Consolidated Communications Q2 2023 Earnings Call Transcript

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August 8, 2023

There are 5 speakers on the call.

Operator

Good morning. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the Consolidated Communications Second Quarter Earnings Conference Call. Please be advised that today's conference is being recorded. All lines have been placed on mute to prevent any background noise.

Operator

After the speakers' remarks, there will be a question and answer session. Thank you. I will now turn the call over to Philip Kranz, Senior Director of Investor Relations. Philip, you may begin your conference.

Speaker 1

Good morning, and thank you for joining the Consolidated Communications' Q2 2023 earnings call. Our earnings release, financial statements and presentation are posted on the Investor Relations section of our website at ir.consolidated.com. Please review the Safe Harbor provisions on Slide 2 of the presentation. Today's discussion includes forward looking statements about expected future events and financial results that involve risks and uncertainties that may cause actual results to differ materially from those expressed today. A discussion of factors that may affect future results is contained in Consolidated's filings with the SEC.

Speaker 1

Call. In addition, during this call, we will refer to certain non GAAP financial measures, which are defined and reconciled in our earnings presentation and press release. With me today are Bob Udell, President and Chief Executive Officer and Fred Grafim, our Chief Financial Officer. Following their prepared remarks, we will open the call for questions. I will now turn the call over to Bob.

Speaker 2

Thank you, Philip, and good morning, everyone. I'll dive right into some of the key highlights from our Q2. First, we achieved yet another record quarter in consumer channel with over 18,600 fiber net adds, demonstrating strong growth of our fit in fiber. This represents a 51% sequential increase for fiber net adds. 2nd, we achieved nearly 7,000 positive total consumer broadband net adds as fiber net adds have offset DSL declines.

Speaker 2

This increase in consumer broadband net adds is roughly 7 times greater than the prior year and reflects 190% sequential growth from the Q1. 3rd, our consumer fiber Internet revenue grew 58%, which contributed to overall consumer broadband revenue growth of over 8%. 4th, consumer broadband fiber ARPU is up 5.1%. And finally, our fiber churn continues to be low at 1.3%. We continue to see favorable trends for FIDIUM Fiber with record breaking monthly results.

Speaker 2

In June, we closed the quarter with 6,600 fiber net adds and in July, we set a new record of nearly 7,300 fiber net adds in the month. This ramp positions us to again exceed our record Q2 fiber net adds results in the 3rd quarter. In addition, we reached an agreement to sell our Washington State assets, resulting from the ongoing review of our market portfolio and supporting our commitment to focused fiber expansion in our core markets. Moving to Slide 4, I'll remind everyone of our journey, including the actions we are taking to solidify our return to growth in 2024. We are executing on a multiyear transformation from a copper based telecom to a leading fiber broadband provider, and there are plenty of proof points to demonstrate we are well on this path.

Speaker 2

I am more confident than ever that we'll leverage our operating expense structure as revenue grows and as our cost rationalization actions take hold. We are targeting a mid teens EBITDA compounded annual growth rate of over the next few years. We also believe that our EBITDA margins have long term upside to the mid to high 40% level as we drive highly profitable fiber penetration across the consumer, commercial and carrier channels. We've recently initiated a significant business simplification and cost savings initiative to further align and focus our organization as a fiber first provider, generate efficiencies, drive improved margins and ultimately provide better customer service. This effort includes resource optimization, rationalization of our real estate footprint and a review of our product portfolios.

Speaker 2

These actions are estimated to result in annualized cost savings of more than $30,000,000 resulting in improved EBITDA and margins beginning in the second half of twenty twenty three. Our fiber investment thesis remains intact. Overall broadband usage continues to rise and consumers' desire for faster speeds and more reliable connections continues to increase. These industry trends align well with our fitting fiber product offering, which we believe is superior to cable and fixed wireless. We currently offer symmetrical 2 gig speeds and our technology is upgradable even beyond our current 10 gig capability.

Speaker 2

Put simply, fiber's future proof characteristics provide us with undeniable long term growth opportunities, and we certainly are excited with what lies ahead. As we've discussed in the past, we benefit from several distinct structural advantages, including our incumbent position. We have a fiber rich carrier class network that we can cost effectively extend, including existing conduit capacity for Berry facilities and pull access where we have aerial plant. These network advantages provide us with favorable unit costs, including an industry leading cost to pass, offering a strong return on investment opportunities. Now I'll update you on our fiber build.

Speaker 2

In the Q2, we built fiber to over 57,000 locations and remain on track to upgrade roughly 225,000 locations during 2023. We are approaching our build with a prudent measured pace. For context, in 2021 2022, we demonstrated that we can build efficiently and with speed. This allowed us to expeditiously reach 40 and fiber coverage, an important inflection point that supports consistent consumer broadband net adds and revenue growth. As evidenced by our results, this is exactly what we are doing.

Speaker 2

Our build strategy and pace is fueled by fiber penetrations and government broadband partnerships, all viewed through the lens of prudent liquidity management. 1st and foremost, we're focused on driving penetration across our existing base of over 1,100,000 fiber passings, which provide support to fund additional fiber builds. With the leadership team previously announced and a refined go to market strategy, we've never been better positioned to drive increased penetration. Second is the continued pursuit of grant or infrastructure funding opportunities that align with our plan and can be synchronized with fiber build activity in our communities. These government funding opportunities help to offset rural high cost passings, allowing us to maximize the economies of our builds for complete communities.

Speaker 2

At this time, we are tracking approximately $110,000,000 of additional broadband government partnership opportunities. This does not include any potential opportunities that come as a part of the $42,000,000,000 BEAT program, which is still too early to project. However, we are working with the state broadband offices on their respective plans and believe that the B partnership opportunities across our footprints are quite significant. As a reminder, we've been awarded roughly $160,000,000 of broadband partnership and grant funding since 2019 across our markets. The positive reputation that we've earned from our previous success with public private partnership and grant awards positions us well to pursue additional funding.

Speaker 2

Given the uncertainty with the timing of awards under the BEAT process and the cost efficiencies which come with building complete markets, we are currently evaluating the pace of the next few years and are no longer projecting to be complete in 2026. We will continue to be diligent and nimble in our order to pursue government partnership opportunities with a focus of balancing the number of passings and cost efficiencies of our build. Let's move to Slide 9. During our previous call, we outlined a comprehensive strategy to increase our fiber penetration. We executed well on this strategy as evidenced by our record fiber net add activity in the quarter.

Speaker 2

Our upward trajectory is fueled by the enhancements we've made to our go to market strategy and our re rally efforts with Fitrium Fiber highlighting its superior value proposition. Additionally, we've continued to add consumer sales partners and door to door reps, which are now up 6 times since year end. We continue to see more upside with sales channels optimization as we scale our door to door and agent resources. Additionally, we've increased our weekend install capacity and call center sales ability to meet demand and better serve our customers. With these changes, we are well positioned to continue to grow our FIDIUM Fiber Services.

Speaker 2

Turning to our fiber cohort penetrations, We are seeing particularly strong performance across our newer cohorts in 2023. Our Q1, 2023 cohorts had a penetration of 12.2% in its 1st full quarter. In our Q2 2023 card, we have already achieved a penetration of nearly 9%. Our new rally plan led by the team now in place is working. Our cumulative Q2 2021 cohort is at 21.5% at the 2 year mark, while our Q22222 cohort at the 1 year mark is at 13.4%.

Speaker 2

Although these older cohorts are slightly below our targets, our re rally efforts are yielding positive results. For example, where we've conducted re rally activities we've generated double digit sequential increases in fiber net adds. In the second half of the year, we will strategically accelerate or rerally efforts across additional older cohorts. Turning to our commercial and carrier channels. With nearly 59,000 fiber route miles and over 14,700 on net buildings, we believe we are the leading fiber based provider in the markets we serve.

Speaker 2

Our deep breadth of services, including fiber broadband connectivity and cloud based services allows us to deliver differentiated solutions to a wide range of customers. During the first half of the year, we've been executing on our strategy to simplify product offerings, enhance our go to market coverage and improve our speed to market to capture more businesses, both on net and near net. And pleased with our progress. Within Commercial Data Services, we're focused on driving growth for our core fiber product offerings of dedicated Internet access and Ethernet connectivity. With success in the fiber connectivity business, we expect to expand and grow our cloud voice security and SD WAN offerings in our enterprise markets.

Speaker 2

We are also ramping sales of our fiber Internet connectivity products, leveraging our symmetrical fiber network for small and medium businesses. These products include fit in at work, which we introduced last quarter for small businesses and Fiber Connect, which serves larger SMBs. Within SMB, installs of our fiber Internet connectivity products are up nearly 2x year over year. We continue to make investments to increase our core network capacity, which benefits all three customer revenue channels. We will continue to leverage new fiber passings within our consumer routes, which provide us with opportunities to use the same fiber to grow both carrier and commercial data and transport services.

Speaker 2

And we are focused on enhancing the visibility of our network in commonly used industry tools and databases, which allow nationwide carriers, channel partners and customers to more easily identify the robust services consolidated and provide as well as the span of our lit buildings and fiber footprint. We increased our on net buildings by 4% in the second quarter after normalizing for Kansas, which correlates to higher margins, increased opportunity to upsell, a greater ability to ensure the best customer experience and or opportunities for additional connections. In summary, I am pleased with our continued momentum during the quarter. Our team is working with an unrelenting focus on driving fiber growth across the business while simultaneously taking aggressive actions to improve our margins. Now I'd like to address the industry wide matter regarding lead sheet cable.

Speaker 2

First of all, we take the health and safety of our workers, the communities in which we live and operate very seriously. Based on the most current information we have, we estimate less than 1% of the company's 100,000 mile copper network contains cable with lead sheathing. In In fact, we have not installed lead sheath cables for more than 50 years. We operate in rural and smaller communities where infrastructure deployment historically happened at later dates. Thus many of our areas never had lead cable utilized.

Speaker 2

We have a history of and will continue following all applicable local state and Federal Environmental Laws and Safety Regulations. We will continue to follow the science and work collaboratively with regulators, Industry and Our Trade Association to engage in constructive conversations on this topic. I will now turn the call over to Fred, who will provide more insights on our Q2 financial results. Greg?

Speaker 3

Thanks, Bob, and good morning. I am pleased with the continued momentum we are seen in the Consumer Fiber business. As Bob mentioned, we have taken aggressive steps to simplify our business, achieve efficiencies and lower our cost structure, which will support higher margins in the future. Further, our agreement to sell our Washington State assets for gross proceeds of $73,000,000 reflects the company's continued focus on its fiber expansion plans in its core regions. For further context, the Washington assets include Consolidated's incumbent networks in Ellensburg and Yelm and revenue of approximately $21,000,000 in 2022.

Speaker 3

We expect the transaction to close in the second half of twenty twenty four and intend to use the proceeds to bolster our liquidity and fund additional fiber expansion. Now I'll move to our operating results. Total operating revenue for the or 3% versus the prior year as normalized for last year's Kansas divestiture. Approximately 75% of the decline or $6,400,000 was driven by lower overall voice revenue across the business. The remaining decline was driven by lower video, network access and other products and services revenue, which was down mainly due to reduced recognition of public private partnership construction projects a year ago.

Speaker 3

We continue to see strong growth in the consumer broadband business driven by our Fidium fiber product, which offset some of the declines previously mentioned. Continued progress in our consumer fiber business is a key driver to achieve overall revenue in 2024. As discussed on prior calls, we expect a decline in full year 2023 EBITDA, principally due to sales of certain non strategic assets and lower legacy revenue. The decline in reported adjusted EBITDA of $31,000,000 for the quarter included $16,000,000 for non strategic asset divestitures $10,000,000 related to declines in the areas of voice, video and access revenue $5,000,000 including higher marketing and advertising costs. Now I'll review revenue by customer channel.

Speaker 3

All of these revenue comparisons will be against normalized Q2 2022 results. In our consumer channel, total revenue was $112,100,000 down 1.3% compared to a year ago. Consumer broadband revenue was $71,300,000 up 8.4 percent with strong fiber revenue growth of 58%. Consumer fiber net adds were up 93% from a year ago as the adoption of Fidium Fiber accelerates. For the quarter, we delivered record broadband fiber net adds of 18,651.

Speaker 3

With our fiber coverage now at 43%, we are clearly executing on our fiber expansion plan. Consumer fiber ARPU was $68.29 in the 2nd quarter, up 5.1% year over year and 1.2% sequentially due to speed mix as customers continue to take higher speeds of our fiber services. Our gig plus speed mix is up 15 percentage points on a year over year basis. Included in that mix is a growing interest in our 2 gig product. Consumer voice revenue was $31,400,000 Down $4,800,000 or 13.2 percent largely due to continued erosion of access lines.

Speaker 3

Video revenue was $9,400,000 a decline of $2,300,000 or 19.7 percent year over year as we continue to deemphasize our linear video. The transition from video is also driving a reduction in video programming costs, thus improving margins. Commercial revenue was $95,800,000 down $2,600,000 or 2.6 percent. Data services revenue was $53,200,000 up 0.5 segment year over year. Growth areas in this channel continue to be dedicated Internet access, up 16% and SD WAN, which is up 36%.

Speaker 3

Voice services revenue was $32,200,000 down $2,200,000 or 6.4 percent in the recent quarter, primarily due to a decline in access lines as commercial customers are increasingly choosing alternative technologies. Other revenue within commercial was $10,400,000 down $1,200,000 or 3.2 percent versus the prior year. Carrier data and transport services revenue was $31,200,000 down $1,700,000 5.1% from last year. In the Q2, our carrier transport revenue declines reflect the impact of churn and pricing step downs in the fiber to the tower business as discussed on prior calls. For the full year of 2023, including the timing of churn and pricing step downs, We now expect a revenue reduction of between $5,000,000 $10,000,000 for the year.

Speaker 3

Once we are beyond the large fiber to tower renewals, we believe we have an opportunity to grow our Carrier business through capacity upgrades for our wireless and wholesale customers, adding new tower connections and expanding sales focus to include a broader set of wholesale customer targets. Wireless tower connections under contract totaled 3,864, down 4% versus last year, reflective of the aforementioned churn. Network access revenues totaled $22,700,000 down $1,700,000 or 6.8 percent, primarily due to declines in special access circuit revenue as carriers moved from TDM to Ethernet based transport solutions. The decline was partially offset by an increase in end user access revenue due to an increase in the state and federal USF factors. As a reminder, the USF revenues are a pass through.

Speaker 3

Cost of services and products expense declined $8,900,000 against prior year GAAP results due to savings from lower video programming costs, including the impact of the sale of our Kansas operations and the decline in access costs related to prior year PPP. These costs were partly offset by an increase in required contributions to the federal and state universal service funds. Utility and fuel costs also increased in the current year. Selling, general and administrative expenses increased $8,100,000 versus GAAP results last and included higher marketing and advertising expenses to drive growth and additional costs related to professional fees for customer service and process improvement initiatives for our fiber broadband products. In addition, employee labor costs increased from the prior year due to additional sales resources.

Speaker 3

These increases were partially offset by a decline in property and real estate taxes in the quarter. Net interest expense was $36,900,000 an increase of 6 point $7,000,000 compared to a year ago. The increase was a result of higher interest on the term loan. Now turning to capital expenditures. Committed capital expenditures totaled $164,000,000 for the 2nd quarter.

Speaker 3

Including in our CapEx spend was $50,000,000 of build CapEx for passings constructed and released $9,000,000 of build CapEx for construction and process $7,000,000 of core CapEx, which supports all of our business lines and is not included in our cost per passing $17,000,000 related to an increase in our construction and CPE inventory $50,000,000 of success based capital for our consumer and commercial businesses. The split between success based capital is approximately 60% consumersmb and 40% business and carrier. Please note that consumer success based capital relates to both fiber and copper installs, includes capital related to other consumer offerings and includes a modest approximately 10% allocation for indirect costs. Finally, the 2nd quarter and digital transformation. For the quarter, our obligatory capital was elevated in part due to seasonal infrastructure projects, which drive incremental plant costs such as road moves.

Speaker 3

We continue to maintain considerable build CP inventory on hand due to previously committed inventory purchases. Such purchases were highly weighted towards the first half of the year and are expected to benefit us in future quarters. As of June 30, we maintained sufficient inventory to execute on a significant portion of our customer growth and build plans for 2023 2024. For our build, our average cost to pass in Q2 was per passing to be approximately $7.80 and our life to date cost per passing to be $6.60 We continue to target an average direct cost to connect in the $7.50 to $800 range. We experienced higher than anticipated over to reduce the cost per install, including rigorous review of installation metrics, monitoring the use of wireless extenders and improving our process for drops.

Speaker 3

Moving to our capital structure. The company recently entered into a new 3 year interest rate swap agreement for $500,000,000 of its term loan debt, commencing upon the termination of its previous swap agreement. Including the new swap agreement, the company has 77% of its total debt at a fixed rate through September of 2026. Further, our $1,100,000,000 of senior notes have fixed coupons. Our overall average cost of debt is 6.72 percent, up from 6.61% in the 1st quarter.

Speaker 3

We maintain cash and short term investments of approximately $203,000,000 with $215,000,000 of available borrowing capacity on our revolving credit facility, subject to certain covenant ratios. Our net debt leverage was 5.55 turns at June 30. Now I'll comment on our 2023 outlook. We have no changes to our previous ranges for adjusted EBITDA, cash interest expense and cash taxes. With regard to adjusted EBITDA, our outlook reflects an improved second half of the year as consumer fiber revenue grows combined with the impact of previously mentioned cost savings measures taking effect.

Speaker 3

We are now updating our outlook for capital expenditures, which are now expected to approximate $495,000,000 largely due to higher expected year end inventory balance than reflected in our prior guidance. This inventory is expected to benefit our 2024 capital outlook and is utilized for customer acquisition and build activities. For 2023, our capital allocations are approximately 37% supporting the fiber build, 37% supporting success based opportunities and 26% for obligatory digital transformation initiatives and inventory growth. For Success Based Capital, the split is estimated to be 60% for ConsumerSMB Fiber and 40% for Commercial and Carrier. Now I'll turn the call back to Bob.

Speaker 2

Thank you, Fred. I'll briefly comment on the take private proposal from Searchlight Capital and British Columbia Investment management that we received on April 13. A special committee consisting of independent directors of the Board is discussing the proposal with the bidders. We are unable to comment any further at this time as the process is ongoing and there could be no guarantee as to the outcome of such discussions. Finally, I'd like to reiterate our transformation to a fiber first broadband company is as strong as ever, and I'm pleased with the significant progress being made on many fronts.

Speaker 2

In addition to driving fiber sales across all three of our revenue channels, we're taking meaningful actions to focus the company on our core markets, simplify the business and remove costs. Accordingly, we'll continue to execute against our strategic priorities for the year, including increasing fiber penetration across our 3 customer groups, delivering an improved customer experience as demonstrated by higher NPS scores and driving operational efficiencies. With consumer broadband fiber net adds of nearly 7,300 in July. We're looking to continue our momentum in the Q3. Operator, we will now take questions at this time.

Operator

Thank you. Your first question comes from the line of Michael Rollins of Citi. Your line is open.

Speaker 4

Thanks and good morning. Just a few follow ups, if I could. First, I appreciate that you mentioned you're not able to discuss the process of review that you're doing with the letter that you received from Searchlight. But can you just provide maybe an update on just timing or background about how that type of review may or may not be affecting other decisions that the company may need to make, whether it's from an operating perspective or a strategic perspective.

Speaker 2

Mike, good morning. It's Bob. I appreciate the curiosity, but I really can't. It's a matter that the special committee and Searchlight deal with. I'm fortunate that I'm recused from that because I'm focused on the long term sustainability of the business.

Speaker 2

And so with having achieved over 43% addressable fiber space. We've got a really great platform to sell into. And so I'm focused Operating within the things I can control and have access to.

Speaker 4

And maybe just Following up on that, as you look at the program that you're going to employ in the back half of the year to improve cost. Can you talk about what you're doing with some of those initiatives? And as you look to grow revenue from these fiber investments over the next number of years, How should investors think about the operating leverage associated with that revenue growth in terms of how much of that revenue can fall to the EBITDA line?

Speaker 3

Yes. Go ahead, Fred. Yes. So first, talking about a little more context on the costs that that we referred to that were taken out of the business. Keep in mind that we divested some non core assets over the last few years.

Speaker 3

So this is A big part of this was just rightsizing the cost base for some of those divestitures in prior years. So we were In some cases, we have transition services agreements that we had to support the businesses. We're largely beyond those things at this point. So from the perspective of the respective of the cost takeouts, it was just time. With respect to the ongoing leverage of the business, I will say that fiber is a very high margin product on an incremental basis.

Speaker 3

So as we think about driving revenue, fiber revenue in the future, A very large portion of that will drop to the bottom line and drive improved EBITDA margins.

Speaker 4

Thanks.

Operator

There are no further questions at this time. I would like to turn the call back over to Mr. Bob Udell.

Speaker 2

Thank you, Sarah, and appreciate the opportunity to report out to you. It's a very exciting time For our business with the consumer revenue now positive, an inflection point that we expected this time of the year on our way in this year on our way headed to full revenue positive in 2024. These inflection points are consistent with our plan and have us very excited as we move into the second half of twenty twenty three. So thank you all for tuning in today and I look forward to updating you on our next call. Have a great day.

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Earnings Conference Call
Consolidated Communications Q2 2023
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