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CenturyTel Inc. (NYSE:CTL)

Q2 2009 Earnings Call

August 6, 2009 11:30 am ET

Executives

Tony Davis – Vice President Investor Relations

Glen Post – Chairman and Chief Executive Officer

Stewart Ewing – Executive Vice President and Chief Financial Officer

Karen Puckett – President and Chief Operating Officer

Analysts

Simon Flannery – Morgan Stanley

Jason Armstrong – Goldman Sachs

Batya Levi – UBS

David Barden – BAS-ML

Mike McCormack – JP Morgan

Frank Louthan – Raymond James

Michael Rollins – Citi

Chris King – Stifel Nicolaus & Co.

Chris Larsen – Piper Jaffray

Donna Jaegers – D.A. Davidson & Co.

Operator

Good day ladies and gentlemen and welcome to CenturyLink's second quarter 2009 earnings conference call. (Operator Instructions). I would now like to turn the conference over to Mr. Tony Davis, Vice President of Investor Relations. Mr. Davis, you may begin.

Tony Davis

Good morning everyone and welcome to our call today to discuss CenturyLink's second quarter 2009 earnings results released earlier this morning. Effective with the July 1, 2009 closing of the EMBARQ transaction, CenturyTel began operating under the trade name CenturyLink. Unless otherwise noted in the press release or in our remarks this morning, the second quarter results discussed in the press release and during this call relate solely to legacy CenturyTel, Inc. Also during today's call we will refer to certain non-GAAP financial measures. We have reconciled these measures to GAAP figures in our earnings release which is available on our Website at www.centurylink.com.

Your host for today's call is Glen Post, Chief Executive Officer and President of CenturyLink. Joining Glen on our call today is Stewart Ewing, CenturyLink's Chief Financial Officer. Also available during the call today is Karen Puckett, CenturyLink's Chief Operating Officer.

We will be making certain forward-looking statements today particularly as they pertain to guidance for the third quarter, second half and full-year 2009, selected information regarding 2009 and other outlooks in our business. Please review our 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.

Our call today will be accessible for telephone replay through August 12, 2009 and accessible for Webcast replay through August 26, 2009. For anyone listening to a tape or Webcast replay of this call, or for anyone reviewing a written transcript of today's call, please note that all information presented is current only as of August 6, 2009 and should be considered valid only as of this date regardless of the date listened to or reviews.

With that, at this time, I'll turn the call over to your host today, Glen Post.

Glen Post

Thank you for joining us today as we discuss CenturyTel's second quarter 2009 operating results and our guidance for the third quarter, second half 2009. Diluted earnings per share excluding nonrecurring items for – was $0.83 for the quarter or $0.02 ahead of the upper end of our previous guidance and $0.03 higher than the first call consensus of $0.80 per share.

Operating revenue excluding nonrecurring items for the quarter were $634.5 million in line with our previous revenue guidance of $628 million to $638 million. Revenue increase this year in the quarter approximately $17 million resulted primarily from growth associated with our 12.2% increase of high speed Internet customers.

These increases were more than offset by revenue declines of approximately $39 million primarily attributable to previously anticipated access line losses, lower universal service fund receipts and lower access revenues. We continue to see strong demand for broadband services during the second quarter as we achieved growth in data revenues of 9.1% over the second quarter 2008. This increase was primarily driven by the addition of approximately 74,000 high-speed Internet subscribers during the last 12 months.

We also generated solid free cash flow of $140 million during the second quarter and we continue to see steady demand for our high speed Internet products as we added over 16,000 net subscribers during the second quarter. Additionally our high speed Internet churn remained at 1.9% for the second quarter, consistent with the first quarter and our all-time low which remains, of course, encouraging.

We entered the quarter with more than 681,000 high speed Internet subscribers for over 42% penetration of our residential customer base and almost 35% penetration of total access lines. We experienced access line losses of 33,500 during the quarter, resulting in a 6.9% line loss over the last 12 months. We believe economic conditions represent the primary driver of line loss in our markets, especially in the business sector where we are seeing fewer business start-ups and more business closing than previous.

We have seen competitive line loss stabilized overall and we also continue to experience solid demand for our satellite video product as we added nearly 14,300 dish customers during the second quarter, and we ended the quarter with more than 139,000 dish satellite video subscribers. Our total video subscribers as a percentage of primary residential lines is 12% compared the 6.5% a year ago. Our IPTV products in Columbia, Missouri and Lacrosse, Wisconsin continue to drive solid customer growth and have a positive impact of course on customer loyalty.

We expect to roll-out IPTV in one of the smaller EMBARQ to the tune of third quarter. We continue to evaluate potential expansion of IPTV and other of the EMBARQ markets. Before turning the call over to Stewart I want to make a few comments regarding the completion of the transaction with EMBARQ. First we are pleased to have received all of the necessary regulatory approvals in a timely manner and to have completed the transaction within the eight-month timeframe we originally anticipated.

While we have been planning integration of our two companies over the past several months, the completion of the merger allowed us to begin the execution of those integration plans. On the day we closed this transaction we lost our Region/General Manager operating model across our new five [recent] structure which provides an intense local focus and that put decision making and accountability close to the customer.

Also we've lost an aggressive broadband strategy with consumer promotional pricing for high speed Internet and began targeting non-customers with our pure broadband product offering. Additionally we have began to process of leveraging our core fiber network to expand our transport footprint for our enterprise customers.

Our line has provided [mended] solutions in eliminating third party transport cost, as well as reducing EMBARQ's cost of transport. From a synergy perspective when we announced the EMBARQ transaction last October, we stated that we expected to realize approximately $400 million in annual synergies over a 24 to 36-month period comprised approximately of $300 million cost savings, $75 million in revenue opportunities and $30 million in cancel synergies.

We've had the opportunity to take a closer look at synergy opportunities for the merger and we now anticipate we will be able to achieve approximately $475 million in annual synergies within the first three years of operation.

We now expect our post-closing integration expenses to be approximately $310 million and that's including capital expenditures, primarily driven at a one-time cost including increase severance, branding and IT costs to achieve the increased synergies we discussed earlier. We continue to expect the transaction to be free cash flow per share accretive in the first full year after closing and excluding those one-time integration costs.

In summary the combination of CenturyTel and EMBARQ creates a larger financially stronger company which we believe will be well positioned to meet the challenges to take advantage of the opportunities as they arise and to potentially create the significant shareholder value both in the near term and well into the future. With that I'll turn the call over to Stewart to provide additional detail on our results for the first quarter.

Stewart Ewing

Thank you, Glen, and good morning. During the next few minutes I'll cover some highlights of our second quarter 2009 operating results and briefly discuss additional financial matters. I will conclude my comments this morning with a discussion of third quarter, second half and full year 2009 guidance provided in our earnings release issued earlier today.

Since we are reporting nonrecurring or one-time items during the second quarter, I want to make a few remarks regarding those items before I discuss the second quarter normalized results. First we recognize $16.3 million of after tax costs related to integration expenses associated with our acquisition of EMBARQ and the settlement of a legal matter.

Second, those items were partially offset by a $2 million after-tax benefit associated with the resolution of previous transaction tax audits. In the aggregate, these two items negatively impact GAAP earnings for the quarter by $0.15.

So with that overview of one-time items which are also disclosed in our press release and related financial schedules released earlier this morning, let's turn our attention to normalized results for the second quarter 2009 excluding these one-time items compared to normalized second quarter 2008 earnings. For second quarter 2009 operating revenues decreased 3.4% to $634.5 million from $657.1 million in second quarter a year ago.

Voice revenues for second quarter 2009 were $207.6 million versus $219.9 million in second quarter of 2008. This 5.6% decrease in voice revenues was primarily driven by revenue declines associated with anticipated lower access lines.

Network access revenues were $190.4 million versus $206.9 million in second quarter 2008. This $16.5 million or 8% decline was driven by revenue declines associated with lower intrastate minutes of use and lower interstate revenue requirements as well as lower universal service bond receipts.

Data revenues increased 9.1% from $131 million in second quarter 2008 to $142.9 million in second quarter 2009, primarily driven by strong high speed Internet customer growth and demand for high bandwidth services during the last 12 months.

Our fiber transport and CLEC revenues decreased 3.2% to $41.8 million in second quarter 2009 from $43.2 million in second quarter 2008 primarily due to the sale of six CLEC markets in 2008. Other revenues were $51.8 million compared to $ 56.1 million in second quarter a year ago, primarily reflecting lower equipment revenues this year versus the same period last year.

Operating expenses decrease 2.2% from $469.8 million in second quarter 2008 to $459.4 million in second quarter 2009 primarily due to lower access expense, marketing costs and depreciation expense that more than offset increased operating costs associated with growth in high speed Internet customer base.

As we discussed with you the last couple of quarters, non-cash pension expense will be higher in 2009 than in 2008 due to the performance of financial markets in 2007 and 2008, which is the case for most, if not all, companies with defined benefit plans.

In the second quarter we reported approximately 3.9 million in incremental non-cash pension expense compared to the second quarter of 2008. For second quarter 2009, we generated an operating cash flow margin of 47.8%. Our operating income for second quarter 2009 was $175 million compared to $187.3 million in the second quarter of 2008.

Other income was approximately $1.7 million lower in second quarter 2009 than in the same quarter a year ago due to lower life insurance proceeds and interest income. Net income attributable to CenturyLink for the quarter was $83.3 million compared to $91.2 million in the second quarter of 2008.

Overall second quarter results were solid and in line with or better than our initial expectations and from a capital structure standpoint we're very well positioned. As of June 30, 2009, CenturyLink's debt-to-equity ratio was 0.92 to 1, and net debt to annualized second quarter operating cash flow was 2.4 times.

So CenturyLink continues to generate strong cash flows, maintains a solid balance sheet and is in great shape financially. You will recall that when credit markets tightened in late 2008, many companies including CenturyLink borrowed funds under their credit facilities to ensure the availability of sufficient liquidity to weather the financial market uncertainty.

By late March of this year, the financial markets have stabilized and we chose to apply our excess cash on hand to our facility thus lowering our net interest expense for the second quarter by approximately $2.5 million.

Our net debt outstanding at June 30, 2009, prior to closing the EMBARQ acquisition, was $2.9 billion compared to $3.1 billion at December 31, 2008. Additionally, when we announced the EMBARQ transaction last October we stated that we expected pro forma leverage of the combined company to be 2.3 times excluding synergies and 2.1 times including synergies.

Based on the debt outstanding as of June 30, and the first 6 months of 2009 pro forma operating cash flow annualized for the combined company, our current pro forma leverage estimate for the combined company has approved it – it has improved and is about 2.1 times excluding synergies and about 1.9 times including synergies.

As of June 30, 2009, the combined net debt outstanding for CenturyTel and EMBARQ totaled a little less than $7.9 billion prior to any purchasing accounting adjustments. This represents a reduction in the net debt outstanding for the combined companies for the first six months of 2009 of nearly $870 million. So we believe CenturyLink's strong cash flows and excellent liquidity position us to continue to take advantage of opportunities and meet challenges as they arise.

Finally, I'd like to discuss the third quarter, second half and full year 2009 guidance provided in our press release this morning. First, the outlook information in the release we issued this morning and the prepared remarks are for the combined CenturyLink and EMBARQ operations.

Additionally, costs incurred by CenturyLink in the second half of 2009 related to the EMBARQ integration will be treated as nonrecurring items and therefore, not included in the outlook or my comments. Also as a result of the FCC's approval of our price cap filing earlier this year, we will discontinue accounting for certain regulated operating entities under Statement of Financial Accounting Standards number 71 effective July 1 of 2009.

As a result of the discontinuance of FAS 71, we expect operating revenues and expenses to decrease approximately $60 million to $70 million during each of the next two quarters due to the elimination of intercompany transactions.

This accounting change is operating cash flow neutral in terms of absolute dollars but will modestly improve operating cash flow margins. Additionally, we expect to recognize an extraordinary gain of approximately $219 million in the third quarter related to the discontinuance for FAS 71.

Due to the discontinuance of FAS 71 and the purchase accounted adjustments related to the EMBARQ merger, we expect quarterly results for the next two quarters to be negatively impacted by the following items.

First increased amortization expense related to amortization of a portion of the purchase price that is allocated to EMBARQ's customer base which will be partially offset by lower depreciation expense associated with the discontinuance of FAS 71.

The net effect of these two items is expected to be approximately $20 million to $ 24 million per quarter. Higher retiree and pension-related expense recognition of approximately $12 million to $14 million; this is due to elimination of the amortization of actuarial gains on the EMBARQ operations.

These items discussed above are subject to change upon finalization of the impact of the discontinuance of FAS 71 and the purchase price allocation. Considering all the matters I just discussed, for the third quarter 2009, we anticipate total revenues to be in the range of $1.85 billion to $1.89 billion, and we expect diluted earnings per share for third quarter 2009 to be in the range of $ 0.78 to $0.82.

It is important to note that EMBARQ experienced more than a $30 million decrease in total cash expenses in the second quarter 2009 versus the first quarter of 2009 primarily due to lower bad debt expense and lower marketing expenses along with a number of one-time items that totaled approximately $15 million in lower expenses.

Bad debt and marketing expenses are expected to return to more normal levels for the remainder of the year and seasonal outside plant maintenance expenses are expected to increase in the third quarter as they normally do.

For the full year 2009, we expect diluted earnings per share to be in the range of $3.20 to $ 3.30. And finally for the second half of 2009, we expect capital expenditures to be in the range of $525 million to $575 million, which includes capital related to the EMBARQ properties but excludes one time capital expenditures associated with the EMBARQ integration.

This concludes my prepared remarks for today. At this time I'll ask the operator to provide further instructions for the question and answer portion of our call.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Simon Flannery – Morgan Stanley.

Simon Flannery – Morgan Stanley

I wonder if you could just give us a little bit more detail about what's really happened in the past month or so since you closed the merger. I think you talked a little bit about some pricing changes in broadband. Perhaps you could provide a little bit more color, and to what extent that was in the EMBARQ markets versus the CenturyTel markets and if there's been any material change in headcount since July 1st?

And then as we go forward, I think you talked about the billing system plans, but if you could give us some more color around the rebranding and how you expect to go forward with that?

Glen Post

As far as changes we've made thus far, we've rolled out a pure broadband product targeting non-customers in the EMBARQ markets that they had rolled out on a smaller scale earlier but we're really rolling this product out throughout their markets and we expect to see in the months – it won't happen immediately, but we expect to see good results from that effort.

We also rolled out a promotional plan with a $14.95 headline price for DSL. We rolled that out this month as well. We expect to start seeing results from that in the weeks ahead, so those are the first two things we've done there. But really overall we're just going to really focus on targeting the underserved areas such as the pure broadband I talked about and a new focus on a [utilities]-based video offering later on this year or early 2010.

We're building a strong original marketing team. We really already have it in place, that's capable of tailoring the marketing approach by geography. We'll be tiering the markets with different offerings which had not been done to any great degree within the EMBARQ operation. So we'll be showing pricing or offering different pricing structures and tactics based on market tiering, and then really a more aggressive direct response marketing strategy that we offer that enable the customers to have an immediate response.

EMBARQ began rolling this out late 2008 but we'll really intensify that network. So that's our approach to the market. As far as headcount changes since July 1st, not really significant changes, there have been some reductions but nothing significant yet. As you know the most significant headcount reductions will be as we convert the, first the financial systems later this year and then as we continue to have the billing, customer care conversions which will take place over the next 24 to 36 months.

Simon Flannery – Morgan Stanley

Great, and then the branding strategy?

Glen Post

So branding we expect to really roll out the full branding promotion in October this year. That's our target and we'll be changing signs; we'll be doing a lot of work around that. Of course we're utilizing CenturyLink at the corporate level from a customer standpoint and in the field markets we expect an October rollout and really a lot of press around the brand then.

Operator

Our next question comes from Jason Armstrong – Goldman Sachs.

Jason Armstrong – Goldman Sachs

A couple question, first, on your comments around the capital structure being well-positioned, I guess just taking the next layer here when should we think about share buybacks being a greater part of the mix again?

And then second question just on the merger synergy update you gave, what have you seen that allowed you to hype the synergies, maybe some granularity there? And then as we think about the increase in synergy guidance how should we think about that sort of trending into the results that – along that same pace as the earlier synergy guidance or is it back end, front end loaded?

Stewart Ewing

In terms of the synergy update, we have about $30 million of synergies loaded into the last half of the year in terms of expense reductions and the increase in the guidance is really partially related to the increase in the integration costs because a fair amount of that increase is associated with severance. So basically I think just the more we've gotten in we've been able to see where we think we can work as a combined company more efficiently than we had originally outlined.

Glen Post

And regarding the cap structure and possible stock buybacks, the board will address that in the months ahead. Right now we're focused on getting integration done properly, hitting our synergy numbers and it's certainly an option for us going forward. We have not made any decision on buybacks at this point.

Jason Armstrong – Goldman Sachs

As you move forward in the integration is there a desire to maybe keep a larger cash balance just in case you run into any issues?

Glen Post

Well the issues are opportunities right now. We'll as we've said we'll return a potential amount of our free cash for the shareholders, but we believe at this point in time with the economy the way it is and with the potential other opportunities that we don't plan any major change in dividend or stock buyback in the near future.

Stewart Ewing

And, Jason, our credit facilities, basically EMBARQ's paid off their entire credit facility which is about $800 million. The CenturyTel credit facility is paid down to about $200 million, so there's approximately $500 million of availability there as those credit facilities really don't expire until 2011, so we have quite a bit of liquidity.

Operator

Our next question comes from Batya Levi – UBS

Batya Levi – UBS

Okay, thanks a lot, just a couple of questions. One, follow-up on the – outside the synergies, can you talk about given the margin progress made at EMBARW versus your expectations on where they would be when you first announced the merger, has that held you back from increasing the synergies more? Do you think there's more room to go from here?

And second one on looking at the new broadband plans that you've introduced in the EMBARQ territory, have you started to see some early signs in terms of maybe [assimilation] of access line losses there, maybe some pick up on DSL?

And a third question on the CapEx. I thought that the second half CapEx number was a little bit higher than the recent run rate. I think it's about 16% of sales. Can you provide some detail on where the increase will come from?

Stewart Ewing

Yes, really from a margin standpoint a partial reason for the increase in their margins this quarter where basically the $15 million of positive one-time items that I mentioned plus actually another $15 million or so of items that we don't really expect to reoccur, such as lower bad debt expense and partially from their exiting the wireless business.

So there're probably some – we built our synergies off of their 2009 budgets and we're really still in the process of going back and reconciling. That's kind of where we are at the end of June versus budget from a headcount standpoint and a synergy standpoint. So there may be some small amount of the synergies that are actually realized in the first half of the year relative to what we originally anticipated but probably not very much.

Glen Post

Regarding the broadband launch in EMBARQ markets, it's too early to tell. I don't, as far as the impact, but we do expect that we'll see impacts on the broadband penetration as well as access line losses in the month ahead. And if we can close the gap just a little ways as far as the penetration level of broadband and EMBARQ markets, the gap between CenturyTel's penetration level and EMBARQ's penetration level, might be pretty significant. We're optimistic we'll make progress there.

As lower – as far as CapEx is concerned second half of the year, really the CapEx total for the year will be in line with the originally announced budgets of each company earlier in the year. We think there are opportunities to expand broadband capabilities and number the EMBARQ markets especially and we'll, that's the real focus that we think will bring real value into these markets by completing those build-outs and expanding the capabilities from a broadband prospective.

Operator

Our next question comes from David Barden – BAS-ML.

David Barden – BAS-ML

Maybe just a quick housekeeping item, Stewart, I'm sorry if I missed it, but on the new synergy guidance, how does that break down into the buckets that you were giving us before in terms of cost revenue CapEx?

Glen Post

Yes, David, basically the earlier cost synergy was about $295 million, now we're about at $375 million. So really the entire increase related to cost reductions we're still at about $75 million from a revenue standpoint and somewhere around $30 million from a CapEx standpoint, although that's going to be a little bit tougher to track from the capital piece of it.

David Barden – BAS-ML

Perfect and just maybe if I could ask just two more strategic questions? Just one, with respect to the cable competitors and your respective footprints, have you seen them attempting or preparing to take advantage of any slippage during the merger integration process now that it's closed?

And then second, could you kind of revisit some of your historical commentary about your appetite for facilities-based wireless and where you stand now on that topic, and is it even really still on the radar screen now that you have this project to do with EMBARQ integration or is it something that's maybe going to accelerate now that the deal's done? Thanks.

Glen Post

We have not seen really, David, any additional activities from some of the cables companies as a result of the integration process or taking advantage of opportunities. It's been pretty much competitive activity as usual, so nothing significant there.

As far as our wireless focus on 700 megahertz, as you know, we own 69 700 megahertz licenses across the company. We covered, of course, at one time, almost 55% of CenturyTel's telco footprint access line with 700 megahertz spectrum, with the EMBARQ acquisition merger, that's down to about 15%.

So we are at this point in time contemplating the potential expansion of the 700 megahertz ownership. We're looking at where the technology is today, we're looking at the rollout of the classically commercial equipment which we expect to really to be about 2012, before it's really at a level we can roll out in a big way.

So we think there is potential to buy or swap for additional spectrum. We just don't know what that potential is and if it's big enough or significant enough for us to want to invest in that spectrum today. So we're looking at that as we speak.

David Barden – BAS-ML

Would you consider selling the spectrum you have?

Glen Post

Well, not today we wouldn't. We think it's valuable spectrum, some of the best spectrum out there, so we don't care about selling. We think that that will retain value because it's such a premium spectrum, but we're not interested in selling right now.

Operator

Our next question comes from Mike McCormack – JP Morgan.

Mike McCormack – JP Morgan

Stewart, can you talk about the potential for cyclicality at EMBARQ, meaning maybe a little more exposure to the business marketplace, and if we do see an economic recovery should we anticipate some benefit from that?

Then secondly, when you're discussing the broadband penetration and sort of comping legacy CenturyTel against EMBARQ, are there differences in what you're seeing there, meaning when CenturyTel is increasing its share of the marketplace, you were going after probably areas that were migrating from dial-up or just new adds to the broadband marketplace, whereas my sense is that EMBARQ would be more of a share taking game. Is there a difference in how you go about that strategy?

Karen Puckett

I'll take that one. In terms of the business cycle improving, I think that the key focus really has been there has been delayed purchases, as one might expect in this time, really around the CTE side. The Ethernet data growth is very solid and we're excited about that. We do believe that we have product sets leveraging our core network into the enterprise market that will extend the footprint, kind of transport footprint. So that's in spite of the economy and a turn around there.

In terms of the broadband penetration, again, the approach Glen laid out going after the non-kind of wire line customers or wireless customers with pure broadband is our focus, and we do plan on going after win-backs from [KANGEL], so that does require a different approach and messaging and we'll follow the playbook that we've been very successful with.

Operator

Our next question comes from Frank Louthan – Raymond James.

Frank Louthan – Raymond James

Can you give us an idea of where you are with IPTV deployment and the legacy CenturyTel territories and do you see – what's different in the EMBARQ markets that you see that as an opportunity? And can you give us an idea of sort of the organizational structure that you've imposed now with the combined companies, what's different about that and what do you expect to gain from the EMBARQ territories that is probably helping with the synergy?

Glen Post

Yes, Frank, as far as IPTV is concerned, we continue to do well, especially in the Columbia market where we're using the Microsoft platform that AT&T is using. We think it's really effective. It works well. We continue to work on our install times and we're getting those down into the four-hour timeframe, which is crucial to make this business case work. So we're very pleased with the technology at this point.

We're pleased in La Crosse where we did not offer [DBR] capabilities nor HDTV, but we still made pretty convincing progress in penetration in a competitive situation there. So we believe that the service is viable. We're seeing about a 90% DSL pull rate with the video products and a significant impact on reduced churn. So we're very pleased with what we're seeing overall in that market.

You need density, you need short loops, shorter loops to make it really work, and we think some of these EMBARQ markets may very well prove to provide real opportunity in expanding our IPTV footprint.

Karen Puckett

Frank, on the operating model, moving to the region structure as we had, with general manager focus, really requires us to be very locally responsive, and there's accountability with that general manager in terms of profit and loss. Every general manager has a market plan that will be driven by what competitively is going on there, the dynamics and what products that they need and what messaging they feel need working with their marketing team.

I think the go-to-market is very different; we're going to kind of walk through that. And on the enterprise side, we have more capability now with the core network. So when you add up with the organizational line, it's a different go-to-market and the intense focus on accountability for results, we believe you're going to see a difference in improving the trend line.

Operator

Our next question comes from Michael Rollins – Citi.

Michael Rollins – Citi

I just want to follow up on some questions in terms of line loss. You're looking at, I think, EMBARQ numbers, if I'm looking at numbers correctly, it looks like it was less line loss on the year-over-year basis, and I guess my question is to what extent do you think lower move churn is leading to some of that improvement relating to the economy versus other factors like the churn cable competition and maybe a competitive response maybe with the bundle from you guys?

And as the economy improves, I guess on the one hand, you can say that there could be more demand for services, on the other hand if people move more, what happens to line loss? How should we be thinking about the puts and takes of the equation?

Karen Puckett

The improvement in the EMBARQ line loss, and again this is pre-close, so this is all about the EMBARQ strategy, but really the improvement in the access line loss is about disconnects and mover churn is down fairly significantly year-over-year from an end worth standpoint. We're not seeing any increase, so there was not a specific program or campaign around end worth. It is around a decline in disconnects.

In terms of the economy moving forward and people moving again, I think that's why we believe that the triple play is important, not only from a data standpoint, but a video as people move. One of the key products they're concerned about is, yes, they have their wireless phone, but they want to get an entertainment package and data, and that's why we think that product set, either a DBS and/or IPTV is important to get that flow share going forward.

Michael Rollins – Citi

If I could just follow up, one of the initiatives, I think EMBARQ may have done this, you might have as well, was the idea that if you call your phone company to churn because you're moving, the phone company would then say, "Oh, well, where are you moving to? If it's out of region, let us connect you to whoever you're moving out to."

I guess what we've heard is when people call up to get services, they tend to call video before phone, so wherever they go for video, there is that propensity to tie into that bundle to your point about the move churn. Is that something that you're participating in and is that something that you're actually seeing some benefit from, in terms of being able to pick more lines from movers coming out of your region into your regions?

Karen Puckett

We are participating in that and I think it's pretty consistent. I wouldn't say that it's up or down. Again, it's getting the message out there and the right distribution strategy to align with video and data, as those movers come in.

Glen Post

Mike, I might just add to that, is that although CenturyTel's line loss was up slightly and EMBARQs was down some, if you look at the ARPU, CenturyTel's consumer ARPU was up almost 9% to $56.00 and our business ARPU was up about 3%. And if you look at EMBARQ their consumer line, consumer ARPU was up 2.5% and business ARPU down slightly, but really just reflecting that we're losing some lines. We're keeping better customers and we're also able to up-sell from a high speed data standpoint, a large portion of our customers. So it's driving our average revenue up which is going to make us focus dollars as well.

Operator

Our next question comes from Chris King – Stifel Nicolaus & Co.

Chris King – Stifel Nicolaus & Co.

Just a couple of quick follow-up questions, just wanted to get an update if I could regarding your kind of longer term structure goals, particularly as it relates to leverage with you guys sitting at 1.9 times now inclusive of synergies and on face at least to generate a fair amount of free cash flow even after dividends going forward. How should we think about your kind of longer term targeted leverage levels now?

And secondly, just wanted to get a quick update operationally on some of the harder hit economic markets in particularly that EMBARQ operates in such as Las Vegas and Florida and whether you guys were seeing any kind of macroeconomic improvement trends there over the course of the last several months or so?

Stewart Ewing

Chris, in terms of our longer term capital structure goals we're pleased that we were able to pay off as much debt as a combined company in the first half of the year as we were. We really want to retain our investment grade credit ratings and we'll be talking with our board over the course of the next six months or so in terms of longer term capital structure goals.

But we want to get the integration behind us, spend the cost associated with that and start getting some of the synergies and basically then we'll address what we do with excess free cash flow. But our goal is to remain investment grade.

Karen Puckett

On the economic environment in the larger markets, Nevada and Florida, first of all I would say that as you know the unemployment rate is higher than the national average so that continued to be a concern, but the key focus or again, the key trend change that we're seeing is this decline in disconnects. Again, not an improvement in end worth but as a sign in disconnects. The mover churn is down year-over-year.

Glen Post

Chris, another thing, too I might add just from a standpoint of – you mentioned our free cash flow and our dividend is very, very secure with respect to the amount of free cash flow that we're generating. If you compare us with the other companies in our industry, basically our payout ratios are around 50% or so and I think that's an important factor, even though our dividend yield is higher than some of the other companies in the sector at about 9%.

Operator

Our next question comes from Chris Larsen – Piper Jaffray.

Chris Larsen – Piper Jaffray

A couple of questions, first on the lower marketing spend at EMBARQ in the quarter. I notice that DSL was also lower. Do you attribute the two to be cause and effect? Was that lower marketing spend more about just promoting the EMBARQ brand which would obviously make sense to slow that down until the merger. I'm really just trying to get a read on how you think DSL could trend in those markets as you bring advertising back up?

And then secondly on stimulus funding, just where you guys stand on that and any sense if the smaller cable companies within your footprint are going to go after said stimulus funding and how that may affect competition in 2010?

Karen Puckett

I think our results for the EMBARQ for the quarter when we looked at the numbers I think was really more driven by less success marketing into the base, the marketing expense that was cut back. There was some change in marketing tactics but it was really more around the mass advertising, moving more to DM, but the DSL results from an end worth standpoint, they actually in terms of attachment rates have improved. It was more the marketing into the customer base.

Glen Post

Chris, regarding stimulus funding we are reviewing the opportunity to participate in the first round of the program. We have to respond August 14th, however there are significant uncertainties regarding various conditions and compliance costs of the program that really make it difficult to participate. We will continue to monitor and review it. We remain open to the possibility of pursuing the funding as requirements are further clarified, but at this point we are not optimistic that we'll be able to participate.

Chris Larsen – Piper Jaffray

In light of that comment we've heard that from a number of other rural carriers. Do you think it's going to be very difficult for the small cable companies that don't have teams of regulatory folks like you guys already have in place, that it's going to be even that much more difficult for them to go and tap those funds and maybe at least you'll have the benefit of them not getting that money as well?

Glen Post

That's difficult to say because they can hire the consultants they need to really do what's needed to get these funds I think. They'll have the same work ethic, the same conditions that we're considering and the costs of compliance, those types of things. There may be some of those that go after these areas but we're talking very, very rural areas. We have about 90% of our customers are invested [back] in CenturyTel, the footprint of access to broadband today and EMBARQ's not too far behind, so I don't expect additional competition from folks going after these funds.

Operator

Our last question for today comes from Donna Jaegers – D.A. Davidson & Co.

Donna Jaegers – D.A. Davidson & Co

I was just exploring a little more on your broadband push. Did I hear correctly that you're rolling – you mentioned your pure broadband product, is that what we would usually call naked DSL?

Glen Post

That's correct.

Donna Jaegers – D.A. Davidson & Co

And then on the – in order to address more of the EMBARQ lines with broadband, what sort of technologies are you looking at currently and do you have those in tests already in your labs?

Glen Post

Yes, we're looking at that, Donna, and at all opportunities to bring more broadband to the EMBARQ markets. As far as the technologies I'm not sure I follow your question.

Donna Jaegers – D.A. Davidson & Co

Well you guys had mentioned [pair] bonding before maybe EMBARQ had mentioned in one of their calls, so I was wondering if you were going forward with that or more VDSL or ADSL Two Plus or just what –

Glen Post

Well, [price] is very important. In fact, we have it in the lab now and it's working in the lab and we believe it's going to be very effective. And of course it's going to really basically double the capacities of these markets, so yes. We are looking at that and are very optimistic that it's going to work for us. And we're going to be looking, considering that factor as we look at the potential rollout of IPTV and its entire broadband speeds across the footprint for both the companies.

Operator

This concludes our question and answer session for today. I would now like to turn the call back over to Mr. Glen Post for any closing remarks.

Glen Post

Thank you. In closing, CenturyLink achieved solid results during the second quarter with the completion of the EMBARQ merger represents a great strategic combination and it makes really CenturyLink a larger, stronger company and we believe it's well-positioned to create significant value in the months and years ahead.

The merger also allows us to diversify our markets, to expand our addressable market and deploy new high value products and services. During the next few months we'll be laser focused really on two primary areas. First our continuing to provide our customers high quality reliable products and services along with a local personalized customer service, and secondly, we'll focus on successfully integrating our two companies into a cohesive strong service provider that's clearly positioned to drive value for our shareholders.

We appreciate you participating on our call today and we look forward to speaking with you in the weeks and months ahead. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect.

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Source: CenturyTel Inc. Q2 2009 Earnings Call Transcript
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