Innovate Corp (VATE) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your fourth quarter 2007 and full year financial results. (Operator Instructions). I would now like to introduce the host for today's conference, Mr. John DePodesta, EVP. Mr. DePodesta, you may begin.

Thank you, Patrick. And good afternoon, ladies and gentlemen, and welcome to Primus' fourth quarter and year end 2007 financial results conference call and web cast. I'm John DePodesta, EVP at Primus. For those who have not had a chance to review the earnings release, it has been posted and can be viewed on our website at www.primustel.com.

Joining me from Primus on today's conference call are Paul Singh, Chairman and CEO, and Tom Kloster, CFO. We will begin with formal remarks from management regarding the Company's fourth quarter and year end. This will be followed by a 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 statement 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 Securities and Exchange Commission. 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.

At this quarterly and year end conference call, it is appropriate to review major developments of the past year and to assess our prospects for 2008. The most significant development in 2007 was our raising $75 million in cash through debt and equity issuances and extending debt maturities. Those events provided the Company, for the first time in several years, the financial resources and the flexibility to invest in strategic infrastructure and sales and marketing initiatives to drive the growth of our high margin retail, broadband, VoIP, data, hosting, local, and wireless products. It has been clear for some time that our ultimate success will be determined by our ability to grow consistently the top line and EBITDA contribution from our retail products at a pace that eclipses the decline in our legacy voice and dial-up ISP businesses and positions us to generate free cash flow and recapitalize our balance sheet.

The second significant development in 2007 was the consistent progress over the past several quarters in increasing the revenue base of our growth products which are now at an annual rate of $233 million, representing approximately 26% of overall net revenues. And this growth was accomplished while steadily improving the margin and EBITDA contributions from these products. We believe we can continue and indeed accelerate these positive trends during 2008.

To this end, while perhaps modest when viewed relatively to the outlay of our major competitors, we have dedicated resources in our 2008 plan to build critical broadband and data infrastructure to support new and migrating customers and to invest in sales and marketing programs, direct sales, and telemarketing personnel and customer retention efforts in order to improve our top line trajectory.

Thus, going into 2008, our fully funded plan is launching off of positive and improving trends, strong revenue growth from our high margin retail products, continued margin expansion, and steady EBITDA growth. Our management task is to augment and to accelerate those trends. Another significant development over the course of the last year was the simultaneous phenomena where the official currencies in each of our major markets, Australia, Canada, and Western Europe, traded at historic highs to the U.S. dollar. With over 80% of revenues generated outside the United States , Primus has been a significant beneficiary of its geographic diversification strategy. I should also add that the U.S. dollar value of our foreign franchises has increased correspondingly.

We have previously stated that one of our objectives is to become more geographically and product focused. To this end, in 2007 we made substantial progress in improving the operating performance of several smaller business units that may be potential candidates for sale. Indeed, during 2008 we plan to improve further the performance of these units in order to enhance their sales prospects. However, given the current turbulence in the capital markets, and a slower economic outlook which has led to contraction of asset valuations, we intend to advance asset dispositions only when we feel we can receive full and fair consideration.

In telecom, we have learned that little, except intense competition and pricing pressures, remains constant. As recently reported, we finally received some regulatory relief in Australia. But we expect Telstra's attempts to stifle competition to continue unabated. As a consequence, we will continue to be vigilant and engaged on the public policy and regulatory front to insure a fair, competitive environment.

Last year in Canada, the retail and residential business market was deregulated for the incumbent former monopoly carriers in most major cities across the country. We also anticipate that regulatory changes, most likely with a gradual transition phase, may be introduced in Canada during 2008. The primary impact will likely be to the terms of wholesale access to the networks of incumbent carriers. We are actively participating in these proceedings and have factored probable outcomes into our 2008 plan.

So on balance, we made substantial progress in 2007 which positions the company to build on a stronger foundation, to accelerate the positive trends of retail revenue growth, margin and EBITDA expansion in 2008. I will now ask Tom Kloster to review the fourth quarter and full year 2007 performance as well as provide guidance for 2008.

John, thank you, and good afternoon. During the fourth quarter, we continued to execute our strategy of renewed investment in both infrastructure and sales and marketing capabilities to support and accelerate growth in our high margin broadband, VoIP, local, wireless, data, and hosting products. In Australia, for example, 31 new DSLAM locations were placed into service and roughly an equal amount are expected in the first half of 2008. However, we could have accomplished much more had Telstra provided reasonable access to additional facilities.

We now have 212 DSLAM sites operational of which 173 are equipped with high capacity fiber thus enabling us to serve more customers while providing higher speed service. During the fourth quarter, we migrated in excess of 15,000 customers onto our network thereby delivering enhanced margins. Also in Australia, the fourth quarter marked the completion of our data center expansion including the addition of 100 new cabinets of space. We also saw continued growth of our commercial direct sales group and we successfully expanded our outbound telemarketing efforts focused on broadband sales to residential consumers

In Canada, we added capacity to three of our existing data center facilities and completed the construction of a new data facility in London, Ontario. As a result, we are now actively selling into all of these facilities. Additionally, we have acquired and are constructing a data center in Edmonson which is expected to be operational in the second quarter of 2008. Also in Canada, we continue to recruit and train direct sales personnel to sell the additional data center space as well as recently introduced hosted IP-PBX products. We are in the final phase of successfully migrating from our legacy TDM switch platforms to state of the art IP based soft switches which will further improve our network operating costs.

We recently completed an exclusive agreement with Aeroplan, the premier affinity organization in Canada which allows Aeroplan members to earn points for consumer telecom purchases from Primus. Additionally, we completed steps to enhance outbound telemarketing resources and capabilities thereby strengthening our marketing efforts to residential consumers. Here in the U.S., our business unit has achieved strong operating performance with Lingo, hosted IP PBX services, and international calling services to ethnic consumers. Under a new president, the U.S. unit is focused on building sales channels in 2008.

In Europe, we have recently migrated our London switch to an IP based soft switch and are in the process of migrating the remaining four European switch platforms to the IP soft switch technology. Consistent with our strategy, these efforts are all designed to enhance the revenue and contribution growth of our high margin broadband, VoIP, local, wireless, data, and hosting products.

Fourth quarter net revenue was $224 million, down $1 million or 1% from the prior quarter. As a result of the U.S. dollar continuing to weaken against foreign currencies, our reported revenue was positively impacted by $10 million. Exclusive of the currency effect, we experienced an $11 million overall revenue decline comprised of $4 million from low margin wholesale services, a $1 million decrease from European prepaid services which were fully discontinued during the third quarter, a $1 million decrease from a nonrecurring commercial legal settlement, and a $5 million decline in retail services revenue.

The $5 million decline in retail services revenue can be further broken down into a $2 million decline from a discontinued European retail product offering and a net $3 million decline in legacy voice and dial-up Internet services partially offset by continued growth in our broadband, VoIP, local, wireless, data, and hosting products. That's a lot to digest. Bottom line, we are pleased with the reduction in the rate of retail revenue decline from $6 million in the prior quarter to $3 million in the current quarter, excluding one-time items.

Revenue from our growth products, broadband, VoIP, local, wireless, data, and hosting services, grew 6% sequentially and now accounts for almost $233 million annualized or 26% of total revenue. The average margin from these products is in the mid 40% range, now roughly equal to our overall retail product margins. We expect these margins to show steady progress as we place more services directly onto our expanded network and the mix of products we sell becomes more weighted toward our higher margin products. The vast majority of our incremental capital expenditures and marketing initiatives are focused on these products.

Net revenue, less cost of revenue, was $92 million or 41.2% of net revenue as compared to $89 million and 39.4% in the prior quarter. The sharp sequential increase is assisted by the $6 million retroactive benefit from the ACCC determinations made concerning excessive pricing for local loops and line sharing. However, third quarter figures hit a similar retroactive price reduction benefit of $3 million. After sifting through these items, it is important to focus on the fact that net revenue less cost of revenue has increased for the third consecutive quarter in both absolute dollars and percentage of revenue. Our consistent progress in this area reflects both the increasingly favorable mix of on net services and the continued success of our ongoing efforts to improve the efficiency and cost structure of our network.

SG&A expense was $72 million or 32% of net revenue in the fourth quarter down $1 million from $73 million and 32.3% in the prior quarter. The decline is primarily attributable to the expected seasonal slowing in advertising spend. We continue to focus on off-shoring certain accounting, network operations, and IT service functions. That program is progressing well and we currently have in excess of 80 personnel based in India performing functions previously performed in the UK and the U.S. Additionally, we are centralizing select functions such as billing operations in an effort to further reduce our cost structure. Our off shoring and centralization efforts have predictably increased our costs in the short term due to transitional training and duplicate employee costs. However, we expect to see financial benefits from these actions during 2008.

Adjusted EBITDA for the fourth quarter was $20 million as compared to $16 million in the prior quarter. Both quarters include benefits from retroactive pricing settlements in Australia. Exclusive of such items, we continue to experience a gradual increase in adjusted EBITDA despite the revenue decline and increased spending on sales and marketing This is a result of continued improvement in cost of sales and lower spend on non-sales and marketing categories of SG&A.

We ended the quarter with an unrestricted cash balance of $81 million as compared to $109 million as of September 30, 2007. However the year end cash balance does not include $7 million received in February 2008 related to the ACCC retroactive cost settlement. Thus on a pro forma basis, year end unrestricted cash would be $88 million.

During the quarter, we retired $16 million of debt. This included the repurchasing and retirement of $7 million face value of our 12.75% senior notes due in October, 2009, the early retirement of a $5 million capital lease obligation at a discount, and $4 million of scheduled principal reductions. We spent $15 million for capital expenditures, primarily to fund the previously announced Australian DSLAM network expansion and the Canadian data center expansion. Finally, we spent $14 million on cash interest payments.

As we look forward to 2008, we believe we are well positioned to further slow the annual revenue decline to be in the range of 2 to 5% versus a decline of approximately 10% experienced in 2007. We expect to invest $30 to $35 million in our network with a majority dedicated to expanding our broadband, data, and hosted IP infrastructure to further increase on net customers. We will continue to reduce non sales and marketing SG&A spending and shift a portion of those savings towards sales and marketing efforts, likely resulting in an approximate $5 million increase in sales and marketing spend.

Our adjusted EBITDA for 2008 will in part depend on the success of our marketing efforts and our desire to attain flexibility to increase spending if our success warrants such action. As a result, we are targeting a 2008 adjusted EBITDA range of $65 to $80 million. I will now turn it back to the Operator to open the call up for questions.

Thank you. (Operator Instructions). Our first question today comes from Ana Goshko. Your line is open.

Hi, thank you very much. A couple of different questions. First of all, I just want to make sure I understand the math on the quarter over quarter revenue change. So what is the incremental growth quarter over quarter in the new initiative revenue once you take the FX out of the picture?

Ana, we stated the net overall retail decline was about $3 million this quarter and that's comprised of legacy and growth products. And that's an improvement from prior quarter of $6 million and I think even prior to that we were in that $4 to $5 to $6 million range. So I think we're pleased that we're starting to see some positive effect of reducing the retail revenue decline. We're still seeing growth in our growth products. We're trying now to sort of, kind of blur those products because they've now been growth products for two years, three years, and we're starting to sell a lot of bundled products. So I don't have an exact answer for you there but we are seeing growth within the growth products probably at a similar pace and overall we're seeing a decline in the retail revenue, the pace of the retail revenue decline.

Okay, I actually unfortunately missed this number when John mentioned it, did you give a run rate number for the new initiatives revenue base?

We did, we said that --

$233 million, Ana.

$233 million? Okay, so that sort of makes sense to me because I think last quarter that was $225 million, so that would mean that if that increased by eight, you probably had about a $2 million gain in the new initiatives revenue if I'm thinking about that correctly.

Yes, and a portion of that's currency.

Okay. Secondly, in your guidance for -- in EBITDA guidance for 2008, are there any one-time benefits that you're assuming in there like you had -- you had a COGS benefit last quarter and the other retroactive Telstra settlement. Was there anything that's included in there that's not just sort of organic?

No, I think that's organic and what we tried to do in our guidance and in our internal models is not count on the rulings from the ACCC which have been the more material one-time items. So no, it's not factored into the figures.

Okay, and then if I could just -- so on the rulings in Australia, can you give us an update on -- I know that Telstra, they can appeal the ruling, but they could seek judicial review. Are they going down that path or have they sort of kind of called off the disputes for now? And then I know that -- have the new prices I think to the local loop are only in effect until June 30 of this year. Do you have any indication that they're just going to leave it at what the new price is or the mandated price was?

Ana, I believe that Telstra either has lodged or intends to lodge an appeal from that determination which is consistent with what they've done with similar determinations with respect to other carriers. So we expect that to be the case. But that does not stay the effect of the ACCC's order. With respect to the rates after I believe it's July 1, the ACCC has to power to basically suggest "indicative pricing" for that future period while the parties may submit filings in terms of altering that indicative pricing. It is our belief that given the proximity of that date to the time of their determination in late last December, we would expect, anticipate the indicative pricing to be at the level that they set in December.

Okay, great. Thank you. I'll let someone else get on. Thanks very much.

Thank you. Our next question comes from David Sharret from Lehman Brothers. Your line is open.

Good afternoon, guys. If I can ask, just given some of the I guess better trend on the retail side in the quarter, I'm just wondering if you can provide a little more color in terms of where the growth products improvement is coming from or even where you're seeing some of the stabilization. So on the growth products side first, can you sort of identify it as being more in Australia than in Canada or more on your DSL broadband issues than in hosting? Where are you seeing improved results?

David, this is Paul. I think the majority of improvements came from broadband services in Australia as well as in Canada. And that combined with, as we have added the hosting capacity in Australia and Canada, I think that one would contribute to ramping up more in the early part of this year as some new data centers are coming online. So I would say broadband would be the primary driver for this growth.

Do you have a sense -- I mean you talked about the DSLAMs that you're adding -- in some of the DSLAMs that you've been in for maybe the longest amount of time, of the lines that are accessible from those central offices, just a sense of kind of what penetration rates you're reaching and maybe just a little more just competitively kind of how are you sort of positioned on price maybe versus Telstra in Australia and the speed that you offer?

On the -- I'd say in terms of DSLAM infrastructure, as Tom indicated, it's frustrating for us as we cannot get timely access to the COLO centers to put additional DSLAMs. And sometimes to add additional capacity which means when the racks get full, that access has not been timely, so which means it's difficult for us to bring more customers on net. And in terms of the DSLAM capacity, without giving you exact numbers, a number of our DSLAM sites are now getting to poor levels, so we want to actually add more racks to those places so we can bring more customers on net. So that actually hurts our gross margins so then we end up putting in on somebody's else's network which means when we transfer them back to on net, we have to pay another big fee to Telstra Anyway, this has been kind of an ongoing issue to get timely and clear access to Telstra's COLO sites.

So anyway, but the utilization of the DSLAMs is quite high in the (inaudible) I would say about half the sites it's very high. The other ones are getting to the 70, 80% utilization. So we actually want to invest money into one, putting in extra capacity where we are getting to 80% or above levels. At the same time, we want to put DSLAMs in new locations. So that allows us to penetrate new marketing opportunities. So that's where we are.

David, somewhat on the density of the DSLAMs, it's not only selling new customers directly on there, but we're migrating existing customers that were previously off net to on net. So we can fill a DSLAM quicker as a result of those migrations if we can get those migrations processed timely as well. Sometimes those take longer to process than we could care.

A similar thing is in Canada. Many of these sites, once we have a DSLAM we have been able to fill them up. And as we have more of the footprint it again allows us to generally market our services in more areas. And the gross margin on net is about two to three times as much as off net, so that's another small difference. So it definitely pays to be on net.

And where are you in terms of pricing versus Telstra or the incumbents in Canada?

Pricing wise, I can't give you exact numbers, but we are probably at -- and I'm guessing right now, I don't have exact numbers, but generally we range somewhat lower than Telstra to give value to our customers. But, as you probably know, in Australia it's very hard to determine the price because some component of this is based on the usage of it. Unlike here where we say it's unlimited bandwidth, you can download, whatever, in Australia there's a fixed price and if you use above a certain amount, there may be an additional charge. So it gets very hard to compare on the baseline price. But we do offer savings over Telstra to bring more value to the customer.

If I could just ask one financial question as far as the free cash flow outlook for 2008. Tom, I don't know if you can comment, you've given an EBITDA range and a CapEx range, apart from the $6 million regulatory payment I guess in February, are there other one- time items as far as working capital or cash taxes that we should be thinking about for '08?

No, the major item, David is actually the $7 million of cash coming through, $6 million of EBITDA benefit and there's some interest that's on top of it, so that's $7 million. We probably have in the neighborhood of $1 million to $2 million of cash taxes and then we factor working capital in to be neutral. We have that working in our favor, but we factor that in to be neutral. There's no other material one-time items though.

Great. Thanks, guys.

Our next question comes from Chris Roberts, the Tejas Securities Group. Your line is open.

Good afternoon, guys. Thanks for taking my call. First in regards to revenue, I guess based upon Primus' last year and your comments, I thought that 2008 might be kind of an inflection year with stabilization in the revenue base and possible some modest growth in the second half of the year. It looks like it may take a little bit longer for that. What elements of the revenue base are contributing to that? Is it the legacy business that's continuing to get hit? Or maybe is it the new initiatives are not catching on as quickly?

I think as you know, we started in early 2007 since this is a two year plan in which we expect to get inflection point. I'm still hopeful towards -- you know, cautiously optimistic towards the end of 2008 we will reach the inflection point. The one thing we have found over last several quarters, the decline in the legacy business has been hard to reliably forecast because it depends on how the mobile telephony how many people change to their cell phone. And that has been hard. I think also transfers from dial up Internet into DSL is one is also difficult to predict it accurately. Combination of those two I think is where the decline in revenues comes. On the positive side, we still see a growth product with broadband and hosted IP PBX, VoIP. Those are the growth products which we do have in different countries. This -- I made the comment last time, which is how much money that we put into sales and marketing to actually grow at the rate we are capable of growing. And frankly it comes out a big portion of it is the acquisition costs for customers. I was -- just an example of -- take Lingo for example, the general Lingo versus Vonage to give you some sense of -- for us, the Lingo business itself is a pretty good business. We do about $30 million in revenues, more than $30 million. We generate about 15% EBITDA on that now. Free cash flow of more than 10%. Total ARPU is $34 more than, about 20% more than what Vonage has. But they are spending $225 to $250, this is their number for 2008. We have been actually limiting our expense to $130 a customer. However, we also have not grown that business much. We grew by 3% year over year. So now that we have made that business quite profitable, the incremental EBIT actually would be much higher than 15%. Now we are looking at how much money do we invest in that to actually grow the top line. And with our limited resources, I think we can grow faster and this time we decided to put in some extra flexibility in sales and marketing. That's why you see a broad range in terms of EBITDA. And so I think the answer to your question is, yes, we can grow faster. I'd like to grow much faster than we did grow because there is a lot of market and opportunity available. And it's going to come down to how much sales and marketing, how much we can save from non sales activities that we can feed into sales and marketing. And grow that faster. That's what will tell me we're in an inflection point.

And Chris, just to add to some of Paul's comments, when you look at the 2007 versus 2008, and we talk about a 2 to 3% or 2 to 5%, I'm sorry, decline, you also have some non retail revenue stream such as our wholesale business in there and we did continue to have some revenue in 2007 from our European prepaid services which has since been terminated and no longer in 2008. So some of the decline comes out of those revenue streams as well because when you're looking at it full year over full year, in the early part of 2007 the wholesale division had a higher revenue base than we currently have.

Right. Okay. And then I guess some housekeeping items. Can you give kind of approximate subscriber data in terms of the year end count for DSL subs and local lines and even Lingo subscribers if possible?

Yes. I think we talked about them in previous calls so just giving you some general idea. Lingo subscribers continue to kind of stay in the general range of about 75,000. So it's stayed relatively stable in there as we haven't devoted too much resources to it, although we're getting a little bit more focused in that area currently. On DSL customers on a global basis, we're in the neighborhood of 215,000 to 220,000. And then on overall VoIP customers, we're at about 112,000 with Lingo obviously being the majority of those.

I see. And on the DSL numbers, can you break out the 215 to 220 range between Australia and Canada? Is it Australia is a little bit bigger, say around 150-ish?

I think just for competitive reasons, If you don't mind I think we'll keep it to the total number.

Okay. All right, guys, that's it for me. Thanks for taking my call and congrats on the quarter.

Thank you. (Operator Instructions). Our next question comes from Grant Peck, a private investor. You may ask your question.

Hello. I've got two questions. I'm curious for 2008 projections how much you may have factored in for expected currency benefit valuation. And secondly, reading your description in the release today about evaluating opportunities for refinancing, exchanging, retiring debt, that kind of thing, I'm wondering if debt or equity is available to enable you to purchase your debt. I see a couple of bond issues trading at a pretty serious discount and I'm curious whether you think financing to fund that type of thing is available.

I think on the first one, your first question, no, we are assuming constant, the current currency levels for the plan, so we are not projecting any changes because we are not capable of projecting what the foreign exchange rates will do. So what we have assumed for 2008 whatever the current levels are, it will just stay there. If the dollar weakens more, being a global company with about 80% of our business coming from overseas, we are best positioned to benefit from that.

In terms of the second one --

With respect to your second question, Grant, there always seems to be opportunity in the capital markets. It never ceases. And suffice it to say that I think we do have some capacity to access capital. And here we'll continue to monitor events and be opportunistic as the situations warrant.

Okay, thank you.

Thank you. Our next question comes from Luciano Morelli from Restoration Capital. Your line is open.

Hi, guys. Did you mention that a portion of the $2 million improvement in your growth revenues came from foreign exchange gains this past quarter? And if so, how much of that came from foreign exchange gains?

No, I think that was without the foreign exchange.

Without the foreign exchange. And I know you don't want to give out particular subscriber numbers like you did in the past, but can you state whether you've lost or gained customers in Australia or Canada?

We continue to gain customers and to gain customers on the product set that we're interested in. So the broadband and the local customers, we continue to see customer increases.

No, we are not giving the numbers because they've declined. It was we just didn't give it in the past and that has not worked to our advantage in Australia that it becomes public information.

Yeah, where we get effective on the revenue side despite some customer increases is especially on standalone long distance there's usage declines. So it's not so much that customers are churning and deciding to go for a cheaper rate but that there's less usage going on wire line and making its way to other means.

And in some cases we are increasing customers even on the voice side. But like Tom said, it's usage declines that gets harder to grow that business.

Gotcha. Thank you.

Thank you. Our next question comes from Steven Jones from ABC Corporation. Your line is open. Mr. Jones, please state your question.

I think we're having some feedback, Patrick.

Thank you. (Operator Instructions). And we show no further questions. I would like to hand it back to Mr. DePodesta for his closing remarks.

Thank you very much, Patrick, and we apologize for that technical difficulty. Hopefully we didn't deprive any participant from questioning, but we'll be available here at the offices after the call. I would like to inform all participants that Primus is scheduled to participate at the Lehman Brothers High Yield Bond and Syndicated Loan Conference which will be held March 12 to 14 in Orlando, Florida which I understand is located at the Disney complex. I know Dave Sharret will be a very generous host for Tom Kloster who will be representing Primus, and by the way, Dave, I'd just like to inform you that Tom's favorite ride at Disney is It's a Small World. That conclude Primus' fourth quarter and year end 2007 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. Thank you for joining us today and good evening.

Ladies and gentlemen, thanks for participating in today's program. This concludes the program. You may all disconnect.