Brett Ellis - Communications
Gene Johnson - Chairman and CEO
John Crowley - Executive Vice President and CFO
Peter Nixon - President
Walt Leach - EVP, Corporate Development.
Jonathan Chaplin - JP Morgan
David Barden - Banc of America Securities
Tom Seitz - Lehman Brothers
Simon Flannery - Morgan Stanley
Barry Sine - Oppenheimer
FairPoint Communications, Inc. (FRP) Q3 2007 Earnings Call November 2, 2007 8:30 AM ET
At this time, I would like to welcome everyone to the FairPoint Communications third quarter 2007 earnings conference call. (Operation Instructions) Mr. Brett Ellis, you may begin your conference.
Good morning, everyone, and thank you for joining the FairPoint third quarter earnings conference call. Participating on today's call are Gene Johnson, our Chief Executive Officer; John Crowley, our Chief Financial Officer; Peter Nixon, our President; and Walt Leach, our Executive Vice President of Corporate Development.
Before we begin, I would like to remind you that certain statements made during this conference call, which are not based on historical fact may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Because these forward-looking statements involve known and unknown risks and uncertainties there are important factors that could cause actual results, events or developments to differ materially from those expressed or implied by these forward-looking statements.
Such factors include those risks described from time to time in FairPoint's filings with the Securities and Exchange Commission including without limitation the risks described in FairPoint's most recent annual report on Form 10-K on file with the Securities and Exchange Commission.
All information is current as of the date of this earnings call and FairPoint undertakes no duty to update this information. In addition, FairPoint's results for the quarter ended September 30th, 2007, are subject to the completion and filing with the Securities and Exchange Commission of its quarterly report on Form 10-Q for such period.
Having said this, allow me to introduce Gene Johnson, our Chairman and CEO.
Thanks very much Brett. Good morning, everyone. We have a lot to talk about today and a number of positive developments we want to talk about, so let's get right into it.
As we did last quarter I'm going to focus my comments on reviewing the status of the transaction and providing a brief regulatory update then Peter will provide or John will – Peter, I guess will come in second and provide more detail about the merger and the transition, and then John will conclude by discussing our financial results for the quarter.
Walt is going to be available to answer any questions that you might have as well. The operation results and the financial results that we reported today we think once again demonstrate our ability to achieve both operational and financial success.
I continue to be very, very pleased that we are running our business well even while working our way through the regulatory process and planning for the close of the transaction with Verizon. And I think the strong financial results we had this quarter enable us again to add to our cumulative cash available for dividends and we're pleased about that as well.
We're knee deep literally in making steady and significant progress in all areas needed to make the acquisition a success. And that includes among others, the planning, design and building of the system, preparing for the systems integration, testing the systems and the various processes we'll be using, engineering our rollout of expanded broadband service and hiring many, many people for our team.
We had outlined in detail our broadband expansion plans, responded to literally thousands of data requests by the Public Utility Commissions in the three states and have settled with many interveners who originally had concerns about transaction.
Just this week we completed the last of the public hearings in the region and the public officials in all three states are diligently moving forward in the public interest. And while we're still experiencing significant resistance to the merger proposal from certain interveners, we have earn the support of many more and have received the endorsement of many groups across the region.
We think we've made a very strong case for the transaction based on the merits we outlined from day one including job growth and we've announced the creation of 675 new FairPoint jobs throughout the entire region. Of course, suppliers and vendors who will be supporting us will create many additional jobs in the region, so we think that's one of the real strong benefits for this transaction.
Broadband expansion, we previously discussed this at length. We're expanding the service in areas where broadband is currently offered, as well as, offering service for the first time in more rural areas that currently are underserved.
And I would also note that we have announced our plans for an advanced broadband network using IP and MPLS infrastructure in Maine, New Hampshire and Vermont and that platform will create the foundation really for a large number of highly reliable efficient business-class services and will also be expandable and will provide the foundation for the growth of our broadband services.
We're also supporting economic development in the region through a number of initiatives including strengthening collaborations between the public and private sectors, building demand driven and broadband-enabled strategies, empowering local leadership to identify their region's unique assets and resources, and leverage them for economic benefit and global economy and expanding local community economic development capacities through knowledge transfer.
And we've announced or in the process of announcing we've named anyway our senior economic development officer in the region a longtime FairPoint employee and we'll be announcing that publicly in the next few days.
So as I previously said, we think we have presented a compelling case to regulators in northern New England, while becoming no assurance concerning the regulatory approvals or their timing, we continue to anticipate the transaction will close on schedule on January 31st, 2008.
So now, I'm going to ask Peter to discuss the progress in greater detail.
Thanks, Gene and good morning, everyone. I'm going to update you on several topics related to a transition and the topics, I’d like to address today include system readiness, business readiness, conversion and training partner readiness.
Let me start with system readiness. I'd like to begin by providing a status of our operational support systems or otherwise known as OSS. Today, we have completed our third build we have one more build remaining.
All OSS applications associate with this build have been delivered to test groups or extensive product and integration tests will be performed. Build III includes core functionality for over 65% of planned functional components and 79% of planned interfaces.
Let me describe examples of core business functions that our OSS must be capable of supporting during a process are being tested. We must have the ability to schedule technician appointments. This capability exists in our Build III environment and is supported through integration between our customer relationship management and workforce management systems.
We must have the ability to monitor system network elements and trigger false alarms, which will automatically generate trouble ticket. This too exists within our Build III environment. This capability is deployed through the integration of individual network elements through our network management and trouble ticketing systems.
Build III introduces our ability to test automated provisioning for local service orders, which supports both our retail and our wholesale customers. The team is currently testing orders that flow between order management, activation, provisioning and inventory management.
In addition to our OSS, we have business support systems or BSS. We have also completed our third build with one build remaining for this. Our BSS is comprised of billing and CRM systems.
Build III represents the completion of roughly 65% of core functionality and planned interfaces. We are presently testing the ability for data to move unaided between our ordering, billing and trouble ticket systems.
Let me move on to business readiness. We continue to be on track for building our organization. We have hired over 85 new employees, comprising mostly a Vice President and director-level personnel to assist in the identification of the desired system functionality’s, development of the methods, procedures and practices, and organizational planning and development.
We have developed draft business cutover readiness plans, which will prepare us for operating the business while utilizing Verizon systems, as well as, operating under our new systems. And we have developed draft-training plans for close and cutover readiness.
Regarding conversion, we have received 158 of the planned first data extracts from Verizon per our agreed upon schedule there are 10 remaining extracts under-valuation as Verizon, Capgemini and FairPoint determine if the data is necessary within our operating environment.
Of the data we have received, we have successfully executed our conversion scripts total 61% of the data extracts into our staging or landing databases. More importantly, we have taken representative data from Verizon's core systems now residing in FairPoint's landing databases and have loaded it into our target systems.
Verizon core systems consisted of three ordering and billing systems, two finance and supply chain systems and two OSS systems. From eight and -- data from eight systems successfully converted into FairPoint's target systems consisting of Siebel, Kenan, E-Business Suite and Oracle Suites respectively. This is not an easy task and requires strong teamwork and dedication between FairPoint, Capgemini and Verizon.
The teams are well organized and disciplined and working together. They have established processes to identify and resolve issues quickly.
Recently, the teams met to review the processes used within the first data extract. This is the first of many planning sessions to continue to improve the process and determine the most efficient means to transition from Verizon systems to FairPoint's.
And finally training partner readiness, FairPoint conducted a demonstration of our wiser wholesale gateway to the CLEC community. This demonstration enabled the CLECs to see GUI interface which supports the order and trouble ticketing processes. And we have also completed our first discussions with the CLECs who will utilize electronic bonding, or e-bonding to communicate with us.
That will conclude my portion of the call today. I'd now like to turn the call over to John to discuss the financial and operational performance during the third quarter. John.
Thanks, Peter. Good morning everybody. I'm pleased to report to you another good quarter ahead of guidance for Classic FairPoint with continued progress on the merger with Verizon, New England.
I'll walk you through the financial results for the first -- for the third quarter first. Revenues were up 7.1% this quarter from the previous year to 75.7 million. Excluding the contribution from acquisitions, revenues were up 4.4%, compared to the third quarter of 2006.
The components of the revenue increased in the quarter, excluding acquisitions where [intrastate access revenues] increased $2.8 million, data and internet revenue increased $1.4 million and long-distance revenue increased 1.1 million. These increases were partially offset by decrease in interstate access revenue of $1.5 million and decrease in other miscellaneous revenue of 900,000.
Operating expenses excluding depreciation increased $13 million compared to the third quarter of 2006 excluding the impact of acquisitions. Of that $12.5 million of the increase is due to the Verizon merger-related expenses and therefore not core operations.
The remaining increase is principally due to an increase of cost of goods sold as the changing mix of our revenue occurs of $600,000, bad debt expense of $600,000, materials and supply expense of $300,000 and these increases were partially offset by decreases in employee related costs of $600,000 and decrease in billing expense of $500,000.
Adjusted EBITDA was $34.6 million for the quarter after adding back the $12.5 million of merger-related expenses, which is above the $29.9 million for the second quarter of '07 and ahead of the $33.4 million for the third quarter of the prior year.
There were two moving parts in the quarter relative to last year that I want to talk about. First, we had a large favorable settlement of intrastate access charges in the quarter in the amount of $4.4 million.
As you probably know, disputes on access revenues are pretty common these days and while we routinely agitate for a better access data, argue for more favorable traffic models and negotiate payments this was unusual only for its size.
Offsetting this was the decline in distributions of $2.1 million because of the sale in the second quarter of Orange Poughkeepsie. Net loss for the quarter was $0.15 on a per-share basis. The loss is principally result of $12.5 million of merger related expenses in the quarter.
However, there was a non-operating item in the quarter, $5.7 million loss on certain interest rate swaps we entered into because of the merger. This is a non-cash item and relates to the January '08 financing.
These swaps, which we've been entering into, are contingent upon the closing of the merger and therefore will not take effect until the merger is completed. Under GAAP, we're required to recognize the change in the fair market value of these particular swaps through the income statement.
Let me just explain the business activity behind the accounting. We have started to hedge the interest rates on the committed bank financing for next year. With the $200 million during the summer in contingent interest rate swaps at about 5.375%. Those are the underwater swaps.
Since that time, we have added $400 million of additional contingent interest rate swaps at rates nearly 1% lower than the ones that we did back in July. We also have about $600 million in swaps on our existing debt that already get hedge accounting and we will leave those in place after the merger. So we're making great progress on giving us a highly predictable capital cost upon the merger.
Before I get into a discussion of cash available for dividends, I want to remind everyone that because of the accounting treatment of the merger The systems build out the OpEx and CapEx impact recorded in the GAAP financials are different from the cash flow impact.
The accounting expense or the accounting costs rather are slightly higher than the cash outlay. In the quarter, we generated cash available for dividends of $21.5 million and we declared a dividend in the quarter as $13.9 million. So we added to the cash available for dividends cushion as we had indicated earlier this year.
We invested $16.3 million in the quarter in capital expenditures of which only $6.8 million was deducted from cash available for dividends because as you know under our credit agreement merger related cash, capital expenditures are excluded from that calculation.
Also in the third quarter, we recognized an additional gain of $2.7 million related to the release of the escrow account for the Southern Illinois Cellular Corporation Investment, which we sold last year.
In addition, during the third quarter we completed the sale of the Yates City Telephone for $2.5 million, which resulted in a gain of $2.2 million, and as we mentioned our last quarter's call, Yates City Telephone had less than 500 access lines. So at the end of quarter, we had $51.2 million of cumulative cash available for dividends.
At the end of September, our access line equivalents, which are, access lines plus HSD subscribers but exclude video subscribers were approximately 310,000 versus 309,000 rather last year.
In the quarter excluding acquisitions we added over 1800 high-speed data subscribers. Our HSD ARPU remained consistent at $41 to $42 range. Voice access lines excluding lines acquired or disposed of in the last 12 months decreased 4.8%, compared to September 30 of last year.
Regarding guidance for the rest of the year, we continued to expect revenues of $281 million to $284 million and continue to expect our adjusted EBITDA to be in the range of $123 million to $125 million.
We estimate the capital expenditures for the full year excluding the expenditures related to the merger will be approximately $29 million to $31 million as we've said all year.
As to the transition as Gene and Peter have said, the work is progressing as planned. The transition is on budget, and so through January 31, we're still expecting nearly $110 million in cash costs before the Verizon reimbursements for the new systems and the hardware.
The total systems budget, that is the aggregate of the pre and post-close investment is unchanged at approximately $200 million. There maybe and in fact probably will be some timing differences, particularly as to what falls before or after the year end but the overall budget doesn't change.
As Gene said, we're very proud of the performance we put in so far at Classic FairPoint. We're diligently preparing for the merger and the transition and are looking forward to integrating these two businesses into a more successful, efficient systems-based, 21st century telecom company.
And now we are happy to take questions.
(Operator Instruction) Your first question comes from the line of Jonathan Chaplin.
Jonathan Chaplin - JP Morgan
Good morning, guys. Thanks for taking the question. I am wondering if you can give us a quick update of what the access line DSL trends were in the acquired properties this quarter.
And then secondly, the comment that I saw in the press release around expected timing said there was still a good prospect it was going to close something along the lines of there's a good prospect's going to close before year end.
I can't remember how you've discussed it in the past, just in terms of the language. Are you a little less convinced that it will close before year-end? I'm just wondering if you can give us an update of what this was timing hurdles are between now enclose.
Jonathan, it's Gene. I'll take the second question first. As we often do, John is we'll take first question last. We think the regulatory approvals will all be in during December but in most -- there's generally a waiting period between the time you get the regulatory approval and the time you were about to close.
And so we still anticipate closing at the end of January, which is what we've said all along and we expect to close in first quarter of next year. So we see no reason -- it clearly will not close during this year. We think it will close early in the first quarter, probably in January of next year.
Jonathan Chaplin - JP Morgan
Jonathan, I hope you'll permit me this quick joke. I assume when you ask about the acquired properties you're not talking about Germantown.
You're probably talking about Spinco. At this point because we are reporting earlier this quarter we only have access line information on Verizon or New England or Spinco.
Spinco finished with 1,417,000 access lines, and 1,623,000 access line equivalence. They now have 206,000 DSL subscribers. So in percentage terms that are 7.7% year-on-year decline in voice lines and a 16.3% increase in DSL accounts. That gives them a 14.5% DSL penetration.
So you know, as you can imagine our marketing people are pretty excited about getting in there, and expanding that pie. I don't have any first or third quarter financials yet. No revenue or ARPU figures. But I can, since we now have the second quarter numbers.
I'll just mention to you for the first half Spinco did $190 million in EBITDA, which is up about 2% from the year before in line with a similar revenue increase.
If you pro forma their EBITDA for retiree re-obligations that we aren't taking that is the people who have already retired there adjusted EBITDA was $211 million. Their obligation is to get us third quarters by November 15th, so we don't have those yet.
Jonathan Chaplin - JP Morgan
Great. Thank you very much.
Your next question comes from the line of David Barden.
David Barden - Banc of America Securities
Thanks guys, and good morning. I guess, kind of along similar lines, you know, just Gene in terms of the process know, there were a lot more disclosures in this release about just in case if things do take a little longer, we are going to have to draw on our credit facility etcetera, etcetera.
Kind of mentioned that you're seeing quote unquote substantial resistance, I guess it seems as though maybe we're not as far down the path as we would have liked at this stage, or maybe there's greater resistance at this stage of the game than was anticipated.
I guess other than just saying is our target was January 30th, beginning of this process, so that's what it still is.
I guess, why you feel like you've got that comfort level, is it because you've gotten 60% or 70% or 80% of the interveners on side and you've got daylight to these negotiations with the staff from the regulators and everything seems to be shaking out pretty well? Because I guess that's going to be just a real issue for people to try to get their arms around, appreciate some comment there.
And then second, I guess on the results this quarter it did look, I think, there was this $4.4 million one-time revenue benefit in access that flow down through the adjusted EBITDA and into the CAPD this quarter.
The guidance didn't get adjusted for that so the implication is that the back half of the year is actually looking marginally softer than you expected. Could you talk about how the economic effects you think are playing in your territories and how that might be having any impact on your expectations for the acquired properties or to be acquired properties? Thank you.
Thanks, Dave. I guess you kind of answered the question for me in the way you asked it, but basically, there's been tremendous progress with the interveners. I wish could I give you a percentage, but by far most of the intervener.
Many of those have come out publicly, not only settling the case, but publicly saying they're in favor of the transaction and would like to see it go forward. So that's a major change from the last time we talked publicly about this. Secondly, we do see a path towards getting this deal done.
The January date that I've given you is not based on that’s the date we've always had in mind. If that date -- we thought there was a reason to change that date, we would. Right now we feel very comfortable that the January date is still a good date.
Now, it's difficult for me to get into any more discussion than that, because obviously we're at a -- what I would call a delicate stage of the transaction with the commissions, and there's a path direction, methodology for us to proceed, and we're doing that, and that's done in private and not in public. So I think I'll stop at that point.
Hi, David. This is John. With regard to the remaining of the year guidance, the remainder of the year guidance, we decided not to change that because would it not be particularly a material change but clear, as you've indicated, we will come in at the very high end of guidance.
We're really quite pleased with the operating results so far this year, and we have every reason to think that will continue.
You asked a very interesting question about the economic effects. As we reported, our bad debt expense was slightly higher in the third quarter, and so I think, clearly that's one of the results of the current economic times. But as far as our access line changes, that was really -- there were a whole bunch of moving parts in there.
One was that we had some account number cleanups in one of the recent acquisitions when we converted to our billing system. It had never been converted to one of our billing systems.
That represented probably 3/10th of a percent of the line loss. Then we had a very unusual seasonal pattern in the northwest this quarter. Aim guessing that winter must have come early out there. And then finally, we had an increase in cable VoIP in one market in New York, which I think is probably -- we'll probably see, from what I'm hearing, probably one other market where that will occur in the net probably should plateau.
Your next question comes from the line of Tom Seitz with Lehman Brothers.
Tom Seitz - Lehman Brothers
As you currently understand the schedule, I undserstand things are influx all the time, but can you tell us when you say you expect the PUC votes in the three states? Is it just December broadly or are there actually dates that you know, we can look to see if maybe there are some news around. And then do you expect the FCC to wait until the PUCs have voted as requested by some member of congress?
And I guess, my final question is. You now, I have your fingernails dirty and at this point are you still comfortable with the synergy guidance that you've laid out before for the -- not the Germantown transaction but the Spinco transaction? Thank you very much.
Sure, Tom. I'll take that. At the end my comments, I'll ask Walt to talk a little bit about the schedule and the states -- the three states. I think he has a better handle on those three dates than I do.
But as far as the FCC is concerned, I do not believe the FCC will wait until the states have issued their approvals before they act on this. I think -- I'm quite hopeful that will happen before the states act on this.
As far as the guidance we've previously given on the savings, yes. We feel quite comfortable now that our fingernails are quite dirty and not only our fingernails are dirty, a lot more is dirty on this transaction. We've worked really hard on it and we feel increasingly confident that our savings projections are clearly in line.
With that, Walt can you give us some sense of the schedule in the three states of when you expect to actually receive the approvals?
Sure. As it relates to the state approvals, they are all three states are pretty much on the same time line. And that is that we would expect an order from the two commissions in New Hampshire and Maine and from the board in Vermont sometime in December.
There is not a specific target date set up for each of those three commissions. Based on what we're hearing; now we expect all three would occur before Christmas, but sometime in December.
Again as you heard earlier in the call there's typically a 30-day non-appeal period that we would wait to lapse before we'd close. And that's why we're shooting for the end January based on everything that's in place today.
On the FCC side, we do expect the FCC approval to occur prior to the state approval probably sometime in the last half of November or early December, based upon a recent meeting that we had with the FCC. So that's our view based on everything we know today.
Your next question comes from the line of Simon Flannery with Morgan Stanley.
Simon Flannery - Morgan Stanley
Thanks a lot. Good morning. If you could talk about Spinco a little bit more, you signed at the low broadband penetration as a big opportunity. Do you have updated sense of what the availability of broadband is in those markets from Verizon and secondly, where we are on cable telephony overlapping those markets? Thanks.
Peter can answer the -- can you answer the second question, Peter? Do you have the facts on that?
Well, I have some information.
Simon Flannery - Morgan Stanley
Okay. Between us we'll see what we have to give you a direct answer. About roughly 62% of their service area in those three states is served by broadband to date. So we've announced plans to substantially increase the broadband investment and over the MPLS network and to provide availability -- excuse me -- availability to a lot more customers. Peter, can you add anything on the cable overlay?
I’ll tell you. But let me talk about that, because I've got some records on that, Simon. Here's what we've done on the cable overlay. You know that, we and Verizon measure this separately. We actually, you know because we're a small company because we're in the communities, what have you, we actually measure where is there cable and we do secret callers, will call the cable company and say, Gee, can I get cable modem service on 25 main street what have you.
So we have some statistics on that. And our experience is that we have about, let me look that up, we have about 51% cable modem competition in our markets. So here's what we've assumed for Verizon. They use a different technique.
They use what you might call the FCC technique, which is if a county has a cable operator it's assumed to have blanket cable coverage and modem coverage what. We've assumed is that given their access lines break out about 44% urban and about 56% rural.
And we define urban as a city of larger than Ellensburg, Washington or continuous to a city larger than Ellensburg, Washington or town with more than 15% see like market share.
We’ve assumed that in the urban areas that there’s in fact a 100% cable and cable modem competition and in the rural areas we’ve assumed that the competition is compare to our 51%.
So on a weighted average basis that implies that’s about high 60s cable modem competition in the markets.
(Operator Instructions) Your next question comes from the line of Barry Sine with Oppenheimer.
Barry Sine - Oppenheimer
Good morning. Just going back on the merger process. The language in the press release seems a bit more cautionary than you've been in the past.
But your verbal comments seem as optimistic as you've been. Is there any change in the outlook in terms of the acquisition? The next question I don't know if you have the data on this or not.
Do you know the total number of interveners they have been in the three states? How many have you settled with how many are they’re to go. And have you given up anything material in terms of your settlements with them?
Yes. Broadly, we had interventions from the roughly 38 independent ILECs in the three state we settled with all 38 of them. We had interventions from the utility companies in the states. We've settled with all of them.
Most of them.
Most of them, Peter says. We settled with certainly the biggest ones and the ones that were the most problematic. We had a number of CLECs that intervened. We settled with most of those announced those settlements.
Let's see. Broadly, those are kind of the three groups, the main groups. The other two groups of interveners would be the public advocates and the union. And I think, I'm going to stop at that point.
I think for the most part we've settled with -- by far the largest majority, I'd say off the top of may head, 80% to 90% of interveners and those are few left that we haven't settled with at this point.
I would not make any further comments about the transaction. I think that unfortunately we live in a world of caution. And so we're just being cautious in our comments. We think appropriately so.
But I think you can tell that we believe still that this transaction will close on schedule. And I think I'll stop at that point, Barry. Are there any other questions?
There are no further questions at this time.
Good. Well, see no one else is in the queue, and our goal to get you off the phone so you can go participate in other of these calls today. I would like to thank you very much for participating in the call.
Thank you for your support of the company. And we look forward to talking to you on the next earnings call after the transaction is closed and we can give you an update at that time on exactly where we are in the integration.
Thanks very much and have a great day.
This concludes today's conference call. You may now disconnect.