Innovate Corp (VATE) 2011 Q2 法說會逐字稿

Welcome to the Primus Telecommunications second quarter 2011 conference call. At this time all participants are in a listen only mode. Following management's prepared remarks we'll hold a Q&A session. (Operator Instructions) As a reminder, this conference is being recorded August 16, 2011.

I would now like to turn the conference over to Mr. Richard Ramlall, Senior Vice President, Corporate Development and Chief Communications Officer. Sir, you may begin.

Thank you, Operator, and good morning, ladies and gentlemen. With me today on the call are Peter Aquino, Chairman, President and Chief Executive Officer; Ken Schwarz, Chief Financial Officer; and Jim Keeley, Treasurer. This call is being Webcast with an accompanying slide presentation that can be accessed in the Investor Relations section of our website at Investors.PTGI.com on the main investor overview page. Once you have registered for the Webcast, a PDF version of the slides will be available for download through that link.

Please note that all the financial information that we're presenting today reflects the impact of the discontinuation of Primus' European retail operations in all periods, as well as the acquisition of Arbinet which was completed on February 28, 2011, and affects second quarter 2011 financial results.

Before we begin our call, we would like to remind you that statements made by the Company during this call that are not historical facts are forward-looking statements for purposes of the Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may include, but are not limited to, statements regarding the Company's revenue and earnings projections, business plans and objectives, capital investments, capital structure, expected future financial and operating performance, future products and services, future market opportunities and other financial matters. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those highlighted in the Company's most recent Annual Report on Form 10-K and other periodic and current filings with the Securities and Exchange Commission. Such forward-looking statements are current only as of the date they are made. The Company disclaims any obligation to update any forward-looking statements in the event of changing circumstances or otherwise.

And now I would like to turn the call over to Peter Aquino. Pete?

Thank you, Richard. Good morning, everyone. So we continue to execute on our strategy to improve operations and to unlock value in Sum of the Parts through ways that we believe will further transform PTGI and create additional value for our shareholders. The second quarter was a huge step in that direction, as we literally knocked out several objectives in just a few short months.

Our first big accomplishment was the improvement in our balance sheet. We started the quarter by buying down $24 million of the 14.25% notes with our excess cash. And we quickly relaunched our debt exchange with lockups in place. By July we closed on $240 million of new notes due 2017. And given current market conditions we got in just under the wire. The weakness in the economy also prompted the Board to recently approve a stock repurchase authorization of up to $15 million, as permitted by our new indenture. Also during the second quarter, with the ringing of the opening bell at the New York Stock Exchange on June 23, the Company's common stock began trading as PTGI. We're certainly very excited to be listed on a major exchange to broaden our investor base and to create value as we march through our key business objectives.

So specifically, we're aggressively focusing on redirecting our resources towards growth products and services in areas where we have a sustainable advantage. Namely, managed services hosting cloud computing in Canada, Australia, and Brazil. Company-wide we are now over 90,000 square feet of raised floor space with two-thirds of our data center assets in Canada. We're focused on staying ahead of growing demand in all locations. And today, we have 11 data centers globally and meeting customer requirements up to tier 3 levels. With our expansion plans into 2012, we estimate that our utilization will be about 25% of our maximum floor capacity. This gives us great room to buildout on a success-based program.

Overall, consolidated data center revenues converted to USD were $12 million this quarter up 22% year-over-year. At this pace, annualized run rate revenues are estimated at over $50 million for our data centers. And if you apply an estimated direct EBITDA margin of 50% this asset could generate $25 million EBITDA in only a year out. This is clearly one of our key priorities.

The other strategic project is the regrooming of our metro rings in Australia. In Phase 1, we will soon be installing new electronics in the backbones of Sydney and Melbourne, the top 2 business markets in the country. Early next year, we'll begin our work in Brisbane, Perth and Adelaide where today we already have fiber weaving through the central business districts. Strategically, we have a significant fiber presence in the 5 top markets in Australia and we aim to take advantage of this by addressing the SMB and enterprise marketplace with state-of-the-art data services, their available leading telecom markets such as the US, and leapfrog the competition. So, as you can see, we're big believers in building value PTGI through the commercial segment in both data centers and metro rings over the coming months.

Moving forward, to support our financial and operating objectives, we made some key organization announcements this quarter by adding Ken Schwarz who you'll hear from today as our CFO. And also appointed Tom Mazerski as the new CEO of Primus Australia. Tom successfully reorganized our US retail business and turned it into a real portfolio contributor. We're expecting to leverage his experience to take advantage of our great opportunity in telecom assets, metro, and data center opportunities throughout Australia. Subsequent to quarter's end, we also had a great opportunity with our partner in Canada, Globility Communications Corporation, or GCC, where we indirectly hold a 46% interest. They agreed to sell their spectrum of 3.5 gigahertz of fixed wireless spectrum for CAD15 million. This deal is subject to approval by Industry Canada and we fully support GCC's decision to monetize these non-core assets.

So in summary, before we get into the details of the financials, of all the things we accomplished this quarter, the balance sheet transformation was a huge success for the Company. It's a milestone that not only saves us $9 million a year in interest but improves free cash flow. But more importantly, better positions the Company to execute in our strategy to unlock value into Sum of the Parts.

So let's move to slide 3 to begin the financial review. Key highlights for the second quarter include a jump in revenue primarily associated with the acquisition of Arbinet in a full quarter of consolidation. Revenue of $283 million produced $77 million in gross margin and nearly $20 million of reported EBITDA. Normalized for severance, Arbinet integration and other costs, EBITDA reached $21 million, which is 4% ahead of last quarter. After putting $7.5 million of capital to work partly aimed at key initiatives and data centers and network upgrades, we produced a healthy $3.5 million of free cash flow from operations. As I define it, EBITDA less CapEx.

Through 2 quarters we invested approximately $14 million in CapEx. And on a conservative pace, with our positive free cash flow objectives in mind. Given all the operations initiatives in place, we have confidence that the Company will continue to move in the right direction and produce positive free cash flow. Much of the focus is on margin expansion and prioritizing investments in double-digit growth areas including on-net broadband, VoIP services, managed services hosting and cloud, and high-speed data transport services.

Our growth products and services are up 18% year-over-year. While the base services are steady, with a 3% increase. Our mix will continue to improve as we shift our attention to higher return on investment offerings. We're presently at a 40/60 mix of growth to base services and aim to flip that ratio with the use of marketing and the capital program over time.

So let's move to slide 4 to review the Sum of the Parts. In this quarter, Canada accelerated in both revenue and EBITDA, increasing EBITDA margin in 21% of net revenue. By holding CapEx relatively flat to prior quarters, cash flow from operations, defined as EBITDA less CapEx, was $10.5 million for Canada alone. Accounting for all of the business units including Brazil, the portfolio produced nearly $17 million in cash flow from operations in the second quarter. Including overhead and one-timers, we netted $12.4 million from cash flow from operations and slightly ahead of the first quarter, while making improvements in our business.

As you can see from the pie charts, revenue contribution is driven by ICS, Australia, and Canada, while Canada and Australia are dominating the EBITDA profile, as expected. Although value creation potential of US retail, ICS, on absolute dollar basis and Brazil with its profitable data center are encouraging, it's relatively a smaller contributor to the portfolio today. However, each of the units provides expertise and services to other members in the portfolio. And this synergy is part of the Company's overall prospects. For example, ICS provides wholesale voice and data services to each of the retail operations in the US, Canada, Australia and Brazil. And this sharing of traffic bolsters ICS value over time while providing discounts to its sister companies. In addition, product development for VoIP services over our soft switch platform can be duplicated for member companies, providing best-in-class solutions across all business units.

Overall we're moving resources to support growth in the higher multiple segments in our business. And this is why we're focused on data centers, broadband, VoIP, and high-speed data transport. And given our traction I believe we're on the right track.

So at this point let me turn it over to Ken to go over the business units in a little bit more detail. Ken?

Thanks, Pete. Good morning, everyone. It's a pleasure to be speaking to you for the first type as PTGI's Chief Financial Officer. It's exciting to be at the Company given the considerable amount of transformation that is taking place. I have been here now for about 6 weeks and as Pete says it's been a busy time. I look forward to getting to know all of you on this call better in the coming months. And I'll now walk through the financial results.

As we indicated in the Q2 press release issued last night, second quarter 2011 results include Arbinet's results from March 1, 2011 on. Therefore, the second quarter results are not comparable with prior periods. I will discuss Arbinet's contribution as I move through the presentation.

Let's start with slide 5 titled Financial Summary, which provides 4 key financial metrics and their trends over the last 5 quarters. In the second quarter net revenue increased 45.2% to $282.5 million on a year-over-year basis. Arbinet contributed its first full quarter of net revenue which in the second quarter totaled $73.1 million. The impact of foreign currency translation was a positive $23.6 million for the quarter. On a constant currency basis, net revenue increased 33%. On a constant currency basis excluding Arbinet, net revenue decreased by 2.5%.

Adjusted EBITDA, as reported and normalized for integration and certain professional costs, was $21 million, or 7.4% of net revenue in the second quarter 2011. Compared to $23.2 million or 11.9% of net revenue in the second quarter of 2010. Adjusted EBITDA as a percentage of net revenue decreased 450 basis points as a 905 basis point decrease in gross margin was partially offset by a 455 basis point leveraging of SG&A. In constant currency, SG&A increased $4.4 million due to the inclusion of Arbinet and the $1.1 million of integration and professional costs.

The decrease in gross margin resulted in the following factors. The inclusion of Arbinet contributing a greater proportion of lower margin, wholesale revenue in the mix. This was partially offset by a better mix of higher margin growth services revenue, particularly data center and the on-net, and the continued focus in wholesale on higher margin traffic. The impact of foreign exchange to adjusted EBITDA year-over-year was a positive $2.4 million. This represents PTGI's tenth consecutive quarter of delivering stable, adjusted EBITDA.

Capital expenditures in the quarter were $7.5 million or 2.7% of net revenue, compared to $5.8 million or 3% of total revenue in the second quarter of 2010. Capital spending in the quarter continued to be driven primarily by investments in Australia and Canada to expand our local on-net presence and buildout our data centers. Free cash flow for the second quarter 2011 was negative $8.5 million compared to negative $7 million in the second quarter 2010. This decrease is primarily due to higher capital expenditures.

Let's move on to slide 6 and look at our operations in Canada. Primus Canada delivered in local currency second quarter 2011 revenues of CAD52 million and adjusted EBITDA of CAD12.8 million, or 20.6% of net revenue. As compared to revenues of CAD59.6 million and adjusted EBITDA of CAD12.2 million, or 20.7% of net revenues in the second quarter of 2010. The pie chart on the left shows the breakout of Canada's revenues by type of service. Data center, VoIP and broadband services comprise 32% of revenue. Long distance, local, prepaid, wireless and dial-up comprise 65%. And wholesale services contributed 3%. Net revenue on a constant currency basis increased 3.9% as increases in local internet, VoIP and data and hosting services were offset by declines in the retail long distance and prepaid voice.

Among faster growth services, broadband revenues grew 9% and data center revenues grew 7.7% compared to the prior year quarter. As Pete mentioned, we continue to focus on driving higher margin services. And this focus, as well as effective cost management, contributed to maintaining Canada's high and stable EBITDA contribution.

Let's now move to our operations in Australia on slide 7. Primus Australia delivered in local currency second quarter 2011 revenues of AUD69.4 million and adjusted EBITDA of AUD8 million of net revenue, as compared to revenues of AUD76.4 and adjusted EBITDA of AUD10.3 million, or 13.5% of net revenues in the second quarter of 2010. The pie chart on the left shows the break out of Australia's revenues by type of service. Data center, VPN, VoIP, broadband and local on-net services comprised 47% of revenue. Long distance, local, prepaid, wireless, and dial-up services comprised 44% of revenue. And wholesale contributed 9%. Year-over-year, on a constant currency basis, net revenue decreased 9.2% as decreases in the business and residential voice, internet and DSL services were partially offset by increases in the data center, wireless and VoIP.

Gross margin increased 100 basis points from 38.8% in Q2 of 2010 to 39.8% in Q2 of 2011, primarily as a result of resolution of the carrier dispute. SG&A increased to 28.3% of revenue in Q2 2011 from 25.2% in Q2 of 2010 as a result of the decrease in revenue. With the change in senior management and increased focus we expect to see improvements near term.

Let's now move to International Carrier Services on slide 8. Primus International Carrier Services revenues in the second quarter of $126.5 million increased 157.2% from the second quarter of 2010, primarily through the inclusion of a full quarter, or $73.1 million of Arbinet revenue. The impact of foreign currency was a positive $6.6 million. On a constant currency basis, and excluding Arbinet's contribution, net revenue increased 3.3%, primarily as a result of increases in US domestic terminations which carry higher margins, as well. ICS gross margin was 5.3% in the quarter compared to 6.9% last year and was primarily affected by the inclusion of Arbinet and favorable cost of sales adjustments in the prior year. Our consolidation of lower margin Arbinet carrier services operations into our higher margin Primus operations remains on track. We continue to expect to achieve the targeted synergies of $3 million in 2011 and $7 million in 2012. We are in the process of implementing a new fee structure on the exchange to enhance Arbinet's margin contribution. And the combined ICS unit will realize $500 million annual revenue run rate. And the increased scale should enable us to leverage the combined minutes to improve our run rate gross margin.

Let's now look at our retail operations in the US on slide 9. US retail net revenues decreased 16.4% in the second quarter 2011 to $10.7 million due to decreases in retail, voice, and VoIP. US retail adjusted EBITDA was $1.3 million or 12.2% of revenue compared to $2.3 million or 18.2% of revenue in the year-ago quarter. Adjusted EBITDA margin was primarily affected by favorable cost of sales adjustments in the prior year. We have recently launched Lingo-go talk as well as Lingo-biz, a service targeted at the SMB segment, both of which are gaining traction. In hosted PBX, our new sales teams are building steam and we signed up new customers in 3 of our new markets. Denver, Dallas, and Los Angeles.

Let's move to the balance sheet on slide 10. We entered the second quarter 2011 with $31.5 million unrestricted cash and cash equivalents, down from $65.6 million at March 31, 2011. Cash was generated during the second quarter in the following amounts. $19.9 million of adjusted EBITDA, offset by the usage of $24 million to redeem the 14.25% senior secured notes. $16.5 million in interest payments. $4.9 million was used in working capital, primarily caused by a temporary delay in receivables collection due to the Canadian postal strike, which has now ended. $7.5 million for capital expenditures. And a $1.2 million dividend paid to our non-controlling interest shareholder.

Our long term obligations at the quarter end stood at $221.2 million. And our leverage and coverage ratios continue to move in the right direction. As Pete mentioned, we completed the note exchange offers that exchange the new 10% senior secured notes due 2017 for the 13% senior secured notes and 14.25% senior secured notes due in 2016 and 2013. We also receive consents from the holders of the 13% notes to amend the note indenture to eliminate certain restrictive covenants. The improvement in our balance sheet, and the additional flexibility we gained through our new debt agreement, further improves our ability to generate free cash flow.

That concludes my prepared remarks. I'll turn the call back now to Pete.

Thanks, Ken. So to wrap up our prepared remarks, turn to slide 11. The second quarter balance sheet transformation was definitely a huge milestone for the Company, as we discussed. And it gives us flexibility to operate our business and to consider significant opportunities to unlock value of a very diversified PTGI portfolio. As you know, the timing was critical to our success, especially given current market conditions. And if the broader economic environment continues to depress our values we'll have the tools in place to consider share buybacks or debt reduction as approved our Board. In addition, we're very excited to be listed as PTGI on the NYSE and believe that the exposure will be great for our shareholders as we begin to gain coverage with equity analysts.

In addition, the good news kept coming right up to this Monday with Globility's announced spectrum sale for CAD15 million. Ultimately, this new money, from what most considered a hidden asset, will strengthen the balance sheets of both GCC and PTGI.

Looking ahead, we'll continue to execute on our strategy, we'll optimize the businesses, we'll focus on margin expansion, and certainly positive free cash flow. We made great progress this quarter in capturing key milestones and getting into position for value-creation opportunities for our shareholders.

So at this point, we would be happy to take your questions. Operator?

(Operator Instructions) Tom Koch of Tejas Securities.

I was just wondering, can you tell us, regarding the Globility asset sale for CAD15 million, can you provide a little color on it? Are there anymore additional assets there? Did they sell all of the wireless? And what's the process for that money flowing back to Primus from the JV?

That was all of the spectrum that we had in Canada. So Globility, who owns the spectrum, found a buyer for the whole lot. In the past, in Primus, had sold a piece of it. And I think this is going back probably 4 years or so. So this is the balance of what we had up there, together with our partner. And Globility is the Canadian partner so they have the cash flowing into their balance sheet. And as a minority owner, we'll get the portion that belongs as part of our deal with them. We have an affiliated note with them for about $4 million. So immediately about $4 million of loan repayment will flow back to us. But for the most part after-taxes will stay on Globility's balance sheet as the majority owner.

Regarding other spectrum in the PTGI portfolio, that's about all the spectrum that we owned. So in terms of hidden assets, that's all we're part of. Again, as part of a joint venture with Globility there, the majority owner technically of that asset.

So just 1 follow-up. So you'll get the $4 million repayment of the inter-Company note. And then are there any other remaining cash or other assets there that you would expect to collect or not?

As part of the spectrum sale?

Yes. Does this wind down Globility basically?

No, that's about it for Globility. They are managing a lot of our CLEC opportunities up there because that's the license that they have and hold. So anything that requires a CLEC for the most part, we're behind Globility on those things and we help them to the extent we can in their CLEC businesses. There's a foreign ownership restriction in Canada, as you probably know, Tom, of 46% max for US. So anything that requires a partner, so to speak, Globility handles all of the CLEC businesses up there.

Adam Mitchell of Scotia Capital.

How many pops did the spectrum cover that was sold?

It's going to be disclosed after Industry Canada goes through their review. Whose speaking, I'm sorry?

It's Adam Mitchell.

Hi, Adam. Yes, Industry Canada has to first review the application. That information will be public probably in the next few weeks.

(Operator Instructions) Robert Niewijk of Katana Capital.

I'm hoping you can spend more than the initial 10 seconds on what happened to gross margin.

Are you talking about consolidated gross margin of $77 million?

Yes.

It's kind of a loaded question, I think. For the most part, we had a pretty consistent second quarter relative to the first quarter. The pricing strategies are in place. A lot of the initiatives that we have on the top line are actually being rolled into the future quarters. There's work that's being done at ICS on the top line, there's work at US retail, there's work in Australia. And also Canada, frankly, on all of the ARPU initiatives that we have in place. But we basically implemented what I would call a very consistent cost of goods sold strategy in the second quarter. Mot much to report relative to the first.

Okay. So gross margin going forward, what are the puts and takes that are going to drive it higher?

The one thing you want to keep in mind is that we had a big acquisition that closed February 28. So gross margin as affected by the wholesale business -- maybe what you're referring to -- sequentially was dramatically impacted by a big wholesale acquisition. The margins in wholesale tend to be around the 5% range as shown in the ICS chart. So maybe that's what you're referring to? I don't want to guess. Maybe you could be more specific.

Just so you know, we are current shareholders, we have been for a while. So I'm well aware of the Arbinet acquisition. But after that acquisition, you're now looking at lower EBITDA than you had before it. So I'm hoping something is going to change here. And when I look at the numbers, it's the gross margin line that caught my eye.

Yes, you're looking at percentages but if you look on an absolute basis, EBITDA is going up. But the definition of the ICS business, if you look at wholesale in general, is, gross margin is only about 5%. So if the rest of the composition of the portfolio behaved more like a telecom asset with retail services, that's the impact you're looking at.

David Marsh of Odeon Capital.

Can you tell us what your CapEx expectations are for the balance of the year?

Yes. Originally, early in the year we guided towards $35 million. But as you can see, through 2 quarters we're only at $14 million. So we're being very careful and conservative and we're pacing it. We may or may not get there. It's probably not going to exceed $35 million, for sure, and I'm not sure if we'll even get to $35 million at this pace. But we're being very careful and prudent. Earlier in the year, we wanted to put out some signal that we would be investing in data centers to the extent the opportunity presented itself to expand. Because we were running up against some capacity in some very good markets. So we basically signaled that if we have the opportunity we're going to jump into it. But at this pace, if you just doubled $14 million it's $28 million. So I don't know that we're going to accelerate that much in the next 2 quarters but we're being very conservative. We have some good opportunities in EBITDA expansion that we're keeping our eye on. So maybe in balance we'll move it up some. But for the most part we're looking for consistency and we're looking for balance. And we're going to be conservative on the capital program to make sure what we invest in really has a good return.

My follow-up question is actually with regard to your data center capacity. If you look at each market, can you talk about where you are in terms of overall capacity by market, and what your expansion opportunity/plans might be on a market by market basis?

Yes, I'm sorry. We probably won't disclose by market. There's a lot of competitive intelligence related to that type of information so we won't disclose that on this call. I would tell you that probably out of our 11 centers there's 1 that's running a little bit hot. To the extent that we can free up some of that capacity in the short-term, we're doing so. The other ones are running hot, as well, but not to the extent that we won't be able to handle it this year and into early next.

We think, especially in Canada, that we could actually do very well in some of the markets as a primary player in the tier 2/tier 3 space. And so we're providing some CapEx planning to move into Canada for end of '11 and 2012. We hope, actually, to be expanding our square footage space globally from where we are today, 90,000 maximum square feet to well over 100,000. But it will be a gradual program and it will be in areas where we already, frankly, have a good problem in that there's so much demand for us to take care of, we just got to make sure we move the capital program realtime to handle the hotspots. But it's a great product set in our Company. It's a great segment. It's a high multiple segment. And short of telling you exactly where our hotspots are, I would just tell you that it's something that the Company is focused on in terms of keeping the capital program available for expansion.

That is all the time we have today. Please proceed with your presentation or any closing remarks.

Thank you, Operator. I hope today's call was helpful in providing some more information. And we look forward to talking to you at the third quarter call. Thank you very much.

Ladies and gentlemen, that concludes your conference call for today. We thank you for your participation and ask that you please disconnect your lines.