Global Crossing Limited Q2 2008 Earnings Call Transcript

Aug. 5.08 | About: Global Crossing (GLBC)

Global Crossing Limited (NASDAQ:GLBC)

Q2 2008 Earnings Call Transcript

July 23, 2008 9:00 am ET

Executives

Suzanne Lipton – VP, IR

John Legere – CEO

Jean Mandeville – EVP and CFO

Gary Breauninger – EVP and Chief Marketing Officer

Anthony Christie – EVP, Managing Director EMEA

Analysts

Winston Lennon [ph] – Goldman Sachs

Jonathan Schildkraut – Jefferies & Company

Romeo Reyes – Jefferies and Company

Carl Murdoch-Smith – Cazenove

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Global Crossing's second quarter earnings conference call. (Operator instructions) I would now like to turn the conference over to Suzanne Lipton, Vice President of Investor Relations. Please go ahead.

Suzanne Lipton

Thanks, Catherine. Good morning everyone. Thanks for joining us today for our second quarter 2008 earnings call. John Legere, our Chief Executive Officer; and Jean Mandeville, our Chief Financial Officer, are here with us today. They will each share their comments, after which we'll open the call for some questions.

Presentation slides can be viewed to help follow our prepared remarks today. They are available via webcast, which you can access through our Investor Relations site, if you go to www.globalcrossing.com, access the Investor site and follow the links to the webcast.

Now before we begin, I'd like to remind everyone that statements made herein 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 actual results to differ materially from those in these forward-looking statements are contained in our reports filed or furnished to the Securities and Exchange Commission, including our annual report on Form 10-K and quarterly reports on Form 10-Q.

We are not obligated to publicly update or revise these forward-looking statements to reflect future events or developments, except as required by law. Information contained herein is in summary format only and is followed by in its entirety by reference to the financial statements and other information contained in our Forms 10-K and 10-Q.

We refer you to our financial press releases posted at www.globalcrossing.com, which include explanations of and reconciliations with the closest GAAP financial measures for our non-GAAP measures such as adjusted cash EBITDA and adjusted gross margins.

With that, I'll turn the call over to John.

John Legere

Okay, thank you all for joining. I have a brief agenda for today's call. What I'm going to do is discuss our financial progress, which did continue in the second quarter, and I'll also update you on the trends that are supporting our growth. So, why don't we get started?

The thing you could – going to continue to hear throughout our discussion today is progress. The second quarter of 2008 marked our nine consecutive quarter of total revenue growth. We grew revenue 4% sequentially to $653 million or 19% when compared to last year. We've expanded Invest and Grow revenue by 6% sequentially to $546 million, that's 26% year-over-year. And we've increased our adjusted gross margin dollars to $347 million that translate to 53% of our total revenue compared to 49% just one year ago.

And within with our Invest and Grow category, we've grown adjusted gross margin by 6% sequentially to $334 million or by 33% compared to the same quarter last year. Sales of our core products and services in our Invest and Grow category are essential to our growth. We continue to expand adjusted gross margin and manage our operating costs.

Our progress in these areas has resulted in $77 million of adjusted cash EBITDA this quarter, an improvement of $69 million from just one year ago and the 15% improvement that we posted sequentially reflects the strong momentum in our business exiting the first half of this year.

In addition, all segments Rest of World, GC Impsat, and GCUK reported growth in revenue, adjusted gross margin, and positive adjusted cash EBITDA. We've also improved the extent to which adjusted cash EBITDA exceeds our growth CapEx, which amounted to $19 million in the second quarter, an improvement of $67 million from one year ago and we ended the quarter with a cash position of $377 million in cash and cash equivalents. Our results demonstrate a positive and improving trend towards free cash flow for our business.

Turning to demand, we continue to see trends in the fundamental market trends driving our growth. First, Global Enterprises are replacing legacy data and voice services with IP VPN and VoIP to drive efficiencies and also to reduce total cost of ownership.

Our advanced Global IP network, coupled with our expertise and experience in IP migration, position Global Crossing as a key partner to enterprises who are undertaking this technology shift. We're also enhancing our position as an alternative to large incumbents for share of spending by Fortune 500 enterprises as a result of market consolidation.

With fewer providers in a number of regions of the world, Fortune 500 companies are seeking to diversify their IP and telecom spend and expand physical and carrier diversity. Our service performance is highly regarded and we've developed a customer support model that differentiates us from our competitors.

Carriers are turning to Global Crossing to extend their data network footprints globally. They're capitalizing on our global reach which spans approximately 690 cities in 60 countries. Cable operators are seeking to increase high speed bandwidth to meet consumer demand for heavy content sites, and we're also helping content in social networking companies meet their growing demands for service, and equally important, provide their end users with an exceptional experience that they compete for consumers amid their changing business models.

The demand I just described across our key market areas of the market have resulted in a revenue increase of 14% sequentially in the form of IP-based Virtual Private Networks and IP transit. Enterprises converting to our advanced services are not only able to support increasingly sophisticated application to greater efficiency, they're also using technology migration to reach their budget targets this year. While we remain watchful for signs of a negative impact from the economy, we have not seen this effect reflected in our sales performance.

During the second quarter, our sales team generated new orders comparable to the healthy levels we saw in the first quarter. Since the last time we reported, the average April through July order volume had actually increased versus our Q1 average with July matching record levels.

There were several traits that continue to differentiate Global Crossing from our competitors. These differentiators are helping us win new business and they're resulting in loyalty and incremental business from our customers.

Our customers value the high quality performance of our network and our IP expertise, and our outstanding account support has given Global Crossing a competitive advantage. Satisfaction scores for the second quarter indicate that 96% of customers surveyed were satisfied with Global Crossing. And while we excel in this area, we continue to improve the customer experience including processes, people, software and systems, which are also resulting in increased operational efficiencies for us as we scale our business.

We also score well in an area strongly correlated with customer loyalty. Recently, 72 % of customers surveyed said they are very likely to recommend Global Crossing to others that compares with 58% for our competitors.

Now, distilling what I've told you today, I'd say this, Global Crossing is capitalizing on demand that exists in the global marketplace. And given the trends we are seeing in our low market share and share of wallet, we believe we have a significant opportunity to grow. We remain focused on executing. We are managing our costs as we grow our revenue and our momentum is helping position the business for future sustainable free cash flow.

Now, as many of you know from our filings several weeks ago, we are conducting a search for a Chief Financial Officer to succeed Jean Mandeville and that search is well underway. We've narrowed our search to a few very solid external and internal candidates through what has been a very rigorous process. My management team and I, the Board and our audit committee, as well as our executive search firm, all are very positive about the group of finalists. We are targeting to close our process sometime in June 3. However, in the meantime, Jean remains very actively engaged as our Chief Financial Officer.

With that, I'll turn it over to Jean now for more detail of our results.

Jean Mandeville

Thank you, John, and good morning to everyone. Before I begin, I would like to address a couple of housekeeping issues that impacted the second quarter as well as comparable period. First, as we state year-over-year comparisons, keep in mind that our second quarter 2007 results include GC Impsat for a partial period beginning on May 9, 2007, the date that we closed the acquisition.

Secondly, we completed the consolidation of our Brazilian operations and transfer of our GC Brazil operations from the company's Rest of World segment to our GC Impsat segment. As regard under US GAAP, we have retroactively restated our segment results to include GC Brazil results in the GC Impsat segment and remove them from the Rest of World segment for all periods presented. For more complete details, please refer to our reconciliation tables in our press release.

Now let's turn to our results. Our business continues to perform well. Our consolidated revenue has grown from nine consecutive quarters. In the current period, consolidated revenues were $653 million, representing an increase of 4% sequentially. Of the $653 million in revenue, Invest and Grow contributed $546 million, an increase of 6% sequentially. Our wholesale voice business generated $106 million of revenue down from $112 million in the prior quarter and $114 million in the second quarter of 2007.

We continue to expect this business to remain relatively flat going forward. Each of our segments performed well in the quarter. We continue to see good growth in our Rest of World business. Rest of World generated $385 million in revenue an increase of $12 million or 3% on sequential basis and $35 million or 10% year-over-year. Within this segment, Invest and Grow increased $18 million or 7% sequentially and $45 million or 19% year-over-year.

Second quarter Rest of World revenue growth was partially muted by wholesale voice performance, which was (inaudible) million compared to $107 million in the prior quarter and $111 million in the second quarter of 2007.

In the quarter, GCUK total revenue grew to $167 million, an increase of $4 million or 3% on a sequential basis and $16 million or 11% year-over-year.

Growth in the second quarter is attributable to Invest and Grow services. Wholesale voice revenues were $3 million, flat versus comparable periods.

Overall, operations continue to perform strongly at GC Impsat. Revenue grew to $115 million, an increase of $8 million or 7% sequentially. GC Impsat growth is also totally attributable to our Invest and Grow services.

Our second quarter orders continue to contribute come in on par with prior months, reflecting a healthy level of average new monthly recurring revenue.

We continue to increase adjusted gross margin as we grow our revenue and manage our access costs. For the quarter, we generated $347 million of adjusted gross margin compared to $331 million in the prior quarter and $266 million in the second quarter 2007.

On a segment basis, the Rest of World contributed $152 million of adjusted gross margin in the quarter, GCUK contributed $109 million and GC Impsat, $87 million. Total Invest and Grow adjusted gross margin was $334 million or 96% of the total.

As a percentage of revenue, adjusted gross margin was 53.1%, an improvement of 60 basis points sequentially and 450 basis points compared with the 48.6% achieved in the same period last year.

Cost of access in the quarter was $306 million, which represents an increase of just $7 million sequentially compared to an increase of $23 million in revenue. Year-over-year access expenses increased $25 million compared to $106 million increase in revenue.

We are committed to be highly focused on controlling costs throughout the business. Over the last several quarters, our costs have remained in line while revenue has continued to grow at healthy rates. If we exclude the impact of our most recent acquisition, GC Impsat, the improvements are even more significant and demonstrate our success in controlling costs.

For the total business, our operating expenses excluding cost of access and stock compensation, which we will refer to as adjusted operating expenses, have improved sequentially as a percentage of revenue by 60 basis points to 41.3% of revenue in the second quarter. Year-over-year, we improved by 580 basis points from 47.2% in the second quarter of 2007, including severance expenses associated with the realignment of the business in the second quarter of last year.

And if you exclude GC Impsat, the improvement is even more pronounced as our adjusted operating expenses as a percentage of revenue improved year-over-year 770 basis points to 38.8% of revenue in the second quarter. Our adjusted operating expenses have remained relatively constant as our revenues grow.

Let us move to the cost components, total cost of revenue excluding cost of access was $158 million for the second quarter, an increase of $4 million sequentially and $9 million year-over-year. The majority of this sequential increase within our real estate network and operation was primarily attributable to an increase in rent and utility charges. Excluding GC Impsat, costs in this category improved $2 million year-over-year or $4 million, if you consider it to total – the additional expense in the second quarter associated with our co-location and hosting investment.

SG&A for the quarter remained essentially flat at $133 million, up $1 million from the previous quarter. Year-over-year, SG&A increase $5 million, including the $40 million in severance expense in the second quarter of 2007. The $5 million increase can be largely attributed to the inclusion of GC Impsat for a full year. Excluding costs associated with GC Impsat, as well as the severance expense in 2007, SG&A increased by $3 million primarily associated with increased salaries and benefits including higher commissions associated with higher revenues. In summary, over the course of the last year, the company has done a very effective job in controlling costs and we'll continue to focus on this going forward.

On a consolidated basis, our adjusted cash EBITDA was $77 million, an improvement of $10 million sequentially and $69 million year-over-year. All segments generated positive adjusted cash EBITDA in the quarter. The most significant improvement came from Rest of World segment, which improved by $6 million sequentially and $40 million year-over-year.

GCUK adjusted cash EBITDA increased by $1 million sequentially and $9 million on an annual basis, and GC Impsat generated $3 million more on a sequential basis and $20 million on an annual basis.

Our adjusted cash EBITDA less growth CapEx continues to improve. It was $19 million in the second quarter, representing an improvement of $13 million sequentially and $67 million year-over-year.

We believe this positive overall trend would continue as we grow our adjusted cash EBITDA. However, quarter-over-quarter fluctuations may result from lumpiness in our capital expenditures. Despite this, the trends are very positive and demonstrate a trajectory towards sustainable free cash flow.

In the second quarter, the company generated $50 [ph] million in cash flow from operating expenditures, including $49 million in interest payments associated with our debt outstanding, as well as IOU related proceeds totaling $31 million. Our total cash use including financing and investing activities was $44 million in the second quarter including $66 million in cash CapEx.

Our second quarter growth cash CapEx was $58 million, relatively flat compared to the first quarter. We expect second half levels to be relatively higher than the first half of 2008, although total levels are expected to be as we anticipated for the year.

At June 30, our cash balance was $377 million, including $59 million of restricted cash and cash equivalents. Our fully diluted share count consists of 56 million common shares, 18 million preferred shares, 6.3 million shares underlying the 5% converts and 1.7 million of outstanding awards on the stock incentive plan, excluded performance share opportunities.

Our overall debt level remained the same in the quarter with $1.45 billion of debt outstanding including $173 million in capital leases. Finally, we have no major debt maturities before 2011.

In summary, we had a solid second quarter and our demand levels continued strong, as proven by our revenue growth and also our order levels. We expect this coupled with continuous cost control would yield continuous progress in all financial results.

Jennifer, please open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And the first question comes from the line of Jason Armstrong of Goldman Sachs. Please proceed with your question.

Winston Lennon – Goldman Sachs

Hi, this is Winston Lennon [ph] for Jason, so thanks for taking the question. You mentioned that new order run rate in Q2 was consistent with Q1 levels, and it sounds like a big part of this strong order flow is market share gain. So, can you talk more about where these customers are actually coming from? And the second part of this is, has the type of customers are kind of (inaudible) they are looking for a change over the past few quarters? Thanks.

John Legere

Yes. Hi, Winston. Yes, a couple of comments as to what we've outlined. I think two things, we've outlined that the average monthly order volume has maintained their level at which we recorded in Q1. And in fact, July moved to a level which matched the record level of orders for the business, and I'll let Gary cover with you kind of where they are coming from, because it's a pretty wide spread global demand.

But I want to remind everybody that the trends that we've been speaking about for a couple of years now, not only continue but they accelerate, which is amongst other things they are just a fewer players, the consolidation has had a positive effect on us especially since we are a specialized differentiated smaller provider. Since supply and demand situation clearly has moved in favor of supply, which has had a positive pricing effect in the market that maintains. And probably the most important trend that has continued that is favorable to Global Crossing is that about the adoption and the accelerated conversions around an IP platform.

So, if you take these factors together, those are the trends that are playing into our order volumes. And outside of a very watchful eye of course that we continue to place on any signs that the macro environment would have an impact on us and we are watching that closely. We don't see those signs yet nor do we see any reason why these particular trends in the enterprise space shows any signs of seizing at this point.

But Gary, why don't you comment specifically on the types of customers or location?

Gary Breauninger

Yes, I think John said – this is Gary Breauninger. On the global front, if you think about the trend from an order perspective, it's been up for all of our segments that we report on, whether you look at the UK Impsat or Rest of World. Most of that growth, as John mentioned, is coming from that technology conversion, whether it's TDM to VoIP, (inaudible) ATM to VPN or clear services over to managed services and/or data center capabilities. So, if you look around the globe, we've been pretty balanced in each month that we see pleasant surprise across our selling channels in each of the regions driven by that technology conversion and those set of products that we offer.

In the case of who they are coming from, to John's point, on a bigger seat at the table, we are taking share from the incumbents in each of the regions of the world. That's the vast majority of our growth. We are also, as John mentioned, taking advantage of just organic growth of the customers as they have requirements for higher bandwidth capabilities, file transfer, et cetera, and they just organically are growing. But the vast majority of the take share is coming from the incumbents in each of the region as those technology refreshes happen and we are able to provide a cheaper or a reduction in our total cost of ownership products or services that they use.

John Legere

Just last couple of comments. One is – what we definitely see, when you look over three or six months of order volumes, truly we benefit from the geographic diversity that we have not only globally but here in the United States. And if you look at each quarter, there will be peaks and troughs from different parts of the world, but they offset each other and have an overall increase in volume. The interesting part too, if you are looking for who can have a visible loss to offset Global Crossing's visible gain, it may be more subtle than that. Because as you see in many of the customers that we may be moving from 5% share to 9% share of, they are not changing out there major carriers.

Some of the bigger more dominant players will continue to be the dominant provider in many of these carriers. However in very specialized global IP applications, simple share shift is taking place to Global Crossing and the positive with that is there is not the same I would say aggressive price competition all the time and/or such a huge retaliation where a small player and we can very quietly at a consolidating market become a bigger player. However, in many cases, not the dominant provider to a major enterprise customer and that is a very lucrative business for us to be in.

Winston Lennon – Goldman Sachs

Thank you.

Operator

Thank you. And the next question we have comes from the line of Jonathan Schildkraut with Jeffries & Company. Please proceed with your question.

Jonathan Schildkraut – Jefferies & Company

Great, thank you for taking the questions. Could you give us an update on how the refurbishing of the European data centers is coming and then also if you could make some comments on IP trends that you are seeing, some of the other players in tangential markets have indicated they thought that the growth of IP traffic was slowing and we love to get your take on that. Thank you.

John Legere

Let's do two things. I believe Anthony Christie is on from the UK and Europe, and I'll ask him to comment on the Data Center development and then I'll start along with Gary and give you some of our idea of what's happening around IP traffic. Anthony?

Anthony Christie

I'd be happy to do that, John. We have mentioned before that in Docklands Phase I, that build-out that is already complete. It's just about sold out, so just to kind of give you a sense, 89% of that is occupied right now and only about 17 racks are available. The pricing trends associated with that too, we've mentioned before, it's actually quite positive for the business where we have probably in that an average price of about $1,200 per rack. Market clearing rates right now are probably closer to $1,800 per rack, that's what we are getting for the new space.

Now coming online, right at the end of August would be Docklands Phase II and that's got about 200 additional racks that will be coming online at those new price points which I mentioned. And right now, about 10% of that space has already been pre-sold. And then further to that, we have recently explored and are developing now a business case for modular development, the first location would be in Amsterdam. So, chunks of [ph] that are quite cost-effective that should be coming online in terms of being able to serve customers in Q1 of next year, but will be available for presale in Q4.

John Legere

John, let me give you a little bit of perspective on what's happening in the IP world that we planned, then maybe Gary can comment a little more overall from a market standpoint. And it's important to note, we are not trying to be the complete clearing house of all IP traffic. I think the best way to describe what we're providing is an IP-enabled quality of service. And our IP traffic actually reached 1.25 terabits in July, which is about 140% increase from the 519 gigs that we had in July of 2007. So, not even a year –

Unidentified Speaker

And that's for innovation, we just launched the (inaudible) deal with the WCP.

John Legere

Has a little crosstalk there, but let me continue. The VoIP minutes that we're carrying are up 5% sequentially, which is about 7 billion minutes. So, we're looking at VoIP revenues up 126% year-over-year and our total IP interconnected minutes are up 19% sequentially to $2.5 billion. As a matter of course, because of this and others, our carrier broadband revenue base is up just about 36% year-over-year, so certainly some very strong trends in the IP aspects of our traffic in revenue. Gary, I don't know if you want to comment on the overall IP base.

Gary Breauninger

Yes, I think to John's point about the – not being the price leader, if you look at maybe just backbone demand to some players only playing that space clearly that you could suggest some selling [ph] but when you look at the total set of capabilities you can offer to, again as we mentioned the cable code where the content providers as well as just raw bandwidth are coupled with the fact that our smaller product capabilities around IP origination and termination, i.e., Voice over IP from end to end are growing. We've actually seen, as John quoted, (inaudible) continued acceleration of the IP set of capabilities that we have deployed. And when you couple that finally with the fact that enterprise that – as they look into the future and think about unified communications or unified collaboration, it all starts with a converged IP backbone. So, we are continually seeing good growth on our IP core services that carriers and enterprises look to optimize their networks, as well as they get ready for what's next. So, still good growth for us, Jonathan.

Jonathan Schildkraut. – Jefferies and Company

All right, great. Thanks for taking the questions.

Operator

Thank you. And the next question comes from the line of Romeo Reyes with Jefferies and Company. Please proceed with your question.

Romeo Reyes – Jefferies and Company

Hi, good morning. Couple of quick questions, can you just run through the, I don't know if you did this already, I apologize if I didn't hear it, but just CapEx and cash at the two different silos or three actually, Impsat, UK and up at Limited.

John Legere

Yes, Reyes, the cash CapEx in the Rest of World was $35 million, $17 million in the UK, $14 million in Impsat for a total of $66 million.

Romeo Reyes – Jefferies and Company

Okay. And what about the ending cash balances?

John Legere

Ending cash balances in total, $217 for Rest of World, $55 UK, $106 Impsat, for a total of $277 million.

Romeo Reyes – Jefferies and Company

Okay and in terms of the subordinated loan balance at GC Impsat, what was that at the end of the period pro forma for the contribution of the Rest of World Brazilian assets?

Gary Breauninger

I believe the – we have the Columbia bond's $22 million and the intercompany loan was $230 million, I believe.

John Legere

But I think it doesn't mean that we're going to think that the balance has not changed.

Gary Breauninger

Right.

John Legere

Really in the debt [ph] levels.

Romeo Reyes – Jefferies and Company

Okay, so that was considered [ph] as equity, the Brazilian Rest of World piece?

Gary Breauninger

That is the debt – the intercompany piece is treated as a loan, an intercompany loan, but it eliminates on consolidation but it hasn't been treated as equity.

Romeo Reyes – Jefferies and Company

Okay, that's fine. Now, just on IRUs, what was the cash received from IRUs this quarter?

John Legere

$31 million.

Romeo Reyes – Jefferies and Company

Okay, great. Thank you very much. Great job.

Operator

Thank you and the next question comes from the line of Carl Murdoch-Smith with Cazenove. Please proceed with your question.

Carl Murdoch-Smith – Cazenove

Good morning. It's Carl Murdoch Smith. And first question, over the weekend, Sunday Times reported Virgin Media might be looking to exit the business markets and I was wondering if that will be operationally attractive to you? And also whether from a balance sheet perspective, you feel that you could come to a solution that would enable you to potentially take advantage of that? Second question is on energy costs, to what extent have energy costs have been a headwind to you and to what extent has that been hedged and what would be the gross exposure where it not for those hedges?

John Legere

Okay. Several things, I had not had any direct information about Virgin. However, clearly, if another player exits serving business customers, we feel we are strong in any fashion to adopt customers' requirements in any part of the world and we'd look forward to doing that. From a cost standpoint on energy, I'll ask John if he has any statement to make, but I will point out that as we are upgrading our network and as we are converting major aspects of our facilities around the world in our migration to a full IP network, there are significant energy cost reductions taking place at each part of the world.

So, clearly, I would see us having some built-in aspects of our business this year that are reducing our energy usage but as far as hedging energy costs and on the implications, I'll turn it to Jean.

Jean Mandeville

What we are roughly seeing for the total business, an increase roughly $2 million this quarter but that's to a large extent also driven by the exchange rates of the euro and pound rather than by just the energy prices itself. We don't hedge those because that's not the really important part of our business at all. So, it does affect us but not that much as John said; we are looking at ways of reducing these energy bills.

Carl Murdoch-Smith – Cazenove

Okay, that was great. Thank you.

Operator

Thank you. And we have no further questions at this time; I will now turn the conference back to back to Mr. Legere.

John Legere

Okay, very simply, I appreciate everybody joining today and I really looking forward to updating you again on our progress at the end of next quarter. Thank you very much.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you very much for your participation and ask that you please disconnect your lines.

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