Citizens Communications Co. Q4 2007 Earnings Call Transcript

Feb.26.08 | About: Frontier Communications (FTR)

Citizens Communications Co. (CZN) Q4 2007 Earnings Call February 26, 2008 9:00 AM ET

Executives

David Whitehouse - SVP and Treasurer

Maggie Wilderotter - Chairman and CEO

Don Shassian - CFO

Analysts

Frank Louthan - Raymond James

Tom Seitz - Lehman Brothers

Mike McCormack - Bear Stearns

Gaurav Jaitly - UBS

Michael Rollins - Citi Investment Research

Jonathan Chaplin - JPMorgan

Jason Armstrong - Goldman Sachs

David Barden - Banc of America

Chris Larsen - Credit Suisse

Simon Flannery - Morgan Stanley

Operator

Good day, everyone, and welcome to the Citizens Communications fourth quarter conference call. (Operator Instructions)

And at this time, I'd like to turn the call over to Mr. David Whitehouse. Please go ahead, sir.

David Whitehouse

Thank you, Michael. Good morning. The purpose of this call is to discuss 2007 fourth quarter results for Citizens Communications, which were released this morning. If anyone needs a copy of the materials, please call Lisa Lombardo at 203-614-5064. We anticipate the Form 10-K 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 will be making certain forward-looking statements, in particular on matters related to 2008 results and estimates. Please review the Safe Harbor language found in our press release and SEC filings. On this call we will 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, and good morning, everyone. Thank you for joining us.

Before I get into the Q4 2007 results, I want to highlight the $200 million stock buyback we announced in our press release this morning. Our goal is to complete this buyback program during the next 12 months. This buyback, approved by our Board of Directors, reinforces our confidence in the business. It is also in addition to the $635 million in buybacks we have completed since 2005.

Citizens Communications had a strong fourth quarter of 2007, building on our momentum of the first three quarters. Revenues were $577 million for the quarter and $2.288 billion for the full year. Expense management resulted in a 55.4% quarterly EBITDA margin and 54.7% for the full year.

Capital expenditures for the year were $316 million, with $113 million spent in the fourth quarter. All of these factors resulted in free cash flow generation of $528 million for the year and a comfortable annualized dividend payout ratio of 64%. Access line losses for the quarter were 45,300, which is up just slightly over third quarter.

We are extremely far along in the integration of our Commonwealth Telephone acquisition, and have recently increased our estimate of annual synergies from $30 million to $40 million. At our Pennsylvania properties, we have achieved 2% growth in average revenue per line and 31% growth in high-speed Internet subscribers.

Our clearly established acquisition criteria and our proven integration process provide an ongoing platform and competitive advantage for us to be disciplined in pursuing future acquisitions, and most importantly, to deliver on our commitments of those acquisitions. We are applying the same rigor to the Global Valley Network acquisition we recently closed on in California.

Our strong fourth quarter revenue performance is a direct result of continued emphasis on growing our customer revenues by delivering a unique customer experience, by providing easy to use products that complement each other and by implementing unique marketing tactics to spur consumers to purchase more services from us.

We continue to invest in our high-speed network with current availability to 89% of households at a speed of 1 Meg or greater. Furthermore, 48% of our customers now have availability at 6 Meg or greater. During the quarter, our high-speed data customers increased to 523,800, representing a 5.4% increase from the previous quarter and a 33% increase over the fourth quarter of 2006.

Our revenue for high-speed customers continues to be over $40 with residential broadband penetration increasing to 32%. We also saw continued success with our dial-up conversion program and converted 6,600 dial-up customers to broadband during the quarter.

Our digital phone offer continued to gain strengths during the quarter. This bundle of local service with four key features, an unlimited national long-distance or unlimited statewide calling is now available to both residential and small and SOHO customers. We now have 333,500 residential customers or 23% penetration of primary residential lines for these bundles in approximately one year.

As I mentioned on our third quarter call, we put in place three very strong promotions in the fourth quarter. The first was our free Dell PC offer, where we bundled digital phone, high-speed and a free PC in exchange for a two-year commitment for new customers and a three-year commitment for existing customers.

We leveraged the experience we gained while running a similar promotion in the fourth quarter of 2006, which allowed us this time to more surgically target our customers. This free PC promotion was offered to customers in our footprint where our PC penetration was less than 65%.

For customers in our markets where the PC penetration is greater than 65%, we offered a free year of the DISH family package with free local channels or a free digital camera with a $50 online photo processing gift card in exchange for a new customer signing up for a two-year commitment and a three-year commitment, again, for existing customers. All three fourth quarter promotions have less than a 12-month payback.

During the quarter, our high-speed Internet net adds increased by 22,400, reflecting customers who opted into these promotional offers and several other high-speed packages. During the quarter, our DISH network video customer base grew to 93,600, an 11.1% increase for the quarter and a 48.9% increase for the whole year.

We are very pleased with the results of our fourth quarter promotional activities. We used these inspirational gifts to effectively target our customers. They create great buzz in our markets around our Frontier brand, and they drive a lot of inbound call activity to our sale centers. The net result is market share and revenue growth, plus we delivered targeted product that meet and exceed customer expectations.

We continue to have a high priority focus with many initiatives underway to also help improve our net access lines. We believe offering best-in-class customer service is one of these priorities.

Frontier provides a unique customer experience. We implemented a new General Manager organizational structure in late 2007 that now allows us to offer the big company advantages of centralized common functions with the small company feel that a General Manager cultivates through local relationships.

We hired over 40 new general and local managers in the second half of 2007, who have hit the ground running. Local touch and engagement is a competitive advantage, and we expect to see the benefits of these leadership upgrades this year and next.

We surround our products with high levels of service and capabilities that really do set us apart. An example of this would be our new piece of mind service offering, which we believe greatly assist our growing broadband customer base and enables customers to view us as easy to do business with.

It starts with the fact that we discourage self installs for our new high-speed customers. Instead, the entire installation is performed by one of our highly qualified technicians, thereby ensuring that every customer experience is maximized.

We also offer a full menu of customer support services, including PC data backup and restore, PC tune up and disk service clean-up, wireless network diagnostics and repair, printer setup and trouble shooting, MP3 and iPod setup and training, security, virus scans and clean-up.

We believe our creative products and unique customer experience ultimately translates into increased customer satisfaction and revenue. We have seen this evidenced by the 22 new product offerings launched between 2005 and 2007, which have generated $100 million of annual new customer revenue. The net result has been a 6% compounded annual growth rate in customer average revenue per user from 2004 to 2007.

I would also like to provide an update on our wireless data initiative. We're up and running in 13 municipalities with 13 anchor tenants, colleges, universities and hotels who pay us a monthly reoccurring revenue fee for the use of that network, and we ended 2007 with over 50 hot spots. We're actively building four more municipalities for launch in the first half of 2008. Our wireless data initiative provides a great compliment to our existing customers and business high-speed offerings by adding Wi-Fi connectivity. Wireless data is yet another key element to our unique broadband customer experience.

Our priorities for 2008 are about staying the course. We move forward into 2008 true to our longstanding objectives of providing a unique customer experience, rolling customer revenue and delivering best-in-class EBITDA margins. We believe successfully meeting these objectives will drive strong free cash flow, which we intend to utilize in shareholder friendly action, such as our commitment to our dollar dividend, and our $200 million share repurchase program.

Here now is Don Shassian, our Chief Financial Officer to give you the financial overview for the 2007 fourth quarter and for the year. Don?

Don Shassian

Thank you, Maggie, and thank you everybody for joining us this morning. Before I get into a discussion of our quarterly financial highlights, I would like to remind everyone that we closed our Commonwealth acquisition on March 8, 2007 and our Global Valley acquisition on October 31, 2007, and accordingly have consolidated the results of these acquired properties since the respective dates of acquisition.

With the integration of Commonwealth essentially complete, and a relatively small dollar impact with Global Valley acquisition, we will no longer be breaking out the results of these properties separately. However, where appropriate, I will highlight certain key items from our Commonwealth property as well as the impact of Global Valley on a few key metrics. We had another solid quarter with strong revenues, EBITDA, our operating cash flow, and free cash flow.

Quarterly revenues of $577 million were slightly up as compared to the prior quarter, and were up 14% over the fourth quarter 2006. Reported EBITDA margin was 55.4%, which includes an $11.4 million charge for our fourth quarter promotion, offset by $14.4 million pension curtailment gain. Our free cash flow was $105 million for the quarter and the company generated $23 million of cash in excess of dividends for the quarter. For the full year 2007, free cash flow was $528 million, which slightly exceeded our guidance. Our dividend payout ratio was 64%, and the business generated $192 million of cash, in excess of dividends.

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 $78.64, which is up 1.7% over last quarter. And if you exclude the Commonwealth acquisition property, it was up 4.2% over last year's fourth quarter ARPU.

Our total year customer revenue was up 13% over last year. Excluding our Commonwealth property and Global Valley, our customer revenue increased approximately 1% in 2007 over 2006, which reflects our focus on introducing new products and increasing the penetration of old products and services to our customers, thereby, increasing our wallet share with their spending.

Quarterly data and internet revenue was up $7.1 million or 5.1% over the third quarter. Our fourth quarter data and internet revenues of $147.3 million, increased $35.9 million or 32.2% compared to last years fourth quarter, due primarily to the Commonwealth property and higher volume of high-speed internet customers and high capacity circuits like DS1s and DS3s in our legacy business. We added approximately 4,240 high-speed customers to our acquisition of Global Valley and, in addition to that, 22,400 high-speed customers to our fourth quarter promotions incentives to the base business.

Local service and enhanced services revenue declined $5 million or 2.2% compared to the third quarter was up 10.1% of our last year's fourth quarter. The Global Valley acquisition added approximately 15,300 access lines to our business and the legacy business including Commonwealth lost approximately 45,300 access lines during the quarter. Our residential line losses were 40,000 and our business line losses were 5,300. Our Rochester line losses were essentially flat with third quarter.

On a pro forma basis, assuming our Commonwealth and Global Valley properties were part of Citizens at the end of 2006, our annual access line loss in 2007 was 5.6%. Access service revenue was up 0.7% over third quarter and 6.3% over last year's fourth quarter. And long distance, directory and other revenue was down $1.4 million compared to third quarter, but up $9.9 million compared to last year's fourth quarter.

As Maggie mentioned, we increased our Q4 promotional push with a lot of strong promotional offers in Q4. Results for the quarter excluding our Global Valley acquisition were as follows; 22,400 new net high-speed customers resulting company-wide penetration of 22% on total access lines and 32% of residential customers, 9,400 new net video customers resulting in penetration of 6.4% of residential customers, 55,700 new digital phone and unlimited state calling customers resulting in penetration of 23% of residential access lines in just one year since we launched that product.

One other successful campaign that we had underway was our second half of 2007 dial up migration offer. This plan offered our dial up customers the ability to convert the high speed with no price changing in year one, and then increase in year two to our standard pricing. We will send one of our highly qualified technicians to install for every customer opting into this program.

Nearly 16,000 dial up customers have specifically stepped up a high speed, since inception on that program. Our dial up base is still significant, where we are pleased that this offer has proven to be a good value for this customer base, and we continue to expect to see a strong response from our 78,000 remaining dial up customers.

On the expense side, we continue to demonstrate effective cost management. Our reported EBITDA margins for the fourth quarter and full year were 55.4% and 54.7% respectively. Our fourth quarter results were impacted by an $11.4 million charge for the cost our fourth quarter promotions and incentives, which is more than offset by a $14.4 million gain on the curtailment or freeze to the pension plan benefits of the Commonwealth non-union employees.

With respect to our Commonwealth acquisition, we have realized $29 million of annualized synergies to-date and have increased our target from $30 million to $40 million of expected annualized cost savings to be achieved for 2009. Furthermore, we have several other cost reduction initiatives underway for 2008, including billing system, consolidations, and long distance least-cost routing.

Our capital expenditures in the fourth quarter were $113 million, which resulted in $316 million for the full year, which is at the low end of our guidance. Looking forward to 2008, we do not see any increased upward pressure on our capital spending levels. We will continue to prioritize capital spending on our return investment driven set of criteria to ensure our competitive position in the market place by delivering growth and cost reduction in return for that investment.

Switching to our capital structure. Our net debt to EBITDA ratio at year end was 3.6 times. Although this slightly is below our announced debt leverage, when we announced the Commonwealth acquisition in 2006, it is above our ultimate target range of 3233. We are confident in our ability to decrease leverage through continued focus on growing our customer revenue, realizing acquisition synergies and ongoing expense reduction initiatives. We have no significant debt maturities until 2011. And we will continue to explore opportunities to reduce debt prior to maturity.

For immediate use of residual free cash flow, we focus on $200 million share buyback program that we have announced today. This buyback in addition to our dividend, approximates 15% of our market capitalization that was returned to shareholders in cash, which is among the highest in our industry. Please note that we did unwind our $400 million in notional value fixed to floating interest rates swaps in January 2008 for $15.5 million gain, which will be amortized in to income for the remaining life of the underlying bonds they were intended to hedge, essentially three to five years.

As for 2008 expectations, we believe that our capital expenditures will be between $300 million and $310 million and our free cash flow will be between $450 million and $47 5 million. We are estimating cash taxes to be between $130 million and $140 million, which reflects the previously communicated run-off of our net operating losses and AMT credit carry forwards.

I should note that this is coming from cash taxes, and our free cash flow, does not include the tax savings that maybe available to us in 2008 as a result of the recently enacted Economic Stimulus Act Of 2008. One through the chance of fully absorbed understand its implications and opportunities we will make any comments at that time.

In summary we are very pleased with what we have again accomplished in 2007. One; we acquired Commonwealth Telephone for $1.1 billion and substantially completed its integration. Two; acquired Global Valley Networks for $62 million and we will complete that integration in Q1, 2008. Three; invested $316 million in our voice and data networks, our wireless data networks, and other new products in our IT systems. Four; generated of $528 million in free cash flow. And five; we turned over $586 million for our shareholders in the form of dividends and share repurchases, which represents return of over 12% of our market cap based on our value back in January, 2007.

We feel very good about the future prospects of this business, continue to grow customer revenues, continue to tightly manage and reduce expenses, continuing to tightly manage our capital expenditure investments, continuing to be opportunistic about M&A and continuing to return cash to shareholders.

With that let me pass it back to the operator and ask him to open the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Frank Louthan with Raymond James.

Frank Louthan - Raymond James

Hi, good morning. A couple of questions, one, can you give us a little idea of what was in the CapEx this quarter a little higher than we are looking for this, what that was going forward. And then if can you give us an idea over time you've looked that your company and others in the group have relatively stable revenue and EBITDA despite access line declines.

Are you still looking for roughly 5.5% line loss in this year that a good estimate going forward and can you give us an idea some of the things that are offsetting some of the loss revenue from those access lines? Clearly broadband has been one over the years and selling more special access for wireless back off probably and other, but can you give us some idea what are the things that we can be thinking about as and model the company going forward to get comfort that these access line losses sort of continue these levels will continue to see the results that you guys have been putting up for last two years? Thanks.

Maggie Wilderotter

Hi, Frank. I thought maybe I'll let Don take the CapEx and then I'll talk a little bit about the line losses. And you can weigh on that too, Don, before you hand it over.

Don Shassian

On CapEx, Frank, and the investments were really -- a lot of strategic investments we made in increasing our availability of high-speed -- increasing the speeds of our high-speed. We're trying to drive all of our customers up to 6 meg. Our wireless data builds were significant. Most of them were finished in the third, fourth quarter and we had some pretty significant IT investments.

We have been making a lot of investments on our IT platform to make our internal workings better and most simple for internal employees and also to make it easier for employees who deal with our customers. So we made very significant investments in IT in '07 We'll be doing it again in '08 as we do some billing system conversions, consolidation, if you would, as well as some other further investments in our customer rep.

So, it was all budgeted for the timing of it sort of came out in later half of the year as much so we tried to push it forward, but it was all for networking critical investments and IT, which is very ,very critical for our business.

Maggie Wilderotter

With regard to the offset on line losses, Frank, I think one of the other things that we've tried to do over the last several years is to start to build capacity and other areas of the business that could generate incremental customers revenues at good margins. So as we have line losses we would be able to replace that revenue in other categories.

You're absolutely right, the major driver is broadband. So, we have not just high-speed internet but a number of products and services that surround broadband platform including our wireless modem. We also have all of this piece of mind services that I mentioned. And those all derive incremental revenue to the bottom line for us.

In addition, our focus on video and triple-play packages, we are also starting to get some very good traction with internet services and portal and advertising revenues. In addition to that our wireless data revenues that we've started to generate with the networks that we built in '07. And enhanced packages, if you look at just providing customers with a package for digital phone with either national or statewide calling, the predictability of knowing what their bill is every single month, provides us with an opportunity to offer them a flat fee, which has actually increased our profitability on the long distance side.

So, I think you'll continue to see us launch new products and services, and continues to surround our access lines with other products. But I will say, if you look at our deactivations year-over-year even for our access lines from 2006 to 2007, we had an 8% improvement on deactivation for access lines. So, we are very focused on that subject and we do know that the major area that we need to continue to work on is the gross add side. And as I have mentioned before, we have a number of initiatives working on that as well.

Don Shassian

If I may also add, Maggie, one other perspective to think about, Frank, with access line losses there is obviously reduction in local revenue and enhance, so we're trying to offset all the numerous things that Maggie mentioned. One very key area that really offsets a very good portion of that is the growth in non-switched and data.

And I'll say, data excluding HSI, just really looking at DS1, DS3s were being sold to carriers large businesses et cetera, more than 60% of the drop that we see in local and enhanced is offset by the growth in those types of products, non-switched and non-high speed data if you would.

And that's been pretty steady and continuous to grow and be a nice offset. So, the end user activities, as Maggie mentioned are very, very critical, but also that, other carrier and large business data sales if you would, are very, very important to that. Did that help?

Frank Louthan - Raymond James

Thank you. That's very helpful statistics and just a quick follow-up with the IT initiatives, billing system conversions. Do you have a dollar amount or a payback time for benefit that we should see that, we start to see the benefits from that on the margins and are in the lower CapEx in '08 for the IT systems.

Don Shassian

Frank, we haven't given that out, but our investments in IT have been quite substantial they have not been to the magnitude of 10% of our CapEx, the less than 10% the payback is in approximately two years of what we estimate on these billing system conversions and the enhancements for customer representatives. So, it's a really -- it's a very important investment for us, it's the crux of the business for us and it really will simplify for us, but it's a sizable dollar amount, but it's not of the magnitude, it's more than 10% of our CapEx.

Maggie Wilderotter

And if you think about this way Frank, by the end of the summer we will have all of our markets on the same billing system, which is a phenomenal thing for us. It really simplifies the whole customer operations of our business. It really provides us with the ability to streamline, how we do business with customer especially on the billing side. So, we are very excited about that, we think it's going to be another competitive advantage and it will also reduce cost.

Frank Louthan - Raymond James

Great, thank you very much.

Operator

Our next question will come from Tom Seitz with Lehman Brothers.

Tom Seitz - Lehman Brothers

Thanks for taking the question. The first one is probably for Don. Don, can you walk through just a little bit more detail the one-timers in the quarter? You breakout the pension curtailment gain in schedule B, obviously, you're not putting in the promotion there. But is the sort of operating cash flow run rate 317 is that, if my math is right. And then, the second question is, can you talk about second line trends in the former Commonwealth property, they were abnormally high and I'm just wondering if that's having any impact on the access line losses? Thanks.

Don Shassian

Tom, you're correct. There's two items that I've noticed in the quarter, the pension curtailment gain is a non-cash gain. We did add a fourth quarter charges of $11 million this fourth quarter, last year's fourth quarter approximately $9 million. We did put a very big effort on that, it was very successful. We don't do those of that magnitude of activities every quarter. So, I think, you certainly can look at that and assume that is not something it's been happening every quarter.

So, revising it back and it certainly a way of looking at the business, but you should be aware that we do, do promotions and incentives every quarter, when we look at it surgically and strategically each quarter. So, those activities we will do throughout the year. So, I just ask you to be cautious about that because we'll do things throughout the year differently.

Tom Seitz - Lehman Brothers

Okay.

Don Shassian

Alright.

Tom Seitz - Lehman Brothers

And then on the second lines in Commonwealth territory?

Don Shassian

Second lines in Commonwealth are very significant change. There line loss in the quarter was about 5500 lines and 4,000 were second lines.

So we've been driving that or bundling their second lines in with our offers, but as we continue to push high-speed penetration and really we will take the trade-off of losing that second line or locking that customer high-speed. We are sort of self inflicting that change and reduction.

Maggie Wilderotter

And we are doing that, not just in the Commonwealth properties, but we are doing at everywhere. But you are absolutely right, it's a very large number. So, it makes the access line losses look a lot higher I think as I mentioned we had close to 7,000 access lines that were, dial up conversions in the fourth quarter and Don mentioned, since we even started our dial up conversion program it's been over 16,000.

So, you have to sort of net those out, the hard thing about access lines is we all look at them as one-offer, one-each when we were actually trading up for more revenues with customers in a lot of these situations and in addition to that in the wholesale side of our business lot of times we are disconnecting basic access lines for businesses. But we are replacing that with other data revenue sources…

Don Shassian

Which don't kind of access lines?

Maggie Wilderotter

Which don't kind of access lines because we don't get credit for that, but it's still growing the revenue exponentially.

Tom Seitz - Lehman Brothers

Great, thank you very much.

Maggie Wilderotter

You're welcome.

Don Shassian

Thanks, Tom.

Operator

Next up is Mike McCormack from Bear Stearns.

Mike McCormack - Bear Stearns

Hey, guys. How is going?

Maggie Wilderotter

Hi. Mike.

Don Shassian

Hey, Mike. How are you?

Mike McCormack - Bear Stearns

Good. Just the follow-up on the margin expectations, I mean we obviously saw the $11 million plus hit in the current quarter, but you talked about those progresses being EBITDA neutral over time, just trying to get sense for, can you expect those margins are rebound down is there some period that we should be looking at in that.

And secondly, on the Citizens organic line loss it's bit of an estimate obviously because it on the Commonwealth numbers, but it's looks like the line loss within the legacy citizens properties stepped up to a little over 7%. Just wondering if any increase promotional activity by any of your competitors out there? Thanks.

Don Shassian

On margins, Mike, I think our margins are going to vary a little bit quarter-to-quarter based on activities we do, but I think 53% to 56% is what you're going to see in our EBITDA margins quarter-to-quarter it really depends on the activities we put forth in a quarter.

The number you put on 7% I don't think that's correct on a legacy business I think it is 6% on a legacy business. The only two perspectives I will say that we did see in the western region only in a western region, we do see a slow down in the economy in our California and Arizona markets those are only 12% of our access lines and we do see it there. And we've seen a little bit of increases some competitive activity by some cable operators, but it's not significant that I'd really want to point out at this point in time.

Mike McCormack - Bear Stearns

Does any impact from the addition of the 40 General Managers to margins or is about meaningful.

Don Shassian

No, that was actually done in a way that was almost neutral. So, it's not it was really a move and relocation of people and upgrading and it was all done to be essentially expense neutral.

Maggie Wilderotter

Well, we actually did Mike, as we restructured the field in such a way that we took layers out of the business and then we upgraded the leadership appropriately. So, it was basically a neutral push from a financial perspective.

Mike McCormack - Bear Stearns

Great, thanks guys.

Don Shassian

Thanks, Mike.

Operator

Next we will go to UBS on Gaurav Jaitly.

Gaurav Jaitly - UBS

Great, thank you. Good morning. Just a couple of questions, just a follow-up first on that access line, Maggie, could you give us some color on how trends were in your California and Arizona market that you mentioned. How they were to the course of the quarter and maybe two months into this first quarter here, have trends kind of remained the same or have they got better, any color on that would be great.

And then secondly on your free cash flow guidance, Don, the cash tax number seems little bit higher than, we were expecting. I think you've said in the past that you expect a 30% cash tax rate for 2008. Just want to make sure that still the case and based on my math here, the payout seems to be about 70, a little over 70% and obviously that will go down, but depending on your buyback. But I think in the past you've said you expect to be well under 70% longer-term in terms of a payout. Just want to make sure if that still stands. Thank you.

Don Shassian

Yeah, there was.

Maggie Wilderotter

Yeah, I'll talk a little bit about California and Arizona. I think we have been sensitive because those are the two markets, really the only two markets that we have that have definitely had the housing issues, surrounding a number of the markets we were in and also affecting some of those markets.

I'll say this, I think it stabilized, I think in the fourth quarter again there is a lot of houses that are on the market, but have not moved. So, from the gross add perspective, what we have seen is a slowdown in growth adds out there, but it is not about the competition necessarily getting them. It is also about housing remaining vacant at the moment until inventory starts to get absorbed.

The West has done a great job of keeping customers. I think if you look at our Elk Grove property, it is probably the most highly competitive market we have. There is always a lot of focus on Rochester, because it's an urban market for us, but Elk Grove is a suburban market has both Comcast and SureWest in that market and it have that type of competition for a long time.

So, they do extremely well in keeping customers and continuing to put more and more customers on price protection plan. So, I think the net and net is we are keeping an eye on it. We haven't seen any material fall off in those markets. And we don't know as what happens with the economy over the next several quarters, but right now we don't see anything material going on in those markets other than what we've talked about.

Don Shassian

Gaurav, free cash flow, cash taxes as you'll see our cash taxes in 2007 were about $55 million. We ended up being able to utilize some AMT tax credit carry forwards more than we anticipated in '07. So, it's enables us to lower our taxes in '07, therefore not having more or less for '08.

The amount of taxes that we are forecasting for '08, is very close to being a full cash taxpayer. It's maybe about $20 million or so short of being a full cash taxpayer. So, we are pretty close up to being a full cash taxpayer, you can cut the math in a bunch of different ways, but we do believe that we are going to be well below 70% in '08 on our payout ratio, when all said and done based on what we got own plans and it's on the table.

Gaurav Jaitly - UBS

Great, thank you. It's very helpful.

Don Shassian

Thank you.

Operator

We have a question from Michael Rollins, Citi Investment Research.

Michael Rollins - Citi Investment Research

Hi, good morning. Just a quick question in terms of the access line trends, if you look at the year-over-year trying to adjust for seasonality, it looks like 2Q, 3Q, 4Q the year-over-year change got a little bit wider in each of the last few quarters and I know you've talked a little bit about the influences to access line losses, but at what point do you think your bundling efforts actually stabilizes the year-over-year change and as you look at the causes, do you think it’s more cable competition versus wireless at this point. Thanks.

Maggie Wilderotter

I'll take a stab at answer in the question, Don. I know you can wait in on year-over-year changes and your thoughts about that. Let me say a couple of things, if you look back in 2007 in the beginning of the year, we didn't have, we probably had competition in the 30% range, that increased to about 58% by the end of the year

So, last year was a big year of Cable VOIP being launched in a number of our markets. So, it was a bit of a beachhead year for us. I think we're very proactive about it with our customers, but still when you get an entrance that comes into a marketplace you're going to get activity associated with that.

In addition to that, I think you're going to continue to see in our markets probably another 10% increase from a competitive perspective in 2008. So, we will continue to see some residual growth in Cable VOIP launches throughout our footprints.

And I do think that in the majority of our locations, it is more about Cable VOIP than it is about wireless. We do have a couple of urban, suburban markets, Rochester, the Sacramento suburbs and the Minneapolis suburbs that you do have some of the wireless substitution as well. But in the majority of our markets, the wireless coverage is not good enough for customers to really look a substitution today, especially in the residential areas, keeping in mind, that our average number of homes per mile is 14. So, I think that there are still ways to go before we're going to start to see some of those material effects.

Don Shassian

And, Michael, the increase on competition, we're not seeing an increase in line losses in Rochester nor we are seeing in our Central region. We're seeing in the West, as we talked about earlier both on economy issues as well as Maggie mentioned very competitive market in our Elk Grove area and that's where we’ve really seen a pretty dramatic change in the past three, four quarters. We have also seen a couple of section sin our Eastern regions, but it's truly been isolated in two places, where there has been an increase in line losses due to economy or competition, not throughout all of our markets.

Michael Rollins - Citi Investment Research

Great, thank you very much.

Don Shassian

Thank you.

Maggie Wilderotter

Thanks.

Operator

Our next question will come from JPMorgan's, Jonathan Chaplin.

Jonathan Chaplin - JPMorgan

Good morning. Don, I wondering if you could give us a just a little more color on CapEx for '08 so I think there was $30 of $35 million in integration related CapEx this year and I understand in '08 that there is some increased spending on some back office initiative, but I'm wondering if once you get those behind you where CapEx revenues should be why shouldn't come down to 12% that we see in some of your peers.? Thanks.

Don Shassian

Jonathan, the amount of CapEx that we spent on the Commonwealth property last year for both the network business and the IT integration was I think almost $40 million. That's a large number and good portion of that, obviously is going down, we are making some other investments.

I think it is a good statement to say that at some point, some of our IT investments may not need to continue at this level, but I think that we see at least for the net for '08 and potentially '09 a number of IT initiatives that we want to continue to enhance the infrastructure of this business.

Credits only go down after that I think that's certainly a possibility. I don't refute that. I think, we just need to see how that plays out, but we are making investments have been in the past couple of years and we'll make it for at least this year and I think in '09 in IT and then we'll see how things play out.

Maggie Wilderotter

The other thing that I add to that, Jonathan, is in our Pennsylvania properties, we also have a requirement in Pennsylvania to deliver a 100% coverage for broad band, it's what's called chapter 30 and it's a regulatory requirement and we will meet that by the end of this year. So, that will require us to spend capital again in those properties this year that probably in '09 you will start to see some fall off from that.

Don Shassian

Let me clarify, when I said the $40 million of the Commonwealth property, only about $10 million of that what I'd say it was one-time, the base business of Commonwealth is approximately $30 million of CapEx.

Maggie Wilderotter

Right.

Jonathan Chaplin - JPMorgan

Okay. Thanks very much.

Don Shassian

Thank you.

Operator

Our next question will come from Jason Armstrong with Goldman Sachs.

Jason Armstrong - Goldman Sachs

Hi, thank you. Good morning. Couple of questions, first on M&A, since your last deal there's obviously the material changes in the credit environment and the latest industry deal we've seen same approved this morning. The deal dynamics sort of had a very different look going in versus coming out of the approval process. M&A has been such a crucial driver for this industry, can you help us think through maybe the current environment and prospects for deals in 2008.

And then second question just on the small business side. I think you said before it's about 80% of business revs and we've heard a lot of others talk about pressure in this segment. Are you seeing that, your comments indicated it hadn't really hit the line trends yet, but are you seeing anything on the bad debt side or anything that would service sort of a leading indicator you're picking up some of the same trends others are? Thank you.

Don Shassian

Jason, I haven't seen what's come across the tape on the deal announced. Can you educate me?

Jason Armstrong - Goldman Sachs

I was talking about New Hampshire approved Verizon this morning which gives them a path towards closure?

Don Shassian

No, I have not seen that, that's good news for them. M&A I mean our view is still, I'm going to be boring by the statement. But we've got a criteria that we're using both qualitative and quantitative, to identify properties and to the extent we can find them at the right price, I think we'll pursue how the best way to finance those.

Our credit markets can make them a little bit difficult, but we don't think that is a total hurdle to looking at and doing transactions. My view is right now it's a very good time to be looking at properties because of the fact maybe some people can't do some things on the financial side. I think it's a very good opportunity to try to continue and enhance and further the consolidation in this industry. So, we continue to be active. We continue to have people calling us and want to talk about things, and continue to evaluate.

Maggie Wilderotter

Jason, on the small business comment that you have made, if you think about our small businesses today they are roughly about 50% of our revenues. They are about 92% of our total businesses, but we have a number of medium and large enterprise customers as well. And we haven't seen anything material for our small businesses on the bad debt side. If you just look at the impact to the economy for bad debt on our third and fourth quarter, say roughly the same.

We basically did see some increase in bad debt expense overall, but nothing extraordinary. And as I mentioned, at the investor conference we attended in January, we actually saw our non-pay disconnects decrease in the fourth quarter of '07 over the third quarter of '07. So, we have not seen anything material on the small SOHO side. We actually launched some new product sets for that customer base including a business digital sound package in the fourth quarter and we're seeing some very robust takes on that.

Jason Armstrong - Goldman Sachs

Great, that's helpful. And if I can just go back to the M&A prospects question. On the approval side, can you sort of address what's happened FairPoint, Verizon, that the conditions there were accelerated broadband build, dividend cut, leverage caps. Is this a one-off situation, where and are about trying to sell lines and the company absorbing obviously, substantially bigger business that won't necessarily impact approvals for you guys going forward or is there sort of read across from the industry?

Don Shassian

Jason, I think every transaction is very unique and stands by its own. We are not as familiar with the lines and the regulatory environment that FairPoint be going through, which you've been reading. But I believe that regulators have a certain responsibility to make sure that customers are going to be protected in networks are protected and that the standalone company that state can self finance if anything ever went wrong. And so the structure of deals got to be able to meet their requirements, so that the regulators can do their job. I think the transaction that we structured was needed to be pursued and pushed by some folks to get comfortable with it.

We look that our views on -- we don't think this impacts how we would approach deals. I think our approach to regulatory approval process has been pretty straight forward and very transparent the regulators and I think all of the issues that had to be addressed by FairPoint. Our issues that we had to address in two transactions we've done. And we are able to satisfy our regulators based on who we are? How we operate? What our investments are going to be? What our commitments are going to be? We were able to get transactions approved in record time.

Maggie Wilderotter

I also think Jason that you've to look at the fact that we do business in 23 states today. We have a very good track record on a regulatory side that both the Commonwealth transaction and the GVN transaction both took place, while FairPoint was trying to get approvals, yeah with the Verizon transaction. And it didn't stop us for moving forward and proactively working to get regulatory approval without having to have any own risk, yeah things put on us in order to do that. And I think it has to do with, how you do business in those states as well. So, we don't really think that what FairPoint going through is indicative of what you will see with future M&A transactions.

Jason Armstrong - Goldman Sachs

Okay. That's very helpful. Thank you.

Operator

(Operator Instructions) And we will hear from David Barden with Banc of America.

David Barden - Banc of America

Good morning, guys. Thanks for taking the question. Just a couple of more questions kind of on these promotions and things going on as far as if you could kind of just give us a sense of to percentage of the footprint you think has PC penetration under 65%. And then, second, it does look like the expenses in that were related kind of jumped out in the network access expense line it wasn't clear to me how promotions would windup in the network access expense lines. If you kind of elaborate a little bit what the money is being spent on, it will be great.

I guess the third thing is, when you say $11.4 million is that like just very targeted specific spending on this particular project or was it kind of all in and I guess Don, you said it was kind of a charge. I guess I'm trying to understand what’s the difference between an expense on promotions and then a charge on promotions.

And then lastly, how you guys felt this relatively large amount of money, they got spent or you kind of paid-off in terms of the metrics this quarter, obviously DSOs were stronger than you are looking for, the lines were kind of in line, but I have to imagine that it had some effect and if you don't spend that money again next quarter, you might not have that positive effect. So, if you kind of just walk us through that, it will be great.

Don Shassian

Let me take a couple of reasons and I'll pass it to Maggie. First of all, the percentage of our lines have less than 65%, PC penetration is 50%. And actually is right to smack in the middle for us to 50% of our markets will proactively [incented] on the PC promotion.

The $11.4 million, I call it a charge essentially what we did is we purchased PCs or in the other 50% of our market digital cameras and processing cards and we purchased those and then we delivered them to our customers. So, the purchase of those, sort of an inventory if you would and then as we released them to the customers in the quarter. We charged them to cost of sales.

So I call it a charge. It's a $11.4 million, was a dollar payment made to purchase PCs, purchase digital cameras and the processing cards and the freight along with those to deliver them. And really it was booked to cost of goods sold because that was the recognition of appropriateness that we went through last year, when we did this promo fourth quarter, in terms of right place to book it.

Maggie Wilderotter

Yeah, I think from the comments that you made with regard to the big push, is it worth it, what happens the quarter after. I will say this, we have traditionally seen when we do big fourth quarter promotion sort of a halo push into the first part of the next years. So, you still have very strong call volumes and activities that take place, as you head into the January timeframe.

We kind of look at from a scheduling perspective, is doing kind of these aspirational promotions maybe two or three times a year. And then what we do our, what are called sustainable offers in the marketplace in the interim periods and those sustainable offers are really decided by our regions and our local and general managers based upon their specific market places and they have a series of offers so that they can sort of pull off the shelf and use throughout their footprint.

And then we try to continue to provide sort of a national air cover, a couple of times a year with these bigger promotions. And I will say David, one of the things that we really like about this approach is, it's not a price promotion. It is an aspirational gift promotion. So, what we do is, we get the customer on service without having to take major discounts to the products and the pricing associated with those products and that's worked very well for us because we are also getting two and three year commitments from those customers to stay on service.

David Barden - Banc of America

That's great. Thanks for those comments. So, just not to be too much of a geek about it, Don, but why do you take the charge for all these kind of millions of dollars worth of stuff in one quarter as opposed to say, amortizing the cost over the life of these customers?

Don Shassian

That was I think you keep asking the question, we really struggled with 2006. The difficulty was it's an economic event, in the fourth quarter, we made a decision to gift this to the customer and then to be able to amortize them over the life of customer we would have to start tracking and amortizing them based on when that customer rolls on, rolls off.

And just seem that, was going to be a little bit more awkward. It's an accounting convention and since we're focused on cash and the cash really went out the door, if you would in the fourth quarter or first quarter it made a lot more sense for us to do as a one timer. An argument can be made to amortize, but we just felt that net income wasn't really the focus here. It really was cash.

David Barden - Banc of America.

Right, okay, cheers. Thanks for that guys.

Maggie Wilderotter

Yep.

Don Shassian

Thank you.

Operator

We have a question from Chris Larsen with Credit Suisse.

Chris Larsen - Credit Suisse

Yeah, actually just I'm going to follow-on to that, it just occurred me. What's the sell through on the aspirational gifts, in other words what percentage of the customers have signed up to get the aspirational gift, actually close the deal sort of like the rebate pay through?

And then I had two other questions, the Economic Stimulus Tax Act is that you mentioned in the press release. If that goes through or doesn't go through, does that windup changing your capital spending plans, whether it would be timing of CapEx, etcetera throughout '08? And then lastly USF payments 4Q and then expectations for '08? Thanks.

Maggie Wilderotter

Okay. I'll take the first part and I know Don is going to jump in on the other part here. Chris, I'd say if you think about these promotions and we continue to refined these promotions, when we do them. In the fourth quarter of '07 based upon the economic environment and based upon some earnings we had from '06, we actually did a credit screen for every customer that called in for the PC promotion.

And there about an 11% of customers that we turned away from that specific promotion because of their credit. So, I think you could say that, the sells through was net that 11%. However, for even at 11% what we did try to do is to offer them an alternative, whether that's a good price on a high-speed bundle or the opportunity even for them if they want to pay for the PC, we would give them a very good price on that.

So, we do feel that these promotions drive a lot of activity into the call center. We think the sell through based upon customers, who are eligible it's basically a 100% and if it's not on that specific promotion we're actually offering them alternative.

Chris Larsen - Credit Suisse

Actually what I meant was, is your some percentage of the customers have signed up for the plan then windup not redeeming the coupon or whatever to get there. Okay.

Maggie Wilderotter

Oh, I see you are saying there is actually no coupon in this situation. We know that there are a lot of peers that actually provide promotions, where it puts the onus on the customers to do something. We don't believe that's the right thing to do. So, the onus is really on us, if you call up and you've got the digital camera promotion, that includes a gift card, we overnight that digital camera to you with the gift card or we send the PC directly to your house and our installer comes simultaneously with that PC and installs its for you. So, there is no redemption process at all on this.

Chris Larsen - Credit Suisse

Got it.

Don Shassian

Chris, I cannot answer your question. We have not fully assessed it and consider the implications, so to make any statements about change in the CapEx spending, I think it’s total really premature right now. So, I'm just going to hold in and really not to answer that question.

On the USF side, USF as you will see in our 10-K that's going to be filed the next year, so our subsidy revenue in '07 was about a $125 million on our Citizen business, that's about $40 million decrease over last year and that you may recall was because last year we had a very sizable benefit because back on our cost structure in '04.

That $125 million like five plus percent of our revenues are exposure subsidiaries really has dropped significantly. In terms of thinking about where there is going to go forward I'd think about a 10% reduction a year. I think that's the way we are looking at it presently that's the best insight I can give you at this juncture.

Chris Larsen - Credit Suisse

A little bit faster than the access lines declines.

Don Shassian

Little bit faster and it's driven -- our subsidiary here is both local switching, it's high cost, it's various states and right now it looks to us as we continue to drive the cost out of the business it's going to drop approximately 10%.

Chris Larsen - Credit Suisse

Thank you.

David Whitehouse

Operator, I think we have time for one more call.

Operator

Thank you. The last question will come from Simon Flannery with Morgan Stanley.

Simon Flannery - Morgan Stanley

Okay. Thanks very much. Don, could you talk about the synergy run rate that we are seeing right now you updated from 30 to 40, if we look at fourth quarter what was the sort of realized synergy there so and how we should think about the get into that 40 number over the next several quarters.

And maybe, Maggie, one for you, in terms of your pricing strategy you have one of the better data ARPUs in the industry, but we did see AT&T put through a $5 DSL increase. How are you thinking about being taking advantage of some pricing opportunities to move the ARPU up over the next few quarters and year? Thanks.

Don Shassian

Simon, the beginning of the fourth quarter, we had completed the billing system conversion, which was the second major milestone for us. We did the financial systems conversion back in June, July and the billing system conversion was in the September that enabled us to really change an awful lot of things in the infrastructure of Commonwealth.

So, we ended up getting, during the quarter a number of wage and non-wage costs started to come out. We did not get the full benefit in the quarter. We'll get a little bit more of that coming through in the first quarter and then if the play out over the next two years, because always said the synergies will take us to get to that $30 million, now revised $40 million is really to get it through '09.

We have a number of activities, that would still continue to pursue both wage and non-wage, IT investments and continued to just mange the business. That are going to take it out a little bit more in '08 and then the balance will be in '09. So, we are 29 if you would, annualized and I think we'll probably get about another $5 million if you would in a '08, another $5 million in '09.

Maggie Wilderotter

Hi, Simon, with regard to our pricing strategy, we were actually happy to see that AT&T increased their high-speed internet pricing by $5 because over the last several years there is been a lot of decreases that we've seen and we've sort of should held our own. Yeah, sort of look at the basic package for high-speed service and when we look at that it's anywhere from one to three meg in our markets and it cost anywhere around $29 to $39 a month depending on the markets and the competitive environments.

And we've had a philosophy to try surround those basic prices, with the ancillary products and services that we can get customers to uptake on that actually adds to the revenue. One is our wireless modem that we provide, and that cost the customer anywhere from $399 to $499 depending on the package, that they might be on with us.

In addition to that, the peace of mind services that we talked about. And we also have different variants of packages for incremental speeds, and in the future we're also looking at things like content packages and different forms of access, whether that's a turbo boost for video downloading etcetera.

So, I think you're going to see us continue with that same philosophy. We think that there are ways to move the revenue numbers up. And we do think that even in just holding our own over $40 a month for data compared to what you see in the industry is a good new story.

Simon Flannery - Morgan Stanley

Thank you.

Maggie Wilderotter

Well, that concludes our call. I do want to thank every one for joining us this morning for our fourth quarter of '07 and full year '07 review. We remain very confident about the business, and we look forward to speaking with all of you on our next call. Have a good day.

Operator

Once again, thank you all very much for joining us. It does conclude the presentation. Have a wonderful afternoon.

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