Frontier Communications Corporations (NYSE:FTR)
Q2 2014 Results Earnings Conference Call
August 05, 2014, 04:30 PM ET
Luke Szymczak – VP, IR
Maggie Wilderotter – Chairman and CEO
Dan McCarthy – President and COO
John Jureller – Executive VP and CFO
Batya Levi – UBS
Simon Flannery – Morgan Stanley
Frank Louthan – Raymond James
David Barden – Bank of America
Phil Cusik – JPMorgan.
Mike McCormack – Jefferies
Michael Rollins – Citi Investment Research
Good day, everyone, and welcome to the Frontier Communications Second Quarter 2014 Earnings Report Conference Call. Today’s call is being recorded. At this time, I would like to turn the call over to Mr. Luke Szymczak. Please go ahead, sir.
Thank you Brendan, and welcome to the Frontier Communications second quarter earnings call. My name is Luke Szymczak, Vice President of Investor Relations. With me today are Maggie Wilderotter, Chairman and Chief Executive Officer; Dan McCarthy, President and Chief Operating Officer; and John Jureller, Executive Vice President and Chief Financial Officer.
The press release, earnings presentation and supplemental financials are available on the Investor Relations section of our website, frontier.com. During this call, we will be making certain forward-looking statements. Please review the Safe Harbor language found in our press release and SEC filings. On this call, we will also be discussing our GAAP and non-GAAP financial measures as defined under SEC rules. Reconciliation between GAAP and non-GAAP is provided in our earnings release. Please refer to this material during our discussion.
I'll now turn the call over to Maggie.
Thanks Luke, and good afternoon, everyone. We appreciate you joining Frontier’s second quarter 2014 earnings call. Frontier continued its solid momentum and delivered strong results in Q2. We are pleased with our sustained operational and financial performance and we remain on track to close the Connecticut acquisition in the fourth quarter. Our total shareholder return for the 12 months ending June 30th was 54% evidenced that our hard work and yielding results that benefit Frontier’s shareholders.
I will start on Slide 5. In Q2, we delivered 27,700 broadband net adds making it our sixth consecutive strong quarter. Growth continues to be broad-based with market share penetration gains in 82% of our local markets through the first half of this year. We also delivered sequential growth in residential revenue in Q2 which is another milestone in stabilizing our revenues. We are pleased that the small, medium enterprise portion of our business which we refer to as SME had good revenue performance this quarter as well and improved trends relative to Q1. Our operational execution has yielded substantial improvement in revenues over the last 18 months. We expect that we will sustain these trends throughout the rest of 2014.
One catalyst for our results this quarter was an increased emphasis on marketing bundles relative to Q1 when simply broad-band was the primary focus. We generally maintain a balance in attracting bundled and standalone customers each quarter. In Q2, more emphasis on bundles resulted in a product mix with higher billing for customer and this is reflected in the sequential uptick in residential average revenue per customer or ARPC.
We continued to increase the rate at which customers move to higher broad-brand speed tiers in Q2, a third of our broad band activity was above the basis speed tier. We also maintained our focus on new product roll outs like our new residential emergency phone line for 499 per month which provides customers a resilient and reliable back up phone for emergencies. We believe the weather patterns of the past two years have convinced many that in an emergency situation a land line can be a true life line. The emergency line availability is unique, because our competitors do not have the same level of network resiliency or reliability that we do.
For the SME market we introduced Frontier Texting powered by Zipwhip. Frontier Texting allows our business customers to stand and receive text messages using their existing land line phone numbers. This is a great way for businesses to communicate with customers and employees who prefer to use text messaging.
Since launch, we have sold close to 800 businesses on this feature and it is driving substantial incremental new voice lines and broad-band service in addition to new customers to Frontier. We are making progress with our Frontier AnyVare hosted business Voice-over-IP telephony platform which is now available in all markets and is targeted at small and medium businesses. Since cyber crime knows no boundaries, we launched a new automated online capability that allows us to market and sign up customers for Frontier Secure suite of products outside of our footprint. Our Internet of Things offerings expanded in Q2 with the addition of the Nest Thermostat, customers can now remotely monitor and set their heat and air-conditioning.
This product along with remote video monitoring security monitoring with our Dropcam product starts to provide customers with home automation products fully supported by our Premium Text Support teams at Frontier.
Watch for continued broadening of these offerings over the coming quarters, the Internet of Things is important because it leverages our broadband capabilities, enhances our revenues and presents more opportunities to offer our customers a monthly Tech Support service.
Speaking of our Tech Support capabilities, I am pleased that we have signed a new three-year contract with Intuit to offer their customers our Premium Tech Support and customer support capabilities for the QuickBooks product line.
This expansion of our business relationship with Intuit was based on the track record we have build with them over the past year and a half and providing U.S. based Tech Support to some of their customers from our call centers.
White Label Premium Tech Support is a growth business for Frontier that we plan on aggressively expanding. Another recent milestone was the anonymous approval on July 25 of our Connecticut acquisition by the Federal Communications Commission or FCC.
We now have secured all federal approvals and we have made strong progress in getting state approval as well. We continue to monitor the progress of the new FCC Connect America Fund or CAF II which is plan to replace tradition universal service fund support that focused on voice products.
The FCC is finalizing some changes to the CAF II program, but as designed it will enable Frontier to build broadband to households that don’t have it today and to increase broadband speeds to current customers in our most rural markets.
The FCC continues to indicate that they are on track to offer financial support to carriers by the end of this year with the program implementation beginning in 2015. We believe the FCC’s new plans for using E-Rate funds to support broadband and WiFi services for schools will ultimately benefit the education of this nation’s children and also offers Frontier an opportunity to provide new advanced services to these important customers.
Everyone on this call is in the fortunate position of taking great connectivity for granted. In unserved and underserved areas, internet access can literally change lives. We are proud to be part of that effort and we plan to aggressively apply for these E-Rate funds in our markets.
Net neutrality continues to make headlines and we remain confident, a consensus can be build that protects consumers abilities to access the internet, allows new businesses to get a start on the internet and creates the competitive commercial environment for network owners like Frontier to continue investing in much demanded capacity.
To clarify, Frontier has been peering with other companies for years now. It is how we connect to services and content hosted by others. The bottom-line for us is that Frontier has promoted an open internet environment since we begin to offer broadband service, regulating the internet will result in dampened investment and innovation.
We will continue to work with other ISPs, content providers, and the FCC over the next several months on this important topic. We believe the best net neutrality result will be one that enables consumers and businesses to participate in the decisions about carriage and prioritization of their content deliver and usage.
In Q2 we delivered strong expense management which has always been a hallmark of how Frontier does business. We still have expense reduction opportunities in our current markets and we will also drive for synergies in Connecticut as soon as we close.
We know that expense management is a key to sustaining our free cash flow and our dividend. Our management team is focused on achieving our free cash flow targets which underpin our dividend. In Q2 we maintained a very attractive and secured dividend payout ratio.
We are excited about the prospects for the Connecticut transaction to create incremental value for our shareholders. We anticipate the transaction will be free cash flow accretive in the first fully year and will increase the security of our dividend by improving the dividend payout ratio.
The all-cash consideration means no dilution for Frontier shareholders. We are prepared to complete the cut over and close the Connecticut transaction in Q4. As we all know the Windstream REIT announcement has attracted considerable attention.
Putting a tax efficient structure in place has a lot of appeal. While they have received the private letter ruling from the IRS, as Windstream has mentioned, there are still other hurdles they need to clear to implement this structure successfully.
As for Frontier, our current top priorities are to deliver on the basic business and ensure a successful and high quality integration of the Connecticut acquisition. We are always looking for ways to optimize our tax structure that compliments our business strategy. We will closely follow Windstream’s progress and evaluate the REIT structure based on what we learned from their implementation.
I will now hand the call over to Frontier’s President, Dan McCarthy, who will provide more color on our Q2 operating results.
Thanks, Maggie. Please turn to slide six. Our focus continues to be driving growth in broadband market share. As Maggie discussed we had another strong quarter of broadband results, with net additions of 27,693.
This quarter our marketing programs produced a sales mix more heavily weighted toward bundled sales and higher speed tiers. This mix resulted in a higher ARPC level and was a contributor to the growth in residential revenue we delivered this quarter. We were pleased with these results especially the expansion of sales in higher speed tiers.
In the first half of this year we have taken share in 82% of our local markets and we remained optimistic in our ability to continue to this trend by offering customer choice and simplicity.
In Q2 Frontier Secure attach rates were 32% on all residential broadband sales. Frontier Secure continues to resonate with customers and provides incremental revenue and most importantly, reduces customer churn.
We continue to invest in our networks to upgrades speed and capacity. This quarter 33% of our sales were in our higher speed tiers. This is up nicely from Q1 and up over 60% higher than Q2 of 2013.
We believe our network investments have been instrumental and enabling this mix change and we see substantial opportunities with our customer base since over 80% are still on our basic tier.
I want to note that nearly 10% of our households are served through a fiber to the home architecture. Over the next several quarters we will introduce expanded speed offerings in select markets including 50 megabit and 100 megabit services.
Some residential areas will also be able to purchase up to 1 gig broadband service. We are excited to bring these new products to market and look forward to making these choices available to our customers.
We continue to believe we have substantial room to increase our broadband market share with current share still below 25%, driving the share growth remains number one priority for us and we’ve aligned our resources and channel partners around this objective.
Please turn to slide seven. Residential revenue grew sequentially in Q2 reflecting our retention efforts and increased focus on bundled product sales and solid market share growth.
During the quarter, the SME revenue trend also improved declining less than $1 million sequentially from Q1. Customer Premise Equipment revenue was up sequentially in Q2 as we had anticipated and we have continue to build a very strong pipeline headed into the second half of the year. This contributed to the SME quarter-over-quarter progress.
In the carrier portion of the business we saw revenue pressures associated with the continued migration of mobility customers from TDM to Ethernet services.
We are working with all wireless carrier partners on the timing of their tower conversions to fiber. As a result, we may see some tower conversions move into 2015. This would be a positive for revenue in the short-term, but may extend the timing of revenue headwinds to the first few quarters in 2015.
Please turn to slide eight. Q2 is a seasonal quarter for Frontier with the completion of the school year which triggers elevated disconnect activities in our markets. This type of activity is normal and expected in the second and third quarters each year.
We did have lower customer acquisition levels due to our focus on bundled sales versus our Simply Broadband product. The combination of these events resulted in an uptick in residential net customer losses to 31,800. However, I want to point out that we did not see a significant increase in customer losses to competition or a significant change in the competitive landscape.
We just didn’t drive as much marketing activity due to the skewed advertising of our bundles over Simply Broadband. When we kicked off our advertising campaign in Q3, we have once again shifted the mix focus towards both Simply Broadband and bundles. So during the remainder of the year, we anticipate sales mix results similar to Q1 with increase Simply Broadband levels. And thus far in Q3 we are seeing this trend.
On the business front, we made excellent progress in improving customer losses, with Q2 losses of $2,190, roughly half the level of Q1 and the best performance since the Verizon acquisition in 2010.
Economic softness continues to contribute to a decline in the number of business in our footprint. We are encouraged that despite that decline, our market share in the business segment has been stable and in some areas increasing.
Please turn to slide nine. Our focus on simplifying our business is helping to drive cost savings. We reduced operating expenses by $7 million sequentially to $614 million excluding pension in OPEB cost. John will discuss this in greater detail.
We pride ourselves on increasing efficiencies in our business and I believe the addition of Connecticut property will provide ample opportunities to drive additional efficiencies as we complete our integration.
Please turn to slide 10. We continue to see strong contributions from our distribution channel partnerships. In Q2 alternate channels accounted for 36% of Broadband gross additions, up from 33% in Q1.
We are pleased with our partner’s performance and their consistency in delivering each quarter. Revenue from CPE improved from Q1 reflecting our strong pipeline and the completion of a number of complex installations.
Our CPE pipeline continues to expand in all categories including Next Generation 911 systems. Although CPE remains the small portion of the overall business revenue it is very important as it allows us to provide a comprehensive solution for our customers.
We are also seeing very good momentum with our Ethernet offerings, with more 34% growth relative to last year second quarter. Ethernet is the cornerstone of our growth strategy on commercial, and we are investing more capital to expand Ethernet to new areas as well as upgrading our MPLS switching platforms.
An area that continues to show strong growth is our deployment of WiFi solutions for commercial customers. We have been pursuing and wining WiFi opportunities for nearly a decade.
This quarter brought some high profile successes including the American Tobacco Campus in Durham, North Carolina. We see the FCC’s decision regarding E-Rate for schools as a catalyst for new Wifi opportunities for us in the education segment. We plan to aggressively pursue those opportunities and leverage our local engagement relationships to facilitate WiFi deployments throughout our footprint.
Slide 11, updates the progress we are making on our network. In Q2, our Broadband availability expanded to additional 14,000 households of which 6,900 were funded with the FCC Connect America Fund program known as CAF.
We also use CAF funds to upgrade broadband speeds to an additional 28,900 households. As of the end of Q2 we can now serve 90% of our footprint with Broadband. We are proud of this accomplishment and look forward to working with the FCC to finalize CAF II rules and drive further expansion and capacity upgrades in our market.
As mentioned we are introducing new speeds in select market up to 1 gigabit. As of the end of Q2, 54% of the households can receive 20 meg or greater speed, 75% can get 12 megabit and 83% can get 6 megabit.
Over the last few weeks we have made great progress in renegotiating several of our large collective bargaining agreements. This included reaching tentative agreement with the Communication Workers of America in West Virginia. This is currently our largest single contract and we are delighted to have reached this agreement.
We are all working diligently to prepare for the Connecticut acquisition. Our teams are preparing for flash cut at close and we will be moving to the Frontier systems immediately. We have been pleased with the corporation from AT&T in facilitating our preparations and they’ve been excellent partners in preparing for the asset transfer.
Our initial plans will be to aggressively market U-verse, while upgrading broadband speeds in many of the more rural market clusters. These upgrades will include improving last mile electronics and migrating middle-mile infrastructure to ROADM technology.
We believe we will have an excellent network platform to compete in Connecticut from day one. We remained confident in our ability to close the transaction in Q4. We have been able to reach settlements with many parties in the state approval case and we have received a strong welcome from the Connecticut business community and we are delighted to have the full support of the Communication Workers in America.
We’ve completed all Connecticut regulatory hearings and preparations for system conversions and integration. And as Maggie mentioned the transaction has received approval from the SEC. We also have good line of sight to the synergy target we have discussed with you in the past. We are on track and we look forward to getting this acquisition closed.
I’ll now hand the call over to our CFO, John Jureller.
Thank you, Dan. I’d like to review the second quarter results. Frontier had earnings per share of $0.04 in the second quarter of 2014, compared to a loss of $0.04 in the second quarter of 2013, and earnings of $0.04 in the first quarter of 2014.
Adjusting for expenses related to the pending acquisition of the AT&T Connecticut properties, severance cost and discrete tax items, our non-GAAP adjusted net income was $0.05 per share in the second quarter of 2014 as compared to $0.06 per share in the second quarter of 2013 and $0.05 per share in the first quarter of 2014. On July 30, the Board declared a quarterly dividend payment of $0.10 per share consistent with past quarters.
Slide 12 shows our revenue composition. Our revenues for the quarter were $1.147 billion, a sequential decline of only $6.8 million, or 0.6% and an improvement compared to the $26.3 million sequential decline in Q1.
Total residential customer revenue was $497 million, an increase of $1.1 million sequentially. This increase was lead by our continuing growth in residential data revenue. Business customer revenue of $516.3 million was down $8.7 million sequentially. This business revenue decline was primarily related to the anticipated step down in wireless backhaul revenue. As Dan mentioned, CPE was a positive contributor at this quarter.
Customer data and Internet services revenue increased by $1.2 million versus the first quarter of 2014, due to residential and business broadband growth, as well increased Frontier Secure revenue partially offset by the decline in wireless backhaul revenue.
As were shown previously on slide seven, Frontier’s data services revenue continues to grow, increasing approximately 8% since Q2, 2013. Further the sequential increase versus Q1 offset the sequential decline in now-switch data revenues, even with the headwinds and wireless backhaul revenues.
Voice services revenues decline $10.7 million or 2.2% as compared to the first quarter of 2014. Regulatory revenue for the quarter was $134 million, an increase of $0.9 million sequentially.
Overall, we are pleased with our revenue performance. We maintained strong residential Broadband acquisition in customer momentum in Q2 which is beginning to drive sequential improvements in our residential revenue. Likewise, we are pleased with continued improvement in the revenue trends in the SME portion of business revenue.
Slide 13 provides an analysis of our average revenue per customer. In residential, average revenue per customer or ARPC of $59.64 represented 1% sequential increase, as well as 1% increase over the prior year.
We had a relatively higher mix of bundled product customer additions that is double and triple plays, as well as some pricing changes which contributed to the uptick. Business ARPC was 0.4% lower sequentially and 0.5% less than the prior year.
The decline was primarily due to the decrease in wireless backhaul revenue from the same base of carrier customers. The percentage decline in business customers improved by 50% from the first quarter and was at its best level since the 2010 acquisition. We estimate that our overall market share in business was stable once again this quarter.
As shown on slide 14, our cash operating expenses remained stable sequentially in Q2 and decline by $1 million relative to the second quarter of 2013. This excludes approximately $20 million of integration related operating expenses for the Connecticut transaction.
As Dan discussed earlier, excluding pension and OPEB cost, the remaining cash operating expenses were down $7 million sequentially and declined year-over-year. Pension and OPEB cash contributions which are funded at various times throughout the year are mostly non-controllable on our quarter-to-quarter basis.
So it’s important to highlight the progress we continue to make in our controllable cost structure. At the same time, we continue to provide visibility to our investors with respect to our annual pension contributions which for this year will total approximately $100 million and are included in our leverage free cash flow guidance.
The adjusted EBITDA margin was 44.9% for the second quarter of 2014. Adjusted EBITDA excluding pension and OPEB entirely was 46.4% as compared to 46.2% in Q1. We remain committed to improving our operating efficiency while investing effectively in our network, customer service, and delivery infrastructure to drive our business forward.
We incurred $126 million of capital expenditures in Q2, and an additional $31 million related to the Connecticut integration activities. Further our CAF funded expenditures in Q2 were $18 million. To-date, we have expended $62 million of the $133 million CAF funds received.
Please turn to slide 15. Frontier’s cash flow remains very healthy. On a trailing four-quarter basis, our leverage free cash flow was $931 million for Q2. Our dividend payout ratio was 46% in Q2. We continue to focus on our free cash flow generation and maintaining a comfortable dividend payout ratio for our shareholders.
On Slide 16, is our leverage ratio and liquidity relative to prior periods. Frontier’s liquidity remains robust. We ended the quarter with nearly $1.6 billion in cash and credit availability. Note that our liquidity has consistently remained strong and our free cash flow generation after dividends has provides for a reduction of $500 million in net debt over the last four quarters.
Frontier’s capital allocation framework remains unchanged, investing appropriately in our network infrastructure and operations, supporting our current dividend and utilizing excess cash generated to reduce indebtedness and our leverage ratio over time. We are comfortable with our leverage rate levels and are committed to maintaining our liquidity along with a prudently managed balance sheet.
Slide 17 shows our long-term debt maturity profile. As we've indicated based upon how management sees the trajectory of the business we’re confident in our ability to generate cash flow from our current business to fund our scheduled debt repayments through 2016 without a refinancing need.
Once completed, the addition of a cash flow from a Connecticut business will only serve to further bolster our cash generation. In the second quarter we completed a four-year renewal of our $750 million revolving credit facility and completed a favorable $350 million term loan commitment. We anticipate being in the public markets in the third quarter for an estimated $1.55 billion for the remainder of the Connecticut acquisition bridge loan refinancing.
Please turn to slide 18. We are reaffirming our 2014 guidance. Our guidance for leverage free cash flow is a range of $725 million to $775 million. Our guidance for capital expenditures excluding expenditures related to integration activities in CAF is a range of $575 million to $625 million. This guidance excludes the impact of additional revenue, EBITDA, CapEx or other cash flow items upon the acquisition of the Connecticut business.
Our guidance for cash taxes is a range of $130 million to $160 million for our current business operations taking into account our estimate of pre-close integration expenditures. Our cash tax guidance does not include any potential impact of extending bonus depreciation into 2014, while the recent actions in this regard in Washington have been trending favorably. We will not include this potential impact in any guidance until it’s more definitive.
We continue to anticipate spending $225 million to $275 million on integration activities for the Connecticut acquisition with most of this occurring prior to the completion of the transaction. Presently, we estimate this could be $140 million to $170 million of operating expenses and $85 million to $105 million of capital expenditures.
In summary, Frontier’s operating results, proven capital investments and expense management provide a strong cash flow base and a solid financial platform for supporting and investing in the business, servicing our debt and comfortably sustaining our dividend.
In addition to our relentless focus on our base business in the 27 states we operate in today, significant activities continue in preparation of the completion of the Connecticut transaction.
With that, let me pass the call back to the operator and open up the line for questions.
Thank you. (Operator Instructions) And we’ll go first to Batya Levi with UBS.
Batya Levi - UBS
Thank you, couple of questions. First, Windstream's decision to spin its network to an independent REIT. We think that the ability to lower taxes definitely creates value, but can you give your thoughts on letting go the ownership of the network assets? Do you think that this could be achieved maybe through forming a qualified REIT structure under a holding company without giving up the ownership of the assets?
And second question on the results -- the margins were bit weaker than we thought, but when you look at it on a sequential basis, there is some stability. First, were there any one timers that we need to think about? And it looks like the headcount's increased a bit. I'm assuming that's related to the Connecticut purchase. How do you think about margins going forward? Thank you.
Hey, Batya, it’s Maggie. Let me start with the Windstream question. I will say that one of the things about the Windstream structure that gives us is the separation of the network assets from the operating company. And how that works for us for strategic flexibility in the long run, both for upgrading the networks, whether we want to acquire more properties or divest of properties. So we need to do some more homework on the various different REIT structures that could be put in place. That is something that we will look at in the coming months to see if the benefit of the tax structure would be better than some of the risks that you would take and how you make a holding company or two separate companies work.
So, it’s early days in this. We’re going to continue to explore it. We’ll also look at what Windstream has to do in order to get their proposal implemented successfully. Another challenge for us I think as being in 27 soon to be 29 states, we have public utility commissions in many locations that would weigh in on whatever we decide to do. So there are still more to come. But as I think you can understand we’re going to look at this very closely and see what the choice points are and what make sense to maximize our position.
Batya Levi - UBS
Batya, this is John. As to the margins, I think when we look at it – it’s a function obviously of our cost structure. And in our cost this quarter as we lowered expense -- our expense is lower by almost $7 million. If you set aside what we have to do throughout the year in terms of pension and OPEB. So, we continue to bring down expense through the course of the quarter. And we’re continuing to make headway and progress in further areas of the expense management and we’ll do that through the year.
The other thing Batya I would mention on the headcount increase. That is for the Intuit contract. So we have added Frontier Secure Premium Tech Support resources in order to fulfill that contract for Intuit.
Batya Levi - UBS
Okay. Got it. Thank you.
And we’ll go next to Simon Flannery with Morgan Stanley.
Simon Flannery - Morgan Stanley
Thanks a lot. Good evening. I wonder if we could come back to the Connecticut transaction. You said it would close in Q4. Can you give us a little bit more color around the timing of the hearings and various proceedings at the Commission? And also, if you have anything you can share with us on the performance of those assets over the last few quarters? And then on the systems prep, perhaps you can just talk through where you are ahead of that cut over versus where you were, say, when West Virginia or where elsewhere you've spent, I think, something like $70 million -- about 28% or so the total spend here. What have you been able to tick the box on so far? Thanks.
Hi, Simon, it’s Dan. First of all on the Connecticut hearings, we’ve completed the hearings at the state level at this point. The parties are briefing the case and we have -- as I mentioned we’ve reach settlement with many of the parties. So it’s been a very good process for us at this point. The current procedural order has potentially has us potentially receiving an order on . And then we’ll take it from there, obviously anything can happen as they get that order out. But that’s that current schedule. As far as the performance…
Simon Flannery - Morgan Stanley
I’m sorry, Simon.
Simon Flannery - Morgan Stanley
You’ll be able to close immediately on that – receipt of that is that right.
Well I have all of the approvals at that point.
Simon Flannery - Morgan Stanley
Yes. And I think if you remember Simon when we did the Verizon acquisition, we closed about 2 to 3 weeks after we got all the approvals. It will depend on the final for the flash cut, because this is similar to what we did with West Virginia. So the big thing is let’s get all the approvals done and then we will close as soon as possible.
As far as the performance of the assets, we continue to get good feedback that the assets are performing well. They continue to execute on their strategy which is really focus on the U-Verse product set in the market and they are continuing to see success there.
And as far as the conversion goes, we are on track compared to where we were with West Virginia. AT&T has been as I’ve said, a great partner. So we are going through mock conversions even as we speak, and we’re very pleased with the results. And we’re confident that after we received the approval we’ll be in a position to move forward with the close.
Simon, one thing to add on in terms of performance, you’ll be able to actually see some of that when we’re in the public debt market as part of those pro formas will be in our offering statement. So you’ll get more specific data on that in this quarter.
But I do think -- to reinforce what Dan said, AT&T has not full back in these markets here in Connecticut. They’ve done a very good job of continuing to take care of customers and grow the business.
Simon Flannery - Morgan Stanley
Great. Thank you.
We’ll go next to Frank Louthan with Raymond James.
Frank Louthan - Raymond James
Great. Thank you. Just wanted -- looking at the broadband penetration, how do you all feel about the recent FCC notice of inquiry redefining -- potentially redefining broadband as 10 megs? And then in addition on the regulatory side, through the small auction that they proposed, sort of $100 million or so ahead of the larger reverse auction, is that something that looks interesting to you to participate in? Any comments there?
Frank, this is Dan. I think we’ve been working with the FCC as many other carriers are, on the definition moving to 10. At this time, we were comfortable with that approach will continue to work with them to make sure that the characteristics for the product stay right where we think it needs to be. But at this point we’re comfortable there.
Frank, this is Maggie. On the spectrum auction that’s going to come up anything on the wireless front we are not going to participate in those auctions. That’s not something that we would look to do as a company. I think as we have a wireless partnership with AT&T and that’s what we’re really focused on.
Frank Louthan - Raymond James
Well, I was commenting -- the FCC authorized a smaller sort of CAF like auction at the May or June -- or the June meeting, actually. I was more describing that. I'm not sure if that fit any parameters. Maybe we could follow up with that off-line, but I just wanted to follow up. Any thoughts on the two Telecom/Level 3 merger? Has that caused you any concern? You have any significant penetration in any of your markets that you might want to try and lockup ahead of that merger?
Hey, Frank, I didn’t realize you’re asking about CAF. So, we know that that specific ruling was pretty narrow to very high cost, very rural areas. We’ve already taken the CAF money that we’re going to take. So from that perspective, we’re really now just focused on the CAF II initiative which we think can be millions of dollars for us on an annualized basis.
So that’s really where our focus is going to be which is not just about extending broadband, which will continue to be able to do, but its really about upgrading a number of our very rural markets to get to whatever the standard is going to be, whether its 10 meg or not.
Frank Louthan - Raymond James
And Frank, as far as the merger goes, they do cover several of our larger markets as you probably know. We’ve been working on locking up customers in extended contracts for while now. And we don’t see any expanded threat from the combination of the two.
Frank Louthan - Raymond James
Okay. Thank you.
And next we’ll go to David Barden with Bank of America.
David Barden – Bank of America
Hi, guys, thanks for taking my questions. I guess just a few, if I could. First just quick – John, an official guidance number yet until we get some more clarity, but I'm sure you've run the numbers. If you could just give us some kind of ballpark figure as to what you think the benefit from a bonus tax depreciation extension of 50%, the way it's been going on for the last couple of years, would be, it would be helpful?
Second, I know you guys called out kind of softer than typical CPE sales last quarter impacting revenue. I was wondering if you could talk about how the CPE sales specifically changed quarter on quarter and impacted the numbers this time. And then I guess the last question I have is going back to the costs. I know, Maggie, last quarter, you called out storms -- winter storms over time, mudslides in Washington, and I think that there was an expectation that the costs were going to be lower this quarter, as we seasoned the FICA and the wage increases and such.
So I was just wondering if you can kind of get a little bit more specific about what maybe was on the docket that didn't happen, what's on the docket that will happen in the second half specifically to kind of -- so we can watch the margin number a little closely? Thanks.
Hey, Dave, this is John. So let just taking your questions in order. First on bonus depreciation, again we’re hesitant to call out to people until we’re done, but we can just say the impact would be material as compared to our cash tax guidance. And let me just leave at that, because we don’t know quite how the final rules will be written, but even at 50% bonus depreciation it would have a material impact for us.
David Barden - Bank of America Merrill Lynch
As far as CPE sales, we did have expanded sales both on the large complex sales, specifically around some very large school districts that are turning up even as we speak right now and should be in the third quarter and we did sell a number of E911 systems, again are very large systems that are complex and take a lot of time to turn up, but we continue to see pretty good sales in the small side and it continues to be a competitive advantage for us against other providers who don’t provide a whole solution.
Yes two things on those questions David one is, if there are tax extended that’s very likely going to happen in the [lame duct] session if at all in Washington. So, I think as in the past we’ve also seen it happen – and then be retroactive. So, with Washington sort of in turmoil on getting anything done, we are going to be cautiously optimistic but we are going to sit back and wait to see what happens.
On the CPE side, I think as Dan and I are pretty pleased with what happened in the second quarter. We knew that there was some momentum that you have to build again because a lot of people spend in the fourth quarter so the first quarter always has a tendency to be lighter. We see a good pipeline into the third quarter for CPE and the real benefit to CPE for us is the maintenance and the ongoing recurring revenue that we get from selling these systems into our customer sites. Some of them are long term and sales like the E911 systems don’t happen overnight, sometime they can take a year to get those system sales done. But we feel good about the pipeline, and we’re encouraged for Q3 as well on CPE.
On the cost side, I want to reiterate what John said, we did reduce cost by $7 million quarter-over-quarter. Some of that was less storms and less overtime, we have a tendency though to be in markets where there is always something going on, so we also are continuing to grow the business and expand in terms of installations and repairs in the market. So, we will continue to have reduction in cost in the quarters to come as we continue to automate and streamline what we are doing. But we are also trying to drive the business on the top line growth path to which in other words we are moving resources from lowering cost in certain areas that are less strategic to supporting the business in terms of the growth that we’re seeing especially on the broad-band side.
Got it. Okay, thanks.
We’ll go next to Phil Cusik with JPMorgan.
Phil Cusik – JPMorgan.
Hi guys, thanks. Following up on an earlier question, Windstream spoke about getting to 80% 10 megs by 2018. Can you remind us where you are in terms of availability in uptick on that kind of product?
It’s a great question Phil. One of the things that are a little different about Windstream strategy versus ours is I think as we’ve been investing very heavily in this network over the last four years since the Verizon acquisition. So we feel very comfortable that we’re going to be at 10 meg and 80% of our markets in a very short period of time compared to 2018. We think probably several years before that happens. So, we are more bullish that the network we have accelerated our investments tin the network to get us there a lot quicker than what Windstream is looking at with their strategic reach.
Phil Cusik – JPMorgan
I’m sorry Phil, at this point we’re at 75% at 12 megs even as we speak.
So as we implement some of the cap funds that we have today as well as cap 2 we actually see getting to 80% much faster than the position when it’s picked up.
Yes and we’re really banking on 10 meg down at 1 meg up, that’s what we are looking at, that’s what we’ve been talking about internally to make sure that we try to deliver that to basically all of our customers.
Phil Cusik – JPMorgan
And then on the business side, what sized businesses have been buying the Ethernet and MPLS products? And what sort of competition are you seeing in that segment of the market?
I would say the area is principally thought a medium size and enterprise on the retail and we are seeing nice uptick on the carrier side as well. We launched those products and enhance them with quality of service and SLAs and we’re staring to see nice ramp on the carrier segment. The competitors on the retail side range from the cable competition to [fee] license on some of the larger markets.
But we’re holding our own against them. I think we’ve done very well in sales as we’ve continued to launch aggressively in all of our markets for Ethernet and we plan to have it in all markets by the end of this year Phil.
Phil Cusik – JPMorgan
Next we’ll go to Mike McCormack with Jefferies.
Mike McCormack - Jefferies
Hey guys thanks. Maggie, just thinking about some of the speed improvements that you're doing and obviously launching the 1 gig and 500 meg in the back half of the year. Are you seeing any sort of change in consumer behavior? Because I know in the past, you guys have sort of identified that for a lot of your customer base, price is more important than speed. I've been trying to get a sense for whether or not you are seeing a sea change in customer behavior on that? And then thinking about the incremental margins for the business overall, the migration from TDM and Voice into IP ethernet, could you just give us a sense for what that means from a incremental margin standpoint when that revenue shifts? That would be great, thanks.
Hi Mike. So I’ll start on the customer behavior and then Dan can also jump in on the Ethernet front in terms of those conversions. It’s pretty interesting as we mentioned over 30% of our activity in the second quarter were speed tier upgrade, so we are seeing some behavior change in terms of customers taking more speed, but if you look at it still 75% to 80% of our customers use 6 meg or less. So, if you look across the board, our customer base is still very well within the parameters that what we are offering.
We also have found that a lot of customers when they upgrade their speed, so not necessarily using more speed, they just think they need speed. So one of the things that we’ve tried to do is position with activities that we sell to customers, whatever they are going to do on broadband we try to match the right speed levels to what their activity levels are. But we think that there is going to be great demand. We did see a big uptick on video streaming in the second quarter and we know as that continues to grow, that will continue to drive customers to take more speeds from us as well.
We’re going to launch in September a rollout of both 50 and 100 meg service as Dan mentioned. That’s going to be across about 16 states. So we are continuing to invest and to provide those choice points to residential customers. On the gig side, I think as we’ve launched gig service to our business customers in many of our markets though our Ethernet products and we do have a plan to launch gig service across a number of our markets over the next several quarters. So we’re going to continue to stay competitive and give customers choice, but we’re also trying to work with customers to make sure they are just not buying speed for the sake of doing so.
And Mike I would just add to that that some of the customers that are taking the higher speed tiers as Maggie pointed out are using it in different ways. We have seen some increases in the average uses especially around those higher bandwidth customers for instance we’ve seen averages approach close to 50 gig on average with the median of about 23 gig in those markets where we have some very high bandwidth. And that’s very different than where we were just recently.
On your other question we have seen and we do anticipate some cost changes as we migrate from TDM both LD voiced and also TDM transport to an Ethernet world. The cost change is really reflective in the maintenance cost as well as the incremental CapEx associated with driving capacity for customers on the transport side and then significantly lower IP transport cost for LD. So those will be two things that we can take advantage of next year as we launch different IP products that’s on the voice side and continue to expand and retire some of the older TDM market texture and replace them with Ethernet.
Mike McCormack - Jefferies
Dan, what are you seeing -- I'm sorry -- with respect to the pricing behavior on Ethernet side. What kind of year-over-year price declines have you guys experienced in that market?
On the retail side we’ve really haven’t’ seen a whole lot of compression certainly on the carrier side there has been pressure especially as people have looked to partner with us on different yields, and the way we are solving that is really meeting people at potential [indiscernible] meet points and then exchanging traffic in a different way that minimizes CapEx and allows us to meet those price points, but that’s really on a one-off basis.
Mike McCormack - Jefferies
Okay. Thanks guys.
So operator lets take one more question.
Sure. Our final question will come from Michael Rollins with Citi Investment Research.
Michael Rollins – Citi Investment Research
Thanks for taking the question. I was just wondering if you talk a little bit more about the operating leverage in the business. And so if I look on a year-over-year basis, then you look at the decline in revenue relative to the change in EBITDA, they almost match each other. And I was wondering if that's coming from just the mix shift in services from legacy to some of the newer product? Is it investment in marketing? If you could just talk a little bit more about -- on a year-over-year basis, which takes care the seasonality question, how that works and how you are looking at that. Thanks.
Yes Mike, this is John Jureller. So I think you’re right in sort of looking numerically at this. But what we do is we have also some embedded cost increases that we have to work through. So for example compensation and benefit cost also continue to increase. So we take on other elements like on a network maintenance cost keep on coming down, our transport come keep on coming down, we continue to manage things around real estate, around procurement and then we have some pressures that go the other way, alright. So, it’s not a one for one [purely] from a contribution margin perspective, but we have to maintain our expense discipline on the face of the revenue, the secular revenue declines that we still have.
Yes and Mike one of the other things that I would add to that is I think as you have seen over these last six to eight quarters we have been very focused on getting revenue stabilized and as we mentioned in this quarter we actually had growth in residential revenue. And the big thing is its continuing to look at broadband growth to offset the declines that we continue to see in voice, so not only do we stabilize revenue but we start to get to that inflection point of revenue starting to even grow. And that starts to change that mix. The other thing is we’re really pressing the business as we’ve turned on more capacity in the networks both from an access and speed perspective. We are driving more broadband penetration to get that penetration rate up and then we’re also selling and up selling those customers overtime to more services to drive more revenues.
So we are doing some more aggressive investment on the marketing side, but as John said we are trying to take the cost down in other areas where we are increasing cost in the business. So we feel good that we are on the right trajectory and that we’re going to start to make those changes in terms of that equilibrium between revenue and EBITDA but as we’ve said it’s going to be another couple of quarters.
Michael Rollins – Citi Investment Research
Thanks for taking the question.
Well, thank you all for joining us today for the Q2, 2014 earnings call. I do want to do a quick thank you to the entire Frontier employee base for their dedication and hardwork each and every day to grow our business and to take care of our customers. We remain confident in our ability to deliver strong results for the remainder of 2014. And we look forward to updating you on Q3 results in early November. So have a good evening everybody.
And that does conclude today's call. Thank you all for your participation.
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