Innovate Corp (VATE) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to today's PRIMUS Telecommunications first quarter 2010 financial results. 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. I would now like to turn the call over to your host, Ms. Amy Gibbons, of Lippert/Heilshorn. You may begin.

Thank you, Patrick and good afternoon, everyone. This is Amy Gibbons of Lippert/Heilshorn & Associates and with me today from PRIMUS are Paul Singh, Chairman and Chief Executive Officer, and Tom Kloster, Chief Financial Officer. This call is being webcast with an accompanying slide presentation that can be accessed at the Company's website at www.primuspel.com, by clicking on the webcast link located in the in the news box on the lower left hand corner of the home page. Once you have registered a PDF version of the slides will be available for download through that link.

Before we begin our call, we would like to remind you that statements made by the Company during this call that are not historical fact 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 investments, 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. 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. And now I would like to turn the call over to Paul Singh. Paul?

Thank you, Amy and good afternoon, everyone. Thank you for joining us for our first quarter 2010 earnings call. This afternoon, I will walk through our operational results, including a brief update on each of our businesses, and then I will turn the call over to Tom Kloster, our Chief Financial Officer, for a review of our financial results. After that, we will open up the lines to take your questions. Let's begin on slide three, to discuss the highlights of the first quarter.

In the first quarter of 2010, we reported revenue of $204.4 million, adjusted EBITDA of $21.6 million, which includes a $1.8 million charge for severance, and free cash flow of $12.8 million. The adjusted EBITDA and free cash flow reflect the benefit of operational efficiency improvements executed by the management team in order to generate stable operating profits. The $10 million cost reduction program implemented in the second half of 2009 contributed to the solid level of free cash flow generated in the first quarter. And has helped us to partially offset the expected decline of cash flow from traditional services.

At quarter end, we had improved our balance sheet cash position to a healthy amount of $52 million in unrestricted cash, after retiring $3.4 million of lease capital debt in Q1. We have initiated the use of $10 million of this cash to buy back our public debt in the second quarter, in order to continue delivering on our commitment to improve our balance sheet. To date, we have purchased 9.5 million of our 14.25% notes.

With respect to revenue mix, we are seeing continued evidence that our strategy of investing in the development and marketing of our growth services is working. During the first quarter, growth services which include broadband Internet, hosted IP-PBX, data center, wireless, on-net local and retail VoIP services, expanded as a percentage of both local and retail revenue as customer uptake of these services increased. While the use of traditional services, that includes long distance, dial-up Internet and off-net local services declined. Notably, in our primary markets of Australia and Canada, we saw good increases in the data center and hosted IP-PBX services sold to business customers. We continue to manage traditional services for cash flow generation while seeking to maximize retention of the users of those services by offering them triple bundle and wireless alternatives. In summary, we are pleased with first quarter results and believe this is a good start towards delivering on our financial and operational objectives for the year.

Now let's move to slide four to discuss PRIMUS Australia. The first quarter is a seasonally weak quarter for PRIMUS Australia because of business holidays and summer vacation. In spite of that, PRIMUS Australia recorded a 1.9% sequential increase in revenue. We are very pleased with this result as it reflects the success of our initiatives to increase both customer acquisition and retention through improved sales, marketing and customer service. This improved operational efficiency offset normal expected seasonal decline. High value data center revenue grew by 21% over the fourth quarter 2009, a particularly strong performance. The steps we have taken in our Australian commercial business to expand our portfolio of high value data services and strengthen the sales and marketing drivers to grow these services are beginning to pay off.

At the end of 2009, we implemented a strategic accounts acquisition program and signed several new customers late last year. The revenue from these new accounts contributed to the quarterly revenue growth in Q1 2010. We define strategic accounts as those with monthly revenue of $5,000 or greater. We will continue to target high ARPU business customers as they're important to meeting our objective of replacing declining traditional service revenue with high margin growth service revenues over time. Traditional voice revenues saw an expected seasonal decline in the first quarter.

Overall, the business division performed very well in the first quarter, despite it being a seasonally weak quarter. Revenue grew across all major product lines, and we are pleased by the progress made by our management team in Australia. First quarter residential broadband subscriber metrics improved, as we strive to grow our base of broadband customers. Residential usage is affected by first quarter seasonality, to a lesser degree than commercial usage, but we still recorded results that were better than expected.

First quarter adjusted EBITDA in Australia increased substantially from both last quarter and last year, benefiting from both revenue growth and from the $10 million per year cost reduction initiative completed toward the end of last year. The quarter-over-quarter increase in EBITDA was aided by a AUD2.5 million per year cost of sales reduction realized as part of the $10 million cost reduction program.

Our business objectives for Australia in 2010 are updated on this slide. And most of them relate to laying a solid foundation of high speed data infrastructure capable of delivering data speeds up to 1 [gigabit] per second. We believe this is the key success factor in gaining market share and expanding margins in the business customer segment. We will focus on expanding growth in commercial sales by selling data hosting and hosted IP-PBX services to mid-markets and large corporations. Our sales group is building traction with strategic account sales and we are positioning the Company to start competing for government business opportunities later this year.

We are expanding our network footprint in Australia by building out additional DSLAMs that will increase our on-net coverage by 7% to 8%. Our on-net profit margin is approximately twice as high as that of off-net margins. This expansion will help improve on-net revenue mix and EBITDA margins starting in January 2011. We are planning to expand the existing metro fiber network in Sidney and Melbourne that would allow us to connect hundreds of multi-tenant commercial office buildings in these two cities to our high-speed backbone data network. We are nearly finished with our plans to start building a new Tier 3 data center in Melbourne, as our existing data center is approaching full utilization. Finally, and by the end of third quarter of 2010, we plan to enable our broadband network for IP-video and TV transmission.

Let's move to slide five, and discuss performance in Canada. In the first quarter, PRIMUS Canada generated net revenue of CAD59.8 million, which decreased 3.6% from the fourth quarter, while EBITDA grew by 2% quarter-over-quarter. Revenue from growth services increased significantly year-over-year, but grew slightly quarter-over-quarter due to Q1 seasonality. Traditional service revenue, primarily long distance voice, declined 5.9% from Q4, a greater than expected decline as a result of decreased usage in the residential long distance business and lower than anticipated prepaid card sales. Despite the weaker traditional services revenue performance in Q1, we are very pleased with earlier and better than expected returns from the customer's churn reduction initiatives we implemented late last year.

Commercial revenue in Q1 saw continued traction in growth services as market demand for our data center and hosted IP-PBX services remained strong. Our Canada sales group continues to focus on increasing the number of strategic accounts we acquire and serve. Again, strategic accounts are those that generate over $5,000 in monthly revenue. Order mix in the quarter reflects the desired outcome from our strategic initiatives. Of all new sales booked in Q1, 70% were for data and hosting services, 15% were for hosted IP-PBX, which included the largest IP-PBX order received in the past five quarters, and only 15% were derived from traditional services. We expanded our data center capacity by 60% in Ottawa, to meet growing demand for hosting services.

On the residential side, new orders in the first quarter for home phone and broadband services were the best of the past five quarters. Percentage sales of Triple Value Bundles increased in the quarter as a result of more focused marketing and advertising campaigns. The efficiency of this spend also enabled us to lower our acquisition cost per customer. Churn rate declined in the first quarter as a result of increased focus on improving on-time service delivery for new customers. Next month we plan to start selling our enhanced wireless voice and data services, including Smartphones. Phase I of our wireless strategy under our expanded MVNO agreement with [Argus] Communications is to offer our existing residential wireline customers attractively priced wireless voice, data and text plans in order to win and retain more customers.

In 2010, our business objectives in Canada are to further penetrate the up-market SME segment by effectively marketing our data, hosted IP-PBX, and hosting services and further expand our managed and hosted service portfolio to include cloud computing. On the residential side, we are pursuing additional success with bundled services. As I already mentioned, we are on track to roll out enhanced Smartphone services this quarter. Lastly, we continue to focus on opportunities to expand on-net coverage and data carrying capacity of our network infrastructure. And further enhance back office processes to support strong sales productivity and customer care and retention initiatives.

Let's turn to slide six to discuss our wholesale business. In the first quarter, PRIMUS's wholesale net revenues in US dollars was $46.5 million. Representing a higher than expected 15% decrease from the fourth quarter. On a constant currency basis, net revenue decreased 12% sequentially, primarily reflecting certain regional seasonality trends, coupled with our decision to limit credit risk exposure with certain customers. Adjusted EBITDA was only minimally affected by the reduced traffic volumes.

As a result of our deployment of new business development personnel focused on the Middle East, Africa, and Asia-Pacific regions, new customer acquisition increased and the level -- and the revenue run rate for the first half of the second quarter is substantially higher from the same period during the first quarter. Our ongoing efforts to reduce costs and expand margins of this division have begun to bear fruit. We expect recurring profit margin from the wholesale division to expand by 50 to 100 basis points from current recurring levels in the second half of 2010.

Our primary business objective for the wholesale business this year is to continue to improve gross margin and EBITDA profitability by expanding our sales focus on higher growth, high-margin markets and to increase the proportion of high-margin US traffic termination as a percentage of the overall traffic mix. We want to expand and diversify our customer base in favor of large cable companies, wireless carrier accounts, and alternative voice providers for diversification and improved revenue stability. We believe we have the right personnel and support systems in place to accomplish this goal.

Let's turn to slide seven to discuss our businesses in the US, Europe and Brazil. As we have already discussed previously, our strategy with these businesses is to primarily optimize their operational performance and manage them for cash flow contribution. Let's review them one by one.

PRIMUS US generated $13.9 million in net revenues in the first quarter, a sequential decline of 11%, resulting from declines in residential voice over IP and traditional voice services. US EBITDA was adversely impacted in the quarter by a tax expense charge that relates to a prior period. Excluding this charge, US EBITDA would have been $2 million in the quarter. Our US division's primary focus is to grow sales of high margin hosted IP-PBX services to business customers, through direct sales force and potentially through other outbound and web based sales channels that are under consideration.

In Europe, PRIMUS generated net revenues of $8.2 million euros, a sequential decrease of 2.7 over the fourth quarter, primarily due to a decrease in traditional services. First quarter adjusted EBITDA increased as a result of sharpened focus on exclusively using online sales channels in the UK and cost rationalization. Going forward, we will continue to focus on web-based sales channels to acquire new customers in an efficient manner and focus on those countries and products in Europe that offer the highest near-term return on investment. We expect that further improvements to our cost structure and our drive for improved sales efficiency should drive additional EBITDA growth in Europe this year.

In Brazil, PRIMUS generated BRL9.5 million of revenue in the first quarter for a sequential increase of 25%, a record quarter. Adjusted EBITDA increased by nearly 50% due to higher revenues and lower cost versus Q4 2009. High-margin data center revenue grew by 14% and lower margin wholesale voice revenue grew by 35% over Q4 2009. During the quarter, we increased sales of data center services by adding several new business customers. In Q1, we began an initiative to double our data center capacity before the end of third quarter, in order to accommodate a growing demand for data center services in Brazil.

Moving to slide eight. With solid first quarter results and operational execution, we are off to a good start toward achieving our key objectives for 2010. We are continuing to emphasize investments in growth products in our primary markets of Australia and Canada. Expanding our net coverage and increasing natural data speeds and increasing data center capacity in these countries. We have built traction in winning new strategic accounts and our commercial sales efforts remain focused on moving up market in the business sector. To deliver stable adjusted EBITDA and free cash flow, we are aggressively managing costs and concentrating new sales efforts on high margin, high growth data and hosting services while we manage traditional services for cash flow. With a $10 million debt buyback initiative in the second quarter, after reducing debt by $3.4 million in the first quarter, we are executing on our strategic objective of improving our balance sheet. Now let me have Tom Kloster, our CFO, review the financial performance of the Company. Tom?

Thank you, Paul. And good afternoon, everyone. Let's now move to slide nine entitled financial summary. Here we have provided a snapshot of four key metrics and how they have trended over the past five quarters. First quarter net revenue was $204.4 million, a decrease of $10.6 million, or 5%, compared to the fourth quarter of 2009. The impact of foreign currency translation was an unfavorable $2.3 million. Therefore, on a constant currency basis, net revenue decreased from the fourth quarter to the first quarter by $8.4 million, or 3.9%. The $8.4 million sequential decrease was comprised of the decline of $1.9 million in retail revenue, and a decline of $6.5 million in wholesale revenue. The $1.9 million decline in retail revenue reflects a slight fall off from the decline of $1.6 million in the fourth quarter of 2009, but continued improvement from declines of $2.2 million, and $5.3 million experienced in the third and second quarters of 2009 respectively. The increased rate of decline in retail revenue is due in part to a heightened pace of traditional long distance voice revenue decline in Canada and seasonality in Australia. The $6.5 million decline in wholesale revenue encompasses normal wholesale revenue fluctuations, a bit of seasonality, and our efforts to reduce credit exposure to certain customers. The Q2 wholesale revenue is now trending back to levels consistent with that of Q4 2009.

Growth services net revenue which includes IP-PBX, broadband Internet, data, data center, on-net local, wireless, and consumer VoIP was $70.9 million for the first quarter of 2010 and was comparable to the fourth quarter of 2009. We continue to see growth in data center, broadband Internet, and IP-PBX services revenue, partially offset by declines in consumer VoIP services revenue. Net revenue from growth services comprised a greater percentage of first quarter 2010 retail revenue, 45%, than in past periods as growth services revenue generation becomes more consistent and customer usage of traditional services continues to decline. PRIMUS's strategy to prudently invest in capital and sales and marketing in higher demand products including data center, broadband Internet and IP-PBX services, is resulting in stronger traction of these services with small and medium enterprise customers.

Adjusted EBITDA was $21.6 million, or 10.6% of net revenue, compared to $23.1 million or 10.7% of net revenue in the fourth quarter. However, Q1 adjusted EBITDA included a $1.8 million charge for severance. This is our fifth consecutive quarter of delivering stable to modestly improving adjusted EBITDA and is reflective of our continual cost management in both cost of sales, in SG&A, while we focus on increasing our retail revenue from growth services and managing our decline in retail revenue from traditional services. Capital expenditures in the quarter were $4.9 million, or 2.4% of total revenue and 3.1% of retail services revenue; compared to $5.5 million or 2.6% of total revenue and 3.6% of retail services revenue in the fourth quarter.

Free cash flow for the first quarter was $12.8 million. Our free cash flow is higher in Q1 and Q3 as a result of the timing of our semi-annual debt interest payments which occur in Q2 and Q4 of the year. Cash was generated during the quarter through $21.6 million of adjusted EBITDA, and $300,000 for currency movements. Partially offset by cash usage of $4.9 million for capital expenditures, $3.4 million for capital lease debt repayment, $3.1 million for working capital, including previously accrued financing and reorganization costs, $700,000 for interest, and $200,000 for taxes.

Let's now turn to slide 10 to discuss our free cash flow a bit further. We have presented an illustrative example of our annual free cash flow using our current level of cash interest expense, our estimates for capital expenditures, cash taxes and working capital and our last 12 months of adjusted EBITDA to arrive at an illustrative annual free cash flow of between $23 million to $28 million. Orderly free cash flow will vary as a result of the semi-annual interest payments occurring in the second and fourth quarters. As you can see in this illustration, PRIMUS continues to be well-positioned to generate substantial free cash flow.

Let's now move to slide 11 to discuss foreign currency. Here we have provided that average currency rates utilized during the reporting periods presented and as of Friday's close. You can see that currency levels for the Australian and Canadian dollars have remained relatively stable from Q4 2009 to Q1 2010, while European currencies have weakened. However, we derive very little cash flow from the European region. As discussed on previous earnings calls, we have somewhat of a natural currency hedge as our operating units receive revenue and incur costs in their respective functional currencies. Our currency exposure comes from the movement of cash from foreign units to the US in order to service our roughly $33 million of interest expense from US denominated debt obligations.

Let's now move to slide 12 to review our capital expenditures. In the first quarter, we spent $4.9 million on capital expenditures. The pie charts on this slide break out the allocation of our investments by service and geography. Once again, over 90% of our CapEx was directed to our primary markets of Canada and Australia, and into higher growth and return projects, increasing our broadband network footprint, speed, and on-net coverage and enhancing data center capacity and service capabilities.

Moving on to the balance sheet on slide 13. We ended the first quarter 2010 with $52.1 million in unrestricted cash and cash equivalents, up from $42.5 million at December 31, 2009. During the quarter, we repaid $3.4 million of capital lease obligations, bringing our total debt at March 31 to $256.2 million, compared to $259.6 million at December 31. Additionally, subsequent to the quarter end, we have initiated a directive to repurchase $10 million of our outstanding debt. To date we have purchased and retired $9.5 million of our 14.25% senior subordinated secured notes due 2013. Our robust free cash flow is enabling us to aggressively reduce our debt and improve our credit statistics as noted on slide 13. In the future, we will continue to assess opportunities to deploy free cash flow toward growth product initiatives or debt reduction. That concludes my prepared remarks. I would now ask the operator to open the call for questions-and-answers.

(Operator Instructions) Please hold for our first question. Our first question comes from Romeo Reyes from Jefferies & Company. Your line is open.

Hi. Couple of quick questions. If you could touch upon your web hosting business, currently how many data centers you have at this point? what's the square footage and utilization rates? Just kind of get a sense of how big that business is at this point. Secondly, with respect to your broadband engaging initiatives, both in Australia and in Canada, can you give a sense of what your utilization is on some of those key plans? How much excess capacity do you have? And (inaudible) the margins, remind us what the difference is between retail broadband versus on-net margin.

Let me -- Romeo, how are you?

How are you, Paul?

Let me give some color on our data hosting and managed services business. We have -- to start with, we have five data centers -- sorry, seven data centers in Canada in five cities. So it's a pretty broad coverage in Canada. And then we have two data centers in Australia and then one data center in Brazil. So the total of 11 data centers in eight cities, in three countries. Annual revenue run rate based on current currency owed by the end -- before the end of last month. That was about $38 million. Gross margins, roughly 76%. Annual EBITDA run rate of about $16 million or 42% of revenue, a very healthy EBITDA performance compared to major competitors in the area.

In terms of the potential for growth and the capacity utilization, right now our goal is to focus on the existing data centers because there is capacity in most of them except our Melbourne and Sidney data centers are almost full. But in Canada we have in several data centers, we can build up additional capacity and, as I stated before, we try to build them in 3,000 to 5,000 square feet at a time. And so as we start getting towards 70%, 75% utilization of the existing space, we start building a new phase of it. And that has kept our investments to a managed level, at the same time to get a better return on investment.

So we are pretty excited about our data hosting business. This is one area I think we can expand faster the incremental revenues from this. I'm going to say roughly about 40% to 50% revenue expansion in the current data centers. But you would have to develop the remaining capacity. So I think that should answer most of the questions. The churn rate in our data centers is about 1%, which is standard for, again, the industry.

Are your customers under contract, Paul and what's the general tenor of those contracts?

Contracts -- first on the services, we have colo services and managed hosting services. I think there is more of colo services than managed hosting today, so we see a larger opportunity to now going towards managed hosting and cloud computing. Our data centers are also connected by a network within Canada and soon they will get connected globally as well. As you know, there's more demand for global data centers now, so we are making a lot of progress in that.

In terms of the customers, contracts would range from one to three years. As there are larger customers that we are trying to now gain, those could go all the way up to five to seven years. But so far, they range between one to three.

And the incremental EBITDA, because all of them are profitable, the incremental EBITDA is roughly about 63% to 65%. So to the extent we can bring revenue in any of them, that would be -- general that's our first priority, obviously.

The second question that you have is on DSLAM utilization. DSLAMs -- I think, first there are two points on DSLAMs. One, so far in Canada as well as in Australia, we have used the capacity primarily for our residential customers. So in Canada for example, we still have business customers who are local lines, as well as the broadband which are off-net for us. So one of the opportunities we have in Canada is this is why I think we focused on how could we expand on-net coverage because we already have customers we can bring on-net. Second is to increase the capacity and data speed so our business customers can come to even our existing DSLAMs. Same thing applies to Canada.

Now, in terms of the expansion part of it, I would say -- I don't have the exact number for the overall network, but I think we have -- we can add capacity to the existing DSLAMs. What we are trying to do is to also increase the coverage itself because we have customers off-net. So for example, in Australia we are looking to add about 20 to 25 additional DSLAMs. It does take about nine to 12 months from the time you start asking, say Telstra or Bell Canada, for the capacity. The whole process by the time they come on service is about nine to 12 months. That's why I said in Canada it would be 2011 impact on that one. But again, in DSLAMs as well we are increasing the processes, general. The data carrying capacity so that could get the DSLAM networks to enable them to carry TV and video traffic as well.

I think the final question was really on margin enhancements off-net, on-net. And there's relatively significant enhancements, depends on whether they take both services; both local and broadband or just one. Typically off-net is to on-net is almost double the gross margin percentages. You're probably in the 20%, 25% range off-net and double that beyond that.

Canada would be a little bit higher. Normally they are in 30% to low 30%, but on-net would be twice as high. So there's a big incentive to have more on-net coverage.

(Operator Instructions) Thank you. We will end the question-and-answer session now. I will turn the call back over to Mr. Singh.

Once again, thank you for participating in our first-quarter call. We look forward to speaking with you again in August when we report our second quarter financial results. Have a good evening.

Thank you.

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