Bandwidth Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Bandwidth provides cloud-based communications services, including voice, messaging, 911 and phone-number APIs, supported by its owned IP voice network. It reports CPaaS and Other segments. This unaudited filing covers the three months ended March 31, 2018, compared with the same period in 2017; balance-sheet comparisons are with December 31, 2017. Amounts below are in U.S. dollars.
Financial and operating highlights
| Metric | Q1 2017 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $39.6 million | $53.0 million | +34% |
| CPaaS revenue | $31.6 million | $38.9 million | +23% |
| Other revenue | $8.0 million | $14.1 million | +77% |
| Gross profit / GAAP gross margin | $18.1 million / 46% | $27.6 million / 52% | Margin +6 points |
| Operating income | $5.2 million | $8.8 million | +69% |
| Net income | $3.0 million | $6.2 million | +107% |
| Diluted EPS | $0.20 | $0.30 | |
| Adjusted EBITDA (non-GAAP) | $6.8 million | $10.7 million | |
| Operating cash flow | $(1.0) million | $11.2 million | |
| Free cash flow (non-GAAP) | $(1.8) million | $9.8 million |
CPaaS revenue growth reflected higher voice and messaging usage, more active customer accounts (1,028, up 26%) and 115% dollar-based net retention. Management cited $4.2 million of usage-price reductions as a partial offset to usage growth. CPaaS GAAP gross margin increased to 44% from 42%; non-GAAP CPaaS gross margin was 46% in both periods. Total non-GAAP gross margin rose to 54% from 48%.
Operating expenses rose 47% to $18.9 million: research and development increased 41%, sales and marketing 77%, and general and administrative 38%. Management attributed the increases principally to personnel, facilities, hosted software and professional costs.
Balance sheet, liquidity and debt
At March 31, 2018, cash and cash equivalents were $38.8 million, marketable securities were $8.5 million, and total current assets were $78.6 million. Total assets were $115.8 million and stockholders’ equity was $83.2 million. The company had no borrowings under its revolving credit facility and reported $25 million of available capacity; capital lease obligations were $67,000, all current. Management said available cash, securities, credit capacity and operating cash flows should meet anticipated working-capital and capital-expenditure needs for at least 12 months, while noting this expectation could prove incorrect.
Q1 operating cash flow included a $5.9 million increase in deferred revenue and advanced billings; the company also reported a $3.2 million increase in accounts receivable. Investing cash outflow was $9.9 million, including $8.5 million invested in marketable securities, $1.0 million for property and equipment, and $0.4 million of capitalized software development. Cash, cash equivalents and restricted cash ended the quarter at $39.0 million.
Material changes, outlook, risks and unusual items
- Verizon settlement: The January 2018 agreement resolved litigation and counterclaims with Verizon, a CABS customer. Verizon paid $4.4 million; Bandwidth also issued $25.0 million in credits against previously reserved billings. The company recognized $6.3 million of revenue from previously reserved receivables, including the cash payment, and wrote off the credited reserved billings. Management attributed a $6.9 million increase in indirect revenue to the settlement. This item materially affects the interpretation of Other revenue growth.
- Other revenue mix: Other revenue increased 77%, while management expects legacy-services revenue to decline over time. The filing attributes the increase primarily to indirect revenue related to the dispute settlement; it does not provide a clear reconciliation of the settlement-related revenue increase to the reported segment growth.
- Investment and spending plans: Management expects operating expenses to increase in absolute dollars and plans continued investment in R&D, sales and marketing, and business growth. No specific revenue, earnings or margin guidance is provided.
- Commitments: Two new office leases, expected to commence in 2018, increased operating lease commitments by about $8.7 million. Total disclosed non-cancellable obligations were $35.2 million, including $25.8 million of operating leases and $9.4 million of purchase obligations.
- Contingencies and regulatory risks: The company faces multiple lawsuits and an investigation concerning billing, collection and remittance of 911 taxes and surcharges. Management believes resolution will not materially adversely affect financial position or results, but states outcomes are uncertain and it intends to defend the cases. Other significant risks include 911 service and regulatory compliance, customer usage and pricing pressure, competition, network and supplier dependence, privacy and cybersecurity, and customer concentration.
- Accounting and tax: The effective tax rate fell to 29.8% from 37.2%, primarily reflecting the lower federal statutory rate under the Tax Cuts and Jobs Act. Adoption of several accounting standards had no material impact. The company was still evaluating the effect of the revenue recognition standard due in 2019.
- Controls and capital structure: Management concluded disclosure controls were effective at a reasonable-assurance level and reported no material change in internal control over financial reporting. The dual-class structure gave pre-IPO holders and affiliates 89.5% of voting power at quarter-end. The company does not intend to pay dividends in the foreseeable future.
Important facts for investors to verify
- How much of Q1 revenue and profit growth, especially in Other, is attributable to the Verizon settlement versus recurring activity.
- Whether CPaaS usage growth and 115% retention can continue despite usage-price reductions and competitive pressure.
- The sustainability of operating cash flow and free cash flow, given the substantial deferred-revenue contribution and higher receivables.
- Developments in 911 tax litigation and investigations, and any resulting assessments, penalties or operational requirements.
- Lease and purchase commitments, planned operating-expense growth, and the adequacy of liquidity if growth or cash generation falls short.
- Customer concentration, voting control under the dual-class structure, and the status and potential effects of regulatory approvals and requirements.