Cincinnati Bell Inc.
Q1 2017 Earnings Call Transcript

Published: 9 May 2017

[Operator:]

Good day and welcome Cincinnati Bell First Quarter 2017 Earnings Release Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Josh Duckworth. Please go ahead.

[Josh Duckworth:]

Thank you and good morning. I’d like to welcome everyone to Cincinnati Bell’s First Quarter Earnings Call. With me on the call today is our President and Chief Operating Officer, Leigh Fox; and our Chief Financial Officer, Andy Kaiser. Leigh’s comments today will recap our highlights for the quarter. We will also provide a financial overview and an update on our segment results. Following the prepared remarks, Leigh and Andy will conduct the question-and-answer session. Before we proceed, let me remind you that our earnings release and the financial statements are posted on our Investor Relations website. In addition, you will also find presentation slides for today’s call, which we hope you will find helpful in your analysis. Today’s call is being recorded if you would like to listen to it at a future time. Now, I would like to draw your attention to our Safe Harbor statement presented on slide three. In our remarks this morning, we will be discussing forward-looking information. Due to various risks and uncertainties, actual results or outcomes may differ materially from those indicated or suggested by any such forward-looking statements. More information on potential risks and uncertainties is available in the Company’s recent filings with the SEC including Cincinnati Bell’s Annual Form 10-K report, Quarterly Form 10-Q reports and Form-8K reports. The presentation also contains certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are also available on our website. With that, I am pleased to introduce Cincinnati Bell’s President and Chief Operating Officer, Leigh Fox.

[Leigh Fox:]

Thanks, Josh, and good morning, everyone. Thanks for joining us today. Our first quarter financial results and highlights are presented on slide six. Consolidated revenue for the quarter was $278 million as strategic revenue growth was offset by declining hardware sales. Revenue from strategic products totaled $165 million, up $13 million compared to the prior year. Adjusted EBITDA totaling $71 million was in line with expectations. Net income was $60 million for the quarter after considering $118 million gain on the sale of our CyrusOne investment. This concludes a multiyear strategy that gets back to our acquisition of CyrusOne in 2010 and the subsequent IPO in January of 2013. From day one, our goal was to use the monetization proceeds to repay debt and improve the health of our balance sheet. This strategy was a tremendous success. We reduced our debt from $2.7 billion prior to the IPO to $1.1 billion as of the end of the quarter. Our leverage is at 3.6 times and provides us with the appropriate flexibility to continue to expanding our fiber network and broadening the national footprint of our IT solutions business. Our quarterly results start on slide seven. Strong demand for our fiber based products generated 16% increase in strategic revenues and continues the trend of year-over-year growth for our entertainment communications segment. Adjusted EBITDA totaling $70 million for the quarter was consistent with the prior year after excluding the impact of amortizing a post-retirement pension credit that ended in 2016. A voluntary severance program per union personnel aimed at reducing legacy network cost resulted in restructuring charges of $26 million, creating $2 million operating loss for the quarter. Once fully implemented, the cash savings from this severance program is expected to save more than $10 million annually. Our consumer results are presented on slide eight. Our competition initiated its rebranding in our market this quarter. And notwithstanding their efforts, consumer revenue increased 8% over the prior year, demonstrating the superior quality of our fiber network and the strength of our Cincinnati Bell brand. As highlighted, Fioptics revenue totaled $74 million for the quarter, up $15 million from the first quarter of 2016. The quarterly update on Fioptics metrics is presented on slide nine, further illustrating the success of our fiber investments and differentiating Cincinnati Bell from our traditional peers. We added another 4,000 net video customers this quarter ending the period with 141,000 subs. Video penetration has remained impressive at 26%, despite the accelerated build over the last few years. Video churn for the quarter was 2.4% consistent with a year ago, while ARPU was up slightly at $86. Fioptics internet subscribers have increased more than 42,000 over the last 12 months, now exceeding 200,000. Total internet customers were up 15,000 year-over-year totaling 307,000 at the end of March. Fioptics internet penetration rate increased from 36% a year ago to an impressive 38% during the first quarter of 2017 in spite of the accelerated fiber build and a 4% year-over-year increase in ARPU. As of the end of the quarter, we upgraded approximately 400,000 addresses or 50% of Greater Cincinnati able to receive a gigabit speed -- gigabit internet speed with an additional 140,000 addresses able to receive at least 30 meg of interest speed. On slide 10, we summarize the business and carrier market results for our entertainment and communications segment. Business revenue has remained relatively consistent as the transition of customers legacy copper services to more strategic fiber offerings continue. Carrier market revenue was down $2 million over the prior year due to ongoing switched access rate reductions and the impact of national carriers increasing their focus on reducing costs and network grooming. Recently, the FCC adopted final BDS perform, which are significantly less impactful than amendment previously proposed. At this point, we do believe a significant portion of our territory will be deemed competitive for our legacy copper services. However, we have not completed the final assessment and determine the overall potential impact new reforms will have on our wholesale operation. Turning to our IT services and hardware results on slide 11. Revenue for the quarter totaled $86 million and adjusted EBITDA was $6 million. Hardware revenue decreased $12 million compared to a year ago due in part to the cyclical nature of these type of transactions combined with customers shifting to the cloud. As evidenced, our cloud services revenue increased 34% compared to the prior year. However, this growth was offset by additional in-sourcing of IT professionals within our market, resulting in a $4 million decrease and strategic IT services revenue. As a leading IT provider in Cincinnati, our long-term strategy is to grow our IT services and hardware statement, and adjusted EBITDA to $100 million over the next several years -- and to further capitalize on the growing demand of our strategic services, particularly our UCAS and cloud services. We increased headcount in branch locations and acquired SunTel Services in Michigan. SunTel’s headquartered in Troy, Michigan and is a trusted regional provider of network security, data connectivity and unified communications solutions to commercial and enterprise customers across multiple sectors. We are particularly impressed with the depth of SunTel’s customer relationships and have already been indications of interest in our cloud network solutions. We are excited about the prospects of SunTel’s future growth and we continue to explore additional M&A opportunities in this space. Moving to slide 12. Free cash flow for the quarter totaled $10 million, in line with our expectations. Compared to the prior year, interest payments were higher this quarter due largely to the timing of payments associated with the 7% 2024 notes issued in the second half of 2016. Capital expenditures for the quarter were $15 million -- $55 million. As illustrated on slide 13, we invested $12 million in success based fiber build for business and managed services projects, an additional $7 million in maintenance. During the quarter, we invested $36 million in our Fioptics suite of products and passed an additional 12,000 new addresses. In closing, we continue to differentiate Cincinnati Bell. We have strategically invested in fiber since 2010, resulting in a network that now exceeds 10,000 fiber route miles. The early decision to accelerate our fiber build has created a network capable of producing higher bandwidth and faster internet speed that will always be one step ahead of our competition. Our ability to capitalize on the growing demand of our fiber and our strategic IT solutions such as UCAS and cloud services is essential for the future growth of Cincinnati Bell. This concludes the prepared remarks for today. Thanks for listening. We will now open the conference up for questions.

[Operator:]

[Operator Instructions] And we will go first to Batya Levi with UBS.

[Batya Levi:]

Can you talk a little bit about the competitive environment that you saw in the quarter? Any change with Charter’s new ramp in the region? And also if you could point out to what kind of price increases did you implement in the quarter in terms of the broadband and the video product? Thank you.

[Leigh Fox:]

Hi, Batya. I’ll answer the first part of the question and then I’ll hand it over to Andy to answer on price increases. We saw effectively the [indiscernible] by the competition in rebranding in the first quarter. We did see a slight uptick in churn at the beginning of the quarter but then that subsided and normalized by the end of the quarter. We feel like -- we did see a slight impact early on based on the rebranding in the marketing push and then that subsided and now it’s more than normalized. So, it’s actually what we expected and pretty happy with the results. And on pricing, Andy, why don’t you answer that?

[Andy Kaiser:]

Sure. Hi, Batya. So, we pushed through a $5 price increase on HSI at the beginning of the year. And what you will see is that would not add a material impact to date from a churn perspective.

[Batya Levi:]

And on the video side?

[Andy Kaiser:]

So, we had a 395 sports fee that also went in place at the front of the year.

[Batya Levi:]

And the competition from charter, do you see any difference in terms of the business segment versus their prior effort?

[Leigh Fox:]

From a business standpoint, yes. I mean, they got fairly aggressive with business marketing in the quarter where they’re offering no contracts and really attempting to attack where we don’t have fiber. And we did see a difference there, where we have fiber to build also businesses, we saw minimal impact; where we saw impact was really where we don’t have fiber build. And so, in those areas, we saw -- we definitely saw an increase in churn; it’s effectively tripled in the quarter. So, I mean, what it proved to us was, where we have fiber, we win and where we don’t have fiber, we’re at risk. So, it’s continued theme with our Company around fiber.

[Andy Kaiser:]

And I’ll just add one additional comment to that. So specifically what they’re targeting is at 60-meg starting speed against to these points where we have DSL call it 5-meg. So that has been obviously a point of vulnerability that they’re going to after.

[Operator:]

And we’ll go next to Sergey Dluzhevskiy with Gabelli & Company

[Sergey Dluzhevskiy:]

Good morning, guys. Couple of questions. First, on capital allocation. Leigh, could you share your thoughts on capital allocation, returning cash to shareholders over the next let’s say 24 months? Obviously this year is still a heavy investment here. At what point stock buybacks become more meaningful tool? And second question on SunTel, if you could provide maybe additional background, any metrics, revenues, EBITDA and also your thoughts on growing the IT services business, as far as both organic and through acquisitions?

[Leigh Fox:]

Thanks, Sergey. I appreciate it. On the capital front, right now, we’re doing a lot of analysis on cash and build obviously. As we said in the past, we believe in fiber, we believe that fiber’s winning; our metrics show that fiber’s winning. We obviously report consolidated metrics. But we look at metrics fiber-to-the-home versus fiber-to-the-node versus DSL. And I’d say where we have fiber-to-the-home, our penetration rates on broadband are higher, our churn is lower; we’re winning. And so, the feeling here is if you’re wining, why slow down? Ultimately, we can hit more and more of our footprint, because we’ve gotten better and better at this. And so, as a company, the strategy is winning. So, as long as it still makes sense and we continue to win and we win at rates and capital investment cycles that are within reasonable ranges of ROI, then why slow down? So, it’s a balancing act right now between cash and what you use that cash for. And right now, I think we’ve been pretty clear, fiber’s winning and we should be more of it. And I think that shows up in the metrics. On SunTel, it’s a pretty small company. We didn’t get very transparent on the metrics because of the size of the company. Overall, I think per year, you’re looking at less than $1 million of EBITDA on a normalized run rate basis. But what it did for us was it really filled in a hole in the Midwest where we were beginning to add organic departments. And organic growth is slow and dilutive. And so, this was a great opportunity for us to fill in a hole in the northern part of the Midwest and really see what the acquisition, buy versus build strategy, what the difference is between the buy versus build strategy, and honestly we’ve been very impressed. With IT services, the real opportunity is if you look at what’s happening in the industry, people are starting to move from the on-prem solutions, which are really hardware based to really platform-based solutions and we have got great product. We just need distribution channel. There is only so much we can do in Cincinnati and we have got high penetration and we have been incredibly successful in territory. And we are attempting to move that out of territory. If you look at the products that are successful, I mean, on UCAS side, if you combine what we have between Cincinnati Bell and CBTS, we have got over $80 million of UCAS revenue that’s growing at mid teens percentages every year. And so, our job over the next year or so or less is to clean that up, and clean that view up, because effectively we are a third the size of 8x8’s revenue and growing. So, if you look at UK as combined with our ability to offer SD-LAN, MAZ [ph] type services and BDC infrastructure. I think we have got a really nice bundled business sweet that’s been very successful. And as I mentioned earlier, we just need distribution in sales and that’s what we’re really growing after. And it seems to be working right now. So, we are going to continue down that path.

[Operator:]

[Operator Instructions] We will go next to David Barden with Bank of America Merrill Lynch.

[Unidentified Analyst:]

This is Angela [ph] filling in for Dave. Thank you for taking the question. My first question is regarding the rate of incremental coverage expansion versus the rate of penetration take-up. Versus last year, Fioptics has an incremental 90,000 new addresses but penetration rate more or less stayed the same, with the exception of the 2% pickup in internet. So, can you comment on the growth you are seeing in your underpenetrated covered path and how that’s affecting the overall penetration rate, and if you are seeing any growth in that segment?

[Andy Kaiser:]

Sure. This is Andy. I think the important note is we passed over a 100,000 new addresses last year and despite that maintained a penetration rate consistent all year along. We’re currently at 26% across our market for video, internet at about 38%, and then voice is at 18%. What we see over the course of several years is that penetration continues to grow in a very strong manner from year-to-year. So from an HSI side perspective when we first roll passed addresses were about 27%; that will grow by year four to about 49%. And Leigh mentioned where we have fiber, we win; we are seeing it in all of the metrics. So, where we’re fiber to the home from an HSI nature side perspective, internet churn is literally a fraction of overall churn. So, we have seen and anticipate that we will continue to see year-over-year penetration expansion as the product is in market.

[Unidentified Analyst:]

And just as a follow-up question on the -- actually, it’s a different question on the IT services segment. You mentioned that the outer territory regions is a growth opportunity. Can you comment on the state of this business and share any insights on -- maybe elaborate on what you mentioned before regarding cloud technology? Is it a threat or opportunity? Thanks.

[Leigh Fox:]

Yes. We definitely look at it as an opportunity. I mean, if you look at the revenue mix, I mean the whole industry is changing. As you can see from hardware sales, I mean, low margin hardware sales are impacted by two things really, the cyclical nature -- so the buying pattern of business customers; and then the movement to cloud. And what we see is a lot of clients are trying to figure out what cloud mean for them and how that affects their purchasing pattern. So, from the standpoint of threat versus opportunity, I would say, it’s going to reduce low margin revenue over time for sure. But we’re in such a great position, because we have platforms that allow us to continue grow with customers, not just in territory. These are products that don’t have to ride on our network. These are non-facilities dependent products. So, our goal -- and we have been winning out of territory. And our goal is to continue to migrate out of territory and expand our footprint with these products and services. So, in the short-term, you’re going to see a bit of an impact on hardware revenue. But, in the long-term, I think you’re going to see services revenues grow at obviously higher margins than you get from revenue and ultimately increase the cash profile of that business. So, I’m actually really bullish on it. I think it’s a great opportunity. I think it really differentiates Cincinnati Bell. If you really look at the profile, what we have is, we have a fiber network that is to me, I think growing to be second to none in the nation. And then, we have an IT services business that gives us from Midwestern to East Coast and a national platform. And to me that’s incredibly attractive to have two assets like that and have the optionality with two assets like that in the future. So, yes, I’m bullish on it than I’m bearish.

[Operator:]

And we’ll go next to Simon Flannery with Morgan Stanley.

[Spencer Gantsoudes:]

Hi. It’s Spencer for Simon. Thanks for taking the question. Just a quick follow-up to the prior question on the IT equipment. It’s been pretty volatile on a quarterly basis, but the overall trend seems to be down. In terms of your guidance, what’s embedded for that line item? Is it more of the same or some stability? And then, I guess you touched on it earlier, but can you remind us the latest thinking on buyback in terms of size and timing? Thanks.

[Leigh Fox:]

Yes. On the first part of the question, the hardware, what we’ve got in guidance is effectively the impact of what we’re seeing. I would say, this is a lower quarter, if I look at deals in the funnel; it’s just going to be volatile. But overall, I mean, all that’s built in within our revenue guidance. But I will -- I mean, I can’t stress that. The way of the industry is trending, a lot of providers are trying to figure out how to transition these on-prem services to sort of platform-based services. And again, I think that puts us in a real good disposition, because we’ve got great products from a platform standpoint. On the buybacks, as I mentioned, right now -- I’ll let Andy elaborate a bit. We are restricted from a payment basket standpoint on how much we can buy back. It’s not significant what we can do; it’s not going to move the needle. And so, that’s one of the things we’ve put in formula as we look at how to create shareholder value in the future. I mean, we stated before you have cash, you could do -- if you think with the cash, you buy back debt, you buy back equity or invest in the business for growth in the future. We believe we have a lot of ability to create long-term shareholder value and investing in the business. And we’ve proven it through our fiber investments and our continued ability to win with fiber. You will see it in our expansion of IT services. As I look at what we do with our cash, obviously we look at many things but one of the things is how substantial we -- what size of buyback could we do and is it substantial enough to move the needle. Andy, do you want to elaborate on that?

[Andy Kaiser:]

Sure. So, just to elaborate a bit on Leigh’s point, under our corporate credit agreement, there is a restriction that we are about 3.5 X from a leverage perspective. We are restricted to 15 million in buybacks. There is an additional provision that would allow 15% of CONE proceeds but that is also subject to a $35 million annual cap. So, back to Leigh’s point at the front and of the conversation, we continue to look at the best use of cash and we will continue to do that. But, it is important to note that with share buybacks, there is a restriction around currently what the size of that buyback could potentially be.

[Operator:]

This does conclude today’s conference. We thank you for your participation. You may now disconnect.