Cincinnati Bell Inc.
Q4 2016 Earnings Call Transcript

Published: 15 Feb 2017

[Operator:]

Good day and welcome to the Fourth Quarter 2016 CBB Earnings Release Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Josh Duckworth. Please go ahead, sir.

[Joshua Duckworth:]

Thank you and good morning. I’d like to welcome everyone to Cincinnati Bell's Fourth 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 2016 highlights and our outlook for 2017. We will also provide a financial overview of the fourth quarter including an update on segment results. Following 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 3. 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. 2016 was a remarkable year for Cincinnati Bell. The success of our strategic investments generated year-over-year revenue and adjusted EBITDA growth. We also achieved our financial guidance targets for the year and made significant strides towards improving the health of our balance sheet by extending the maturities of our bonds at a significantly lower rate. Additional highlights for the year are included on Slide 6. Revenue from strategic products increased more than $100 million resulting in 2% consolidated revenue growth. Adjusted EBITDA was $305 million, which was up $3 million compared to 2015. Net income for the year totaled $102 million and includes a gain on the sale of our CyrusOne investments losses on the extinguishment of debt and charges related to a voluntary severance program. Diluted earnings per share for the year equaled $2.18. Now turning to our consolidated quarterly results on Slide 7. Revenue for the quarter was down from the year prior year due to declines in lower margin hardware sales. Strategic revenues totaled of a $166 million increasing 15% compared to the prior year. Adjusted EBITDA totaled $74 million which was in line with expectations as we incurred additional operating expenses to support the growth of Fioptics. Our quarterly segment results start on Slide 8. Entertainment and Communications revenue increased $5 million from a year ago as the 21% growth from our strategic fiber-based products continues to outpace legacy copper declines. Adjusted EBITDA totaled $70 million for the quarter resulting in 36% margins. Our Consumer results are described on Slide 9. Consumer revenue increased 7% over the prior year on continued strong demand for Fioptics. As highlighted, Fioptics revenue increased 33% during 2016 totaling $69 million for the quarter and $254 million for the year. Slide 10 includes an update on key Fioptics metrics and demonstrates a superior quality of fiber assets and our right to win is the hometown provider. This quarter we added 4000 video subscribers ending 2016 with a 138,000 subs. Video penetration remained consistent throughout the year at 26% even as we continue to pass towards at an accelerated rate. Fourth quarter video churn of 2.4% was improved from a year ago while ARPU was up slightly at $82. Fioptics internet net activations 12,000 during the quarter as we ended the year with a 198,000 subs. Penetration rates remained impressive at 37% as ARPU increased 7% compared to a year ago totaling $48 for the quarter. To further highlight the success of our Fioptics investment, we increased our internet base by 16,000 during 2016 closing out the year with more than 300,000 internet subs. On Slide 7 we summarize the business and carrier market results for our entertainment and communication segment. Business revenue remained consistent with prior year as we continued to defend our market share and Cincinnati by transitioning customers from legacy copper services to more strategic fiber offerings. Carrier market revenue was down slightly to an ongoing switched access rate reductions and the impact of national carriers increasing their focus on improving network efficiencies. On the regulatory front, we were pleased to learn that the BDS proposals sponsored by former Chairman of the SEC has likely been taken off of the table for consideration. However, we expect continued challenges for the carrier market as well as the ongoing legacy revenue declines across all markets in 2017. In order to balance the required maintenance of our legacy copper network with the growth opportunities from our strategic product offerings, we offered a voluntary severance program that resulted in charges during 2016 and the first quarter of 2017. Once fully implemented, the impact of these cost out initiatives is expected to generate cash savings of more than $10 million annually. Now turning to our IT Services and Hardware results on Slide 12. Revenue for the quarter decreased compared to a year ago due to declines in lower margin hardware sales. Strategic revenue growth also slowed to 3% as a result of increased insourcing of professional services. Revenue growth from cloud services continues to remains strong increasing 37% year-over-year. Adjusted EBITDA was down $1 million from a year ago totaling $8 million for the quarter resulting in consistent adjusted EBITDA margins of 9%. Moving to Slide 13, free cash flow negative $113 million. Interest payments totaling $71 million decreased $38 million compared to a year ago. Contributions to the pension and post-retirement plans were down $7 million in 2016 totaling $13 million. For 2017, we expect interest payments and contributions to our pension and post-retirement plans to remain consistent with 2016 results. As presented on Slide 14, capital expenditures were $286 million for the year as we ramped up investments significantly in the fourth quarter to capitalize on the continued strong demand for Fioptics. In total, we invested $180 million in Fioptics during 2016. Construction cost to pass $101,000 new addresses accounted for $90 million of the investment in installation cost or $60 million. As we experienced a record high 44,0000 Fioptics internet activations, net activations, we also invested $62 million for success-based fiber builds for business and managed service projects. Looking forward to 2017, free cash flow will improve by more than $100 million. We remain committed to generating positive free cash flow for the full year, while opportunistically investing in fiber and IT services for future growth. We are currently forecasting 2017 capital expenditures to range between $180 million to $210 million with approximately $90 million planned for Fioptics. We expect to pass an additional 35,000 new addresses during the year and anticipate demand for business fiber and managed service projects to require $50 million of capital expenditures. An update of our current capital structure is included on Slide 15. During the fourth quarter, we issued an additional $200 million of 7% senior notes due to 2024 at a 105% as an add-on to the notes issued in September. The proceeds from the fourth quarter issuance were used to repay $208 million outstanding on the tranche B term loan. In the fourth quarter, we sold additional shares of CyrusOne for proceeds of $9 million and have continued to opportunistically monetize this investment during the first quarter of 2017. These proceeds have been primarily used to repay debt as we continue to explore additional opportunities to improve our capital structure. As of year-end, our leverage ratio based on 2016 results, and after considering our remaining stake in CyrusOne was approximately 3.5 times, well within a reasonable range. We had $184 million of liquidity and our NOL balance was approximately $295 million. Our 2017 guidance is presented on Slide 16. We are forecasting revenue of $1.2 billion and adjusted EBITDA of $295 million. As highlighted on the slide, we expected adjusted EBITDA to be consistent year-over-year after excluding a multi-year $10 million non-cash post-retirement amortization adjustment that ended in 2016. In closing, 2016 was an excellent year for Cincinnati Bell. Our goals and objectives remained consistent for 2017. We are focused on efficiently expanding our fiber network and IT services business, while identifying opportunities to further reduce cost associated with our legacy products. This team’s ability to capitalize on demand for our strategic products will be the key for creating shareholder value. The remarkable success of our strategic investments will continue to be the driving factor in our ability to generate future revenue and adjusted EBITDA growth and positive free cash flows in 2017. This concludes the prepared remarks for today’s call. Thanks for listening. We will now open the conference up to questions.

[Operator:]

Thank you. [Operator Instructions] And we will take our first question from Simon Flannery with Morgan Stanley.

[Simon Flannery:]

Good morning. And, yes, thanks for the questions. So, Ted, thanks for the color around the guidance. As you mentioned, you are planning to become free cash flow positive. Perhaps you could give us a little bit more granularity you are still going to put, call it, $100 million in just fiber, Fioptics. Is that really in the first or the six, nine months of the year, so we might see a continued cash burn in first half and then a nice cash generation in the second half? And how should we think about runrate as we go into 2018? It looks like, if you are doing 35,000 addresses this year presumably you will be doing more or like 10, 15 in the year after. So that there was this CapEx is dropping 30% year-over-year, there will be another step-down in 2018 and then a more substantial free cash generation. So how should we think about that, because presumably you still have installation CapEx in 2018? And then, any thoughts on use of that cash flow as you guide into a strong free cash flow position, how are you thinking about deleveraging buybacks, dividends, acquisitions, et cetera? Thanks.

[Ted Torbeck:]

Okay, thanks for the question, Simon. First of all, in the free cash flow strategy in 2017, we see it pretty steady throughout the year quarter-over-quarter. That’s how we see it. And one thing that we’ve been telling you all along is, any capital we spend on Fioptics is success-based. So, we are going to get if we are getting the results that we’ve been achieving up to this point, we are going to continue to invest. We have about 67% of the city covered with Fioptics. Due to the cost to build it out as well as install being better than what was in the plan and the penetration rates being higher, our returns are better and we are going to continue to build. So, again, it’s success-based and once we see those numbers change, we will stop building. As far as the use of cash flow, I mean, we are very open to buying back shares at the appropriate time. We also are very bullish on Fioptics and as I said before, if it continues to show success based, we will continue to invest in Fioptics. We are inclined to pay a dividend.

[Simon Flannery:]

Okay, and any comments on strategic activity, it seems like the industry has been pretty busy and obviously, on the wireless there is stuff to come there, but you’ve really haven’t done a whole lot on the acquisition or M&A front. Is that something you might consider going forward?

[Ted Torbeck:]

Yes, we continue to look for opportunities. We’ve got an very aggressive group that’s looking at it. We are not going to overpay as we see multiples being higher than what we are willing to pay. But we are going to continue to look. Again it’s, we are very bullish on the IT front, IT services front as well as expanding out of territory.

[Leigh Fox:]

So those are the areas that we are really looking as well as product enhancements.

[Simon Flannery:]

Great, thank you.

[Operator:]

We will take our next question from Batya Levi with UBS.

[Chris Schoell:]

Hi, this is Chris for Batya. On the guidance, you are pointing to flattish trends for both consolidated revenue and EBITDA standpoint after delivering growth in both in 2016. Can you help us unpack that by segment and how you are thinking about performance in entertainment specifically?

[Ted Torbeck:]

Sure, we continue to see pressure from a legacy perspective. So as it relates to entertainment communications, we anticipate that trend will continue. To Ted’s point, that’s being offset entirely from a revenue perspective due to our investment in strategic products, primarily Fioptics. On the IT front, we will still see some pressures from a hardware perspective and likely some professional services pressure.

[Leigh Fox:]

And Chris, this is Leigh, just to add some color to that, on the business side, the revenue, the flat in the revenue is really hardware-related. We expect, we were down year-over-year this year in hardware. We expect that to continue as companies look at migrating the cloud and what they spend and we saw a little bit that in the fourth quarter plus a little bit of disruption based on kind of decisions around the election and seen what the world is going to look like, ultimately. So, we don’t expect to have a huge hardware year in 2017. And then on the wire – wireline entertainment communications front, carrier, as Ted mentioned, we do see pressure on carrier and we’ve been talking about that now for a few quarters. So that’s really one of the key drivers on entertainment communications. The only other thing to add to both those is that we are also investing in growth out of territories. So we’ve invested in an out of territory presence in a few branches and any time that you invest in organic growth, it’s going to put short-term pressure on your profits while those branches get up and rolling. So, just a combination of those three, what you are seeing in the results.

[Chris Schoell:]

So is it fair to say that the pressure in carrier is going to prevent you from growing entertainment revenues in 2017?

[Ted Torbeck:]

I think it’s really a combination of our expectation around the carrier markets as well as continued legacy pressure.

[Chris Schoell:]

Okay, thank you.

[Operator:]

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

[Sergey Dluzhevskiy:]

Good morning guys. Thank you for taking the questions. My first question is around 5G. Could you share your thoughts on 5G? Where do you see the opportunity, given your fiber presence in the markets and obviously capability that you have including your capabilities in wireless as you are in that business? And also, I mean, to what extent do we see to the front? And I just have a follow-up.

[Ted Torbeck:]

So, I guess, as we – I’ll address the 5G question. I think it’s to be determined, I think if you look at it a high level, there is a lot of opportunity based on our fiber footprint. And as you mentioned, our capabilities in wireless, it’s been a bit of a slow rollout from the carriers as we’ve seen, but we are very well positioned in territory to take advantage of any kind of spend and any kind of need from wireless carriers and in fact, we sort of been building a many tower network effectively and so ultimately, we’d like to take advantage of that. So we do have a strategy on positioning ourselves well for that build out. From a threat standpoint, I think it’s to be determined, we’ve done our modeling on what the investments would look like in order to offer a real wireless threat to broadband and at what fees and right now, it’s hard to see that it would be a massive threat against terrestrial while speeds given the investment needed, but again, we are watching it pretty closely. Right now, we feel pretty good about our position and believe have enough fastest terrestrial network that being fiber in the city as we are going to win the future. So, we see nothing that changes that position. But we are definitely keeping an eye on technology trend.

[Sergey Dluzhevskiy:]

Great. And my second question is on IT services and more so kind of M&A related and I think you touched on a little bit already. So, obviously, I think in the past you said that you would like to double the size of that business get to somewhere to $100 million in EBITDA and as you look at acquisitions, potential acquisitions in this space, what areas of IT services look more interesting to you? Where do you have , I guess, your primary interest and also from organic growth perspective as you look at your existing IT services business, where do you see the largest growth opportunities for you in the space?

[Ted Torbeck:]

Well, the IT services, there is a couple areas that we are looking at. First of all it’s not going to be initially, we are not looking at a large acquisition, but we are looking at areas that can give us geographic expansion with the ability to upsell customers with new products and so that’s one area that we got a lot of focus on. As far as organic growth, there is still, as Leigh alluded to, we have opened up a couple new branches in the last few years and we think that there is tremendous opportunity. We’ve hired very good people that are very connected with the customer base in those regions and we expect to get good organic growth out of those areas.

[Leigh Fox:]

From a – Sergey, from a product standpoint, we’ve seen a lot of success and UCAS, and really when we look at companies, we look at a combination of, as Ted mentioned, how does this help us out of territory? And when we say out of territory, we do put ourselves in a bit of a box from the Midwest standpoint at least right now, because kind of that – that’s our strength in the area we are pretty strong. And so, we are looking at a Midwest presence, growing the Midwest presence and then we look at relationships. The IT landscape is incredibly complex right now and it’s going through a pretty decent transition and we feel like we are well positioned with the assets we have from the people side, the talent that we have from the ability to staff, from the ability to sell hardware to the – to helping people migrate to the cloud. We are very curious around helping people migrate to as you are an AWS, we are looking at areas where our relationships can bring products around cloud-based voice or UCAS where companies may not be selling that or may not be a core competency of theirs and then around just managing infrastructure in general. So, there is a lot we look at. It is a complex industry, but there is a – just a absolute kind of opportunity.

[Sergey Dluzhevskiy:]

Great. Thank you.

[Operator:]

We will take our next question from Frank Louthan with Raymond James.

[Unidentified Analyst:]

Thank you. This is Alex here for Frank. I was hoping to drill down and do a few of the free cash flow items. What’s the biggest variable to the wide range in the CapEx guide? Is the midpoint of it based on the 35,000 homes passed number and then based on success, we could see those homes passed be, say 30% higher or lower? And then, just a clarification on the interest part of the guide, does that assume you retain your remaining CyrusOne stake for the full year? Thank you.

[Leigh Fox:]

So, starting with your question regarding the range, it’s – the range is driven by success-based capital. Part of that is Fioptics in the 35,000 homes, but also other strategic investments that we intend to make through the year, provided that to Ted’s point earlier. We see the returns and we then would obviously move forward with the investment. So, the range is primarily going to lock in around 35,000 doors. From a cone perspective to answer your question on CONE, we’d assume consistent ownership of CONE. However, we have been and this was in the release we have been selling down cone, in 2017, and the market has been strong, cone has performed very well and we will continue to look for opportunities to sell CONE on a go forward basis.

[Unidentified Analyst:]

Okay, I guess just a follow-up then on those other strategic investments, is that around the $50 million of the business services investments you talked about? Maybe some more color on what that might be in terms of in-market building fast versus out of market?

[Ted Torbeck:]

Sure, the focus there would primarily be in-market and it’s really kind of fiber opportunities from a business perspective. We’ve focused a lot on the front-end of our Fioptics build on the consumer market where in a sense, we build out the business, but the primary focus is clearly consumers. We are now focusing more on as we reach 70% penetration likely by the year end of 2017 on a consumer front. We are looking at a lot of opportunities from a business perspective to build out fiber.

[Unidentified Analyst:]

Okay, great, thank you.

[Operator:]

We will now take our final question from Barry Sine with Drexel Hamilton.

[Barry Sine:]

Good morning gentlemen. Couple questions, if you don't mind. First of all, on CapEx. You've talked about some favorable cost trends. Could you update us on what you are seeing in terms of costs to pass the new home and then costs to provision that home once you get a subscriber in that home?

[Ted Torbeck:]

Sure, so for 2016, that number was around $850 from a cost to pass perspective and I believe Ted mentioned, that was probably 10%, 15% better than what we had anticipated. So, we continue to see opportunities to build out at a significantly reduced cost relative to what we had anticipated. From a CapEx per install, we are around the $900 range. We continue to see we are having discussion early this morning where pieces of that install are coming down in price. But what we saw in 2016 was around $800, $900 per install.

[Barry Sine:]

Okay. And then I think you also mentioned that you are seeing better than expected trends in terms of penetration. Where are we - how high are we getting in some of the more mature markets that you have been in for a number of years in terms of video and internet penetration?

[Ted Torbeck:]

Sure, so, it – and again, this sort of addresses the 100,000 doors that we passed in 2016. We consistently saw the same rate of penetration which again is demonstrating the success of the products. But we are seeing across the base around a 26% rate of penetration for video, internet around 37%, but as the area that as pass matures from year one as an example, HSI coming in, in the mid-20s, by year four, it’s pushing 50%. From a video perspective it’s low 20s in year one, by year four that’s low to mid 30s.

[Barry Sine:]

And, maybe an update in terms of the competitive environment? Your cable competitor has obviously gone through a merger, I don't know if they have fully integrated and fully rolled out new branding and new pricing. What are you seeing competitively in your markets?

[Leigh Fox:]

Hey, this is Leigh. Yes, spectrum, the branding of spectrum was released in our market, call it mid-January. So, we did see the rebranding of our competitor. The branding in the pricing is what we expected. So there were really no surprises there. We mentioned they are going to be a good competitor. We knew that going into it. And I think the good news there is, we just saw no surprises. And we are continuing to compete well against them. So, but the rebranding has officially begun in the market.

[Ted Torbeck:]

And we’ve countered very successfully with a very good campaign or so that we are going to able to continue to grow our business significantly.

[Barry Sine:]

Okay, and then, lastly, I wanted to shift gears and talk about some cost reductions you mentioned. First of all, you said there was a headcount reduction and that will result in about a $10 million recurring reduction in cost. Can you give us a little more color on that, timing and so on? And then, also there is a line in the press release that talks about reducing expenses on the legacy copper network. What exactly are you doing there? How much can that save? And when might that impact the income statement? Thank you.

[Leigh Fox:]

Yes, hi, this is Leigh. I’ll take that one. So, what you are seeing is, what I consider really the first move in network transformation and transformation from the copper legacy side of our business and truly becoming a fiber company. That announcement was us focusing on a voluntary separation package on copper-based work. And so, you will see that come out over the next two to three years and it will be probably in year three where you see that kind of greater than $10 million runrate. On top of that, as we migrate farther with fiber, you are going to see more of the same. We believe that there is a huge opportunity here and that we can take advantage of as we penetrate more and more of the market, we can start to get to what I consider true network transformation. And so, that’s what we are focused on. We are going to - we have teams dedicated to legacy cost out. You saw that again in the charge in the first quarter or in the fourth quarter you are going to see another charge in the first quarter. It’s not going to end. We are very, very focused on taking cost out of that side of the business and transitioning the company and really changing the company, as I mentioned from, what we were and what we now are and are going to be and I think, there is a really huge opportunity here for us. It’s still hard to see, but it’s – we are starting to see bits of it as we, like I said in this first round, but as we penetrate farther and farther with fiber, there is a really huge opportunity to take that legacy network out and really fundamentally transition and transform the network. So, we are excited about it. But more to come.

[Barry Sine:]

All right. That's very helpful. Thank you.

[Operator:]

This does conclude today’s question and answer session and also brings to the conclusion of today’s conference. Thank you for your participation and have a pleasant day. You may now disconnect.