EarthLink Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 1.13 | About: EarthLink, Inc. (ELNK)

EarthLink (NASDAQ:ELNK)

Q2 2013 Earnings Call

August 01, 2013 8:30 am ET

Executives

Louis Alterman

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

Bradley A. Ferguson - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Michael Crawford - B. Riley Caris, Research Division

Donna Jaegers - D.A. Davidson & Co., Research Division

Mark Kelleher - Dougherty & Company LLC, Research Division

Barry McCarver - Stephens Inc., Research Division

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Scott H. Kessler - S&P Capital IQ Equity Research

Ankit Sharma - Jefferies LLC, Research Division

Anthony Klarman - Deutsche Bank AG, Research Division

Operator

Good morning. My name is Nicole, and I will be your conference operator today. At this time, I would like to welcome everyone to the EarthLink Second Quarter 2013 Earnings Call. [Operator Instructions] I will now turn the call over to Louis Alterman, Senior Vice President of Finance for EarthLink. Please go ahead, sir.

Louis Alterman

Thanks, and welcome to our call. During today's call, we will refer to earnings slides that are available for you to view in the Investor Relations section of our website at earthlink.net. Following our comments, there will be an opportunity for questions.

Before we continue, I would like to point out that certain statements contained in our earnings release and on this conference call are forward-looking statements, rather than historical facts that are subject to risks and uncertainties that could cause actual results to differ materially from those described. With respect to such forward-looking statements, the company seeks the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks include a variety of factors including competitive developments and risk factors listed in the company's SEC reports and public releases. Those lists are intended to identify certain principal factors that could cause actual results to differ materially from those described in the forward-looking statements, but are not intended to represent a complete list of all risks and uncertainties inherent to the company's business. In an effort to provide useful information to investors, our comments today also include non-GAAP financial measures. For details on these measures, including why we use them, and a reconciliation to the most comparable GAAP measures, please refer to our earnings release and the Form 8-K that has been furnished to the SEC, both of which are available on our website at earthlink.net.

Prior to handing the call over to Rolla, I'd like to point out that we are in the process of running a sale process for our systems business, which was previously part of our legacy CLEC business. The business is approximately EBITDA neutral, and we expect the sale proceeds to be immaterial. Given the progress we've made in the sale process, in the second quarter, we accounted for our systems business within discontinued operations. This accounting treatment applies to all historical numbers, reducing our first half 2013 revenues by just over $5 million, and we will continue this accounting treatment perspectively for a full year revenue impact of approximately $10 million.

After Rolla's opening comments, Brad Ferguson, our Chief Financial Officer, will discuss the quarter's financial results.

Now I'd like to hand things over to Rolla Huff, our Chairman and CEO.

Rolla P. Huff

Thanks Louis, and good morning to everyone joining us on the call. I'd like to start by sharing some of our operating metrics in the second quarter, along with my assessment of our progress, and then hand it over to Brad to dive deeper into the quarterly results and full year guidance. I'll come back at the end for some closing remarks around our capital allocation.

I'll start on Page 2 with new customer bookings. As you recall from 3 months ago, our Q1 sales bookings were $3.4 million of monthly recurring revenue, which was up considerably over our 2012 production. This morning, we announced that we had a strong second quarter of bookings as well, maintaining and in some cases, accelerating our positive sales momentum. As you can see on the bottom half of the page, not only did the total MRR bookings hold to Q1's high levels, but for our growth products, bookings grew sequentially from 40% to 47% of the total. This is important because these are the products that are the future of EarthLink and are in the early stages of adoption in the marketplace. Total contract value grew from $84 million in the first quarter to $93 million in the second quarter. So not only are we selling more and selling proportionately better products but customers are signing up for longer contract lengths. These bookings don't eliminate the fact that we still have a portion of our base made up of legacy CLEC products -- and I'll get to churn in a second -- but they continue to validate the substantial demand that's out there for the new platform we put in place.

Turning to Page 3. I want to remind everyone that we increased our total sales in the first half of this year with 200 less people than we had at the end of 2012. As we described, we exited sales force headcount in small markets, but retained and invested in the most productive reps in key markets. The sales force that we have today is only getting stronger, and as a result, we averaged $4,300 in MRR bookings per rep per month or $4,500 if you include our wholesale channel. Retail productivity grew 32% sequentially from Q1. And Q1, I'll remind you, was a record quarter that was already 45% above historical levels. This is a key foundational element of our transformation. Also, as we told you we would do, we took some of the savings from our more efficient sales force and invested it in demand creation initiatives. Since mid-March, we've delivered over 96 million impressions on targeted online sites. In the second quarter, our search engine marketing efforts resulted in $190,000 in MRR bookings or $2.3 million in new annualized revenue. This is more than double the $1.1 million from search in Q1. And looking ahead at the pipeline, through a combination of search engine marketing and digital advertising, we've increased the number of IT leads by 72% over the -- over Q1. So not only are we selling more and doing so with less sales reps, but we're moving up market and at a very fast clip. The dollar amount of large deals that we sold, defined as $10,000 or more of MRR per transaction, has doubled over the past 2 quarters. And across all sales, our average deal size grew by over 35%. And as we look at our sales funnels, we expect this trend to continue.

Turning to Page 4. Last quarter, I described how those of us within the company were beginning to feel the effect of what we call the virtuous cycle, where the products' ability, better markets and new talent we've added are attracting bigger customers, who in turn attract other large customers and allow us to, as a result, to continue to attract more talent to our company. Clearly, from our sales results, you can see that is materializing. And I'll spend a few minutes to update you on the various components.

First, as you know, we invested over the past several quarters in building our top tier nationwide cloud platform. These capabilities are at the very beginning of secular growth, and they are in larger markets where in most cases we've not historically had a presence. In these markets, there is a richer density of customers who have multi-location business models and a higher propensity to buy IT services. We've now rolled out all 5 of our next-generation data centers. In the second quarter, our IT services bookings were up 45% over the prior sequential quarter, which was the previous record.

Second, we're right on track with our fiber network expansion project. We turned up additional routes in the second quarter and now have approximately 85% of the fiber expansion complete. And that's up from 70% in Q1, with a few projects remaining that will complete in the second half of the year. These are unique routes that carriers and large content providers value for their ability to provide diversity.

Third, we continue to invest in hiring salespeople in key markets around the data centers and in other Tier 1 markets like Los Angeles. We've brought on over 150 new sales reps so far this year that are focused on selling upmarket products like IT services. I described last quarter that the investments we've made and capabilities we've built are not only appealing to customers, but are now allowing us to attract incredible sales and engineering talent who want to be a part of those types of products. The new tech sales talent we're hiring are accustomed to carrying much higher quotas, and they come to us with quality business relationships with the type of customers we're now targeting.

We're just at the very beginning of benefiting from bringing these types of people into the company. And even though the fiber expansion is not yet fully complete, it's good to share with you that in the second quarter, we booked $1.4 million of annualized wholesale revenue on our new fiber routes, bringing the cumulative total to $5.3 million. And even though all the data center capabilities and local sales forces are just now -- having been put in place, we've now sold $1.9 million of annualized revenue on the new cloud stacks. This is all revenue that we would not otherwise have been able to compete for before making these investments. So all this continues to feed on itself, the product capabilities, the better markets, the new talent we can attract and the bigger customers who can become references. Clearly, sales can and will be lumpy from quarter-to-quarter, but we believe we're now beginning to feel the benefit from this virtuous cycle that we've been talking about, and we expect our long-term trend to be positive as a result. Overall, I have to tell you, I couldn't be more pleased with our sales progress.

Moving past demand creation and on to customer retention. As you can see on Page 5, churn in our business segment ticked up this quarter to 1.8%. Churn for our growth products remained relatively steady at 1 -- around 1%, but for our smaller legacy single location customers, it rose from 1.6% to around 2%. There are several moving parts behind this increase. First, we consciously drove part of the churn increase as we purposely took some pricing actions that we knew would provoke some churn. We've taken similar actions in the past, and as we expected, the moves were still economically rational as the churned revenue ended up being more than offset by the benefit from the higher pricing dropping all the way to the bottom line. Part of the churn increase, however, was larger than we had expected. We've been talking every quarter about the highly competitive environment for single site customers. I think we've used words like fierce and ferocious to describe the competition from the cable companies who generally do not serve multi-location accounts, but take advantage of better network economics for single location customers. As an aside, that's precisely why we focused our new customer acquisition activities upmarket. But for the legacy lower-end customers that are already in our base, we had a tranche of them coming out of contract term this quarter. Now that's not unique, and we know that the most price-sensitive customers tend to be most prone to leave shortly after their contract term expires. But this quarter, we saw proportionately more willingness than we've seen in the past for these low-end customers to take an offer from the cable companies. Needless to say, we spent a lot of time in the past month or 2 talking to the small customers that have churned, and they told us that it's not about things like the quality of our service, but that they're getting a price that's compelling enough to make it worth the hassle to switch. We've got significant resources doing additional analysis and implementing churn mitigation plans. Our revenue guidance anticipates we should be able to slowly tick churn back down into the mid-1s later this year, with the improvement beginning in the second half of Q3 as we get past the bubble of customers coming out of contract. In the near term, however, given the contract profile of our customers, as well as the highly competitive environment, we believe there could be continued churn pressure in the low end of our base for the next few months. We're quickly working to provide more value to these customers by selling them bundles of IT services. Considering the long term, if you think back to when I talked about our average deal size growing, the more complex multi-location customers once installed are undoubtedly going to be stickier. So over the long term, we believe churn will improve as they'll be proportionately less low-end customers, and we'll continue to provide our customers with a broader, more relevant mix of products.

On the consumer side of our company, churn ticked down to 2.1%, an improvement over last quarter's historical low and continues to improve over time.

Putting this all together, as you can see on Page 6, we continue to see improvements in our year-over-year revenue trajectory. Business services is now declining at 4.1%, a 120-basis-point improvement on a normalized basis over the prior quarter. The total company is also 120 basis points better from the 7.5% year-over-year decline a year ago to a 6.3% decline this quarter. Last quarter, we signaled that you should expect these improvements in Q2. They were largely driven by pricing actions that we took in the spring, as I mentioned earlier, and higher levels of new wholesale installations following the large Q1 sales. These benefits were only partially offset by the higher churn levels, which will have a larger negative impact on the second half of the year than they did in the second quarter. It's a bumpy path, but over time, we're still working our way closer to the inflection point of sustained revenue growth.

Before I hand it over to Brad, I'd like to briefly touch on our integration progress. We continue to make progress on both our network and IT service platforms in the quarter, as we have now divided the remaining integration activities into manageable chunks each at various stages of development testing and implementation. For our IT services business, we rolled out our next-generation OSS platform in the second quarter. This tool enables us to present enhanced proposals to our customers and ultimately have more standardized orders that can be more quickly and effectively provisioned. 10% of July orders originated in this platform, and by the time we exit this quarter, we'll be utilizing it for all our IT service orders. That was a meaningful integration deliverable for us given -- especially given the strong growth profile of IT services. In the next 2 to 3 quarters, we'll begin integrating key capabilities from our recent CenterBeam acquisition, connect our current customer portals with our next-generation IT services cloud control platform and integrate customer services systems. We'll continue to have components of our integration coming online throughout the next few quarters.

As you know, in each quarterly call, I remind everyone that we're managing a very complex transition and the progress will never be perfectly linear. But looking to the longer-term view, I fundamentally believe that the value creation of this business is going to be driven by new customer adoption of our growth platform, and I couldn't be anymore encouraged by the demand for our next-generation services that we're seeing in the marketplace.

Now I'll turn it over to Brad to dive deeper into the financial results and guidance. Brad?

Bradley A. Ferguson

Great. Thanks Rolla. I'll begin on Page 7. For the second quarter of 2013, we reported revenue of $313 million and adjusted EBITDA of just over $59 million. Included in adjusted EBITDA were several settlements which in aggregate resulted in a net favorable $1.8 million, split between cost of revenue and operating expense. As we've said in the past, the nature of our business is lumpy, and we should expect that we will continue to have these types of items, positive or negative in the future.

For the quarter, we generated unlevered free cash flow of $25 million, up from $19 million in the first quarter, and we reported a net loss of $11 million. The net loss included a $4 million quarterly sequential increase in interest expense as a result of redeeming the Deltacom notes at around 105.

Turning to Page 8, which contains the components of our revenue. We continue to encourage our investors to use this slide as a guidepost when modeling 2013 and 2014 revenues. In Q2, our retail revenue growth products comprised 12.5% of total company revenues, with approximately $157 million on an annualized run rate basis. Compared to Q2 of last year, our retail growth products revenue grew 22%. Our wholesale business generated $39 million of revenue in the second quarter and now comprises 12.5% of our total company revenue. This business grew at 3% year-over-year, which is above the growth rate we laid out in our 2012 Investor Day. We should be able to continue to grow our wholesale business in the low-single digits as we capitalize more on the new unique fiber routes within our footprint. Our total growth business including wholesale, which was at a $280 million run rate exiting 2012 has scaled so far this year to a run rate of approximately $313 million. It grew 12% in the second quarter versus the year-ago quarter and now represents 1/4 of our total company revenue. Earlier, Rolla mentioned our $3.4 million of MRR bookings in the second quarter, which included several large deals getting closed. As I said last quarter, there are more large deals in the pipeline, but the timing of when these deals close will not be evenly distributed from quarter-to-quarter. Therefore, we expect total bookings number may bounce up and down a bit sequentially, but regardless of how the quarterly fluctuations play out, the overall trend is strengthening. Focusing on the legacy CLEC part of the business. In the second quarter, these products comprised 53% of total company revenues, down from 55% last year. I said last quarter that cable competition was fierce, and Rolla just talked about that at the low end, and that we had no illusions about growing these products. If anything, we see the competitive forces increasing. However, we are able to partially mitigate the top line declines in the second quarter through some pricing actions. The timing of these actions tend to exacerbate the lumpiness of this part of the business and can impact the sequential comparisons all at once rather than smoothly throughout the year. We do not have similar pricing actions planned over the next quarter or 2, so we expect the quarterly sequential declines in Q3 and Q4 to be largely -- to be larger than they were in the second quarter. These products declined at 10% in the second quarter of 2013 over Q2 of last year, and we expect low-teen declines in the second half of the year as we experience a full quarter's impact of the churn we experienced over the summer. In the meantime, we continue to take a focused approach to managing cost out of this part of the business.

Our consumer business continues to perform well. Year-over-year declines were 13%, an improvement versus the 14% declines we experienced in the first quarter. We expect consumer revenue to be slightly better than we originally guided earlier this year.

The key sources and uses of cash during the second quarter are outlined on Page 9. We ended the second quarter with $142 million of cash and marketable securities. During the quarter, we utilized $34 million for capital expenditures, down from $42 million in the first quarter. Of the $45 million commitment that we outlined late last year for the fiber and data center projects, we have now spent a cumulative $38 million. The remaining capital will trickle in as we complete the projects.

Our debt issuance cost, debt insurance proceeds and interest payments during the quarter netted out to a $50 million use of cash. We spent approximately $9 million on integration and severance costs and paid $10 million of dividends during the quarter.

Moving to the balance sheet on Page 10. As you know, during the quarter, we refinanced our 10 1/2% Deltacom notes due in 2016 and replaced them with a 7 3/8% notes due in 2020. We have $600 million of gross debt outstanding, which equates to approximately 2x net leverage. Also, not reflected in these numbers, early in the third quarter, we just -- we used just over $22 million on the purchase of CenterBeam.

Now I'll discuss some of the operating results and metrics in a little more detail beginning on Page 11. Of the $313 million of total revenue in the second quarter of 2013, business services comprised 78%. Our total cost of revenue was $153 million in the second quarter of 2013, yielding a gross margin rate of 51.2%, which was down slightly from 51.7% last quarter. Normalizing for settlements, our gross margin rate is between 50% and 51%.

In the consumer segment, net subscriber losses were 40,000, improved from 45,000 last quarter and 55,000 in the second quarter of 2012. Total consumer churn hit an all-time low of 2.1%. We continue to expect seasonality to impact some of the quarterly trends in the consumer side, but generally expect consumer churn to continue to decrease over time. Approximately 68% of our consumer subscribers have now been with us over 5 years or more, and they have churn rates that are down in the 1s.

Total selling, general and administrative expenses were $105 million for the second quarter, down $1.6 million sequentially.

Now for the updated financial outlook for 2013, which is on Page 12. Note that the prior revenue guidance ranges I referred to have been adjusted to reflect the accounting treatment of our systems business moving to discontinued operations. As discussed earlier, we had a strong new bookings in the quarter and the revenue from these customers will favorably impact future periods once installed. We also had the higher churn, which has a more immediate impact in the second half of 2013. For the full year of 2013, we're tightening our revenue guidance range to $1.245 billion to $1.250 billion. This is within, but at the low end, of the previously issued guidance range and in the middle of the original guidance range we issued at the beginning of this year. We're also narrowing our adjusted EBITDA expectations to a range of $214 million to $225 million. This is no change to the bottom end of our previously issued guidance range and a reduction of $2 million at the top end.

We're taking aggressive actions to control costs in response to the churn we experienced this summer. The adjusted EBITDA guidance is at the high end of our originally issued guidance at the beginning of this year. We're projecting a net loss of $283 million to $288 million. This reflects an approximately 12% tax rate, which differs from the approximate 38% rate that we typically book, primarily due to the impairment of nondeductible goodwill last quarter.

A reconciliation of our adjusted EBITDA guidance to the nearest GAAP measure is provided for your reference on Page 18. We're maintaining our previous capital expenditures guidance of $140 million to $155 million. This year included investments in fiber and data center assets. Going forward, absent large opportunities that could come with incremental revenue, we expect to return to our more normal CapEx spend rate, which equates to approximately $125 million to $135 million annually.

Before we open the line for questions, I'd like to hand it back over to Rolla for some concluding remarks. Rolla?

Rolla P. Huff

Thanks, Brad. I'd like to briefly discuss our thoughts on capital allocation and strategic alternatives on Page 13. So starting with the ways that we could deploy capital, and you've heard us talk about these things, and I want to just give you how we're thinking about those areas now. As we've described in the past, we're comfortable with the size of our dividend today. While we've done a significant amount of buybacks in the past, we'll continue to look at that as an opportunity when the trading window is open. Of course, both our buybacks and our dividends are limited by the restricted payments portion of our bond indentures. We think the best use of our capital is to help get our business to a point where it's not declining. That can be through organic investments, like the fiber and data assets that are already paying off, and we'll, of course, continue to remain open to those kinds of investments when we have customer demand and a risk-adjusted return that is available to us that meets our hurdles. We could also consider inorganic investments as a way to get our business to a point where it's not declining. As we think about inorganic investments, there are a few categories of transaction types that I've talked to you about in the past. And so let me run through those and how we're thinking about that now.

First, we've clearly been interested in adding technology and product capabilities, and that has really been the bulk of our last several acquisitions. While I can never say never and certainly technology evolves rapidly over time, we believe we're now at a good place with our portfolio of products. We have the new product -- we do have new products coming in our future product roadmap, but they're being developed organically or through partnerships. So we feel good where we are in terms of our product portfolio.

Now as I've said many times, we'd love to have more data center assets for colocation, but we don't believe that's likely given the current multiples for those assets. And we're always looking for opportunities to acquire revenue streams in bulk in a less expensive manner than acquiring the customers one at a time. Those sorts of opportunities are pretty rare, but when they happen, we'll be interested at the right price. So while we'll continue to look at opportunities as they come up, I'm increasingly satisfied that we have a viable product platform for our new growth business.

In addition to potential acquisitions, we're also always considering whether there are opportunities to sell portions of our business that are not core to our long-term strategy. Our announced activity around selling our systems business is an example of that. Among other transaction structures, we, along with our advisors, have spent a considerable amount of time over the years thinking about, is the viability of a sale or spin of our consumer business? I want to take a couple of minutes to dive deeper on to this not to give you any sort of hint that anything is pending because it's not. But because this is a subject that investors ask about from time to time, and we thought it made sense to just lay out our thinking.

Investors ask about it for good reason, because certainly in theory, separating declining assets from growing assets could unlock shareholder value which we would be all for. However, to determine if such a transaction could truly create value, we've had to think about it more than just the theory of it, but rather we've looked at the specific assets and considerations around those assets. So let me comment on the top 3 to 4 considerations as they relate to the consumer business in particular.

First, since the business and consumer segments are now integrated on many levels, including IT, network and management, there would be negative synergies to making each a standalone business.

Second, there are tax considerations. We, and a potential buyer, would both have to be very careful about impairing an otherwise productive use of NOLs. Also, given that the assets are nearly fully depreciated and the limitations around using NOLs that were acquired in the past 5 years are real, there would likely be a cash tax impact on the sale of these assets.

Third, our bond indentures include limitations on spinning assets for more equity value than the restricted payments basket. And on top of that, there are limitations around returning cash proceeds to equity holders.

And fourth, there are few real buyers of that kind of business who would or could pay us a value that's greater than the value we can create with them uniquely. Certainly, we've seen others publicly shopping similar assets, and they've not been successful to date at solving this issue. We know this business has a long tail, but it's tough for others to get their heads around paying up for the level of our DCF for a declining asset. And they would have to pay up enough to offset all the friction I just mentioned.

So for all these reasons, despite the theoretical logic of a separation, we've not, thus far, have been able to find a path that was actionable. But know, we'll continue to evaluate a full range of strategic options with smart and creative people, but in the meantime, continue to believe the best way for us to create value is to create and nurture our growth business, while running the consumer and low-end business -- businesses for cash optimization. Given the demand we're continuing to see in the marketplace, we're as optimistic as ever about the long-term prospects to make this happen.

So with that, operator, let's open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Mike Crawford.

Michael Crawford - B. Riley Caris, Research Division

Just to take it a bit further, what would be -- how would you characterize your appetite for new unique route fiber build? So the organic investment, say, next year is similar to what we've seen this year?

Rolla P. Huff

I think Mike, it's completely driven by what our customers are asking for. So we probably will not be all that interested in building a route because we think customers might eventually get around to wanting it. But clearly, if a customer comes to us and says, "We want this route." And they can give us economics that make it an easy decision for us, we'll be always be open to that. So it's really customer-driven, and that's probably the best I can say.

Michael Crawford - B. Riley Caris, Research Division

And I know that the data center asset multiples and expectations are fairly high. Have you noticed any, say, shift in expectations of sellers or buyers in the market?

Rolla P. Huff

You're talking about customers?

Michael Crawford - B. Riley Caris, Research Division

No, this is more on kind of the businesses.

Rolla P. Huff

Oh, I see. Not really. I would say that -- I would say that valuations are still very elevated in that space. And frankly, it seems to me that the strong guys are getting stronger, i.e., they're continuing to update their data centers and expand their footprint. So I don't see that changing anytime soon.

Michael Crawford - B. Riley Caris, Research Division

Just shifting gears, that was nice productivity improvement from the sales reps. How would you characterize the $4,300 a month per rep productivity versus where you'd like to see it?

Rolla P. Huff

Well, I think we're starting to get into the range that works. I think it can go a little bit higher. What we're seeing is, we're moving up market and we're seeing bigger and bigger deals. Probably deal size has been stronger than we had expected. And so when you're doing deals that -- on a regular basis that are $10,000 a month or more of recurring revenue and every once in a while, we're doing deals with -- that are hundreds of thousands of dollars a month of recurring revenue, it really drives that productivity. So we'll -- I wouldn't be surprised over the next several quarters to see that inch up a little bit, but it will be big-deal driven. And we'll -- what I'm hoping is that we can -- there's enough demand that we'll be able to continue to open up new markets like we just did in Los Angeles.

Michael Crawford - B. Riley Caris, Research Division

And then last question relates to -- you said you were fairly pleased with the technology assets you've acquired so far. Seems like to help drive some bigger multi-location deals, something like a contact center functionality would be -- was that something that would be high on your list?

Rolla P. Huff

You're talking about a call center as a product?

Michael Crawford - B. Riley Caris, Research Division

Yes.

Rolla P. Huff

Yes. That's on the product roadmap, but that's not something that we would -- that's something we're doing organically. So you'll hear more about that in the coming months.

Operator

Your next question comes from Donna Jaegers with D.A. Davidson.

Donna Jaegers - D.A. Davidson & Co., Research Division

Three quick questions, I guess. On the restructuring charge, was that all due to the discontinued operations? Or was there a part in there for ongoing operations?

Bradley A. Ferguson

No. The restructuring really had nothing to do with that. I mean, so that's just integration. Just more severance expenses, but really just to -- it's not related to the equipment business.

Rolla P. Huff

It's severance, Donna, and we're doing -- Brad and his team are spending a lot of time collapsing real estate holdings, and so there's -- as we're getting out of some of these facilities, that's driving some of that. It's absolutely the right thing to be doing long term, but we're collapsing real estate facilities pretty quickly.

Donna Jaegers - D.A. Davidson & Co., Research Division

And that's because less people in the real estate, so you're concentrating them more?

Bradley A. Ferguson

Yes, so reducing the footprint.

Rolla P. Huff

And we're really building our -- we're really building the bulk of our business now in Atlanta and Rochester. And so a lot of the little satellite things that were with the companies that we acquired, the little satellite markets, we're collapsing those into the 2 bigger employee centers.

Donna Jaegers - D.A. Davidson & Co., Research Division

Great. And then the CenterBeam acquisition that you closed early in the quarter. Can you talk a little bit more about -- it seemed like the main attraction there was their product set with the 365+ Enterprise Cloud solution and the IT help desk. I understand they didn't have much of a sales force. So can you talk a little about the product set and then have you trained the sales force yet in that product?

Rolla P. Huff

We were very excited about the product set. It really filled out what we thought were the remaining holes in our platform. They've really got a terrific platform around hosted exchange. Their -- the other thing that they had that we just didn't have yet was endpoint management capability. So the ability to tunnel into our customers' PCs and help them that way, as well as help our customers understand what they have hanging off of their network. So whether it be software licenses that they should have but don't, we -- it just gave us a capability to add more value to our customers. We've started the training of our engineering folks first. So the way we trickle down training is we go to our IT engineers first and make sure that they're -- they understand the product capabilities. And then we go to the sales force. You're right on the money. They only -- I think they might have had 2 sales people, and it was going to be the cost of distribution that put them into the selling mode. But I -- we just hear from our customers all the time that they're interested in these kinds of products. So we're very excited about -- in fact, I think we've already closed 3 deals just in the first 30 days. So we feel good about it.

Operator

Our next question comes from Mark Kelleher with Dougherty & Company.

Mark Kelleher - Dougherty & Company LLC, Research Division

I want to talk about the new data centers. How is the fill rates going on there? What's the utilization rates? And what effect do you expect on EBITDA margins as those begin to fill?

Rolla P. Huff

We're -- we feel good about it. I think we just -- I think we talked on the call about -- in the quarter we had $1.9 million of new revenue in the quarter that went into the data centers. As you know, we really -- I think we opened Miami last week and Chicago a couple of weeks before that. So we've got quite a few customers on our Upstate New York CloudStack because that was the first one that launched, but we feel good about it. It's ramping the way we had hoped, and you see it in our IT services sales, which are up considerably quarter-over-quarter.

Mark Kelleher - Dougherty & Company LLC, Research Division

And were you preselling into Miami and Chicago?

Rolla P. Huff

We are pre -- what we're doing is -- I guess the answer would be, yes. We didn't have deals sold, but we're qualifying leads and clearly talking about it in the marketplace.

Mark Kelleher - Dougherty & Company LLC, Research Division

And is that data center footprint enough? You mentioned that you're going to ramp down CapEx next year because you spent on those this year. Would there be a need for more data centers and more CapEx spending next year?

Rolla P. Huff

Not -- it's not on the -- we don't see it right now. I don't -- I think we've got a good edge network in terms of data centers, so we can -- we've got -- we're spread out enough that we don't have latency issues from data center to data center. The sales that we've had so far really took up about 10% of the capacity of these data centers. So I hope it's a big issue in the next 12 months, but I really don't see it at this point.

Mark Kelleher - Dougherty & Company LLC, Research Division

And then just one quick numbers question. On the interest expense, jumped up a little this quarter as you switched out that debt. What's the run rate of that going forward, that line, interest expense?

Bradley A. Ferguson

Yes. So we're at about kind of a $50 million run rate just with the $600 million debt that we have. And really what happened this quarter was just some of the friction around the deal of replacing the Deltacom notes.

Operator

Your next question comes from Barry McCarver with Stephens Incorporated.

Barry McCarver - Stephens Inc., Research Division

Just a couple of questions, housekeeping and then I guess a bigger-picture question. First off, back on that restructuring charge in the quarter, the $29 million. That's come up for a couple of quarters. It seems like we expected at the beginning of the year to be a little bit smaller, kind of high-teens. Moved up the last quarter, and now it's up again. Can you give us a little guidance on what you think you could end the year in terms of that line item?

Bradley A. Ferguson

Yes. The $30 million that we have for the year anticipates just really the extension of some of the integration efforts. Certainly, we have done, I think, 9 or 10 deals at this point so. Certainly, there are -- we're doing more deals and more things. With the CenterBeam transaction, a little will get rolled into that. But really, the more deals and the extension of the integration cycles have just increased that over time. And we continue to do some more projects on integration with the network. We've brought in some consultants to help us evaluate certain things we've already talked about, taking out costs on the low end. So there are a few other things that we've embarked on that should really have some bigger and long-term payoffs.

Barry McCarver - Stephens Inc., Research Division

So if I hear you, what you're saying is, there definitely is potential for more in the 3Q.

Bradley A. Ferguson

Yes. I mean, we talked about -- even going back to the bigger deal when we talked about 3-year timelines which would take you out into mid next year, early mid next year. So certainly, just on the timelines that we laid out for the original deal that would take you into next year where we're...

Rolla P. Huff

But keep me honest here, Brad. I don't...

Bradley A. Ferguson

It's not at that level.

Rolla P. Huff

I don't see it continuing to escalate over the coming quarters. As Brad said, we've -- since we did the first 2 deals, we've done 7 more. And as we're integrating those things and turning down real estate and so on and so forth, that gets impacted. And we absolutely are bringing our headcount down as you've seen.

Bradley A. Ferguson

Yes, right.

Louis Alterman

Barry, it's Louis. You'll see in our year-to-date results we've done about $18.5 million. And then back on Page 18 of the deck, you'll see a reconciliation where we're guiding for the full year to $29 million. So obviously, seeing the pace of that decelerate.

Bradley A. Ferguson

Yes, that's right.

Louis Alterman

Those projects usually come with benefit above the operating expense lines.

Barry McCarver - Stephens Inc., Research Division

That's helpful. And then on the systems business that's now part of discontinued or held-for-sale operations. I think you've been talking about headwinds in that business for a couple of quarters. I'm a little surprised that there wasn't already some of that business built into the revenue guidance for the year. Was there something that occurred more recently that kind of triggered this decision?

Bradley A. Ferguson

The decision we talked about it -- actually at the end of the year, really, the first quarter, we talked about exiting the business where we are going to stop new sales, and we did exit some of the people that were working on that. Really, what triggered this in Q2 was just got to the stage where we could actually sell the legacy customers that we had. So we had a portion of the business but we are still supporting the maintenance piece of it. And from an accounting perspective, once you get to that conclusion, that you can sell the business, that's when you move it to discontinued operations. So this is just the evolution of that process.

Louis Alterman

Yes, but to be clear, there's no impact on the EBITDA guidance as a result of that decision. It only -- it takes revenue down, but also takes down an equivalent on our cost.

Barry McCarver - Stephens Inc., Research Division

Did that have any effect on SG&A in the quarter? It looks like it came in a little lower than what I was expecting. Was part of that from this?

Bradley A. Ferguson

Yes. So there was probably $1 million that was in OpEx that we would have moved below the line.

Barry McCarver - Stephens Inc., Research Division

And then just lastly kind of a bigger picture question for Rolla. You talked about the intense cable competition. A little over half of the CLEC peer group has reported 2Q, clearly it was a very, very challenging quarter in the telecom world. Have you seen any significant change in competition during 2Q? Or a couple of months here into 3Q? Or is it just been pretty much what we've seen all year?

Rolla P. Huff

Well, it feels a little more intense to me. Cable -- really the issue is the cable companies. They're coming in and they're just very, very strong competitors. And as you know, they have their plant already in place. So the nominal cost of extending it to a small business is pretty small. I think -- I'm disappointed with how -- with what we did in the quarter because I think we've -- I think we can do better around selling IT services into the base. I think one of the things that we're managing through right now is that our account management people at the low end just aren't in a position to really talk about IT services at a level that they need to, to get a deal closed. So we're doing some things to improve our motion into the base around IT services. But I believe that there continues to be a big opportunity to leverage what we're doing in IT services to keep that base a little bit longer. And frankly, I just -- we've got to be better at leveraging the meaningful capabilities we've created because the cable companies will continue to go after that low-end base, and I think the IT services are the best way for us to differentiate ourselves and not have the whole decision set be around the price of the circuit.

Operator

Your next question comes from Barry Sine with Drexel Hamilton.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

A question on the competitive environment that you're seeing. Obviously, you've talked extensively about the low end of the market, where cable is moving in. As you guys move upmarket, you're obviously seeing pretty good success. Who are you seeing competitively in that marketplace? What is the discussion you're having with customers? I assume you're not getting into the level of the ILECs, but is it people like TW Telecom or Level 3 that you're seeing now that you're moving upmarket?

Rolla P. Huff

Not so much so on the IT services part of the platform. Certainly, we might see them on the occasional MPLS. But I think they're more big pipe-oriented, where we're very much distributed business model-oriented. So we continue to compete pretty heavily with AT&T in that realm. In the IT services, we see CenturyLink because they also have -- they have Savvis. And just individually on an IT service, Rackspace is clearly there. So there's plenty of competition, but there's even more opportunity. And it's important to note that we really try to focus on what we define as the mid-market. A customer that is a $50,000 a month customer, we call that a mid-market customer. I think the AT&Ts and the Verizon would look at them as very, very low end, and they don't even have salespeople assigned to them. They'll sell those customers remotely. So that's how we win there.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

And then in terms of the M&A slide that you had, kind of an update in the slide deck. What I'm hearing out of that in terms of the potential for another large CLEC acquisition. If you saw one, you would still have an appetite for that, but you're not seeing pricing terms in the market that you're comfortable with? Is that a fair way to characterize that?

Rolla P. Huff

I think as time goes on, I would say that we're -- we've become less and less enamored with the CLEC space, primarily because so many of them have the small end of the base. And we just had this conversation about, even though I might like the higher end of their base, the MPLS customers in their base and fiber assets they -- one of them might have, it's just -- this issue of the cable companies at the low end make it increasingly less attractive to us. So I would -- again, it just doesn't pay for guys like me to say never because as soon as I say that, if I had a chance to buy something at 2x EBITDA, maybe I would do that. I don't have that chance -- but -- right now, but -- so I would never say never. But I just -- there's just a wide gap between the value that we see and the value that the owners of these businesses see. And so I just don't see it happening.

Operator

Your next question, from Scott Kessler with S&P Capital IQ.

Scott H. Kessler - S&P Capital IQ Equity Research

I guess 2 questions. There obviously have been a lot of, I guess, queries about the competition on the low end of the business services area. I guess one of the questions that I'm wondering about is, why does it seem like it's intensified so much over the last handful of months? Any kind of comments around kind of the timing and magnitude and how they maybe relate to one another? And then I guess more of a general question on the systems business and why you're choosing to pursue the sale or another strategic alternative for the business at this time as well?

Rolla P. Huff

I think the cable competition has intensified, and I was interested -- there was a large cable company that just announced their results, and I think the fastest-growing part of their business was small -- was their small business services group. I think it was growing at -- I think I heard 26% a year. So they are getting more and more aggressive. There's just no two ways about it. And in my judgment, we can't compete with them on just the price of a circuit. If we can't figure out a way to attach value in other ways, i.e., IT services, I think it's going to be a long hard road with those guys, which is why I'm not looking to buy a lot more of that kind of base. But I do -- I just want to -- I think we need to do a better job of attaching our IT services. We have a meaningful portfolio now. And even at the low end, they should be interested in some of our compliancy products and data backup and hosted exchange now that we have that capability. And I feel like we need to do a better job of attaching those capabilities with those products. As it relates to your question around systems, the answer is really clear. That systems business was really selling old-line PBX systems, and we have now launched a product where we're selling virtualized PBX Hosted Voice. And so it was -- we were actually competing internally with each other, where we had one sales group that was trying to sell them old technology and another group saying, "You don't want the old technology, you want the new technology." So it was just -- it was sort of silly. And then even more importantly, the margins were leaving the business because it is older technology. So that's why we announced 6 months ago that we were going to stop selling it so that we'd stop the confusion in the marketplace. And then we began to look for ways to sell the base that we have, the maintenance base, and I think we're very close to completing that sale.

Operator

Your next question comes from Ankit Sharma with Jefferies.

Ankit Sharma - Jefferies LLC, Research Division

Can you please talk about the competitive landscape that you're seeing in the cloud market? And can you break it down by public, private and hybrid? And how are you competing with the likes of Rackspace, AWS or the other CLECs?

Rolla P. Huff

Yes. It's a great question. The whole secret to what we're doing is that we're out trying to sell a broader solution to a customer. If the customer is already sophisticated enough that they know what they want to virtualize, they -- they're just buying VMs, chances are we're not going to get that deal because AWS is increasingly owning that space. And I think we've talked a lot about that. We won't compete for big VM projects only. The way we win is, we win because we're also providing Tier 1 support, and we're providing connectivity through our MPLS platform that AWS can't talk about. So we're trying to -- and that's why it's the mid-market that's the biggest opportunity for us because they're the ones that don't have the resources to be terribly sophisticated around this. They need help with a broader-based solution. So that's really sort of gets to the very point. I think you've heard us talk in the past that we won't win -- we won't be the best point solution company for really almost anything in our portfolio. We'll win when we can put them together -- the good point solutions in a solution that works for the customer, and where we are spending time in development is our control point technology to bring these various point solutions together in an easy way for our customers. I think that's the way we win and create value. And so is that helpful?

Ankit Sharma - Jefferies LLC, Research Division

Yes.

Operator

Your last question comes from Anthony Klarman with Deutsche Bank.

Anthony Klarman - Deutsche Bank AG, Research Division

Most of my questions were covered, but Rolla maybe a question for you. First, there's been a lot of talk about the CLEC business and the competition that has intensified at the hands of cable. I guess, the thesis around owning the CLEC businesses originally was, clearly, you were -- had to make a decision about how to redirect the legacy business and the cash that it had generated and you acquired assets that had real hard assets and terminal value in the business. I guess I'm wondering if the thesis behind owning the actual CLEC assets themselves has changed? And whether there could be potential room today to divest some of those assets as other consolidators look to consolidate assets themselves and find a more capital-light way of deploying some of the CLEC models that are out there?

Rolla P. Huff

It's an interesting perspective, Anthony. I don't know how much time we should take trying to get into this in a lot of detail, but I think the original thesis behind how we look at this space has held up. We had to be extraordinarily price-sensitive. So remember, I think our blended acquisition cost for these assets were less than 5x. And they were fiber-rich, and we don't see the fiber losing its value. It's really at the low end of the base, and where at the high end of the bases that we acquired are absolutely we're selling into, and we're selling our new services to. But you bring up another question that I think is starting to get some -- at least we're doing some thinking about it, which is the -- how do we get the part of the network that supports that low end more efficient? And I think this is something that all of the folks with bases like this have to be thinking about at the same time. So we're giving it some thought on whether, first of all, we should own that kind of base or that kind of network. And I'm thinking about a colo network. Or how we can get the relative cost of that down? But it's an interesting perspective that we're giving a lot of thought to.

Anthony Klarman - Deutsche Bank AG, Research Division

Yes, I think sort of the line of questions that I've gotten from some folks, particularly on the bond side is, if you look at ITC, for example, because they have their own financials that they report. Colocations are up, voice and data switches are up. Look, you've clearly made investments in the assets since you've taken ownership of them, and that was part of the thesis. But there's pervasive headwind, and so it becomes a question, I guess, of how long are you willing to deploy the same levels of capital intensity if you're not seeing the turn on the top line as quickly as what was anticipated because of the encroachment that cable has had on the lower end? But I think it sort of all ties into that same concept.

Rolla P. Huff

Yes, I think across the competitive environment, you've got an increasing number of companies that are built into colos with not a lot of density in individual colos. And so I think that's something as an industry, we have to solve at the low end. And there are several ways to do that.

Anthony Klarman - Deutsche Bank AG, Research Division

My only other question maybe is for Brad or Rolla for you is, you seem to be back in a similar place where you're thinking about additional investment opportunities again. And you obviously went through a pretty methodical process when you entered the CLEC business, and it seems like you're potentially at another stage in that point. And at the time that you did the CLEC acquisitions, clearly, you were looking at a bunch of other things. And you're obviously looking at other things now and you mentioned some valuations just didn't make sense, but I'm wondering if you'd be willing to be a bit more aggressive with the balance sheet given that you do have now growth products in the portfolio. You do have at least some better stability in some of the core CLEC assets and none of which you had when you made your initial investment. Is there the potential that you would perhaps be a bit more aggressive, not necessarily in valuation, but in the size of the transaction and where you could potentially take leverage over time?

Rolla P. Huff

Oh, gosh, I thought I was basically saying just the opposite. Just so that we're not talking past one another. I think what you heard me say is that, I started with overall how we think about these things, but as I thought as I said, I don't think we need a lot of -- a lot more product capability. I think we've got sort of that portfolio. I'd love to have data centers, but I don't see that happening. Just if they go to half their valuation multiple, maybe we could afford them, but as it stands right now, we're trying to build our solutions around virtual platforms that aren't just data center-dependent. I think I've said that, certainly, price is much lower than what people are looking for. We'll always been interested in customer bases, but increasingly, the more intense the cable competition, the harder it is for me to put -- I think the values are going down. They're not actually -- that we'll assign to the CLEC types of models, they're going down. They're not coming up. And so, I think that the deals that you will see us do will be very reflective of the last 7 or 8 where we don't spend a lot of money on them, and they're more tuck-ins. But even that, if you look at the last 6 or 7 deals that we've done, they've been done so that we can create the product portfolio that we now have and are feeling pretty satisfied with. So unless we're buying customers that we think we can get good cost synergies out of, I think we're where we want to be in terms of platform.

Well, I'll close the call. I just want to thank everybody for listening and for your continued support. Clearly, we're excited about the new markets that we've opened up for ourselves and the growth business that we're building. We continue to have considerable financial strength, and we believe we're on a solid path to create value. So thanks again for joining us this morning and take care everybody.

Operator

This concludes today's conference call. You may now disconnect at this time.

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