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

Greetings, and welcome to Axtel First Quarter 2023 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Adrian de los Santos. Thank you. You may begin.

Thank you, Rob, and welcome, everyone. Our call today will be hosted by Mr. Armando de la Pena, Axtel's Chief Executive Officer; Mr. Bernardo Garcia, Executive Officer of Business Strategy; and myself, Axtel's CFO. Financial information, including our unaudited first quarter report is already available in our corporate website. Let me remind you that information discussed in this call may constitute forward-looking statements. 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. So 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 with us today. I hope you are all doing well. Let me start by making some comments about the company's performance and relevant events during this first quarter. In the quarter, we implemented a new operating and commercial model based on the specialization strategy that we initiated last year. We consolidated our operations in business lines with end-to-end responsibilities, integrating presale, product, design, delivery and customer service areas, creating greater proximity and focus with our customers. COVID pandemic changed the priorities and the way clients consume telecom and IT services. Accordingly, and working with external consultants, we adapted the organizational structure to be aligned with current market trends, demand for industry-specific solutions and a lean and agile operating model to deliver quick solutions. The objective of our [Axtel] new model is to be aligned with clients' needs, resulting in a new streamlined organization with vertical and horizontal specialization. Vertical meaning by industry and horizontal meaning by service or business line, thus generating focused business opportunities and profitable growth. In this new organization, we are eliminating meaningless controls, simplifying our internal architecture and continue working to automate and reduce processes. Due to this, a onetime MXN 190 million of organization change -- charge was recorded in March. Ongoing benefits from reduced personnel expenses will compensate from the extraordinary charge in 7 to 8 months in this year. Concerning our performance, first quarter was positive and in line with our expectations, excluding the onetime organization's charge. Revenues in each of these 3 business segments increased year-over-year, and this, the comparable EBITDA. In the Enterprise segment, new contracts, recurring revenues accumulated MXN 21 million in the quarter compared to negative MXN 1 million in the first quarter of 2022. Wholesale Infrastructure Customer segment was flat in recurring new contract revenues compared to negative MXN 7 million a year ago, maintaining and accelerated this trend increases the overall revenue base and therefore, accelerates our growth and profitability. In the Government segment, as evidenced since the second semester of last year, the trend in both federal and local government is positive with 60% of 2023 contract renewals already executed and new project funnel considerably larger than a year ago. Briefly, let me share with you that this quarter, Axtel was chosen as the 2022 Equinix Americas Emerging Partner award winner. Due to a breakthrough value we delivered to our customers, business using cloud, digital infrastructure solutions. We are also awarded as Fortinet's Growth Partner of the Year, being the only recognized service provider in Mexico due to our outstanding commitment to excellence in performance and dedication to strengthening cybersecurity in organization. These 2 awards from key partners recognize our effort to move Axtel further into digital transformation and specialization. We expect a consistent improvement in the rest of the year driven by our new commercial and operating model and with a more agile and flexible organization. The attractive funnel in Enterprise and Government segments, we focus on cybersecurity, cloud and system integration opportunities should contribute to an overall better year. As always, we will maintain a strict control on investments, costs and expenses to meet our expected cash flow for the year. I will now let Adrian make some additional remarks and discuss Axtel's first quarter results.

Thank you, Armando. We continue progressing in the refinancing of the outstanding $314 million of our 2024 senior notes. As informed in February, we secured $100 million loan and made progress with commercial banks to implement a syndicated bank facility. Finally, we're also working with international development or multilateral banks to complete the comprehensive liability management exercise and refinance all outstanding notes. Our goal is to execute this refinancing before November this year. Concerning the process to lease Controladora Axtel on the Mexican Stock Exchange, we believe this could happen soon. ALFA and Axtel continue diligently working with regulators to conclude the process as soon as possible. As Armando mentioned, we recorded a onetime charge related to reorganization expenses in the quarter. There will be no further expenses associated with the new operations and commercial model this year. Due to the extraordinary and nonrecurring nature of this charge, our MXN 3,300 million EBITDA guidance for the year will be measured as comparable EBITDA. That is, we will exclude this onetime charge for its determination. I will now move on to review our financial results for the first quarter. Company revenues increased 8% year-over-year in the quarter. Enterprise segment revenues increased 5% in the quarter, explained by a 14% increase in digital transformation services revenues compensating a 20% decline in voice-related revenues. The growth in digital transformation revenues was driven by a 21% in cloud and cybersecurity services in the quarter. Voice revenues represented 8% of Enterprise segment in the quarter compared to 11% in the first quarter of last year. Government segment revenues increased 23% in the quarter due to the low margin nonrecurring service revenue with a federal entity this period. The decline in Government segment standard and Digital Transformation revenues was due to pending formalization of certain expired contracts expected to be signed in the upcoming months, as our policy within Government segment is recognizing revenues only in validly executed contracts, even though services had been provided. This is a not uncommon situation occurring at the beginning or first quarter of every year. Revenues from Wholesale Infrastructure segment customers increased 11% in the quarter due to more revenue recognition from Altán. During the first quarter, we did not book revenues from that quarter or upfront capacity contracts. However, some projects were closed this first quarter in addition to an attractive services funnel that will contribute to Wholesale Infrastructure segment revenues in the rest of the year. Cost of revenues, excluding depreciation and amortization charges, increased 15% bringing total contribution margin down from 71% to 69% year-over-year, mainly due to the low-margin Government segment transaction. Without this effect, contribution margin will have reached 72% this quarter. Enterprise segment cost of revenues increased 9% in the first quarter compared to a 5% increase in revenues, thus reducing contribution margin slightly from 74% to 73%, primarily due to costs associated with cloud services. Since last year, we have been implementing commercial strategy actions to optimize profitability in cloud services. Government segment cost of revenues increased 46% in the quarter, reducing contribution margin from 40% to 30% this quarter, mainly due to the low-margin transaction. Excluding this transaction, contribution margin in the Government segment will have had increased year-over-year. Concerning Wholesale Infrastructure segment customers costs declined 13% thus increasing contribution margin to 83% compared to 78% a year ago. Starting this year, we're further distributing the commercial and operational expenses into our 3 business segments, maintaining only finance, HR, legal and similar expenses as general corporate expense. We believe this further distribution of expenses into the business segment will help us to better understand and pursue profitable revenue growth. Commercial and operational expenses increased 9% year-over-year due to increases in Enterprise segment, personnel and tower lease payments, both due to inflation and uncollectible provision expense. The increase in uncollectible provision is explained by the fact that in the first quarter of last year, revenues from Altán were booked net of provisions. Since last May, we changed this and started recognizing all 100% of monthly services rendered to decline as revenues and booking an expense provision for service revenues that are not collected in cash, but rather paid under the financing facility put in place under the Concurso Mercantil. General corporate expenses increased 26% compared to first quarter last year due to an extraordinary expense provision cancellations recorded a year ago. Comparable EBITDA was MXN 736 million in the quarter, 3% higher year-over-year. This improvement resulted from a 1% increase in the contribution to EBITDA from the business segment and a benefit in net other income, compensating the higher general corporate expense. Including the onetime reorganization charge, EBITDA declined 24% in the quarter. CapEx this quarter was $90 million compared to $60 million in the first quarter of 2022. Cash balance totaled $44 million at the end of March compared to a starting balance of $80 million. Cash flow this quarter was negative $6 million, resulting from $40 million in comparable EBITDA, onetime $10 million reorganization charge, $10 million negative working capital, $19 million in CapEx and $7 million in interest expenses and cash taxes. Additionally, we reported $31 million net outflow in debt movement during this quarter. Excluding the reorganization charge, cash flow would have been positive $5 million. As of the end of March, net debt was $552 million and the ratio of net debt to comparable EBITDA was 3.6x. Debt related to IFRS 16 represented $13 million. In the quarter, we executed an offer to purchase up to $120 million of principal amount in our 2024 senior notes. Holders tendered $89 million, resulting in a new outstanding amount of $314 million as of the end of March. With this, we conclude the presentation and open the call for audio questions. Rob, if you could please ask participants to prompt for questions.

[Operator Instructions] Our first question comes from Carlos Legarreta with Itaú.

Quick questions, if I may. The first one, you had a cash outflow, I guess, related to an increase in accounts receivable. So I'm wondering if you could detail what's behind that? And secondly, I guess more on the strategic side, if Armando could explain what's the logic and what's the expected outcome of this commercial reorganization? Just so we understand better the implication of the reorganization expenses.

Yes. Carlos, the first question about cash outflow in the quarter. It was, if I understood you correctly, you asked what it was about. And this quarter, cash outflow was mainly due to the tender offer that was financed with -- partially with existing credit facilities and also with cash available at the beginning of the quarter. Concerning the increase in accounts receivables, if that was your question. It would mainly be -- sorry, that was also your question?

Yes, yes, exactly. The sequential increase in accounts receivable around $400 million.

Yes. This was mainly due for 2 reasons. The first is, as we described, we had a relevant transaction in the Government segment that services were provided, and we bill the clients and this invoice has not been paid. However, costs associated to this service have not been paid as well. This transaction is structured in such a way that once we collect from the customer, we will pay the associated costs. So in terms of working capital net did not have significant effects. The other element quite relevant is regarding the financial clients or financial sector that usually at the end of the year, last December, large certain and some large financial institutions, they pay the invoices that should have been paid in January and February. So that significantly reduces the accounts receivable. Therefore, this quarter, we don't collect those invoices because they have been collected already. So that's a seasonality effect that we see every first quarter of every year. So if you look at the end of first quarter '22 compared to first quarter 2023, there is no significant change in the balance, neither in the accounts receivable days. And concerning your second question about what's behind the new commercial and operational model and the strategy that was implemented, Armando will take that.

Yes. As I explained briefly, we are looking forward to serve better our customers. So we have organized ourselves into business lines in order to promote specialized solutions to industries or commercial type of customers. We will get closer to our customers, have faster and better processes in order to have a quicker response to the market. In that reorganization into these business lines, there were some opportunities in order to be better and faster in our decision-making. Taking that into consideration, we made an organizational reconfiguration that made some downsizing as a result of it, approximately like 8% to 10% of our workforce and close to 15% to 20% of our management personnel that we have in the company. So it's like a mixed strategy, both to serve better our customers, to be more agile and also to be more cost effective.

Our next question is from [ Ricardo Oviedo ] with GBM.

I'd like -- the first one would be on the refinancing. I'd like to know basically what's been biggest delay you've seen in the negotiations? And secondly, on AxNet, you mentioned a decrease in connectivity contracts and no dark fiber revenues. I think Adrian mentioned something in his remarks, I'd just like to know what is the competitive landscape. And what do you expect for the upcoming quarters? Do you expect this to recover?

Yes. About the refinancing, certainly has taken longer. We're making progress. The overall liability management includes a bank loan, a syndicated bank loan that requires approval, participation and so many things from many different participants that the company, along with ALFA, had been working to put in place. We're making progress on that. And as we mentioned, bottom line, we want to have [lease] refinancing. Our goal is to have [lease] refinancing being executed before November this year. And concerning the performance of the infrastructure business segment or AxNet. Yes, indeed, we did not have a dark fiber contract revenues this quarter. As mentioned, we signed some contracts that are in the implementation process and should be recorded as revenues in upcoming quarters. We have an attractive pipeline of other projects. The decline in some connectivity revenues with wholesale customers, it's due to some dynamics in the industry, some changes in the way our customers and multinational companies operating in Mexico, migrating from their global operator to local operators. So that's the reason behind this decline. We think prospects are better. There is a strong activity, particularly in Central and North Mexico with near-shoring, we see new companies putting facilities in this part of the country. And there is the connectivity demand. There is obviously demand for other services. And we also expect that the increase in data center and large-scale streaming and social media companies that are installing and putting operations, particularly in Querétaro or on some other areas are also increasing opportunities for the Infrastructure segment. I don't know if that answers your question.

Yes. Thanks, Adrian.

[Operator Instructions] Our next question comes from Alejandro Gallostra with BBVA.

I have a follow-up question regarding the business reorganization. So the question is for Armando. You provided a very good explanation about the rationale behind this reorganization, explaining that you will provide more specialized solutions, will provide better services to clients, and it will help you be more agile and more efficient. But I would like to know if this business reorganization should translate into an accelerated growth or improved margins? So if this will help you increase market share? What should we expect from this business reorganization? Could you please be more specific on what we should expect out of this, please?

Yes, of course. Thank you for the question. We will review and -- our portfolio of products and solutions based on customer needs, the specific type of customers per type of industry. So the solution that we will be implementing in the near future will help us to foster growth, mainly revenues-wise. We used to be very pushy about new innovation, technology innovation, and we are complementing that focus to develop solution based on current and future customer needs. So it's a different approach to the market. The solution that we are going to develop will help to improve the core processes of our customers. So the approach will be more on to the users or the leaders of the core processes in order to help the IT departments with the customers to develop this type of resolution. So if I come to assume it will foster growth, revenue growth, and we will measure our share per type of industry and the business line related. Thank you.

And to complement that, Alejandro, about the margins, as Armando mentioned before, the lean or -- and more efficient, less process organization, less nonessential processes will definitely help to improve margins going forward.

So what are the business lines that should benefit the most from this business reorganization? When should we expect to see this positive impact in revenues and profitability?

Let me hand over to Bernardo García, who is in charge of business strategies. Please, Bernardo, go ahead.

Alejandro, nice talking with you. Thanks for the question. Yes, what we are looking at right now is an increase in the sales funnel. That is the number of opportunities that we have working with the customers. And given this new realignment of all the expert teams that we have in the company who are in close contact with the customers seeking to speed up the adoption of technologies with them, we are looking at a steady growth from -- in the future. Starting by this year's end, it's time to show, and then -- but with a strong trend going forward. Because as you know, our business is one of accumulating a customer base and customer services with long-term contracts. So we are gradually, week after week, adding up new contracts on top of what we have in it to increase the recurring revenues that we have. So yes, this is -- we see this as a change in the trend of the internal growth of the business from now on.

Okay. So [indiscernible] during the call, you said that all the expenses related to this business reorganization amounted to MXN 186 million, if I remember well, correct? So I just want to make sure these are all the expenses related to the business reorganization that will not be repeated throughout the year? And if that will also now -- have you changed your guidance for the year on the EBITDA level or not?

Yes, Alejandro, as mentioned, we don't expect and we don't have in our plans to have more extraordinary charges or expenses related to the new operation and commercial model. What we've recorded in the first quarter, that's it for the year.

Yes. Let me [come to the question] again. The reorganization, it was part of the new business strategy. It was not just a cost decision or expenses decision. So the [ result time] of this new strategy, of business lines, and the way we are going to approach the market has the result of the reorganization. So it's not like an effort just to make some savings, it's kind -- it's related to the new strategy. So we don't foresee any bigger impact in this year or the years to come. It will depend on the business lines with better growth. And I think in the future, if there's need to reinforce them, that could be a possibility, but we don't see it this year with the organization we have currently in place. We have the right amount of capabilities in order to serve our customers better.

Okay. And my last question is -- and if you could help me better understand why you bring expenses, increased at double digits. And I was reading your press release, you mentioned some sort of provision related to a mobile wholesale customer. I thought that you were done with provisioning for Altán? I mean, if you could help me better understand this provision in this quarter, please?

Yes. As I mentioned in my introduction, the way we record services provided to Altán changed in May last year. Prior to May, revenues -- the revenues from the services provided were reported or booked net of the provision from the portion that's not paid in cash that's financed under the finance -- under the credit facility Axtel put in place under the Concurso Mercantil of Altán. Therefore, revenues were booked at a smaller amount, and there was no expense associated to the services provided. In May, we changed that and the services provided, the revenues from services provided started to be booked 100% and the portion of the invoices or services that are financed will create an expense [of] provision for that. Therefore, on an EBITDA basis, it's the same. But the way you see expenses is different. That's why we now have a provision and we did not have in the first 4 months of 2022. Our assumption today is that the facility, the credit facility we put in place for this client should be fully used by August, November, let's say, by the end of the third quarter. And after that, we should be paid 100% in cash. Therefore, we will not have this provision from that time going forward. Was that clear?

Okay. Last thing. Could you tell us what was the nonrecurring amount coming from the Government segment that helped this increase 23% this quarter?

Could you repeat the question, Alejandro? It wasn't very clear.

There was a nonrecurring revenue in the Government segment coming from value-added services that helped with this business segment increase 23% in the quarter. Could you please give us that amount, please?

Yes, about the Government segment nonrecurring transaction. Yes, we don't provide specifics regarding customers, obviously, for confidentiality and commercial reasons. But it was north of MXN 100 million. That's all I can say.

Less than MXN 100 million, can you say that again?

Yes, more than MXN 100 million.

More than MXN 100 million. Okay.

There are no further audio questions. At this time, we will address any web questions that have come in.

Yes. Rob, we have some questions from the webcast, and I will go -- we will go through them. Concerning the refinancing, there is a question about whether the company will launch another tender offer. And also whether the company is working or what's the details on the conversations with the multilateral banks, whether we can provide details about security on this financing. Let me comment on that. We have all options open on the table. We don't have any decisions at this moment. We will obviously look what's in the best interest of the company or stakeholders and that's how we make decisions. About the conversations, negotiations with multilateral banks or organizations, we're not putting security or any tangible guarantees in any facility, either with commercial banks or with any other institution at this time. That's something pretty clear that we have right now. The amount that's available under the committed credit facilities. Today, we have about $30 million, $31 million available in committed credit facilities. Do we have a debt reduction target or objective yet? Our objective is to come down to net debt EBITDA ratio of 2.5x. We're not close to that. But definitely, it is our target. We want to be there as soon as possible, perhaps the end of next year. It's our goal at this moment. About -- there's a different topic concerning strategy, market strategy. And this is a question for Bernardo. It says, how will the business be affected by artificial intelligence? And I will let Bernardo take that.

Yes, regarding artificial intelligence. While our company has evolved through technological cycles over time, our portfolio saw an increase in -- by adding up cloud services in 2011, then IT services, then multi-cloud, then digital transformation, IoT and recently mobile services. In this kind of thoughts, we consider artificial intelligence as part of this evolution. And it provides opportunities to enhance the value that our services provide to our clients. And with the new specialization approach to the market, we should take advantage of these new opportunities in the best possible way for our customers.

Thank you, Bernardo. We have a couple of more topics on the webcast questions. One is about results, guidance, the effects of the new organization and commercial strategy. About what's the benefit of these? Well, I think Armando clearly described all the strategic and commercial and value for clients' benefits of this strategy. Specifically in terms of efficiencies, the new organization and the reduced expenses related to personnel, this should have an annual benefit of more than about MXN 250 million on an annual basis. So that's just the economic benefit of this. Definitely the benefit -- the large part of the benefit comes from the value creation for clients translated into profitable growth opportunities. And the one final topic is regarding the spinoff of Controladora Axtel. This is something that ALFA has been working diligently. Axtel has been supporting ALFA on this. And we think it will happen soon. That's what I can comment at this time. And then the last question about the refinancing lease, whether we will make an announcement if we execute the refinancing or well, the senior notes or securities that are public. Therefore, we do announce everything related to the senior notes. As in the past, we will do accordingly the same. And we don't have any further questions. We thank you for your participation and Rob -- this concludes our call today.

Okay. This concludes our conference. You may disconnect your lines at this time, and we thank you for your participation.