Windstream's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Nov. 7.13 | About: Windstream Holdings, (WIN)

Windstream Holdings, Inc. (NASDAQ:WIN)

Q3 2013 Results Earnings Call

November 7, 2013 8:30 AM ET

Executives

Jeff Gardner - President and CEO

Brent Whittington - Chief Operating Officer

Tony Thomas - Chief Financial Officer

Brent Whittington - Chief Operating Officer

Bob Gunderman - Senior Vice President and Treasurer

Analysts

David Barden - Bank of America

Scott Goldman - Goldman Sachs

Barry McCarver - Stephens

Simon Flannery - Morgan Stanley

Phil Cusick - JPMorgan

Batya Levi - UBS

Timothy Horan - Oppenheimer

Donna Jaegers - D.A. Davidson

Michael Rollins - Citi Investment Research

Operator

Good day, ladies and gentlemen. And welcome to the Windstream Third Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator instructions)

As a reminder, today’s conference call is being recorded. I would now like to introduce your host for today’s conference, Mr. Bob Gunderman, Senior Vice President and Treasurer Mr. Gunderman, please begin.

Bob Gunderman

Good morning and thank you for joining Windstream’s third quarter earnings call. To accompany today's call, we have posted the presentation slides, earnings release and supplemental pro forma results on our Investor Relations website.

I would like to draw your attention to our Safe Harbor statement on slide two. Today's discussion will include statements about expected future events and financial results that are forward-looking and subject to risk and uncertainties. A discussion of factors that may affect future results is contained in Windstream's filings with the SEC, which are available on our website.

The presentation also includes certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measure are available on the Investor Relations section of our website.

Turning to slide three. For the third quarter, we reported earnings of $0.05 per share on a GAAP basis, which includes an after tax loss on the early expansion of debt, merger and integration and restructuring and other expenses.

Excluding these non-operational charges our adjusted EPS would have been $0.08. For the remainder of the call, the quarterly growth rates discussed today are presented on a pro forma year-over-year basis unless otherwise noted.

Turning to slide four, participating in our call this morning are Jeff Gardner, our Chief Executive Officer, who will discuss our 2013 priorities; Tony Thomas, our Chief Financial Officer, who will discuss our financial results; and Brent Whittington, our Chief Operating Officer, who will review our operational results. At the end of the presentation we will take a few questions.

With that, here is Jeff Gardner.

Jeff Gardner

Thank you, Bob, and good morning, everyone. During the quarter, we continue to focus on improving our sales execution and winning in the marketplace. Our team was able to grow business revenue by 1% despite a softer sales environment and grew consumer broadband revenue by 4%. This combined with declining capital expenditures and lower cash interest expense resulted in strong free cash flow generation during the quarter.

As we’ve often said, it is our vision to be the premiere enterprise services provider while maintaining our stable consumer business. I’m very proud of the work we’ve done to achieve this transformation evidenced by the change in composition of our revenues. When we were born seven years ago, business revenue comprised roughly one third of total revenue. Today business revenue represents 61% and is now a $3.8 billion annual revenue stream.

We’re continuing to evolve and improve the business and are focused on three key areas to advance our goals. First, enhancing our business capability, second, investing in strategic opportunity and third, strengthening our balance sheet.

On slide five, I will review our progress in achieving each of these objectives. First, we are making investments to enhance our business capabilities and increase sales and profitability. Since 2010, we have increased our data center footprint to 26 centers through acquisition and organic investments.

This expansion has been indirect response to increasing demand for data center and cloud-based services, which naturally compliment our full set of advanced network and communication solutions.

In addition, we are working to reduce our network costs and simplify our enterprise system to increase deficiency which will drive operating leverage as we grow business services.

Our second objective, to invest in capital, in strategic opportunities, also we are showing solid progress. In particular, we are making strategic success-based network investments to expand our fiber footprint and facilitate growth opportunities. We invested roughly $550 million over the past few years to expand our fiber to wireless towers.

This investment have been enabled us to meet the growing data needs of our wireless carrier partners and has also augmented capacity within our core network. The work on this project is ramping up and the associated CapEx is declining.

In addition, we are pursuing attractive investments within our consumer network related to stimulus and the first phase of the Connect America Fund or CAF I investments. We have applied for $60 million, allocated to Windstream in the second round of CAF I, as well as an additional $64 million from the unused funding carried forward from the first round.

The [FTC] is reviewing our application and we expect the decision could be made as early as the fourth quarter on the final amount to be allocated to Windstream. These investments which Windstream will match over a three-year period will expand availability and increase broadband speed, allowing us to remain competitive in this rural market and generate incremental revenue opportunities. Taken together, these investments will enable us to better serve our customers provide opportunities for future growth.

Finally, to advance our third objective, we have improved our balance sheet, we completed refinancing during the third quarter, which extended certain debt maturities and will generate cash interest savings of approximately $45 million in 2014. In addition, we paid down our revolver balance by roughly $100 million.

We are confident in our strategy and vision, and believe that our strategic initiatives will drive further improvement in the business and position us for continued success. Windstream generate substantial free cash flow that is supportive of our capital allocation strategy, which strike a prudent balance among reinvesting in the company, paying an attractive dividend and reducing our debt overtime.

With that, let me turn the call over to Tony who will discuss our financial results.

Tony Thomas

Thank you, Jeff, and good morning, everyone. Turning to slide six, we delivered growth from the business channel along with steady consumer results. This helped to offset the wholesale decline, which were due to the second step down in intercarrier compensation rates.

Total revenue in the third quarter was $1.5 billion, down 3%. On a sequential basis, total revenue declined slightly by $2 million. Business service revenue was $916 million, up $10 million or 1%. Overall, our business growth rates slowed moderately during the quarter. This was in line with our revised expectations, which reflected the slower start in sales we experienced earlier this year. Looking at the components of business revenue, data and integrated services increased by $18 million or 5% due to growth in integrated voice and data and data center services.

Carrier revenue increased $7 million or 4% driven by our fiber to the tower installations or partially offset by weakness in carrier transport services. Business voice and long distance revenue declined by $17 million or 5% due to customer migrations from traditional Voice-to-IP services and declines in usage. This was partially offset by an increase in a customer access charge by the inter-carrier compensation reform. The consumer channel delivered consistent results, the service revenue at $324 million representing a decline of 3% year-over-year.

Voice and long distance revenue declined $15 million or 8% due to fewer voice lines. This was offset partially by an increased in broadband revenues of $5 million or 4% driven by increased sales of broadband features and faster speeds. Wholesale revenues were $148 million down 19% primarily due to switched access revenue declines of $32 million resulting from lower interstate access rate and fewer minutes of use.

Correspondingly, USF revenues increased by $3 million due to new recoveries implemented to mitigate the transition to lower inter-carrier rates. Product sales were $56 million, lower by $4million. This decrease was primarily due to a decline in sales of network equipment to contractors and directly related to the year-over-year decrease in our capital expenditures

On Slide 7, total cash expenses decreased by approximately $25 million or 3%. If we continue to improve our cost structure and are making meaningful progress on lower interconnection expense, which will help our operations scale as enterprise services grow. Specifically cost to services decreased by $29 million or 4% due primarily to network grooming and cost initiatives driving lower inter-connection expense, which was partially offset by higher datacenter expenses related to expansion.

Cost of products sold decreased by $9 million, consistent with lower product sales. SG&A expenses decreased $13 million or 6% due in part to increased business sales expenses related to the datacenter expansion I just mentioned as well as other miscellaneous corporate expenses. Adjusted OIBDA was $575 million which was down 3% year-over-year and the adjusted OIBDA margin was 38%. Sequentially, adjusted OIBDA decreased by $8 million. We are making solid progress on our capital initiatives shown on Slide 8.

During the third quarter, we spent $187 million on adjusted capital expenditures. This included $149 million in recurring CapEx which contains our regular maintenance capital as well as growth initiatives such as fiber deployment, datacenter and broadband expansion and success based enterprise opportunities. We also spent $39 million on fiber to the tower projects and the company’s portion of broadband stimulus investments.

To date, we have completed 4200 towers and we have another 600 in progress. We expect both of these projects to significantly wind down as we exit 2013. In addition, we spent $6 million in integration capitals. On Slide 9, adjusted free cash flow was $264 million which reflects a $33 million reduction in CapEx as our elevated capital investment period is now declining. During the quarter working capital continues to improve and was a source of $17 million.

Turning to the balance sheet accomplishments on Slide 10; we retired the $800 million 2013 notes with proceeds from our revolver. Just provide the flexible way to reduce debt over time while resulting in significant cash interest savings. In addition, we refinanced our 2019 notes allowing us to extend maturity for two years at an attractive rate. During the quarter, we paid down $100 million of our revolver borrowings and approximately $550 million available under the facility. We ended the quarter with net leverage of 3.7 times adjusted OIBDA.

Turning to the full year, we affirm our 2013 guidance. Total revenue is tracking to revise guidance range provided last quarter. In addition, combined with our cost management initiatives, we expect to reach the low end of our previously provided adjusted OIBDA and free cash flow guidance ranges.

We are nearing the end of an elevated capital investment period and our refinancing actions will provide approximately $45 million in cash interest savings in 2014, both of which should help mitigate in increased taxes. As we look forward, we continue to expect this business to generate substantial cash flows supported by the dividend and we remain focused on creating our returning value to our shareholders.

With that, let me turn the call over to Brent to provide more color on our operating results.

Brent Whittington

Thanks Tony and good morning everyone. Let me begin with some of the business channel highlights. During the quarter, we grew business revenues by $3 million sequentially. Although the year-over-year growth rate slowed due to the softer start to the year, our team is working hard to improve sales progress and renew enterprise opportunities in the market place.

Our business brand is based upon differentiating our services by providing customized, innovative product to drive efficiency and productivity for our customers. In addition, we’re taking steps to improve our performance by investing in growth areas, such as data center expansion and we remain focused on improving sales execution to increase our share of enterprise customers.

Turning to Slide 12, during the quarter, average service revenue for our business customer were 5% year-over-year due to growth in IP-based solutions. In addition, we are expanding our business relationships with increased sales of managed services and cloud computing solutions, which drive incremental revenue and improved margins.

Enterprise customer locations grew 6% year-over-year, driven by both new customer additions and increased sales to existing small businesses, elevating their customer status to the enterprise level. Small business customers overall declined by 9%, primarily due to the migrations I mentioned as well as economic-related business closures and competitive pressures. The majority of our small business customer disconnects continue to be in our CLEC market while our sales focus is on larger enterprise customers.

Carrier circuit declined by 1000 sequentially or 10% year-over-year, largely related to migrations from traditional TDM circuit to our fiber network. Fiber provides the needed capacity more efficiently resulting in fewer connections but is positive from a revenue perspective and in total, carrier revenue increased 4% and ARPU grew 15% year-over-year.

Turning to our consumer channel on Slide 13, consumer lines decreased by approximately 31,000 and high speed Internet customers declined by 11,000, a result of our already high penetration rate of 72% of household with voice services. Given the tight penetration, we are focused on balancing unit performance with overall profitability.

Despite broadband customer losses, we grew broadband revenue by 4% by selling vertical services and faster speeds to both our existing base as well as the new customers. Vertical services bundles includes security package with virus and identity theft protection, online backup and tech health that add between $10 to $20 per month of incremental ARPU to our base products.

In additions, approximately 60% of new customer additions are electing to take faster broadband speeds, which increases ARPU by 5% on average. We believe we have several opportunities to grow broadband ARPU and we’ll continue to protect our broadband household and further enhance our opportunities with the capital line and stimulus investments.

In summary, our operational results in the third quarter show we’re continuing to make progress in attracting new enterprise customers and winning a larger share of our customer’s business with our full suite of product and services.

The Windstream team is working hard to reach our goals while making steady progress on improving our cost structure and consolidating our systems to provide greater scale in the future. We are focused on the right initiatives to drive improvement in the business and position Windstream for continued success.

We’ll now take a few of your questions. Operator, if you could, please review the instructions and let’s open the call to questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question is from David Barden of Bank of America. Please go ahead.

David Barden - Bank of America

Hey guys, good morning. Thanks for taking the questions. A few if I could. Just first, maybe Tony on reiterating the goal to get to the low end of the guidance range, especially look into EBITDA number. It looks like we’ll have to have roughly a sequentially flat EBITDA quarter in 4Q after three sequential declines. Could you talk about kind of what the moving parts are that give you the confidence that we’re going to see something flat maybe better than that in 4Q like the billing system savings or incremental CPE benefits, those sorts of things.

Second I was wondering just as a result of the inter-career compensation in third quarter step down, could you kind of tell us the mix of how consumer run business maybe benefited from recovery charges in the quarter sequentially versus kind of what got hit maybe in wholesale or regulatory. And then the last thing I guess would just be, maybe Jeff if you any color or perspective right now on where government sits on bonus tax depreciation fiscal stimulus generally and where their heads at, is it a focus? So I’m imagining it’s a focus for Windstream, but do we get (inaudible) kind of your color on what’s happening inside the ball way there. Thanks

Jeff Gardner

Right, thanks David.

Tony Thomas

Good morning, David. I’ll start with your first question on the adjusted OBITDA guidance. Yeah, we do feel confident, we’ll -- would be at the low end of our adjusted OBITDA guidance. Year-to-date, we’re down 2%. And if you look to the fourth quarter, there are a couple items that we do believe we’ll kind of be beneficial to the cost structure. First, we do see a seasonal decline in our costs, typically 3Q has higher operations, engineering costs and principally associated to weather, and that typically lessens into 4Q.

The other item is quite notable is interconnection expense. We continue to expect to make progress driving our interconnection expenses down from 3Q to 4Q given that we’ve recently gone through a significant sourcing review for interconnection. Those are really the two principle elements that look from improvement of 3Q and 4Q, of course we need very good execution as we always do every quarter across the sales organization.

Turning to your second question on inter-career compensation, and I think we noted all year, we do expect roughly $20 million of or without pressure in 2013 associated with inter-career compensation. And right, if you go from 2Q to 3Q, we did see the second step down from interstate to interstate for all the switched access rates in Windstream on determining access side or at the interstate access rate. And that provided pressure of -- call it $5 million to $6 million and that is partially offset by the increase you see in USF, approximately $3 million and then I would describe it as approximately we were able to benefit from roughly $3 million increases spread across the consumer in business and we would call the access recovery charge.

Jeff Gardner

Great, thanks. And David, this is Jeff. And just on the wholesale expenses relative to west going down. If you recall from the ITC reform, we’ve now stepped down to the interstate rate. For Windstream, the relative effect on revenue is greater than some of our peers just because of the nature of our rural market just keep that in mind. And our bonus depreciation, Windstream along with our trade associations mostly U.S. Telecom and other leading broadband providers are all urging congress to extend bonus depreciation in the calendar 14. We’re not counting on it or planning on it, but policy makers have used extensions of bonus depreciation to incentivize investments previously. We think this would be a good time to do it again especially with where we’re at with respect to the reform of the overall tax policy. That’s clearly not going to get down this year. This would be a nice bridge as we look at a more broad advancement of the US tax policy -- corporate tax policy.

David Barden - Bank of America

All right, thanks sir.

Jeff Gardner

You’re welcome.

Operator

The next question is from Scott Goldman of Goldman Sachs. Please go ahead.

Scott Goldman - Goldman Sachs

Hey, good morning guys. I want you to talk about the business services side where growth slowed a bit. This quarter, you guys laid out some of the impacts on the last quarter call that would be driving that. Just reaching the last I think in the last quarter you targeted about a 2% growth for the full year, which would imply you will have to sort of step up into the mid-2% range for 4Q.

And, Jeff, I think in the past you’ve talked about this business targeting sort of a 3% growth range. So, curios as you sort of come out of this quarter with where we are in the macro and where you guys are from an execution side, how you think about the growth of this business, both as a potential rebound in 4Q and then sort of longer-term in ’14 and beyond and what the growth capabilities are there?

Brent Whittington

Scott, this is Brent. I’ll start by answering the question and Jeff and Tony can jump in as appropriate. But, first off and we have seen a softer business sales environment really at the beginning of this year and that what led us to lower some of the revenue guidance last time. As Tony mentioned, revenues were kind of line in with our expectations this quarter but maybe from a sales perspective, in Q3, we did see some modest improvement, not to the levels we were shooting for earlier this year but it was our best sales quarter of the year, which is good. We are clearly taking steps to try to get back to the growth we planned on, which is building off of 2012 levels. We are still seeing sales above ’12, which was a great year for us but not growing as fast as we hope this year.

The things we are continuing to do to accelerate that to get back to that trend line that you mentioned is really stepping up our focus in growth areas. We specifically spoke to data center, we more than doubled our sales team this year and continue to have great success and certainly year-over-year and then sequentially in addition, really stepping up the training that we got in our sales team, trying to increase our share of new buyers and then secondly really increasing your sales to existing customers by focusing on other services. We think a couple of those things can really help, really get back to what growth levels we think in the past.

Jeff Gardner

And, Scott, our long-term view of our opportunity in current phase has not changed. We still believe in it. We are building our capabilities every day. So, Windstream is going to continue to get better. Brent mentioned some of the specific things we're doing. In addition to that, network integration, systems simplification, focus on customer satisfaction, all of these initiatives are going on full steam ahead at Windstream to support our sales channel to drive those better results that we are looking for in the future.

Scott Goldman - Goldman Sachs

Great. Thanks, guys.

Operator

The next question is from Barry McCarver of Stephens. Please go ahead.

Barry McCarver - Stephens

Hey. Good morning, guys and thanks for taking my question. I guess first off, can we just think broadly about free cash flow in 2014 versus this year? I know you don’t want to give any kind of specific guidance yet, but looks like CapEx will be down as you finished these tower projects. You paid down some debt, refis and others and in all likelihood, taxes will be up minus the bonus depreciation outside of that, kind of your thoughts on what that’s going to look like next year?

Tony Thomas

Barry, this is Tony. I will take your question and again, we do think it probably is premature to provide specific guidance around 2014. As I mentioned earlier, you're correct, we do expect our fiber-to-the-tower investments and our portion of broadband stimulus investments to wind down. We’ve been making significant progress on the balance sheet and we do believe the combination of those two will help offset the increase in cash tax that you alluded to. But at this point, we think it would be inappropriate to provide further guidance for 2014. We will try to provide wholesome update on 2014 in February.

Jeff Gardner

And importantly, Barry, this is Jeff. You see evidence of two of those big initiatives, specifically on the CapEx with the improvement that we this quarter and the refinancing activities that we undertook to help drive those interest expense savings that we expect to offset some of the tax increases next year.

Barry McCarver - Stephens

Great. That’s helpful. And then I guess secondly, are you feeling any pressure on special access rates I know the [bigger box] have been maneuvering to push those up a little bit?

Jeff Gardner

Barry, to date, we have not seen the pressure. You are right. There is a proceeding as part of the FCC associated with some tariff changes that are being requested by AT&T and we continue to monitor those developments and we can provide our inputs to various groups that that we think help and ensure that Windstream has the ability procure special access at appropriate prices.

But importantly as we look forward, special access is an older technology and as we talk about the services we are now selling, we’re selling much more Ethernet based and IP services that are not under these special access rules. And our datacenter services of course a big growth area for us simply leveraged the connectivity of our own fiber as well as the Middle East in the last mile for Ethernet purposes. So we feel like we’re monitoring the situation closely. But the business is evolving away from those services and we expect frankly that evolution to accelerate as we look beyond 2013.

Barry McCarver - Stephens

Okay, that’s helpful. And then I guess just last question and then I’ll let somebody else come on. You mentioned either (inaudible) and datacenter services a couple of time. Can you break out what the revenue component of that is and how big is that and then what was the growth in the quarter? Thanks.

Brent Whittington

Okay. We just don’t break that out separately. I can tell you when you start looking at our business revenue growth it’s a significant piece of that. In totality though datacenter services for us is just around $100 million and we’re seeing nice growth there and continuing to open new centers. We’ve got three that we’ve opened this year recently in the third quarter, both national and Chicago, nice year-over-year in sequential sales momentum as I mentioned. And that’s one of those that we just want to continue to care and feed for, make the bigger part -- discussion with our customers by really teaming with our network sales team along with our datacenter sales team to bring solutions to our customers and we’ve been very happy with how that has gone for us overall as the company.

Jeff Gardner

And Brent, if you recall, we acquired Hosted Solutions in 2010, a small company based in North Carolina. At the time, they had four datacenters. As Brad mentioned in his remarks, we’ve increased that to 26 the way that team has stayed together, that original management team and helped drive our datacenter strategy as a real success story. I think what the sales team is doing particularly well at Windstream is we can bring to bearer one stop shopping, selling equipment network and datacenter as well as anyone in the industry.

Barry McCarver - Stephens

That’s very helpful, thanks guys.

Operator

Our next questioner is Simon Flannery of Morgan Stanley. Please go ahead.

Simon Flannery - Morgan Stanley

Thanks so much, good morning. Just coming back to the CapEx, there was a helpful slide on Page 8. I wanted to just understand more of what's recurring CapEx is looking like. You have 10% this quarter. I mean usually, I think, outside plant and so forth Q3 is a higher maintenance CapEx kind of quarter. A year ago, it was 13%, the year before that it was 12%. So what do you think is sort of a steady state range and was this sort of abnormally or are we hitting some new levels here at 10%, is that something that can be sustained?

And then if we can just come back on the business side to the software sales environment, I think you referenced a lot about the pressures early this year. How did it go in the last sort of three months or so? Has it been a pick up or are you still sort of seeing a little bit of softness there? Thanks.

Tony Thomas

This is Tony. I’ll start this off on the CapEx discussion and turn it back to Brent to talk about the business sales environment. You are correct that we are benefiting in the first nine months of 2013 really from a significant sourcing initiative that we undertook in the later part of 2012. So we could buy goods and services more cost effectively. We are not changing our overall view on capital intensity of 11% to 13%. But in the near term, we have benefited from those sourcing actions and that really is the principal driver of the decline in CapEx intensity.

Simon Flannery - Morgan Stanley

Is that like, that you’re agreeing to buy larger volumes or what was that?

Tony Thomas

Yeah, definitely it was thoughts on negotiations with all of our vendors and not, I would say, we did not provide significant commitment, we simply went through a varied tail sourcing to make sure we had the right network so we could support the business services over any of the coming years. Sort of on the business, I mean I kind of mentioned -- actually third quarter was our best sales quarter of the year. So we did see some improved momentum, still not quite to the growth levels we hope as I indicated.

But building off, it was such a great 2012. So we’re still growing, but just not at the rates we anticipated early in the year. You might remember we talked early this year about adding sales headcount. That really just hasn’t come to fruition because we were doing that as we began to see success in certain areas and we’re just not getting to the growth levels we anticipated early on. But I’m pleased with what we’ve done in the third quarter and we’re trying to just build from there and excel the rates of momentum on that front.

Simon Flannery - Morgan Stanley

Is it you’re not adding the sales heads or you’re not getting the productivity added, the sales heads you added?

Tony Thomas

I would tell you the productivity levels aren’t really need them to be yet. The sales heads that we are adding are in areas where we’re having tremendous growth like data centers specifically that I mentioned before.

Simon Flannery - Morgan Stanley

Okay. Thank you.

Jeff Gardner

Welcome.

Operator

The next question is from Phil Cusick of JPMorgan. Please go ahead.

Phil Cusick - JPMorgan

I guess on the consumer broadband, I wanted to talk about a little bit of subs we talked about, you are losing subs there, but much more focused on revenue, but even that seems to be decelerating a little bit? Can you talk about where penetration is, things like the price ups and security uptake and whether we should expect that to reaccelerate from here? Thanks.

Jeff Gardner

Yeah. Thanks Phil. Remember I think overall our strategy has been to focus on cash flow and profitability in that channel. And so where we do, we have seen some pressure on units, we are taking a measured approach to manage the migration down in terms of pricing our way. So, what we did this quarter was, we have aggressive promotions in our most competitive markets but in those that are less competitive, we don’t have that same discounting.

As far as future opportunities, there is definitely still opportunity, we are continuing to improve our network, improving speed, building out a stimulus market, the cap markets in front of that, that will allow us to continue to gain there.

We talked about our penetration rates on -- I don’t think we gave specific penetration rates on the added services, where we are selling those they are adding about $20 a month for our customers and we have very good opportunities to increase that percentage.

Our strategy all along as once we get to the penetration rates that we have achieved, which around 70% of all of our lines have our broadband services then we really start monetizing the broadband types into the homes and our teams have been very effective. So we expect a lot of future success there as well.

Phil Cusick - JPMorgan

Can you give us any sort of rounded numbers on the penetration of other increased speed take up and home security product?

Jeff Gardner

Well, just, not on the home security. I don’t have that number with me. But in terms of increased speeds 60% of our customers are signing up for 6 meg and above, and that’s a big improvement over last year.

Phil Cusick - JPMorgan

Thanks.

Jeff Gardner

You’re welcome.

Operator

The next question is from Batya Levi of UBS. Please go ahead.

Batya Levi - UBS

Hey. Thanks. Couple of questions on the EBITDA and margin side. Can you talk about there were any one-timers in EBITDA, any true-ups. I think you mentioned a $3 million on the USF side. And just looking for a long-term on the EBITDA margins outlook, how do you balance leasing and/or owning the last fiber mile that you mentioned and if you could provide a little bit more color on the network grooming initiative and how that will impact margins going forward, and maybe just lastly an update on the billing conversion? Thanks.

Jeff Gardner

Batya, I will start this off on the USF and take the EBITDA question and then turn it over to Brent for your last question. And to be clear on USF, we did see an uptick but that’s part of the intercarrier compensation reform plans. So we did expect to see the arm grow sequentially and we do expect that to continue from 3Q to 4Q, but you shouldn’t look at that as a non-recurring item.

I would tell you when we looked at the rest of the financial statements, there is various puts and takes, but frankly nothing significant in our third quarter results. When you look at EBITDA and you start thinking about where the larger components of our expense structure, you are right to focus on interconnection. And as we evaluate how we access our customers, we use various methods, but the most common one is we leased the last mile from either the ILEC or competitive access provider.

And increasingly, we have been leasing those over Ethernet versus special access as we talked about earlier and we were able to do that very cost effectively to complete, because we you continue to see fiber fighters extending more and more options into buildings. But admittedly that’s ultimately where we didn’t focus from a sourcing perspective as well as to make sure we are procuring those services as effectively as possible.

And the network grooming is really just a kind of a continuation because we expand our network. We look for opportunities to take circuits where we are paying a third-party and bringing those on to our network. And that’s been a consistent plan of Windstream. We have basically various initiatives each year to help us get better economics across our network. And I would say at this point, we are entering kind of a normal course approach to network grooming, but we expect to continue to see benefits from that in the remainder of ‘13 as well into ’14.

Brent Whittington

And Batya, this is Brent. The conversion networks, we are referencing are really in broader than just billing conversions and it’s been kind of a long term goal to really roll out a suite of systems and improve our ability to provide not only a better customer experience, but a much improved, just ease of doing business within Windstream, serving our business customers. So every single quarter we're having I'd say improvements in our system's environment and due to this iterative, it's kind of rollout process of this effort.

We do have more of the billing components to that plan for 2014 and then they'll ripple through with some last pieces in the 2015. But we are getting better kind of consistently along the way. We're very pleased with those efforts, those we always have to pay special attention to, but importantly, we think we're really building something that's going to improve our capabilities in the future and that remains a big part and our focus is to certainly hand our team here at Windstream.

Batya Levi - UBS

Just putting everything together, would you expect margins at these levels to make it stabilize, given all these initiative ?

Jeff Gardner

Yeah. We continue to work towards improving our margins, like a whole of Windstream each and every day. And that will remain our focus, is to improve our margins. And these are some of the ways in which we’re going to be able to do it.

Batya Levi - UBS

Okay. Thank you.

Operator

The next question is from Tim Horan of Oppenheimer. Please go ahead.

Timothy Horan - Oppenheimer

Thanks, guys. Could you give us some color on what your average customer pays for voice services? Secondly, are you seeing the cable competition ramp-up, I guess (inaudible) talked about something about $50 promotion, I know. By the time you take to the modem it’s probably up in the mid-20s and everything else, but if you are much overlap there -- and then last, I guess Jeff you must be -- it sounds like you’re fairly confident on stability on revenue and EBITDA, you’re done a lower CapEx. Just because we’ve seen a lot of your peers -- I’ve seen on the datacenter side, (inaudible) side and seen it in many, many different segments of the market when service providers cut their CapEx, it does tend to hurt their revenue growth quite a bit. If I guess and it’s the last point, what have you been seeing in terms of success based CapEx, how does that kind of translate the success based revenue. Thanks.

Jeff Gardner

Well, Tony you want to take the first part.

Tony Thomas

Yeah. In terms or what customers are paying for voice services, Tim, I would describe it that really we’re anchoring all of our services around IP and data and voice is really simply an add-on service. But typically customers are buying a bundle of services from Windstream, so there's not necessarily what I call a specific voice only ARPU on a lot of our customer's bills, but obviously it's an integral service that we provide especially to our business customers, but that’s been in the value package.

Tony Thomas

And we still have a very attractive rate. When you look at the double pay bundle, it’s very attractive relative to the competitive players in our space. And as you know, one of the things that we’ve got a lot attraction with over 50% of our broadband customers on our price (inaudible) products that really differentiates us from cable.

On the CapEx side, we feel like that 11% or 13% range will allow us to make the success based capital investments that we need to. When you look at our CapEx, over the last couple of years, it's been harder than that, but as we said earlier in the call Tim, those specific success based opportunities, specific to fiber to the tower and stimulus and then we’ll have some Capone in there next year. Our discreet, the fiber to the tower and stimulus are nearly complete, you can see that decline in our CapEx going forward. So we think that a 11% to 13% range given our unique hybrid approach to deploying to our customers in the market place is going to continue to be sufficient for us going forward.

Timothy Horan - Oppenheimer

Thanks, guys.

Operator

The next question is from Donna Jaegers of D.A. Davidson. Please go ahead.

Donna Jaegers - D.A. Davidson

Hi guys, thanks for taking the question. Specifically on your broadband stimulus builds, when do you expect to start marketing to those households, obviously frontier is seeing really good take rates from new households since they’ve never had broadband as a big option?

Brent Whittington

Donna, this is Brent. I mean, we’re marketing to them as soon as those sides are turned up. And we’ve got very close linkage between our engineering team and then our marketing team. Just a few of those has been really completed and actually activated here in the quarter. And they'll begin stepping up in the fourth quarter. We’re much of the outside plan and the true construction is completed and you continue through really the first six months and next year for the most part. We really activate all those slides and (inaudible) began actively marketing those customers.

But then I don’t know if that’s what frontier is seeing, but our early view is, yes, it absolutely represents opportunity for us and as we think about the next frontier for broadband growth in terms of customer opportunity is our biggest and we will remain totally focused on them.

Donna Jaegers - D.A. Davidson

And it's at least 35,000….

Tony Thomas

When you look at our result, just keep in mind the penetration rate is relatively higher than most in the space and so that's affecting us. We are taking full advantage of the seamless opportunities as Brent explained but doesn't show up as much in the net as it might with some others.

Donna Jaegers - D.A. Davidson

Okay. Then one other question for you Jeff, obviously when you embarked on the sort of convert mode to business revenues and buy some CLECs, cable guys were not as aggressive as they are in the space right now. Cbeyond yesterday had really lousy results, what's your appetite for any further acquisitions in that small business CLEC space?

Jeff Gardner

Well, without commenting on any specific acquisition targets, I mean, let me just talk about how we feel about the business market in general. Our sweet spot is really more of multi location Fortune 2000 that's kind of our target area. Our sales force has been moving up in terms of customer revenue size from the -- over the last couple of years. And so our strategy has always been around differentiation.

Cable is doing much better on the low end micro SNB side, very simple application, where we need to focus and our focusing to be successful is more in managed services, where we can add some value and differentiate. In our CLEC markets, especially that's where our sales rep spends all of their time.

Donna Jaegers - D.A. Davidson

Just one quick follow up on that Jeff, earlier Tony I think threw out a $100 million number for revenues in data centers, that's an annual number, right, not quarterly?

Jeff Gardner

Yes.

Donna Jaegers - D.A. Davidson

Okay. Thanks.

Jeff Gardner

Operator, we have time for one more question, please?

Operator

The last question will be from Michael Rollins of Citi Investment Research. Please go ahead.

Michael Rollins - Citi Investment Research

Hi. Thanks for taking the question. Just wondering, you’ve addressed, I think some of these points along the way of the call, but if you only give us the sense of timing for when -- whether it's on the revenue side, where you see more turn there or you are able to get through more of the efficiencies on the cost side, how far away is Windstream from being in a position to grow EBITDA on a year-on-year basis -- year, two years, is there some time that you guys have and maybe, what are the key things that we just have to be watching for, kind of, the leading indicators, how we are getting closer to that fraction? Thanks.

Jeff Gardner

Michael, thanks for the question and I think it’s the right question because how we think, how can we get there, when will we get there, we can't be specific on the timing. What we are looking to do is improve each and every quarter. We think we’ll continue to make improvement in the revenue going forward. We’re trying to drive as hard as we can on the operating leverage side, that will be help to a lot as we work through some of the systems integration as Brent mentioned earlier.

In addition, when you look through 2012 and ‘13, not only are we going through this tremendous transformation from consumer to business but the intercarrier comp impacts are greatest in ‘12 and ‘13. And so as we move away from those, the revenue comparisons get better and that too will help.

So it’s a focus over the next several quarters, the drive is there gradually overtime, getting revenue better, doing these things on the operating leverage sides to improve the profitability of the business and managing towards this revenue mix that we’ll have going forward.

Michael Rollins - Citi Investment Research

Thanks very much.

Jeff Gardner

You are welcome.

Well, thank you for joining our call this morning. I just wanted to conclude with a few comments. During the third quarter we grew strategic revenues by 1% and maintained consistent performance in our consumer channel, both of which helped overcome wholesale pressures related to regulatory reform. We continued to focus on improving our sales executions and winning in the marketplace to allow us to achieve our goals that we have set forth for 2013 and beyond.

We are confident in our strategy and ability to achieve profitable growth in our strategic areas of business and broadband. At the same time, we continue to improve our cost structure. We believe this focus will continue to produce strong and sustainable free cash flow which supports our dividend. Thank you again for joining us this morning and for your interest in Windstream.

Operator

Ladies and gentlemen, thank you for participating in today's program. This does conclude the presentation and you may all disconnect. Everyone have a great day.

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