Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

David Whitehouse - Senior Vice President, Treasurer

Maggie Wilderotter - Chairman of the Board, Chief Executive Officer

Donald R. Shassian - Chief Financial Officer

Analysts

Tom Sykes - Lehman Brothers

Chris Larsen - Credit Suisse

Jonathon Chaplin - J.P. Morgan

Gaurav Jaitly - UBS

Michael McCormack - Bear Stearns

Winston Lim - Goldman Sachs

Frank Louthan - Raymond James

Steven Douglas - Banc of America

David Janazzo - Merrill Lynch

Citizens Communications (CZN) Q3 2007 Earnings Call November 6, 2007 9:00 AM ET

Operator

Good day, everyone, and welcome to the Citizens Communications third quarter conference call. This call is being recorded. At this time, I would like to turn the call over to Mr. David Whitehouse. Mr. Whitehouse, please go ahead, sir.

David Whitehouse

Thank you, James. Good morning. The purpose of this call is to discuss 2007 third quarter results for Citizens Communications, which were released this morning. If anyone needs a copy of the materials, please contact Lisa Lombardo at 203-614-5064. We anticipate the Form 10-Q will be filed later this week.

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, in particular on matters related to 2007 results and estimates. Please review the Safe Harbor language found on our press release and SEC filings.

On this call, we’ll be discussing GAAP and non-GAAP financial measures as defined under SEC rules. In our earnings release and on our website, czn.com, we have provided a reconciliation of non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP. Please refer to this material during our discussion.

I will now turn the call over to Maggie.

Maggie Wilderotter

Thanks, David. Good morning, everyone thank you for joining us. Citizens Communications had a solid third quarter of 2007. Revenues for the quarter were $575.8 million, our operating margin normalized after excluding a $12.1 million severance charge, was 54.9% due to increased expense control, and capital expenditures for the quarter were $90.9 million. Capital spending is traditionally higher in the second half of the year as we are able to complete many projects with favorable weather conditions.

All of these factors resulted in free cash flow generation of $118.9 million. We have achieved a dividend payout ratio of 60% for the first three quarters of the year. Don Shassian will elaborate on the financials for the quarter, including details of our commonwealth acquisition synergies and our closing of the Global Valley acquisition.

Global Valley is a great tuck-in acquisition for us. The 15,000 access line operation is located in four markets in Northern California, specifically in the Patterson and Livingstone areas of the Central Valley and contiguous with our Elk Grove and Susanville markets. These properties continue to have access line growth.

We received approval from all regulatory entities, including the California Public Utilities Commission, in less than four months, which enabled us to close on October 31st. We had anticipated a six- to nine-month regulatory approval process so we are very pleased to close Global Valley in just three-and-a-half months from announcement.

This acquisition is cash flow accretive on day one. There are some small operational and system synergies that we will leverage, but we also believe we can grow revenues in these markets by layering in our digital phone product, our dish network triple play product, and our commercial bundles. Our west region is managing the integration effort.

During the quarter, we have made great progress integrating our Pennsylvania properties. Since we closed on the commonwealth transaction in early March, we have streamlined the organization structure, removed [inaudible] management, consolidated sales teams for the ILEC, the CLEC, and the equipment sales into one core team, have sold a large portion of the equipment business to Share Technologies, and completed all system conversions, including financial, human resources, and billing.

We completed our billing conversion ahead of schedule in September so we would be prepared to off all of our fourth quarter promotions throughout the Pennsylvania properties. We are well on our way in achieving the $30 million in reoccurring annual synergies.

During the quarter, our high-speed data customers increased to 497,241. Our company wide average revenue per high-speed customer continues to be over $40, and residential broadband penetration increased to 30%. Our total net adds were 17,900, up over the previous two quarters. We were very successful with a dial-up conversion program and we converted 7,855 dial-up customers to broadband during the quarter.

Once again, we were surgical in our Q3 promotions and offers. We focused on dial-up conversions and a jump start program in markets where we turned on new high-speed elements in neighborhoods.

In addition, we used aggressive price points in a few key markets [with] cable launch telephone service. We did not run any new mass market promotions during the third quarter.

Even with this segmented approach to promotions, our average daily high-speed sales were the highest of all three quarters this year. We were up 6% over Q1 high-speed adds and 20% higher than Q2 performance.

Our digital phone offer continued to gain strength in the third quarter. This national product bundle, which we rolled out in the fourth quarter of 2006, includes local and either unlimited national long distance or unlimited statewide calling. There are four key features included in this package and the customer receives digital phone for a very competitive monthly price. We now have 277,559 residential customers, or 19% penetration on this bundle in less than a year.

In mid-September, we have now launched a business digital phone package for our small and Soho customers. We have started to aggressively promote this package throughout our markets this quarter.

We believe digital phone is a strategic weapon in the marketplace to fight against access line losses to competitive alternatives, like cable phone offerings or wireless.

Access line losses for the quarter were 42,100. While this number was higher than the previous quarter, there are several factors for this increase. First, we converted dial-up customers to broadband. Second, we are not seeing any material increase in access line losses to competition in our markets, but we have seen the decline in access line growth adds. One of the factors is a slowdown in housing sales in our Arizona and California markets, along with mortgage foreclosure issues in several states.

In addition, we did clean up company used lines this quarter and we also implemented a rate increase for certain customers in Rochester, so we had anticipated a spike in access line losses resulting from this increase. That spike had settled down in September but it did affect the overall numbers for the quarter.

We continue to have a priority focus with may initiatives underway to help improve our net access lines.

Finally, on the product front, dish sales remained strong. Our total customers with dish is now 86,400, with approximately 33,500 sales thus far this year. In partnership with EchoStar, our Q3 offers included a DVD package and a high definition package.

I want to touch on the fourth quarter promotions that we are running in our markets. As many of you know, the fourth quarter is a big retail quarter for our industry and key promotions give us the opportunity to take advantage of this selling season.

We were very pleased with our two aggressive offers last year, a free Dell PC offer and a free year of DISH network. We have seen a good payback on these offers and strong retention of these customers.

This year, we did some further analysis on PC ownership in our markets. Nationally, 78% of households own a PC. In our footprint, that number is 63%. Through several sources, we were able to estimate PC ownership at the market cluster level. We have launched a free Dell PC offer in those markets in our footprint that have 65% or less PC penetration.

In many of our markets, close to 40% of our customers do not own a PC. We are bundling digital phone, high speed, and the free PC in exchange for a two-year commitment for new customers and a three-year commitment for existing customers.

In the markets with more than 65% PC penetration, we are offering a free year of the DISH family package and free local channels in exchange for a new customer signing up for a two-year commitment to our Connection Triple Play bundle and a three-year commitment for existing customers on the Triple play.

We also have a high-speed offer in these markets that includes a free digital camera and a $50 gift certificate for an online photo service. All three promotions were launched October 1st and we are seeing strong results thus far.

I want to reiterate that our philosophy is to use promotions to push market share for both high speed and video. We find that churn is reduced with multiple products in our bundles. We also protect our reoccurring revenue stream when we utilize aspirational gifts as our offer versus just lowering monthly prices. As I mentioned, our average high speed revenue per user remains over $40 per customer.

On the operations front, we completed our call center consolidation in the third quarter. We closed two call centers in Rochester, New York and Kingman, Arizona. I am pleased that we were able to keep 85 of our seasoned reps in these two centers through our work-at-home program. Our Delan, Florida; Burnsville, Minnesota; and Dallas, Pennsylvania call centers are handling all of our customer service calls and they share a universal queue with our 180 work-at-home representatives.

As I mentioned last quarter, work-at-home now represents about 20% of our customer service workforce. Their numbers are also impressive. The work-at-home team has the highest revenue per call and the lowest average handle time.

During the third quarter, we successfully ratified four key labor contracts, including our two contracts in Rochester, New York. To date, we have ratified 14 contracts this year, covering over 1,500 employees. These contracts provide needed operational flexibility and expense savings over the three- or four-year terms of these agreements. We still have one remaining contract to negotiate this year.

The national moves and transfers program continues to gain momentum. In Q3, AT&T launched their first market in the program. All of Verizon’s markets are now launched, as well as markets with Quest, Embark, Century Tel, and Windstream. The remaining companies and market expansion will continue in Q4.

All of us are committed to a cohesive program management approach in 2008, so we can ramp this channel and leverage it for new customer additions.

Shifting over to new products, here is the latest update on our wireless data launches. We are up and running in nine municipalities, with five anchor tenants and 20 hot spots. We turned on service in Burnsville, Minnesota; Fort Dodge, Iowa; and Wilkes-Barre, Pennsylvania.

We added two colleges and one city as anchor tenants during the third quarter: Blackburn College in Shepardstown, West Virginia; Wilkes University, and the City of Wilkes-Barre, both in Pennsylvania.

We are also actively building four more municipalities for launch in Q4: Elk Grove, California; The City of Rochester; Pittsford, New York; and Griese, New York. We plan to launch six more key anchor tenants in the fourth quarter, including King’s College in Pennsylvania and several hotels in our markets.

Our strategy for wireless data is to supplement our customers for both consumer and business high-speed offerings with WiFi in key markets. We also get to create three new data revenue streams; subscription revenues from existing customers, casual use revenue from hour and day passes, and anchor tenant monthly reoccurring revenues.

We will have 13 municipalities built by the end of this year with a dozen anchor tenants and close to 40 hot spots.

Here now is Don Shassian, our Chief Financial Officer, to give you the financial overview of the 2007 third quarter.

Donald R. Shassian

Thank you, Maggie and thank you, everybody, for joining us this morning. Before I get into a discussion of the quarterly highlights, I would like to remind everyone that we closed the Commonwealth Telephone transaction on March 8 and accordingly, have consolidated the results of Commonwealth, or as we call it our new Pennsylvania property, since March 8.

In order to facilitate our investors’ insight to and understanding of the impact that our new Pennsylvania property had on our quarterly financial and operational results, we have once again attached to our press release additional schedules that break out the legacy Citizens financial numbers and operating metrics from the new Pennsylvania property numbers.

We had another solid quarter with strong revenues, EBITDA, or operating cash flow, and free cash flow. Quarterly revenues of $575.8 million were up 13.5% and included $80.5 million from our new Pennsylvania property. Excluding that increase, our quarterly revenues were $495.3 million, essentially flat when compared with our second quarter of this year. Excluding our Pennsylvania property, third quarter revenues were below last year’s third quarter, primarily due to lower subsidy revenue.

Our reported EBITDA margin was 52.8% for the quarter; however, our normalized EBITDA, after excluding a $12.1 million charge for termination and severance costs, was 54.9%.

Free cash flow was $118.9 million for the quarter. Our dividend payout ratio for the quarter was 70% and the business generated $35.6 million in cash in excess of our dividends for the quarter.

For the nine months ended September 30, our free cash flow was $422.7 million. Our dividend payout ratio was 60%, and the business has generated $168.6 million of cash in excess of our dividends.

During the third quarter and into November, we accomplished a number of financial related initiatives. First, during the quarter we repurchased 10.5 million shares for $148.4 million, which brought the total repurchase program through September 30 to 15.1 million shares for $219.1 million, which was approximately 88% of our $250 million authorized program. We completed the remainder of this program in mid-October.

Secondly, during the quarter we retired approximately $31 million in industrial revenue bonds and [rural] utilization debt. As you know, our next significant debt obligation on our maturity ladder is not until 2011.

Third, on October 31, we closed on our acquisition of Global Valley Networks for $62 million in cash. Global Valley has approximately 15,000 access lines and operates in the towns of Patterson, Livingstone, San Antonio, and Guinda in Northern California. It is a great property providing excellent customer service to a geographic area that has had 3% to 5% access line growth the past two years. It has solid EBITDA margins and the purchase price represents 7.5 times multiple of trailing EBITDA.

Fourth, in July we sold a portion of the equipment business that we acquired in the Commonwealth transaction. This was a sale of customer contracts in the southern and southeastern portions of Pennsylvania, while we still retain all of the customer contracts in Wilkes-Barre, Scranton, and Lehigh Valley areas. The sales price equates to one times recurring revenue and was less than $2 million.

Now let’s discuss Q3 results. Our revenue for the quarter was up 13.5% compared to last year’s third quarter. Our Pennsylvania property’s revenue in the third quarter was $80.5 million, which was slightly below last quarter due to some switched access disputes and the sale of a portion of the CPE business I just mentioned.

Excluding the impact of our new Pennsylvania property, our revenue decreased $11.9 million, or 2.4% from third quarter 2006, but was flat on a sequential basis. We continue to experience strong growth in data and non-switch access revenues, offset by reductions in federal and state subsidies and local revenue.

Our average revenue per access line for the quarter was $77.31, which is up 1% over last quarter. Excluding our new Pennsylvania property, our quarterly average revenue per line on a monthly basis was $80.37, up 3.3% over last year’s third quarter ARPU.

Quarterly data and Internet revenue of $133.9 million was up 22.6% over last year’s third quarter. Data and Internet revenue from our new Pennsylvania property was $11.5 million, which is up over last quarter. Excluding the new Pennsylvania property, our third quarter data and Internet revenues of $122.4 million increased $13.1 million, or 12% compared to last year, due to a higher volume of high-speed Internet customers and high capacity circuits like DS1s and DS3s.

On a sequential basis, our data and Internet revenue was up $1 million, again on higher volumes.

Local service and enhanced services revenue of $231.2 million was up 13.9% compared to last year’s third quarter. Local revenues from our Pennsylvania property was $36.2 million, essentially flat with last quarter. Excluding the new Pennsylvania property, our third quarter local services revenue of $195 million decreased $8 million as compared to the third quarter of 2006, primarily due to the loss of access lines. On a sequential basis, our local revenue was down $1.2 million on fewer lines.

Access service revenue of $113.1 million was up 7.8% over last year’s third quarter. Access revenue from our Pennsylvania property was $20.3 million, which is down sequentially $2.4 million due to some carrier access disputes.

Excluding the new Pennsylvania property, our third quarter access service revenue of $92.9 million decreased $12.1 million as compared to third quarter of ’06. That decline was driven primarily by lower subsidy and to a less extent, lower switch minutes of use.

On a sequential basis, our access revenues increased $2.1 million, primarily due to the fact that last quarter had an unfavorable true-up resulting from local switching support fund.

Other revenue of $21.4 million was down 5.2% compared to last year’s third quarter. Other revenue from our Pennsylvania property was $3.9 million, which is below the prior quarter due to the sale of a portion of the CPE business. Excluding the new Pennsylvania property, our third quarter other revenue of $17.5 million decreased by $5.1 million compared to last year’s third quarter, driven by higher un-collectibles, our free TV promotion credits in certain markets, and a decrease in roaming minutes associated with our Mojave wireless partnership.

On a sequential basis, our other revenue was down $2.6 million, driven by higher un-collectibles and a decrease in roaming minutes associated with our Mojave wireless partnership.

As Maggie mentioned, we increased our Q3 marketing activities, incorporating some additional promotions and incentives. The result for the quarter was the following: 17,900 new high-speed net adds; 27,800 new net bundles; 5,400 new net video customers; 55,400 new digital phone and unlimited state calling customers.

With respect to high speed, we added 17,900 high-speed data customers during the quarter, which brought us to approximately 497,200 high-speed Internet customers at September 30. Our high-speed penetration rate is 20.2% on total access lines and our residential high-speed penetration is approximately 30%. Both of these numbers are slightly diluted by the Pennsylvania property, whose penetration rate on total access lines is 13.3% and on residences is 27.3%.

We are making good progress in increasing the high-speed penetration in Pennsylvania as our product mix, pricing distribution channels, and overall marketing are demonstrating strong results.

Most importantly, as Maggie mentioned, our ARPU for high-speed remains above $40 per month per customer.

During the quarter, we added 27,800 new bundle customers, which brought our total bundle customers to 620,800 at September 30. Penetration rate for our bundles is 25.2% of total access lines. This rate is also diluted by our Pennsylvania property, whose bundle penetration rate is only 14.8%, but is growing quite nicely as we introduce our bundle packages, specifically digital phone. We have achieved nearly 18,000 Pennsylvania customers signing up for this unlimited national voice product bundle.

During the quarter, we added 5,400 new video customers, which brought our total video customer base to 86,400 at September 30. The residential penetration rate for video is 5.8%.

Our access line losses were 42,100 during the third quarter of this year, which is up 7,300 compared to second quarter. On an annual basis, our access line losses were 5.1%. Primary residential line loss for the company was 32,000, which is up approximately 4,500 compared to last quarter. Our second line residential losses were 4,900, which is up 500 over last quarter as we continue to aggressively promote our dial-up to broadband program. Business line losses for the company for the third quarter were 5,200.

In addition to seasonality losses that we experience as some of the vacation locations in our properties, we also had a spike in line losses in Rochester after a planned primary line rate increase and we have continued to experience some line losses based on housing vacancies and a stagnant real estate market in California and Arizona.

From a competitive viewpoint, 57% of our access lines are in areas where alternative wireline voice providers, or VOIP, are available. That is slightly up compared to last quarter as Comcast has rolled out voice in our Elk Grove, California market and Time Warner has rolled out voice in the old Adelphia properties in New York state.

On the expense side, we continue to demonstrate very effective cost management. Our reported EBITDA margin for the quarter was 52.8%. As we disclosed in a press release on October 3, we recorded a $12.1 million charge for severance and other termination costs related to our call center strategy, early retirement for some field operations personnel, and some other matters. Excluding this charge, our normalized EBITDA would have been $316.1 million and our margin would have been 54.9%. Our Pennsylvania property’s EBITDA margin for the quarter was 56.8% when excluding our corporate allocations.

Excluding all charges for severance and termination costs and excluding integration costs from our acquisition, our other operating expenses had decreased nearly $8 million as compared to last year’s third quarter and over $11 million when comparing the first nine months of ’07 to ’06.

With regard to the CT integration, our financial systems were installed for the Pennsylvania property effective July 1 and our billing systems were converted in September. Through the third quarter, we have achieved over $21 million in annualized cost savings. Our previously announced estimated annual synergy target of $30 million to be achieved in three years is on plan and we are confident that we will achieve these savings as originally disclosed.

Our capital expenditures in the second quarter were $90.9 million, which is up compared to second quarter and includes $11.3 million related to our new Pennsylvania properties. Our capital expenditures through September were $202.6 million, including $24.2 million pertaining to the new Pennsylvania properties. Our capital spending will continue to ramp through the fourth quarter. Our spending continues to be focused on initiatives which utilize a return on investment criteria and our focus on our growth opportunities and our competitive position in the marketplace.

As for 2007 expectations, we continue to believe that our capital expenditures will be between $315 million and $325 million, and our free cash flow will be between $500 million and $520 million.

You will note that our cash taxes through the third quarter were $53.7 million, and after completing the filing of our new Pennsylvania property’s 2006 tax return and our Citizens 2006 tax return, we estimate that our cash taxes for 2007 will approximately $60 million.

In closing, we have a very positive outlook for the future performance of our business and its ability to generate free cash flow. The integration of our new Pennsylvania property is going great. We expect to be able to keep our annual dividend payout ratio below 70% even when we become a full cash taxpayer in 2009 while maintaining a reasonable level of leverage.

Thank you for your interest. Operator, I would ask you to please open this up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Tom Sykes with Lehman Brothers.

Tom Sykes - Lehman Brothers

Thanks for taking the question. Can you tell us where you are at with respect to offering a home zone like box for video service, integrating the ability to download information from the Internet and then play it over on your DBS offering?

On top of where the equipment is at, can you tell us if there are any sort of changes to how you might contemplate the revenue arrangement with DISH if you do proceed with such a box? Thanks.

Maggie Wilderotter

Let me take a shot at the home zone product. We are in discussions with EchoStar about the home zone box. They are doing a new generation of this box, which is something we’re waiting for. We believe that box will be ready around the first part of 2008, and then we will start to test that box.

We are very excited about it. We think it’s a great opportunity for us to be able to deliver in the home both linear television from the DISH network as well as streaming video and content from the broadband network. And by having one box with one user interface, it makes it very easy for the customer to use that television set as an appliance for both capabilities.

We have not gotten into all of the revenue back and forth with EchoStar, but in preliminary discussions with them, if there is content we want to put up, we would be able to collect dollars on that content. I think EchoStar will also probably make certain content available from a broadband perspective and then we would talk about how the revenues work from there.

In addition, we’ve also been part of an ancillary team to AT&T on their home zone launch, and we have several of the home zone boxes in our lab in Elk Grove that we are testing as we speak, so we really do believe that with our network build in that three to six meg range, there’s plenty of capability to offer this type of a combo box in many of our markets in 2008.

We’re hoping it’s going to be third or fourth quarter of next year but it really just depends on when the new box comes out.

Tom Sykes - Lehman Brothers

Thank you very much.

Operator

We’ll take our next question from Chris Larsen with Credit Suisse.

Chris Larsen - Credit Suisse

Thanks. Two questions, if you don’t mind; you talked a little bit about the business access lines you lost. Can you talk about who you are losing those to? I imagine there’s not a lot of wireless substitution going on there.

Second, Don, do you have a sense for where cash taxes might be in ’08 as opposed to ’07? Thanks.

Donald R. Shassian

Chris, on business line losses, the increase -- we had an increase in business line losses this quarter over last quarter and it actually was not so much on the competitive side. There was one major ISP in the Pennsylvania CLEC that we lost. We knew that was going to happen many, many months ago. And we also had fewer CLEC adds in the Pennsylvania property as we have refined our approach on that CLEC property. As you may recall, we’re looking to really own the geographic build that exists, not trying to expand that geographic build, so we’re trying to focus on customers in that area and really not reaching out further. So we are trying to harvest it a little bit better than it was before, utilizing the CapEx investments.

So the decrease was some fewer adds -- out of the 2,400 increased losses of business, 1,600 were on the CLEC side, on the Pennsylvania side, and another 800 who truly was us doing it to ourselves. There’s some own -- our own official accounts lines used for internal purposes that we cleaned up and groomed and took away, so we really didn’t see an increase in business line losses during the quarter coming from competition.

On the cash taxes, Chris, ’08, the guidance I’ve given out previously of 30% effective tax rate on a cash basis is still a good targeted number.

Chris Larsen - Credit Suisse

Thanks a lot, Don, appreciate it.

Operator

Our next question comes from Jonathon Chaplin with J.P. Morgan.

Jonathon Chaplin - J.P. Morgan

Thanks. I’m wondering if you could just remind us what the subscriber acquisition costs are for the PC and DISH offers and how those compare to your typical subscriber acquisition costs. And then I’m wondering if you could just give us an idea of how much you realize in synergies, if any, from the CT acquisition this quarter. I’m just wondering how much of the margin increase you saw came from synergy realization.

And then forgive me if you mentioned this earlier on the call, but now that the share repurchase program is done, when should we expect an announcement on when you re-up that or uses of cash for next year? Thank you.

Maggie Wilderotter

What I’ll do, Jonathon, is I’ll talk about the subscriber acquisition costs and the share repurchase and I’ll have Don actually talk a little bit about the synergies for the quarter based upon Commonwealth.

We have not disclosed our subscriber acquisition costs with regard to this quarter, or really any time when we do these big promotions. But I will say this, the payback is less than a year and that’s really what we look at, is an analysis of how much does it costs to acquire that customer, what are the revenues we’re getting from that customer, and then what is the payback overall. So we used the exact same analysis last year and again, we had less than a year payback on these offers and it’s exactly the same, actually just a little bit better this year because of the mix of products that we are actually putting into the marketplace.

On the share repurchase, yes, we did just complete it. We will be evaluating share repurchase with our board of directors. We continually do that. Usually when we have those discussions, it’s in the February timeframe but it’s on the docket to discuss at the next board meeting that we have.

Donald R. Shassian

Jonathan, with regard to the Commonwealth synergies, last quarter I mentioned that we had achieved $12 million annualized synergies. We’ve now achieved about $21 million annualized synergies.

The increase from quarter to quarter, most of that happened at the end of -- middle and end of September after we completed our billing system conversions, so if you are looking at it for the quarter in terms of operating results, it’s probably about $3 million to $4 million, maybe a little bit north of $4 million of expense synergies for the quarter that were reflected.

Jonathon Chaplin - J.P. Morgan

Thank you very much.

Operator

We’ll take our next question from Gaurav Jaitly from UBS.

Gaurav Jaitly - UBS

Great, thanks. Good morning. Just a couple of questions; I was hoping to actually get some more color on the line loss trends. It would be very helpful actually if you could give us a sense of how much of the year-over-year increase in access line losses, you know, of the 11,000 year-over-year increase was related to California and Arizona from the housing impact.

And then secondly, just following up on the last question, as we think about your priorities for use of cash, your leverage as of the end of the third quarter by my math is about 3.5 times, [but to think] at the high end of your target leverage, has there been any change in your thinking about your leverage, your target leverage ratios and what you might do with your use of cash? Thank you.

Donald R. Shassian

Let me take the second question first, in terms of leverage. It’s about 3.5, that’s correct. We have cash on the balance sheet at the end of the quarter that is going to be used to complete the stock buy-back which happened in the first half of October as well as cash out on the Global Valley acquisition, so leverage is about 3.5. I think it actually goes up a little bit to 3.6.

The thought process still is that we would like to get ourselves to the 3.2, 3.3 zone, so our utilization of cash, we’ll continue to look at on a very balanced approach of managing our leverage structure, as well as returns for shareholders and evaluating reinvestments into the business.

But our view still would be that we would like to be in the zone of 3.2, 3.3, and continue to drive ourselves in that direction.

In terms of line losses in our western region, quarter to quarter it is really up about 2,000 additional line losses quarter to quarter, third quarter to third quarter. The increase that we’ve seen is primarily -- the vast majority I think I would say is because of the housing and foreclosures. There’s about 1,200 that I think we’ve identified for this quarter was an increase in housing vacancies as well as foreclosures in our California and Mojave County, Arizona market.

Our Elk Grove, California market is in Sacramento County, which is one of the large counties in this country that has probably the largest foreclosure rates in the country, and we’ve got a fair number of vacancies we have to deal with.

That is the only markets, the California market and Arizona, where we are seeing any significant impact from the economy.

Maggie Wilderotter

And keep in mind too that when we talk about access line losses, it’s really about gross adds. Our deactivations are doing very well. As a matter of fact, we’re doing better year over year in terms of keeping the customers in markets but we have seen that softness in the housing market.

Gaurav Jaitly - UBS

Thank you. That’s very helpful. If I could just follow up, the 2,000, Don, that you talked about, year-over-year increase, how much was that in the second quarter, so we could just get a sense of the trend in that number?

Donald R. Shassian

The increase over second quarter was about 2,000.

Gaurav Jaitly - UBS

So it was up 2,000 from second quarter ’07 to third quarter ’07?

Donald R. Shassian

I’m sorry, no. The increase from Q2 to Q3 is about 1,200.

Maggie Wilderotter

It was 2,000 year over year.

Gaurav Jaitly - UBS

Great. Thank you. That’s very helpful.

Operator

We’ll take our next question from Jonathon Chaplin from J.P. Morgan.

Jonathon Chaplin - J.P. Morgan

Just a quick follow-up on that last question; could you give us an idea of how many of your access lines are in the two markets that are really affected by the slowdown in housing?

And then also, something that’s really interesting that came out of the Embark call is they said new housing builds cost them about $1,500 per home, so as housing slows down, they should see a reduction in CapEx. I’m wondering if there’s a similar impact in your markets. Thanks.

Donald R. Shassian

Percentage wise, let me just say the California and Arizona markets are well less than 20% of our total access lines.

Maggie Wilderotter

And Jonathon, if you think about it, the hot spots are probably 10% of our access lines of that 20% footprint, so it’s not the entire California marketplace. It’s mostly in the Elk Grove area outside of Sacramento and Mojave County.

Donald R. Shassian

And the issue on CapEx, the cost to build out into a new development, $1,500, could be as high as $1,800. It’s a ballpark good number.

What we are seeing is as developers come in though, and they open up trenches, instead of doing 500 home developments, they are paring it back down to 125, 150. So we are having a smaller potential investment in some of those developments but we are also looking at those and saying well, wait a second -- do we really believe that this developer is really going to be successful in the next couple of years with how things may turn out, and is it more efficient for us to maybe put a conduit in while the trenches are there, and therefore not have to really put in the fiber all the way through. Put a conduit in, it lowers our cost initially. Could increase it overall because we might have to go back into that conduit a couple of times, but we may be able to lower our CapEx a little bit in being more prudent as the builders are coming out.

But we are still seeing, even in these markets where there is a housing issue, we are still seeing developments being initiated, although they are smaller developments and we are trying to tone down our CapEx accordingly to be more prudent with their builds.

Does that help, Jonathon?

Jonathon Chaplin - J.P. Morgan

It does, Don. So the CapEx guidance for this year hasn’t come down, but is there a prospect if housing weakness continues into next year that we’re looking -- that this could translate into a lower level of CapEx for next year?

Donald R. Shassian

It could but it’s not a huge number. I mean, it’s not -- our CapEx guidance, a ballpark 320 for next year, we’re not saying it’s going to come down from 320 to 280 or 250. It’s probably like a $10 million move is all it really could be.

Jonathon Chaplin - J.P. Morgan

Okay. Thank you very much.

Operator

Our next question comes from Michael McCormack with Bear Stearns.

Michael McCormack - Bear Stearns

Thanks, Don, for the increased cash flow disclosure this quarter. A couple of things; first, on the -- I think Maggie mentioned some aggressive price points. Can you give us a sense for where you were having those aggressive price points, what they were and what the price points of cable were in the market as well?

And secondly, just your thoughts on looking at flow share but also the current marketplace share of high-speed subscribers between cable and you guys would be great. Thanks.

Maggie Wilderotter

Mike, let me take a stab at it. As I said, we did some aggressive price plans in a couple select markets. We tested $19.99. We also tested $24.99 and $29.99 as price points, and again they were for promotional periods of time.

And if you look at our pricing compared to the competition, in most cases we are very competitively priced and probably with a little bit of a premium over the cable competition in our markets, but not a significant amount, maybe within a $5 range. So we try to keep the price points very competitive to cable.

If you look at flow share from a share percentage, we do very well in our markets against the cable guys. We truly are the leaders in providing high-speed Internet service in all of our markets except for Rochester, and we’ve actually been catching up in Rochester but when we launched high-speed in Rochester back in early 2001, Time Warner had had about an 18-month head start on us, so they had taken a fair amount of share that we had to catch up to. But we are holding our own in that market as well, but if you look at the rest of our rural properties, we are doing extremely well against the competition.

Donald R. Shassian

Mike, one way I would look at it is 88% of our residential lines are high-speed capable, and as Maggie mentioned earlier, PC penetration is about 63, 65 -- 63%. So if you look at residential lines that are capable for high-speed and with PCs, we believe we’ve got north of 50% of that market. And then, when you put the dial-up customer base which we have, which is about 88,000 today, it puts us way north of 50 in a very strong position we believe in that marketplace.

Michael McCormack - Bear Stearns

Yeah, I guess just to get a sense for the opportunity on a going forward basis, not knowing what the cable share is, it just makes it a little more difficult.

Donald R. Shassian

Well, the key for us obviously is continue to increase the capable lines, which is going to be moving maybe a little bit north but not too far north, really try to put competitive offers to win back customers from the cable folks, and then to be able to increase the pie. Our PC promotion, as you know, is really trying to increase that pie to drive that 63% PC penetration, which we feel last year we moved pretty significantly. We want to move that again this quarter.

Maggie Wilderotter

We probably moved it three to four points last year, Mike, so part of the challenge is you have to have a PC to have broadband be viable in the home.

Michael McCormack - Bear Stearns

Right. Don, I’m sorry, just to add one more on that; the one-time item, was there a cash impact this quarter?

Donald R. Shassian

That $12 million is going out fourth quarter.

Michael McCormack - Bear Stearns

Okay, so is there going to be a cash impact in Q4?

Donald R. Shassian

Cash will come out in Q4, yeah. It will be through the -- as you are looking at that working capital statement, it will be coming out in Q4, yes.

Michael McCormack - Bear Stearns

Okay, so is that sort of a de facto, slight improvement in the free cash flow forecast for the year?

Donald R. Shassian

No, there is a lot of balances there. We’ve got also this Q4 promotion activities as well. We’ve got a number of moving pieces occurring here.

Michael McCormack - Bear Stearns

Thanks, guys.

Operator

Our next question comes from Winston Lim from Goldman Sachs.

Winston Lim - Goldman Sachs

Good morning. In terms of the promotions, I just want to get a bit more granularity there. How many of the markets will have the free PC offer and how many will have the free DISH offer, and how does that compare versus the last time? And maybe you can just remind us of how the costs will be recognized over the life of the contracts as well? Thanks.

Maggie Wilderotter

I’ll take the split on the share question, Winston, and I’ll let Don talk a little bit about how we are accounting for the costs.

If you look at our markets today, the split is almost 50-50. It’s about 70 markets where we are doing the free PC and about the same number of markets where we are doing free TV and the camera offer.

And we are seeing, early results, we’re seeing a trend of about the same number of PCs in the October timeframe that we did when we launched the free PC offer last year everywhere.

So again, we’ve gotten a lot more segmented on the offer. We are getting a lot better take rates on the offer as well, because I think we’ve really hit the right kind of markets and the right customer segments within those markets.

Donald R. Shassian

The accounting that you will see going forward, the PC and camera will hit our P&L in the fourth quarter based on the sales and the installations that occur during that quarter, so like last year’s fourth quarter, for all those PCs, there was a large fourth quarter charge for the cost of those PCs. We have something similar in Q4 for the PCs and camera.

On the TV promotion, that is booked as a contra to revenue. Essentially the payment that will be made to DISH network, we are making and the customer is not reimbursing us for that, so it ends up being a contra to revenue each month over the 12-month period.

Winston Lim - Goldman Sachs

Thank you.

Operator

We’ll move on to our next question from Frank Louthan from Raymond James.

Frank Louthan - Raymond James

Great. Thank you. Could you give us an idea of what the financial impact was from the call center shutdowns in the third quarter? Is that something we are going to see more fourth quarter and next year?

And then, give us an idea of how you are thinking about your pricing on high-speed data. You mentioned this a little earlier. You said you were doing some price promotions but I know over time, you’ve had the philosophy of keeping the price higher but maybe having a little bit lower penetration overall, kind of maximizing the value, but how is that continuing to trend? What sort of impact do you think your higher pricing is having on your line losses? And looking at the long-term lifetime value of an access line relative to maybe maintaining a higher margin on the high-speed data in the near-term, looking over the long-term -- what are your thoughts there? Have things changed? Is that something you may be rethinking as far as you think you are going to need to lower your price to maintain access line losses? Thanks.

Maggie Wilderotter

Don, why don’t you take the first question with regard to the call centers and I’ll take the question on the high-speed pricing.

Donald R. Shassian

Frank, on the call centers, we announced the charge this quarter. It ends up being the end of the consolidation program. It is being implemented last month and a little bit more for the next -- into November as some of the people are still leaving and as we continue to integrate and enhance the very large call center that we’ve built now on Delan, Florida.

The savings from the program, if you look at our costs for our call center functions back in late 2005, before we initiated the program to the cost for those same functions that we are going to have when this is all finished in early ’08 is about a $9 million to $10 million annualized savings for us. It is somewhat of a headcount reduction. It is somewhat of a movement of people to a different wage scale. It is some productivity improvements and it is a very big fundamental operational move for us that we are going through.

We feel very pleased about the progress we are making but it is a very sizable savings that we are going to be harnessing the latter part of this year and then beginning of next year. It ends up being not as much savings necessarily built into this third quarter because the bulk of the changes are occurring -- the final changes, which is really -- because you’ve hired a number of people to be able to handle a call volume as you decrease somewhere else, those savings are coming off into the fourth quarter.

Maggie Wilderotter

Frank, on the high-speed Internet pricing strategy, we have had a philosophy to sell value associated with high-speed. As I mentioned, doing more aspirational promotions with gifts and keeping our prices in the ranges where they are today.

However, we do believe that growing high-speed market share is critical to our business and because of that, what we’ve been doing is testing some different price points in the marketplace to see if the changes in pricing actually does drive share and if it does, to what extent does it drive share?

And I think you’ll see us do more surgical type pricing promotions throughout 2008 to sort of give us a sense where we have very highly competitive markets, can we drive share in a different way?

So it is something that we are focused on. We don’t believe today that our access line losses are associated with having a high rate for high-speed, because we are, as Don said, the leaders in our market and we continue to drive I think good share in our markets.

But we are also cognizant that if there is a way to balance that value, do some more aggressive price promotions and still accomplish that price value on the product and grow some share, that’s what we’re going to try to do.

Frank Louthan - Raymond James

Okay, great. And what is the competitive situation where you still have the higher price point? Is cable fairly rational? Are they following your pricing, or do you see them trying to undercut that if they have that opportunity?

Maggie Wilderotter

Cable is pretty rational in our markets. We see them following our price points instead of coming in and undercutting.

Where we have seen cable be more aggressive is usually in that first 60 or 90 days when they launch phone in a market, and they’ll come out with a bundled price that’s aggressive, but it’s the same basic price point that we have for our triple play in the marketplace.

Frank Louthan - Raymond James

Great. That’s very helpful. Thank you.

Operator

We’ll take our next question from David Barden from Banc of America.

Steven Douglas - Banc of America

This is Steven Douglas, actually. I have two quick questions. First, some of your peers have talked about an increase in bad debt expense this quarter and I was wondering if you guys had seen anything on that front.

And second, again on the buy-back, having completed it ahead of plan, is there anything to read into there, I guess besides maybe opportunistically buying or something like that? Thanks.

Donald R. Shassian

On the bad debt, as I mentioned in my prepared remarks, our bad debt provision for this quarter did increase over last quarter by $2 million. We did see a deterioration in aging occurring in the second quarter. Our write-offs have increased and there was a $2 million increase in the quarter. Say it’s economy driven, could say a variety of items but it definitely -- you do see in this industry an increase in un-collectibles when there is a softening in the economy.

With regard to the buy-back, there is nothing really by signal there. We established that program as a 10B5 program, meaning we establish it with an institution and we set parameters with them to begin with, and said that look, if the stock price during a day is between A and B, you can buy back so many shares. Stock price goes up, you buy less; stock price goes down, you buy more. And that way we are able to let it happen.

We, as an executive management and all of our management does not have to be concerned about being in that market and making decisions. If we end up looking at acquisitions or anything else, we are able to have a little bit more flexibility to run the business and not be trying to guess the market.

So it was a program put in place and as the stock dropped last quarter, it just accelerated itself and that’s what happened, so there is nothing else to read into that.

Steven Douglas - Banc of America

Thanks, guys.

David Whitehouse

James, I think we have time for one more question.

Operator

And we’ll take that question from David Janazzo with Merrill Lynch.

David Janazzo - Merrill Lynch

Good morning. Maggie, you had ticked off a number of the wireless data program stats. Can you give us your thoughts on returns on that investment? And then, we’ve seen a number of the WiFi projects not pan out. Why are yours different?

Maggie Wilderotter

I’ll talk a little bit about why we think ours are different. I know Don can pipe in on the returns.

Let me say this; one of the reasons why we believe that this is different is because we have a nationwide data backbone, so the amount of capital that it takes for us to build these networks in our markets is a minimal amount of capital compared to someone who comes in from a greenfield perspective and has to build a WiFi system, mesh system into a market. So we are leveraging a lot of our capital that we already have in these markets.

In addition to that, our strategy has been to get anchor tenants to help pay back on that capital investment, to the casual users and the ability for our customers to use these networks becomes incremental revenue on top of payback revenue. So our strategy in having multiple anchor tenants as well as hot spots gives us a reoccurring revenue stream, a monthly reoccurring revenue stream to pay back on that capital.

And we do have a pretty stringent, I would say, ROI process that we go through in analyzing what markets we build, how we build them, and what the returns have to be on that capital.

Donald R. Shassian

Let me also -- some of the others that have announced wireless data builds that were slowed down or shut down, their economic model was an advertising-based model. Ours really is a subscription-based model, whether it’s day pass, hourly day pass, weekly, monthly, or anchor, where we’ve got an institution or a business paying us a monthly fee for a fixed number of users. So it’s a different economic model.

The economics are different based on the customer that we are approaching. If it’s an anchor where we have a college or university that is a multi-year contract that is subscribing for a fixed number of users, several hundred for five years, we build the network out and get a return that’s got a nice two-year payback.

If it is a hot spot where we are going to a business and are putting up something, a very cheap, inexpensive, depending on the day uses and casual, it could be a little bit longer. It really depends on the flow and depends on how many hot spots we can put into a geographic area of a downtown community.

And then there’s a municipal build that obviously is really dependent upon getting all those hot spots built out.

So on the short end, it’s an 18-month to two-year payback on some. On others, we think it could be maybe a four-year payback. But the longer ones are ones that are really unknowns, because right now we are seeing an increase in the volume of takes on the casual day passes and we’re seeing some very good increases and takes on the hot spots. So we feel like that four years may be longer than maybe actually will pan out. But so far, we are seeing some very interesting takes on these and very promising and it is a CapEx expenditure for us that is quite manageable within our total CapEx budget, to be able to get a decent return, we feel.

Maggie Wilderotter

And if you look at the mix, we are going to have 13 municipalities, as I mentioned, over a dozen anchors and 40 hotspots by the end of the year. And if you look at that mix from a payback perspective, it’s probably two years to two-and-a-half years.

David Janazzo - Merrill Lynch

Thank you.

Operator

Mr. Whitehouse, I would like to turn the conference back over to you for any additional or closing remarks, sir.

Maggie Wilderotter

I’ll just close and say that our priorities for the fourth quarter of 2007 are about staying the course, a focus on a strong customer retention efforts as well as a strong focus on our employees, integrating our Commonwealth and Global Valley acquisitions, improving and driving sales of high-speed, video and packages, our service delivery, completing that, and maximizing our financial returns.

So thank you again for joining us on the call and we do look forward to speaking with you in February when we report our Q4 2007 earnings.

Operator

That does conclude today’s presentation. We thank you for joining us. Have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Citizens Communications Q3 2007 Earnings Call Transcript
This Transcript
All Transcripts