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Edited Transcript of Y.TO earnings conference call or presentation 13-Nov-19 1:30pm GMT

Q3 2019 Yellow Pages Ltd (Canada) Earnings Call

MONTREAL Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Yellow Pages Ltd (Canada) earnings conference call or presentation Wednesday, November 13, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Alan Eckert

Yellow Pages Limited - President, CEO & Director

* Franco Sciannamblo

Yellow Pages Limited - Senior VP & CFO

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Conference Call Participants

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* Adam Mitchell

Polar Asset Management Partners Inc. - Investment Professional

* Aravinda Suranimala Galappatthige

Canaccord Genuity Corp., Research Division - MD

* Bentley Cross

TD Securities Equity Research - Associate

* Drew McReynolds

RBC Capital Markets, Research Division - MD of Canadian Telecommunications and Media Research & Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to Yellow Pages Third Quarter 2019 Earnings Release Call. Today's conference call contains forward-looking information about Yellow Pages outlook, objectives and strategy. These statements are based on assumptions and are subject to important risks and uncertainties.

Yellow Pages actual results could differ materially from expectations discussed. The details of Yellow Pages caution regarding forward-looking information, including key assumptions and risks can be found in Yellow Pages management discussion and analysis for the third quarter of 2019.

This conference call is being recorded and webcast, and all of the disclosure documents are available on the company's website and on SEDAR.

I would now like to turn the meeting over to Mr. David Eckert, President and Chief Executive Officer. Please go ahead, sir.

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [2]

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Thank you. Good morning, everyone, and welcome to our third quarter call. We appreciate you dialing in today, and always appreciate your continued interest and support.

As usual, on these calls, I will make a few overview comments, and then Franco Sciannamblo, our CFO, will address some of the specifics of our third quarter results. And then we'll endeavor to answer all of your questions.

We're very happy with our results in the third quarter and year-to-date. And there are kind of 3 general comments I'd like to make about that. First, I'd point out 2 weeks from Monday, we will be paying in full our senior notes. And our cash generation over the last 2 years, since we issued those notes, has been so strong that these notes will be paid scarcely 2 years after we issued them and 3 years ahead of when they would otherwise mature.

After making those payments, this year alone, we will have paid approximately $194 million in cash to our debt holders. And after we make the payment, 2 weeks from Monday, it will leave only our convertible debentures as debt, setting aside leases. And net debt -- debt net of cash will be well below $100 million. We're very gratified at all of that.

My second point is that in the third quarter, our EBITDA minus CapEx continues to be strong, we report at approximately 36% of revenue. And we believe that is the best in the world among major legacy Yellow Pages companies in their core business.

We continue to align our spending with whatever are the realities of our revenue. Now we hope, of course, always, that the realities of our revenue are great. But regardless of whether they're fantastic or not so fantastic, we continue to align our spending with reality. Therefore, we produce the best in the world in the third quarter, we believe, EBITDA minus CapEx margin in our -- in the core business.

Third, even as we continue to generate very healthy cash flow, we are making important and focused investments to help bend the revenue curve in our business, and help further establish strong, sustainable business and company for all of our stakeholders. And those investments we believe are paying off. And as evidence of that, this past quarter that we're reporting on this morning, for the third quarter in a row, for the third time in a row, happens to also be the third calendar quarter, the percent change in our revenue compared to the prior year is improved. Is it improved enough? Absolutely not yet. Absolutely not. But 3 quarters now, it's improved, and we're moving in the right direction.

We are making a whole bunch of investments, as I said, focused, important. Let me just mention a few of those. Just, for example, one this year, we actually -- in this industry, people talk a lot about headcount reductions. And we're not immune from that, of course. But this year, we will have increased our headcount in our Telesales group. We will have increased our headcount in our customer care group. We will have spent important amounts of money on SEM in our IYP product line. And we will have been spending important amounts of money increasing the variable compensation for our high-performing salespeople, which we're now allowed to do under our new collective bargaining agreements.

So we are making what we think are the optimal and smart investments, while at the same time, generating world-class EBITDA minus CapEx and very gratifyingly wiping away debt that could be a burden for any company down the road.

So with those overview comments, I'd like to pass the baton here to Franco Sciannamblo, our Chief Financial Officer, to give you some specifics on the quarter, and then we'll answer all your questions. Thank you.

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Franco Sciannamblo, Yellow Pages Limited - Senior VP & CFO [3]

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Thanks, David. Good morning, everybody. I will now take you through our financial results for the third quarter ended September 30, 2019.

As you will recall, we report operations in 2 segments. The first segment is the YP segment, which provides small- to medium-sized businesses across Canada digital and traditional marketing solutions. The second segment is the Other segment, which includes the operations of businesses we have disposed off or liquidated this year and over 2018.

As of this quarter, we no longer have any operations in the Other segment. So the current Q3 results are made up entirely of the YP segment, and it's where my comments will be focused.

So on revenues, the YP segment revenues decreased by $19.5 million or 16.6% year-over-year and amounted to $98.1 million. The decrease is mainly due to the decline of our higher-margin YP digital media and print products, and to a lesser extent, our digital -- our lower-margin digital services products. This created pressures on our margins. This marks the third consecutive quarter that the year-over-year rate of revenue change has improved, as you heard from David earlier.

YP digital revenues decreased 16.1% year-over-year and amounted to $74.3 million. The revenues were adversely impacted by decline in the number of digital customers, partially offset by fifth consecutive quarter of higher spend per customer. The lower digital customer count is mostly attributable to our lower level of acquisition, driven in part by our focus on profitability.

YP print revenues increased by 17.9% year-over-year to $23.8 million from a decline in the number of print customers and lower spend per customer.

Onto adjusted EBITDA. Total adjusted EBITDA for the third quarter decreased by $8.5 million or 18.3% and amounted to $37.8 million. The adjusted EBITDA margin for the quarter increased to 38.5% from 35.5% for the same period last year. The decrease in adjusted EBITDA was the result of revenue pressures in the YP segment as well as the divestitures in the Other segment.

Adjusted EBITDA for the YP segment for the third quarter decreased by $8.2 million or 17.9% as a result of lower overall revenues, pressures from the change in product mix and investments in customer care. The adjusted EBITDA margin for the YP segment for the third quarter of 2019 was 38.5% compared to 39.1% for the same period last year.

The slight decrease in adjusted EBITDA margin for the third quarter is due to the revenue pressures and investments in customer care being mostly offset by increased focus on the profitability of our products and services and reductions in both our cost of sales and other operating costs.

The reductions in cost of sales were mainly due to workforce reductions primarily in noncustomer-facing areas in the first quarter of 2018, and to call center consolidations, and optimizations of our servicing model in the second quarter of 2018.

The decrease in other operating costs included reductions in our workforce and associated employee expenses, reductions in the company's office space footprint as well as other spending reductions across the segment.

Adjusted EBITDA less CapEx decreased by $8.7 million or 19.6% to $35.4 million during the third quarter of 2019 mainly due to lower adjusted EBITDA partially offset by decreased spending on software development. Adjusted EBITDA less CapEx was further negatively impacted by lease incentives received in 2018.

Adjusted EBITDA less CapEx margin increased to 36.1% as compared to 33.9% for the same period last year as a result of the divestiture of the profitable or nonsynergistic businesses and revenues as well as cost reductions in the YP segment.

Our total workforce as of September 30, 2019, was 883 active employees, which represented 28.8% decrease versus the same date last year. The YP segment represented the whole population of active employees and was down 21.7% versus last year.

Restructuring and other charges of $2.3 million for the third quarter consisted mainly of charges relating to workforce reductions.

And I'll turn to net earnings. We recorded net earnings of $13.8 million during the third quarter of 2019 as compared to $27.1 million during the same period last year. The decrease is mainly due to the net earnings for the third quarter of 2018 benefiting from a $7.5 million gain on the sale of the assets related to the operations of RedFlagDeals and a reversal of income tax provisions of $18.3 million recorded with respect to previous taxation years.

Furthermore, net earnings were impacted by lower adjusted EBITDA, which was more than offset by lower depreciation and amortization expenses mainly from the lower software development expenditures, and by lower financial charges from a reduced level of indebtedness.

On November 1, 2019, as previously announced, the company made a $30 million optional redemption payment on our senior secured notes. The company will also make a mandatory redemption payment of $50.7 million on its notes, including accrued and unpaid interest of $0.4 million on December 2, 2019. With this payment, the company will have paid the notes in full.

As at September 30, 2019, the company's net debt, excluding lease obligations, have reduced by approximately $100 million to $82.5 million compared to $182.2 million as at December 31, 2018.

This concludes our formal remarks. I will now turn over the call back to the operator.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Aravinda Galappatthige with Canaccord Genuity.

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Aravinda Suranimala Galappatthige, Canaccord Genuity Corp., Research Division - MD [2]

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David, I just wanted to focus a little bit on the customer count. We continue to see sort of generally similar decline rates around 8,500 per quarter. I was keen to understand what the dynamics are inside of that base right now. I mean, I suspect there's a cohort within that, that is holding their spend either stable or perhaps even increasing. And obviously, a cohort where you're sort of -- because of unprofitability, you're looking to -- you're loving to recede.

At the same time, I was also kind of keen to understand like what -- is there an element of that base where you think is sustainable over the medium term? Just was looking for some color on that to start with.

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [3]

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Thank you for that question. It's a great question. We certainly are very aware of customer count, and we are very aware that you can't have a business that's got sustainability and long-term strength and value, if you're not -- if you're losing a lot of customers and not adding many customers. And that's obvious.

What I will say though is that a year or so ago -- a year or 2 ago, early in the time that this management team was in place, we noted that what our company, and I think a number of companies may be in this industry, but I know our company had been making a lot of efforts to add a lot of customers, frankly, so that we could tell people on telephone calls like this one that we're adding a lot of new customers. And the company was expending enormous resources to do that.

Taking an objective look at that though, there is a huge fraction of those new accounts that never even paid us. Of the ones who paid us, there is a huge fraction that were demonstrably unprofitable. Of the ones that weren't demonstrably unprofitable, there was a huge portion that clearly weren't worth the effort that it had taken to land them. And of the relatively small remaining ones, the lifespan and churn was often pretty short -- short lifespan, high churn. And we had, as a company, been pouring huge attention, rewards, resources in that direction. And I'm sure on some of these phone calls -- I wasn't on them at the time, others were. But I'm sure that there might have been comments about how we were getting a bunch of new accounts. We would rather have a profitable business and profitable customers.

But I circle back to the first part of my response here. We're not so dumb as to think that we can do that by not adding accounts. What we did at the time is we blew away all what was going on there because it was a huge waste of resources.

Now we've done a lot of cleaning up. We have got a lot of great direction. We got a lot of accomplishments. We got a lot of momentum. We got a lot of stuff going on. And literally, just yesterday afternoon at our -- the quarterly meeting of our Board of Directors, I was talking about our -- the steps that we're taking now to devote focused resources to, once again, in a smart and profitable way though, add to our -- at least on the gross basis, add to our customer count.

So we know we've been doing that. We know there are holes in the bottom of the bucket. We know we haven't been adding in the top of the bucket. And we know the inevitable consequence if you were to do that forever. That's not what we intend to do. And indeed, we were discussing it less than 24 hours ago, steps that we are already taking. And I alluded in my opening remarks here that we will have added head -- net headcount, not gross, added net headcount significantly so in our Telesales operations and our customer care operations with that -- a very specific goal in mind.

So it's a great question, thank you. And it is the next -- it is one of the most important kind of next frontiers in our -- in completing our turnaround efforts here.

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Aravinda Suranimala Galappatthige, Canaccord Genuity Corp., Research Division - MD [4]

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And just one sort of follow up for me. With respect to the digital sales base, I know that a discussion that was occurring maybe a few couple of years ago was around sort of the increasing mix of sort of, call it, for lack of a better word, the reseller-type customers. It's not so much you selling the YP platform, but obviously, sort of, selling some of your expertise in terms of reselling Google AdWords or whatnot. I know that was a high-margin business, but it was a -- actually, it was a low-margin business, but it was high in demand and that component was growing.

Can you give us a sense as to what that mix looks like? What proportion that represents of your digital sales right now?

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [5]

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What -- the question is what proportion of what represents of the digital sales?

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Aravinda Suranimala Galappatthige, Canaccord Genuity Corp., Research Division - MD [6]

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Sort of the reselling.

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [7]

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Reselling the products of others?

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Aravinda Suranimala Galappatthige, Canaccord Genuity Corp., Research Division - MD [8]

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Yes.

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [9]

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Let me make a comment on philosophy, and then Franco will have the numbers.

Without a doubt, our profit margins on print and IYP in this industry are -- the gross margins, without a doubt, generally speaking, are better than if we are selling products of others. But that is -- and we love print and we love IYP, and that's great. And we do everything, and we've aligned our new compensation plans to reward our sales people more for selling products that are more profitable for us. And we have every hope in the world and expectation that in the medium term, that will lead to better sales and better rates of growth of the more profitable as opposed to the less profitable products. And we weren't allowed to do that before we took the shackles off of the collective bargaining agreements that we inherited here and had been here for decades or seemingly millennia. And so granted that. However, it's also the case that some players in this industry seeking high gross margin percentages chase after strategies where there is a huge amount of spending required in order to have products -- support products that are owned by the company or operated by the company at the expense of where you can make decent margins without much -- without undue effort on products that are provided by partners. And I think that the -- that classic strategy can sometimes lead to quite a bit of ruin.

So we're happy to also sell products that are made by our -- provided by our partners. And I know people who'll point, well, gross margin is less and this and that. Yes, okay, but if we don't have to do much to either sell it or support it really, it can be a very important and complementary part of a very successful strategy. And that is what we're doing.

Franco, I think, has some numbers for you, while I'd been answering your question at the higher level.

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Franco Sciannamblo, Yellow Pages Limited - Senior VP & CFO [10]

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Yes. Our high margin products, if you will, that you're alluding to, it depends what you included in it, but it will range between 40% to 45%. So it's still by far our strongest and largest revenue segment.

Print, as you can see, it's in the 23% to 25% range now, and then the balance would be in, what I would call, medium range, so probably about 5% to 10% are in the medium range. And then the lower more reseller products that you're alluding to are more in about the 25% to 30% of our revenue base.

So I don't think it's changed a whole lot. And as David alluded to when he talked about investing in our IYP, we are making very targeted, not that the level of investments we've made in the past, which didn't generate any returns anyway, or the returns we were expecting. Very targeted investments to support the IYP and also bundling it with other products, which we think add more value for the customer overall.

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Operator [11]

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The next question is from Bentley Cross with TD Securities.

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Bentley Cross, TD Securities Equity Research - Associate [12]

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David, on the last call, you were kind enough to share kind of the bookings trajectory. Wondering if you might have any commentary to share with us this time around.

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [13]

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Sure. Yes. I think the essence of what I said last time is that we're encouraged by what we see in the bookings. I don't think I released any numbers or specifics, and I don't think I should have and I don't think I should and I don't think we will, numbers or specifics. But I think I gave a little color. And I would say the same comment applies now.

We are -- now that we have the shackles off of the antiquated and fatally restrictive former collective bargaining agreements, all bets are off. We're able to kind of begin operating our company and our sales force like we're in the 21st century and in a competitive and fluid and dynamic market and with kind of modern management techniques, not from the 1950s and all that.

And we are -- we've got, I think, the right people in the right places doing the right things. We have a great sales force, and there's a great attitude and kind of a refreshed approach to the marketplace that we see every day.

And I -- so I would -- I'd kind of continue the comment that I made 90 days ago, which is what we see as we look at the early indicators of future reported revenue, I would say, is encouraging. And my hope and my expectation is that it would continue to be encouraging and maybe even more encouraging.

As -- we got a lot of tricks up our sleeves here that we've just never been able to apply. And now for the first time and -- it takes a little longer. And as -- you know how the accounting and stuff works in this industry. Even if it didn't take long at all, it would take a while to kind of work its way through the pipeline -- through the accounting pipeline, if nothing else. So we are more than hopeful. We're encouraged by what we see.

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Bentley Cross, TD Securities Equity Research - Associate [14]

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Thank you for that. And then on the balance sheet side of things. I mean, at the beginning, you talked about $120 million in senior secured repayments. Then last quarter, you suggested there'd be a balance of $10 million, and now you're saying nothing.

Just wondering how -- obviously, things have improved relative to your initial expectations? But wondering how all things have improved? And where are the outperformance is coming from?

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Franco Sciannamblo, Yellow Pages Limited - Senior VP & CFO [15]

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Overall, our margins continue to be very strong, even stronger than we anticipated or used in our forecasting and we'd like to be conservative. And we also had a -- if you look at our cash flow, we had a really strong working capital quarter as well. Good collections on AR. And so I think in combination of strong EBITDA, good working capital and conservatism on our part to make sure that we hit what we say we're going to hit.

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [16]

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Yes. I think we are -- it think it's fair to say that we are guilty. And what we're guilty of is, Franco and I, each of us, we find that we're kind of conservative people. We hate to disappoint. We'd rather overperform than overpromise. So just to be honest, I think that's -- I hate saying we're going to do something and then not do it. I'd rather the opposite.

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Bentley Cross, TD Securities Equity Research - Associate [17]

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Feeling is mutual.

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Operator [18]

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The next question is from Drew McReynolds with RBC.

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Drew McReynolds, RBC Capital Markets, Research Division - MD of Canadian Telecommunications and Media Research & Analyst [19]

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A couple for me. First, maybe for you, Franco. Can you just update us on the CapEx of the business now that you've flushed through and look to have a pretty clean and lean business going forward? What kind of the CapEx investment you see in the business?

And then also you've done an incredible job on taking operating costs out. Wondering with even a bending of the revenue trajectory here going forward, the operating leverage that's in the business, maybe a percentage of fixed cost. In other words, can you sustain north of 30% EBITDA margin as you try and bend the revenue curve?

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Franco Sciannamblo, Yellow Pages Limited - Senior VP & CFO [20]

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I'll take the -- so the first question -- what it was on, again?

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Drew McReynolds, RBC Capital Markets, Research Division - MD of Canadian Telecommunications and Media Research & Analyst [21]

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CapEx.

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Franco Sciannamblo, Yellow Pages Limited - Senior VP & CFO [22]

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CapEx. Yes, sorry. Yes, so the range that I will give you typically, in our mind, and to execute our strategy, 2% is what I will be using going forward. That's what we strive for. And we don't think there's a need to exceed that.

And in terms of our level of spending and our ability to keep that, I think you've heard David make this comment before. It's -- we like to view all our cost as not fixed and variable. And there are some levels, obviously. And it's gets harder as you keep cutting. But we -- as you see, we've been able to maintain the levels of strong margin. What exactly the percentage will be, we'll see. But we do not think that we're out of options in terms of cutting costs. And we -- as you could tell, our headcount was down again. And we continue to -- we expect that to continue going forward.

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Drew McReynolds, RBC Capital Markets, Research Division - MD of Canadian Telecommunications and Media Research & Analyst [23]

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Okay. And one last one here. When you look at your business, again, pretty lean and mean here. Do you -- are you open or looking across the landscape to try and understand where Yellow could potentially partner with other local advertisers or publishers and to try and bend the revenue curve that way? Just wondering, from that perspective, if you can give us an update.

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [24]

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Yes, sure. First, on the one hand, we're pretty pleased with what we got. I wouldn't have been able to say that 2 years ago. But we're pretty pleased with what we got, the momentum and the direction and where we think we can end up for the benefit of all of our constituencies, and in particular, our shareholders. We're pretty comfortable with that.

But at the same time, we are always 100% open-minded and with our eyes wide open and kind of looking around at any kind of more out of the ordinary ways that we might be able to create value for our shareholders. And any -- that would -- that might incorporate different approaches or different alliances in whatever form. We do not believe in doing that just for the sake of doing it or for the sake of being able to kind of generate some razzmatazz.

But if there's strong fundamental economic reasons why it would be good for our shareholders and our people and our other constituencies, we are willing to think about anything, I always say, as long as it's legal and ethical. So yes, and the obvious note on all that sort of thing, we would never comment on any of that specific unless and until that was something that we're actually doing and prepared to publicly announce.

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Operator [25]

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The next question is from Adam Mitchell with Polar Asset Management.

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Adam Mitchell, Polar Asset Management Partners Inc. - Investment Professional [26]

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Just a question on use of free cash flow going forward. Now that you have no secured debt. You've got cash on the balance sheet. You're free cash flow positive. The only remaining debt instrument is the old legacy convertible, which is not callable now at [110], but call steps down in May of '21. So going forward, it appears that you're on a trajectory to generate significant free cash flow over -- at least over the next year or 2. And my question is what is the priority in terms of using that free cash flow? Further debt reduction, acquisitions, stock buybacks, et cetera. Just curious, you're on -- what you can say about that?

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [27]

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Another great question. And I can first say, we certainly intend absolutely not to waste it or fritter it away to the extent that it -- let me be careful not to say, we make no projections or forecasts, but I hear exactly all the logic in what you're saying. And the logic, I think, is very strong and very valid. And second, wins, if that were to occur, we absolutely do not intend on wasting it or frittering it or trying to look around for acquisitions that might be emotionally exciting or get some headlines somewhere or anything like that, unless it would make complete economic sense.

Noting who's asking the question, geez, we have all kinds of -- all the options are on the table. I would imagine at some point, even shareholders might like to see some cash. I don't know, you could inform us better than I could on that. You correctly pointed out the constraints that exist in the -- in our convertible debentures. And we're not very interested in paying penalties about -- for things. And so that's -- but barring doing that, I think all the options are on the table. And now after 2 weeks from Monday, when we paid off all the notes, we're in a position to evaluate that. And we're all ears on what might make sense to do.

So it's real and it's tangible and very gratifying.

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Operator [28]

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(Operator Instructions) There are no further questions registered at this time. So I would like to turn the meeting back over to Mr. Eckert.

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David Alan Eckert, Yellow Pages Limited - President, CEO & Director [29]

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We thank all of you for calling in today. We thank all of you for your continued interest and support in the mission that we're in the middle of here, and appreciate all the great questions today. Look forward to talking with all of you, again, in 90 days. And hopefully, we'll, at that time, also have good -- another good quarter to talk with you about. Thanks very much and have a great day, everybody.

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Operator [30]

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Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.