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

Greetings, and welcome to the Axtel Third 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, Ms. Nancy Llovera, Investor Relations and Corporate Finance Manager for Axtel. Thank you. You may begin.

Thank you, Melissa. Good morning, and welcome to Axtel's earnings conference call. It's my pleasure to participate in today's call together with Armando de la Pena, Axtel's CEO; and Adrian de los Santos, CFO. Financial information for both Axtel and Controladora Axtel, including the unaudited third quarter report, is available on each corporate website. After Armando and Adrian's comments regarding quarterly performance and relevant events, we will be taking your questions for both Axtel and Controladora Axtel. Let me remind you that information discussed today may include forward-looking statements. These statements reflect management's current views, which are subject to certain risks and uncertainties. Axtel is under no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. I will now turn the call over to Armando for his initial remarks. Armando?

Thank you, Nancy. Good morning to all, and thanks, everyone as well for being with us today. Before reviewing our financial results, I would like to briefly comment about the quarterly performance and opportunities we see in our business. In the third quarter, Enterprise segment revenues improved 6% and Government segment, 17%. Our Wholesale segment revenue declined 19%, mainly due to extraordinary dark-fiber contract in the year earlier quarter. Total revenues improved 2% and EBITDA 1% year-over-year. Sequentially, revenues increased 6% and EBITDA 5%. We expect our Enterprise and Government segment to continue posting good increasing results in the fourth quarter and into next year. More than offsetting the challenging market conditions in the wholesale segment. Where most of the dark-fiber capacity contracts in the pipeline will materialize next year and primarily as a recurring monthly rent, rather than one-time upfront revenues. In the Enterprise segment, new contract revenues -- recuring revenues accumulated MXN 171 million year-to-date, more than double compared to the MXN 80 million in the same period a year ago. This metric, new contract recurring revenues, is key to see -- and we follow it since it's the basis for future revenue generation. Likewise, the Government segment pipeline of opportunities is 2x larger than last year. The core business lines defined under our new operating and commercial model accumulated an 8% increase in revenues year-to-date compared to previous year. In our new model, we are also designing specialized solutions to certain industry verticals. In the quarter, more than 20 specialized offers were created based on proven best practices for specific industries. This offers capitalized on our infrastructure, our expertise and the solid customer base of Axtel. An avenue of new business opportunities for Axtel, arising from the nearshoring trends has been connectivity and IT services demand from international companies established in Mexico. In recent years, we have increased our coverage, reaching a total of 800 industrial parts throughout 76 cities, mainly in the North part, Central and west of Mexico. We connect 92% of the total industrial parks in North, West and Central Mexico, I have a dedicated team to provide a specialized focused solution for these customers. During the quarter, for our data network, we announced an increase in our bandwidth capacity up to 400 gigabits per second, using next-gen optical technology. In addition for our transport network, we achieved optical transmission channel up to 1.2 terabits per second each, 12x our current bandwidth. This translates into better performance with world-class standards for e-commerce, supply chains, connection to clouds and data centers among others. This quarter, Axtel obtained the ISO 25001 recertification and related to the new version of the standard. Axtel became one of the first telecom companies in Mexico to obtain this certification, validating the effectiveness and integrity of our information security management systems. In order to resume consistent revenue growth, increased profitability and create a more agile organization for our customers, our prime concern is the steady progress of our new operations and commercial model and transformation strategy. Within our focused business lines, we want customers to perceive Axtel as the best and most reliable partner to their digital transformation. As we continue progressing in our strategies, we also expect to simultaneously maximize value for our shareholders. I will now let Adrian discuss the results of Axtel for this quarter. Thank you.

Thank you, Armando. Now let me review our financial results for the third quarter. Company revenues increased 2% year-over-year. Enterprise segment revenues increased 6% in the quarter, explained by a 16% increase in digital transformation services and value-added services revenues, compensating for an 8% decline in voice revenues. An 11% growth in digital transformation revenues were supported by 13% and 29% increases in cloud and cybersecurity service revenues, respectively. Voice represented 9% Enterprise segment revenues in the quarter, down from 10% same quarter of last year. Government segment revenues increased 17% in the third quarter driven by good progress in the renewal of contracts. Revenues from recurring revenues improved 35% in the quarter, while the rate -- the rate of success in the renewal of services expiring during this year reached 95% at the end of September. Revenues from Wholesale infrastructure segment customers sustained a sequential 3% growth. However, decreased 19% year-over-year, impacted by a 50% decline in dark-fiber and capacity contracts and an 8% reduction in access and IP services revenues. In this respect, during the quarter, revenues from dark-fiber and upfront capacity contracts totaled MXN 59 million compared to MXN 118 million in the third quarter of last year. As mentioned before, we expect that our current pipeline of new capacity and dark-fiber contracts to materialize until next year, and has recurrent monthly rent instead of one-time upfront revenues. Cost of revenues, excluding depreciation and amortization charges, increased 14% in the quarter, explained by a significant increase in Government segment costs. Contribution margin declined from 75% to 72% in the third quarter. Enterprise segment cost of revenues increased 6%, in line with the increase in revenues, maintaining its margin of contribution unchanged at 73%. Government segment cost of revenues almost doubled in the quarter, explained by an extraordinary benefit in this year earlier quarter related to the cancellation of excess cost provisions and also due to a large one-time equipment sales this third quarter. Contribution margin stood at 50%, in line with the margins achieved in the previous quarter. Going forward, Government segment contribution margin should be maintained close to this low 50s level. Concerning wholesale infrastructure segment customers, costs declined 11%, as dark-fiber, our capacity service revenues carry a low cost structure, thus affecting the overall margin. As we mentioned before, we're further distributing commercial and operational expenses into our 3 business segments, maintaining only finance, HR, legal and similar as general corporate expenses. Commercial and operational expenses declined 7% year-over-year mainly due to a significantly lower uncollectible provision expense in our infrastructure segment. Excluding the uncollectible provision expenses to make it comparable, Commercial and operational expenses will have increased 4% year-over-year. General corporate expenses also increased 4% compared to third quarter of last year due to personnel and rental expenses, mostly, however, below the inflationary rates we have seen in the last 12 months. Comparable EBITDA was MXN 801 million in the quarter, 1% and 5% higher year-over-year and sequentially, respectively. This improvement resulted from a 3% increase in the contribution to EBITDA from the business segments year-over-year. Comparable EBITDA in the first 9 months of the year totaled 4% higher than the same period last year. CapEx was $20 million in the quarter compared to $14 million in the third quarter of 2022. Cash balance at the end of September totaled $34 million compared to a starting balance of $35 million. Normalized cash flow was positive $6 million in the quarter, resulting from $47 million in EBITDA, $6 million in negative working capital, $20 million in CapEx and $15 million in interest expenses. Additionally, we reported $8 million net in debt movement during the quarter, $6 million loss in exchange rate forward transactions and $9 million in fees related to the senior notes prepayment and related syndicated loan transactions in July. As of the end of September, our net debt was $570 million, and the ratio of net debt to comparable EBITDA was 3.3x. With this, we conclude our presentation and are happy to open the call for questions for both Axtel and Controladora Axtel. Melissa, if you please ask participants to prompt for questions.

[Operator Instructions] Our first question comes from the line of Alejandro Azar with GBM.

Two quick ones. The first is if there is any expected payment on the Altán account? we saw impacts in the past 18 months. I was just wondering if you guys already are expecting some income coming in the next quarters? And the second, Adrian, is I'm a little bit worried about free cash flow. It seems that with CapEx and interest expenses, you have a little margin to generate operating free cash flow. I was just wondering if going forward, the expectation is that the new contracts or the EBITDA is going to help you on that front. And in regard to that question, you guys mentioned something about doubling the size of the amount of contracts in the last 9 months of 2022, would you give us more color on that? What does doubling? Is that $100 million, $200 million in new contracts? When are we going to see that revenue coming in?

Yes. Alejandro, thanks for your questions. I think we have 3 questions, we'll take the first two and probably Armando will take this one on the funnel of enterprise and government segment, that's what you were referring to, the -- double the number of net recurring revenues and pipelines in these segments. Concerning Altán, it's a relevant client of Axtel. As we have said since the beginning of 2022. We have taken a conservative bookkeeping. Basically, we reflect in our EBITDA, the amount that we received in cash. In other words, we have been financing part of the services we provide every month, that financing, it's almost concluded or was concluded in the quarter. And we will continue with this -- with the same bookkeeping, meaning that we will record the -- we will reflect in the EBITDA payments received in cash. We were seeing nothing abnormal with the customer. We have seen progress in their business plan. But again, it's customer that we do have a conservative accounting approach. Concerning cash flow, let me comment some particular lines in there. First of all, working capital in our business, it's highly cyclical or seasonal. We have a very positive fourth quarter and negative working capital throughout the first 3 quarters of the year. So if we go into our estimate for the full year, we will have approximately $42 million of normalized free cash flow, what do we refer to normalize? This year, we have some extraordinary expenses that are affecting our cash flow. In the first quarter, with the implementation of the new commercial model, we incur in $10 million in extraordinary expenses, and also in this quarter, the third quarter, we incurred $9 million in expenses related to the prepayment of the senior notes and expenses, fees and related costs with the loans that we took to refinance the notes. So that's $20 million approximately that are not recurrent. So if we consider -- if we exclude that and also the effect of -- on the foreign exchange, that's the $42 million we expect for the year. If we take those into the reconciliation well then we will have a lower cash flow this year. But again, it's mostly a non-recurrent extraordinary expenses that we had this year. So we feel comfortable with the cash flow we are generating. We said that we have a steady cash flow of close to $40 million. We had that in the last 3 years, and it's a number we do expect for this year as well, excluding those extraordinary items. I don't know if you have any questions or comments on this one.

No,no. That's perfect Adrian.

Okay. And I think Armando will take the -- your third question, Alejandro.

Thank you for your question. We are expecting new contract revenues closer to MXN 300 million, could be MXN 350 million. This metric is very important for us because it's the growth of our current base, income base. Where do we expect to get those new revenues come from? As I was referring, we have a new strategy, a new commercial and company model. And we are providing specialized solutions to certain industry verticals as we referred in my message. These solutions, we call it a Spanish [ contribution ] are related to our business lines of connectivity, cybersecurity, IT and mobile solutions. We are building, we call it the best practices in order to increase our wallet share with our current customers and to look into new ones. So this approach will give us a better understanding of our customer needs and pains, and we will put on the table, solution that had previously worked to similar customers in other parts of the country. So our growth is based on offering true solutions with very professional expertise personnel, in order to fulfill this transformation with the customers. So it's being more proactive in the way we approach them and help them to improve their P&L and their core businesses. So we expect a growth both from Enterprise and Government segment as was referred. And this will give us the foundation for the EBITDA increasing next year, Alejandro. I don't know if that's clear.

Okay. So Armando, the MXN 300 million of new contracts, and I understand this is not a guidance, we could see that in the next 12 to 18 months regardless of what happens with all the other revenues, right?

Yes. It's trying to project our tendency. So that's -- the number is approximately [indiscernible].

[Operator Instructions] Our next question comes from the line of Andres Coello with Scotiabank.

Yes. First question, I mean, are you saying that Government and Enterprise is performing better, that you have new contracts, you're also reiterating your free cash flow guidance. So I'm wondering what you're thinking for next year, what you are thinking for 2024? Adrian, do you think there is upside to free cash flow next year? Perhaps if you can just give us some color on what you are expecting? My second question is on the much stronger Government segment. If the growth is coming from federal state or municipalities? If you can just give us a little bit of color? And finally, on the nearshoring opportunity, if I heard correctly, you are reaching 800 industrial parks? That's the number I heard in 76 cities. So I'm just wondering, in your opinion, if you could perhaps quantify or if you can perhaps give us a little bit more color as to whether the increase in enterprise has to do with nearshoring, if you're optimistic about the possibility of the company actually providing services to factories.

Thank you, Andres. Yes, let me go to the first question. Free cash flow for next year, we're still working and preparing our next year budget and we will have to go through our Board for approval. But we -- in general, we expect a positive trend in -- as Armando mentioned, in the Enterprise and Government segment. We will have the challenge of interest expenses next year vis-a-vis all the -- well, the first 7 months of this year when we paid the senior notes, when we paid the coupon on the senior notes that was at the fixed rate. As you know, when we refinance the senior notes today, most of our debt is floating. So we are some extent under the effect of the still high interest rates. That will represent somewhere at this moment of an additional $4 million to $5 million in interest expenses on a 12-month basis. So that's the only headwind I can see today with respect to next year's cash flow. However, we have to prepare the entire budget and business plan and get our Board approve it before we can have the final estimates. Concerning the Government segment, Armando will share that with you.

Andres, both you were asking about federal and state government and municipalities. We are seeing better prospects and a big funnel in both. We have covered like twice the federal entities we used to cover 2-years ago. So we have doubled the opportunity there. And state and municipality related, we didn't have coverage in 10 states of Mexico. So we couldn't have funnel in those states. So with the reinforcement of the government part of Axtel, one year ago, we have been having new opportunities, new interaction with both state governments and municipalities. To give you a current data is that up to date to September, we have renewal almost 95% of our contracts with -- in the government area. That's a very good indication of the new approach we are having with both federal and state governments. And if you could please repeat your third question related to Enterprise?

Yes, as nearshoring, just if you could repeat, you're reaching 800 industrial parks in 76 cities? And this represents 92% of all parks in Mexico. But I think that more importantly, if you are actually seeing more or even the stronger growth in Enterprise is related to, directly related to nearshoring?

No. It's not related, Andres. We currently have to build the connectivity to the industrial parks, that's the thing we are right now working on. And then the foreign investors or domestic investors buy the line or they do the contract [ build to suit ] whatever option they have. And so we are looking forward to an increasing connectivity services and mostly in the second half of next year and 2025. There's a lot of land on sale and a lot of transactions as we speak. But the building phase, in my opinion, it will come for the second semester of next year. So that's when we will see an increase in funnel, not really industrial park, but within the customer of the industrial park. As we speak, we are and reaching all the industrial park managers in order to have our fiber in the premise and then to have offerings for the customers of the industrial partners.

Our next question comes from the line of Carlos Legarreta with Itau BBA.

And I have two quick ones. And I guess this one is more for your shareholders, but Armando, perhaps you can provide an update of the process to merge Controladora Axtel and Axtel? That will be the first one. And secondly, obviously, now that you refinance successfully refinanced the notes, obviously, Controladora already spun from Alfa. I was wondering what is your top priority for Axtel going into the near future? Can you just strategically -- it would be helpful to understand that.

Carlos, thanks for your questions. Concerning Controladora Axtel, the merger -- potential merger of Controladora Axtel and Axtel, it's a process that will take significant time. It will have to start by an analysis and decision and proposal from the Board of Controladora Axtel to its shareholders. Thus far, that proposal has not been presented. So that's the current status. It's a long process from the experience of the spin-off from -- of Controladora Axtel from Alfa, and that's how it will start. I should say that the top right priority for Axtel management is the commercial and operational strategy that was implemented in the first quarter, second quarter this year. We're focused on that. We're focused on the growth of the segment. And that's really where we have our time and all efforts in the company.

Let me complement, Carlos, in this new strategy for growth, sustainable growth, we have been trying to be more focused on the strength and on the opportunities in certain industry verticals. We used to have a very wide portfolio, a very wide customer base. We are not going to lower our customer base, but the growth will be based on these new opportunities on the business lines I was referring, connectivity, cybersecurity, IT and mobile services. So like Adrian was saying, the future for Axtel is becoming a trustable partner in the digital transformation of our customers. And to do that in these new solutions, in this specialized solutions, we are getting more in depth with the needs of the core processes of the customers. So we want to help our immediate contact, the IP or the CISO guy in order to help the value chain of our customers. So we want to move from being just considered as a very good supplier to a partner in the digital transformation and helping to remain that connectivity, AI and everything related to customers. So we will have a strong push in order to be more resourceful with these industries we were referring to, Carlos.

If I may follow up, I guess I'm not all too clear to why do you we require a partner for this value-added or cybersecurity services. Is it a matter of funding? Is it a matter of technology? What's the rationale behind that?

Sorry, Carlos, we cannot hear you very clear. Can you repeat your question, please?

Sure. As a follow-up of the last comment of Armando. I guess I'm not too clear into the rationale of why are you still looking for a partner for cybersecurity services? Is it a matter of funding? Is it a matter of technology? Or I mean, just what's the rationale behind that?

Sorry, Carlos, maybe I was misunderstood, that we will become a partner with our customers.

Okay. Apologies. I mean I was thinking of [indiscernible] comments, I guess, what you've said on. I appreciate the clarification.

Thank you. Ms. Llovera, that concludes the questions that we have on phone lines. At this time. I'll turn the floor back to you.

Yes. Thank you. So we have one more question coming from our webcast participants. Some of these questions have been answered already, but there is one pending regarding Controladora Axtel and Axtel CPO. So for both Axtel CPO and Controladora Axtel considering the stock price, is there a strategy of buying back shares?

Yes. Thanks, Nancy. Let me first clarify, Axtel cannot buy shares from Controladora Axtel. That's part of the regulations in Mexico, in order for Controladora Axtel to have a share buyback program, it would have to go through shareholders' meeting and approve an amount. It will have to come from accumulative net earnings. And given that it's recently created, it will have to have net earnings that at this moment it doesn't have. So that's just to clarify about share buyback in Controladora Axtel. Concerning Axtel, we have seen volatility and volume coming down to more normal -- well, I don't know if normal but to levels that it has had in the last 2 years, about 1 million shares average per day. So we think that all the volatility after the Controladora Axtel listing has settled down. And then we always are analyzing the correct timing and other factors as to whether participate or not in the market. Our priority this year has been to refinance our debt to have a new capital structure. And we're significantly advancing that with the refinancing of the senior notes, we're fine-tuning in other transactions that we expect to close towards the end of the year in that respect. And regarding share buyback, what we were always open to analyze and make decisions as to whether that is the best use of the company's cash.

Thank you, Adrian. So we have one more question. What are the prospects for the Wholesale segment for the rest of this year and next year?

I think we touched on that briefly, but let me go into a little more detail. We expect a flat behavior for the whole segment for the following year. Let me try to explain. We have our reconfiguration in our dark-fiber or capacity contracts. Most of our current funnel comes from international operators. When in the past, half of it were for domestic players. So there is a change in the way we will make the deals, and we will have more monthly recurring revenues in the near future. With domestic players that we use to recognize and register upfront these concepts, and we gradually are expecting to change into a monthly recurring revenue stream. This will have better supported growth in the future, but we don't have like big one-offs as we did in previous years. Likewise, there is a lack of deployment of 5G, as you already know for mobile operators. That could be an issue that could make a steady growth, but we have been very conservative. We are pushing our growth mostly through Enterprise and Government that I was referring in this call. So it's important to note that monthly revenues will increase in wholesale, but we will not have those one-time charges or capacity contracts that we had in past.

We have no more questions. I'd like to remind you that you can find quarter results and a replay of today's conference call on our website at axtelcorp.mx. Adrian?

Thank you, everyone, for participating today. And thank you, Melissa.

Thank you to everybody.

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.