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Executives

Robert W. Starr – Senior Vice President and Treasurer

Analysts

Ana Goshko – Bank of America Merrill Lynch

Frontier Communications Corporation (FTR) Bank of America Merrill Lynch 2013 Leveraged Finance Conference December 3, 2013 11:30 AM ET

Ana Goshko – Bank of America Merrill Lynch

Good morning. And again I’m Ana Goshko and I cover telecom and technology from the credit research standpoint for Bank of America Merrill Lynch. And we thrilled to have Frontier with us this morning. We have Robert Starr, who is the company’s Senior Vice President and Treasurer and then we also have Luke Szymczak, who is the company’s Vice President and Head of Investor Relations. So without further ado Robert have had some opening remarks and we’re going to have a big Q&A type format today, but Robert will start with some – an overview of some of the key strategies and – for the company and then we can open it up for Q&A.

Robert W. Starr

Great, well, thank you for having me. 2013 has been a terrific year for Frontier. We’ve made terrific strides in growing our broadband base, which is, our main product is to lead the broadband. And so far this year, or the revenues declined sequentially in the third quarter. It was overall down only 0.4% and within customer revenue it was down less than $2 million. So we continue to make strides in improving the revenue trajectory to hopefully get to stable and then take it to growth.

The main way we’ve done this is to really come out with a simplified offer that our customers really like. It’s a no contract, no termination fees, no step-up fees, no modem charges, no surcharges. So it’s a very simplified offer, it’s at a very attractive price and it’s at speeds that our customers want, our basic speed is a 6 Meg speed which still represents about 80% of our current sales.

And even in those places where we have higher speeds available of 12 and 20, most of our customers still take a 6 Meg speed, which really gives us an opportunity in the future to expand the revenue, average revenue per customer by selling them on higher speeds. The other objective is to continue to sell the Frontier secure product, it’s a whole suite of services and about 25% of our existing base takes that product today. And it’s a very nice add-on product and helps our average revenue per customer.

The broadband growth this year, it really started in mid February. Part of the simplified offer allowed us to utilize alternative channels of distribution. These are digital media, which are search engine optimization companies that are able to go out and find customers for us. We pay them a commission, about 30% of our current sales are coming through these alternative channels. And these simplified offers really help with the alternative channels because when it’s too complex a pricing structure, it’s too difficult for these alternative channels to sell the product.

At the very end of the second quarter, we started to do the same thing with our small business customers. We came out with simplified offers at attractive prices and we’re starting to see the gains of that during the third quarter. Thus far in 2013, we’ve had 84,500 broadband ads. And one of the interesting trends though also is that we continue to grow our data and Internet revenue. And in the last two quarters, the increase in the data in the Internet revenue exceeded the loss in revenue from voice declines. So it’s a very positive trend.

One of the other focuses on our business is to maintain our existing customers, who keep trying to push the trend numbers lower, and year-over-year we’ve made terrific strides in that way. It jumped up a little bit in the third quarter but that had nothing to do with our use of alternative channels or any other issues. We did a migration of customers that were on older pricing plans and we move them into our current plans and that sometimes generates a little bit of churn. And we also had built up some properties in areas that mostly had vacation homes, and we had a little bit of churn at the end of the summer.

Through cost savings, we remain focused on it. It’s part of the mantra in our company. And we maintain very healthy EBITDA margin. So 46.6% in the start of the year and moved up to 46.8% in the second quarter, third quarter came down just a little bit to 46.3%, so very healthy margins. And that’s led to a strong cash flow generation and healthy payout ratios on our dividends. So the dividend payout ratio in the third quarter was 43%. Just to comment on credit liquidity, we remain very liquid.

We have the $750 million revolver plus significant cash on balance sheet. Our target is to get ourselves down to a leverage ratio of 2.5 times over time, but our capital allocation model really is to first and foremost invest in our network and make sure we have the right speeds and the right capacity for our customers. And then to make sure, we pay out the dividends to our stockholders. But all of the residual free cash flow has been dedicated to paying down debt and to reducing leverage. This may take some time. The prices of some of our debt is a little bit high right now, and if the predications of interest rates going higher for the last five years finally come to provision, we’ll have a lot better opportunity to pay down the debt.

If you take a look at our maturity profile of our debt, you’ll see that we did a lot of liability management earlier in the year and we’ve really smoothed out the maturity profile such that we can from existing cash and from our free cash flow generation to pay down all of our maturities through at least 2017 or 2018. So there is really no need for us to have to go back into the capital markets.

With that Ana, I’ll turn it over to you.

Question-and-Answer Session

Ana Goshko – Bank of America

Okay, great. I’ll start off with some Q&A and then we can open it up to the audience. So Frontier stopped reporting access lines I think it was earlier this year and now only reports customers. And looked at it this way the pace of the year-over-year decline in both residential and business customers have recently slowed which is a good thing. And but wondering if you could give us some insights on the underlying trends in the access line cord cutting. Is the pace of that access line cord cutting? Is that starting to add or if I mean…

Robert W. Starr

Yes, I got the question. So I mean we don’t report the access lines because we think that it’s so much more important to focus in on customers, and the more customers you have and the more you earn from those customers really tells you what’s happening with revenue. So while we don’t share information about access lines anymore, what I can share with you is that the growth in data and Internet revenue has now – the increase has now exceeded the loss in revenue from voice customers and that’s a very positive trend.

Ana Goshko – Bank of America Merrill Lynch

Okay. And you would have talked about the company’s talked about that it’s taking broadband share from cable and about 75% of its market?

Robert W. Starr

Right

Ana Goshko – Bank of America Merrill Lynch

I think you’d talk about some of the new pricing plans you have out there. Has there been any cable response in any material new ways and response?

Robert W. Starr

Nothing substantive. There’s been a couple of promotions we’ve seen in the few markets where they’ve offered some free backup services or a $200 gift card in a couple of places. The Time Warner came out with a – I think it is a 1 Meg product for a price that I think is very comparable to our 6 Meg product, so I’m not so sure that that’s going to get a lot of traction, but we haven’t seen anything substantive.

Ana Goshko – Bank of America Merrill Lynch

Okay. I think the Company said most recently, I mean, in both the second and third quarter earnings results that it feels about 30% of its broadband growth positions are coming from non-call center, but alternate channels.

Robert W. Starr

Right

Ana Goshko – Bank of America Merrill Lynch

If you could describe what these channels are and why you’re having such success with them?

Robert W. Starr

Well, sure. The alternative channel as the way we define it’s really anything other than an inbound telephone call. So there is many different ways to go out there and we actually have a local engagement strategy, where we put the – we give our local managers out in the field the opportunity to decide the best way to go to market, whether it’s door hangers or go to a county fair accounting fair or set up a booth at a mall et cetera.

So one of the things that that’s happened is when we implemented these simplified pricing plans it made it much more attractive to the alternative channel, these digital media companies to be able to go out and sell our plans for us. When you’ve got a complex pricing structure, it’s very difficult for those folks to figure out what plan to sell to which customers.

With the simplified model, it works so much better with, it enables these digital media companies to go out there and source more customers for us and at the same time, as soon as that sale is made, we’ve built an interface so that the data gets fed directly into our systems and we can immediately go to work on doing the install. So that has really – that is I think the biggest change in the alternative strategy. The benefits we got were – really came from the simplified offer and the interface to these alternative channels, enable them to sell much, much better than in the past.

Unidentified Analyst

Okay. And you talked about the success you’re having in having broadband customers move to higher speeds which should hopefully drive ARPU growth. And you talked about the Secure product, which is a data backup product. Are there other things you have in the hopper in terms of adding – of add-on products? And some examples that come to mind is cable companies such as Time Warner and Comcast have added home monitoring and automation including things like door locks and temperature control, Web cams. Is this something that you’ve thought about adding to the bundle?

Robert W. Starr

Sure, there are a number of trials out there that we’ve got on different products. We’re thinking about a TV product that would be over the top. We’ve talked about in the past AT&T mobility trials. So there is always the thoughts about new products and what we could – what else we could sell to our customer base. I do want to point that Frontier Secure is a whole host of products from personal identity protection, backup services, help desk, virus protection, firewall.

We’ve added a new product recently, which is insurance protection on some of your equipment. So if you take a look at the Frontier Secure website, there is a whole host of products that are out there that and 25% of our existing broadband base already take at least one of those products. So there is an opportunity for us to sell them more. And the other thing about Frontier Secure is that it doesn’t necessarily have to be only sold within our footprint. We can really take it outside the footprint.

Ana Goshko – Bank of America Merrill Lynch

Okay. And then on home automation space, it’s not something that you’re trialing right now?

Robert W. Starr

There is nothing that we have right now.

Ana Goshko – Bank of America Merrill Lynch

Okay. And in terms of – since you mentioned over the top, where are you in those rollouts? Are they still pretty nascent or…

Robert W. Starr

They are. In one or two markets, we’ve trialed them just to try and make sure that we understand how it works and what the customer demands might be. It’s way too early to decide whether this is a product that we would actually want to rollout or not.

Ana Goshko – Bank of America Merrill Lynch

Okay. And it’s same with wireless. You have an agency relationship that I believe with AT&T?

Robert W. Starr

Well, it’s called AT&T mobility, and it’s basically stores where folks can come in and pick up an AT&T cell phone and a wireless plan from AT&T provided, however, that they take the Frontier broadband for their home.

Ana Goshko – Bank of America Merrill Lynch

Okay. And no decision yet about rolling wireless out more broadly?

Robert W. Starr

No decision.

Ana Goshko – Bank of America Merrill Lynch

Okay. Wanted to engage you on just the business environment and the Company strategy both of SMEs and larger enterprises. So first on the SME front, what cable activity been like and their ability to take share in your markets on the SME side?

Robert W. Starr

Well, it’s a little bit of reverse. We’re really starting to get some traction with the new simplified offers that we’ve got in the small business market. Very attractive pricing. And so, we’re seeing some stability in this small business segment here. We’ve rolled out in the medium and enterprise, we rolled out GigE to about 86% of our footprints and we’re getting traction as well with some of our enterprise customers.

The Carrier segment has shown some growth in the past quarter and the one headwind that we really still have to deal with is the wireless backhaul. So in 2013, we said that back that that headwind was about $25 million to $30 million. It looks like it’s going to roll into the first half of next year. And so we still have to deal with the complete – the fact that we’re going to be losing some more towers. We also have some towers that we’re building out to and we think that will all be completed about half way through the year.

Ana Goshko – Bank of America Merrill Lynch

Okay. Well, what about on the larger enterprise side? How has competitive carrier activity been in your markets?

Robert W. Starr

We’ve landed some large logo customers in the third quarter and that’s terrific progress now that we have this GigE product that is so widely available in our footprint. And so not only do we get traction with a few customers, but we’re seeing the pipeline with a whole bunch more. So we’re very excited about that.

Ana Goshko – Bank of America Merrill Lynch

Okay, and in terms of the competitive environment though, I mean, you have a couple of different CLECs presenting here today and generally there’s a view that there is increased competitive activity as many, even incumbent move into a CLEC strategy outside of their original territory. Do you feel that there’s increased competition on the enterprise side in your markets?

Robert W. Starr

There is definitely a lot of competition in that space. We see a lot from the cable companies, we see a little bit from the CLECs as well, but like I said we’ve just made some recent progress on that. So we’re feeling pretty good about it.

Ana Goshko – Bank of America Merrill Lynch

Okay, great. On the cost cut front, the company had a goal of achieving $100 million of net annualized cost savings this year. Wanted to understand where you feel you are as of December 2nd on achieving those cost cuts?

Robert W. Starr

Cost cutting is a big focus for the company. All of us are – think about different ways we can do it. For a while, I ran the real estate and facilities division where I focused on that. Within treasury, there are a number of initiatives that are underway to cut costs. So it’s not just a one time thing even though we talk about the $100 million net savings for this year, it’s a continuous process. We think we’ve made some great strides there. We’ve also taken some of those savings and we’ve re-invested in the business because we see the opportunities on the revenue side. Hope we think we’re in great shape on that.

Ana Goshko – Bank of America Merrill Lynch

Okay. Moving to the capital structure side, I think you mentioned a lot of the debt reduction opportunity – actions that you took earlier in the year. And but per my math, I think that Frontier’s cash balance includes maybe about $270 million give or take of bond proceeds that were raised by debt refinancing that that haven’t been put out to work yet to reduce debt, so even after that tender completed earlier this year. So are you looking to still opportunistically buyback debt or you really at this point more focused on the upcoming maturities that you have in the next few years?

Robert W. Starr

Well, we certainly have enough cash we believe to pay off all maturities for the next few years. We did take out a net reduction about $800 million of debt. So we use a whole bunch of cash off the balance sheet plus the proceeds of the debt offering in order to take out that debt. Our objective really is to take the residual free cash flow and continue to reduce leverage towards the 2.5 times long-term goal of 2.5 times leverage. It would be a heck of a lot easier if interest rates were higher and of course the Wall Street’s predicted they would go higher for a long time now. But you can’t wait, so we certainly did a lot of it earlier – in the early part of this year and we’ll continue to pay down debt.

Ana Goshko – Bank of America Merrill Lynch

Okay. The dividend payout is, give or take, about 50% of free cash flow right now. You have addressed a lot of the upcoming maturities don’t have a need to refinance, but correct me if I’m wrong. I don’t think that company has an authorized share buyback program at the moment, is that correct?

Robert W. Starr

No.

Ana Goshko – Bank of America Merrill Lynch

Okay.

Robert W. Starr

Let me correct you, the dividend payout ratio for the third quarter was 43% and for the first time of this year it was less than 50%.

Ana Goshko – Bank of America Merrill Lynch

Okay. And you haven’t bought back shares for quite a while. And I mean is there something that could be resurrected in the near future?

Robert W. Starr

Well, this is a decision entirely for our executive management and Board, and I don’t want to speak for them. I will tell you that in the discussions that I’ve been involved in that the focus has been on paying down debt. So residual free cash flow after investing in our infrastructure and then paying out that dividend has been dedicated towards reducing leverage.

Ana Goshko – Bank of America Merrill Lynch

Okay, let me open it up to the audience if there is any questions. Okay. So still staying on top of the capital structure. One of the benefits of having high-yield debt, just from an issuer’s standpoint, is to have call futures on the bonds which allows companies to opportunistically repay debt in advance of maturities without having to pay call premiums and tender premiums – or tender premiums from my point. But why has the company continued to issue only bullet debt maturities or bonds?

Robert W. Starr

That has been our standard mode of operation. We wanted to keep the interest cost as low as possible. It’s always possible that in the future we’ll take a look at doing some callable structures, but so far we just wanted to save the interest expense in the early – certainly in the early part of following the acquisition in 2010 to reduce expenses and improve cash flow was our main focus.

Ana Goshko – Bank of America Merrill Lynch

Okay, [Indiscernible]. One right there.

Unidentified Analyst

Thanks. Just a quick question, I’m assuming you haven’t hit it, I apologize. On the expectations for the extension of bonus tax appreciation and/or the transition to some other kind of fiscal stimulus measure in Washington. I think that with the shutdown and the budget crisis and the potential additional shutdown, and potential additional budget crisis in January, February next year, I think that the enthusiasm or expectation that something will happen is kind of diminishing, but I think it’s been an expectation that it will continue in the marketplace. So kind of I’m assuming that a company like yourselves where its relevant is probably very much in the mix there. It would be hugely helpful in kind of get your perspectives on what you think is going to happen. What should we budget in the models for next year?

Robert W. Starr

Look it would benefit us – it would certainly benefit us, but we are just operating under the assumption that we’re not going to get it, if we get it, it will be a terrific benefit. The bonus depreciation that was put in place last year actually didn’t improve or help us on the cash basis until the first part of 2014 but absent that we expect to be a full-rate payer. But we don’t really have a specific view as to whether bonus depreciations going to come through. again.

Ana Goshko – Bank of America Merrill Lynch

But staying on the topic of what we may expect for 2014, can you short of providing guidance, which I believe you’re probably not prepared to do yet, but can you think of – help us think about what your capital expenditures needs will be? What buckets you may think of as growth? And what we should expect for really maintenance capital expenditures for Frontier?

Robert W. Starr

Sure, well for the past two years leading up to 2013, we spend about $715 million, building up the backbone, enhancing speeds, doing builds to reach more customers and a large part of that has been completed, and more and more of our CapEx monies have gone towards increasing speeds to customers. So this year, our CapEx guidance was 625 to 675. So if you take the mid point of 650, we came down by about $100 million year-over-year. And even though the biggest part of the build has been completed meaning the backbone and the reach to customers there is a lot of CAF money that we’ve got.

We picked up $72 million in the CAF 1 Phase I and that was to build out to about 92,000 additional homes over the course about two to three years. And then we’ve applied for another $72 million or so in CAF 1 Phase II and most of that money would be dedicated towards enhancing speeds for customers that are – that receive speeds below 3 Meg. So I think that a larger and larger proportion of the CapEx budget can go towards speeds which is a really much lower cost proposition in some of these other builds. And therefore, we think that the capital intensity has an opportunity to come down.

Ana Goshko – Bank of America Merrill Lynch

Let me introduce the topic of M&A. So Frontier has not participated in any material M&A really I think since the Verizon line acquisition, so with that integrated, is there interest in acquisition and if so you are most focused on the business or on the residential side?

Robert W. Starr

We focused on all the wide space ahead of us in our existing business. We’ve gotten terrific traction in growing our broadband customers on the residential side. We are starting to see them in the small business side. We think there is opportunity to increase the average revenue per share of our customers through the Frontier Secure and through selling higher speeds. And so most of our focus right now is on that wide space and the opportunities that is ahead of us.

There are opportunities that are out there that we get presented with from time to time to do an acquisition. I think our focus on that is to really benefit from the lessons learned from the acquisition done in 2010, as well as to think about what are the benefits to our shareholders than our stakeholders. To do an acquisition and pay a lot of money to buy revenue, but not necessarily benefit the stakeholders doesn’t seem to make a lot of sense to us and so we would have to look at each transaction and it would have to stand on its own merits, but it’s always the possibility, but right now we think there is a lot of wide space ahead of us in our existing business.

Ana Goshko – Bank of America Merrill Lynch

Okay. If the right opportunity was presented to you at the right MPV to your shareholders I mean is it possible that the company would be willing to acquire another heavily residential sort of ILEC, given all the experience that you’ve had with the Verizon acquisition?

Robert W. Starr

That’s a decision that would have to be thought about and discussed by Executive Management and the Board, so I’m not really prepared to decide for the company which acquisitions we are going to do just yet.

Ana Goshko – Bank of America Merrill Lynch

Okay. Are there any areas, other assets, or IT assets, or IT products and services that and the company believe it needs to build out its portfolio still of services for its customers?

Robert W. Starr

Yes, sure, it would be nice to expand our product set especially for the business customer, there are some spaces that we think that we could benefit from some add-on products, but we want to do it in a smart way which is not to just spend a lot of money just to by revenue. So well, we’ll take a look around, but again it has to make sense for the shareholder.

Ana Goshko – Bank of America Merrill Lynch

Okay. Specifically, if you can talk about the company’s asset base right now with regards to datacenters, I mean one of the continued major themes both in telecom and in the technology space is customer demand for hosting and for managed services. Do you feel that you’re positioned well to meet the needs of business customers?

Robert W. Starr

It’s a pretty crowded space right now. And it’s a product that we think would be a nice add-on to our product set and so we are thinking about ways that we potentially do that, but we are just not prepared to spend a lot of money on something unless we think it has true value.

Ana Goshko – Bank of America Merrill Lynch

Okay, we open up again. David?

Unidentified Analyst

Some recent data came out suggesting that, actually for the first time in years, bank lending to small businesses is starting to grow. We’ve actually had negative small business formation being one of the big fundamental headwinds and getting better traction in the business services sector at Frontier and other company. Could you talk about what kind of – if any green shoots you’re seeing in the markets that you are serving, if any around the business services segment?

Robert W. Starr

Let me talk a little bit about the CPE sales that we’ve focused in on – in our real markets there isn’t a lot of competition, a lot of opportunity for others to service the client in the same way that we can and so we are using the CPE not only for the sale of the equipment itself, but also the opportunity to as an entree to those customers to get to another customers and then hopefully to sell them on our network services and earn a monthly recurring charge. So CPE is becoming a more important part of our business again not just for the equipment, but for the entree to the customer and the fact that we can sell them the maintenance and the support and that repair services as well.

Ana Goshko – Bank of America Merrill Lynch

Ask you another credit question. So back numerous years ago, I think the company, which was then called Citizens, was really sort of the inventor of the high dividend payout strategy and when the company implemented that strategy its proactively headed credit rating downgraded to BB and/or to give those returns to shareholders. So I wonder where you guys think about your credit rating goals right now. I mean is investment grades an aspiration for the company, or are you content to remain high-yield rated so that you retain flexibility for shareholder returns?

Robert W. Starr

It’s not a specific goal as we need to do the following things in order to get to investment grade. We do want to reduce our leverage. We do want to hit that 2.5 times leverage target over time and I think if we do that then we’ll get the benefit of ratings improvements.

Ana Goshko – Bank of America Merrill Lynch

Okay. Have you had any feedback from the rating agencies on what it would take to achieve an investment-grade rating?

Robert W. Starr

We haven’t had any – I mean, we actually have an annual review due with them and it’s usually in January of each year. So we haven’t had any recent conversations with them about that. No.

Ana Goshko – Bank of America Merrill Lynch

Okay. Last call. A call from the audience. Any – we’ve got a new FCC Chairman in place with an agenda about rollout. Is there anything at a regulatory front and as we look in the 2014 that you either see as an opportunity particularly with some other new Chairman or anything that is kind of a headwind that you will be dealing with?

Robert W. Starr

Well, you know, the CAF I phase-two monies we’ve applied for, hopefully we receive those monies and that would be a terrific benefit to us and that enables us to primarily go out and increase speeds for some of our customers that that don’t have the very high speeds right now. And then of course there is a CAF 2 and that could be a very interesting tailwind if it comes out with significant monies for us.

Ana Goshko – Bank of America Merrill Lynch

Okay. And can you remind me the timeframe of when you...?

Robert W. Starr

I don’t know any other details behind the CAF II.

Ana Goshko – Bank of America Merrill Lynch

Okay. Okay. Anything else from the audience? Okay, great. Well Robert, thank you very much for being with us.

Robert W. Starr

Thank you.

Ana Goshko – Bank of America Merrill Lynch

Okay, great.

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