EarthLink's CEO Presents at Deutsche Bank's DbAccess 21st Annual Media and Telecom Conference (Transcript)

| About: EarthLink, Inc. (ELNK)

EarthLink, Inc. (NASDAQ:ELNK)

March 04, 2013 2:20 pm ET

Executives

Rolla P. Huff - Chairman, Chief Executive Officer and President

Unknown Analyst

We're going to go ahead and start now. All right. If everybody will just find a seat, we're going to go ahead and start with the next session here this afternoon. This is not Brad Ferguson, the CFO of EarthLink. This is Rolla Huff, the CEO of EarthLink, so apologies for the misprint there in the conference guide. Rolla, we're actually thrilled to have you back at the conference again for another year.

Rolla P. Huff

Glad to be here.

Unknown Analyst

I think that the way we'll get things started here is just for the benefit of people who are getting up to speed on the story. A quick recap on what you've done at EarthLink, to get people away from the legacy mindset of what the company is, in particular, the meaningful and interesting investments you're making in the IT space and then I'll have a series of follow-up questions after that.

Rolla P. Huff

Sure. Yes. EarthLink is well underway in a pretty substantial transformation from being a consumer business to now being a leading-edge IT services business that leverages both emerging -- an emerging cloud business with the -- with an underlying MPLS network and putting them together, focused on the midmarkets.

Unknown Analyst

Great. Just reported your quarter, you gave a little bit of -- actually, you gave a lot of guidance for 2013, more so than you've given, I think, since you've been with the company. Maybe just recap for us a little bit what you're hoping to accomplish this year, and then why do you feel confident enough to give that level of specificity around what you think the company can achieve, when in the last couple of years maybe you were a little more reluctant. What are you seeing?

Rolla P. Huff

Sure. Well, first of all, as the business are coming together, we're getting a lot more visibility into the business. As you know, EarthLink, we bought 2 fairly large companies, and 1 of them had -- was really a compilation of companies that had not been integrated. We bought these companies at 4.5x, so we knew we had a lot of elbow grease that we were going to have to put into these companies. But as we've brought the companies together, and we're still working through the integration, but we're well on our way. The further we get through, the more visibility we feel like we have in the business. And any kind of transformation story, like EarthLink is, we think the best thing that we can do is tell people everything we know about the business as best we can. So 12 months ago, when we were giving guidance, we were still in the early -- earlier stages of the integration. And while we had reasonable visibility, we didn't feel like we had good visibility. As we start to have product line reporting and better geographic reporting, it's just a lot easier to reach into the business and get a view of what to expect.

Unknown Analyst

And just give us a recap on where you are in the integration of that because you had a nice series of timelines in your earnings presentation. It's sort of like you have lined of sight here on being through the last real phase of integrating these 2 assets. What are the -- I think you have 2 key hurdles you have to get over and then you're pretty much done.

Rolla P. Huff

Yes. Well, we think that some time this summer and hopefully, it's early summer, we will have about 70% to 80% of the core foundation of the new platform put in place. We'll still have 1 or 2 network inventory systems that we'll integrate in, but we will have collapsed probably 5 to 6 of the OSS platforms. That will really allow us to change how -- what our workflow looks like and a lot of cost structure that we'll be able to address after that. And then I think by the end of 2013, we should be through the bulk of it.

Unknown Analyst

I guess what I wanted to spend a little more time on is understanding -- because your revenue mix is shifting in a very interesting way. You have -- the majority of it is still your older businesses, whether it's consumer or on the enterprise side. And there is ongoing secular pressures there. The portion of your business that's growing is growing incredibly quickly, over 20%.

Rolla P. Huff

Correct.

Unknown Analyst

And so I guess what I want to kind of spend some time on is, let's think about the 2 buckets of stuff that's legacy, whether it's your old consumer business, which is you'll people sort of remember from the old days and then your sort of the legacy component of your CLEC business, and how you're able to leverage what those businesses create for you, whether it's cash or customers, in order to continue the acceleration of the IT business.

Rolla P. Huff

Sure.

Unknown Analyst

Do you understand the concept of the question there?

Rolla P. Huff

Sure, absolutely. So we have the consumer segment that we'll continue to manage just the way we we've been managing it. We manage it to optimize cash flow, it's generated a lot of cash in the past and it'll continue to generate a lot of cash flow. We've taken the business services segment to your point and separated those business customers that are more likely to require technical IT solution. And we've separated those out and the remaining part of the business, which is the legacy CLEC type of stuff usage in single T1 types of businesses. We'll run that in a way that's very similar to the consumer business. In fact, the same guy that's been running the consumer business will now run that segment of the business. Well, the objective is we want to keep every customer we have, we want to give them a reason to stay with us, but we don't want to spend a lot of money to get more of those kinds of businesses. I mean, when we've seen softness in the business, that's the sector we've seen it in because clearly, that part of the business is under attack by the cable companies. The part of the business that's growing, we -- actually, there's 2 components of business services that are growing. One is our IT Solutions, MPLS and Hosted Voice. That part of the business is about $140 million today, and it's growing at about 20% a year, a little over 20%. Then we have a wholesale business that's also about $140 million-ish roughly, and that business is growing in the single digits. So we've got a core piece of business that's over a quarter of a billion dollars that has a decent growth profile on it. We've got the other pieces of the business that we think we can manage for cash, and that's important because we're using the cash to go out and really create our cloud platform, our underlying IP infrastructure that supports those growth products.

Unknown Analyst

And let's talk about some investments you've been making. You've talked about some, what I'll generically refer to as data center investments and there are some incremental network that you're putting in place. Could you maybe give us a little more detail as to exactly what it is you're investing in? I know it's not space in power. It's a little bit of a different investment and understand how that accelerates the IT platform you're bring out to your customers.

Rolla P. Huff

Absolutely. So we're deploying 5 Gen 2 cloud stacks. One will deploy in a data center that we own in upstate New York. The other 4 will be deployed in either Equinix or DRC facilities. And we've got the ability to sell collo in addition within those 4 facilities. And so in those platforms, we'll sell, really, our whole line of cloud products. Underneath that, we're building a, really, a cloud to cloud IP infrastructure. We -- the -- all the fiber that we acquired was really built to support a telecom company. And so there's lots of hops on the fiber. Basically, what we're doing is, we're taking the hops out of the fiber. We're building sort of direct highways between the cloud stack so that we can go to a customer and give them, if they want, a hop replication on a geographic dispersed basis. So as -- we just brought the Dallas cloud platform up. It is mated with the upstate New York, so today, a customer can ask us to replicate their data. Somebody in the Northeast, we can replicate their data in Dallas in pretty much realtime because we've built these direct routes. And we'll -- and so all of our data centers will be connected that way, all of our cloud platforms.

Unknown Analyst

So 2 questions. What are -- what's in the cloud stack? I mean, it's a broad terminology to say cloud. And what are the exact applications that you're helping your customers with? And then, who is that addressable customer that you're going after? Is it exactly the people who are using Delta and One Comm and the old New Edge business? Or is there something beyond that, that you're targeting there?

Rolla P. Huff

So we're selling infrastructure as a service on our cloud platforms. We're a platinum provider of VMWare, for example. We're doing the e-mail hosting types of platforms, so exchange platforms is part of that. We host people's applications. We're trying to really build, between our cloud and our network, a product that's all about application performance. It's not just hosting it, but it's hosting it and then providing customers, in a virtualized way, providing customers with real application performance. So this IP network that I was just talking about will be a very low latency cloud platform that's out on the edges. And that's -- we're a fairly significant player in the retail industry and we're -- we believe that will be really important to retailers as they're looking at more and more of their products and catalogs being online and having their products out on the edge in our cloud platforms with low latencies so the customers can get to them quickly. We think is a great product.

Unknown Analyst

And so it sounds like a lot of this is upselling into a customer base that you already have for traditional telco.

Rolla P. Huff

We are -- I just read a statistic and I -- this came out of product marketing, so I want to just verify it a little bit. But I think we send an invoice to roughly 1/3 of the retailers in the United States. That doesn't mean that we have all of their business, but roughly 1/3 of the retailers has some relationship with EarthLink today. And so we think there's a huge opportunity there to expand that relationship. We do have customers with thousands of nodes that bill hundreds of thousands of dollars, but we've got a lot of retailers that we may have 1 or 2 or 5 or 10 sites that we think we can grow into.

Unknown Analyst

And just to put a name with the face, can you give us an example of a retailer that you do business with and maybe how you've been able to grow their business, even if it’s a generic, you know a large...

Rolla P. Huff

Well, like the General Nutrition Centers, we've probably got 3,000 of their locations on our network. And I think we give them ubiquity, we give them class of service and we give them a better data security because of -- their information is not traversing the public Internet.

Unknown Analyst

I've noticed that you've definitely put a lot of thought into thinking about how you can improve your sales organization within the context of the business that you're trying to win, and you made some pretty meaningful changes to your sales and support in the last quarter.

Rolla P. Huff

Yes.

Unknown Analyst

Would you mind recapping for us of -- what are you doing in terms of changing the size of the sales force? Where have you scaled it down and where are you trying to scale it up a little bit?

Rolla P. Huff

Yes. Well, this has been a process that's actually been going on for 2 years. I think if you look at when we first brought these companies together, I think we probably had 600 direct sales people and 500 to 600. And so quarter after quarter, we've been bringing those numbers down because a lot of them were located in Tier 3, Tier 4 markets, where our target customer that is going to have a higher propensity to buy IT services, they're just not a big base of customers there. So what you're referring to is in the fourth quarter, we took about 2 dozen markets and we essentially said, we're not going to have a direct sales force in those 2-dozen markets. We'll have account management, we'll take care of our customers or customers that want -- new customers that would want EarthLink, we've handed those markets over to our channel partners. They're basically agents for us. And we'll take -- that was really just taking cost out of the business. We just didn't feel like the business they could win was in the legacy part of the business, where we didn't believe we could be competitive with the cable companies. And so that was really that idea, but if you look at it over the last 2 years, we've been gradually bringing that part of the business down. We've been aggressively hiring people on the IT side of the business. It's a -- we found, in general, it's quite rare that somebody that has been selling T-1 circuits can make the switch to selling IT solutions. It's a -- just a wildly different motion. And so we've been taking costs out of the CLEC part of the business, and we've been building cost in the IT services part of the business. We're getting solution consultants out there and obviously, building out our platform and product.

Unknown Analyst

As you think about the addressable market out there, how do you kind of figure out the type of customer that probably the cable companies will serve better because they're already on a local infrastructure and they don't want to get differentiated? And how do you figure out where you can offer a level of service and the type of service that the cable companies really can't replicate because they don't have the IT stack? I mean, where do you figure that out? Where do you draw the line?

Rolla P. Huff

Sure. Well, what we're finding right now is that the cable companies really are focused at the lower end of the business, it's easy pickings for them, they've got a better cost model than we could ever have. But we -- our chances of winning go up exponentially when it's a multi-location customer. When it's a customer with 5 to 10 locations, especially with the locations not being centered in one particular city or region that a cable company would cover. No question when a customer has locations outside of the cable company's footprint that they're in. It's tough for the cable company to help them, especially if they want an integrated network, a secure network. So we win when it's multi-location. We generally win when the customer doesn't have a lot of IT people. You would be amazed at the number of customers out there that are fairly large, but they just have not made a big investment in IT infrastructure. They're running their business out of a computer closet or -- but technology is basically moving faster than they've moved. That's a great opportunity for us. Certainly, at the Fortune 1000, the Verizons and the AT&Ts, there's a whole bunch of people going after those folks. But once you get below the Fortune 1000, there's just a lot of opportunity. We think for just the products that we offer, it's a $100 billion opportunity. But these people been need help in sorting out how to variabilize their cost structure. And ultimately, that is the platform that we put forward, whether it's Tier 1 support, technical support. Whether it's the security around mobile devices and their network, we can help customers who are not in a position to help themselves and that -- we think that's just a huge opportunity for us. Because ultimately, if you believe that we're not going to be seeing robust top line growth in most businesses today for the next several years, the cost of their technology in securing their data will continue to go up. I think it'll just -- EarthLink has lived the life of having to variablize our cost structure. We did it on the consumer side and really, in many ways, that was the genesis for this strategy. We saw what we had to do, and we're trying to put together a platform that addresses that.

Unknown Analyst

We talked earlier about an investment you're making in your cloud stack into a network to be able to sell that to your customers. How do you feel about the rest of your product portfolio? Do you feel like you have the IT platform that they need or are there incremental investments that you feel you want to continue to make to either meet that opportunity or expand that opportunity?

Rolla P. Huff

I think we have most of what we wanted. About 1.5 years ago, we were considered -- seriously considering getting into the data center business. It was a business that was growing quickly, it was attractive to us to go out and acquire a piece of revenue that was growing fast and would sort of get us over that inflection point. Ultimately, because we do have a piece of our business that is declining, how we manage risk is almost as important as -- it's probably the most important thing that we do every day. We just felt like the valuation multiples were too rich. So we got to that product in a different way to the partnership that I mentioned with Equinix and DRC. So when I look at the portfolio now, we've got, I think, the ability to do ubiquitous MPLS networks. We've got most of the IT infrastructure that we need. The stuff that we don't have, we've actually gotten through partnerships, the last 2 things that we've done. One being our micro BM [ph] product that we're putting in. We've done that through a partnership, and I think we'll be -- you'll be hearing that we're going to be coming out with a PCI-compliant cloud product that we're doing through a partnership that are trying to buy these companies. So for now, I think what we're focused on is executing on what we have. If we have the ability to go out and buy customer relationships that will have a higher likelihood to buy our services, we'd have to consider that, but we just have to be very value conscious. I mean, we just -- we have no choice there.

Unknown Analyst

So I want to ask you some questions here about how you managed cash flow and then talk about the structural structure a little bit because you had -- you were in the market for a little while. But I think we stopped at cash first. So if I look at the guidance you gave, you actually had a very nice chart, where you sort of talked about what the EBITDA run rate was coming out of the year and kind of stair-stepped it through to the midpoint of the EBITDA guidance you expect to achieve in 2013. And without getting into too much gory detail, maybe I did my math wrong, but it looks like the step down off of the run rate is fairly moderate, right? You're getting to a point where you're almost at EBIT stabilization, maybe a single digit, small single-digit decline off the run rate. What's your view on how close you are? I know revenue may lag a bit, but you've done a great job with cost. What's your view on EBITDA sort of flattening? And how do you think about managing cash? You've been such a great steward of cash throughout the management of the old business. Are you feeling like you need to be stepping up investment at all at this point? Or is it still sort of a very disciplined focus on making sure that you are generating cash even through this transition?

Rolla P. Huff

Well, I -- clearly, over the last 5 years, we've been very focused on cash flow. It's important because we needed to be able to fund the strategy that we're executing on now and not have to rely on the capital market. I sort of see 2013 as being that trough. I mean, it's at that -- we're at that inflection point, where we now have products to grow. So we'll spend -- we will spend money on acquiring the customers, but we're also -- we've deployed a lot of expense around our IT services strategy in front of the revenue coming, and you just have to do that. I mean, there's not a -- we're not going out and buying data centers, but we're buying expertise that can sell the product and support the product. We had the bubble in CapEx that we talked about. Our CapEx run rate has been $130 million, $135 million pretty consistently. We really believe that it was a smarter thing to invest the $45 million and do it organically, even though it's more painful than going out and spending $500 million on a data center that already had some revenue and growth but was going to either leverage us up or dilute the heck out of it. So I sort of see the EBITDA flattening out after 2013, and we ought to start seeing the impact of our new product sales that have better margin profiles than a lot of the legacy CLEC products start to kick in.

Unknown Analyst

So EBITDA flattening out as we move through this year and into next year -- but on the CapEx side, do you feel like that the level of CapEx you're spending now, is this what you consider sustainable? Is it actually higher than you think you might spend because you do have this investment bubble you're making? That's what I'm trying to get to.

Rolla P. Huff

It was a one-time investment bubble. I think that -- I think for the MPLS business, which is the biggest consumer of capital, that's a pretty understood capital model. We know how much of it's success based and how much of it's maintenance. The incremental $45 million, and we tried to get out there and tell people what that was, it was the 5-cloud stack and it was the IP network and the IP network that supported the cloud stacks, as well as the wholesale business. We're starting to see, and it's why wholesale is probably growing a little bit better than we expected, our wholesale business is now starting to be impacted by a lot of social media companies instead of just selling to other transport companies. And so that was a big part of our -- we saw, I think I mentioned on the call, January has come in a lot strong -- came in a lot stronger than what we had seen in the second half and happy to say that February was stronger than January. And part of it is wholesale and part of it is we're just -- I think the second half of last year, especially on the usage and legacy side was, it was just a -- we just saw a slowdown in terms of new sales. So as I look at our business, our churn is -- looks pretty solid. Our growth products are growing. Our consumer business is predictable as ever. We saw the slowdown in usage and in single T1s. And I think part of that is cable companies are all over the low end. Part of it is the SMBs are probably more impacted by all the craziness in Washington. And obviously, we had some weather events in the fourth quarter in the east coast that impacted usage for sure.

Unknown Analyst

But you're still generating cash to pay your dividend. You're still generating cash for your share repurchase program. And so then, your focus and priority of those things hasn't changed.

Rolla P. Huff

Absolutely. Yes. I think we've taken a pretty balanced view of our balance sheet. We used $40 million to pay down some debt at 1 02 off the Deltacom note. So that was one use of it. We bought some shares back in the fourth quarter. We used some cash to deploy to the IT services strategy, so I don't see us changing that motion. I think it's a balanced motion that we try to get to.

Unknown Analyst

Now you do have some very expensive debt outstanding, and you had taken a look at the market recently and decided not to go ahead. But what are you seeing out there? I mean, how do you think you can really kind of get the cost of your debt down?

Rolla P. Huff

Yes. Let me talk about that. I -- we had an unforced error in my opinion on Friday. We were approached a few weeks ago or actually several months ago by the banking world, all due respect, not you guys. But we were approached about this opportunity to take down very inexpensive bank debt and take out these very expensive Deltacom notes. It made sense to me, we were -- I liked it because we could get out of the bank debt at 1 01, so it gave us a lot of flexibility. We'd take our debt service down, made all the sense in the world to me on the terms that they -- that the bankers said they could get. Once we got to the market, all of a sudden, the terms started to change. And we didn't need to do anything, we have plenty of cash. So I don't know whether it was just the bankers didn't know what they were talking about. But at the end of the day, I wasn't going to do a stupid deal. It just didn't make any sense to me. We've got plenty of cash to run our business. If we can do it better, if we can get better cost in our capital structure, jeez, I'm all for that. But I'm just -- I wasn't going to be led to the trough and do something stupid. So we pulled it.

Unknown Analyst

And the note's recallable in April, right?

Rolla P. Huff

Yes, absolutely. 1 05.

Unknown Analyst

So if the market comes back or you see something that makes more sense, you do have the ability to go 10.5 percentage there?

Rolla P. Huff

Yes.

Unknown Analyst

So you do have the ability to do this. There's -- the penalty is not that steep.

Rolla P. Huff

Yes. I mean, we've got unsecured debt out there that's trading at, I think, roughly 7.5% type of yield. So anybody that believes that the debt markets aren't open to us, I think is probably misreading it. We thought we had the opportunity to do something at a good -- with a good deal, and it just didn't happen that way. And so if we would have been squeezed for cash, we would have probably gone ahead and done it. But it just didn't make any sense. Didn't make any sense to me.

Unknown Analyst

All right. I definitely want to see if anyone out here has a question. We do have a little bit of time left. I could stick with this for a while if you want. All right. So I want to get back to talking about sort of the philosophy you guys have had in terms of rewarding shareholders because -- and I want to step back because you came to the company at a time when you had nothing but a declining legacy business, and you were very successful in generating a ton of cash out of that, implementing an attractive dividend, repurchasing shares, you started to make some investments in assets that you saw could create a platform for growth that you're showing a lot of traction against, reset the dividend but continued paying one, continue repurchasing shares. Where's the dividend yield right now just to...?

Rolla P. Huff

About 3.2%.

Unknown Analyst

3.2%. EBIT, EBITDA is on...?

Rolla P. Huff

If we have another stupid bank deal, it could be 3.4%. But yes, I think right now it's 3.2%.

Unknown Analyst

So EBIT to EBITDA is pretty low as well, I think it's under 4 turns right now. So low onto this sector, are you -- if you can do an accretive refinancing, would you increase share repurchase? I'm just trying to think about how you managed cash going forward. Or are you at the point where you feel like you are reasonably balanced in giving cash back to shareholders and there's enough attractive investment potential that excess cash, and you do already have excess cash, would be prioritized towards investments in the business?

Rolla P. Huff

Yes. I think we'll continue to take a balanced approach. We have a platform that's worth investing in now, and it's going after a, I think, an opportunity that is only going to get bigger over the next 2 years. The CLEC platform, essentially, was a platform that was meant to catch a wave that came through 10 years ago, and it was little wonder that it was a difficult platform to create value on. We're putting together something that is -- that we believe will catch the next substantial wave that's building out there, which is, not just IT outsourcing because I don't think that's really what we're trying to build. It's giving companies the ability to variablize their IT costs. And that's worth investing in, and so we'll use our cash to try to be balanced in the way we're providing our returns. But also, we know that the only thing -- I mean, the shares that I own, the only way that this will have been a good investment for me, the checks that I've written, is we've got to grow this business. Period. We've got to get this business to grow. And but growing without growing into a business that makes money, CLECs proved years ago that you can grow something but not necessarily make money. This has got to be a business model that can make money. And so that's what we're focused on.

Unknown Analyst

All right. Anyone else? We have a question down here.

Unknown Analyst

Yes. On that last point about making money, it seems like you're going into very new exciting areas, but they're also very highly competitive with some very large incumbents. So how do you differentiate that? I guess, because that's what leads downsized margins of profit. How do you see that?

Rolla P. Huff

I think that the way we differentiate ourselves, first of all, is the market that we go after, so we're not trying to -- we're not trying to go after the really big companies. But the thing that makes us different is the way I think we put together our networking assets with our IT assets for that market. We compete every day with Rackspace, but we can win with Rackspace because we can put their services on a private network, and that matters for data -- from a data security perspective, right? There's just more of the portfolio that we can bring to the customer. There's no question if AT&T or Verizon is looking to compete with us for a customer and give the customer the time that we're willing to, then it's always safe to go with the largest players. But it's such a big emerging opportunity and unlike the CLEC world, we're not trying to take customers away from monopoly. These are -- all of this opportunity is sitting in the IT departments of businesses all over the country. And so we're competing with their next best alternative, and we think we have a strong product platform for those kinds of customers.

Unknown Analyst

But the market size for that? Is this for the legacy consumer business, the temp [ph] size of the market?

Rolla P. Huff

Well, so we think that for the products that we offer, if you're below the Fortune 1000, we think it's about $100 million -- $100 billion marketplace. And if you look at the 451 Group or Gartner or any of the industry analysts, we are in the early stages of adoption around these IT services. And so EarthLink really has a position -- has the ability to establish itself. Our brand is known, we haven't taught people to hate who we are, and that's been -- that's a plus for us, honestly. I mean, they don't necessarily know that -- they don't associate the EarthLink brand with IT services, we're going to help them with that in 2013. But we built a trusted brand, and I think we've got as good an opportunity as anybody to take a position in this market that's going to grow quickly. I was -- I had the good fortune of being in the early stages of the wireless industry, that's why I'm -- got so much gray hair and not much of it. But it looks a lot the same way to me. It's -- you can look at this wave that's building and how it's going to impact how businesses do business, and it's just a massive opportunity, and we want to get in front of it. And we don't have to own 20% of the market. If we have 3% of the market, I'll feel a lot better about my shares.

Unknown Analyst

All right. Well, it looks like we've just about run out of our time. Rolla, thank you very much. We appreciate it.

Rolla P. Huff

Thanks so much.

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