Innovate Corp (VATE) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the PRIMUS Telecommunications first quarter 2008 financial results 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 be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. John DePodesta, Executive Vice President and Co-founder. Sir, you may begin.

Thank you. Good afternoon, ladies and gentlemen, and welcome to PRIMUS' first quarter 2008 financial results conference call and webcast. I am John DePodesta, Executive Vice President at PRIMUS. For those who have not had a chance to review the earnings release, it has been posted and had can be viewed on our website at www.primustel.com. Joining me from PRIMUS on today's call are Paul Singh, Chairman and Chief Executive Officer, and Tom Kloster, Chief Financial Officer. We will begin with formal remarks from management regarding the Company's first quarter. This will be followed by a questions-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, 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 10-K and 10-Q, and other periodic filings with the Securities & 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. Last quarter, we expressed a belief that our fully-funded 2008 plan was launching off of positive and improving trends, revenue growth from our high-margin retail products, continued margin expansion, and steady EBITDA growth. We also had confidence because a platform for growth had been put in place. We had invested in broadband, IP, and data infrastructure. Our retail gross products had been established and were gaining acceptance, and we devoted resources to augment our sales and marketing efforts.

However, reflecting the worsening economic environment and an intense competitive environment in telecom, our external guidance for 2008 was a decline in revenues in the range of 2 to 5%, which was an improvement over revenue decline of 10% in the prior year. Thus, we were encouraged by the stabilization of retail revenues experienced in our first quarter. Our challenge is now to extend those results into a positive and sustainable trajectory. Getting normalized revenue growth back as part of the PRIMUS story has been a prominent goal, as we recognize that only a company growing its top line and increasing its profitability is likely to draw the support of investors. This continues to be a primary focus of management.

While we focus on operational improvements, we also intend to continue our efforts to improve the balance sheet. In the first quarter, we continue to chip away at our public debt, maturing in the latter half of 2009, reducing the aggregate amount outstanding to $28 million after purchasing $15 million principle amount of debt at discount.

While the current economic climate is not the most opportune to obtain full and fair valuations for telecom assets, we were able to conclude two small sales that generated $3 million in cash proceeds during the first quarter. We continue to pursue opportunities that are likely to produce favorable valuations and to advance our objective to become more geographically focused in our major market franchises in Canada, Australia, the U.S., and western Europe.

Early returns on the regulatory front in 2008, in our two largest markets, have also been encouraging. In Canada, after a year-long process that included extensive hearings in which PRIMUS Canada was an active participant, the CRTC rendered its decision on essential services. Incumbent carriers had urged that industry negotiations should set the prices for wholesale services under their control. We were pleased that the CRTC supported the need to continue its incremental approach to network development in Canada. In doing so, the Commission recognized that access networks or the last mile into the consumer's home of the incumbent telephone and cable companies can never or economically be duplicated by competitors. Accordingly, the CRTC established a new, clear definition of essential facilities, including associated pricing rules and phaseout provisions, that together set an appropriate playing field for nonincumbent service providers such as PRIMUS in Canada.

In Australia, we received two long awaited decisions from the Australian Competition and Consumer Commission that addressed historical competitive abuses by Telstra. While we are gratified by the ultimate outcomes, we nonetheless note that the retroactive nature of these awards never fully compensates for the true economic and market loss caused by Telstra's anti-competitive pricing and practices. Indeed we have raised these very concerns in the context of the United States trade representatives' required annual review for the Congress on the status and functioning of bilateral telecommunications trade agreements.

This year's review involved a broad range of participants including trade and governmental officials in Australia, the ACCC, Telstra, competitive carriers, and consumer interests. In its report, the USTR observed, and I quote, "Telstra's longstanding efforts to resist network access obligations through legal challenges to the regulator and political pressure on the government continues to create an environment of legal and financial uncertainty." To address these concerns, USTR has recommended that the ACCC consider a price reregulation process that would, rather than have Telstra arbitrarily set pricing, have the ACCC initially impose indicative pricing.

In addition, USTR suggests that the ACCC should take steps to ensure that Telstra is not unreasonably denying access to its facilities. USTR also noted that a critical determinant of competitive opportunities in Australia will be transparency and the government's selection of a winning bidder to operate a state-subsidized national broadband network. The access obligations the government imposes with respect to this network - and PRIMUS advocates open access - will be crucial. A decision is expected this year, and the Australian government has commenced the RFP process which the United States trade representative intends to monitor closely.

With that, I would now like to ask Tom Kloster to review the operating and financial results for the quarter.

John, thank you, and good afternoon. During the first quarter, we began to see positive results from our strategic decision to invest in infrastructure, and sales and marketing capabilities targeted at enhanced growth in broadband, VOIP, local, wireless, data, and hosting products. Our success is evidenced by our sequential growth in total revenue and even more significantly, net growth in retail services revenue. For the first time in over nine quarters, retail revenue growth exceeded the decline in legacy voice and dial-up internet services revenue.

In Canada, we took advantage of our recent data center expansions by more aggressively marketing our data and hosting products. In addition, we began to presell into our Edmonton data facility which is expected to be operational in the second quarter of 2008.

We also made definitive progress in adding residential customers onto our bundled plans which include broadband, local, and voice services. We enhanced our outbound telemarketing capabilities for long distance services, and hope to migrate new stand-alone long-distance customers to bundle services as well. We began to see benefits from our previously announced agreement with Aeroplan, the premier affinity organization in Canada which allows Aeroplan members to earn points for consumer telecom purchases from PRIMUS. The above actions combined to enable us to deliver retail revenue growth in Canada in excess of 1% sequentially.

Also in Canada, we completed migration from our legacy TDM switch platforms to state-of-the art IP-based soft switches, and we are now focused on implementing network operating cost improvements which are available with the IP switches.

In Australia, while normalized retail revenue was stable this quarter, we experienced 4% growth in on-net services including broadband, local, and VOIP which generated enhanced margins. This quarter, five new DSLAM locations were placed into service. We now have 218 DSLAM sites operational of which the vast majority are equipped with high-capacity fiber, thus enabling us to serve more customers while providing higher speed service.

In the U.S., our retail revenue declined 3% sequentially as we saw softness in our legacy business. Our U.S. management team is focused on stabilizing overall net revenue through increasing efforts in a number of areas, driving growth in our lingo VOIP business, emphasis on the sale of hosted iPBX services bundled with broadband access to business customers, introduction of creative international calling services for ethnic consumers, and reenergizing the agent distribution channel.

European retail revenue was stable with the prior quarter. We recently migrated our London, Milan, and Madrid switches to an IP-based soft switch platform. and are in the process of migrating the remaining two European switch platforms in France and Germany to the IP soft switch technology as well.

First quarter net revenue was $227 million, up $4 million or 2% from the prior quarter. During the quarter, the U.S. dollar weakened slightly against both the Australian dollar and the Euro, but strengthened against the Canadian dollar and the Great Britain pound. The net effect to our sequential quarterly revenue was minimal. Thus, the sequential revenue growth we are reporting for the quarter is wholly the result of operations, and not currency movements. The $4 million of sequential revenue growth is comprised of $3 million from wholesale services and $1 million from retail services. We are encouraged to be able to report improving retail revenue on a sequential basis for the first time in over two years. We feel that our efforts in investment over the past few quarters in enhancing our network infrastructure, rolling out now product offerings, and shifting portions of our SG&A spending to support sales in marketing efforts have begun to generate the positive results that we have targeted from the beginning.

We continue to see an increase in revenue from broadband, local, VOIP, wireless, data, and hosting services with total revenue of $60 million, up 3% from the prior quarter. The average margins for these products continue to expand and now, are in the high 40% range. We expect these margins to continue to show progress, as we place more services directly onto our expanded network and the mix of products we sell becomes more weighted towards our higher margin products. We continue to focus the vast majority of our capital, and sales and marketing expenditures on these products.

We are also quite pleased with our $3 million increase in wholesale revenue this quarter. Although wholesale revenue provides lower margins, we are seeing an increase in large carriers using our network, as we have expanded our routing capabilities and our product offerings. All in all, a very pleasing quarter from a revenue growth perspective.

Net revenue less cost of revenue was $84 million or 37.3% of net revenue as compared to $91 million and 40.9% in the prior quarter. The sequential change is primarily due to the prior quarter including a $6.4 million benefit from ACCC determinations made, concerning excessive pricing by Telstra for local loops and line sharing. In April 2008, the ACCC issued an additional final determination related to unconditional local loop connection and call diversion charges. As in the past, this final determination will result in a retroactive return of excess payments previously made to Telstra for such services, plus interest. The final amount of the retroactive payment and interest is still being calculated and confirmed among the parties. Accordingly, the retroactive financial benefit to PRIMUS as a result of this ruling, will be reflected in our Q2 results, both from an income statement and a cash flow standpoint.

SG&A expense was $69 million or 30.6% of net revenue in the first quarter, down $5 million from $74 million and 33.3% in the prior quarter. The decline is partially attributable to $2 million of charges taken in the prior quarter related to possible foreign tax audit obligations. The remaining decline is in reduced non-sales and marketing expenses.

Adjusted EBITDA for the third quarter was $15 million as compared to $17 million in the prior quarter. The prior quarter included benefits from retroactive pricing settlements in Australia, as well as certain negative items related to the possible tax audit obligations mentioned above. Exclusive of such items, we continue to experience a gradual increase in adjusted EBITDA.

We ended the quarter with an unrestricted cash balance of $56 million as compared to $81 million as of December 31, 2007. During the quarter, we spent $13 million to retire $16 million face value of debt. This included the repurchase and retirement of $13.8 million face value of our 8% step-up convertible debentures due in August 2009, and $0.8 million face value of 12.75% senior notes due in October 2009, as well as $1.5 million for scheduled principle reductions on capital leases and other debt.

We spent $16 million on cash interest payments, a bit higher than normal, as Q1 is a little heavier on cash interest than other quarters. This amount also includes accrued interest paid on the bonds we repurchased and retired. Exclusive of any bond repurchases, we would expect cash interest payments in Q2 to return to the $14 million range.

We spent $7 million for capital expenditures, primarily to fund the previously announced Australia DSLAM network expansion and the Canadian data center expansion. And we utilized $7 million on working capital, including the acceleration of payments to traffic vendors to obtain preferred pricing. These cash usage items were offset by $15 million of adjusted EBITDA and $3 million of asset sales proceeds.

Although we are encouraged with our first quarter results, we also realize that one quarter does not make a trend, and there remains a lot of work ahead to stabilize the retail revenue throughout 2008. Accordingly, we are maintaining our previous guidance of year-over-year revenue decline of 2 to 5%, versus a decline of approximately 10% experienced in 2007. We also are reaffirming our adjusted EBITDA guidance of $65 million to $80 million for the year. With the projected network capacity availability as a result of our infrastructure investment to-date, we now expect to spend $25 million to $30 million on capital expenditures during 2008, down from our previous guidance of $30 million to $35 million. I will now turn it back to the operator to open the call up for questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) The first question comes from Ana Goshko, Banc of America.

Hi. Thanks very much. Can you hear me okay?

Very clear.

Great. Just a couple of questions on the trends, both on revenue and EBITDA. It just sounds like you guys are being very conservative. You had a good quarter in revenue, but you still think that you're going to have declines for the year from 2 to 5%, so wondering what parts of your businesses are making you conservative in that manner? Are there things that you're seeing already in the second quarter that would lead us to believe that in some of the coming quarters we are going to see actual revenue declines again?

Ana, this is Tom. From the revenue standpoint, most of what we just spoke about was sequential revenue increase, so Q4 to Q1 our revenue increased as we just described. When you look at it on a year-over-year basis throughout 2007, our revenue had been declining quarter-over-quarter, so for example, back in the first quarter of 2007 that was a bit higher number than the sequential revenue increase. When you look at 2 to 5% on an annual basis, have you to factor in where the revenue was at the early part of 2007. That's one, just the simple facts of that.

I don't think we believe that there is any negativity in the revenue, but we're very encouraged, especially on the retail side as to how we've stemmed the decline in the quarter-over-quarter retail revenue, and actually we're able to report some growth. But we also have done that for one quarter, so we're just a little cautious to commit to that being a trend.

Ana, this is Paul. I think Tom is correct. In terms of keeping the same guidance, we just talked that we give another quarter and look at revenue trends, and then we would be able to change the guidance, so that's basically the reason. Nothing in particular that we see in the second quarter thus far that will say, no, we know it is going to go down by 5 to 10%.

Okay. Great. My second question is sort of a similar question just on EBITDA. I want to make sure I am thinking about quarter-to-quarter EBITDA on an apples-to-apples basis. The $15 million this quarter, in the press release and in your comments I think you compare it to about $17 million last quarter. But when you first reported EBITDA last quarter, and I hope I don't confuse you here, but it was -- I think $20.5 million, right? Then what I initially did is I normalized that for the ACCC benefit that you received in the quarter. Then you subsequently came out, lowered your headline number because of the reserves you had to take on the European prepaid services business. Those also seem to me to be one-time in nature. So, in thinking about a normalized EBITDA for the fourth quarter, I also in my mind have been excluding those, so I stuck with about a $15 million normalized EBITDA for your continuing operations in the fourth quarter, and that seems to be where you came in in the first. Is that the right way to think about it on an apples-to-apples basis?

I think that's pretty close. Those are the larger items that were in Q4 that were nonrecurring or nonstandard items. I think there is some other items that are smaller that are puts and takes. When we factor in those, we look at Q4 to Q1, and we do see some growth in our normalized EBITDA, but it is in the neighborhood of $0.5 million range or so. I think you're pretty close with your figures.

Great. Thanks very much.

Okay.

Our next question comes from Chris Roberts from Tejas Securities Group.

Good afternoon, guys. Thanks for taking my call. I was wondering if you could provide a little more color on gross margin. Specifically the last couple quarters, it's trended higher. And this quarter was off a bit, despite the fact that it seems like the gross margin in new initiatives continues to do very well. Is it right to assume then, that there is margin compression going on in the legacy business that's -- I guess offsetting the growth you're seeing in new initiatives gross margin?

Now, I think it is kind of similar to what we were describing on EBITDA. Unfortunately, for example, in Q4 we had a large benefit from the ACCC settlement. I say unfortunately because it makes it harder to explain the numbers, but it is obviously a very beneficial factor for us. When you pull out the nonrecurring items, such as the ACCC benefit which improved our margins in Q4 and kind of inflated the margins in Q4, and you come back down to more normalized margin, I think our margin quarter-over-quarter was relatively stable, wherein the previous quarters we had seen some improvements in our gross margin. Even when you normalized prior quarters, we had seen some improvements as we were doing network grooming and a variety of things.

This quarter I think we saw that margin stabilize a little bit when you normalize it for the ACCC matters. We're still optimistic that it can increase from where it's at, but I think one thing we have to remember is the business that we lose, the legacy business that we lose has high margins associated with it as well. The growth business is strong. We like where the margins are and they're growing, but the business that we lose is every bit as strong sometimes.

The other thing that affected our margins this quarter is for the first quarter, and sometime our wholesale business, grow quarter-over-quarter. And our wholesale business is a lower margin business, so as the wholesale margin grows, that puts pressure on the overall margins.

Okay. Thanks. Just one follow-up. Can you detail the outstanding face amount of the remaining '09 maturities, being that the step-ups and the 12.75%, just what's left after the bond repurchases?

Yes. One second here. I know the rough numbers, but I will give you the exact figures. Okay. We had two issuances. We have the first comes due in August of '09, our 8% step-up debentures, and we have $8.641 million face value that remains.

Okay.

And then in October of 2009, we have our 12.75% senior notes that come due, and we have $19.495 million face value that remains.

Okay. Great. Thanks, Tom. That's it for me. Thanks for taking my call.

Okay, Chris.

Next question comes from [Matthew Dunnon] from NCR Securities.

Hi. A couple things. I still have on my model that you have Canadian equipment finance facilities coming due this year. Is that the case and if so or if not the case, can you walk through the balances on the Canadian and Australia facilities and their maturity and amortization schedules?

Sure. In Canada, there is really no capital lease facility that matures in the current year. The biggest facility that's in our Canadian operations is there is a $35 million credit facility, U.S. denominated $35 million credit facility, and that matures in 2012. There is some very small capital lease facilities that are amortizing, but they're probably less than $1million. In Australia, we do have one facility which related to a purchase of network fiber that has approximately $5 million remaining on it. Its payment terms is to be paid in full by the end of 2008, so that may be the one you're thinking of.

Okay. Yes. Then were both of the step-down in the 12.25s, those were both done by March 31, and fully included in the 3/31 balance sheet?

Yes, that's correct.

And there has been nothing since?

We have not announced anything, so if it is material, we would announce it.

Okay. Thanks. That's it for me.

(OPERATOR INSTRUCTIONS) Our next question comes from Michael Spector from Scoggin Capital.

Hi, just had a couple quick questions. One, the cash that you guys have, I was just wondering, is that all accessible or is that in various countries that you really can't touch?

We quote an unrestricted cash balance which was the $56 million, so that is available cash with no restrictions associated with it. It is in a number of different countries, so we have operating cash in all of our major operating units. Then we have in effect the central Treasury here in the U.S., so it is spread out, but there is no restrictions on that number. In addition to that $56 million of unrestricted cash, then there is about $10 million of restricted cash that's on our balance sheet that supports letters of credits or vendor commercial commitments, those type of things. The largest of which is in Australia to support our relationship with Telstra.

I guess let me ask the question a different way. How much of the unrestricted cash do you need at the various countries that would reduce down the availability, the excess availability of cash? In Australia, I am assuming that you need some cash just to run your operations. In Canada and in Europe, you still need cash to run your operations to pay people. Just trying to get an understanding of how much that is?

So we have -- I understand the question. We have peaks and valleys, depending on when vendor payments come due and collections come in. Certainly in each country, there needs to be cash maintained to meet those peaks and valleys. I think that's the large question as to what is that optimal level of cash, ideally how low could that go or how much is available to use for such things as bond repurchases that we had 30% returns on when we made those purchases in the first quarter. Our belief is that number is probably down in the 30 to $40 million range, and it just depends on the nature of our operations at the particular time.

The 30, $40 million is what's needed at the subsidiary level? Or 30 to $40 million is above and beyond what you need to run the operations in the various countries?

I think it is intended to mean roughly what's needed to run our operations.

Okay. Great. Just one quick question. On the 14.25% piece of paper, you have $108 million of face value issued. It is a $200 million issue. Are you allowed to issue the remaining $92 million, and you can use that additional funds to buy back in essence or to take out maturities as they come due?

John DePodesta, Michael. Not quite. The 14.25s have been issued. The $108 million that you referenced was issued out of a $200 million permitted indebtedness basket. But also being issued out of that basket was approximately $56 million face amount of 5% exchangeable notes. So under that $200 million dollars basket, we currently have authority to issue around $36 million of additional debt securities. However, I should add that for every dollar of the 5%s that are brought in, or the 14.25s for that matter, it enhances that basket by a similar amount. It is basically a revolver basket.

So you could use the second lien to take out the 5% exchange notes, the $56 million?

I could.

Okay. Great. Thank you.

Our next question comes from Anton Anikst from Morgan Stanley.

Good afternoon. Thanks for taking the question. Two quick ones. One, I know you haven't finalized the settlement amount with ACCC, but as an order of magnitude, can you just tell us if it should approximate what we saw in 4Q? Larger, smaller? That would just be very helpful as we think about liquidity going forward.

Secondly, with the CapEx reduction versus earlier guidance, just directionally, what categories were you able to cut back on? Is it data center, CapEx, or any other areas? That would be helpful. Thanks.

Yes. This is Paul Singh. I think the answer to your second question is that we believe that we have enough revenue producing capacity in our network and the assets we have already purchased to meet our 2008 goals. As a result of that and by focusing on realizing those unrealized revenue potential, we thought we can actually reduce the CapEx without having any impact on our plans. On the question number one --

On the ACCC final determination announcement, we're cautious in putting out such a number until all of our figures are accurate. There is another party in file that has to be comfortable with those figures as well.

We know it will be in single-digit.

Yes.

That would be fair to say.

I hope you mean seven figures.

Single-digit.

Millions, yes.

Thanks so much.

Okay.

Your next question comes from Steve Carney.

Hello. Good evening. I am a private investor. I have two quick questions and one comment. As private investors, the majority of us are underwater. Is there any plans to go on the A mix? When is the shareholder meeting? Could you do better with your press releases? They're often nonexistent between quarters. And when we receive one, they're usually vague but hopeful, so it is harder for us that are underwater to double down and try to increase our shares at these low prices. That's about it. Thank you.

Mr. Carney, I think with respect to the press releases, suffice to say, that when we think there is material news or developments, we endeavor to get that release out publicly. We try to be as helpful and explanatory as possible, and I regret and apologize to the extent we may be under shooting that objective at least in your eyes. But we do issue the press releases generally. We try to give them wide circulation. We issue them through news wires, and those are more localized in terms of their content and effect. We would usually seek to include them on our website as well. Recent news releases or articles that describe or talk about PRIMUS, under the PRIMUS in the News section of our website, so I would encourage you to look there as well.

With respect to the stock price, you have around this table and on this call, many who share your frustration and your concerns. Suffice it to say as we have been saying for some time, in order for our equity to begin to be recognized in the markets, there are a couple of major steps that we have to take. One of which I think we're starting to make progress on as we reported today, namely as being able to demonstrate that the operations of the Company, in terms of the ability to grow the top line and to generate steadily increasing EBITDA and profitability, can be established in a clear trend line. Hopefully, this first quarter is the first step in that direction.

Secondly, even with dramatically improved operations, we still have to aggressively address our balance sheet. We have over $600 million worth of debt, and it is too much for this company in its current circumstance to bear. We have tried to address that opportunistically. We reported again this quarter that we've taken out some debt at discount, the early maturing debt in 2009. We will continue to look at opportunities for us to continue to reduce debt.

So it is our hope and our expectation that success on those two fronts, namely improving operating performance and profitability together with reducing debt, is what is going to unlock value for the equity holders. And as the three people in this room have a lot at stake in seeing that accomplished, you can be assured that that's an objective that is uppermost in our minds.

I'd like just to add to that, you had asked about the shareholders meeting. The proxy statement that we had filed last week, it is publicly available. It is in the process of being mailed, and it has the shareholder date for early June. I can't remember the exact date off the top of my head, but it is sometime in the first half of June.

I am showing no further questions at this time. I would now like to hand the conference back over to Mr. DePodesta for any closing remarks.

Thank you very much. I would like to inform the participants on the call that PRIMUS is scheduled to participate at the Kaufman Brothers Eleventh Annual Investor Conference which will be held in New York City on September 3 and 4, 2008.

This concludes PRIMUS' first quarter 2008 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 this afternoon. Goodbye.

Thank you, sir. Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect, and have a wonderful day.