Cincinnati Bell Inc.
Q3 2016 Earnings Call Transcript

Published: 2 Nov 2016

[Operator:]

Good day and welcome to the Cincinnati Bell third quarter 2016 CBB earnings release call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Joshua Duckworth. Please go ahead, sir.

[Joshua Duckworth:]

Thank you and good morning. I would like to welcome everyone to Cincinnati Bell's third quarter earnings call. With me on the call today is our Chief Executive Officer, Ted Torbeck, our President and Chief Operating Officer, Leigh Fox and our Chief Financial Officer Andy Kaiser. Ted's comments today will recap our highlights for the quarter, provide a financial overview as well as an update on segment results. Following the prepared remarks, Ted, 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. 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 that, I am pleased to introduce Cincinnati Bell's Chief Executive Officer, Ted Torbeck.

[Ted Torbeck:]

Thanks Josh and good morning everyone. Thank you for joining us today. For the second consecutive quarter, we generated year-over-year consolidated revenue and adjusted EBITDA growth. As highlighted on slide six, consolidated revenue totaled $312 million, which is an increase of $12 million resulting from an 18% growth in strategic products. Adjusted EBITDA remained strong at $78 million. Net income equaled $19 million, including the $33 million gain on the sale of a portion of our CyrusOne investment, partially offset by the $11 million loss on debt repayments. After adjusting for a one-for-five reverse stock split, diluted earnings per share for the quarter totaled $0.38. Now turning to slide seven. Entertainment and communications segment revenue for the quarter was up $8 million over the prior year and adjusted EBITDA increased $1 million. Strategic revenues were up 22%, as our fiber expansion continues to drive favorable returns. On slide eight, we summarize our entertainment and communication segment results by market. Business revenues totaled $72 million for the quarter, which is consistent with the prior year as we continue to transition customers from our legacy copper services to more strategic fiber offerings. This transition is designed to move our mid-major customers to VoIP platform customized to fit their business needs. Carrier revenue was down $3 million year-over-year, as national wireless carriers have increased their focus on improving network efficiencies. The carrier market has also been adversely impacted by ongoing switched access rate reductions mandated by the FCC. We are monitoring all FCC proposals including special access reform as we expect future regulatory decisions combined with network grooming efforts to create future headwinds for our carrier market. Despite these challenges, we continue looking for growth opportunities within small cell and added territory solutions. As highlighted on slide nine, strong demand for Fioptics generated 12% year-over-year growth. Fioptics revenue for the quarter was $65 million, increasing 32% compared to a year ago. During the quarter, we added at 7,000 video subscribers ending the period with 133,000 subs. Video penetration was down slightly due to passing doors at an accelerated rate. Churn improved compared to the prior year, but was seasonally higher than the previous quarters due to the back-to-school move season. Video ARPU totaled $83, up 5% compared to the third quarter of 2015. Total Internet subscribers grew by more than 18,000 from a year ago as we ended the quarter with nearly 300,000 subscribers. Fioptics Internet subscribers totaled 186,000, adding 11,000 subscribers for the quarter as penetration rates remain impressive at 36%. Fioptics Internet ARPU was $47 for the quarter, which is up 9% compared to a year ago. Turning to slide 10. IT services and hardware revenue increased $6 million compared to the prior year, generating 11% adjusted EBITDA growth. Strategic revenues were up 10% compared to the third quarter of 2016 on continued demand for cloud services with our existing customers. Hardware sales for the quarter totaled $66 million, up slightly compared to the prior year. Now moving to slide 11. Free cash flow for the quarter was negative $21 million. Interest payments totaled $17 million and capital expenditures were $67 million. Discretionary investments totaled $55 million, including $43 million for Fioptics and $12 million for success-based fiber builds for business and managed service projects. Our Fioptics suite of products continues to drive impressive financial and operational results quarter-after-quarter. Through nine months, we have passed nearly 78,000 new homes and businesses with Fioptics, giving us 64% coverage of Greater Cincinnati. Based on our current trajectory, it is likely this year's build could exceed 95,000 new addresses. In order to capitalize on opportunities within our market, we will continue to accelerate our fiber builds through the end of the year and expect capital expenditures to be in the range of $280 million to $290 million in 2016. In addition to our strong financial results this quarter, we issued $425 million of 7% senior notes due 2024. Net proceeds from the note issuance were used to redeem the higher coupon 2020 notes reducing interest payments by more than $3 million annually. Our ability to issue the notes at a significantly lower rate highlights the combined success of our fiber deployment and CyrusOne monetization strategies. As of the end of the third quarter, we held threes million shares of CyrusOne common stock value at $144 million and our NOL balance was approximately $270 million. In closing, we remain focused on a disciplined approach to improving our capital structure and maximizing shareholder return as we execute on our strategic initiatives. We continue to make significant progress towards transforming into a state-of-the-art fiber and IT solutions company. As a result, we are reaffirming our full year revenue and adjusted EBITDA guidance. This concludes the prepared remarks for today's call. Thanks for listening. We will now open the conference up to questions.

[Operator:]

[Operator Instructions]. We will take our first question from David Barden with Bank of America.

[David Barden:]

Hi guys. Thanks for taking the questions. I appreciate it. So just to follow-up, I guess, on the comments, first on entertainment margins. EBITDA stepped down a little bit in the quarter. I think that might be related to your comments around the switched access step down mandates, but it would be helpful to get a little more color on that? And then second, you said you were reviewing some of the regulations from the SEC, including presumably the BDS procedure. Obviously we have the fact sheet, Frontier came out and was able to size some of their exposure there. Can you put a similar kind of sizing around that issue or even kind of identify net payer, net receiver and to what magnitude? Thanks?

[Ted Torbeck:]

Okay. David, first of all, the margins were down a little bit. There was really two things that drove it. One is, you are absolutely correct on the pressure on the carrier revenue and that's both a combination or network grooming and the FCC switched access rate reductions. The second reason is really, we had a one-time hit. It was accounting for unreturned modems and set-top boxes. It was a one-time impact that won't re-occur.

[Andy Kaiser:]

So after all of that, given that we would anticipate on a go forward basis margins would move back into the normal range.

[David Barden:]

And how much was that one-timer? Sorry.

[Ted Torbeck:]

It was about $2 million.

[David Barden:]

Okay. Great. Thanks.

[Andy Kaiser:]

And from a BDS perspective, David, this is Andy Kaiser, thanks for the question. We have, as everyone else out there, spent a lot of time analyzing what all of this means. As you know, there is still a lot of unanswered questions that's still moving a bit, particularly from an Ethernet perspective. What we have identified as sort of currently at risk is approximately $90 million if consider Ethernet and then $60 million if Ethernet is not on the table. When you factor the 11% retroactive reduction assuming a couple of years and then the ongoing 3% with CPI adjustment, you are looking somewhere between likely $10 million and $20 million. Again, all of this is still subject to a lot of movement. And in fact, Ted is making his way to meet with the SEC tomorrow.

[David Barden:]

Got it. And the fact sheet as laid out now is focused just on the tedium side. So that would be 11% over three years on the $60. Is at the right way to think about it?

[Andy Kaiser:]

Absolutely.

[Ted Torbeck:]

Yes.

[Andy Kaiser:]

And then again, the 3% on ongoing basis. I don't think they have been clear if that is indefinite. My assumption is that it is. So the 3% adjusted for CPI would also apply on an indefinite basis.

[David Barden:]

Got it. Okay. Thanks guys.

[Andy Kaiser:]

Thanks David.

[Operator:]

[Operator Instructions]. We will go next to Simon Flannery with Morgan Stanley.

[Simon Flannery:]

Great. Thank you. If I could just come back to Fioptics for a minute, you talked about accelerated build this year and some higher CapEx. What does that mean for 2017? Are you still going to push for through sort of mid-2017? And what is your target year-end? Why do you think its economic to build Fioptics out to? We have seen Google and others take a look at fixed wireless type solutions, perhaps for that last drop to the home? And any interest there? And then on the penetration, I think if I have it right, the video is about 26%, data is about 36%. What sort of levels are you seeing in your more mature Fioptics markets as we think about the for potential there? Thanks.

[Ted Torbeck:]

Okay. Simon, thanks for the question. First of all, any acceleration 100% success based. So we are seeing tremendous success and that's why we are increasing the speed at which we are building out. So as you mentioned, we are up about $15 million is what we are projecting, anywhere from $5 million to $15 million of incremental. So not only is it -- but we are seeing also good value in the savings that we are getting on this additional spent. Some of that will be realize next year, but we are getting about 20% savings in the increased spend. But if you look at the key metrics of why we are making this decision, everyone of them is going in the positive direction. Penetration metrics are exceeding the initial plan. The cost to pass are approximately 10% less than what we initially had in the plan. Fiber is the future proof asset that provides opportunity to deploy any number of future consumer applications. So we are building a network that we think is very, very strong for the future. So we still are positive that we will generate positive free cash flow next year. Again, once we get to the point we will make the decision on where that cash goes and there's many directions. Of course, we are going to keep our shareholders 100% focused on what we do. So we are very excited about what we are accomplishing with the fiber build and that's the reason for the increased spend. As far as penetration rates, our first pass yields are somewhere around 20%. And once we get into the mature market, we are in the mid-30s, somewhere around 35% and even higher up. If you look at the high-speed Internet, we are probably right around 50%, 48% is what we are realizing. Now on the video, it's mid-30s.

[Simon Flannery:]

Is there a change from Time Warner now that they have been acquired?

[Ted Torbeck:]

We haven't. I mean, we do see some more sensibility, what we call sensibility in pricing. But Time Warner was a good competitor and we expect Charter to be the same.

[Simon Flannery:]

Great. Thank you.

[Operator:]

We will go next to Batya Levi with UBS.

[Batya Levi:]

Very thank you. The increase in the CapEx guidance for this year, is that pulled forward from next year's levels? And as you near your fiber expansion targets, can you talk about capital intensity going forward? And any use of cash as that drops off? And then a second question on the EBITDA, your guidance implies that we will see a stepped down in 4Q. Anything you would point to that would drive that? And where do you think the run rate margins can get to in the entertainment segment? I think you had originally suggested to level off around mid-30s and then could start to move up. Are we coming to that inflection point? Thank you.

[Ted Torbeck:]

Okay. On the CapEx, again, this is 100% success based and as long as we see the returns that we have committed to and talked about, we are going to continue to build. We think that, I don't want to lead into what, we are still developing the plans for 2017, but we again, the spend on the capital this year, there is about $5 million to $15 million that we have negotiated a lot better pricing on and so will continue to build that out. And again, it is success based and as we continue to develop our 2017 plans, we are committed to free cash flow, but we don't have that file number yet, Batya.

[Andy Kaiser:]

And regarding your second question, I believe you are asking why relative to the strength of Q3, we anticipate Q4 to be a bit lighter. I just want to make certain of that, that was the essence of your question?

[Batya Levi:]

Right. That's right. If we look at the guidance for the full year, it would imply that there is a step down in EBITDA.

[Andy Kaiser:]

Sure. So we anticipate that will have incremental margin spend in the quarter, which was done in the past which sets us up nicely for the following year.

[Ted Torbeck:]

Batya that will -- I am sorry.

[Andy Kaiser:]

Batya, if you look at previous quarter, you typically see a dip. A lot of it are based on holidays and we make investments in the holidays in marketing and advertising so that we get a nice pop going into the New Year. That's probably the single largest driver.

[Batya Levi:]

Okay. And then maybe some long-term color in terms of entertainment margins?

[Andy Kaiser:]

Again, I think there are, what we have told you in the past, we are going to still see -- we will see some pressure from the carrier, but we still think we are in the mid-30s.

[Batya Levi:]

Okay. Thank you.

[Operator:]

We will go next to Sergey Dluzhevskiy with Gabelli & Company.

[Sergey Dluzhevskiy:]

Good morning guys.

[Ted Torbeck:]

Hi Sergey.

[Sergey Dluzhevskiy:]

Hi. A couple of questions, if I could. First one on cloud services. Revenues were up 51%. Could you talk a little bit about composition of that revenue bucket? Whether you are seeing strong demand for particular products or services? Or this is across the board? And maybe talk a little bit about margins, if you are realizing on those services? And second question, if you could share your initial thoughts on the reaction on the CenturyLink/Level 3 deal and potential implications for competitive environment in Cincinnati? I believe Level 3 is a big competitor in the market for you?

[Leigh Fox:]

Hi Sergey. It's Leigh. I will answer the cloud question and then I will hand it over to Ted. On cloud based services, it's really enterprise based cloud platforms that we sell. And so we are just seeing a lot of demand within our current customer base that is beginning to somewhat spread to new customers. We are getting a little bit of movement. But a lot of that's growth within our current customer base as they expand on their infrastructure. So think of it as really a lot of ICB-based products that we develop for enterprise clients and they are just growing within their our own infrastructure. We see a heck a lot of demand and we see that continuing, at least in the near-term. And then Ted, you want to answer?

[Ted Torbeck:]

Yes. The Level 3, like any acquisition, we look at it in the short-term, as really an opportunity. It's an opportunity to take additional share. As they look to integrate, there is a period of time there where they are in a flux. We also feel that that we will be able to capitalize on the disruption. Our added territory strategy should continue to benefit from merged companies increase, in that we have increased an fiber route miles. And we have a very good relationship with Level 3. The potential negative, again and this is probably couple years down the road, is that they are looking for a significant amount of synergies and those synergies would one of the areas that they could look at is network grooming opportunities of that we could see. But in the short-term, we see it as a real benefit and a real opportunity for us so we can capitalize.

[Sergey Dluzhevskiy:]

Great. And last question is on the local economy, if you could share your thoughts on just state of the economy in Greater Cincinnati state and then your thoughts going into 2017?

[Ted Torbeck:]

The local economy remains very strong. I don't know if you read that GE opened their new location on the river. So that's up and running now and they expect to have that whole building filled. So they will be hiring a lot of people. But overall the economy is going very strong. Aviation, GE is very strong. P&G, some of our larger enterprise customers are doing extremely well. So it continues to do very well.

[Andy Kaiser:]

And Sergey, just to add to that, in Cincinnati, the jobless rate hit a 15-year low in May. So to that point, there is just a lot of development, lot of opportunity within the Cincinnati-Dayton market currently.

[Sergey Dluzhevskiy:]

Great. Thank you guys.

[Operator:]

We will take our next question from Barry McCarver with Stephens.

[Barry McCarver:]

Hi. Thanks, guys, for taking my questions. A good quarter. And good morning. I wanted to talk on the video side just a little bit. We saw another nice uptick in video ARPU. I was wondering if you could help a little more color on what's driving that?

[Ted Torbeck:]

Absolutely. So we have, over the past year, implemented several price increases. So in August, we had a price increase that we pushed through of a couple of dollars, January another $3 per sub from a modem fee perspective. So we are able to, I think, on the strength of the product increase price without seeing any real impact from a churn perspective. We remain very competitive with Time Warner, now Charter. And so we anticipate on a go-forward basis, there is still opportunity for price increases to boost ARPU but also to remain competitive in market.

[Barry McCarver:]

Very good. That's helpful. And then on the remainder of account stock that you own, any thoughts on when the timing of the rest of that comes up?

[Andy Kaiser:]

Yes. Barry, again, we are very bullish on CyrusOne. They announced results yesterday, I think the other day, that were tremendous. Their backlogs are strong. All of their pricing is going well. So we remain bullish. We are going to continue to monitor it. And we don't have a significant amount left, but we will opportunistically look at the best timing when to do that. So there is no real set timing. But we will look at it based on the market.

[Barry McCarver:]

Okay. Very good. Thanks guys.

[Andy Kaiser:]

Thanks Barry.

[Ted Torbeck:]

Thank you.

[Operator:]

We will go now to Frank Louthan with Raymond James.

[Frank Louthan:]

Great. Thank you. So can you comment a little bit on the split between MyTV and linear TV? Anything you have learned there from skinny bundle and the tweaks you are offering or any other, any plans for a Roku-based app or something like that to access content?

[Leigh Fox:]

Hi Frankly, it's Leigh. Yes. I think what we have learned is, there is definitely a demand for it and a demand from the customers. We saw, as we mentioned in previous calls, the demand far exceeded our expectations on that bundle. On the over-the-top, we are absolutely looking at an over-the-top application. In fact, we are looking it up with Roku. We are looking at a lot of different options to basically push our services out into the network. And those would be kind of next-generation over-the-top services. So we are definitely looking at all the options you can think of, as you can see the landscape changing, we are trying to stay on the forefront of those. Obviously we will be a fast follower in a lot of our cases, but I think there is a lot of change to come over the next 36 months from everybody, including us.

[Frank Louthan:]

Okay. Great. Thank you.

[Operator:]

[Operator Instructions]. We will take our next question from Jennifer Fritzche with Wells Fargo.

[Jennifer Fritzche:]

Great. Thank you. Can you hear me?

[Ted Torbeck:]

Yes, Jennifer.

[Jennifer Fritzche:]

Great. Sorry. I just wanted to follow-up on some of the Level 3 questions. Obviously in the last 10 days, the world has changed a lot with different carriers making different bets. But I know you are not going to buy a content company. But can you talk a little bit about your, if there is an M&A strategy? There seems to be a lot of fiber assets for sale and I would argue you guys have done, to your credit, a lot of heavy lifting in the cyber spend in the market you have, which other probably wish they had done. But as you look at the world now, is there things you look at and would they have to be contiguous to Cincinnati? Or would you look outside, if at all?

[Ted Torbeck:]

Well, again, we think part of our job is to make sure that we do have a good look at M&A and we got a group that continually focuses here and again we are going to evaluate opportunities that are presented to us but our view has not changed. We think that we consider a lot of different opportunities. We currently believe the IT services business, there is tremendous opportunities. We do believe that the valuations are a little high. So we are not going to overspend or overpay for something, but I think if you look at it, that's probably our biggest opportunity, is in IT services and we will continue to look at opportunities.

[Jennifer Fritzche:]

And Ted, if I made this a separate question on dark fiber, are you seeing, I mean, we have heard mixed reviews there that there is a demand for dark fiber. Yet then, some would say, no, it's actually more lit. What are you seeing? And would you consider a more serious dark fiber strategy?

[Ted Torbeck:]

Yes. We see dark fiber. What I consider --

[Andy Kaiser:]

It's mixed. We are seeing mixed. What we see, there was a lot of fervor about a year ago on development of dark fiber, but I think the pace and management, pace from some of these carriers moved it to the lit side and the lit services. So I think you see a shift, back and forth in intent. Honestly, in my opinion, over the last six to eight months, the fervor has calmed down quite a bit that we saw over a year ago. But again, it's still mixed and it really depends on who you are talking to.

[Jennifer Fritzche:]

Great. Thank you.

[Operator:]

There are no further questions at this time. So we will end the question-and-answer session. And that concludes today's conference. Thank you for your participation. You may now disconnect.