Neutral Tandem Q1 2009 Earnings Call Transcript

| About: Inteliquent, Inc. (IQNT)

Neutral Tandem (NASDAQ:TNDM)

Q1 2009 Earnings Call

April 30, 2009 9:00 am ET


Richard Monto - General Counsel

Rian Wren - President and CEO

Rob Junkroski - CFO


Mark Derussy - Raymond James

John Bright - Avondale Partners

Simon Flannery - Morgan Stanley

James Breen - Thomas Weisel Partners

Tim Horan - Oppenheimer

Jonathan Ho - William Blair

Will Power - Robert W. Baird

Hamed Khorsand - BWS Financial


Ladies and gentlemen welcome to the Neutral Tandem first quarter Earnings Call on the 30th of April 2009. Throughout today's recorded presentation, all participants will be in a listen-only mode.

(Operator instructions)

I will now hand the conference over to Richard Monto, General Counsel.

Richard Monto

Welcome to the Neutral Tandem first quarter 2009 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 those risks and uncertainties accompanying these forward-looking statements can be found in our earnings release issued today and in certain of our SEC filings.

Neutral Tandem undertakes no obligation to update any forward-looking statement. 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 introduce Rian Wren, Neutral Tandem's President and CEO.

Rian Wren

Thank you, Richard. And I'd like to thank all of you for joining our first quarter 2009 earnings call. As you will note from this morning's release, we are very pleased with the strong results for the quarter. This quarter we reported $38.2 million in revenue, which reflects a 45.8% increase over the first quarter of 2008.

This translated into strong profitability, as our net income grew to $9 million during the quarter, which is more than doubled, the $4 million we earned in the year-ago period. Rob Junkroski, our CFO will provide additional detail on the financial results later in this call, including our increased 2009 guidance.

The first quarter of 2009, established a strong start to the fiscal year, and we are encouraged by the growth that we have been able to achieve. Neutral Tandem's market reach, extended interconnections, and customer profile positions us to operate successfully throughout a wide range of economic environments, while executing on our long-term growth plans.

We continue to believe that we will see favorable industry trends for our business, particularly the increased use of wireless and cable telephony services, as end user calling preferences continue to shift to competitive carrier services instead of incumbent local exchange carrier wireline services.

The challenging economic conditions might actually reinforce the trend of subscribers seeking low cost options and moving from incumbent landlines to competitive wireless or cable providers, or eliminating landline in favor of exclusively using a wireless carrier.

Neutral Tandem is well positioned to benefit from this trend, since we provide services to these types of carriers.

We continue to focus on our strategy to grow the business, both in the short and long-term. The strong results we reported for this recent quarter, reflects the execution of this strategy, which consists of broadening our geographical presence, expanding our interconnections with new and existing customers and increasing traffic types across our network.

We continue to prioritize broadening our geographic presence in order to expand our reach. This past quarter, we successfully commenced operations in nine new markets, bringing the total number of operational markets to 109. This expansion has enabled us to continue to increase the number of telephone numbers to which we can terminate calls.

As of March 31, 2009, the total number of addressable telephone numbers assigned to competitive carriers in the 109 operational markets we serve has increased to 642 million. As of March 31 2009, our customers can terminate traffic to approximately [416 million] of these numbers.

Our plans for the full-year 2009 include the addition of 21 more markets, being our projected total market served to 130.

Our second strategic priority is dedicated to expanding our interconnections with new and existing customers. This means connecting deeper and deeper into the markets we already serve.

Of note, our customer, as of March 31, 2009 can route traffic to approximately 65% of Neutral Tandem's total addressable footprint in the current 109 operational markets. This is an increase of 40%, or 118 million phone numbers when compared with the numbers our customers could reach at the end of March 31, 2008.

Significantly, a large portion of the first quarter growth in the number of minutes we carried over our network was associated with the 71 markets we established in the first quarter of 2008 or earlier. In fact, these markets contributed approximately 80% of the growth in minutes during the current quarter.

In comparison, the 38 markets we established after the first quarter of 2008 contributed the remaining 20% of our growth. This demonstrates that we have continued opportunity to increase growth in our established markets, as we deepen our interconnections as well as those recently launched and planned for the future.

As we increase the number of customers connect to our network by deepening our penetration in existing and established markets, we continue to leverage the benefits of the network effect, which is an essential component of our growth strategy and fundamental strength of our business.

As we previously discussed, the value of our service offering directly increases with the number of customers connected to our network. We believe that scalability of our business model and the momentum we have generated has helped us to create a position, from which we will be able to grow our core business by also allowing for expansion into new types of traffic.

To that end, during the past quarter, we continue to make efforts to increase the types of traffic we interconnect and carry over our network. While we remain focused on our core local transit business, we are optimistic that we can increase minutes transited across the Neutral Tandem network, by developing our termination service business.

These new product offerings, which include the terminating switch access service are similar to our core business and that we continue to perform a Tandem function.

However, the cause supported our interim market in nature versus local. Unlike our local transit business, we market these terminating services to inter-exchange carriers, also referred to as IXCs. And have entered into contracts with several of these carriers.

We continue to increase the amount of this traffic carryover our network during the first quarter, and expect this trend to continue in 2009. [Tying] all our strategic growth initiatives together, we are now able to offer a variety of options and expanded services, in part, as a result of our continued progress towards deploying an advanced, all-IP technology platform.

Since the beginning of 2006, we have made significant investments in soft-switch technology, which improves the network scalability and offers our customers a state-of-the-art platform to help them more cost efficiently exchange all types of traffic.

Once we decided to utilize this next generation technology in our network, we began deploying soft-switches at all of our new switch sites, as well as, replacing most of our older circuit-switched technology with soft-switches.

As you may recall, we previously announced our plan to replace the remaining three circuit switches in our national network, which were located in Illinois, Indiana, and Minnesota. These upgrades are now complete, and I am pleased to announce that we have reached our network platform goal of being 100% IP compatible.

These internal investments had allowed us to reduce our operating expenses and improve capital efficiency, while facilitating our ability to deliver new service offerings.

As a result of these investments, we believe we now operate the largest IP-capable Tandem transit network in the United States, which puts us in a strong position to compete, to be the interconnection provider of choice for carriers as they upgrade their networks to IP.

In closing, we are very pleased with our results for the first quarter of 2009, which we believe demonstrate the successful execution of our business plan. We will continue to manage resources to encourage ensure progress against all three of our strategic priorities, in order to drive growth and development of Neutral Tandem.

With that I'd like to turn the call over to Rob Junkroski for a financial review.

Rob Junkroski

Thank you. As Rian mentioned, we are very pleased with our financial and operational achievements made during the first quarter of 2009, and look forward to building on the successful start to the year.

Turning to our results, our first quarter 2009 revenue was $38.2 million, compared to $26.2 million in the first quarter of 2008, an increase of 45.8%.

In the first quarter of 2009, we transited 19.7 billion minutes across the network, up from 12.9 billion minutes in the first quarter of 2008, an increase of 52.7%. This increase in minutes was driven by our growth in both new and established markets and the increase of terminating service minutes.

Turning to expenses, our network and facilities expense, which is the operations expense associated with transiting calls through our network, was $11.5 million in the first quarter of 2009, compared to $9.1 million for the first quarter of 2008.

The increase in network and facilities expense was largely due to greater traffic volumes transiting our network, and an increase in the number of markets we serve.

Combined operating expenses, consisting of operations, sales and marketing, and general and administrative expenses, came to $8.9 million during the first quarter of 2009, up from $7.6 million during the first quarter of 2008.

The increase was primarily due to higher employee expenses, including additional headcount associated with our business growth. Adjusted EBITDA and non-GAAP financial measure was $19.1 million for the first quarter of 2009, up 107.6% compared to $9.2 million for the first quarter of 2008.

The Adjusted EBITDA margins for the first quarter of 2009, was 50%, up from 35.1% in the year ago period. Depreciation and amortization increased by 21.2% to $4 million from $3.3 million in the first quarter of 2008.

We have recorded accelerated depreciation of $800,000 related to the decommissioning of our Illinois, Indiana and Minnesota circuit switches. Income from operations for the three months ended March 31, 2009 was $13.9 million or 36.4% of revenue, compared to $6.2 million for the three months ended March 31, 2008 or 23.7% of revenue.

This reflects our ability to increase revenues, while decreasing cost as a percentage of revenue. As Rian noted previously, we have gained cost efficiencies by deploying next-generation soft-switch technology, as well as in-sourcing our signaling assets and optimizing our nationwide interconnection network.

These impacts combined with our ability to grow our business while adding less incremental headcount, are the main driver of our operating margin expansion.

Pretax income was $14.3 million for the first quarter of 2009 compared to pretax income of $6.3 million for the first quarter of 2008. Our income tax expense for the first quarter of 2009 was $5.3 million, compared to an income tax expense of $2.2 million for the first quarter of 2008.

Our effective tax rate for the three months ended March 31, 2009 was approximately 37.1%, compared to an effective tax rate of approximately 34.9% for the three months ended March 31, 2008.

Net income for the first quarter of 2009 was $9 million or $0.27 per diluted share, compared to net income of $4 million or $0.12 per diluted share for the first quarter of 2008.

Taking a look at our current financial condition, our balance sheet as of March 31, 2009 is showing approximately $212.3 million in total assets, up from $195.8 million at December 31, 2008. Our current debt is $2.3 million, and continues to amortize. Our total stockholder equity as of March 31, 2009 is $193 million, while our cash and cash equivalents are $128.6 million, and our share count is approximately 32.8 million shares.

I'd now like to address our outlook for 2009. Based on our actual results for the first quarter of 2009 and our current belief about minute-based revenue trends expenses in the competitive environment, we have adjusted our guidance for certain metrics and now estimate that revenue for the full year of 2009 is expected to be between $158 million and $165 million, an increase from the previous forecast range of $151 million to $158 million.

Adjusted EBITDA, a non-GAAP financial measure for the full year of 2009 is expected to be between $74 million and $78 million, an increase from the previous forecast range of $66 million to $70 million.

Billed minutes for the full year of 2009 are estimated to be between 83 billion minutes and 87 billion minutes, an increase from the previous forecast range of 81 billion minutes to 85 billion minutes.

Capital expenditures for the full year of 2009 are expected to be between $18 million and $20 million, consistent with the previous forecast range, and we plan to commence operations in 30 new markets during the full year of 2009, consistent with the previous forecast.

We remain excited by the opportunities we see for our company, as we continue to expand our business and execute on our long-term growth strategy.

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

Question-and-Answer Session


Thank you, sir. (Operator instructions). The first question comes from Mark Derussy from Raymond James. Please state your question.

Mark Derussy - Raymond James

Good morning, everybody. Could you speak a little bit about what the penetration levels are in pre-2Q '08 markets? You mentioned that 80% of your growth came from those markets versus 20% coming from the 2Q, '08 going forward market. So I am just curious what the penetration is in those legacy markets?

Rian Wren

I don't think Mark right with us we have those numbers. Typically what we have done is we've given an overall penetration rate that we based it on assigned phone numbers and that's 65%. So, if you look at the entire business, we've got it to say that, we believe, we've got from a phone number perspective connected to 65% or reachable to 65% of the addressable phone numbers.

Now, what we've tried to do this time, since, we tried to describe that when connect through an office, and we basically take, we claim the ability to have connectivity to all the phone numbers at office.

The processes that really occur are little bit more complicated. We don't necessarily have all the capacity to that office, customers are not necessarily routing to all their calls to that office and it takes a process we described over several quarters to get to that point in time.

So we attempted to do at this time was to combine and I give you some guidance in terms of penetration with both processes connecting and routing and that's why we actually gave some information on minutes where we talked about the 80% of our minute growth in the first quarter of '09 really came from markets that have been established over a year ago or prior to that.

We don't actually breakout market specifics, in terms of what a specific penetration is in the market or not, but we try to give a little bit more detail to describe that. In fact, markets take time to actually mature and for us to realize all the revenue associated in the market.

Mark Derussy - Raymond James

So the salient point there with that comment, as we should look at this as you are 65% penetrated and take that revenue number that we have today and use that as a run rate to get to what the potential market opportunity is for you?

Rian Wren

Yeah. I think you had it. I mean, we were somewhat concerned when we've talked about we go into the market and people thought, well that market is done. So we moved towards saying, hey we were connected to 65% of their numbers, but that truly doesn't looks like the fact that it takes time for those numbers actually route calls, so we don't exactly know.

The problem has always been there is no publicly available information in terms of the size of the minutes for transit. What we do know that our penetration of the minutes is less than the penetration of the phone number. So it's somewhere less than 65%, but this at least give some real facts that show that of all of the minutes that we grew the incremental growth in the first quarter, 80% of them came from markets that had been an operation at least a year and upwards of three to four.

Mark Derussy - Raymond James

Just a housekeeping item, you mentioned you wanted to get the 130 markets by the end of this year. What would that represent in terms of covered competitive lines?

Rian Wren

Yeah, I think it adds a total to last year's of about 52 to 54ish.


The next question comes from John Bright from Avondale Partners.

John Bright - Avondale Partners

Rian, given the lag in [MOU] traffic how would 20009 markets look like in pricing versus what we're seeing now and have seen in the legacy markets?

Rian Wren

Good question, John. As we have been describing the pricing dynamics, you are actually starting to see a little bit of that variability in the first quarter. If you notice, basically for the first time our revenue growth exceeded our minute growth and what drove that, the first quarter performance, part of which drove that was better than expected ARPU realization and a lot of that was driven by basically the terminating switch business.

When we gave our guidance at the end of the year, we had guided a certain set of revenues and a certain set of minutes, which imply what we saw would be the mix of ARPU. When you look at our guidance today, ARPU is implied to be a little higher than what we had guided previously that. So, we are expecting to see the terminating switch business come on as we have planned. So far that's what we have seen.

The upside [surprise] has been a little bit, but the ARPU in that business has been a little bit better than we had expected. That's mainly could be happening because of where it's coming from? Since the rates that drive that business vary by state also, similar to the local type of rates.

What we've been trying to do is to help you by guiding you to what we think, although you never quite know, how the business is going to materialize across the states and from what customers. We do our best to try to guide that, but we have to take a look at that we do believe that it was prudent to signal that that the ARPU would be a little higher than we thought originally.

John Bright - Avondale Partners

So, let's then take that further on the terminating switch business, may be give us some color on what that meant in the quarter currently? What does that mean for '09 and may be if you flushed out the market a bit better, any thoughts on the market potential and may be the margin profile of that business now?

Rian Wren

Okay. Let me talk a little bit about that. With regards to the terminating switch business, as I heard you said it is ramping along expectations as we had hoped. As I did say, last quarter, we work on a go-forward actually breakout what the percentage of that service was. And then the reasons for that really are some technical complications we have and wanting to be accurate.

Having said that, I think I can give you an idea which is almost exactly what you are asking for. What we had been giving you is some guidance in terms of the categories of our customers. And so if you look at the relative contribution by customer category, we've added the interexchange carrier because they primary are the drivers of terminating switch business. So, it really is a very, very close representation of how that business is doing.

The only other complication before I give you these numbers is that the national transit service which was really an intermarket service, which I've described in the past that we do for our customers, but its more a secondary service or niche service for us versus the core local or the core terminating. It really was driven by some of the more [pure VoIP] customers and yet some of our local exchange customers are beginning to take themselves to that. So some of that's a little buried into their numbers.

I'll come back and explain that a little bit if I give you these, if you look at our customer categories, we really have cable companies, we have the CLECs which are your traditional enterprise focused competitive carriers, we now have the interexchange carriers, the IXCs. And we have a small category called VoIP, which is really pure over the top for our bandwidth providers and then we have the wireless category.

When you look at contribution across that, starting from the bottom again, the wireless carriers in the first quarter contributed 61% of our business. The VoIP carriers were 2%, the IXCs are 7%, the CLECs are 18% and the cable is 12, and when you look at how that's changed, when we talk about last quarter, when we talk about of terminating business, we really lumped together the terminating switch access and the NTS, because they are really focused on intermarket services and that was 7% if you combine those two, you really combine the IXC and VoIP, its about 7% which what we said in the fourth quarter. That's increased to 9% than the fourth quarter.

So effectively the IXC business is gaining three points sequentially in the quarter, as a relative base of our business, that's all what we had expected. We're pleased with it. Along with I think slightly stronger delivery in some of our core transit business this quarter. That combined with a little upside on the ARPU was what we believe to be a pretty strong first quarter.

John Bright - Avondale Partners

Last question for, Rob. Rob on your headcount now as well as what do you see the needs for a headcounts in 2009?

Rob Junkroski

We have ended the quarter at a 138, so we had a 1% in the first quarter. We've not really given out headcount guidance, but for the full year of 2008 we added 12 people. And I wouldn't think that that we would exceed that for the remainder of 2009. So, it would be dozen of 10 people added during the year probably. And it's choppy. Sometimes we add, sometimes we don't.

John Bright - Avondale Partners

Thank you.


The next question comes from Simon Flannery from Morgan Stanley. Please state your question.

Simon Flannery - Morgan Stanley

If I can just stay on the (inaudible) here and the increase in guidance, you talked about the ARPU already, Rian, but you're also raising your minute target. It sounds like some of that is probably due to better performance by the IXCs, but where else are you seeing minute strength that would sort of above your expectations. Is this better performance in the new market, the old market? Is it customer specific? Is this wireless prepaid unlimited offers starting to impact you if you can sort of [trisect] that sort of increase in the guidance that will be helpful.

Then on the CapEx, $1 million was pretty low, but you're guiding to basically another $6 million a quarter for the rest of the year. Is that something that is possible that you come in below that guidance? And maybe you can just be a bit more specific about, what you see the shape of the spending over the next two year? Thanks.

Rian Wren

To your first question, Simon on guidance, with respect to the minutes of use, indeed we are comfortable; we feel we are right on expectations for the termination switched business, and we expect that to continue along our ramping stage this year. So, we feel little more comfortable with regards to how that business is developing and as you know it's relatively new to us. So, in the early stages, we want to get at least another quarter. So, we are feeling more comfortable about our ramp there.

In general, we did see strong growth out of our core business, out of the local transit business and we saw across, both existing and in newer markets. As you know our business clearly is a momentum business. It's a recurring revenue model. We came off very strong fourth quarter in terms of growth. We have now as we said fully achieved the ability to terminate to our fairly large termination field that was connected to the Verizon wireless project that allowed a lot of the CLECs and the wireless companies to terminate there.

So our business has been robust in the core. Our terminating minutes are coming along as we expect and it showed itself a little higher than we had expected in the first quarter, and that will play its way out.

When we looked at it we became convinced ourselves that it was appropriate to change the minute guidance. The ARPU guidance added to it and that's helped us a little bit with our revenue change.

With regards to the margins, I think we've seen the benefits of all our optimization programs. We continue to optimize our transport circuits and we're seeing that the technology investments we have made have reduced our expenses. We haven't had to add as much headcounts in that area.

The ability to add network minutes to an infrastructure that grows incrementally cheaper than it did, all that is reflected. So that's kind of input that we talk to put together our guidance on that.

Rob Junkroski

With regards to your question on CapEx, it was low in the first quarter, but we are continuing to estimate the same guidance $18 million to $20 million. CapEx is lumpy. We do expect to expend those dollars later in the year. I really couldn't say it's going to be evenly over the next three quarters, but we do expect it to expend that money before the end of the year.


The next question comes from James Breen from Thomas Weisel Partners.

James Breen - Thomas Weisel Partners

I just had a couple of questions. One on the margin side, you had a fairly high contribution margin this quarter in terms of the incremental revenue that went to your EBITDA line and got to an EBITDA margin around 50%. Is that something we can expect going forward, you think on average the EBITDA margins to remain in the 50% range for the year and is there any thing that happened seasonally in the first quarter that would cause the contribution margin to be aside?

Rob Junkroski

There was really nothing seasonally that happened in the first quarter. The midpoint of the guidance will have adjusted EBITDA at 47% for the year. As I previously said, we didn't add any people, but we only added [one person] in the first quarter. We are expecting to add 10 or so people later in the year. So, we feel that will be a slight drag on EBITDA to keeping it at 50% level.

Our new products, there's going to be some network pre-provisioning on those new products and that will have a little bit of drag at gross margin, which obviously flows through to EBITDA margin. On the positive side, we've managed circuits better. We have got bigger pipes more efficient. So that's a positive, but we anticipate margins to be for the rest of the year to be a little bit lower than the first quarter.


The next question comes from Tim Horan from Oppenheimer.

Tim Horan - Oppenheimer

Just trying to get a sense of where the growth is coming from over the next year. In that regard, I was just curious where you're maybe out with a Verizon if you could talk about it at all. Where you are with their ability to terminate on them, but also to originate kind of you could just give some color on the ability to originate in Verizon's network.

And then secondly on the LD front, could you talk about your ability to provision the customers now and where customers are and they are of using you and may be where some of the bottlenecks are there. And then ultimately on LD what percentage of revenues you think (inaudible) growth that we've seen here for last year. Thanks.

Rian Wren

Yeah. I think to sit back a little bit, Tim in terms of general growth over the next year, 18 months, we are still quite confident about our core business and you've seen it in this quarter. So, as we continue to grow deeper and broader, we continue to expect a good contribution of growth to continue out of the transit business. We continue to be surprised at the robustness there.

Secondly, you are starting to see the ramp out the terminating business, which is really being driven by the IXC community, and we expect that ramp to continue now. How much of a contribution that becomes? We are not exactly clear, but it's at nine, it's clearly going to drive towards, the high-teens maybe 20% of our business at some point. Exactly, when that is I am not sure.

What's driving the pacing of that is the IXCs acceptance of the product. So far, we are very pleased with that. We see them taking actions to roll it out in more and more terminating markets. A little bit of it is their prioritization of their workloads, then our ability to keep up with the capacity needs on the terminating side.

So, we continually have to augment the termination capacity as IXCs handle more and more traffic tests. That's sort of the operations associated with pacing that growth.

Tim Horan - Oppenheimer

In that regard, do you have most of the country provisioned now? And maybe we can talk about maybe what percentage of IXCs do you have as customers, or utilizing that, or percentage of cities that they are utilizing some kind of metrics about where you are on the process?

Rian Wren

I don't have an exact metric, but I can tell you qualitatively. I'm going to guess because I don't have it in front of me. It's probably five markets, six markets that we're terminating in. So it's less than 10, it's not widely deployed it. So now one of the market, I'm aware of is New York. New York is a large market, but we're rolling that out as I said into other markets, but it's less than 10, so it's still in its early stages of roll out.

Tim Horan - Oppenheimer

And the number of customers you have on that, or percentage of the IXC customers?

Rian Wren

Right now I think we probably have four active IXCs, all are in different stages of rolling out. It clearly is a little bit I mean named as same, but its a little different process. They tend to be in the backbone network organizations versus the local operations. There are different people in these companies and they're getting to know us. It may sound strange, but you know some of these people didn't even know that they did a lot of business with us on the local site.

Tim Horan - Oppenheimer

And maybe what do they like or dislike about it? What is the resistance to using it and how much can you kind of save them?

Rian Wren

Probably the only resistance early on was understanding who we are and what we did, not because if you think about this is the first time that there has been a significant competition in the switched access business in the United States. And so this was new to them, so once they got over that and then of course they always go through the network integrity issues, I mean, who are you, how strong is your network, because you're talking about major carriers utilizing us for significant amount of their customer's traffic.

Having said that, once you got through that I think we are, they like the product, and they like the product because it offers them an alternative and it reduces their cost. And that is what we see from one of our customers today, they are very focused on reducing cost.

The only last thing I would say is, you've got the core business. As I was talking a period of time, a year, two years, we see the ramp up of our terminating switch business and we are saying much as I mentioned to you on the originating side, we talk to you that before we qualified it as in development. I will say that we're pleased with our efforts to date. It's still in development. Hasn't been officially prioritized, but we expect to win in that area and you'll see that as a third lag begin to roll out, if you're lucky at sometime late this year and beginning into next year.

Tim Horan - Oppenheimer

Was that the 800 originating you are referring to?

Rian Wren

800 is one type of origination. It happens to be a largest.

Tim Horan - Oppenheimer

Where are you with having Verizon using you for termination out of their territory?

Rian Wren

I think the answer for that is, it's still an opportunity. I can't say we've made significant progress in that area to date.

Tim Horan - Oppenheimer

And the resistance so far?

Rian Wren

You might ask me why somebody wouldn't want to save money, but it's a matter of getting comfortable. As you remember, our interconnection with them was somewhat of a long time coming. We do expect to win business because the [product] is good, and they have begun to usage, but only at certain locations. So the way I look at that is as upside on our core business.


The next question comes from Jonathan Ho from William Blair.

Jonathan Ho - William Blair

My question is in terms of the competitive environment, are you guys seeing anything on that side or anything that's potentially shifted in this quarter?

Rian Wren

I wouldn't say anything different and than what we saw last quarter, but as I went back and reviewed by notes in the last quarter call, I was pretty clear that the marketplace is becoming competitive. We don't have prefect information in this ability. We obviously put up some great numbers in terms of growth.

We do believe that customers are looking to reduce their cost and competitors are out there. We've talked about some of the local price, some we may not even know, so we believe we take seriously the competition that's in the marketplace. We expect this will continue.

I think what we are saying now is that we think we are well positioned with our reach and now multitude of products we offer, carriers and on the quality and delivery that we've had so far. So, we think we can compete with what's coming, but I would be [remiss] to not think or to say that competition is out there.

Jonathan Ho - William Blair

With regard to direct connections, are you guys seeing sort of the same type of dynamics that you are seeing earlier on, particularly as minutes ramp?

Rian Wren

Yeah, I think Jon, there is the process continues along the same, we haven't seen a reduction and what we think are direct reductions. I mentioned to you because of the amount of minutes that (inaudible) our connections, it's difficult sometimes to see a particularly the direct connection occur, but we do believe that they are occurring.

I think that given the focus on costs, carriers probably take those little more seriously. We haven't seen the dramatic increase, direct connections when we do our guidance. We do it implicit analysis of what must be in our historical growth of direct connections. So, we haven't seen anything dramatically changed. We do believe they are part of our business, they do occur, but we haven't seen it really rise significantly or reduce significantly in either way.

Jonathan Ho - William Blair

My last question is on EBITDA margins and the potential there. I know you guys talked about it a little bit earlier, but just wanted to get a sense of, let's say, a few years out, what do you think you guys can potentially achieve in terms of the EBITDA margin?

Rob Junkroski

John, we have never given a couple year outlook. Our incremental margins are fairly significant. I believe sequentially we had high 60% incremental EBITDA margins. So I guess, you can summarize from that that we still got some growth at the EBITDA outline.


The next question comes from Will Power from Robert W. Baird.

Will Power - Robert W. Baird

I guess, first, I wondered if you could update us on some of the new product and initiatives that you already alluded to, as you're going to get pass switched access, which sounds that you're still early in the ramp.

Then my second question is some of the big carriers have talked about lower voice usage and your number seem to suggest otherwise, but any signs of reduced voice usage in some of your older markets on a same customer basis, or is there any way really for you all to [monitor] that?.

Rian Wren

On the last point, I've had this decision internally several times. It's very hard because if our network was static and we have built it out and we connected everybody who's static. I think we might have a chance of measuring that, but its not.

We continue to interconnect a more switches in particular carriers. They are in different stages of routing. It's been very difficult to see.

Now I think to the extent that a particular type of carrier has some slowdown in minutes, intellectually you would think that we have to have that incorporated into the impact on our business, but I think the fact that the stage of this company where we're really just beginning to really extend deeper and to grow to become more interconnected to grow in more markets. It doesn't appear to show up in our numbers now.

We've said before, what does that mean that our growth this quarter over last years' quarter of 45% say, we could have been at 46%, may be. So I can't say that slowdown will come through, but currently at the stage we are and that fact that we're going to take share type of mode of our business, it isn’t slowing our growth. In fact, it's a little higher than we had thought.

The other question you had was on the new products. I really can't go much further than what we've laid out. I think what's encouraging is that on the terminating business, we are really just getting our legs going. And so that is a product that we're pretty excited about to see how it performs this year.

On the originating side, we're very excited, as I mentioned to where we are, but we are in development, but we think we are going to get that to the product stage and we think there is some opportunity there.

Beyond that would be products that we are thinking about well over a year from now, we preferred to particularly for competitive reasons, just to keep a lot of what we are doing in the longer term view wraps at this point.


The next question comes from Hamed Khorsand, BWS Financial.

Hamed Khorsand - BWS Financial

Could you explain the cost reasons to expand new markets? Are these markets less profitable, making it better focus on the other types of traffic instead?

Rian Wren

No. Actually most of our new markets today really have no capital investment at all. They tend to be backhaul cases to our core switching hub which is already constructed and therefore the costs are incremental. So what has been really encouraging to us versus, let's say two years ago, is that we've been able to scale our cost structure down so much that we go in our core business on the local side to market, and those pricing levels really have what our average rates are and can still generate the margins you are seeing.

So, we don't go in markets that we don't think can be attributed to the margin base. So, I don't know if we have been suggesting otherwise, but all of our local business has been accretive to our margin.


There appear to be no further questions. Are there any further points you wish to raise?

Rian Wren

I just would like to thank everybody. We have a large group of people on for participating and we look forward to the next quarter call.


This concludes the Neutral Tandem first quarter earnings conference call. Thank you for participating.

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