Bandwidth Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018. Amounts are in U.S. dollars. Financial statement amounts are shown in millions unless stated otherwise.
Business context
Bandwidth provides cloud-based communications platform-as-a-service (CPaaS), including voice, messaging, 911 and phone-number services, supported by its U.S. IP voice network. It reports CPaaS and Other segments. CPaaS accounted for 84% of Q1 2019 revenue, up from 73% a year earlier.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2019 |
|---|---|---|
| Revenue | $53.0 million | $53.3 million (+1%) |
| CPaaS revenue | $38.9 million | $45.0 million (+16%) |
| Other revenue | $14.1 million | $8.3 million (-41%) |
| Gross profit / margin | $27.6 million / 52% | $24.6 million / 46% |
| Operating income (loss) | $8.8 million | $(5.8) million |
| Net income | $6.2 million | $2.0 million |
| Adjusted EBITDA (non-GAAP) | $10.7 million | $(1.7) million |
| Operating cash flow | $11.2 million | $(9.0) million |
| Free cash flow (non-GAAP) | $9.8 million | $(10.9) million |
Q1 2019 basic and diluted EPS were $0.10 and $0.09, respectively, versus $0.35 and $0.30 in Q1 2018. The 2019 income statement included a $7.6 million income-tax benefit despite a $5.6 million pretax loss; management attributed the unusually high effective tax rate to tax deductions from stock-option exercises and RSU vesting.
At March 31, 2019, cash and cash equivalents were $138.9 million and marketable securities were $59.5 million, for $198.4 million combined. Total liabilities were $41.8 million. The company had no revolving-loan borrowings and $25.0 million of available capacity under its amended three-year, $25.0 million KeyBank facility, which matures March 1, 2022. The facility requires minimum liquidity and quarterly minimum revenue covenant compliance; the company reported compliance.
Cash and restricted cash increased by $97.6 million during the quarter, primarily reflecting the follow-on stock offering. Investing activities used $43.8 million, principally for purchases of marketable securities. The March offering covered 2.875 million shares at $54.25 per share; reported net proceeds after underwriting discounts and offering expenses were approximately $146.6 million.
Changes versus the prior comparable period
- CPaaS growth was driven by increased voice and messaging usage, phone-number and 911 services, and a 31% rise in active CPaaS customer accounts to 1,351. Pricing reductions offset growth: management cited approximately $3.5 million of CPaaS revenue impact from lower usage prices. Dollar-based net retention was 111%, down from 115%.
- Other revenue fell $5.8 million, largely because Q1 2018 included approximately $6.3 million of revenue associated with a Verizon settlement. Excluding that settlement, management said total revenue grew 14% and Other revenue grew 6% year over year.
- Reported gross margin declined to 46% from 52%; management said the prior-period settlement lifted Q1 2018 gross margin. Excluding the settlement, gross margin was 46% in both periods. CPaaS gross margin was 44% in both periods.
- Operating expenses increased 61% to $30.4 million, with R&D up 104%, sales and marketing up 85%, and general and administrative up 36%. Management cited personnel costs and growth-related investment, among other factors.
- Operating cash flow moved from $11.2 million provided to $9.0 million used. The 2019 period included working-capital outflows and a deferred-tax benefit adjustment; accounts receivable rose $3.9 million and deferred revenue and advanced billings decreased $0.5 million.
Outlook, risks and unusual items
- The filing provides no specific numerical revenue or earnings guidance. Management expects operating expenses to increase in absolute dollars and plans continued investment in R&D, sales and marketing, and business growth. Other revenue as a share of total revenue is expected to decline over time.
- Management said cash, marketable securities, the credit facility and anticipated operating cash flows should meet working-capital and capital-expenditure needs for at least the next 12 months, while cautioning that actual cash needs could be higher.
- The company adopted ASC 606 on January 1, 2019 using the modified retrospective method, recording a $0.174 million increase to opening accumulated deficit. Management said adoption did not materially change revenue recognition for most contracts.
- Bandwidth faces multiple lawsuits and investigations concerning billing, collection and remittance of 911 taxes and surcharges. The Georgia Supreme Court ruled in February 2019 to dismiss counties’ damages claims for lack of legal authority; in April 2019, the Pennsylvania Supreme Court upheld dismissal of the Butler County case. The Illinois case returned to the trial court after an appellate reversal of its dismissal. The company intends to defend the matters; outcomes remain uncertain.
- A potential tax exposure relates to whether the 2016 Republic Wireless spin-off could be treated as taxable. The filing describes possible tax and indemnity liabilities of approximately $50 million if specified conditions trigger tax under Section 355(e); this estimate is not assured.
- Other disclosed risks include competition and pricing pressure, customer usage and retention, network and supplier dependence, cybersecurity and service reliability, 911-service regulation, privacy compliance, and execution of growth and international expansion plans. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether CPaaS growth, customer additions and usage can continue to offset lower prices and declining legacy/Other revenue; monitor the 111% net retention rate.
- Whether spending growth can translate into improved operating profitability and cash generation after the offering-funded increase in liquidity.
- How much of the year-over-year revenue and margin comparison reflects the one-time Verizon settlement in Q1 2018.
- Developments and potential financial exposure in the 911 tax and surcharge litigation, the North Carolina investigation, and the potential spin-off tax matter.
- Potential dilution and governance implications: Class B shares carry ten votes per share, and the filing reports 73.5% of voting power held by directors, executive officers, significant stockholders and affiliates as of March 31, 2019.