Sure West Communications (NASDAQ:SURW)
Q1 2008 Earnings Call
May 8, 2008 11.00 am ET
Misty Wells - Investor Relation Officer
Steve Oldham - President and Chief Executive Officer
Fred Arcuri - Chief Operating Officer
Dan Bessey - Chief Financial Officer
Good day, ladies and gentlemen, and welcome to the first quarter 2008 Sure West Communications earnings conference call. My name is Gracia I will be your coordinator for today. At this time participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions). As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Ms. Misty Wells, please proceed.
Misty Wells – Investor Relation Officer
Thank you, Gracia. Good morning and welcome to SureWest first quarter 2008 earnings conference call and webcast. SureWest reported financial results for the quarter this morning. The earnings press release is available on the Investor Relations section of our website at surwest.com and the first quarter 10-Q will be filed tomorrow. With us on today's call are Steve Oldham, President and Chief Executive Officer; Fred Arcuri, Chief Operating Officer; and Dan Bessey, Chief Financial Officer.
I would like to remind you that some of the statements, comments, and discussions which occur during this call are forward-looking in nature and relate to future events and/or performance. These statements should not be relied on as historical or absolute fact as future performance and future events are subject to numerous risks and uncertainties that frequently cause actual results and actual events to change. There are many such risks and uncertainties which could affect the economy, our industry, and our Company in particular, some or all of which could effect future results. Before making any investment decisions about our Company, we encourage you to review the Company's most recent filings with the Securities & Exchange Commission which contain a description of many of these risks and uncertainties under the heading risk factors.
These reports are available on the Investor Relations section of our website at surw.com. I would like to now turn the call over to Steve Oldham, President and Chief Executive Officer.
Steve Oldham – President and Chief Executive Officer
Thank you, Misty, and good morning, everyone. Thank you for joining us today on the call. I am going to spend a few minutes discussing the progress we made on our long-term strategy. I will then hand the call over to Fred Arcuri, our Chief Operating Officer, to discuss what we accomplished in the first quarter. After that Dan Bessey our Chief Financial Officer will walk you through our financial results. We of course have time for questions at the end of the discussion.
Over the last couple years we made continued progress in upgrading our existing copper network to an advanced and superior fiber-to-the-home platform and expand this network in the areas we previously did not serve. We believe that providing outstanding customer service over a superior network will make us the provider of choice for all of our customers. These relatively straight forward tactics are the key to success in generating long-term shareholder value. We're very pleased with our success in the Sacramento region where we have grown revenues by adding new customers and increasing sales throughout a challenging California housing market and stiff competition.
The broadband segment reported solid results in Sacramento in the first quarter compared to the same quarter last year. Total marketable homes in the Sacramento region increased over 4% over the prior quarter to 295,600 homes while we have also upgraded over 8000 copper homes to fiber Even with the expanded network residential penetration continued to increase to 30.3% from 29.2 in the previous year and total residential RGUs increased 7.5% compared to the previous year. Broadband business customers in the Sacramento market increased more than 9% over the previous year.
Another important tactic in our long-term strategy has been narrowing our focus to provide advanced network services constructing new network and acquiring additional high quality network assets. We have done this while exiting non network related business segments through the sale of non-core assets. During the first quarter the broadband segment achieved positive EBITDA and broadband revenue surpassed telecom segment revenues for the first time in the Company's history. This is due in large part to the successful acquisition and operation of our Kansas City network.
Rapid growth of our voice, video, and data services in Sacramento add to this transformation. Positive EBITDA in the broadband segment helped to increase consolidated operating EBITDA from our continuing operations by 16% and the Kansas City operations which were reflected in our results during the last six weeks of the quarter at a very positive impact on our consolidated revenues which increased by 20% compared to the first quarter of 2007.
Total broadband revenues had a 64% increase which more than offset a 7% decline in telecom revenues. It is clear that we've made great strides implementing our deliberate plan to transform SureWest into a fully integrated communications provider focused on operating advanced broadband voice, video and data services over a state of the art network. An important piece of our continuing transformation came with our announcement last month that SureWest will cease paying quarterly dividends. We believe this decision is in the best interest of shareholders because it will facilitate additional network expansion and conversion to continue our growth.
We believe that shareholders will receive a higher total return through this growth strategy. While we are continuing to invest in success-based capital and the expansion of our advanced network, we're placing an increased emphasis on driving residential penetration of our existing marketable homes and signing up new business customers. By emphasizing increased penetration, we will leverage our existing network investment while growing revenues which will lead to increased shareholder value.
We continue to invest in technology in order to remain ahead of our competitors in providing premier services for our customers. We're very optimistic about the future of the Company, and we're committed to improving long-term shareholder returns by growing the business and increasing sales revenues and cash generation. We have proven our ability to address a competitive environment, and we continue to invest in the Company to expand the network and successfully drive penetration.
I will now ask Fred Arcuri our Chief Operating Officer to discuss our operating results.
Fred Arcuri – Chief Operating Officer
Thank you, Steve. Good morning, everyone. I will start with a brief discussion of the progress of the Kansas City integration. To date our efforts is in Kansas City show a lot of promise. Our managing and reporting structures in place, and I am pleased to say it includes several key employees in the Kansas City business including Ken Johnson. Ken has agreed to lead our expansion in Kansas City as Vice President and General Manager of operations in that region. The marketing and sales effort hit the ground running in the area during March when we launched a number of marketing initiatives which will be evident in the coming quarters.
Part of our overall marketing and integration plans include rebranding Everest to SureWest which is under way and will like lie take until the end of the year to complete to ensure a smooth transition. Working with our team in Kansas City we completed a detailed capital and operating budget for 2008 in addition to a five-year operating plan. The plans call for efforts that focus on driving revenues in residential and business segments through new customer acquisition and ARPU growth. Network expansion in or around our existing Kansas City network is already under way. We currently have approximately 40,000 residential and business customers on our Kansas City -- on our network in Kansas City and passed more than 91,000 homes We're looking to expand further to take advantage of excellent customer demographics that exist in the region by beginning work on the expansion of the existing hybrid fiber co-ax network to pass an additional 2,000 homes very soon.
We are also completing engineering design on further expansion plans that will utilize a fiber-to-the-home network in Kansas City for an additional 8,000 marketable homes by the end of 2008. This will give us a total of 10,000 new homes in the region this year. On the business side we'll be leveraging and expanding our extensive fiber ring in the Metropolitan Kansas City region to reach out to many more business customers. We are very excited about the growth possibilities in this region, and we look forward to seeing the full effects of our expansion and penetration initiatives.
In fact, as Steve mentioned, broadband segment revenues are greater than telecom segment revenues for the first time in our Company's history. This is a very exciting development for all of us at SureWest as it demonstrates we're able to plan for and do what it takes to succeed in this rapidly evolving industry.
Let's look at the broadband segment. During the quarter we realized strong residential growth in business expansion on our broadband network, and I am confident that we are the most advanced broadband voice, video and data provider in the markets we serve. Our customers demand for Internet bandwidth has been growing by nearly 50% per year and is expected to increase in even greater pace moving forward. Because of this demand across the industry, we're also signing up new hyper speed data customers at a significant pace.
There are many industry wide efforts under way to address home networking needs and our fiber-to-the-home network in Sacramento region which offers symmetrical Internet speeds of up to 10, 20, and 50 megabits per second will continue to provide SureWest with a competitive advantage. SureWest continues to lead the premium television market in high definition offerings. Today we provide 50 HD channels in the Sacramento region and are adding over 15 additional channels in each market during the second quarter. Enhancements to our HD DVR offering as well as increased demand for other premium features including video-on-demand and HDTV provided additional contributions to RGU growth during the quarter.
We saw strong video growth on the fiber-to-the-home network in Sacramento with an increase of 11% compare to the first quarter of 2007. As expected, we experienced RGU losses on our legacy video over copper platform. However, we are continuing to advance the reliability and copper network even as we upgraded selected portions of the network of fiber-to-the-home. Residential triple play marketable homes consisting of both reasons increased by 103% to 211,000 compared to 104,100 at the end of the first quarter of 2007. This increase was comprised of 91,100 new marketable home from the Kansas City operations, 7,700 new fibre homes in Sacramento and 8,100 upgraded from copper to fibre where the expectation is to achieve greater than 35% penetration.
In addition to the increase in triple play marketable homes ARPU in those homes increased from $108 to $110. On March 10th, we launched our new Voice over IP digital phone product in Sacramento which presents a more competitive broadband triple play option with price flexibility and the inclusion of enhanced features in addition to traditional telephone service options.
SureWest broadband now offers this service in both the broadband footprint and the ILEC telecom service territory. As a result of this new offering we're already seeing elevated take rates on the product, and we're successfully offsetting some access line loss in the telecom segment by migrating these customers to voice RGUs in the broadband segment. Looking forward, we anticipate the offering will add to the strength of the voice package and will result in an increase in triple play RGUs. In our telecom segment we continue to see revenue declines as we experience access line loss due to Wireless substitution, competition, and declining regulatory subsidies.
Now let's look at business services growth. Business services in both our broadband and telecom segments are extremely important growth vehicles for us. Approximately 25% of the revenue streams in the broadband segment and 37% in the telecom segment are are attributable to our ability to offer customized solution for business, data and voice needs. Business revenues are stable and are a driver of growth for the Company.
Looking at our overarching business strategy, I will quickly explain the differences between our customer category from an operational standpoint. The businesses we serve fall into three general categories and our marketing branding campaigns are targeted to each of their specific needs. One is the small office customer, usually with one to four employees who require just a basic voice and data connection. Small to medium-sized business customers consist of fewer than 50 employees who have more than one location so they have networking and equipment needs as well as higher bandwidth requirements. Our large business customers are focused more on reliability, connectivity between multiple locations, very large bandwidth needs and large customer solutions.
The ARPU on these large customers is obviously much higher than a small office customer. We have and will continue to introduce new products geared to the small, medium and large business customers to make our state of the art network that much more appealing. The Company's business expansion through its integrated access service across lease transport in the Sacramento area resulted in a significant increase in our number of adjustable marketable businesses.
We continue to experience year-over-year growth in business revenues for both regions and in Sacramento customers increased over 9% from the prior year quarter. As a result of these efforts we will continue to drive the adoption of our business services in both Sacramento and the Kansas City regions. Before I turn the call over to Dan, let me update on the sale of the Wireless assets, which will close in the second quarter.
Although the sale of assets to Verizon is complete, while being reimbursed, we will continue to operate in the market on behalf of Verizon Wireless, for a period of up to six months from the close to ensure a smooth transition of network facilities and the customer base.
In closing we're pleased with the progress of our broadband division and excited with the progress of our broadband division and excited about the prospects for future growth we see in Kansas City and for SureWest as a whole. With that I will turn the call over to Dan Bessey, our Chief Financial Officer, who will discuss our financial results in greater detail. Dan.
Dan Bessey – Chief Financial Officer
Thanks, Fred. The first quarter of 2008 has been an exciting one for SureWest as we have implemented several key strategic initiatives that we believe will drive long-term shareholder value. As Steve and Fred have mentioned, we completed the acquisition of our Kansas City operations on February 13th, and in January announced the sale of substantially all of our wireless assets to Verizon Wireless. These two events had a profound effect on our financial results for the quarter and will continue to improve our financial and operational results for the remainder of 2008, and beyond.
Given the resulting changes from these two events, we have taken this opportunity to enhance how we report our revenue sources and associated operating metrics. First, we have combined the results of our broadband operations in Sacramento and Kansas City into our broadband segment. It is important to note that the first quarter broadband results include the Kansas City operations for six weeks, not the typical full twelve.
Secondly, we are now reporting our wireless segment results as discontinued operations which will enable you to focus your attention on our core operations, the broadband and telecom segment.
Lastly, starting in the first quarter and moving forward, we are now separating our revenue streams in both our telecom and broadband segment into residential services and business services. We have also changed our operating metrics to say include both residential subscribers and business subscribers along with the associated ARPU for each of these components of our business.
As ARPU for each of these components of our business. As Fred noted earlier, the business services component of our operations represents a sizable source of revenue for us and is an integral part of our growth strategy. We are pleased with this new reporting format, and we believe it will provide greater clarity and insight into our core financial and operational results.
My discussion of our financial performance for the quarter will now focus on results from continuing operations, first the broadband segment.
For the first quarter of 2008 total broadband revenues were $27 million, an increase of $10.5 million over the prior year. The increase in both revenues and the associated RGUs is due to the inclusion of the Kansas City operations and also reflects growth in both residential and business customers in our Sacramento operations. Residential subscriber growth increased 77% of which 69 was related to Kansas City operations and 8% was within Sacramento. Total subscriber penetration of marketable homes increased to 33.8%. RGUs increased 119%, 111% of which from Kansas City operations and 8% from growth in Sacramento.
Within the residential broadband segment data RGUs increased 74% and in Sacramento alone RGUs increased by 8% year-over-year. We experienced 180% growth in video RGUs and in Sacramento the video RGUs increased 8% over the previous year.
Also of note in Sacramento was a video ARPU increase of over $5 or 9% as customers responded positively to enhanced features and content and targeted promotions for high-end packages featuring premium content.
Broadband voice RGUs posted 180% growth in the quarter, and RGUs in the Sacramento market increased 6% reflecting the strength of our triple play bundle. The recent launch of SureWest digital phone adds to the strength of the voice package and an anticipated increase in triple play RGUs.
In the Sacramento and Kansas City triple play footprint RGUs per subscriber increased to 2.59 from 2.41 in the first quarter of 2007, and average revenue per user increased $2 from 108 to $1108.
Turning to broadband business services, business service revenues increased 56% or $2.3 million business subscriber counts increased 54%, up 2,100 from the prior year. Contributing to this increase was the inclusion of the Kansas City market as well as the rollout of new and enhanced business services to an expanding footprint in the Sacramento region. I would also like to note that total broadband business ARPU grew 60% to $412.
To summarize the broadband segment as Steve noted, broadband EBITDA was positive this quarter and broadband revenue surpassed telecom revenues in the first quarter which is consistent with our efforts to aggressively grow our broadband business through strategic acquisitions and by penetrating the market in which we serve.
The telecom segment which operates only in the Sacramento region reported revenue declines of 7% in the first quarter of 2008 compared to the prior year which were due to the continuing impact of wireless substitutions, competition, and the loss of regulatory subsidies.
Telecom residential revenues decreased 1.6 million resulting from anticipated declines in telecom, residential VoIP RGUs of 14%.
Telecom access revenues also declined slightly due to the scheduled reductions in the California high cost phone subsidies of 500,000 and the reduction switched access revenues from a decline in residential VoIP services. These reductions in access revenues were partially offset by increases in revenue received from NECA for carrier common line services.
Total business -- telecom business revenue decreased slightly due to the loss of small office customers from the downturn in the local economy in Sacramento. Now looking at overall Company results, consolidated operating EBITDA from continuing operations increased by 16% to $14.8 million from $12.8 million which was driven by positive broadband EBITDA during the quarter.
Consolidated operating expenses exclusive of depreciation and amortization increased 22% to $36.8 million in the first quarter of 2008 from $30.1 million in the first quarter of 2007.
Cost of services and selling expense increased due to the inclusion of costs for Kansas City operations and the growth associated with expanding the broadband subscriber base in Sacramento.
General and administrative expenses increased primarily due to upgrades to information systems and consulting costs associated with supporting the Company's ongoing strategic acquisition and disposition initiatives. These increases were offset in part by reduced labor related costs resulting from freezing the Company's pension plan effective April 1, 2007, and continuing to take advantage of normal attrition to reduce headcount and create operating efficiencies.
Consolidated depreciation and amortization increased by 10% in the first quarter of 2008 to $12.2 million from $11.1 million in the prior year quarter. The increase was primarily due to the inclusion of Kansas City operations and the continued expansion of the Sacramento network.
Let's move to the balance sheet. For the quarter cash and short-term investments were $8.4 million compared to $52.3 million at December 31, 2007. The decrease in cash is the result of funding a portion of the acquisition of the Kansas City operations in February 2008 and ongoing investment in the Sacramento network.
Regarding our debt and liquidity position, overall SureWest is in a strong financial position. We have a solid balance sheet and have the resources and capital in place to continue to build the business and increase our penetration in all of our markets. This will allow to us aggressively continue our growth strategy while affording us the financial flexibility to adjust capital spending as necessary.
As of March 31, 2008, total debt was $277.8 million with the sale of our Wireless assets to Verizon Wireless which will close in the second quarter, we will be repaying $30 million of the $60 million one-year term loans and the current outstanding balance on our revolving credit facility leaving the balance of available credit of $60 million to fund capital needs going forward.
We are currently evaluating several options to convert the remaining $30 million of the one-year term loan to a fixed term facility and expect to have this completed by the end of the third quarter of 2008.
Consolidated capital expenditures of $17.8 million for the first quarter, an increase of over $8 million over the same period in the prior year due to the timing of the network build. The Company continues to focus its capital expenditures on its targeted network build and success-based capital associated with increased penetration and ARPU on the existing network. Capital expenditures for 2008 are expected to be approximately $78 million including the expansion of the Kansas City network footprint.
In summary, we're pleased with the financial results and operating metrics for the first quarter, and we have made great progress in the growth of the business as we continue working to increase broadband penetration and successfully integrate Kansas City operations into our business. Now I will hand the call back to Steve Oldham, President and Chief Executive Officer.
Steve Oldham – President and Chief Executive Officer
Thanks, Dan. As we discussed this morning, the Company continues to see remarkable progress and continued success of our strategy. Looking at our successful sales and marketing results, our market-leading customer satisfaction levels, and the cost containment efforts we have made and the expansion of our advanced networks, it is clear that we are operating from a position of strength.
In the near term SureWest focus on customer service is designed to increase penetration and result in long-term customer satisfaction. Our goal to achieve penetration rates in excess of 35% in those areas we serve will increase profitability of our existing network, and we believe the goal is very achievable. Today SureWest has the most advanced and reliable broadband network in the Sacramento and Kansas City markets.
On the fiber-to-the-home network in Sacramento we delivered impressive 100 megabits of bandwidth to each of our fiber customers allowing us to provide the fastest symmetrical Internet speeds and very impressive video services.
In summary the residential broadband segment continues to deliver services that are superior to our competitors. Superior products and features coupled with best in class customer satisfaction provide the company with the opportunity to increase our penetration and ARPU.
Early results reveal excellent take rates on our SureWest digital phone, voice-over the Internet product, which we believe will provide some mitigation to the effects of voice competition. The success of SureWest digital phone will also result in a migration of voice RGUs from telecom segment to our broadband segment. In the business segment we continue to add new marketable businesses to our footprint and increase sales and marketing efforts to reach more potential business customers. We see the business segment as a significant driver of growth for the Company.
As Dan discussed SureWest is operating from a position of financial strength and flexibility. We have the resources to fund our continued growth and our business plan with the flexibility to modify our expansion investment plan as necessary to meet our business needs. SureWest Board and management team has demonstrated our ability to identify and act on opportunities quickly and efficiently. We have taken the steps necessary to ensure success and execution of our long-term strategic plan and deliver enhanced shareholder value.
With that, we can hope it up for questions if there are any.
(Operator Instructions). No questions at this time.
If there are no questions, this concludes the call. Thank you all for attending and have a great day.
Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.