Inteliquent Inc (NASDAQ:IQNT)
Q2 2016 Earnings Conference Call
August 2, 2016, 10:00 am ET
Richard Monto - General Counsel
Matt Carter - President, Chief Executive Officer
Kurt Abkemeier - Chief Financial Officer, Executive Vice President
Frank Louthan - Raymond James
Lisa Lam - Morgan Stanley
James Breen - William Blair
Hamed Khorsand - BWS Financial
Good day and welcome to the Inteliquent second quarter 2016 earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to General Counsel, Richard Monto. Please go ahead sir.
Thank you and welcome to the Inteliquent second quarter 2016 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. 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 would like to hand the call over to Matt Carter, Inteliquent's CEO.
Thank you, Richard and good morning everyone. Thanks for joining us as we discuss our results for the second quarter 2016. Today I will provide an overview of our results and an update on the progress we have made towards our growth forward plan. After that, Kurt will review our financial performance and provide certain detailed operational metrics for the second quarter 2016. We will then have a Q&A session at the end of the call.
Let me first start with an overview of our results for the second quarter. We achieved our fourth straight quarter of sequential revenue and minute per use growth. We generated revenue of $91 million in the quarter which reflects top line growth of 72% year over year and 10% on a sequential basis in the second quarter which reflects continued execution of our business strategy, the growth forward plan, and strong business momentum driven by the overall traffic growth.
Our net income in the quarter was $9 million, while our adjusted EBITDA, a non-GAAP financial measure, was $19.2 million. In his remarks, Kurt will discuss why our adjusted EBITDA is below where we would have reported this metric in prior quarters. He will also discuss our revised financial estimates.
During the quarter we transited 53.9 billion minutes of use on our network, an increase of 56% compared to second quarter 2015. This marks our fourth consecutive quarter of breaking our minutes of use record. Additionally, the average rate per minute for the second quarter 2016 increased 10% compared to a year ago which contributed to revenue growth. Overall, I am pleased with our consistent results and the progress we continue to make in advancing our growth forward plan.
I will now provide some highlights of the progress we're making in executing our plan. We continue to focus on grow and protect the core, which is one of the key pillars of our business strategy. As you'll recall, this pillar is focused on optimizing our legacy business so that we continue to be the service provider of choice for traditional phone carriers. Our strategy for this pillar centers on delivering organic growth opportunities, improved pricing and profitability analytics and opportunistic future industry consolidation.
We continue to organically grow our minutes of use by expanding the existing customer relationships. Over the years we've developed very strong relationships with our customer base, which is an area of strength for our business. And in a point component in our strategy to grow and protect the core, we’ve earned our customers’ confidence by delivering the largest volume of minutes while also delivering the most reliable call experience every time.
In addition to winning existing minutes of use from current customers, our dedicated sales and product team work directly with customers to evolve the service offerings available to meet their needs. The communication industry is changing at a rapid pace. So we're very focused on fueling innovation for our customers. This can lead to increasing the types of minutes available to us. For example, we have continued to deploy several variations of a new tandem service all of which allow customers to connect to the ILEC tandem through us using our existing network infrastructure through new TDM trunk. This minimizes the need for our customers to deploy switch resources and build out their own network. This is just one example of the way we are innovating our product set to increase the minutes of use that are available to us.
The second pillar to our business strategy is diversify our revenue stream. To accomplish this, we are diligently focused on expanding the power and reliability of our network into the next generation communications space through the Omni IQ product line, a comprehensive voice and messaging solution for the next generation customers. These next generation customers include providers of VoIP and OTT services, API platforms and cloud-based communications services. This is a growing, yet largely untapped market where we are confident we can lead.
Our customers are demanding more than just simple voice connections. They want tailored connections that enable them to create new services for their customers, uncover efficiencies, increase their competitiveness. They're looking for communication networks that provide voice, messaging and data capabilities, plus more, all in one place. We are serving those demands by growing up Omni IQ offering.
As you know, we recently acquired Shopety, Inc., a developer of communications software next generation switching technology to enable us to expand the capabilities and addressable market of our Omni IQ product line. We've also hired several industry innovators to drive the expansion of our next generation voice and messaging offerings. The team will focus on bringing leading edge communication solutions to life with a growing market of unified communication providers, VoIP carriers, API platform providers, cloud conferencing services and others. These new hires cover Omni IQ sales, strategy, product and market development.
As indicated by our recent hires, we are diligently focused on developing our next generation voice and messaging offerings and executing on our sales approach to win customers in the space. We currently have 36 active customers using the portal and have sold 690,000 telephone numbers. We remain enthused with the customer response to our Omni IQ solution as our conversion rate for agreements remains strong.
We believe the metric of telephone numbers provision is a good leading indicator of success in the market. Telephone numbers placed into service by our customers will enable us to provide both inbound and outbound VoIP and messaging capabilities to our customers. We are then able to build and collect revenues associated with this usage. As we continue to provision telephone numbers and we put on this statistic it will provide a meaningful insight into the overall growth of the product and provide an indicator of expected future revenue growth.
However, I should note that revenue for this product will be predominantly generated from the usage we build, the minute that terminates to the telephone numbers originate from the telephone numbers. The minutes of use often lag the provision of telephone numbers placed in service. So we're not yet experiencing the full benefit of the numbers we are providing to our next generation customers but the future shows that we will be able to provide those numbers and traffic will follow.
Turning back to our growth forward pillars. Our third initiative is to drive margin optimization. We continue to work diligently to leverage the large volume of long distance traffic we began carrying over the past year. In addition, we have built and continued to enhance the tools needed to identify the most cost effective route for the long distance traffic. We expect our efforts to result in increased margin on the long distance traffic we carry.
Moreover, as discussed in prior calls, during the third quarter we expect margins to improve due to intercarrier compensation reform. As part of the reform, we will see a step down in the end-office rates we pay to terminate a large volume of long distance traffic. This is the third year of the rate step-down and in the final year which is next year the end-office rate will go to zero. Given the significant increase in long distance traffic we now carry on our network, the impact of the step-down in the third quarter of this year and the third quarter of next year will be a meaningful tailwind for us.
Overall, I am pleased with the momentum in our business and our strategic transformation underway focused on our growth forward plan. Our second quarter results demonstrate the consistency of our performance and our improved competitive positioning. The effort and teamwork of our employees throughout the company were key to achieving these results. Our strategic growth investment in Omni IQ have us well positioned in the next gen space to capitalize on the growing market opportunity and delivering value to our shareholders.
With that, I will turn the call over to Kurt.
Thank you, Matt. Now on to the results. We experienced yet another quarter of significant MOU and revenue increase, as we ramped up traffic for one of our major tier 1 customers and worked as best as we could through some of the challenges that arise with such a dramatic increase in traffic.
On the topic of traffic, we experienced strong MOU growth with an increase of 4.5 billion MOUs compared to the first quarter of 2016, largely due to the continued ramping of traffic related to one of our larger customers, which represents a growth rate of 9.1% sequentially.
To further punctuate the degree to which we have ramped up traffic, we've increased minutes of use by 56% year over year. That's a massive increase to assimilate in such a short period of time.
As for ARPM, it has continued to exhibit stability and even grew modestly this quarter to $0.00168 from $0.00167 in the first quarter of 2016. This resulted in revenue of $90.8 million in the second quarter, representing a 10.3% increase from the first quarter of 2016, or an $8.5 million sequential change.
Network and facilities expenses were $58.6 million in the second quarter of 2016 which represents a 16.7% increase compared to the first quarter of 2016. A significant component of our revenue growth was in lower margin off-net traffic products. As such, there is an increase in variable costs associated with this traffic.
In addition, as we build up our network for the significant amount of traffic we have ramped over the year, we've incurred a number of non-recurring charges to establish circuits. Those expenses were $1.2 million for the quarter, bit higher than expected. We anticipate these to taper down during the second half of the year as we complete the bulk of the ramping project. Gross profit per minute was $0.0006 or 35.4% of revenue in the second quarter of 2016 compared to $0.00066 or 39.0% of revenue in the first quarter of 2016.
Moving to profitability. Adjusted EBITDA was $19.2 million in the second quarter of 2016, an increase of $100,000 from the first quarter of 2016. Our adjusted EBITDA per minute came in at $0.00036 which was slightly below our most recent level of around $0.0004 per minute.
Similar to the comments I just made about network expenses, adjusted EBITDA per minute is also diluted, so to speak, by some of the relatively low margin off-net long distance traffic, fixed costs associated with the significant ramping up traffic during the first half of the year, as well as some of the elevated non-recurring costs associated with the ramping up of the traffic.
I think it's also worth noting that there were between $500,000 and $1 million of additional expenses that are generally non-recurring and are unexpected and transitional in nature that occurred in the second quarter, which negatively impacted adjusted EBITDA. Some of these are related to the significant ramping up traffic that we've experienced and some are not related to that. But the takeaway is that these will be largely transitional in nature and that while they will impact 2016 results, we don't expect them to impact 2017 and forward in a similar fashion.
As for capital expenditures, we spent $7 million in the quarter largely to augment our network to accommodate the significant MOU growth we anticipate over the next year. This amount during the second quarter was slightly higher than normal due to the lower than anticipated spend during the first quarter, which resulted in shifting some expected CapEx spend from Q1 to Q2.
As announced in our press release earlier today, we have revised our financial projections for fiscal year 2016. Our revised estimates are based on management's current beliefs about business trends, expenses and macro economic and competitive environment. We've also adjusted the manner in which we project our financial estimates due to some recent interpretive guidance from the SEC on reporting non-GAP financial metrics.
As for some of our estimates for metrics, we continue to anticipate MOU levels to increase from the current level of 54 billion MOUs in the second quarter of 2016 to an excess of 60 billion by the third quarter, consistent with the projections we have provided during the last few quarterly calls.
As for revenue, we are adjusting our 2016 range to $360 million to $370 million which is a lower and tighter range than prior estimates. While our confidence in our growth opportunities remains unchanged, revenue estimates for 2016 have been adjusted primarily due to two factors. The first one, an opportunity that we had originally expected to be a revenue opportunity is actually being realized as a contra expense and was implemented a couple months later than originally anticipated. Economically it results in a similar gross profit or adjusted EBITDA outcome, but because of the classification difference our revenue range needs to be adjusted for this new classification determination.
For the second factor, there are some larger customer opportunities in the pipeline that have been slightly delayed from an expected ramp date. We are working on the issues surrounding these opportunities and we'll work on ramping them as soon as possible but they unfortunately will not have as much of an impact on 2016 results as we would have initially expected.
As for adjusted EBITDA, we are adjusting our 2016 estimates to a revised range of $80 million to $85 million from a range of $82 million to $92 million prior, which is a modest lowering of the bottom end of the range and a tightening of the entire range. While our adjusted EBITDA margin expectations are largely unchanged, the absolute level of adjusted EBITDA is expected to be modestly impacted primarily by a lower level of revenue than previously expected.
Consistent with what we articulated over the last few quarters, we remain confident in our belief that adjusted EBITDA should increase with each successive quarter throughout the year, which results in an upward slope throughout the year.
So far this year we reported $19.1 million in adjusted EBITDA in the first quarter of 2016 and $19.2 million in the second quarter of 2016. This is the third consecutive quarter of adjusted EBITDA growth since the third quarter of 2015, which was the first quarter during which we initiated the on-ramping of significant new amounts of traffic.
As for capital expenditures, we are adjusting our 2016 estimates to a revised strange of $23 million to $26 million, an improvement from a prior range of $25 million to $28 million. We have been working to use our CapEx spend more efficiently and with some modestly delayed ramping of traffic, there are additional opportunities to push some of that spend out a bit until we get visibility of additional traffic demand.
While our revised estimates reflect a decrease from our original expectations, they still represent continued growth for our business that has supported on over 50% increase in traffic volume year over year. As I noted before, the takeaway from a financial perspective is that we believe we can consistently deliver increasing adjusted EBITDA results even as we work on all of the strategic imperatives that strengthen and enhance our position for the future.
And with that, I'd like to open it up for questions. Operator?
[Operator Instructions] We’ll take our first question from Frank Louthan with Raymond James.
Great, thank you. Can you quantify the intercarrier comp benefits this year in terms of sort of gross dollars and so we can see exactly what that is? And then can you be a little bit more clear on the network costs, why those are increasing, just be a little bit more clear on what's driving that up? At this point I would have expected some of that -- those costs to have come down as you've gotten a full year under your belt with T-Mobile but just an idea of what the short term changes on that?
Sure. On the first question, Frank, about intercarrier compensation reform benefits. In each quarter we might expect something that would be measured in north of $1 million. I won't get into more detail than that but it's definitely going to be a benefit especially considering that we have so much more long distance traffic now with some of the ramping of business that we've had over the last year.
As for the network expenses, I would say a lot of that in the second quarter had to do with the types of traffic that we’re taking on. There was a significant portion of long distance traffic which as you know it's a very low margin business because there is a lot of variable costs associated with determination portion of it. At this point, I would say that we expect our gross margins to be at a bottom and that they would be improving from here, largely because we have taken on not only a lot of -- at this point all of the long distance kind of traffic that we expect to be taking on but we also have done a lot of the build out that puts in a lot more fixed circuits and fixed network costs that we will be bringing that traffic on, some of it was during the second quarter but the rest of it during the third quarter. So we feel pretty confident that from here on out gross profit margins should improve as well as adjusted EBITDA margins.
So was that some of the one-time costs that you have that impacted the network, some of this build out and so just to kind of summarize you have a very good idea what the traffic patterns are now. So going forward we shouldn't see more of these changes – as dramatic change in mix as you've seen in the past and you start to see the benefits of some of the circuit costs you spent.
Yes. What I would say is that whenever we're ramping up such a significant amount of traffic like this, we don't necessarily know exactly what the profile looks like. Before we're taking it on we have a good idea and we work with our customers to get a sense. But it's only after we get it on that we can then go, hey you know what, we had to over-build before, now we can optimize a little bit better. In advance of this, especially with a lot of the traffic that we were doing during the second quarter, we did have elevated NRCs. They were higher than we expected but really the point I want to make here is they should be transitional in nature.
As we really get done with getting a lot of this traffic on, they should reduce pretty significantly throughout the rest of the year and while we will still do some optimization, I would say next year, it should be with NRCs that are lower than what we are realizing right now. And that is part of the reason why I think that our adjusted EBITDA was a little bit less than we would have hoped. The NRCs were higher than expected but the silver lining in that is that they are transitional in nature.
Can you quantify the one time and then maybe going forward, how much lower you expect that to be and then sort of following up on that, I was under the impression you've been working on some of this network optimization for most of the year. But if not, it might been finished, maybe I didn't understand the pace, how long you think it takes to get the network optimization plan? Yet pretty fully in place.
Yeah, just with respect to network optimization, that's really more of a once we have the traffic on, we then can see what we will do with it. As we reported we got up to 54 billion minutes of use this quarter. We still expect to get up to 60 billion and that started from a base of around 34 billion, not quite even a year ago. A lot of the traffic that we took on during the second quarter, not only with some of that long distance which definitely is very low margin but we had to do -- I would say compared to the prior quarters a lot more of a particular kind of traffic that requires a lot more hands on activity and fixed circuit that we put in place that have a lot of NRCs. So in my prepared comments I noted that we had about $1.2 million of non-recurring costs during the quarter.
Now I don't want to necessarily give the impression that $1.2 million goes to zero. Those were our total NRCs. We might have a normal base rate that few hundred thousand dollars, call it 300,000 to 500,000. So we were definitely elevated by 700,000 during the quarter and that's the part that we would expect to trail down throughout the back half of the year. We'll have some of the third quarter because that fixed network costs that we're really putting in a place that really ramped up in Q2, we expect some more of that in Q3. But as we get through Q3, that part should reduce. Once we have all the traffic we would anticipate to be doing a little bit more of network optimization but I would characterize it is it's much lower scale than the ramping up that we've been doing during the second quarter and third quarter.
And just to be clear, is this traffic all coming from one particular customer or if you’ve added some new customers, maybe some of the M&A in the industry has brought you some new customers that have changed some of the pace, as well or is this still kind of optimizing for the customer you announced last year?
Sure. A lot of it is the follow through from that large customer ramping but there were projects that we were doing during the second quarter for some of our other major customers too that impacted these costs as well.
Thank you. And we'll go next to Simon Flannery with Morgan Stanley.
Hi, this is Lisa for Simon. Thanks for taking the question. With regards to the guidance change for 2016, how should we start framing 2017? Does this change kind of the longer term outlook for that or is it just -- are you still going to be able to get to kind of a run rate point where ‘17 is largely not impacted?
Sure. Should largely not be impacted. Just as a follow on to a lot of those comments about non-recurring to us, that played a significant role in bringing down the guidance on because they obviously impact 2016 but we want to expect this to necessarily be recurring in 2017. As we've articulated since third quarter of last year and especially as we brought out our guidance for 2016 we anticipate upwards sloping adjusted EBITDA throughout the year, such that probably the best kind of guidance I might be able to provide to you on 2017 is where we exit the year would be pretty indicative of what we think 2017 might look like as we sit right now, wouldn’t be impacted by these non-recurring costs, we would have more than 60 billion minutes of use on our network and working with all the major carriers just as we have in the past.
We’ll go next to James Breen from William Blair.
Thanks for taking the question. Please talk about – in a revision to guidance, how much of it is from the re-recognition of the revenue as contra expense versus just intended to the traffic close?
Sure, on the revenue part I would frame it as between $5 million to $10 of the revenue was due to the reclassification of how some of the economics will flow with our customers.
And then from a margin perspective, are you seeing more MOU growth from lower margin product that's part of what's driving down the EBITDA?
A lot of that is related to taking on the long distance traffic is one of our major contracts that just by the nature of it that the margin of LD is so much lower than other kinds of minutes of use that it just dilutes the margins overall.
Is there change going forward in terms of -- you obviously sort of kept MOU you expect more of that MOU growth now to shift towards the LD side but visually –
I would say at this point we're probably at a new level of mix that won't change much. It was really during the last year as we ramped on a whole bunch of long distance traffic and keeping in mind if we didn't deal much with long distance traffic to begin with and especially not often that long distance traffic, that's the stuff that is very low margin. At this point we've gotten to what I'd say is the new level. The new mix that I wouldn't expect margins to continue to trend down which is what happens whenever you're taking on a whole bunch of low margin one just as traffic and it's at this point as I noted in my prepared comments, I expect gross profit margins and even EBITDA margins to improve going forward, largely because we have got into this new mix model and we will be getting benefits not only from an air carrier compensation reform but will be getting a lot of the non-recurring costs out of the way such that that won't be ahead when that we have to face during the early results and
And then just lastly on the off-net LD traffic. Is an effort there or is there opportunity to bring some of that on net to improve margin profile. No, not really if we. It just depends where the traffic terminates to and if we have particular relationships with those carriers and keep in mind we do already have relationships with all the major carriers. That I wouldn't expect that to change that much. But I would note that we're always working with new vendors to lower our costs and with the scale that we've taken on recently we do believe that it provides us more opportunities to negotiate better deals.
We'll go next to Hamed Khorsand from BWS Financial.
Kurt, can you just talk about the revenue guidance here because based on your commentary Q3 gets 60 billion minutes. If I even bring down the MOU rate to $0.00166 for both Q3 and Q4. I'm above your revenue guidance. So I'm just trying to get an understanding of what are you assuming here as far as rates and minutes of use after Q3.
Give me just a second here. You expect the rates to be going down some for some of the traffic, the overall ARPM that I think would be addressing your question there.
But ARPM has to go down quite significantly, right, we’re at $0.00168 and I'm telling you it's at 0.00166 that would still be above your guidance.
There are some types of traffic there that we would be taking on, during the third and fourth quarters that do enhance other parts of our cost structure but our relatively low ARPM minutes. Keeping in all of that’s factored into not only our revenue guidance but also our EBITDA guidance. So although there might been some lower ARPM minutes coming on it does not impact EBITDA in a negative way.
And you just were talking about how -- on the reclassification revenue was about a $4 million to $10 million impact. Could you just quantify the remaining -- almost $20 million of revenue guidance that you're basically saying it's not going to happen this year?
Well it's not $20 million but there has been a shift in key different things with customers that some of the ramping takes a little bit longer. There are also impacts with the step down with Inter-carrier comp that does actually have a negative impact on some of our revenue for our customers DID customers but it's primarily just shifting some stuff out a little bit that we do expect we'll be getting on later in the year. So that will have it in 2017 but we wouldn't necessarily have had it for as many months of 2016 as we would have initially hoped for.
My last question is, just talking about the Omni product, the growth you've seen there as far as the number of customers and the phones number sold it. What kind of revenue contribution do you think that could provide going into latter part of this year and then 2017? Is it going to be material at all or there's more to 2018 development?
I suppose it would depend on what exactly you might mean by material but we're very optimistic with what Omni can do. It's a very exciting space and we would expect that as we get more and more phone numbers and we get the usage pull through and following on to Matt’s comments, it's not just a matter of getting a phone number on but you need to get the traffic flowing through it. We believe that this year is a ramp up year, we would see revenue that would be double digit millions next year and 2018 we would be optimistic that we would be even significantly higher than 2017. We’re in the very early days but we're ramping up as aggressively as possible and just pivoting into the space that we see as the future.
Is it profitable yet for as a standalone business?
Profitable, no. Keep in mind that this kind of a business when you're growing rapidly it will take cash to be able to grow it and if anything it would have a modest drag on results over the shorter and medium term as the business grows largely due to the rapid growth. It might be helpful to look at companies such as Twilio which went public recently and I think you'd be able to see even from their filings that they are at about an EBITDA neutral point even at this stage while they're growing rapidly.
End of Q&A
And we have no further questions at this time. I’d like to turn the call back to our presenters for any closing remarks today.
Well, again we want to thank everyone for joining us on the call today. We look forward to speaking with you next quarter. Thank you.
This does conclude today’s program. Thank you for your participation. You may disconnect at any time.
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