Bandwidth Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing also reports unaudited fourth-quarter results. Amounts below are in U.S. dollars; financial statement amounts are generally shown in millions unless otherwise indicated.
Business context and reporting period
Bandwidth provides cloud communications APIs for voice, messaging and 911 services, supported by its owned and managed IP voice network. It reports two segments: CPaaS and Other. CPaaS accounted for 85% of 2019 revenue. No customer represented 10% or more of annual revenue. Network uptime was 99.9% in 2019, according to the company.
Financial results and liquidity
| Metric | FY2019 | FY2018 |
|---|---|---|
| Total revenue | $232.6 million | $204.1 million |
| CPaaS revenue | $197.9 million | $164.4 million |
| Other revenue | $34.7 million | $39.7 million |
| Gross profit / GAAP gross margin | $107.6 million / 46% | $96.0 million / 47% |
| Operating income (loss) | $(17.7) million | $6.8 million |
| Net income | $2.5 million | $17.9 million |
| Adjusted EBITDA | $(1.1) million | $16.1 million |
| Operating cash flow | $(1.3) million | $24.6 million |
| Free cash flow | $(27.0) million | $10.2 million |
CPaaS GAAP gross margin was 44%, up from 43%; CPaaS non-GAAP gross margin was 48%, up from 45%. At December 31, 2019, cash, cash equivalents and restricted cash totaled $185.0 million, including $184.4 million of cash and cash equivalents. The company had no marketable securities at year-end and no borrowings outstanding. Its revolving credit facility provides $25.0 million of capacity and matures March 1, 2022, subject to covenants.
FY2019 capital expenditures were $22.2 million for property and equipment, with $3.5 million of capitalized software development costs. The company raised approximately $146.6 million net from a March 2019 follow-on offering. The GAAP tax benefit was $17.7 million; the filing notes a $13.5 million excess tax benefit from equity compensation, a material factor in reported earnings and the effective tax rate.
Fourth quarter: Revenue was $62.0 million, including $53.4 million of CPaaS revenue and $8.6 million of Other revenue. Gross profit was $29.0 million; operating loss was $3.5 million and net loss was $2.0 million.
Material changes versus the prior comparable period
- Total revenue increased 14%; CPaaS revenue grew 20%, while Other revenue declined 13%.
- Active CPaaS customer accounts rose 40% to 1,728. Dollar-based net retention was 113%, down from 118%.
- Management attributed CPaaS growth primarily to higher voice and messaging usage and more phone-number and 911 services, partly offset by $9.6 million of pricing reductions.
- Gross profit increased 12%, but total GAAP gross margin declined one percentage point to 46%, partly because 2018 Other-segment revenue included a dispute settlement. Operating expenses increased 40%, led by research and development, sales and marketing, and general and administrative costs.
- Operating results shifted from $6.8 million of income to a $17.7 million loss. Net income fell despite the operating loss, reflecting the substantial income tax benefit.
- Operating cash flow and free cash flow turned negative. The filing cites working-capital uses, including higher receivables and prepaid expenses, as well as increased investment in property, equipment and software.
Outlook, commentary, risks and unusual items
The filing provides no quantified 2020 revenue, earnings or cash-flow guidance. Management said it expects operating expenses to rise in absolute dollars and plans continued investment in product development, sales and marketing, customer support and international offerings. Two data centers in Frankfurt and London were completed in 2019; the company was authorized to conduct business and provide telecommunications services in 13 European countries.
- Contingencies: The company faces lawsuits alleging underpayment or failure to collect and remit 911-related taxes and surcharges in several jurisdictions, plus a North Carolina civil investigation. Management intends to defend the matters; outcomes are uncertain. The filing records a $5.4 million liability for estimated non-income taxes and fees at year-end.
- Tax risk: If the 2016 Republic Wireless spin-off were determined taxable under applicable rules, the company estimates potential tax-related liabilities and indemnity obligations of approximately $50 million, while cautioning the estimate may be inaccurate.
- Regulatory and operating risks: The filing highlights evolving telecommunications, 911, robocalling, privacy and data-security requirements; competition and pricing pressure; dependence on network suppliers; service outages and cybersecurity; and risks associated with international expansion and Brexit-related uncertainty.
- Accounting and controls: The company adopted lease accounting in 2019 and recognized operating lease assets and liabilities. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting; the auditor identified revenue recognition as a critical audit matter because of complex, highly automated systems.
- Capital structure: Class B shares carry ten votes per share versus one vote for Class A, concentrating voting control. The company reported no cash dividends and does not intend to pay them in the foreseeable future.
Important facts for investors to verify
- Whether CPaaS usage growth and customer expansion can offset pricing reductions, and whether retention stabilizes or improves from 113%.
- Whether the significant increase in operating expenses converts into improved operating income, Adjusted EBITDA and operating cash flow.
- Cash conversion and investment needs, including the drivers of negative FY2019 free cash flow and the pace of future network and software spending.
- Developments in 911 tax litigation and investigations, the recorded tax provision, and the potential Republic spin-off tax exposure.
- Compliance with the revolving facility’s minimum-liquidity and quarterly-revenue covenants, despite no year-end borrowing.
- Progress and costs of international expansion, including regulatory compliance, provider costs and foreign-currency exposure.