Global Crossing Ltd. Q3 2008 (Qtr End 9/30/2008) Earnings Call Transcript

Global Crossing Ltd. (GLBC)

Q3 2008 Earnings Call

December 11, 2008 9:00 am ET

Executives

Suzanne Lipton – Vice President of Investor Relations

Anthony D. Christie – Managing Director, Global Crossing UK

John A. Kritzmacher – Chief Financial Officer

Analysts

[Kevin Coin] – Goldman Sachs

Donna Jaegers - D. A. Davidson & Co.

[Philip Growth] – Merrill Lynch

Romeo Reyes - Jefferies & Co.

David [Kildona] – J.P. Morgan

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Global Crossing UK third quarter 2008 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded Thursday, December 11, 2008. It is now my pleasure to turn the conference over to Miss Suzanne Lipton, VP of Investor Relations. Please go ahead, ma’am.

Suzanne Lipton

Thanks Nick. Good morning and good afternoon. Welcome everyone to GCUK’s third quarter 2008 earnings conference call. John Kritzmacher, CFO and Anthony Christie, Managing Director of GCUK have some prepared remarks after which we’ll open the call for some questions.

Before we begin, I’d like to remind everyone that statements made during today’s conference call that are not historical financial results are forward-looking statements as defined in Section 21-E of the Securities Exchange Act of 1934. Our actual results could differ materially from those projected in these forward-looking statements. Factors that could cause material differences are contained in our reports filed with or furnished to the Securities and Exchange Commission including GCUK’s annual and quarterly reports on 20-F and 6-K.

We are not obligated to publicly update or revise these forward-looking statements to reflect future events or developments except as required by law. We refer you to our press release on our third quarter 2008 earnings posted on our website at www.globalcrossing.com, which includes explanations of and reconciliations with the closest IFRS financial measure on our non-IFRS metrics, such as adjusted gross margin and adjusted IFRS EBITDA.

I would now like to turn the call over to Anthony Christie. Anthony.

Anthony D. Christie

Thanks Suzanne and good afternoon everyone. Today I’ll take you through a few key updates on the GCUK business. I’ll briefly address our performance for the quarter and I’ll update you on the momentum of our business, including demand trends we’ve been seeing.

I am pleased to report GCUK has delivered solid results again this quarter. We grew revenues to 82 million pounds, an improvement of 2% from last quarter and 13% from the third quarter of last year. We generated adjusted gross margin of 56 million pounds or 68% of revenue. We generated adjusted IFRS EBITDA of 21 million pounds, and 14 million pounds in cash from operations after interest paid.

Let me start my commentary on demand trends by saying that, while we’re not immune to the impact of the macroeconomic climate, we have not yet seen an impact to our business. We believe this is largely because of the efficiencies our solutions provide to our customers, which continue to be very desirable, as well as the result of the momentum we have from the traction our sales force has gained so far this year. This positions us well in the months ahead.

Our sales team has been performing well across all channels; commercial, government, and our carrier data channel. And we have been experiencing healthy levels of order activity as we continue our efforts to develop business in each of these areas of the market. Commercial and government customers have been turning to Global Crossing UK for products and services that will improve the efficiency of their operations in these challenging times.

We continue to see demand in the form of managed services, which lowered total cost of ownership for customers and helped make their operations more productive than before. Customers turn to GCUK because of our differentiated value proposition, including our deep national network; our global solutions portfolio; and, as third party surveys tell us, due to our overall value and the exceptional customer experience we deliver, particularly to UK based mid-sized enterprises that value having a dedicated account team with deep IP solution experience.

Carrier demand for our services has continued in the current economic climate, driven by end users needs in the form of mobile and fixed line broadband. Mobile broadband demand is being driven by end user needs to access the Internet on the go at increasingly high speeds, and fixed line Internet service providers are also adopting our services to respond to demand for increased speeds from their end users.

Carriers seek GCUK services because of our ability to address these requirements. Our customers tell us the combination of deep national network we have in the UK and the variety of global services differentiate our offer for this customer set. Also, our ability to inter-operate wave and Ethernet services seamlessly on a common platform enables our carrier customers to capture their consumer market more quickly and efficiently than through competing solutions.

Lastly, on the demand front, UK customers are responding well to our data center services offering, such as server monitoring and management; back-up; storage; and security solutions. And although it remains immaterial to our results this year, demand for these services has been healthy as customers view hosting and managed services outsourcing as a way to lower their costs, and provide a more predictable cost structure for their business compared to operating these applications in-house.

It is the aforementioned environment and our execution in it which has allowed us to deliver on our goal to replenish [Camelot’s] revenue. As we’ve previously reported, we expect that will roll off substantially through the fourth quarter of 2008 and into the first quarter of 2009. The precise impact on GCUK will depend on the details and timing of Camelot’s actual network transition.

Although we anticipated depth in our GCUK revenues ahead as a result, we also expect that new orders already signed during 2008, which will be installed and built in the months and quarters ahead, will mitigate that impact and return GCUK to quarterly, year-over-year top line growth as we move through the back half of ’09.

We are well positioned as a competitive provider amid what is an active UK landscape, alongside the large providers here and as I referenced earlier, we are seeing demand continue through today. In fact, during Q4 a government sector customer launched a project with us that will enable them to converge multiple services on their network by taking advantage of our secure managed IPBPN service offering, resulting in greater efficiency for their organization.

And a large global defense contractor recently purchased a combination of solutions from us, including private IPBPN and public Internet access, pointing to our flexibility in addressing their requirements and efficiency gains they expect from deploying these solutions.

Also on the competitive front, some providers in the UK appear to be in a state of flux at the moment as they either realign their sales management teams, seek to integrate recent acquisitions, or undertake significant headcount reductions. We are fortunate in that we undertook these actions ourselves 18 to 24 months ago. Today, our management focus remains steadfast on acquiring new customers who will benefit from our solutions and on retaining and further developing existing customer relationships.

This focus, coupled with our continuous actions to maintain a high performing and talented sales and sales support force, is benefiting us as well. And we are continuing to add sales people because of the traction we have gained. In summary, we are pleased with our continued progress in winning new business, efficiently serving our customers needs and delivering solid financial results.

And with that thought in mind, let’s turn to John for more detail on our third quarter performance. John.

John A. Kritzmacher

Thank you Anthony. As a reminder, the results I’m about to discuss are prepared under IFRS in pounds sterling. These results were previously reported under U.S. GAAP and U.S. dollars as part of the parent company’s consolidated financial results on November 5.

We are very pleased with GCUK’s results so far this year. Our sales engine continues to perform effectively. GCUK revenue grew 2% sequentially to 82 million pounds, and is up year-over-year by 9 million pounds or 13%. The sequential and year-over-year increases were due to the continued growth of our enterprise and carrier channels resulting from strong order intake for our services.

As we mentioned last quarter, quarterly year-over-year comparisons include a significant contract won in the government sector in October, 2007. As Anthony noted, the sales engine is delivering on our goal to replenish Camelot’s revenue. Over the next two quarters, we expect to see slight erosion of our top line as a result of disconnects for this customer. However, we expect new orders already signed during 2008 to mitigate that impact and return GCUK to quarterly, year-over-year revenue growth on a local currency basis as we move through the latter half of 2009.

GCUK’s cost of access expense for the quarter was 26 million pounds, an increase of 1 million pounds on a sequential basis and an increase of 5 million pounds year-over-year. The higher access expense was driven by the previously mentioned revenue growth. In addition, the year ago period includes a cost reclassification benefit of 2 million pounds, which I’ll speak to in just a moment.

Adjusted gross margin was flat sequentially at 56 million in the third quarter, and increased by 4 million from the same quarter last year. The variances can be attributed to the same drivers I’ve just mentioned. On a percentage basis, our adjusted gross margin was 68% of revenue in the third quarter compared with adjusted gross margin of 69% in the second quarter and 72% in the third quarter of 2007.

Please note the third quarter of last year included a benefit of 2 million pounds to cost of access due to reclassification of cost from cost of access to depreciation and amortization in order to align Fibernet’s accounting policies with GCUK’s. Excluding this benefit, adjusted gross margin as a percentage of revenue in 3Q ’07 was similar to the second and third quarters of 2008.

As we continue to generate incremental revenue, we also continue to focus on managing our cost structure. Cost of revenue, excluding cost of access, was flat sequentially at 26 million pounds in the third quarter and increased 2 million pounds year-over-year. The year-over-year increase was primarily due to higher equipment costs associated with revenue from the large government contract I referenced earlier.

SG&A was flat sequentially at 10 million pounds and increased 1 million pounds from the third quarter of last year. The year-over-year increase in SG&A was primarily attributable to an increase in sales commissions as well as higher salary costs for additions to our sales force earlier in this year.

GCUK generated adjusted IFRS EBITDA of 21 million pounds in the third quarter, staying flat on a sequential and year-over-year basis. As a reminder, the adjusted IFRS EBITDA for the year ago quarter includes a 2 million pound benefit for the aforementioned access cost reclassification related to Fibernet.

We generated cash from operations of 14 million pounds, including interest payments of

1 million pounds. After using 9 million pounds for capital expenditures, including 2 million pounds for principal payments on financed leases, the business end of the third quarter with a net cash position of 34 million pounds, an increase of 6 million pounds versus the prior quarter’s cash balance. Looking ahead, please keep in mind we make interest payments on our bonds only in the second and fourth quarters of each year.

I’m encouraged by GCUK’s stability, by its strong focus on retaining our existing business, and its demonstrated momentum in earning new business. Anthony and I will now be happy to take your questions. Operator, please open the lines for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from [Kevin Coin] – Goldman Sachs.

Kevin Coin – Goldman Sachs

As we think about the pricing environment, I was just wondering as the global economy continues to feel some pressure, have you seen any changes where potentially customers are coming back and asking for price adjustments? And also, have you seen any changes in October and November since the close of the quarter?

Anthony D. Christie

Thanks, Kevin, for the questions. This is Anthony. I’ll take those. In terms of pricing environment as a result of, you know, the macroeconomic conditions, haven’t really seen anything, you know, that’s off what I’ll call the “normal” course of business. And what we have seen is, you know, for some solutions for some managed solutions that might have capital expenditure in them up front, clients are asking for those costs to be smoothed over the life of the deal, which for a commercial customer is around three years and for a government customer, you know, approximately five years.

But in terms of opening up minimum usage guarantees and things like that and re-pricing, you know, we haven’t seen that yet. As far as order trends, you know, continuing through Q3 as I mentioned, while we’re not immune from the macroeconomic climate, we just haven’t seen an appreciable change in the business momentum, you know, that we’ve developed here for the past couple of quarters.

Kevin Coin – Goldman Sachs

Just one other question, I know in the past you’ve mentioned that there was another significant contract expiring in 2010 but you’re obviously working on renewing that and negotiations were ongoing. Can you provide an update on that?

Anthony D. Christie

Yes, sure. You’re referring to the FTN, which is a contract that we have with the FCO. You know, we’ve got a dedicated team in place to look after this. We’ve been following every step of the way, every milestone required for this bidding. You know, we’re on track for where we need to be. We received some good news recently in terms of our company being named to the long list of providers, you know, for this re-bid. And what we’ll do between now and when this contract is up for renewal is continue to comply, you know, with all the requirements.

And us being the incumbent and also providing very high level of service with a deep relationship with the client, I believe and the team believes puts us in a good position to not only retain what we have but also to grow it in the context of this new procurement.

Operator

Your next question comes from Donna Jaegers - D. A. Davidson & Co.

Donna Jaegers - D. A. Davidson & Co.

Tony, can you give us a little more color on what you’re trying to do to take advantage of the competitive environment? With DT really trying to cut costs, does that open any doorways for you guys?

Anthony D. Christie

I think – appreciate the question, Donna, and as I mentioned in my comments the majority of our competitors here really have quite put a few things that they’re trying to accomplish, whether it’s the integration of a recent acquisition or senior leadership change that’s taken place in a few of them, or as you say cost reductions. As I also mentioned, because of the momentum that we have and the traction that we have in our sales channel and our intent to continue to hire sales people through Q4, that’s precisely what we aim to do in the target market that we have been successful in.

And that is in the mid-size enterprise, so we still view that as our sweet spot. That’s where we’ve been successful, there and of course in the government, and with the additional headcount in sales and sales engineering we aim to continue that.

Operator

Your next question comes from [Philip Growth] – Merrill Lynch.

Philip Growth – Merrill Lynch

Other than the [Farning] Commonwealth Office renewal, are there any other major contracts that are in your top ten on a revenue basis that come up for renewal in the next one to two years? A second question is given your outlook for 2009, where you’re suggesting growing revenues in the second half and given that the business does seem to be very service revenue focused, could

you give us a rough percentage of how much revenue do you think are already sort of booked for 2009?

And then finally, it’s my understanding that as contracts come to the end like the Camelot one there, they’re at the most profitable stage and I was wondering do you think that EBITDA for the business will be affected proportionately more than revenues as this contract ends? And do you see basically EBITDA potentially growing in the second half or do you have to let some of the new contract wins sort of catch up? Thanks.

Anthony D. Christie

Okay, Phil, I’ll try to answer some of your questions and then maybe ask John to comment on the revenue mix as well. In terms of renewals, you know, the next large one we have is not until December of 2011. So we’re okay for the next couple of years as it relates to our top clients.

As far as the second question, I’m not sure I fully understood that. If you can rephrase that I would appreciate that.

Philip Growth – Merrill Lynch

I was just wondering how much of your revenue is already contracted for 2009? I guess that’s a simpler way of saying it, you know, so your run rate revenues right now were just above 300 or 317 million, you know. Do you have 100% of that level? Obviously you don’t have 100% since Camelot rolls off, but is 90% of that booked for next year? Or what portion of the contracts are only one year revenues?

John A. Kritzmacher

This is John Kritzmacher. Let me try to give you a little bit of sense as to our visibility into revenues ahead. Typically as you know we have a large, recurring revenue base and that forms a good bit of our ability to predict revenues out into the future. In addition to that, the typical order fill rate for us is anywhere between say four to six months. So we have a pretty good bit of visibility out into the future as to the revenues that will be coming from orders to be implemented over the coming months.

I think that gives you a reasonable sense of our level of visibility and then beyond that, of course, you’re doing some forecasting about the momentum we’ve seen in the business.

Philip Growth – Merrill Lynch

And then just the EBITDA impact of Camelot rolling off and whether or not that will be impacted disproportionately versus revenues.

John A. Kritzmacher

In general as we’ve said on prior calls and in prior communications, the margin associated with Camelot was a bit lower than our average in the UK. So it rolling off will have a bit of a lesser effect in terms of both to the bottom line and then at this point in terms of additional revenue coming on. Of course, it will depend on the mix of new revenues we acquire.

Anthony D. Christie

The only thing I’ll add to that is the revenue replenishment plan we have for Camelot, you know the gross margin profile associated with those customers that we’re acquiring is equivalent to or greater than that of Camelot.

Operator

Your next question comes from Romeo Reyes - Jefferies & Co.

Romeo Reyes - Jefferies & Co.

Just a quick follow-up on the previous question on EBDA, I guess you mentioned that revenues are going to grow in the second half of ’09 during your there’s going to be a dip in the first half if I heard correctly. Is that the same sort of forecast that you’re giving out for EBITDA as well?

John A. Kritzmacher

We’re not forecasting EBITDA today, so let me try to track a little bit, okay? It’s not really our practice to provide guidance down to that level of guidance. It’s not typical for us, so what we’ve said in order for you to understand the flow of our business is we do expect that on a year-over-year basis, the quarters will show growth as we move through the latter half of 2009. In terms of the flow through to EBDA, I think you’ll see a consistent pattern of what you’ve observed in our business over recent periods.

We’re going to grow revenue and we’re going to continue to seek operating leverage as we grow revenue to improve EBDA. But beyond that I’m not prepared to start forecasting down to EBDA at this level and at this point in time.

Romeo Reyes - Jefferies & Co.

In terms of Camelot, how long does it take to transition? Anthony, can you help me out with that?

Anthony D. Christie

I think as we said, you know, all along Romeo we haven’t seen any impact in Q3. As a matter of fact, the actual migration is slower than we had anticipated. We’re seeing disconnects now. We’ll see an impact in Q4 and I would expect the majority of that network to be off sometime early next year.

Operator

Your next question comes from David [Kildona] – J.P. Morgan.

David Kildona – J.P. Morgan

I just wanted to ask what you were planning to do with excess cash after making the offer for [Barns at R] and what capacity you would have to make any dividend payments up to the parent company?

John A. Kritzmacher

So in respect to excess cash beyond the cash required for the offer, we’ll use that cash to continue to fund the operations of our business through 2009. With respect to the dividend ending up to the parent, at this point in time we’re not permitted to dividend up to the parent.

Operator

And pardon me, moderators, there are no more questions from the phone lines at this time. I’ll now turn the conference back over to you.

John A. Kritzmacher

Okay. So thank you very much everyone for joining our call today. As you can see from the results that we posted for the third quarter, continued strength in maintaining the business we have, the strong relationships that we have with our existing customers, and acquiring new customers, we feel quite good about the momentum of the business and look forward to the coming quarter end to 2009. Thank you all for joining us. Have a good day.

Operator

Ladies and gentlemen, that does conclude our conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day everyone.

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