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EarthLink Inc, (NASDAQ:ELNK)

Q3 2010 Earnings Call

October 26, 2010 8:30 am ET

Executives

Brad Ferguson - CFO

Rolla Huff - Chairman & CEO

Joe Wetzel - COO

Michele Sadwick - VP, Corporate Communications

Louis Alterman - VP of IR

Analysts

Ingrid Chung - Goldman Sachs

Youssef Squali - Jefferies & Co

Sri Anantha - Oppenheimer

James Cakmak - Sidoti & Co:

Mike Crawford - B. Riley & Company

Donna Jaegers - DA Davidson

Scott Kessler - Standard & Poor’s Equity

Operator

Good morning everyone and welcome to the EarthLink Third Quarter 2010 Earnings Conference Call. Today’s call is being recorded. At this time I would like to turn the conference call over to Mr. Brad Ferguson Chief Financial Officer for opening remarks and introductions. Please go ahead sir.

Brad Ferguson

Thanks and welcome to our call. This morning I’m joined by EarthLink’s Chairman and CEO Rolla Huff, our President and Chief Operating Officer Joe Wetzel, our Vice President of Communications Michele Sadwick and our Vice President of Investor Relations Louis Alterman to discuss our third quarter 2010 results and 2010 guidance. Following our comments there will be an opportunity for questions.

Before we continue I’d 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 risk 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 the 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 matters. For details on these measures including why we use them and reconciliations to the most comparable GAAP measures please refer to our earnings release in the form 8-K that has been furnished to the SEC, both of which are available on our website at www.earthlink.net.

Now I’ll turn things over to Rolla.

Rolla Huff

Thanks, Brad and good morning everyone and thanks for joining us today to discuss our third quarter results.

We certainly had an exciting quarter and today I will share three important updates with you. First we will talk about the ongoing stability and cash generation from our consumer business. Second, I will give and update on continued traction we have seen out of New Edge Networks, that enabled the top-line in our business segment to grow sequentially this quarter and third we will end with a discussion of the recent announcement of our Deltacom acquisition and EarthLink’s transition to a leading IP infrastructure and services company.

First, lets start with our consumer business. We had another solid quarter. We reported $51 million in adjusted EBITDA and three years after we restructured the business the consumer business remained healthy, generating $48 million in free cash flow in the quarter.

First, adds this quarter were strong as we added 77,000 new customers. While that is down from a 108,000 a year earlier, its up over 10,000 from Q2 of this year. Cable adds were particularly robust and over 70% of our customer added were on the broadband product platform.

Our average monthly churn rate was 3% in the third quarter. That’s down nearly 20% from the 3.6% we reported a year earlier and up about 5 basis points over Q2, partly due to seasonality and partly due to the early impact of our strong gross add performance.

Next subscriber losses for the quarter was 95,000, down from 109,000 in the second quarter this year and 35% less from the 146,000 loss year earlier. I said many times on this calls absent to material change and historical customer behavior, we believe that our consumer customer churn will continue to improve as the weighted average tenure of our customer base increases. We believe the cash flow that these customers generate in the future would be meaningful for years to come.

We recorded $145million dollars in revenue in the third quarter, which was down $6 million from the prior quarter excluding the second quarter impact of a one-time partner settlement we discussed with you last quarter. As we discussed in the past we expect that as our churn continues to come down our revenue attrition will continue to flatten out as well. That’s exactly what has happened as the quarterly sequentially declines, I just mentioned were about half of $12 million sequential revenue decline we reported in the year ago quarter.

While we are pleased that revenue declines continues to attenuate as we expect, we also clearly recognize that we must stay focused in taking actions, keep our consumer cost structure in line with revenue. On this front Joe Wetzel his team had lots of success again and is evident as adjusted EBITDA margins remain robust at 35% of revenue.

Now, to put this in perspective, while revenue this quarter was $30 million dollars lower than it was a year ago and gross margin percentages were 100 basis point lower due to the ongoing shift of our customers to broadband adjusted, EBITDA margins were flat to Q3 2009. Now what that means, is that we took out a lot of fixed cost over the past year.

I don’t need to tell you that happened automatically, especially if you want to do it in a way that maintains or even improve customer experience. This kind of performance requires advance planning, creativity and expertise.

I am so grateful to our people for there unwavering commitment too, but I think more importantly for their hard work and skill at optimizing the cash flows of the consumer business.

Next, I would like to briefly discuss our continued progress at New Edge Networks. As you know we had begun a substantial evolution at that business three years ago. The New Edge was a business dominated by wholesale revenue streams, low end product offerings, a very dated network infrastructure that resulted in inconsistent reliability.

Over the past two years we’ve substantially updated the technology platform, rolled off substantial portions of the legacy products and revenue streams and reportedly leading edge end-to-end national IP product platform. In recent quarters I have been telling you that I believe we were making progress in repositioning New Edge as we reported improving sales and churn trends.

Well I am pleased to report today that our business segment revenues actually grew this quarter by $900,000 over last quarter. Prior to this quarter we had 12 consecutive quarters of sequential revenue declines in our business segment dating all the back to early 2007.

Today New Edge partners with multi-location national accounts to provide managed network services over an IP platform that has national reach, we give our customers a variety of cost effective access type that their business needs all over a CMOS IP platform that can extend well wherever their business demands.

Where quarterly results were always be a bit lumpy in a business like this particularly with a continued volatility and the US economy, we are encouraged by the teams continued progress. Reaching this inflexion point at this point in time creates a perfect segue into our third subject today which is our Deltacom transaction.

As we announced a few weeks ago EarthLink is acquiring Deltacom in a transaction value at approximately $516 million including the assumption of debt. The purchase price represents a multiple of approximately 5.8 times adjusted EBITDA for the 12 months ended June 30, 2010. Excluding one-time transaction costs and including $20 million expected annualized cost synergies by the end of 2012, the multiple would be 4.7 times.

With Deltacom, EarthLink is creating a leading IP infrastructure and services company. We have acquired a business that had meaningful revenues steams, strong gross margins and unlabored free cash flow. As I mentioned a few weeks ago, it’s also very attractive to us that Deltacom has a solid pool of talent who share our IP-centric vision of the future.

Let me walked you through a few of the reasons we think this acquisition makes such fundamental sense for our shareholders. First, we are acquiring this asset at what we believed is a reasonable price. A network asset that is dense, well set with capital investment and an asset that cannot be easily replicated. This network’s 16,000 fiber route miles will have a growing future strategic value. Cloud computing software as a service and 4G wireless networking will all result in the continued exponential growth of IP traffic and services.

We believe that IP assets such as those we’ve acquired with Deltacom, combined with the IP based services and security that’s always been a part of EarthLink’s core D&A assets improves the future value of our company.

Second, we believe Deltacom's network is a very complementary asset to New Edge. We plan to combine our New Edge national managed IP solutions company with Deltacom’s integrated communications business and its fiber network.

The combined entity will be able to offer a comprehensive suite of MPLS and IP based internet telecommunications and managed services. New Edge will significantly expand the Deltacom network’s reach and we believed we can close more sales together than we could otherwise close apart.

Third, Deltacom enhances our ability to better maximize the cash flow in our consumer business by allowing us to accelerate overtime the elimination of some fixed costs required to support the consumer revenue stream. It also allows us to offer more carrier path options to the talented people we rely on to optimize the long-term value of the consumer business. This ability to attract and retain talent reduces the risk profile around the cash flow tail of the consumer business.

Four, we expect to realize $20 million of recurring cost synergies by the end of 2012. I spoke earlier about the success our team has had in reducing EarthLink’s cost structure. We are confident that we'll be able to leverage this skill-set to much greater degree with our increase scale.

Fifth, Deltacom brings with it tax assets that we believe have roughly a $50 million cash net present value to our company.

Sixth and finally, we believe companies that hold strategically relevant assets could and should consolidate further. While consolidation is not required to make the economics of Deltacom transaction work for us, further consolidation would be beneficial to our share holders by expanding scaled based synergies.

After this transaction our company will still be highly unlevered. Our strong balance sheet and ongoing future cash flow will provide us an expanded set of organic and strategic alternative.

Now I will turn things over to Brad, to walk you through our financial metrics and than will provide some concluding comments before we go to Q&A. Brad?

Brad Ferguson

Thanks Rolla. During the third quarter we generated adjusted EBITDA of $51 million, which represented a decline of 10% compared to the second quarter of 2010 and 16% from the third quarter of 2009.

EarthLink’s net income during the third quarter of 2010 was $21 million or $0.20 per share compared to $28 million or $0.26 per share in second quarter of 2010 and $30 million or $0.28 per share in the third quarter of 2009.

The third quarter of 2010 included $2.6 million or $0.02 per share of expenses directly related to our transaction with Deltacom. Of the $2.6 million $2 million was for bankers fees and it is reflected in our financial statements as restructuring and in acquisition related costs. The additional $600,000 is for legal and accounting services and is reflected in G&A.

As for the balance sheet, we entered the quarter with $771 million of cash and marketable securities, up $30 million from the second quarter of 2010. During the quarter we paid $17 million in dividends and $3 million for capital expenditures.

From a tax perspective we expect to record a non-cash income tax provision of just under 40% for the year, though we continue to utilize our federal and state net operating loss carry forward, which will result in a 3% to 4% effective cash tax rate in 2010.

At the closing of the Deltacom transaction we expect to use approximately $200 million of net cash for the cash portion of the purchase price. Also, as we announced last week our Board of Directors declared another $0.16 cent per share quarterly dividend, which will be paid in December of this year. As for share repurchases management has the authority from Board of Directors to buy up to an additional $146 million of its shares under our share repurchase program.

At the right price when our trading window is open we will continue to revaluate share repurchases as a viable way to create value for our shareholders.

Now I will discuss some of the operating results and metrics in more details. As Rolla mentioned earlier, total subscriber losses improved to 95,000 in the third quarter down from a loss of 109,000 subscribers in the second quarter of 2010 and loss of a 146,000 subscribers in the third quarter of 2009, due to the stronger consumer cable growth adds and churn performing in line with our recent trends.

We expect that seasonal factors will continue to influence some of the quarter-over-quarter trends in the future. However, consistent with our prior guidance we expect both consumer gross adds and churn to continue to generally decrease over time.

Total revenue for the quarter was a $145 million, a 5% decrease from the second quarter of 2010 and a 17% decrease from the third quarter of the prior year.

As mentioned earlier and described on our second quarter call, the second quarter of 2010 included a $2 million favorable revenue item that was nonrecurring and inflated the sequential quarter-over-quarter decline. We expect that quarterly sequential revenue declines will resume the attenuation in the mid single-digit million dollar level and the trends to continue to improve as we have described in the past.

Our total cost of revenues declined 2% or $1 million compared to the second quarter of 2010 and improved 15% from the prior year third quarter. We had a 61% gross margin rate in the third quarter 2010 compared to 62% in the second quarter of 2010 in the prior year third quarter.

Generally gross margin rates have continued to move slightly down over time due to continuing shift in the mix of our customer base from narrowband to broadband and business segment services, which have lower growth margin rates.

Operating expenses, which include customer support, operations, G&A and bad debt expenses but exclude sales and marketing expenses were $32 million for the third quarter of 2010. Flat compared to the second quarter 2010 and down 21% from the third quarter of 2009.

As we’ve described, the year-over-year decreases is primarily driven by fewer and longer tenured subscribers coupled with our employees continued effort to take cost out of the business.

Sales and marketing costs were $12 million in the quarter, which was flat with the second quarter of 2010 and down 16% from the prior year third quarter due to lower, discretionary, marketing spend, and lower sales and marketing employee cost in 2010.

We continue to invest modest levels of marketing dollars in programs and channels within our consumer segments that provide a sufficient financial return and continued to fund the positive sales traction at New Edge in our business segment.

Now, for the outlook for 2010. The third quarter met our revised expectations as the underlying drivers of our business performed in line with the favorable trends we experienced earlier in 2010.

As discussed on our call regarding the Deltacom transaction, for 2010 we expect to generate full year adjusted EBITDA of $207 million to $211 million. We are also maintaining the previously issued expected capital expenditures guidance of $10 million to $14 million.

The projected adjusted EBITDA in capital expenditures translate into a projected, $193 million to $201 million of free cash flow for the total year 2010. This guidance reflects the continuation of the favorable trends we experienced throughout 2010, the continuation of our marketing spend in profitable channels such as cable broadband, a moderate decline in total gross adds from Q3 levels and the expectation that consumer churn rates will remain stable by cohort and reasonably predicable for the remainder of the year.

This guidance does not reflect any potential financial impact if the Deltacom transaction were to close prior to January 1, 2011

We will give 2011 guidance in February as we have historically. At the time we will know and be able to project more accurately the impact of THE purchase price allocation in other Deltacom related factors, such as the transaction closing date that can materially impact the financial outlook.

Now I would like to say a few words about the Deltacom business and its current trajectory. Since Deltacom has not publicly released its Q3 results. I will still refer to its Q2 numbers. For the 12 months period ended June 30 2010, Deltacom reported $451 million of revenue.

Revenues for Deltacom declined by just over 7%, relative to the 12 period ended June 30, 2009, due to the company continuing to transition away form non-core legacy, retail voice service to a suite of products with more sustainable revenues and profits and moving up market to enterprise and wholesale customers.

Earlier we mentioned that New Edge in our business segment had reached inflexion point where sales were outweighing churn and revenue could grow. We see a lot of parallels in the Deltacom business. Deltacom revenue is declining moderately but churn has been coming down and while full year 2011 revenues are expected to be lower than full year 2010 we see a path to ultimately stabilizing growth to Deltacom’s top-line.

For the 12 months ended June 30, Deltacom recorded $89 million of adjusted EBITDA. We expect to continue Deltacom’s recent improvements in cost structure but do expect that pre-synergy adjusted EBITDA will moderately decline next year over 2010. Of course the portion of this adjusted EBITDA we recognized on our P&L will depend on our timing of the closing.

All that said and assuming we close within the time lines we have specified, we do expect to begin realizing some synergies starting in late 2011. As we stated on the Deltacom call, our expectation is to be at the $20 million run rate by year end 2012. To achieve these recurring synergies we expect our onetime integration costs to be around $15 million, most of which will be incurred in 2011.

Subsequent to the transaction EarthLink will continue to have a strong and under-leveraged balance sheet, especially when compared to others in the telecom sector, which gives us the flexibility to continue to be opportunistic in deploying capital in the manner that creates value for our shareholders.

I now like to turn things back over to Rolla for some concluding remarks.

Rolla Huff

Thanks Brad. We have already begun integration planning work for Deltacom. We have been very pleased to see that the culture at Deltacom is much like the culture in our business. There are a group of experienced people that are dedicated to great customer service and are passionate about their company, again very much like the people we have in our company.

Finally let me close this part of the call by giving a quick update on where we are in closing the transaction. We are making good progress and don’t anticipate any difficulty closing our acquisition of Deltacom in late December or early in the first quarter of 2011.

The FTC has already granted early termination of the waiting period under the Hart-Scott-Rodino Act. Deltacom has filed its 14-C information statement with the SEC and will mail it to its shareholders after the SEC review process.

We have already received the required approval from some of the state PUC’s and are waiting to receive the remaining required approvals.

We aim to keep our remarks brief in order to answer as many questions as we can and still close the call before the market opens. So with that operator why don’t we go to questions.

Question-and-Answer Session

Operator

(Operator’s instructions) Your first question comes from Ingrid Chung of Goldman Sachs.

Ingrid Chung - Goldman Sachs

Good morning thank you, I have a few questions. First, in terms of the pro forma entity once you’ve closed the Deltacom acquisition, what is the management team going to look like on the business services side and I was wondering what you are going to be doing with branding, whether you will be a keeping the New Edge service brand or will you be under the ITC Deltacom brand?

And then in terms of the improved churn on business services, is that due to a more benign macro environment or is that due to improvements that you have implemented?

And then finally, in terms of the cash that’s left over in your balance sheet, you have talked about how there could be further consolidation and you had also wanted to maintain flexibility in terms of share repurchases. I was wondering if you could rank to your capital allocation alternative? Thanks.

Rolla Huff

Sure. The first question, the management team. That is something that we're thinking through right now. We’ve started an integration effort where both the Deltacom management team and the EarthLink management team are talking periodically.

Obviously we both have our individual businesses to run. But our view is that at close we're going to field the best players available. You have to remember that substantial part of our business is the consumer business. So, we don’t have major overlaps with Deltacom. So, we would plan on keeping substantial numbers out there, management and people.

From a branding perspective, it’s something that again we’re evaluating. We’re doing some work right now to understand what brand position all of us have individually, New Edge, Deltacom as well as EarthLink and we’ll try to put the brand out there that we think will most work in the market place. So, that’s again work that is currently underway.

In terms of the improvements that we’re seeing in this churn, I think it's probably a basket of things. Clearly the macro economic environment looks to be slightly improving. So, that’s helpful. There has been any enormous amount of work that’s been done to make the customer experience, better by making sure that our network reliability is what it should be. We have spent lot time on how we want to interact with our customers and first call resolution. So that has also been a big help

And then I think the third thing is as we have been moving up market at New Edge and getting into larger accounts, the he churn profile of those accounts just look different than lower end churn, the lower end type customers that New Edge had been historically focused on. So I think it’s a combination of those three things that are driving the results.

The last question I believe was about cash and how we would rank our alternative. That’s a hard one for me to answer. We sort of have the all of the alternative always on the table. We tried to be opportunistic around how we deploy our cash. There is no question that with the Deltacom acquisition, the next thing we would do in that space will be easier and more synergistic, but we are going to continue to be extraordinarily disciplined in how we look at strategic alternatives.

And we clearly got the financial capacity to buyback shares, if there is an opportunity there at a price that we think makes sense for our shareholders and obviously we’ve chosen to maintain dividend. Again as we said in our comments we believe that our core business is going to generate meaningful cash flow and as we, continue to evolve Deltacom and potentially add things to it, we expect that those businesses will create cash flow.

So I think we are in a pretty unique position in terms of having a lot of different alternatives but not getting away from this idea that we what to be disciplined in our approach and really played at the strength of what we as team we think we do best.

Operator

Our next question comes from Youssef Squali at Jefferies & Co.

Youssef Squali - Jefferies & Co

Thank you very much. I have a couple of questions first on New Edge could you share with us this size of that business right now. How big is it? What kind of margin characteristics does it have. I think the last time we talked about, it was slightly cash flow negative. May be you can just update us on that and I guess the sustainability of that slight sequential growth, do you think that sustainable on it’s own before kind of it in to move into or get integrated into Deltacom and I have a follow up?

Rolla Huff

I will let Brad talk.

Youssef Squali - Jefferies & Co

Yes.

Brad Ferguson - Chief Financial Officer

So on New Edge so it makes up for the largest piece of our business services segment and right now in a little over $100 million of revenue but as we’ve kind of talked in the past really round cash flow, slightly negative, but certainly the cost factor with Deltacom getting some more scale and I think that gives that a better profile over time but those are kind of the economics. And the kind of gross margin in the that 25% range and Deltacom improves that a lot, that’s why we really thought that the two businesses together,

Obviously what New Edge does very well is, it has national reach. What Deltacom and assets like Deltacom will do is deepen that the margins associated with the enterprise level accounts and that’s why we believe the combination makes so much sense. As it relates to Deltacom’s ongoing or sorry New Edge’s ongoing business and momentum, we feel very good about the funnel of activity that we have. We have a great backlog of business to install, so we a feel good about the continued momentum of the business.

There is no question that the fits and starts of the US economy impact businesses better that are focused on mid sized level accounts because what they decide to invest in capital really is driven by their perception of what is happening around them. but just the business that we have identified and signed and we have in the installation funnel we feel pretty good about our progresses there.

Youssef Squali - Jefferies & Co

Generally in terms of strategy as you look at New Edge and Deltacom, I think New Edge as you said earlier was initially wholesale with the kind of an older network and you are taking that away from wholesale into enterprise and I think you said Deltacom, you’re effectively taking them mostly from retail too to enterprise/ wholesale. So can you just explain how is that complementary?

Rolla Huff

Yes. I think the Deltacom network gives us a lot of options around how we monetize it. Deltacom has had a strong retail presence over the years. I think in particular over the last couple of years, Randy Curran and the management team there have done a great job of starting to move Deltacom into the enterprise space with IP services.

What is so synergistic about Deltacom with us is that, when Deltacom goes and calls on an account in their footprint, they clearly can provide an IP-based platform in the southeast region but they were limited to their ability to support a customer outside of their footprint. What New Edge will do is really give us now the ability as a combined business to support that customer wherever they are with a seamless IP platform that we can overlay managed services.

A New Edge customer today that has locations in 30 states, we have the ability to show them their network every morning and not only look at where the network elements are up on our network but we can look into their network and their devices and really help them with a managed network solution. And the ability for Deltacom to take that offering to a larger number for multi location accounts that reside in the southeast we think will have a lot of traction.

Operator

Your next question come from Sri Anantha, Oppenheimer

Sri Anantha - Oppenheimer

Rolla could you just touch on Deltacom business mix like how much of the revenue is still coming form legacy, voice-related services and as the company continues to make progress towards IP-based services, could you talk about the margin profile of the services, especially when you talked to us about some of the select providers, initially there is a margin head as you move from those legacy products to an IP-base service, presumably because of the lowed price, but I am just curious, how is Deltacom’s financial profile for this IP-based services?

Rolla Huff

Sure I believe that just as a range, I think about 20%- 30% of their revenue that’s still voice-based services but clearly the biggest, the growing part of their business is IP-based service and as we look at all of the companies in the space, I think that’s pretty typical if not probably on the low end of what we see in terms of voice, data mix. I think the ability to layer on.

There is no question that if you are only selling IP circuits the margin impact of just selling IP circuits would be driving margins down compared to the older line TDMA types of circuits. That is not the strategy and I think I had just been talking about, what we were able to do with the margin profile at New Edge even thought the margins are relatively lower New Edge owns almost zero circuits/.It’s a service more than it is a network. We do have some network assets but it really is an overlay service and we just think there is enormous amounts of opportunities in the securities layer and in the network monitoring layer that we can overlay on the Deltacom platform that will help with their margin profile.

Sri Anantha - Oppenheimer

One question on the enterprise penetration, I know you have talked about Deltacom trying to move up market and focus on especially mid to large enterprises. But given your past experience with the CLEC companies and with the other CLEC company’s that are out there, there are very few examples where we can point like CLEC’s have been really successful in doing that. What gives you the confidence today that Deltacom combined with EarthLink can finally make the transition in running those mid to large enterprise accounts? Thank you.

Rolla Huff

Sure, it is a great question Sri. I think that the end of the day when you look at EarthLink, our core D&A the way we have won generally is a web based view of the world and I think the best example of that is what has happened at New Edge. New Edge was a circuit-based company when we came in and it was a low end circuit-based company and if you look at where that has evolved over the last three years there is not $1 of voice revenue that we have put on that business, it is surely and IP services business and so I think that the core of what EarthLink thinks about and that’s way I think these two things together will have the ability to have a lot of traction.

We think in those terms and will continue to think in those churns and drive that part of the business. I completely agree with you that’s not something that in the traditional CLEC business we’ve seen, because I think the traditional CLEC business has been a circuit-based business and I think I have been pretty outspoken on these calls over the last several quarters that I believe that the traditional CLEC business is not a growth business.

And I haven’t changed view on that actually. I think what is different is we are combining a very much of IP centric business with a great set of assets and it remains to be seen but we think we can do something with that and take the part of the business that’s not a growth business and optimize it. Similar to what we have done here. We are not afraid to make those kinds of decision to optimize those businesses. So that’s how we have thought about that.

Operator

Your next question comes from James Cakmak of Sidoti & Co.

James Cakmak - Sidoti & Co:

I guess, I understand that the New Edge national platform will be a key asset to the regional Deltacom. But now, looking forward what is really the end game. Are you seeing other opportunities to acquire other regional players to consolidate the overall national platform?

Rolla Huff

There are clearly other opportunities and there have been for a couple of years. What has not been the case is that the other opportunities have been in a valuation profile but we think that we thought made sense. So, we will continue to be very involved as we have been over the last couple of years in everything that’s going on out there. But I think we have to stay pretty disciplined on what we believe we do best to create value.

So, as I look at this going forward, we want to continue to put together great IP Asset, that’s key to our strategy. And, we want to stay really disciplined on not trying to force a non-growth business to grow, but rather to optimize the value of those kinds of businesses. So, there can and will be growth at the services level, at the IP services level and the IP connectivity level. But, I think some of the traditional revenue streams were going to value the heck out of those customers but we’re not going to throw a lot of money in trying to grow them.

So as we look at acquisitions out there before we move on them., we need to feel good that we got a plan of around how we would manage those businesses and create value and its got a work with the valuation.

James Cakmak - Sidoti & Co:

Okay and do you feel that Deltacom gives you the kind of scale that you need or at this point it just sounds like you might need more?

Rolla Huff

Well, as we talked about the idea of a national IP platform is terrific and we got that with New Edge but as we have also said the margins on just New Edge don’t work for us. We need deeper margins and where you get deeper margins is to have deeper network, The more the deep network footprint expands, the better the margin profile on the new business acquired.

So because of that we’ll continue to look-to bring assets into the fold, but I would tell you that what we have with New Edge and Deltacom we can make a good business out of that there is no question about that. I don’t feel like we have to do something in order to make the Deltacom acquisition a good acquisition. I thing there is lots to do there, its very complimentary, its in the fastest growing part of the country and there is a lot we can do organically there. But where we can be opportunistic in expanding that footprint that will allow us to get deeper margins we are going to be very interested in.

James Cakmak - Sidoti & Co:

Okay and lastly, when you look at EarthLink and New Edge, can you talk about what you bring to the table that a business would prefer over another national player

Rolla Huff

Well I think there is probably two or three things that I think people are going to pay attention to. I think EarthLink is not a Johnny-come-lately type of company I mean believe it or not, it still amazes me, we’ve got brand recognition. Even after we have really taken most of our marketing spend out we’ve got substantial brand recognition on a national basis.

Secondly we have a platform of IP orientation that I think a lot of the people in the sender tree don’t, that are just more circuit sellers. Number three and I think probably the most important thing is we got a financial position, an under leveraged balance sheet and an ongoing cash flow that will give a lot of these big customers a lot of confidence that they can partner with us and put mission critical applications on our platform without worrying about us running out of money.

And that has mattered for the last couple of years with New Edge when we sit down and talk to some of the very large accounts that are billing two or three or $400,000 a month, they want to know that we are going to be around. And you only have to take one look at our financial statements to know that we are a long-term viable business.

Operator

Your next question comes from Mike Crawford, B. Riley & Company

Mike Crawford - B. Riley & Company

Just a couple of follow up questions, so. One Rolla if there was another CLEC that hit the evaluation profile today, I don’t you will able to move on it today, again like Deltacom. So is this something you would citer as an opportunity was available that it would be may be not until second half next year or do you think will be able to move sooner if the right opportunity was there.

Rolla Huff

I think that we are going to be very aware of our capacity to do things. There is not a massive immigration that comes with Deltacom just in general. We have got the New Edge business, which is relatively small. It’s something that will complement the motion at Deltacom but there is not just massive integration of two big companies with two big networks.

I think we are going to take a measured view of what we think we can do, the capacities that we have to put assets together and so I am not going to set a time frame that says we wont or we will do something. I think every situation is different because it requires a different level of integration. Just conceptually the most integration comes from taking two companies that are right on top of one another and integrating networks and market presence. If you are expanding your footprint, the level of immigration goes down. There is always the integration of billing systems and that sort of things, but we get that. Remember the core of EarthLink has done 131 acquisitions over the last several years. So, we’re going to take a measured approach.

Mike Crawford - B. Riley & Company

Also, the synergies of savings you’ve outlined for this seems to be quite modest. I guess, as the software goes part and parcel with the different regional networks, but would you characterize that $20 million as being conservative or only first phase or is that really about all that you would expect?

Rolla Huff

It was our best view that we communicated. So, generally as companies come together, you begin to see opportunities that don’t come up in diligence but remember again, this is not going back to the first question. This is not an overlapping network, and that’s why there is not a lot of integration activities that will happen. Along with that, there is not a lot of synergies that come with it.

It’s the next thing that happens that will allow us to leverage an existing billing system and then existing trouble ticketing system and an existing network inventory system. So, that’s where we will get those kinds of synergies in future things. This was very much as we described it, a platform deal. And it gave us a platform to sort of launch new strategy for this company at a valuation that made sense.

Mike Crawford - B. Riley & Company

Okay thank you. And then another question just switching gears to the ISP sites. So if you were to fast forward at a time in the future whether its two years or six years but at some point past the intermediate future now just assuming you have the Deltacom platform, which enables to accelerate some cost reductions, is there some kind of a minimum or rough EBITDA threshold you expect to be able to maintain as that business tails off us for the next five to ten years?

Rolla Huff

I think this acquisition actually dramatically reduces a threshold, at which we would go negative. And you guys have all asked good reasonable questions about the idea of how much fixed cost can you take out before you just can’t take out any more to support the business.

The reality is we know that there are a lot, you heard me say this, there are a lot of 3000 subscriber ISPs out there that still generate, that still are quite profitable for their size but they have no assets. They are truly a mom and pop operation and our big heavy lifting was to go from a very large national ISP to a mom and pop shop gracefully. What this allows to do is to have a platform that has long-term legs that allows our consumer business to just be optimized.

So we will never have to have a big dedicated chunk of fixed cost around the consumer business now and that is why you heard me say and I think it was in Brad’s comments that it really in our mind de-risks the consumer business, because it isn’t the business that have to support the enterprise. It can now be absolutely optimized for years to come.

And so, I don’t think there is a threshold now with the consumer business and that is one of the very attractive things about doing this acquisition.

Mike Crawford - B. Riley & Company

And the revenue declines continues to decline?

Rolla Huff

Yes. I mean you don’t have to take out cost to the extent we have in the past. So I think as we see the churn profile, just customer base age out those declines as we said are kind of forward-looking, these we will continue to attenuate.

One thing I think is the best execution around EarthLink is and I give Joe and the operating team so much credit for this is, you never get to a point where you say, Okay, it’s done. Literally every quarter in a business like that you have to rebuild the company to a different cost structure without loosing the customers. This really gives us the ability to leverage assets that we are going to need anyway for our business to business strategy.

So it’s really an important point because this consumers business we believe will generate, the math says, 10 years of data says that there is going to be meaningful cash flow off of that business as long as we can continue to take dedicated cost structure down when we need to and this helps us to do that.

Brad Ferguson

We are going to try to squeeze in two more quick questions.

Operator:

Your next question comes from Donna Jaegers of DA Davidson.

Donna Jaegers - DA Davidson

Hi guys, two quick questions. I thought I heard Brad say that the guidance he thought EBITDA would be lower for ITC.com in 2011 can you give us a little more on it?

Brad Ferguson

Yes. So with the revenue declines, as we talked about that and again I said its kind of moderately declining, just as they’re transitioning out of some of the legacy services and the POTS services and transitioning to a more up-market, we will see that decline and the EBITDA will decline slightly with that.

Donna Jaegers - DA Davidson

Okay and that’s before any synergies that you guys bring to the party?

Brad Ferguson

Yes. so we expect to start realizing the synergies assuming the timing of the closing is in line with our expectations towards the back half of next year.

Donna Jaegers - DA Davidson

The back half of this year, right?

Brad Ferguson

2011, we will start seeing some of the synergies.

Donna Jaegers - DA Davidson

Exactly.

Brad Ferguson

Right we don’t think close the transaction until the first part of next year we will be investing in the business to get to the synergies and we will start seeing the results of those investments as we get into the second half of the year.

Rolla Huff

And then ramping up until we realize at the end of 2012.

Donna Jaegers - DA Davidson

Okay and then on your ISP business and the consumer business, I am assuming that one customers disconnect their service you guys ask them why and I am wondering what the mean reason is currently?

Rolla Huff

The biggest reason that people want to get to broadband and we try hard to anticipate, we can tell from their activity when they’re starting to think along those lines and we try to make them an offer to get them on our broadband network. But there is no questions, when we lose a customer to cable or to somebody else, a lot of times we lose them before we have a chance to pitch an offer. So we really do try to monitor how they are acting.

Our customers don’t want to be bugged and this is an art and its just like giving them that offer at precisely the right time. And, that’s the art of it.

Donna Jaegers - DA Davidson

That’s tricky. On your new broadband subs, you’re picking up from mostly cable. It seems like, what sort of churn are you seeing amongst those newer subs and any reason why people might not be happy with the EarthLink service?

Rolla Huff

The churn profile on broadband is actually quite solid, pretty steady with what we’ve seen historically. Clearly newer subs churn more than subs with a year tenure or two year tenure. So, as we done the economics on those subs, there are very profitable customers for, even as we wait in the early life churn on broadband.

On the narrow band customers that we acquired now, our acquisition costs are almost de minimis So, they are immediately accretive even if they are with us for three months. What we can do is invest a lot of money to go out and try to stimulate those kinds of customers but broadband customers the churn is fairly stable and I think that our brand matters out there.

Operator

Your last question comes from Scott Kessler of Standard & Poor’s Equity

Scott Kessler - Standard & Poor’s Equity

So this is been a helpful call, I appreciate the information provided related to the Deltacom transaction previously. I am wondering perhaps in summary if you can provide maybe another two or three either primarily rationales of deals or potential opportunities that you see as a result of the acquisition? Thanks.

Rolla Huff

Sure. I think when we looked at the transaction, I am going to expand it to probably four. Number one was the assets that we acquired will be relevant for years to come, there is no question about it, data transport will matter in two year, five years or 10 years. So we loved that about the business.

Number two Deltacom was an adult business it was not a business that had been starved for capital both on the network side as well as the people site. We have been extremely impress with the quality of people at Deltacom and that mattered to us a lot,

The third thing was, what we been taking about here it really we believe takes the risk profile out of our future cash flow from the consumer business. We never been in the business of making a lot of bold predictions about what is going to happen with it but what I will predict with this transaction is that we will optimize the cash flow from that business and we think it will be fairly significant for years to come.

And I think the last point and as part of the third point it gives our people that are focused on the consumer business a career path to stay with us. And that’s going to be really important that EarthLink people are extraordinarily talented and being able to take there culture and their D&A stat and apply it to a business model that I think is dated in terms of being just circuit-orientated. I think it’s a key part of the strategy

And then I think the fourth thing that I will throw out there is, because our consumer business is so profitable we love the NOLs, the cash value of the NOLs that came out of this. It was a meaningful number to us.

So when you put all these together it really and I told people so many times that the goal post around what we could do in our first deal were pretty narrow and that way it took us a long time but this way was inside the goal post and we felt great about that.

Scott Kessler - Standard & Poor’s Equity

It sounds like you were prepared for that question?

Rolla Huff

All right, I think that’s it. I appreciate everybody getting on the call look forward to talking to you in the future and have a great day. See you

Operator

This does conclude the conference. You may all disconnect.

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