GTT Communications, Inc.
Q2 2019 Earnings Call Transcript

Published: 8 Aug 2019

[Operator:]

Good morning, and welcome to the GTT Communications Second Quarter 2019 Results Conference Call. [Operator Instructions] Please note, today's event is being recorded.I would now like to turn the conference over to Chris McKee, General Counsel and Executive Vice President of Corporate Development. Please go ahead.

[Chris McKee:]

Thank you, and good morning. I'm joined today by Rick Calder, GTT's President and CEO; Mike Sicoli, GTT's Chief Financial Officer; Brian Thompson, GTT's Executive Chairman of the Board. Today's discussion is being made available via webcast through the company's website, www.gtt.net. A telephonic replay of this call will be available for 1 week. Dial-in information for the replay as well as access to a replay of the webcast is also available on our website.Before we begin, I want to remind you that during today's call we will be making forward-looking statements regarding future events and financial performance made under the safe harbor provision of the U.S. securities laws, including revenue and margin expectations, projections and references to trends in the industry and GTT's business. We caution you that such statement reflects our best judgment as of today, August 8, based on factors that are currently known to us, and that actual future events or results could differ materially due to a number of factors, many of which are beyond our control.For a more detailed discussion of the risks and uncertainties affecting our future results, we refer you to our SEC filings. GTT disclaims any obligation to update or revise these forward-looking statements to reflect future events or circumstances. During the call, we'll also discuss non-GAAP financial measures, including certain proforma information, which were not prepared in accordance with GAAP. A reconciliation of our GAAP and non-GAAP results is provided in today's press release and is posted in the Investor Relations section of our website.I will now turn the call over to Rick Calder. Rick?

[Richard Calder:]

Thank you, Chris, and good morning, everyone.This was a challenging quarter for us as we have not yet returned to organic rep-driven growth. Overall, net installations of monthly recurring revenue remains negative at this stage. We ended the second quarter with approximately 320 quarter bearing reps, the same level as last quarter, with a similar level of sales and sales productivity at approximately $7,000 per rep.As we discussed before, to return to positive net installs and organic rep-driven growth, we need a larger sales force to drive a larger volume of sales and installs to outpace our churn at the mid-1% level.We are now targeting 400 quarter bearing reps by year-end 2019 and 500 by year-end 2020. Our installs in 2Q were similar to last quarter, though our installed productivity remains lower than our sales productivity at approximately $6,000 per rep in monthly recurring revenue with opportunity to improve the pace of installations of our backlog, which remains at approximately $10 million in monthly recurring revenue. Year-to-date, our churn remains at 1.5% and were slightly lower in first quarter and slightly higher in second quarter.Looking at a division level, year-to-date, we have seen positive net installs in our Europe division, and since our last call, we consolidated leadership of our Europe division under Jesper Aagaard who will drive investments to accelerate growth throughout our 5 European regions, including the U.K., Nordics, Benelux, Germany, Austria, Switzerland or DAC, and south, which includes France, Italy and Spain. We have had weaker performance and negative net installs year-to-date in our Americas division.Since our last call, we announced a leadership change with Ernie Ortega joining GTT in June as President of our consolidated Americas division. We are very excited to welcome Ernie to our team as he brings a tremendous track record of success in our industry running large sales organizations at XO, Cogent and Colt and will bring fresh leadership to the Americas division.As we grow our sales force to 400 by year-end 2019, we are converting existing trained resources at GTT into quarter-bearing account executives, directly assigned to clients, to focus a higher percentage of our workforce on direct selling activities.As of today, we have increased to 370 quarter bearing reps. We are also recruiting aggressively to add sales development reps, or SDRs, as our lead generation engine; inside sales account representatives to cover our smaller accounts; and selectively, for higher end account managers and account directors for larger accounts.While we expect these resources to increase our overall sales, average sales productivity per rep will be slightly lower as we move forward since our inside sales account representatives and our account executives will carry a lower quarter than our more experienced reps.We expect to fund most if not all of the planned sales force expansion by reducing costs in other areas of the business, most notably non-headcount-related SG&A. For the balance of 2019 and through 2020, our focus is returning to and accelerating organic rep-driven growth. Very simply, we must grow our sales force to expand our overall sales and backlog.We must increase the pace of installations to keep sales productivity, installed productivity at similarly high levels. And we must maintain our churn levels in the mid-1% range. Within our Americas division and Europe division, Ernie and Jesper are focused on each of these three areas as follows

[Michael Sicoli:]

Thanks Rick.Second quarter revenue increased 33% year-over-year and decreased 4% sequentially to $434 million. Exchange rates had a negative impact on our reported results as approximately 51% of our revenue is denominated in non-U.S. dollar currencies. In constant currency, revenue increased 37% year-over-year and decreased 3% sequentially.On a proforma basis, including Interoute in prior period results and in constant currency, revenue decreased 3% both year-over-year and sequentially. The year-over-year decline was driven by 2 main factors

[Operator:]

[Operator Instructions] Today's first question comes from Jon Charbonneau of Cowen and Company. Please go ahead.

[Jon Charbonneau:]

Great, thanks for taking the questions. How should we now be thinking about the timing of when you can get back to sales rep-driven growth especially given that you expect 400 sales reps by year-end? And then in terms of your free cash flow target of $175 million to $200 million in 2020, what assumptions have you made within that for sales rep-driven growth in additional M&A? Thank you.

[Michael Sicoli:]

Jon, it's Mike. I'll start and I'll let Rick answer as well. In terms of the timing, as you know, we don't provide specific quarterly guidance. So we're not providing a specific time frame today, although as Rick said in his prepared remarks, we are optimistic and think that it's sooner rather than later. In terms of the assumptions of free cash flow next year regarding rep driven growth there is not a significant assumption of rep driven growth underneath that. And in terms of M&A, we've got the KPN deal that we've already announced and talked about which we have assumed will be in the numbers for 2020, but we have not assumed additional M&A in that number.

[Richard Calder:]

Yes, and then just to reiterate the point Jon, I mean we are single mindedly focused at this stage and returning our business to rep driven close. As we've noted in the prepared remarks, we're close we're simply too small from the sales force perspective and we've need installed productivity to basically be equal to sales productivity, we have the backlog to achieve that. We have not achieved that yet.And we have to maintain churn at a constant level. So as we grow 400, 450 by mid next year or 500 by the end of next year. We certainly see the opportunity to return relatively quickly to rep driven growth get to positive and accelerate that growth moving forward.

[Operator:]

And our next question today comes from Frank Louthan of Raymond James. Please go ahead.

[Frank Louthan:]

How close are you to the 50% level, can you give us – some color on how much cushion you have before you trip the change of control. And then to be clear – you hired an advisor not to sell the whole company just some particular assets. And can you give us an idea of kind of what those assets might be and range of what they might be worth?

[Michael Sicoli:]

Sure regarding the 50% level, around the 382 change of ownership guidelines. We haven't provided a specific number. I would say it's not as if we are 1 or 2 percentage points away, but it's high enough that we felt like it was a prudent thing to do to take this step at this time. I would just say it was above 40%.

[Richard Calder:]

And then on, we're early in the process on – we have engaged an advisor, the vast majority of our business is strategic. Clearly as we bought many different assets over the past 2.5 years or certain select portions that are less strategic. To be focused on our cloud networking strategy, our highly strategic products are clearly wide area networking LAN leading with our most strategic product software to wide area networking, wide area networking. Our Internet services, Transport & Infrastructure Ethernet wavelength and unified communications.So things that fall outside of that portfolio are less strategic to us they generally represent relatively small portions and as it were in early stages, probably wouldn't comment specifically on how much we would expect to generate. But we do expect to take whatever proceeds we would generate and use it to paydown debt.

[Frank Louthan:]

I can appreciate you don't necessarily boxed in, but I mean is it I mean we’re talking yeah, north of a 100 million or something more like 5 million to 10 million kind of a sale – are there meaningful assets and that someone would want to buy?

[Michael Sicoli:]

Yes, without being specific, just reacting to your range yes, we're talking about north of $100 million not $10 million, if it was $10 million we wouldn't bring it up, right. It's meaningful.

[Frank Louthan:]

And then can you quantify the billing credits that you have left for the remainder of the year that will be elevated so we could have a better idea how to put that – how to model for that?

[Richard Calder:]

Yes, if you - go back to what I talked about in the prepared remarks there was sort of a $12 million number sequentially that was a combination of the negative net installs and the billing credits, billing credits. It was roughly half and half between those two items. So call it $6 million approximately in this quarter from billing credits. Our expectation is that Q3 will probably be a similar level to Q2 meaning it shouldn't generate additional declines sequentially, but it will remain elevated during the third quarter.While we resolve all of the outstanding issues that are preventing payment and then, as we had out of the third quarter. That level of credits should go down such that that alone would produce some incremental revenue quarter-over-quarter and then it should be sort of normal from there.

[Operator:]

Our next question today comes from James Breen of William Blair. Please go ahead.

[James Breen:]

Thanks for taking the question, just a couple the EBITDA margin came down sequentially. Can you just talk about what's driving that and how you feel about that progressing throughout the year. And then secondly, you gave the free cash flow guidance for 2020 given the 5.5% ratio for CapEx it sort of implies a revenue number somewhere between a 1.6 billion and 1.8 billion, which is a pretty broad range, some of the asset sales factor into that guidance. And then, yeah how do you think about that going forward? Thanks.

[Michael Sicoli:]

Sure, from a margin perspective, obviously disappointing, this quarter the revenue credits that we talked about a minute ago are essentially a 100% margin reductions to revenue in period. And so that clearly had a big impact on margin this quarter. And we'll probably weigh a little bit on margins again in the third quarter. Longer term, there's really no change in what we have said before and what we expect.I think getting into the high 20s and ultimately up to 30. I think it's still achievable and still our goal. In terms of – trying to infer, the revenue guidance from the CapEx guidance that was in the non-GAAP reconciliation. We're clearly not trying to provide revenue guidance, the range on CapEx is really based on the way we think about forecasting CapEx, it's not based on our revenue expectation.

[James Breen:]

And sorry if I missed it did you quantify the credits?

[Michael Sicoli:]

Yes, we said it was roughly $6 million in the quarter – of sequential decline. There's always some level of credit activity in our P&L. No one is a, it's completely perfect at billing but the incremental above the normal or above the first quarter level was about $6 million.

[James Breen:]

And how do you feel about that going forward.

[Michael Sicoli:]

Sure, literally just answer that question. We expect a similar level in Q3 versus Q2. So shouldn't produce additional declines from Q2 to Q3 and we expect it to return to normal by the time we get to Q4.

[Operator:]

And our next question today comes from George Sutton of Craig-Hallum. Please go ahead.

[Jason Kreyer:]

Good morning guys, Jason on for George. Just a couple from me so just wondering if you can comment on the hiring and retention trends that you're seeing, are you seeing the employees that you want to hire out there for the economics that you're looking at. And then if there is anything unique that you're seeing in – for the internal attrition trends. And then kind of along those same lines you talked about the productivity levels that you're seeing today.Maybe that dips down a little bit as you accelerate hiring over the long-term. Can you get that back to where we are, can you get that back higher to levels that we've seen in the past? Thanks.

[Richard Calder:]

Yes, probably two comments there, I think at the high end, as we said in the prepared remarks, we're very selective in hiring at this stage. We think we have the right number of higher-end account managers and account directors to cover – what we tag internally is our premier and gold accounts. We have some selective hiring there. And I think we see enough and generally, those are people that are well known to us or known to the teams in terms of recruiting them.We're generally not trying to hire people that we do not know. Most of our recruiting will be focused at the SDR level of sales development rep which are usually either graduates or first jobs. And then into the account representative, which is the inside sales. We are – absolutely as we grow from – to 400, 450 and 500. It will be much more of an internally generated development program.And we're investing significantly more in training as we bring up SDR to account representative then into outside sales account executive and beyond. And we have and that will do twofold things, one the pace the piece of our base that is not as well covered today is the silver or smaller accounts. And we think that will not only allow us to sell more, but actually maintain if not even potentially lower churn and we see lots of opportunity to recruit that level of focus throughout the 16 countries that we sell in. So we're very aggressive there.We do expect that because those quotas on account representatives and the lowest end of account executive and outside sales are lower than our sales growth. It will come down somewhat, though as our more tenured folks actually continue to improve sales. We think that will offset it slightly, but as we noted in the prepared remarks, we would, we would expect some small decline in sales productivity moving forward.

[Operator:]

And our next question today comes from Brandon Nispel of KeyBanc. Please go ahead.

[Brandon Nispel:]

Thanks for taking the question. I'm curious, Mike or as EBITDA declined sequentially in potentially I guess could going forward given the growth trajectory here, where are you at with your debt covenants and where does where the equity is trading now impact any impairment -- asset impairments test that you might have? And then secondly, can you size maybe the revenue impact for from KPN so we can square our models. Thanks.

[Michael Sicoli:]

Sure, I can go and sort of reverse order. In terms of KPN revenue. It's a similar expectation to other small acquisitions at approximately one times revenue. The purchase price being approximately one times revenue.In terms of impairment, we did -- if we haven't already we will be filing the Q shortly. And in the Q, you can see the commentary regarding impairment. We did look at the stock price decline as a triggering event to review the fair value of the goodwill and determine there was no impairment as of today, obviously there could be impairment in the future, depending on what happens at the stock price, but as of today, no impairment.In terms of the debt covenants, we still have plenty of room today, as you know, there is only really one covenant, one maintenance covenant that is in the revolver, to the extent that the revolver is greater than 30% drawn it is today, greater than 30% drawn.However, our expectation is, we'll be paying below 30% and all the way down to zero at some point as the free cash flow returns. That being said, we did also, which you'll see in the 10-Q, we did push out the covenant step downs a bit as well just to sort of take that issue completely off the table. So we have plenty of room today and we will have plenty of room under that covenant for quite some time.

[Operator:]

And our next question today comes from Timothy Horan of Oppenheimer & Company. Please go ahead.

[Timothy Horan:]

The free cash flow guidance or range for 2020, does that include any impact from working capital, either positively or negatively?

[Richard Calder:]

As we've said, we do expect to improve working capital significantly over the next several quarters. I expect a lot of that to be done this year. There probably is a little bit more upside in 2020 as well, but we did not forecast any significant improvement in working capital as part of that number.

[Timothy Horan:]

Because if you normalize in a 6 million this quarter, you're at close to 120 million of EBITDA and what your interest expense and CapEx, you're close to $50 million of free cash flow in the quarter. It is a working capital improvement. So I mean it's kind of implying 5 -- around the 500 million range of EBITDA. Next year, I know you're not kind of guiding to that, but you really not I guess got into any real improvement, not the trends that we've seen in the first half of the year for either revenue or EBITDA onto next year with this type of free cash flow guidance?

[Richard Calder:]

Sure. One thing to point out is the bond interest payment was made in July, because the last day of the quarter was in June. So the cash interest year-to-date, doesn't have the bond interest in it. But that's a relatively small component of the overall free cash flow. I think your point is that we have a conservative expectation. And I think that's a valid point. And I think that's prudent for us to do a really at anytime, but especially now, so hopefully we'll outperform

[Timothy Horan:]

I guess just on that point. And can you tell us, I mean I know you don't guide. But if you normalize for the 6 million, should EBITDA trend up from here or should we expect a few more quarters of EBITDA, declining at a high level and just offer that run rate for the first half of the year to next year, we expect an increase on EBITDA. Broadly speaking

[Michael Sicoli:]

Yes. Tricky to answer because we don't provide guidance. I think go back to what I said before. Clearly, the $6 million from the second quarter that was related to the billing credits is a effectively 100% margin, and we don't expect that to be there forever. It should, it will likely be there in Q3, but beyond that, no. So I think that's a fair adjustment to make.I also mentioned that there is still some additional synergy realization to hit the P&L, which should also drive some upside. And then ultimately, we expect to get back to organic growth as well, which should drive additional growth and margin expansion on top.

[Operator:]

And ladies and gentlemen, this concludes your question-and-answer session. I'd like to turn the conference back over to GTT, CEO, Rick Calder for any closing remarks.

[Richard Calder:]

All right, thank you operator, and I'd like to turn it over to Brian Thompson, our Chairman, for some closing remarks.

[Brian Thompson:]

Thanks, Rick. I just wanted to be brief, but make a comment, it's historical in nature. Most of all, but that's that over the 14 years since we started the first acquisition. We have been a public company and we have fairly assiduously avoided guidance to the investment community going forward because of the obvious difficulty in determining how and when so many one-time charges both income and balance sheet related would fall. And beyond that the learning experience that we have with each acquisition and how that will turn itself into things like organic growth and technology.We are a company that is built itself on acquisitions to the size we are because we felt that we have to be a size like we are now before. We can really do the kinds of things technologically that the customers requiring worldwide, which is a very important factor as well. So that we could have a value proposition that would be very comfortable for our sales force to be out there bringing to the customer demand. We believe we're at that point.I think it's fair to say that because of our lack of providing guidance, the most important thing that has come about in this time frame is that we feel comfortable about where we are in terms of generating the positive cash flow that we have said for years that we were focused on because it's that cash flow that allows us to have a lot of flexibility as we meet the marketplace both technologically, as well as in things like adding sales force et cetera.Because we are no longer a major acquisition mode company and we are committing ourselves to what I would call the performance test of the model that we started with 14 years ago, I feel that the strength of the company is as it has never been before it, it is terrific.The people that we've got now going forward, not just at the leadership level but at the secondary level and down, I really quite confident, comfortable and able to bring forward the value proposition and the basic tenants that make this company successful going forward.We're quite bullish, frankly, about our ability to move this company forward from where we are now, having taken advantage of all of the issues that have come through our acquisitions and importantly, the headwinds and the difficulty and doing an acquisition of the size of Interoute and getting that behind us I think has created a very valuable lesson for everybody in the company going forward above what is critically important both as we do acquisitions, but more importantly as we operate the company.Therefore I think it's fair to say number one, the projection that we have made finally, of what we think cash flow would look like in the next year is a one-time thing that we have not done before and it's very important. We feel comfortable that we can make that projection.We hope to be able to put ourselves into a position where we can get even better guidance going forward in future years, because we will be a very dominant factor in the marketplace that we serve, which is basically the cloud network services activities.So with that I wanted to say thank you for the call. Thank you for the questions. And we're looking very much forward to the third quarter and the fourth quarter. Thanks.

[Richard Calder:]

Great, thank you everyone. This concludes our call for this quarter. We look forward to reporting in the third quarter. Thank you.

[Operator:]

Thank you, Sir. Today's conference has now concluded. And we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.