Cincinnati Bell Inc.
Q1 2015 Earnings Call Transcript

Published: 7 May 2015

[Operator:]

Good day, and welcome to the Cincinnati Bell First Quarter 2015 Earnings Release conference Call. Today's conference is being recorded. At this time, I'll like to turn the call over to Josh Duckworth. Please go ahead.

[Joshua T. Duckworth:]

Thank you, and good afternoon. I'd like to welcome everyone to Cincinnati Bell's first quarter earnings call. With me on the call today is our Chief Executive Officer, Ted Torbeck; and our Chief Financial Officer, Leigh Fox. Ted's comments will provide an update on our strategic initiatives and Leigh will provide a financial overview and discuss our quarterly segment results. Following Leigh's discussion, we will conduct a brief question-and-answer session. Before we proceed, let me remind you that our earnings release and 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 8-K 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.

[Theodore H. Torbeck:]

Thanks, Josh, and good morning – or good afternoon everyone. Thank you for joining us today. We were off to another great start this year. With each passing quarter, we are rapidly progressing towards our goal of transforming Cincinnati Bell into a growing fiber-based entertainment, communications and IT solutions company. Our highlights for the quarter are summarized on slide six and demonstrate this team's continued ability to execute on our financial and operational objectives. Demand for our strategic products generated 4% year-over-year revenue growth and resulted in a strong adjusted EBITDA totaling $79 million. Now turning to our wireless business, we successfully transitioned all subscribers off our network and shutdown all business operations. In April, we transferred certain tower lease obligations and assets to Verizon and have now started the process of decommissioning the network. Next, to our investment in CyrusOne. In the past, we communicated our goal was to be a patient investor and use proceeds for monetizing this asset to repay debt and improve the health of our balance sheet. In April, we completed the second sale of this asset for cash proceeds totaling $426 million. In the weeks leading up to the sale, CyrusOne was trading at a record high and we again executed a swift and well-timed transaction. We have done exactly what we said we would do and our strategy has been successful. In total to-date, we have monetized 78% of our ownership in CyrusOne paying down $1 billion in debt and reducing interest payments by approximately $85 million. Subsequent to the sale, we maintained a 22% ownership stake in CyrusOne, which is valued at approximately $450 million and sheltered by a $525 million NOL. We remain bullish on CyrusOne, and we'll continue to be a patient investor with the goal of maximizing our shareholder value. Now turning back to our operational results on slide seven. The future success of Cincinnati Bell now relies on our ability to grow our strategic revenue and translate that growth into profit. Strategic revenue increased 22% compared to the prior year, and now accounts for more than 50% of our total recurring revenue. Strategic business revenue has grown by more 16% year-over-year, as we continue to foster relationships with our largest customers. Consumer strategic revenue increased 34% compared to the prior year, demonstrating the continued demand for faster data speeds and further supports our decision to accelerate the expansion of our Fioptics network. During the quarter, we passed over 22,000 new addresses with Fioptics and the product is currently available to approximately 44% of Greater Cincinnati. Our Fioptics highlights are presented on slide eight. Fioptics revenue for the quarter totaled $42 million, which is up more than 35% over the prior year and penetration rates remain consistent, even as we aggressively expanded our Fioptics coverage. Our churn results for the quarter were at the lowest rates in the past 12 months, and single family churn is approaching 2%. In addition, ARPU for the quarter was up on average 6% compared to prior year. Fioptics' net activations also continue to be impressive, as we added more than 4,000 video subscribers and a record high 9,400 Fioptics Internet subs during the quarter. More importantly, our total Internet subscriber count, which includes legacy DSL customers, increased sequentially, even as our main competitor recently reported the highest quarterly subscriber net adds since 2007. We compete in a constantly evolving competitive environment and any news of change creates more opportunity for us to win our share of the Cincinnati marketplace. Regardless of the competition, we believe fiber is a superior asset with long-term relevancy and our goal is to get Fioptics in the hands of as many customers as soon as possible. As we've communicated several times, our investment decisions remain success-based and we continue to actively monitor the key metrics that drive returns, especially during this acceleration process. We had a tremendous start to the year and are in a great position to achieve our objectives for 2015. Now, I'll turn the call over to Leigh, to provide additional details on the first quarter results.

[Leigh R. Fox:]

Thanks Ted, and good afternoon everyone. As Ted mentioned, we are off to an exciting start to the year and our strategic investments continue to positively impact our financial results. As highlighted on slide 10, revenue for the quarter totaled $293 million, growing 4% compared to the prior year resulting in strong adjusted EBITDA of $79 million. Net income for the quarter was $49 million, including the recognition of the $113 million gain on the sale of wireless spectrum. Starting this quarter, current and prior year financial results from the wireless business will be presented as discontinued operations. Moving to our segment results, starting on slide 11. Entertainment and Communications revenue for the quarter totaled $188 million increasing year-over-year for each of the past six quarters, as demand for our strategic products continues to outpace legacy declines. Adjusted EBITDA for the quarter equaled $75 million, resulting in 40% margin that are in line with expectations when considering the cost absorbed from shutting down the wireless business and accelerating our fiber investment. Access line loss remained elevated for the quarter at 10% due to the high turnover of wireless subscribers and the migration of business customers from copper-based access lines to VoIP lines. As of the end of the quarter, we had 69,000 VoIP access line equivalents, up from 50,000 a year ago. Adjusting for the inclusion of VoIP lines, our total access line loss has been a consistent 6% over the past several quarters. Turning to slide 12, the IT Services and Hardware segment generated revenues totaling $108 million for the quarter, up 6% from the prior year as the growth in strategic managed and professional services revenue offset anticipated declines in hardware sales. Adjusted EBITDA for the quarter totaled $8 million, resulting in margins of 7%, both consistent with the prior year. Starting on slide 13, we have included an update on our capital structure subsequent to the recent sale of CyrusOne. The completion of this transaction has not only limited our exposure and risk associated with owning a large equity investment, but has also significantly increased our operational flexibility and expanded the opportunities to efficiently manage our capital structure. As noted on the slide, proceeds from the sale totaled $426 million and were used to repay our highest coupon notes, decreasing interest payments by $26 million annually. Our adjusted liquidity now exceeds $300 million and our updated leverage ratio is 4.5 times. If leverage was further adjusted to include our remaining 22% ownership in CyrusOne, our leverage would be 2.9 times, well within an appropriate range. Moving to slide 14, free cash flow was negative $36 million and capital expenditures totaled $58 million in the first three months of the year. During the quarter, we invested $35 million in Fioptics, including $17 million to pass an additional 22,000 new addresses. Capital expenditures to increase core network capacity totaled $13 million and installation costs were $5 million. In addition, fiber builds for business and managed services projects equaled $14 million. Interest payments in the quarter totaled $21 million and cash dividends from CyrusOne equaled $6 million. For the year, interest payments are now expected to total $110 million and dividends received from CyrusOne are anticipated to be $24 million after considering our new ownership percentage. First quarter free cash flow results included pension and OPEB payments of $5 million. As a result of stronger than anticipated asset returns and changes in regulations, we now expect full year payments to total $25 million, which should trend down to approximately $15 million in 2016. In closing, we have repeatedly executed on each of the milestones required to achieve our transformation and goals of creating a company with growing revenues, profits and significant cash flows. Our first quarter results were outstanding and we are confident that we will achieve revenue and adjusted EBITDA guidance for the full year. This concludes our prepared remarks for today's call. Thanks for listening. We will now turn the conference open to questions.

[Operator:]

We will go first to Dave Barden with Bank of America.

[David W. Barden:]

Hey, guys. Thanks for taking the questions. Just first I guess maybe, Ted, on the line loss comments. I think you were saying that the line losses have been elevated because of the wireless shutdown. But at the same time looking at the totality of VoIP in line losses, things have been kind of constant. So is the expectation then as we go forward that we should be seeing kind of a net improvement both in absolute line losses and then in that combination of line in VoIP? And then just second, just to understand your comments around competition and the kind of winding down of the Comcast, Time Warner Cable deal. I know that you guys had a fairly aggressive game plan that you were pitching or planning to pitch during this deal. I guess, it's probably still going to go ahead, but, I know you said, there is opportunity here, but if you could be more specific it'd be great. Thanks.

[Theodore H. Torbeck:]

Thanks, Dave. Thanks for the question. First of all on access lines, I think you got to break it out into consumer and business. And if you look at consumer, we had the wireless shutdown, and we attributed about 4,000 subs to that shutdown, which should not reoccur. Then we had about 3,100 that were competition driven and Time Warner was offering a very aggressive credit, it was a $300 credit for a starting offer and we don't know how long that will continue. But the wireless shutdown seriously is behind us. On the business side, churn was about 7% in the quarter, which is up a little bit, but it's primarily due to the customers transferring to VoIP. So if you look at the equivalents, we total on the VoIP line equivalents about 69,000 as Leigh said, which is an increase of about 2,000 compared to a year ago. So again, we think it should stabilize and actually get better than what the loss has been due to the wireless on the consumer side. As far as competition is concerned, I mean first of all, Time Warner is very aggressive. They are a very good strong competitor. They have been all along. So we've learned how to compete, we actually feel our product is superior and we're very confident that we'll be able to continue to perform at the levels that we have. So we see the Comcast deal – it just provides us more time to build-out our fiber to more homes and it just gives us time that we needed to remain extremely competitive. So we see it as a real positive.

[David W. Barden:]

Good. All right. Great. Thanks guys.

[Operator:]

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

[Frank Garreth Louthan:]

Yes, thanks. If you could just kind of walk us through the changes in the pension and OPEB, be a little more clear on that, that would be helpful. And then I've got a follow up.

[Leigh R. Fox:]

Hey, Frank, this is Leigh. Yeah, so asset returns were a lot more favorable than we had planned and then with the half the changes also. And then we've used a little bit of the proceeds of CyrusOne to prepay pension. So that's a lot of what you're hearing from us. So forecasted cash impact of OPEB and pension, we're looking at approximately $25 million this year, dropping to $15 million next year.

[Frank Garreth Louthan:]

Okay, great.

[Leigh R. Fox:]

As long as asset returns remain solid.

[Frank Garreth Louthan:]

Okay, great. And then, just on the promotional activity with Fioptics, has that continued, do you feel the need to match any of that to try and grab some market share? And then walk us through what if any sort of your strategy is on trying to capture share on over-the-top with any sort of streaming apps or things you might embed in your product that maybe the completion doesn't have? Thanks.

[Theodore H. Torbeck:]

Well, we expect Time Warner to continue to be competitive. And we're well positioned to compete directly with them. So in the future, we think the promotions will continue and we'll be able to offer something that's extremely competitive. So we're well set and well positioned for that.

[Leigh R. Fox:]

On the product side, Frank, yeah, we're in constant development. Our CTO, Tom Simpson, has a team that develops – constantly developing products and interfaces that integrate over-the-top. So, yeah, we're absolutely looking at it. We think different types of product offerings for different tiers of customers is what will be extremely relevant in the future and that's our goal and that's where we're migrating from a product development standpoint.

[Frank Garreth Louthan:]

All right. Great. Thank you.

[Theodore H. Torbeck:]

Thanks, Frank.

[Operator:]

Now let's take our next question from Batya Levi with UBS.

[Batya Levi:]

Great. Thanks. Couple of questions. First on the wireline revenue side. Growth is strong, but it came down slightly on a sequential basis. Is that mostly due to some hits on the wireless backlog side? And when do you expect that pressure to lift? And second question on the ARPU, Fioptics and video ARPU were down slightly in the quarter. Was that also a function of the promotions you talked about or is there some timing in terms of the price increases that you pass through on the video side?

[Leigh R. Fox:]

Yeah. Batya, on the wireline revenue, yeah, that was absolutely a function of the wireless, some of the gap rolls in discontinued ops, you're going to see some funkiness from quarter-to-quarter. At the end of the first quarter – the first quarter of 2015 would be the last quarter that you see that, so you'll see that trending out over time. But yes, the main issue there was that the wireless backhaul from the wireless shutdown. And I'll toss it to Ted on the ARPU.

[Theodore H. Torbeck:]

Yeah. ARPU is really driven by the promotions we've offered. And again, remaining very competitive with Time Warner.

[Batya Levi:]

Okay. Maybe if I could ask another one. If you could talk a little bit about what kind of small cell build-out you're seeing in the region? And if they are on your – if they touch your fiber footprint right now, some of the recent fiber deals we've seen in the market had received great multiples. Can you talk about, if there are other strategic options you would consider for your fiber asset?

[Theodore H. Torbeck:]

Well, I think we've built out 36 sites so far with small cells. We are getting a lot of interest as far as quotes, but we did win a $30 million deal that's over several years. But there is a lot of interest that seems to be increasing over the period of time, it continues to increase. But we have won one order, and we're very well positioned within the city to win.

[Batya Levi:]

Okay, great. Thank you.

[Operator:]

We'll take our next question from Simon Flannery with Morgan Stanley.

[Simon Flannery:]

Thank you very much. Nice job on the margins. If I look at the annualizing Q1, you're above the top end of your full-year guidance and your top line is growing. Are there any kind of puts and takes that might impact margins in the coming quarters? And then there's been a lot of talk about the future of TV. Verizon's got their skinny bundles. Dish has Sling TV. AT&T is scaling up. How do you think about the profitability of TV, the future of TV and how you position the company for that? Thanks.

[Theodore H. Torbeck:]

Okay. Simon, well, thanks for the comments on the margin. It is a primary focus for us to continue to be extremely competitive on margins and to do what we can to remove cost. As the wireless business wound down last year, we absorbed about $25 million of cost that is now behind us and is absorbed within the business. So we're going to continue to focus on cost as well as trying to drive as much price as possible. I think we've said in previous calls that our margins would be in the high 30%s. We think that that's probably the low point and we'll do everything we can to get it up into the 40%s, in the low 40% margin range.

[Leigh R. Fox:]

Hey, Simon. This is Leigh. For the year, really what we're expecting and what we said is lower hardware for the year, which will impact margin dollars and our EBITDA. So yeah, from a trending standpoint, it does look like we're ending up just about the higher end of the range, but we're still pretty comfortable with our guidance range.

[Simon Flannery:]

Okay, good. And on the TV?

[Leigh R. Fox:]

From the standpoint of technology, yeah, look, we stay abreast to all the movement in the industry. Obviously it's like the Wild West right now. But we are huge believers that ultimately it comes down to having the best and biggest pipe to the home, period, and that's what we focus on. We've got a fantastic product team, fantastic technology folks looking at this. We believe Verizon's look at a skinny bundle is probably what the customers want for the future, over-the-top optionality as mentioned earlier in the call, and the other thing that customers want. So yeah, we stay abreast and on top of everything, but ultimately the big pipe wins.

[Simon Flannery:]

Okay. And you're okay with the profitability you're seeing with the content cost to inflation on the TV line, product line?

[Theodore H. Torbeck:]

Well, I'll be okay with it, and continues to get squeezed, there's no doubt about it, but the ability to bundle that product with broadband is so important. And so we look for other ways to take cost out as well as trying to get margin. So that's where the focus is. And so far, we've been very successful, we plan to do the same in the future.

[Simon Flannery:]

Great. Thank you.

[Operator:]

And we'll take our next question from Sergey Dluzhevskiy with Gabelli & Company.

[Sergey Dluzhevskiy:]

Good afternoon, guys. A couple of questions if I could. First, tw telecom was one of your main competitors in the enterprise space in Greater Cincinnati area and obviously they were taken over by Level 3. Could you comment on whether you saw any changes in competitive intensity since that merger took place. And whether you were seeing anything different from the combined company?

[Theodore H. Torbeck:]

Sergey, we have not seen a lot of additional competition especially in the enterprise space. The thing that we have is we have excellent relationships in Cincinnati with the enterprise customer base. And actually we're seeing growth in our largest customers. So we really haven't seen any strong competition from that merger at all.

[Sergey Dluzhevskiy:]

Okay. And another question maybe a bigger picture question. Obviously, Fioptics is your primary growth opportunity that is in front of you and this is your primary focus. But could you share your thoughts on maybe other sources of growth that you see over time that could become meaningful whether it would be cloud, hosting, managed services, just any color on additional sources of growth?

[Theodore H. Torbeck:]

Yeah, one of the moves we've recently made is, and we're putting a lot of focus on is the commercial SMB marketplace. As we talked earlier the migration of companies from TDM to VoIP, we lose about 30 points of margin, 30 points to 40 points. This gives us a hole that we in the past we've tried to manage down. What we're trying to do is develop a product line and bundle that we can then fill that hole with. So we think there's a big opportunity in that marketplace and we're putting a lot of focus in there to develop products such as you said, to grow in that space. So we think that's a big opportunity. The other thing is taking those products in other regions or in other markets, we're in Columbus, Louisville and Indianapolis, and they're all very applicable there as well.

[Sergey Dluzhevskiy:]

Okay. Thank you.

[Operator:]

We'll take our next question from Arun Seshadri with Credit Suisse. Arun A. Seshadri - Credit Suisse Securities (USA) LLC (Broker) Hi everyone. Thanks for taking my questions. Just a couple. Is there any way you would be able to sort of look at, if you look at EBITDA without the wireless shutdown cost, is there any way you could sort of break out sort of how much, what EBITDA would have been excluding that?

[Leigh R. Fox:]

Yes. We do look at, Arun, this is Leigh. We do look at that currently. So we do look at adjusted EBITDA on trending basis for that. And for the most part, that gets a little bit clouded because some of the investments we've made. Obviously what we said in the past is, as you invest in fiber, the acceleration of that investment digs a bit of a hole initially. But if you look at it over time, I mean it's declining slightly, but you see it flattening out. And I think when you adjust for those investments and accelerating your fiber optics, it looks a lot more plausible from the standpoint of turning the corner from a profitability standpoint. So a lot of what we look at is that EBITDA on adjusted basis. Arun A. Seshadri - Credit Suisse Securities (USA) LLC (Broker) Okay. Got it. That's helpful. And then as far as your bonds, your senior unsecured bonds, obviously callable this year later on. What are your current thoughts in terms of potentially refinancing that? Are there any other discussions in terms of switching to between a fixed and a floating cap structure, any thoughts around that? Thanks.

[Leigh R. Fox:]

Thoughts around all of it, we're looking at it all very closely. Obviously with the most recent moves, with the sub-notes, and I do want to highlight we have, as of today, we no longer have sub-notes on the balance sheet, which is a great thing for this company. But, yes, we are looking at that right now. We've got a strategy going forward. We're obviously keeping a very close eye on high yield market. But, yeah, we're obviously analyzing that on a weekly basis. Arun A. Seshadri - Credit Suisse Securities (USA) LLC (Broker) Okay. Thank you.

[Operator:]

Let's take our next question from Ana Goshko with Bank of America.

[Ana Goshko:]

Hi. Thanks very much. So on the wireless shutdown you mentioned that you're going to be taking down the cell sites from the tower that weren't transferred. What's the cash cost of that, and I assume that's going to go through the income from discontinued operations? How long is that going to last and when does that go away?

[Leigh R. Fox:]

Hey, Ana, this is Leigh. The costs are already embedded in the ARO liability. So this is an ongoing operation. We are accelerating it a little bit. We had initially planned from a cash flow standpoint this to hit over a two-year period. But what we decided from a operational efficiency standpoint was to just do it all at once and get it all done. It was much more efficient and actually saved us a little bit of money. But the dollars we're talking are not major. I believe there are around $10 million to $15 million. And again, it's already on the balance sheet.

[Ana Goshko:]

Okay. And then when you say accelerated it, is that over a quarter, two or ...

[Leigh R. Fox:]

No – I'm sorry, over the year. So we had initially projected to do that as slowly as possible. So that $10 million to $15 million we had spread out a few years, but just looking at the efficiency, we'll shoot to have that done this year.

[Ana Goshko:]

Okay. And then, so I know you said that there was $25 million of leases that got transferred on April 1. So if we pro forma the balance sheet, it would take $25 million off the balance sheet. Is that correct?

[Leigh R. Fox:]

Yes. It gets a little more complicated than that with discontinued operations and if you look at the financials. I would start there and then if you have questions, we could walk you through – after the call, we could walk you through discontinued ops. But it's a little trickier than that.

[Ana Goshko:]

Okay. So hopefully, well, let me just ask. So then, in your net debt table in your press release, on the capital leases and other, that went up by $54 million over the quarter, from $16 million to $70 million. And I wasn't able to tie that to the cash flow statement, maybe it's just me, but I was just wondering what that $54 million increase was?

[Leigh R. Fox:]

The $54 million increase was associated with the transfer of the lease obligations, the remaining lease obligations to the core business effectively.

[Ana Goshko:]

Okay. So, I am confused. So I'll follow up afterwards.

[Leigh R. Fox:]

Yeah, we'll follow up afterwards.

[Ana Goshko:]

Okay.

[Leigh R. Fox:]

But the best way to think about it is – all right.

[Ana Goshko:]

Thanks.

[Operator:]

We'll take our next question from Davis Hebert with Wells Fargo.

[Davis s Hebert:]

Hi everyone. Thanks for taking the question. Actually, Leigh, maybe if you could finish that thought, I'd be curious to hear the best way to think about it is?

[Leigh R. Fox:]

Yeah. So the best way to think, prior to the close of the business, those assets and liabilities sit in the wireless business. And then effectively what's remaining – what just shifted over into the balance sheet on the core business was the remaining liability, the obligation of the remaining leases. And the best way to think about it, it's just debt, right. We now have a debt obligation for capital leases. We have contracts on those and the way I think of it, that's just debt for the core business, and we'll pay that off over time. Josh, do you have any other comments on that?

[Joshua T. Duckworth:]

Yeah. Well, so if you look at the balance sheet as of December 31, 2014 as presented, it'll be presented in the 10-Q we file in the morning. Those liabilities were presented as liabilities from discontinued operations at 12/31/2014 once we shutdown wireless, because they'll become the liability of the continuing operations. Those liabilities are moving out of disc ops as a liability, and into debt on the balance sheet. So that is the $50 million -

[Leigh R. Fox:]

That's right.

[Joshua T. Duckworth:]

...that you're seeing. And the $25 million that Ana was referring to is sitting at discontinued operations liabilities in both periods.

[Davis s Hebert:]

Okay, understood.

[Joshua T. Duckworth:]

We can talk offline.

[Leigh R. Fox:]

Yeah, discontinued ops was pretty complex. Josh and the team did a good job, and we'll go through a lot of detail in the Q, but if you have any questions, which I have a feeling we'll have quite a few, please call us.

[Davis s Hebert:]

Okay. And then on backhauls, some of your peers have talked about the near-term pressure as things switch from TDM to Ethernet. And you have a small cell contract. So just kind of wonder if you could talk directionally, would you expect backhaul revenue to have a positive trajectory year-over-year over the next 12 months?

[Joshua T. Duckworth:]

Yeah, we think it would be slightly positive.

[Davis s Hebert:]

Okay. And then last question from me. I think you had some retail stores you are keeping after the divestiture of the wireless business. Just curious how that's working out for you, do you feel like it's something you want to continue longer-term?

[Joshua T. Duckworth:]

Yeah, we have eight stores. We've converted them all to Fioptics stores where they're not only selling, but demonstrating our product as well as servicing for customers. So every one of them is a great experience and we're finding out some very good channel for sales.

[Davis s Hebert:]

Okay, thank you.

[Operator:]

And that does conclude our Q&A session and our conference call for today. We appreciate your participation. You may now disconnect.