Frontier Reports in Line 3Q

Frontier Communications ( FTR - Analyst Report ) , a provider of telecommunication services to rural areas, reported third quarter 2012 adjusted earnings per share of 7 cents, in line with the Zacks Consensus Estimate. Adjusted earnings increased 40% from 5 cents earned in the year-ago quarter.

Adjusted earnings for the quarter excluded the impacts of severance costs of $6.8 million, integration costs of $4.5 million and losses on the early debt retirement of $0.2 million and impact of reversal of uncertain tax positions of $7.8 million.

Revenues

Revenue of $1,252.5 million surpassed the Zacks Consensus Estimate of $1,238.0 million but dropped 3% from $1,290.9 million in the year-ago quarter. The decline was due to lower residential and business customers and switched access revenues.

On a year-over-year basis, local and long-distance services revenues dropped 8.1% to $556.4 million, while data and Internet services revenues grew 0.7% to $461.2 million. Other revenues registered an improvement of 19.6% to $94.9 million.

Operating Income & Expenses

Operating income in the third quarter increased 52.6% year over year to $275.2 million, driven by lower depreciation and amortization, integration costs and network access expenses. Operating margin improved 800 basis points to 22%. Operating expenses decreased 12.0% year over year to $977.3 million.

Customer Trends

Frontier exited the quarter with 4.9 million total access lines, down 8% year over year from 5.4 million lines in the year-ago quarter. Residential and business segments registered year-over-year decreases of 9.5% and 5.5%, respectively.

Frontier added approximately 983 broadband customers in the third quarter to reach 1,782,278 (up 1.7% year over year). The company lost 179,897 video customers, bringing the total number of customers to 388,257 (plunged 30.2% year over year). The steep decline was due to the loss of 203,100 DirecTV subscribers in the reported quarter as Frontier discontinued DirecTV services from its bundled packages.

Liquidity

Frontier exited the quarter with $1,099.5 million of cash and cash equivalents compared with $326.1 million at year-end 2011. Long-term debt increased to $8.5 billion at the end of the third quarter from $8.2 billion at the end of 2011. Free cash flow was $215.3 million compared to $267.5 million in the year-ago quarter.

Dividend

The company paid a total of $99.8 million in dividend in the third quarter, being equal to a dividend payout of 46% of free cash flow compared with dividend payments of $186.6 million, which was equal to a dividend payout of 70% in the year-ago quarter.

Guidance

For fiscal 2012, the company maintained its estimates on capital expenditures and free cash flow, excluding integration expenses and integration capital expenditures, in the bands of $750-$775 million and $0.9–$1 billion, respectively.

The company expects operating expenses and capital expenditures on integration activities of approximately $80 million and $50 million, respectively.

The company also incorporated guidance for 2013, which includes capital expenditure estimates in the range of $625 - $675 million. It also expects cash taxes expense in the range of $125-$150 million.

Outlook

Frontier focuses on generating new revenues through customer retention, customer wins, new product deployments, tiered pricing, broadband expansion, and profitability and cash flow management through reductions in operating expenses and capital expenditures. In addition, the reduction of access line losses would boost Frontier’s profitability and provide cost synergies going forward.

However, intense competition from the company's peers like Windstream Corporation ( WIN - Analyst Report ) , a highly leveraged balance sheet, regulatory pressure as well as integration risks in converting the acquired properties into its own system might limit the earnings potential in the upcoming quarters.

Consequently, we maintain our long-term Neutral recommendation supported by a Zacks #3 Rank (short-term Hold).