Bob Gunderman - Senior Vice President of Financial Planning and Treasury
Jeff Gardner - Chief Executive Officer
Tony Thomas - Chief Financial Officer
Brent Whittington - Chief Operating Officer
Frank Louthan - Raymond James
[unintelligible] - BofA Merrill Lynch
Michael Rollins - Citi Investment
Scott Goldman - Goldman Sachs
Simon Flannery - Morgan Stanley
Ana Goshko - Bank of America
Batya Levi - UBS
Barry McCarver - Stephens
Windstream (WIN) Q4 2012 Results Earnings Call February 19, 2013 8:30 AM ET
Good day ladies and gentlemen, and welcome to the Windstream Corporation Q4 2012 earnings conference call. [Operator instructions.] I’ll now turn the call over to your host, Mr. Bob Gunderman, senior vice president. Please go ahead.
Thanks, Operator. Good morning, and welcome to our fourth quarter 2012 earnings call. We appreciate you joining us today. Before we get started, let me remind you that our earnings release, supplemental pro forma results, and our earnings presentation are available on the Investor Relations section of our website.
Today's discussion includes certain forward-looking statements. Please review the Safe Harbor language found in our press release and in our SEC filings, which describe factors that could cause our actual results to differ materially from those projected by us in our forward-looking statements.
The presentation also includes certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measure are available on the Investor Relations section of our website.
Before I’ll turn the call over to Jeff, I’d like to cover a few accounting items. First, this month we revised the accounting treatment of a consumer promotional credit, which was designed to help consumers with the up-front costs of switching their service to Windstream.
Originally, after diligence and review, we applied an accounting treatment that we believe represents the economics of this promotion, which is to amortize the credit over the two-year commitment period of paying from our customer. Due to a technical accounting issue identified during management’s year end audit process, we concluded that we should recognize the entire customer acquisition credit when it occurs.
The effect of this change is to accelerate the full amount of the promotional credits given to residential customers thus far, resulting in a reduction of previously reported consumer service revenue of $5 million and product sales of $12 million and a reduction to adjusted OIBDA of $23 million for the nine months ended September 30, 2012.
During the fourth quarter, this resulted in a reduction of our previously estimated revenue of $2 million and adjusted OIBDA of $5 million. Importantly, the credits were recorded, from a cash flow perspective in all historical periods, as they occurred. So this modification does not have an impact on our cash flows. In the appendix of our earnings presentation, we have provided a summary of the changes in historic quarters due to this revision in accounting treatment.
Moving to other items, we have provided supplemental pro forma financial results that include the PAETEC business for all periods shown. In addition, the supplemental has been updated to reflect the accounting revision of the consumer promotional credit I just mentioned.
And finally, we reclassified the pass-through taxes and surcharges previously reported in USF revenue to our other category, as these are margin-neutral revenues and are collected and passed through, making them different from the subsidies that are reported in the USF caption.
Turning to slide three, let me cover the differences between reported and adjusted earnings. In the fourth quarter, we reported earnings of $0.02 per share on a GAAP basis. This included several significant nonoperational charges that we exclude from adjusted earnings and which I would like to highlight.
First, we reported a noncash charge of $0.07 per share related to the year end mark-to-market adjustment of our pension plan, which was primarily due to a reduction in the discount rate from 4.5% last year to 3.9% this year. Our GAAP results also included approximately $0.02 in after-tax merger and integration and restructuring expense. Excluding these items, our adjusted EPS would have been $0.11 for the fourth quarter. For the full year, adjusted EPS was $0.45.
For the remainder of the call, the quarterly growth rates discussed today are presented on a pro forma year over year basis unless otherwise noted. Turning to slide four, participating in our call this morning are Jeff Gardner, our chief executive officer, who will discuss the progress we are making on our strategic goals; Tony Thomas, our chief financial officer and treasurer, who will discuss our financial results; and Brent Whittington, our chief operating officer, who will review our operational results.
At the end of the presentation, we will take a few questions. With that, here’s Jeff Gardner.
Thank you, Bob, and good morning everyone. I appreciate you joining us today. Let me begin by making a few comments, then I’ll review our 2012 accomplishments and discuss our key priorities for 2013. First, if you take one thing away from this call today, let it be this: Windstream’s management team and board of directors unanimously support continuing to pay our dividend at its current rate and believe it is the best way to create value for our shareholders.
This company produces substantial free cash flow, allowing us to invest in the business and pay down debt while returning a significant portion of this cash flow to our shareholders in the form of our $1 annual dividend. This capital allocation strategy is well-supported by Windstream’s business model and ability to generate free cash flow.
Beginning on slide five, we made significant progress on key initiatives during 2012, which will advance our strategy, which to reiterate, include maximizing business growth opportunities and maintaining our stable consumer business while optimizing the cost structure.
First, we achieved significant milestones in integrating the PAETEC business. We have combined all functional workgroups and corporate systems, and are operating as one organization from a sales and operations perspective. The former PAETEC markets have been rebranded and the combined business sales organization is leveraging our advanced solutions and nationwide network to gain market share and improve business revenues.
Second, we invested in strategic initiatives, including deploying fiber deeper into our network, expanding our data centers, and enhancing our broadband infrastructure. In addition, we made opportunistic capital investments to deploy fiber to wireless towers secured by long term contracts and we will extend our broadband addressability from 90% to 93% through our partnership with the [RUF] on stimulus projects.
Both the fiber to the tower and stimulus capital initiatives are finite opportunities that provide attractive investment returns, strengthen Windstream’s network capabilities, and enhance our growth prospects.
Third, we strengthened our balance sheet by refinancing certain maturities and high-cost notes. Collectively, we reduced our average cost of debt by approximately 70 basis points to 6.4%, and have improved our debt maturity profile by addressing all significant maturities through 2017.
Fourth, we continue to grow strategic revenue. Business and broadband revenues now represent 70% of our total revenue, and in total grew by 2%. More importantly, our combined business and broadband service revenue grew 3.4%.
Finally, we improved our cost structure by realizing the targeted PAETEC synergies and completing a company reorganization designed to streamline our processes and improve efficiency while lowering expenses.
Together, we achieved approximately $110 million in annual run rate savings from these initiatives. Our continued focus on cost management has allowed us to maintain steady margins as we have repositioned the business in growth areas. These accomplishments improve our capabilities and position us well as we enter 2013.
Turning to slide six, our priorities for 2013 include first, we expect to substantially complete our capital investments related to fiber to the tower projects, reaching 4,500 towers by the end of 2013. In addition, we will finish most of our broadband stimulus initiatives, which expand ours addressability to roughly 75,000 new households. As we exit 2013, we will see capital spending related to these projects decrease substantially.
Next, we plan to make targeted investments in our business channel, including opening several new data centers and hiring sales personnel in an effort to drive sales performance and enhance the customer experience. The business channel is very important to Windstream’s future, and we believe these investments will improve revenue and profitability.
And finally, we plan to continue to improve the balance sheet by directing our excess free cash flow, after our dividend, to debt repayment.
On slide seven, our business model has evolved substantially over the years, as strategic growth areas have a become much more significant part of our company. Growth in these areas, including business and broadband, is offsetting most of the revenue pressure from declining intercarrier compensation and consumer voice.
This revenue mix shift, combined with solid expense management, is enabling us to navigate the multiyear impact of regulatory reform and evolving consumer preferences while maintaining solid adjusted OIBDA. As we move to 2014, the impact of intercarrier compensation reform lessens, which will result in further improvement in our trends.
Before I close, I want to offer a few comments on why investors should have confidence in Windstream and our dividend policy, especially as others in our space have made changes to their capital allocation strategy.
We believe Windstream is in a different position within the industry, thanks to our transition path and our business mix. First, we are well down the path of transformation. With a high concentration of revenue in strategic growth areas and with our aggressive expense management efforts, we are positioned to produce stable revenue and adjusted OIBDA trends.
Second, our residential customers remain concentrated in very rural areas where there is less competition, which has contributed to a more stable consumer business. In addition, we are leveraging our relationship with Dish to provide our customers with a video solution versus a more capital-intensive facilities-based technology.
Third, our enterprise delivery model is efficient and less capital-intensive. Unlike some peers, we serve business customers through a mixture of owned assets and leased facilities that demand less capital.
Finally, we are at a different point in our investment cycle. We are winding down our investments in fiber to the tower and stimulus projects. This means, in 2013, we will be making a sizable reduction in our capex spending, and this will benefit our free cash flow trends going forward. The result is that Windstream generates significant and sustainable free cash flow, giving us confidence in our capital allocation strategy.
With that, let me turn the call over to Tony, who will discuss our financial results.
Thanks, Jeff, and good morning everyone. Turning to slide eight, strategic growth areas represent 70% of total revenues, and collectively increased 2% during the fourth quarter. This growth is resulting in relatively stable total revenues, despite declining wholesale revenues related to intercarrier compensation reform and declining [unintelligible].
Total revenue in the fourth quarter was $1.54 billion, down 2%, and revenue for the full year was $6.16 billion, a decrease of 1%. As the revenue mix shift continues, we expect further stabilization in our top line trends.
Turning to revenue by channel, on slide nine, business service revenue was $917 million, up $29 million, or 3%. Our business team has done a great job leveraging our competitive advantages to drive steady improvements in business service growth. Specifically, data and integrated services grew by $35 million or 10% due to growth in IP, next-generation data, and data center services.
Carrier revenue increased $3 million, or 2%, related to the fiber to the tower installations which were partially offset by a slowdown in non fiber to the tower carrier sales and wireless TDM disconnects due to fiber migrations.
While we expect fiber migrations to result in long term growth, we may experience an initial revenue pressure, which dissipates as the wireless carrier’s bandwidth demands continue to increase.
Business voice and long distance revenue decreased by $11 million, due to ongoing migrations from traditional voice services to integrated voice and data services, offset somewhat by the implementation of higher end-user rates.
In the consumer channel, service revenue was $334 million, down 2%. Voice and long distance revenue declined $10 million, or 5%, due to fewer voice lines and declining feature packages, which were partially offset by higher end user rates.
Broadband revenues increased $5 million, or 5%, driven by increased sales of broadband features and faster speeds. Also, revenues were $169 million, down 17%. Switched access revenue decreased by $44 million, related to the discontinuance of certain switched access products in the first quarter of 2012, lower interstate access rates as part of the intercarrier compensation reform implemented in July 2012, and fewer minutes of use consistent with declining access lines.
USF revenues increased by $10 million due to new recoveries implemented in conjunction with intercarrier compensation reform designed to mitigate the transition to lower intercarrier rates.
Other revenues were $64 million, which were comprised of pass-through surcharges and taxes and the residential [unintelligible] business. These revenues declined by $5 million, or 7%, related to the [unintelligible] residential business, which we stopped marketing to new customers in early 2012.
Product sales were $54 million, down $12 million, primarily related to fewer enterprise product sales.
On slide 10, total cash expenses decreased by approximately $37 million, or 4%. Specifically, cost of services decreased by $8 million, or 1% due to incremental deal synergies, network initiatives, lower benefits, and other cost reductions that offset network circuit growth and data center expense due to growth and expansion.
Cost of products sold decreased by $6 million, consistent with lower product sales. SG&A expenses decreased $24 million, or 9%, due to incremental deal synergies, lower benefits, and other cost management initiatives including the management reorganization completed in the third quarter.
For the fourth quarter, adjusted OIBDA was $619 million, an increase of 2% and a solid finish to the year. Adjusted OIBDA margins improved 190 basis points to 40%. Excluding the recent noncash accounting change related to our consumer promotion, our fourth quarter adjusted OIBDA would have been $624 million.
Sequentially, adjusted OIBDA improved by $27 million, driven by the savings achieved by the management reorganization, continued synergy realization, and other cost structure improvements.
Turning to slide 11, during the fourth quarter we spent $270 million on capital expenditures, comprised of $190 million in recurring capex and $80 million on fiber to the tower projects and our portion of broadband stimulus investments.
Recurring capex, which includes growth initiatives such as data center investments, broadband capacity, and success-based fiber, in addition to the capex required to maintain our network, , remains steady at 12.4% of revenues, where it has been consistently over time.
In addition, we spent $21 million in integration capital during the fourth quarter related to to the PAETEC network optimization projects and worked on the billing system conversion.
On slide 12, during the fourth quarter adjusted free cash flow was $122 million. For the year, Windstream generated adjusted OIBDA of $2.389 billion. The business is performing in line with our expectations, and excluding the noncash accounting revision related to the consumer promotional credits, we would have generated adjusted OIBDA of $2.417 billion, which was within our updated guidance range.
Capex for the year was $1.05 billion, adjusted free cash flow was $768 million, and we returned $588 million to our shareholders in the form of dividends, which were represented in an adjusted free cash flow payout ratio of 77%. As we move into 2013, we expect improvements to the payout ratio resulting from a significant decline in capex and cash interest.
Turning to slide 13, our debt maturity profile is well-positioned, with maturities staggered in a very manageable way. We completed several refinancing activities in January, which have improved our liquidity position and lowered our cost of capital.
We have roughly $800 million of debt maturing in the third quarter of 2013, and plan to repay a portion of this with free cash flow. And, we have ample flexibility to refinance the remaining portion with revolver borrowings at our discretion. The recent refinancing activities extended certain maturities and effectively addressed all significant maturities through August of 2017.
We ended the quarter with net leverage of 3.7x adjusted OIBDA, and plan to direct excess free cash flow toward debt paydowns to reduce our leverage ratio over time to our pre-acquisition range of 3.2x to 3.4x.
Slide 14 provides our outlook for 2013. We expect growth in business revenues and consistent trends in consumer revenue to largely offset declines in wholesale revenue such that total revenue is within a range of a 2% decline to a 1% increase as compared to 2012 total revenue.
From an expense standpoint, we will realize $40 million in annual run rate savings related to the business reorganization completed in 2012 and roughly $15 million of incremental PAETEC synergies, taking us to an $85 million cumulative synergy run rate by the end of 2013.
We plan on making investments in our business channel in 2013 where we see opportunities to drive growth and profits. Specifically, we are increasing the size of our sales and service teams to improve sales momentum and the customer experience. We are also adding several new data centers. All of this will increase our near term expenses.
In addition, the second intercarrier rate shift down occurs in July of 2013 as part of the ITC reform, which should result in roughly $20 million in adjusted OIBDA pressure.
Taking these items into account, we expect adjusted OIBDA to be within a range of a 3% decline to a 1% increase as compared to 2012.
We expect capital expenditures of $800 million to $850 million, a reduction of over $200 million versus 2012. Cash tax payments should be between $37 million and $42 million, which includes a benefit of 50% accelerated depreciation for capital investments and other tax saving initiatives. Our guidance also assumes net cash interest of $608 million.
With these components, we expect our adjusted free cash flow range to increase by 13% to 25% versus 2012, resulting in a dividend payout ratio within a range of 61% to 68%. During 2013, we expect merger integration expense to be approximately $15 million. Moreover, we do not expect significant M&I capital, and consequently, we have embedded M&I capital in our capex guidance I just discussed.
Looking beyond 2013, we expect stable adjusted OIBDA results, combined with further reductions in capital spending and cash interest, which will position us to deliver solid and sustainable free cash flow, even with the expectation that cash taxes may increase.
Importantly, our business model and strategy are designed to provide long term support for our current dividend policy and our investment thesis remains the same: We produce very strong free cash flow and return a significant portion of it to our shareholders in the form of a $1 annual dividend.
With that, let me turn the conference over to Brent to provide more color on our operating results.
Thanks, Tony, and good morning everyone. Turning to slide 15, our business channel is focused on building more profitable relationships with new and existing business customers by upselling managed services. This was demonstrated in the fourth quarter as the team achieved 7% growth in average service revenue per business customer.
Enterprise customers, who are customers who generate $750 or more in revenue per month, grew 6% year over year. We are leveraging our strengths, which include a national fiber footprint and our value proposition of smart solutions and personalized service to drive new enterprise sales.
In the small business market, we are responding to increased competition, which led to a decline in customers of 7%. We are differentiating Windstream’s small business offerings from the competition by creating comprehensive bundles that combine our voice and data offerings with other services such as website design, hosting, and security.
As Jeff said, we see the business channel as an essential driver of our growth in the future, and as such, we plan to make targeted investments in 2013 to maximize our future sales opportunities and profitability.
Specifically, we plan to focus on three areas, including expanding our sales team, adding several new data centers, and taking steps to improve the customer experience. In addition, we are increasing our focus on selling higher-margin managed services to promote stronger business relationships and increase profitability.
Carrier circuits declined by 4%, related to wireless partners migrating from traditional TDM circuits to our fiber network, combined with the slowdown in non fiber to the tower carrier sales. Importantly, carrier revenues continued to increase year over year and sequentially, as the growth in fiber to the tower connections is exceeding the decline in TDM circuits.
On slide 16, our consumer channel continued to produce steady revenue trends. During the quarter, we lost 2,000 high-speed internet customers and ended the quarter with 71% penetration of primary voice lines. Consumer voice lines declined by approximately 23,000, and represented a 4.5% decline in total customers year over year.
Our consumer strategy is focused on increasing bundle penetration to reduce churn and sell value-added internet services and faster speeds to maximize profitability. In addition, we should have an opportunity to win new broadband subscribers from the broadband stimulus projects that are completing later this year.
We are updating our consumer sales promotions so that we continue to drive consumer acquisitions. During 2012, our promotion incentivized consumers by helping them with the cost of switching. For 2013, we plan to return to our price for life promotion, coupled with a discounted video offering over an introductory period, which we believe provides attractive value to consumers and is competitive in the marketplace.
On slide 17, we made great progress on our 2012 capital initiatives, which included building a stronger network with greater capacity and pursuing growth initiatives to better position the business.
To date, we completed and installed fiber to 2,600 towers, and have roughly 1,800 towers currently under construction. By the end of 2013, we expect to complete these projects and in total will have installed fiber to roughly 4,500 towers.
In the consumer markets, we strengthened our broadband network by enhancing capacity and speed and work is continuing on the broadband stimulus project, which will expand our addressable lines and provide an opportunity to further increase our broadband penetration. We have consistently invested in our network, and are well-positioned competitively as a result.
To wrap up, much was accomplished in 2012. The Windstream team is executing well, and I like how we are positioned for 2013. Thanks for your time this morning. We’ll now take a few questions. Operator, if you could, please open the call to questions.
[Operator instructions.] Our first question comes from Frank Louthan of Raymond James. Please go ahead.
Frank Louthan - Raymond James
I appreciate a little bit of the color on the EBITDA, but can you give us an idea of, on some of the SMB erosion there, that’s probably contributing to that, how much of that is from SMB losses within Windstream legacy territory versus some of the PAETEC properties? And is any of this really due to resale T1s that have lower speeds than cable? Are you finding a competitive disadvantage there?
Really, the answer is there’s two things going on. Most of that loss really was in our CLEC business, and if you think about what we’re trying to do CLEC side, much of our sales force is really moving up-market. We define SMB as that $750 and below. You know, whenever I look at the results, that’s really where the erosion’s coming, just because of a slowdown in growth because of our focuses I shared.
On the ILEC side, which is where most of our revenues, and more importantly, most of our profits come from, we fared very, very well, with modest losses. I feel like we’re doing a great job there from both a sales perspective, where we’re actually growing our high-speed franchise, [stealing] that space, but importantly, revenue trends as well. So it’s more of a focus in terms of direction where our direct force is in the marketplace.
Frank Louthan - Raymond James
So how much of that $750 and below market do you still have, and how much more of that business do you think you have when that erosion starts to stabilize?
You know, differentiate between CLEC and ILEC. I mean, in the CLEC markets, I’ll tell you, it’s in pockets, where companies we bought in the past few years had a big presence in certain areas. And I’ll tell you, our focus primarily there, direct marketing only. Not with a field sales force.
And so I’d expect continued erosion in that space, just simply because of how aggressive it is, both with cable companies as well as smaller CLECs that are focused on that T1 type access. So I think we’ll continue to see that. You know, Cavalier, that PAETEC bought, had some of that concentration, and that’s where some of that came from.
And our focus is primarily there on the call center side, where we’re trying to retain those customers to the best of our ability, and then sell managed services to that base. And then direct marketing, bringing new acquisition. But it’s not a huge area of focus, because those customers just aren’t as profitable. Much of our SMB emphasis is really within our ILEC space.
Frank Louthan - Raymond James
Can you quantify that non-ILEC SMB that’s sort of at risk, and you’re just kind of managing the decline?
I don’t want to break that out separately. All of those results are in our total business service revenues, importantly. And so whenever you look at the trends that you’re seeing, in our total business service revenues, which are up 3.3% in the quarter, that’s reflective of those declines that we’re seeing, even in that small business customer segment.
Our next question comes from David Barden of Bank of America. Please go ahead.
[unintelligible] - BofA Merrill Lynch
Hey guys, this is actually [unintelligible] for Dave. Maybe we can go back to the dividend for a second. Just looking at CenturyLink’s decision last week, why should investors take comfort that this is the wrong decision for Windstream, particularly when you start paying cash taxes, which presumably is next year? Why shouldn’t investors be worried that CenturyLink of last week is not just a snapshot of an inevitable future for Windstream?
We do recognize that Century’s actions raise concerns about WIN, but let me reiterate that it is our expectation to maintain our current dividend practice. As we said in the call, we believe that we’re in a very different position. The things that we highlighted around where we are at in our transformation, our focus on the enterprise segment, we’re much further along there.
If you look at the consumer business, we’re in much more rural areas, we’re not investing in a video facilities based solution, and that over time, we think that, because of where we’re at in our business mix, and our transformation, that we’re much better prepared.
We’ve been paying this dividend for seven years. From time to time, we’ve been asked about that. We’ve demonstrated time and time again that our capital allocation makes sense for this business. And we believe that will be the case going forward.
As it relates to our investment in the business, we still believe that we’re able to continue to invest adequately to drive growth in our business segment and to continue to manage our consumer business well. I think if you just look at this year, you get real evidence of that, where I think in the script we said that 12.4% was our ongoing capital investment rate if you take out some of the more finite opportunities, and with that, Brent just reported that we grew our business revenue over 3%.
So those are some of the reasons why I think we’re a different business, much further along in our transformation. And our business model is less exposed to the consumer business for the reasons that I talked about earlier.
And then at the end of the day, we go back time and time again that the dividend is the core to Windstream’s investment thesis, and we believe it’s the best way to return value to our shareholders.
Our next question comes from Michael Rollins of Citi Investment. Please go ahead.
Michael Rollins - Citi Investment
Jeff, if you could talk a little bit about the cost cutting that you did in 2012. And as you think about the EBITDA opportunity for 2013, and going forward, how much incremental cost cutting, whether it’s through the merger synergies that you highlighted, or other efforts, does Windstream need to achieve to stabilize or grow EBITDA over time? If you could give us some help on how investors should think about that.
In 2012, we benefitted from the synergies related to PAETEC, where we’re right on track. I think that we’re up to a run rate of about $85 million through 2012. We did a management reorganization that drove another $40 million. And in the fourth quarter we realized the first full quarter of that benefit and we’ll see that for the full year in 2013.
Going forward, really what’s important to us is two things. On the revenue side, continuing what we talked about in our script, which was to maintain business growth and broadband growth at sufficient levels to overcome some of the pressures that we’re seeing in wholesale and the consumer business. And we think that will be true. You saw that we’ve been able to do that.
As we grow our enterprise business, I think that we expect that to continue to improve. And as you said, cost cutting, it’s just a part of that process. In order to manage this business and to manage the evolution from higher margin to good margin, but lower margin business, cost cutting will always be a part of that equation.
In 2013, we’ll see the last bit of the PAETEC synergies being realized. We’ll see the full benefit from the restructuring that we did last year. We’re also going to be doing a lot of systems work, systems integration work, that will allow us to realize some savings as well.
So it’s really what we’ve done, year-in and year-out: managing this revenue mix transformation, as well as targeted cost savings that will allow us to produce a stable revenue and OIBDA that will drive and support our dividend strategy.
Our next question comes from Scott Goldman of Goldman Sachs. Please go ahead.
Scott Goldman - Goldman Sachs
Jeff, just wanted to return back to the dividend question and look at it from a couple of ways. One, I guess, from the mathematics. You know, you’ve laid out expectations for relatively stable EBITDA this year, capex coming down.
Obviously, as you look into 2014, and look at the moving parts, obviously it looks as though, perhaps, that fiber to the cell and the stimulus capex can come down another $100-125 million next year if I interpret the comments correctly. But it also looks as though cash taxes would increase from roughly $40 million this year to what could be a couple of hundred million more than that next year.
So I just want to see if the math is correct as I look at that, and what that may imply for the payouts. But more broadly, I think one of the things that your peer discussed last week was looking out into 2015 and the fact that their payout ratio would probably creep somewhere into the mid-70s, let’s say. You’ve laid out expectations for mid-60s this year.
Are you guys looking at the payout ratio? I know that’s not your guiding principle, but are you guys looking at that any differently than you think your peer is? Or do you think that the payout ratio as you’ve laid out this year is really sustainable given all the trajectories of the business that you laid out today?
I think you did have the math correct in terms of we just announced significant capital declines this year. We will complete, essentially, our fiber to the tower, and our stimulus projects, in 2013, and see another reduction in capex. And so 2014 you should see standalone capex in that 11-13% range, without any additions for the finite projects that we had.
In addition, as you look at 2013, there’s a couple of things. Also, big decreases in merger and integration, both expenses and capital. Expenses are going down significantly from $65 million to $15 million on the M&I side in 2013. And integration capital is going down from $51 million to zero.
And to the question that you asked, in terms of what is our view on payout ratio versus our competitors, well, I can’t speak to our competitors, but I think we certainly do have a business model that’s different. We’re much further down the transformation path.
Over the last four years, our acquisitions have been very targeted on businesses that are growing in the strategic growth areas that we’re focused on, and we’ve really changed the mix very significantly here, away from the consumer business toward the enterprise space, and I think that puts us in a very different position with respect to the stability of our revenue and OIBDA over time. Tony said, in his comments, that we expect that to continue to improve in 2014.
And then as that relates to our comfort with our dividend go-forward, it’s that stability that gives us that comfort and I think it’s fair to say that we do have a different view in terms of this business model can support a higher level of payout ratio. And you saw what we guided for this year.
I think in the 2014 and beyond, you can count on us continuing to deliver steady revenue and OIBDA, managing our capex, and having a very manageable payout ratio that we are comfortable with, and we believe our investors will be comfortable with.
Our next question comes from Simon Flannery of Morgan Stanley. Please go ahead.
Simon Flannery - Morgan Stanley
I wanted to pick up on the last question. I think you mentioned revenue stability a couple of times. Q4 was -2%. Your guidance is -2% to +1%. Going back to Century, I think they have guided to improved revenue trends throughout ’13 and then moving to stability or above in ’14. Can you help us think about your trajectory here? Is this something where we’ll start to see that improvement? And do you think there’s a hope that we can actually get positive territory on revenues exiting this year?
And then I think you had mentioned that the intercarrier [comp hit] would be $20 million to OIBDA. I just was trying to figure out is that an annual number, or is that $20 million in the second half. Just to clarify that point would be great.
Maybe I’ll start with the second question first. The $20 million is expected to be the annual impact to 2013. We had a $5 million impact in 2012. This is just the second [leg] associated with the intercarrier compensation rate step down.
Simon Flannery - Morgan Stanley
Okay, so that includes the step down from last year as well?
Yes, this is the cumulative effect. And to your first question about -2% to +1%, I think we start looking at the components of revenue. As we talked about on the call, we expect to see consistent business service revenue growth going forward. We expect a stable consumer business, and we expect to continue to battle against double digit declines in the wholesale business.
And we do see a point where we get to modest growth. We’re not projecting a specific day, but you simply run the math. As business service revenue growth becomes a larger part of the company, and wholesale becomes a smaller portion of our total revenues, there’s an inflection point.
And at what point exactly that occurs, it’s a little bit difficult to estimate, but it occurs here in the near future. So we are definitely on the right track with the investments we’re making to improve our business service and business sales capabilities, and with a really stable consumer business, we’re in a very good position to have stable revenues in the near future.
Our next question comes from Ana Goshko of Bank of America. Please go ahead.
Ana Goshko - Bank of America
I have a question on your plans for reaching your leverage target. So, as you said, you’re at about 3.7x now. Your goal is to get to 3.2x to 3.4x. But I did some quick math, just on the midpoints of your guidance ranges, and if I assume that all of your excess free cash flow after your dividend, which would be about $325 million, is used to pay down debt this year, but then I fast forward to the end of the year, and you do have a slight decline at midpoint in your EBITDA, your leverage at the end of the year would still round up to be about 3.7x.
But at the high end, I think it would round to 3.6x, because about a tenth of return of delevering. So as we think forward, assuming that you’re able to have the stability that you’re talking about, including on your dividend payout ratios, should we think about a tenth of a turn of delevering a year? So to get to 3.4x, it would really kind of be at an end of 2015 target.
We’re not giving specific targets in terms of when we expect to reach our leverage goals, but what we can state, and what we’ve stated many times publicly, we plan to direct our excess free cash flow to pay down debt. And you are correct, that will bring us closer to our target. Importantly, Windstream has a strong balance sheet. We’ve had access to capital at very attractive rates. And we have a manageable debt maturity profile. We continue to remain committed to our leverage goals of 3.2x to 3.4x.
And the question for us, to achieve that, is going to be our ability to generate stable OIBDA, at the same time producing excess free cash flow to pay down debt. It’s really a combination of those two factors. And in terms of what specific quarter or what specific year, we don’t necessarily cross over. We’re not going to give that level of guidance. But the clear statement here is that we’re directing excess free cash flow to pay down debt, and we’re committed to getting back into the pre-acquisition range of leverage of 3.2x to 3.4x.
Our next question comes from Batya Levi of UBS. Please go ahead.
Batya Levi - UBS
I want to tackle the payout question one more time. I think based on the 2013 guidance, if we didn’t get the stimulus extension, payouts would have been approaching about 90% of free cash flow this year. So just looking out into ’14, can you help us with your expectation for cash taxes? And with stable revenue and EBITDA, and assuming some slowdown in capex, where do you think payouts will be next year?
We’re going to guide one year at a time, as you can probably imagine. But let me give you some guidance as we look out beyond 2013. As Jeff mentioned earlier, we do expect a significant decline in capex as we wrap up our fiber to the tower and stimulus investments. And most notably, we did some very significant refinancing activities earlier in the year.
So while we expect a $60 million decline in cash interest from 2012 to 2013, we expect another significant reduction in cash interest from 2013 to 2014. So once again, you’re going to see reductions in capital. You’re going to see reductions in cash interest. And that’s going to put us in a very good position to be able to limit the potential increases in cash taxes.
And I think as we evidenced in 2013, we were able to take what we anticipated being a $250 million cash tax payment in 2013. Bonus depreciation helped offset half of that. And tax planning initiatives were the other half. So of course, we remain very vigilant in finding other tax initiatives to help offset that pain as we get a chance to reset. Because you’re right, with the expiration of bonus depreciation, you are going to see higher cash taxes.
So if we put all those moving parts together, what we really do get at the end of the day is stable free cash flows. Lots of moving parts, but the outcome is stable free cash flows that put us in a very good position to support the dividend.
And Tony, just to add to that, can you give a little color on the NOL situation and the tax trajectory going forward? Because I think there are some very big differences here as you look at Windstream and the fact that our NOLs mostly were derived from the PAETEC acquisition as opposed to maybe some others in the space who had some very big NOLs generated from a larger transaction which had a much bigger impact on their outlook going forward.
And we’ve gotten this question a lot, from investors. And I think a key differentiation is our NOLs are fairly insignificant to our cash tax story. When you look at what’s driving cash taxes for us, it’s really the last six years of bonus depreciation has pulled forward deductions into earlier periods. So as we look at our 2014 tax return, what we’re seeing is a lack of tax deductions associated with depreciation. But the NOLs do not play a significant story in Windstream’s cash tax profile.
Batya Levi - UBS
Just to follow up on that, with the other tax benefits you received this year, will they reverse next year? Do you think $250 million in cash taxes is sort of a ballpark to use for ’14?
I think it is important, as you talk about bonus depreciation and how it flows back through. You still get depreciation deductions in the next year. There is not an immediate turn associated with a bonus depreciation. It gets paid back over a multiyear period. It is a timing item, but it’s a multiyear timing item, not a single-year timing item. And still, at this point, we’re not going to provide specific guidance as it relates to 2014. We have several initiatives underway to help minimize cash taxes in 2014, and that remains one of our principal focuses this year early in 2013, is to address that 2014 cash tax bill.
Batya Levi - UBS
And just to follow up on the other tax savings, not the bonus depreciation, are they a one-time benefit, or will they reverse next year?
No, there’s a mix of discrete and ongoing benefits.
Our next question comes from Barry McCarver of Stephens, Inc. Please go ahead.
Barry McCarver - Stephens
I think you’ve got most of my questions. You touched on the NOLs. But in relation to the fiber to the tower project that we’re expecting for 2013, are we still to assume that those are very front-end loaded in the year?
You bet. We’re doing our best to wrap up construction and trust me, internally that’s been a big effort, that we’d like to see the closure as fast as possible. The big limiting factors will be weather and our ability just to fight through temperatures this year, where we can and can’t handle construction. That will be the biggest issue. Our customers want it as fast as we can deliver, and we’re doing everything we can internally to meet those dates.
Barry McCarver - Stephens
Do you think it’s fair to assume that in terms of that specific capex level, we’re at the peak, or have seen the peak, around Q3 and Q4 of 2012?
Yeah, I’d say we’ll have a consistent level of activity around that project specifically, probably through the first six months of the year. Again, depending on weather. We’ll still, within our ILEC territory, some of those buildouts will continue in the latter part of the year, but you’ll definitely see it in the first half of 2013, [unintelligible] dipping down after that.
And just to add, that’s obviously why we anticipate over a $200 million decline in our capex plan from 2012 to 2013.
Operator, I think that’s our last question. In closing, I’d like to thank the Windstream team for their hard work. During 2012 we accomplished many of our strategic initiatives, and we’ll continue advancing these goals in 2013. It is our vision to be the premier enterprise communications and service provider in the United States while maintaining our strong, stable consumer business.
To reiterate, on slide 18, this business generates substantial free cash flow, which has enabled us to pay a $0.25 quarterly dividend to our shareholders for each of the 27 quarters since we were formed. The dividend is, of course, Windstream’s investment thesis, and we believe is the best way to return value to our shareholders. Thank you again for joining us this morning, and for your interest in Windstream.
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