Cincinnati Bell Inc.
Q3 2015 Earnings Call Transcript

Published: 5 Nov 2015

[Operator:]

Good day, and welcome to the Cincinnati Bell 3Q 2015 Earnings Release Call. Today’s call is being recorded. At this time, I would like to turn the conference over to Josh Duckworth. Please go ahead.

[Josh Duckworth:]

Thank you and good morning. I’d like to everyone to Cincinnati Bell’s third quarter earnings call. With me on the call today is our Chief Executive Officer, Ted Torbeck; and our Chief Financial Officer, Leigh Fox. Ted will provide a summary for our highlights for the quarter and an update on our strategic initiatives. 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 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 report, and Form 8-K report. 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’m pleased to introduce Cincinnati Bell’s Chief Executive Officer, Ted Torbeck.

[Ted Torbeck:]

Thanks, Josh. Good morning everyone. Thank you for joining us today. We had a very strong quarter of execution. This is highlighted by impressive IT services revenue growth and a continued demand for Fioptics, which is now available to 50% of our market. As noted on Slide 6, strategic revenue increased 22% over the prior year, and now accounts for approximately 60% of our recurring revenue base. Our consumer market results continue to impress. The Fioptics suite of products continues to resonate with customers, even as our cable competition aggressively focuses on increasing market share. Fioptics revenue increased 34% compared to a year ago, totaling $49 million for the quarter. We also established new record highs for both Fioptics Internet and video net activations. Now moving to business market results on Slide 7, total business revenue for the quarter was $216 million. Strategic revenue for our commercial and enterprise customers increased 20%. Entertainment and communications business revenue for the quarter totaled $101 million. This was up 2%, after excluding revenue generated from wireless operations in the prior year. The increase is attributable to increased VoIP revenue, as our business customers continue to migrate away voice products. VoIP sales create a predictable, recurring revenue stream with long-term contracts. This migration to a newer technology platform also provides the opportunity to expand scope of services we provide these customers. As evidence of the success of this approach, IT services and hardware revenue totaled $115 million for the quarter. Strategic managed and professional business revenue totaled $45 million in the quarter. This was up 32% compared to the prior year. Our team continues to do an outstanding job fostering relationships with our customers, while identifying solutions that meet their needs. Our consumer market results are on Slide 8. Revenue totaled $84 million for the quarter. This is up 4% as the growth in Fioptics continues to outpace access line and DSL subscriber loss. As we navigate through the ever-changing landscape, we continue to focus on our key metrics. Video penetration rates have remained consistent at 27%. During the quarter we achieved a record high, 7,000 video net activations, ending the period with 109,000 video subscribers. Net activations from Fioptics Internet were equally impressive. We added 11,000 subscribers in the quarter, and our Internet penetration rate now exceeds 35%. Total Internet subs grew by more than 10,000 from a year ago, and we ended the quarter with over 280,000 subs. Churn for the quarter was 3%. This was in line with seasonal expectations, and improved from a year ago. ARPU for the quarter was up, on average, 3% compared to the prior year. However, the pace of ARPU growth has de-accelerated. ARPU was impacted by competitive pressure and also the industry’s move to more standard price bridging strategies for customers leaving promotional based pricing. As we have communicated in the past, our investment decisions are success-based. We continue to see excellent results in the evolving landscape, and remain confident that fiber is the long-term solution to consumer bandwidth needs. Our results demonstrate that we can be a market disruptor, and we’ll continue to adapt as the landscape evolves. In closing, our team’s ability to execute on our financial and operational objectives has us well positioned to achieve our goals for 2015. I am confident that we will successfully navigate through this challenging environment and create a company with growing revenues, profits, and significant, sustainable cash flows. Now I’d like to turn the call over to Leigh to provide more detail on our third-quarter results.

[Leigh Fox:]

Thanks, Ted, and good morning everyone. Starting with consolidated results on Slide 10, revenue for the quarter totaled $300 million. Adjusted EBITDA for the quarter was $77 million. Income from continuing operations was $79 million. Income included a $180 million gain on the sale of CyrusOne, and an $8 million loss on extinguishment of debt. Moving to our segment results, starting on Slide 11. Entertainment and communications revenue for the quarter totaled $185 million. This was up $5 million compared to the prior year, after excluding the loss of intercompany wireless backhaul revenue. Adjusted EBITDA for the quarter was $68 million. Margins were 37%, down from the prior year, primarily due to costs absorbed from shutting down the wireless business and accelerating our fiber investments. As Ted discussed, we added an impressive number of video and Internet subscribers in the quarter. Video net ads were 7,000 in the quarter, bringing total video subscribers to 109,000. Consolidated Internet ads were 6,000 in the quarter, bringing total Internet subscribers to 281,000. Total voice lines ended the quarter at 528,000, a decrease of 4% compared to prior year. Declines in voice and consumer voice lines were partially offset by growth in business market voice lines, as customers are migrating from copper-based lines to VoIP lines. Turning to Slide 12, the IT services and hardware segment generated revenues totaling $117 million for the quarter. This is down 3% from the prior year, as the growth in strategic management special services revenue was offset by an anticipated decline in hardware sales. Adjusted EBITDA for the quarter was $10 million, resulting in margins approaching 10%. As noted on Slide 13, our capital structure continues to improve. We completed the sale of 6 million CyrusOne partnership units in July for cash proceeds of $170 million. The monetization of our stake in CyrusOne over the past 18 months has improved our capital structure and limited our exposure to the volatility within the equity markets. Subsequent to the completion of this transaction, our remaining 11% ownership at CyrusOne is highly liquid, and valued at approximately $300 million. As of the end of the quarter, our NOL balance was approximately $500 million. Our leverage ratio now stands at 4.1 times. During the quarter, we used proceeds from CyrusOne to repay $138 million of outstanding senior notes due in 2020, at an average redemption rate of 105%. If leverage was further adjusted for our remaining ownership in CyrusOne, our leverage would be 3.1 times. Moving to Slide 14, free cash flow for the quarter was negative $1 million. Capital expenditures for the quarter totaled $73 million. This included investments of $44 million in Fioptics, $14 million for success-based builds for business and new managed services projects, and $15 million in maintenance. Specific to our Fioptics investment, the Company spent $22 million to pass an additional 26,000 new addresses, $14 million for installation, and $8 million to expand core network capacity and improve the customer experience. Capital expenditures are expected to end the year at the high end of the guided range for 2015. Interest payments for the quarter totaled $11 million, and cash dividends from CyrusOne equaled $5 million. For the year, interest payments are now expected to total $105 million, and dividends from CyrusOne are anticipated to be $22 million. On an annualized basis, interest payments are expected to be approximately $18 million, and CyrusOne dividend now stands at $10 million. Third-quarter free cash flow results included pension and OPEB payments of $3 million, and we expect full-year payments to total approximately $20 million. In closing, we continue to execute against our goals, and we expect full-year adjusted EBITDA results to be in line with the high end of our guidance range. This concludes the prepared remarks for today’s call. Thanks for listening. We’d like to now open the conference up to questions.

[Operator:]

[Operator Instructions] Our first question today comes from David Barden, Bank of America.

[David Barden:]

Hi, guys. Thanks for taking my questions. I guess some, just the first one, if I could

[Ted Torbeck:]

Yes, with the transaction costs, we were looking at a possible acquisition. It didn’t pan out. But we’re always looking for opportunities in areas where we think we can show growth in our strategic growth areas. The second question on churn, this is – again, we were down year-over-year. The third quarter is a high move quarter, where people move a lot, and it was to our expectations. It wasn’t greater; it was actually a little bit better than what we thought it would be. So I think that’s a major driver. It’s seasonal, and those are the months that most people move.

[David Barden:]

Okay, great thanks guys.

[Operator:]

And our next question from Simon Flannery with Morgan Stanley.

[Simon Flannery:]

Good morning and thanks a lot. So, on the Fioptics, it’s pretty striking to look at the continued strength in Internet, and the voice lagging behind; and video, to a lesser extent. Can you talk to us what’s going on in terms of people taking triple play, double play, cord shaving? How are those moving over time? And what does this tell you about the bundle of the future? And then you guided us to the upper end of the CapEx guidance range for this year. How should we think about the pacing into 2016? Any changes in the pacing of household homes past, or the cost per homes past? Or is 2016 going to look very like 2015? Thanks.

[Ted Torbeck:]

Okay, first of all, you’ve got to go by demographic to really understand. The Millennial are clearly – there’s cord-cutting going on; it’s not a great number, but there’s clearly cord-cutting that are happening. And our team is aggressively looking at different options like over-the-top and skinny bundles. Nothing to report there yet, but we have a team that’s actively looking at that. But, some of the older clientele demographics that we have, they are basically taking the triple play. But it’s generally the Millennials that we’re seeing the cord-cutting.

[Simon Flannery:]

And are they going broadband only? Is that…

[Ted Torbeck:]

Yes, a lot of them are going broadband only, and then going over-the-top.

[Simon Flannery:]

So, you are basically seeing a lot of single play and a lot of triple play.

[Ted Torbeck:]

Yes.

[Simon Flannery:]

Okay.

[Ted Torbeck:]

Okay. And then on the exit, I’m not going to give you a lot of guidance on 2016, but we’re clearly anticipating to at least keep it the same level that we’re – or close to the same level we’re building in 2015.

[Simon Flannery:]

Okay. And is there any change – are you ahead of target, on target, both in terms of your pacing and your [indiscernible].

[Ted Torbeck:]

We are on target. We’re absolutely on target.

[Simon Flannery:]

So that takes us through to basically mid-2017, and then the passing starts to decelerate.

[Ted Torbeck:]

Yes.

[Simon Flannery:]

Okay. Thank you.

[Operator:]

Next question comes from Sergey Dluzhevskiy, Gabelli and Company.

[Sergey Dluzhevskiy:]

Good morning guys.

[Ted Torbeck:]

Good morning, Sergey.

[Sergey Dluzhevskiy:]

A couple of questions, so, obviously you had a very strong quarter in Fioptics. Could you talk a little bit about what you saw from Time Warner Cable in that quarter? And now that obviously you’ve reported third quarter results, are you seeing anything different from them in the fourth quarter, as they are trying to response that?

[Ted Torbeck:]

I don’t think there’s been a lot of change, Sergey, but they’ve been aggressive. They’ve been aggressive all year in trying to get as many subscribers as they can, and not only in the initial pricing, promotional pricing, but also when they come off promotion, aggressive retention offers that they put. But it really hasn’t changed a lot in the third quarter. It’s been that way for a while.

[Sergey Dluzhevskiy:]

Okay. And the eventual monetization of CyrusOne

[Ted Torbeck:]

Yes, if you look at our Company, we have an IT services business that’s been showing tremendous growth. We would like to have a greater presence outside of Cincinnati. That’s one area. And then also on the fiber end, we’d look opportunistically at that. So if there was something that could be possible that was out of territory to look at in that area, that’s something we’d consider.

[Sergey Dluzhevskiy:]

All right. And in terms of leverage, obviously you users spent a lengthy period of the time trying to deliver. What is your kind of target leverage that you could go to, to be comfortable with for the right acquisition?

[Ted Torbeck:]

Well, we haven’t come off the 2 to 3 times, is where we’d like to end up. As Leigh alluded to in his presentation more, if we sold it today, we would be somewhere around 3.1. So we’re close to the target that we set aside a long time ago. And that was before we ramped up the spending on fiber.

[Leigh Fox:]

And Sergey, on just comfort level with respect to acquisitions, I think it really depends on the opportunity right? For the right opportunity, you may have the ability to lever up a little more. It’s all very dependent on the opportunities you see, and what the combined company looks like.

[Sergey Dluzhevskiy:]

Okay. And the last question for me. So obviously, you have an extensive fiber footprint in greater Cincinnati. Your Fioptics availability is going to improve. Maybe if you could share your thoughts on some additional services that you could offer to better monetize this fiber footprint that potentially, you’ll have lower incremental costs, but could develop new revenue streams for you over time.

[Ted Torbeck:]

Well, on the business side, you can’t forget that we’re also sending – or building fiber to businesses.

[Sergey Dluzhevskiy:]

Right.

[Ted Torbeck:]

It’s an opportunity. Where Time Warner has gained some advantage is at the businesses that we don’t have fiber built to. So going back and winning that business, and then the possibility of offering more services on the IT side, is an option that we’re constantly looking at.

[Sergey Dluzhevskiy:]

Thank you.

[Operator:]

Our next question will come from Frank Louthan, Raymond James.

[Frank Louthan:]

Great, thank you. Can you talk to us a little bit about your opportunities outside of your region, either selling to other businesses or possibly constructing fiber? And also just following up on the following question, the potential for small cell deployments in Cincinnati and how you see that? And then lastly, can you talk to us about the – you won a little bit of the CAF money. When can we expect to see that impact? And should we assume that there’s a video opportunity there, as well, as you deploy that? Thanks.

[Leigh Fox:]

Frank its Leigh. Capital – I’ll take it one at a time. Capital deployment in and out of territory, we are actually looking right now at plans to deploy network on a test environments in different regions surrounding Cincinnati. So we are actively looking at it. Small cell opportunities in Cincinnati, we continue to see the same opportunities we have. We are responding to RFPs actively. But for the most part, other than the carrier that we are dealing with right now, most of those – the progress has been slow. I think folks are still trying to figure it out. And then some of the carriers are obviously very busy with other items on their plate. And then with respect to CAF, CAF impact, you’ll more than likely begin to see CAF impact in the fourth quarter. But it’s minor. Again, comparatively, our CAF dollars are extremely low compared to the industry.

[Frank Louthan:]

Then, how are you recognizing that on your income statement?

[Leigh Fox:]

That’s what we’re still working through.

[Frank Louthan:]

Okay, thank you.

[Operator:]

Our next question will come from Barry McCarver, Stephens Inc.

[Barry McCarver:]

Hi, good morning guys. Thanks for taken my question. I guess, first off, on the guidance, now you’re suggesting the high end of the adjusted EBITDA range. If you look at the three strong quarters you put up this year already, it certainly seems like beating the upper end of the range is a very doable. So, just a little bit more color there. And then in regards to EBITDA margins for the year, I know the shift in mix of revenue is affecting that, but kind of your expectations for where margins could go in 4Q.

[Ted Torbeck:]

Hi, Barry. This is Ted. A couple things are driving the fourth quarter. One is we are seeing pretty good run of our stock price, and it’s running above the budgeted amount. So we’ve included over $1 million of market-to-market that we feel will have an expense in the fourth quarter. We’re also looking at – we always do, every fourth quarter – we’re looking for opportunities that would enhance either spending the money in 2015, that would enhance the performance in 2016. So we’re looking at ideas that could do that, as well. But the execution continues to remain very strong throughout the year.

[Leigh Fox:]

Barry, on your margin question, we would – I would expect margins probably to fluctuate a bit downward in the fourth quarter. Again, margins do fluctuate from quarter to quarter; there is seasonality built into even the entertainment communications margin. It’s just not a kind of straight path. So I would expect it to decline a little bit, especially given some of the investments we’re looking at in order to hit the ground running in 2016 that Ted mentioned.

[Barry McCarver:]

And then if I could just ask one follow-up. You mentioned just briefly, when you were talking about the Fioptics business, competition. A little more color there. What are you seeing in the market? Anything change dramatically from the previous quarter?

[Ted Torbeck:]

Not really, Barry. It has remained the same. Time Warner has been very competitive; and not only, as I said earlier, on the promotional rates, but also to retain customers, they’ve been very aggressive. And we’ve been able to continue to be very successful against that competition. So there hasn’t been a lot of change from the second quarter.

[Barry McCarver:]

Okay. Thanks a lot guys.

[Ted Torbeck:]

Thank you, Barry.

[Operator:]

And next you hear from Batya Levi, UBS.

[Batya Levi:]

Great, thank you. A couple of follow-ups. First on the margin question, I think it’s going to have some seasonal pressure. But do you also have some long-term target that you would expect to go back to high 30% to 40%? Is that still the target? And with higher volumes and higher video in the mix, do you think that’s achievable? And another question on the Fioptics, can you tell us if you see any differences in terms of new penetration of new homes that you have been building, versus trying to penetrate the existing base? And are you approaching those any differently? Thank you.

[Leigh Fox:]

Hey, Batya, I’ll answer the margin question, and then I’ll hand it over to Ted for the second part. On a normalized basis, we would expect once we get out of the investment cycle, and begin to kind of normalize and run the wire-line business, post the investment – you would expect an incremental increase in margins. And, initially, that’s absolutely what we modeled. To be honest, now with some of the unknowns in pricing, I’m not sure that you still end up in the 40% range. I think you’re not going to be wildly off, but with pressure that we’re seeing on pricing, first and foremost in the declines in ARPU. And the reason I probably sound a little bit hesitant is there’s another factor around skinny bundles, and your ability to manage cost out with respect to different content provisioning in those bundles. So there are just a lot of unknowns that we’re modeling right now. And so, I don’t see drastic changes, but I do see a lot of unknowns that will kind of shift both the revenue and the cost side. And so we’re being very cognizant and we’re staying on top of all those. Ultimately, we’ll just – we’re going to manage the business as efficiently as possible. And so, that’s really our focus.

[Ted Torbeck:]

As far as the penetration, we’re getting a first pass; we’re in the high teens, 20%. It’s been pretty consistent with what we’ve run in the past. And then as we do read suites, we continue to increase our penetration. We’re very pleased with not only the first pass, but the additional penetration rates we get, as we continue to grow out.

[Batya Levi:]

Got it, okay. Thank you. Operator And does conclude our question and answer session also that does conclude today’s conference call. Thank for your participation today.