Innovate Corp (VATE) 2012 Q2 法說會逐字稿

Welcome to the PTGi second-quarter 2012 conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will hold a Q&A session. (Operator Instructions). As a reminder, this conference is being recorded today, August 9, 2012.

I would now like to turn the conference over to Richard Ramlall, Senior Vice President Corporate Development and Chief Communication Officer. Please go ahead, sir.

Thank you, operator. Good morning, ladies and gentlemen. With me today on the call are Pete Aquino, Chairman, President, and Chief Executive Officer; Andy Day, CEO of Primus Canada; and Jim Keeley, acting Chief Financial Officer.

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've 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 are presenting today reflects the results from continuing North American operations including Canada and US retail. We are also presenting segment data for these continuing operations for the first time, our Canadian pure play data center business units and in North American Telecom units which includes US retail.

PTGi completed the divestiture of its Australian operations on May 31, 2012. Results from these operations as well as from PTGi's international carrier services segment are classified as discontinued for all periods presented.

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. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors and risks which are more fully described in our annual report, quarterly reports, or other filings with the Securities and Exchange Commission.

Although we believe that the expectations reflected in the forward-looking statements are reasonable and represent our views as of today, there can be no assurance that any of the estimated or projected results will be realized. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so.

During this call, we may also refer to certain non-GAAP financial measures. A discussion of any non-GAAP financial measures and reconciliations of the most direct the comparable GAAP financial measures are available on the investor relations page of the PTGi website.

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

Thank you, Richard, and good morning, everyone. Welcome to our second-quarter call. There has been a lot of activity over the past few months which results in a transformation of the PTGi portfolio.

Post the sale of Australia and our recent decision to ultimately sell ICS through our continuing strategic process, we have consolidated many operations functions under Canadian management while maintaining our business in the United States. My discussion today will exclude Australia and ICS results since they are no longer part of continued operations.

In addition, given the strategic value of our Canadian data centers, we are moving forward to create a separate legal entity for this business and redefine our financial reporting segments as follows -- data centers and North American Telecom, with North American Telecom comprised of Primus Canada and US retail. So this is the new alignment that you will hear about today.

Let's turn to slide 3, where I can walk you through some of the second-quarter highlights.

We completed the sale of Primus Australia to M2 on May 31 and had $210 million of cash in the bank at the end of June soon after we paid a $14 million cash dividend to shareholders resulting in net debt currently at around $42 million. We also commenced a par tender offer for the 10% notes as required in our indenture and as most of you know, our bonds are currently trading above par. And as expected, the offer expired without any change.

The next step is to execute on high return on investment projects in our data centers especially in Toronto, where we just completed construction of a state-of-the-art certified Tier III facility. It is our third data center in Toronto, and referred to as Toronto DC3. And it is arguably one of the highest quality and tested centers in the country.

In addition to our growth prospects and data centers, we are now constructing our first metro fiber ring in Ottawa's central business district. Due to a recent legislative change in Canada, US and other foreign companies with less than a dominant market share can now own transport facilities.

Historically we worked with our Canadian partner, Globility Communications Company or GCC, to complete certain network solutions with its CLEC license. So given this change, we went forward and acquired the remaining 54% of GCC from our partner for an immaterial amount and plan to utilize this entity to hold our fiber assets.

Another key advantage of owning fiber is that it will lower our lease transport costs. We plan to migrate SMB customers to own fiber facilities where possible and improve our margins. We will start with our SMB footprint in Ottawa and provide services such as Metro Ethernet on Fiber, and at the same time, we will begin to sell up on market to enterprise and government customers who require high-capacity and low latency services. Ultimately our goal is to connect our data centers to our fiber rings down the road.

So for a current snapshot of our new profile, excluding Australia and ICS, PTGi delivered $13 million in EBITDA this quarter from operations on $65 million of revenue. This nets to approximately 20% EBITDA margin from data centers in North America Telecom combined before corporate overhead.

As our plan unfolds we aim to drive more EBITDA from our data centers growing telecom services and on-net fiber to more than offset anticipated changes in our consumer and SMB legacy base.

So let's now turn to slide 4 for a quick overview of the new PTGi.

As you can see, Data Center revenue is only 12% of revenue but already 23% of the EBITDA pie. $8 million of Data Center revenue this quarter is driven by seven existing facilities with about 39% EBITDA margin including build expenses.

Please note that this second quarter includes startup costs for rent for our newest facility in Toronto. And looking ahead, we expect margins to improve from here as Toronto DC3 goes live this month.

We also divided CapEx into two categories, first ongoing CapEx needed for success-based investment in our seven existing centers and construction CapEx used to build new facilities such as Toronto DC3.

Moving onto the Telecom segment, the North American Telecom group is a contributor to free cash flow from operations defined as EBITDA less CapEx and more than offsets the CapEx used for our Data Center expansion.

The Telecom group is still the majority of our revenue and EBITDA so we want to take advantage of those cash flows over time as part of our reinvestment strategy.

Telecom EBITDA is 18% primarily driven by local, long-distance, and Internet access is a good benchmark for competitive reseller model, but we continue to strive for ways to go beyond this and harvest cash flows from our Canadian nationwide footprint and select US markets.

Moving down to corporate overhead, you'll note that we took a charge of $2.6 million this quarter associated with severance and other nonrecurring charges to kick off our corporate cost reductions. Our corporate overhead annual run rate of about $14 million before the Primus Australia sale is on track to be cut by more than half towards the back half of this year.

So in summary, PTGi's normalized EBITDA was $10 million this quarter and at this point, what I would like to do is introduce to you a new speaker, Andy Day. Andy is the CEO of Primus Canada. Both Data Center operations and major parts of North America Telecom now reports up to Andy has been with the Company for more than 13 years, moving up the ranks in Primus Canada. His background includes AT&T, Gillette, and Xerox. He has been a great partner, has been very instrumental in our turnaround, and also our future growth plans.

So with that, Andy, why don't you give a little bit more detail by segment?

Thanks, Pete. Good morning, everyone. Now is an exciting time for Primus Canada as we lead the continued transformation of PTGi. Today Primus Canada operates as a well-known nationally branded full-service telecommunications provider comprised of a mixture of on-net and off-net revenue streams. We believe at this moment we have excellent opportunities for growth given our increased capital spend program on facilities-based revenue stream, specifically Data Centers and fiber, and the recent changes to Canada's Telecom Act, allowing us to own transmission facilities.

As Pete mentioned to give a much clearer view on our go forward vision, we will begin reporting our results in two segments -- Data Center and North America Telecom.

Let's turn now to slide 5 to look at our Data Center segment. Our Data Center business unit contains some of our best growth opportunities. Our centers located in five top business markets in Canada are geographically dispersed, providing a national footprint. We provide Data Center services to thousands of Canadian businesses ranging from SMB to enterprise level and have a proven uptime track record for the past decade.

In Toronto with the launch of Toronto DC3, we now have eight fully operating data centers in Canada. Our newest and largest raised floor footprint opened just last week. The new center located in Canada's largest city was fully certified by Uptime Institute as Tier III and is Canada's first designed and constructed Tier III certified multitenant site.

Uptime Institute is a US-based company and a leading independent authority to the global data center industry in over 50 countries. This certification ensures clients will benefit from concurrent maintainability, meaning Toronto DC3 will never be shut down for maintenance or to replace any element of the Center. Customers are assured of 100% uptime.

The site not only achieved certification by performing 39 functional demonstrations while Uptime Institute was on site, the tests were all passed on the first attempt. Quoting Uptime Institute, we can say with confidence this new facility will offer its clients the best in class data center services in Canada.

We have already signed contracts with new customers and I am pleased to report our first customers in the site will be going live this month. Over 200 prospective customers have toured the site in the last 60 days and we will report more on the customer growth of this site in the coming quarters.

Now I will give you some insight into our Q2 results for our Data Center segment. For ease of comparing year-over-year information, I'm going to talk in Canadian dollars. Currency translation effects are captured in Jim's financial overview.

For the seven operating Data Center sites, Q2 revenue was CAD8 million, a 9.6% increase over last year's CAD7.3 million. Driving this overall revenue growth, our colocation business grew a strong 17.1% year-over-year. Our managed services portfolio grew 8.5% and inside of this category our cloud computing business although less than 5% of total revenue today nearly doubled year-over-year.

Our network connectivity component grew 6.5% while declining noncore revenue streams such as shared and dedicated hosting dropped 14.2%.

With the recent breakout of the Data Center organization and as we place more dedicated sales focus on this business, we are seeing quarter-over-quarter strengthening of our sales funnels. Focusing the sales organization on being technology experts and emphasizing colocation, cloud, and managed services is taking us up market and resulting in an increase in average deal sites closed and in the funnel.

In Q2, colocation revenues represented 43% of the division's revenue. Managed services and network connectivity represented 15% and 30% respectively while other hosting revenue rounded up the mix at 12%.

Our portfolio of highly certified Data Centers with both uptime tier certification and audited operational certification combined with larger sites such as Toronto DC3 aligns perfectly with the demand in the market today.

Q2 Data Center unit adjusted EBITDA was CAD3.1, which represents 38.9% of revenue but excluding costs associated with Toronto DC3 was 42% of revenue. EBITDA grew 6.1% year-over-year including Toronto DC3 costs or 14.6% year-over-year excluding costs associated with the Toronto Center.

Capital spend during Q2 was CAD4.9 million as we invested CAD4 million in the construction of Toronto DC3 while maintenance and success-based growth capital was CAD0.9 million. Today with the recent opening of Toronto DC3, we now sit at 64% utilization of built raised floor. Including Toronto DC3, we have over 38,000 square feet of built raised floor and in total have over 90,000 square feet of current leased real estate. Lots of headroom for expansion as we continue with our aggressive growth plan with the Data Center business unit.

Our focus for the remainder of the year in the Data Center unit is to grow our pipeline of colocation business especially in Toronto DC3 and continue to increase our cloud revenue stream.

Let's move to slide 6 to look at the North America Telecom segment. Our North America Telecom unit provides traditional telecom services such as local, long-distance, and Internet as well as next-generation Hosted PBX and Internet as first mile services. Overall our focus in this segment is to grow our net facilities-based revenue opportunities while maximizing margins associated with off-net revenues. North America Telecom's revenue is compressed of a one-third business, two-thirds residential mix. Let's discuss business services first.

Key revenue focuses inside our business services group are Hosted PBX and on-net Ethernet, both of which are in demand in our markets. We are already one of Canada's largest providers of Hosted PBX services in the fast-growing SMB market and in the quarter launched a new suite of Hosted PBX services for call centers. Our installed base of Hosted PBX phones grew 29% year-over-year with June being a record-setting sales month. We sell our services via direct sales reps in Canada and recently opened a sales office in Austin, Texas expanding our Hosted PBX footprint.

Launched just over a year ago, on-net Ethernet services have also grown rapidly and by year-end 2012, we expect to have one of the largest Ethernet over copper footprint in Canada to sell into.

Primus Canada's residential group provides standalone and bundled telecom services both on-net and off-net nationally to Canadian consumers while our US focus is on expanding or Voice-over-IP services under the Lingo brand. Our overall residential services focus is to maximize margins while managing the industry attrition of local and long-distance revenues.

In US dollars, Q2 revenue for the North America Telecom business unit was $57.4 million, down $14.6 billion from $67.2 million last year. Excluding a negative year-over-year currency effect, the change was driven by the declines in local and long-distance services.

Q2 adjusted EBITDA was $10.2 million, down 10.6% from $11.4 million last year but excluding a one-time cost recovery in 2011 was only down 4.4%. Adjusted EBITDA as a percent of revenue increased to 17.8% from 15.9% a year ago excluding the one-time cost recovery in 2011. Looking ahead, we are focused on continued aggressive cost management within the Telecom unit. This is in alignment with our maximized EBITDAR strategy.

Q2 capital expenditures in North America Telecom were $2 million as we finalized our Hosted PBX for call center platform and invested in success-based customer premise equipment.

I will now turn the call over to Jim to go through consolidated results.

Thanks, Andy. Good morning, everyone. The financial results from continuing operations reflect the new PTGi. As discussed earlier, we have changed our segment reporting to more accurately reflect how we run the business. The Data Center business has been segregated into its own segment and the remaining Canadian Telecom operations have been combined with US retail to form our North America Telecom segment.

The financial results from discontinued operations which include Australia, Brazil, and ICS have been removed from all current and prior periods unless otherwise noted.

Let's now moved to slide 7 entitled financial summary which provides four key financial metrics and our trends over the last five quarters.

In the second quarter, net revenue decreased 12.8% year-over-year to $65.4 million, which includes a $2.4 million decrease from foreign currency translation. On a constant currency basis, net revenue decreased 9.6% due to a decline in local and long-distance services offset in part 9.6% growth in Data Center revenues.

We continue to shift our investments from traditional services into growth areas for the Company, specifically data centers, Hosted PBX, and metro fiber.

Adjusted EBITDA as reported was $7.5 million or 11.4% of net revenue in the second quarter 2012 compared to $10.7 million or 14.3% of net revenue in the second quarter 2011. Included in adjusted EBITDA in the second quarter of 2012 was $2.6 million of severance and other nonrecurring costs. Excluding these costs, normalized adjusted EBITDA was $10.1 million or 15.4% of net revenue compared to $11.4 million or $15.2 percent of net revenue in the second quarter of 2011.

Normalized adjusted EBITDA margin has increased to around 15%, up from approximately 9% to 10% prior to reflecting ICS and Australia as discontinued segments. We believe these margins more accurately reflect the profitability of our core businesses and as we scale down our corporate function to align with the size of PTGi, we expect adjusted EBITDA margins to continue to improve.

Normalized adjusted EBITDA margin increased 20 basis points from last year's quarter primarily due to continued SG&A optimization and contribution from higher-margin growth services revenue particularly Data Center, data services, and SMB VoiP services.

On a sequential basis, normalized adjusted EBITDA decreased 5.4% driven by lower traditional services revenues. Again, despite overall revenue declines, we have been able to maintain the Company's stable adjusted EBITDA contribution as a result of changing our revenue mix to include higher-margin growth services revenues and effectively manage our SG&A costs.

Capital expenditures in the second quarter 2012 were $10.6 million compared to $7.5 million in the second quarter of 2011. Excluding discontinued operations, capital expenditures for continuing operations were $7 million compared to $3 million in 2011. Capital spending in the quarter continued to be driven primarily by core investments in Canada to expand our Data Centers.

The increase year-over-year is specifically related to investment in the new Toronto Data Center. Sequentially capital expenditures from continuing operations increased $1.9 million again due to the investment in the new Toronto Data Center.

Free cash flow for the second quarter of 2012 was a negative $12.5 million compared to a negative $8.5 million in the second quarter of 2011 due primarily to the semiannual interest payments on our notes. Excluding interest payments, free cash flow in the second quarter of 2012 -- 2011, would have been a negative $500,000 and a positive $8 million respectively.

The decrease year-over-year is due primarily to a $3.2 million decrease in adjusted EBITDA from continuing operations, a $3.1 million increase in capital expenditures, and a $2.7 million decrease in adjusted EBITDA from discontinued operations, partially offset by a $4.5 million decrease in interest paid.

On a sequential basis, free cash flow decreased $22.4 million as a result of semiannual interest payments made in the second quarter, an increase in capital expenditures and a decline in adjusted EBITDA.

Let's move to slide eight to discuss our balance sheet. Cash and cash equivalents as of June 30, 2012 was $209.7 million, up from $46.2 million at March 31, 2012. Cash was generated during the quarter in the following amounts -- $183.3 million of net proceeds from the sale of Australia; $7.5 million of adjusted EBITDA; and $0.9 million of working capital. The cash generated was offset in part by the usage of $10.6 million for capital expenditures, $12 million for interest payments, and $5.6 million for transaction costs and cash disposed of in the sale of Australia.

We did not repurchase any shares in the second quarter 2012 under our buyback program.

Also in the second quarter, we committed to selling our ICS segment and therefore classified the ICS segment as discontinued operations. In accordance with accounting standards, we are required to adjust the carrying values of the assets and liabilities to their estimated fair values and classify them as assets held for sale on our balance sheet. As a result of this revaluation, we recorded a charge of $10.3 million to net income or (inaudible) discontinued operations.

Our long-term debt including current obligations at quarter end was $237.7 million, down from $249.3 million at year-end 2011. The decrease is attributable to the elimination of capital leases in Australia that were part of the sale.

Our current outlook of 2012 capital expenditures for continuing operations is approximately $26 million and we will continue to manage the business to generate sustainable growth in adjusted EBITDA for our ongoing businesses.

This concludes my prepared remarks. Now I will turn the call back to Pete.

Thanks, Jim. So to wrap up our remarks, please turn to slide 9.

As we discussed, we are focused on investing in high return on investment projects mainly in data centers, growing telecom products and services, and metro fiber. We are very excited about our new Tier III facility in Toronto and look forward to turning our growing pipeline into sales.

We also plan to execute a two-cushion shot whereby we can migrate SMB customers onto our own fiber in Ottawa and address large enterprise and government customers with advanced high-capacity services. Then finally, we will continue to focus on cutting overhead costs and moving consumer and SMB customers on-net where possible to improve profitability and invest in areas of the business that continue to build value.

So at this point we would like to take your questions. Operator?

(Operator Instructions). [Peter Reed], [MAZ Capital].

Richard, how are you?

Fine, thanks, Peter. How are you? Good morning.

Very well, thanks. Really helpful overview and it looks like a pretty nice quarter. Could you perhaps give us an update on where ICS stands?

Peter, it's Pete's. We decided as a Board to classify as discontinued ops. We are going to probably sell it within the next 12 months. It is part of the strategic process we've been running for several months now and that's the status.

It's a good company to be combined with another carrier business to grow scale and we think the next thing we should focus on, frankly, is just the data centers in Canada and really rehone our efforts on the opportunity there. So we decided as a Board just to set it up for discontinued ops and to sell it over the next couple of months.

Makes sense and so it sounds like you are reasonably down the path on that sort of process.

Yes, our process has been going on for a while and we've been looking at the whole portfolio and trying to figure out who we are going to be down the road and where we landed through the process and the review is actually a great place in Canada with the metro ring strategy that's now possible given the legislative change. The foreign ownership rules changed just a couple weeks ago and between that and data centers, that's where we are going to really focus our time and our money.

Great. And speaking of the metro fiber ring, I realize it's early but do you have some sense of how long it will take you and some -- would you be prepared to talk about how much it might cost to build that ring?

I can give you some reference points. It's an interesting civil work strategy that we are deploying in Ottawa whereby we are using surface inlaid fiber or micro-trenching to use a less intrusive build in the streets for the central business district. It's been used a lot in Canada not so much in the US. We are taking advantage of this ability and it's quite economical to do it.

You are basically dropping fiber and multiple fiber cables into a groove in the street and we really can rock 'n roll through the central business. It won't take long at all. We think by the end of the third quarter, early fourth we are done in the first phase of Ottawa and hopefully we are addressing on-net buildings by the end of the year.

The other interesting thing in this model is that whereas a lot of companies that have metro fiber business, they approach the commercial market and the enterprise sector directly and that's their model. We have an SMB base that could use fiber especially with a metro Ethernet so we are going to migrate those customers to the extent we can onto fiber, upsell them while at the same time addressing the enterprise and government customers in the largest commercial buildings in Ottawa. And we hope to stamp that in other major cities. So we are really excited about the launch and the legislative change made at all possible.

In terms of cost, it's really a fraction of traditional methods for civil works. We're not going to disclose exactly how much it is but you can watch the capital program as we go and this year we are basically guiding to about $26 million for all the ongoing businesses. It's not dramatically different, frankly, than what we estimated in the beginning of the year, which would suggest the civil works isn't that bad. And we are pretty excited about this method and we are at it right now.

Sounds great, thanks.

Ron Silverton, ALJ Capital.

Good morning, gentlemen. I wanted to get a little clarity on a couple points you made. With the Data Center businesses up in Canada you indicated that 39% I believe of the EBITDA came from the Data Centers themselves -- or the hosts -- sorry, the co-location services. But that that was depressed a little bit by the lease costs of the marketing facility. What would that look like if we were to strip that out?

I think Andy said it in his script. 39% is loaded EBITDA and it's not just for colo. It's for all of the Data Center segment. And when you take out the Markham, Toronto costs, it gets to about 42%. So it's about 300 basis points just for this quarter. So we're going to keep our eye on the build cost but the OpEx associated with the new build is in that number and that's why even with the capital program we separated the CapEx into ongoing for the seven existing and the new CapEx for construction.

Got it, and remind me again -- you said $26 million for continuing operations. $7 million of that was spent in the second quarter. How much was spent in the first quarter for continuing ops?

$3 million.

Got it, so we are talking then $16 million in the second half? And while you still have the ICS business, is there going to be any CapEx requirements for that?

There's really not much capital required in the carrier business at all.

Got it. Is that -- since you are going to at least for now have that business until it's sold even though it is classified as discontinued ops, is that EBITDA positive? How should we think about the contribution that's going to make until it's sold?

In the last quarter, we basically reported somewhat neutral, slightly positive but it's really a function of what we are going to do with it. And right now we're running it day to day. We have customers -- we're addressing the customers. We are growing it where we can. We're really operating the business as we should. It's not turned down in any sense.

So this is an ongoing business and we're trying to improve it as we go. The history of it is such that it's really a scale business. We actually put Arbinet and Primus carrier business together. We did the best we could to streamline the carrier business as well as we burst out of that the US retail business which before that was kind of buried inside of our carrier business.

So we basically were able to extract a good US retail business and we always said that the carrier business really is a scale business needs to be moved to a bigger fish syndrome and I think we are on track to do that.

Ron, let me correct myself on that $3 million in the first quarter. That was $3 million in last year's quarter. It's $5.1 million for continuing operations in the first quarter for CapEx. So the total is $12.1 million to date.

Got you. But still $26 million for the full year?

Yes.

That's right.

Sorry, Pete, I'm not sure make sure if -- I just want to make sure I'm not reading something into your comment. ICS, the carrier business for the second half in terms of thinking about how the impact on EBITDA -- is it at least -- is it fair to assume it is at least break even?

It's in a neutral state and it's really up to us to either pull out some more costs or depending with who the potential buyer is and how they're going to use it, there were certain concepts we had whereby we could migrate to certain new platforms. But it's somewhat in a holding pattern before we figure out exactly who the buyer is but for the most part it is in neutral -- doesn't harm the Company at all.

As you indicated, you took an impairment charge of $10.3 million on the business in the second quarter. If I take the value of current assets held for sale and subtract from that on your balance sheet the current liabilities held for sale, I get about $14 million. Is that what the Board thinks the fair value of that business is?

That's the analysis we ran for the impairment charge and I can't really comment on the value, but we basically ran the accounting algorithms through to get to that number and that's what we booked.

Got you. So you also mentioned that you thought there was clearly room to take out some more corporate overhead and I believe on the call as part of your remarks at the beginning you said that number would come down by more than half. Did I get that correctly?

That's right, we are running about $14 million when we add Australia in and we think that gets cut in half immediately so that's 7 run rate and we think we can do better than that. So what you saw even in this quarter is a charge for severance and other nonrecurring charges as a kickoff really to start cutting at that. But it's a logical realignment given we are half the size with Australia out of our body. So that's on track.

There are no further questions at this time. I will turn the conference over to Mr. Aquino for closing remarks.

Thank you, operator. I hope we were clear enough today on the new realignment. We look forward to talking to you about our progress in the next quarter. Have a nice day, everyone.

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