Innovate Corp (VATE) 2003 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter earnings release conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star than zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. John DePodesta, Executive Vice President. Mr. DePodesta, you may begin.

Thank you, Jennifer. Good afternoon and welcome to PRIMUS's second quarter 2003 financial results conference call and webcast. I'm John DePodesta, Executive Vice President, PRIMUS. For those who have not had a chance to review the earnings release, it has been posted and can be reviewed on our website at www.primustel.com.

To summarize our results for the second quarter and other information provided in the release, we reported record net revenue of $320 million, record income from operations of $13 million, net income of $20 million, or 21 cents per fully diluted share, positive cash from operations was $19 million, W further reduced debt in the second quarter of 2003, and we had record gross margins of 38.7%, a 190 basis point increase from the prior quarter.

Management will review these highlights in greater detail during the formal remarks and question-and-answer session of the conference call. Joining me from PRIMUS on today's call are Paul Singh, Chairman and Chief Executive Officer, and Neil Hazard, Chief Operating Officer. We will begin with formal remarks from management regarding the company's second quarter 2003 and recent developments. This will be followed by the question-and-answer session.

Before we begin, please be advised that statements made by the company during this presentation that are not historical facts are forward-looking statements for purposes of Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. These statements may include but are not limited to revenue and earnings projections, statements of business plans and objectives, and capital structure and other financial matters. Forward-looking statements may differ from actuality, and relying on them is subject to risk. Factors that could cause forward-looking statements in this presentation to differ materially from actual results are discussed in the company's Form 10K and 10Q and other periodic filings with the SEC. These filings may be obtained from our website at no cost. The company is not necessarily obligated to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

I will now begin the management remarks. Well, looks like Neil is going to have another enjoyable experience this quarter in reporting another record quarter for PRIMUS. This improved operating and financial performance is finally attaining some recognition in the capital markets. Our stock price has more than doubled since our last conference call, clearly aided by our restoration to NASDAQ's national market and our inclusion in the Russell 3000 Index. In fact, the day that we announced our likely inclusion in the Russell 3000, our stock closed at $5 per share. The significance of that fact is that by breaking through the $5 barrier, PRIMUS' stock once again became an eligible investment for many institutions.

Shortly thereafter, Morgan Stanley sponsored PRIMUS on a five-city nondeal road show where Paul and I were introduced, or in some cases reintroduced, to over 25 institutional investors in the United States and Canada. I hope that a number of them are participating in this call with a newfound status. We were extremely gratified with the reception we received from potential investors. We truly have a great story to tell, not only with respect to what we have accomplished but also with regard to our potential. Almost uniformly, investors were struck by the anomaly PRIMUS presents in the telecom services space, one of the few carriers that is robustly growing its revenues and dramatically improving its profitability.

Invariably, we are presented with this question: How can PRIMUS produce these results when other carriers are experiencing eroding revenues and profits? Tempted to respond that the difference of management, we nonetheless sought to differentiate our business model based on global presence, retail focus, and limited incremental capital expenditures. From the outset, our strategy has been to grab market share from the large incumbent carriers. Unlike those carriers, we are not dependent on an expanding market to grow our revenues. The over $100 billion market opportunity that we address is more than adequate to fuel our growth.

We also benefit from participating in multiple major markets globally and focusing our efforts on residential and small-to-medium size enterprises that disproportionately utilize international long distance services. Uniquely, approximately 75% of our revenues are generated outside the United States.

As we built scale in our key markets, we introduced other services, particularly Internet access and increasingly VoIP to deepen our customer relationships. Our goal is to make steady gains in top line revenue growth and percentage margin expansion in order to drive earnings per share and free cash flow per share. As Neil will report, our model is clearly working.

Correspondingly, we have continued to reduce our overall debt and anticipate through refinancing to lower our cost of capital which, in turn, should provide us with a balance sheet to accommodate growth. To this end, we were benefited by Standard & Poor's recent upgrading our outlook to stable. That might sound nuanced to casual observers of the bond markets, but for a major rating agency to say something positive about a telecom carrier these days is significant. Hopefully the results we report today will prompt even more favorable responses from the rating agencies.

I expect that today's earnings results will generate additional interest in the PRIMUS story, and we plan over the next several months, with the assistance of several sponsoring investment banking firms, to spread our message among the institutional equity investor community. Now I would like Neil to report on the encouraging substance of the message we will be delivering. Neil?

Thank you, John, and good afternoon.

To sum up our financial results for the quarter, it's really record high, record high, record high, and record high. We had record high revenues for the quarter, record high gross margins, record high operating income, and record high net income before gains on early debt retirement.

The revenue was $320 million, which is a record high for PRIMUS, and we have now surpassed the previous record quarterly high of $310 million, which we achieved in Q4 of 1999. Revenue has grown 27% over the prior year while other companies are declining.

There are three factors which contributed to this record revenue growth. We've had very good organic growth among our various business units, we have had acquisitions, which included the cable and wireless customer base in the U.S., and the foreign currencies have increased in value.

Our gross margin also is a record high in terms of both dollars and as a percent of net revenue; and this has resulted from lower variable termination costs that we've received from other carriers, a higher revenue mix of retail and data Internet revenues, and finally, more traffic going over the internet through our own VoIP network.

Our SG&A for the quarter was higher due to increased sales and marketing expenses which were really investments for the future for continued revenue growth for the remainder of the year 2003. During the second quarter, we had a one-time loss on a sale of an asset in Europe amounting to $804,000, and this resulted in operating income of $13 million for the quarter, which is also a new record high.

We had an $8 million gain from the early retirement of debt, resulting from our repurchase of high yield bonds in the open market at a discount, and the settlement of a vendor debt at a discount. We also recorded a $15 million foreign currency transaction gain during Q2 due to intercompany loans that are denominated in foreign currencies to our foreign subsidiaries. This gain is over and above the normal increases and decreases in revenues and expenses in each quarter due to fluctuations in the value of the foreign currencies. And at the bottom line this all resulted in a net income of $20 million, and that is income.

In this quarter we also had a one-time Dean dividend on the preferred stock that we had sold to AIG, and this is a noncash, nonrecurring item relating to the last piece of their investment on April 1st. Thus our earnings per share for the quarter are 21 cents positive for Q2.

Looking forward for the rest of the year, our outlook for the entire year 2003, and this assumes stable foreign currencies at the current levels, we are -- our goal is to achieve revenue at the high end of our 20% to 25% growth range. It's to achieve operating income at the high end of our $52 million to $60 million range, and it's to achieve earnings per share of 38 cents to 42 cents for the entire year.

Our balance sheet is in good shape and has been steadily improving. We have now reduced our long-term debt down to $542 million, which is a recent record low over the past four years, and our corresponding quarterly interest cost is now down to $14 million per quarter. We had another outstanding quarter from a cash flow perspective, and our cash flow from operations, or operating activities, we generated $19 million in the second quarter, which is very similar to almost the same as the $20 million that we generated in Q1. Our capital expenditures and business acquisitions were $6 million for the second quarter, which resulted in a free cash flow for the quarter of $13 million, and we also paid out $24 million in cash to reduce our long-term debt. This resulted in an ending cash balance of cash and restricted cash of $78 million.

So in summary it's a very strong quarter, and our goal is to keep improving the results over the next months of 2003. And with that we would like to open up for questions.

Jennifer, would you please review the polling process and start taking questions?

Thank you. If you do have a question at this time, please press the 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, if you do have a question at this time, please press the 1 key. One moment for questions. Our first question comes from Vik Grover of Kaufmann brothers. Please go ahead.

Hey, guys, great job.

Thanks, Vik.

Nice to see it. It looks like obviously Europe international still is very strong. Can you talk more about your prepaid launch there maybe, you know, how many points of sale do you have or distributors and some insight into what are your best selling cards? On the other hand, minute growth in Asia remains weak. What are you doing there to kick-start growth, especially considering that's one of your more mature markets where you have a great brand? And then as a follow-up, can you give us an update on the voice-over-IP business, especially your PC-to-phone relationships with other carriers and maybe usage on the network to help cut line costs? Thanks.

Well, to begin with, you mentioned prepaid cards in Europe, but we like to use the term Virtual Mobil Network Operator because most of our customers in Europe are mobile phone users who purchase our cards when they travel from their home country to another European country, and as you know, the cellular charges for roaming from the PPCs in Europe are extremely high. So we offer customers a way to dial local access numbers when they are traveling and use PRIMUS for their international calls, and that makes up the majority of our prepaid customers in Europe, which is growing very nicely, has hit a record high for us in the second quarter, and we are also expanding those services in the U.S. and in Japan again to capture not only the prepaid market but really the mobile cellular phone users when they make international calls.

Our growth in Asia, yeah, the minutes are a little bit, you know, versus the other companies, maybe a little low, but we actually have had very good success with our data Internet business in Australia, and they will be doing a separate press release in several days on their business, but we are now the number two DSL carrier in Australia next to Telstrip. And as you know, we have all of our equipment in all of the Telstra central offices. So we are a facilities-based DSL carrier just leasing the copper wire into Telstra. Our Australia business remains from revenue and operating income, net income, you know, very, very strong. It's having records of its own.

The V-over-IP business for us continues to grow. We have one of the most extensive V-over-IP networks and business. It's small compared to all of PRIMUS. We don't get, you know, as much publicity as those companies just to V-over-IP but as you know, we are now listed in Microsoft XP in all of our PRIMUS countries now. So users can now register with PRIMUS and make phone calls from their computer and, you know, as we said, you know, we have, particularly as we expand the service among more and more ISP partners, particularly in some of the lesser developed countries, our network reach continues to expand and, again, we use an open network approach. So any ISP with Cisco equipment can hook up to PRIMUS and utilize our services, billing software and things like that. We are open to, which really expands, you know, the potential market for us.

And if I may, one last question. What should we assume in terms of a long-term tax rate and what time will you potentially start flowing through, at least from a P&L perspective for reporting purposes taxes? I imagine it wouldn't be necessarily 38%. Can we assume something lower? Is there a way for you to manage your tax payments, given your international make-up?

Our situation with income taxes is that, you know, so far we've been -- we've had enough losses in the past that we have not paid any significant income taxes in any country. As you know, PRIMUS Canada and PRIMUS Australia particularly have been, you know, very, very profitable over the last several years, and they are starting to get to where they have used up their losses and will be in a tax-paying position in their respective countries beginning next year in '04. Then eventually -- so you are going to start to see income taxes which are paid to the foreign countries for those units, and then the U.S. comes later. So, you know, the tax rate's going to go from zero and it's gradually going to rise to, you know, 15% to 20% of total and then eventually the U.S., which is also making money now, will use up their losses and, you know, I would say over a three- to five-year horizon will be in the 20% tax range over a seven, eight, nine year horizon then we would be up in the 25% tax range.

Thanks a lot, guys. Great job.

Thank you, Vik.

Thank you and our next question is from Gary Gugliomo from Salomon Smith Barney. Please go ahead. Gary, your line is open. Perhaps he did not have a question. Our next question is from John West of Fund Stock Oppenheimer. Please go ahead.

Great quarter, gentlemen. My question is, how does the current accounts receivable compare with previous quarters and how comfortable are you with the ability to collect those receivables?

Well, you'll notice if you track to last quarter, our accounts receivable in terms of total dollars has increased and that's primarily a reflection of the function of the foreign currencies increasing quite a bit in the last three months. So in terms of days, it's constant from the first quarter. You know, in terms of flexibility, we're very confident of them because as we reported last quarter, we were at a record low for the company in terms of, you know, days accounts receivable outstanding. So we've been doing, you know, as good a job as ever in collecting our receivables. Our accounts payable in terms of payable days, because our revenue and business has grown, has also decreased. So, you know, that's bad news from a work count point of view but the good news is we're paying our vendors more timely and bringing those payments more current. So we're in a very good cash collections and payment situation, you know, overall for the company.

Okay. Thank you. And keep up the good work.

Thank you.

Thank you. And our next question is from Al King of Scott and Stringfellow. Please go ahead.

Hi, gentlemen, good quarter. Two questions. Regarding the foreign currency exchange transactions, $20 million net income and is it right, $14 million of that was from currency gains, transaction gains?

Yes, that's correct.

Okay. And secondly, on the refinancing of some of the debt, or issuing new debt at more favorable rates, there's been an uptick in interest rates. Does that affect you to any great degree? Are you more affected by the financial condition of your company in the eyes of the lenders?

This is John DePodesta.

Hi, John.

I think it's our hope and expectation that our performance is going to keep the gap closed in terms of interest rates. I think hopefully the rating agencies will respond favorably to some of these developments, and we can get some lift there, as well as our overall operating performance. I think from our standpoint in terms of evaluating refinance -- and this is something that we're looking at on a continuing basis. We also recognize that this really presents the opportunity for PRIMUS to take a step that could dramatically reduce our cost of capital for an extended period of time. So we are going to be very opportunistic and very cautious in terms of entering into that transaction because it's one that we're going to live with for ten years. And when we do it, we want to generate the kind of interest savings and cash flow savings and weighted average cost of capital decrease that is going to position us as a growth company for the long term. And we think hopefully if the markets remain somewhat stable with our improving operating performance, we'll see the lines cross where the favorable terms that we're seeking will be available.

Okay. Great.

I was just going to add, you know, our interest rate on all of our high-yield bonds is extremely high. Up between 11% and 13%. So we've got a long way to go to come down to long-term U.S. treasury rates.

Well, I was a little ambiguous about that because you hold some of those bonds.

One other question, Neil. The current, you list on the balance sheet the current portion of long-term obligations is $65 million. Does that include the '04 bonds, or not?

Yes, that would include the '04.

That includes the 11 3/4 of '04?

There's $23.5 million of principal outstanding.

Congratulations, guys.

And our next question is from John Hale of Xerion. Please go ahead.

Gentlemen, congratulations again on a fantastic quarter. Can you comment on the opportunities you are seeing in the market for additional acquisitions that could fuel some growth? Are you still seeing opportunities like the cable and wireless out there? And then secondly, in terms of the SG&A run rate, can you maybe give us some guidance on, should we be projecting something flat off the second quarter, or will that come down for the second half of the year?

I think on acquisition opportunities, you know, we are very selective because we want to do acquisitions which are accretive to our operating income, accretive to net income, and we want to -- you know, traditionally PRIMUS, as you know, we tend to buy things at a bargain and not pay overinflated prices. So, you know, acquisitions that meet all those criteria, you know, ending at a reasonable price are pretty few. There's not a lot of them out there. You know, we maintain -- we take opportunistic -- we keep feelers out there and we look at a lot of things but, you know, there aren't a lot of great bargains out there now. I think there are a lot of companies that are distressed, that aren't doing very well but I think, you know, we have to be careful, you know, that we don't want to make an acquisition that we overpay for or the results are going to be detrimental to the good performance that we've been delivering.

I think the other comment I should make on acquisitions is we do keep -- we sum up the names on our radar screen and then it becomes a function of, you know, that is where our currency is. So at some point, you know, depending on how well the stock behaves and what the valuations of other companies are, I think that's when the opportunities are going to come. So there are companies, especially in the countries in which we want to build more scale and scope and it's just when the start get aligned is a function of, you know, when our stock would be in the stock of the companies that we may want to acquire.

John, your question on SG&A, as I mentioned, we have been spending additional money on sales and marketing which, you know, we expect to turn into revenue, you know, additional revenues in Q3 and Q4. So I think you will see, you know, additional revenue growth in those quarters from where we are now. The SG&A dollars will increase proportionate to the revenue growth, but as a percentage, I would say it's going to be fairly flat or consistent with our second quarter.

Okay. Again, guys, congratulations. Keep up the good work.

Thanks.

Thank you. Again, ladies and gentlemen, if you do have a question at this time, please press the "1" key. Our next question is from David Levison. He is a private investor. Please go ahead, Mr. Levison. Perhaps he did not have a question. Our next question is from Drew Kumar, private investor. Please go ahead.

Which region is providing you the largest gross margins?

Right now it's Canada. And that's because we have one of the most extensive, you know, underlying networks in Canada compared to our other -- both Canada and Australia have the most extensive underlying networks, but right now Canada is the highest, followed closely by Australia.

Thank you.

And I would just add, our Canadian operations will be reporting their financial and operating statistics later this week. So please check our website if you would like more precise granularity into that performance.

Our next question is from Bruce Feldbaum of Ulysses Management. Please go ahead.

Hi. I'm thinking about your discussion about the refinancing prospect, and I guess I would be -- I'm a little bit concerned that the refinancing window may be closing potentially, and I'm wondering if you're tempting to get into the rating agencies sooner rather than later to try to facilitate this. First point. Second point is, obviously a number of your bonds are callable within the next six-nine months. Might we think that that would be the route you would go in order to take fullest advantage of a refinancing opportunity? Thank you.

We're not -- Bruce, we're not going to really comment in terms of the status of our bonds or their call positions other than to say that that's a matter of public record. In terms of what those provisions are. I think the first question with respect to the financing window, I think the first thing under score, and this puts us actually in a pretty good position, PRIMUS doesn't have to do anything, in a very favorable position in terms of our operating performance and our projected performance, and we have a very clear path in terms of liquidity. So if the market conditions are not going to be opportune for us, we're not going to be forced to take a transaction that we do not think is favorable to the company. But we're hopeful that the capital market's position will remain available to us, and again with our improved financial and operating [INAUDIBLE], hopefully we can close the gap and get to terms that we think are going to be favorable to us for the long term.

Right. Well, given the strong performance of this quarter to the last quarter and some terrific performance, I'm just, I'm wondering about the degree of urgency you have in actually trying to get the rating agency to take a fresh look.

Well, I think --

Are you able to do that, to push them to take another look?

Well, the rating agencies on a regular basis, I think, review the situation. I think one of the difficulties that we labor under is that we're in the telecom sector, and as a general industry, the rating agencies have been very hard on telecom. And as I mentioned in my remarks, we're somewhat of an anomaly in terms of a rating agency. We're one of the few carriers in this space that is showing top line growth, expanding profitability, improving financial metrics in terms of our leverage ratios and our interest coverage, and we hope that with that progression of improvement and performance that the rating agencies will take appropriate action in a timely manner.

Another question as it relates to the cable and wireless transaction. I know when you did the -- shortly after you did the transaction, I think you all were warning investors that you weren't really sure how much, what portion of the customers you would be retaining, and that was reflective really in the price that you had paid. Can you talk about the portion of the customers that cable and wireless had that you've actually retained?

Bruce, we had given the guidance that it would be between $50 million to $60 million. So that range still holds.

Got it. Okay. Thank you very much.

Thank you.

Thank you. And our next question is from Steven Pakowitz of CIBC World Markets. Please go ahead.

Good afternoon. Fine quarter, gentlemen. Just quick, I jumped on here a little late and I was just reviewing some of the news headlines that had talked about your equity and convertible financing plans, the debt financing plans. Then I didn't see anything after that. I'm sure this is probably addressed prior to my getting on the call. I just wanted, just running through this and the information out there, these are things that you plan to do, but you haven't set a target in terms of the amount of debt or anything along those lines or any sort of mix of debt equity, et cetera.

That's correct.

Okay. Just wanted to verify that. Thank you very much.

And we do have time for one more question from Farley Shiner of Scott and Stringfellow. Please go ahead.

Thank you. In terms of rates in general, both domestic and international, any change to the trends there in terms of rates coming down slightly?

I mean -- Farley, this is Neil Hazard. I think the rates are fairly stable as far as the answer for PRIMUS. On a year-over-year basis, our overall average revenue per minute, rate per minute decreased about 5%, which is much less than it has in prior years, but correspondingly our average cost per minute has gone down 11%. So again, our cost decreased at a much faster rate than our prices and hence we have growing gross margins, and we like that very much.

Do you see any network opportunities to bring the cost per minute down even further?

I mean, we always pursue those. Yes, there are opportunities. We always pursue them. Our cost per minute every quarter has come down. So that's an ongoing process and, again, we hope that prices are stabilizing and, you know, not a lot of our competitors are in bankruptcy that, you know, with a crazy, you know, discount pricing is kind of -- you know, those pressures have subsided and the bigger carriers are now worrying about their profitability and, you know, at least we'll stop cutting and maybe someday start raising rates.

Farley, another major area of favorable developments in cost reduction is the regulatory trends in Canada, the U.S., and Australia, particularly with the reduction of access charges, which is one of our major cost components. In all three of those jurisdictions we are the beneficiaries of aggressive regulatory action.

Those actions taking effect immediately or next year or -- .

They have been ongoing over the last 18 months. I would say part of what we are experiencing in terms of our reduced cost per minute is a reflection of access charges declining.

So they are just continuing to scale in?

Right.

I'm sorry.

Farley, what I was going to mention as I said earlier in my remarks, the other factor is that our V-over-IP minutes and revenue are growing steadily each quarter and, you know, we are, every quarter, putting more and more minutes over the public Internet. So again, those -- you know, it's another way we reduce our costs.

Yeah. On the guidance that you gave for 2003, have you done any sensitivity analysis, assuming maybe the rates move against you 10%? What happens to that range, or if you have done it, can you share it?

No, Farley. As you know for last -- since we've started the company, we make certain assumptions about price reductions, and like Neil said, 5% is much lower than what we have generally assumed over the years, and I think the key factor is the costs have been coming down faster than the prices.

All right. And I was just asking more about the exchange rates in case they have started moving against you.

I mean, that can always happen. It's something that's not under our control.

Right.

You know, again our -- as I said, our goals that we stated for the rest of the year have the implicit assumption that rates are stable where they are today.

Okay.

If they move -- you know, since the dollar continues to weaken, that's great and good for us. If it continues to strengthen, then that will have an effect. We are, as I mentioned, we are naturally hedged in terms of our revenues are in Canadian dollars and Australian dollars and Euros, but so are our costs because we have significant operation in each of those countries. So you will see, you know, a large fluctuation in revenue and cost and the actual impact on net income, there is an effect, but it's very small because of our natural hedge.

The mode of the translation that you have I think on percentage basis is going to be much smaller difference.

Thank you. And this does conclude the question-and-answer session. I would now like to turn the conference back to management for their concluding remarks.

Thank you, Jennifer. Before closing, I would like to mention that management will be presenting, at the Kaufmann Brothers' annual telecom conference September 3rd and 4th in New York City, and we will also be presenting at the Jefferies Telecom high-yield bond conference later in the fall also in New York City, and we hope to see you there.

That concludes PRIMUS' second quarter 2003 financial results conference call. Replay information can be found on our website at www.primustel.com. The replay will be available in about an hour hour. Thank you for joining us today and good evening.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the conference. You may now disconnect and have a good day.