Neutral Tandem Management Discusses Q4 2012 Results - Earnings Call Transcript

Mar. 7.13 | About: Inteliquent, Inc. (IQNT)

Neutral Tandem (NASDAQ:IQNT)

Q4 2012 Earnings Call

March 07, 2013 10:00 am ET


Richard L. Monto - General Counsel and Secretary

G. Edward Evans - Chief Executive Officer, Director and Chairman of Capital Allocation Committee

David Zwick - Chief Financial Officer, Principal Accounting Officer and Executive Vice President


Hamed Khorsand - BWS Financial Inc.


Ladies and gentlemen, thank you for standing by, and welcome to the Inteliquent Fourth Quarter and Full Year 2012 Earnings Call on the 7th of March 2013. [Operator Instructions]

I will now hand the conference over to Richard Monto, the General Counsel. Please go ahead, sir.

Richard L. Monto

Thank you, and welcome to the Inteliquent Fourth Quarter and Full Year 2012 Earnings Conference Call.

In our remarks today, we will include statements that are considered forward looking within the meaning of federal securities laws. The forward-looking statements are based on current expectations and are subject to substantial risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. A description of certain of these risks and uncertainties accompanying these forward-looking statements can be found in our earnings release issued today and in certain of our SEC filings. Inteliquent undertakes no obligation to update any forward-looking statements.

In our remarks, we will also refer to non-GAAP financial measures, which we believe, in combination with GAAP results, provide additional analytic tools to understand our operations. Tables that reconcile non-GAAP financial measures to GAAP results are also included in our earnings release issued today.

Now for the substance of the call, I'd like to hand the call over to Ed Evans, Inteliquent's CEO.

G. Edward Evans

Thank you, Richard. And good morning, everyone. Thank you for joining us today as we discuss our full year results for 2012. First, I will provide an overview of our operational results, as well as a few observations about our business, and then David Zwick, our CFO, will provide a more detailed review of our financial performance, as well as certain detailed operational metrics. We will also provide time for questions following our prepared comments.

Let me start by saying how pleased I am with the results for the fourth quarter and with the results the fourth quarter helped us achieve for the full year of 2012. We faced many changes and challenges during the year, and I'm happy with the way the team weathered the storm and produced solid results that beat our revised guidance for the quarter and for the year.

I believe we've made significant changes necessary to move forward and grow the company. And I believe we have the right team in place to accomplish our goals.

For the year, we increased revenues by 3% over 2011. We accomplished this in spite of several major repricing exercises with our largest customers. Voice services revenue grew to $206 million for 2012. The data business also saw a record revenues of over $69 million for the year.

While our revenue performance was good, we spent a great deal of time in the fourth quarter focusing on our expenses. We have completed a review of many parts of the business, and we will continue to evaluate every cost in the business by line item.

I am pleased to report that we've made significant progress in understanding our cost structure and more importantly, we have become much more diligent in managing our expenses. We saw some benefit in the fourth quarter of 2012, and I expect to see additional improvement in 2013.

While our understanding of the voice business is amongst the best in the industry, we are now making significant progress in reaching a similar position with respect to our data business. During the previous quarter, we began developing tools that allow was to see profitability down to the customer level. For the first time, we are now able to comprehensively understand the actual revenue and cost of individual customers in our data business. We continue to refine these tools, however, the preliminary results have been very enlightening.

Customers that are on the surface would appear to be very profitable are in fact not profitable at all, while some customers that would appear not to be profitable have proven to be profitable based on the actual traffic flows and methods of interconnection.

Armed with this information, we are now aggressively working to either find a way to make unprofitable customers profitable or to begin serving notice that we will be terminating contracts for this unprofitable business. We are very focused on this exercise, and we expect to see improved results throughout 2013.

Additionally, we are spending more time and effort on pricing new data service contracts. Only by providing accurate traffic flow data will customers be able to obtain our best pricing. Absent traffic flow information for a new customer, higher rates will apply until we are able to analyze actual traffic flow.

Our analysis of the data business has shown that this business has been less profitable than we previously thought, as some costs were not being fully allocated to the data business. I am pleased with the analytical work that has been done around this business over the past few months, and I believe we have a much better understanding of the business and we are well-positioned to improve its financial performance.

With respect to the voice business, our analysis has shown that this business is actually performing better than we previously believed. In fact, its cost allocations were reviewed and refined, we found the voice business be more profitable than we previously thought.

While the voice business has been doing well, we have found many additional areas for cost improvement. Specifically, we are becoming much better at managing our network expenses and grooming the network. We will continue to drive cost out of this business throughout 2013.

The net result of our efforts was adjusted EBITDA of $14.5 million in the fourth quarter of 2012 and adjusted EBITDA of $72 million for the full year.

During the fourth quarter, we adjusted our relationship with one of our largest customers. As I discussed during our last conference call, there were significant changes to traffic volume and pricing with that customer. While we are continuing to evaluate the effect of the changes, our initial analysis of the changes appears to be accurate. This gives us increased confidence in our ability to forecast the business results for 2013.

As we continue to stabilize the core business, we are becoming very focused on growth opportunities. We believe there are several significant opportunities in the voice business to add services and grow existing services.

We have enjoyed several customer wins in recent weeks, and we look forward to continuing this trend.

The data business growth will continue to come from our EtherCloud services. We remain optimistic this business -- about this business, and we are continuing to see growth in the service.

The IP Transit business will require a much more focused effort. We will not pursue business that is unprofitable, and it is likely we will shed unprofitable business going forward.

We are continuing to work around enhanced service offerings for wireless and wireline carriers. Specifically, we are preparing to introduce RCS+ [ph] services to carriers. These services are designed to allow carriers to provide rich communication services to their customers. These services allow for true unified communications across multiple platforms like LTE, Wi-Fi and other platforms. We believe this is a natural extension of our current service offering.

Several of the largest carriers are beginning to trial RCS+ services now, and we believe our timing around entering the market is appropriate.

In summary, while 2012 provided us many challenges, I believe we're well positioned for 2013. I am much more confident in our ability to forecast and our ability to operate the business.

I want to thank the entire Inteliquent team for all their hard work in 2012. It was a difficult year for the organization in many respects, but I am confident we will see the results of our efforts in 2013.

With that, I'll now turn the call over to our CFO, David Zwick. David?

David Zwick

Thank you, Ed. We are pleased to have exceeded our most recent financial guidance for 2012 revenue and adjusted EBITDA, a non-GAAP financial measure.

As a reminder, we had guided to revenue of $265 million to $275 million. Our actual 2012 revenue was $275.5 million.

We guided to adjusted EBITDA of $60 million to $65 million. Our actual 2012 adjusted EBITDA was $72 million.

However, to keep matters in perspective, we fell well short of the initial financial guidance that the company provided at the beginning of 2012. That fact is not lost on us.

In the fourth quarter of 2012, there were 3 key factors that allowed us to outperform our most recent guidance for the full year. First, the voice business performed better than expected. Second, our IP Transit business experienced greater volumes than expected due to a large seasonality effect this past holiday season. And third, we experienced lower employee compensation-related expenses than previously expected as year-end bonuses were lowered across the board to reflect the fact that the company's results financially fell short of our original goals for 2012.

I would also note that Hurricane Sandy had only a negligible effect on our financial performance in Q4. This was a result of tireless work performed by our employees to maintain and restore service in affected areas, and it underscores what we believe is a preeminent operational and network quality.

Fourth quarter revenue was $68 million, representing a 2% sequential decline from the third quarter and a 3% year-over-year decline compared to the fourth quarter of 2011. Adjusted EBITDA was $14.5 million, representing a 16% sequential decline from the third quarter and 34% year-over-year decline compared to the fourth quarter of 2011. Our adjusted EBITDA margin was 21.5% in the fourth quarter, down from 25.1% in the prior quarter and 31.7% in the fourth quarter of 2011.

The main reasons for the decline in profitability are the revised economics with one large voice customer and the failure in the data business to reduce our per unit data direct costs as fast as data pricing is declining.

The fourth quarter also contained several one-time items that we recorded in our continued efforts to clean up some legacy issues and that were added back to EBITDA in the calculation of adjusted EBITDA. First, we recorded an $89 million asset impairment charge for goodwill and long-lived assets. As part of this charge, all of the goodwill and intangible assets associated with the 2010 Tinet acquisition were written off.

Second, as discussed in our third quarter earnings announcement, we previously decided to shut down our hosted services business line. As a result, we recorded an additional impairment of $1.6 million in Q4.

Third, on our call last quarter, we mentioned that we expected to incur an additional severance charge in the fourth quarter. The Q4 cash severance expense was $0.7 million.

As announced in our press release, our financial guidance for 2013 is as follows. Revenue is expected to be $240 million to $250 million. This is approximately 11% lower than our 2012 revenue. Adjusted EBITDA is expected to be $27 million to $34 million. This is approximately 58% lower than our 2012 adjusted EBITDA. Capital expenditures are expected to be $20 million to $25 million. This is approximately 9% of revenues.

As implied by that guidance, we expect to generate positive free cash flow in 2013.

The expected revenue decline is related entirely to the voice business. The largest element of the revenue decline relates to the new economic agreement with one of our largest customers, which became effective on October 5, 2012. Phase 2 of the terms net agreement became effective on January 1, 2013, which resulted in a further unfavorable adjustment to the pre-existing economic terms. This also accounts for the majority of the expected decline in adjusted EBITDA.

As mentioned previously, the new agreement significantly reduced the rates that the carrier pays to us. We also now pay the carrier a significant amount for terminating long-distance voice minutes to them.

Other factors impacting our adjusted EBITDA estimates include a reduction in operating expenses. In the fourth quarter of last year, we initiated a comprehensive cost review and instituted a new focus on increased discipline related to all spending.

Finally, we recently put in place a 3-year revolving credit facility. The interest rate is LIBOR plus 3.25%, which equates to a current rate of 3.45%. While we have no plans to draw on the facility, we believe that having access to debt capital on these attractive terms provides financial flexibility. Furthermore, it is a validation of our business model to have successfully completed the credit approval process associated with such a debt facility.

We have implemented many changes to the business over the past few months, including a shift to more of a bottom line focus, increased discipline related to all spending and improving operational efficiency. We have more work to do. We are heading in the right direction.

That concludes our remarks. We would now like to open up the call to questions. Operator?

Question-and-Answer Session


[Operator Instructions] Our first question comes from Hamed Khorsand from BWS Financial.

Hamed Khorsand - BWS Financial Inc.

Just a couple of questions I want to talk on. First off, the minutes on the voice side, they've been declining on a sequential basis even before the customer contract was revised. So is that -- is it -- are you facing competition or -- what's happening there?

David Zwick

Yes, the overall voice minutes over the past 4 quarters prior to this quarter had been fairly stable in the 33 billion to 34 billion minutes of use area per quarter. And then in the current quarter, they ticked down to just under 32 billion minutes. Most of the impact related to the one large customer renegotiation was held in the termination category, where we lost about 1 billion minutes from Q3 to Q4. And that's sort of the one unusual effect that happened during the quarter. Other than that, the origination business continues to grow nicely from a minutes of use perspective. And the local transit business, the minutes continued to attrite off of that service as they have over the recent quarters.

Hamed Khorsand - BWS Financial Inc.

I guess, what I'm trying to get to is -- I understand you're managing your costs, but it also seems as though the costs haven't really come down that much, even though it seems as though we're now in a declining revenue kind of a business environment.

G. Edward Evans

Well I think we've got certain segments in the business that are declining. And remember, local transit service was 85% of this business not too long ago, and has been falling off fairly significantly. We do have other voice services that are coming in and starting to make up for that. They do have a different cost structure around them and a different way of accounting for those minutes coming in as well. So the cost-cutting measures that have gone into place really started in the fourth quarter. And while there was some impact in the fourth quarter, we suspect that you'll see the bulk of those going forward as opposed to baked into the fourth quarter numbers. So I think the message is, we believe the voice business is still a very viable business and we still think there's some growth opportunity in that business, and we're going to continue to aggressively manage the cost. And we believe there is some opportunity to cut additional costs out of the business.

Hamed Khorsand - BWS Financial Inc.

And then my -- other topic I want to talk on was the guidance. You provided a $240 million to $250 million range on revenue. I mean, if I just look at it from an annualized run rate basis, you should be doing somewhere around $275 million or so based on Q4. So how much customers are you trying to hack off the data business, and what kind of revenue loss are you expecting on the voice business?

G. Edward Evans

Well, it's really not the data business that is impacting it. It's the fact that the -- all of the changes around the large customer implementation were not felt in the fourth quarter. It took time throughout the fourth quarter for that to happen. By the end of the fourth quarter, we felt like we have a pretty good run rate at a go-forward look. And so, that's really what's driving it is that it took time for those minutes to come off of the network in the fourth quarter. And by the end of the fourth quarter, we had the real run rates to look at.

Hamed Khorsand - BWS Financial Inc.

You're talking about upwards of $25 million in lost revenue for this 1 customer?

G. Edward Evans

That's correct.

Hamed Khorsand - BWS Financial Inc.

It didn't sound like that was how much you guys were talking about the loss when you first announced this, though.

G. Edward Evans

I don't know that we gave any guidance around that.


[Operator Instructions] It appears to be no further questions. Are there any further points you wish to raise?

G. Edward Evans

Not at all. Thank you very much for joining us. And we look forward to talking to you next quarter. Thank you.


This concludes the Inteliquent Fourth Quarter and Full Year 2012 Earnings Conference Call. Thank you for participating. You may now disconnect.

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