Cincinnati Bell Inc.
Q3 2017 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Good day and welcome to the CBB Third Quarter Earnings 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 third quarter 2017 earnings call. Before we start, let me remind you that our press release and presentation slides 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. Now, 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. This 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, Andy and Tom Simpson, our Chief Operating Officer will conduct a 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 strong performance this quarter highlights Cincinnati Bell's continued ability to differentiate itself in the marketplace through ongoing investment and high-speed, high-bandwidth fiber networks. As illustrated on Slide 5, strategic revenue for the quarter grew by 3% year-over-year primarily driven by 21% increase in Fioptics revenue. Similar to previous quarters and consistent with our expectations, strength in our strategic products was offset by ongoing declines in lower margin hardware sales resulting in a 7% decrease in consolidated revenues year-over-year. Adjusted EBITDA was $76 million compared to $70 million in third quarter of last year. Before moving into the quarterly update by segment, I’m excited to announce the closing of the OnX acquisition in early October. The addition of OnX represents a significant milestone and strategic development of our IT services business and brings immediate financial and operational scale across North America more than doubling the number of markets we serve. As presented on Slide 6, the combined CBTS and OnX will posses enhance scale with 20 plus offices access to 50 plus data more than 5000 employees serving 2400 plus customers. A combination creates the platform necessary to capitalize on market megatrends tap into the $250 billion cloud market and accelerate the progress towards our goal of creating an IT services business with adjusted EBITDA totaling $100 million or more. Now turning to our quarterly segment results starting on Slide 7. The entertainment communications business generated revenues of $196 million an adjusted EBITDA of $73 million this quarter up to an 5% respectively year-over-year. The increase in demand for fiber-based offerings drove a double digit increase in our strategic revenue again this quarter and more than offset ongoing legacy revenue declines. In our network business, the primary focus remains on expanding our Fioptics suite of products to support the migration of legacy products to advanced fiber networks. Our pending merger with Hawaiian Telcom which is expected to close in the early second half of 2018 is an extension of our strategy and further differentiates Cincinnati Bell from traditional carriers. This combination positions us to capitalize on the growing demand for fiber by adding operational scale and expanding our fiber centric footprint. With more than 10,800 fiber route miles throughout Greater Cincinnati and the addition of 4300 fiber route miles in Hawaii, we lock in fiber density value for our shareholders as a demand for faster data speeds and broadband usage continues to accelerate. Proof that we win with fiber is illustrated on Slide 8. The superior quality of our fiber network is evident in a strong Fioptics metrics. In the third quarter we added both video and total Internet subscribers despite increasing advertising intensity from our primary competitor. Fioptics revenue totaled $79 million for the quarter increasing 21% year-over-year. We added 7100 Fioptics Internet subscribers during the quarter and with penetration rate approaching 40%, while ARPU increased 5% compared to the prior year. Video subscribers were up 8% year-over-year with penetration rates remaining relatively consistent at 25%. ARPU increased 6% and third quarter churn was improved compared to a year ago yet seasonally impacted by university class schedules. As mentioned, the impressive numbers of Fioptics subscribers added again this quarter further highlights the success of our fiber investments. In the first nine months of 2017, we passed an incremental 31,300 new addresses. Our Fioptics suite of products is now available to approximately 70% of the homes and businesses in Greater Cincinnati's footprint. This represents an 11% increase and addresses year-over-year mix our fiber network one of the most competitively advantaged in the country. Moving on to Slide 9, we provide an overview of our performance in the consumer, business and carrier markets for entertainment and communications. Similar to last quarter, our consumer market revenue increased 7% year-over-year driven by the continued growth in Fioptics. Our business market revenue remained in line with prior quarters as business customers' transition from legacy copper product offerings to strategic based fiber solutions. While we expect challenges from ongoing price pressure and network grooming to persist in the carrier market, we are encouraged by our recent win that is expected to increase our wireless macro tower market share to nearly 100% and partially mitigate these revenue declines once fully operational in 2019. Now turning to the IT services and hardware segment on Slide 10. In the third quarter we generated revenues of $96 million and adjusted EBITDA of $8 million. Our performance is consistent with last quarter as we continue to be impacted by major cost-cutting initiatives by one of our largest customers. We are also experiencing ongoing declines in our lower margin hardware sales due in part to the pattern of IT spending by our customers within Greater Cincinnati. To get back this trend, the integration with OnX and the expansion of our geographic footprint including the diversification of our customer base remain top priority. By combining CBTS and OnX we're positioning ourselves as a leading IT service provider for next-generation cloud-based products. The combined company will have dramatically strength in North American platform offering a complete portfolio of enterprise networking, unified communications and cloud solutions. We're excited about the progress being made with our new expansion strategy. As evidence of this progress, we recently signed a major deal for our national Network as a Service or NaaS cloud solution including security with SD-WAN switching and 18,000 UCAS handsets at more than 3500 retail locations. The project is scheduled to start soon and will be phased in over three-year period. We believe that our 140 plus year history as a voice and network provider gives us competitive advantage as customers look for experienced service providers to migrate them to new digital-based services. While at the same time, due to our historically limited geography the upside and sales of digital based services such as NaaS, SD-WAN and UCAS will make us a net beneficiary of these market trends as we continue to expand our geographic presence. With that, let me turn the call over to Andy who will walk you through our updated capital structure, cash flow performance and provide outlook for the year.

[Andy Kaiser:]

Thanks Leigh. Turning to Slide 11, I would like to start a quick summary of our recent activity to finance the merger we closed OnX and Hawaiian Telcom. In early October, we syndicated a new credit agreement comprising a seven-year $600 million senior secured term loan facility and a five-year $200 million senior secured revolving credit facility. This new agreement provides us with ample financial flexibility to execute our strategic initiatives, as well as liquidity for future needs. In addition, we raised and closed in escrow $350 million of senior unsecured notes to fund the cash portion of the merger consideration with Hawaiian Telcom. Once both transactions are finalized, we expect the combined company's leverage to remain in line with our current levels including run rate synergy. Moving on to our cash flow performance, we generated $37 million of free cash flow for the first nine months of 2017 compared to negative $41 million for the same period last year. The significant increase in free cash flow is primarily attributable to a decrease in capital expenditures and changes in working capital. Our net leverage remains consistent year-over-year and reflects our commitment to continue to build our fiber network without taking on additional debt. Expanding on capital expenditures on Slide 12, we invested $43 million in the third quarter and $148 million year-to-date. During the third quarter, capital expenditures for Fioptics was $25 million, success based business fiber builds and new IT services projects totaled $8 million and maintenance was $10 million. As discussed earlier, we have passed 31,300 new addresses with Fioptics year-to-date and we are well on our way to achieve the plan to 35,000 new addresses for the year. Our capital investment for 2017 remains focused on supporting the growth of our strategic fiber network as we need fiber to compete effectively. As we mentioned earlier, we win with fiber and we will continue to invest what we see opportunities to gain or maintain market share. We're targeting the high-end of our CapEx range of $180 million to $210 million for the full year as we look for opportunities to capitalize on purchase and volume discounts near year end. Turning to Slide 13, let me walk you through our updated financial guidance for the full year 2017. We now expect revenue to be in the range of $1.35 billion to $1.4 billion versus $1.2 billion previously and anticipate adjusted EBITDA increasing to $305 million plus or minus 2% compared to our previous guidance of $295 million. This update reflects fourth quarter contributions from the OnX acquisition completed in early October which is projected to generate between $150 million and $200 million in revenue and approximately $10 million in adjusted EBITDA in the fourth quarter of 2017. With that, I'll turn the call back over to Leigh for some closing remarks.

[Leigh Fox:]

Thanks Andy. We're very excited about the opportunities ahead of us for both our fiber and IT services businesses. Over the last couple of months we've spoken with a number of shareholders and we greatly appreciate the feedback and open dialogue. The combinations of Hawaiian Telecom and OnX support our strategy to bring Cincinnati Bell greater financial and operational scale and establish two market-leading positions and new geographies to capitalize on the ever-increasing demand for data capacity and cloud migration. In our IT services business, we are confident in our ability to successfully integrate the OnX acquisition to provide our customers with enhanced service abilities and product offerings. We are working diligently to complete the acquisition integration and I want to thank all employees for their tireless efforts in bringing these two companies together. In our fiber network business, the pending merger with Hawaiian Telcom is an important step towards scaling our base of high quality fiber assets having capacity to meet demand of growing IoT ecosystems and delivering on the future promise of 5G. Since that announcement, we've made solid progress with local regulators towards securing the necessary approvals for the transaction. And as you know the transaction will be subject to approval by a majority vote of Hawaiian Telecom shareholders. A special meeting of shareholders to approve the transaction will be held next week and we remain confident in a positive outcome. Lastly, we have completed our internal reorganization leading to two distinct business units with the appropriate scale, structure and leadership committed to driving the respective brand forward. While our top priority remains the expansion of our fiber network and IT services to fuel growth and generate sustainable cash flows we also remain committed to a strong and flexible balance sheet. We are executing on our strategy while we continue to maintain discipline approach to capital allocation and in the line to the best interest of the company and its shareholders. We’ve also continue to look for opportunistic ways of creating additional shareholder value in the future. I will now turn the call over to the operator and open it up for Q&A.

[Operator:]

[Operator Instructions] We'll take our first question from Simon Flannery with Morgan Stanley.

[Simon Flannery:]

Leigh, can you just talk a little bit about the IT services and hardware segment obviously you’re doing a number of deals here and there is some one-time items like the large customer. But how should we think about the underlying trends in this business over the next few quarters. But when do we start to see this starting to return to growth. And longer-term you obviously carved out CyrusOne a few years ago that's been very successful, how are you thinking about the two segments in terms of combined versus standalone over the medium to long-term?

[Leigh Fox:]

So the way we’re thinking about the new company we actually have four practices. We're going to see ongoing pressure in hardware sales, I think that's an ongoing trend it’s a bit cyclical, but I think - I don't know that's going away. The good news is we have the cloud-based service based offerings such as you UCAS and SD-WAN and NaaS will help us grow in future. We also have a very strong professional services bench we're developing a stronger cloud integration expertise within the company. So I think the combination of assets going forward are the right assets as you deal with companies who are looking to move from kind of the traditional means of compute storage networking into the kind of new world of where do you put into the "cloud". So from a trend standpoint, I do expect this year because of what's happening with one of our large customers to be a compressed year but hopefully we begin growing next year. Beyond that with the separation of the two companies, look the way I view things is I want to make it as simple as possible for folks to understand what we have and we have two distinct businesses. We've structurally reorganized, next year we're going to reorganize the financial statements to give greater and greater clarity in both of those units both from a financial and operational metrics standalone point. And ultimately that just creates options and hopefully creates greater value from some of the parts standpoint. I think one of the issues that we had as a company is that it’s been a little bit confusing to understand what we have as an example I don't know that people necessarily understand the robust nature of our UCAS business as evidenced by the win that we recently had. We have a very robust UCAS business and if you look at how those companies are trading, they’re trading at high multiples for a reason they are very service oriented from a recurring revenue standpoint and they have a lot of growth in front of them. So I think by separating we further simplify and cleanup the views of the company and as for our intent, I've been pretty clear that if the sub of the parts valuation doesn't equal the total value of the company stock then you've got options in the future. As a company we have a history of spinning out assets and trying to get the most out of any asset that we have. So I'm very open to anything in the future my focus is to create as much shareholder value as possible.

[Simon Flannery:]

Is the scenario where you’ll do more deals or do you think on executing - you’ve got what you need at this point?

[Leigh Fox:]

What I like about that area it’s a very fragmented space and why I say fragmented, you find companies of all sizes and then you find assets that help your portfolio in different ways from a product standpoint. I think OnX was very important for us from a scale standpoint. We needed to initially gain momentum with the North American platform. I think there is ability on the IT services side to see further smaller tuck-ins that help enhance some of the products that we have, but you know at this point we have nothing immediate. We are as I mentioned in the past constantly looking, but right now we’re focused on integrating OnX and then working with Hawaiian to complete that merger. So that's our focus within the next 12 months.

[Operator:]

We'll take our next question from David Barden with Bank of America.

[David Barden:]

I guess the first one would be, I think Leigh touched on something you said that there had been some elevated levels of competition from I guess Charter and your footprint, I wondered if you can elaborate a little bit on that. And then also the in the carrier side, you are noting that there would be a mitigation of the carrier decline as a result of the big macro what if you kind elaborate a little bit on does that offset the decline for '19 or does that revenue kind of blunt the carrier market declined in its entities we cannot model it out on a longer-term basis? Thanks.

[Leigh Fox:]

Yes, so I'll start with the carrier comment. I would say that you would start just mute the decline in '19 obviously we will continue to see increase pressure as carriers continue to optimize and groom their networks. There’s pricing pressure as they make transitions, but obviously that’s a complex migration and I think we've seen sort of the worst dip in kind of the trajectory declines last year. But I don't expect that trend to stop anytime soon, but I do think that this macro deal will help mitigate this declines. On a consumer side, spectrum continues to be a good operator. We said in the past they’re very competitive, they’re good operator. I think being effectively the two horse race from an Internet standpoint in Cincinnati, you’re going to see trading off of sales. I think what's important is having a product that you can sell against your competitor and I do believe that we have a superior product. Ultimately the speed that we can achieve with our customers and provide our customers are greater, so I think from an asset standpoint we’re focused on having a better product but they are great competitor I mean they are big company, they can out shout you and they are out shouting us but that's been consistent. There's been no change, they’ve been consistently out shouting us. So effectively from a consumer standpoint we went from the aggressive nature of Time Warner when they were deal mode to a bit of a transition to I think the ongoing aggressive nature of charter. So and we've been able to compete well all through the cycles and I don't see that being any different moving forward.

[Andy Kaiser:]

David one thing I would add to that Leigh touched on this, while they've been really increasing their advertising sort of a media campaign where we have fiber we have the strongest metrics across our entire footprint. So where we are competing against them with our fiber-to-the-home product we continue to see incredibly strong metrics across the board.

[Leigh Fox:]

David you look at the macro trends in the industry that you still include us in which I don't think we should be included in but look you have to have a product to compete and I think our investments give us a very good product to compete. And we need to stay focused on that we need to offer good service and good product, but that’s the bottom line you need a product to compete and I think we do have one.

[Operator:]

We’ll take our next question from Batya Levi with UBS Financial.

[Batya Levi:]

Maybe just a follow-up on competition from Charter, can you talk about your longer-term expectations for penetration for both the video and the data product. I think on data you had expected to be north of 50% and video maybe get around 25% to 30% is that still the goals. And how do you balance that with profitability of the Fioptics business. Another question I had was on CapEx, can you provide more color on why it’s at the high-end of the range for this year? And I think you mentioned you would take advantage of some volume discounts, what you were referring to on that? And as you expand your geographic presence to attract the business segment, do you think that you would need to own fiber optic data of the region? Thank you.

[Leigh Fox:]

So there is really lot of questions, I will try to hit as many as I can and then I will pass it over to Andy and even maybe Tom here for some color. On your first question as it relates to the penetration rates, I think what you quoted is accurate. I think the only thing that's changing is how we look at video. You know I think we've definitely transitioned from last year to more of an Internet first priority. And I think that’s because of the growing trends of how consumers there are viewing various content. I do see a shift in how video is being absorbed and then content being absorbed. And I think over time that might affect the video subs and the video revenues but it also affects our content cost and should honestly increase our profitability over time. We are looking at how to take the best advantage of these shifting trends. So you know partnerships with over the top providers et cetera et cetera. But of anything, I think I would say that you're Internet assumptions are exactly correct. Video is going to be a little bit challenging and weird just because of the change that we are seeing. But it will be gradual, I don’t think it will be overnight. Do you want to comment on that?

[Tom Simpson:]

What I would add is, you know we are seeing a trend and it's not, we are not talking about a hockey stick trend to Leigh's point, it’s gradual. We are seeing a definitive trend from folks moving more from the bundle including video to Internet only. And you know to answer your question by way of margin, obviously the content cost, there’s a huge portion of our video expense. And as folks continue to migrate, we anticipate, you know you would see an ARPU decline but you would see a corresponding margin increased as folks shift from video to Internet.

[Leigh Fox:]

On your capital question, I would expect capital to stay very consistent. I don't think that we are going to be wildly, why? I think we will be in line this year. And I don't think we will be super different next year but we still haven't determined that and we’ll talk about that a lot more in the first quarter call. But the bottom line is, we've got a consistent build platform happening right now and we want to maintain that. We think it's important for the future. So that’s what to expect in capital. I don't know that again, the only thing you should take out a statement I don’t see a wild increase in capital expenditures coming. On the business fiber front, you know I don't see a need to own fiber out of territory for businesses, I think that one of the benefits I mentioned the script, you know most of the business products are now moving to software defined products and with our historic capabilities in managing these platforms and some of the products that we have, I think we've got a really nice opportunity to grow out a territory. I think that's where historically having such a small footprint, its going work to our advantage. I think a lot of folks are going to see traditional big buckets of revenue being cannibalized by these new software defined products where for us it’s not as much exposure on the downside and it’s a lot more upside for us. Is that helpful?

[Batya Levi:]

Yes, thank you.

[Tom Simpson:]

The only thing I would add to that is, I think you asked specific to why are we guiding towards the higher end of our CapEx range. And I think you started to say this. We are absolutely looking for as we do every year, volume discounts and term opportunities to the extent we can find those. We are guiding towards the high-end of CapEx. Again to the extent that we cannot in the likely probably mid-range.

[Operator:]

We will take our next question from Sergey Dluzhevskiy with Gabelli & Company.

[Sergey Dluzhevskiy:]

Two questions, if I could. First one on, kind of a broad question on M&A looking past Hawaiian Telecom. Leigh if you could talk a little bit about your M&A philosophy. And as you look at your portfolio, possibly pro forma for Hawaiian Telecom, what their sounds areas of interest to you and as subpart of this question is, as you look around and sounds of markets that are in your close proximity to Cincinnati. Do you see any fiber consumer fiber, consumer broadband businesses that there may be of smaller scale, but could be of interest do they even exist that would move a needle for you. And my second question is on IT services you mentioned UCAS as one of the growth drivers there as you look at your pro forma IT services business what are some of other products and services as that show most promise and could be meaningful growth drivers over the next five years?

[Leigh Fox:]

On the M&A front, my philosophy is you keep looking and M&A is a very complicated process that combines the right assets and the right pricing and a lot of variables. And that's what we look for. There are fiber assets around us, there are assets closer to us but they've got be the right assets and they have to be for the right price. And so it gets complex and low probability and that's why you have to keep looking and you have to keep being fairly aggressive that everything you look at from the standpoint of just looking at more to find those opportunities. What I look for isn’t much different than that my level and folks brings up to me I look for the right asset at the right price. There are opportunities around us, there are assets available and on the network side it is a little more challenging, but I do see in the future given what's happening from a macro standpoint maybe a big maybe, maybe stuff opens up more efforts are put near us I don't know that’s complete speculation. But were open to looking right but again it’s got to be the right asset at the right price and that's really what we focus on. For IT services, UCAS is obviously a big product for us. I think cloud migration services will be a growing product for us and something that we get into more from a professional services standpoint and offering smart people to help companies solve problems. I do think that our professional services business is quite robust and that’s a very good job and if you look at from a national standpoint we got with OnX, we’ve now expanded we have a lot of smart people across North America and we're extremely impressed with that. The other ones that we're really excited about SD-WAN, as I mentioned in the script we got one a pretty nice deal in our new SD-WAN product and we’re seeing a lot of momentum there. And then our NaaS Solutions, Network-as-a-Service solutions also - these new software defined products are really what customers are looking for to migrate legacy products and really save money and so get the same or better services while saving money. And I think as I mentioned they're looking for reliable service providers to help them with these migrations, who is more reliable than 140 plus year-old telephone companies that's been doing this for so many years. So we’re pretty excited about those solutions.

[Operator:]

We'll take our next question from Barry Sine with Drexel Hamilton.

[Barry Sine:]

First of all on OnX, on your legacy IT services business you breakout I think its five product categories the revenue composition. Could you give us a sense of what OnX looks like on that same breakout and then related on OnX could you give us an update of what your combined sales force headcount looks like and how much that's grown as a result of the transaction?

[Leigh Fox:]

Barry I'm actually going to toss this one over to Andy to answer.

[Andy Kaiser:]

So from a product mix perspective I'd say roughly 80% of the revenue 80 plus percent of the revenue comes from hardware. And so that was one of the things that we really liked about the OnX acquisition is they're very good from a hardware perspective, but there are products and services and offering that they simply have not been able to bring to the customers. They've got long deep relationships with some very big high quality customers. But they've been unable to provide them many of the services that we have actually been talking about in this call. So SD-WAN, Network-as-a-Service, UCAS solutions and they are very excited to be able to bring these solutions to their customers. But currently their mix is roughly 80 plus percent hardware. From a increase in employee based, it brings on approximately 500 additional employees and again they are located across Canada and effectively across the U.S. and 20 plus branch locations.

[Barry Sine:]

And if I could turn over to the telco side of the business. You mentioned I think Fioptics about 70% coverage in Greater Cincinnati. The other 30% that's not covered, could you give us an update of what your thinking there is? How many can you get to economically over what timeframe and my guess is that most of the year turn in revenue decline and comes in that 30%, so if you could just do something to mitigate that that might improve the overall growth rate.

[Tom Simpson:]

I can tell you that we as we look at returns from a built standpoint, we see a point in the core of the metro service area we can actually achieve 80% to 90% fiber pass, some of that is with overbuild fiber in the neighborhood fiber in the networks. And with that we see again where fiber is we win and that certainly got the penetration.

[Barry Sine:]

So ultimately you would get to somewhere in the 10% to 20% range that would remain copper-based network.

[Tom Simpson:]

And that would be predominantly in some very rural areas where you have very, very low household per mile entities and those areas that we can we can extend the fiber to the node network very close to the houses and still achieve comparable speeds. Lastly in the MDU areas i.e. apartments and complexes, we are still exploring G.fast technologies which is effectively a fiber to the prim but copper inside the building to achieve spectrums bandwidth north of spectrum's capability.

[Barry Sine:]

And any timeframe on getting that 80% to 90%?

[Tom Simpson:]

We’re continuing to look at it. We’re going to the build planning right now to get us there but it's within the current build range at the pace that we're at. You'll see a bit more of that.

[Andy Kaiser:]

And Barry I’ll add on to that. As we look out over the next several years, getting to the 80% to 90% will likely happen over the next two years, you heard Leigh say, you heard me say it, we will continue to invest, continue to build but we would do so without increasing leverage. So we have to do it in a fairly methodical way and that works well give the number of doors that would pass this year looking out of the next couple of years, we think it's a pretty efficient build strategy. We're probably looking three years out to get to the 80% to 90%.

[Operator:]

It appears there are no further questions at this time. I’d like to turn the conference back to Leigh Fox for any additional or closing remarks.

[Leigh Fox:]

Thanks. In closing it's been a very busy few months for us at Cincinnati Bell and I can tell you that all of our peers in the company are very excited about the direction for both - in the potential for both of fiber network business and the IT services business. I just want to thank you guys all for your interest and your continued support. And I look forward to talking to you guys again next quarter. Have a great day.

[Operator:]

This concludes today's call. Thank you for your participation. You may now disconnect.