INNOVATE Corp. quarterly report, Q3 FY2012

Business context and reporting period

The supplied filing is Primus Telecommunications Group, Incorporated’s unaudited Form 10-Q for the quarter ended September 30, 2012—not a filing identified in the text as INNOVATE Corp. Primus provided communications and data-center services, primarily in Canada and the United States. It sold its Australian business in May 2012 and classified its International Carrier Services (ICS) business as discontinued operations while pursuing a disposition.

Financial highlights

Amounts are in U.S. dollars; financial-statement amounts are in millions unless noted.

• Continuing-operations operating margin was approximately 2.3% in Q3 2012 and negative 0.8% for the first nine months of 2012. Cost of revenue was 49.3% of revenue in both periods.
• Q3 continuing-operations loss attributable to common shareholders was $22.6 million, or $1.63 per share; nine-month loss was $43.7 million, or $3.16 per share. The nine-month reported profit includes a $98.7 million after-tax gain on sale of discontinued operations. Discontinued operations recorded losses of $2.5 million in Q3 and $18.0 million in the nine-month period.
• Cash and cash equivalents were $66.0 million at September 30, 2012, versus $41.1 million at year-end 2011. Current assets were $145.0 million and current liabilities $92.8 million; both include balances classified as held for sale.
• Net cash from investing activities was $150.8 million, including $177.7 million net cash proceeds from the Australia sale; capital expenditures were $25.1 million. Financing activities used $148.9 million, including $119.0 million for note repurchases and $13.8 million for the special dividend. Operating cash flow less capital expenditures was approximately negative $1.3 million.
• Long-term obligations were $117.9 million, including $116.2 million of 10% senior secured notes due 2017 and $2.4 million of 13% notes due 2016. Cash exceeded reported debt by about $52 million. Q3 interest expense was $6.3 million; nine-month interest expense was $20.1 million.

Material changes versus comparable periods

• Q3 continuing revenue fell 14.0% year over year; management attributed the decline mainly to North America Telecom, particularly retail voice, local, and prepaid services. Data-center revenue increased 10.2% as reported. For nine months, revenue declined 10.9%; data-center growth partly offset lower telecom revenue. The stronger U.S. dollar further reduced reported revenue.
• Q3 net loss widened from $10.0 million to $25.0 million, notably reflecting a $21.1 million loss on early debt extinguishment or restructuring. The prior-year quarter benefited from an $11.4 million CVR valuation gain versus $0.2 million in Q3 2012.
• Nine-month net income improved from a $35.6 million loss to $37.0 million income, primarily because of the Australia-sale gain. Excluding that gain, continuing operations remained loss-making.
• Debt fell from $236.1 million at December 31, 2011 to $117.9 million, following repayment and repurchase activity. Primus repurchased $119.0 million principal amount of 10% notes at 109% of principal, plus accrued interest, in September.

Outlook, commentary, risks and unusual items

• Management stated that available cash should fund debt service, fixed obligations, and operating needs for at least the next 12 months. It also disclosed $9.4 million in future purchase obligations and $57.5 million in future operating lease payments.
• Primus said it was focused on growth services, including broadband, SME VoIP, data, and data centers, while managing traditional voice services for cash flow. It continued to seek a sale or other disposition of ICS. A board special committee was evaluating strategic alternatives; no timetable or specific transaction was assured. The filing provides no numerical earnings or revenue guidance.
• Holders challenged amendments to the 10% notes indenture, alleging covenant breaches and seeking to block reliance on the amendments. Primus agreed not to take actions newly permitted by the amendments pending resolution; a hearing was scheduled for January 4, 2013.
• The Australia sale price was approximately $195.7 million before adjustments; $9.8 million was held in escrow for potential indemnification claims. The 10% note repurchase generated $10.9 million of premiums and other costs, alongside write-offs of deferred financing costs and original issue discount.
• Management cited declining traditional voice usage, competition and pricing pressure, economic conditions, foreign-exchange movements, substantial indebtedness, and the pending indenture litigation as risks. Approximately 86% of nine-month revenue came from outside the United States. The company also reported a $76.8 million gross unrecognized tax benefit.

Important facts for investors to verify

• Confirm the filing entity: the source text identifies Primus Telecommunications Group, Incorporated, not INNOVATE Corp.
• Assess continuing-business performance separately from the Australia-sale gain and discontinued operations; verify the status and terms of any ICS disposition.
• Review the outcome of the noteholder litigation and the operative covenants, defaults, and restrictions on the remaining debt.
• Monitor cash generation, capital spending, debt service, and whether management’s stated 12-month liquidity expectation remains supportable.
• Evaluate the effect of foreign exchange, ongoing telecom revenue declines, and potential claims against the Australia-sale escrow.