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

Good morning. Welcome to Axtel's Third Quarter 2024 Earnings Webcast. I am Nancy Llovera, Axtel's Investor Relations and Corporate Finance Manager, and today, I am joined by Armando de la Pena, 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. We will spend a few minutes reviewing the business, and then we'll be happy to take your questions. For your convenience, this webcast is being recorded and will be available on our website. 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. And now I will hand it over to Armando.

Thank you, Nancy. Good morning to all. Axtel's performance continued improving in the quarter, posting the best results in revenue and EBITDA so far this year. Improving results in Enterprise segment revenues increasing 5% year-over-year and a strong 15% growth in Government segment revenues contribute to compensate a soft performance in our Infrastructure segment. A $7 million cash flow generation in the quarter and a 6% year-over-year growth in EBITDA reflects the benefits of the new commercial model and more agile operations in the organization. Better performance in the Government segment is driven by our strategy of diversifying opportunities with state and local entities and a more active federal government sector after a slow first semester due to federal elections in the month of June. In the quarter, revenues with state and local entities increased 68% with participation in 24 out of the 32 states in Mexico. In September, we won the public bidding process to continue supporting for another 3 years, the digital documentation of international trade in Mexico. We anticipate more opportunities to contribute in the digitalization of government processes. The commercial model implemented last year based on business lines such as cybersecurity or IT services and industry verticals enabled us to generate more business opportunities and therefore, new contracts closing. In this respect, year-to-date Enterprise segment funnel is 65% larger and acquisition of new projects, 21% compared to the same period last year. In our business line model, both cybersecurity and cloud services continue reporting solid results with 70% increases in revenue. In September, Veritas Technologies awarded Axtel as a Top Managed Service Provider in Northern Latin America. Additionally, we introduced Oracle Cloud as a managed service, adding powerful option to our multi-cloud strategy, complementing existing offerings of AWS and Microsoft Azure. We are committed to continuously improve our cybersecurity solutions. We've seen a strategic alliance with SPLUNK to manage the portfolio of intelligence, visibility and threat response through a single platform. Our objective is to expand the penetration of cybersecurity services to multiple industries. In the quarter, cybersecurity revenues increased 32% year-over-year. During the quarter, Axtel participated in Mexico Connect 2024, increasing the funnel for wavelengths and dark fiber contracts with national and international operators. These solutions to hyperscalers constitutes a relevant avenue of new Axnet business to compensate for slow fiber-to-the-tower pipeline and declining legacy services offered through global operators. Artificial intelligence is driving demand for ultra-high bandwidth, secure fiber infrastructure and significant connectivity between data centers. Axtel's fiber network of more than 50,000 kilometers nationwide and redundant connectivity to all major data centers and industrial parks represents a unique opportunity to continue to the evolution of AI in Mexico. Using web scrapping and artificial vision technique, we have managed to increase our operational efficiency, customer satisfaction and reduce the risk of human error. Critical validations that previously required human intervention 48 times a day are now executed 30,000 times automatically. Diligent operators, out-of-the-box thinking and an agile workplace environment are enabling us to better service our clients and convert proposals into revenues faster. Performance continued improving in our Enterprise and Government segments. Web links, data center connectivity, fiber to the hyperscalers and AI have improved the funnel and perspectives for our Infrastructure segment business. Additionally, prudent management and cost controls have enabled us to improve margins, generate cash flow and continue deleveraging our balance sheet in the best interest of customers, shareholders and stakeholders of Axtel. Now I will pass it to Adrian to explain the next [indiscernible].

Thank you, Armando, Nancy, and good morning to all participants. As of September, we maintained foreign exchange forward representing approximately 30% of our committed 6-month forward dollar obligations. In August and September, we did not enter into new hedging transactions and volatility increased significantly. We remain vigilant to resume our rolling cash flow hedging strategy while proactively managing the trade-off between risk mitigation and its respective impact in our cash flow. In the year, we have invested MXN 41 million, acquiring 30.6 million AXTELCPOs at an average price of MXN 1.34. After the quiet period due to our quarterly report, we will resume our share repurchase program. In our view, the stock price valuation does not reflect the positive cash flow generation, improving business performance and balance sheet delevering in Axtel. Let me now move on to review our financial results for the third quarter. Third quarter revenues increased 3% year-over-year. Enterprise segment revenues increased 5% in the quarter, explained by the combined 12% improvement in digital transformation and system integration services revenues. Digital transformation revenues overall was supported by a 17% increase in cloud and cybersecurity service revenue. Legacy voice revenues declined 12% in the quarter, coming down to represent 7% of total Enterprise segment revenues, compared to 9% in the third quarter of last year. Excluding voice, standard enterprise services revenues would have increased 5% year-over-year. Government segment revenues increased 15% year-over-year, driven by a 21% improvement in recurring service revenues. Year-to-date, recurring service revenues increased 27%, mostly by value-added and digital transformation services revenues. Non-recurring revenues slightly increased 1% compared to third quarter of last year. This third quarter, the revenue mix was 46% federal and 54% state and local entities. Revenues from wholesale infrastructure segment as net customers decreased 12% year-over-year impacted by non-recurring upfront capacity contracts and a 53% decline in continuity services from the 2019 mass market divestment. Excluding these continuity services and non-recurring upfront capacity services, revenues increased 4% year-over-year. Third quarter cost of revenues, excluding depreciation and amortization charges, increased 9% year-on-year due to an increase in Government segment costs. Contribution margin declined 1.6 percentage points year-over-year. Enterprise segment cost of revenues increased 4%, less than respective increase in revenues. Government segment cost of revenues increased 29% due to a margin contraction in recurring revenues related to a higher proportion of system integration services which have lower margins compared to standard and digital transformation services. Concerning wholesale infrastructure segment customers, costs increased 10% related to third-party services. In respect to expenses, all commercial and operational expenses are distributed within the 3 business segments, while corporate or central expenses remain unallocated. In the quarter, commercial and operational expenses remained flat year-over-year as lower uncollectible provision expenses compensated increases in personnel and tower rent. General corporate expenses declined 13% compared to third quarter of last year, reflecting the benefits of rightsizing implemented in the last quarter of last year and the transfer of certain staff expenses to business units. EBITDA was MXN 845 million in the quarter, 6% higher than EBITDA recorded in the same quarter of last year. The growth in EBITDA resulted from a 2% increase in business segment's contribution and a 13% improvement in general and corporate expenses. CapEx in the quarter was $18 million compared to $20 million in the third quarter of last year. Cash balance totaled $70 million at the end of September compared to a starting balance of $67 million in July 1. Cash flow was positive $7 million in the quarter, resulting from $45 million in EBITDA, $4 million in negative working capital, $18 million in CapEx and $16 million in interest expenses. Additionally, we recorded $3 million net in debt reduction and $1 million in share buybacks during the quarter. As of the end of September, net debt was $530 million, and the ratio of net debt to EBITDA was 2.8x or 2.6x net debt to comparable EBITDA. This compared to a 3.3x ratio a year ago. With this, we conclude our presentation and open the call for questions concerning both Axtel and Controladora Axtel. Nancy, please go ahead and open the webcast for questions from participants.

Thank you. At this time, we will be taking your questions. [Operator Instructions] Our first question comes from Carlos de Legarreta with Itau BBA. Carlos, please proceed with your question.

So I have 2 questions from my end, please. The first one is regarding the possibility or if there's any developments regarding the potential merger of Controladora Axtel and Axtel. I know that's a question for the shareholders more than the management, but would be great to hear something. And then secondly, perhaps for Adrian. I'm a little confused because I see, let's say, your year-to-date CapEx seems to be very much on track to reach the guidance, yet the top line performance seems to be -- if I analyze the year-to-date performance, it looks like it's going to be at least 10% below the guidance that you provided. So I don't know if it's just an issue of collections or maybe you expect a very strong fourth quarter. Maybe you can help us understand a little bit that disconnect?

Good morning, and thanks for your question. About the potential merger of Axtel and Controladora Axtel, we have no update or nothing new from our last conference call. As we said before, this is a decision to be made by Controladora Axtel shareholders from a recommendation of Controladora Axtel Board and thus far, we have no knowledge that there is an active process in that respect. We have seen less volatility in both Controladora Axtel and Axtel shares in recent quarters compared to last year. So one of the concerns, which was that the trading between the two, at least in terms of volatility has declined a little bit. So again, there is no update in this respect. And about CapEx and results for the full year. Right now, we have a CapEx estimate for the year that probably will be 4% to 6%, 7% less than our guidance. We estimated $78 million in CapEx at the beginning of the year. Right now, we're about 4% to 6% less in our outlook in terms of CapEx. And that, to some extent, goes in line with more your comment concerning year-to-date revenues or results. I have to say that the fourth quarter has been always a strong quarter or most of the times is a strong quarter in terms of results. We are a company that works in -- well, many of our services are provided in contracts, in 3-, 4-, 5-year contracts that accounting-wise, or projects that we use provisions, for example, that at the end of the year, we go in detail as to whether the provisions we have made will -- are in line or we have other provision. So that sort of extraordinary items, among others, help us to have usually a strong fourth quarter. As a reference, over the last 4 years the average of extraordinary items, most of the time reported in the last quarter, it's MXN 235 million. So that's a number. I'm not saying that we will have that number in the fourth quarter in extraordinary items. But gives you an idea that the fourth quarter helped us to catch up with their guidance usually.

That's very clear. And maybe as a follow-up. Is there any kind of threshold or target that perhaps Controladora's shareholders are looking for or waiting for? Is it an operational issue? Or I don't know -- is there something that could help us understand the potential timing of this transaction eventually materializing?

Carlos, we're not aware of any metrics or targets that would trigger a yes or no about a merger. So it's not any sort of KPI or action, particularly on us that could trigger a potential merger.

Okay. I appreciate your comments.

Let me complement on that one, Carlos. As we have stated in the calls, we are focusing on getting to our guidance, our financial KPIs and the transformation of Axtel to be a more customer-oriented, agile organization and specialization solutions. So our effort and our strategies are mainly focused on that. And when we get some information, we will properly communicate it to you. You have our commitment on that.

[Operator Instructions] Our next question comes from Alejandro Azar with GBM. Alejandro, please go ahead.

My question is simple. There's been a lot of news flow and rumors about Altan CFE restructuring the company and the debt and if I'm not mistaken, you guys are -- have collectibles with them. I'm just wondering if according to the rumors, if you guys are already finished with that account receivable and you'll be making the corresponding collections in the next couple of quarters or the next 12 months?

Alex, this is Adrian, and thanks for your question. Altan, it's an important client of Axtel. And as all clients, we don't disclose particular details. But I can tell you, and it's been in the press that, as you said, Altan has been in a process where potentially CFE will take over. That's something that Axtel as a shareholder, as an important provider of connectivity has been involved in all the legal aspects of it. But thus far, that's the status of the process, nothing has been materialized as of today. We continue providing connectivity to Altan. Altan has been paying on time for -- since it came out of the Concurso Mercantil. We have no issues on collections, our services continue to be provided with the highest standards in terms of quality. So yes, there is the process that you mentioned as has been made public in the press, but nothing concrete as of today that we can share.

Thank you, Adrian. So the -- let's say, the extraordinary income for the fourth quarter has nothing to do with this. So...

Yes, this is Armando. Not at this moment, we are not considering any extraordinary income with that. We are very -- I can -- conservative in the way we forecast our quarters. But let me add that with Altan we have long-term contracts, that they end by 7 to 10 years now. We don't see any big impacts in those contracts and any big or structural changes in the way Altan serve their customers as a part of CFE. As Adrian was saying, we have been collecting all payments on time. So our relationship with Altan is more holistic as a provider, as a customer and as a shareholder. But when we have information that we can share, we will do it.

Thank you. We have some questions from the Q&A function. And the first question is considering the business line model implemented more than a year ago, how has it worked so far?

Yes, let me give that one, Nancy. The business line model, it's in, I can say, ramping phase. We reassigned like 6,000 customers in the sales force to have a specialized commercial executives and specialists to serve those customers that was made on the first quarter of this year. So we are still looking at the advantages that this model is having. We are being more present with those customers and getting close to them to understand their pains and their needs. And so we are conducting several meetings and processes to get more detailed information of the type of solutions in our business lines, cybersecurity, IT, cloud, telco and mobility. So I can tell you that we are in the first stages still. We have been, as you saw, having the first results with the increasing cybersecurity more than 30% and close to 20% also in cloud services. So I think we have in place the right strategy, but it's a never-ending story. So that's the strategy to help us to meet our objectives, and we will see more results in the future. I'm sure of that.

Thank you, Armando. Our next question comes from Leonardo Curtidor with Scotiabank. Leonardo, please go ahead.

Just to confirm on [indiscernible] question, going back to it. Can you please -- could you disclose how much do they owe you or how much is in your accounts receivable? And I guess, if you're willing to take the discount from the reports of the press that the federal government is offering to pay 10% of the debt owed. I know you already answered this but [indiscernible]

Yes. ado, thanks for your question. This is Adrian de los Santos. As we disclosed in our financial statements, when Altan went into Concurso Mercantil, Axtel's debt that went into the Concurso Mercantil process was about MXN 385 million. That's the amount that we have under Concurso Mercantil. We also have been a shareholder of Altan since its inception. And with respect to terms and conditions, it's part of our customer provider relationship as part of a process that, unfortunately, we cannot disclose details as you're asking.

Thank you. We have another question from the Q&A function. You mentioned that with artificial intelligence, hyperscalers will demand a lot of bandwidth. When can we expect this to be reflected in the company's results?

Let me get that one. There has been a lot turmoil about artificial intelligence and the data centers that are installing in Queretaro and in other places of Mexico. As you know, artificial intelligence needs a lot of energy, both for processing the information and to put the data centers and to make the right conditions, temperature conditions. So the amount of energy needed is a lot. So the development and the growth of data centers that are needed to process artificial intelligence, depends a lot of the energy availability that there are. I have heard that in Queretaro, some of the data centers hasn't been operational and mainly because of that issue of energy. Nevertheless, saying that, we have been participating in some investments that have been -- are being asked to connect Queretaro with the border in order to get into the data centers in the U.S. As you know, the capacity needed for that network, it's very important. And there are mainly 2 routes that are with a lot of demand. One is from Queretaro to the border, both Laredo and McAllen and the other goes to the coast to the Gulf of Mexico, Veracruz and Cancun to get to submarine cable to the Florida and Georgia. We are participating in some of those proposals. And also, we have 50,000 kilometers of fiber and metropolitan rings that will also help to that communication. I see the benefits mostly in the next year, maybe second quarter and third quarter, but mostly depends on what I was telling you about energy. I think also in telling -- artificial intelligence is being used internally to improve our customer satisfaction. We have a lot of robots and digitalization of processes that will -- is helping us as well to serve our customers, not just as a provider of infrastructure. To give you just an example, some processes that has to be executed manually, we could reach to, I don't know, something around 40 times a day. Now we can do it like 300 times without any human intervention like we had example, there's several within the company. So artificial intelligence is here to stay, it's in the early phases. There's a lot of analysis on the real benefits and the cost benefit solutions place. So there will be some -- so there will be a lot of demand for next year. That's my bet.

Thank you, Armando. We have another question and do you have tax losses to be amortized? If so, how much are those losses?

Yes, Nancy. We have give or take at the end of the third quarter, approximately MXN 3,600 million in tax losses. These are not due in the short term. So -- so this is an asset that we value because it helps us to optimize our effective cash flow.

Thank you, Adrian. So regarding the share buyback program, AXTELCPO price should be a lot higher with the results and guidance. How much capital are you planning to allocate on your stock repurchase program for the remaining of the year?

We totally agree that the share price does not reflect the performance, the improvement in our balance sheet, the trends in our business segment, government and the turnaround we're starting to see or we expect to see in wholesale. We have a share buyback program that's $100 million and we have used $40 million thus far. So we have the capacity remaining, it's $60 million. As mentioned, we will resume our participation in the market after today's call. And we try to support and acquire the stock, given its significant undervaluation. We also want to have the market to rubber stamp the value and the price as we try to improve it. And that's part of the day-to-day strategy that we continue and do every day. Just to clarify, the share buyback program is MXN 100 million and we have used 40% of it thus far.

We have another question from the Q&A function. Regarding your yearly revenue guidance, are you still confident you will reach it? So we mentioned about EBITDA, and this is about revenue guidance.

Well, revenues in the fourth quarter, we were optimistic about performance. We're seeing, as reported in our results, the government is gaining traction. We're very happy about it. Enterprise segment also usually have a larger amount of non-recurring transactions in the fourth quarter. That also helps revenues. And Axnet, we think that the fourth quarter vis-a-vis fourth quarter of last year will be better than what we have seen in the 3 previous quarters. So we're optimistic about the fourth quarter. Whether in terms of revenues, we could reach the guidance, that's still challenged. As we said before, the extraordinary items usually complement results and most of the time come in the last quarter of the year.

Thank you, Adrian. There are no further questions at this time. Thank you all for your interest in Axtel and joining us today. Should you need any further information, please reach out to us. Have a great day.