Tom Gerke - Chief Executive Officer
Gene Betts - Chief Financial Officer
Harry Campbell - President, Consumer Markets Group
Tom McEvoy - President, Business Markets Group
Trevor Erxleben - Investor Relations
Jason Armstrong - Goldman Sachs
Batya Levi - UBS
Simon Flannery - Morgan Stanley
Jason Brienen - Raymond James
Tom Seitz - Barclays Capital
EMBARQ Corporation (EQ) Q1 2009 Earnings Call May 6, 2009 4:30 PM ET
Good afternoon. My name is Lesley and I will be your conference operator today. At this time I would like to welcome everyone to the EMBARQ first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator’s instructions)
Mr. Erxleben. You may begin your conference.
Good afternoon, and thank you for joining us for EMBARQ Corporation’s first quarter 2009 investment community update. With me today are Chief Executive Officer, Tom Gerke; and Chief Financial Officer, Gene Betts. In addition, Harry Campbell, President of our Consumer Markets Group, and Tom McEvoy, President of our Business Markets Group will join us for the Q-and-A session at the end of the call.
Before we get started, there are two items I’d like to bring to your attention. First, if you’ve downloaded the fourth quarter presentation from our website, please turn to the cautionary statement on slide two. As that slide indicates, our comments today will include forward looking information and expectations involving a number of risks and uncertainties that could cause actual results to differ from our expectations. With that in mind, I would strongly encourage everyone to review the detailed discussion of risks and uncertainties included in our SEC filings, and particularly the Risk Factors section of our annual report on Form 10-K.
Second, during our remarks today we will be referring to certain non-GAAP measures. In the appendix of the presentation as well as in the definitions section of our press release, we’ve included reconciliations of those measures to the appropriate GAAP measures. Again, I would strongly encourage everyone to take a few minutes to review those reconciliations so that it’s perfectly clear how the non-GAAP measures are derived.
With those topics covered, I will go ahead and turn the call over to Tom.
Thanks, Trevor. As we enter 2009, our primary objectives were to maintain the momentum that enabled us to post record cash flow in 2008 and to continue to make solid progress on our merger with CenturyTel. In both respects, I think the EMBARQ team clearly demonstrated their continued commitment by delivering another successful quarter.
From a result standpoint, there were highlights in a number of key areas that are particularly notable given the broad economic slowdown. First, our cash flow results were very strong again this quarter exceeding the record levels we achieved in Q4. In addition, we saw a marked improvement relative to the recent trend in consumer access line losses, which were nearly consistent with the prior year level for the first time since the fourth quarter of 2007. Finally, high speed Internet subscriber additions also improved relative to the recent trend increasing more than 65% compared to each of the last three quarters.
As each company focused on delivering solid Q1 results, the EMBARQ and CenturyTel teams also continue to work together to move the merger approval process forward and prepare for successful integration. In both areas we made substantial progress during the quarter which I will talk more about in a bit.
Turning to slide four; the impact of the economy continues to be evident in our top line results. In total, revenue declined 7.6% year-over-year to $1.35 billion in the first quarter. As we’ve noted in the past, part of the revenue pressure is attributable to our wireless operation which we began winding down roughly a year ago. In the first quarter of 2008, the wireless business generated $16 million in revenue, but it diluted operating income by $14 million. This quarter we reported positive income of $3 million and just $9 million in wireless revenue.
While wireless was a contributing factor, the primary driver of the overall decline in revenue was continued access line attrition. In total access lines declined by $144,000 in the first quarter which is an improvement relative to each of the last three quarters of 2008, but a bit worse than the year ago period. This year-over-year increase in line losses was largely attributable to the impact of the economy on our Business Markets Group.
New business orders declined from the prior year while economic disconnects were up, particularly amongst small business customers. In contrast to business, absolute line losses in our Consumer Markets Group were nearly the same this quarter as in the year ago period. The last time we were able to say that was in the fourth quarter of 2007.
On our last call, we noted that the gap in consumer line losses versus the prior year had narrowed from November through January. Since then that trend has continued, in fact we lost fewer lines in March and April than in the same months a year ago. This relative improvement in consumer line losses is primarily a result of lower disconnects.
New consumer orders continue to run below prior year levels. Geographically, we saw the biggest year-over-year improvement in the states of Nevada and Ohio, conversely North Carolina led the states in which losses increased from the prior year period.
Moving from access lines to data revenue category, the impact of the economy has resulted in somewhat slower growth than we’ve reported recently. First quarter revenue totaled $203 million, which represents a 2.5% year-over-year rate of growth.
Among retail business customers, the sales cycle for new data services continues to be longer than normal. Meanwhile, wireline special access in our wholesale markets group was soft this quarter, due to the impact of the economy on small and medium businesses, but wireless backhaul continues to grow at a very solid rate.
Notwithstanding the cyclical slowdown in wireline special access, our wholesale group has been successful due in part to a strong commitment to service quality. We have received multiple customer driven service awards over the last few years and we continue to invest and enhance our wholesale service capabilities.
For example, we’ve undertaken development projects to automate order flow to our provisioning and billing platforms, increasing the speed and accuracy of our order process. We are also investing in our network gradually increasing the number of cell sites served by fiber. In fact, we increased our fiber investment by more than 70% compared to year ago quarter and we expect to maintain that level throughout 2009.
The final revenue category I’ll discuss today includes consumer and business high speed Internet services. In the first quarter, HSI revenue totaled $143 million, representing more than 7% year-over-year growth.
Q1 subscriber additions totaled 40,000, which is below the prior year level, but well ahead of our results in each of the last three quarters. Similar to consumer access lines, the improvement in HSI net adds was driven by improvement in churn.
HSI ARPU has been relatively stable over the last few quarters holding in the $33 to $34 range. This is due in part to the ongoing demand for our three, five and 10-megabit speed gears, which now comprise more than 45% of our HSI subscriber base.
RescueIT, our new computer support service is also beginning to make a contribution to HIS revenue. Although the amount is relatively small at this point we think the revenue could be $10 million or more in 2009. This outlook implies an expectation of strong subscriber growth which we certainly saw in Q1, in fact we added 18,000 new RescueIT subscribers during the quarter, doubling our subscriber base to 36,000 in total.
Following the launch of RescueIT for business customers, we introduced several packages this quarter that funded RescueIT with HSI service and value-added IT products such as McAfee Desktop Security and EVault Remote Backup and Restore Services.
We also introduced safe and secure Wi-Fi solutions to help small businesses increase productivity and generate additional revenue. Customers can choose a basic Wi-Fi offer that includes professional installation, customization and security or a premium offer that adds functionality to control access and online duration. Premium subscribers who want to charge their customers for Wi-Fi service can also set their own rates and prepared method of payment using a simple web management tool.
Enhancing the ability of both companies to bring new products and services like this to our customers is in an important aspect of our pending merger with CenturyTel. Working together, the two teams have made a great deal of progress during the quarter, both in the approval process and in preparing for a successful integration as outlined on slide five.
From an improvable standpoint, we are waiting for clearance from the FCC in just five of the 33 states in which the combined company will operate. We’ve had productive discussions at both the federal and state levels and continue to expect to receive all necessary approvals in the second quarter. The EMBARQ and CenturyTel teams have also done a great deal of work to facilitate the integration of the two companies. To give you a sense for our level of preparedness, I’ll outline our approach and progress in a few key areas.
Organizationally, we’ve announced leadership appointments across the company and additional staffing decisions will be made over the next several weeks. In addition, to facilitate planning, communication and decision making, we have a dedicated integration management organization that is leveraging Executives, Project Managers and Subject Matter Experts from both companies, as well as the expertise of third party resources.
Systems integration is important in any merger and is certainly a focus of our integration planning efforts. The process is simplified by the fact that we are migrating to established proven systems, but we are still taking a prudent approach, the migration will be gradual, success based and since the systems are already well established and working effectively, new development work will be limited.
Too often companies go wrong by trying to do too much at the time of integration and taking a flash cut approach to conversion. No less important than the IT transition is making sure we have the right operating model going forward. Given such retail success with the regional structure for customer facing sales and service functions, the combined company will continue to utilize that approach. Moving decision making closer to the customer enables the company to be more responsive to local customer needs, in addition it helps drive ownership and accountability among employees.
In summary, due to the efforts of both the EMBARQ and CenturyTel teams, I think we are well positioned in terms of both merger approval and execution after the close. Looking at the aggregate results of confidential internal surveys we do periodically, its clear EMBARQ employees remain very engaged. In fact in our January survey overall employee commitment was relatively consistent with the prior year level and above comparable company benchmarks. I think that commitment was also evident in our Q1 performance and it bodes well for a solid Q2.
With that, I’ll hand the call to over to Gene, so he can share his thoughts on our first quarter performance and outlook for the future.
Thanks Tom. My comments today will focus on income and cash flow with the degree of commitment Tom just mentioned translated into very strong results. In fact earnings per share from continuing operations and cash flow before dividends reached their highest levels ever which I’m not sure many people would have predicted following our spin-off nearly three years ago.
Looking first at income on slide seven, we continue to largely offset top line pressure with efficiency gains. Although the non-recurring loss in the sale of EMBARQ Logistics negatively impacted net income, income from the continuing operations was very solid again this quarter. At $410 million, Q1 operating income was among the better quarters we have reported compared to the record $436 million in the prior year period; operating income declined just 6%.
Operating margin meanwhile improved year-over-year to 30.5% this quarter. Although the sale of EMBARQ Logistics helped that percentage, if you compare it to the Telecom segment results we have reported previously this was still close to our best quarter census then.
Naturally the margin increase was driven by ongoing improvement in operating expenses which declined $26 million sequentially. $16 million of the improvement is attributable to declines in cost of products and depreciation. The remaining $10 million is largely a function of lower personnel cost, including the run rate benefit of the workforce reduction we undertook beginning in August of last year. Below the line, interest expense declined to just $96 million and our income tax rate was a little under 37%. As a result diluted earnings per share from continuing operations reached $1.39, the highest level in our three year history.
Taking into account the sale of EMBARQ Logistics, total diluted earnings were $1.21 per share. The loss in the sale of cell was $24 million and we recorded an additional $2 million loss related to the results of the business prior to the close of the transaction.
In contrast to the impact on net income, the cash impact of the sale was modestly positive taking into account sale proceeds as well as benefits related to working capital and income taxes, the sale was expected to provide a cash benefit of more than $40 million. Additionally, it enables us to focus on continuing to optimize our core telecommunications business, including successfully executing the merger with CenturyTel.
Turning now to slide eight, solid income performance combined with lower capital expenditures resulted in very strong cash flow this quarter. At just $105 million, first quarter CapEx reflects the continued benefit of the slowdown in construction which is helping offset top line pressure attributable to the economy.
Since speaking in 2006 at approximately 250,000, the number of new service addresses to which we are required to build facilities has declined to an annual run rate of less than 100,000. Of course we are still making prudent investments in the business, for example by extending fiber to wireless towers and extending data capacity where it makes sense to do so. However even data related CapEx tends to be counter cyclical to some degree because the demand for additional capacity is largely driven by sales success.
The combination of lower capital requirements and solid operating profitability resulted in record cash flow before dividends of $339 million this quarter. This is well above the $287 million we reported in the same period a year ago.
Going forward as Tom indicated earlier we remain very focused on maintaining the performance of our business as we continue to work toward prompt completion of the merger. In fact we would expect results in the second quarter to look very much like what we’re reporting today for Q1. More specifically in light of the relative improvement in consumer access line attrition, we think the decline in total revenue could moderate a bit in Q2.
In addition, we would expect cash flow before dividends to remain above the prior year level driven by ongoing expense discipline and sequentially higher, but still relatively modest capital requirements.
In closing, I would offer my thanks to investors for their support over the nearly three years that we have been publicly traded. I’m proud of what the EMBARQ team has accomplished and believe the combined strengths on EMBARQ and CenturyTel will provide opportunities for further success going forward.
On that note, I’ll turn the call over to Trevor again so he can facilitate the Q-&-A.
Thanks, Gene. Since our prepared remarks were relatively brief today, we have 20 or 30 minutes available for Q-&-A, which means that we should actually be able to accommodate a multipart question or two and still get everyone who is in the queue.
Lesley, before you introduce the first question, would you mind reviewing the process for submitting a question?
(Operator Instructions) Your first question comes from the line of Jason Armstrong - Goldman Sachs.
Jason Armstrong - Goldman Sachs
I guess a couple of questions since, Trevor you extend that to us this quarter. Maybe first on just the second quarter improvements and what sort of give the confidence in that note, I know there were obviously some positive comments around the access line trajectory, given what we thought in terms of the step up in the rate of change year-over-year from fourth quarter to this quarter, may be would help to sort of have the monthly progression on the revenue side through 1Q just to build a little bit of confidence that does get better in the second quarter?
Then the second question, strong broadband quarter on the add side, I know you talk about churn being down. On the gross add side, is there any sort of promotional activity that we should know about in the first quarter?
Thanks for those questions, Jason. On the revenue thing, it really is largely a function of improving access line trends and then and obviously if you look at some of the other revenue categories if you will, hardware revenues, other service revenues, those sorts of things were down year-over-year in this quarter and we would expect those perhaps to be able to better next quarter. So, nothing terribly exciting to report there, I don’t think, Harry you want to take the HSI question.
Hi, Jason, this is Harry Campbell in Consumer. From a HSI standpoint, we didn’t do anything that was particularly out of balance or special from driving top line sales and the new orders have been softening intact because of the economy. We did try some things and tested as we do on an ongoing basis all the time and some of those hit and some of them didn’t, but nothing that I would say was out of balance.
What really happened was we focused on the base, we run after base management with a fervor, we did some early life outbound calls not necessarily to make sales, but to handhold some customers and make sure they got what they want and they were happy, we did a whole lot of testing on some different things to try to make sure people stay with us on high speed.
Finally, I think there is a cumulative impact of a lot of the business process improvement we’ve been making over the last 24 months. We’ve been edging up pretty nicely in voice and data, particularly data on customer satisfaction is measured by folks like J.D. Power. I think the cumulative effect of that really start to come home.
Your next question comes from the line of Batya Levi – UBS.
Batya Levi - UBS
I have a question on margins which SEDAR estimates. I was wondering if you could provide some detail on the drivers of the improvement, you mentioned wireless, I was wondering if you could maybe quantify the upside from the head count reduction and what are the cost initiatives helped margins. Do you think some of the easy $300 million synergy target was already pulled through in the first quarter? And I also have a follow-up on CapEx.
Batya, I think on expenses, Gene mentioned in his prepared comments that it was largely a function of head count and so that really is a factor I’m not aware. I don’t think there were a point forward synergies, but it remains be seen. But I don’t think that is the issue here, really isn’t. The head count actions we took in the third and fourth quarters of last year. So that shouldn’t be redundant.
I would just tackle the comments that Harry just made. We are seeing a combination of some significant business process improvement efforts that have run across multiple silos or groups within the company and we continue to see that show itself.
Batya Levi - UBS
On CapEx, I was wondering if you weren’t merging with CenturyTel at this level it would have been a sustainable level, or do you think that network will need to increase spending going forward?
As part of the merger process we, have passed a few items as you would expect if we have different types of equipment. We want to make sure that we’re deploying things that make sense, but by and large, that was fairly a minor factor, I think what you’re seeing as you see others report out, if you can strip away the wireless activity and make it apples-to-apples because the economy, I think everyone is running fairly light on CapEx in this, what we mentioned earlier, new service address is being down from 250,000 to now under 100,000.
It’s making a significant impact, plus I think we’re just doing a better job of targeting capital and we feel really good about it. We’ve actually increased our capital spending in all the data areas and the growth areas, but the shock absorber effect to the economy has really helped this out. So, I don’t see any major swing other than what could be occasioned by a stronger economy, actually that would have an impact.
Batya Levi - UBS
And you mentioned that trend should continue into the second quarter, right on the CapEx levels?
Well, we mentioned that it should continue, although not at as lower level as in the first quarter. Of course in the first quarter in some of our states because of weather, there are limitations on construction and now with the warmer weather, we’ll be doing more. So I would expect it to go up in the second quarter over first quarter and quite a bit on a percentage basis, but I think the total will still be well below last year.
Your next question comes from the line of Simon Flannery - Morgan Stanley
Simon Flannery – Morgan Stanley
Just contrasting your consumer and business units, the consumer revenues were fairly flat sequentially, but business was up about 5%. Perhaps you can just dive into business a little bit more, was this bankruptcies or was it usage based minutes and so forth really softening with the weaker economy or other drivers like CPE, and then on the consumer side, you seem to be guiding to some stabilization line loss. Is that something you expect to continue and what you think is driving that clearly disconnects are helped by fewer housing starts perhaps.
Is it a combination of gross adds and disconnects, what’s the sort of the biggest improvement that you’re seeing over the last couple of quarters? Thanks.
Simon, this is Tom McEvoy. Thanks for the question. I’ll start and then will hand it over to Harry for consumer. On the business space, couple of areas, one, definitely the customer premise equipment business and the associated business that come along with that are maintenance services, we’ve seen some declines both sequential and year-over-year, the other piece of the business really have been around the economy.
We’ve seen a tick up on economic disconnects for bankruptcy and business is shrinking, if you think about the enterprise space, we’ve got customer staying with us but they’re ordering less and they’re shrinking some of their remote sites. So we’ve seen that definitely impact us on the access line side.
Then down, in the small business of SOHO, we continue to see economic issues there and I’m delighted actually in the first quarter we actually saw less competitive losses sequentially. So really the economy has been our number one factor.
Simon, this is Harry, I’ll pick up where Tom left off. You asked about stabilization. Yes, we’ve seen this; it’s kind of been a march forward month-over-month, things getting a little bit better as we talked about. I think we talked about it in the last call and then I think Tom and Gene both mentioned it here.
We continue to see that the drivers, it is really not the end this much, the new orders continue to be relatively soft, I think further reflective in the new service addresses and the CapEx that Gene talked about also.
The wins really are in the disconnects. We’re seeing cable losses frankly softened and I’ll use that as a good term, wireless disconnects had, we’ve seen those start to pick up some those have kind of stabilized. We’ve done a lot of base management efforts in addition to that to try to make sure the customers we have are on the right plans and are staying with us; our satisfaction measures are going up.
I think when you accumulate all these together plus effect some of our markets took a pretty heavy hit early on with regard to the economy. I think that’s what’s really happening to kind of fundamentally stabilize with that.
Your next question comes from the line of Jason Brienen - Raymond James
Jason Brienen - Raymond James
Just a couple of quick ones. Can you give us an update on the Pennsylvania approved process whether are they along those lines and do you have any better color on when you expect to build or close? Second, is there a minimum spend provision in terms of the deal conditions? Thank you very much.
There are five states, and I think Pennsylvania and Washington are probably vying to be the ladder of that group, but we still think we’ve made great progress in both of the very public that we got a very favorable ALJ recommendation in Pennsylvania and we’ve made great progress in Washington.
So, no specific place in the calendar to point beyond the second quarter just because of the nature of the regulatory process but we feel very good about the progress that we’ve been able to make. Then in terms of any minimum spend or anything like that, while there are some very modest commitments made and a couple of the different state approvals, it's nothing that I would view as being material certainly to the overall company at all. Frankly I’m not sure of material in the scheme of any given state.
Your final question comes from the line of Tom Seitz - Barclays Capital.
Tom Seitz - Barclays Capital
Thanks for taking the questions. First one, in CenturyTel’s call, Glen mentioned that they were encouraged by the price curves on IPTV gear and the throughput that they were getting with some of the testing they were doing out in the field with respect to pair bonding. They actually mentioned the density of the EMBARQ properties as a potential opportunity to do some trials.
I was wondering if you’ve done any prep work in this regard or you taking bonding out of the lab anywhere or pushing fiber out to the node in any neighborhoods that you might, if it weren’t for the fact that you were taking with the CenturyTel network folks.
Thanks for the question, Tom. Consistent with just kind of the way these things work, we’re able to plan for post-close integration and therefore we have done a lot in terms of understanding that offering, understanding the underlying network and other characteristics of the offering and overlaying that if you will on some of the markets that we have, and it definitely improves, the density improves those business cases.
So, we are very pleased with the advanced work that’s been done by CenturyTel in La Crosse, Wisconsin, Columbia Missouri, we think it allows us to kind of click a little bit faster forward on that strategic initiative, we think that can be a very powerful additional arrow in the quiver if you will and look forward to get it closed, and then working together to figure out where the right markets to roll that out and how to continue to improve it.
I might add, Tom just as a factual matter which could be beneficial for IPTV on bonding is that as a policy matter for number of years, we dropped multiple pairs to houses. I think as many as five corporate pairs to houses, particularly back in time when second lines were actually growing. So I think in our territory, we do have a lot of bonding potential should that be desirable.
Tom Seitz - Barclays Capital
If I don’t get the chance to speak with this group again in June, thanks so much for all your help.
In fact, maybe if I could just close out here by echoing the comments Gene shared earlier. We’d had three very successful years since as a public company due to the efforts of the EMBARQ team and I’d like to thank my fellow teammates for those efforts, for those results. Obviously I would also like to express appreciation for the recognition and support of those efforts by the investment community.
Looking back, we’ve faced some pretty big challenges following our spin-off in May 2006, but we made a great deal of progress since then. Today, as we look forward to our merger with CenturyTel, there are both old and new challenges in front of us. However, given the strategic operational and financial strength of the combined company, I believe we’re positioned for even greater success in the future. So, thanks again for joining us today and for your ongoing support.
Thank you and this concludes today’s conference call. You may now disconnect.
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