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By: Ahmed Ishtiaq

Frontier Communications (FTR) had successful third quarter and reported remarkable results. Analysts were pessimistic about the revenue figures, but the company revenues beat the expectations. Taking into account the poor performance of the telecom sector due to the high churn rate, Frontier came out with impressive figures. Let's take a deeper look at the results of the firm.

Third Quarter Financial Results:

The company reported third quarter revenues of $1.25 billion, slightly better than the expected revenue of $1.23 billion. According to the company, the quarter was the best since the closing of an acquisition in 2010. Although, the revenues fell compared to the same quarter last year, the company was still able to increase its income threefold. For the same quarter last year, Frontier reported revenues of $1.29 billion. A decrease in the operating expenses helped the company achieve an impressive earnings figure. Frontier reported net income of $67 million, or $0.07 per share. Moreover, the operating income for the quarter stood at $275.2 million and operating margin at 22%. Operating income figures increased substantially from the year ago and second quarter figures of $180 million and $267.7 million, respectively.

Operating expenses for the quarter stood at $674.4 million for the quarter. There was a decrease in the operating expenses from the year ago figure of $691.3 million. However, severance costs increased during the third quarter and went up to $6.8 million from $1.5 in the second quarter. In addition, the company incurred costs of $15 million due to the damages caused by storms. Further, depreciation and amortization expense for the company is declining. Depreciation and amortization expense was $298.4 million during the third quarter slightly less than $307 million it reported in the second quarter.

It looks like the company is finally coming out of the integration process, and the acquisition has started to pay off. Frontier reported substantially lower integration costs for the third quarter than the previous quarters. Integration costs stood at $4.5 million, lower than $28.6 million reported in the last quarter and $67.4 million for the last year. These integration costs in 2012 were incurred for the final nine states onto Frontier's platform of system applications in March 2012. The company expects integration costs and related capital expenditures to be completed by the end of the year. During the past year, operating margin for Frontier has been around 22%, an extremely impressive figure compared to the industry average of 13%.

One of the most important expenditures for the company is CAPEX. Capital expenditures during the third quarter and the first nine months for Frontier stood at $195 million and $571.1 million, respectively. Moreover, cash flows from operations stood at $581.3 million for the quarter, showing a cash flow margin of 46.4%. Cash flows from operations did not include $6.8 million severance costs and $4.5 million in integration costs. Additionally, free cash flows stood at $215.3 million for the quarter and $753.3 million for the first nine months. At present, Frontier is in a strong liquidity position and has a working capital surplus of $608.2 million.

At the end of the quarter, Frontier had over 2.9 million residential customers and 291,400 business customers. The company lost about 51,800 customers as compared to 65,700 customers in the three months ended June 30, 2012. Furthermore, the average monthly customer revenue per customer increased $2.09, or 1.9%, over the second quarter of 2012.

Dividends, Cash Flows and changes in Debt:

Frontier offers one of the best dividend yields in the telecom sector at 8.8%. Dividends are an extremely important factor for Frontier being such an attractive investment. The company announced a $0.10 per share dividend on November 2. In my previous articles, I have analyzed the dividend stability of Frontier and maintained that the dividends are safe in the short term. Free cash flows for Frontier are expected to fall in the full year target of $900 million to $1 billion. During the past quarter, free cash flows came down by 24%. Frontier did not change its outlook for the year, indicating free cash flows will go down in the next quarter.

However, even $900 million in free cash flows will put Frontier in a better position than the previous year. For the last year, Frontier had $748 million in free cash flows, which it has already crossed this year. Frontier issued $250 million worth of debt in October yielding 7.125%. However, the notes were issued at a premium of 4.250%, which brought the effective yield down to 6.551%. In addition, the company also repurchased some of its costlier outstanding debt. Along with the previous dividend cuts and interest savings, the cash flow situation will further improve. Strong free cash flows and a payout ratio of 40% should help the company maintain its dividends.

Summary:

The telecom sector is seeing a decline of 8% year-over-year in the access lines, and most of the participants are suffering. Frontier earnings look extremely impressive taking into account the overall situation of the sector. At the time of declining access lines, it is important that the revenue per customer grows at a healthy rate. Frontier was able to increase monthly revenue from its existing customers. As I mentioned above, one of the most important factors for Frontier's investors is the dividend yield. I believe the dividend yield of the stock is safe. At the moment, Frontier dividends are adequately covered with its free cash flows. Next year's outlook of the company indicates that the capital expenditures will come down, and cash taxes will go up significantly. However, I expect the overall cash flow position to remain strong.

Source: Frontier Communications: A Deeper Look At Earnings And Dividends