Earnings Transcript for FYBR - Q3 Fiscal Year 2022

Operator: Welcome to the Frontier Communications Third Quarter 2022 Earnings Call. My name is Harry and I'll be coordinating your call today. [Operator Instructions]. I would now like to hand you over to your host, Spencer Kurn, Head of Investor Relations to begin.

Spencer Kurn: Good morning, and welcome to Frontier Communications' Third Quarter 2022 Earnings Call. This is Spencer Kurn, Frontier's Head of Investor Relations. Joining me on the call today are John Stratton, our Chairman; Nick Jeffery, our President and Chief Executive Officer; and Scott Beasley, our Chief Financial Officer. Today's presentation can be followed within the webcast available in the Events & Presentations section of our Investor Relations website. Before we start, please turn to Slide 2. Here, you'll see our safe harbor disclaimer. This is a reminder that this conference call may include forward-looking statements that involve risks and uncertainties that may cause actual results to differ materially from those expressed today. During the call, we may refer to certain non-GAAP financial measures, which are defined and reconciled in our earnings presentation, press release and trending schedule. With that, I'll turn the call over to John.

John Stratton: Thanks, Spencer, and good morning, everyone. Thank you for joining us today. As you saw in our press release, the team delivered another strong quarter of operational results. Our transformation to a fiber-first company is fast becoming our reality. If you turn to Slide 4, you'll see an updated company overview through the third quarter. Let me run you through a few highlights. By the end of this month, we'll reach the five million fiber passing mark, which puts us halfway to our $10 million target. We've also continued to expand our customer reach. We now serve 2.8 million broadband customers across our consumer and business markets. In the last 12 months, we've generated $5.9 billion of revenue and $2.1 billion of adjusted EBITDA. This represents a 36% adjusted EBITDA margin. Our relentless focus on fiber investment has reaped strong results. Fiber products alone generated $2.7 billion of revenue, and $1.1 billion of EBITDA in the last 12 months. And fiber now represents the majority of customers and EBITDA, a crucial benchmark as we build Gigabit America. You can see on Slide 5, the four levers that anchor our strategy

Nick Jeffery: Thanks, John. We delivered another quarter of record-breaking results, which has enabled us to reach a number of critical milestones ahead of schedule. As we build Gigabit America, our strategy is simple

Scott Beasley: Thank you, Nick, and good morning, everyone. Let's start with a look at our third quarter financial results. Revenue was $1.44 billion, a decline of $15 million sequentially as higher fiber and subsidy revenue was more than offset by lower copper revenue. We earned $120 million of net income and $508 million of adjusted EBITDA, $276 million of our adjusted EBITDA came from fiber products. This was down modestly year-over-year as revenue growth of 1% was more than offset by higher energy and growth-related customer acquisition costs. Additionally, we generated $284 million of net cash from operations in the quarter, bringing cash from operations in the first nine months of the year to $1.0 billion. Our healthy cash flow demonstrates the underlying cash generation potential of our business and as a result of our increased focus on liquidity and working capital management. Moving to Slide 20. Fiber revenue increased 1% both year-over-year and sequentially. Our biggest growth engine, consumer fiber broadband accelerated to 14% year-over-year revenue growth. The bulk of our capital and management focus in our first 18 months has been allocated to our consumer fiber growth. So this mid-teens growth rate is highly encouraging. Additionally, our fiber revenue from business and wholesale grew sequentially as we started to transform these businesses and see the fruits of the repositioning that Nick discussed. As expected, copper revenue declined 9% year-over-year, consistent with prior quarters as both consumer and business faced legacy product headwinds. On Slide 21, fiber EBITDA declined 1% year-over-year. Our revenue growth was more than offset by higher energy and growth-related customer acquisition costs. Total EBITDA, excluding subsidies, declined 3% year-over-year which represents a material improvement versus the past five quarters. Sequentially, roughly half of our higher expenses in Q3 related to higher electricity costs which we expected given higher electricity rates and usage during the summer months. Additionally, we achieved roughly 22% higher gross adds in Q3 than Q2. So this accelerating growth led to higher customer acquisition costs. We remain confident that we will hit our sustained EBITDA inflection during Q4, a target that we have been working towards since our Investor Day last August. Slide 22 shows our more than $3.3 billion of liquidity to fund the fiber build. We ended the third quarter with $2.6 billion of cash and short-term investments and $767 million of available capacity on our revolver. In addition to this strong liquidity, we also have ample balance sheet flexibility. Our net leverage was 3.1x at the end of the quarter. Approximately 84% of our debt is now at fixed rates, and we do not have any significant maturities earlier than 2027. Our capital structure and maturity timeline provide us with a clear runway to continue advancing our fiber build. Moving on to for the future initiatives on Slide 23. We have made rapid improvements streamlining our cost structure. And as Nick shared, we nearly achieved our initial target of $250 million of gross annualized cost savings more than one year ahead of plan. We captured these cost savings earlier than expected. And as we dug deeper into our operations, the scope of the opportunity has increased. We now see a runway to $400 million by the end of 2024, and we have raised our target. Consistent with our strategy, we will continue to reinvest a portion of these savings into initiatives that accelerate top line growth, while a portion will flow directly into improved margins. Turning to Slide 24. We're well positioned in the current macroeconomic environment. I've talked about this on previous calls, and I'll reiterate that our business is well insulated from a range of macroeconomic headwinds. The connectivity services we provide are critical for consumers and businesses to connect to the digital society. Our consumer health metrics continue to trend favorably with bad debt expense and days sales outstanding better than one year ago. Our cost structure, including our fiber build is well positioned to withstand inflation. And finally, our capital structure is well positioned in a rising interest rate environment, with 84% of our debt at fixed rates. Turning to Slide 25. We are reiterating the guidance that we provided last quarter. We expect capital expenditures of $2.5 billion to $2.6 billion, reflecting our accelerated build to 1.1 million to 1.2 million fiber locations this year. Our projected build cost per location of $900 to $1,000 remains unchanged. We also continue to expect EBITDA of $2.05 billion to $2.15 billion. We are on track to deliver a sustainable EBITDA inflection in the fourth quarter, and year-over-year revenue and EBITDA growth in 2023. I'll close by reiterating our investment thesis on Slide 26. First, there is strong and growing demand for fiber driven by expanding household data consumption. Second, fiber is a superior product. Fiber has symmetrical upload and download speeds that far exceed cable's capability, a lower cost of ownership because of its passive technology and lower latency levels that enable uses like video conferencing and gaming. Third, we have a clear strategy and purpose. We have rallied around our purpose of building Gigabit America as we build fiber, we're making it possible for everyone in our footprint to connect to reliable, high-speed broadband. Fourth, we have ample liquidity and a strong balance sheet, providing us with access to capital to fund our strategy. Last, I'm proud to be part of an experienced leadership team that has consistently delivered on our commitments every single quarter. Today's results mark our eighth consecutive quarter of record fiber builds and our fifth consecutive quarter of record fiber net adds. This team has executed extremely well in a challenging environment, and we're all motivated to continue this operating momentum. Now I'll turn the call back over to Spencer to open the line for questions.

Spencer Kurn: Thanks, Scott. Operator, we're now ready for Q&A.

Operator: [Operator Instructions]. Our first question comes from the line of Jonathan Chaplin of New Street. Jonathan, please go ahead.

Jonathan Chaplin: Thanks guys. Two quick questions, if I may. Given that EBITDA was a little bit lower than consensus this quarter. I'm wondering if you can give us a little bit more context for the inflection in EBITDA that you're anticipating for next quarter? For example, if we sort of back out the impact of the lost CAF II funding, will we see year-over-year growth in EBITDA in the fourth quarter or do we still have to wait for 1Q next year to really see that magnitude of improvement. And then I'm wondering if you can give us some comments just on the pricing environment generally and expectations for -- potentially for price increases next year. I think we heard from Verizon and AT&T that they're expecting to take prices up for their products broadly we saw a big increase in Charter's pricing this year. And I'm wondering how that sort of factors into your thoughts about ARPU growth for next year? Thank you.

Scott Beasley: Sure, Jonathan. This is Scott. Let me take the first question, and then I'll pass it to Nick for the second question. So in terms of our adjusted EBITDA, let me give you a little more color in Q3 and then we'll talk about Q4 in a second. So excluding the onetime tax refund highlighted in Q2, our EBITDA was roughly $20 million lower in Q3 sequentially. Half of that was due to higher electricity costs as we had higher rates plus elevated usage during the summer months. And then the other half was sequentially higher marketing and commissions. I said in the prepared remarks, we had 22% higher gross adds in Q3, and our cost per gross add was roughly flat, but that acceleration in total gross adds led to those higher commission costs. So that's good expense growth related expense. Even with those incremental electricity costs, which should persist a bit into Q4 and higher growth costs, we expect to inflect EBITDA in Q4 from Q3. And then have a sustainable year-over-year EBITDA growth in 2023 versus 2022. We're not giving specific quarterly guidance, but we do expect that inflection and expect that growth to persist into next year.

Nick Jeffery: Yes. Jonathan, Nick here. As I've said many times before, Frontier will be a rational pricing actor in this market. But having said that, along with almost every other business right now, we're seeing inflationary pressures. And if those don't moderate, then of course, we may be considered -- have to consider pricing actions to compensate for those just as I think we're seeing others doing. But I've got it always to provide a great range of products and services at competitive prices in order to make sure that we can meet our wider financial and operational goals. And if I take a little bit of a step back from that. I also think there's an opportunity for us to build on our -- on cable positioning that we've now made public to really turn on the head the kind of pricing practices that the rest of the industry does, but we know customers really hate. So we're doing a way with price step up and other things, which I think unattractive to customers, whilst maintaining our competitive price position, but always with one eye on input costs. And if we need to think about pricing actions to compensate for those, we of course will.

Jonathan Chaplin: Great. Thanks guys.

Spencer Kurn: Thanks, Jonathan. Operator, we'll take our next question, please.

Operator: Great. Maybe our next question comes from Greg Williams of Cowen. Greg your line is now open.

Gregory Williams: Great. Thanks for taking my questions. First one, just on access to capital. You guys have mentioned in the past maybe tapping the markets again in 2024. Just wondering if there's any updates there to that time line with rising costs that you just mentioned in rising interest rates, but it does sounds like you have a great cost savings program that's been accelerated and 84% of your debt is fixed. And I'm just wondering if anything there has changed? Second question is just on cost per home passed. Yesterday, one of your peers telco fiber peers took up their cost per home passed modestly on labor and some of equipment seeing if you're seeing any pressures there on the cost per home pass specifically. Again, it sounds like you have a cost savings initiative that's helping out. But just wondering, you hear your latest thoughts. Thanks.

Scott Beasley: Sure. Thanks, Greg. This is Scott. Let me take both of those questions. First, on funding. So you're right. When we completed our debt rates and upsized our revolver in May, we said that, that should fund us until early to mid-2024. We're still confident in that timing. And we have a number of options to fund there including additional debt, non-core real estate asset sales government subsidies and then the cost savings program that you mentioned that we just raised from $250 million to $400 million. So we're still confident on that timing, and we'll share more as we make decisions there. On the second part of your question, cost per home passed, we still are confident in our $900 to $1,000 per location range and really three points there. One, I think we were fortunate to get a head start on most of the industry and lock up labor and materials ahead of time roughly 18 months ago where we got a head start. Second, we've diversified the scale of our build in the number of states. So we've said we'll be building in 12 states by the end of this year and then 15 to 16 by middle of next year. And that gives us the flexibility to avoid any certain hotspots where labor is particularly challenging. And so we're confident there that we'll stay within the $900 to $1,000. We are seeing moderate inflation there, but that was -- a bit of inflation was factored into the $900 to $1,000 guidance that we gave about 18 months ago. So we're still confident that we'll hit that $900 to $1,000 range.

Gregory Williams: Got it. Thank you.

Spencer Kurn: Thanks, Greg. Operator, we'll take our next question, please.

Operator: Great. Our next question comes from Frank Louthan of Raymond James. Frank your line is now open.

Frank Louthan: Great. Thank you. How quickly do you get fiber that you build to market? Meaning when you start building a market, how quickly are you able to start marketing and selling there? And how much larger will you available to market base be, say six to 12 months from now from what it is now? Thanks.

Spencer Kurn: Yes, let me take the first one and hand that back to Scott and Nick. Yes, how quickly do we get selling fiber is something we worked very, very hard on since we started our fiber build just over a year ago. And what we developed is what I think is now a reasonably sophisticated playbook for taking fiber sales to new markets. So in fact, as we plan to build into an area, we start premarketing before that build and even gone in. Moring people are to the idea that fiber is a better product, fibers coming to town, but they have a better alternative and informing them about how they are able to order as we build it. So as we then roll into town, we do the bill pretty much in line with that, we sell door-to-door, we sell online and so on. So that we won the market up, we fulfill the market as we build and we look in a near real time as we can. That's the goal that we've been working towards over the last year. But as I said, I think the playbook there is now reasonably sophisticated and something we could be cover out as we build into new markets. John?

John Stratton: Yes, yes. Hey, Frank, it's John. I'll take the second part of your question, which is regarding sort of the addressable opportunity, I think, is what you're getting at. And I think the best way to look at that is simply to review the speed with which we're accelerating our fiber build. And so when we talk about doing $1.1 million to $1.2 million this year. Remember, our original target was $1 million for this year, so almost a 20% improvement over that number and accelerating. It's also important to note that the run rate that's now embedded in a business as such that it portends an even more significant build next year. Why this matters. As we've said throughout our time here, speed is a critical success factor. And we recognize that the faster and better we build the network at the proper cost with the right discipline at the highest level of quality, the more opportunity we have to expand the addressable market set. This is paying out. It's one of the reasons when you look back at our gross add and net add performance third quarter 2022 versus third quarter 2021. Yes, we continue to sell into our legacy markets. That's an important KPI for us, but look at the contribution that's coming from the new markets, it's really becoming incredibly volumes. So you should expect that to continue. We certainly do, and we'll look to drive that in the quarters to go.

Frank Louthan: All right. Great. Thank you.

Spencer Kurn: Thanks Frank. Operator, we'll take our next question, please.

Operator: Great. Our next question comes from the line of Anthony Nemoto of Citi. Anthony, please go ahead.

Anthony Nemoto: Great. Thank you for taking the questions. On the business segment, are you noticing any potential elongation in the sales cycle with some of your business customers? And then on the SMB side, what have been the key factors of success there given cable is well entrenched and then you have the heightened focus from the big three national carriers? And then lastly, just on leverage, as we kind of enter the inflection in EBITDA in 4Q and into '23, have your views on your leverage targets evolved for the mid-3s?

Nick Jeffery: Yes. Anthony, it's Nick. Let me take the first couple of those and hand to Scott for the leverage question. So our elongation of sales cycles. Both the way we think about the commercial segment for us, we probably just need to sort of build on a bit before I get to that question. I mean the first thing to understand about our presence in that market is that we are not in the market. So any kind of metrics you see about why the market trends and so on in a way of flying much less to us because we're really a very smooth commercial player where it is to the big guy in the market. So we have a small market share from which to build. The second point, I think is relevant is that our commercial customer base does not have the same profile as the commercial customer base is you see in other larger commercial players. Typically, a large commercial customer for us would be viewed as a medium-sized commercial customers for others. So we bought a smaller customer base at a small market share. Thirdly, the commercial segment to be very open with you, that marginally ignored by the previous rounds of fund the amount. [Indiscernible] is a great opportunity for us to put it back on its feet and really get out and attack the market. So what we're seeing elongation of sales cycle, the straight answer is no, we're not. Why? Because we're bringing a product that these customers really need fiber or fiber related products to largely unreserved markets where there [indiscernible] before with new management, new focus, new execution, innovation in product, innovation in pricing, innovation in channel management, channel delivery and execution and actually, I'm very optimistic about the early results we're seeing there. And to your point on SMB, many similar points, but in SMB, there was really no focus on SMB at Frontier in the past. And so we very significantly increased our marketing product channel activity there. And frankly, Frontier has passed many SMB businesses historically, particularly not gone back and done the hard and slightly obvious work of connecting those customers. We're now going back and doing that in our base market, we're finding our offer in our expansion markets, and we're increasingly sophisticated with digital as a market and scaling our channel. And we're seeing great results on the back of that. So I'm really pleased with the results of the team, but it's in SMB and enterprise, and I think is more to come. Scott?

Scott Beasley: Yes. Sure. Thanks, Anthony. On the leverage question coming out of bankruptcy in 2021, we said the mid-3s was the appropriate leverage target, but we did say that the target may move higher as we pass more locations with fiber as we hit our penetration targets as we improve the quality of our EBITDA with higher fiber percentage. And then eventually, once we began growing our revenue and EBITDA again. So I think we're on track to do all of those things and we may decide that higher leverage is appropriate for a period of time, while we finish the build and then eventually come back down to the mid-3s.

Anthony Nemoto: Got it. Thank you.

Spencer Kurn: Thanks Anthony. Operator, we'll take our next question, please.

Operator: Great. Our next question is from the line of Simon Flannery of Morgan Stanley. Simon please go ahead.

Simon Flannery: Thank you very much. Good morning. You talked a little bit about copper churn. Could you talk about fiber churn a bit and what your expectations are for Q4 and beyond given a little bit of a tick up sequentially on year-over-year. And relating to that is the competitive environment. Any update, we obviously see a lot of these bundled offers now from the cable companies with wireless from the wireless companies bringing in FWA. So how are you thinking about potentially looking at an MVNO or something like that to get some of those customers that are interested in those bundles? Thanks.

Scott Beasley: Sure, Simon. This is Scott. Let me take the first one and then pass to Nick. On fiber churn, it did pick up a tiny bit, I think it was 4 basis points year-over-year. But most of that was in voluntary just kind of returned to normal levels, fiber churn was right in line with our expectations, maybe even a little below our expectations. So we feel like we're not losing customers to competitive options. We feel like fiber churn is very healthy right now.

Nick Jeffery: Yes. On fixed buybacks, I think we've said before, very fundamentally different proposition to our core fiber offer. And we all know from the market data that you see and we see in every analysis that it appeals to potentially younger, more mobile demographics for some carriers and more kind of business-to-business, particularly like construction yards and mobile sites that need access for a while and then not so much transient business. And then the underlying question on SW about its overall economics as data volumes grow and the fact that it's perhaps the great sort of flash in the pan -- but if you have the chance to sell those same customers fiber, you almost certainly would better long-run economics, probably less churn and a better customer experience as data volumes grow. So we, of course, are looking at FWA and MVNO closely all the time, and we have been right since the start, but we've also got fantastic return on capital from building fiber. And while we see our churn rates still being stable and most of you know, whilst we see our growth rate still coming through at a very healthy rate the arguments for using some of that scarce capital to divert into an MVNO to solve a problem that we don't yet have. I think would probably not make our shareholders super happy. Now as I said that, with my experience in Vodafone, John your experience in Verizon, Veronica Bloodworth's experience with AT&T, Ettienne Brandt's experience with British Telecom and there was many, many, many others across the team. We do have deep experience in running, managing wireless network. We understand the economics of that really well. We understand bundling really well some of us, myself included a set up MVNOs in the space before, so we know practically how we would do that. So we're watching it very closely. And if consumer behavior changes or if the market changes in a material way that impact us such that using some of our scarce capital to build or partner and MVNO would be a smart thing to do, we'll do it, and we'll do it very quickly. But now it is the moment for us.

Simon Flannery: Great. Thanks a lot.

Spencer Kurn: Thanks Simon. Operator, we'll take our next question, please.

Operator: Great. Our final question of today comes from Nick Del Deo of MoffettNathanson. Nick, please go ahead.

Nicholas Del Deo: Hey, thanks for taking my questions. First, I want to follow-up on Simon's question about fiber churn, which you attributed to higher involuntary churn. Can you talk a little bit about your screening processes at the time of customer intake and how you're ensuring that you're not acquiring customers with a high propensity to churn down the road?

Scott Beasley: Sure, Nick. This is Scott. Yes, we have a very solid screening mechanism upfront. I think it's working well. So in addition to the screening mechanism, we're giving customers an incentive to get on to Autopay. And the combination of those two things has led us to record low bad debt expense in the quarter, record low days sales outstanding. So I really don't have any concerns about the quality of our customer base, and we're seeing customers pay on time for what's a critical service for them.

Nicholas Del Deo: Okay. Okay. Good to hear. And then also, obviously, fiber broadband ARPU, you noted was a little pressured because of the way you account for gift cards and some of the promotions there. I think you had previously suggested that fiber broadband ARPU growth should kind of be back to a more normal 3% range exiting the year as you kind of lap some of the initial impacts of that. Is it fair to say that ARPU growth may have come in below that target given recent trends? And I guess, more generally, are your subscriber acquisition costs kind of come in consistent with plan or other unit costs changing?

Scott Beasley: Sure. Let me answer the second one first. Subscriber acquisition costs are right in line with our plans. We did have a sequential increase in total marketing and commissions, but that was really growth driven based on the 22% higher gross adds than we had in Q3 versus Q2. So we're largely looking to always be as efficient as possible, but that's right in line with our plan. In terms of fiber ARPU, you're right. So we had two kind of headwinds related to programs that we put in place in the second half of last year. First, we ought to pay discount. Second was the promotional gift cards. Both of those have been effective. I just talked about the quality of our bad debt expense related to auto pay and then the gift cards have helped us compete effectively in the market. So without those two programs, we'd be at roughly 4% year-over-year ARPU growth with those, it's more flat sequentially. And once we lap the impact of those and then put in place a number of the kind of pricing ladder changes that Nick talked through, we'll be back on track for the 3% to 4% long-term growth in ARPU.

Nick Jeffery: And Scott, if I can ask to build on that as a reflection, if I stand back a little bit from the kind of day-to-day fight we have to grow our costs. I think its maybe more as I look at this business, which is still in early phase of the turnaround. Let's just be very transparent about that with year-to-year and there's still a long way to go. I think about it like this. Phase 1 of our new pricing structure matter was really that make us competitive. In some cases, the lignin to industry norms, good costs and things like that, getting us back in the game. Taking the fight to the competition make us with making it the format. We're really pleased with, I think, the progress that we've made there. I think in Phase 2, as we brought in some really great players from across the industry and indeed across the world. We're now beginning to see innovation come through in all parts of our business and in pricing specifically, I think KTM [ph] brands, who recently came in to either consumer segment has been putting into the market very quickly and very gladly to new pricing data structures, which I think are extremely interesting because we've taken stuff that we used to bundle and give a lease of free. Unbundled it and started to price for the stuff that we gave away previously. Now [indiscernible] we have to actually go out and sell with this stuff. Well, we have channel capability of selling stuff that we previously gave a way for free. But what's been amazing to watch is that adoption rate on these services have actually gone up. And that means more customers are willing to pay more money to staff that we used to previously bundle we give away for free. And in that one example, we've seen acquisition ARPU on our SMB segment go up by 10%, which is phenomenal. Now of course, I will not say to be clear that we can replicate that right across our business. But I am saying the relevance of that, that we can now believe across into our consumer market begin to innovate experiment with and see how we can start to grow this ARPU innovative market and demonstrate the customers that we really are uncapable company.

John Stratton: Yes. Maybe if I could just echo one last point here, and it's something that Nick said earlier in the prepared remarks. When you look back and asked the question about what's possible here. One of the critical data points that Nick pointed out earlier is the fact that our embedded base looks different than the new subscribers we're bringing on. The best parameter of consumer health and the company's competitive posture is the value that's described as a new sale. And if you look at the mix of gigabit plus activations in broadband for new customers, it's substantially higher than our embedded base. And as we think about it, new customers sort of reflect current market needs and requirements. Our job now will be to migrate the embedded base to look more like what we're bringing in new -- that is probably our single greatest engine for our growth as we go forward here on the consumer side, particularly. So hopefully, as we go forward, we'll be able to demonstrate that in our quarterly results and in the full-year.

Nicholas Del Deo: Great. Thank you.

Spencer Kurn: Thanks, Nick. That concludes our third quarter 2022 earnings call. Thank you all for joining us.

Operator: This concludes today's call. Thank you for joining, and you may now disconnect your lines.