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Edited Transcript of GTT earnings conference call or presentation 3-Aug-18 12:30pm GMT

Q2 2018 GTT Communications Inc Earnings Call

MCLEAN Aug 15, 2018 (Thomson StreetEvents) -- Edited Transcript of GTT Communications Inc earnings conference call or presentation Friday, August 3, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher T. McKee

GTT Communications, Inc. - EVP of Corporate Development, General Counsel and Company Secretary

* H. Brian Thompson

GTT Communications, Inc. - Founder and Executive Chairman

* Michael T. Sicoli

GTT Communications, Inc. - CFO

* Richard D. Calder

GTT Communications, Inc. - CEO, President and Director

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Conference Call Participants

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* Brandon Lee Nispel

KeyBanc Capital Markets Inc., Research Division - Research Analyst

* Frank Garrett Louthan

Raymond James & Associates, Inc., Research Division - MD of Equity Research

* James Dennis Breen

William Blair & Company L.L.C., Research Division - Communication Services Analyst

* Jason Michael Kreyer

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Jonathan David Charbonneau

Cowen and Company, LLC, Research Division - VP

* Michael L. McCormack

Guggenheim Securities, LLC, Research Division - MD & Telecommunications Senior Analyst

* Scott Goldman

Jefferies LLC, Research Division - Equity Analyst

* Walter Paul Piecyk

BTIG, LLC, Research Division - Co-Head of Research and MD

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Presentation

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Operator [1]

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Good day, and welcome to the GTT Communications Second Quarter 2018 Results Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Chris McKee, General Counsel and EVP of Corporate Development. Please go ahead.

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Christopher T. McKee, GTT Communications, Inc. - EVP of Corporate Development, General Counsel and Company Secretary [2]

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Thank you, and good morning. I'm joined today by Rick Calder, GTT's President and CEO; Mike Sicoli, GTT's Chief Financial Officer; and Brian Thompson, GTT's Executive Chairman of the Board.

Today's discussion is being made available via webcast through the company's website, www.gtt.net. The telephonic replay of this call will be available for 1 week. Dial-in information for the replay as well as access to a replay of the webcast is also available on our website.

Before we begin, I want to remind you that during today's call, we will be making forward-looking statements regarding future events and financial performance made under the safe harbor provision of the U.S. securities laws, including revenue and margin expectations, projections, and references to trends in the industry in GTT's business.

We caution you that such statements reflect our best judgment as of today, August 3, based on factors that are currently known to us, and that actual future events or results could differ materially due to a number of factors, many of which are beyond our control.

For a more detailed discussion of the risks and uncertainties affecting our future results, we refer you to our SEC filings.

GTT disclaims any obligation to update or revise these forward-looking statements to reflect future events or circumstances.

During the call, we'll also discuss non-GAAP financial measures, including certain pro forma information which were not prepared in accordance with GAAP. A reconciliation of our GAAP and non-GAAP results is provided in today's press release and is posted under the Investor Relations section of our website.

I'll now turn the call over to Rick Calder. Rick?

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [3]

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Thank you, Chris, and good morning, everyone. Second quarter 2018 marked an important strategic milestone for GTT. We delivered revenue and adjusted EBITDA growth of 72% and 40% from last year, respectively, and we closed our largest strategic acquisition, Interoute, at the end of May, on the early end of our expected timeframe. Through the addition of Interoute, GTT has nearly doubled in size with the most comprehensive and competitive global cloud networking platform in the industry, serving a significantly larger base of marquee multinational clients with a tremendous global team. We immediately began executing across the 3 dimensions of integration, including organization, systems and network, which we expect to complete within 3 to 4 quarters, if not sooner. We will complete the organization integration phase by the end of August, 90 days post-close, and we further expect substantially all of the corresponding reductions to be completed by year-end. We expect to complete the majority of systems and network integration by year-end as well.

During the quarter, we also completed our integration of Accelerated communication, extending GTT's market presence and unique network footprint in Canada.

In terms of future M&A, we may consider a smaller deal in the second half of 2018, but we will hold on any larger strategic acquisitions until next year after we have completed the Interoute integration. Our pipeline of potential large and small deals remains robust, particularly given our enhanced presence in Europe. Going forward, our target selection criteria remains the same, to find opportunities that fit our strategy of providing cloud networking services to large and multinational clients that can be integrated quickly and that can be acquired at highly accretive post-synergy prices.

Moving to rep-driven growth. On the legacy GTT side, we have approximately 190 quota-bearing reps, and the combined sales force now stands at well over 300 reps. We will continue hiring additional reps in the second half of this year and beyond, consistent with our prior plan, as we target double-digit growth from a combination of rep-driven sales and small acquisitions.

We have revised our division structure in connection with Interoute, now consisting of 5 divisions, Americas, Carrier, U.K., Europe and SMB. The Americas and Carrier divisions serve Enterprise and Carrier clients in North America respectively, and the U.K. and Europe divisions serve both Enterprise and Carrier clients in their respective territories. SMB serves our lower-MRR clients across all geographies.

Since moving to our division structure last year, we have consistently grown total sales as well as rep productivity, both of which reached record levels in the second quarter, and we remain very bullish about growing the scope and scale of our sales force going forward.

GTT's greater scale and brand awareness is coming at a great time, as many clients are evaluating the move to software-defined wide-area networking or SD-WAN. GTT is uniquely positioned to succeed with SD-WAN, given our Tier 1 Internet backbone, our deep experience offering diverse cost-effective local loops to any location in the world, and our track record of installing, managing and maintaining over 100,000 managed equipment services worldwide. We have a healthy funnel of SD-WAN opportunities and are starting to see increasing traction and order flow as enterprises transition from the trial phase to adoption.

For example, we signed a contract with Nilfisk, a large supplier of professional cleaning solutions headquartered in Denmark, for a 120-site SD-WAN global deployment to improve the efficiency and performance of their network infrastructure to run their cloud applications. We are implementing a 274-site SD-WAN service for a large retail clothing company in the U.S. to support a more interactive in-store experience using digital technology. GTT's PCI-compliant network and flexible offering were the key differentiators that edged out the competition for this business, demonstrating how our portfolio positions us to win.

In addition, we also won an SD-WAN service contract with a large supplier of measuring and monitoring technology serving the manufacturing industry. This client is deploying a GTT-managed SD-WAN service across 45 sites in the U.S. to reduce the complexity of its network operations. These examples, which are a subset of our SD-WAN order flow, are indicators of the massive potential that we see for SD-WAN across industries and geographies, and we remain very confident in GTT's competitive positioning to be a leader in this space.

A few weeks ago, we were also pleased to announce that we were awarded a contract by the Defense Information Technology Contracting Organization or DITCO, the contracting arm of the Defense Information Systems Agency, to provide telecom services in Afghanistan. This contract award builds on our established track record of providing telecom services to the U.S. military and reinforces the fact that GTT has unique network assets and service capabilities to serve the stringent requirements of large government organizations for high-performance secure connectivity to locations around the world.

In the second half of the year, we are focused on our 2 main priorities: completing the Interoute integration and delivering rep-driven growth. We are well positioned to succeed on both fronts as the disruptor brand in the multi-hundred billion dollar cloud networking services market, providing our clients with a significantly better experience compared to the incumbent telcos, as we fulfill our purpose of connecting people across organizations around the world and to every application in the cloud.

With that, I will turn the call over to Mike to provide more details on the numbers. Mike?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [4]

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Thanks, Rick. Second quarter revenue grew 72% year-over-year and 25% sequentially to $327 million. Second quarter adjusted EBITDA grew 40% year-over-year and 20% sequentially to $75 million. Our growth was driven by acquisitions, with Interoute and Global Capacity having the largest impact. On a pro forma basis, including both Interoute and Global Capacity in prior period results and in constant currency, revenue grew 1.2% year-over-year and decreased 0.6% sequentially, while adjusted EBITDA grew 0.7% year-over-year and decreased 3.1% sequentially. The sequential pro forma revenue decline was due to a combination of factors, including Interoute's pre-close trajectory as well as a onetime increase in churn from 2 large clients and lower nonrecurring revenue on the GTT side. The sequential pro forma EBITDA decline was driven by the revenue decline I just noted as well as higher cost of revenue due to some integration-related delays in disconnecting certain vendor services and higher SG&A due to continued investments in rep-driven growth.

As we noted in prior calls, we were not expecting to see growth in the first half of the year, given the trajectory of our recent acquisitions, though, as Rick mentioned, we're still targeting revenue growth in the second half of the year as well as significant margin expansion as we realize synergies from our various acquisitions. We estimate that there's approximately $15 million of annualized adjusted EBITDA not yet realized in our reported results from cost synergies related to acquisitions prior to Interoute, plus the additional $100 million to be realized from Interoute per our previous comments.

During the quarter, we incurred $8 million of transaction and integration costs related to the Interoute acquisition, which are included in our reported SG&A but excluded from adjusted EBITDA. We also incurred $5 million of exit costs, primarily related to Interoute. Over the next few quarters, we expect to incur an additional $45 million to $55 million in exit, transaction and integration costs related to Interoute, which would bring the total to $60 million to $70 million, $10 million lower than our prior estimate.

In addition, we recognized a $14 million loss on the extinguishment of debt and an $89 million loss on a foreign currency hedge, both related to Interoute. We entered into the currency hedge at the time we announced the Interoute deal, which we felt was a prudent move to ensure certainty of funds flow, and rates happened to move lower between signing and closing. From an accounting standpoint, this shows as a loss, but from a cash standpoint, there is minimal impact compared to our expectation of the cost of the deal at announcement. Collectively, these nonrecurring costs drove our second quarter net loss to $136 million compared to net income of $1 million last year and a net loss of $31 million last quarter.

Capital expenditures in the quarter were $19 million or 6% of revenue compared to $9 million last year and $13 million last quarter. We continue to expect our CapEx to be approximately 7% of revenue going forward including Interoute.

During the quarter, we paid $2.3 billion in cash for Interoute. As previously discussed, the debt portion of the consideration was financed through a new $2.9 billion credit facility, comprised of a $1.8 billion U.S. term loan facility, a EUR 750 million EMEA term loan facility and a $200 million revolving credit facility, which together replaced both the prior GTT and Interoute facilities. The equity portion of the consideration was comprised of $425 million in GTT stock committed by Spruce House, Acacia and Aleph Tiger investors.

At quarter-end, our cash balance was $74 million and our outstanding debt balance was approximately $3.3 billion, comprised of the senior secured facilities I just mentioned and $575 million of senior unsecured notes already outstanding. We had $186 million of availability under our revolver, net of $14 million in letters of credit issued.

Our net leverage ratio in the second quarter was 5.6x using pro forma combined trailing 12-month adjusted EBITDA, including all acquisitions and expected cost synergies in prior periods. Over time, we continue to expect to reduce leverage to our long-term target range of 3 to 4x through growth in adjusted EBITDA and cash flow generation.

In summary, we continue to execute against our growth plan, including rep-driven and M&A, and while there's still a lot of work to do on both fronts, we look forward to a strong finish for the rest of the year.

This concludes our prepared remarks. And now we'll open up the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Walter Piecyk of BTIG.

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Walter Paul Piecyk, BTIG, LLC, Research Division - Co-Head of Research and MD [2]

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Mike, if I look at the sequential decline on a pro forma basis, I think you said, it's like 0.6%. But then you look at Interoute and it's down, I think it was about 2% in a constant-currency basis. So I know Global Capacity has had some issues. But I mean -- I guess, the math on that would say that the rest of the business grew sequentially. Is there something in the math that I'm doing there that's wrong that would suggest that the overall business is in decline sequentially?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [3]

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Sure. So we don't break out the results of the different acquisitions after the deals have closed, obviously, as you know. But the...

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Walter Paul Piecyk, BTIG, LLC, Research Division - Co-Head of Research and MD [4]

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But the Interoute stuff is effectively provided though, right? In terms of -- what was -- it's 2 months, it's $134 million. That business, I think, was down 2%. If that's down 2% and the overall business was only down 0.6%, then the rest of the business should've -- that implies growth for the rest of the business sequentially, no?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [5]

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Yes. I understand the question. The -- I'm not sure where you're getting the 2% on the Interoute piece. I think that the Interoute piece was a portion of that sequential decline, and there were also some impacts from the legacy GTT part of the business as well as I noted, between the 2 specific churn events that won't be repeating in the future. And also, nonrecurring revenue is lumpy by definition, and in any given quarter could be plus or minus a couple of million. And it just so happened in the first quarter, it was on the little bit of the higher side and the second quarter it was a little bit on the lower side. So those all came together to create the 0.6%.

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Walter Paul Piecyk, BTIG, LLC, Research Division - Co-Head of Research and MD [6]

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And can you give us a little bit more color on the 2 churn events? Was this -- maybe I missed out in the prepared remarks. Was that a bankruptcy? Was it a nonrenewal? Did the salesperson originally responsible for that leave the company? Like, any type of color. And do you have any possible events like that that's coming up in the quarters to come?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [7]

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Yes. So in one case, it was 2 clients merged and they reduced their spend, as happens sometimes. And then in the other case, there was a CIO change and the business came out of term, and the CIO had an existing relationship that was not GTT and moved the business over. We're not aware of anything on that magnitude going forward, at least not at this time.

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [8]

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Yes, and it's Rick, Walt. A couple, sort of, comments in general. I mean, it is -- we've been saying over the past couple of quarters, we did not expect growth. We probably grew a little bit into the first quarter, but we did not expect growth in the first half of the year, given the trajectory that we saw from both Global Capacity and Interoute. Where we are today, given at the end of this quarter into July and August, we see that actually changing. And so moving forward, we have actually our largest backlog, defined as sold but not installed, at this stage across both the legacy GTT and the legacy Interoute base. Our productivity, as we noted in the prepared remarks, is the highest we've seen. And so we've also seen sort of the decline. Most of the businesses that we have purchased have declined. And one of the things we've been able to do is stop the rate of decline and then start the growth. And so in the second half of the year, we see our business growing. We see the net trend of month of recurring revenue installations growing into the second half of the year as we complete the integration of both -- of Interoute and sort of the final legacy integrations of the previous deals.

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Walter Paul Piecyk, BTIG, LLC, Research Division - Co-Head of Research and MD [9]

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Got it. And then just last one, which is, obviously, Interoute took a lot of time and money this quarter. Is this trough EBITDA margins? Should we expect sequential growth in EBITDA margins from here? Are you giving us any sense on where you think you'll exit this year or next in terms of EBITDA margins?

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [10]

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Yes, definitely. I mean, we see probably a short-term issue we talked about with cost of revenue and integration and just taking it out. We generally, as we actually integrate businesses in, fight with our vendors about taking cost to revenue out that's not real. And so there's overlapping cost of revenue. We have identified it. We are now in the process of disputing and taking it out of our business, disconnecting it and disputing, actually, the tails of some of those spends that we have with vendors, and we absolutely expect our gross margin and our EBITDA margin to continue to uptick. In terms of exact pace, we'll report that in future quarters. But we see no reason why this business cannot grow to a 50% gross margin business in the near term, the mid-term and that, as SG&A continues to come down as a percentage of revenue to the 20% range, that the EBITDA margins in our business can grow, as we've mentioned in the past, to 30%.

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Operator [11]

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The next question comes from Jon Charbonneau of Cowen.

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Jonathan David Charbonneau, Cowen and Company, LLC, Research Division - VP [12]

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In terms of Interoute, would you call out anything surprising, particularly as you work through the integration in the past few months? And any change in how we should be thinking about the longer-term sales rep-driven growth pro forma for Interoute going forward?

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [13]

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Jon, well it's -- last call we -- we're head -- we're about a month before close. I've spent a lot time with it. In another 3 months we close, as we mentioned, on the early end. And I have gotten that question from lots of folks actually privately, and the short answer is, no. I mean, we think the combination of these 2 businesses creates a fantastic opportunity. We saw an interesting trend where a pre-close, a lot of clients had held purchase orders in terms of not signing prior to the close. Immediately after the close, we got a significant number of really big sales wins on the Interoute side. I think there was some trepidation about what would happen to the business if we were not to close, and that we heard directly from the large CIOs saying we think the combination of the 2 businesses is even a more compelling player for us, and 2 of those were very large SD-WAN transactions that we didn't disclose in the prepared remarks but were both in Europe, big multi-site locations for big food processing companies. We also had 3 major renewals, 3-, 4- and 5-year renewals from clients who just really are very excited about the potential across the 2 companies. We're also starting to see the early opportunities on the cross-sell across to the U.S. One of the, obviously, Interoute's biggest weaknesses was the inability to serve sites effectively in North America. And we've started to see that dialogue with clients who say, "Well, we hadn't given you our locations in North America to bid. We'd like to do that moving forward." So in terms of performance and productivities, we've put the businesses together. We saw record productivity. So we want to continue to grow the scope and scale of the sales force. We didn't give you a specific number on the total sales reps for the entire company. We're well over 300. We're actually sorting between quota-bearing client reps and support client account managers and determining that we'll have a very precise number on the next call and then we'll grow from there. We do expect to be able to grow throughout Europe. We have never had a real, sort of, presence in Europe. We mentioned that we appointed a new leader, Jesper Aagaard, who came to us from Interoute to run Continental Europe. And we think it's an area that we should be investing in moving forward.

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Operator [14]

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The next question comes from George Sutton of Craig-Hallum.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [15]

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It's Jason on for George. Rick, you touched on this a little bit. But just wondering if you can give us some details on how you move forward with the cross-sell opportunities. What are the steps that you take with the sales force? And then is it all focused on geographic expansion? Or are you also focused on adding additional services?

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [16]

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Sure. Great question. Thank you, Jason. One of the things that we find in this interregnum period, we call it, before we integrate the systems, is that every rep in the company is interested in cross-selling and getting access to not only the services, the service portfolio, but really the reach and the depth of the suppliers and the depth of the network we have everywhere else. And which is why we focus so rigorously on cutting over to one systems infrastructure, which we have planned now for the 1st of October. We believe we're on track towards that to allow the company to operate in one global system with access to the full reach of the network everywhere in the world, all of the Points-of-Presence, all of the network interconnects to our local loop providers everywhere in the world and have one consolidated service platform across the world. So there's only a couple of months before that, right? So we think we're there. We do -- and as every good rep is -- want to do, say how do I do it today? So we do have a group that handles those. And they're very busy, right? Because we're seeing, as I mentioned just a second ago, we're seeing that interest from both sets of clients, some legacy clients in the U.S. who have deeper reach and opportunity in Europe. And clearly, the Interoute clients who are very interested in getting quotations and delivery for services into the Americas. So -- but the key focus on the cross-sell is to get the systems integrated, and then we think that we'll see real upside opportunity in terms of productivity and sales, even above the record levels that we've been at today. In terms of depth of services, to your other question, generally we sell the same thing. So we think 95% of what Interoute did was exactly what we did. There's a little bit of overlap in cloud services or additional services in cloud services. We're setting up an advance solutions group to continue to support the cloud service business. It's sold to some really great marquee clients, and we want to continue to grow that part of the advanced solutions business. So we see some opportunity to cross-sell and upsell there. However, we think the core business that we're in, cloud networking services, is very similar across the 2 platforms, which is why we thought it was a fantastic deal for us.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [17]

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Okay. One quick follow up. You talked about the DITCO contract that you had recently won. I believe that's part of the GNS contract that we had talked about a year or so ago, and it seems like that contract has moved a little bit slower than we would've expected. So just wondering if you have any sense or if you're hearing anything on some developments out of that GNS deal?

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [18]

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Correct. It did. That service came out of the global network services, which are serving the U.S., some military need outside of the continental United States. And we do -- and it was slower, you're correct. It's slower than we originally anticipated. However, we have a nice funnel of opportunities there. We were actually seeing -- some of our best performances is actually coming from the government sector right now, and we're very competitive for a whole series of bids that are coming out of the GNS contract. And clearly, the business that we just acquired with Interoute and the deep access in network that is outside the U.S. positions us perfectly, we think, to be the winner in many of these upcoming bids.

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Operator [19]

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The next question comes from Mike McCormack of Guggenheim Partners.

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Michael L. McCormack, Guggenheim Securities, LLC, Research Division - MD & Telecommunications Senior Analyst [20]

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Mike, I think you mentioned earlier in the prepared remarks, in addition to the churn you had installation issues. Can you just sort of give us a sense for what that was? And then secondly, with Century, Level 3 coming together, just from maybe competitive standpoint but also from a sales talent standpoint, any pressure you're seeing because of that transaction and any activities they're up to?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [21]

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Sure, Mike. The -- I didn't say anything about installs, I mentioned something about integration-related delay which was impacting cost of revenue. And that's what Rick was talking about earlier when he said there's a little bit of overlapping costs right now that we haven't yet taken out of the business but we expect to in the next couple of quarters. So no, it was not installs. And I'll let Rick answer the other one.

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [22]

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Yes. I mean, we have always thought of Level 3 and now with CenturyLink as one of the sort of closer comparables to our business in terms of selling cloud networking services to large multinationals. And we are seeing opportunity there. We -- we've always felt that we are a great brand for great talent to join and that our purpose is powerful in helping large corporations help connect their people across their organizations around the world. And we are seeing that flow. And we continue to recruit and attract some of the best sales talent and support talent in the industry. And some of it is coming from the firm you mentioned. And we get it from other places as well. So we clearly see opportunity. Not only for talent, we see opportunity for business. We're seeing opportunity from large corporations who're saying, "Yes, we're not as happy with the incumbents, whether it's CenturyLink or any of the other incumbents, BT, AT&T, et cetera." Particularly, the other ones as they focus their business much more on other things, specifically mobile and content services, media. And so we're seeing an opportunity to attack what is a multi-hundred billion dollar business and being the small player and having a great combination of a better value proposition with a Internet-based SD-WAN solution with a fantastic team of people that can deliver and live our values of simplicity, speed, agility and give them better value in terms of, ultimately, price, which is really the third criteria that people really think about. So that -- I think that really is showing in our results in terms of the increasing performance of our sales force and the ability, as we grow the number of reps, to keep productivity per rep growing. And which is unusual. Usually, productivity per rep declines versus grows as you grow reps, and we're seeing it grow. So again, probably the biggest limiter for us in -- well, it actually continues to attract. So we're very aggressive in trying to attract the best talent in the industry.

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Operator [23]

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The next question comes from Scott Goldman of Jefferies.

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Scott Goldman, Jefferies LLC, Research Division - Equity Analyst [24]

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Just following up. First, on the integration-related delays. Just sounds like that's timing. Is there anything you need to do specifically to address that or is that just a function of timing? And related to that, doesn't look like from what I can see in the slides that there is any real change in terms of the long-term synergy for all the deals included, but just want to confirm that. Secondly, Mike, maybe you can just talk a little bit about the timing in terms of when you think you can get to your leverage target.

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Michael T. Sicoli, GTT Communications, Inc. - CFO [25]

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Okay. I'll...

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [26]

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I'll take on the cost of revenue. No, that's just a timing issue, absolutely. So we have identified the specific segments that we need to take out of our business and we, as I just mentioned, we're tussling with the vendors who claim that they weren't disconnected and we're disconnecting them. So we're taking them out, and we expect that to show, as I mentioned earlier, increasing gross margin flowing down through to EBITDA margin, and we expect to complete most of that over the next couple, several quarters as we actually complete those integrations and then layer on top. And we think we could do a lot of it this quarter because in fourth, once we integrate CMD, fourth quarter, first quarter really is the work of making sure that we've totally integrated the Interoute business as well. But no, absolutely just timing.

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Michael T. Sicoli, GTT Communications, Inc. - CFO [27]

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Yes. And in terms of the long-term margin expectations, I think Rick covered it earlier as well. But you are correct, in the slides also. When you just layer in the expectation of the future synergies that we talked about earlier, we're still looking at a 30% business and 7% capital intensity. So no change there. I think it is pure timing. We did put more resource on it in the past 30 days to -- in order to speed it up versus the pace it was running at. But no fundamental change in the way we approach it or where we will ultimately end up. In terms of the leverage target, we want to get there as quickly as we can. I don't think that's going to happen overnight, obviously. But we've talked in the past about a 1- to 2-year time frame in order to get there. And getting there will be a combination of execution against the things we've already talked about, getting the synergies realized and obviously growing the business as well, as Rick talked about before. So there'll be growth in EBITDA and cash flow that will create it. And then we have an expectation of additional M&A in the future in the next year or 2. And the additional M&A presents an opportunity to further delever, particularly with the small deals that we do there, typically 5x or less post synergy. By definition, relative to our current levels, those would be delevering. But even in the future, we would expect them to continue to be delevering.

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [28]

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And just a bit, I think, may I directly address your question. We absolutely see the synergy targets remaining the same. So that we have some -- about $50 million less, I think -- left, I think, as Mike said in the prepared remarks, with respect to previous integrations and $100 million for any of it that was right in front of us. And so we noted in the prepared remarks that the organizational integration will complete at the end of this month by September 1 and that almost all of the headcount associated in all -- the majority of that $100 million is in headcount. So the $60 million of that is headcount-related, and we see that coming out of the business by the end of the year. And likewise, the other SG&A of $20 million and the cost of revenue in the network synergy of $20 million, we also see proceeding over the 3 to 4 quarters or sooner, post close. All very much on track, very, very clearly identified by individual line item, and we're prosecuting on it as we speak.

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Operator [29]

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The next question comes from Frank Louthan of Raymond James.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [30]

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Can you give us -- so like, what are the assumptions you're making for FX for the rest of the year here? And then can you give us a little more detail on, sort of, some of the specific tactics you're taking with the sales force at Interoute, and how you're getting them integrated with the products and so forth. Any specific changes you're making there?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [31]

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Sure. On the FX side, not dissimilar from other businesses. From an operational standpoint, we really focus on constant currency. So we're not as focused on FX swings in terms of our day-to-day activity. From a cash management standpoint and a treasury planning, absolutely, we're looking at it. But the thing to remember about our business, while we have a fair amount of revenue that is denominated in other currencies, we also have a lot of cost in those same currencies. So the net impact of FX from a real cash or economic standpoint is relatively small, even today, pro forma for Interoute. So it's not a major driver of the business.

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [32]

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And then on sales force, I mean the major sort of tactic that we take is to divide the business into divisions so that the client experience and all elements of the client experience, from quoting, selling, ordering, service delivery, installation, overall client account management, billing, collection, all of that is owned by the division president and the resources in the division. And we felt it was very important in Europe to pick Europeans to run our divisions. So Martin Ford is the Division President for the U.K., which includes Middle East, Africa and Asia-Pac. And he came to us originally from Hibernia, previously from Level 3. And we think he's an outstanding leader to run the U.K. division. And he's inheriting a significant team from Interoute and is in the process of integrating them into the GTT way. Interesting though, we told the whole Interoute team prior to the CMD cutover on October 1, business as usual. And interestingly, June and July, we're probably across legacy Interoute, 2 of the best sales months they've had in any of the quarters that we've looked at in the diligent spot. So as I mentioned before, we're seeing some nice uptick. So we're sort of telling them, in short term, business as usual. We don't want to -- until we cut over. And I'll come back to what we're doing at cutover in second. And then we've elevated a guy by the name of Jesper Aagaard who's running the Dane, came to Interoute 5 years ago, and we think he's an outstanding leader for us to run Continental Europe. And we'll divide that into 5 regions with 5 regional leaders in Europe to work for Jesper and help drive the success there. And they're having great traction in the short run. The key there is to basically make sure that -- and we started in the month of September to train, right? So pre -- we don't -- our belief is you don't want to train too early, otherwise you'll lose it. So we'll start in the month of September to train the entire organization, the legacy Interoute organization, now GTT, on CMD, products and services, ordering and process procedure, et cetera, and then where that's ongoing. But there's a really big push in September and October as we cut over to CMD. So -- but I think if I would leave any point is that we are seeing great productivity on both sides of -- so legacy GTT, legacy Interoute. And so our goal is to continue to drive that productivity up as we continue to hire. I mean, we are absolutely continuing to hire quota-bearing reps across all geographies at this stage as we look to drive ever-increasing levels of rep-driven growth.

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Michael T. Sicoli, GTT Communications, Inc. - CFO [33]

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I'll just make one other point here. I think Rick mentioned this a little bit before, but just to clarify that. In the interim, before we've done all that deep training and systems cutover, there is a group of people who is responsible for helping to do the cross-sell and upsell opportunities that do arise during this interim period. So we have had a few of those already driven by entrepreneurial reps and/or inquiring clients. But in the near term, that gets sort of handled on an individual-case basis from a corporate standpoint until everybody is in the single system.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [34]

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Great. That's very helpful. One follow up on the FX, just as it -- more as it relates, I guess, to Interoute on the CapEx side. Is the CapEx also in local currency? Or is any of that in U.S. dollars?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [35]

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It -- it's primarily in local -- well, it's wherever it gets spent. And obviously, the majority of our CapEx going forward would be outside the U.S., given the relative capital intensity of Interoute versus legacy GTT. So yes, that's local currency denominated.

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Operator [36]

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The next question comes from Brandon Nispel of Pacific Crest Securities, KBCM.

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Brandon Lee Nispel, KeyBanc Capital Markets Inc., Research Division - Research Analyst [37]

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On the churn from the 2 large customers, is there any way that you can quantify the impact in terms of revenue and EBITDA, maybe on an annualized basis? And then two, it's nice to hear some deal momentum in SD-WAN. Can you give us a sense of what percentage of your total bookings that was this quarter?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [38]

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Sure, I'll take the first one. In terms of the churn, we highlighted sort of 3 things: Interoute trajectory, the churn from the customers and then the nonrecurring lumpiness. I would say, each of those was in the same, sort of, ZIP Code in terms of the impact. We haven't provided the specifics of each one of those. But they're each in the, sort of, couple million ZIP Code.

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [39]

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And in terms of SD-WAN total bookings, usually it had historically been relatively small as that's going. It's actually increasing now in terms of new sales and the installs are coming. So across the 3 deals that we talked about in the prepared remarks and the 2 or 3 others that I mentioned in a previous question, we're seeing a nice uptick. We think the movement is accelerating from legacy MPLS to SD-WAN. And from a relatively de minimis part of our total sales, it's now meaningful and a double-digit and growing part of our total sales numbers, and we see that accelerating. Moreover, we believe GTT is one of the best positioned software-defined wide-area network players because the entire technology is based on using the Internet as a mechanism where, historically, less than 20% of enterprise's traffic was destined for the Internet. And we sit down with CIOs today and they say, "70% of my traffic is destined for the Internet, and I need to be able to have that traffic flow from each location diversely and securely." And that's our forte. We can deliver diverse local loops across multiple access technologies. We have a deep -- we are an Internet backbone with the ability to deliver at lowest latency, highest-performance traffic to the hyperscale cloud service providers as well as to the public Internet in general, very securely across our global backbone. And we have very deep experience procuring, installing, maintaining, managed SD-WAN Edge devices for clients on their premise. And so we think we're very well positioned to be the big recipient of this. We have relatively small exposure to sort of what I would consider legacy WAN technologies at this stage, given that the Internet is -- comprises the bulk -- vast bulk of our business at this stage. And we see it accelerating, absolutely.

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Brandon Lee Nispel, KeyBanc Capital Markets Inc., Research Division - Research Analyst [40]

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And if I could just follow up on that. Are customers buying with this SD-WAN product a dedicated IP connection as well as a private connection? So they're essentially purchasing 2 connections?

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [41]

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Sure. Generally, the -- I mean, there's lots of different local loop access options that we can provide. We think the most compelling is a dedicated Internet access option that comes over a ethernet fiber loop directly to our network, to our provider edge devices and SD-WAN gateways. And then a broadband Internet connection, either through DSL or cable, that is a load-balancing, load-share opportunity. It could even be delivered over a 3G, 4G wireless connection for small location. So we see that as being the actually most compelling bundle for clients. And our ability to deliver dedicated Internet access options over fiber everywhere in the world, we think it's second to none at this stage. And we have one of the deepest array of broadband Internet buying from last mile providers and local providers around the globe. And so it's one of the reasons that we think we really stand out as clients look at being able to, a, confidently purchase and our ability to install, maintain, trouble manage services around the globe to any location in the globe and get that traffic securely back to our global Tier 1 Internet backbone.

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Operator [42]

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The next question comes from James Breen of William Blair.

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James Dennis Breen, William Blair & Company L.L.C., Research Division - Communication Services Analyst [43]

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Just a couple. On the sales rep side, as you talk about getting to sort of mid-single-digit organic growth, 4% to 6%, if you have just over 300 reps today, given what you're seeing in churn and your rep productivity, what's the right number? Is it 400? Is it 450, in order to sort of be in that range? And then just on a pro forma side, looking at the slides, it looked like sort of the jumping-off point for revenue this quarter was around $461 million and $108 million in EBITDA. Is that how we should think about what the full quarter impact would've been and then move from there in terms of modeling? And then just one last one, on Interoute EBITDA, looks like it went down year-over-year from $47 million to $33 million. Just -- what's -- what are the adjustments there as we think about that growth trajectory?

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [44]

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I'll take the reps one first. So in terms of reps, I think the short answer to that is, as many as we possibly can recruit and bring on effectively to our business to drive as high levels of rep-driven growth as possible. Our objective, I think as we just restated, is to have double-digit growth with a combination of rep-driven and small M&A, which we view as a sort of organic part of our business as we buy books of business. So at double-digit, 10%, if half-and-half are coming from that, great. But I think as we've said on earlier calls, there's no reason why we can't double-digit from each component over time as we continue to grow. And it is limited more than anything else by the number of reps. So I'd say, Jim, we're not as focused on saying what is the right number to get to right now. I think what we've been reporting to you is, we want to keep it growing. And we see an opportunity to attract great talent, as I mentioned earlier. And so we don't really see any end. We think our -- for the size of our business, our sales force is still relatively small. And that opportunity to, with a great leadership team in place, hire in some of the best geographies in the world, in North America, the U.S. and Canada and throughout the United Kingdom and all throughout Continental Europe, is just right in front of us. And as we've traveled around, we think our sales force is too small in all those organizations, and likewise, all the sort of the attendant business. We also see churn, while we had sort of a slight uptick this past quarter by some of the 2 things that Mike said. As we look forward in our business, we don't see any real discontinuities and we think our churn rate will maintain in that 1.5% range as we -- mid-1s as we move forward in our business, so that if we keep productivity high, it's really just about adding reps.

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Michael T. Sicoli, GTT Communications, Inc. - CFO [45]

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And in terms of the other 2 questions. I'll address the second question first, which is the pro forma number that you see for Interoute in the second quarter is just the 2 months pre-close. So their second quarter EBITDA, if you were just looking into Interoute versus Q1, would have been pretty similar. The -- in terms of the jump-off point question, yes, I -- subject to currency fluctuations, yes, I think that's a reasonable jump-off point to consider as you look at future quarters.

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James Dennis Breen, William Blair & Company L.L.C., Research Division - Communication Services Analyst [46]

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Okay. And on the Interoute side, I was looking at second quarter '17 versus second quarter '18 in terms of EBITDA. It's $47 million and $33 million. Is that -- so the second quarter '18 only includes key months?

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Michael T. Sicoli, GTT Communications, Inc. - CFO [47]

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Correct.

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Operator [48]

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This concludes our question-and-answer session. I would like to turn the conference back over to Richard Calder, President and CEO, for any closing remarks.

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [49]

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Great. Operator, I'm going to turn the call over to Brian Thompson for some concluding remarks. Thank you.

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H. Brian Thompson, GTT Communications, Inc. - Founder and Executive Chairman [50]

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Thanks, Rick. I'm pleased to be on the call again this quarter. I know it's going to be a difficult quarter for most people to understand from the standpoint of all of the moves and changes that have taken place both in the...

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [51]

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Operator?

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H. Brian Thompson, GTT Communications, Inc. - Founder and Executive Chairman [52]

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Operator, am I connected?

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Operator [53]

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Yes, you are. Yes, sir.

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H. Brian Thompson, GTT Communications, Inc. - Founder and Executive Chairman [54]

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Okay.

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [55]

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Oh, he's back. There you go.

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H. Brian Thompson, GTT Communications, Inc. - Founder and Executive Chairman [56]

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Okay, thanks. Let me start over.

I was just saying I'm glad to be able to be on this call again with you. And I'm especially -- understand that you folks have got a difficult time trying to work through the quarterly results only because of the moves and changes that have taken place, especially as part of the Interoute transaction. There are only 2 things that I'd point out and that I think are going to confuse the general public. One of them obviously is the huge loss in the quarter, as reported, recognizing that virtually most of that is coming from the way in which accounting treatment has to be taken on the transaction itself and especially the FX impact on the values that are associated with that transaction.

The second thing, obviously, that is difficult to go through and something like that is a 1-month treatment of the acquired company, especially in the size being the largest that we've done. On the positive side, though, that I think is most important, and Rick and I think, and Mike have very well laid it in place, and that's the positioning of the company in the way we are going forward. We are continuing to integrate in a way that I think is second to none, in any companies I've been involved within the past 50 years, and these guys have the ability to do the right thing and they continue to adjust as they go forward in creating the kind of values that we have laid in place for the company. The team is really involved in this integration and very, very bullish about the possible future that comes from it, not just from the standpoint of the income statement and balance sheet of the company, but the people that we're taking into the company and the way the people are approaching the customer base and the challenge and the future of our industry. I think we've got a company well worth everything that you all are interested in and very much for the investors going forward, that the future looks just as good as the past has been.

With that, I'm going to turn it back to Rick. And thank you very much for being on the call.

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Richard D. Calder, GTT Communications, Inc. - CEO, President and Director [57]

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Great. Thank you, Brian, and thank you for everyone for joining us, as we continue and focus on our 2 key priorities of integrating Interoute and driving rep-driven growth. We are very excited about reporting to you next quarter. So thank you for joining us. Cheers.

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Operator [58]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.