Innovate Corp (VATE) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2008 Earnings for Primus Telecommunications. 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.

(OPERATOR INSTRUCTIONS)

I would now like to introduce the host of your call today, the Executive Vice President, Mr. John DePodesta.

Thank you very much, Patty, and good afternoon, ladies and gentlemen, and welcome to Primus's second quarter 2008 financial results conference call and webcast. 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 Chief Executive Officer, and Tom Kloster, Chief Financial Officer. We will begin with formal remarks from management regarding the Company's second quarter. 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 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 10-K and 10-Q 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. Encouraged by the operating and financial results reported today for the second quarter, I thought it would be useful to track our results against the specific goals we articulated when we announced our two-year transformation strategy over 16 months ago.

At the time we announced the transformation strategy, we were emerging from 2006, a critical transition year for the Company. You may recall that our annual adjusted EBITDA dipped to $21 million in 2005, and it was essential to improve that performance dramatically if we were to become financially self-sustaining.

Through a combination of initiatives, we were able to grow adjusted EBITDA to $61 million for the full year 2006 up more than 240% over the prior year. With the groundwork laid by that substantial progress, we launched our two-year transformation strategy in March 2007, targeting the following key objectives. First, a priority was to resume top-line revenue growth before the end of 2008.

Given the then-existing and continuing industry revenue declines, I am sure this goal was treated with some healthy skepticism. However, the Company has already had two successive quarters of revenue growth in 2008, and our adjusted guidance now targets positive revenue growth for the full year 2008 over the prior year, assuming constant currency rates. Thus, this key objective of the strategy appears to be on a trajectory for a successful outcome.

Another key objective was to strengthen our balance sheet significantly. At December 31, 2006, we had a $640 million of debt principal outstanding. Through a series of subsequent debt issuances and exchanges, we have reduced that figure to $584 million.

Significantly, that net debt reduction was accompanied with an improvement to liquidity from sales of debt and equity, a more favorable schedule of maturities and no material increase in cash interest obligations. Thus I believe it fair to assess that this strategic objective has been partially addressed, but we have more to accomplish.

Generating double-digit annual growth and adjusted EBITDA was another critical objective. For the full year 2007, we generated $67 million of adjusted EBITDA. With the revised guidance issued today, we now project full-year 2008 adjusted EBITDA to be in the $75 million range, which, if achieved, will represent a year-over-year growth of 12% in adjusted EBITDA.

At the time we announced our transformation strategy over 16 months ago, we candidly admitted that they were, and I quote, "an aggressive set of goals." We have to commend the Primus management team on their focus and effort on executing across a wide range of initiatives in a very challenging economic environment to get us to this point where progress on the major goals of the transformation strategy are either ahead of plan or on target to meet the 2000 year-end goals.

While gratified with this progress, we also realize that significantly more needs to be accomplished to get us to the point of being financially self-sustaining. With annual debt service of approximately $58 million, anticipated annual capital expenditures in the range of $25 million and some $3 million in cash taxes, we need to attain adjusted EBITDA levels in the mid-$80 million range to become free cash flow break even.

With the improvements we have shown to date, we are gaining ground on that critical objective. It is our belief that, if we can continue to grow top-line revenues and generate adjusted EBITDA sufficient to sustain free cash flow, the Company should be in a position, assuming normal credit market conditions, to refinance debt and thereby obtain further flexibility to develop the business and to enhance profitability.

As we move towards that point, we need to address the $23 million of debt maturities that come due in the latter half of 2009. Our current thinking is that cash to meet those maturities will come from a combination of sources, proceeds from asset sales, proceeds from potential financings, excess unrestricted cash not required to operate the business and improved operating results and increased adjusted EBITDA.

We intend to continue to explore means to reduce our debt and interest expense, while we focus on continued operating improvement, which in the end is what will create an increasing range of options for the company. I will now turn it over to Tom Kloster to comment on the financial and operating results for the quarter.

John, thank you, and good afternoon. During the second quarter, we continued the operating trends established in the prior quarter, sequential growth in total revenue, overall stability in retail revenue, solid growth in revenue from broadband, VOIP, local, wireless, data and hosting products, containment of cost of revenue and SG&A expense and the resulting higher levels of adjusted EBITDA.

In addition to these operating accomplishments, in May, the Company completed a debt exchange transaction whereby we issued $67 million of our 14.25% senior secured note and $4.7 million of cash in exchange for $130 million of various outstanding debt issuances. This transaction reduced the principal balance of the Company's debt obligations by $63 million, or 10%, and substantially reduced our 2009 and 2010 debt maturities.

Our second half 2009 maturities now stand at $23 million, and our 2010 maturities are at $58 million. In Canada, our retail revenue grew 1.4% sequentially, following growth of 1.1% in the prior quarter. We continue to make progress in selling our expanded data center services and IP hosting products.

Further, we are finalizing our migration from legacy TDM switch platforms to state-of-the-art IP-based soft switches, enabling us to implement network operating cost improvements which are available with the IP switches. In Australia, we realized revenue growth in our commercial segment, but our consumer revenue declined, resulting in a 1.6% overall revenue decline.

However, our revenue less cost of revenue for Australia grew this quarter, as a result of a 4% growth in on-net services, including broadband, local and VOIP, which generate enhanced margins. In addition, 14 new DSLAM locations were placed into service this quarter. We now have 232 DSLAM sites operational, the vast majority of which are equipped with high-capacity fiber, thus enabling us to serve more customers on-net while providing higher-speed service.

In the US, retail revenue declined about 3% sequentially, reflecting continued softness in our legacy business. Our US management team is focused on stabilizing retail revenue through the expansion of a direct sales force focused on sales of hosted IP PBX services bundled with broadband access to business customers.

We have also introduced creative new international calling services for ethnic consumers and optimized marketing efforts focused on our Lingo VOIP product.

European retail revenue was stable with the prior quarter. We are continuing our efforts to expand marketing to small and medium-sized businesses and are seeing signs of success in France, Belgium and the UK. In further support of our European efforts, we have substantially completed the migration of our London, Milan, Madrid, Paris, and Frankfurt switches to an IP-based soft switch platform.

Second quarter net revenue was $236 million, up $10 million, or 5%, from the prior quarter. The $10 million of sequential revenue growth is comprised of $7 million from wholesale services and $3 million from the weakening of the US dollar, primarily as compared to the Australian dollar.

We are pleased to report, for the second quarter in a row, retail revenue was stable, as the revenue increase from our growth periods is offsetting the decline in our legacy products. We feel that our efforts and investment over the past several quarters in enhancing our network infrastructure, rolling out new product offerings and shifting portions of our SG&A spending to support sales and marketing efforts have begun to generate the positive results that we have targeted from the beginning

We continue to see a steady increase in revenue from broadband, local, VOIP, wireless, data and hosting services, with total revenue of $62 million, up 3% from the prior quarter. Significantly, the average revenue, less cost of revenue, from these products have also continued to expand and are now approaching 50%.

We expect these margins to continue to show further 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. We continue to focus the vast majority of our capital and sales and marketing expenditures on development of these products.

We are pleased with the $7 million of wholesale revenue growth this quarter, which follows growth of $3 million in the prior quarter. Although wholesale revenue provides comparatively lower margin percentages, we are also gratified to see an increase in large, stable carriers using our network, as we have expanded our routing capabilities in our domestic and international product offerings.

With existing network capacity, we can further expand this business with minimal investment. Net revenue, less cost of revenue, was $94 million, or 39.6% of net revenue, as compared to $84 million and 37.3% in the prior quarter. The $10 million sequential change includes a $6 million award as a result of a regulatory ruling for previously paid excessive fees for Australian local loop connection and call diversion charges.

It should be recognized that while we recorded this regulatory award this quarter, it reflects the aggregate negative impact that our operating results bore in prior periods due to excessive charges by Telstra. The remaining sequential increase of $4 million is as a result of higher revenue this quarter.

SG&A expense was $70 million, or 29.7% of net revenue in the second quarter, up $1 million from $69 million and 30.6% in the prior quarter. The slight SG&A increase is attributable to a $1 million increase in advertising expense. Adjusted EBITDA for the second quarter was $24 million. Exclusive of the Australian regulatory award, adjusted EBITDA was $18 million, as compared to $15 million in the prior quarter.

Continued revenue growth, combined with managing our cost of revenue and SG&A expenses contributed to a strong quarter-over-quarter increase in adjusted EBITDA. We ended the quarter with an unrestricted cash balance of $56 million, stable with the balance as of March 31st, 2008. During the quarter, we spent $14 million on cash interest payments, $8 million for capital expenditures, $5 million to repurchase and retire debt as part of the May debt exchange transactions and $1 million on scheduled debt principal reductions.

These cash usage items were offset by $24 million of adjusted EBITDA, $2 million of interest income and $1 million from working capital movements. The second quarter financial results have reaffirmed the financial results we experienced in the first quarter, sequential growth in total revenue, stability in retail revenue and improving adjusted EBITDA through revenue growth in cost containment.

Although there still remains a lot of work ahead to continue to these trends throughout 2008, we are encouraged by our performance in the first half of the year. As a result, we are adjusting our previous guidance upward to year-over-year revenue growth versus the previous guidance of a decline of 2% to 5% in 2008.

Additionally, we have adjusted upward our full-year adjusted EBITDA guidance to the vicinity of $75 million, versus our previous guidance of between $65 million to $85 million for the year. Also, we reaffirm our full-year capital expenditure guidance of $25 million to $30 million, approximately $5 million lower than our initial guidance.

I will now turn it back to the operator to open the call up for questions.

Thank you. (OPERATOR INSTRUCTIONS). One moment for our first question. Our first question comes from Ana Goshko of Banc of America Securities.

Hi. Thanks very much for taking the question. I have a couple. The first is on the wholesale revenue increases last quarter, and then this quarter it got stronger. I wanted some more color on what region that's coming from. Is it coming from one carrier or a handful of carriers? How sticky is that revenue, and is that largely price driven, or what do you think is really driving the sequential increases in the wholesale revenue line?

Ana, this is Tom. As far as what region it comes from, we primarily due wholesale business out of Europe and the US. We do interact with a number of Asian carriers, as well, but it's managed out of those two regions. A significant amount of the growth is coming out of our European region, but also there is growth in our US region.

It's not tied to one particular carrier. It's somewhat across the board, and a number of large carriers have increased their business with us. Some new carriers we've added as customers, as well as a handful of what I'd say are mid-sized to smaller carriers have joined our revenue stream.

As far as maybe what's driving that, we have started developing a more in-depth routing table so that, in particular, countries, specifically in the U.S., we can route much deeper to the NPA-NXX levels, and that allows us to price the product more appropriately. So for somebody that can route that traffic to us can enjoy a better price point, because we can price it based on our specific routing as opposed to a blended route. So all of those things have really contributed to the growth.

Okay. The second question is the requisite question that everyone's getting asked on second quarter earnings calls. It's on the economy, so I know you're very diverse in terms of customer segments and geography as well, but are you feeling anything either on the consumer side or on potential the small-medium business side, where the economy is either impacting your pace of sales or potentially churn?

Ana, this is Paul. The economic environment is pretty tough and it's pretty much I think more in the U.S., but it's spreading in other countries, as well. And I think it does affect us. Obviously, it is reporting all of the other carriers who are reporting results, and I think it will reflect in different fashions.

Obviously, as you probably heard, Amex reported their long-term credit card holders who are late in payments went from 3% to 6%. When those kind of things happen, there are a lot of people who pay us by credit card. So you will see, I think -- we expect and we are trying to manage that proactively.

In bad economic times, you always have the payments are getting later, so that's always a risk. I think also people are less likely to -- they'll drop their wirelines, so the progression towards mobile accelerating these things, when you have to cut costs. And the businesses spend a little bit less, so it is a tough economic environment, and so I think in view of that our ability to manage the revenue increase I thought was quite good.

Just to follow on, on the consumer side, where I think we can kind of see that and quantify it a little bit is in the credit card processing we see a higher level of credit cards that reject, so people's limits are maxed out. We try and hit their credit card to pay their telecom bill, and the credit card rejects. So those percentages have gone up slightly on the consumer side in Canada and in the US. Not significant to our operating results, but it's a trend that we're paying attention to.

Okay, that's helpful. Thanks very much.

Our next question comes from Chris Roberts of Tejas Securities.

Hey, guys, thanks for taking my call and congratulations on the strong quarter.

Thank you.

First, it seems like this is the second quarter in a row that retail services revenue has stabilized. Is it too early to kind of call the bottom, or do you believe you're past the inflection point?

Are you assuming constant currency rates?

I won't ask you for any currency predictions.

Because that, it's somewhat of a wildcard. I think many of us sort of privately applaud the hopeful strengthening of the dollar as a matter of patriotism, but it doesn't necessarily [read down] to our benefit across the board here, in terms of our financial results. So depending on the trend of the dollar, as compared to some of the other major currencies and our operating jurisdictions, that could have an impact on top-line revenue growth and retail growth.

I think it's probably a little bit early to say that we're bottomed out. I think right now we are doing kind of in half the countries we -- as you know, we have grown or stabilized. In the other half our revenue dropped. I can tell you that we believe we have put in enough investment in sales and marketing and new projects and even the infrastructure upgrade, which all of it is not completed yet, but will happen in the second half.

All of those things, if they work as we hope they would work, I think that would help us to make it more sustainable. So the costs are there, which is like direct sales force, some increased advertisement spending, some of the cost-saving initiatives, which is coming from the network infrastructure investments we have made.

So I think we have taken all the right steps. Now it is a question of what our competition does and those things can always surprise you and how does the economy do, but that, I hope it doesn't get much worse than where it is, because it's bad enough. Anyway, a combination of those, but we still have to see that all the countries get closer to stable. I think then one or two outperform, then I would feel actually much, much better. But I'm feeling much better than I was two quarters ago, when we had spent some money and the results were still to come. So at least what we started 18 months ago, at least we see some results are beginning to come, so that I think makes us feel comfortable.

Okay, great. Next, on the Canadian spectrum sale, am I reading it correctly that the cash consideration of $5 million is only for a small piece of the total spectrum and that this Canadian affiliate still has a fairly large piece of spectrum?

Yes, I think if you valued just based on what we have sold, if you prorated that valuation to the total one, I think it's about a $50 million valuation for that spectrum.

Okay, and you own almost 50% of the equity of this affiliate.

Yes, slightly less than that, yes.

So I guess it would be fair to say, I guess the value that contributed to you would be just under $25 million.

Yes.

It's a little bit more complicated, Chris, because we sold specific spectrum, the majority of it being rural spectrum versus metro spectrum. So there's some thought that maybe rural spectrum is less valuable than the metro spectrum.

We sold roughly 10% of the total megahertz POPs that people like to value spectrum based on. But it doesn't necessarily equate perfectly linearly, but I think it should be somewhere in that range.

It's [simply] worth more. Spectrum is in high demand in Canada, as you know, so this also places a value on that asset which was not visible before, so that's always good to have, that visibility.

I appreciate the disclosure. I've read about your Canadian spectrum before but haven't gotten much more information than that, so thank you. And then, finally, just some housekeeping. Could you break out the dollar amounts of the debt issues that changed significantly during the quarter, primarily being the eights, the 14s and the 5% exchange notes? And if you don't have that handy, I maybe just get it offline?

Yes, that'd be good.

Yes, Chris, that'd be great, if I can call you afterwards because I don't actually have that in front of me.

Okay, all right. Thanks, guys. Appreciate it.

Thank you.

Our next question comes from Romeo Reyes of Jefferies and Company.

How are you?

Good, how are you.

A couple of questions. First, a follow up on the spectrum. How many megahertz POPs did you sell? Basically, what's the valuation and do you have spectrum in some of the larger cities in Canada, Toronto, Montreal and others? That would be the first one. And the second one, is it contiguous spectrum or is it different pieces of spectrum? That's just a follow up on the spectrum.

And then on the guidance, can you give us a sense of whether the second half adjusted EBITDA, if that includes that $6 million, you're doing that as one time in your $75 million guidance, or if that's included in there, so the recurring number is closer to 69?

You can answer the last one first.

On the guidance, on the EBITDA, so we said in the vicinity of $75 million. That would include the $6 million from the ACCC award. So it is inherent in total and when you factor that in, so in the first half of the year, we had EBITDA of about $38 million.

Now, is that at all recurring, any of that $6 million?

No, that $6 million relates to expenses that we incurred in prior periods, and it's a retroactive claim for that, so none of that's recurring.

So there was no repricing of the services that you get from Telstra?

So what this award relates to, Romeo, is in effect the pick fees, so when you transfer a customer on our network you have to pay a pick fee. So as we transfer new customers in the future, there is a lower pick fee than what we historically had been paying, but that pick fee had been adjusted when the interim determination was issued so that we were paying the lower pick fee since that point forward, and then this is a retroactive amount for prior to that interim determination period, when we were paying the higher amount.

So from the last couple of quarters, if our new customers migrated are this same level, there wouldn't be any forward-looking benefit. It's really a retroactive benefit.

Okay.

On the other question you asked, the answer to the first one, do we have spectrum in major cities? I believe we have spectrum in most of the major cities. I think we are missing one, and I don't recall the name of that one, but mostly the cities we have a good amount of spectrum. That's what makes it valuable.

I am not 100% sure in each of the cities is continuous. I believe it is, but I'm not 100% user of that one.

Is this 2.5?

No, it's in 3.5.

Oh, it's 3.5.

Yes.

Okay, and what was the valuation for a megahertz POP?

We sold about 70 million megahertz POPs for $5 million.

Thank you.

Our next question comes from [David Sherratt] of Lehman Brothers.

Hi, thanks for taking the question. If I can just ask you just a few questions on the cash flow side, Tom, you mentioned, if you can get EBITDA up to the mid 80s range then you'll be free cash flow breakeven and I know that's within kind of the current CapEx levels. Just if I think about it over the longer term, your CapEx levels are down a lot, you've made the investments over the last few years. Is this level sustainable over the longer period of time in terms of CapEx?

Yes, I think we believe it is, David. Years back, we obviously were spending much more on CapEx, in the days of expensive switches and fiber capacity. We then went through a period where we actually spent less than this, $25 million to $30 million of CapEx. I think then we jumped up a little bit and we initiated the DSLAM buildouts and the data center buildouts, both in Canada and Australia and I think we're on the tail end of those costs. So I think we feel it's very realistic to manage CapEx in the $25 million range going forward.

Okay, no, that's great. And you talked about the lower debt maturities for 2009, 2010, post the exchange. Now, obviously, those are the par amounts. Can you just touch on what are your limitations in terms of covenants or otherwise on using some of your cash balance to buy back some of those notes in the open market at obviously levels well below par?

I don't think I'm prepared to comment on that.

Okay, maybe a different way. You talked about excess cash as apart from asset sales and other ways to fund those maturities as they come up. I guess that excess -- sorry?

Clearly, you can use available cash to meet maturity for maturing debt.

Right. I guess my question is, when you talk about excess cash, what is sort of the minimum amount of cash you need to keep, given all your different operations across the globe? What's the minimum cash you kind of always need in those individual markets?

Yes, that's the magic question, and we've been asked that question before and I think where we feel is the range is somewhere in the $30 million to $40 million range, and that has to do with needs within the month, up and down, depending on major carrier payments. And I think it probably sounds maybe a little bit high, but we've got operations in a number of countries around the world that makes it a little bit more complicated and the need to have it a little bit higher than if I think we were all domestic based.

Yes, that's what I would have thought, and that number includes your restricted cash?

No, it does not.

It does not.

It's just unrestricted.

That's just unrestricted. Okay, all right, great. Thank you very much.

Our next question comes from [Bob Cohenfal] of Phoenix Investment Adviser.

Thank you. A couple more follow ups on the spectrum. Is that $5 million net to you, or is that $5 million gross and you split it?

It's $5 million gross into MIPS, which is the owner of the spectrum.

And does your partner need to sort of approve sales? If you were to do subsequent sales, there needs to be an approval process, right? You need to agree to do it.

That has been the course and under the shareholders agreement if there's any material disposition of assets, it would require shareholders to approve it.

Okay, and then on this $6 million regulatory award, how many prior quarters did that cover? I mean, is it like $1 million a quarter, or is it less than that?

Well, it goes back, they repriced it all the way back into the 2005 timeframe, so I think that the fourth quarter of 2005 forward is what the repricing covered. But as far as how that award breaks out to us quarter by quarter, it's very dependent on how many customers we migrated onto our network or off the Telstra network in any given quarter. I don't have that breakout but the repricing went all the way back to 2005.

Okay, and you continue to have the benefit of those lower rates until when, went it sort of reopens for consideration from the ACCC? Is that out until '09?

I believe the ACCC has already entered an interim determination that extends it beginning July 1 of this year for an additional year and they can then during this period of time the anticipation is that they would come out with a final determination which would set the period beyond that point.

And the last question, a real quick one, outside of those bond maturities you laid out in '09 and '10, you have no more maturities, right?

There's capital lease payments, so there's other principal payments on debt of probably about $2 million per year ,and then there's $1 million of amortization on the term loan per year.

Okay, that's it for me, thank you.

Okay, Bob.

Our next question comes from Frank Bianco of Argent.

Hey there. My question was answered. Thank you.

(OPERATOR INSTRUCTIONS). Our next question comes from [Steve Robinson] of [Arastela].

Yes, hi, it's Steve Robinson from Arastela Capital. I was just wondering, have you guys engaged in any additional swaps in your capital structure post the end of the quarter?

Post the end of the quarter. No.

Steve, swaps meaning currency or do you mean exchanges, debt exchanges?

Exactly, and the answer's no?

No on both fronts.

Okay, okay, and then could you just elaborate a little bit, when you were talking about how you might do additional financings to satisfy the '09 maturities, sort of what you think your options are there and sort of how that might fit into the capital structure?

Not prepared to discuss that, Steve.

Okay, yes, that's it for me. Thanks.

I'm not showing any further questions. I will now hand the call back to Mr. DePodesta for his closing remarks.

Thank you very much, Patty. I would like to inform you that Primus is scheduled to participate at the following upcoming conferences, Kaufman Brothers 11th Annual Investor Conference, which will be held in New York City on September 3rd and 4th, Jefferies Sixth Annual Communications Conference, also in New York, on September 8th and 9th and Bank of America's 2008 Credit Conference, which will take place in Orlando on November 19th through the 21st, where Tom will once again hold court in the karaoke bar.

That concludes Primus's second 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 today, and good evening.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, you may all disconnect. Everyone have a great day.