FairPoint Communications, Inc. (NASDAQ:FRP)
Q4 2013 Earnings Conference Call
March 04, 2014 08:30 AM ET
Paul Taaffe - VP of Corporate Communications and Development
Paul Sunu - CEO
Ajay Sabherwal - CFO
Mike McCormack - Jefferies
Good day, ladies and gentlemen, and welcome to the Quarter Four 2013 FairPoint Communications Incorporate Earnings Conference Call. My name is Sheryl, and I will be your operator for today. At this time all participants are in a listen only mode. We will conduct a question-and-answer session towards end of this conference. (Operator Instructions). As a reminder this call is being recorded for replay purposes.
I will now like to turn the call over to the Paul Taaffe, Vice President of Corporate Communications and Development. Please proceed, sir.
Good morning everyone. Our speakers today are Paul Sunu, Chief Executive Officer; and Ajay Sabherwal, Chief Financial Officer.
I would like to remind you that certain statements made during this call, which are not based on historic facts, including any statements relating to financial guidance may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements.
With that I’ll turn the call over to our CEO, Paul Sunu.
Thank you, Paul. Good morning. Thank you for joining us. We're very pleased with our 2013 performance and we're proud to have achieved or exceeded our 2013 financial guidance. We also note some key operational objectives and milestones during the year. We started building from nothing to connect over 400 healthcare facilities and we finished the year with over 250 locations on our network. In New Hampshire we completed the 95% broadband access commitment. Maine, accepted the first stage of our next generation 9-1-1 system and last month we began converting the first of 26 public service answering points.
In Vermont, in collaboration with the Vermont Public Service Board and the Department of Public service, we’ve brought broadband access to more than 4,000 new locations in the state. And across the company we crossed the 1,000 tower mark as we continue to add fiber to towers.
Utilising our strong sales team to consistently fill our pipeline with solid bookings using selective rate increases to help mitigate legacy line losses and through on-going revenue assurance activities we are able to significantly slow our year-over-year revenue loss.
Early last year, we believe that we could flatten our revenue by the end of 2013. We beat that objective, and announced in our second quarter call that we believe we have entered into that period of revenue stabilization.
And since then we supported that statement with our results. During this period of revenue stabilization our objective is to transform the mix of revenue so we continue to add more growth oriented revenues such as fiber-based, ethernet-based and business-based revenues. But we need to do more.
As discussed on our second and third quarter calls, we're focused on improving the quality of our revenues. First, we exited one of the NECA pools that lowered our quarterly revenue by $1.6 million while increasing quarterly EBITDA by over $160,000. Then we announced our program to improve the credit quality of our customer base by instituting higher credit standards and improved treatment efforts for non-paying customers. This program lowered our broadband subscriber adds in the third quarter and we saw some of its impact continuing into the fourth quarter. But revenues in data and internet services remained strong.
Our objective is to better understand the character of our revenue to improve its quality and profitability and lower churn. Now with less noise in our revenue numbers, one aspect that has become more apparent is the seasonality in our business. Seasonal customers disconnect or suspend service when they leave the market and reconnect when they return. While operating in three contiguous space, provides competitive advantage of reach and scale and operating benefits of economies of adjacency, it does also tend to highlight seasonality. As you would imagine we have both winter and summer seasonal residents in Maine, New Hampshire and Vermont.
However we see the bulk of service removals happening in October and reconnects beginning in April. Now, we have been able to trace this effect as far back as 2010. This by the way includes not only the part-time residents but also the small businesses that tend to support seasonal activities. So, seasonality for us means a revenue uptick in the second and third quarter and a down-tick in the fourth and first quarter. This seasonality has been somewhat masked by the more pronounced quarterly revenue fluctuations in the past few years, but really has become more apparent as revenue stabilizes.
So we believe the fourth quarter was impacted by seasonality to the tune of about $1 million and we expect to see an additional $500,000 to $600,000 impact in the first quarter; then we should see the $500,000 to $600,000 swing back to revenue in the second quarter and see a rise of approximately 1 million between the second and third quarter due to seasonality. We’ll be analysing the seasonality further and look in to see how we might better address the needs of our seasonal customers.
I’ve always said that our revenues will be stable when viewed in the aggregate and factors such as seasonal fluctuations, scheduling of selective rate increases, revenue insurance activities and the timing of technology churn, will lead to quarter to quarter variability in total revenue.
Looking ahead to 2014, we do expect some revenue churn due to technology conversions that is going from TDM to IP. These include services that we worked on in 2013 that’s going to churn off including the TDM circuits that support NG 9-1-1 and the fiber to the tower projects. Our objective is to cover these churns with new revenues. But we could see some upsized technology churn that could exceed the revenue generated from our regular sales bookings for that period. So while we expect revenue generated from our sales bookings to be able to cover these churns over time, there could be periods where revenue churn is noticeable in our quarter over quarter numbers.
When it comes to rate increases, our strategy is to implement them on a rolling basis. On a select subset of our customers during any given increase cycle and executing several cycles throughout the year, and we closely monitor the impact on churn. Our first increase for 2014 is scheduled to go into effect later this month.
Let me speak a bit about retention as this is another area of focus. We have identified potential churn customers and our retention team is proactively reaching out to them. One example is identifying customers who are approaching a contract term exploration or coming off a promotion. By proactively reaching out to these customers we’re protecting revenue and creating stickiness. For residential customers coming off promotions, we provide transition packages, for business customers, we work with them to understand their needs and typically see an increase in bandwidth requirements upon a renewal.
Another example is to proactively increase broadband speeds for select customers from 3 megabit to 7 megabits. This inoculates the base from having to assess alternatives and provides the platform for additional conversation to offer even higher speeds at attractive rates. Both of these programs are seeing early success.
Ajay will review our guidance in a few minutes. But we expect to remain in this period of revenue stabilization throughout 2014. Now as many of you know, two of our collective bargaining agreements that cover the majority of our represented employees in Northern New England expire in August. While formal negotiations have not started, we have met informally with labour leadership about getting the process started. We’re going to conduct good faith negotiations.
The competitive nature of the communications industry and the rapid rate of technology advancements are clear realities of operating in our business environment today. Having said that let me point out that our expectation is to remain in this period of revenue stabilization as we negotiate these agreements. Let me also point out that the adjusted EBITDA numbers that we report and as defined on our credit facilities exclude any cost related to these negotiations.
While in this period of revenue stabilization we also want to build a pipeline of meaningfully relevant products and services for our customers. In 2013, our product development teams rolled out our hosted voice offering and we’re seeing solid customer interest and sales bookings. We continue to develop additional products and services that we feel are appropriate extensions of our current business and leverage out Ethernet network. Internally, we’ve been developing services under the umbrella of logistics and integration services. These services today are often labelled managed services and cloud services. We look forward to discussing these offerings with you as they get introduced in the market this year.
Having a wide array of relevant and cost effective solutions that leverages the reliability and reach of our next generation network and 16,000 miles of fiber will help us to meet the growing needs of our current and future customers. One last priority of emphasize at the team is our commitment to customer service. We have a great network, outstanding products and more in the pipeline. And through great service I believe we can accelerate our momentum.
So in summary the way we operate is not flashy but we make steady and sure progress to create value. We take a methodical and disciplined approach. We set out objectives, we meet them. I’m proud of our team and the work we’re doing to transform our revenues while we’re in this period of revenue stabilization. And I’m excited about the opportunities to continue to create value in 2014.
So with that let me turn it over to Ajay to review or financial numbers. Ajay?
Thank you Paul, and good morning everyone. I will discuss our annual results and the sequential comparison of the fourth quarter versus the third quarter of 2013, as well as provide our financial guidance for 2014. We had a solid quarter and a great year. With full year unlevered free cash flow of $113 million that exceeded our guidance of $100 million to $110 million.
Full-year adjusted EBITDA of $265 million was at the top end of our guidance range and capital expenditures declined $17 million from $145 million in 2012 to $128 million in 2013; slightly lower than our revised guidance of $130 million.
We’re also pleased to have reported $6.1 million in net income this quarter. However, while our operations and reported financial numbers have shown improvement, net income before taxes remains in a loss position. This quarter, we had some one-time favourable tax valuation allowance adjustments arising from a number of drivers.
Now let me take you through the financial results for the quarter from revenue through unlevered free cash flow. We reported revenues of $233.4 million in Q4 compared to $236 million in Q3. The decrease is due to the continued decline in voice services revenue resulting from fewer lines in service, higher service quality penalties and seasonality. Access line losses slowed in the quarter and broadband subscribers declined at a slower pace than Q3. While we continue our efforts to improve customer credit quality, the impact on subscriber account is beginning to lessen.
For the quarter and the year, revenue was right in line with our expectations and our quarterly results support our belief that we are in a period of stabilization, as data and internet revenues become a larger percentage of our total revenue. Revenue in 2013 was $939.4 million versus $973.6 million in 2012. The decline of 3.5% or $34.3 million compares to a decline of 5.4% or $55.8 million in 2012. Voice access lines pro forma for divestitures declined 7.1% in 2013 versus 7.7% in 2012, and Ethernet circuits grew 60.1% in 2013.
On a sequential basis operating expenses before depreciation, amortization and reorganization declined to $186 million from $187.2 million in Q3. The decrease was primarily the result of lower employee expenses. For the year operating expenses of $770.9 million declined from $782.7 million in 2012. The decline was driven by lower cost of goods sold, back-office expense and operating taxes. Employee headcount declined by 198 from 3,369 in 2012 to 3171 at the end of 2013.
Adjusted EBITDA was $67.2 million in the quarter versus $67.5 million in Q3. Lower operating expenses helped offset lower revenue in the quarter to yield essentially flat adjusted EBITDA. Adjusted EBITDA margin of 28.8% was up 20 basis points from Q3 and at the highest rate since the second quarter of 2012. For the year adjusted EBITDA was $265 million and declined from $277.9 million in 2012. The decline was primarily driven by lower revenue, partially offset by lower operating expenses.
Q4 CapEx of $37.2 million was higher than Q3 of $33.8 million. This sequential increase reflects an expected higher Q4 spend as we completed some IT and year-end maintenance projects. As stated earlier our full year CapEx was $128.3 million. For the year unlevered free cash flow of $113.3 million resulted from adjusted EBITDA of $265 million less CapEx of $128.3 million and $23.4 million of pension and cash payments. We were able to more than offset the $34 million decline in revenue with solid operating and capital expense control to deliver a year-over-year increase in unlevered free cash flow. Based on the calculation prescribed by our credit agreement, we do not expect any cash flow suit for 2013.
In 2014, we are providing the following financial guidance; we expect to generate $930 million to $940 million in revenue, resulting in unlevered free cash flow of $100 million to $110 million. This results from adjusted EBITDA of $260 million to $270 million, capital expenditures of approximately $125 million and cash used for pension contributions and OPEB on a combined basis of approximately $35 million. For the year, we expect scheduled annual principal payments of $6.2 million and cash interest expense of $75 million to $80 million. At the end of 2013, our cash balance was $42.7 million as compared to $23.2 million at the end of 2012. Our $75 million remained undrawn at year-end with $15.9 million committed for letters of credit.
So before I turn it over for Q&A, let me reiterate some key themes. We had a strong year and we met/exceeded our guidance on key financial metrics. We believe we are in a period of revenue stabilization. Unlevered free cash flow generation remain strong at over $100 million annually through solid operating and capital expense control we delivered a year-over-year increase in unlevered free cash flow.
So with that let me ask the operator to open the call up for Q&A.
Okay, we’ll take our first question.
And this question comes from the line of Mike McCormack from Jefferies. Please proceed.
Mike McCormack - Jefferies
Hey guys thanks. I think you did a very good job of explaining the seasonality on the revenue side Paul let me just dig into the cost side I guess did a pretty good job of forming cost out of the business even before the new negotiations just completed. But thinking about as we get back into a busy year sort of second and third quarter how is the cost structure look at we go through that period? And then also maybe at seasonality but the broadband business we’ve seen a pretty good deceleration here. I am not sure how much of that is [threaten] credit standards the seasonality that you mentioned or maybe competitive threats that you can just walk through the fees parts of that would be great. Thanks.
Thanks Mike. Yes, so on the -- we have done a good job of managing our cost. And I think that there is more room here like we inherited a business that had lot of low hanging fruit in terms of efficiencies and I think we’ve been able to take advantage of that. Our operating team has done a really good job of instituting processes and utilizing some systems to gain some advantages. I expect that there is more to do. I mean we’re still continuing to groom the network. We continue to work on ways that we can improve under that transact cost and such. And so I expect that we’ll still be able to manage our cost and that’s reflected in our guidance for the year.
On the broadband side of things, as I said in my opening remarks it’s pretty important for us to make sure that we have the quality revenues that we’re looking for as we continue to move forward. We think that bringing in low credit customers who then end up not paying us and we have to spend efforts to treat and then ultimately disconnect them right off is a resource [grind] and it’s better for us to kind of call through this and take the heat if you will, early rather than later. And so while we’re in this period of revenue stabilization we’re in the process of doing that.
We saw the impact in the third quarter, we saw some of it in the fourth quarter and I do believe that we’re kind of going through this pretty well. And so we should start to come out of this period and see some daylight in terms of growth.
Mike McCormack - Jefferies
Hey Paul you mentioned price increases as a potential uplift in the revenue size as we progress through the year. Is that a particular product you're going after and how should we think about that rolling across the entire base of is it just new people signing up how should we look at that?
Well, one of the things that we have done here is we do price increases on a select base of customers and we institute a number of these throughout the year. Part of this is when you -- when we first started doing this we wanted to make sure that we didn’t end up with a bad reaction and so doing a small sample was a good idea and a good way to do it. But more importantly from an operational perspective when you do these rate increases it can start to flood your call centres with a lot of calls about it and then it takes away from the work that our reps are doing, and so part of what we want to do is to manage these things well.
And so it’s not only the revenue side of things it’s really managing the process and the productivity of our work force. And so we do these things multiple times during the year and they’re small increases. We’re not looking to make big moves. What we want to do is to just make sure that our price increases here are helping us to keep our revenues buoyant as the legacy lines are going away.
Mike McCormack - Jefferies
Paul and if I could just sneak one more and just thinking about the revenue mix shift obviously moving into your high growth products. How should we think about that from a capital intensity standpoint you guys are maintaining a sort of 13% to 14% type range. Does that climb up over time as that revenue mix shift continues?
We’ve spent a lot of money on our next generation network. We also have 16,000 miles of fiber that runs through Maine, New Hampshire and Vermont. So, our -- the arteries of our transport network are very, very strong. So when we’re provisioning things we’re trying to get as much on to fiber as possible which as you know is quite efficient from a repair and maintenance point of view.
And we’ve always been able to -- we’ve described our business as a having a capital intensity -- CapEx intensity been in the low teens. I think our numbers this year at the midpoint of revenue ends up being like 13.4%. So, we’re kind of getting to the low end of that range. And we still feel that that’s probably the right direction for the company. But in a year like this year we think that the number that we set up of 125 million seems very appropriate in light up the projects that we see in hand and the work we need to do.
Sir you have no further questions at this time. I would now like to turn the call over to Paul for closing remarks.
Thank you again for your interest in FairPoint. We look forward to speaking with you again on our first quarter call. Have a great day.
Thank you for joining today’s conference. This concludes the presentation. You may now disconnect. Have a good day.
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