Windstream Holdings, Inc. (NASDAQ:WIN) Q4 2016 Results Earnings Conference Call March 1, 2017 8:30 AM ET
Christie Grumbos - Senior Vice President and Treasurer
Tony Thomas - President and Chief Executive Officer
Bob Gunderman - Chief Financial Officer
Gregory Williams - Cowen and Company
Simon Flannery - Morgan Stanley
Matthew Niknam - Deutsche Bank
Batya Levi - UBS
David Barden - Bank of America Merrill Lynch
Good day, ladies and gentlemen, and welcome to the Windstream fourth quarter earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded.
I would now like to turn the conference over to Christie Grumbos, Senior Vice President, Treasurer, Windstream. You may begin.
Thank you, Nicole. Good morning, everyone. And thank you for joining Windstream’s fourth-quarter and full-year 2016 earnings conference call. Joining me on the call today are Tony Thomas, our CEO, and Bob Gunderman, our CFO.
To accompany today's call, we have posted the presentation slides, earnings release and supplemental schedule on our investor relations website. It is important to note that the financials that are discussed and presented in this presentation are on a pro forma basis as if the merger of EarthLink occurred on January 1, 2015, unless otherwise noted.
Today’s discussion includes statements about expected future events and financial results that are forward-looking and subject to risk and uncertainties. A discussion of factors that may affect future results is contained in Windstream’s filing with the SEC, which are available on our website.
With that, let me turn the call over to Tony.
Thanks, Christie. Good morning, everyone, and thank you for joining us today to discuss what has been a transformative period for Windstream. It has been just over two years since I became CEO, and last July marked our 10th anniversary as a public company.
I'm extremely proud of the progress our team has made during this time in positioning Windstream for long-term success. We have a clear vision and we are making smart, targeted investments to better leverage our extensive network to provide advanced, reliable services to customers and create value for our shareholders.
Starting on slide four, on Monday, we announced the completion of our merger with EarthLink to create a stronger, more competitive company to serve our customers. This merger provides improved competitiveness and the ability to serve our customers through increased scale and enhanced product portfolio; an expanded network in key areas with the addition of EarthLink's unique fiber assets, significant annual synergies of more than 150 million within three years, an increase of 25 million over our previous estimates; an enhanced balance sheet that will provide financial flexibility for the long-term; and finally, significant adjusted free cash flow accretion, which will be used to reduce debt, support our continued network investments and provide greater coverage of the dividend.
We remain very excited at the prospect of working with our talented new colleagues at EarthLink to better serve customers and drive value for our stakeholders. To our EarthLink colleagues, welcome to the team.
The completion of the EarthLink merger is an appropriate capstone for 2016. And so, before I discuss our goals for 2017, let me first review on slide five Windstream’s standalone achievements over the past year.
Our strategy continues to drive solid financial performance and we delivered consistent results across our core business units. We expanded our network on all fronts and increased its capabilities.
For our ILEC consumer and SMB network, that meant providing faster speeds and improved competitiveness, including the launch of gigabit Internet service [indiscernible] for markets.
On the wholesale front, we expanded our long-haul express fiber transport network throughout the Western United States, increasing our access to some of the fastest-growing technology and start-up companies in the country.
Our enterprise unit made great strides in its ongoing effort to expand our metro fiber network in key cities. We also announced our intention to expand our fixed wireless offering to 40 markets and we laid the groundwork for the launch earlier this year of SD-WAN, a technology that will transform how businesses design and manage their networks.
Our focus on enterprise sales with higher margins has significantly improved our enterprise contribution margin with year-over-year increase of 32%. We exited 2016 with margins in the high teens and are on track to meet our goal of 20% contribution margins in 2018.
Debt reduction remained a focus in 2016. We completed the last step in our spinoff of Uniti Group by executing a debt-for-equity exchange for $672 million. Combined with 2015 and 2016 open market debt repurchases, we have reduced debt by $748 million. Additionally, we refinanced debt and improved our maturity profile and lowered our cash interest expense.
Finally, we returned significant value to our shareholders in the form of the dividends.
With the completion of the EarthLink merger, I want to review the strategy for each of our four business units on a combined basis.
Slide six outlines our ILEC consumer and SMB business, which produced approximately $1.6 billion in revenue and $899 million in contribution margin. Our network enhancements enabled us to establish a strong foundation for sustainable growth.
This segment generates attractive cash flow by serving largely rural footprint. Approximately 40% of the footprint does not compete with a national cable or broadband provider.
Continuing to slide seven, our operational strategy for ILEC consumer and SMB is to continue to enhance the broadband network and deliver more speed to more people by expanding premium speed availability, deploying additional gig markets and leveraging next-generation broadband technology, such as vectoring and G.fast.
As you know, Project Excel has been a big driver of increasing Internet speed availability. And once completed in the first quarter, we will be able to offer premium Internet speeds of 25 meg or higher to over half of our footprint. Our focus will then transition to activating more customers and increasing our penetration where we have implemented premium broadband speeds.
Currently, 89% of our existing customer base subscribes to Internet speeds of less than 25 meg. With the increased availability of premium broadband speeds, we have a significant opportunity to migrate customers to faster speeds, which will reduce churn and improve the customer experience. This will position Windstream to take market share and grow revenue and contribution margin.
Turning to slide eight, the wholesale business produced revenue of $757 million and $494 million in contribution margin. Our extensive network now spans 147,000 route miles of fiber, providing high-bandwidth Ethernet and Wave transport services to wholesale customers, including high-growth customer verticals such as content providers, cable and other network operators.
With strategic fiber routes in the Southeast and Northeast and the expansion of our long-haul express network throughout the Western US, we expect increased sales opportunities.
On slide nine, the enterprise revenue was $2.4 billion with a contribution margin of $372 million, a growth of $75 million over 2015. Our enterprise strategy is to increase contribution margin, by focusing on higher-margin sales, reducing costs and improving the customer experience.
Enterprise business unit targets midsize enterprise customers where we can best leverage our network and our people to provide high-value solutions, which also produce higher margins.
We expect to continue to improve operating efficiencies and reduce network access cost through network modernization and on-net market expansion. These initiatives are driving significant improvements in contribution margin.
On slide ten, the CLEC consumer and SMB revenue was $916 million and contribution margin was $352 million. We will improve contribution margin trends by growing profitable customer relationships and managing costs. The relative scale and the ability to leverage the enterprise infrastructure will drive improved cost efficiency via optimizing the cost of revenue and improving the support cost structure.
Turning to slide 11, our 2017 priorities build on the advancements of 2016. First, we will execute on the merger integration to achieve the higher synergies we have outlined. Second, we will improve ILEC consumer trends by capitalizing on network investments to enable greater broadband speeds, increase ARPU and improve broadband customer trends. Third, we will grow enterprise contribution margin and reach our margin goal of 20% in 2018. And finally, we will leverage our next generation technology such as SD-WAN to drive sales and improve the customer experience.
Now, I’ll turn the call over to Bob.
Thank you, Tony. And good morning everyone. Beginning on slide 12, we achieved the financial guidance provided for 2016 as our strategy drove improved financial performance.
Before we review our 2017 guidance as a combined company, let me review our standalone performance. On slide 13, fourth-quarter service revenue was approximately $1.3 billion, with adjusted OIBDAR of $482 million. Adjusted OIBDAR improved $17 million sequentially and was stable throughout the year with the exception of the third quarter, which was impacted by seasonally higher expenses.
The ILEC consumer and SMB segment delivered solid results. For the quarter, service revenue was $392 million, down slightly sequentially. Contribution margin was up 21 million or 10% sequentially. Consumer ARPU increased for the eighth quarter in a row with an increase of 1% sequentially and more than 6% year-over-year, driven by speed penetration gains across all tiers and sales of bundled services.
Wholesale generated service revenue of $153 million and a contribution margin of $109 million or 71% for the quarter. These results were in line with expectations.
The segment continues to experience revenue pressure from certain declines in legacy services, which we are offsetting in part with growth products such as Ethernet and Wave sales as well as with sales to new customer verticals.
Enterprise service revenue for the quarter was $486 million and contribution margin improved $2 million sequentially to $85 million at a margin of 17%. For the full-year, enterprise service revenue increased 1% and we expanded contribution margin by $78 million or 32%. We continue to be disciplined with our focused sales approach and reducing costs to drive higher contribution margin.
In the quarter, CLEC SMB service revenue was $111 million and contribution margin was $35 million or 32%. We're focused on selling a simplified product lineup, while managing margins at the account level.
Our CLEC SMB business unit performed better than expected for the year with a contribution margin of $155 million, representing a full year decline of $26 million. This compared to a decline of $69 million in 2015.
Slide 14 shows quarterly and full-year pro forma financial results for Windstream and EarthLink combined. This information will be helpful as we review our 2017 outlook.
Let me begin by providing directional color by business unit as shown on slide 15. Starting with ILEC consumer and SMB segment, service revenue declined less than 2% in 2016 with a contribution margin of $899 million or 57%.
For 2017, we expect improvement in broadband customer and revenue trends relative to 2016. We will capitalize on our network investments, allowing us to provide higher broadband speeds to enhance the customer experience and increase ARPU and improve market share.
Further, we see additional opportunity as we leverage new network capabilities. We’re confident in the success of our ILEC consumer and SMB strategy for 2017 and have already seen the benefits with solid first quarter sales in units.
2016 pro forma wholesale service revenue declined 6% generating contribution margin of $494 million or 65%. In 2017, we expect the decline in revenue to accelerate slightly compared to 2016 due to continued pressure in our legacy [indiscernible] services with similar trends in contribution margins.
2016 enterprise service revenue declined less than 1% with contribution margin of $372 million, which is a $75 million increase over 2015.
In 2017, we expect a modest decline in enterprise service revenue as we continue to focus on more profitable sales. Importantly, this sales focus, combined with cost optimization, will drive continued growth in enterprise contribution margin dollars in 2017. As such, we remain confident we will achieve our enterprise contribution margin percentage goal of 20% by 2018.
The CLEC consumer and SMB service revenue declined 15% with a contribution margin of $352 million or 38% in 2016. For 2017, we expected decrease in service revenue, similar to 2016 trends, and an improved rate of decline in contribution margin as we narrow our customer focus to higher-margin opportunities. Additionally, in 2017, we expect continued pressure in switched access and state USF revenues.
With the [indiscernible] business unit in mind, 2017 guidance is provided for the combined company on slide 16. In 2017, we expect service revenue declines to be similar to full year 2016 trend and we expect adjusted OIBDAR to be in the range of $2.0 billion to $2.06 billion. We expect adjusted CapEx to be between $790 million and $840 million for the year. Our network initiatives support the operating plans of our business unit and advance our goal of stabilizing and growing adjusted OIBDAR.
Our EarthLink integration plan is progressing well and we have identified an incremental $25 million in synergies over our previous estimates and now expect more than $150 million in synergies within the next three years. We expect to exit 2017 with annual run rate synergies of $85 million, which consist of $60 million in OpEx and $25 million in CapEx synergies.
On slide 17, we have continued our efforts to optimize the balance sheet. We have an attractive debt maturity profile with no near-term maturities and have continued to improve on this in early 2017. Earlier this year, we refinanced an existing term loan to extend the maturity from 2019 to 2024 and closed on the remaining portion of a $600 million term loan add-on to refinance EarthLink’s debt.
Additionally, to the benefits of our EarthLink merger, we have already reduced leverage by 0.3 times and we have reduced leverage by a total of 0.5 times after synergies and will continue to opportunistically look for ways to optimize the balance sheet.
Slide 18 provides a closer look at our 2017 capital initiatives. At the midpoint of our CapEx guidance, we are targeting total adjusted CapEx of $815 million as we pursue strategic initiatives to advance our high speed Internet capabilities, strategically expand the wholesale network, enhance overall network performance and reduce network operating expenses. These strategic network initiatives support the operating plans of our business unit and advance our goal of stabilizing and growing adjusted OIBDAR.
On slide 19, in 2017, we expect to generate adjusted free cash flow of approximately $200 million based on the midpoints of adjusted OIBDAR and adjusted CapEx guidance. We expect cash interest to be approximately $360 million and cash taxes of $5 million.
We will now take your questions. Operator, please read the instructions open the call to questions.
Thank you. [Operator Instructions] Our first question comes from the line of Gregory Williams of Cowen and Company. Your line is now open.
Great. Thanks for taking my questions. Just a few, if I may. One on your contribution margin in the consumer segment. One of the highest in a very long time at 60%. Can you just help us understand what's driving that and how we should think about that segment going forward as you think about the legacy services sort of going away and the high-speed adoption that you guys mentioned?
The second question is around just your guidance. I think you mentioned it was really – the revenue guidance was really on a consolidated basis, because on a segment levels, it seems consumer trends are improving.
And more specifically, on the enterprise side, you said there’s going to be a modest decline. Does that modest decline include sort of a [indiscernible] synergies with the EarthLink merger as you realign your sales guys? Thanks.
Hey, Greg. This is Bob. Thanks for the question. So, as you look back at fourth quarter, we were certainly pleased with the sequential progress in our ILEC contribution margin. Now, keep in mind, third quarter for us is typically a heavier cost quarter. I would point back to our prior comments. This past third quarter, we actually had some higher overtime, just kind of better working days in the summer months that really drove some higher cost in the third quarter. Obviously, in fourth quarter, that kind of reverses. I think this year that sort of sequential trend was a little bit more pronounced than what we’ve seen in the past, but we just found some additional efficiencies in addition to what we’ve typically seen in that seasonal kind of trends.
Your second question, in terms of what does it look like going forward, really, our ILEC business, we expect to have continued improvements at our ILEC and consumer trends on revenue and units. And so, we’re encouraged by the progress that we have seen early in first quarter really on both fronts, and so we’re continuing to see the benefits of the investments that we’ve made over the prior year in Project Excel and some of the other speed enhancements. And so, the team has done a nice job of really capitalizing on that and we’re encouraged by the start that we have.
Speaking to the guidance for broadly around revenue, certainly, as you look at the trends in 2017, we continue to expect progress both in the consumer business certainly, the ILEC SMB trends, we expect to improve somewhat. As you look at enterprise, we are seeing a little bit of pressure on top line. However, the way that we’re getting those sales, we’re targeting the right type of opportunities, we’re really focused on the most profitable sales, driving on-net mix which is driving some improved contribution margins. You saw that continue in fourth quarter.
Really, we’re going to keep looking to do that in 2017. And as you think about the progress in enterprise, we continue to see that that opportunity continued for a very long time. We do have a view that revenue trends can improve over time, but we want to be selective in the types of deals that we sign up and the types of margins that we get from those.
As you look across the rest of the revenue guidance, certainly, we are not making as much progress on the wholesale revenue trends as we had hoped in 2017. We have seen a bit of a headwind there, while our team has done a really nice job of selling strategic services and extending sales into our added network on strategic routes. The pricing compression on the legacy base of TDM has been more consequential than what we expected. So, that’s holding back top line just a bit in 2017.
And then, certainly, within our CLEC SMB segment, we continue to make progress there, being very focused on account management and profitability at the account level and we expect to make some good contribution margin trends there in 2017 as well.
So, keep in mind, if you look at the EarthLink overlay to our combined trends, that certainly does influence the trends modestly. As a point of reference, in full year 2016, the revenue trends on a combined pro forma basis, relative to the WIN standalone, are about 100 basis points less because of that overlay. And then the adjusted OIBDAR trends are about the same. But as you look ahead, we expect, obviously, the synergies from the EarthLink transaction to really significantly improve the trends going forward in addition, of course, to our legacy initiatives.
That’s great color. Thank you.
Thank you. Our next question comes from the line of Simon Flannery of Morgan Stanley. Your line is now open.
Great. Thanks very much. So, on Project Excel, can you just talk about where you are in terms of the marketing? I think you had said you basically want to finish Excel before you roll out the marketing or have you started to market the 25 meg product and what sort of success have you seen where you’ve done that?
And related to that, I noticed the breakout with Charter, what are you seeing in terms of Charter's rebranding and the impact on your business? And then any perspective on M&A going forward? Is this going to be a quiet year for you given you've just done the EarthLink transaction? Are there opportunities to do other smaller deals or asset sales, sale leaseback, et cetera? Thanks.
Good morning, Simon. It’s Tony. I’ll jump in with Project Excel. Project Excel we have been training that up throughout 2016. I think we mentioned on our November call, we were roughly 30% complete. We’ve continued to make progress there. And as we do turn up those assets, we are marketing to them. But, of course, that means we’ve made a lot of progress here in the fourth quarter and we’ve made progress already in the first two months of 2017. So, as we turn on those assets, we’re definitely seeing the benefits flow-through in terms of consumer broadband units ARPU. Bob talked about the eighth quarter in a row of growing consumer ARPU. Bob also mentioned we’ve seen significantly better trends in the two months on our consumer broadband units. So, that’s all very encouraging. And that will only continue as we wrap up Project Excel first quarter. And that’s what gives us confidence as we lean into 2017 that we’re on the right path in our consumer and ILEC business.
In terms of Charter and its rebranding, obviously, anytime you go through a rebranding, there's always potential noise associated with it. I wouldn’t tell you right now it’s anything significant. We know both Charter as well as Comcast are formidable competitors, but they were before as well. So, we’re focused on what we can control and that’s increasing the speed into the marketplace and making sure we get that into the hands of our customers as quickly as possible. And as Bob mentioned, I’ll reiterate, we’ve seen really good trends in the first two months of the year. So, I think we’re holding our own, but it’s clearly something we continue to focus on.
Your last question on M&A, you're right. Obviously, we’re focused first and foremost on moving forward with the EarthLink integration. On legal day one, Windstream’s practice is to integrate the corporate systems – that’s the HR and finance systems. We completed that with no issues. And then we’ll integrate the operational elements, think about that as OSS and billing support systems over time. Think about that over a staged implementation that takes place over a 24-month period. And that minimizes disruption and makes sure we can provide the experience that our customers expect from us.
But in terms of our capabilities, I feel very good. The team did a really good job integrating the plan and we’ll, obviously, be very cognizant around M&A opportunities to make sure they advance our strategy in terms of either our financial performance on a free cash flow basis, improving our leverage goals, advancing our product and network capabilities. But given where we’re at, I feel good about our ability to take on additional M&A. And, of course, we’ll continue to look for ways to be creative around structure, as you alluded to, the sale-leaseback of our friends at Uniti Group. Obviously, any transaction there has to be a win-win for both of us, but we continue to look for ways to augment transactions to get the most value from them.
Okay, thank you.
Thanks for the question, Simon.
Our next question comes from the line of Scott Goldman of Jefferies. Your line is now open.
Good morning, guys. A couple of questions. One, I guess on the enterprise side, a lot of releases around metro fiber expansions that you guys have been doing. Tony maybe you guys could just talk a little bit about what that entails from a cost perspective, but probably more importantly what are you seeing around a demand or response in those markets? Is it predominantly just to get the enterprise margins up or are you actually seeing that drive incremental sales?
And then, secondly, on the CapEx side, just wondering –it sounds like Project Excel is wrapping up this quarter. How much, if any – I don't think Project Excel CapEx may be in the budget for this year and whether or not the low teens capital intensity as a percentage of service revenue is sort of the long-term view going forward? Thanks.
Scott, certainly, I’ll kick it off with the enterprise metro fiber, we’ve mentioned this before, but it definitely bears repeating, one of the advantages Windstream has had with its metro fiber expansion is we had a lot of latent fiber in the network. You’re probably alluding couple of announcements we’ve done recently, one in Dallas last week. There was latent metro fiber rings, recently had to go in, kind of dust that off, put the right electronics, metro Ethernet cable electronics into that network. And now, we’re selling on-net and near-net Ethernet services to those customers. And it advances two goals as you alluded to.
First and foremost, it gives us increased competitiveness in the marketplace, so we can win [indiscernible] sales opportunities. We sell a lot of multi-location opportunities at Windstream in the midmarket. But being able to leverage our own network helps us improve the competitiveness of the sales force. And you’re right, where we also are using another carrier, we will transition from using that carrier on to our own network. And all those are advancing our goals of expanding margin. And when you look at our enterprise margins, you'll see on page 15 on our presentation, the blend of the Windstream, we saw modest growth where EarthLink had high single digits contractions for the year. It is worth noting that contribution margin on a pro forma basis expanded $75 million year-over-year. And in legacy Windstream, it expanded $78 million and you saw minor contraction in EarthLink. With the smart targeted investments we’re making in metro Ethernet, combined with access cost initiatives, the benefits of the synergies, we’re confident we’re going to be able to grow that enterprise contribution margin through a combination of actions, including metro fiber capital investments.
Bob, do you want to take the question on CapEx?
Thanks, Scott. This is Bob. Just in terms of Project Excel, things are progressing well there. We came out of 2016 with really a lot of the physical plant builds in the field complete and so now in the first quarter we’re really going through and finishing off some of what we call the test and turn-up activities and really making a big push with our vendor partners to get that completed first quarter. So, still tracking well there. Obviously, once those activities get done, you would expect to have additional speed and to sell to our consumer, customers in ILEC SMB, in some cases. Where that CapEx actually lands in terms of completion, we could see some of it bleed over into 2Q as the vendor invoices come in, but we’re excited about getting that wrapped up real soon and the team is pushing really hard to really finish that off and get even greater set of speed capabilities into the hands of our customers.
I think as you look forward in terms of capital intensity, I think we feel comfortable where we’ve been. Obviously, one of the benefits of doing Project Excel was creating a scalable Ethernet infrastructure. So, every fiber-fed node on the backend of Project Excel in our network will be a fully scalable Ethernet architecture. That’s a big advancement. So not only do we get to increase speed capability, we’ve future-proofed the network. And prospectively, we feel good about our historical CapEx intensity. You see it embedded in our guidance. Where we have opportunities after making investments like we did in the wholesale business, we have the chance to ratchet CapEx, and I think that's demonstrated in our 2017 guidance.
Yeah. I'll jump on the CapEx color, we did see some benefits in our 2017 CapEx. It kind of put both of the businesses together. Really, three or four things helping us there. Obviously, CapEx synergies are helpful with the acquisition – merger with EarthLink, so that's great. We also saw an earlier reduction. We’ve been foreshadowing this time for sometime. An earlier reduction in 2017 of our wholesale CapEx, some of the strategic expansion. Quite simply, this is just an outcome that we’ve been so active in and extending so many routes that we’ve got on our great network to sell and the combination with EarthLink gives us even more. And so, we were able to kind of back off the CapEx spend without really hurting our opportunity for strategic sales.
We saw some modest declines in our [indiscernible] program CapEx. We would expect to see that maybe take another step down in 2018 as we wrap up some of the bigger projects on the WIN legacy side this year. Obviously, the EarthLink merger, billing system conversions will go on a little bit longer, but that's obviously going to be a little bit of a tailwind for us on the CapEx side as well.
And then, back to the point on capacity CapEx, really Project Excel, one of the nice benefits that they provided for us was little bit of a boost in terms of capacity CapEx deflection, if you will, on the organic business. So we’ve done so much there just to really bring the network to current. We took a little bit of a step down in terms of 2017 CapEx spend around broadband capacity. And so, that's not necessarily linear. That does kind of come up and down depending upon whether the consumption is on the network. But that was a nice tailwind for us into 2017.
That's helpful. Just to clarify, how much incremental CapEx should we be expecting on Excel in 2017?
We expect to spend probably $25-or-so-million higher than the $250 million right now. But we’re still early. We’re tracking through that, and so we might do better than that, Scott, but that’s kind of the current view.
Okay, very helpful. Thanks, guys.
Thank you. Our next question comes from the line of Matthew Niknam of Deutsche Bank. Your line is now open.
Hey, guys. Thank you for taking the questions. Just two if I could. One on free cash flow. So, it sounds like you are going to do about $200 million. Should on my math give you give you about $80 million in excess cash flow beyond the dividend. So just want to understand how you prioritize excess cash post the dividend. Is it primarily going to be leveraging or other uses to bear in mind?
And then secondly, just on enterprise revenue growth, just wondering, we sort of dipped slightly negative this quarter in terms of enterprise service revenues. Wondering if some new products like SD-WAN, some potential revenue synergy with EarthLink, how we should think about that trajectory and maybe a path towards enterprise stability over time. Thanks.
Hey, Matt. It’s Bob. In terms of free cash flow, yes, so we’re going to generate approximately $200 million for the year. Keep in mind, on a pro forma basis, the full year dividend impact is around $115 million, $116 million, and so the excess that we would have after satisfying the dividend, obviously, we’re looking to pay down debt and continue to make progress on the balance sheet there. And so, that’s our current views on free cash flow use.
Thanks, Bob. And on enterprise revenue growth, Matt, as we look forward, I think it’s important, as we look back on 2017, even in the fourth quarter where we saw kind of a sequential decline from 3Q to 4Q on service revenue, contribution margin in the enterprise business unit expanded by over $2 million. So, we’re definitely bringing the right types of sales opportunities and driving access costs out of our business. And as we look forward, that will be important. We have $1.7 billion of access cost that we spend across the entire company with other carriers and that will remain an opportunity for us to make sure we leverage our network when it’s available to us to advance the margin goals.
And when I think about the opportunity for EarthLink kind of revenue synergies, I think it’s real. I look at the kind of combination of the SD-WAN portfolios of our two companies. They are significantly improved by putting these two companies together. This merger will advance both of those. It will also enable incremental. We’re putting a lot more investment into SD-WAN on a combined basis and I think there will be opportunity. I don't think that probably materializes as much in 2017, but I think you'll see it as we go out of 2017 and into 2018, and that’s what gives us confidence that we can get back to growing our enterprise business unit at the topline.
Regardless of whether we can grow it at the topline or not, in 2017, we expect significant absolute dollar margin contribution expansion in 2017. We did $75 million in 2016. We will take another big stair step up in 2017.
Got it. Thank you.
Thank you. Our next question comes from the line of Batya Levi of UBS. Your line is now open.
Great, thank you. Couple of questions. First, on the guide to bridge the revenue decline to margin, I think you are looking for flat margins for 2017 and with a lot of focus on improving the margin contribution. What are some of the drivers that would keep margins flattish in 2017?
And the second question on CapEx, a lot of focus on, again, profitable enterprise growth. But it looks like CapEx for enterprise on-net expansion is coming down a little bit in 2017. Why not expand that more to move more traffic on-net?
Hey, Batya. This is Bob. Thanks for the question. In terms of the revenue guide and how does that influence our margins, if you look on a pro forma basis in comparison to WIN on a standalone, so for 2016 we ended up on a standalone basis, right around 35% and 35.5% of OIBDAR margin percentages. On a combined basis, when you put in EarthLink's lower OIBDAR contributions, we kind of land somewhere around a couple hundred basis points [indiscernible]. But because of the significant synergy opportunities that come from this transaction, we expect that by later this year we will be back up to that 35% range. Obviously, quarter-to-quarter, you have some changes in the results in terms of seasonal cost, and so that will be an influence. But certainly, by the end of the year, we expect that to help us considerably. The other thing I would say is that as we get more profitable within the enterprise business, our largest revenue segment, we continue to make progress on the contribution margins there. That, obviously, supports margins. And then we’ve seen some good results in our consumer business. Our biggest cash flow generating business, good stable margins there. I expect that, as we look into 2017 as we make more progress on ARPU and really stabilizing and getting to some good trends on revenue, we expect to carry a lot of that momentum down to the bottom line, and so those will all be things that support the trends into 2017. I will point out, while we’re talking, just the trajectory of OIBDAR in 2017, keep in mind that first quarter for us is typically a higher cost quarter. We typically have a higher spend around advertising and we also have a higher cost around payroll taxes and other resets that happen in the first quarter, and so that’s something to keep in mind as you look at the first quarter trends.
But, notably, as the year plays out, largely because of the legacy access and interconnection cost take-out initiatives that supports the enterprise and SMB businesses, and then in addition to the SG&A synergies, they’ll start pretty quickly for the merger, we start to really make some significant progress in OIBDAR margin trends as the year plays out. So, keep in mind that there'll be a little bit of a difference as you kind of look at the quarters by – over the year. We’ll start out with a higher decline, but significantly improve as the year goes on.
–And then on CapEx, really the bucket we’ve referred to in the CapEx is a blending of two sets of initiatives, one is on that metro expansion and the second is interconnection cost savings. And really, the bucket that’s going down significantly there is interconnection cost savings. Our metro Ethernet kind of investment will be very similar in 2017 to 2016. Our interconnection cost savings is going down because we’re able to deflect some of that capital because of the network capabilities that we picked up in the EarthLink merger.
Got it. Just one quick follow-up. How much of the $135 million in OpEx synergies do you expect to reach this year?
Hey, Batya. This is Bob again. So, in terms of the OpEx and CapEx synergies, just at a high level, I’ll give you all the breakouts here, so 2017, we would expect to end the year at a run rate level of $60 million of OpEx achievement and $25 million of CapEx, so $85 million total. But within the year, the amounts that we would see impacting OpEx would be about $20 million and then the CapEx numbers, obviously, we would get that in the year. And so, as you look at that sort of ramp up, it’s toward the back end of the year that we really start to get more of the OpEx savings and it’s really because we get a first kind of hit of the SG&A synergies and then the access synergies start to build as we get further into the year and frankly into 2018.
That’s helpful. Thank you.
Thank you. Our next question comes from the line of David Barden of Bank of America Merrill Lynch. Your line is now open.
Hi. Thanks for taking the question. This is Angela Zhao for Dave. So, two if I could. First, could you dive a little deeper into the enterprise margin opportunity at EarthLink? Are these in the synergy estimates and what's the revenue mix for off-net and on-net for enterprise post-deal?
And second question is regarding 2017 guidance, can you give any insights into what a standalone EarthLink and Windstream EBITDA for 2017? And for the EarthLink number, and just to clarify, does that include 10 months of EBITDA or full year?
Hey, Angela. This is Bob. In terms of enterprise margin opportunity, so as you look at those opportunities, obviously, even before the merger, we were making a tremendous amount of progress in improving the enterprise contribution margins largely through more on-net sales, but also significantly through lowering the cost of access and really optimizing the network and the cost of serving those customers that led to 30-plus-percent increase in contribution margins in 2016 on a standalone basis. That’s going to continue. We’re going to continue to have progress on that in 2017. Obviously, you add on to that the opportunities for the synergies that come from the EarthLink merger. The access synergies in the aggregate by year three, when we get to the full run rate will be around $60 million on an annualized basis. Now, it’s going to take some time to get there because we have to build out some network and really start to work through those project plans. And so, it’s not a very big impact at all for 2017. But as you work your way through the next couple of years, that becomes more a consequential number for us. And so, that is really how to think about enterprise contribution margin. The legacy business continue to have opportunity and, obviously, overlay the synergy opportunity that adds to it. So, that’s what gives us confidence on the margin profile of enterprise going forward. In terms of the revenue mix, off-net, on-net, we haven’t really broken that out specifically, but I will tell you we’re still pretty high percentage off-net. Obviously, as we sell new customers, we take every advantage as we can to push more of those customers on-net. And in some cases, it’s a hybrid approach where you have customers that are completely on-net. That’s obviously a desired outcome, but in our case that's not always possible, and so we try to mix in off-net and on-net together to get the overall lower cost down and make us more competitive and have higher contribution margins.
And I’m sorry but the last question I forgot.
So regarding guidance, the standalone EarthLink versus Windstream, and then for the EarthLink number, is it 10 months or full year?
Yeah. So all of the guidance that we’re giving for 2017 is a pro forma guidance number and we’re not separating the Windstream guidance separate from EarthLink because quite frankly we’re going to manage the business on a combined basis and I just don’t think it’s going to be that meaningful to look at that going forward. So, everything we’ve given you is on a pro forma basis and it’s on a combined basis.
So, it includes 12 months of EarthLink.
Thank you. And at this time, I’m showing we have no further questions. I’d like to hand the call back over to Tony Thomas for any closing remarks.
Great. Thank you all for joining us this morning. Our 2016 results demonstrate continued progress on executing our focused strategy. Looking ahead to 2017, we will continue to build our momentum and, of course, remain focused on creating value for our shareholders. Bob and I will be on the road over the next month. We look forward to meeting with many of you and thank you for joining us this morning.
Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program. You may disconnect. Everyone, have a great day.
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