Cincinnati Bell's (CBB) CEO Theodore Torbeck on Q2 2014 Results - Earnings Call Transcript

Aug. 7.14 | About: Cincinnati Bell (CBB)

Cincinnati Bell (NYSE:CBB)

Q2 2014 Earnings Call

August 07, 2014 10:00 am ET

Executives

Joshua T. Duckworth - Vice President and Controller

Theodore H. Torbeck - Chief Executive Officer, President, Director and Member of Executive Committee

Leigh R. Fox - Chief Financial Officer

Analysts

Batya Levi - UBS Investment Bank, Research Division

Simon Flannery - Morgan Stanley, Research Division

Barry McCarver - Stephens Inc., Research Division

Sergey Dluzhevskiy - G. Research, Inc.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Ana Goshko - BofA Merrill Lynch, Research Division

Adam Abbas - Driehaus Capital Management LLC

John Grendi

Operator

Good morning, everyone. Thank you all for holding, and welcome to Cincinnati Bell's second quarter earnings release conference call. Your host for today's conference will be Josh Duckworth. Today's conference will begin with prepared remarks, followed by a question-and-answer session. Instructions on that feature will follow later in the program. Today's call is being recorded.

At this time, I would like to turn the call over to your host, Josh Duckworth. Your line is now open.

Joshua T. Duckworth

Thank you, and good morning. I would like to welcome everyone to Cincinnati Bell's second quarter earnings call. With me on the call today is our Chief Executive Officer, Ted Torbeck; and our Chief Financial Officer, Leigh Fox. Ted will provide an update on the progress we're making on our strategic objectives. I will then provide a financial overview and discussion of the quarterly results as Leigh is recovering from the flu. We will then conduct a question-and-answer session and in which Leigh will participate.

Before we proceed, let me remind you that our earnings release and financial statements are posted on our Investor Relations website. In addition, you will also find presentation slides for today's call, which we hope you will find helpful in your analysis. Today's call is being recorded, if you would like to listen to it at a future time.

Now, I would like to turn your attention to our Safe Harbor statements presented on Slide 3. In our remarks this morning, we will be discussing forward-looking information. Due to the various risks and uncertainties, actual results or outcomes may differ materially from those indicated or suggested by any such forward-looking statements. More information on potential risks and uncertainties is available in the company's recent filing with the SEC, including Cincinnati Bell's annual Form 10-K report, quarterly Form 10-Q reports and Form 8-K report. This presentation also contains certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are also available on our website.

With that, I am pleased to introduce Cincinnati Bell's Chief Executive Officer, Ted Torbeck.

Theodore H. Torbeck

Thanks, Josh, and good morning, everyone. Thank you, for joining us today. We've had a great first half of 2014. Slide 6 highlights the key areas of execution in the first half of 2014, and demonstrates the milestones achieved towards our goal of transforming Cincinnati Bell into a growing fiber-based entertainment, communications and IT solutions company.

Our financial results for the quarter were impressive and continue to exceed expectations. Total business revenue for the quarter increased 3% over the prior year and adjusted EBITDA totaled $100 million. Josh will provide additional comments on our financial results in a few moments.

My comments today will focus on the execution of our strategic objectives and the key steps completed. Our 4 key areas of focus heading into 2014 were to manage wireless for cash, opportunistically monetize our investments in CyrusOne, invest in our strategic fiber assets, and to strengthen our balance sheet.

Key progress was achieved with an agreement to sell our wireless spectrum. As illustrated on Slide 7, the transaction is valued at $210 million, including cash proceeds of $194 million, which will be used to pay down debt. This transaction has broadened our relationship with Verizon and created opportunities we're exploring in both our business and consumer markets. The completion of the transaction is also important because it allows us to provide greater focus on the continued investment and growth of for strategic products.

As noted on Slide 8, revenue from these products totaled $107 million in the quarter, which is up 23% compared to a year ago. On the consumer side, the 45% year-over-year revenue growth in Fioptics has once again surpassed our expectations. Revenue from this suite of products totaled $34 million in the quarter and is on track to exceed a 134 -- $135 million for the year. Also, strong demand for faster data speeds and IT solutions generated revenue growth of 15% for our business markets.

Now turning back to Fioptics. Our execution in delivering the high-demand product combined with the recent M&A activity in the sector, has created a unique opportunity for us to accelerate our fiber investment and aggressively expand our market share. We are currently in the final stages of planning for an acceleration in our investments, and are confident that any success-based acceleration will provide attractive returns and achieve operating metrics in line with what we've done historically. We will share more details surrounding this acceleration strategy over the next several months.

The next key strategic initiative was successfully monetizing the first tranche of our CyrusOne investment. We teamed with CyrusOne to execute a well-orchestrated and appropriately timed modernization strategy that culminated in CyrusOne's stock trading up 2% at the close of the transaction. As summarized on Slide 9, many factors were considered as we approached our decision. The S&P 500 was trading near all-time highs and CyrusOne was trading close to its 52-week high. We also believed, by selling an initial tranche would increase float and alleviate any perceived overhang as a result of our significant ownership.

Based on the successful response to this process, we sold 16 million partnership units netting proceeds of $356 million, which will be used to repay debt. The market reaction to this transaction has been very positive, as our stock prices recently increased more than 5% and CyrusOne has been steadily trading at or above $25. Our goal for this investment has not changed. Subsequent to the sale, our 44% ownership interest in CyrusOne is valued at $700 million, and we have $9 million of NOLs remaining to shelter future tax gains.

We remain bullish on CyrusOne and following our recent sell down, are now in a position to be extremely opportunistic and patient investor.

In the first half of 2014, we have taken significant steps in completing our transformational initiatives. We have also significantly strengthened our balance sheet, using the proceeds from the sale of CyrusOne to call a large portion of our 8.75% subnotes. The combination of this and the use of wireless proceeds to pay debt will increase operating cash flows by more than $40 million annually. The progress we have made demonstrates this team's ability to transform Cincinnati Bell into a growing fiber-based entertainment, communications and IT solutions company.

I would like to now turn the call over to Josh, who will summarize our quarterly results.

Joshua T. Duckworth

Thanks, Ted. As Ted previously mentioned, we have experienced a tremendous amount of success in the first half of the year, and we are well-positioned to achieve our goals of year-over-year wireline revenue growth, while generating positive free cash flow.

As noted on Slide 11, revenue for the quarter totaled $320 million, up $8 million from the prior year, as increased demand for our strategic products and strong hardware sales more than offset legacy and wireless decline. Revenue from our strategic products increased by $6 million from the previous quarter, and was up 23% over the prior year. Adjusted EBITDA [indiscernible] $100 million for the quarter, consistent with the prior year after excluding wireless results and changes in mark-to-market as a result of our increased stock price.

Second quarter net income totaled $114 million, producing diluted earnings per share of $0.53, driven primarily by the gain recorded on our initial monetization of CyrusOne.

Moving to our quarterly segment results, starting on Slide 12. Wireline revenue totaled $185 million for the second quarter, up $3 million from the prior year. Wireline strategic revenue was up 27% compared to the prior year and now accounts for more than 40% of all our wireline revenue. Wireline adjusted EBITDA for the quarter was $83 million, as margins remained strong at 45%.

As noted on Slide 13, Fioptics penetration rates and churn remain consistent year-over-year, as the product is now available to 307,000 addresses. At the end of the quarter, we had 98,000 Fioptics Internet and 83,000 video subscribers, both of which were up more than 30% compared to the prior year. Fioptics ARPU by product was up, on average, 6% compared to a year ago, as video ARPU totaled $76, and Internet ARPU totaled $38 in the quarter. Customer response to our strategic products has been remarkable and for the third consecutive quarter, we have achieved year-over-year wireline revenue growth.

Year-to-date, wireline revenue is up $7 million compared to 2013, and we are on target to achieve year-over-year wireline revenue growth for the first time since 2007.

Turning to Slide 14, our IT Services and Hardware segment reported an equally impressive quarter. Revenue for the quarter was $102 million, up $16 million over the prior year due to strong hardware sales and increased demand for our manage to staff augmentation services. Strategic managed and professional service revenue totaled $34 million, up 16% year-over-year. Adjusted EBITDA was also up $2 million from the prior year, totaling $6 million for the quarter and resulting in margins of 6%.

Our wireless results are presented on Slide 15. Wireless revenue of $41 million was down 20% from the prior year, as the rate of churn has increased. We anticipate this pace will further accelerate once we receive approval from the SEC, which is expected within the next few weeks. Adjusted EBITDA for this segment totaled $15 million in the quarter and $32 million for the first half of 2014. During the quarter, we recognized $5 million of restructuring charges associated with the shutting down of these operations. We are aggressively targeting other cost out opportunities and expect additional restructuring charges over the next several quarters. We ultimately expect ongoing cost leakage to be absorbed by the remaining core operations once the wireless business is shut down to be in the range of $25 million to $30 million.

Moving to cash flow results on Slide 16. For the quarter, free cash flows were $18 million and were impacted by interest payments totaling $42 million and capital expenditures of $41 million. Additional details on the second quarter capital expenditures are on the next slide.

During the quarter, we invested $19 million on Fioptics, passing 19,000 additional addresses. For the quarter -- for the year, we remain on target to invest $75 million to $80 million in this suite of products and expect to exceed our initial homes passed estimate of 62,000 addresses for the year. In addition, we also invested $9 million in other fiber business-based builds and managed service projects which bring measurable deal driven returns. Positive free cash flow for the quarter is consistent with our expectations and puts us on track to be free cash flow positive in 2014. As the year progresses, we are actively monitoring our cash flow forecast, particularly as it relates to onetime charges associated with winding down wireless operations.

On Slide 18, we have separated the components of our 2014 financial guidance. Our total adjusted EBITDA guidance is $383 million with the wireless segment accounting for $50 million. Year-to-date, adjusted EBITDA for the remaining business totaled $173 million, in line with our expectations. We have had an extremely successful first half of the year, as evidenced by the progress achieved. However, we continue to identify transformational initiatives. Similar to the IT initiatives mentioned during the first quarter call, which may be dilutive in the short-term, yet achieve both cost and service improvements over time. With that in mind, we are comfortable reaffirming our financial guidance for the year. We are very pleased with our year-to-date results and look forward to the continued progress of transforming Cincinnati Bell into a fiber-based entertainment, communications and IT solutions company, with growing revenues, growing profits and sustainable free cash flow.

I would now like to turn the call back to Ted for some final remarks.

Theodore H. Torbeck

Thanks, Josh, and before we begin the question-and-answer session, I would like to call your attention to the press release issued this morning announcing that we have reached a tentative agreement on the new contract with our union employees. This is a significant step in our partnership with these key employees. It allows the company to remain focused on its key initiatives moving forward. I would also like to remind everyone of our Investor Day scheduled for Wednesday, September 24. The event will be held in the Cincinnati Bell Pavilion at the Reds Stadium. The presentation will include an in-depth perspective on our progress and the positive impacts of accelerating our fiber expansion. We also plan to have key business customers share how we create value for their organizations through access to our fiber platform and IT solutions. You should be receiving formal invitations for this event very soon. If you have any questions, please feel free to reach out to Josh and our Investor Relations team. We look forward to you visiting Cincinnati and sharing more about the excitement we are creating at Cincinnati Bell.

With that, I'll turn the call over to our moderator for the question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Batya Levi from UBS.

Batya Levi - UBS Investment Bank, Research Division

First, I wanted to ask you about your thoughts on Windstream's decision to spend network assets to an independent REIT. You still have NOLs on the book. But is this something that you would consider down the road? And as you went through that REIT structure with the CONE assets, can you talk about, if you had considered to put the network piece in there as well? And secondly on the fundamentals, can you talk a little bit about the expected return that you're -- on your Fioptics investments? Maybe provide some color on what kind of churn reduction do you see as you shift customers over to Fioptics or the ARPU increases that you'll have in this business? And how long do you think it takes before you break even on Fioptics?

Theodore H. Torbeck

Okay, Batya, thanks for the questions. First of all, on the REIT. Yes, we still have, as we said in the script, that we have about $900 million of NOLs. So we're not a taxpayer at this point in time. So it really doesn't benefit that portion of it. However, at some time in the future, that could be a possibility for us. But the good news is we have, Windstream now that's out in front and we can see how that progresses and make the decision at the right time. We didn't get your CONE REIT question. Could you repeat that please?

Batya Levi - UBS Investment Bank, Research Division

While you were in the process of transitioning CONE into REITS, if you had considered to put the network assets back then as well?

Theodore H. Torbeck

We did. And actually, we did consider it at that time, but we pulled back from, when we had CONE going into a REIT. On your third question, expected returns, we're doing very well on the returns, we're seeing and we're getting about 20% returns. And the ARPUs are climbing every month, as people come off promotions. So we're very excited about both those events, and we expect it to continue. Again, if we do -- and we're doing an in-depth analysis of increasing the spend. If we -- we'll come out with a number that we're going to spend, but it's clearly success based. We have to continue to generate these returns or we'll pull back from the investment. But right now, we're significantly below the cost that we thought that we were probably 25% down on the build cost, which is significant. And the returns we're getting are -- we're very pleased with.

Operator

We'll take our next question from Simon Flannery from Morgan Stanley.

Simon Flannery - Morgan Stanley, Research Division

So obviously, nice execution on the CONE stake. I think, you used the words patient and opportunistic. I think, in the past, you sort of talked about selling down, kind of over 3 to 4 years. Is that still the kind of the base case we should be assuming that, unless the stock goes to 30 or something, we won't see anything else until maybe early next year. And then, maybe something beyond that? And then, you -- you highlighted the partnership arrangement that you have with Verizon. Yes. So might we see you reentering the wireless market later this year with sort of Verizon resale agreements or something -- some other opportunities?

Theodore H. Torbeck

Thanks for the questions, Simon. First, on the sell down of CONE. Again, we're extremely bullish on CONE. We -- the results that they're getting, you saw yesterday's results, are tremendous. And, I think, they have tremendous team at CONE and they're executing extremely well. So and the other good thing is, with this tranche that we've sold down, we've been able to position our balance sheet in a very good position. So we don't really have to do anything, and so that gives us the luxury to really watch and see what happens. Again, it really depends on what the stock price is, as you alluded to. We think they're going to get tremendous growth over the next couple of years. And we'll sit back and be a patient investor that will jump at the right time to give our shareholders the best return possible. So that's the strategy. On the Verizon question. We are still in some of the negotiations with them. So I can't really allude to anything that's going on. But right now, in our mind, we have no plans to get back into the wireless business. And I think, that's a definite. But we're talking to them about certain business opportunities, both on the business side, as well as on the consumer side.

Operator

We'll take our next question from Barry McCarver with Stephens Inc.

Barry McCarver - Stephens Inc., Research Division

So I guess, first off, on the labor contract, at this point, can you give us any details on the annual compensation increases and change to 401(k) benefits?

Theodore H. Torbeck

Barry, I'd love to but I just can't. It's still a tentative agreement. It has to be voted on by the membership. And until that's done, we're not going to share any information. I apologize for that.

Barry McCarver - Stephens Inc., Research Division

No, that's okay. And then just secondly, in terms of the sale of the wireless assets, everything there still, time-wise, on track with your original expeditions to close?

Theodore H. Torbeck

Yes, the good news is that there really were no oppositions that were filed in connection with the wireless license transfer. The transfer is still under review by the SEC, and we expect a favorable ruling shortly. That's all I can say. So we're still very optimistic. It's in the timeframe, I think, it's within the next couple of months or earlier.

Barry McCarver - Stephens Inc., Research Division

Okay, that's good to hear. And then, I guess, last question. As it relates to your competition in the market from the cable operator, any change during the quarter in maybe the competitive level there, given the pending acquisition?

Theodore H. Torbeck

Yes. I mean, they're -- they've -- Time Warner has been a good competitor, and they're looking at different things about the ways to increase their speeds as well. I mean, it's -- they haven't gone away. Their pricing, especially on the entry-level meg is -- they've got a price out there like $14.99, which we've come down to match. But yes, they haven't acted a whole lot different, but every quarter, they're -- they're coming up with competitive ideas that we have to compete against. So I don't expect that to change until the new competition, if the turnover happens. We got to worry about ourselves, and we got to get more presence out there. And we think, we got a better product. We know we have a better product.

Barry McCarver - Stephens Inc., Research Division

And it's really interesting to hear your comments about the opportunity to accelerate the fiber buildout and thinking about -- talking more about that over the next couple of months. Is that a program you think you can ramp-up pretty quickly or is that going to take some time to prepare for?

Theodore H. Torbeck

It will take a while to do that. We'll probably do the ramp over a year's time. But each month, we'll get -- and you'll do it in batches of where we'll hire techs. We spent about 6 weeks in a training program before they're released to go do their job. So -- and we can only handle so many techs at a time. So you're going to see it increase, once we get the first class through, you're going to see increases every 6 weeks of our team out there building fiber. But the total build-up will probably take close to 12 months to get to the level where we want to be.

Operator

And we'll take our next question from Sergey Dluzhevskiy with Gabelli and Company.

Sergey Dluzhevskiy - G. Research, Inc.

Couple of questions. So now that the first tranche of CONE is being monetized, what are your thoughts on returning a portion of those cash prices to shareholders through buybacks or special dividends? How should we think about returning cash to shareholders over the next few years in general? And also, on the operating side, on the Fioptics, can you talk a little bit about average speeds for Fioptics product that you have in the market at this point? And maybe talk a little bit about different customer here and different speeds here. What percentage of customers is on higher-speed, lower-speed, middle-speed?

Leigh R. Fox

Sergey, this is Leigh. I'll take your first question. Yes, with this first tranche, we felt it was pretty important to strictly go after the debt. But we're constantly looking at the intrinsic value of the stock price. And are always open and looking at returning value to the shareholders. So yes, it's something that we've said we will look at, that hasn't changed. And I don't see it changing. So the next several months to several years, that is definitely a strategy of ours to possibly look at buybacks depending on where the stock price sits. Obviously, there's a challenge there, because if we're too successful, that stock price rises. It doesn't make a whole lot of sense but we're going to constantly look at it. And it's definitely -- that strategy hasn't changed for us.

Theodore H. Torbeck

On the speed side, our average speed is probably in the range between 10 and 30 meg. And we're pretty proud of this. We'll be the first one in Cincinnati to offer a gig. And -- so we're now offering it to our business customers, and we're -- later this summer, we're -- about now, we're about launching it to our consumers. So we're really excited about that. There are a number of customers that are requesting it and requiring it. And we'll be able to provide it.

Sergey Dluzhevskiy - G. Research, Inc.

What percentage of your customers would be on 20 to 30 meg at this point, just a ballpark?

Leigh R. Fox

Yes. 25% to 30%.

Operator

We'll take our next question from Frank Louthan with Raymond James.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Are you taking any steps with business customers looking ahead at some of the CLEC mergers out there, maybe lock some of those customers up ahead of those mergers? And then secondly, just conceptually on the target leverage ratio following the first round of the selling off some CyrusOne. In the past, you've talked about 3x leverage. I mean, any thoughts on that, is that still the line in the sand? And any thoughts about redefining success there? 3.2x or 3.4x really isn't so bad relative to 5x, where you were. Any thoughts on maybe just getting that out of the way while you can where the stock is rather than holding off and taking the market risk on maybe hitting that arbitrary target?

Theodore H. Torbeck

Yes. On your first question, we look at every opportunity to -- for growth and trying to lock customers up. So we look at ideas like you mentioned. So yes, we are considering it. And on your second question, right now, if you would -- if we could monetize CONE today, we'd be about 3.2x. And our goal is still to get somewhere between 2 to 3. So we're not too far apart. And -- but again, we remain very bullish on CyrusOne. We think there's tremendous growth opportunity there as well. And so we're going to continue to monitor it very closely and just like the first tranche, we'll do it at the right time, and really, with the shareholder in consideration to give them the best return.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Great, I'm sure that will be a topic at the Analyst Day. I'll wait for that.

Theodore H. Torbeck

Yes, it will, Frank. Thanks.

Operator

We'll take our next question from Ana Goshko with Bank of America.

Ana Goshko - BofA Merrill Lynch, Research Division

So on the cost leakage that -- from the wireless operation shutdown, you guys said it would be $25 million to $30 million? So I'm assuming that's sort of allocated corporate overhead and maybe some unwind of sort -- intercompany transfer payments, is that what that is?

Theodore H. Torbeck

The 2 biggest things are intercompany revenue that we will no longer get. And the second is we want to maintain the stores. We have 8 stores. And the reason we want to maintain those is because they'll provide service and sales for our wireline business.

Ana Goshko - BofA Merrill Lynch, Research Division

Okay, so...

Theodore H. Torbeck

Those are the 2 biggest.

Ana Goshko - BofA Merrill Lynch, Research Division

Okay. And then, if I look at the company's guidance table, is it Slide 18? So when you excluded the wireless piece and showed that core business has $333 million for '14 guidance for EBITDA, on a pro forma basis, would it be fair to subtract the $25 million and $30 million from that, because once you exit the wireless business, you'll have that additional cost pressure?

Theodore H. Torbeck

Yes.

Leigh R. Fox

Yes, it would.

Ana Goshko - BofA Merrill Lynch, Research Division

Okay, just wanted to clarify. Okay. And is there any potential through cost cutting to bring that number down?

Theodore H. Torbeck

I think, that's...

Ana Goshko - BofA Merrill Lynch, Research Division

Kind of a fully baked cost cut number?

Theodore H. Torbeck

Ana, believe me, we've taken -- we started out with $109 million of cost in wireless, and we got it down to $25 million to $30 million. I think that's the number it's going to be.

Operator

We'll take our next question from Adam Abbas with Driehaus.

Adam Abbas - Driehaus Capital Management LLC

Ana just asked my exact 2 questions, so...

Operator

We'll take our next question with John Grendi with Third Law Consulting.

John Grendi

Can you also just expand upon that, as it relates to controlling cost, as you continue to make investments related to growth both on the indirect and direct side?

Theodore H. Torbeck

Well, we go through an exhaustive study on cost. I mean, we meet for sure monthly with each team. And Leigh and his team -- Leigh can expand on this. But believe me, we stay all over the cost side of it. And if we see any leakage, it's addressed.

Leigh R. Fox

Yes, there's still -- as Josh mentioned in the script, there are still opportunities that we feel -- there are areas we can address, similar to the IT outsourcing initiative that we announced in the first quarter. There are still areas in the business to look at. So, I think, there -- as we grow, there's still plenty of areas to get more efficient at. And what we focus on are not only cost efficiencies but service improvement. So if we can get service improvement and get better at what we do and get better cost, I mean, that's what we're really concentrating on. So...

Theodore H. Torbeck

And back to Leigh's point, we got 3 very detailed projects we're doing analysis on. And that at the Investor Day, we'll go into more details of those with you. And some of them are dilutive in the first few months but then afterwards, tremendous payback. So we'll go through in more detail in September on those.

Operator

And with the no following questions, this will conclude today's conference. Thank you all for your participation.

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