Shenandoah Telecommunications Co (SHEN) 2011 Q3 法說會逐字稿

Good morning, everyone and welcome to Shenandoah Telecommunications' third quarter of 2011 earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference over to Ms. Adele Skolits, CFO. Please go ahead, ma'am.

Good morning and thank you for joining us. The purpose of today's call is to review Shentel's results for the quarter ended September 30, 2011. Our results were announced in a press release distributed this morning and the presentation we will be reviewing is included on our website at www.Shentel.com. Please note that a replay of the call will be made available later today. The details were set forth in the press release announcing this call.

With us on the call today are Christopher French, our President and Chief Executive Officer; Earle MacKenzie, our Executive Vice President and Chief Operating Officer and Willie Pirtle, our Vice President of Sales and Marketing. Willie will be reviewing our operating results in our prepared remarks, while Earle, who is a bit under the weather, saves his voice for the Q&A. After our prepared remarks, we will conduct a question-and-answer session.

I will begin with slide 2 of the presentation. While we don't provide guidance with respect to specific future financial results, we caution that this call may contain forward-looking statements, which involve a number of known and unknown risks and uncertainties. These may cause our actual results to differ materially from these statements. Shentel provides a detailed discussion of various risk factors in our SEC filings, which you are strongly encouraged to review. You are cautioned not to place undue reliance on these forward-looking statements. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statement.

Also, in an effort to provide useful information to investors, we note on slide 3 that our comments today include non-GAAP financial measures. Details on these measures, including why we use them and reconciliations to the most comparable GAAP measures, are included in our SEC filings. I will turn the call over to Chris now.

Thank you, Adele. We appreciate everyone joining us this morning. Highlights for this quarter were again led by our Wireless segment and we continued moving forward with our upgrade projects and our acquired cable properties. Slide 5 lists the highlights of the results in our Wireless segment. We again had positive net wireless additions in both our postpaid and prepaid services with the number of total customers up 3% in this quarter and up 13% over the year-end 2010 number.

Prepaid contributed nearly 72% of the net customer growth, adding nearly 7000 net customers this quarter. Since we began offering prepaid in June of 2010, we have added over 48,000 net customers. We also had solid growth in postpaid adding over 2700 net customers. Operating income in our Wireless segment increased by $3.7 million, a 40% increase over third quarter 2010.

Specific Cable segment highlights are shown on slide 6. The total number of revenue-generating units rose to 136,000 at September 30. This segment had gains in all three offerings of video, high-speed Internet and voice. Major upgrades in the markets we acquired from JetBroadband began in April of this year and continued in the third quarter. We have now completed upgrades to approximately 25% of the homes passed by these systems and we will continue with upgrades the rest of this year and into 2012.

Financial results on a consolidated basis shown on slide 7 are still being negatively impacted by the significant costs associated with depreciation and amortization on the acquired businesses. We are reporting net income of $3 million for the quarter compared to $4 million from the third quarter of 2010.

Despite the impact to current earnings, we continue to believe our cable acquisitions and our entry into prepaid will result in long-term growth of shareholder value. Since the end of the quarter, our Board of Directors have declared a cash dividend of $0.33 per share, which will be paid on December 1. This is our 52nd consecutive year of paying an annual dividend.

We have been having productive discussions with Sprint Nextel regarding our participation in their network modernization plan known as Network Vision. We have made good progress towards a mutually beneficial arrangement and expect to be able to make an appropriate announcement prior to the end of the year.

Finally, the Company recently executed two asset purchase agreements to sell certain Converged Services properties to two buyers for a total of $4.7 million. The Company just closed on the sale of some of these properties and is receiving $2.2 million up front with two additional closings expected in the next 60 to 90 days following receipt of consents necessary for the transfer of the properties.

Since the sale price approximated the net carrying value on these properties, we do not expect to record a gain or loss. The Company continues to negotiate with purchasers on the remaining Converged Services properties. I will now turn the call back to Adele to review the details of our financial results.

Thank you, Chris. I will begin on slide 9. Adjusted operating income before depreciation and amortization or OIBDA for Q3 '11 was $22.2 million or up $1.1 million from Q3 '10. In order to better understand the forces driving this change, I have provided the OIBDA results by segment on slide 10.

Here, you get a picture of how the segment's results are contributing to the consolidated financial results. In a moment, I will go into the segment's OIBDA changes in depth. What you see from this table is that adjusted Wireless OIBDA has increased. We are now generating more in revenues from existing prepaid customers than we are spending to acquire new customers.

In the Cable segment the impact of the incremental OIBDA from the JetBroadband acquisition is being offset by incremental expenses for customer acquisition, network and programming as we will see in greater detail in a moment. The Wireline segment's adjusted OIBDA increased slightly.

On slide 11, I have analyzed the changes in the Wireless OIBDA results between Q3 '10 and Q3 '11. Postpaid revenues continue to grow as a result of the continued steady growth in its customer base. The prepaid business is now making a meaningful contribution to our results with $3.5 million in new revenue related to prepaid customers.

These incremental revenues were $2 million above the incremental cost to acquire the new customers of $1.1 million and the costs to support existing customers of $600,000. We will go into greater depth on this significant milestone on the next slide.

The 6% growth in postpaid customers since Q3 '10 and the impact of the $10 smartphone fees we began charging in January 2011 resulted in a $2.3 million uplift in postpaid service fees. The decrease in lease revenue resulted primarily from a one-time adjustment in 2010 to reflect longer lease terms on certain leases. The growth in postpaid customers resulted in $500,000 in incremental customer acquisition costs, including a higher handset subsidy for new and existing customers related to smartphones and 4G devices.

We continue to enhance our network to handle the increasing customer base and the increased data traffic. As a result, network costs increased by $800,000 in Q3 '11. The growth in data traffic associated with smartphones will continue to drive increased operating and capital spending.

We have spoken for the past year about how the investment in the startup of prepaid has depressed our Wireless financial results. Slide 12 provides you a visual of the impact over the five quarters we have been selling prepaid service. The top of the bar is the total prepaid revenue in the quarter. The sections of the bar show the various costs related to prepaid and the bottom of the bar is the net contribution of prepaid to the Wireless segment's results. You see that we have turned a corner in the third quarter and the current revenue is sufficient to cover all of the current marketing and operating costs and the amortization of the costs to acquire the initial 50,000 Virgin Mobile customers. We expect that trend will continue to be positive in net contribution going forward, but the amount will be a function of the gross adds in the quarter.

Let me take a moment to comment on each section of the bar starting at the bottom. The rust colored part of the bar represents the amortization over 48 months of the initial $6.9 million we paid for the 50,000 Virgin Mobile customers we purchased from Sprint in July 2010. The blue represents the cost to acquire new customers. The orange is the cost of maintaining existing customers. And finally, the green is the 6% management fee we pay to Sprint for the use of the spectrum and national brand.

On slide 13, I have shown the components of the changes to adjusted Cable OIBDA, which decreased by $1.2 million in Q3 '11 over Q3 '10. As you can see in the first four bars, revenues have grown by $5.2 million. The Q3 '10 results included two months of revenues from JetBroadband customers acquired July 30, 2010. An additional month of revenues contributed over $3.3 million to the growth in revenues in Q3 '11. The remainder relates to a 13% growth in RGUs since the third quarter of 2010.

As with Wireless, the growth in customers comes with an immediate cost related to acquiring customers. This incremental cost was $1.5 million in Q3 '11 over Q3 '10. The increase in video customers resulted in an increase of $1.6 million in programming costs in Q3 '11 over Q3 '10. In addition, the improvements in the network and increase in broadband customers and the addition of JetBroadband resulted in a $2.2 million increase in network and backhaul expenses.

Slide 14 shows the forces driving the $300,000 increase in Wireline OIBDA. Success in selling fiber capacity resulted in a $1 million increase in facility revenues. The sale of the directory business last fall resulted in a $500,000 drop in net directory revenues. At this time, I will turn the call over to Willie to go into greater depth on some of the operating factors driving our results.

Thank you, Adele. Slide 16 shows the continued positive trend we have experienced in our postpaid wireless net adds. We are proud that we have had positive growth in every quarter since becoming a Sprint affiliate in 1999. We ended the quarter with 243,548 postpaid customers, a nearly 6% increase in the past 12 months.

On slide 17, in Q3 -- as shown on slide 17, in Q3 2011, we had 2,686 net postpaid adds on 16,126 gross adds compared to 3,175 net adds on 16,716 gross adds in Q3 2010. Our churn rate is up slightly from Q2 2011, but lower than the same quarter last year. We continue to manage the mix between Shentel locally controlled channels and the national channels with between 50% and 55% under Shentel control.

We continue to see the recent trend of increasing gross postpaid build revenue per user on slide 18. The average has increased $1.97 per user in the past year to a total of $57.46. The increase is driven by data usage that has grown by $4.42 per user in the past year to $26. Total revenue per user has grown by $0.40 in the past quarter and data revenue grew by $1.06. The biggest contributor to the increase in data revenue and total revenue per user is the additional $10 Sprint started to charge on all smartphones sold starting in January of this year.

Slide 19 provides you the details in reconciling between our gross postpaid build revenue and the net postpaid service revenue. Q3 2011 gross build revenue was up nearly 10% year-over-year to $41.8 million. We had a small uptick in bad debt and credits resulting in an increase in net revenue of $2.2 million, up over 8%.

Slide 20 shows the same three price plans continue to dominate our postpaid gross adds, growing to 76% of all gross adds, up from 75% in the past quarter. We currently offer 4G coverage only in Harrisburg and York, PA area of our footprint. Despite this, for the first time, a 4G phone was the bestseller. Customers are buying the phone for the features rather than 4G coverage.

We continue to see the majority of new sales and upgrades buying smartphones. At September 30, 48% of our postpaid base had a smartphone, up from 43.5% at the end of the second quarter and 28% a year ago at the end of third quarter 2010.

I will say a few words on the iPhone launch from a few weeks ago. To date, we have only had iPhone 4 in our stores, but we have been able to get customers iPhone 4s devices over the Sprint website. For the period through November 3, we have sold 2,489 iPhones in our area, split 50/50 between the 4 and the 4s with approximately two-thirds going to upgrades and one-third going to new activations.

Moving to our prepaid wireless subscribers on slide 21, we continue to have strong growth, ending the quarter with 98,272 total prepaid customers, an increase of over 42,000 in the past year. For the quarter, we have had 19,545 gross prepaid adds and 6,940 net prepaid additions.

On slide 22, you will see we had our best churn percentage since entering prepaid with prepaid churn dropping to 4.4% in Q3, down from 4.6% in Q2. We continue to see an increase in average gross build revenue per user as Boost customers grow as a percentage of our total base.

The third-quarter Cable results on slide 23 show growth in video, high-speed Internet and voice. As you will recall, the second quarter was impacted by the loss of college students for the summer, but they did return in Q3. Total RGUs grew by 4,745 with the strongest growth in high-speed Internet.

During this quarter, we completed the migration of thousands of former Jet voice customers from a third party to our own switch. This will decrease the monthly costs for these voice users by about $5 per month.

At September 30, we had 75,131 customers. We tracked the number that do and do not purchase video from us. Approximately 9,000 of our customers do not purchase a video product from Shentel. We see that number growing as we continue to target satellite customers that might want to stay with their current video option, but are not happy with their data and voice choices from the local telephone company.

Slide 24 provides further detail on our customer base with number of homes passed where we can offer the service, the number of users and the penetration of applicable homes passed. You can see the growth in digital video as we continue to upgrade our systems and offer more robust programming, including expanded HD channels. We expect over the next few years to grow our high-speed Internet and phone penetration to comparable national averages. With the limitations of DSL and upward pressure on regulated telephone rates, we believe that ultimately we can achieve penetration rates higher than the national averages.

Our Wireline results on slide 25 remain consistent. We continue to have access line losses of about 2% per year. Although slowed, we continue to have growth in DSL customers with DSL penetration at 53% of access lines. Total connections, that is the total of access lines and DSL users, remained relatively constant at 35,500.

My final slide, number 26, is a current view of our 2011 CapEx spending compared to the past two years. We have lowered the expected spend in 2011 to $77.6 million from the $84.9 million we projected at the end of the second quarter. Approximately $1.4 million of the difference will be carried forward into 2012.

As of September 30, we had completed 25% of the Jet system upgrades, but we have had a lot of effort underway in Q4 and should end the year with 52% of the Jet Virginia and 48% of the Jet West Virginia systems completely upgraded. This is a change from what we projected at the end of Q2. At that time, we expected to have all of Virginia and none of the West Virginia systems upgraded. Changes in availability of resources changed our plans, but we should have all of Virginia complete by the end of Q1 2012 with West Virginia and Maryland later in 2012. Much of the construction left in West Virginia and Maryland will be impacted by the expected winter weather. I will now turn it back Adele.

This concludes our prepared remarks. Earle MacKenzie will now be joining us for Q&A. Huey, would you please review the instructions for posing a question?

(Operator Instructions). Ric Prentiss, Raymond James.

Thanks, good morning. A couple questions. One on the iPhone. So I think I heard 2,489 was the number I was writing down quickly there. So that was from the launch date to last week. I am just trying to figure out what timeframe did that cover?

Launch through November 3.

November 3. On sales there, as you think about the two-thirds upgrade, one-third new, are these people upgrading from an existing smartphone or are these people moving for the first time to a smartphone? Just trying to think through what the revenue impact might be.

Ric, this is Earle. The vast majority are moving from a smartphone to an iPhone, so they already had an Android.

Okay, okay. And have you seen any network pressuring from the iPhone coming on the network? I notice you've mentioned on your CapEx slide increased [EVGO] spending.

No, actually we have a very small base of iPhones, but we are actually seeing that the average iPhone user is using less than our average Android user today. That may change as we get a bigger base. So we really haven't seen any real impact on our network.

Okay. And then when you think about the CapEx change, is this to help the reduction of the CapEx for 2011 or is this to help fund kind of the iPhone margin pressure or prepare for principal repayments? Just trying to think through as you guys are looking at your CapEx budget versus your margins and your debt repayments.

No, this was some success-based CapEx that we decided we really didn't need to do this year and also a few cell sites that we were going to upgrade and install this year we postponed pending a final decision on Network Vision.

Good. I will come back in for some questions later.

Barry Sine, Drexel Hamilton.

Thank you, good morning. I want to ask an additional question on the iPhone if I could. I understood you said you don't have the 4s in stores. Do you have that in stores now and if not, what is the visibility on having 4s and how important do you think that is to your sales? Would you have done much better if you had the 4s versus just the 4?

This is Earle. We have no visibility on exactly when we will be able to get a 4s, but we have been able to get 4s'es over the Sprint website for the customer within a couple of days. So I am not sure it has had a significant impact on our sales.

And next question in terms of the cable upgrades, could you give us a little more visibility where you are in the process, what you still need to do and what was the cause of some of the delays and the changes in timing?

As far as -- each system is different. Some of them require only upgrades in the electronics with a very small amount of outside plant work. Other require a lot of outside plant work along with that. We are using a number of contractors. So as far as changing around what we have been working on, it has really been the availability of contractors as much as anything. So we are still on target to get the entire project done on time. It is just different -- specific systems have moved forward or backward based on the availability of subs.

Okay, and my last question, I wondered if you could discuss, at least in broad terms, the 2012 capital spending outlook, at least in general terms directionally both on Wireless and Cable. I am assuming Cable spending comes down as the upgrades are completed. Wireless, especially as you look out to Network Vision, there may be some upward movement in Wireless capital spending.

You are correct on both counts. We should be finished our cable upgrades around the middle of next year. It could be pushed out a little bit depending on how severe a winter we have in West Virginia and Maryland. On the Wireless, the big impact will be Network Vision. As Chris mentioned, we have been under discussions or in discussions with Sprint for the last several months about modifying our contract in order to be able to do Network Vision and assuming that everything moves as we anticipate, we should be able to get started next year on that Network Vision upgrade. And we anticipate that the range of the project will be somewhere in the $100 million to $120 million to do Network Vision in our footprint.

Okay, thank you.

Greg Burns, Sidoti.

Good morning. Thanks for taking the questions. In terms of the cost savings on moving your cable voice customers onto your own switch, how much in annual savings are you expecting from that and did we see any of that impact in this quarter or is it going to all show up in the next quarter?

The impact is all to be shown because we didn't convert the customers over until right at the end of the third quarter and that was kind of a contract that the full cost was in place until right at the end because you are paying not only for the switch, but also for the facilities to connect to the local telephone network. So going forward, we are anticipating that that will be somewhere in the $600,000 a year savings from that conversion.

And the savings come in the form of lower backhaul expenses, as well as lower fees to the third party who had been supporting that.

Okay. And in terms of I guess the cable upgrades and upgrading the fiber backbone, will we start to see some benefits from that on the OpEx side also as we move through 2012?

Yes, because, in 2011, we have some duplicate expenses where you had facilities that Jet had in place that we needed to turn down while we were bringing up our own facilities. So there will be some economies showing up in the 2012 results.

Okay. And then in terms of funding for the Network Vision upgrade, do you think that could be handled internally and do you look at your tower business as a strategic asset and is that potentially something that you could look to monetize to fund the upgrade?

We are still working through the timing of the spend for Network Vision. Because it may very well be timed to coincide with the completion of the CapEx spending for our cable upgrades, we may not need as much as the full amount to be funded externally. We have a revolver in place now in our current credit facility of $50 million. We also have an accordion feature in the existing debt facility, which could be helpful in funding this effort. We also have a financing arrangement that can very easily be refinanced should that need to occur, but we are still working through the details of all of that.

With respect to the towers, Chris, would you like to --?

Yes, Greg, I guess we view that tower portfolio as currently an important part of our business, but recognize that if needed that is something we could look to. I guess our feeling at this point is that would not be necessary, but it is I guess a fallback if things don't go as planned.

Okay. And lastly, Adele, the tax rate looked a little high in the quarter. If you could just give us a little color on that and then maybe also what part of the interest expense is I guess adjustment versus the swaps?

Very little of the interest expense relates to the swap in this quarter, to answer your second question first. And I'm sorry, Greg, the first part of your question?

Oh, the effective tax rate looked a little higher than normal.

Yes, the effective tax rate is high in this quarter. It is related to making money in two states, Maryland and Pennsylvania, that do not allow us to consolidate our tax returns. So that has a pretty profound effect on things, especially when the revenues in those states are growing appreciably, the net income, taxable income in those states is growing appreciably while the losses in cable are happening in states with lower tax rates where we can consolidate the financial results on the tax return.

Okay. So would you expect that the going-forward rate will be more towards historical levels or where we are at now?

I think in the short run here, we will continue at the relatively high levels that we are seeing for the next quarter or so. And then it should come back down over time as the mix of net income shifts.

Okay, thank you.

Will Lauber, Sterling Capital Management.

I had a question on the iPhones. You said there was about 50% in stores. Is that just your stores or does that include like Best Buy and RadioShack and things like that?

The numbers we gave you includes all the distribution channels, including the third parties and the Web.

Okay. There was 50% online and then 50% in stores and out of that in stores, that includes your stores, as well as other retail outlets?

Yes.

Okay. And if I understand it correctly, if Best Buy sells your phone or if it is done online, that you guys do not pick up the equipment subsidy on that?

The cost of that phone is included in the net service fee.

Okay. All right. That is all I had for now. Thanks.

(Operator Instructions). Ric Prentiss, Raymond James.

Thanks. With the FCC working on the USF solution, can you update us a little bit about the different aspects of your business and how it might be impacted?

We are still evaluating that. As you know, we are an ILEC and have some implications for our ILEC as we shift from the existing USF funding to the Connect America Fund, but we are also a cable entity and so may very well benefit on that side from the new legislation once it is released. But we are still evaluating that at this point.

And on the content cost, how are you guys feeling on content cost, kind of where it is headed, availability to get it?

This is Earle. It is available; it has just become very pricey. We have got a couple of things going on right now. Many of our local broadcast contracts or retransmission expire at the end of this year and so we are in the process of negotiating retransmission agreements as has been in the press. The broadcasters are asking for a significant increase over prior years. One of the things that we are doing is actually we have taken the position that we are starting to break that out on the customer's bill and so the customer can see the amount that he is being charged or we are paying for retransmission fees. We think that will be helpful to educate the customer that free TV is not really free.

As far as other programming, we get the majority of our programming through NCTC and the expiration on those contracts come up almost constantly throughout the year. And so we don't have any big contracts that are pending right now between now and at year-end, but we do see kind of the 6% to 8% increase in programming from many of the channels that we carry for next year.

The biggest concern is that of sports programming. That is really where you are seeing some of the huge increases. As a result, some of these very large contracts that programmers are signing with the various leagues to carry games.

And then Sprint surprised folks back at their Analyst Day in early October accelerating the Vision spend on the CapEx side, accelerating the iDEN customer base migration. As you think through the contract that you haven't signed yet, I realize, with Sprint, does the acceleration of Vision for them imply that you guys would need to spend that $100 million to $120 million Vision cost much quicker than you thought and what kind of negotiating room do you have with Sprint? And then on the flip side, with them getting folks off of iDEN onto CDMA is there any other benefits possibly for you?

Let me answer the second question first. The answer is we think there is some potential benefit on the iDEN customer because Sprint has no other network in our footprint. So we don't have the exact number of iDEN customers in our footprint. That is not something we have been privy to in the past, but we assume and these are part of the discussions we have been having with Sprint that those customers would migrate to Shentel within our footprint.

As far as the speed at which we will spend the money for Network Vision, Sprint has had some headstart on this obviously as far as the planning stage. So for us to exactly match their timeline may be very difficult, but on the other hand, part of Network Vision is having a more robust 4G solution. Obviously, from our standpoint, the quicker we can have that more robust 4G solution the better. So as we are doing our planning, we are going to try to accelerate it as quickly as we can within what is reasonable for being able to finance it and to what is reasonable from being able to actually execute.

So our plan is once we sign this contract with Sprint, which we anticipate will be soon, we will have a special call where we will outline kind of our plans as of that time as far as where we can see us going and what timeline people can anticipate from us.

Makes sense. Thanks, Earle.

There appear to be no further questions. Thank you for participating. Our 10-Q will be filed tomorrow morning. Please let me know if there are additional details you would like to see on future calls. My contact information was provided on the press release.

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect.