Cincinnati Bell Inc.
Q2 2017 Earnings Call Transcript

Published: 4 Aug 2017

[Operator:]

Good day and welcome Cincinnati Bell 2Q 2017 Earnings Release Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Josh Duckworth. Please go ahead sir.

[Josh Duckworth:]

Thank you and good morning. I’d like to welcome everyone to Cincinnati Bell’s second quarter 2017 earnings call. Before we start, let me remind you that our press release and presentation slide for today’s call are posted on our Investor Relations website. Today’s call is being recorded if you would like to listen to it at a future time. I would like to draw your attention to our Safe Harbor statement presented on slide 2. 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 me on the call today is our President and Chief Executive Officer, Leigh Fox and our Chief Financial Officer, Andy Kaiser. Leigh’s comments today will recap our highlights and segment performance for the quarter. Andy will then provide additional detail on our financial performance and 2017 guidance. Following the prepared remarks, Leigh and Andy will conduct the question-and-answer session. With that I am pleased to introduce Cincinnati Bell’s President and Chief Executive Officer, Leigh Fox.

[Leigh Fox:]

Thanks, Josh, and good morning, everyone. Thanks for joining us today. Our performance in the second quarter demonstrate our team’s ability to execute as we expand our fiber network and broaden the national footprint of our IT services business. As highlighted on slide five, revenue from strategic products increased 9% compared to the prior year due to continued demand for Fioptics and Cloud Services. Consolidated revenue for the quarter was down 2% from the prior year as the growth in strategic revenue was offset by declines in low margin hardware sales and ongoing legacy product declines. Adjusted EBITDA was $77 million representing a 9% increase sequentially and a 1% increase over the prior year. We also initiated an internal reorganization to better align the company for future growth that resulted in a $4 million restructuring and severance charge in the second quarter. This, in combination with the previously announced voluntary severance plan should generate an annual cash savings of more than $20 million when fully phased in by 2019. This quarter’s performance and specifically the contributions from Fioptics and Cloud Services offerings highlights the potential for future growth generated by continued investments in our strategic products. The increased needs for fiber infrastructure that support high density data transmission and the migration of business services, data services and the cloud are reshaping the markets in which we operate. Through a combination of ongoing organic investments and strategic acquisition, we are building the scale necessary to capitalize on these significant market opportunity. The recently announced combination with Hawaiian Telecom and OnX, which are outlined on slide six accelerate our leadership in next generation fiber infrastructure and IT Cloud migration and position us to take advantage of these favourable market dynamics. The announced merger Hawaiian Telecom will add operational scale and expand our fiber centric footprint and commercial opportunities into Hawaii. This deal also aligns with our belief that dense natural fiber networks will become the backbone of future data consumption and allow and allow us to expand our footprint on a reasonable cost per route mild basis. Hawaiian Telecom’s distinctive brand, unique strength and its local territory and it’s continued investments in expanding its fiber network throughout the Hawaiian island will position it well to capitalize on future data trends. The announced acquisition of OnX print meaningful scale service offerings, free cash flow generations and customer diversification to our IT services business. OnX’s North American platform will dramatically increase our IT services business runway for growth, providing access to reverse [ph] slide customer base including several Fortune 500 companies and opening up additional synergies with our growing Cloud product based products. These combinations with our current assets create two distinct the complimentary lines of business with expanding our geographic reach and each with one billion plus in annual sales. The combined companies will have significant greater financial scale and will be well positioned to generate strong free cash flows. Finally, I’m pleased to share that we have made good progress on multiple fonts regarding the approval of the Hawaiian Telecom transaction, which is expected to close into 2018. We have had very positive in person meetings with local regulators on the announcement and as previously disclosed, we have already secured voting agreement from a shareholder of roughly 23% of Hawaiian Telecom’s stock. Moving on to our quarterly segment performance on slide seven, entertainment, communications revenue increased by 5% compared to a year ago, as strong demand for our fiber-based products drove an 80% year-over-year increase in strategic revenue, which continued to outpace legacy copper declines. The increase also reflects one time contribution of approximately $5 million from a fiber build project completed in the second quarter. Adjusted EBITDA was up 3% year-over-year totalling

[Andy Kaiser:]

Thanks, Leigh. As I outlined on slide 11, free cash flow for the first half of 2017 totaled $30 million compared to negative $17 million last year. This increase in free cash flow is primarily attributed to a decrease in interest payment, working capital and lower capital expenditures. We ended the quarter with net debt of $1 billion, resulting in a current net leverage of 3.6 times. As previously announced, Cincinnati Bell secure committed financing of $1 billion, subject to customary closing conditions from Morgan Stanley and certain other arrangers to fund these mergers. We are considering replacing a portion of the secure committed term loan with unsecured senior notes and have increased the capacity on revolving credit facility to $180 million. Once both transactions are finalized, and synergies are achieved we do not expect a material change in leverage. As presented on slide 12, capital expenditures were $50 million in the second quarter and $105 million year-to-date. During the quarter we invested $30 million in our Fioptics suite of products, $10 million in success based fiber builds for business and new IT service projects, and an additional $10 million in maintenance. As Leigh mentioned earlier, we have passed 23,000 new addresses with Fioptics year-to-date and we are on track to pass the plant’s 35,000 new addresses during the year. Our capital spending for 2017 remains focused on efficiently expanding our fiber network as we need fiber to compete effectively. We are still on track to hit our expected range of between $180 million and $210 million of CapEx for the full year. Turning to slide 13, let me walk you through our 2017 financial guidance, which we originally provided on February 15. In light of our year-to-date performance, we are reaffirming our 2017 financial guidance, I’ve highlighted on the slide. Please note that this guidance does not include any contribution from pending acquisition. Lastly, we expect 2017 interest payment and contributions to our pension post retirement plan to remain consistent with 2016 results. I will now turn the call back to Leigh for some closing comments.

[Leigh Fox:]

Thanks Andy. In conclusion, we are excited about the direction of our two businesses and the significant growth opportunities ahead, and we will continue to invest in our strategic offerings where we are winning. In our fiber network business, including the pending merger with Hawaiian Telecom, fiber density is proving to be a key market differentiator and our continued investment in fiber will position us to be on a leading edge of our industry just as the importance of this asset begins to increase with growing data consumption trends. In our IT services business, the acquisition OnX creates a transformational opportunity to differentiate us in the marketplace with greater scale, more diversified product offering and improved business mix. Our goal is to create two well run growing companies with a continued disciplined approach to capital allocation that is aligned with the best interest of the company and its shareholders. Our top priority continues to be investing for profitable long-term growth through success based investments to expand our fiber network and IT services. Also, as we have demonstrated in the past, we remain committed to a strong balance sheet. This includes maintaining adequate liquidity and managing our leverage level. Beyond that, we will also continue to look for opportunistic way of further creating shareholder value. Our historic approach at managing this company remains unchanged. We will create a strong business with sustainable cash flows, then use net cash to one, reinvest in the business, two, pay debt, three or three opportunistically buy back shares in whatever order creates the best sustainable returns. We are excited about the path for and the ability to create value for our shareholders and the customers as we continue to execute on the strategy. I will now turn the call over to the operator and open up for Q&A.

[Operator:]

[Operator Instructions] Our first question comes from David Barden with Bank of America. Your line is open. David Barden, your line is open; please check your mute function.

[David Barden:]

Sorry about that, thank you. [Indiscernible].So I guess the first one, Leigh is more strategic. I guess as we watch this WOW transaction with Verizon kind of come together where you know there I guess selling/sharing their infrastructure with Verizon’s whose is kind of made it clear that they have this kind of large-scale 5G capillary fiber infrastructure appetite. Could you say either, whether you received interest in the kind of fiber infrastructure you’ve built or whether you might be advertising that you have this infrastructure now to people to gauge its level of interest, I would look to kind of hear your thoughts on that. And then I guess the second piece would just be kind of some more color on the restructuring, the $20 million savings that you are hoping to get by 2019. Could you kind of elaborate a little bit on what you are trying to do with the organization and for your sample [ph] on? Thanks.

[Leigh Fox:]

Yes, thanks David. On the fiber infrastructure, yes, let me use this as an announcement of advertising on our dense fiber networks to anyone who wants to come. Yes, I mean, I think the trends that you are seeing with Verizon and the recent acquisitions by Crown Castle. I think it all points in the direction that we believe as it existed for a little while that you know fiber is needed for future where future consumption of data is going. And so, as we look at everything that we invest in, we are looking at the value of those investments in the future and do they align with where we think industry trends are heading and we absolutely believe that fiber density wins. And so, you know I mentioned in the script if you look at Hawaiian Telecom as an example, from a traditional telecom viewpoint people look at us in certain ways because we are kind of positioned in these RLEC sectors and we have various names associated with us. But if you look at the underlying investments and what we are investing in, it’s quite different. And both companies, us and Hawaiian have invested in fiber. And I think that the value of those investments only increase over time. And I think the Verizon acquisition with WOW and that the announcement and again the others in the market are showing that trend. And it will continue to move in a direction. And so we’re big believers and yes, I will advertise the use of our fiber network and in any way shape or form. I think in our territories we will have the best network and most reliable network and we’ll continue to invest in that way. On the cost structure side, clearly we’re moving to a new strategy from the standpoint of how we’re aligning our companies and in doing so we took a look at our organization and just said, if we’re truly going to drive efficient effective growth in these two businesses that we have, do we have the proper organization and do we have the most efficient, effective organization? And that’s everything from the top down, that each of these companies have a leader that is focused on getting out of bed every day and really focus on growth and what happens in the company too. What’s the financials support look like. What are products look like. And doing so what we found is we had a lot of redundancy on how we were managing the company historically. And so over the past two months or so we've taken out approximately 10 plus million dollars in cost and in the script that combined that with VFP, we announced that really focused on taking down costs very specific to the copper network, that's where the other 20 plus million dollars comes in where and stays in. My stands as you say, I hope that what people see from me and this management team is that we’re very focus. We believe in simple business structure and very efficient business structure. And we will focus over the next several years taking out cost where applicable and adding cost where we’re driving growth and investing in growth. And so you'll see more and more of this as we move forward, but I think the highlight is I really believe in simple structure and efficient efficiency and then using that efficiency to drive growth.

[David Barden:]

Great. Thanks, guys.

[Operator:]

Our question comes from Simon Flannery with Morgan Stanley. Your line is open.

[Simon Flannery:]

Great. Thank you very much. Good morning. I’m just following up on this Dave’s question. On the cost side you’ve talked a lot about the subscribers on the Fioptics network, but what are you seeing in terms of things like maintenance and trouble reports and even close to counting things? What sort of changes in your cost structure there. And how do you get more people onto that, get the copper just our where you about to rebuild the fiber pass the home, is that a decade long things or sort of big chance to accelerate that and really just get that copper out? And then maybe just on the Hawaiian deal. Any updated thoughts, early discussions with regulators just around what that timeline will look like for approval in Hawaii? Thanks.

[Andy Kaiser:]

Thanks, Simon. On the cost side and moving down to the network costs, yes, we see improvement. We see improvements with repair rates. We see improvements with churn. We see improvement during storm except that they’re lightning storm. I would say that the new nemesis from the weather standpoint or lightning storms with the electronic, but you do see efficiencies. Network transformation is incredibly difficult. We've done various tests over the years and we continue to take a look at that certain different service areas within our footprint and look to see how we can migrate effectively and efficiently, and you we were less concerned on the consumer side, though there are some regulatory items that we work through and we will continue to work through. It’s more of a business issue. And we’re getting there with the business side, but I always use example when I talk about network transformation of – when you rip out of copper network, if I -- and I’ll take the extreme example. If I just completely rip out the network and I have one business that has one copper line attached to an alarm in an elevator. It's very difficult to have that conversation with that business to say, I’m no longer supporting that copper line that runs that alarm in that elevator. And so we are actively working on solutions. Still it’s really small tactical things like that. It working its way forward, its moving and its progressing, but I would say that it -- you mention the timeline of 10 years. I don’t know if its 10 years, but it’s probably closer to a 10-year migration than it is the one migration. Does that helpful?

[Simon Flannery:]

Yes.

[Andy Kaiser:]

And then, on Hawaii, look the Hawaiian, the process with regulators is a process and we've begun the process through in person discussions. We will continue the process and filings over time, but we’re going to respect the process and run through it. I don't expect as we sit here today any major delays, but we’re early on the process and we’re just taking the posture of just very much respecting the process and working with the folks there to make sure that we do at the right way.

[Simon Flannery:]

Thank you.

[Operator:]

Our next question comes from Sergey Dluzhevskiy -- excuse me. Your line is open.

[Sergey Dluzhevskiy:]

Good morning, guys.

[Leigh Fox:]

Hey, Sergey.

[Sergey Dluzhevskiy:]

Couple of questions if I could. So, first one is strategic. So, in light of obviously, the recent announced acquisitions of Hawaiian Telecom and OnX, Leigh, if you could update us on your M&A philosophy as it relates to your core network-oriented business and in the IT services segment what are the key criteria for positions going forward and what kind of assets potentially, could be focusing on once you close the acquisitions and do some initial integration work?

[Leigh Fox:]

Yes. Thanks, Sergey. Obviously right now we’re very busy. And so, I would say that we’re to be fairly head down on things for a while. That said there are still opportunities I think in both segments and for both businesses. On the IT side, what we look for is just a combination of things everything from product mix and how it aligns with our product to customer base, to the diversification of geography, sales folks, and that trickles -- all that trickles down to price and whether you paying the right price for the asset or not, in your minds. And so it's fairly complex, but I will say that in that industry things are still very fragmented and that there are opportunities for tuck-ins and smaller acquisitions and I believe that will remain for the next several years. And so I'm encouraged on the ability to look at asset strategically and possibly do some tuck-ins over the next several years that help us grow. On the network side it’s a little more difficult. We look at fiber. We look at the operations. I think we said with the Hawaiian merger that we really started with a discussion just between two like businesses and on comparing those with competitors and saying, hey, how are you dealing with this and how are you – we rely culturally. We were very much alike from the standpoint how we thought about one, our customer base, our employees and how we invest our capital. And they had the same philosophy we did on fiber. Fiber and fiber density wins at the end of the day. And that, the market may not completely see it now, but over time we do believe it will see it. And so, that’s how that really started. I don’t know if there is that many out there. We will continue to have conversations with folks just like for the last several years, but I’m in no hurry to jump in anything. And honestly as I said the script one of things we look at is maintaining the healthy balance also and how does that relate. So yes, look we’ll continue to look at. There's no straight answer, you know I hate to say it. One of the things that I believe happen with Hawaiian, that conversation, we think we surprise the market with that conversation. And I knew that going into it. But you can't time M&A, right? And so it gets very complex. What I can say is, look, we’ll look will be inquisitive but we’re very busy now and our focus right now is making what we have work and driving results with the assets that we’re building in the two companies that we’re building.

[Sergey Dluzhevskiy:]

Thanks. And my question is for Andy. I think revenues and EBITDA were ahead of our expectations and part of it I think was that your services and other line in the EMC segment was up significantly. Was this one-time fiber build a big part of it or I guess what else is in that line?

[Andy Kaiser:]

So, part of the increase was due to the carrier one time fiber build, it accounted for about five million from a revenue perspective. The rest really was just very strong performance across our Fioptics products and being able to offset legacy decline.

[Sergey Dluzhevskiy:]

Great. Thank you.

[Andy Kaiser:]

Thanks, Sergey.

[Operator:]

Our next question comes from Barry Sine with Drexel Hamilton. Your line is open.

[Barry Sine:]

Hey, good morning, gentlemen. First of all on Fioptics, it’s continuing to grow pretty strongly there. Is a 50% penetration expectation still realistic and related to that, if you could update as any change in the competitive posture I know you compete with the charter/spectrum in those markets and they've been in my mind a pretty reasonable competitor. Can you update us on that, please?

[Andy Kaiser:]

Leigh, do you want to take this.

[Leigh Fox:]

So I’ll start, Barry, with the question regarding penetration, absolutely we think that it is achievable. In fact when we isolate and look at our fiber-to-the home product Internet penetration is essentially there after a few years. So, we have no doubt and kind of till lease point at the front of this conversation, it really is all about the delivery and the transport and with fiber we have the ability to deliver and transport whatever folks need by way of bandwidth consumption. So, we absolutely have no doubt that from a fiber perspective penetration above 50 is feasible.

[Andy Kaiser:]

Yes. And Barry, on the competitive side, we’ve not anything changed materially and I don't know that we expect. They are good competitor. I think you're going to hear us say that every quarter we’ve been pretty consistent with that. I don't know that I expect it to get more aggressive or get less aggressive. They're just – they are good competitor and we’ll go out to do what we do and they do what they do and I think to me the underlying case here is the product, right? And our continued investment is really focused on having a better product at the end of the day. And we’re not 100% there yet, but we’re making good strides in that direction and that what we’re focused on. I think if you have a good product you can you compete with anybody. And so I don't expect it to ever be a lay down with them. They are great competitor and they will continue to be one. But I think we’ll have a very competitive product and one that’s growing in its competitiveness. So, that’s what we’re focused on and I don't see things changing in the short term.

[Barry Sine:]

Okay. And then you’re also at around 70% build to your homes and I think that's a bit beyond when you first started this process you're a little further along them, you thought you might get. Obvious construction costs have been a little lower, electronic cost lower and you got a lot more experience now on penetration. Can you update on what your thinking is on how far you might go and then beyond the Fioptics footprint any thoughts of other technologies for example a fixed wireless because in those markets that where you’re still seeing the customer losses and revenue declines.

[Leigh Fox:]

Yes. Barry, honestly I’m going to handover – we’ve got our Chief Operating Officer Tom Simpson here with. I’ll hand it over to Tom for that question.

[Thomas Simpson:]

Hi, Barry, this is Thomas Simpson.

[Leigh Fox:]

Hi.

[Thomas Simpson:]

We are in fact evaluating fixed wireless trails for real service market as well as fiber to the prim for apartment buildings and including G.fast to up to speeds in part with fiber into those areas. As far as fiber penetration, we continue to look at that on where it makes sense, but we believe that we can heavily cover our market servicing areas and really agile.

[Andy Kaiser:]

And you have to remember Barry that 70% on what we call the Fioptics product there is approximately 15% of that is still just fiber-to- the-node using copper. So over time you'll see us go and over build to the prim. If you look -- our metrics and we break down metrics very, very concisely by household and product type, and if you look at the product that prim product it is a great product. And so over time you just slowly migrate things and continue to invest and beating up the density of fiber in your market. And I think – where that ends, it will really -- it will be determined by a few factors on metrics if we continue to win the way that we’re winning I think we will continue to just steadily invest. And then there's the cost, right. As you mentioned the cost came in better than we expected when we’ve originally model things out and we became as you mentioned, better at this. So we’ll keep a very close eye on cost. So as long as we’re wining and we could do it effectively we’ll continue to look at ways of covering the market.

[Barry Sine:]

That's helpful. And then on CBTS in the quarter, the laggards are obviously hardware sales which is not a big deal because that’s low-margin and then you call that professional services. And I think he talked about a trend of in sourcing. So on that is that just one or two large customers and that’s a one-off and you can continue to grow that business? Or should we think about that as an ongoing trend? And if that's an ongoing trend why have you been bullish with your M&A and buying other companies in the same sector?

[Leigh Fox:]

That was really one customer to be completely honest. And that one customer is going through quite a bit including a CO transition. So, we always take the approach with our customers of being there to be helpful and responsive to their needs. We've been through different iterations with a lot of our large customers where we’ve seen downturns on our business because of things happening in their business which ultimately affect us, but we in every case try to be as supportive as possible for those customers. This is no different. This customer is -- they're going through a transition and we're doing everything that we can to help them with that transition. But unfortunately that did impact us. It’s started impact us, I would call it midway through the fourth quarter of last year and into the first quarter of this year. As we mentioned we do believe that’s behind us and so we think that things have normalized a bit, but these do happen every ones while but we don't see it as an ongoing trends.

[Barry Sine:]

And then, a trend to Hawaiian Telcom, I have asked this back when you announced – talked about it when you throw it out again. They’ve talked about roughly $40 million in upfront capacity payments coming in this year from of the undersea fiber and then a similar amount of capacity yet to be sold. Have you talked to them about that what you're thinking on that or you still not willing to comment on their operations?

[Leigh Fox:]

I'm still not willing to comment on that operation. You would have to ask Scott and company to get that one.

[Barry Sine:]

Great. Thank you.

[Leigh Fox:]

Thanks Barry.

[Operator:]

[Operator Instructions] Our next question comes from Batya Levi [ph]. Your line is open.

[Unidentified Analyst:]

Great. Thank you. Couple of follow-ups. First on the fiber build project that you had 5 million, is there any recurring contribution from that for further periods? And could we expect it to see looking at other projects like this, further out? And then on the fiber build out question when I look at construction for the home pass it look like the trends have been increasing actually. Is there anything to point out there? And is that sort of the new norm for future build-out? Does the remaining 10%, 20% gets a little bit more expensive to build out? And when you look at the returns on the fiber build-out what do you expect for video penetration to kind of normalize that? Thank you.

[Leigh Fox:]

Thanks, Batya. On the fiber, the one-time fiber construction we do these types of projects here and there where they make sense for customers. There are not anything we do on a regular basis. There was no recurring revenue associated with that project. But we will when they make sense we will do fiber build for specific customers where they makes sense, and so, but there is nothing I could point you to say that I have a trend in mind. They just -- when they come out we analyze them and then we work with the customer or we pass. On the cost to install and build, yes, I mean things have been steadily creeping up. Its -- I won’t say, greatly, you have to sort of take the lumpiness of our – out of our cash base capital reporting to really get to the underlying trend, but have been steadily increasing. We watch it like we said in the past, we expected – probably number was 20% ,20 plus percent-ish. We expected to be 20 plus percent-ish higher than today than we actually are from a cost standpoint. So we’ve got room. As Tom mentioned earlier we were looking at alternate technologies as we build into areas that honestly will be cost prohibitive and there are other there, so as you as you mention as you creep out cost to increase to a point where it doesn't make any sense to build and we won't, but we will look at alternate technologies to try to increase speed for those customers and be competitive in those areas in and as technology changes I think we see more and more of a potential of covering more and more of a territory which is positive. So, look, we look at it from multiple angles, but we’re constantly looking at our cost per unit basis and we’ll continue to do so.

[Andy Kaiser:]

And Batya, what I’ll add to that is we and Leigh alluded this, but we internally have become more efficient, the vendor ecosystem that we work with both from a labor as well as CPE perspective we’ve become more efficient there. So, all of that has contributed to driving cost down below where we thought they'd be today. One reality is obviously we go after at the front end we go after the more dense aerial neighborhoods, but we look at a whole lot of data and we’ve got a whole lot of data and historical information to help support where we go next and ultimately then what that cost per pass looks like, which will continue to do, but to Leigh’s point we been able to manage cost per pass at a level that makes absolute economic sense to continue to build out. To your final question where do we think video penetration rates ultimately settle in. That’s somewhat of a difficult question just given the reality of over-the-top, but we’re probably talking somewhere around 30% that's what we see when we’ve been in areas for extended periods, but again that the one the one variable there is the reality of over-the-top, but in that regard and we talked about this a lot, we are very well positioned with our fiber Internet that as folks do cut over-the-top we benefit from that migration. So Leigh’s point we continue to look at the cost closely and we’ll continue to monitor those and we’ll continue to build provided that the economics makes sense.

[David Quezada:]

Okay, great. Thank you.

[Leigh Fox:]

Thank you. That concludes today’s conference. Thank you for your participation. You may now disconnect.