Bandwidth Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. Bandwidth provides a cloud communications platform (CPaaS) and related legacy and carrier services (“Other”).
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $48.3 | $39.5 | $101.3 | $79.2 |
| Gross profit | $21.7 | $17.2 | $49.4 | $35.3 |
| Operating income | $1.2 | $4.2 | $9.9 | $9.3 |
| Net income | $10.5 | $1.9 | $16.7 | $4.9 |
| Adjusted EBITDA | $3.2 | $5.8 | $13.9 | $12.7 |
| Free cash flow | $2.6 | $4.1 | $12.5 | $2.3 |
- Q2 revenue rose 22%; CPaaS revenue rose 26% to $39.8 million. Active CPaaS customer accounts increased 26% to 1,092. Dollar-based net retention was 119% for Q2 and 117% for the first half.
- Q2 gross margin improved to 45% from 44%; CPaaS gross margin was 42%, versus 40%. First-half gross margin was approximately 49%, versus 45%.
- Q2 operating expenses increased 57% to $20.6 million, led by higher R&D, sales and marketing, and general and administrative costs. Operating income fell to $1.2 million from $4.2 million.
- Q2 net income included a $9.3 million income tax benefit, versus a $1.2 million tax expense a year earlier. The reported effective tax rate was (741.6)%; stock-option exercise tax deductions were a key factor. Q2 diluted EPS was $0.50, versus $0.13.
Cash, liquidity and debt
- At June 30, cash and cash equivalents were $45.8 million and current marketable securities were $11.0 million. Cash, cash equivalents and restricted cash totaled $46.0 million.
- First-half operating cash flow was $17.1 million. Investing activities used $15.7 million, including $14.0 million invested in marketable securities; financing provided $6.7 million, primarily from stock-option exercises. Cash, cash equivalents and restricted cash increased $8.1 million.
- There was no balance outstanding on the $25.0 million revolving credit facility; the company reported compliance with its covenants. Management said available liquidity and operating cash flows should meet anticipated needs for at least 12 months.
- Non-cancellable obligations totaled $32.5 million, principally operating leases ($24.9 million) and purchase obligations ($7.6 million). The company entered into new office leases during the period.
Material changes and management commentary
- Revenue growth reflected higher customer usage, particularly voice and messaging, and customer-account growth. Usage growth was partly offset by lower usage prices: management cited a $3.9 million Q2 CPaaS revenue offset from pricing decreases.
- Management attributed higher CPaaS costs mainly to increased voice usage and network costs, partly offset by lower vendor cost per minute. It expects operating expenses to rise in absolute dollars and plans continued R&D and sales and marketing investment.
- Verizon settlement: the company received $4.4 million in February 2018 and recognized $6.268 million of revenue in Q1 from the settlement, including previously reserved receivables. It also issued $24.968 million in bill credits against previously billed CABS amounts. The settlement established terms for future CABS billings.
- The first-half increase in Other revenue included a settlement-related contribution; management said legacy-services revenue is expected to decline over time. The settlement and the unusually large tax benefit affect comparability of reported results.
Risks, contingencies and outlook
- The company faces multiple lawsuits and a North Carolina investigation concerning billing, collection and remittance of 911 taxes and surcharges. Management intends to defend the cases; outcomes are uncertain and adverse judgments or settlements could affect results.
- Other key risks include competition and pricing pressure, customer usage or churn, dependence on third-party network suppliers, service outages and cybersecurity, regulatory changes affecting telecommunications and 911 services, and data privacy obligations, including the EU GDPR.
- Management provided no specific numerical revenue or earnings guidance in this filing. Its liquidity outlook is subject to business needs and risks; it cautioned that actual capital requirements could require additional financing.
- Bandwidth had a dual-class share structure, with Class B shares carrying ten votes per share. The filing states that directors, executive officers, significant holders and affiliates held 62.4% of voting power as of June 30, 2018.
Investor verification priorities
- Assess how much reported earnings growth reflects the $9.3 million Q2 tax benefit and the first-quarter Verizon settlement, versus ongoing operating performance.
- Track whether CPaaS usage and customer growth can offset continuing price reductions, and monitor retention, customer churn and gross margins.
- Review the status and potential exposure of 911-tax litigation and the North Carolina investigation; management’s view that resolution will not materially harm results is not assurance of outcome.
- Verify cash generation against rising operating expenses, capital investment, office leases and other contractual obligations.
- Consider dilution and governance implications of stock awards, Class B voting control, and any future share conversions or issuances.