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Frontier Communications Corporation (NASDAQ:FTR)

Q4 2011 Earnings Call

February 16, 2012 4:30 pm ET

Executives

Gregory Lundberg – Assistant Treasurer, IR

Maggie Wilderotter - Chairman and CEO

Donald Shassian – CFO and EVP

Daniel McCarthy – COO and EVP

Analysts

Batya Levi – UBS Investment Bank, Research Division

Simon Flannery – Morgan Stanley, Research Division

Philip Cusick – JP Morgan Chase & Co, Research Division

Michael Rollins – Citigroup Inc, Research Division

Scott Goldman – Goldman Sachs Group Inc., Research Division

Kevin Smithen – Macquarie Research

Michael Hodel – Morningstar Inc., Research Division

Frank Louthan – Raymond James & Associates, Inc., Research Division

David Coleman – RBC Capital Markets, LLC, Research Division

Christopher Larsen – Piper Jaffray Companies, Research Division

Operator

Good day, everyone, and welcome to the Frontier Communications Fourth Quarter 2011 Earnings Results Conference Call. This call is being recorded. At this time, I'd like to turn the call over to Greg Lundberg. Please go ahead.

Gregory Lundberg

Good afternoon, everyone. Purpose of this call, to discuss the 2011 fourth quarter and full year 2011 results for Frontier Communications. The press release, earnings presentation and supplemental financials are all available in the Investor Relations section of our website, frontier.com.

On today's call are Maggie Wilderotter, Chairman and Chief Executive Officer; and Don Shassian, Chief Financial Officer.

During this call, we'll be making certain forward-looking statements. Please review the Safe Harbor language found in our press release and SEC filings. On this call, we'll also be discussing 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.

Maggie Wilderotter

Thanks Greg, and good afternoon everyone. For today’s call, it would be helpful for you to follow along with the supplemental slides available on our Investor Relations page of the frontier.com website.

I’ll begin today by addressing our dividend announcements. I will follow with a summary of the quarter, and then hand the call over to Frontier’s Chief Financial Officer, Don Shassian.

To begin, if you could turn to Slide 4. After the market close today, Frontier issued a press release announcing that its Board of Directors declared a quarterly dividend of $0.10 per share, a reduction from our prior levels of $0.1875. We recognized the impact that this difficult decision has on all of our stakeholders, but it is important and an important step to take at this time to strengthen our balance sheet and to provide greater operational and financial flexibility.

First and foremost, Frontier is a healthy business that is expected to generate approximately $1 billion of free cash flow before dividends in 2012. Our Q4 2011 financial performance is our strongest quarterly performance and EBITDA margin since the Verizon acquisition which occurred only 18 months ago, when we nearly tripled in size.

In addition, we have accelerated our final systems conversions to begin in March of 2012, almost a full year ahead of our original plan, which will eliminate over $100 million of annual cash operating expenses. This has allowed us to announce today an increase in our estimated annual cost synergies from $600 million to $650 million by the end of 2012.

I also want to reiterate that once we convert systems and get the Frontier go-to-market implemented consistently over several quarters, we accelerate the improvements in both revenue and cash flow. West Virginia is a great example of what we can expect in all of our markets. The turnaround in 18 months has been very successful with customer churn now approaching our legacy property level, steady net growth and high-speed and video sales, and strong incremental revenues in the commercial segment.

Don will take you through more detail on West Virginia. But I wanted you to know that this is a case study of the improved business fundamentals that we will see in all of the acquired properties several quarters after conversion. These West Virginia and Q4 results clearly show that our business continues to improve.

Let me go over the three primary considerations behind the Board’s decision to reduce the dividend as seen on Slide 5. The first and most important consideration was to deliver on our goal of leverage reduction and to improve access to capital. Since the announcement of the Verizon acquisition on May 13, 2009, we have consistently expressed our goal of reducing leverage to 2.5 times net debt-to-EBITDA.

While our cost synergies are ahead of target, our revenues are behind plan. This has caused our leverage ratio to remain over three times. At the end of 2011, this leverage ratio was 3.18 times. Our Q4 2011 results show that our revenues are now making significant improvement. But this improvement is coming later than expected. To reach our 2.5 times leverage goal, we must begin to reduce our outstanding debt -- to reduce our outstanding debt.

We have $581 million of debt that comes through in January of 2013. The dividend reduction provides $348 million of incremental residual cash flow per annum that will be used to pay down that debt. Likewise, in 2013 and beyond, we will now have more residual free cash flow to continue paying down future debt maturities to enable us to reach our 2.5 times leverage target more quickly. The leveraging will also low our cost to capital in any refinancing.

The second consideration was to enable increased investment in strategic initiative. Frontier’s customers remain our top priority. We need to continue investing in our networks to meet growing business and consumer demand for Internet data and faster speeds.

Our 2012 capital expenditure guidance of $725 million to $775 million reflects continued investments in broadband expansion, improved speeds and capacity for business and residential customers in select markets, and investment in high bandwidth data connection to wireless communication towers. Additional strategic capitals will enable us to speed up process automation and invest in new products and services to grow our customer revenue.

The third consideration was to provide a more sustainable return. The new dividend level provides income to our stockholders with a much lower payout ratio of free cash flow. At our midpoint 2012 free cash flow guidance, the new dividend represents a payout ratio of 42%. This level should give our investors confidence in Frontier’s ability to maintain this dividend with additional financing flexibilities when addressing debt maturities and to handle potential expense increases by cash taxes, pension contributions, and investments in the business.

This was not an easy decision for our Board to make. Frontier has been and will continue to be shareholder-friendly. We believe the new dividend level is more appropriate for the company at this time, and our Board will continue to review our dividend policy at each Board meeting. I want to emphasize that the Board, senior management, and our employees are all stockholders of Frontier as well.

In summary, this change strengthens our balance sheet to reduce debt, allows us to have an improved cash position, provides operational flexibility to serve, keep and win back customers and provides more investment dollars for network upgrades, IT automation, and new products. The result is that Frontier will be competitively stronger as a business in both the near-term and the long term.

I would now like to address highlights of the Q4 2011 results, which you can see on Slide 6. Our revenue performance improved substantially quarter-over-quarter in Q4. Q2 to Q3 revenue declined by $31 million. Q3 to Q4 the decline was just $8 million. This was the best quarter since closing the acquisition in July 2010.

Our business sales grew 1.7% sequentially and business is now 52% of total customer revenues. We continue to cut operating costs. Our 48% EBITDA margin was the strongest since the acquisition. Our new synergies of $14 million resulted in an annual run rate of $552 million. We are very much on track to achieve our new $650 million goal in 2012. We expanded broadband to 415,000 new household and businesses in 2011, within our guidance range and fully aligned with State and FCC mandates.

And finally we concluded a successful four-state conversion of 1 million customers on to our legacy Frontier platform. Based on our conversion track record, we are targeting March of 2012 to begin the conversion of our final nine states. This new target is nine months ahead of our original conversion plans that we announced back in 2009. Not only would this nine state conversion eliminate costs of $100 million of incremental annual cash operating expense, but it will allow all Frontier operations to go to market the Frontier way. We expect a stronger second half of 2012, once we have all markets fully functioning on the same system.

Let me now hand the call over to Frontier’s Chief Financial Officer, Don Shassian, who will provide more Q4 2011 and full-year financial performance insights. Don?

Donald Shassian

Thank you, Maggie. And thanks to all of you for joining our call today. I'm changing my usual ordering of topics to begin with the focus on liquidity and our balance sheet. Slide 8 illustrates the positive impact that our improving revenues and margins are having on free cash flow.

In 2011, our residual free cash flow after dividends was $359 million. An additional $348 million will be available on an annual basis at the new dividend level, equating to $1.4 billion of cash over the next 4 years, which will help to address $2.2 billion of upcoming debt maturities.

We believe that this is the appropriate time to proactively change our dividend policy to increase our operational and financial flexibility. This excess cash flow from our new dividend policy will significantly improve our leverage ratio.

As shown on Slide 9, our leverage decreased significantly with the acquisition, but has increased slightly each subsequent quarter. We have been monitoring this increase. We currently have $326 million of cash on hand and an undrawn $750 million revolving credit facility that matures in January 2014. We prefer to leave the revolving credit facility undrawn and now expect to meet our principal payments of $94 million in 2012 and $639 million in 2013 with cash on hand and internally generated funds. We also remain opportunistic with regard to the credit market to proactively manage future debt well in advance the maturity as part of our goal of making progress towards our ongoing commitment of 2.5x net leverage.

Let me now turn to a discussion of many of the positive trends delivered in Q4. Slide 10 is an update of our commercial and residential business. Commercial is the majority of our customer revenue. We had a positive 1.7% sequential revenue growth in Q4. This was driven by increased productivity from our new sales force selling services like Ethernet, which is now available in 75% of our markets. It was also driven by sales of customer premise equipment, which helped us engage new customers and increase the corresponding sale of high-value-added network and management services.

On the Residential side, we posted the lowest churn and net customer losses since closing the acquisition with good results in both legacy and acquired. IT net additions were lower as expected, due to systems conversions and the absence of any major promotional activity the quarter. You can see these trends in the key metrics chart on Slide 11.

As expected, broadband and satellite net additions were lower in Q3, due to systems conversions. Although we did see positive growth in FiOS data subscribers for the first time during 2011, we also saw a decline in FiOS video losses. Our overall access line loss rate continued to improve to 8.3% as the acquired properties were at 9.6%, their lowest levels since closing and legacy remained at 5.9% this quarter. These good results are driven in part by lower churn, which improved significantly in the acquired properties in Q4 to 1.6%, a significant improvement and only slightly above legacy Frontier residential churn. As a reminder, residential churn in the acquired properties was over 2% at closing.

On Slide 12, I'd like to make reference to our West Virginia operations, which continues to improve. West Virginia is the indicator of the potential for the rest of Frontier's acquired markets since it has been operating on legacy system since closing.

In Q4 2011, broadband availability in West Virginia was up to 81%. You may recall that West Virginia broadband availability was 68% at closing. The penetration of available homes in West Virginia was 21% at year-end versus 18% at the end of Q3.

As our team sold [ph] into these available homes, total 2011 broadband additions in West Virginia were solidly positive compared to a loss in 2010. Video net additions doubled year-over-year, and customer disconnects were down 27% year-over-year.

Overall, total access line losses in West Virginia were just 6.7% in 2011, which is nearly 3 percentage points better than the acquired properties overall and very close to legacy levels. Our residential customer churn in West Virginia is 1.5%, a full 1 percentage point improvement since closing and very close to our legacy Frontier customer churn. And lastly, we have seen a very strong commercial sales growth in the State over the past 4 quarters.

Slide 13 focuses on our revenue composition. Frontier's fourth quarter revenues continue to have one of the smallest exposures to regulatory revenue in the industry at just 5.7% for intercarrier compensation and 3.8% for universal service. Excluding this regulatory revenue, the resulting customer revenue of $1.1 billion for the quarter is 52% business, and 65% of our customer revenues come from business and broadband.

Slide 14 shows revenue trends during the quarter. Residential ARPU was a bit weaker as expected due to our 4-state conversion. We expect residential ARPU improve later in 2012 as we saw more double and triple play bundles, especially post the final 9-state conversion. Commercial, as I've already highlighted, had our strongest quarterly performance since the acquisition as our investment in its sales force is beginning to deliver.

Turning to our cost structure, Slide 15 shows that we've doubled the rate of expense reduction during the quarter to $15 million. Of this amount, $14 million was from cost synergies realized in the quarter.

Slide 16 shows our cost synergy progression. Our conversion of the operating systems for 4 states and the financial systems of all 13 states over the legacy on October 1, enabled us to recognize $10 million of savings in the quarter, or $40 million on an annualized basis, which was earlier than originally anticipated. These savings are part of over $100 million in information technology and administrative cost savings to incur once the 9-state conversions are complete.

Our annualized cost synergy run rate is now $552 million, which is tracking toward our target of $600 million by mid-year 2012. The bulk of the remaining savings are related to information technology and are expected to be realized as the final 9 states systems are converted.

Our conversions enable us to leverage our information technology and administrative processes, and most importantly, enable us to standardize our marketing field and call center operations. As a result, we are raising our overall cost synergy goal to $650 million by year-end 2012, based on line of sight on additional IT, network real estate, administrative and customer support projects from our cost synergy target list.

Slide 17 shows our systems integration process. And you can see, they are nearing the finish line with one large conversion left commencing next month, March 2012. This final conversion represents 53% of the acquired lines and is significantly earlier than our original year-end 2012 plan.

Turning to capital expenditures on Slide 18. Our overall spending decreased as expected in Q4, as we completed our broadband expansion to 415,000 new premises, including 54,000 during the quarter and wrapped up other capital projects. For the year, our capital spending was $748 million, just under the low end of our guidance of $750 million and equated a 14.3% of revenues.

Our annual 2012 guidance is shown on Slide 19, alongside our 2011 performance to plan. We believe that our 2012 capital expenditures, excluding integration CapEx, will be between $725 million and $775 million; our adjusted free cash flow will be between $900 million and $1 billion; and our cash taxes would be approximately $25 million. We also expect to incur $80 million of integration expense and $40 million integration capital expenditures in 2012.

In summary, Frontier delivered its best quarterly financial results since closing the acquisition in July 2010. The Board's dividend action was a difficult one, but the decision was based on 3 considerations. Of one, delivering on our stated goal of leverage reduction and improving our access to capital; two, enabling increased investments in key strategic initiatives; and three, providing a more sustainable return for our shareholders.

The change will reduce our debt, strengthen our balance sheet and give us increased operational financial flexibility. For our customers, this means more investment in the network and new products and services. For our company and shareholders, it means we are better positioned for growth in the near term and long term.

With that, let me pass the call back to Marites to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Batya Levi with UBS.

Batya Levi – UBS Investment Bank, Research Division

It's been a difficult waiting time for this release. So what I'm hearing -- everything I'm hearing from your comments is incrementally more positive than the last time you addressed The Street, I think it was back in December, revenue decline is improving, churn is improving, synergies are ahead, integration is going well. And you're actually accelerating the conversion of the remaining states. So I want to ask, based on this momentum, why was the magnitude of the dividend cut so large? And you mentioned you want some financial flexibility, but it looks like the CapEx that you want to spend in 2012 is pretty much in line with the prior targets that you've talked about. And how do you think about balancing the view for lowering the leverage or maybe buying back stock at this time given where the stock is?

Maggie Wilderotter

Hi Batya, it’s Maggie. I’ll start and I know Don will chime in. Again, when we took a look at the dividend and the sustainability of the dividend, we took a lot of things into consideration. We do think that the fourth quarter was a very good quarter for us. It’s the first quarter of the churn, but it’s against the backdrop of getting leverage reduced, debt coming due, the ability for us to continue to invest in the business. You know, we have competitive response in all of our markets that we want to gear up for and make sure that we have our networks where they need to be from an investment perspective. And we also have some expense headwinds that will continue to change over the next couple of years, which includes cash taxes and pension contribution.

So we looked at what would be the right level to have also a payout ratios that would keep the sustainability of the dividend positive for all shareholders. This is not something we would want to do again. So we felt doing this once, giving us the operational and financial flexibility now would enable us to do what we need to do over the next several years, and still pay out a very large dividend to our shareholders.

We have, you know, we have looked at stock buybacks. We don’t think this is the appropriate time for us to do that. We think that leverage reduction is the right choice point of how to use the cash. And you know, I think as we approach that 2.5 times leverage ratio, then we have an opportunity to look at stock buyback. But the priorities will definitely be strengthening the balance sheet at this point.

Donald Shassian

I don't have anything else to add. It's really focused on getting leverage now. And we see on a lot of scenarios and where you think you're going to be in the future, where we wanted to be, and this enables us to get to that 2.5x level a lot earlier that otherwise would occur. And we think that's extremely important for all stakeholders.

Batya Levi – UBS Investment Bank, Research Division

When do you think that you'll get to that level?

Donald Shassian

I think you're going to see that, a couple of years. But we're going to be using cash that's generated in each of these years to pay down the towers that come before [ph] us and we'll continue to refinance. But it's -- a couple of years out, but it is...

Donald Shassian

A lot closer than it possibly would have been otherwise.

Maggie Wilderotter

Yes.

Batya Levi – UBS Investment Bank, Research Division

Okay. Thanks

Donald Shassian

Thank you.

Operator

Our next question comes from Simon Flannery with Morgan Stanley.

Simon Flannery – Morgan Stanley, Research Division

On the systems conversion, you talked about starting it in March. Can you just take us through how that impacts the year? When do you expect to finish it? And when does that start to benefit your cost structure and allow you to really get some of the sort of go-to-market, the revenue type of opportunities? And you talked about the business side, positive growth there. You talked about importance of the sales force. Are you also seeing some macro improvement driving that as well? And do you think that, that sort of revenue growth is sustainable into '12?

Maggie Wilderotter

Let me start on the conversions. We have been preparing for this nine-state conversion since we started the four-state conversion. And since the four-state conversion was very successful, we took the lessons learned from that conversion, in addition to the lessons learned from West Virginia. And so we’ve been in prep mode of getting ready for these nine states to convert, starting March 1. We have done mock conversions on the nine states similar to what we did for the four-state conversions. We’ve been working on all of the user test cases to make sure that we close the gap on any issues or discrepancies on the billing or error perspective. And we feel very good in terms of the shape that the conversion is in as we speak.

We’ve also been able to reduce the amount of blackout time for the customer in this conversion, even though we are converting double the size of the customer base. So if you think about it, we really, for our March 1 conversion, you sort of start next week. It’s sort of the 20th of February you start to get ready. You start the conversion process the first part of March. You start to send bills out around the middle of the month. And then you go through your bill cycles through into April.

Simon Flannery – Morgan Stanley, Research Division

You're doing [indiscernible] at the same time, you are not staggering them?

Maggie Wilderotter

Well, they are staggered. They go out on a cycle basis. But they are going to continue to go out every day. And then we have double workforce that put in place in our call centers. So we had extra hands on deck and staff, just like we’d done with the other conversion to manage through that. So I believe all the cleanup and sort of getting over the hump of any customer calls and activities would be through the May timeframe, which really sets us up for the third and fourth quarter to really hit the peddle on the accelerator in terms of promotions, driving share in the market, and really using the Frontier go-to-market model with everybody on those same systems.

We also get to eliminate a lot of the costs right after the actual system conversion takes place. So a lot of that is overhead contractor costs for the conversion itself. And by the June timeframe, we will have eliminated the software payments to Verizon as well, which is a big issue here. So we have a number of moving parts that are associated with this conversion. And we have lot of experience doing this. And we feel very good about where we are and getting through this. So, the last two quarters of the year are good. I will let Don kind of talk a little bit about the commercial side.

Donald Shassian

From the -- commercial is -- we've been talking about the 4 quarters and I anticipated improvement, as the sales force has gained strength, gained capabilities. I think it's really both the pipeline. Yes, the economy is improving. We've been talking about that in the Northeast, Southeast, and in the Central starting to see some improvements, some optimism. It's not necessarily hiring as much, as much as hearing businesses, so more proactive about expanding their facilities, more businesses looking to build more manufacturing plants. Just seeing more activity in and around business, a little bit more optimism.

We had a very good quarter. We hope we continue to do that. The decline has been great. We had a little bit of CPE improvement, but not a lot. The amount of CPE amount in Q4 over Q3 was about, I think, $3.9 million. So there's awful lot of other services being sold during that quarter which are very solid. So we're expecting to continue to see light movement, some seasonality from pipeline that obviously moves around. But feeling pretty good. I'm not saying I'm being bold, that it's going to stop continuing to ramp. So we're having a nice improvement. Nice, steady improvement, improving the network and improving our capabilities. And if I can just go back on Maggie's comments, just to clarify, on the conversion, you'll see financial benefits, on the cost side, the end of Q1 and then throughout Q2, and they really should be done by the end of Q2. And then, operationally, as all of our employees are now working on one set of systems, in Q3 and Q4, and they've had a number of months to learn and they become more proficient, we're expecting to see much more -- better improvements in our sales and retention on both residential and commercial in the last 2 quarters.

Maggie Wilderotter

Simon, I’ll just add one thing on the commercial revenue side, because I think it’s important. We are focused on a handful of key products that really represents a lion’s share of the commercial revenues. Those products are you know, wireless backhaul, Metro E, our CPE business, our business high-speed Internet for small business, dedicated Internet, and wireless data.

So if you think about those sets of products, it represents over 50% of the commercial revenue. And those sets of products in 2011 grew by 8.6%. So that’s what we are focused on again in ’12, is that set of category products. We think that has the biggest opportunity for us.

Simon Flannery – Morgan Stanley, Research Division

Great. Thank you.

Operator

We'll take our next question from Phil Cusick with JPMorgan.

Philip Cusick – JP Morgan Chase & Co, Research Division

Two questions, I guess. First, if you could talk about the balance sheet. The payables and receivables shifted around a lot this quarter, is there anything we should be thinking about there? And second, as we come to a sort of 2-year anniversary pretty soon, there's another carrier out there who's starting to talk about the possibility of selling lines. And I wonder if you would consider doing a transaction, as we get into the second half of this year and what the criteria for that might be?

Donald Shassian

So, on the receivables and payables, no, I don't think there's anything there. We did a conversion in October of large amount of lines. We did some collection activity there, we had some payables, all the financial systems converted. There's nothing more fundamental there. And all I see, it's managing a little bit of working capital, nothing fundamental. I would, however, point out that we look if we look at the payables, I do recognize that we're finishing the conversion for the 4 states in October, and we're also ramping up contractors and vendors, helping us with this conversion. So there's a pretty significant amount of integration CapEx expense that's built into some of those payables that maybe, you might not have anticipated. But obviously, it will slow down once we get through all these activities.

Maggie Wilderotter

So on the – coming up on our two year anniversary, which again, we all are excited about that too. It’s felt like the dog years, as we have gone through this. But our heads are down. We delivered a very good fourth quarter. We’ve always done a good job since we closed on this acquisition on integration, on cost synergies. But this was really the first quarter where we still have a revenue turn and we’ve been saying that. We knew it’s going to take us to the fourth quarter to get there.

So what we want to do is to go through the next several quarters and build the track record on both the cost synergies and the revenue opportunities here because I look at that as you know, earning the right to do other acquisitions. So our heads is down, proving out what we can do with these markets. We still have ways to go. So we are not thinking about anything other than that at this point.

Philip Cusick – JP Morgan Chase & Co, Research Division

Thanks guys.

Operator

Our next question comes from Michael Rollins with Citi.

Michael Rollins – Citigroup Inc, Research Division

I was wondering if you guys can give us more detail into the CapEx 2011, breakdown of the different pieces in 2012. Can you frame for us the size of the fiber-to-tower opportunity in your footprint and what kind of penetration that you're going to get to through the end of 2012?

Donald Shassian

Mike, I don't have that. We have been very selective in pursuing the fiber to the cell. There have been some very significant, I'll call it, price competitions, some very significant CapEx requirements and returns that we have not seen as being very attractive. And where it has been, we've been pretty aggressive. I don't think we've given that numbers in '11 and '12, but the number is -- it is sizable. But we are not buying share. We are trying to be smart about where we're getting a return on dollars invested. That -- the increase, the $725 million to $775 million, sort of the mid-point of $750 million, is actually a little bit higher than from previous discussions that we've had publicly in the arena. We are saying they're probably going to be in the low-7s, about $700 million. So there's about a $50 million increase in there. Some of that's for wireless towers and some of that is from some other things in the network and for products. So we've been trying to be very judicious about it.

Maggie Wilderotter

I would say that we have thousands of towers in our footprint, Michael. And we look at all of the bids for all of the towers on a case by case basis. We want to make sure that we are getting the appropriate return, so that the investments that we put in we get paid back on those investments.

Donald Shassian

The right payback.

Maggie Wilderotter

The right payback. So we are judicious about it. We are winning our fair share of these towers and in many of the locations when you get very rural, we are the only provider in those areas. So, we feel good about it. We think backhaul is a very strong business. It’s a double-digit growth business for the company. But we do have a good economic discipline on how we looked at capital.

And when we think about capital, we think about what we call business as usual capital, which is really maintenance on the network. We also think about the broadband capital that we needed to expand the broadband footprint that we’ve committed to in these new markets. We look at what’s called strategic capital, which is investments in the IT systems automation and processes and new products. And then last, but certainly not least, we also look at the wholesale business, and how we work with our carrier partners.

So that’s how we break the capital down in the company. We’ve a very strict capital review process. We look at capital and really every job to make sure that we are spending it the right way, and only spending what we need to.

Michael Rollins – Citigroup Inc, Research Division

And could you just, speaking of investment, can you just frame for us, as a follow-up, where your broadband speeds are tiering-wise, you have x percent of your footprint with this kind of speed and run us through the portfolio? And then, given your investment, where you think that can get to on a 2- to 3-year time frame.

Donald Shassian

So I'm going to ask Dan McCarthy, our Chief Operating Officer, to respond to the split.

Daniel McCarthy

Right now, we have about 83% of our footprint is capable. 76% is at a 3 meg speed, about 66% at 4 meg; 56% is actually at a 6 meg capability; and about just under 30% is at a 20 meg. And we'll be investing throughout the year to improve speed-reaching capability in all our markets.

Maggie Wilderotter

Now Dan you might want to talk about some of those network upgrades you are doing in order to do that with VDSL and some of the DSLAM upgrades.

Daniel McCarthy

Sure. As you look at where we're going this year, it's really about adding Ethernet in the core so that we improve the deliverability. And as we do that, we'll be adding VDSL2 and we'll be looking at VDSL2 bonding as means of driving both speed increases in the residential and the commercial markets. At the same time, we'll continue to expand Ethernet so that we have a differentiated product for the commercial space. And when you look at the combination of the three, it really does improve both the reach and the speed, virtually in every area that we touch with those capacities. And we'll be doing that in markets throughout 2012. And as we do that, we'll be launching products, especially after we come through the 9-state conversion. So it'll be in the second half of 2012 that you'll start to see that.

Maggie Wilderotter

Yes, we will have several markets, Michael, with this year we will have 50 meg on our network, you know, with our combination of Ethernet, fiber, VDSL, DSL in the marketplace. So we are pretty excited about that.

Michael Rollins – Citigroup Inc, Research Division

Thank you.

Operator

We'll take our next question from Scott Goldman with Goldman Sachs.

Scott Goldman – Goldman Sachs Group Inc., Research Division

A couple of questions. One, I wanted to talk on revenue. Obviously, you guys put a very good fourth quarter number and I'm just wondering what you guys are thinking about the trajectory for 2012. I know you don't usually put guidance out there, but is this something that you think is sustainable going forward? Or would systems conversions in March really slow that down a little bit and then you pick up steam at the back half of the year? And then, secondly, Don, I guess in the free cash flow guidance, it looks like you've lowered cash tax expectation, the $25 million, from some comments you've made not too long ago, about $150 million. Just wondering what was behind that, the lower cash tax number and is that just something that gets deferred into 2013?

Donald Shassian

Scott, on the revenue guidance, we don't give guidance out. We had a great fourth quarter. We are very, very focused right now on getting the conversions. I'd certainly love to be able to say we're going to continue to see improving sequentially but I'm going to be very cautious into alluding [ph] on that. The first 2 quarters, we've got some major work to do and while our call centers and our sales force are going to be very aggressive in the marketplace, I think we've got to be very careful in making sure we can deliver on customer expectations and get to this very cleanly.

I think we are expecting to see, in Q3 and Q4, some nice seasonal revenue. So while declining revenues in Q3 to Q4 was a very nice improvement in prior quarter, I would not start expecting to see continued improvement on a quarter-to-quarter basis till we get through with these conversions. On the free cash flow guidance and cash taxes, the reduction is due to the fact that we really spent a lot of time looking at our strategies around repair and maintenance and tax policies and really making sure we understood what we had, as well as whether there's actually -- how much we'd be able to carryover. We actually looked in our 10-K that's filed, we had about a $500 million net operating loss in the federal level. That's an NOL unless we got a new tax effect after that. It reflects a number of deductions in 2011, including bonus depreciation and other items that were in excess of what we're able to utilize in '11, and so it sort of carried itself forward.

It was really the finalization of all those deductions and the tax depreciation number that was greater, carrying to '12 than I had previously anticipated. I do not expect to have NOLs carried to '13. So you see '13 cash taxes start build back up but the real change in improvement here is really a better line of sight on '11 on a tax basis, which really does help us complete this communicated guidance.

Scott Goldman – Goldman Sachs Group Inc., Research Division

And just a follow-up on the revenue front. Maggie, on the residential side, maybe can you talk about -- I know you talked about no promotions in the fourth quarter. Just something that promotions are really off the table until all the conversions are done and then you're fully operating under one set of systems and then you really hit the ground running hard at that point in time. And so maybe the residential should pick up. And how do we think about promotions that may be coming off in the early part of the year and what kind of boost that could give on the residential side?

Maggie Wilderotter

Well I think one of things to keep in mind is we did a very aggressive video promotion for all of 2011 that ended in January. So all of the customers that we signed up for that promotion will start to pay full board for their DirecTV or Dish service in this first quarter.

And I think as you know, we have that sort of contractual revenue for us, and we have to pay DirecTV or Dish for any percentage of that revenue. So that will give us some lift in the first quarter. But you are absolutely right. We have limited the promotion. We are not doing any aspirational gifts in the first part – in the first half of this year. So we can get through the conversions. We do have IPO good offers in the marketplace today, that those offers will continue with the continuity through the conversions.

So we are not training people on new offers, at the same time, we are trying to take care of 2 plus millions new bills that are hitting the Street. But we have a very aggressive plan for Q3 and Q4 on the marketing and offer side. So you will see us ramp as we get out of conversions and start to make those offers possible.

Scott Goldman – Goldman Sachs Group Inc., Research Division

OK. Thanks.

Operator

Our next question comes from Kevin Smithen with Macquarie.

Kevin Smithen – Macquarie Research

I wondered if you could comment on your dialogue with the rating agencies and with, in regard to the dividend cut, what do they want to see? And what is likely to be the response tomorrow? And in the near future, what you expect from your bondholders? And what dialogue have you had with them regarding this dividend cut?

Donald Shassian

Kevin, how much I would -- probably give an answer to what do they want to see. We made a decision that we thought was in the best interest of all of our stakeholders. And we obviously, we did discuss with them and let them know what we're planning to do. I think they think it's a smart move. It's obviously for their constituency, it improves the creditworthiness of all of the bonds and debt that is out there. So I think they're pleased by that. We're going to -- we've always said we're going to get 2.5x. We're basically saying the same story, were going to get there.

We're changing the dividend to be able to get there quicker. And we'll see how they react to the news. We think it's a positive news. I'm not sure how they're going to put words out. I assume they'll put some sort of announcement out within the next several days. But I think it's a smart move. It's a great -- it's a smart thing for us to do, it's the right thing to do. And we've got debt coming up every year, we're going to use a lot of cash to pay off the near term. But we certainly would like to go back up the market and do some refinancings to some of the longer-dated debts. So hopefully, all of our bondholders will see this is a good move and it will improve our capabilities and flexibility to deal with the balance sheet going forward.

Kevin Smithen – Macquarie Research

Was this decision made before the S&P action a couple of weeks ago? Or was it made in response to it or after that action?

Maggie Wilderotter

We had a Board meeting yesterday. The decision was made yesterday.

Kevin Smithen – Macquarie Research

That’s helpful. Thanks a lot.

Operator

Our next question comes from Mike McCormack with Nomura Securities.

Michael Hodel – Morningstar Inc., Research Division

This is Mike Hodel pinch-hitting for Mike. I was hoping to follow up on Scott's question and hope you guys can shed some color on the current state of the residential high-speed market. What's going on -- where you're seeing the competitive landscape? Can you -- if you can highlight any changes in the share versus competition or changes in pricing trends?

Maggie Wilderotter

Well Mike I will start and jump in there, I might have Dan give me some color also about what we are seeing in the residential area. But I kind of look at – I look at two things. I look at our growth in high speed, and I also look at our churn and our overall customer churn. And I think we are seeing the fundamentals are moving in the right direction. We have competitive market. So there’s no doubt that. We are investing to keep up. So we are competitive from a speed and capacity perspective in all those markets.

And we are also delivering a fair amount of new broadband to markets where there is no competition, because no one build to those areas in the past. So we have a fair number of households that we’ll deliver in 2012 to unserved or underserved areas. So I think we feel good that we are in a good position. We do believe in ’12, as we continue to see a huge amount of usage lift year-over-year, especially for streaming videos that we have to continue to invest to keep up with that so we don’t get congestion to our networks again.

So we are investing where we need to and we are monitoring the networks to make sure we stay we have to be, to be competitive. Dan?

Daniel McCarthy

Mike, and I'll just say that from a competition perspective it's been very rational from a price perspective. There hasn't been any kind of signs that there are outrageous activities from a promotion. I think we have done a good job, as Maggie pointed out, in taking share in the areas that we're introducing products and we continue seeing a lot of good opportunities as we go through '12 as we continue to expand the footprint and go after taking share in some of those areas.

Maggie Wilderotter

And we have some pretty good hard hitting advertising that we are doing in a number of markets where our cable operators [inaudible] are all raising rates. So we are taking advantage of that as well.

Donald Shassian

And I would just like to add on one item that Maggie mentioned, our churn on high-speed continues to decline, both in legacy and acquired, which is really, really important. And as we obviously continue to enhance the network and reach out, as Dan mentioned, it gives us good opportunity to further penetrate, but the churn numbers continue to improve. And we are the company below 2% on churn on high-speed, which is great.

Michael Hodel – Morningstar Inc., Research Division

Just one follow-up. When you guys were speaking earlier about the new products that you're bringing to market, the bonded lines and the VDSL lines, when you guys look out into the market next year and about the future capacity in each, do you envision to be able to come in at a premium price? Or is that -- or do you plan on coming in below cable on pricing? How do you guys view the pricing market playing out with the new products?

Maggie Wilderotter

I don’t think that one size fits for all. We don’t look at our pricing from a – like a homogeneous perspective. We actually look at it from a market engagement perspective. And we have what we call leader markets and challenger markets. And we do price differently in those markets where we are trying to grab share and win back versus maintain the base, both on the commercial side and the residential side.

And we also look at differentiating with different product sets based upon where we think we can drive more revenue per household or more revenue per business versus in other areas where there might be high unemployment, may be more economical challenged areas, less sophistication from a business perspective.

So we do what’s called local engagement. We have our general managers and our regional presidents that really make those decisions.

Operator

Our next question comes from Frank Louthan with Raymond James.

Frank Louthan – Raymond James & Associates, Inc., Research Division

My question is really more around revenue, which seems to have been more of the issue over the last couple of years. Can you be a little more specific on some of the projects that you're going to invest in? And what are some of the projects that we can see a tangible return over the next 12 months, if you're taking this dividend money and reinvesting it?

Maggie Wilderotter

Well I can start and Don you can jump in. When we think about where the investments are to grow revenue, the majority of those investments, Frank, are all around broadband. So it’s really about -- on the residential side, it’s access. So it’s reach. And it’s speeds and capacity and being able to charge customers based upon, if they want more capacity and speed, they pay more than a basic package, and moving customers up through that.

In addition, it surrounds products and services on residential broadband like our Frontier secure products, our second connect products. And we are also strategically putting wireless modems in every household and we are taking wireless – non-wireless modems out of existing broadband households that we inherited in this acquisition, and upgrading the customer to a wireless modem, where we get somewhere between $5 and $7 a month for that service as well. So we put Wi-Fi hotspots in every home.

On the commercial side, I’d mentioned the five or six products that we are very focused on investing in. I think you will also see us this year launch a VoIP BHSI cloud service for small business, which is a killer product. We are trailing it right now in West Virginia and in Portland, Indiana. So we are actually covering not just the high-end with big pipes for large businesses and Metro E, we are also taking down markets to make sure we have very robust product set for our small businesses as well.

So we feel very good about the revenue growth opportunities in those categories.

Frank Louthan – Raymond James & Associates, Inc., Research Division

So it appears it's somewhat business as usual, at least until June, July timeframe as for as some of these products and getting the systems converted. I mean, what is your level of confidence that competitive forces won't accelerate during that time period -- from between now and then? Or what would have to -- what has to go right to make sure that we don't sit here a year from now and sort of the back-half plans didn't really work out as we have -- as you're laying them out today?

Maggie Wilderotter

Well, let me be clear. I think we have good offers in the markets today to be competitive. I don’t think we are sitting back and not doing anything and going dark and not having any offers at all. We are just not going to put the pedal to the metal until after we get through the conversion. So I believe we will stay competitive in these markets. And I believe we will continue to take share. Also keep in mind, 50% of our markets are already on the legacy system, right. They are not affected by this conversion, and we will continue to drive in those markets for improvement in terms of growth, market share and reducing access line losses and customer churn.

So where we won’t get the full deal for 4 million customer until we get these conversions done, we will continue to be you know, active these markets in terms of competing against the cable operators.

Donald Shassian

And just one other to the confidence, Frank. West Virginia is great. We've seen really good results out of it. We've converted 4 states back in October. And while I can't as yet declare victory that we're seeing all the numbers accelerating, we're seeing some really good signs of very similar improvement, just like West Virginia, which is just out of the gate. And I think that continues to give us a lot -- very good confidence that those 4 states are going to be even more competitive throughout 2012 and that likewise, we'll be able to catch on with other 9 states being converted.

The other one that Maggie, I think, alluded to earlier, Ethernet is available to 75% of our market and it's going to be available to even more throughout the year. So from the commercial side, we're trying to continually give them more products and capabilities, and that is, you can call that business as usual, I agree, we'll just continue to push that out and make products available and continue to push it. I don't think we're going to be eating with both hands tied behind our back for 6 months if that's what you're implying. We've got a lot of activities going on, we'll continue on this business and be aggressive in the market. But our ability to be really aggressive like we've done in prior ways, as legacy alone, is going to have to hold off until we get conversion completed.

Operator

Our next question comes from Dave Coleman with RBC Capital Markets.

David Coleman – RBC Capital Markets, LLC, Research Division

Can you just disclose what the percentage of fourth quarter residential broadband gross ads were from West Virginia?

Donald Shassian

We have not, I'm not sure I want to do that, David. I usually don't want to give out -- we've only got a couple of competitors down in West Virginia and I'm not sure I want to give out that information. The numbers are pretty solid.

Maggie Wilderotter

A 3 percentage point increase in share.

David Coleman – RBC Capital Markets, LLC, Research Division

I'm sorry, could you repeat that?

Maggie Wilderotter

A 3 percentage point increase in share in West Virginia for broadband. But we don’t necessarily give out those – the growth numbers.

David Coleman – RBC Capital Markets, LLC, Research Division

I believe last quarter, you talked about increasing marketing spend over third quarter level. But if I look at the -- the broadband net adds actually stepped down sequentially. Typically, fourth quarter is stronger than third quarter, so I'm just wondering if we saw a slight uptick in marketing spend, why did that not translate into stronger broadband gross adds or net adds, rather?

Donald Shassian

Well, I think, David, we had a slight increase in marketing spend. Promotions were not very aggressive. We continue to just do the marketing. And I think we've had a nice improvement in the FiOS side. And as we got into conversion, I think we -- for those 4 states, it's really important to continue our lean in. I think that we're going to be very aggressive in those new markets coming out of the gate. And we sort pulled back and said, wait a second, let's make sure all the service quality is right, the network's right, everything is done cleanly, and so we sort of pulled back a little bit. So while there's a little bit of marketing spend, it may not be as efficient because of the conversion, and those 4 states didn't give up a lot of lift in the quarter. The other states did, but those 4 states did not.

Maggie Wilderotter

Which we had anticipated.

David Coleman – RBC Capital Markets, LLC, Research Division

I understand.

Maggie Wilderotter

But we didn’t – but the other point is we didn’t want to go dark during the conversion either. We wanted to at least have some air cover in the marketplace on Frontier.

David Coleman – RBC Capital Markets, LLC, Research Division

So just going back to the earlier question on fiber to the tower, talked about not wanting to get too aggressive and just chase revenues. Any estimate as to what percentage or what number of sites that you're currently providing T1 backhaul to that you're not competitively bidding on? Because basically, I don't understand whether there's a potential of carrier revenue loss or access revenue loss by not going after the sites that you currently provide backhaul.

Donald Shassian

Yes, there is.

Maggie Wilderotter

There’s always that challenge. Right, because if you don’t bid on certain sites or certain sites go to somebody else over time, you are not going to just make that up in volumes. So, we are cognizant of that and we use that as a choice point on how we think.

David Coleman – RBC Capital Markets, LLC, Research Division

Can you quantify how much that is?

Donald Shassian

No. There, Dave, I haven't. But there's -- the places where we have not agreed with some of the bidding has been in very, very remote areas. And we sort of are going to wait for the counties to come back to us. So, understand, we're not in the urban markets where there's been a tremendous amount of competition and post being pursued on every tower in urban America. We are more in suburban and rural, and those quotes and bidding processes, are still underway. It's not like it's all been completed. So we're still in the throes of many of them. We've got a number of bids in for several hundreds of towers that we're waiting for responses on. So I think it'd be premature to give out any information. But we are trying to be smart about it. If it's a remote area, we're not going to price something ridiculously low where we really think we're the only one that can provide what they need. And so we we're trying to be smart and judicious about it.

Operator

We will take our next question from Chris Larsen with Piper Jaffray.

Christopher Larsen – Piper Jaffray Companies, Research Division

I just wanted to really think about how we should figure the access line impacts from the conversions will go. If you can share any statistics with us, whether it's churn or financial, give incentives that you've done to prevent churn during previous conversions. And then, is there anything -- you obviously did have a very good fourth quarter, is there anything you can sort of point to as, well we did this, this and this and now, starting to pay off and we see that, we've set all the blocks in place so it's going to carry through. Is there anything that you can sort of point to as we think about 2012 that you did in '11 to sort of create that good fourth quarter?

Donald Shassian

Okay. Chris, on access line, the preventing churn is primarily making sure that we do handle our service with the customer, cleanly. That bills go out cleanly. Our reps can respond to questions because people will get a new bill that's going to be different colors, different format. If he sends us orders then we deal with those orders promptly and cleanly, and if there's troubles, we deal with those cleanly. You do a conversion, the biggest challenge is you start with the backlog and how quickly do you clear up that backlog.

We did that extremely well in the 4 states we did on October and we have geared up to be able to deal with it even more efficiently here. So I don't expect churn to increase because of conversion, whatsoever. I think we have now done these conversions so many times, I think we really try to understand what's some of the nuances are from residential and commercial customers. So I don't expect to see any uptick on churn whatsoever on conversion. What I am expecting is that churn is going to improve several months after the conversion. And I do think it's what is most important to us.

Christopher Larsen – Piper Jaffray Companies, Research Division

That’s helpful.

Maggie Wilderotter

Let me kind of take you through what I think some of the major drivers are, that are – if I look at fourth quarter and how we knew that we needed to get to fourth quarter to start to see these revenue turns that will continue. I think first and foremost on the commercial sales side, we – as I mentioned in the beginning of 2011, we had to hire an entirely new sales force in this market. We didn’t get any sales people from Verizon.

So we hired several hundred sales people on medium enterprise, 150,000 sales people on small business, and we had to train them and get them up their seat. And we knew it would be in the second half of the year that we would start to see a trajectory of that bearing fruit. And our pipeline was very strong going into the fourth quarter. And it continues to be strong into this quarter. So we feel very good about that. We also put a separate sales team in place on CPE sales for business.

So we have a group of people in the company that are very savvy and working with our CPE partners to go after fairly large deals with large customers both on the medium and enterprise side.

In addition to that, we built out over 400,000 new households for high speed. This was sort of the fertile ground for us to go grab penetration. And I think through the end of 2011, we were at the 14% penetration rate on both new households. As we mentioned, in West Virginia, we are at 21% and our goal is to get that up to 30% and 40% over the next 12 months. So we will continue to drive in both new household areas, because that’s opportunity we didn’t have before.

And then the last thing I would mention is we lead with high speed, no pun intended on it rhyming. And we try to get double and triple plays with our customers. We have a formula at Frontier we call “left to right” where if you take a single phone line customer and you get them to take high-speed, and then we come back at them and get them to take video if we can’t get a triple play right up front. And we are very successful in taking customers from a single product to a double product to a triple product. And we launched in the second half of last year what we call custom value pricing that provides discount to customers to take multiple products, and with a contract. So you get a 5%, 10% or 15% discount depending on how many products you take.

So we feel very, very good that we will continue to take the households – the two high speed households, and those are not just high-speed sales opportunities but they are double and triple play opportunities. And we also have very aggressive offers based upon our partnership with Dish. That was a strategic play that we made in the middle of the year picking a partner. And they are working with us very closely on a number of offers in the marketplace.

Donald Shassian

If I just may emphasize and reiterate what Maggie said on the commercial side, we've been talking to some people in May, that the fourth quarter will have a nice improvement in commercial because of the sales force that was hired out of the gate, and their improved capabilities and experience and reach and the consistent improvement in the pipeline that we kept seeing. And it was coming to fruition in the fourth quarter, we expect to continue to see that going into 2012. So commercial has just been a nice slow build, building up a very nice pipeline. So we've been very pleased about that.

Maggie Wilderotter

Great. Well thank you so much everyone for joining the call. We appreciate the support of Frontier. I know as I mentioned in the beginning that it is tough for us to make this dividend decision but we know it’s the right thing to do. We are very pleased with our fourth quarter results, and we think they are showing what we have said we are going to do and that’s not just take the cost of these new properties, but really start to leverage the revenue growth.

So we look forward to talking to all of you on our next quarter earnings call. Thanks again.

Operator

That concludes today's conference. Thank you for your participation.

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