Q3 2023 Bandwidth Inc Earnings Call
Participants
Daryl E. Raiford; Executive VP & CFO; Bandwidth Inc.
David Andrew Morken; Co-Founder, CEO, & Chairman; Bandwidth Inc.
Sarah Walas; VP of IR; Bandwidth Inc.
Unidentified Analyst
Presentation
Operator
Good afternoon, and welcome to the Bandwidth Inc., Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note, this event is being recorded. I would now like to turn the conference over to Sarah Walas, Vice President of Investor Relations. Please go ahead.
Sarah Walas
Thank you. Good afternoon, and welcome to Bandwidth's Third Quarter 2023 Earnings Call. Today, we'll discuss the results announced in our press release issued after the market close. The press release and an earnings presentation with historical financial highlights can be found on the Investor Relations page at investors.bandwidth.com. With me on the call this afternoon is David Morken, our CEO, and Daryl Raiford, our CFO. They will begin with prepared remarks, and then we will open up the call for Q&A.
During the call, we will make statements related to our business that may be considered forward-looking, including statements concerning our financial guidance for the fourth quarter and full year of 2023. We caution you not to put undue reliance on these forward-looking statements as they may involve risks and uncertainties that may cause actual results to vary materially from any future results or outcomes expressed or implied by the forward-looking statements.
Any forward-looking statements made on this call and in the presentation slides reflect our analysis as of today, and we have no plans or obligation to update them. For a discussion of material risks and other important factors that could affect our actual results, please refer to those contained in our latest 10-K filing as updated by other SEC filings, all of which are available on the Investor Relations section of our website at bandwidth.com and on the SEC's website at sec.gov.
During the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our press release issued after the close of market today as well as in the earnings presentation, which are located on our website at investors.bandwidth.com. With that, let me turn the call over to David.
David Andrew Morken
Thank you, Sarah. Welcome to Bandwidth's Q3 2023 earnings announcement. Despite the continued choppy macroeconomic environment, we are pleased to announce that we have exceeded both our revenue and profitability guidance for the quarter and made strong progress toward our goal of growing profitability by 30% for the full year.
We want to express our appreciation to our customers for building and scaling their mission-critical communications with us to our band mates around the world whose hard work drives all our success and to God for giving us this opportunity.
In today's economy, migrating voice, text messaging and emergency calling to the cloud is the fastest way for enterprises to build a better brand experience, reduce operating costs and leverage new AI technologies. At Bandwidth, we provide one of the most compelling routes to the cloud, thanks to the global and owned and operated network that we have at Bandwidth. Enterprise-grade APIs with best-in-class integrations through our Maestro software platform and trusted expertise from years of powering Gartner leaders and hyperscalers. Our aim is to streamline complex global communications into one strategic partnership with one contract, one customer experience, one trusted adviser and one source for software integrations. Our Maestro software platform is already integrated with the services we offer, reducing IT development time from months to hours.
Further, we've added new best-in-class services to Maestro, such as our new AI bridge solution launched in Q3 with two recognized leaders in conversational AI, Google Dialogflow and Cognigy. Conversational AI is so powerful because it not only empowers enterprises to improve their customer experience and operate 24/7, but also reduces costs by resolving contact center calls right in the communications cloud without needing a live agent, and it's available today.
We have focused our go-to-market strategy on bringing the future of cloud communications to three distinct customer categories; global communications plans, programmable services and direct to enterprise. Each of these delivered solid customer wins in the third quarter. Let me highlight an example for each. In our global communications plan category, a European-based cloud contact center customer managing many carrier relationships around the world chose to make Bandwidth their primary provider across several regions. Our programmable voice quality and reliability, award-winning support and the ease of use of our API-driven portal all help them now more efficiently and effectively manage fewer relationships for all their communication needs. They understand that the Bandwidth communications cloud provides effortless global expansion opportunities for wherever their business takes them in the future.
In our programmable services portfolio, we recently welcomed a new client that specializes in consumer engagement for the automotive industry. Car dealerships are revving up their text message marketing strategies to connect with customers and our customer has helped to lead the charge in this area. With our help, this customer was able to speed up their time to market and scale up operations to meet strong demand, especially during the peak season for car sales. This is just one example of the growing trend of text messaging being used for conversational commerce across various retail industries as more and more retail sales shift online, 60% of brands have recognized the power of text messaging for marketing their products. Why? Because text messaging offers unparalleled engagement potential with a 98% open rate and 90% of messages being read within the first three minutes.
We are proud to offer a dynamic and scalable messaging platform that powers some of the most demanding, high-volume customers in e-commerce. Our platform provides global reach, reliability, security and unbeatable customer support. We are committed to helping our clients succeed and grow by providing them with the tools and solutions they need to connect with their customers effectively and efficiently.
Turning to our enterprise category. I want to share an example of what we often hear from the largest multinational organizations, how to migrate to the cloud in stages rather than all at once. A Global 2000 manufacturing conglomerate with over 30,000 employees came to us with an extraordinary complex challenge to move the internal portion of their communications to the cloud while simultaneously preserving their contact center physical infrastructure on-premises for a future migration. Solving this level of what we call telecomplexity has become one of our specialties. That's because with Bandwidth, our communications cloud can support both types of environments simultaneously. We help the customer deploy state-of-the-art dynamic 911 and voice services for their employee communications stack, and they will be able to take advantage of our Maestro platform as they migrate future phases to Microsoft Teams direct routing. While this customer's ultimate goal is to be 100% cloud-based, they chose Bandwidth as their trusted guide to help them make the transition at their own pace.
Our ability to meet the customer where they are and help them navigate even the most complex digital transformations is what sets us apart in the tech industry. Regardless of the challenge, we are committed to providing our customers with the best possible solutions, the highest level of support and the kind of innovative thinking they need to thrive in a rapidly involving communications landscape.
In summary, we are pleased with our progress and how we've navigated through this year as a team. For example, in recognition of our unique culture that lists each other up to better serve our customers, we were honored yet again to win a Best Place to Work award in our home region of Raleigh, North Carolina. We've executed well against the choppiness we expected at the beginning of this year, and we are looking forward to finishing out 2023 with strong momentum.
With 2024 on the horizon, we are encouraged by our track record of success, strong financial position and our commitment to innovation. We are confident Bandwidth will remain fully on track to achieve our 2026 medium-term targets we laid out at our Investor Day last February.
I'll now turn it over to Daryl to walk through the details of our Q3 financial results.
Daryl E. Raiford
Thank you, David, and thanks, everyone, for joining this call this afternoon. Accelerating sustainable, profitable growth is a core principle for Bandwidth, and our results this quarter reflect exactly that with revenue and adjusted EBITDA both beating the high end of guidance ranges as we benefited from our growing market position in commercial messaging and strong operating discipline. Third quarter revenue of $152 million grew 5% from last year when excluding surcharges and the year-over-year effect of $7 million of cyclical political campaign messaging revenue in 2022. We are very pleased with the revenue contribution from commercial messaging which grew 51% from last year, benefiting from usage tailwinds into e-commerce, conversational marketing and financial services sectors.
Total messaging revenue in the quarter represented 17% of revenue, excluding carrier surcharges. Pass-through carrier surcharges associated with messaging were $32 million in the third quarter compared to $27 million last year. We've been making strategic investments in software features and messaging capabilities to drive sustained growth. The returns are beginning to be evident. In our programmable services category, which mainly utilizes our messaging portfolio to drive a multitude of commercial use cases, our revenue grew 47%, excluding prior year's political campaign messaging revenue. We're very pleased with the strong 47% growth in our commercial usage and the favorable implications it has on future performance.
In our direct to enterprise customer category, we grew 19% year-over-year, benefited by new customer additions as well as healthy growth with existing customers. Our direct to enterprise pipeline is dominated by cloud contact center opportunities and fueled by our expanding software solutions. For example, our award-winning Maestro product, along with dividends from our extensive partnerships and integrations with the CCaaS industry leaders, including Genesys, Five9 and NICE, to name a few. We're pleased to see our investments pay off and continue to see a lot of tailwind from the CCaaS partnerships.
The programmable and direct enterprise customer categories are cornerstones of our strategy, and we believe our ability to enable better brand experiences, reduce our customer operating costs and leverage new AI technologies will keep the momentum going.
In our remaining customer category, global communications plans, our third quarter revenue, excluding surcharges, was in line with our expectations as our volumes from customers with a large voice component continued to be pressured. In terms of operating metrics, our focus on growing the programmable and direct enterprise customer categories is again evident in the results. Average annual revenue per customer, which has steadily increased over the past six quarters, reached $177,000 in the third quarter, again demonstrating our success in serving large customer opportunities.
In the third quarter, non-GAAP gross margin was 55%, in line with our expectations and unchanged sequentially. A reminder that quarterly gross margins can modestly vary within any given year from fluctuations in usage across voice and messaging. We've made great progress over the last several years with growing gross margins, yet again another demonstration of sustainable profitable growth and expect to see margins continue to rise towards our 2026 goal of greater than 60% driven by additions of enterprise customers, a favorable product mix and continued scale of our network.
The power of our business model to drive profitable growth was evident in the third quarter as we achieved quarterly adjusted EBITDA of $14 million. We ended the quarter with a cash and securities balance of $139 million, a more than sufficient amount to meet our business needs and provide a great deal of financial flexibility. Also, for the third quarter, we reached an inflection point by accelerating quarterly free cash flow to a record $18 million. We said before that we expect free cash flow to accelerate, and we think this last quarter's free cash flow result is a good proxy for our cash flow producing potential.
For example, taking our third quarter free cash flow achievement of $18 million and annualizing it is a powerful illustration. The third quarter annualized result taken into the implied 2023 revenue guidance, excluding surcharges, results in a 2023 annualized FCF margin that is essentially already achieving our 2026 medium-term target of 15% free cash flow margin. Looking forward, we continue to expect 2023 full year revenue to be approximately $590 million and also continue to expect 2023 profit to improve by 30% from last year to $45 million at the midpoint.
In closing, we feel confident that our third quarter financial results along with momentum from commercial messaging and enterprise customers positions us for a solid fourth quarter and full year of profitable growth against a macro backdrop that does remain constrained. With 2024 on the horizon, we're pleased that our focus on our enterprise and programmable customer categories is generating strong momentum. This year, we've emerged as a leading and trusted platform for a multitude of commercial use cases valued by our programmable and enterprise customers after coming off a strong campaign season in 2022, and we expect another strong campaign season in 2024. We believe both commercial and campaign will be strong drivers of growth and profitability and feel confident we are fully on track to achieve our 2026 medium-term targets, which are all about sustainable, profitable growth. With revenue CAGR of 15% to 20%, growing gross margins greater than 60%, greater than 20% profit margins and greater than 15% free cash flow margins.
Now with that, I'd like to turn the call back to the operator for questions.
Question and Answer Session
Operator
We will now begin the question and answer session. (Operator Instructions). At this time, we will pause momentarily to assemble our roster. Our first question will come from Ryan MacWilliam with Barclays.
Unidentified Analyst
This is Amin on for Ryan. How did usage volumes trend throughout third quarter? And have volumes been more challenged from macro headwinds so far in the fourth quarter?
David Andrew Morken
This is David. We've navigated through the environment, which we described as choppy and as expected throughout the year. Usage trends across our categories of service are as we would have hoped that supported our results for the period. And we think that looking into the fourth quarter that they'll continue to trend the way we've expected and guided, and we're encouraged about what that will mean for 2024, if that answers your question.
Unidentified Analyst
No, it's perfect. And then just for next year, how are your enterprise customers thinking about usage and their budgets for 2024?
David Andrew Morken
Well, we've got a number of different categories of customers, and so my answer would vary depending. Certainly, some sectors are more challenged than others, but there are really an enormous number of improvements being made in the contact center space that's driving lots of activity and lots of energy, but it's very difficult to characterize in a universal statement how customers broadly are thinking. Certainly, in the enterprise space, we're seeing the digital transformation and movement to the cloud continuing. That's not changing at all. There's some pressure on folks to get there and get to the cloud because of the emerging applications that are helping both employees and an efficiency and productivity context do better. But in the contact center, there's an enormous amount of activity going into contact center rep call resolution, adding AI into call flows and doing very, very important things. And so, if you're not in the cloud, you don't get to take advantage of any of that. So, usage and uptake of our Maestro platform and of our global solution, we think going into next year is certainly healthy, but difficult to characterize broadly a customer sentiment.
Operator
Our next question will come from Jamie Reynolds with Morgan Stanley.
Unidentified Analyst
I guess just firstly, where are you seeing initial traction with Maestro? And what is the priority list for integrations to bring in so that it can scale further?
David Andrew Morken
We launched general availability in September. We've already got six customers on the platform. We're excited about the prospect of this orchestration tool for consuming the services that we offer globally. So, we're fired up. The customer value prop is obvious once someone's experienced the solution, and we've added AI bridge capabilities with both Google and Cognigy Solutions. And so, we've watched financial sector customers, industrials, manufacturing, transportation, it's broad, and it's supposed to be broad. So, we're excited about it and so are our customers.
Unidentified Analyst
Got it. And then are there any use cases that you're seeing outsized traction with respect to Maestro? And that's all my questions.
David Andrew Morken
Yes. No, it's a good question, and thank you. Maestro's appeal is broad. You have so many different third-party integrations across different use cases involved that if you're a C-level decision maker to a large enterprise, Maestro solves very elegantly a challenge that is the breadth and depth of which we think will not just appeal to the sectors I just mentioned, but around different use cases for that decision maker across their entire business.
Operator
(Operator Instructions). Our next question will come from Arjun Bhatia with William Blair.
Unidentified Analyst
I appreciate you guys taking the question here. I heard the commercial messaging growth was 51%. It sounded like you said, I think e-commerce, conversational messaging among some of the contributors there. What is your sense for how durable that is? I mean, we all know that it's a little bit of a choppy macro but it's a very strong growth rate. How do you anticipate that might trend through Q4 and into next year?
David Andrew Morken
I'll use the example that we laid out in the quarter of a customer in the automotive industry. They've engaged with us for commercial messaging and are using messaging to have conversations in a marketing context. That's an example of something that we think is very durable. Messaging drives open rates that are extraordinary, 98%, for example. That kind of effectiveness is going to lead to more and more uptake. And the reason why a customer like we talked about for the quarter came to us is they value the support that we have, especially for enterprise users of messaging and the scalability. They can grow massively. They can grow globally with us. And so, when you look at use cases, whether you're driving with the relationships you have with businesses you relate to or if you look out there at examples that we're using messaging between businesses and end users and customers is only going to increase. And so, we think it's quite durable.
Unidentified Analyst
Got it. Understood. Very helpful. And then just when you're thinking of -- I guess, for Q3 and maybe what you're seeing thus far in Q4, are there any verticals that stick out that are doing relatively better or some that are doing maybe relatively worse, just given the macro backdrop here?
David Andrew Morken
No, I appreciate the question, but I don't have any particular vertical that we call out is under more pressure than others.
Operator
This concludes our question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
