GTT Communications, Inc.
Q4 2014 Earnings Call Transcript

Published: 10 Mar 2015

[Operator:]

Good day, and welcome to the GTT Fourth Quarter and Year End 2014 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Chris McKee, General Counsel and Executive Vice President of Corporate Development. Please go ahead, sir.

[Chris McKee:]

Thank you, and good morning. I’m joined today by Rick Calder, GTT’s President and CEO; Mike Bauer, GTT’s Chief Financial Officer; and 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 replay of this call will be available for one month. Dial-in information for the replay, as well as access to a replay of the webcast is available on our website. Today’s comments will contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are predictive in nature, that depend upon or refer to future events or conditions or that involve the use of words such as anticipates, expects, intends, plans, believes, may, will and similar expressions are intended to identify forward-looking statements. Forward-looking statements include by way of example, revenue and margin expectations or projections and various references to trends in the industry and GTT’s business. Such statements reflect current views with respect to future events and are subject to risks, uncertainties and other factors, some beyond our control, which could cause the company’s actual results to differ materially from those anticipated in these forward-looking statements. There are many risks, uncertainties and other factors that can prevent the company from achieving its goals or cause the company’s actual results to differ materially from those expressed in or implied by the forward-looking statements contained in our comments. These factors and others are more fully discussed under Risks Factors in GTT’s Form 10-K as filed with the SEC. Statements in this call should be evaluated in light of these important factors. Also, the discussion this morning will refer to adjusted EBITDA which is a non-GAAP measure. The presentation of GAAP financial measures and a reconciliation of non-GAAP information to GAAP financial measures is included in the press release we issued this morning, which is also available on GTT’s website. I will now turn the call over to Rick Calder. Rick?

[Rick Calder:]

Thank you, Chris and good morning everyone. And thank you for joining us. 2014 was a terrific year of growth and accomplishment for GTT. We continued to execute on our gross strategy, we demonstrated the power of our business model with rising operating leverage in both gross margin and adjusted EBITDA margin. We expanded our sales force to drive further organic growth, we improved our financial profile by significantly strengthening our balance sheet and lowering our cost of capital, we solidified our competitive position in every aspect of the organisation with our increasing scale and we moved our public listing to the New York Stock Exchange big board reinforcing our credibility in the market place as the premier global provider of cloud networking services. We ended the year with strong fourth quarter performance. Revenue increased 36% driven in large part by the inclusion of a full quarter of UNSi which closed on October 1st. Churn remains squarely in our mid to high 1% range and adjusted EBITDA in the quarter grew 27% reflecting gross margin expansion of 180 basis points. UNSi was an excellent strategic acquisition and expanded our cloud networking portfolio particularly in broadband internet services and an expanded managed services portfolio. We added a number of very strategic multinational clients as well as an expanded sales force and added to and strengthened our engineering and overall operations teams. We have substantially completed the integration of the fourth quarter of 2014 as part of our established and proven integration template. Q4 reflects some of the integration benefit from this acquisition and we expect the full financial benefits based on a 5 to 6 times multiple or better of post synergy EBITDA by the second quarter of 2015. On February 19, we announced the definite agreement to acquire MegaPath’s Managed Services business. MegaPath provides private wide area networking, internet access services, managed services and managed security. With over 500 large multinational clients and approximately $124 million in recurring revenue and $20 million in recurring EBITDA in 2014, this represents a significant strategic scaling for GTT that fits precisely with our gross strategy. We expand our network connectivity by broadening our reach in the U.S. and expanding on the broadband data offering from the last acquisition. We further expand our cloud networking services with a comprehensive portfolio of managed services with particular focus on multi tiered managed security services. We significantly expand our roster of large multinational clients with significant growth potential. We add an experienced sales client service and engineering and operations team who are committed to delivering outstanding client service and we accelerate our progress towards our next financial objectives of $400 million in revenue and $100 million in adjusted EBITDA. We expect to achieve synergies through our proven integration template as we have in the past. We expected the transaction to close upon receipt of [Indiscernible] approval on or around April 1. Mike will offer more detail on the acquisition financing in his prepared remarks. GTT enters 2015 in an extremely strong position to execute our gross strategy. One, to extend ubiquitous network connectivity to any location in the world and with any application in the cloud. Two, to expand our cloud networking services to multinational clients and three, to deliver outstanding client experience by living our core values as simplicity speed and agility. In 2015, we will focus on increasing our organic revenue growth by continuing to invest in growing our direct sales force. We ended the year at just under 70 laps [ph] and plan to grow this force to over 100 by year end 2015 in both our Americas and EMEA APAC business units. We will enter into further partner agreements such as the one we announced with BroadSoft and as BroadCloud Unified Communication services to serve both Europe and the U.S. and to make additional cloud services available across our network. BroadSoft offers an excellent example of the accelerating demand businesses are experiencing for cloud services and GTT was selected because of the superior client experience, reliability, scalability and network performance that we provide. We have also achieved preferred supplier status with IBM as we look to partner on providing cloud network services to multinational clients to access IBM cloud services. We will also continue to do small transactions that allow us to add customer bases that we can grow with our strong value proposition. GTT is bringing increasing credibility of scale with a proven growth strategy and we are emerging as the challenger brand for multi nationals that are underserved by the incumbent telco monopolies. We are superbly positioned for a great 2015. Now, I’ll turn the call over to Mike for review of the financials.

[Mike Bauer:]

Thanks, Rick. Fourth quarter revenue of $62.7 million grew 35.9% year-over-year compared to $46.1 million in Q4, 2013 sequentially, revenue increased 27.5%. Growth in the quarter was driven primarily by the UNSi acquisition. Fourth quarter 2014 revenue was negatively impacted by approximately $1.3 million compared to the third quarter of 2014 due to the U.S. dollar strengthening against the Pound, Sterling and the Euro. The impact of adjusted EBITDA however was nominal as weaker foreign currencies lowered GTTs cost of revenue and SG&A expenses. There is a natural hedge in our P&L that we get from balancing our foreign currency related revenues with our foreign currency related costs. Fourth quarter gross margin of 38% expanded 180 basis points from 36.2% in Q4 last year. Sequentially, gross margin decreased 120 basis points from Q3 due to the lower margin base of UNSi. Moving forward though we expect to see gross margins increase as we continue to sell and install higher margin services utilizing our top five global network backbone. Fourth quarter adjusted EBITDA of $10.1 million increased 26.6% year-over-year; sequentially adjusted EBITDA grew 13.5%. We generated unlevered free cash flow of $7.4 million in Q4 and $30.2 million for the full year. Capital expenditures in the quarter were $2.8 or 4.4% revenue. Year-to-date CapEx was $5.8 million or 2.8% of revenue. We recorded a $6.1 million restructuring charge in the fourth quarter for cost associated with the acquisition of UNSi for severance and other employee related costs, professional fees, network integration and travel expenses. Turning to the balance sheet. On October 1, we acquired UNSi for $40 million, which included approximately 232,000 shares or $2.9 million in GTT stock. We used our $15 million Delayed Draw Term Loan to help fund the cash portion of the purchase price. In December, we completed a public offering of 4 million shares of common stock raising net proceeds of $48 million. As of December 31, our cash balance was $49.3 million and our outstanding debt balance was just under $124 million. As of today, we have approximately 34 million shares outstanding and 1.3 million employee stock options outstanding at an average strike price of approximately $6.10. As you know we have entered into a definitive agreement to acquire MegaPath’s Managed Services Business. From $152.3 million comprised of $144.8 million in cash and approximately 610,000 shares of GTT stock, representing $7.5 million based on the 20 day trailing volume weighted average price prior to signing. We will use cash on hand and raise approximately $105 million in new term loan debt to fund the acquisition. We are working with key bank capital markets and Webster Bank to amend and increase our existing credit agreement on similar terms and similar interest rates. As Rick indicated, we expect to close on April 1 pending regulatory approvals and want to thank our lenders in advance for their support. Given our execution of performance in 2014, the transactions we have completed and those that are pending we are very excited about GTTs prospects for 2015. We are accelerating towards our next financial objective of $400 million in revenue and $100 million in adjusted EBITDA. With that, I’ll turn the call back to the operator who will open up the call to your questions. Operator?

[Operator:]

[Operator Instructions] And we’ll take our first from James Breen with William Blair.

[James Breen:]

Thanks for taking the question. Just a couple of questions one, you saw some FX impact this quarter a little over $1 million. How does that play into sort of the sequential numbers as we look towards the first quarter? And then, with MegaPath to the extent that you talk about sort of the synergies there, do you feel as though the post synergy multiple will be similar to the some of the other deals you have done in terms of timeline or recognize those synergies over the two quarter period? Thanks.

[Rick Calder:]

Thank you very much for the question, Jim. I’ll take the second one and let Mike address the FX impact moving forward you know particularly the top line and then bottom line EBITDA. On MegaPath, as we know in the prepared remarks we clearly see the ability to extract synergies as we have done in the past successfully. We are embarking upon the integration phase as we speak though we are not closed. And so we are going to hold any specific comments on guidance until we close and so we would give guidance with respect to synergies and multiple after close but we certainly see the ability to take synergies from across both cost of revenue and SG&A in both people and other operating expenses, so we clearly see that capability here. We also expect that we can as we have proven in the past and we disclosed in our general investor presentations the ability to integrate within one to two quarters. So we see the ability to complete the integration in the second quarter and the third quarter of 2015 so that the synergies that we would expect would materialize through those partially through those quarters as well as fully by the fourth quarter of 2015. And with that, let me turn it to Mike to talk about the FX impact.

[Mike Bauer:]

Yes, Jim in the first quarter we will continue to feel the impact of the strengthening U.S. dollar again more so in the top line. The Euro and the Pound have weakened again in the quarter versus the dollar compared to the fourth quarter but again we have a natural hedge in our P&L sort of the margin neutrality if you will that will really kind of insulate EBITDA from being impacted.

[James Breen:]

Great, and then as you guys look forward in sort of doing more M&A is there a certain range you are looking at from a leverage perspective you know you’ll be taking that the leverage up a bit here the fund [ph] MegaPath, you know what’s your sort of your target range?

[Rick Calder:]

We’ve always been comfortable for seeing that leverage in the three to four times range and we think we’ll remain in that range post this deal and infact based on potential synergies we see our ability to maintain at or even potentially better than where we are now. So, we think that yes, we feel comfortable seeing that range of three to four times and then showing a rapid deleveraging as we continue to generate with our proven business model, high free cash flow, unlevered free cash flow defined as EBITDA less CapEx.

[James Breen:]

Great. Thank you.

[Operator:]

And we’ll take our next question from Michael Bowen with Pacific Crest.

[Michael Bowen:]

Okay, good morning thanks guys for taking the questions. The first question I like to hear a little bit more about was I think Mike you had mentioned that you expect margins to increase and I wanted to see if you could perhaps give us a little more detail on what exact types of services do you anticipate will be the biggest drivers of those increased margins. And then with regard to the sales force moving upto a 100, can you help us I know it maybe a little bit early, but if you can help us think about how that will be growing organically versus the acquisitions that would be helpful? Thanks.

[Rick Calder:]

Okay, great. In terms of margin increasing, we continue -- I mean as Mike mentioned in the prepared remarks, the main moved down sequentially was purely the fact that UNSi base was at slightly lower margin than our overall base. However, we continue to sell and install services at gross margins that are at around 60% of that, and so we continue to expect our gross margins to rise to your direct question of products and services that the power of GTTs global network backbone and the ability to sell the majority of our services onto that backbone with delivering tail extensions anywhere to any location in the world has allowed us to enjoy these higher margins in our business over the last two, three years. That said, we also will be adding a series of even higher margin products with the managed services portfolio that we started with UNSi and that will significantly expand with the MegaPath acquisition. So we think that the full portfolio of managed router or managed security services fail over services secure, remote access services as to your socket layer services will add significant margin potential to our business and incremental growth potential in our multinational client base. So we are bullish on our ability to continue to grow our gross margin and EBITDA margin moving forward. On your question of sales force, clearly there will be integration of the existing sales force, probably a little premature to give you – given that we haven't closed and don't have complete visibility into everyone of the employees and what we'll be keeping and not keeping. We see tremendous great employee team throughout the MegaPath team that we've been able to talk with so far. And so, we're very excited about the sales, service, engineering and broader operations teams that will be adding for MegaPath. And we expect that to be a big driver of the growth of our sales force. At the same time, the value of – our value proposition and improving value proposition has made us a very attractive destination for great sales talent in our industry. So, we continue to grow our business organically in our sales force organically and all of the support organizations organically as well. So I would say, it is a combination driven in some part by the integration of MegaPath and then continued organic growth of sales engine as well.

[Michael Bowen:]

And then, Rick, one quick follow-up, am I kind of hearing a sense that perhaps the MegaPath suite of services might be generating currently even better margins than perhaps GTT organically?

[Rick Calder:]

Yes. It is. I mean, it’s a higher margin business right now given the deep mix of managed services that they have in the portfolio which are higher margin, so, while it is completely consistent with our strategy of providing a broad portfolio and expanding our portfolio of cloud networking services, the richer mix of managed services makes it inherently higher margin business.

[Michael Bowen:]

Okay, great. Thank you very much.

[Operator:]

[Operator Instructions] And we'll take our next question from George Sutton with Craig-Hallum.

[George Sutton:]

Thank you. Good morning, guys. So, Rick, I'm wondering on the MegaPath acquisition, if you could talk about some of the revenue opportunities or service opportunities you see being able to bring your services to the MegaPath, to the 500 MegaPath customers. What sort of opportunities lie there? And then, I'm very curious on the Managed Security Services side, what kind of an opportunity you see with your customer base there?

[Rick Calder:]

Great. Excellent. So, one of the real opportunities for us in the MegaPath client base, it’s a great multinational client base. However MegaPath is a company as we've seen many companies or industry have focused pretty exclusively on North America, U.S. and Canada, and have not focused on the Myriad international opportunities that these multinational clients have. And so, clearly with our strategy to deliver service to any location in the world, we have a significant opportunity to expand the breadth of many of these multinationals with the scope of our global network. We also run one of the larger backbone networks where it still remains a Top 5 internet backbone. We have the capability to serve some of the higher bandwidth applications that some of these clients clearly have. And so, we see tremendous growth potential as we noted in the prepared remarks with many of these clients as we introduce ourselves over the next several quarters into what are some very long standing and great relationships that MegaPath has build with some very large multinational clients. On the managed security we believe is an excellent fit for our business and as we’ve mentioned, multi-tiered clearly having network-based intrusion detection services that are PCI or Payment Card Industry compliant and compliant with the new 3.0 standards is something that will be a nice addition to our network. There are increasing needs for premise-based security, premise based firewall and we have one of the now larger platforms to be able to deliver premise-based security services anywhere in the globe. And then, a very unique capability to deliver secure socket layer remote access for third-parties or employees to be able to remotely access the secure private wide area network is another very interesting capability that we think will be in demand from our existing multinational client base, so lots of up-sell opportunities as we expand our cloud networking portfolio significantly in the security space.

[George Sutton:]

Yes. It's perfect. Relative to IBM, I am aware you've done some work with them in Europe. I wasn't aware of the preferred supplier relationship. Can you discuss what that means in your opinion?

[Rick Calder:]

Sure. I mean, to be – to do business with IBM you need to go through a gate of becoming a preferred supplier. So we reach that gate and what we believe at least internally for IBM is relatively record fashion. Based on the fact that we have a significant number of opportunities in Europe that we're working collaboratively on with them and we think that really reinforces our value proposition not only to deliver service to any location but with any application in the cloud. And we think the demand for IBM cloud service is significant. However, enterprises need a secure private cloud network to be able to access those services and reaching preferred suppliers status with IBM to be a trusted partner to deliver those services to enterprise clients initially in European region we think is a good proof point for the power of our network offerings.

[George Sutton:]

Okay, great. Thank you, guys. Appreciate it.

[Rick Calder:]

Thank you, George.

[Operator:]

Our next question comes from Scott Goldman with Jefferies.

[Scott Goldman:]

Hi. Good morning, guys. I guess couple of questions. One, Mike maybe you can share with us with the UNSi contribution was on revenue and EBITDA if you have that, just trying to get a sense with your organic growth might have been in the quarter? And then secondly, as you look at MegaPath, I think you guys share the revenue and the EBITDA run rates there, but wondering if you can give us a sense for what their growth trends look like there and whether that something that you think will be supportive of the 8% to 10% growth outlook you've had or maybe even accretive to that. And then lastly for Rick, you've targeted – you talked about expanding your – I guess the share of wallet with certain accounts by $100,000 or so for bunch of targeted account. Just wondering sort of what the strategy has been to do that and what you're hearing back from clients and how successful you've been on that endeavour? Thanks.

[Rick Calder:]

Great. About outlook why don't I do this? Scott, thank you for the questions. I'll start with the MegaPath and $100,000 account strategy and Mike talk about UNSi and I may give some follow-up comments on that as well. In terms of growth trends, we see MegaPath has been in the market for many, many years and we think it has developed a very stable and growing business in the series of 500 plus multinational accounts that we are adding. We do believe that we have the opportunity to expand their growth rates based on the discussion I just had with George with respect to the incremental geographic reach we have and the incremental service reach we have to service some of these clients. We won't have a good feel for that until we close and are in with these accounts, but clearly conceptually we see tremendous opportunity to grow the business. Not ensure we would change our sort of intermediate term focus of growing the top line at 8% to 10% and the bottom line at 15% to 20% at this stage or they could probably feel comfortable with those ranges. But we clearly see the ability to take the accounts that we will be adding and have that growth potential with them. We absolutely, as I've said publicly I think our goals are not to sell 5000 new SMB clients, where our goals to take 100 accounts or 200 accounts and grow them by $50,000 to $100,000 and that generates tremendous growth potential for us. We've seen increasing ability to do that even from zero to 50 or $100,000 to $150,000 select wins we've had recently and we clearly see some of the larger accounts in our base to build anywhere between $50 and $500,000 a month and their ability to grow by $100,000 incrementally. We see tremendous demand growth in the multinational space driven by these three trends in our industry. The increasing growth of the public internet usage in public corporations, the increase in demand for private wide area networking as file size and application demand within the walls of an enterprise continue to grow, which places incremental demand at each location. And then finally this trend of moving services to the cloud, whether it's with the player like BroadCloud, BroadSoft, whether it’s a player like IBM, the movement of applications from enterprises into the cloud once again places tremendous demand on the bandwidth at each location in an enterprise. And so, we see tremendous growth potential in the multinational space and we think our ability to take share there is and our value proposition continues to improve and grow very strongly. So, I think we remain solidly focused on taking a series of accounts. If we can do more than a 100 that will be great, but you know sort of growing 100, 200 accounts significantly worldwide is a real opportunity for us. Let me turn it to Mike to talk about specifically fourth quarter in UNSi.

[Mike Bauer:]

Yes. Scott thanks for the question. And UNSi contribution in the fourth quarter, we generally don't break out or disaggregate our revenue high. After we do an acquisition we very much take a one company approach and immediately begin integrating companies. On a constant – I will tell you this on a constant currency basis there was organic growth in the quarter excluding the UNSi acquisition, but given the FX headwinds that we did face, it's muted. On the EBITDA line because the acquisition was consummate on October 1st, we have not seen the full synergies. So, when you look at the EBITDA line that does not reflect the synergies that we expect to continue to see as we go into the first you really start to see the impact of the synergies and the actions that we took in the fourth quarter on the EBITDA line.

[Scott Goldman:]

Great. Thanks a lot guys.

[Rick Calder:]

Thanks, Scott.

[Operator:]

[Operator Instructions] And at this time, there are no further questions over the phone.

[Rick Calder:]

Great. Thank you, operator. I'm going to turn it for few closing remarks to our Executive Chairman, Brian Thompson.

[Brian Thompson:]

Thanks, Rick. I think you can begin to see finally the impact that we are having at GTT. The ability of this team to put together integrated single company as Mike just said. The key all along has been even with acquisitions as well as organic growth. To make sure that the people that we have on board, the people who are a part of GTT recognize that this is a single company with the single purpose in its growth strategies. And you know the key to it just as it will be in the case of the MegaPath acquisition is to bring the people and the processes on to our CMD platform which is very critically important to us both communicating throughout the company and managing throughout the company, and to integrating the network into a single network, so that we get the synergies and the value of that. The second thing is that we are able now to acquire just wonderful customer bases. Bases of customers that really as Rich pointed out have great upside potential because of the things that we bring to the party along with the acquired organization or the merged organization. And so, there really is a two plus two equal five kind of capability here in terms of serving the customer. And then finally, we bring into the company terrific strengths as in the case of MegaPath and in the case of UNSi, and the ability to manage customer services and security. So we are able to bring more services, more capabilities to the combined company and that's so critically important to creating an entity that really can attack share and get the market to come to us. And I really have to take my hat off to this team, not only have they been able to go through a merger acquisition of a very large organization with UNSi, but also at the same time to identify and bring into the company, hopefully we close in a few weeks. Another great acquisition on the part of the company which for the people that are coming in as a merger. It truly is, and they will be part of GTT just as the people in the past have been. It’s extremely exciting to me because this was a strategy we put in place a long time ago and now we've got a team of people and an augmented team of people each time we close, that are able to pick up that ball and run with it and take it further and further into the marketplace that really demanding marketplace that Rick identified. We've got a terrific upside potential. You will see the impact of synergies of the UNSi acquisition when we close the books for the first quarter, in fact, this will be a clean quarter assuming we take the new acquisition in on April 1st. So you'll see the real impact of merger and the impact of leverage, and the impact of what this team is able to do. And then we'll enter into another six months or so of integration and we'll be in a position to continue this process and I'm really excited about where we in the future of this company. Just wanted to share that with you, and I'll turn it back to you, Rich.

[Rick Calder:]

Great. Thank you very much, Brian. And for all of our shareholders that have been with us for many years this is I think my 32nd earnings call. We enrolled the new shareholders that have joined us recently. We are very committed as a leadership team and employee base and a Board of Directors to drive great value for you moving forward and we’re very excited to report our progress on our next quarterly call in May. So thank you very much for your investment in GTT and we look forward to being back with you. Cheers.

[Operator:]

Thank you for your participation. This does conclude today’s call.