Frontier Communications Parent - Q3 2022

Transcript

Operator (participant)

Welcome to the Frontier Communications third quarter 2022 earnings call. My name is Harry, and I'll be coordinating your call today. If you'd like to ask a question during the Q&A, you may do so by pressing star one on your telephone keypad. I'd now like to hand you over to your host, Spencer Kurn, Head of Investor Relations, to begin.

Spencer Kurn (Head of Investor Relations)

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 and Presentation section of our investor relations website. Before we start, please turn to slide two. 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 (Executive Chairman)

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 four, 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 5 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. Fiber now represents the majority of customers and EBITDA, a crucial benchmark as we build Gigabit America. You can see on slide five the four levers that anchor our strategy. Build fiber, sell fiber, improve the customer experience, and streamline operations. It's been about a year since we assembled our new leadership team, and I'm proud that we continue to perform against our four levers of value creation. By all accounts, the team has executed extremely well on each lever since we emerged from bankruptcy in April 2021. Let's run through the details. We've built fiber to a total of 1.4 million locations. That's a 40% increase in our fiber footprint.

We've added more than 250,000 fiber broadband customers, driving a nearly 20% increase to our fiber broadband customer base. We've improved our customer experience with a 30-point improvement in our fiber Net Promoter Score. We've radically streamlined our operations. You'll hear more from Nick and Scott about how we've nearly reached our initial cost savings target more than a year ahead of our plan. The team has consistently set records against our four strategic levers, which is even more impressive given the challenging market. It takes intense operational discipline to win in this environment, and this team continues to put points on the board quarter after quarter. If you turn to slide six, you'll see that the long-term trends in our business remain extremely encouraging.

Our industry thesis is based on the view that the significant growth in data consumption that we've seen over the past two decades will continue to ramp up, tripling over the next four years alone. We're confident that fiber is best positioned to meet the long-term demand for data consumption, and there are several reasons for this. First, fiber is a vastly superior product to cable and wireless alternatives. Nick has said it before, it's like comparing a Ferrari to a horse. That's because fiber provides dramatically faster download speeds, exponentially faster upload speeds, and significantly lower latency. Second, fiber has the best economies of scale of any technology as data throughput and consumption continue to increase across networks. Our core fiber network is already capable of 10 Gbps and requires only minimal capital investments to enable faster speeds.

Lastly, fiber is the future-proof infrastructure our country needs to compete and to lead. The government has recognized the critical nature of digital infrastructure and earmarked funding to help build it. We've won more than $440 million of grant funding since we started our build, and we'll continue to apply for funding so we can bring fiber to even more Americans. Within the investable universe of fiber companies, we've achieved a paramount position as an industry leader. We have the second largest fiber build in the country, with our plan to reach at least 10 million locations by the end of 2025. Our scale and first-mover advantage provides us the advantage of speed and cost benefits. We expect our fiber build to yield IRRs in the mid- to high teens, a very attractive return on capital.

We have a strong leadership team and a deep bench of operators with a track record of success. We're well-capitalized with a strong balance sheet, low leverage, and healthy free cash flow generation that we're reinvesting into our fiber expansion. Before I turn it over to Nick, I want to share an update on our ESG commitment. I'm proud to share that we launched our first-ever social impact program, Broadband for Good, a few weeks ago. As part of this program, we'll identify opportunities to connect vital community-loved hubs in the communities we serve to our reliable, high-speed fiber broadband technology. The program will demonstrate what's possible with the power of our technology. We're hearing from employees across the country that Broadband for Good is quickly becoming a source of pride. We're also making good progress on our energy-saving and carbon reduction initiatives under our Red Loves Green program.

We have a solar pilot running in Connecticut and California, and our first order of electric vehicle transit trucks are being delivered later this year in California. If you haven't had a chance to read our inaugural ESG report that we published back in June, you can find it online in our newsroom. Our ESG journey is just beginning. It's at the heart of our purpose of building Gigabit America. I'm proud of all we're accomplishing as we transform our business. With that, I'll turn the call over to Nick to review our performance in the third quarter. Nick?

Nick Jeffery (President and CEO)

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, to build fiber, sell fiber, improve the customer experience, and streamline operations, and it's clearly winning in the market. Let's cover the highlights from this quarter. We built fiber at a record pace again, adding 351,000 new fiber locations. As John shared, we'll hit the halfway point in our initial goal of passing 10 million fiber homes later this month. We also added a record number of new fiber broadband customers this quarter, 66,000 to be exact. For context, that's twice the number we added in Q3 last year. As we deliver an improved product to small businesses across our footprint, we're seeing record customer growth in the SMB sector too.

More than we've seen at any point in the last three years. What's remarkable is that we've been able to materially accelerate our fiber expansion while at the same time delivering significant cost savings. In fact, we're nearly at our $250 million cost-saving target one full year ahead of schedule. As a result, we're now raising our gross cost-saving target to $400 million by the end of 2024. Finally, we continue to generate healthy, free cash flow from operations, which we're continually investing back into our fiber expansion, and Scott will cover this in more detail later in his section. Before we get into our quarterly results, let's zoom out and look at how we're doing on our transformation. On slide 10, you can see the inflection points we've already delivered and those we're on target to achieve.

First, we scaled our fiber build in the second quarter of 2021, and we have consistently hit record fiber builds every quarter since. In the third quarter of 2021, we delivered an inflection in fiber broadband net adds. That's also the point at which fiber EBITDA surpassed copper EBITDA for the first time. Our acceleration of fiber net adds continued in the fourth quarter of last year. For the first time in more than five years, fiber adds were greater than copper declines, resulting in positive total broadband customer growth. Last quarter, we accelerated our fiber build and delivered a sequential increase in EBITDA, the magnitude of which Frontier has not seen since 2015.

As I just shared, at the same time, we achieved our initial total cost-saving target this quarter by radically simplifying our business and maintaining a laser-sharp focus on delivering our strategy. The team is delivering our fiber-first strategy, and it's showing in our results. The success we're having with our operational initiatives gives me great confidence that we'll achieve our financial goals in the fourth quarter and beyond. Now let's turn to slide 11 to dive deeper into our two core strategic initiatives, building fiber and selling fiber. I'll start with our fiber build performance this quarter. As I said earlier, we added a record 351,000 fiber locations. We've now outperformed for eight consecutive quarters and scaled our build six-fold since we began our fiber build pilot in late 2020.

This keeps us right on track to hit our target of 10 million fiber locations by the end of 2025. Notably, we're the only company in our sector to have announced an increase in our fiber build this year. As the second-largest fiber builder in the country, our scale gives us a competitive advantage in a tight supply chain environment. Early on, we put in place a strategy that has allowed us to attract leading vendors and secure cost-efficient material and labor. As a result, we now have vendors actively choosing us for their scarce capacity because they see that we're well-funded, we're here for the long term, and we deliver. This is why we've thrived, building ahead of plan and within our cost parameters, even with a tough macroeconomic backdrop of inflation and supply chain challenges. Our second strategic initiative is selling fiber.

We're transforming the way we sell, the way we price, and the way we're perceived in the market. We're also becoming more digital, which is good for both our customers and our business. Quarter-over-quarter, we're seeing this work pay off. Now you know the results. We added a record number of fiber broadband customers again this quarter. We continue to outpace our competitors, gaining share against every one of them in every geography in which we operate, and we are now taking this good momentum into the fourth quarter. A time when we'll also have the wind at our back in Florida, one of our largest markets, as snowbirds return to the Sunshine State for the winter. On slide 13, we take a closer look at our base and expansion markets to better understand where the growth is coming from and what we can expect.

It's no secret that we're taking the majority of our new customers from cable based on a fundamental truth: Fiber does what cable can't. Any way you look at it, fiber is a much better experience, and the proof is in the penetration numbers. In our base fiber footprint, we have 3.2 million homes. These homes are in more mature markets that have had fiber for several years. Penetration in this footprint in Q3 increased 30 basis points sequentially to 42.9%. When we look at the growth over the past year, we see a clear path to achieving our long-term target of 45% penetration in our base markets. If you look at our expansion fiber footprint, our 2021 cohort is right on target and our 2020 cohort is exceeding expectations.

Sales is part art and part science, and every quarter since the new leadership team came on board, we've improved our go-to-market strategy. We're becoming smarter in the way we operate and increasingly efficient. Now it's showing in the numbers. Moving forward a slide, you can see that the actions we are taking are beginning to support our long-term ARPU growth. This includes our structural price increases and rising Gig+ speed adoption. ARPU growth is up 2% year-over-year if we adjust for short-term promotion. In the third quarter of last year, we implemented gift card promotions, which is slightly disguising the year-over-year ARPU growth trend. One of our largest drivers of ARPU growth is customer demand for faster speeds. 45%-50% of our new fiber customers continue to choose 1 Gig speeds or above.

In fact, customers on 1 Gig+ speeds now make up 15%-20% of our base, and that's up from 10%-15% last quarter. As the mix of the base on 1 Gig+ speeds catches up to the mix of activations, our ARPU should naturally rise over time. As a specific example of how we're strengthening our pricing power, let's look at what we're doing in the SMB sector. First, we enhanced our product by launching 2 Gbps speeds network-wide. Secondly, we simplified our pricing structure to enable broadband-only pricing with flexible add-ons. Thirdly, we introduced value-added services like RingCentral, which perfectly complement our lightning-fast fiber broadband. These added services create greater value for our customers, increase ARPU, and reduce churn. Now we've structured our pricing ladder to incentivize customers to adopt higher Gig+ speeds.

The net result of these changes has been a 10% increase in acquisition ARPU. This is a strong model that we've already begun to put in place in our consumer business too. Now, I want to take a moment to talk about our copper footprint, as these customers play a critical role in our transformation to a fiber-first company. The best way to keep these customers happy and improve their lives is to bring fiber to their homes and businesses as quickly as possible. We expect that by the end of 2025, fiber will be available in at least 2/3 of our copper footprint. In the meantime, we are seeing churn. This quarter specifically, we saw an increase in copper churn for two main reasons. The first one is a good trend. We continue to see our copper customers migrate to fiber.

The second is actually bad weather. Some of our markets were impacted by bad weather and the outages that come with it. As you'll remember, copper is negatively impacted by weather in a way that fiber is not. Until we can bring fiber to our copper customers, we're focused on improving their experience. We've invested in our customer care operations, we've improved customer communication with a more personalized approach, and we've added retention specialists to our call center operations. As a result, our expectation is that copper churn will stabilize in the fourth quarter. Finally, and with great pleasure, I'd like to talk about the positive momentum we're seeing in our commercial businesses. A few months ago, we welcomed new world-class leadership to advance our fiber-first strategy for the benefit of our business customers, and the early results are encouraging.

Across all three business units, we're seeing a sharp increase in order volume and a more favorable sales mix, which is leading to higher pricing. As I shared earlier, SMB achieved a 10% increase in acquisition ARPU, and Enterprise had record high bookings in the month of September. Wholesale is making great progress on our fiber to the tower initiative. It really is excellent to see this momentum building in areas that were previously ignored by the old Frontier. We're confident that we can achieve year-over-year revenue growth in our commercial businesses and look forward to sharing our progress with you over the coming quarters.

Now, before I turn it over to Scott, I want to take just a moment to recognize the incredible dedication and commitment of our people. When Hurricane Ian hit Florida, our employees kept our customers connected to our critical services and to each other, despite the extraordinary challenges they faced personally. To ensure we have a way to support our employees and their families during this and any future natural disasters, we've set up our very first employee relief fund. The fund will provide financial assistance to employees who've been impacted by a natural disaster just like Hurricane Ian. We're building Gigabit America, and I am so proud that we're taking good care of our customers and each other as we do it. Scott, over to you.

Scott Beasley (CFO)

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 is 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 in 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 Fit for the Future initiatives on slide 23, we have made rapid improvements, streamlining our cost structure. 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've 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 are 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. 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-$2.6 billion, reflecting our accelerated build to 1.1 million-1.2 million fiber locations this year. Our projected build cost per location of $900-$1,000 remains unchanged. We also continue to expect EBITDA of $2.05 billion-$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 are 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 (Head of Investor Relations)

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

Operator (participant)

If you would like to ask a question, please dial star followed by one on your telephone keypad now. Our first question comes from the line of Jonathan Chaplin of New Street. Jonathan, please go ahead.

Jonathan Chaplin (Managing Partner)

Thanks, guys. Two quick questions, if I may. Given that EBITDA is 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? I'm wondering if you can give us some comments just on the pricing environment generally and expectations for, you know, 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 (CFO)

Sure, Jonathan. This is Scott. Let me take the first question, and then I'll pass it to Nick for the second question. 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. Excluding the one-time final 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. 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 for gross add was roughly flat, but that acceleration in total gross adds led to those higher commission costs.

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 (President and CEO)

Yeah. Jonathan, Nick Jeffery here. I've answered many times before, Frontier will be a rational pricing actor in this market. Having said that, along with almost every other business right now, we're seeing inflationary pressures. If those don't moderate, then, of course, we may have to consider pricing actions to compensate for those, just as I think we're seeing others doing. Our goal is always to provide a you know great range of products and services at competitive prices in order to make sure that we can meet our wider financial and operational goals.

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 Un-Cable positioning that we've now made public to really turn on its head the kind of pricing practices that the rest of the industry does, that we know customers really hate. We're doing away with price step-ups and other things which I think are unattractive to customers while maintaining our competitive price position, but always with one eye on input costs. If we need to think about pricing actions to compensate for those, we of course will.

Jonathan Chaplin (Managing Partner)

Great. Thanks, guys.

Scott Beasley (CFO)

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

Operator (participant)

Great. Moving on. Our next question comes from Gregory Williams of Cowen. Gregory, your line is now open.

Gregory Williams (Senior Equity Research Analyst)

Great. Thanks for taking my questions. First one just on access to capital. You guys have messaged in the past, maybe tapping the markets again in 2024. Just wondering if there's any updates there to that timeline with rising costs that you just mentioned and rising interest rates. It does sound like you have a great cost savings program that's been accelerated and 84% of your debt's 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 passed specifically. Again, sounds like you have a cost savings initiative that's helping out, but just wondering to hear your latest thoughts.

Thanks.

Scott Beasley (CFO)

Sure. Thanks, Gregory. This is Scott. Let me take both of those questions. First on funding. You're right. When we completed our debt raise and upsized our revolver in May, we said 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-$400 million. 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-$1,000 per location range. 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 a number of states. We've said we'll be building in 12 states by the end of this year and then 15-16 by middle of next year. That gives us the flexibility to avoid any certain hotspots where labor is particularly challenging. We're confident there that we'll stay within the $900-$1,000. We are seeing moderate inflation there, but a bit of inflation was factored into the $900-$1,000 guidance that we gave about 18 months ago.

We're still confident that we'll hit that 900-1,000 range.

Gregory Williams (Senior Equity Research Analyst)

Got it. Thank you.

Scott Beasley (CFO)

Thanks, Gregory.

Operator (participant)

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

Frank Louthan (Managing Director of Equity Research)

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? How much larger will your, you know, available, you know, to market base be, say, 6-12 months from now from what it is now? Thanks.

Nick Jeffery (President and CEO)

Yeah. Let me take the first load and hand that back to Scott. It's Nick here. Yeah. How quickly do we get to selling fiber is something we've worked very, very hard on since we started our fiber build just over a year ago. What we've developed is what I think is now a reasonably sophisticated playbook for taking fiber sales to new markets. In fact, as we plan to build into an area, we start pre-marketing before that build has even gone in, warming people up to the idea that fiber is a better product, fiber is coming to town, they have a better alternative, and informing them about how they are able to order fiber as we build it. As we then roll into town, we do the build pretty much in line with that.

We sell door to door, we sell online and so on, so that we warm the market up, we fulfill the market as we build, and we do it in as near real-time as we can. Now, of course, that's a goal that we've been working towards over the last year. I think the playbook there is now reasonably sophisticated and something we can continuously roll out as we build into new markets. Go, John.

John Stratton (Executive Chairman)

Yeah. Yeah. 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. I think the best way to look at that is simply to review the speed with which we're accelerating our fiber build. When we talk about doing 1.1 million-1.2 million this year, remember, our original target was 1 million for this year. You know, almost a 20% improvement over that number and accelerating. It's also important to note that the run rate that's now embedded in the business is such that it portends, you know, an even more significant build next year. Why this matters? As we've said throughout our time here, speed is a critical success factor.

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 voluminous. So you should expect that to continue. We certainly do, and we'll look to drive that in the quarters to come.

Frank Louthan (Managing Director of Equity Research)

All right. Great. Thank you.

Scott Beasley (CFO)

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

Operator (participant)

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

Anthony Nemoto (Equity Research)

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? Then on the SMB side, you know, what have been the key factors of success there, you know, given cable is well entrenched, and then you have the heightened focus from, you know, the big three national carriers. Lastly, just on leverage, you know, as we kind of enter the inflection and EBITDA in 4Q and into 2023, have your views on your leverage targets evolved, you know, from the mid-threes? Thank you.

Nick Jeffery (President and CEO)

Yeah. Hi, Anthony. It's Nick. Let me take the first couple of those and hand to Scott for the leverage question. On elongation of sales cycles. Well, 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 the market. Any kind of metrics you see about wider market trends and so on, in a way, apply much less to us because we're really a very small commercial player relative to the big guys in the market. 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 bases you see in other larger commercial players. Typically, a large commercial customer for us would be viewed as a medium-sized commercial customer for others. We've got a smaller customer base and a small market share. Thirdly, the commercial segment, to be very open with you, was largely ignored by previous rounds of Frontier management, and therefore is a great opportunity for us to put it back on its feet and really get out and attack the market. Whether we're seeing elongation on sales cycles, 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 underserved markets where there was no alternatives before, with new management, new focus, new execution, innovation in product, innovation in pricing, innovation in channel management, channel delivery, and execution. Actually, I'm very optimistic about the early results we're seeing there. To your point on SMB, it's many similar points, but in SMB, there was really no focus on SMB in Frontier in the past. We very significantly increased our marketing product, channel activities there. Frankly, Frontier had passed many SMB businesses facilities, but simply 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 markets.

We're refining our offer in our expansion markets, and we're increasingly sophisticated with digital go-to-market and scaling our channel. We're seeing great results on the back of that. I'm really pleased with the results we're seeing both in SMB and enterprise, and I think there's more to come. Scott?

Scott Beasley (CFO)

Yeah, sure. Thanks, Anthony. On the leverage question, coming out of bankruptcy in 2021, we said that mid-threes was the appropriate leverage target. 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. 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-threes.

Anthony Nemoto (Equity Research)

Got it. Thank you.

Scott Beasley (CFO)

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

Operator (participant)

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

Simon Flannery (Managing Director)

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 and year over year? 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. 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 (CFO)

Sure, Simon. This is Scott. Let me take the first one, then pass to Nick. On fiber churn-

Simon Flannery (Managing Director)

Thanks.

Scott Beasley (CFO)

It did tick up a tiny bit. I think it was 4 basis points year-over-year. Most of that was involuntary. It's just kind of returned to normal levels. Fiber churn was right in line with our expectations, maybe even a little below our expectations. We feel like we're not losing customers to competitive options. We feel like fiber churn is very healthy right now.

Nick Jeffery (President and CEO)

I want to fix Scott's answer. I think we said before, it's very fundamentally a different proposition to our core fiber offer. We now know from the market data that you've seen, we've seen, and everyone else sees, 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. It's like transient business. The underlying question on FWA about its overall economics as data volumes grow, and the fact that it's perhaps a great sort of flash in the pan. 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.

We, of course, are looking at FWA and MVNO closely all the time, and we have been right since the start. We've also got this fantastic return on capital from building fiber. While we see our churn rates still being stable and relatively low, while we see our growth rates 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, having said that, with my own experience in Vodafone, John, your experience in Verizon, Veronica Bloodworth's experience with AT&T, Etienne Brandt's experience with British Telecom, and, many, many, many others across the team, we do have deep experience in running, managing wireless networks. We understand the economics of that really well.

We understand bundling really well. Some of us, myself included, have set up MVNOs in the States before, so we know practically how we would do that. We're watching it very closely. If consumer behavior changes or if the market changes in a material way that impacts using some of our scarce capital to build or partner in an MVNO would be a smart thing to do. We'll do it, and we'll do it very quickly. Now isn't the moment for us.

John Stratton (Executive Chairman)

Great. Thanks a lot.

Scott Beasley (CFO)

Thanks, Simon. Operator, we'll take the next question, please.

Operator (participant)

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

Nick Del Deo (Managing Director)

Hey, thanks for taking my questions. You know, first, I want to follow up on Simon's question about fiber churn, you know, 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 (CFO)

Sure, Nick. This is Scott. Yes, we have a very solid screening mechanism up front. I think it's working well. In addition to the screening mechanism, we're giving customers an incentive to get onto auto pay. The combination of those two things has led us to record low bad debt expense in the quarter, record low Days Sales Outstanding. 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.

Nick Del Deo (Managing Director)

Okay. Okay, good to hear. Also, you know, obviously fiber broadband ARPU, you noted, was a little pressured because of the way, you know, 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 come in below that target given recent trends? I guess more generally, are your subscriber acquisition costs kind of coming in consistent with plan, or are those unit costs changing?

Scott Beasley (CFO)

Sure. Let me answer the second one first. Subscriber acquisition costs are right in line with our plans. We did have the sequential increase in total marketing and commissions, but that was really growth driven based on the 22% higher gross adds that we had in Q3 versus Q2. We're obviously 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. We've had two kind of headwinds related to programs that we put in place in the second half of last year. First, the autopay 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 autopay, and then the gift cards have helped us compete effectively in the market. Without those 2 programs, we'd be at roughly 4% year-over-year ARPU growth. With those it's more flat sequentially. I think 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%-4% long-term growth in ARPU.

Nick Jeffery (President and CEO)

Scott, if I can perhaps build on that in a reflection. If I stand back a little bit from the kind of day-to-day fight we have to grow ARPU, of course. I think phase I, as I look at this business, which is still in its early phase of a turnaround. Let's just be very transparent about that. We're a year and a half in. There's still a long way to go. I think about it like this. Phase I of our new pricing structure ladders was really about making us competitive. In some cases, aligning to industry norms, gift cards, and things like that. You know, getting us back in the game, taking the fight to the competition, making us win, making us perform. I'm really pleased with, I think, the progress that we've made there.

I think in phase II, as we've 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. In pricing specifically, I think Etienne Brandt, who recently came in to lead our consumer segment, has been putting into the market very quickly and very aggressively some new pricing data structures, which I think are extremely interesting because we've taken stuff that we used to bundle and give away for free, unbundled it, and started to price for the stuff that we gave away previously. Now, of course, that means we have to actually go out and sell this stuff as well. We have to have channels capable of selling stuff that we previously gave away for free.

What's been amazing to watch is that adoption rates on those services have actually gone up. That means more customers are willing to pay more money for stuff that we used to previously bundle and give away for free. In that one example, we've seen acquisition ARPU on our SMB segment go up by 10%, which is phenomenal. Now, of course, I'm not saying, just to be clear, that we can replicate that right across our business. I am saying there are elements of that we can now bleed across into our consumer market, begin to innovate, experiment with, and see how we can start to grow ARPU in a really innovative, market-leading way, and demonstrate to customers that we really are the Un-Cable company.

John Stratton (Executive Chairman)

Yeah. Maybe if I can just echo one last point here, and it's something that Nick said earlier in the prepared remarks. When you look back and ask 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 barometer of consumer health and a company's competitive posture is the value that's described as a new sale. If you look at the mix of gigabit plus activations in broadband for new customers, it's substantially higher than our embedded base. 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 ARPU growth as we go forward here on the consumer side, particularly. Hopefully, as we go forward, we'll be able to demonstrate that in our quarterly results and in the full year.

Nick Del Deo (Managing Director)

Great. Thank you.

Scott Beasley (CFO)

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

Operator (participant)

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