Consolidated Communications Holdings' (CNSL) CEO Bob Udell on Q2 2016 Results - Earnings Call Transcript

Consolidated Communications Holdings, Inc. (NASDAQ:CNSL)

Q2 2016 Earnings Conference Call

August 04, 2016 11:00 AM ET

Executives

Matt Smith - Vice President and Treasurer

Bob Udell - President and Chief Executive Officer

Steve Childers - Chief Financial Officer

Analysts

Frank Louthan - Raymond James & Company

Scott Goldman - Jefferies & Co.

Barry Sine - Drexel

Operator

Good day, ladies and gentlemen, and welcome to the Consolidated Communications Holdings Second Quarter 2016 Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions following at that time. [Operator Instructions] And as a reminder, this conference is being recorded. And now I'll turn the conference over to your host, Matt Smith. Please begin.

Matt Smith

Thank you, operator and good morning, everyone. We appreciate you joining us today for our second quarter earnings call. At the end of the prepared remarks, we will open the call up for questions. Joining me on the call today are Bob Udell, President and Chief Executive Officer, and Steve Childers, Chief Financial Officer.

Please review the Safe Harbor provisions in our press release and in our SEC filings for information about forward-looking statements and related risk factors. This call may contain forward-looking statements within the meaning of the Federal Securities laws. Such forward-looking statements reflect, among other things, management's current expectations, plans and strategies and anticipated financial results, all of which are subject to known and unknown risks, uncertainties and factors that may cause the actual results to differ materially from those expressed or implied by these forward-looking statements.

In addition, today's discussion will include certain non-GAAP financial measures. Our earnings release for this quarter's results, which has been posted to the Investor Relations section of our website, contains reconciliations of these measures to their nearest GAAP equivalent.

I will now turn the call over to Bob to provide an overview of our second quarter results. Steve will then provide a more detailed review of the financials. Bob?

Bob Udell

Thanks, Matt and good morning, everyone. I appreciate you joining us today. I will provide some highlights for the second quarter and then turn it over to Steve for a more detailed review of the financials. We've had a solid first half of the year with consistent financial results and the announcement of two transactions which were the acquisition of fiber-based Champaign Telephone Company and the sales of our ILEC in rural Iowa.

The second quarter results reflect our continued focus on our strategic objectives. Total revenues were $186.9 million and adjusted EBITDA was $78 million. Revenues were led by our year-over-year increase of 5.2% in commercial and carrier, data and transport services. Growth in our Metro Ethernet circuits was a strong 19% and our overall data connections increased by 3,000.

We're pleased with this performance during what has historically been a seasonally soft quarter. Our overall business and broadband revenues moved higher to 81% of total revenues. The dividend payout ratio for the quarter was 73.4% and the year-to-date ratio of 66.9% is on target with our plans.

Now let me turn to some more specifics for the quarter. Commercial and carrier revenues increased by 1.8% compared to the second quarter of last year. We are continuing to place more investments in resources towards the strategic area as we extend our fiber network connecting to new buildings and towers. During the quarter, we added nearly 200 new fiber-lit buildings with anchor tenants and 50 new fiber-to-the-tower sites under contract.

With respect to our equipment sales, revenue in the quarter was lower than expected at $10.4 million. As you know, this revenue can fluctuate quite a bit given the nature of the hardware sales cycles and the revenues are primarily driven from reselling Cisco equipment as a Gold Certified Partner.

Our strategy is incrementally shifting with a larger focus on the professional service and maintenance portion which are among the more recurring revenue in nature and carry higher margins. On the consumer side, our strategy continues to focus on securing the broadband pipe into the home with competitively price speed options and enhancing our position as the service provider choice for home networking needs.

We call this our connected home strategy where we can help consumers with support for all of their devices and security. We developed a self-served user friendly portal that all customers can utilize to do such things as monitor their own bandwidth usage, view how much they are using from each device and see how much bandwidth is available at their home if higher speeds are needed. This portal has been a very successful support and retention tool as well as a way to reduce operating costs.

Now let me touch on CapEx. Our guidance of $125 million to $130 million for 2016 has not changed. We have a disciplined approach to our investment decisions with new builds and expansion efforts requiring minimal internal rate of return thresholds and payback targets. CapEx side, the video is declining as we advance our strategic shift to emphasize product profitability and over-the-top video for our customers. This also allows us to allocate the video CapEx to higher margin commercial and carrier growth opportunities. The benefits from these capital investments of course produced better quality revenue over time.

Overall, we continue to operate with about two-thirds of our total CapEx as success based investments providing significant flexibility in our capital plans.

Finally, before turning the call over to Steve, let me discuss both the acquisition and asset sale we announced in the second quarter. We continued fiber-based expansion strategy with the acquisition we made in Champaign, Illinois, which closed on July 1. This transaction added 275 route miles of fiber and over 300 fiber-lit buildings. We are excited about the pipeline of opportunities and we plan to use the scale and resources of our larger Company to expand and grow in this market.

Also in the second quarter, and consistent with our strategic focus, we announced the sale of our rural ILEC in Northeast Iowa for which we expect to receive approximately $20 million in cash proceeds. We are working through the final regulatory approvals and expect to close this transaction in the third quarter.

So in summary, I'm pleased with the consistent results we've delivered throughout the first half of the year and our employees are engaged and committed to winning in the marketplace. We have the infrastructure in place to continue to capitalize on the data explosion and deliver on our strategic objectives, including providing our shareholders with a comfortable dividend payout ratio. With that, I'll turn the call over to Steve for the financial review. Steve?

Steve Childers

Thanks, Bob. Good morning, everyone. Today, I'll review our financial results for the quarter compared to the results for the same quarter last year. I'll follow that by reiterating our 2016 guidance.

So starting with revenues; operating revenue for the second quarter was $186.9 million, as compared to $201 million last year. Revenues from equipment sales were down $9 million in the second quarter of last year, including approximately $1 million in revenue from the Enventis billing company that we sold last October. Excluding these items, revenues declined by $4.1 million, primarily due to continued erosion in legacy voice services and network access as well as the scheduled step-downs from CAF II and Texas USF. These declines were partially offset by our overall 1.8% year-over-year growth in commercial carrier revenues.

Total operating expenses, exclusive of depreciation and amortization, were $120.4 million compared to $129.7 million for the same quarter last year. The $9.3 million reduction in operating expenses is primarily tied to lower equipment sales and continued efficiency improvements. These were partially offset by accelerated advertising, service costs related to storms in Texas as well as a non-cash impairment charge for the sale of the Iowa ILEC as outlined in our release.

Net interest expense for the quarter was $19.1 million, which was a $1.3 million improvement to the second quarter last year. As a reminder, we significantly improved our cost of debt capital structure with the successful refinancing redemption of our 10-7/8% senior notes that we executed in June last year.

Other income debt was $8.6 million compared to $9 million for the same period last year. Cash distributions from our Verizon Wireless partnerships in the quarter were $7.8 million and $7.1 million for the second quarter of 2015. Weighing all these factors and adjusting for certain items as outlined in the table in our press release, adjusted net income was $10 million and adjusted net income per share was $0.20. This compares to $11.9 million and $0.24 per share respectively for the same period last year.

Adjusted EBITDA was $78 million in the quarter compared to $80.3 million for the second quarter last year. Capital expenditures for the quarter were $33.6 million. From a liquidity standpoint, we ended the quarter with approximately $24.6 million in cash and $65 million available in our revolver. For the quarter, our total net leverage ratio, as calculated in our earnings release, was 4.2 times. Cash available to dividends was $26.7 million resulting in a comfortable dividend payout ratio of 73.4% for the quarter.

Now let me reiterate the 2016 guidance we provided last quarter. Capital expenditures are expected to be in the range of $125 million to $130 million. Cash interest costs are expected to be in the range of $73 to $75 million. And cash income taxes are expected to be in the range of $1 to $3 million. With respect to our dividend, our board of directors have declared the next quarterly dividend of approximately $0.39 per common share payable on November 1, 2016 to shareholders of record on October 14, 2016. This will represent our 45th consecutive quarterly dividend.

With that, I'll now turn it back over to Bob for closing remarks. Bob?

Bob Udell

Thanks, Steve. So the first half of 2016 continued our path of delivering on our strategic initiatives. We will maintain our focus on investing for the future, expanding the fiber footprint and growing our strategic revenues, all of which provide long-term benefits to our customers and shareholders. So with that I'd like to open it up for questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] First question is from Frank Louthan of Raymond James. Your line is open.

Frank Louthan

On the equipment part of it, can you talk to us, underlying trends from your larger enterprise customers? Are you seeing any correlation there with sales? And then can you comment on some of the FCC proceedings, the set-top box proceeding and the legislative services, in particular, to what extent do you think that those impact your businesses? Thank you.

Steve Childers

All right, Frank thanks for the question. Let me take, of course the EIS question first. We're seeing strong metro Ethernet demand from our network customers, and while the equipment business has been a good pull-through with over two-thirds of the equipment customers taking a network service from us, actually upwards 80%, the real issue there is we've seen a softening in decisions, partially because of the economy and maybe election year, but they're slower than previous years in large equipment, big box purchases.

And that's partially, I think related to the shift to the cloud. We're seeing a good ramp in our pipeline for cloud services, and Cisco in particular are shifting their strategy with more focus on supplying hardware and network equipment for cloud service providers. So I can't comment specifically on their long-term strategy. I can say we are seeing those trend lines and that's affected our equipment business, but not our network business. It continues to be robust with metro Ethernet, the lead product and value-added services like cloud helping us solve problems for our customers.

With related to the set-top box and the FCC proceeding there, we're on both sides of that issue, but mostly in favor of seeing the FCC regulate less and let the market work through the transitions over the top. We don't see that negatively impacting our business although we understand the plight of both the content providers and the large cable guys we happen to be aligned on wanting less regulation when it comes to the set-top boxes.

But I remind you, our strategy is primarily focused on the broadband pipe and adding value and making sense out of how our customers use that pipe and over-the-top video consumption is something we're investing in. Our unified portal for consumers makes it easier for them to digest and to get content where they want, when they want it. And we see that as a more profitable forward path for us.

Frank Louthan

Okay, and on the Ethernet customers and the network customers, are those primarily other carriers and or are they large enterprise type customers? Where is the growth coming from with that business?

Bob Udell

The growth Metro Ethernet region is coming from both. We're seeing a tempering on the fiber-to-the-tower. But as you've heard across the industry, those extensions to new towers largely out of our service territory have given us the cause to build fiber network past commercial and enterprise opportunities. The metro Ethernet growth that we see is predominantly in the 500 to 600 and up per month customer range, with some of that moving a little bit lower than that monthly recurring revenue on those customers that are expecting growth.

So overall, it's a mix, with I think the trend shifting towards more of the enterprise customer.

Frank Louthan

Hey, great. Thank you.

Operator

Our next question is from Scott Goldman of Jefferies. Your line is open.

Scott Goldman

Hey, guys. Thanks. Actually I have a few questions, if I can squeeze them all in. I guess first for Steve, just wondering if maybe you can help us understand or frame what the impact of the acquisition will do to financials as we go forward? You closed at July 1, so you should get a full quarter impact going into 3Q?

Second, just on the Verizon Wireless distributions, obviously I think you may be worried Verizon shifted, how they're securitizing some of the receivables and moving more to an asset-backed securities market which shifts how they recognize cash flow from some of that activities. And just wondering if that has the potential to change what your distributions might look like or perhaps the distributions are done off of different measure and not impacted at all?

And then lastly, wondering if you could just comment on the broadband revenue trends got a little bit soft this quarter, presumably it's probably just tied to the video losses, but just wanted to see if there's anything else we should be thinking about there? Thanks.

Bob Udell

Okay, Scott, thanks for the questions. Yes, relative to the closing of the Champaign acquisition that we did close in July 1. So we've talked about that in the past to being $10 million in revenue. So we will have a full quarter for that. I'm not prepared to give guidance on the margin for that. But you will see a little pick up on that acquisition. Again, we think it really fits into our strategy, with the fiber focus. I think it's a template for what a tuck-in type acquisition should look like for us going forward.

Relative to your second question, with Verizon and on their cash distributions and the different ways they're factoring or looking at the questions on the wireless, it's probably too early for us to tell that. Since they went through the hedge program the last couple years, the last several quarters, let me say that way, cash flow has been a little bit I should say volatile, but fluctuated more than normal. With that we have - we don't think we're quite caught up with that in the first half of the year. But I will say that past - for the last several years, our distributions the last half of the year are always larger than what they'd been in our first half of the year on run rate.

So as you know, Matt sits on those boards for those partnerships and again, we're still searching for information on what the distributions will be going forward relative to whether they're factoring securitizing or how they're trying to accelerate the cash flow piece.

And finally on the broadband question, I think your question is just - you're seeing some up and downs on the - if you look at the table in the press release, the consumer broadband number kind of up and down. And I think if you look at second quarter of 2015, that's probably tied to when - when we tied it to our price increases. And then also first quarter of 2016 is when we implement or did some additional price increases. We're doing a lot better job and being a lot more aggressive in passing some of the video content increases in that.

So I mean, it's sort of like price increases, and then maybe as you mentioned, the video churn, the video subscriber accounts being down over time. So again we still think we have the right focus and the right balance on video profitability and growing broadband, as Bob mentioned, with an emphasis on fatter, faster pipes than just what we used to sell. So we feel pretty good about that strategy that we're executing on right now.

Scott Goldman

Great, and one follow-up to the Champaign. Any guidance or help, but maybe guidance is the wrong word, but help you can give in terms of how the revenue coming from Champaign might fall into your product buckets?

Bob Udell

Scott, that's a great question, I would say that 90% of that's going to be in the business and broadband side. It's not 100%, it's going to be very [indiscernible]. There is no commercial - I'm sorry there's no consumer video piece of that. [indiscernible] whatever. So it's primarily commercially focused.

Operator

Thank you. [Operator Instructions] Next question is from Barry Sine of Drexel. Your line is open

Barry Sine

Good morning, gentlemen. Continuing on questions on M&A, wanted to ask more about the sale of the Iowa ILEC asset, can you give us the rationale for selling that business, talk a little bit about valuation, I'm trying to get a handle on how to keep those numbers out of the model. So I don't know you can share any high profile financials, and is that the sign of a more to come or do you see additional [indiscernible] like assets around the edge of your properties you might continue to sell?

Bob Udell

Hi, Barry, good to hear your voice. When you look at the strategy that was really opportunistic. The neighboring providers approached us. We're not actively looking to divest of network assets. But it is distinct from our core Minnesota and Central North asset. And so when we look at that and the opportunity of Champaign Tel as an example to extend our fiber foot print in a contiguous way, and our capital, very disciplined capital investment strategy, it just seems like a logical transaction to pursue.

So going forward, we're going to be looking at assets like Champaign Tel, it's a tuck-in, it makes a lot of sense. Something not contiguous with - be $100 million in revenue or greater, and give us a beachhead for new expansions, but I wouldn't expect to see many divestitures, that's not part of our core strategy.

Steve Childers

Hey Barry, this is Steve. Just to add on to that, to your question on - to help you with the model, I think about it maybe $8 million books in revenue and probably the EBITA from the way we're thinking about, give or take, I think these aren't large transactions on either side of them that largely offset into the Champaign Telephone Company business, again just as Bob articulated, Iowa that - the rural ILEC nature of that property didn't fit our long-term strategy which Champaign acquisition does.

Barry Sine

So you've talked about the asset sale bringing in about $20 million of proceeds, have you given the price you're paying for the Champaign Fiber now that you've closed that what you paid?

Steve Childers

I think we announced that is - $30 million [ph] was the purchase price for Champaign.

Barry Sine

And then shifting gears, I guess for you, Steve, the equipment revenue number has always been a random number fluctuating so much, you talked a bit about some of the trends on the Cisco side, it sounds to me - you also have a change in your philosophy towards that business. If we just look at that from a short-term perspective, the rest of the year, what kind of trends are we likely to see in that line item, equipment sales?

Steve Childers

Yes, Barry, I'll remind you two years ago we made the comment that we were going to evaluate that business long term and the revenue stream is primarily driven by the resale of Cisco hardware and was given access to that resource that has helped us launch our cloud roll out, our cloud services and the four services we rolled out. So we see the value beyond the hardware sales. But that said, we don't like the volatility of that business and we'll continue to evaluate how it fits for us as a whole.

Based on results through June, and what we see in revenue recognition for July, the sales funnel and full-year results are more likely to be in the mid $40 million range versus what we previously thought would be the $50 million to $55 million range.

Barry Sine

And similar question on network access, obviously that's driven a lot by the regulatory process. Any thoughts on what that looks like for the remainder of the year?

Bob Udell

Barry, I don't - I guess looking at the - I would just - we're thinking about that as basically the current trend we're seeing, we're trying to protect the special access, additional minutes of use on a switch, I would say is probably going to be the same trends you're seeing going down, maybe 10% a quarter or something's probably the way to think about it.

Steve Childers

And that's all part of the CAF - and you add that to the CAF II agreement we made with the FCC last year, that's a predictable step down that we've been offsetting with the long-term benefits of the metro Ethernet and broadband growth. So it's not a surprise to us, that part's been predictable, and overall the EBITDA and cash flow characteristics of our business are consistent with our plan for this year.

Operator

Thank you. There are no further questions at this time, I'd like turn the call over to Bob Udell for any closing remarks.

Bob Udell

Thank you all for joining us today. I continue to feel good about our strategic position, and I'm very excited about the future. We hope you would join us again in next quarter and hope you all have a great day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, you may now disconnect. Have a wonderful day.

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