Fusion Telecommunications International, Inc. (NASDAQ:FSNN) Q4 2016 Earnings Conference Call March 20, 2017 10:30 AM ET
Brian Coyne - IR
Matt Rosen - CEO
Mike Bauer - CFO
George Sutton - Craig Hallum
Mike Crawford - B. Riley
Josh Nichols - B. Riley
Good morning and welcome to the Fusion's Fourth Quarter and Full Year 2016 Financial Results Conference Call and webcast. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Brian Coyne, Fusion's Vice President of Investor Relations and Financial Planning. Please go ahead, sir.
Thank you and good morning to everyone joining us on this conference call. Earlier today, Fusion issued a press release announcing its results for the fourth quarter of 2016, which is available on the Investor Relation section at Fusion's Web site at ir.fusionconnect.com. There will also be an audio replay of this call available for a limited time on our Investor Relations Web site.
Presenting on today's call are Matt Rosen, Fusion's Chief Executive Officer and Mike Bauer, Fusion's Chief Financial Officer.
Before we begin, let me remind all participants that during this call, we'll be making forward-looking statements that are subject to risks and uncertainties. Any forward-looking statements are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Expressions of future goals, including without limitations, expressions using the terminology may, will, believe, expect, plans, anticipates, predicts and forecasts, along with other expressions, which reflect something other than historical fact are intended to identify forward-looking statements.
These forward-looking statements involve a number of risks and uncertainties, including factors discussed in the risk factor sections of our Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q and in our other SEC filings and company releases. Our actual results may differ materially from any forward-looking statements due to such risks and uncertainties. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call, except as required by law.
Also the discussion this morning will refer to adjusted EBITDA, which is a non-GAAP measure. The presentation of GAAP financial measures and a reconciliation of non-GAAP information to GAAP financial measures is included in the press release that we issued this morning, which is also available on Fusion's Web site.
And now I’ll return the call over to Matt.
Thanks Brian, and welcome to everyone joining us on today's call. I'd like to start off by highlighting some of our many accomplishments during the fourth quarter and throughout 2016 that have further strengthen Fusion in the market place and have positioned us to create additional value for our shareholders. I’ll also spend a few minutes discussing Fusion's results for the quarter and emphasis several important customers wins illustrating how Fusion is succeeding in the market place as a single source for the cloud. I’ll then provide an update on our progress integrating the Apptix acquisition and leveraging the breadth of opportunities it has brought Fusion and on our growth strategy within the business services segment. Following that I’ll turn the call over to Mike for a more detailed review of our results after which we'll open the call to your questions.
2016 was a year mark by measure accomplishments for Fusion. The acquisition of Apptix in November was a major step forward towards achieving the company's strategic goals of gaining scale to become a more significant player in the cloud services market and creating an infrastructure that can support substantial future growth particularly in private and hybrid cloud, disaster recovery and enterprise storage. We exited the year with a revenue run rate of approximately $110 million in our business services segment, from the starting point four years ago of just $2 million at which time we made the strategic decision to expand into the cloud services market.
Since then, we've seen our business opportunity increase dramatically, as companies of all sizes have moved toward cloud base solutions and away from premises based infrastructure. We have done so not only because the cloud is far most scalable and cost effective, but also because of how significantly it improves communication, collaboration and productivity. The bankruptcy of one of the major on-premises provider in January is another indication that the cloud has won and that this market will remain a dynamic, fast moving and exciting opportunity for Fusion in the years to come. To underscore that point, last month Gartner updates it's worldwide cloud services market forecast projecting it to grow 18% to $247 billion in 2017, a remarkable rate of growth given how large the market opportunity already is.
Additionally, we continue to see the cloud services market evolve towards customers demanding integrated end-to-end solutions more and more frequently which placed Fusion's competitive positioning as the single source for the cloud. Companies are realizing that working with multiple providers is becoming harder for them to manage and often leads to finger pointing when something goes wrong. As businesses become more sophisticated and their needs become more complex, Fusion's advantage in the market places grow, thanks to our ability to provide companies with everything they need to move to the cloud.
Our single source strategy is also designed to capture a wider portion of the cloud services market opportunity. Along these lines and other exciting accomplishment during 2016 was our entering to the multi-billion dollar contracts in a market through our acquisition of TFB last March. This transaction positions Fusion not only cloud services -- as the only cloud service provider that we know of that can offer an enterprise grade contacts in a platform one which we consider to be among the very best in the market which is integrated with our own cloud based unified communication solution delivered over our own nationwide network.
I'm also pleased to announce that in the fourth quarter, Fusion successfully delivered positive organic revenue growth in business services, which bodes well for our performance in future periods. This achievement is the result of our investment in sales and marketing efforts that we have discussed on previous calls, along with strong execution on part of the team.
Now, I’d like to review our results. For the fourth quarter, Fusion reported consolidated revenue of $28.9 million up 8% year-over-year. The increase was driven by our business services segment, which grew at $24.2 million up 41% over the fourth quarter 2015. Revenue of the company’s carrier services segment was $4.8 million compared to $9.8 million in the fourth quarter of 2015. On previous calls, we’ve noted that we managed our carrier services division, as a balance between revenue and margin contribution and given the lower margin of our carry division the overall impact to EBITDA is nominal.
Although, we do expect revenue in this segment to increase meaningfully in upcoming quarters, our primary strategic focus continues to be on growing our higher margin, recurring revenue business services segment, which in turn will drive higher consolidated gross margins and EBITDA margins.
Our adjusted EBITDA in the fourth quarter was $2.2 million up 36% versus Q4 2015 and 29% versus the third quarter of 2016. For the first quarter of 2017, we expect adjusted EBITDA to show a meaningful sequential increase as it will include the full quarter contribution from Apptix and reflect our achievement of a significant amount of planned cost synergies from that acquisition.
We also remain focused on bookings of monthly recurring revenue as a key metrics for the momentum in our business. For the fourth quarter MRR bookings were $300,000 up 44% year-over-year. These bookings represent a total contract value of $9.9 million, which grew 39% over the same period prior year. And as for the full year 2016, total contract value of bookings was $38 million grown 66% over 2015.
Our organic gross sales contributions during the fourth quarter included a three year $640,000 contracts to provide specialized secured cloud solutions to a leading teaching hospital and medical center in the Northeast. Fusion's solutions for this customer integrates our unified communications with a truly diverse connectivity to the cloud in support of the hospital's technology innovation and disaster recovery planning strategies.
This win highlights Fusion's strength in the healthcare vertical where our solutions are designed to address the specialized needs for hospitals and medical offices for reliability and security as well as the strict, regulatory requirements within the industry.
Another example of Fusion's success as the single source of the cloud with a three-year contract we secure with a leading provider of payment processing solutions to the financial services industry. This solution for the customer seamlessly integrates Fusion's Cloud Voice and networking services with advanced business continuity at a powerful enterprise grade contract centered solution. Something that truly distinguishes Fusion from competitors that typically focused on one or two services.
Finally, during the fourth quarter, Fusion's Cloud Communications platform was selected by a rapidly expanding chain of Asian inspired quick service restaurants. Fusion is initially connecting 40 of the company’s locations on the West Coast with significant opportunity to grow with the client in support of its aggressive nationwide expansion, which could reach several hundred locations.
Now, I’d like to spend a few minutes updating you on our progress with Apptix. As a reminder, we closed this acquisition on November 14, adding a range of hosted enterprise solutions including hosting exchange virtual desktop, collaboration, security and compliance along with additional infrastructure to provide private and hybrid cloud disaster recovery and enterprise storage solutions on a wider scale.
These solutions are highly complementary to Fusion's offering and greatly increase our point of service beyond communication and connectivity. Apptix also brought a powerful cloud computing infrastructure with significant available capacity to accommodate our future growth, enabling us to expand our cloud computing services more quickly and at a much lower cost than if had built it ourselves.
We’re extremely pleased with the business and the professionals that are now part of Fusion and are excited about the breadth of opportunities ahead for the combined company. Apptix contributes to Fusion approximately $25 million in annual revenue with over 90% monthly recurring and with a gross margin of approximately 60%. Once we fully realized our anticipated synergies, we expect Apptix to generate approximately $8 million in adjusted EBITDA. As you'll recall, we follow a rigid process to tightly integrate the businesses that we acquire and that process is well underway with Apptix. In the four months since the deal closed, we have completed a significant number of integrations tasks including the consolidation of offices, network and system infrastructure and financial operations.
The tasks not only represent important steps towards combining the businesses, but also toward realizing meaningful cost savings. As of today, we’ve already achieved approximately 70% of the synergies that we identified prior to completing the deal and we anticipate realizing the full run-rate of our expected synergies by the second half of 2016. We are also actively expanding the scope of new business opportunities, as a result of the Apptix acquisition. We have completed extensive training sessions for our combine sales and marketing, product and support teams and are implementing and introducing up-selling and cross-selling plans into the market. These efforts have already resulted in several new sales involving key product offerings that combined the strengths of both companies including UC, manage services and host [ph] exchange.
Another key benefit we’re seeing is that the enterprise cloud computing skill set we gained through the acquisition is adding real value to the rest of Fusion's offerings by allowing us to better assist our customers in moving of their businesses to the cloud. We view that capability as an exciting opportunity to expand Fusion's reach and further differentiate ourselves from the other providers.
In summary, we feel very good about our progress with Apptix on the integration and on the business front and continue to expect to contribute significantly to Fusion's financial results as we execute on revenue and cost saving opportunities.
Now, I’d like to turn the call over to Mike, who will provide us with additional details on Fusion's fourth quarter and financial performance. Mike?
Thank you, Matt. [Technical difficulty] 2016, Fusion's consolidated revenue was $122 million up 20% versus 2015. Business services revenue was $86.6 million up 31% from the previous year, while carrier services revenue of 35.5 million was flat compared to 2015. Our adjusted EBITDA for the full year was 8.9 million up 9%.
In the fourth quarter of 2016, Fusion's consolidated revenue was $28.9 million, up $2.1 million or 8% versus our fourth quarter of 2015 due to very strong growth in our business services segment offset by a decline in our carrier services revenue.
Business services revenue grew 41% year-over-year to $24.2 million due primarily to the acquisitions of Fidelity in December 2015 and Apptix in November 2016. In our Carrier Services segment revenue in the fourth quarter was $4.8 million compared to $9.8 million in the fourth quarter of 2015. In the first quarter of this year 2017, we expect Carrier Services revenue to increase sequentially to over $6 million.
Our consolidated gross margin during the fourth quarter was 51.2% compared to 42.7% in the fourth quarter of 2015 and compared to 44.8% in the third quarter of 2016. This increase was due to a greater mix of business services revenue in the consolidated results. The business services segment gross margin was 60% compared to 63% in the fourth quarter of 2015 due primarily to the acquisition of Fidelity which carried a lower gross margin. Carrier Services gross margin during the fourth quarter of 2016 was 7% compared to 7.2% in the fourth quarter of 2015.
Adjusted EBITDA for the fourth quarter was $2.2 million, up 36% compared to $1.6 million in the fourth quarter of 2015 and up 29% sequentially from 1.7 million in the third quarter of 2016. Loss before income taxes in Q4 2016 of $6 million was flat compared to Q4 of 2015. In the fourth quarter of 2016, we recorded a $1.6 million income tax benefit related to the Apptix acquisition. This was a result of certain intangible assets having a different book bases versus tax basis. In 2015, we had recorded a $7.7 million income tax benefit related to the Fidelity acquisition, driven by an even larger difference in book versus tax basis.
4Q '16's net loss was $4.4 million compared to $1.6 million net income in Q4 of 2015, the year-over-year difference a result of the lower tax benefit in 2016. In conjunction with the Apptix acquisition in the fourth quarter, we also completed a five year $70 million senior credit facility led by East West Bank at an interest rate of LIBOR with no floor plus 500 basis points for approximately 6%. The facility consists of a $65 million senior term loan and a $5 million revolver. Fusion simultaneously retired it's previously outstanding $40 million credit facility.
The new facility reduced our weighted average cost of debt by approximately 50 basis points. Our weighted average interest rate has dropped from over 11% two years ago down to approximately 7.7% today. We are constantly looking at ways to strengthen our balance sheet. Over the course of this year, we will be focused on deleveraging our balance sheet by continuing to improving our EBITDA performance as we begin to realize the fully synergized impact of Apptix as well as reducing our outstanding debt levels to reschedule principal payments of $3 million.
We also expect our acquisition strategy will continue to provide opportunities to improve our leverage ratio. We ended the year with approximately 13,300 business customers with an average monthly revenue per customer or ARPU of $679 up from $544 last year and up from $568 in the third quarter of 2016. Our churn rate was 0.8% in the fourth quarter, slightly down from our historical average of 1% to 1.2%.
With that, I’ll turn the call back to Matt.
Thanks, Mike. Fusion ended 2016 having achieved a number of important milestones and with significant momentum in the business and I’m pleased to see that continuing 2017. The market is embracing Fusion's fully integrated end-to-end cloud services suite, which significantly distinguishes us versus competitors. We’ve also made the investments to build a highly scalable service delivery platform, which we are enhancing with a new unified, OSS or Operational Support System, while consolidating our billing systems to a single new billing platform. The process of migrating data to these systems is well underway and we expect to fully integrate them during the third quarter of this year.
This will enable us to achieve several things. We’ll reduce our operating expenses, we’ll deliver an enhanced experience for our customers particularly in a deployment of new services and maintenance of existing customers. We’ll shorten the interval between securing a new contract win and recognizing revenue associated with those contracts and we’ll be able to integrate future acquisitions more quickly and efficiently.
We remain committed to our immediate -- intermediate financial goals of consolidated annual revenue of $200 million 50% gross margin and 15% adjusted EBITDA margins. We firmly believe that our strategy of growing our business services segment through targeted M&A complimented by moderate organic growth enables us to acquire customers at a meaningfully lower cost than our peers.
We view this as a major benefit of our growth strategy as it creates significantly greater value for our business and ultimately for our shareholders. Earlier I mentioned our success in Q4 of generating organic revenue growth in business services, which gives us confidence in our ability to reach our goal of 5% to 7% annualized organic growth later this year.
We expect to achieve this while maintaining our sales and marketing costs of approximately 10% of revenue, which is in stark contrast to several of our other peers that have -- are having to spend more and more, over 50% of revenue in recent quarters to fund their top line growth.
And finally, we’re optimistic that we can continue to buy one or two businesses per year, that'll add a material amount of customers, revenue and cash flow to our business, while expanding our market opportunity with additional software and services. Our current M&A pipeline is robust and we plan to remain highly disciplined in evaluations we’re willing to pay to acquire customers through acquisitions.
In summary, 2016 was a year that strongly validated Fusion’s position and growth strategy. The market is clearly moving in our direction and I've never felt better about the opportunities ahead. Our investments in sales, marketing, service delivery, and billing in back office platforms have positioned us well to execute our strategy. We expect to continue to drive solid cost efficient growth from our internal sales effort and the Apptix acquisition as well as potential future acquisitions in order to create long term shareholder value in 2017 and beyond.
Now, I'd like to turn the call back to the operator to open up to any questions you guys may have.
Thank you, Mr. Rosen. [Operator Instructions] And your first question will come from George Sutton of Craig Hallum. Please go ahead.
So, Matt can you discuss your position as an end-to-end cloud provider? I'm wondering if you could break down, how those deals are coming about, are you wedging your way in with a single service, are you actually seeing RFPs where you can respond relative to this breadth of the services or if you could kind of break it down I think that'd be helpful.
Sure. Absolutely, so when we go into a customer I think there is two major components that we focused on initially. The first is just to give them a very high level sense of the types of things that Fusion can provide because it is fairly unique in the marketplace, so we want to start by just giving them a sense of our overall holistic offerings. And then we sit back and listen, I was always taught; you have two ears and one mouth, so listen twice as much as you talk. So, our team believes the same. So our goal is to really go in to clients, listen to what their needs are and then respond to those needs with particular solutions that we have.
Now, what we'll typically find is that customers from day one are not going to say oh, that sounds great, let me move all of my services to Fusion and move the whole company to the cloud. What we’ll typically see is, the company will embrace two or three of our service offerings, but then great comfort in the fact that as they do decide to expand into the cloud more aggressively that we can handle that as well. So, it's really a dual pronged strategy there, which is right off the bat they're more comfortable because we can deliver the two or three services they need at that time, but also great comfort that we can provide a growth trajectory for them to handle more and more services that they need as they expand further into the cloud.
Okay. Thanks for that. And I think a somewhat related question relative to a couple of your metrics, both were surprisingly good. I wanted to understand the sustainability. So, first your ARPU was up about 20% sequentially. What's driving that, is that the breadth we just talked about, is that larger size customers? And then secondly churn, that was half the level we expected, and I know it’s a little bit below your typical churn rate. Is that sub 1% level sustainable?
So, the first question, George about the ARPU. I think there is two reasons driving that, and I think you hit on both of them. We’re focusing on larger clients as we have in the past. And again, for us the larger the client, the more sophisticated their needs, the more we excel. So, we’re able to focus on larger clients because we can offer more products and services. And the second reason ARPU is driven higher is because we can offer those additional product and services. So, it's really been driven by the size of the customer as well as the breadth of services that we can deliver or the number of services we deliver to each customer and close to 90% of all the customers that we bring on today are buying at least two services. So, we’re really seeing the traction around that.
Now, the next thing is the churn. I would say that we’re going to kind of hold fast to the average churn rate of kind of that one1% to 1.2%, and I think it's going to fluctuate between a little bit less than 1% up to 1.2% depending on the quarter. But, I think that that range is something that we’re quite comfortable with.
Okay. Last if I could, relative to the Apptix addition, you mentioned the cross-selling train that you've been working on, when would that logically start to equate to new deal opportunities? Like when should we expect that to have that impact?
So we're actually starting the process of cross selling now, because as it's important that when you are starting to cross sell, it's not just training the sales people, there is a tremendous amount of back office work that needs to be done in order to prepare to be able to cross-sells. So for example, we wouldn’t want to go to the Apptix customer base and start selling them, a connection to the cloud or a contact center unless we were prepared to take that customer calls, to have the bill reflect how it should reflect.
So there is a tremendous number of back office processes, procedures and systems that also needs to be aligned in order to accommodate the cross-selling. So those things have been done for the most part and we are actually starting the cross-selling now, we have a number of campaigns where we're selling our services to the Apptix customers, their services to our customers and we're starting to see fruits of that. I would say reasonably we are not going to see kind of results until kind of mid to end of second quarter.
Mid-to-end of second quarter. Okay, perfect, thanks guys.
The next question will be from Mike Crawford of B. Riley. Please go ahead.
Regarding Carrier Services, you mentioned they are going to step up in Q1 to over 6 million from the 4.8 million level in Q4. Now is that -- does that include some -- any seasonality or is that more of a good run rate to expect for the year?
Yes, I think that that’s -- it doesn’t really reflect seasonality, that business doesn’t have a lot of seasonality other than some peak days throughout the year that are just around the holidays. I think that what we've seen is, if you recall the beginning of last year, we were much higher, and we kind of scaled it down throughout the year. So I think that the $6 million to $8 million a quarter at this point unless we do something differently at this point, that’s a reasonable figure to target. I think 6 million is probably like for second quarter through fourth quarter, but the first quarter we feel that we've started to accelerate obviously beyond the fourth quarter's revenue.
Okay, thank you. And then switching gears, Apptix, I believe you had given some metrics previously and what that business looked like before you acquired it, like 6.3 million of revenue and 800,000 of EBITDA possibly in Q3. Do you have some more metrics for Q4, as a standalone?
So, while we acquired it on November 14th, so we actually got essentially 45 days of results from the acquisition. We haven't published the kind of pre-synergy, what we've done is we've talked about once we ramp up all of the synergies of which we've already accomplished 70% of them. We expect it to be at an $8 million annualized EBITDA run rate. So you can kind of run the math, I've run it in my head, but we can kind of run the math that way.
Okay, all right. Thank you.
[Operator Instruction] The next question will come from Josh Nichols of B. Riley. Please go ahead.
I mean revenue has been ramping pretty quickly, you achieved organic revenue growth on the business services segment Q4 and I know you’ve talked about these intermediate term goals of $200 million of revenue 15% EBITDA margins. At what point do you think the company may be poised to transition to kind of more sustainable positive free cash flow generation?
So we are actually looking to achieve free cash flow by the end of this year, so not for the full year obviously 2017, but if you start taking a look at the run rate kind of at the end of this year, we expect to start generating positive cash flow.
Great, and the contact center appears to be one of the big growth opportunities going forward. Could you dive into that a little bit more about how you see that offering evolving and expanding over the next say 12 months to 18 months?
Sure, and I think you hit it right on the head there, Josh. the opportunity in the contact center is quite significant. As you'll recall, last March we bought a business that was focusing only on deploying their services to large scale enterprises. So they had 500 deployments, 450 of which were recognizable names. So they had a tremendous experience in deploying large scale enterprise contact center solutions. We have spent the better over the last year, taking that solution and making a lot of adjustments to, one is make it -- integrate it with what we have, both the unified communications platform as well as our network. And number two to be able to sell it in a more packaged way to the middle market as well.
So we're actually bringing a large-scale enterprise product, continuing to sell it to enterprises, but also making it kind of middle market friendly as well. So it’s been a lot of, lot of, lot of preparation for us to get to where we are, I would say [indiscernible] because there has been a lot of development in back office preparation to be able to launch it in a more aggressive way. We have signed a number of contact center opportunities since we bought that business, but we’ve holding back a little bit in terms of large scale and broader distribution until we accomplished a couple of things in the back office and infrastructure. And so I would expect that by mid-second quarter we'll be at full swing there pushing the contact center much more aggressively than we have.
We think it’s a terrific opportunity, we’ve got an application that in our view routinely has beaten out all the top contact center applications out there. So we think it’s in the top three most powerful contact center applications that we're aware of in the marketplace. And it is the only one, again, that we're aware of that has our UC platform integrated and it rides over our own network. And the importance of that is really associated with the problems that will inevitably arise for a business and if there is a problem with the voice call, as an example, is it the contact center's problem, is it the -- you know the third-party voice provider that’s typically brought in. Is it the network that it's riding over, where does that problem reside? With us, we own and control all of it. So it’s an incredibly compelling solution for the business customers that we're focusing on.
Thanks. Just last question from me. Just curious about what percentage of your customer base is in the healthcare vertical and do you see any material changes that mix over the next year or so?
I don’t see any material change in the mix, at least from an organic standpoint. About 20%, 20 plus percent is in healthcare.
And ladies and gentlemen, this will conclude our question-and-answer session. I would like to hand the conference back to Matt Rosen for any closing remarks.
Thank you, operator. We look forward to talking to you again in our -- for our first quarter conference call. I appreciate everyone's time today and enjoy the rest of the day.
Thank you, sir. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. You may now disconnect your lines.
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