Axtel, S.A.B. de C.V. (AXTELCPO) Earnings Call Transcript & Summary

Greetings, and welcome to the Axtel Second Quarter 2022 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Adrian de los Santos, Chief Financial Officer. Thank you. Please go ahead.

Thank you, Donna, and welcome, everyone. Today's conference call will be hosted by Mr. Armando de la Pena, Axtel Chief Executive Officer; Mr. Bernardo Garcia, Executive Officer of Planning and Development; and myself, CFO. Axtel financial information, including our second quarter report, is available in our corporate website at axtelcorp.mx. Let me remind you that information discussed in this call may constitute forward-looking statements regarding future events or future financial performance of the company. These statements reflect management's current views, which are subject to different risks. Therefore, the company disclaims any obligation to update statements discussed in this call based on new information available. Now let me turn the call over to Armando de la Pena for his initial remarks. Armando, please?

Thank you, Adrian, and thanks, everyone, for being here in my first conference call. I'm looking forward to sharing with you details of our performance and development in our strategic agenda every quarter. Before commenting on my plans in Axtel, I want to first thank Eduardo Escalante for his time as an interim CEO. Eduardo came to Axtel to lead the company's management team and to continue strategic process defined since early 2020. He excelled on the continuity of our operations throughout the various COVID waves, implemented our multicarrier Alestra Móvil service, also continued the digitalization and optimization processes, which helped us reduce our expenses, among many other achievements through his tenure as CEO. Axtel will continue benefiting from Eduardo's expertise through his new role as a Board member. I wish him every success of his responsibilities in ALFA. And now let me comment about my priorities and plans for Axtel. My priority is the growth of the company throughout its 2 business units, Alestra and Axnet; excel in the services we provide to our customers to consequently boost the company's revenues. To achieve this, we must maximize our strength. We should reactivate strategies to be closer to our customers and technology partners; provide integrated, innovative and profitable information and communication technology solutions; further develop our commercial strategy supported by our business line initiatives; continue investing in expanding our robust fiber optic network coverage; and lastly, continue fostering a culture of empowerment and talent development. Our plans also have to address the current global environment, hybrid and remote work scene, price increases and supply chain disruption. Not less relevant, taking into consideration changes in technological trends and prepare for the further increase in cybersecurity threats. On July 12, ALFA shareholders approved the spin-off of ALFA's entire ownership, taking Axtel to its shareholders. Subject to other customary approvals, Axtel will be majority controlled by Controladora Axtel, which is expected to start trading on the Mexican Stock Exchange before year-end. Axtel will maintain the same Board of Directors, management team, policies and internal controls. As in every industry, specialization will be increasingly necessary and intensive. Hence, we are evaluating opportunities for association or joint ventures to accelerate growth in high-performance market segments. Concerning Alestra, growth in Enterprise segment will be driven by our business line strategy. Acquisitions for the first half of the year are 20% higher than 2021, and we are expecting to continue this strength in the quarters to come. In the Government segment, we introduced a new team in May. In the short term, we are focused on renewing our contracts, stabilizing the current portfolio and capturing opportunities for 2022. In the medium term, we are actively redesigning the strategy to foster growth in the federal, state and municipal governments all over Mexico. Concerning Axnet, our commercial team was reinforced to better serve customers while expanding our fiber deployment in strategic locations, derived from the growth in data centers and also in 5G technology. In June, Altán Redes reached a financing agreement for over $380 million. The financing structure includes Mexican development banks, vendors, shareholders and customers. Axtel shareholder, customer and relevant supplier supported this financing as we believe in Altán's important role to develop competition in mobile services in Mexico. We also share its social commitment to bring much needed connectivity to remote and rural communities, bringing the digital device in Mexico. Axtel should grow again and excel on the services and satisfaction of our customers. We have an extremely qualified team with ample expertise on ICT. Our second semester results will improve. I am confident that the different initiatives currently in place will win better medium- and long-term performance for the company. I will now let Adrian discuss the results of Axtel this quarter. Thank you.

Thank you, Armando. In the quarter, we entered into foreign exchange forward agreements for $30 million. We executed all transactions resulting in a blended forward exchange rate of approximately MXN 20.28 per dollar. At this point, we have covered approximately 70% of our CapEx and interest payment obligations up to November. We will continue to proactively manage our foreign exchange and interest rate risk to reduce volatility in our financial obligations and cash flow. Our 2024 senior notes mature in over 2 years and is our closest relevant debt maturity. We are diligently working to refinance this maturity. We're having conversations with a group of relationship banks as one of the avenues we might consider for the refinancing. Before discussing the detailed financial performance in the quarter, let me share with you our outlook for EBITDA and CapEx for the year. Taking into consideration results in the government segment, certain delays in 5G rollout in Mexico and the data centers' constructions, extended delivery times in certain equipment, reduced contribution to EBITDA from a major Axnet customer. Given all this, we expect EBITDA this year to reach MXN 3,300 million. With respect to CapEx, we will evaluate ongoing results and adjust accordingly with the current estimate between $70 million to $80 million. With this estimate, our expected free cash flow after CapEx and interest expenses is $35 million. I will now move on to review our financial results of the second quarter. Company revenues were down 15% year-over-year in the quarter. Revenues of Alestra, our Services business unit, declined 7% in the quarter. Enterprise segment revenue declined 1% in the quarter, resulting from an 11% in voice-related revenues and stable other nonvoice services revenues. Digital transformation solutions increased 5% in the quarter driven by cloud and cybersecurity services, which increased 17%. Value-added services, including system integration and managed services revenues, also posted positive results, increasing 7% year-over-year. Enterprise segment voice revenues were down 11% year-over-year, smaller impact than the 20% year-over-year decline we experienced in previous quarters. Government segment revenues declined 42% in the second quarter. Recurring revenue declined 34% while nonrecurring revenues declined 70% year-over-year. Effective last May, we reinforced the Government segment team. This new team has the responsibility to renew contracts expiring in the coming months and design strategy for key existing accounts and the final roadmap for new accounts, as Armando explained earlier. The underperformance in revenues from the Government segment has not affected our ability to collect and maintain a very healthy receivables indicator for this segment. With respect to Axtel Networks, revenues were down 21% in the quarter, explained by lower contribution from our wholesale mobile customer and dark fiber contract revenues. Cost of revenues, excluding depreciation and amortization charges, declined 8% in the quarter, contracting our gross margin by 190 basis points. Alestra cost of revenues declined 5% in the second quarter compared to a 7% decline in revenues due to increased costs associated to recurring revenues in cloud and system integration services. Concerning the infrastructure business unit Axnet, costs declined 27% related to the decline in dark fiber contract revenues. Operating expenses increased 6% vis-à-vis second quarter 2021 as a 1% reduction in personnel rent and maintenance expenses did not fully compensate the increase in bad debt provisions. Operating expenses declined 13% in Alestra and increased 22% in Axtel Networks due to the bad debt provisions of a wholesale mobile customer. EBITDA in the quarter totaled MXN 701 million, down 39% when compared to second quarter of last year. On a sequential basis and excluding extraordinary bad debt provisions, EBITDA remains stable. This quarter, 53% of EBITDA came from Alestra and the other 47% from Axtel Networks. CapEx in the quarter was $16 million compared to $17 million second quarter last year. CapEx was allocated 69% for Axnet and 31% for Alestra. Cash balance totaled $87 million at the end of the quarter compared to starting balance of $76 million. Cash flow in the quarter resulting in a $50 million net debt reduction was positive $50 million, resulting from $35 million EBITDA, $16 million in positive working capital, minus $16 million CapEx and $20 million in interest expenses and cash taxes. Additionally, we reported a $6 million outflow in debt movements during the quarter. As of the end of June, our net debt was $570 million and the ratio of net debt to EBITDA was 3.7x. Debt related to IFRS 16 represented $15 million in the quarter. Now, Donna, if you could please open the session for questions?

[Operator Instructions] Our first question is coming from Andres Coello of Scotiabank.

Yes. First on Red Compartida, Adrian, if you can confirm, please, that the amount that Altán owes to Axtel is close to USD 50 million or MXN 273 million as disclosed in the Mexican press. I just wanted to confirm the amount. Second question on Red Compartida is what you have seen after the government takeover of the project. If negotiations are changing, do you think that the credit outlook of Red Compartida has improved after the federal takeover? And perhaps if you can just let us know if your guidance, which improves a significant improvement for the second half of the year, incorporates already a recovering of the amounts that Red Compartida owes you and perhaps a restart of the relationship in terms of building infrastructure for Altán?

Thanks for the call, Andres. About the relationship with Altán, overall, we have a very good relationship. And as Armando mentioned, we're very supportive of the project. Axtel's debt under the Concurso Mercantil, is $40 million plus value-added tax. That's part of the Concurso Mercantil debt. That's not been executed yet and we don't have final terms for that. Usually, it's a very long-term structure. That's the usual for the sort of processes. And concerning the recent developments and as mentioned, Altán obtained slightly less than $400 million financing in June. We are participating in that structure as a supplier. We are paid partially in cash and partially will be financed in a sort of factoring structure that's being executed. And that's the way going forward for existing services until our commitment is fully used. And regarding the first part of -- concerning the amount due under the Concurso Mercantil process. we will provision 100% of it this year. As we reported in our year-end financial statements and discussed in our previous call, it's an amount close to MXN 300 million. We will fully provision that this year. We're probably halfway or 3 quarters of that as of the second quarter. And by the end of the third quarter, most of it or all of it will be provisioned already. And concerning Altán in our guidance, the benefit or the positive impact is that in the fourth quarter, we will not have to provision the -- any further debt under the Concurso Mercantil amount. We are also having conversations regarding additional services accordingly to Altán's priorities and business plans. So we continue on that open dialogue for new opportunities. I don't know if that answered your question, Andres.

It looks like he has removed himself from the queue. We'll move on to the next question from Carlos Legarreta of GBM.

Armando, first of all, congratulations on the appointment. I'd like to talk about -- a little bit about the pricing in the Services segment. I understand, Adrian, for a number of quarters, I believe you've told us that there's a lot of pricing pressure. I'd like to understand if that is still the dynamic and perhaps part of why you have seen underperformance in this segment. If you could talk about that, that would be great.

Yes. Carlos, thanks for the question. I will give you some comments and Bernardo might further complement. Overall, the industry and the services have pricing pressures over time as the cost of technology, the cost of equipment come down and that transferred into new offers, new services. That's been around forever in the industry. And in particular, in recent quarters, the pricing pressure we experienced was more than the usual trend, for example, in voice services. This quarter, we were able to have an 11% decline in voice services, which is more or less the trend -- the long-term trend for these services in the industry. But until last year and then for the last 2 years probably, voice services from pricing pressure and lower volumes were coming down faster. So in general, I should say that in order to increase revenues, there is always the new offers and new services being integrated into existing clients. But very important is to continue growing the customer base but not the customer base only, the services provided to existing customers.

Yes. That's exactly right. I would just add that price pressures are most seen in mature services. Adrian was referring to voices -- to voice services. Also, you can see some of that on Ethernet services that have been into a slow but fair substitution for newer technologies and new ways to provide the solution to the customer. So that part of the business that we have, our experience is the highest pressure. And we are compensating those with new services. And eventually, we will continue our growth. I don't know if that hits that.

No, it does. As a follow-up, I mean -- just to confirm. On the guidance side, you don't mention a change in revenue, I believe. So that means that you're expecting now a margin, instead of about 30% to 27.5%?

Our guidance implies a margin -- an EBITDA margin somewhere between 29% to 30%. That's actually the full year EBITDA margin we expect now.

Yes. We are also -- this is Armando. We are also implementing some cost-saving strategy in order to improve also the EBITDA margin.

The next question is coming from Declan Hanlon of Santander.

I have a couple of balance sheet-related queries. I guess it's obvious to this point the decision to spin off Axtel has had a very profound impact on Axtel bonds. Can you discuss a bit more the plans to refinance the issue? Should the market be expecting a tender for the bonds well below par at this point? The second part is, I guess, as a follow-on to this. There's limited expectation for an asset sale built in at this point despite the fact that I think logical analysis suggests that parts of the business at least are worth multiples far higher than your present EV multiple. Can you update us on the specifics of any particular divestment plans that are currently in process? Because I guess the market is kind of viewing the decision to spin off the asset is the parent's way of saying that there were no processes that met or nearly met the requirements of ALFA over the past 18 months.

Declan, thanks for your questions. Let's go to the different parts. First of all, regarding our capital structure regarding our debt. We're very surprised regarding the price in our senior notes recently. We have close to $90 million in cash. We have $40 million available in committed lines of credit. And the maturity is until the end of 2024. So really, we don't see the recent reaction in the price of our senior notes related to our current situation. And having said that, we are proactively working on the refinancing. That's a priority for the company. We're working together with ALFA on primarily looking at the refinancing with the banking facilities. And we hope we can execute that soon. We will inform of anything as soon as we have a plan to execute. And hopefully, that can be fairly soon. And concerning any tender offer at significant reduced prices, at this moment, we are not planning on that. We -- as I said, our priority is to refinance the senior notes, and we are working diligently on that part. And going to the next part of your question, Declan, concerning the asset sale and the strategic look for investors, I will ask Bernardo and Armando to complement and take that part.

Sure. Declan, this is Bernardo. Regarding the assets that we have, what we're looking right now is that there are high growth areas of the business that offer a great opportunity to expand the business to grow in a profitable manner. So the way we are approaching this is seeking ways to fund these initiatives in order to -- well, to bring them to execution. I'm talking about opportunities in cybersecurity, in mobility. We see some others in cloud. But we are not considering as a priority to divest any assets. Instead of that, what we are -- have been considering based on the interest of investors that we have been in concept with because of the previous process. We're looking at potential partnerships with them. That could include some monetization of the current business. Partnerships in some conversations have a wide coverage of services. And so the investing could be not only in the new [ break ] but could include some partial [ prioritization ] of Axtel. But in summary, it is not an asset divestment. Partnership is our priority right now.

This is Armando. We are looking to grow the company. That's my way of performing and deliver results for the Board. And we will look for growth opportunities. Whatever we have to make internally and looking for partners in order to grow in the business lines that we see as the more profitable than ones we have better capabilities, we will do so. So the management priority, we will focus on growing the company, on being close to our customers and at the same time, as Adrian was saying, moving to have a strong financial position. But growing is pressure for our future.

The next question is coming from [ Tali Mora ] of Compass.

Mine is regarding margin. I know that you previously said that operating expenses increased 6%. And I think that is completely related with the decrease in margin. But I don't know if you could give us more color? And what are the main like increasing costs and expenses? And why is this happening? Because 10 percentage points, I think it's an important decrease.

Yes. Thanks for your question. Margins this year have compressed. The gross margin has been affected to some extent by a change in the services mix. We've been growing faster or the services that are growing have lower gross margin than declining services. As we have mentioned many times, voice services, for example, it's a high-margin service that's on a declining trend. So that's something that occurring in the company. It's something that we have to address with faster top line growth. So that's, in general, concerning the gross margin. And going to operating expenses. Operating expenses this year, in particular, has been affected by the bad debt provision. We've been booking every month. As I mentioned before, we'll be recording close to $15 million in bad debt provision just from one customer. That's on top of the business as usual. So that definitely will have an impact on our EBITDA margin this year. Going forward, without this onetime effect, we expect the margins to gradually go back to mid-30s. That's our medium-term objective, to be back at the 33%, 34% EBITDA margin.

We also will compensate the increase in operational expenses, as Adrian was saying with the top line. I think we will look for more revenues. So 30% of more revenues is better than the 35% of less revenue. So also, I will reinforce that growth is our main strategy at this moment, driving growth, customers' growth, reach geographic growth. So that's a way to compensate those increases and the new reality of the service margins that we will have in the near future.

The next question is coming from Lee Sun of T. Rowe Price.

I have two. Firstly on growth, if I look at the Infrastructure segment, it looks like you had a good quarter of 8% quarter-on-quarter growth. Should we expect kind of similar growth rates going forward for this business as you kind of start to recover some lost revenues? And then my second question is you gave a guidance for free cash flow of $35 million. What do you plan to do with the free cash flow generation?

Yes. Lee, thanks for your question. Let me start with the free cash flow. Well, it's part of our refinancing and capital structure management, the use of cash, how we reduce debt and refinance the 2024 senior notes. So it's embedded and it's considered as part of the plans that we have to take care of the 2024 maturity. And could you repeat the first part of your question, please?

Yes. It's the infrastructure segment. I'm just curious, like I saw quarter-on-quarter, you have 8% -- or 8.4% growth. Is that a type of trend we should expect in the next few quarters?

Yes. The growth in Axnet has been delayed -- or certain plans concerning growth in Axnet has been delayed, as we mentioned already. We expected contribution for -- from data centers sooner. We also expect a certain contribution from a faster rollout of 5G in Mexico that translate into fiber-to-the-tower opportunity for Axnet. We're seeing data centers almost being finished in Mexico, particularly in Querétaro. There are many projects there that are being concluded already or are close to being concluded. We deployed significant fiber there in the last 12 months to serve these opportunities among many other expansion concerning Axnet. And that's embedded in our plans for the second semester for Axnet. We think that there are better opportunities. The acquisition pipeline is coming stronger. So we expect that acquisition to be translated into results in the second semester.

Okay. That's helpful. And one quick follow-up on your comments about the bad debt provisions. As the government go through the restructuring of Red Compartida, is there a possibility, maybe next year, you could cover some of that bad debt?

Concerning the debt under Concurso Mercantil, as I said, the Concurso Mercantil has not -- or let me rephrase that. The agreement to exit Concurso Mercantil has not been executed yet. So at this time, we couldn't elaborate on the future of the debt that we have under the Concurso Mercantil of this customer.

The next question is coming from Andres Coello of Scotiabank.

In the press release, you disclosed a 20% year-over-year increase in terms of the new acquisitions for the corporate segment. So can you just give us a little bit of color regarding where this growth is coming from, perhaps specific industries where this 20% growth is coming from? And also, and perhaps if you can tell us how long it will take for this growth to translate into stronger revenue? And I guess this is probably going to happen in the second half of the year. I just wanted to confirm that.

Andres, this is Bernardo. Thanks. Well, these acquisitions are coming mainly from the lines of services or líneas de negocio, a new commercial model that we launched in the beginning of this year. We tested that approach last year in cybersecurity, and we decided to expand it to other lines of services, where we are having a highly specialized approach with experts technically, very highly knowledgeable people interacting in a new way with customers so that we reinforce our approach to -- our go-to-market approach. We are putting more consulting into the selling process. And that has been increasing the interest of customers into services that we already have in the portfolio. So we're seeing a very high -- higher takeoff rates from existing services due to that new way of delivering sales process. So we are very excited about the progress of this project. Quarter after quarter, it has been higher than the previous one. We are fully committed into that. So that's something that we expect that will continue while giving a very big momentum to the company. You were asking about when will that convert into revenues. Typically, depending on the complexity of the projects and the amount of, let's say, equipment, installations and system integration required by that, typically, these projects take 4 to 5 months to start generating revenues. So we have a very good expectation of revenues going forward.

This is Armando. Aside at the specialization approach to our customers and understanding more closely their needs and pains, there's also a part related to motivation of personnel in Axtel. We have been getting very close to the concerns that we had internally. And we are fostering the motivation and the way to approach the market more proactively. And we really believe that the personnel that we have in the company is the best one. And we have to show that into the market and make it a reality.

Bernardo, just one clarification. When you mean 20% increase in acquisition, do you mean the number of contracts or in terms of monetary terms, in terms of the total contract size? So it's -- do you know what I mean? If it's in terms of the money or in terms of just how many new contracts you are signing versus the prior year?

Yes. The way we measure acquisition, Andres, is in terms of monthly revenue expected from the contracts. I mean if you sign a contract, let's say, for MXN 100,000, those MXN 100,000 adds to the acquisition of the month. So that's an indicator that we've been having for many years and is a way that we measure the moment of the sales that we have. That's monetary terms, in terms of monthly revenue that we generate for the length of the contract.

At this time, I'd like to turn the floor back over to Mr. De los Santos for web-submitted questions.

Yes. Thanks, Donna. We have multiple questions on the webcast. I will start with the question -- or with comment that will summarize some questions concerning the refinancing, concerning the senior notes, concerning the Axtel spinoff and the implication of that in the senior notes. And my comment regarding that question is that the Axtel spinoff does not represent a change of control under the senior note in venture. The spinoff does not change the underlying shareholder base prior to and after the spin-off. So the definition of change of control regarding this spinoff does not apply. So that's concerning the change of control question. Concerning the plan for the refinancing, I think we covered that question. We see the banking facility as the most efficient alternative right now. Definitely, the current conditions in high-yield market are complex in general. As I mentioned, our bonds are trading at a level that we really don't see reflect current risks given the liquidity, given the tenor and given the access to credit lines that we currently have. So our focus is on a banking facility that we're working with relationship banks alongside ALFA. Concerning the guidance for the second semester, how we will accomplish that. I think we cover different aspects throughout the call, but let summarize [Technical Difficulty] will improve. We still have a long way to go. We have very high expectations on the new team. Obviously, that's not an overnight project. But we do expect improvement in the second semester. So that will add on top of results of the first semester. Second, Axnet, as we mentioned, we have acquisitions on the pipeline that we expect could translate into revenues, into the P&L in the second, mostly [Technical Difficulty]. That's something that we'll [Technical Difficulty]. As Bernardo mentioned, the 20% increase in the level of acquisitions should continue adding on top of first semester results. So the 3 segments should do better in the second semester. And concerning expenses and costs, as Armando mentioned, we have certain initiatives to optimize margins, to optimize expenses. And the bad debt provision that we have referred multiple times will mostly conclude by the third quarter. So that will not be a drag by the fourth quarter and in years to come. So that's, in summary, how we expect to achieve a better second semester this year. And one question concerning how many kilometers of fiber optic we have. We have almost 50,000 kilometers. We have 48,000 kilometers of fiber optic. Roughly, it's half metro fiber, half backhaul or transport. And we have plans to expand on fiber. We see an opportunity in many cities in Mexico that we are not present as we would like. We were investing significantly in the Querétaro area. We're investing significantly in Northern States that are having benefits from the trends concerning globalization and nearshoring strategies. So we -- it's part of, as Armando mentioned, part of his priorities is to make our network even more robust. Going back to the senior notes refinancing and the refinancing plan, will ALFA provide guarantees on bank debt? Axtel's obligations has never been guaranteed by ALFA, not in the past and not in the future. We will continue without any guarantee from ALFA as it had been in the past. So there's no change in that perspective. And one final question. Why did government segment declined more in 2Q versus 1Q? What were the drivers? Second quarter of last year, the government segment recorded certain nonrecurring revenues. As I mentioned in my initial remarks, nonrecurring revenues declined 70%, 7-0 percent. So that would be the driver for the further decline in the Government segment. Actual [Technical Difficulty] we think not. Not in our share price, not in the senior notes definitely. Results, we think is the best way to prove and to reflect the current value of securities, including shares and notes. So that's our primary objective, the growth of revenues, top line and being closer to customers to translate into revenues. Donna, I think we have covered all the questions or the subjects being reflected in the webcast questions for today.

Thank you. Ladies and gentlemen, this concludes today's event. You may disconnect your lines. We do thank you for your participation. You may now disconnect your lines from the phone or from the webcast. Please enjoy the rest of your day.