Innovate Corp (VATE) 2012 Q3 法說會逐字稿

Welcome to the PTGi Third Quarter 2012 Earnings Conference Call. At this time all participants are in a listen only mode. Following management's prepared remarks we will hold a Q-and-A session.

(Operator Instructions)

As a reminder this conference is being recorded today November 8, 2012. I would now like to turn the conference over to Mr. Richard Ramlall, Senior Vice President Corporate Development and Chief Communications Officer. Please go ahead sir.

Thank you Operator and good morning ladies and gentlemen. With me today on the call are Peter Aquino, Chairman, President and Chief Executive Officer, Andy Day CEO of North America, and Jim Keeley, 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 http//investors.ptgi.com on the main investor overview page. Once you have registered for the webcast a pdf version of the slides will be will be available for downloads with that link.

Please note that all the financial information that we are presenting today reflects the results from continuing North America operations, including Canada and United States retail. As well as segment data for these continuing operations. Results from the Australian operations as well as PTGi international carrier services segments are classified as discontinued for all periods presented.

Before we begin our call we would like to remind you that the statements made by the company during this call that are not historical facts are forward-looking statements for 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 very important factors and risks which are more fully described on our annual report, quarter 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 elected to update these forward-looking statements at some point in the future, we specifically disclaim an obligations 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 reconciliation. For the most directly 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 third quarter call. For those of you who are effected by Hurricane Sandy and now the nor'easter, I hope that things will start to get back to normal for you and your families very soon. Overall PTGi had minimum service disruption given most of our business is now in Canada. However some ITS traffic that was passing through some of our switches located in lower Manhattan had to be rerouted.

We are very proud of our Network and IT Teams who mobilized, traveled to New York and New Jersey to keep our equipment protected and operating through very challenging times. It was really an incredible effort and we thank all of them for their hard work.

Let's now move to slide three to cover our third quarter results. We delivered a strong quarter with adjusted EBITDA of $11 million, up 10% from the second quarter. This reflects our progress of down sizing our corporate overhead, post the sale of Primus Australia and our continued effort to deliver profitable growth across all of our products. Ultimately we are aiming to reduce corporate overhead by more than half or to less than $7 million a year in annual run rate.

Total revenue of $64 million is generating more gross margin and higher EBITDA percentages on a relative basis. With normalized EBITDA at 17% which is up 200 basis points from the second quarter and up over 350 basic points from a year ago.

Top line changes, primarily in traditional telecom services have declined at a slower rate, allowing us to preserve cash flow over a longer period of time. This is due in part to our strategy to concentrate on growing data and IP services for both the consumer and SMD markets, as well as upside in data center revenue as we add cabinets to our available space.

In the third quarter we opened our new Toronto DC3 site for business on August 1, 2012 and re-branded our Pure-Play data center business at BLACKIRON Data. We expect that Toronto DC3 a certified Tier 3 center will be flagship for PTGi, with data center capacity serving the largest market in Canada.

In addition, we also recently completed our first Fiber ring in downtown Ottawa. Ottawa ring one has 288 dark fibers weaving through the central business district, passing both large commercial and residential buildings. Given our ability to now own transport, permitted by recent regulatory changes on foreign ownership, we were proactive and creative in planning and constructing a unique micro-trench designed for adding laterals and extensions on a success basis.

Our test bed in Ottawa allows PTGi to address three distinct markets. Consumer, SMB, and large business and government accounts. Step one will be to migrate Primus Canada SMB customers and buildings we already pass to metro Ethernet on fiber. This drives margins, efficiency and band width up to 10 gigabits. This is a first for Primus Canada and a significant differentiator to even some of the largest providers in the country.

Step two ideas include a fiber to the building trial to provide high speed data and VoIP to large residential buildings and ultimately high capacity services to large customers providing an alternative to incumbents. Our fiber routes will provide route diversity, redundancy, and ultra high speed transport. With our experience ramping up in Ottawa we plan to duplicate this model in other markets down the road.

And despite the incremental investments in Data Centers and Metro Fiber our third quarter CapEx was down sequentially as Toronto DC3 was near completion and the micro-trench project in Ottawa is very economical.

Finally, the third quarter answered the question as to what we would do with the proceeds from Primus Australia, by repurchasing a majority of our 10% notes we deleveraged the company by $119 million down from $235 million. This will results a significant interest savings, down almost two-thirds from almost a year ago.

So let's now turn to slide four for a snap shot of the new PTGi segments. Our Canadian management team is now responsible for on-going PTGi operations divided into two segments. North American Telecom, encompassing Primus Canada and United States retail and data centers. The two segments drive all of our revenue with North American Telecom producing 87% and BLACKIRON data producing 13% of total revenue.

However, as you can see the highly profitable data center business currently produces 39% EBITDA margin and drives an increase in its share of the pie by almost double when it comes to EBITDA. Data centers generate 24% of the company's EBITDA while North American Telecom delivers 76% of the total.

Overall, our goal is to continue to fuel possible growth and high return on investment fiber projects in the telecom business, harvest the declining revenue streams and traditional services, and aggressively sell into the data center capacity that we have available across all of our markets.

As we stay on this track and continue to drive excess costs out of corporate overhead, we expect to continue to deliver positive, free cash flow from operations defined at EBITDA less CapEx.

And in this quarter alone PTGi produced over $5 million on a normalized basis, primarily driven by the productivity of our North American Telecom business. So at this point let me turn it over to Andy to discuss the operation in a little bit more detail. Andy?

Thanks Pete, good morning everyone. As we discussed last quarter a key financial objective in the transformation of PTGi is to grow our facilities based revenue and EBITDA streams from businesses such as data center, fiber, Hosted Phone, Ethernet and All Net bundle. At the same time we are focused on continuing to manage stability in telecom EBITDA associated with legacy and off net revenue strengths.

During the third quarter we made continued progress on these goals. Both data center and telecom adjusted EBITDA grew versus last year and sequentially versus second quarter. Let's turn to slide five to look at the first of our two segments, our data center unit BLACKIRON Data.

With the grand opening of the Toronto DC3 during the quarter our national footprint contains eight fully operating data centers in Canada, currently offering over 38,000 square feet of raised floor. We are underway with a 4000 square foot expansion of an existing facility and have an additional 49,000 square feet of expansion space already under lease. We expect to further add real estate in 2013, thus providing us with over 110,000 square feet of total raised floor potential.

Consistent with our strong and dedicated corporate focus on our data center unit we have re-branded our data centers, cloud, and managed services portfolio as BLACKIRON Data. BLACKIRON Data operates as a highly certified data center company in Canada with extra technicians and systems engineers ready to assist customers 24/7.

Our data center unit was recently named to the Champion Quadrant in Info-Tech Research Group's Vendor Landscape Canadian Co-location and Managed Services Report. According to the report, organizations that require geographic separation and reach and an overall broad offering of services will find success with BLACKIRON Data. Also the report recognizes BLACKIRON's diligence in assuring that we are exceeding all standard certification.

During the quarter we launched an enhanced BLACKIRON cloud server platform to give client's significantly more control over their server performance. We also added expertise inside our Management Services and Professional Services Group. The professionals joining our team bring long standing customer relationships and certified skills in information management and technology development. Together these moves will enable us to further enhance our relationship with our customer's technology environment. Allowing us to migrate more data and workloads to our cloud and data center offerings.

Let's look at some of our Q3 operating metrics for our data center unit. Since the data center business unit is entirely located in Canada I will present results in Canadian Dollars. Jim will capture currently translation effects in his financial overview.

Q3 revenue was $18.4 million a 12% increase over last year's $7.5 million and a 5% sequentially over Q2. Supporting this overall revenue growth was a 13% increase in co-location services. Our cloud computing service offering, although only a small percentage of total revenue today, again nearly doubled year-over-year this quarter.

Our sales organization is continuing to focus on securing larger and more sophisticated business opportunities with potential customers.

Q3 Data Center business adjusted EBITDA was $3.2 million which represents 39% of revenue and excluding costs associated with the newly opened Toronto DC3 was 41% of revenue. EBITs accrued 7% year-over-year including Toronto DC3 or 12% excluding costs associated with the new center. EBITs accrued 4% sequentially versus second quarter.

Total Data Center capital spend during Q3 was $4 million as we completed the construction of Toronto DC3. Maintenance and success based growth capital represented $1.1 million of the total. Capital spend will remain focused on capacity expansion and success based initiatives through 2013. We remain focused on continuing our sales and success based momentum of our newly formed business unit BLACKIRON Data.

Let's move to slide six to look at the North American Telecom segment. As discussed during our Q2 earnings call our North American Telecom unit provided traditional VoIP services such as local and long distance as well as next generation services such as internet, Hosted Phone, and Ethernet as first mile.

In US Dollars, Q3 revenue was $55.4 million. Our focused toward on-net services helped lift normalized adjusted EBITDA to $10.5 million. At 19% of revenue, EBITDA was 120 basis points higher than Q2 and grew in absolute dollars despite the slight drop in total revenue.

The changing consumer segment revenue was entirely driven declining transitional and local services. Partially offsetting these declines was continued strength in our internet revenues. Currently representing 22% of the consumer revenue mix, internet revenue was up 3% versus Q2 and up 11% year-over-year. We expect continued internet revenue strength from our on new DSL internet services.

(Inaudible) focused on increasing on-net revenue streams provided a 32% increase in Hosted Phones year-over-year and a tripling of our Ethernet as first mile revenues year-over-year.

Although representing only about 15% of SMB's total revenue today, these services are high-margin and therefore over indexed as a contributor to segment EBITDA.

US retails exclusive focus on voice over IP services has not yet been able to offset the decline in legacy revenues but the higher margin products focus has resulted in steady overall earnings from the segment.

Within our metro-fiber segment, we are launching new services with the construction of our first fully-owned fiber ring in Canada's national capital city Ottawa. The ring, completed in October, extends on our strategy to better serve mid sized and enterprise businesses. Customers now activating on the fiber-optic network are leveraging data speeds that are among the fastest in the industry.

Q3 capital expenditures in North America Telecom were $1.8 million. The spend was focused on success based hosted phone and internet growth, network upgrade and our Ottawa fiber construction. North American Telecom units normalized adjusted EBITDA less capital expenditures provided a strong $8.7 million of cash flow in the quarter which was $0.5 million higher than Q2.

Moving forward we will continue to aggressively manage our telecom business unit costs and continue our path toward legacy revenue streams with our on-net growth product.

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

Good morning everyone. 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 us know move to slide seven, entitled Financial Summary which provides four key financial metrics and our trends over the last five quarters.

In the third quarter, net revenue decreased 14% year-over-year to $63.9 million which includes a $1 million decrease from foreign currency translation. On a constant currency basis net revenue decreased 12.6% due primarily a decline in local and long distance services, offset in part by 12% growth in data center revenues. We continue to shift our investments from traditional services into growth areas for the company, specifically data centers, Hosted Phones, and more recently metro-fiber.

Adjusted EBITDA as reported, was $10.1 million or 15.8% of net revenue in the third quarter of 2012. Compared to $11 million or 14.8% of net revenue in the third quarter of 2011. Included in adjusted EBITDA in the third quarter of 2012 was $1 million of severance and other non-recurring costs.

Excluding these costs normalized adjusted EBITDA was $11.1 million or 17.4% of net revenue. Compared to $10.3 million or 13.8% of net revenue in the third quarter of 2011. As I mentioned in our second quarter call we continue to expand our normalized adjusted EBITDA margin as we manage our operating costs and scale down our corporate function to align with the size of the new PTGi.

Normalized adjusted EBITDA grew 8.5% year-over-year and 10.4% sequentially. Due primarily to continued SG&A optimization and contribution from higher growth margin services revenue. Again, despite overall revenue declines were have been able to consistently maintain the companies stable adjusted EBITDA contribution.

Capital expenditures in the third quarter of 2012 were down to $6.4 million compared to $8.9 million in the third quarter of 2011. Excluding discontinued operations, capital expenditures for continuing operations were $5.9 million compared to $4.6 million in 2011.

Capital spending in the quarter continued to be driven by the core investments in Canada to expand our data centers. The increase year-over-year is specifically related in the new Toronto data center. Sequentially, capital expenditures from continuing operations decreased $1.1 million.

Free cash flow for the third quarter of 2012 was a positive $1.3 million compared to $2.1 million in the third quarter of 2011. As a result of financing activities we paid $5 million in interest related to the repurchase of debt in the third quarter 2012 and $2.3 million in 2011 related to the exchange offering. Excluding these interest payments free cash flow in the third quarter of 2012 and 2011 would have been a positive $6.3 million and $4.4 million respectively.

The primary contributors to the decrease in free cash flow over the prior year quarter were $900,000 decrease in adjusted EBITDA and $2.7 million increase in interest paid. This was partially offset by a $2.5 million decrease in capital expenditures and a $300,000 increase in working capital over the prior year quarter.

On a sequential basis free cash flow increased $13.7 million due primarily to the semi annual interest payments made in the second quarter and increased in the adjusted EBITDA.

Let's move to slide eight to discuss our balance sheet. Cash and cash equivalents as of September 30, 2012 was $66 million. Down from $209.7 million as of June 30, 2012. Cash was generated during the quarter from $10.1 million of adjusted EBITDA and $1.3 million of working capital.

This was offset of usage of $119 million for the repurchase of 10% senior secured notes, $10.9 million for the premiums and costs associated with the repurchase of those notes, $5 million in interest payments, $13.8 million in dividends paid, and $6.4 million for capital expenditures.

Our long term debt including current obligations in quarter end was $118.7 million, down from $249.3 million at year end 2011. The decrease is attributable to the repurchase of $119 million of the 10% notes and the elimination of capital leases in Australia that were part of the sale.

We now expect our capital program for continuing operations to finish the year slightly below our previous outlook of $26 million. And we 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.

Thank you Jim. So to wrap up our remarks, please turn to slide nine. The management team is committed to growing our data center business as of Pure-Play aimed at co-location and beyond. This will include managed and cloud services, which result in higher ARPUs per (inaudible). BLACKIRON Data is in a great position to capture demand across many of Canada's top markets. Mainly Toronto, Vancouver, Ottawa, Edmonton, and London outside of Toronto.

We also entered a new chapter in North America Telecom with upside expected from a metro-fiber strategic initiative. We designed and constructed our first fiber ring with civil works technologies that can be stamped beyond Ottawa.

The next step is to overlay a state of the art Ethernet network that our SMB enlarged customers will find very beneficial as the premier network upgrade.

And finally regarding pending litigation associated with the note repurchase and indenture amendments, we have been very busy to resolve this matter. As a result we will not be taking any questions today on this topic. We look forward to providing you with a complete update as soon as it is available.

So at this point we will turn it over to the operator to take your questions.

(Operators Instructions). Our first question will come from line of Barry Sine of Drexel Hamilton.

Good morning gentlemen. Very nice quarter. Question on the fiber ring you are building in Ottawa. Maybe you could give us a little more color on it. You talked about 288 dark fibers in the ground and I guess that means that they are not yet lit. What can you share the length of the fiber and the number of buildings past? Where it covers, what the initial targets will be and what services will be on that fiber ring?

Yes, that is good question Barry. Let me give you a snapshot of Ottawa. It is very small central business district, so we probably have 2 km to 3 km of fiber weaving through, today. And that is just the backbone. We probably have 50 targeted buildings. Many of which we have customers in already in the form of SMB services.

The traditional SMB services are IP/PBX and dedicated access to the internet, certainly VoIP services. And those types of customers would love to move upstream on fiber with metro Ethernet which is a technology certainly many businesses are accustomed to in other markets, other key markets.

That equipment is now being reviewed as to which type of equipment we will be putting in and which building equipment that basically is associated with that will be installed in buildings to light buildings. So it is a two step process, the civil works backbone goes first usually it is the harder part.

The micro-trench is very economical because it is a technology where its surface layer may be 12 inches down, it goes very fast, we have four cables in a very thin conduit weaving through the town. It is not intrusive at all, the municipalities love it, it is very well accepted across Canada and I think that starting to gain acceptance here in the United States. But not so much of late.

We love the technology because it is also service detected, it is a utility, it is part of the family of utilities that have to be detected and the fiber provided an alternative to incumbents and many buildings don't have a fiber alternative in those buildings. So the short of it is it's just like moving through any central business district and you can imagine the types of buildings that are there, large premier residential buildings, penthouse types that we could think we could do, ultimately, even something like fiber to the building for resi and offer high speed data for apartments.

So we are looking at that strategy. We are also looking at high capacity, because once we light Ottawa and start to bring commercial customers maybe even some government accounts, the next step is to get them from Ottawa to another town and that kind of activity, connecting other cities, is our upside. Because that is something we do well, we have a lot of experience in telecom service all along it was just that we were never able to own fiber. So it is very exciting for us to have own control over our own transport and connect the medium to large customers to state of the art services.

So it is a work in progress, we are just beginning, we are very excited. Ottawa is the test bed, as I mentioned. We get it right and we move on to other markets.

Just a quick follow up on that. That is very helpful, now I understand the construction progress. As you are currently putting the electronics in the buildings it sounds like meaningful revenue from that fiber is going to be more like a first quarter event rather than a fourth quarter event?

You know it is again a construction project first, so we are already testing some of the existing SMB customers, bringing in them on different types of services now on fiber. Not necessarily metro Ethernet yet, so it is a work in progress. You will see a two-step process where by you are rolling guys onto the fiber and then adding new services through new electronics. So it is going to be gradual at first and then by next year we hope to have very good momentum.

Okay, thank you.

(Operator Instructions). There are no further questions at this time. I will now turn the conference back over to Mr. Aquino for any closing remarks.

Thank you Operator and thank you all for your participation today. We look forward to giving you an update as soon as possible and on the fourth quarter. Thank you.

Ladies and gentlemen, that concludes your conference call for today, we thank you for your participation and ask that you disconnect your line.