Cognigy and Google and Pindrop, they need to add additional integrations for contact center efficiency. That's the focal point that I think is top of mind right now as we focus on Maestro expanding. But if you fast forward 12 months, 24 months from now, you should expect to see dozens and dozens and dozens of new integrations to best-of-breed UCaaS, best-of-breed CCaaS and conferencing and then a whole slew of emerging AI and machine learning solutions. But first, I think in the enterprise, the focus of effort is in the contact center at the enterprise.

And are you seeing amplification with Cognigy or with Google now kind of pointing customers to Maestro that helps kind of amplify the effect of your sales force?

There's no doubt that early integrations draw a lot of attention from others that want to be part of our ecosystem and want to be part of the Maestro -- part of the orchestra that Maestro conducts, if you will.

Back of the band.

I can't help but -- guilty as charged, yes.

You just gave me my next title.

Yes.

But just in terms of -- okay, so that brings other people who want to be a part of the platform. But are they then pointing -- a Google customer is now saying, hey, if you want to use us, a really easy way is to use Maestro and so bring that in?

So much so that we launched a channel program for the first time for enterprise this last year to take advantage of those relationships and compensate parties for bringing us to the table in an enterprise sale. So not only are they doing so, we've established a channel to support that and invested in.

Okay. Perfect. And any conflict that that's caused between kind of your own direct sales force versus the channel or just early days and it's largely additive for now?

No, it's apparent that we have room within our long-term gross margin targets to compensate appropriately sales staff that are essential in the relationship and a channel partner that brings them to the table. And so that's something that we've thought very -- pretty much about as we're very disciplined bottom line operators, and there's plenty of room.

Okay. Perfect. I mentioned upfront, maybe the comm software space and just kind of the UC space, there's been some wait or just kind of slowdown of growth over the past couple of years. But where are you still kind of seeing the biggest opportunity with those kind of comm software cloud customers that were such a big driver of growth early on in Bandwidth?

Yes. The cohort I think you're talking to is the Internet giants. Those in UCaaS and CCaaS and conferencing who emerged, we are now focused on the Global 2000 and growing with them around the world with our 65 countries that support full voice capabilities that are regulatorily compliant and last year started international messaging to be a bundled product for those large enterprise. But as we started growing significantly with Internet giants, we have focused on enterprise. And as I said, we're doubling between now and '26 the percentage of our revenue attributable to enterprise. And I think Maestro is a critical part of that. And that's where our focus of effort is, Global 2000s, many of whom are actually at this conference.

I think we've bumped into both of them. And so in terms of -- I know in the past -- maybe this is a different question. But in the past, you haven't wanted to compete -- have competing products with a lot of those customers of your kind of cloud giants or comm software customers just because they were such good customers and you didn't want to compete with them. Just as you think about expanding the portfolio and addressing more of the enterprise market, does any of that philosophy change? Or just kind of how are you thinking about evolving that portfolio?

That's a terrific question. Communications is suddenly at the very center of the AI season because in conversational AI, you have to support that dialogue. So the feature set and the benefits that we have to make real for enterprise customers in the communications layer is more than enough red meat for all the young lions that we have at the company. And so we know our goal. We think it's vital. And the Maestro orchestration layer on top of a global owned and operated network is a massively important piece of infrastructure to support what our customers are doing up-stack. So nothing changes about our philosophy. It's been very effective.

Okay. So kind of remaining the agnostic layer, but just expanding the reach of the agnostic layer?

The agnostic layer is becoming an ecosystem of pre-integrations that allow a CIO at a global enterprise to rely on for speed, for efficiency, for capability so that ecosystem is more than a large enough mission for us.

Okay. I mean just -- I've asked you this a number of times. But you've been very successful in the past of -- you kind of get a beachhead customer in one type of vertical or use case and then really exploiting that to all of the customers kind of within that vertical or use case. As you go towards kind of this Global 2000, are you slicing it into certain verticals or use cases? Or just kind of how are you best approaching that opportunity?

Global enterprise for us is not a leap of faith. It's more of a hop, skip and a jump. It was, as you said, cohorts by cohorts that we grew it. And now we're more than capable of serving the Global 2000s broadly. Whether it's health care, fintech, retail, manufacturing, we've seen dozens of companies adopt Maestro across the Global 2000 verticals. And so I think in this season, it's unlikely that we will concentrate in a particular Global 2000 vertical because the voice and messaging needs are so universal. That's what we're seeing in the early days of Maestro, and I expect that to continue.

Okay. Perfect. Maybe stepping into the '24 outlook and just kind of the political season, you had laid out that political messaging would contribute upwards of $40 million this year. Just kind of what drives the remainder of the balance of the growth that you pointed to from the '24 outlook? And just kind of how would you characterize visibility you have in a lot of these different factors?

I'll take that, if it's okay.

Yes.

Thank you, Meta, and thank you also for hosting us and -- hosting us at the conference. We really appreciate it. Like David said, it is an awesome event. We reported $601 million of revenue this last year, in '23. And we just last week guided '24 to $700 million at the midpoint. And so that's roughly where that is, right, at $100 million of revenue growth or 16% year-over-year for '24. That's broken down -- you can think about that being broken down into half and half. Half of that growth is from surcharges with the carriers, and the other half is in our Cloud Communications revenue. The 2/3 of the Cloud Communications revenue is coming from our commercial revenue and 1/3 from the political or the amount that you were describing. So of that 2/3 growth, which is commercial nonpolitical, it breaks down into being -- we are expecting all 3 of our market categories to grow, global communications plans, programmable services and direct enterprise. But it breaks down mostly into growth, again, continuing on from our -- in enterprise, continuing on from our 21% last year and in programmable services continuing on from our 31% growth year-over-year from the last year.

Okay. I mean just in terms of -- I know this question kind of comes up a lot on earnings calls, but just this idea that how much -- yes, we see an elevated political season as we go into '24, but it seems as if we're in this kind of constantly elevated political environment. And so how much of a surcharge -- of a ramp do you really see when we're kind of in this -- like we all get texts a million times a day from that environment. So just how do you kind of measure how to differentiate what comes in an election season versus kind of what's more normal state?

When we -- what comes into election season is generally what we know to be the traffic related to political campaigns. In the midterm elections of 2022, we reported around $37 million of political campaign-related messaging. Again, we're guiding to about $40 million this coming year. We do understand that cyclicality. We've been working really hard over the 18 months since we laid out our strategy to grow our commercial business and reduce the cyclicality -- the cyclical nature of that political. And I think that '24 is really beginning to characterize that in the sense that we've guided to $700 million of revenue at the midpoint, but the political cyclicality revenue is only $40 million, $40 million in $700 million. So the effect is beginning -- as our commercial business grows to the extent that it has been, it is really beginning to -- we love our cyclical campaign revenue. It produces a very nice gross margin. But the effect, the swing effect is beginning to diminish. We just did, as I said, last year, grew our commercial messaging 32% over the year, '23 over '22. That was accelerating in Q3 and Q4. In the third quarter, we grew at 51% over the prior third quarter and 66% over the prior fourth quarter. So the acceleration is not necessarily -- it's accelerating, and we like that. That gives us -- as we project that forward into the growth for '24, it pretty much emissions the $40 million in terms of the cyclical nature being noticed. And that sets us up very nicely as we move forward towards our medium-term targets in '26.

Okay. And just for people who might be less familiar with the name, that $50 million that's coming in surcharges, that's certainly a faster growth rate on the surcharges than it is kind of on the core business. And so can you just kind of give us a sense of why surcharges would be growing faster than messaging?

And for those not familiar with the name, the industry when it comes to messaging and working with the carriers is characterized by this phenomenon that the carriers introduced a few years ago called surcharges, where we are charged the surcharge from the carriers. And then under a contract, we provide that or pass that through 0 profit to our end user who then remits it to us and we remit it back to the carrier. So it's kind of a 0-profit thing. We are not in control. It's a bit of a tax without it being actually a government jurisdiction doing it. And so we are not in charge of pricing. We don't control that pricing. The carriers have raised surcharges from time to time. I believe in October, AT&T did raise prices on surcharges. That was always in our projection. We got a good amount of lead time to understand that. So we incorporate that into our total revenue guidance. But we don't really control that pricing. It has grown. And in our -- it's predicated that within our $700 million midpoint guidance that $50 million of growth that it will grow. And it grows on the fact that our messaging volume is increasing so much, growing our commercial revenue as well as the carriers can raise prices.

Okay. And then sticking with outlook, just what kind of macro assumptions are embedded in your outlook? And how does that compare to '23, particularly as you kind of start to target more enterprise customers?

We expect to be able to thrive throughout different economic seasons, and we certainly have proved that in the past. I'll go all the way back -- it will be 25 years since we started the company in August of this year. And we've survived through '01, '04, '08.

You were 10 then.

I was 29. I'm now a grandfather of 6, true story. But yes, I think we've really got an essential service that has seemed recession-proof in the past. And we expect this year in terms of the macro assumptions underlying our guide -- but it's okay, absent global anarchy, I think we're going to thrive. And I think 25 quarters of exceeding guidance in a row, since Morgan Stanley was our primary partner going public, is a pretty good track record.

Okay. So any particular verticals or customer size where you're thinking about seeing those impacts? Or are we kind of in a more stabilized environment now as you're kind of thinking about '24?

We are looking -- '23 was certainly characterized by crosswinds. We have seen some stabilization that was embedded into our '24 guide. Again, we are looking for 8 of those 3 market categories to grow. Our global communications plans at the modest single digits is a large base for us and then programmable services driven by massive commercial messaging and political in the year of 2024 to grow really well. And then enterprise, our funnel is -- we feel really good about our funnel. We have some demonstrable trajectory entering the year. And we see -- with the Maestro adoption, we see some good things ahead.

Okay. And so you kind of teed up my next question about this kind of stabilizing environment and new products. Just what drives the improvement to the NRR sustainably to kind of expand from where we've been over the past couple of quarters?

We -- our commercial business -- our business, excluding the political effect from the missing cohort that was in '22 but not in '23, reported 109% net retention. That's in a year -- in 2023, with again, the crosswinds that I think everyone was experiencing, that's a pretty good figure. That's a really good figure. We are -- we think that moving forward into '24 that, that figure is going to reflect the commensurate level of activity that we have in our 16% revenue guide going forward.

Okay. I mean maybe on the international piece that you were just talking about, you guys did the acquisition of Voxbone a couple of years ago. Just where are you in kind of the integration of that? And how much of that is kind of some of the reasons that you can see this NRR expansion or bringing that global platform to customers?

That global platform has been unified as a single technology stack and infrastructure and user experience for customers that's vital, driving 18% of our revenue from international and contributing 25% of our EBITDA. That acquisition has proved incredibly accretive to both gross margin, and importantly, every conversation with enterprise prospects. We have an incredibly unique footprint across 90 countries, 65 of which are full stack. So those global enterprises that are moving everything in their messaging and voice to the cloud are doing so to go global and we're able to support them. So whether it's on the infrastructure being unified, contribution to gross margin or user experience for Global 2000, it was a phenomenal addition to our team.

And all of that -- I think you were recently saying kind of all of that has finally been -- kind of the bells and whistles below the surface have finally been into them.

Huge hat tip to our Chief Operating Officer, Anthony Bartolo, and the whole team that's been focused on that. Yes, we're there. And that's why our CapEx will continue to be a very low percentage of revenue. We're efficient in that regard, but a really heavy lift, and we're done.

Awesome. Okay. As you just mentioned, you guys have always been relatively efficient kind of from an OpEx perspective. R&D and SG&A have stayed relatively steady, yet there's a lot of things that you want to do, areas, integrations that you need to build out. Just where would you invest in? And how much of that has always been going on and so we may not have seen it, but the dollars were being spent on that purpose?

Yes. The feet below the surface of the water are kicking pretty hard. And they'll continue to innovate at the Maestro orchestration layer with footprint globally at a consistent percentage or ratio that you've seen in the past with creative new opportunities. So I think it's probably important to note, we have not done any layoffs at all. So our team is intact, whether it's the R&D team, sales team, support team. And so we'll continue the mission for all those teams the way we've planned, including our R&D.

Okay. But any areas where as a CEO, if you had incremental dollars that you would be spending on right now?

If we had incremental dollars, we would probably put them toward growing the go-to-market team larger. I think our maturity in the product area and the unified experience global area would let us go to market more aggressively. But again, we reconcile a real tension between top line and bottom line profitability. And we just came through a year where we did extraordinary growth of, I think, 39% on our EBITDA number in '23. And we're going to do a 50% growth on EBITDA again in '24. So we could grow a lot faster, more expensively perhaps, but we choose not to. So if I had free money, yes, we might increase go-to-market.

But Meta, putting a fine -- let me just put a fine point on it. We will, in '24, implied in our guide of $78 million of EBITDA, which is a 50% growth over '23. We will grow R&D and sales and marketing in whole dollars. It is going to grow. It's our long term -- and it's because we're innovating. And as our pipe grows, our sales and marketing activities grow too, and that's a healthy dynamic. We are committed through our '26 medium-term targets to have a model -- to have an operating scale model that puts us at around 40%, maybe slightly less, but 40% of operating expenses as a percent of Cloud Communications revenue. In '23, we were not there. We were above the 40% range. So while those expenses aren't going to grow and we're going to continue to innovate, we are going to get within our model that allows us to drive from the 14% EBITDA margin in '24 that we've guided to, to above 20%. And part of that is operating expense leverage across the revenue growth.

Okay. And so balance sheet has been another area of -- just as we've gone through the past couple of years, it was a little area of concern with investors. You've taken a number of actions kind of on the capital structure to kind of reduce risk. Do you want to just -- can you just walk through for investors some of those steps?

We have. Well, in terms -- we spent some time on our earnings call last week and in dialogue really going over -- and I think putting a nail in the coffin when it comes to the health of our very solid balance sheet. We ended last year with $153 million of cash and securities. And our first debt maturity is in March of 2026 at a face value of $175, trading at roughly $150 today. So well in the future -- 2 years in the future, we essentially have the cash and securities balance at the trading value to retire it, notwithstanding our $50 million undrawn revolver and things along those lines and other access to liquidity. We have guided in our $72 million of EBITDA in '24, we have projected and helped those walk down to free cash flow that $72 million as a proxy for free cash flow in terms of EBITDA, less 3% CapEx, roughly something over $50 million of free cash flow. You complement the $153 million with $50-plus million of free cash flow, by the end of '25, we will have more than sufficient amount to retire our March 2026 notes 14 months in the future. So in terms of our capital structure, we have a great deal of flexibility. I'm not -- we're not even projecting for in '25 free cash flow and the like. We think that we'll do the right things but that we are not hamstrung in any way, shape or form in terms of our balance sheet. It's very healthy, and we are in control of what we want to control.

Okay. Perfect. Mentioned Voxbone. You guys have done some kind of selective M&A over time. Are there any areas where you would think that would make sense inorganically?

Selective M&A over time is very kind for a company that's done 2 deals in 25 years. So thank you for that.

Well, of late, of late.

Probably -- of late, okay. We're a very healthy organic growing team. It would take something extraordinary to take us off that mission.

Okay, okay. So Daryl, you just kind of guided to talking about the EBITDA margin target being 13% to 14% this year, kind of excess surcharges. Just what gives you confidence about -- like just what should be the cadence we should be thinking of, of getting towards that kind of greater than 20% target that you have out there?

The first thing I'd look at is the demonstrable trajectory of the path that we've been on. We've -- in '23, we grew to 14% EBITDA margins, a 39% profitability growth in '23 over '22. So that was a step for -- and EBITDA margins of 10% in '22 to 14% in '23 to -- or excuse me, 10% in 23% to 14% guide in '24. I see us as on a similar trajectory into '25, and that's how we'll be -- we feel confident about our medium-term margins of greater than 20%.

Okay. So steady Eddie along the way?

Yes. And a quick view of the data shows it's happening.

Okay. Perfect. And then similarly on gross margins, what kind of brings you to that CPaaS 60% target?

We are -- well, we reported 55% non-GAAP gross margins in '24. We feel confident that we're on our way to greater than 60% by 4 attributes that we spent the last 18 months rearticulating around scale. We own our cloud, as David said. We own our network. We do not rent our network. The more transactions and volume that we drive across the fixed cost platform, the more variable contribution margin you make. And so we think through scale, through revenue growth, through improving our product mix, clearly, messaging and enterprise is outgrowing our global communications plans category, which we've called for modest growth in '24. Those categories of programmable services led by messaging and enterprise exceed -- those categories exceed our -- their margins exceed our company-wide gross margins. So as we mix towards that, we intend on growing our international business. As David had remarked, just a little disproportional with the American business. Our international business benefits from higher margins just because of the pricing dynamics overseas. And then we're really good at operating efficiencies. We take -- we can invest in our cloud. We take actions to reduce the cloud cost, where if we had rented the cloud, we wouldn't be able to control what the landlord is doing on that.

Got it. And then, I mean, just in terms of -- it always comes up kind of talking about the CPaaS base of -- there's a lot of different mixes to the gross margins, but everybody kind of wants to get a sense of what like-for-like messaging margins or within voice margins, just any pressure? Or have those largely kind of stayed the same, particularly as you've gained scale?

We've only grown our gross margin even as we've changed our product mix. So we haven't sacrificed gross margin to gain revenue. We've been disciplined about it. And I think we'll continue to exercise that discipline as we grow. And as Daryl said, Maestro is beneficial to growing gross margin with scale, so is our own and operated voice network. So we've got a great track record. And I'll confess when we started the company, our gross margins were 2%. We've come a long way. I think when we went public, they were 47%. So I think we've continued now. And I see 60% plus as well within reach.

Okay. Any questions from the audience? All right. Perfect. So you saw a big move off of the quarter last week. Just how have conversations with investors changed from last year, from the last week? And just what do you think are still kind of the most misunderstood pieces of the Bandwidth story?

The conversations are definitely encouraging coming off of the quarter. There's no denying that. There are still common misperceptions around the diminishing cyclicality of our business as commercial grows. There are continued misperceptions about surcharges and what they mean, and we'll continue to address that. But there are very real substantive challenges to understanding the complexity in our model. And we'll continue to endeavor to convince and explain and teach what the upside looks like for us in the midterm plan as we've reiterated for now until '26. But there are, again, rewards for engaging and understanding our model and our success profile going forward, and we're working hard with investors to make sure they understand that.

It's been a really interesting dialogue. It's been an interesting journey, Meta, that you have been on with us for the last 18 months. In the middle of '22, the team -- we set out a very determined strategic plan and objective about what we wanted to do and to execute. In this -- in February of last year, we held our Investor Day, where we articulated that. And I think -- and we have been executing and achieving that all along the way. And I think what we just saw -- what we just reported last week is simply progress on those strategic objectives and that resolve to operate the company the way that we said. We're -- I think with investors, it's beginning -- the point is beginning to be taken that Bandwidth is a say-do company. What we say we do. But we're also a say-do-more company. And I think the more part is beginning to really sink in.

Probably one other point, which is, I think, coming out of the announcement about '23 results and guiding '24, there was a viability question that existed about how much free cash flow we could generate to take responsibility for our debt appropriately. That question has been answered. So you can compare and contrast conversations with investors about debt a year ago. We don't have those questions anymore. And that's wonderful.

All right. Perfect. Well, David, Daryl, this has been a great discussion. Thanks so much for being here.

Thank you, Meta.

Thank you, Meta.