Innovate Corp (VATE) 2008 Q3 法說會逐字稿

Ladies and gentlemen, thank you for your patience and welcome to your Primus Telecommunications third quarter 2008 earnings call. At this time, all participants are in a listen only mode. Later we will conduct a question and answer session and instructions will follow at that time. As a reminder today's call is being recorded. I'd now like to turn the call over to your Executive Vice President, and Co-Founder, John DePodesta. Sir, you may begin.

Thank you very much, and good afternoon, ladies and gentlemen, and welcome to Primus's third quarter financial results conference call and webcast. I'm John DePodesta, Executive Vice President at Primus. For those who have not yet 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 third 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.

It was slightly over three months ago that we reported our second consecutive quarter of growth in retail revenues, which was the impetus for raising our adjusted EBITDA guidance for 2008 to $75 million; however, during that call, we also emphasized that with our debt current structure, we had to generate adjusted EBITDA in the mid $80 million range to be cash flow breakeven. Immediately following that call, our senior managers began to plan and to implement a broad ranging cost reduction program which would place the Company on a trajectory exiting this year to be free cash flow positive in 2009. The actions that were implemented over the last 45 days were broad and deep, including a reduction of 13% in total headcount and the elimination of bonuses, yielding an estimated annual cost reduction of $15 million. This planning and execution were premised on two key assumptions. Relatively stable business conditions and constant currency exchange rates, and then the world shook.

At Primus, we had always assumed that our portfolio of operations around the globe provided diversification, in natural hedges against dislocations and a particular country. What we did not anticipate is that a systemic shock would cause widespread damage to the global economic border. While we are beginning to experience the impact of global recessionary trends in our business, the most immediate and significant impact has been the volatile movement of currency exchange rates, as the US dollar strengthened significantly against the local currencies in our major operating regions. If the current US dollar exchange rates are maintained or worsened, this alone could dramatically reduce or offset the recent $15 million of annual cost reductions. The combined impact of currency exchange rates, recessionary trends, and constrained credit globally which has frustrated our plan to sell assets for cash, has put strains on our liquidity.

While distinctly different in nature and scope, the current global economic crisis presents circumstances similar to what Primus faced in the early part of this decade. Then, the so-called dot com implosion combined with the 9/11 disaster paralyzed financial and credit markets. With corporate carnage strewing the landscape, Primus had to fight for its survival against the impact of those external events. At that time, Primus had approximately $1.2 billion in annual revenue, $8 million in adjusted EBITDA, and over $1.3 billion of debt. We aggressively implemented a multi-faceted strategy that reduced costs, eliminated under performing businesses, and through a combination of negotiated transactions with our bondholders and open market purchases, we were able to reduce our debt by half. While most of out former peers were liquidated, Primus survived.

In some respects, we are in a relatively better position today. Our projected adjusted EBITDA for this year is between $60 million and $65 million, and we have $582 million of debt; however, the challenges for Primus to be a financially self-sustaining entity without deleveraging are formidable. Particularly in these times of credit starvation and a worsening global economy. We will, of course, continue to pursue aggressively further cost reductions and efficiency improvements to bolster our liquidity. Also, though the environment is admittedly difficult, we will continue to pursue selective asset sales. More is required, however, and as we did some years ago, we need the cooperation and support of our bondholders to enhance enterprise value.

Most immediately, we need to extend the maturities of our near term debt issues, $23 million of which comes due in the latter half of 2009 and $57 million of which come due in the latter half of 2010. At this point, it is difficult to predict how long the current global financial crisis will endure and consequently, we think it prudential to address now all of our 2009 and 2010 maturities.

While debt extensions will bolster near term liquidity, the remaining overall annual debt service obligations are too constraining for Primus to attain its economic potential. For example, with limited liquidity, we cannot invest adequately in capital expenditures that will improve our profitability and expand capacity in our data centers and on our broadband and IP infrastructures. Thus, we plan to confer with our bond holders to explore alternatives to deleverage our balance sheet through debt and interest reductions. Our approach is grounded on some fundamental premises.

First, Primus has core franchises that represent considerable enterprise value and represent platforms for future growth opportunities in non-voice business applications. Second, our ability to enhance these values is seriously constrained by our current level of debt service. And third, the economic dislocation that will result from the current economic global credit crisis should create opportunities for Primus to expand its business, if we have the means and circumstances to do so. We are confident that our stakeholders will share this vision and as before, will work cooperatively with the Company to enhance enterprise value. I will now ask Tom to comment on the results of the third quarter.

John, thank you, and good afternoon. During the third quarter, we began to feel the effects of the severe global economic and financial market decline. Most notably, foreign currencies in our major operating markets have fallen sharply. Collections from our retail customers, especially in Canada and the US have slowed, and the ability to sell non-core assets has been reduced. During the third quarter, and even more dramatically in October, the dollar strengthened against most major currencies. Since the end of last quarter, through October 31, the Australian dollar is down 30%. The Canadian dollar is down 16% and the euro and pound are each down 17%. The concerning effects of Primus of these currency movements is that funds generated from earnings of our foreign subsidiaries and upstream to the US result in less US dollars available to service our US dollar denominated debt. At October 31, 2008, exchange rate levels approximately $2.5 million less US dollars per quarter would be generated than if currency rates had remained constant from rates at June 30, 2008.

During the third quarter, we recorded charges of approximately $1 million in excess of normal levels for doubtful retail customer accounts receivable. We believe the general decline in economic conditions is the factor behind the slowdown in customer payments. In July, a Canadian entity of which the Company owns 45.6% sold approximately 10% of its Canadian WiMAX spectrum capacity for CAD$5 million. Despite this success, the global economic and financial market conditions have clearly frustrated our efforts to sell other assets to enhance liquidity. In an effort to improve our liquidity, and accomplish our goal of attaining free cash flow for 2009, management met during the middle of the third quarter and defined an action plan which included a 13% reduction in headcount and additional savings in other areas of SG&A. This plan was implemented in late September and October; however, the recent adverse changes in the currency exchange rates if maintained or worsen could dramatically reduce or offset the anticipated 15 million annual benefits from these cost reductions. Accordingly, management is formulating further cost reduction plans to address our liquidity needs.

Now let's review the third quarter operating results. In Canada, exclusive of additional provisions for doubtful accounts receivable, retail revenue grew 0.5 of 1% following growth of 1.4% in the prior quarter. Revenue from commercial data center services and hosting products grew 3% quarter-over-quarter offset by declines in residential and commercial long distance revenue.

In Australia, we experienced revenue growth in our commercial segment from nearly all product lines; however, consumer revenue declined in the quarter driven mainly by attrition of our dial-up Internet customer base and revenue from resold local voice services. This resulted in an overall revenue decline of 1.5% quarter-over-quarter. We continue to place customers directly on to our expanded DSLAM network and realize higher margins as a result. Accordingly, adjusted EBITDA from operations in Australia grew slightly this quarter as compared to the prior quarter. In the US, retail revenue declined 6% sequentially, reflecting higher than expected churn in our Lingo VoIP business, attrition in the legacy consumer long distance business, and additional provisions for doubtful account receivables. The US management team remains focused on cost containment and optimizing marketing efforts across all product lines. European revenue, European retail revenue remained flat from the prior quarter which is comprised of growth in our French and Belgium operations offset by declines in other European countries. Our efforts to market to small and medium sized businesses are bearing fruit in France and more recently the UK.

Third quarter net revenue was $232 million, down $4 million from the prior quarter. The $4 million sequential revenue decline is comprised of an $8 million negative impact from the strengthening of the US dollar and a $2 million decline in retail revenue. These declines are partially offset by a $6 million increase in wholesale services revenue. After two quarters of stable retail revenue, this quarters $2 million decline was comprised of $1 million from the increased provision for doubtful accounts receivable and $1 million from long distance, dial-up Internet and VoIP revenue declines primarily in Australia and the US.

We experienced another strong quarter of revenue growth from our wholesale unit. The $6 million revenue growth or 11% this quarter follows growth of $7 million and 17% in the prior quarter. Although wholesale revenue provides comparatively lower margin percentages, we continue to see an increase in large stable carriers using our network as we have expanded our routing and domestic and international product offerings. Additionally, our focus on maintaining extremely prompt payments to our carrier vendors allows us a competitive advantage in the wholesale marketplace. In view of the current economic environment, the future focus of our wholesale team is to continue to improve profitability while being very prudent in managing customer collection risks, even if that means less revenue. Revenue from broadband, local, VoIP, wireless, data, and hosting services was $59 million, and remains stable from the prior quarter, exclusive of the effects of currency movements. The profitability or revenue less cost of revenue from these products continues to expand and is now above 50%. Our significant DSLAM network and data center expansion activities are behind us and accordingly, the majority of our future capital expenditures will be success based to support growth in these products.

Net revenue, less cost of revenue, was $82 million or 35.3% of net revenue. As compared to $94 million and 39.6% in the prior quarter. The prior quarter included a reduction in cost as a result of a $6 million regulatory award in Australia. The margin percentage decline was further influenced by the additional uncollected -- uncollectible revenue provisions, the higher percentage of total revenue from lower margin wholesale revenue and from currency exchange rates. SG&A expense was $70 million or 30.3% of net revenue, flat with the prior quarter. SG&A in the quarter included $2 million of sales and other indirect tax accruals as the result of ongoing audits and $1 million of severance costs.

Adjusted EBITDA for the second quarter was $12 million as compared to $24 million in the prior quarter which included the benefit of the $6 million Australian regulatory award. As noted previously, the third quarter also included $4 million of charges in the quarter related to doubtful accounts receivables, indirect tax accruals, and severance. We ended the quarter with an unrestricted cash balance of $48 million as compared to $56 million at the end of the second quarter. During the quarter, we spent $12 million on cash interest payments, $6 million for capital expenditures, $2 million on scheduled debt principal reductions, $1 million on income tax payments, and $1 million on business acquisitions. Additionally, the exchange rate movements reduced our reported cash balances by $3 million. These cash usage items were offset by $12 million of adjusted EBITDA and $5 million of proceeds from the sale of certain Canadian WiMAX Spectrum capacity.

While we began to experience in the third quarter the impact of deteriorating global economic conditions and the volatility in currency exchange rates, these forces are likely to present us with significant challenges in the fourth quarter and in 2009. Our immediate operating priorities are focused on improving our near term liquidity. Accordingly, we expect to pursue the following operational actions. Additional cost reductions beyond the $15 million of annual savings implemented in late September and October and reducing capital expenditures. Based upon the third quarter results, the deteriorating global economic conditions, and the volatile currency exchange rate levels, we are revising downward our adjusted EBITDA guidance for 2008 from our objective of $75 million to now be between $60 million and $65 million for 2008 which is in the lower range of our initial guidance this year. In addition, given the impact of currencies on our consolidated revenue, it is now our expectation that 2008 revenue would decline between 2 and 5%.

Finally, we expect that our full year capital expenditures will be at the lower end of our guidance range of 25 million to $30 million. I will now turn it back to the Operator to open the call up for questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from Ana Goshko with Banc of America.

Hi, thanks for taking the question. Can you hear me?

Yes, we can.

Oh, great. So first just a couple of questions on what you're trying to do with the balance sheet. So when you say negotiate extension of near term debt maturities are those capital leases or something of that nature?

What I'm really addressing there, Ana, is the 8% step up debentures and the 12.75 senior notes which are due in 2009 and the 2010 maturities are the 5% exchangeable notes and the 3.75 convertible debentures.

Okay. And then secondly, on the additional cost reductions, maybe if you could just give us some more granularity on the areas where you think you can cut and what the potential impact would be on the offset of how much revenue growth you may end up having to give off if you're cutting back on some of your cost items?

This is Paul. I think we have just completed actually a couple of weeks ago the 13% headcount reduction and some other costs, so those are being finalized, most of those have been executed. We are actually in the middle of preparing what other cost cuts we could have, but it's going to involve a combination of some of the functions, for example, in the combining of the US and UK operations, the network operations because now we have a common platform throughout Europe and the US of our network, so those organizations now would be combined and some of those functions would also be outsourced, and so that's just one example of it. So I think what we are trying to do now is the same thing with the IT group in the two countries, trying to combine certain functions to achieve efficiency and by doing so, I think it will have positive impact on other costs as well. We are combining, for example, billing operations of the US and Canada, so all of the billing could be done from one country instead of each of the countries doing their own operations. So after making the first adjustment, we are looking to make some headcount reductions by combining certain functions as well as we are looking at non-LOE related items as well.

Okay, thank you very much.

Thank you. Our next question comes from Chris Roberts with Tejas Securities.

Good afternoon guys. Thanks for taking my call. First, on gross margin for your new initiatives, last quarter you commented that it was approaching 50% with expectations there might be some additional improvement. Tom, I know you've kind of provided some good details on what was going on in Australia but on a consolidated basis are you still seeing a 50% type gross margin range for your new initiatives?

Yes, Chris. The new initiatives still has to have fairly strong gross margins and we actually saw a slight increase in our gross margin percentages on the new initiatives this quarter versus last, so we're still comfortable with how that is progressing. I think from a revenue standpoint and the new initiatives, the revenue was somewhat stable this quarter as opposed to growing when you take out the effect of the currency, and that continues to be growth in our data and hosting products and growth in some of our local services. The difference I think this quarter was we had a decline in our VoIP revenue as we saw a little higher churn rates in our VoIP product in the US and we started to back off some of our marketing dollars in that product as we've focused them more on some of our other products.

I see. Are you seeing, I mean, other than VoIP, are you seeing subscriber losses in your other markets, such as Canada and Australia?

I wouldn't say subscriber losses, no. We're seeing probably enhanced challenges and growing them, but I wouldn't say that the churn rates are detrimental.

Except I would say the dial-up Internet which has been declining, so the dial-up Internet will continue to have more churn, as people move to DSL.

Yes. In the past, you've provided some guidance about your subscriber levels in Canada, Australia, and Lingo. Can you provide I guess general levels now or as of the end of the third quarter?

I can give you some general ideas on those if you'd like, and from a broadband customer standpoint, on a global basis we remain in the little over 220,000 range from a local customer standpoint, we're somewhere North of 285,000 local customers and then I would say from on net services which is another significant metric that we track, especially from a margin standpoint, that's continued to grow and from an on net service standpoint we have a little over 210,000 on net services primarily focused in Canada and Australia.

Okay, great. All right, Tom, thank you very much. I appreciate you guys taking my call.

Okay, Chris.

Our next question comes from Bob Konefal with Phoenix Investment Advisory.

Thank you. John, about a month and a half ago or so at a conference I asked whether you thought Primus could achieve double digit growth on a constant currency basis for EBITDA. Obviously the currency headwind is there but do you still believe that is achievable on a constant currency basis, double digit EBITDA growth?

I guess I might ask which constant currency? It has been so volatile to really plan, and actually, it might be helpful for us to maybe give you some metrics in terms of what the impact is in our two major markets, Australia and Canada, with changes in the currency rates and the implications that has on EBITDA. Tom, do you have--?

Yes, I think the currency as we said in our stated remarks, both John and mine and in the earnings release, are very concerning to us, and it affects us certainly on the top line and it affects us also on the converted EBITDA level. Where a substantial amount of our profitability made is in our Canadian subsidiary and our Australian subsidiaries. Those currencies obviously have moved very significantly. If all of our calculations have been focused on the October 31, currency levels, and actually they have gone up a little bit or improved in the first 10 days of November, but given the effect from where they are currently or the October 31, rates on the EBITDA, it can have an effect of in the neighborhood of $2.5 million for the quarter. So at the same level of earnings in our foreign subsidiaries will convert into about $2.5 million less of EBITDA, so that's the hump that we have to get over and I think on the revenue side, it's even more dramatic, although the EBITDA is more significant one for us but on the revenue side based on the currency levels that have really just dropped off the table in October, the effect quarter-over-quarter can be in the neighborhood of $25 million if these currency levels remain throughout the rest of the fourth quarter.

Okay, just as a follow-up to your answer there, so that $2.5 million, the way to think of that is if October levels just held, it would be a $2.5 million quarterly EBITDA hit. Is that right? Is that the way to think of it, and approximately a $25 million revenue hit?

Yes, if currencies stay at the levels they're at at October 31, okay? And they are up slightly right now, so the effect would be somewhat less, but yes. Those numbers are right if they stay in this depressed state.

Okay. And then where is the cash housed? Is it housed locally mostly or is it housed in the US? Your cash balance?

It's both, so we have cash out in our operating units that is needed for day-to-day working capital and then the operating units that are profitable will build up cash and then it will get swept to the US on a monthly basis, so I would say at any given time, you have somewhere about two-thirds of the cash in foreign units and one-third in the US.

Okay, and just a couple quick ones on laying out a possible bond restructuring here. What's the trigger? Should we expect a -- should bond holders expect, or certain classes of bond holders expect some sort of proposal from Primus at some point in the near future?

Well, Bob, what I would envision at least at the outset is multi party, multi faceted set of discussions involving us and various bond holders because I think I'm in a position where I would like to exchange views and get ideas from our constituents and hopefully out of that will emerge an ability to put together a proposal that works for both of our mutual interests.

And then sort of a related point, I believe you have virtually exhausted the $200 million carve out in the 8% indenture, so there's no more 14.25 exchanges you could do at this point?

It's very limited. I think there's very little capacity left under that unless we were to in effect exchange out some of the 5% convertible notes which could restore capacity.

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

Thank you, Bob.

(OPERATOR INSTRUCTIONS) Our next question comes from [Nick Delionardis] with Bond Tree Capital.

Hi, guys, just a quick few questions here. On the 2.5 per quarter, is that adjustment from 6/30 to 10/31 or is that from third quarter end to 10/31?

Nick, that's an adjustment from June 30, to October 31, currency rates.

Okay.

Yes, Nick, just let me just make a comment. I think for every $0.01 strengthening in the US dollars, of a Canadian EBITDA will get impacted by 560 K in approximate 560 K for year in EBITDA. Similarly, $0.01 strengthening of US dollars against the Australian currency will result in 280 K change in annual EBITDA. This is just the sensitivity to the exchange rate, so we have seen I think currencies in a period of three days go up and down by 10% so I hope they stabilize, and so just forecasting becomes slightly easier.

Sure.

Then, I think the other part that these currencies have an impact in is on our gross margin because we purchase of a cost of sale, result in traffic globally so some are made in dollars, some from maybe euro and Australian dollars and when the currencies change too fast, that is very hard to adjust of a cost of sale, so I think the volatility of currency values also has an impact on the gross margin. If they change slowly then at least you can adjust the, negotiate the cost downwards or upwards, but the fast velocity of changes really has kind of gross margins as well.

On the 13% cuts that you guys attribute that and some other things about $15 million of annual savings, how much, if any of that 15 of savings was included in the third quarter?

No, third quarter did not include. It didn't include any.

Yes, Nick, there were very little. There were certain actions taken at the end of the third quarter to some headcount reductions and so on, and part of this severance that's reflected in the third quarter is as a result of that, but very little of the deemed $15 million of annual savings hit in the third quarter.

And at the same time when we made the changes, the currency from the day-to-day general would actually have absorbed all of the savings, not all of it but a majority of it. This is how fast the currency values have come down since I guess September 25, or that week when we took the actions.

Sure and should we see the majority of that annualized benefits start to appear in the fourth quarter or will that likely be the first half of next year?

No, I think most of it would be, we should have seen a majority of it in the fourth quarter except I think we are going to get compensated for the currency, strengthening of the dollar.

Okay.

The losses that we will get from strengthening of the dollars and we will probably compensate to a large degree, unfortunately.

On the bad debt and the sales tax accruals that you took, any sense is that bad debt number likely to be something that you'll continue to see just higher going forward given the economy or do you expect that to be more of a one-time charge? And then on the tax accruals same sort of question is that something we should expect to be recurring or is that just a one-time catch up?

Nick, on the tax accruals I would say you should expect that to be a one-time item we believe. Periodically we get involved in audits for various tax jurisdictions so it's conceivable it could come up again, but that's sort of a one off item related to the additional provisions for bad debt. It is in our consumer business and seems to be a little bit more focused in the US and Canada so we're just seeing a slowdown in customer collections and formula driven as we see customer collections age out then we tend to take provisions that are higher in nature to support that.

I think on a positive side we had a large base of our business that's paid through direct debit or credit cards and that's an immediate charge to the customer. So that I think minimizes the effect of the economic conditions. It doesn't eliminate it because sometimes you hit credit cards that are at their maximum and it rejects and so on but I think that helps us minimize but as an example, our allowances for bad debt in Q3 was about 1.4% of revenue, it was about 1.2% of revenue in Q2, so we are optimistic that it's not going to deteriorate further but these economic conditions certainly present that possibility.

Thank you.

Our next question comes from Matthew Dundon with Miller Tabak Roberts.

Hi, thanks for the question. A couple things on your enterprise, end user, non-consumer retail, what do you see there in terms of collections, disconnects, anything about the sales channel you can comment on? And secondly, you've talked about a capital structure you don't like, i.e. the current one. When you're talking to bond holders do you have some ideal in mind? Is there a correct level of leverage that makes sense to you and does something need to be done on the common equity capital side of the equation to put the Company on what might be thought of as a permanent capital structure footing?

Well, I'll try to address the second part of your question first, Matthew. The answer is yes, we're clearly looking for a new capital structure, for a long time now we've been suggesting that the existing level of debt is just too large for our current level of operations to support, so we will be looking for a substantial reduction in overall indebtedness and in that connection, we also need to look at the equity capitalization of the Company as well. We have no fixed notion or plan to advance here in the near term. As I mentioned to Bob Konefal, my expectation is that we will be talking to a number of our holders getting their views and thoughts and hopefully out of that be able to formulate a structure and a plan that makes sense for the large constituency. Tom, do you have a response to the first question?

Yes, I'm not sure I understood that question if you don't remind repeating it that would be great.

Business customers, business customers, you don't have debit cards against the charge. Are you seeing similar account performance for business customers and also anything you can talk about, any changes in sales channel in the past few weeks or a couple of months? Whatever period--?

On that collection side of the business customers, I think we haven't seen any marked deterioration there, so I think it's primarily focused on our consumer channels.

Okay.

And then I think from the standpoint of just the businesses, our sales levels on the commercial side of the business in Australia and actually in Canada seem to be fairly good, so we seem to be encouraged by our ability to continue to sell into those markets. We expect and we see a little bit of less decisions being made at the consumer level but it hasn't really manifested itself right now in our revenue figures.

And at the business end.

That's at the commercial level?

Yes.

Seeing an increase in the sales cycle but not necessarily people closing the door and just saying we're not buyers for the time being?

Correct.

No, we have not seen that.

Actually, last month, the order input was pretty much on track, so I guess at least last month we didn't see any.

Okay, did you take any headcount in reductions in sort of the commercial enterprise focused salesforce?

Yes, I think we had, in our headcount management part, what we have done is basically looking at performance of individuals and sales. So to the extent, so yes, there was some cuts made but more in sales, we kind of make it based on the individual performance itself.

Okay, thank you very much, gentlemen.

Okay.

Ladies and gentlemen, that is all the time we have for questions. I will now hand the conference back over to John DePodesta for concluding remarks.

Thank you very much. Ladies and gentlemen, this concludes Primus's third 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 again for joining us today and good evening.

Once again, ladies and gentlemen, thank you for your participation. This does conclude our program. You may all disconnect and have a wonderful day.