Frontier Communications Corp. (NASDAQ:FTR)
Q3 2009 Earnings Call
November 03, 2009; 9:00 am ET
David Whitehouse - Senior Vice President, Treasurer
Maggie Wilderotter - Chairman & Chief Executive Officer
Don Shassian - Chief Financial Officer
Jason Armstrong - Goldman Sachs
Frank Louthan - Raymond James
Chris King - Stifel Nicolaus
Mike McCormack - JP Morgan
Michael Rollins - Citi
Chris Larsen - Piper Jaffrey
Batya Levi - UBS
Ana Goshko - Banc of America
Kevin Coyne - Goldman Sachs
Good day everyone and welcome to the Frontier Communications third quarter 2009 results conference call. This call is being recorded. At this time, I’d like to turn the call over to Mr. David Whitehouse; please go ahead, sir.
Thank you, Roselle. Good morning everyone. The purpose of this call is to discuss 2009 third quarter results for Frontier Communications which were released this morning. Anyone needs a copy of the materials; please contact Lisa Lombardo at 203-614-5064. We anticipate the Form 10-Q will be filed later this week. On today’s call, Maggie Wilderotter, Chairman and Chief Executive Officer; and Don Shassian, Chief Financial Officer.
During this call, we will be making certain forward-looking statements in particular on matters related to 2009 results and estimates. Please review the Safe Harbor language found in our press release and SEC filings. On this call, we will also be discussing GAAP and non-GAAP financial measures as defined under SEC rules.
In our earnings release in on our website, www.frontier.com, we have provided a reconciliation of non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP. Please refer to this material during our discussion.
I will now turn the call over to Maggie.
Thanks very much, David and good morning everyone. We appreciate you joining us today as we discuss the third quarter 2009 results for Frontier Communications Corporation. This represents the first full quarter of operations since we announced our transformational acquisition of Verizon properties last May.
Our employees are performing the hard work and showing the dedication necessary to consistently execute on our financial goals and to carry our company to the finish line, which is the closing of the transaction in the second quarter next year.
We are excited to have the opportunity to provide millions of Verizon customers with the unique Frontier customer experience. By this time next year, we plan to be reporting our results to you as a much larger company, giving shareholders upside potential from scale, a capital structure approaching investment grade, an attractive dividend yield and an outstanding platform for growth.
Today, I will be providing an overview of our operating results for the third quarter of 2009, followed by an update on the pending Verizon acquisition, including, I’m pleased to report, a resounding of approval from our shareholders last week and from the public utility commissions of Nevada, South Carolina, and California.
Frontier’s third quarter of 2009, financial results were very solid and continue to track in line with the plan we’ve committed to you. Revenues were $527 million with adjusted operating cash flow or EBITDA of $288 million. The company generated adjusted free cash flow of $120 million for the quarter. Adjusted free cash flow for the first nine months of 2009 has comfortably covered our dividends with a payout ratio of 64%.
Frontier’s operating metrics were inline with our expectations, even though we did not run any major promotions during the third quarter. We continue to run various sustaining campaigns such as our national and local smart value offers, which reach are double and triple play packages. We have launched a new promotion in this fourth quarter that provides free video for six months when a customer signs up for digital phone with Frontier fast high-speed.
In Q3, 2009, we added 7,000 new dish customers, up 51% over Q3, 2008. Our total dish subscriber count at the end of the quarter was 164,500, an increase of 46% year-over-year. Our video penetration of residential access lines increased from 8.2% in Q3, 2008 to 12.9% at the end of Q3, 2009. During the quarter we added 7,500 high-speed Internet subscribers bringing our total high-speed base to 621,300 this is 8.6% growth in subscribers over Q3, 2008.
In this difficult economy, we’re pleased with our year-to-date growth rate. Our total monthly revenue for high-speed customer remains over $40 with broadband penetration increasing to 29% of total access lines and over 43% of residential lines. We’ve also built more stability into this revenue stream with 77% of residential high-speed customers on price protection plans, up a full nine points since this time last year.
Over 90% of all new high-speed customers are on Frontier price protection plans with a one, two or three year commitment. We have now sign access line loss rates improved for the past three quarter, thanks in part to increase bundled sales, price protection plans and fewer residential customers moving out of territory. Our net line losses of 37,400 represent a 6.3% annual decline, which is an improvement from 6.5% in Q2, 2009 and 6.7% in Q3, 2008.
The improvement was most dramatic in residential, where our line loss rate was down nearly a full point from last year. We are encouraged by these trends and also note that our customers are seeing value in our voice services with over 50% of our phone customers on multiyear price protection plans.
Digital voice product bundles continue to gain strength during the quarter. We now have approximately 631,000 customers on digital voice bundle, which is a 24% annual increase, and a 49% penetration of primary residential access lines. Residential bundled penetration of all of our products increased to 56% of our primary lines.
Frontier prides itself on launching new products in a constant push to drive new revenues beyond our traditional services. In Q3 2009, we continue to increase revenues and customer penetration on ancillary services. For example, Peace of Mind customers expanded to 31,000 at monthly recurring revenue price points ranging from 499 a month to 12 99 a month, this is an 11% increase.
Incremental revenue per residential customer for Peace of Mind products is averaging over $10 per month. Quarterly internet revenues, which include our Peace of Mind product suite, internet advertising and security software for our high-speed customers grew 19% over the second quarter.
Wireless data revenues also grew in the quarter. Our 19 Wi-Fi network markets covering downtown centers and campuses now have 15,000 monthly recurring revenue licenses with colleges, hotels, and municipalities. This is a 36% increase year-to-date. These unique products set Frontier apart from a competition and build loyalty with our customers. Overall, these products and others help drive our Q3 average monthly customer revenue per access line to $67 from $66 year-over-year, a 1.5% improvement.
Moving down the income statement, our proactive expense management during the third quarter contributed to EBITDA margins of 54.6%, adjusted for acquisition and integration related costs and non-cash pension expenses. Our industry leading Q3 margin is well within our target of 53% to 56%.
I will now switch gears and give you an update on the activities taking place with respect to our acquisition of Verizon access lines in 14 states. Overall, the transaction is progressing as planned on all key fronts and we remain on track for a closing during Q2, 2010.
We are pleased to report that we received overwhelming support on October 27 from shareholders who voted to approve the transaction. On the regulatory front, we received early termination of the waiting period from the department of justice on September 1. The state regulatory processes continue to move forward for both Public Utility Commissions and local video franchise authorities. As I mentioned, we received Public Utility Commission approvals from Nevada, South Carolina, and California last week.
Our full time dedicated integration team is working extremely hard on the required pre-merger initiatives and post merger plans. The West Virginia transition is progressing nicely and we do not see any impediments to transitioning this state to our financial and billing systems by closing.
Finally, as it relates to the financing of the transaction, we’ve made excellent progress. To prepare for the closing, we’ve raised $600 million of long term debt financing to reduce our 2011, 2012 maturities, which Don Shassian will talk about in greater detail. I want to reiterate that we continue to proactively manage our balance sheet wisely and the Verizon transaction is a deleveraging event for Frontier, as we pursue a capital structure approaching investment grade.
Prior to closing in Q2 2010, we plan to raise $3.3 billion of debt for SpinCo and discussions are underway with a consortium of banks. In summary, we are very pleased with our results for the third quarter of 2009. Our employees are working hard on a day-to-day basis to deliver results in our core business, while simultaneously preparing for a successful closing and integration of the Verizon properties. We’re excited about giving our future Verizon customers high-quality service, innovative products, and local market engagement.
Our previous acquisitions have shown that our management team has the skills, experience, and focus to deliver on this challenge. The merger will accrue many benefits to our shareholders, including greater scale, a better balance sheet, and improved platform for revenue growth, greater free cash flow generating capabilities, and an attractive and sustainable dividend. These are all the key elements that drive shareholder value.
Now here is Don Shassian, our Chief Financial Officer to give you the financial overview for the third quarter 2009. Don.
Thank you, Maggie and thank you, everybody, for joining us this morning. The third quarter was a period of good execution in our business as usual, and a step up in activity as we prepare for the Verizon acquisition. It’s exciting to see our team performing so well on these two paths, and we’re looking forward to them coming together closing in the second quarter 2010. As I’d discussion in more detail in a minute, we also had a very successful capital raise in the debt markets and we are raising our free cash flow guidance for 2009.
Our operating cash flow EBITDA margin in Q3 was 52.3%, and adjusted to exclude acquisition-related costs and non-cash pension expense with 54.6%, the highest in two years and comfortably within our stated quarterly target as adjusted to 53% to 56%. Free cash flow for the quarter was $120 million.
We continue to experience strength in data and non-switched access revenues offset by reductions in federal and state subsidies and local services revenue. Customer revenue for the quarter was $436 million, a 2.1% decline sequentially compared to second quarter ‘09. Our average revenue per access line for the quarter was $66.90, which is up 1.5% of our last year’s third quarter. We continue to grow customer wallet share.
Our third quarter data, Internet revenues increased $160 million, increased $5.9 million or 3.8% compared to last year’s third quarter driven by additional sales of high capacity Internet and Ethernet circuits. We added approximately 7,500 net high-speed customers in third quarter. As Maggie mentioned, this was without meaningful new promotions in the quarter.
Access service revenue declined 8.4% compared to the third quarter of 2008 and we have seen consistent quarterly year-over-year reductions in access revenues as a percentage of our total revenue since 2007. Switched minutes of use were down 13.9% compared to Q3, 2008, this marks were four quarters of increasingly lower reliance on switched access minutes.
Where we look at the absolute number of lost lines in every quarter of 2009, we’ve improved access line results versus the prior year, and that is especially true in the residential sector. This improvement can be attributed to the value of our product bundles and as trialing impacts of cable telephony, which is maturing in our marketplace.
Our residential access line declined by $30,400 during the quarter, although our absolute number decline increased sequentially from the second quarter of 2009, we are pleased that our residential quarterly line loss is better than every quarter in 2008 and that our annual residential line loss rate has stabilized.
We continue to pursue a bundled strategy to positively impact our customer base. Business line losses were $7,000 which is up over Q2, but substantially below every other quarter in 2008 and 2 009. On a year-over-year basis, business lines are down 4.3%. This improvement helped our Q3, 2009 total line loss to shrink to 6.3%, our lowest level in five quarters and better than 6.7% in Q3, 2008.
On the expense side, we continue to demonstrate effective cost management. Our reported operating cash flow EBITDA margin for third quarter was 52.3%, after excluding $3.7 million charge for acquisition related costs incurred in connection with the Verizon transaction and $8.3 million non-cash pension charge, our operating cash flow EBITDA margin was 54.6%, our highest level since Q3, ‘07.
As a result to a number of revenue in expense initiatives that have been implemented, we continue to view 53% to 56% as our quarterly EBITDA margin target, excluding any acquisition integration expenses and non-cash pension. As a reminder, we expect $35 million of integration expenses in 2009, of which we have recognized $14.5 million to-date.
Our capital expenditures were $54.1 million for the third quarter. We have tightened our expectation to a range of $240 million to $250 million in 2009, excluding all capital expenditures in connection with the Verizon transaction. We have substantially completed our cash tax payments for the year and we do not expect any cash funding to our pension fund until 2011.
Our net debt to adjusted EBITDA ratio of quarter end was 3.9 times. Our liquidity position remains very strong with a fully available $250 million revolving credit facility. In October, we issued $600 million in aggregate principal amount of senior unsecured notes and a nine year high yield offering with net proceeds of the company of approximately $578 million.
To-date, we have used the proceeds and a portion of our September cash on hand, which was $436 million at that time to repurchase existing debt and a cash tender offer completed in October. We used $702 million to repurchase $648 million principal amount of 9.25 notes to 2011 and our 6.25 notes to 2013 through the tender offer.
Schedule C in the press release illustrates our maturity schedule at September 30 and at October 31, after reflecting our successful financing and tender. As you can see, we have virtually no payments due in 2010 and a dramatic step down in our 2011 maturities under $311 million. In addition, our 2012 maturities are under 200 million. We’ve achieved our strategic financial goal ahead of financing activity for the Verizon acquisition in 2010. We will continue to proactively address these maturity towers in the coming quarters.
As for 2009 expectations, we are raising the low end of our guidance for free cash flow excluding expense and capital expenditures incurred in connection with the Verizon transaction. Our new estimate is the range of $470 million to $485 million. We are estimating cash taxes to be $60 million to $70 million due to the premium paid in our tender or bonds and higher reductions for interest and other matters.
I would now like to give a brief financial update as it relates to the Verizon transaction. We have received September 30, 2009 operating results from Verizon, which I’d like to share. Please note that we have not received the September 30, 2009 financial statements. Thus, I will limit my discussion to only the key operating metrics at this time.
Access lines as of September 30, 2009 were $4,342,000 down $150,000. This represents a 3.3% sequential decline and 11.5% decline year-over-year. High-speed Internet subscribers representing both DSL and FiOS technologies were 1,055,000 with net ads in Q3 of 7,000. FiOS TV subscribers were 107,000 with net ads of 4,000 for Q3. We see tremendous opportunities to further improve these metrics posed closing as we implement our Frontier local go-to-market strategy.
As we work through the end of 2009, we’re keeping our two key objectives clearly in focus. First, we’ll continue to drive sector leading operating results in the core Frontier business. Second, we’ll continue to position our strategic resources to ensure clean closing of the Verizon transaction.
We’ve checked off as Maggie mentioned several key milestones and we’re moving closer to the finish line in the second quarter of 2010. Every leader of Frontier is focused on the day-to-day and the transformation of our organization is going through and we’re taking all the steps to drive long term value with our shareholders through superior financial results. By this time next year, we tend to reporting TU as a much larger company and we’re really truly excited by that opportunity.
With that, let me pass the call back to Roselle and ask her to open the call up to questions.
(Operator Instructions) Your first question comes from Jason Armstrong - Goldman Sachs.
Jason Armstrong - Goldman Sachs
Maybe just a quick one on the approval processes you’ve been through and just more granularity there. There was some language that we picked up in the South Carolina approval that talked about requirement to maintain existing back office systems for a five year period potentially and then also a requirement to provide free PC’s to any new broadband contract subs.
I think you offered both of these up and just you could talk us through how that sort of plays into how we should think about this deal over since the initial expectations and then how to think about this type of condition sort of extending into other states? Thanks.
With regard to South Carolina, on the systems side it’s about availability for five years. We don’t have to stay on the systems for five years and with regard to the free PC promotion, the way the language is written it’s very broad based. I mean, we can offer a free PC promotion as part of a public interest benefit, there’s no requirement of offering it to all customers versus a segment of customers or when we would have to do it or how we would have to do it. Frankly, we think that’s good business for us anyway. So, we don’t really see any issues associated with that.
If I also may on the South Carolina on the back office system, Jason, the order says that for five years we have to notify the commission of any plans to change systems and we just need to provide insurance of system and properly test in notify so. We will migrate those systems onto our systems when we’re ready.
We’ll keep the commission and consistencies informed of our progress and our plans and operate on our timeframe. This really was, I think, the commission discharging its responsibility in a way that was smart and put does in impact and thing about how we would go forward and into the integration whatsoever. So, we feet it’s pretty consistent for what we’re planning.
Jason Armstrong - Goldman Sachs
On geographical trends and Don, historically you’ve sort of taken us through different regions and how they’re trying to do that this quarter especially with sort of the better or that the improvement inline loss trends? Thanks.
An economy standpoint, we are in three regions each region, we are seeing some improvement, it’s been several months now are operations in eastern continue to see some improvement in the amount of downsizing, the additional services, discretionary spending and so we see improvement on the East Coast central, I would say macro stabilizing.
It’s not necessarily getting better it’s not getting worse it certainly just stabilized. Out west it’s gotten a little bit worse we had seen we saw thought for a couple quarters some improvement there. We saw housing homes move, but the economy really has going to little bit worse are there’s been more lay off and we are not will seeing that pick up as much. That’s from an economy standpoint.
The competition side, I think we’re seeing some increases in competition on the business side. You’ll ask us what we’re seeing from our cable competitors on the business and we really haven’t seen a lot in the past I think this past quarter, we have been seeing them little bit more on the small, some medium competition in terms of putting more feet on the street and being a little more aggressive, but we’ve not seen people being aggressive on price being more aggressive in terms of some of the marketing and feet on the street aspects.
Jason, too, in the east a lot of the downsizing we saw in 2008 through the first part of 2009 specifically hit us in Rochester with bigger companies downsizing and that seems to have stabilized and we’re not seeing further downsizing at the moment. That’s not to say there won’t be more, but I would say net/net overall, we are not seeing improvement on the economy in any region.
So we are running the business under the pretense that things are not improving and that we can continue to need to stay short both on how we spend money and or focus on customer and customer value. With regard to the competition, despite the fact that we have seen some skirmishes in certain markets with cable operators on the small and medium business side, our insurance for business is the lowest it’s been in many quarters. So, we’re doing a good job of keeping our business and we have continued to push to get more business customers on price protection plans.
Your next question comes from Frank Louthan - Raymond James.
Frank Louthan - Raymond James
Can you give us an update on some of your wireless strategy on the WiFi and any wireless opportunity you’re looking at in the larger markets and can you comment a little bit on running fiber to cell towers? It’s been a conversation we’ve heard from several companies.
Is that something that you all are aggressively pursuing in your markets and then with regards to the Verizon purchase, I know Verizon has been one of the more aggressive developers of running fiber to various cell towers? Have they done much of that within the regions that you’re buying? What are your thoughts of being able to capture that business once you purchase the lines?
With regard to wireless, I think we’ve been pretty aggressive on the Wi-Fi side with the 19 markets that we have today with wireless mesh networks. We’re continuing to expand more hot spots in those markets and actually in other markets around the country. We also believe that positions us very well from a wireless voice perspective.
We’re going to start a trial actually this quarter in Tennessee that will provide a cellular like service, where we will wholesale on a network. With a hand set as multiple handsets that the customers can choose from for a Frontier wireless voice solution and when customers are in their homes or businesses or actually out and about where we have our Wi-Fi network, they will be on the Wi-Fi network instead of the basic cellular network.
They will only transition over to the cellular network, where our IP network is not available. So we have tested this and it is a seamless handoff for the customer and we believe, we can actually reduce cost for these customers in the 35% to 40% range on a monthly basis, because they’re not using minutes on the network when their on our network.
So, it’s a great integration of the local service with wireless voice and wireless data. So we’re going to test that in Tennessee, and that will give us an opportunity to see how that works. Based upon those results, we would look to roll that out into other places. With regard to wireless back haul, it is a big strategic initiative to the company. We have seen increases over the last several years of wireless players needing more and more capacity in our market.
We are meeting with all of the major wireless players. We are working on back haul capabilities for them in our markets and we feel very good about that positioning. In addition to that, we also believe, because Verizon uses back haul on their networks in the markets that we’re purchasing. We have the great opportunity with Verizon in those markets as well.
So we’re continuing in the dialogue with all of the major providers and we’re at the table with regard to this. We’re proactive in terms of where we think we can get fiber into these sites, where we can maximize revenue and profitability for the company.
Your next question comes from Chris King - Stifel Nicolaus.
Chris King - Stifel Nicolaus
Two quick ones for you, first of all just wondering if you could give us a quick update on West Virginia, I guess both from a regulatory standpoint as well as from systems standpoint how that process is moving along as you look toward the acquisition. The second question I had was with respect to the other revenue line item. It was down about $5 million sequentially. Just what wondering if there is anything in particular that contributed to the sequential decline there in the third quarter?
I’ll start with just a quick overview on West Virginia and then Don can handle the other revenue question. We are making progress in West Virginia, I think as all of us know West Virginia will be the largest state that Frontier has once we complete this acquisition. Frankly, we will have just about the entire state from a telephone and broadband perspective. Because of the significance of our presence in West Virginia, the process that the Public Service Commission is going through in that state is a process that has a lot of comments, testimony, etc.
If you remember, we are the second largest phone company in West Virginia today. We have close to 150,000 customers and 38 exchanges in the marketplace and we’re doing a very good job there. So our track record is really helping us from a regulatory perspective. Just to give you an example, we’re at 92% reach on broadband in the state of West Virginia. The properties that we’re acquiring from Verizon are around 60% reach.
In addition to that, we don’t have complaints at the Public Service Commission. We have a very high satisfaction rates from our customers in the state and all of those things are leading, I think, to a good outcome, but we don’t believe that we’ll see a ruling in West Virginia till after the first of the year, and we continue to work with the different constituencies that have been asking questions about how we’re going to deliver broadband? How we’re going to be the right type of provider in that marketplace?
I was actually in West Virginia last week with the Governor, and spoke at one of the key conferences that they have on global competitiveness and trying to use technology and broadband to really help the state create jobs in the long run. So there’s a lot of partnering going on in the state and we feel good about that. We do have noise in the system though too, that we’re going to need to deal with, because we are so large and that is just part of the basic approval process that we see in states like this.
On the transaction part in terms of the conversions, we have great cooperation from Verizon on this. We have dedicated employees in our company working on these conversions. We have mapped out what needs to be done and when it needs to be done in order to deliver the systems for closing, and we feel good about that. We will have a number of test runs on these systems before we do cutover.
So on balance, we also feel good that we have our arms around what needs to be done to get West Virginia converted and keep in mind, West Virginia is not that materially different in terms of size from Commonwealth. So we’re using the same type of processes and rigger that we went through with the Commonwealth transaction down in West Virginia today.
Chris, your question on other revenue, comparing other revenue on sequential quarters, Q3 versus Q2 of ‘09, the drop in revenue is partially due to fewer CPE sales, and also due to an increase in uncollectibles. On the uncollectible side, our aging is actually gotten better over the past several quarters and our non-paid disconnects are pretty flat. We are seeing as some people are disconnecting service.
We’re seeing more of a prevalence of people walking away from the bill and not paying their final bill. So we’ve had a little bit of a catch up this quarter for uncollectibles, but the aging overall looks very strong. We feel good about that. So out of the $5 million that you referenced, $3 million increase on uncollectibles about $1.5 million is fewer CPE sales.
Now, if look at that is not necessarily the same reason if you comparing other revenue to Q3 of last year. Q3 of last year would be both uncollectibles and then the other real difference is we had the Echostar DISH campaign at the beginning of the year, where we offered our customers 250 channels at $9.99 a month for the rest of the year. So the payment that we’re making to Echostar as a subsidy for our customers this year really is an increase, because we didn’t have the similar promotion last year. So the different reason, if you’re looking at Q3 this year versus Q3 last year.
Your next question comes from Mike McCormack - JP Morgan.
Mike McCormack - JP Morgan
I just have a couple of items on the access revenue, look to a little bit stronger than we anticipated. Was there anything sort of onetime signature there. Then secondly, the guidance for the reduction of CapEx versus the increase in free cash flow doesn’t seem to flow directly. Is there some sort of incremental pressure you’re expecting going forward? Thanks.
On access revenue, Mike, if you’re looking at it sequentially, we had a true up on local switching support in the second quarter of each year. Second quarter of ‘09 had a downward pressure of almost $4 million, that didn’t have to recur and that really was part of the reason for the kick up. So subsidy’s a little stronger if you would sequentially. Switched was down a little bit. There’s no other real significant one timers that are reflected in there.
The CapEx to free cash flow it is simply a tightening up of what we’re spending. We’ve lowered the guidance, there’s obviously less building than we ever anticipated. There’s a little less municipal road jobs going on then we would anticipate even with the stimulus plan that’s out. We think we’re going to see more of that next year. So that was one of the items we just lowered that a little bit and took the free cash flow up.
Mike McCormack - JP Morgan
Don that disconnected between the CapEx reduction and the free cash increase, Is there just incremental margin pressure offsetting some of CapEx reduction?
The guidance was $250 million to $270 million. We’ve really taken it to $240 million to $250 million. So it really for lower end is about a $10 million move really as we were looking at it, Mike.
Your next question comes from Michael Rollins - Citi.
Michael Rollins - Citi
I was wonder if we can get broader update just on regulatory environment in terms of how you see some of the key issues playing out for you over the next two years whether it be that neutrality, inter carrier comp USS, secondly, if you can just talk a little briefly about as move rates pickup overtime or if they pickup overtime, on an economic recovery, how do you think that plays into, the business model in terms of your gross ads and your turn in the voice business? Thanks.
With regard to the regulatory environment, we do think that, activity has definitely picked up at the Federal Communications Commission now that the commission is fully staffed and Chairman Genachowski has specific initiatives that he’s looking at. I actually met with the Chairman on Friday and I would say that the number one priority they’re focused on at the moment is broadband.
They have a report due to Congress in February on what they see as the state of broadband in the country and I think a number of different recommendations on how to increase broadband reach and capacity in the United States overtime. It simply a report, it’s not a ruling, but I do believe that focus on broadband is a major priority for the commission, because of that, I think initiatives like reforming inter carrier comp and universal service will come after that report comes out in February.
So, we’ll probably be more of a second or third quarter reviews if in fact, they take it up at the commission in 2010 and I also think that there’s some discussion about how you tie broadband to changing universal service funding, instead of it just being about voice service and last resort for voice. How does broadband play into that, so there’s a number of moving parts with regard to those three initiatives.
In the interim with all of that are the rules on net neutrality, I think as, comments are due after the first of the year in January. We have taken a look preliminarily at the notice of proposed rulemaking and the proposed rules and we think that there needs to be better clarification on our ability to manage our networks appropriately and our ability to be able to differentiate with price based upon usage and based upon different applications that get used on the network.
Not necessarily discrimination against specific companies, but really application based management and pricing associated with that. We’ll definitely file our comments on this I don’t think that it’s materially unaligned with where the SCC is, but we also want to make sure that there is enough flexibility for us to continue to invest in these networks.
So, the dialogue continues, and we will keep an eye on that and we are proactive in working with the commission on both inter carrier comp and universal service. We have been in chatting with them about this along with other members of our industry. So I think there’s a better transparency from a process perspective that we’re seeing out of this commission than last year. I hope that helps answer that question.
As the economy changes, Michael on the residential side, I think it’s both the two aspects are seeing to think about the economy improves once in the residential side, one is on the business. On the residential side that’s very interesting is our gross ads over the past several quarters have been strong and consistent. The benefit that we’ve seen is a decrease in deactivations over the past numbers of quarters as people are not moving.
As the economy improves and people start to move some more and maybe we’ll see some crease in deactivation maybe we don’t, but we’ll also definitely see an increase in activations as we come more aggressive going after the opportunities of people moving back into those homes. So I think there’s an opportunities a challenge in the residential side.
The business side is a pure upside in opportunity. What we’re seeing today is a downsizing by businesses they laid off employees and their decreasing services, voice services with us, maybe increasing data, but decreasing voice, but they start hiring more employees back in they’re going to need more voice services. So the opportunity of increasing those services and revenues with them to help their businesses increase. So I think there’s an opportunity to challenge on resi, this is a very, very big opportunity as the economy improves. Does that help?
Michael, I just add to that, one of the things that we’re doing and again, it’s a percentage of our churn comes from Rosetta Territory and we have seen decline in that, but one of the things we’re trying to do in our markets is to make sure that as that picks up, and I think all of us are hopeful at some point it will, right, to get the economy moving again that we are well prepared to be proactive with new people moving into the homes in our markets.
We have embarked on a number of alternate channels to make sure that we are very prevalent in these markets. We have partnerships with real estate agents, we moved companies both national regional and local. I think that we’re doing all the right things that when we start to see things pick up again, including door-to-door and feet on the street, we will be very aggressive than our markets to make sure that we get those customers onto Frontier service.
Your next question comes from Chris Larsen - Piper Jaffrey.
Chris Larsen - Piper Jaffrey
A couple of question, the first, wonder if you could just touch on what you’re seeing competitively from the cable guys particularly on high speed data. Secondly, any update on stimulus funding for your business?
With regard to cable, we have not really see any material difference in the competitive environment on high speed. We haven’t seen aggressive offers in the marketplace anything innovative that we would be worried about.
More advertising, more dollars, these kind of marketing, but no significant fundamental shifts from a pricing standpoint.
Yes, now with regard to the stimulus funding, the only place where we put in for some stimulus money, was West Virginia in a joint application with the State of West Virginia for Middle Mile. We do know that the first round of stimulus funding won’t be granted until probably the December timeframe. So we don’t really know where that application will be from a granting perspective. I think everybody knows, I think this were $29 billion worth of applications that have been put in.
We have not applied for stimulus money anywhere else. We have provided feedback that we think the overhead associated with the reporting and the terms and conditions have a tendency to be pretty onerous based upon what you can get. For us, we’re at 2% reach, so most of the project we looked at would not have material dollars associated with those that it would be worth it for us to be providing audits and reports, etc. So that’s basically, where we stand on stimulus.
Then, Don, just a quick clarification of a question somebody asked earlier. The midpoint of your CapEx looks like it was down $15 million, free cash flow was up $5 million. I think what the person was trying to get at was, is there a change in operating numbers or it seemed to me that it might have just been some of the debt refi costs. I’m not sure if that was the difference or not. I just wanted to clarify that.
It’s a variety of items, Chris that I really don’t think it’s an estimate I can pinpoint it too. CapEx certainly was bringing it down as you’re looking at the midpoint, you can see the midpoint is really down $15 million or look at was really downturn from our standpoint, but there’s a lot of moves in here. EBITDA is down slightly. We’ve got a little bit of interest expense cost, because of the financing after tax, we had a couple of other items in there, but that’s a number of items that I think are a little bit smaller than that. The main shift is really in the Cap Ex.
Your next question comes from Batya Levi - UBS.
Batya Levi - UBS
Just one question on the business market, looks like the revenues decline accelerated late in the third quarter. You’ve mentioned that part of it is because of some incremental competition from cable guys. Can you sort of talk about the economy impacts versus increased competition and how you are responding to that increased activity and on to this side, I noticed that the headcount went up a little bit. Have you heard any sales people sort of increase focus on this segment?
Let me talk a little bit about the business segment. I would say that from a revenue perspective, it is mostly about businesses downsizing and not necessarily competition, that’s what we’re seeing. So in other words, if somebody had five lines as a small business, they’re downsizing to three. We are not seeing any material losses of customers, but we have seen customers that are hunkering down in terms of how they utilize the services. So I don’t think it’s directly attributable to the competition.
With that being said, we are watching closely what the bigger cable operators Time Warner and Comcast specifically in our market are doing on the business side. In anticipation of them coming into our markets more aggressively, and they start to talking this about a year ago if you recall.
We started to increase the number of feet on the street, especially around small business. We have Account Executives, that cover Medium and Enterprise, but we created a Small Business Account Executive sales team. We also created a Telephone Account Management team focused on small business and we also utilized agents and have aggressively increased our agent program in our market.
So we do believe that we’ve got the right counterbalance in terms of customer touch, where we have competitive initiatives going in the marketplace. So that’s really where the headcount has been from a business perspective. Most of the headcount has been shift and around though within the organization in terms of downsizing other areas in order to support increases of headcount in business.
Overall, Batya, on the headcount side, we did, as you may recall earlier in the year, we had retirement offers in severance. Some people left the business. We try to accelerate what we would have done later in the year that we move it earlier into the year. As a result of some of those activities we had part timers that were in place and we had to move those to full time to build and some work to be done. There’s no real fundamental strategic increase that you see in some of those small increase in headcount Q2 to Q3.
I do think it’s important to look at the track record, which we have in this business of significantly increasing our employee headcount over the years as we continue to find ways to be more productive, more efficient, and be responsive to the needs of the business. So it increasing slightly Q2 to Q3 is not an indication specifically anything to the business. It was more something we did earlier in the year and had a just balanced the work load a little bit better.
Our headcount year-over-year is down by several hundred.
Your next question comes from Ana Goshko - Banc of America.
Ana Goshko - Banc of America
On the pending $3 billion debt rates, I know you’ve said that you were thinking to start raising that in increments in advance of the transaction close. Just wanted to know what the updated thinking and advice you’re getting as on that front. In particular, would you be willing to start that raise before you get the final regulatory approvals from the states and SEC. If so, how would the mechanics of a contingent financing work? Then secondly, an update on your thinking on raising unsecured versus secured financing for that $3 billion?
Ana, nothing here is certainly set in stone. We are working with our counterparts at Verizon in looking at the financing alternatives. We would like to be able to fund as much as we can before closing to take any pressure off of when closing may occur. We only need to work that through with Verizon, but we’re hoping that we can do something.
In terms of getting things to do the financing before regulatory approval, I do think that is possible and I do think there’s a mechanism to be put in place where the funds are put in escrow and then if for some reason, transaction changes, the escrow release and we’ll have to work those out and I think there’s a number of mechanisms that would be done, that would be safe for bond holders, interested in putting money in and would be safe for both Verizon and ourselves and we’re looking at a variety of alternatives in that regard.
On your second question about thinking of unsecured versus secured, we really do want to do this on an unsecured basis. The markets have firmed up quite nicely. I think the financing that we did in early October certainly demonstrates the interest in a company like ourselves, where’s we did a $600 million offering, and we had a book that came in several factors above that with an opportunity.
So we really want to focus on unsecured and only last resort. If for some reason, we couldn’t do it, we’ll reduce something secured, but we really focused on unsecured basis. We’re actually focusing as, going out as a high yield basis, but this company’s going to have statistics coming out the gate, this going to look investment grade. We think we’ll be able to attract both high yield investors and investment grade investors and so we really think the opportunity in the market is there for doing the whole thing on an unsecured basis.
Your final question comes from Kevin Coyne - Goldman Sachs.
Kevin Coyne - Goldman Sachs
I guess is it still your intention that if you reach the goal of doing unsecured debt, is that debt going to be still expected to be carry pursue with the existing debt and in the event you the markets turned a little bit and you did need to do some secured debt, can you give us what the capacity is to do secure under the existing structure?
Kevin, yes, it would be carry pursue and we had to secure I believe the available basket today about 1.5 billion right now, we don’t see any need to do that and our preference is not to do that. We don’t want to put somebody on a higher preference on the latter to unsecured bondholders. We really want to keep does unsecured but we had to, yes, there is significant room, is that help?
Thanks, everybody, for joining us for this call. We appreciate it. I think you know we have our heads down and running our business from a core business perspective in addition to making sure that we’re getting the regulatory approvals for closing, focused on the finances for closing and also the integration work that needs to be done both for West Virginia and the other 13 states. So, we look forward to updating you again on our fourth quarter call. Have a good day.
That we’ll conclude today’s conference, we do thank you for your participation.
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