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Frontier Communications Corp. (NASDAQ:FTR)

Q4 2009 Earnings Call

February 24, 2010 9:00 am ET

Executives

Gregory Lundberg – Director Investor Relations

Maggie Wilderotter - Chairman and Chief Executive Officer

Don Shassian - Chief Financial Officer

David Whitehouse - Treasurer

Analysts

Simon Flannery – Morgan Stanley

Chris King – Stifel Nicolaus

Frank Louthan – Raymond James

Jason Armstrong – Goldman Sachs

David Barden – Bank of America

Scott Goldman – JP Morgan

Michael Rollins – Citi

Todd Rethemeier – Hudson Square Research

Operator

(Operator Instructions) Welcome to the Frontier Communications Fourth Quarter 2009 Results Conference. At this time, I would like to turn the call over to Mr. Gregory Lundberg.

Gregory Lundberg

The purpose of this call is to discuss 2009 fourth quarter results for Frontier Communications which were released this morning and are available on our website. If anyone needs a copy of the materials please contact Lisa Lombardo at 203-614-5064. We anticipate the Form 10-K will be filed later this week.

On today’s call, Maggie Wilderotter, Chairman and Chief Executive Officer, and Don Shassian, Chief Financial Officer, and David Whitehouse, Treasurer.

During this call, we will be making certain forward looking statements in particular on matters related to 2010 results and estimates. Please review the Safe Harbor language found in our press release and SEC filings. On this call, we will be discussing GAAP and non-GAAP financial measures as defined under SEC rules. In our earnings release and 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’ll now turn the call over to Maggie.

Maggie Wilderotter

Thank you for joining our call today to discuss the fourth quarter and full year 2009 results for Frontier Communications Corporation. Today I am going to provide you with an update on the business environment in our markets, our top priorities for 2010, a review of 2009 results, and an update on our transformational Verizon acquisition.

As a company we are fully aware of the challenges and opportunities in the marketplace. At Frontier we’ve always been a fierce competitor and we continue to improve our position everywhere we do business. Our 2009 results show that growth of new products and our constant focus on high speed internet penetration continued to reduce access line pressure. We’re succeeding because of our proven local engagement model where we are active in all of our communities. This, coupled with a robust product portfolio for businesses and consumers, results in a strong market leadership position.

Our broadband internet network keeps getting faster, our online computer backup and tech support is more widely used and we are the choice for cell sight cyber backhaul. Just a few examples of why Frontier is the best technology choice in our market.

We’re also succeeding because our strategies are targeted to sell in a sluggish economy. The new normal is reduced spending and personal household de-leveraging. Every American is searching for value at better price points. Our double play and triple play products help us capture wallet share through these bundled discounts that we provide and we’re currently having about a third of our primary access lines in these bundles.

Our price protection plans give customers certainty of price. On the residential side, Frontier has contracts on 79% of residential high speed customers and 53% of residential voice customers. We help customers budget and save while the cable operators keep increasing prices. Customers also appreciate the consistency of our broadband speeds which gives them the ability to do what they want, when they want, without degrading the network when more users come online.

We’re giving customers innovative new products like My FITV. My FITV launched February 9th and is a ground breaking website with free access to online video content but with a guide that makes it easy to find TV shows and movies online, just like your television guide experience. My FITV allows the TV viewer to make the switch and become a broadband TV viewer.

Our tagline says it well, “Search Less and Watch More for Free with My FITV.” We expect My FITV to improve high speed retention and help us grow share since this website will be part of our basic high speed service. We also will generate advertising revenue, search revenue, and video on demand revenue from the national and local perspective.

The commercial market contributes nearly half of our current customer revenue. We see upside potential across all commercial business segments. Today we have evenly split revenue mix from TelCom carrier clients, medium and large enterprises, and small and home office customers. We segment our offers and utilize different distribution channels to sell and service our business customers. We touch all business customers live every 90 to 120 days.

Our business product portfolio has expanded to include more CPE choices, hosting services, specialized broadband products, and fiber backhaul. Local sales account executives work closely with our general managers to service businesses in our market.

For 2010 we’re staying the course with a primary focus on increasing our broadband capacity and speeds, expanding our piece of mind services and two hour installation/repair appointment windows, pushing a higher percentage of sales through alternate channels, using our call centers and local initiatives to attract and retain customers, launching new products and driving penetration of all products and bundles, and enhancing the customer experience with more value at competitive prices.

We have and will continue to launch segmented promotions in our markets. For example, we have just launched a free netbook offer in 32 markets where we see low PC penetration and attractive high speed growth potential.

Fourth quarter 2009 results showed a consistency of our execution in a competitive marketplace with a tough economy. Revenues were $521 million with adjusted operating cash flow or EBITDA of $285 million. This 55% quarterly margin continues to lead the industry. Frontier generated free cash flow of $124 million in the fourth quarter and paid 63% of this to our shareholders as dividends.

Frontier’s fourth quarter operating metrics clearly show the strategic focus and business philosophy that I described earlier. Our Q4 revenue decline was better than the three previous quarters in 2009. This was driven in part by residential and business line loss rates that were the lowest in over a year and also by the sales of additional products to our customers.

We aggressively promoted our broadband network and drove fourth quarter high speed internet additions to 14,600 units which is a 72% growth rate over Q4 2008 net adds. Total 2009 high speed net adds were 56,000. We now have 636,000 broadband subscribers or 30% penetration of our total access lines.

Our dish bundles were also strong in the fourth quarter. We added approximately 8,400 net subscribers to bring our penetration to 12.8% of residential lines up from 8.2% in Q4 2008. Digital voice product bundles are up 13% from last year and now represent 51% of primary lines. This strong metric performance helped push up Q4 average monthly customer revenue per access line to $67.16 from $66.08 in Q4 ’08 a 1.6% improvement.

Now I’ll switch gears and give you an update on the Verizon transaction. We announced this transaction last May and we’ve achieved several critical milestones. These include DOJ approval in September, a resounding shareholder vote of approval in October, three state approvals in October and two more state approvals in Ohio and Arizona this month.

We’ve also received all 41 necessary local franchise area video approvals. The remaining steps to close include approvals in four more states, all the required hearings and testimony in these states are completed and we anticipate approvals in the very near future. In addition to the remaining state approvals, we anticipate FCC approval in the same timeframe.

On the operational front, our West Virginia conversion is on track and we are working with Verizon to oversee their testing of the SpinCo entity. We will commence formal testing of this 13 state SpinCo entity in April, to make sure all systems work well and the business runs smoothly on a stand alone basis.

Finally, we plan to go to market in the near future to raise financing for the transaction. We believe we can pre-fund a good percentage of the $3.3 billion of debt that is required to close the acquisition. We expect the acquisition to close in late second quarter.

The integration of these Verizon markets will give our investors a new Frontier with leverage approaching investment grade, more scale, and a great platform for improved product penetration, revenue growth, significant cost savings opportunities and an attractive and sustainable dividend. All of these factors will also benefit our employees and our customers.

In summary, we’ve delivered good results in the fourth quarter 2009 and for the year. Our team’s solid and consistent execution is one of the critical factors that will drive success in the Verizon acquisition markets. We remain confident in our ability to improve results in these new markets and look forward to close so we can get started.

Let me now hand the call over to Don Shassian our Chief Financial Officer, who will give you the financial overview for the fourth quarter 2009 and for the full year.

Don Shassian

Today I’d like to walk you through the business as usual results, introduce and discuss some operating metrics we use internally to run the business, discuss our 2010 outlook, and provide an update on the Verizon transaction.

With year ending December 31, 2009, we delivered free cash flow of $491 million which is just above the top end of our guidance. Operating cash flow or EBITDA margins as adjusted were 54.2% for 2009 which is within the guidance range of 53% to 56%. This year’s performance continues our philosophy of say what we’re going to do and do what we say, the ability to deliver these results in a challenging economic environment and as we move along in our Verizon acquisition, demonstrate the entire company’s focus on the customers, on our revenues and on our costs.

Our Q4 EBITDA margin was 50% and when adjusted to exclude acquisition related costs, severance and early retirement costs and non-cash pension expense, the margin was 54.7%, a very strong quarter and consistent with the results we have delivered every quarter for the past few years.

Network access expenses declined in the fourth quarter as compared to last year’s fourth quarter due to less aspirational gifting costs in 2009 and other operating expenses excluding the adjustments with 35.4% of revenue in Q4 ’09 a level that has been fairly consistent over the past several quarters. This discipline on the expense side carried down to free cash flow which was $124 million for the quarter of which $78 million or 63% was paid out as dividends. Our payout ratio for the year was 64%.

On the revenue side, Q4 results overall represented a lower year over year decline than any other quarter in ’09 and saw stable trends that included positive results in data and internet and a lower contribution from regulatory revenues. Data revenues for the quarter grew 4% over Q4 ’08 and now represent 31% of our revenues compared to 28% at this point last year. We saw strength here in our broadband business which delivered 14,600 high speed net adds up 72% over Q4 ’08 high speed net adds. For the year, high speed net adds were 56,000.

Access service revenues or what we call regulatory revenues for the quarter declined 5.6% compared to the fourth quarter of ’08. Switch minutes of use were down 11.5% compared to Q4 ’08. We continue to see a lower reliance on access revenues which were 17.4% of revenues in Q4 and 17% for all of 2009 compared to 18.1% in fiscal ’08. Please note that Verizon SpinCo’s access revenues in 2008 were only 10.4% of revenues. On a pro-forma basis assuming the Verizon transaction closes, the new Frontier is expected to have a lower reliance on access revenues.

Customer revenue which is all non-regulatory revenue was $430 million for Q4 or 1.3% decline sequentially. We continue to sell more and more products to our customers to increase wallet share. Our average monthly customer revenue for the quarter which includes both residential and business was $67.16 which is up 1.6% over last year’s fourth quarter.

In addition, selling more products, our access line losses also improved. Our Q4 2009 results in both residential and business showed the lowest year over year declines and a marked improvement over Q4 ’08. Overall, our total access lines were down 6.1% year over year in Q4 ’09. This compares to a decrease of 7.2% in Q4 ’08. This improvement can be attributed to the increasing penetration of bundles, fewer home moves, fewer business losses, and lessening impact of cable to lessen any competition which exists in 73% of our footprint.

Our residential access lines declined by 25,300 during the quarter, this is an improvement on a sequential and year over year basis as resting solid improvement in our East and West regions. Our total residential line count was down 7.2% from Q4 ’08. Business line losses were 8,900 which is up over Q3 but much better than the Q4 2008 losses. On a year over year basis, business lines are down 4% compared to 4.9% in Q4 2008.

I’d like to take a moment to introduce some new reporting metrics that we use internally and will begin to report externally. Today we’re pleased to introduce some new metrics in our earnings release to give you more transparency and a better understanding of the key drivers of our business. Our previous releases and SEC filing have disclosed PA accounts like access lines, high speed internet and video. We will continue to report those PA accounts but the important measure we believe is the customer, both in numbers of customers, numbers of products they buy from us, their average monthly revenues, and the strength of our customer retention.

We are introducing, on page two of the attachments to today’s release, new residential metrics with business metrics to follow in the near future. In addition to reporting access lines, we are reporting residential customers. We’re taking it a step further by showing products for residential customers, residential customer churn, residential customer average revenue, and percentage of residential customers on price protection plans. We will continue to report our traditional metrics until we have published a year’s trend of the new metrics and we also plan to expand this customer reporting to our business segment in 2010.

Under the new metrics our Q4 2009 residential customer base is down 6.9% compared to Q4 ’08. This is lower than our reported residential access line decline of 7.2%. We’ve also driven a 10 basis point reduction in customer churn from 1.5% for Q4 ’08 and 1.4% for Q4 ’09. Churn on customer bundled offerings is considerably lower than on unbundled products, which is why we remain very focused on bundling HSI and dish services into our customer base.

You can see part of this focus in the 7.2% increase in the products per customers in Q4 ’09 versus Q4 ’08 which helped drive the corresponding 1.5% lift in our customer average revenue over the same period.

Turning back to our financial statements, our capital expenditures were $69 million for the fourth quarter excluding integration CapEx; this was up sequentially as the fourth quarter generally is our largest quarter for spending. However for all of 2009 CapEx excluding integration was $231 million below the low end of our guidance. While we continue to spend money on broadband and other strategic initiatives, other capital spending like municipal road construction work was lower because of the economy.

As for 2010 expectations for the legacy Frontier business, we believe that our capital expenditures will be between $220 and $240 million and our adjusted free cash flow will be between $450 and $475 million. Please note that this guidance excludes all Verizon related integration and acquisition spending and its associated tax benefits.

Our net debt to adjusted EBITDA ratio at quarter end remained 3.9 times. In addition, the $359 million of cash on the balance sheet, our liquidity is enhanced by an un-drawn $250 million revolving credit facility. During the fourth quarter we issued $600 million in aggregate principal amount of senior unsecured notes in a nine year offering with net proceeds to the company of approximately $579 million.

To reduce near term maturities in advance of our Verizon financing, we repurchased in aggregate $648 million principal amount of our 9.25 notes due 2011 and our 6.25 notes due 2013. Schedule C in the press release graphically illustrates the improvements in our maturity schedule from September 30 to December 31 after reflecting the successful financing and tender. We are also moving forward on raising a portion of the estimated $3 billion debt financing for the Verizon acquisition.

I would like to give a brief financial update as it relates to the pending Verizon transaction. During the fourth quarter we incurred integration expenses of $13.9 million and integration capital expenditures of $22.4 million, all spent in connection with the integration of the networks as well as for the conversion of the West Virginia systems. Our guidance for integration spending in 2010 is approximately $100 million of expenses and approximately $75 million of capital expenditures. These numbers are excluded from the legacy business forecast I just gave you.

Our integration spending is higher than our original estimates of approximately $192 million due to higher spending than anticipated on the West Virginia conversions, to set up FIOS in the three FIOS markets and to be ready to take over the other 13 states. While those costs in aggregate are estimated at approximately $230 million, and we continue to quantify all the integration spending, we are still confident in our ability to achieve the $500 million in cost savings by 1/1/2013.

We have received December 31, 2009, operating unit results from Verizon which I’d like to share with you. Please note that we have not received the December 31, 2009, financial statements. Therefore, I will limit my discussion to only the key operating metrics.

Access lines as of December 31, 2009, were 4,215,000 down 127,000. This represents a 2.9% sequential decline and an 11.6% decline year over year. High speed internet subscribers representing both DSL and FiOS technologies were 1,061,000 with net adds for Q4 of 6,000. FiOS TV subscribers were 111,000 with net adds of 4,000 for Q4.

These results are overall where we expected the business to be when we went into this transaction last May. We continue to be very excited about putting our local go to market strategy to work in these properties to close the gap between their metrics and the way we run the business.

2010 is going to be a very big year for Frontier and operationally and financially we’re working very hard on all fronts. There are four primary areas of focus for us in the first half of 2010:

Continue to deliver strong operating results in the legacy Frontier business.

Obtain the four remaining state approvals plus the FCC approval.

Complete the SpinCo financing to establish the balance sheet structure and liquidity at the close of the Verizon acquisition.

Focus on making sure the West Virginia systems are converted at closing with minimal customer impact and that the 13 state systems being set up by Verizon are thoroughly tested and also working with minimal customer impact.

Together these focus areas will get us over the goal line in Q2 2010 when we expect to close. When that day arrives all of our stakeholders and employees can look forward to Frontier putting our business and financial execution into markets will be happy to see us come to town.

With that let me pass the call back to the operator to open up the call to questions.

Question-and-Answer Session

Operator

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

Simon Flannery – Morgan Stanley

Getting a lot of questions around the West Virginia timeline, perhaps you could just update us on where you are with the CWA and some of the other parties and what we should look for in terms of the next dates there? I think you made some comment about improving economic trends in the East and West regions. Is that related to housing, employment, or perhaps you could provide a bit more color around that?

Maggie Wilderotter

With regard to West Virginia the process for approval is well underway. We have been in discussions with all interveners in that case. We completed four days of testimony with the public service commission in West Virginia just a couple weeks ago and we are basically in negotiation with all of the parties down in West Virginia. We feel very good about bringing this to closure.

I think as many of you know West Virginia will be the largest state where we do business after this acquisition and we will be the phone company in that state. They are more cautious than some of the other states where we are not as big a player. We feel very good with the outcome for West Virginia and we’re going to continue to work that over the next several weeks.

With regard to the East and West operations, we are optimistic, Central is doing fine as well but we have no signs of improvement really in any of the regions. What we see if more stability. Some of that stability in the improvement area is really in 2008 we had a number of large businesses that did a substantial amount of downsizing. We’ve seen some of that downsizing work through the system so there is a little bit more stability from the business customer perspective as well. The net, net is I think we’re all holding our own in these markets but we’re not seeing economic improvement.

Simon Flannery – Morgan Stanley

The line loss is really from competitive or lower wireless substitution, lower cable share gain?

Maggie Wilderotter

Yes, I would say all of those things plus we’ve done a very good job of continuing to put more customers on price protection plans and bundles. I think the strategy of our service strategy, our bundled strategy, and our strong promotion of rolling thunder in the first quarter of 2009 really made a difference in improving deactivations year over year.

Operator

Your next question comes from Chris King – Stifel Nicolaus

Chris King – Stifel Nicolaus

Regarding the Verizon properties, 6,000 high speed data adds for Verizon in the quarter seems a little bit light, just was wondering if in your discussions with them they view that as more of an economic issue going forward. Secondly, along those same lines, I know you guys have talked a little bit in the past about your plans going forward with FiOS and those subscribers, was wondering if you had any additional commentary there or have sorted out that business plan at least in your eyes going forward.

Don Shassian

On the data adds and on the FiOS TV ads I think you’re going to have to get more color from Verizon on their business. As we’ve looked at it and as we’ve understood it and as we’ve dug into it and had interactions with Verizon on those properties they are to the best we can tell continue to do their best in those marketplaces, continue to introduce their promotions and activities that they’ve been continuing to do.

I think there has been a drop off on the economy for them; I think there’s been some increased competition, some competitors trying to take advantage of the situation. I think they also are running into some very high penetrations in certain areas so the ability to move that bar is a little more challenging.

The results, however, I do want to point out are very, very similar to Q3. Its a stable environment which is the most important thing from our standpoint is making sure that we did see the drop off from Q2 to Q3 we really got into that to understand it but we’re now seeing a stability as we see it. We’re hoping it will stay at that kind of level so we can do our thing. I would leave it in that macro perspective.

Maggie Wilderotter

One of the other things that I would add is the numbers that we’re seeing in the Verizon markets is the reason why we’re very excited about the opportunities we have as a company to improve the results in those markets. Part of that has to do with building out more broadband. They are only at an average 60% broadband penetration level build out, we’re at 92% so we think the sooner that we start operating in those markets we can aggressively start to change the paradigm on the results that we’ll see. I think to Don’s point, we’re not surprised in what we’re seeing, its stable, it’s what we expected and from that perspective we think that the markets are holding their own.

With regard to FiOS we do have FiOS in four states of which three states have rolled out video on the platform. We have been working very diligently to replicate the FiOS system in Indiana, in Oregon, and in Washington for the customers that have video in those states. We are committed based upon the franchises that we have in those locations and we’re planning on making sure that when we launch in those markets we will have a very minimal customer impact.

Keep in mind; it’s about 110,000 customers that are on the FiOS video platform out of the 4.2 million that we’re going to be inheriting here. We also have DirecTV in those markets. We are looking overall at a video strategy for the new Frontier and we do think that we have a great opportunity to learn about on net video by running these FiOS markets and really getting a sense for what that takes and the profitability associated with that end market.

Operator

Your next question comes from Frank Louthan – Raymond James

Frank Louthan – Raymond James

When do you anticipate Verizon will be done with the testing on the GTE properties for you to begin your own testing and do you anticipate taking a full 60 days as you have with the agreement? What is the visibility on the final approval from all the regulators including the FCC?

Don Shassian

The approval contractually Verizon needs to have 13 states set up separated and a separate data center by March 31. Verizon is already testing the systems that they’ve set up, it’s got to be done from their standpoint and set up for us to begin testing once that data center is set up. We’ve got about 60 days. I do think we’ll probably us the full 60 days, I think that’ll be important to give ourselves the right comfort level for our customers that everything’s working appropriately and I think that the regulators are expecting us to utilize that time to make sure from their perspective as they discharge their responsibility. The 60 days starts about that time period frankly and I think we’ll use the whole time period.

Maggie Wilderotter

I also think from a final approval visibility none of us can predict when you’re dealing with regulators what the exact date will be on approval. We believe we are in very good positions in the remaining four states. Some of them are just simply procedural, we’ve settled with all of the interveners so it’s just a matter of those states taking the process through what they have to ask the public utility commission level.

With regard to the FCC, our shot clock has been running, its basically finishes this week. We’ve seen no material issues, there have been questions back and forth, we continue to meet with the FCC and reinforce our commitment to deliver great products and services in these markets. I think from the FCC perspective they are very focused on broadband I think as we all know and they are pretty excited about us taking over these markets and accelerating broadband to rural America.

We don’t foresee any major issue there; we’re going to continue to work with the staff and with the commissioners. I think part of it is they like to see the state approvals take place, it’s a balancing act. Getting approval at both the four states and the FCC over the next several months, we don’t see any issue with that at all.

Frank Louthan – Raymond James

Regarding the metrics that you put out, looking at your residential access lines and the customers and the monthly churn all tracking about 7% declines, what conclusions have you come to looking at those correlations? It’s a nice decline in the churn but still seeing the pressure on the customers and the access lines. Is there any correlation between the types of customers that you’re losing and is there visibility on a base of customers where those trends might start to flatten out? Any thoughts on when you might see that begin to stabilize a bit?

Don Shassian

These are not really new metrics, these are metrics that we obviously have managed the business by and we continue to focus on customer internally. We’re constantly trying to segment the customer base on a residential basis whether its demographics, whether it’s geographic or the like and continue to find ways to target customers.

One of the biggest challenges is continue to move customers from left to right. How do you move a customer that is simply one residential line and get them into more products and services, more bundles, because that churn does drop there. That is where we continue to put our time and attention. We continue to find, as we move customers further to the right on that, aiming to more products and services into the triple play and other services, churn really drops off significantly.

I think our strategy has been that we continue to execute on it, I think we’ve been successful but we have more to do, continue to get to those customers that are sometimes difficult to get to, to get more products and services, to win them over with our products, with our services, with our dependability and reliability and really push on that.

On the business side, for which you don’t see those customer metrics yet, it is really about servicing those business customers. We’ve got a great network that gives them reliability they need for their businesses and really focus on giving them the services they need at a competitive price.

Maggie Wilderotter

The only thing I would add is what we’re trying to do with these metrics is to expand the transparency on the business based upon customers, based upon revenue per customer, based upon keeping customers and growing wallet share. We move away from this 100% focus on access lines being the be all and the end all of the business, we don’t look at the business that way. What we want to do is to be able to move customers through products and choices that make sense for them from a telecommunications perspective.

I think as we continue to add to these metrics with the business metrics it will definitely give you a sense of how we’re doing from a long term growth perspective for the business and that’s what really matters.

Operator

Your next question comes from Jason Armstrong – Goldman Sachs

Jason Armstrong – Goldman Sachs

Anything surprising surfacing in the remaining approval process? I know post the fair point actual filing there was increased activity at the PC level people wondering let’s make sure that this is different. I know historically you’ve talked about the idea of cash traps being floated in a couple of these states so maybe just an update there. Second question, on broadband, any change in your view there as it relates to participation in broadband stimulus plans either at the legacy markets or in the Verizon territories?

Don Shassian

On the regulatory approval process I don’t think it’s been surprising, the regulators are all doing their job, they’ve got a fiduciary responsibility to meet the public service requirements in each one of their states and they’ve gone through a process and pushed in a lot of different areas. The fair point scenario certainly raised some additional questions and concerns and I think we’ve worked through all of those.

We have, as you’ve seen, there are a number of settlement agreements which have been publicly filed that are not in commission orders as of yet but there have been some items that have been floated about having some restricted cash. Pre-funding of broadband commitments in the balance sheet not very significant dollars but they are overall consolidated otherwise but significant for those states but not consolidated wise. We’ve worked through some of those.

There are no items coming through this process to date that I’ve seen that is what I’m going to call more onerous than we’d anticipated. I think the things coming through are good issues and good conditions that the staff or interveners are putting on the table to put our feet to the fire. They’re reasonable, they’re rational, and the things we sort of anticipated if you would in a macro sense and feel like we’re going to get through the process okay.

Maggie Wilderotter

With regard to broadband stimulus I don’t believe you’re going to see Frontier going after projects from the stimulus perspective. I think I’ve mentioned this on calls before the reporting and some of the uncertainty about changes that could get made, if you took stimulus money are just so onerous it doesn’t make any sense for us to do that.

With that said, I do know there are a couple states, there are a couple non-profit institutions and colleges and universities in our markets that are applying for some stimulus dollars and we are in partnerships with them that if in fact they get the dollars we will in turn put those dollars to work to improve the networks and the quality of their telecommunication services. From a direct perspective we will not be participating.

Operator

Your next question comes from David Barden – Bank of America

David Barden – Bank of America

Higher level and also on the regulatory front, the master broadband plan coming out in a month, I wonder if you guys could talk about first, your expectations about what’s going to happen, how that would conceivably if implemented impact Frontier, and how that changes with the merger of the Verizon properties in terms of your exposure to things like universal service and switched access?

Maggie Wilderotter

The national broadband plan we have been working closely with the FCC, we have met with the broadband team several times to give them input not just on the need for reach for broadband and capacity in the markets for broadband but also about access in the home because I think there’s been several studies that have come out over the last couple weeks that show that there are many Americans that just choose not to use broadband because either they don’t see the value of it or they don’t have a piece of equipment like a PC or a netbook to actually hook to broadband.

We have been very active with the FCC as they are going through their process. What they will do is report to Congress in March and that report is not law making, it’s making recommendations to Congress on certain things that Congress might take up from a broadband initiative perspective. The Congress will then take that report and probably deliberate on it and then they might make some decisions on certain bills that they would put in place on broadband which would then in turn give the FCC authority to do something on broadband differently than what they’re doing today.

We see this as a fairly lengthy procedural process but I think for our focus we believe broadband is the future for our business. We are continuing to upgrade speeds and capacity in our current Frontier markets; we look forward to doing that in the Verizon markets in addition to expanding reach. We think that they are lots of opportunity both on the business side for broadband and on the consumer side. I think the fundamental of broadband is good and more reach and more expansion is going to be important.

I think we’ve also been very proactive with the FCC on the ability to manage networks. As they look at net neutrality as well. That its important that everyone has a good experience with broadband and that the high end users should not put the lower end users in a situation where they’re subsidizing high end usage. I think there’s a lot of moving pieces here but I feel good that the commission is listening and I think what we will see come out of this broadband report will be a starting point for more dialogue both with Congress and the FCC.

Don Shassian

In terms exposures and reliance on access revenues, Frontier stand alone switched access is about 12% of our revenues, subsidy is about 5% so say about 17% of our revenue is regulatory revenue. The switch revenues continue to decline as switch minutes are going down. The subsidy portion which is about 5%, about $113 million for the year, a good portion of that is surcharges which is a pass through revenue so its in both revenue and expense which is about $35 or $36 million, you back that out its about $78 million and about $9 million of that is state so there’s about $70 million that’s federal.

High cost fund was like $15 million local switching support below that you’ve got calls revenue. Net net, Federal is about 3% of our revenue. It will continue to decline as we reduced our costs and so it ends up becoming a lower reliance on it if you would, as well.

We look at the Verizon properties; their total reliance on regulatory revenue is below 10% and subsidies even lower than ours. The combined companies reliance on switched access and on subsidy while any changes that go on in Washington certainly we’ve got to be very mindful of, we’ve got to be very proactive to manage. The degree of reliance is relatively smaller compared to others in our peer group.

David Barden – Bank of America

Verizon was 10% relative to your 12% in terms of switched access revenues?

Don Shassian

Switched access is below 10%, ours is 12%, they’re below 10% and their subsidy was even lower than ours. Their regulatory revenue was below 10% in total.

David Barden – Bank of America

Presumably their call party so changes in levels of interstate, inter carrier compensation on a permanent basis were probably less impactful for them than they would be for the stand alone FTR business?

Don Shassian

It should be because the Verizon properties were GTE properties. GTE many years ago implemented a regulatory framework to have more extended local calling areas, local rates were a little bit higher for extended calling areas and therefore intrastate access was much lower. A minutes basis it’s much lower than you would see many other places around the country.

Operator

Your next question comes from Scott Goldman – JP Morgan

Scott Goldman – JP Morgan

Wondering if you could just talk to us a little bit about what’s embedded in the free cash flow guidance as far as cash taxes and pension expense for 2010? Also wondering if you can just update us on the promotion update for the quarter, how you saw that relative to previous promotions in past quarters?

Don Shassian

Free cash flow guidance, what’s built into the guidance of free cash flow cash taxes is approximately $60 to $70 million in cash taxes. It is benefiting from change in tax accounting that we implemented last year that will be receiving the benefits of this year. It does not reflect any anticipation that may happen from any change in legislation in Washington to extend bonus depreciation that is not included. I will mention to you that the cash tax number is simply for business as usual.

I will tell you when we think about our company as whole, as a result of the integration spending and everything else, all those other expenses and capital expenditures are going to also consolidated wise significantly decline, reduced our cash taxes. From a business as usual standpoint, which is the guidance I’m trying to give to all of our stakeholders of the free cash flow numbers, it’s a BAU (business as usual) cash tax number.

Pension is a $10 million contribution on pension. While we had some good improvement in the pension assets, during the year we were just slightly on the curb of having to contribute and so we’re anticipating that we’re going to need to contribute $10 million evenly spread over the quarters during the year.

Scott Goldman – JP Morgan

What about from a non-cash pension expense through the P&L, is that the $10 million you’re talking about or is that a contribution?

Don Shassian

The total pension expense is I think about $40 to $45 million for the year. Both of these numbers, all the things you just asked about will be disclosed in the 10-K you’ll see later on this week.

Scott Goldman – JP Morgan

On the free cash flow I’m assuming that includes any reversal from bonus depreciation you guys have received in past years due to government stimulus?

Don Shassian

Yes, we’ve assumed there is no additional bonus depreciation in 2009 that’s correct.

Scott Goldman – JP Morgan

On the promotion update relative to past promotions?

Maggie Wilderotter

You’re talking about the fourth quarter promotions that we did?

Scott Goldman – JP Morgan

The fourth quarter and if you guys have made any changes heading into Q1.

Maggie Wilderotter

In the fourth quarter we ran basic promotions, we didn’t do any aspirational gifts in the fourth quarter. We did do a broadband promotion across the board and had pretty good results from that so we felt good about that. I think we had very good lift with our net adds for high speed and that also drove a lot of bundles and it also included a very strong video take rate in our marketplace.

In the first quarter again we have not done any big aspirational gift promotion like we did last year. We just started with the netbook promotion in the last 30 days so its early days on the results of that. What we’ve done this time differently is we’ve only targeted markets with low PC penetration and high share growth opportunity for broadband. It doesn’t cover a huge amount of our subscribers; it’s only about 15% to 20% of the subscriber base.

We have basic promotions running in our other markets and you will continue to see us bring out different promotions throughout the year to make sure that we continue to stay aggressive competitively in the marketplace.

Operator

Your next question comes from Michael Rollins – Citi

Michael Rollins – Citi

I wanted to follow up on this conversation of switched access. Can you give us a sense of how to compare maybe switched access revenue to switched access costs so we could think about more the cash flow implication of a possible change in rate? Maybe if you can also give that for both the Frontier stand alone and how you perceive that in the pending acquisition of the Verizon line?

Don Shassian

As you well know, switched access revenue is a subsidy that started way back in the creation of the entire Bell system. Subsidies were created to enable local phone service to be affordable and accessible to all homes in this country, 98% home availability. Both federal and states developed mechanisms for other products and services to subsidize it, whether it was higher long distance rates, the Bell breakup changes and all of a sudden it ends up being switched access changes being paid to the local system.

As a result of being a subsidy therefore it is 100% margin, there are no real costs associated to that. It is subsidizing a cost to deliver local service that is costing us more than we bill our customers for local service revenues, that’s the nature of the system and it’s trying to rebalance that over time in a variety of different ways that people have been trying to do for a number of years.

If there’s reform that occurs on switched access we’ve got to find ways to be able to deal with that but it is not something that we’ve got immediate variable costs that are going to fall away.

Michael Rollins – Citi

I perceive that you’re the largest long distance provider to your customers in your region. I presume that you pay switched access costs for those customers. Suspecting that if there’s reform to rates, while your receipts go down from that your costs for the long distance services that you offer your customers go down as well.

What I’m curious about is how to think about the net amount that you actually receive for switched access, recognizing that yes you received this high margin revenue coming in from other carriers but you also pay some out. I’m trying to think of the totality of how a reform of switched access could affect your business model?

Don Shassian

It does have a reduction in the network access costs we’re paying other long distance carriers. It is not a dollar for dollar and we don’t give guidance out of what that relationship would be. Our provision of long distance service for our customers is on a residential basis well over 70% of the customers use us for long distance calling and the like. There is a reduction that does occur with that but I think the important aspect to understand is that switched access minutes of use are declining and continue to decline.

Revenue is declining and the costs we’re paying to underlying carriers are also declining. I don’t have a good number to give you as a relationship and what percentage of switched access revenue are we in turn paying long distance carriers for cost of access. I’ll think about a way of communicating that to you all, let me think about the right way to phrase that because there’s some carriers that we pay originating, terminating and carriage too, others have a different framework, so it all has a different complexity to it.

Maggie Wilderotter

The other piece of this puzzle too as the government looks to maybe make changes to inter carrier compensation and universal service funding, is I think they will also make changes to the issue of fraud on our network which a lot of people refer to as phantom traffic. I think they will also make changes to IP traffic. There’s going to also be some quid pro quo on the revenue side for our business if in fact there is reform. Those pieces have to get taken into consideration as you look at the entire picture as well.

Operator

Your last question comes from Todd Rethemeier – Hudson Square Research

Todd Rethemeier – Hudson Square Research

Has Verizon been doing anything in their markets to counter the competitive offers that are taking place, anything to try to win back or keep some of those customers for you before you buy them? Second, you’ve had these free PC offers going for several years now, have you done any studies to look at the long term effectiveness, how many of those customers that took a free PC the first year do you still have paying you for broadband?

Maggie Wilderotter

In terms of the counter of competitive offers, Verizon I think is running these markets from a business as usual perspective and they have basic promotions in the marketplace. I think that they’re competing against the cable operators just like they always have. We haven’t seen any over the top offers that are specializing on a market by market basis because that’s really not how they run their business today, its really more national offers that they do, which is another reason why we think are huge opportunities for us because we’re going to go into these markets and really attack these markets from a local engagement perspective. We think that’s where the rubber meets the road and where you could really truly win in the marketplace.

With regard to the free PC offers.

Don Shassian

We’ve do track this quite closely and we’ve tried different things with these promotions, whether it’s been the free PC, it’s been a free dish, whether it’s been HDTV, digital camera, we did a MasterCard, we track every one of these. While they all have pluses and minuses they all have churn characteristics for new customers that are better than customers that come on without those promos. They stay with us longer.

We also make these offers available to existing customers as well. They have to either add additional, either the price protection plan or they buy some other products and services. Their churn is significantly lower than other customers on high speed, whether on a promo, not on a promo. We’ve seen some of the offers have done better than others. We’ve done some things in terms of how we marketed, how we’ve serviced, we’ve looked at some credit statistics, we’ve done a variety of different things over the year and we continue to try to refine that.

We continue to do these because we see them as beneficial. They create very good buzz in the marketplace and for customers that opt in as new or existing, if we structured it right the churn characteristics are much better. Outside of that if people don’t want to opt into the programs we do have customers that call in so our call center representatives, our technicians that are contacted by people in the field they’re able to suggest other products and promotions that they can get into something else. It creates a nice pull through for us and we find it extremely attractive.

Maggie Wilderotter

We think from all of the variety of aspirational gifts we do, the free PC drives the most stickiness in the marketplace. It also drives increased penetration because we do go after households that don’t have PCs today. In getting the PC in that home we get usually a three year commitment for high speed internet service and that’s usually again bundled with other products. We are very bullish on these types of offers.

I think that wraps up for us today. We do appreciate all the support that you all continue to give us. We are very excited about the next several months; our heads are down to get all of the Verizon acquisition transaction issues handled so we can close late in the second quarter. In addition to that, continuing to deliver on the basic business. We’ll look forward to updating you again our next call. Thanks

Operator

That does conclude today’s conference. Thank you all for your participation.

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Source: Frontier Communications Corp. Q4 2009 Earnings Call Transcript
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