Bandwidth Inc. — Q3 2017 Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2017. Amounts below are in U.S. dollars; financial statement amounts are rounded to millions unless otherwise noted. Bandwidth provides cloud-based communications APIs and network services through its CPaaS and Other segments. Republic Wireless was spun off in November 2016 and is presented as discontinued operations for the comparative 2016 periods.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $41.3m | $38.6m | $120.5m | $113.4m |
| Gross profit / margin | $18.8m / 45% | $17.1m / 44% | $54.1m / 45% | $49.2m / 43% |
| Operating income | $3.1m | $4.4m | $12.4m | $12.6m |
| Net income | $1.6m | $3.3m | $6.6m | $7.9m |
| Adjusted EBITDA | $5.2m | $6.2m | $17.8m | $18.5m |
| Operating cash flow from continuing operations | $4.8m | $2.2m | $9.8m | $12.7m |
| Free cash flow | $2.7m | $1.3m | $4.9m | $8.5m |
Q3 CPaaS revenue rose 10% to $33.4m; Other revenue fell 5% to $7.9m. For the nine months, CPaaS revenue increased 11% to $96.6m while Other revenue declined 10% to $23.9m. CPaaS gross margin improved to 42% for Q3 and 42% for the nine-month period, versus 40% and 38%, respectively, in 2016. Active CPaaS customer accounts grew 18% year over year to 918. Dollar-based net retention was 105% in Q3 and 106% for the nine months.
At September 30, cash and cash equivalents were $5.4m, current assets $30.2m, current liabilities $25.9m, and total liabilities $65.2m. Term debt was $38.5m; the revolving facility had no balance and $25.0m of available borrowing capacity. The company reported compliance with debt covenants. After quarter-end, it raised approximately $69.1m of net IPO proceeds after underwriting discounts and offering expenses and repaid the $38.5m term loan on November 14, 2017; the revolving facility remained in effect.
Material changes and management commentary
- Q3 revenue growth was driven by higher usage, particularly voice and messaging, and more active accounts. Pricing reductions of $3.1m partly offset CPaaS revenue growth. Management attributed the lower Q3 retention rate in part to a strategic decision to stop serving a particular customer.
- Operating expenses rose 24% in Q3 to $15.7m, with increases in R&D, sales and marketing, and general and administrative costs. Management cited hiring, executive separation costs, hosted software, bad debt, taxes, and public-company readiness costs. It expects operating expenses to rise in absolute dollars and plans continued investment in product development and sales and marketing.
- Net income declined despite higher revenue and gross profit. Q3 tax expense was $0.9m versus $0.1m, and the effective tax rate was 35.5% versus 3.3%; management attributed the higher rate to the release of a deferred-tax valuation allowance in December 2016. For the nine months, the effective rate was 37.2% versus 3.4%.
- Cash from continuing operations for the nine months declined to $9.8m, with working-capital uses including higher deferred costs, receivables and prepaid expenses and lower accounts payable. Investing outflows were $4.9m, mainly property and equipment and capitalized software.
- Other revenue is expected to continue declining as legacy services diminish. The filing provides no quantitative revenue, earnings, margin, or cash-flow guidance.
Risks, contingencies, and unusual items
- The company faces multiple lawsuits and investigations concerning the billing, collection, and remittance of 911 taxes and surcharges. Management stated it could not predict outcomes but did not expect the matters to materially adversely affect financial position or results. The filing gives no quantified range of potential exposure.
- Verizon disputes intercarrier compensation billings. The company reported approximately $7.2m billed to Verizon for the nine months, recognized revenue only for payments or undisputed amounts, and fully reserved disputed unpaid balances. Verizon asserted counterclaims; Bandwidth said it would contest them.
- CABS billings deemed not probable of collection were $7.6m for the first nine months of 2017 and were recorded as a reduction of revenue. The related allowance for CABS revenue was $29.9m at September 30.
- A September executive separation agreement resulted in approximately $0.7m of severance liability and $0.4m of additional stock-based compensation expense in Q3.
- After quarter-end, the company completed its IPO, converted preferred stock into Class B shares, adopted a dual-class structure, and terminated a shareholders’ anti-dilutive arrangement. The IPO and subsequent debt repayment materially changed the company’s capital and debt position after the reported balance-sheet date.
- Bandwidth is an emerging growth company and elected the extended transition period for adopting certain accounting standards. Its assessment of the new revenue recognition standard was ongoing; it had not concluded whether the quantitative adoption effect would be material.
Important facts for investors to verify
- How CPaaS usage growth, customer additions, pricing reductions, and retention develop; Q3 retention was 105% and management cited a customer exit.
- Whether CPaaS margin gains continue and whether Other-segment legacy revenue declines as expected.
- Cash conversion and working-capital trends, especially deferred costs, receivables, CABS collectability, and cash flow after the IPO.
- Final outcomes and potential financial exposure from 911 tax and surcharge proceedings and the Verizon dispute; no clear quantified exposure is provided.
- The post-IPO capital structure, actual debt repayment effects, and future borrowing under the revolving facility.
- The eventual impact and implementation costs of the new revenue recognition standard and other accounting changes.