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CBB > SEC Filings for CBB > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for CINCINNATI BELL INC

Form 10-K for CINCINNATI BELL INC


27-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Annual Report on Form 10-K and the documents incorporated by reference herein contain forward-looking statements regarding future events and results that are subject to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, are statements that could be deemed forward-looking statements. See "Private Securities Litigation Reform Act of 1995 Safe Harbor Cautionary Statement," for further information on forward-looking statements. Executive Summary
Segment results described in the Executive Summary and Consolidated Results of Operations section are net of intercompany eliminations.

For the year ended December 31, 2013, the Company was a full-service regional provider of entertainment, data and voice communications services over wireline and wireless networks, a provider of managed and professional information technology services, and a reseller of information technology ("IT") and telephony equipment. In addition, enterprise customers across the United States rely on CBTS, a wholly-owned subsidiary, for efficient, scalable communications systems and end-to-end IT solutions.
On January 24, 2013, we completed the IPO of CyrusOne, which owns and operates our former data center colocation business. CyrusOne conducts its data center business through CyrusOne LP, an operating partnership. Although we effectively own approximately 69% of the economic interests of CyrusOne through our ownership of its common stock and partnership units of CyrusOne LP, we no longer control its operations. Effective January 24, 2013, we no longer consolidate the accounts of CyrusOne in our consolidated financial statements, but account for our ownership in CyrusOne as an equity method investment. Due to the change in presentation of CyrusOne, our results of operations and cash flows for the year ended December 31, 2013 are not comparable to prior periods. On a consolidated basis, revenue for the year totaled $1,256.9 million. Excluding the results of our former data center segment, revenue for 2013 totaled $1,241.7 million, down 1% from the prior year. Revenue from our strategic products totaled $358.6 million in 2013, up 17% compared to 2012, and continues to increasingly mitigate the revenue declines from our legacy Wireline products and the loss of revenue from a declining postpaid Wireless subscriber base.
Operating income in 2013 was $163.8 million, down from $270.1 million in the prior year due in part to the deconsolidation of CyrusOne, which accounted for $27.2 million of the decrease. Operating income was also negatively impacted by continued loss of postpaid Wireless subscribers and higher margin access lines, in addition to the $42.6 million of transaction-related compensation paid as a result of the successful IPO of CyrusOne.
During the third quarter of 2013, the Company amended and restated its Corporate Credit Agreement, originally dated as of November 20, 2012, to include a $540 million Tranche B Term Loan that matures on September 10, 2020. Net proceeds of $529.8 million were used to redeem all of the Company's $500 million 8 1/4% Senior Notes due 2017 on October 15, 2013 at a redemption price of 104.125%. Consolidated Results of Operations
2013 Compared to 2012
Service revenue was $1,039.3 million in 2013, a decrease of $233.5 million compared to 2012, primarily due to the deconsolidation of CyrusOne, which accounted for $199.7 million of the decline. Wireless service revenue was down $39.6 million from the prior year as a result of continued postpaid subscriber losses. Wireline service revenue declined by only $2.7 million compared to 2012 as the growth in our strategic products continues to increasingly mitigate the loss from access line, long-distance and DSL subscriber declines. IT Services and Hardware service revenue was up $8.5 million from a year ago due to strong demand from enterprise customers for managed and professional services. Product revenue totaled $217.6 million in 2013, up 8%, compared to 2012. The increase was largely due to a $17.9 million increase in sales of telecommunications and IT hardware. These increases were partially offset by slight declines in both Wireline and Wireless product revenue.


Table of Contents
Form 10-K Part II Cincinnati Bell Inc.

Cost of services was $427.1 million in 2013, compared to $489.9 million in 2012, which included CyrusOne costs of services totaling $73.0 million. Excluding CyrusOne, cost of services increased year-over-year primarily to support the growth in Fioptics and managed and professional services. Wireline cost of services was up $7.5 million compared to the prior year and IT Services and Hardware costs were up $8.9 million. Wireless cost of services was down $10.8 million as a result of a declining subscriber base.
Cost of products sold was $215.9 million in 2013 compared to $204.7 million in the prior year, an increase of $11.2 million due to a $16.9 million increase as a result of higher telecommunications and IT hardware sales. Wireline and Wireless cost of products sold were down $2.6 million and $3.1 million, respectively, compared to the prior year.
Selling, general and administrative ("SG&A") expenses were $220.8 million in 2013, a decrease of $48.7 million, or 18%, compared to 2012. The decrease is partially the result of no longer consolidating CyrusOne, which accounted for $28.5 million of the decrease. Corporate costs were down $20.7 million from the prior year, primarily as a result of recognizing a $5.6 million stock compensation mark-to-market gain in 2013 compared to a $7.9 million stock compensation mark-to-market expense in 2012. The remaining decrease is due to a $4.7 million decrease in bonus expense and a $2.5 million decrease in payroll and other headcount related costs as a result of cost-out initiatives. Wireline and IT Services and Hardware SG&A expenses were up $1.1 and $2.4 million, respectively, primarily to support the growth of our strategic products. Wireless SG&A expenses were down $3.0 million as a result of cost-out initiatives as we focus on operating the segment for cash flow and profitability.
Depreciation and amortization was $169.6 million in 2013, a decrease of $47.8 million compared to the prior year, primarily due to the deconsolidation of CyrusOne. In 2012, CyrusOne's depreciation and amortization expense totaled $70.6 million compared to $5.2 million in 2013. Wireline depreciation and amortization increased by $6.2 million due to the expansion of Fioptics and our fiber-based network. IT Services and Hardware was $1.9 million higher than the prior year as a result of new assets placed in service to support growth in managed and professional service revenue. Wireless depreciation and amortization expense totaled $41.2 million in 2013, up $9.3 million compared to the prior year. In the first quarter of 2013, the useful lives assigned to network software was shortened resulting in $8.5 million of higher depreciation charges. In the fourth quarter of 2013, the remaining useful life for all property, plant and equipment, and finite-lived intangible assets was reduced to 30 months as of December 31, 2013. This change in estimate resulted in additional depreciation and amortization expense of $3.0 million in the fourth quarter and is expected to increase depreciation expense by approximately $36 million in 2014. The useful life change in the fourth quarter of 2013 also resulted in the acceleration of the deferred gain associated with the 2009 tower sale. In 2013, the amortization of the deferred gain associated with the tower sale totaled $3.3 million, compared to approximately $14 million expected to be recognized in 2014.
Restructuring charges were $13.7 million in 2013 compared to $3.4 million in the prior year. In 2013, restructuring charges represented severance associated with employee separations, consulting fees related to a workforce optimization initiatives and lease abandonments. Employee severance costs associated with the Wireline and IT Services segment are related to workforce initiatives associated with the continued integration of the Wireline business market with the IT Services and Hardware segment. Corporate employee severance costs were associated with the consulting fees and cost-out initiatives as a result of our smaller size due to the IPO of CyrusOne. Lease abandonment costs for the Wireline segment totaled $3.9 million as we consolidated office space. The Wireless segment recorded a $0.2 million lease abandonment charge due to the closure of a retail store. In 2012, restructuring costs were incurred for employee separations totaling $2.5 million primarily related to Wireline and Wireless. Lease abandonment charges were $0.9 million in 2012.
In 2010, the Company's Board of Directors approved long-term incentive programs for certain members of management. Payment was contingent upon the completion of a qualifying transaction and attainment of an increase in the equity value of the data center business, as defined in the plans. On January 24, 2013, the initial public offering of CyrusOne was completed, which represented a qualifying transaction requiring payment under these plans. Transaction-related compensation expense of $42.6 million was recognized for these awards at the Corporate level and not allocated to the segments. Payments to CyrusOne employees amounted to $20.0 million of the associated expense.
During the three months ended June 30, 2013, the Company amended the management pension plan to eliminate all future pension service credits effective July 1, 2013. As a result, the Company remeasured its projected benefit obligation for this plan, and the Wireline segment recognized a curtailment gain of $0.6 million in the second quarter of 2013.


Table of Contents
Form 10-K Part II Cincinnati Bell Inc.

The loss on sale or disposal of assets totaled $2.4 million in 2013 compared to a gain on sale or disposal of assets of $1.6 million recorded in 2012. The Wireline segment recorded gains primarily on the sale of copper cabling that was no longer in use totaling $1.1 million and $1.8 million in 2013 and 2012, respectively, and the Corporate segment recorded a loss on sale or disposal of assets of $0.4 million in 2012. In 2013, Wireless recorded a $3.5 million loss on disposal of assets for equipment that had no resale market or has either been disconnected from the wireless network, abandoned or demolished. CyrusOne recorded a $0.2 million gain on the sale of assets in 2012.
There were no asset impairments recorded in 2013 compared to $14.2 million in 2012. In 2012, CyrusOne recorded impairment losses of $13.3 million on a customer relationship intangible asset and property and equipment that was primarily associated with our 2007 acquisition of GramTel. Wireline and Wireless asset impairments were $0.5 million and $0.4 million, respectively, during 2012. Transaction costs of $1.6 million were incurred in 2013, down from $6.3 million incurred in 2012. In 2013, these costs represent expenses incurred for exploring strategic alternatives for our Wireless business and legal and consulting costs associated with the CyrusOne IPO. In 2012, these costs represented legal and consulting costs incurred to restructure our legal entities in preparation for the proposed IPO of the common stock of CyrusOne and to prepare CyrusOne to be a real estate investment trust.
Interest expense was $182.0 million in 2013 compared to $218.9 million in 2012, a decrease of $36.9 million. The deconsolidation of CyrusOne resulted in a $7.0 million decrease and the November 2012 redemptions of the 7% Senior Notes due 2015, certain CBT Notes and a portion of the 8 3/8% Senior Notes due 2020 reduced interest expense by $27.3 million year-over-year. In the fourth quarter of 2013, the Company redeemed all of the $500 million of 8 1/4% Senior Notes due 2017 at a redemption price of 104.125% using proceeds from the $540 million Tranche B Term Loan facility that was issued on September 10, 2013. The refinancing of the 81/4% Senior Notes with the more economical Tranche B Term Loan resulted in $1.8 million additional interest savings in 2013. The remaining difference was primarily due to lower amortization of note issuance costs. The redemption of the 8 1/4% Senior Notes due 2017 in the fourth quarter of 2013 resulted in loss on extinguishment of debt totaling $29.6 million. Redemptions of the 7% Senior Notes due 2015, certain CBT Notes and a portion of the 8 3/8% Senior Notes due 2020 in the fourth quarter of 2012 resulted in a loss on extinguishment of debt totaling $13.6 million.
Loss from CyrusOne equity method investment totaled $10.7 million in 2013 and represents the Company's share of CyrusOne's net loss which, effective with the IPO date of January 24, 2013, is now recorded using the equity method. Other income of $1.3 million in 2013 primarily related to tax refund claims received on assets that had previously been disposed or abandoned. Other expense of $1.7 million recorded in 2012, primarily related to a loss recorded on the termination of a lease financing arrangement.

An income tax benefit of $2.5 million in 2013 was the result of pre-tax losses. The Company has certain non-deductible expenses, including interest on securities originally issued to acquire its broadband business (the "Broadband Securities") or securities that the Company has subsequently issued to refinance the Broadband Securities. In 2013, income tax expense includes a valuation allowance provision of $10.7 million for Texas margin credits which, effective with CyrusOne's IPO on January 24, 2013, are uncertain of being realized before their expiration date. In periods without tax law changes, the Company expects its effective tax rate to exceed statutory rates primarily due to the non-deductible expenses associated with the Broadband Securities. The Company used federal and state net operating losses to defray payment of federal and state tax liabilities. As a result, the Company had cash income tax payments, net of refunds, of $2.8 million in 2013.

2012 Compared to 2011
Service revenue was $1,272.8 million in 2012, an increase of $22.0 million compared to 2011. Data center revenues increased by $32.3 million primarily due to the expansion of data center facilities. IT Services and Hardware revenue increased by $16.1 million compared to 2011 due to the growth in managed and professional services. Wireline service revenue was up $1.5 million over the prior year as a result of accelerated growth in VoIP and audio conferencing services. Growth in Fioptics and other business fiber-based products was more than offset by declines in legacy local voice, long distance and DSL revenue. Wireless service revenues were down $27.9 million as a result of fewer postpaid subscribers.


Table of Contents
Form 10-K Part II Cincinnati Bell Inc.

Product revenue was $201.1 million in 2012, down $10.5 million compared to 2011. The decrease was largely due to lower sales of wireless handsets which drove a $7.9 million decrease in sales compared to 2011. IT Services and Hardware sales of telecommunications and IT hardware decreased $3.4 million compared to the prior year, a reflection of the cyclical nature of capital spending of enterprise customers. These declines were partially offset by a $0.8 million increase in Wireline product revenue.
Cost of services was $489.9 million in 2012, up $25.6 million, or 6%, compared to 2011, primarily due to $14.6 million and $13.3 million increases in the IT Services and Hardware and Data Center Colocation segments, respectively, to support the growth in these operations. Wireline costs were up $9.4 million due primarily to increased programming costs associated with the growth of Fioptics and increased operating taxes resulting from higher regulatory rates and higher franchise taxes. Wireless costs were down $11.7 million primarily due to lower network costs as a result of a declining subscriber base.
Cost of products sold was $204.7 million in 2012, a decrease of $8.3 million from the prior year, primarily due to a $9.3 million decrease in Wireless costs of products sold as a result of lower handset sales. IT Services and Hardware cost of products sold was down $0.1 million from the prior year as opposed to Wireline costs, which were up $1.1 million.
SG&A expenses were $269.5 million in 2012 compared to $263.1 million in the prior year, an increase of $6.4 million. Corporate costs were up $5.7 million compared to the prior year primarily due to a $7.3 million increase in stock compensation mark-to-market expense resulting from the 81% increase in stock price. These increases were offset by decreased payroll related expense due to cost-out initiatives. Data Center Colocation and IT Services and Hardware costs were up $7.2 million and $5.7 million, respectively, due to increased payroll costs. In addition to increased payroll costs, Data Center Colocation marketing and legal costs were up $1.5 million and $1.4 million, respectively. These increases were partially offset by an $11.5 million decrease in Wireless SG&A due to cost containment initiatives combined with a $2.8 million reduction in bad debt expense. Wireline SG&A was down $0.7 million from the prior year. Depreciation and amortization was $217.4 million in 2012, up $17.9 million compared to 2011. Data Center Colocation depreciation and amortization was $15.8 million higher due to new assets placed in service for data center facilities. Wireline expenses were up $3.6 million as a result of expanding our fiber network. Wireless depreciation and amortization was down $1.6 million due to fewer new assets being placed in service as a result of a declining subscriber base. IT Services and Hardware and Corporate expenses were relatively unchanged. In 2012, restructuring costs were incurred for employee separations totaling $2.5 million primarily related to Wireline and Wireless. Lease abandonment charges were $0.9 million in 2012. In 2011, the Wireline segment recognized $7.7 million of restructuring charges. Wireline employee separation charges totaled $3.5 million, lease abandonments totaled $2.5 million and contract terminations were $1.7 million. In addition the IT Services and Hardware and Corporate recognized employee separation charges of $1.9 million and $2.6 million, respectively, in 2011.
In 2011, the Company ratified a new labor agreement which curtails future pension service credits for certain employees. As a result of this event, the bargained employees' pension plan was remeasured and a curtailment loss of $4.2 million was recognized in the Wireline segment. In 2012, no events occurred to trigger a remeasurement of our pension plans or curtailment loss. Gain on sale or disposal of assets was $1.6 million in 2012, down from $8.4 million in 2011. In 2012, a gain of $1.8 million was realized primarily from the sale of copper cables no longer utilized in our Wireline network. The Data Center Colocation segment recognized a $0.2 million gain on sale of generators following an equipment upgrade at a Texas data center. In 2011, a gain of $8.4 million was recognized as a result of selling substantially all of the assets associated with our home security monitoring business.
Asset impairment losses amounted to $14.2 million in 2012 compared to $52.4 million in 2011. In 2012, impairment losses were largely driven by $13.3 million of impairment losses in the Data Center Colocation segment on a customer relationship intangible asset and property and equipment that was primarily associated with our 2007 acquisition of GramTel. Wireline and Wireless asset impairments totaled $0.5 million and $0.4 million, respectively, in 2012. During 2011, the Company recognized goodwill impairment losses totaling $50.3 million that were related to the Wireless segment. Impairment of assets, excluding goodwill, totaling $1.1 million in 2011 related to the write-off of canceled or abandoned Wireless capital projects. The Wireline segment recorded impairment of assets excluding goodwill in 2011 of $1.0 million related to abandoned leasehold improvements on vacated office space and the write-down to fair value of certain assets that were held for sale.


Table of Contents
Form 10-K Part II Cincinnati Bell Inc.

Transaction costs of $6.3 million were incurred in 2012, up from $2.6 million incurred in 2011. In 2012, these costs represented legal and consulting costs incurred to restructure our legal entities in preparation for the proposed IPO of the common stock of CyrusOne and to prepare CyrusOne to be a real estate investment trust. In 2011, transaction costs represented legal and consulting costs to investigate acquisition opportunities. Transaction costs are reported as Corporate expenses.
Interest expense was $218.9 million in 2012 compared to $215.0 million in 2011, an increase of $3.9 million. The increase was largely due to the issuance by CyrusOne of $525 million of 6 3/8% Senior Notes due 2022 in the fourth quarter of 2012 which increased interest expense by $3.8 million, higher interest costs of $2.4 million from lease obligations, as well as $0.8 million of lower capitalized interest. The impact of these increases was partially offset by lower interest expense from the redemptions of the 7% Senior Notes due 2015, certain CBT Notes and a portion of the 8 3/8% Senior Notes due 2020. Loss on extinguishment of debt of $13.6 million was a result of the debt repayment and partial redemptions made during the fourth quarter of 2012 as discussed in the preceding paragraph. No debt extinguishment occurred in 2011. Other expense of $1.7 million in 2012, increased by $0.8 million compared to 2011, primarily due to a loss recorded on the termination of a lease financing arrangement.

Income tax expense was $24.7 million in 2012, substantially the same as the prior year. Pre-tax income was lower in 2012 but was largely offset by a higher effective tax rate. The Company has certain non-deductible expenses, including interest on securities originally issued to acquire its broadband business (the "Broadband Securities") or securities that the Company has subsequently issued to refinance the Broadband Securities. In periods without tax law changes, the Company expects its effective tax rate to exceed statutory rates primarily due to the non-deductible expenses associated with the Broadband Securities. The Company used federal and state net operating losses to defray payment of federal and state tax liabilities. As a result, the Company had cash income tax payments, net of refunds, of $0.1 million in 2012. Discussion of Operating Segment Results
The Company manages its business based upon products and service offerings. At December 31, 2012, we operated four business segments: Wireline, Wireless, IT Services and Hardware, and Data Center Colocation. Effective January 24, 2013, the date of the CyrusOne IPO, we no longer include CyrusOne, our former Data Center Colocation segment, in our consolidated financial statements and now account for our ownership in CyrusOne as an equity method investment. Therefore, at December 31, 2013, we operated three business segments: Wireline, Wireless and IT Services and Hardware.
Certain corporate administrative expenses have been allocated to our business segments based upon the nature of the expense and the relative size of the segment. Intercompany transactions between segments have been eliminated.


Table of Contents
Form 10-K Part II Cincinnati Bell Inc.

Wireline
The Wireline segment provides products and services such as local voice, high-speed internet, data transport, long distance, entertainment, VoIP, and other services. Cincinnati Bell Telephone Company LLC (CBT), a subsidiary of the Company, is the Incumbent Local Exchange Carrier (ILEC) for a geography that covers a radius of approximately 25 miles around Cincinnati, Ohio, and includes parts of northern Kentucky and southeastern Indiana. CBT has operated this territory for approximately 140 years. Voice and data services beyond its ILEC territory, particularly in Dayton and Mason, Ohio, are provided through the operations of Cincinnati Bell Extended Territories LLC ("CBET"), a competitive local exchange carrier ("CLEC") and subsidiary of CBT. The Company provides long distance and VoIP services primarily through its Cincinnati Bell Any Distance Inc. ("CBAD") and eVolve Business Solutions LLC ("eVolve") subsidiaries.

                                                     $ Change          % Change                         $ Change          % Change
(dollars in millions,
except for operating
metrics)                   2013        2012       2013 vs. 2012      2013 vs. 2012        2011       2012 vs. 2011      2012 vs. 2011
Revenue:
Voice - local service    $ 229.1     $ 255.4     $        (26.3 )          (10 )%       $ 280.3     $        (24.9 )           (9 )%
Data                       317.8       306.9               10.9              4  %         291.5               15.4              5  %
Long distance and VoIP     107.2       113.9               (6.7 )           (6 )%         111.3                2.6              2  %
Entertainment               55.2        35.4               19.8             56  %          26.6                8.8             33  %
Other                       15.5        18.9               (3.4 )          (18 )%          22.4               (3.5 )          (16 )%
Total revenue              724.8       730.5               (5.7 )           (1 )%         732.1               (1.6 )            0  %
Operating costs and
expenses:
Cost of services and
products                   287.2       283.8                3.4              1  %         270.0               13.8              5  %
Selling, general and
administrative             127.8       125.6                2.2              2  %         126.7               (1.1 )           (1 )%
Depreciation and
amortization               112.2       106.0                6.2              6  %         102.4                3.6              4  %
Restructuring charges        9.1         3.5                5.6            n/m              7.7               (4.2 )          (55 )%
Curtailment (gain) loss     (0.6 )         -               (0.6 )          n/m              4.2               (4.2 )          n/m
Gain on sale or disposal
of assets                   (1.1 )      (1.8 )              0.7             39  %          (8.4 )              6.6             79  %
Asset impairments              -         0.5               (0.5 )          n/m              1.0               (0.5 )          (50 )%
Total operating costs
and expenses               534.6       517.6               17.0              3  %         503.6               14.0              3  %
Operating income         $ 190.2     $ 212.9     $        (22.7 )          (11 )%       $ 228.5     $        (15.6 )           (7 )%
Operating margin            26.2 %      29.1 %                           (2.9)      pts    31.2 %                           (2.1)      pts
Capital expenditures     $ 162.6     $ 114.2     $         48.4             42  %       $ 112.6     $          1.6              1  %
Metrics information (in
thousands):
Fioptics units passed      276.0       205.0               71.0             35  %         134.0               71.0             53  %
High-speed internet
subscribers
DSL                        188.5       202.6              (14.1 )           (7 )%         218.0              (15.4 )           (7 )%
Fioptics                    79.9        56.8               23.1             41  %          39.3               17.5             45  %
Total high-speed
internet subscribers       268.4       259.4                9.0              3  %         257.3                2.1              1  %
Fioptics entertainment
subscribers                 74.2        55.1               19.1             35  %          39.6               15.5             39  %
. . .
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