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TW Telecom (NASDAQ:TWTC)

Q2 2014 Earnings Call

July 31, 2014 11:00 am ET

Executives

Carole Curtin -

Larissa L. Herda - Chairman and Chief Executive Officer

Mark A. Peters - Chief Financial Officer and Executive Vice President

John T. Blount - President and Chief Operating Officer

Analysts

Simon Flannery - Morgan Stanley, Research Division

Colby Synesael - Cowen and Company, LLC, Research Division

Brian Hawthorne

Michael McCormack - Jefferies LLC, Research Division

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Operator

Good morning, and welcome to tw telecom's Second Quarter 2014 Conference Call. Today's call is being recorded. With us from the company, are Chairman and Chief Executive Officer, Ms. Larissa Herda; President and Chief Operating Officer, Mr. John Blount; and Executive Vice President and Chief Financial Officer, Mr. Mark Peters.

At this time, I will turn the call over to Carole Curtin Jorgensen, Vice President of Investor Relations. Please go ahead.

Carole Curtin

Welcome to tw telecom's conference call. We're pleased to have you join us today. To review our results for the quarter, please visit our website at www.twtelecom.com, where you can find our press release, supplemental quarterly information and SEC filings.

Before we start, I'd like to draw your attention to your Safe Harbor statement included in our supplemental materials, which you can find on our website. Information in our quarterly earnings materials and our discussion today contain statements about expected future events and financial results that are forward-looking and are subject to risks and uncertainties. A discussion of factors that may cause our results to differ materially from our expectations is contained in our filings with the SEC under Risk Factors and elsewhere available on our website. Additionally, all comments regarding the company's future performance are provided for our standalone results.

I also want to point out our earnings materials and discussion today contain certain non-GAAP financial measures. You can find reconciliations between the non-GAAP and GAAP financial measures in the materials on our website.

Now I'm pleased to introduce tw telecom's Chairman and CEO, Larissa Herda.

Larissa L. Herda

Thanks, Carole. Hi, everyone, and thank you for joining us today. As we shared with you on our June 16 call, we executed a strategic merger agreement with Level 3 Communications bringing together our complementary businesses by combining tw telecom's premier domestic network with Level 3's extensive international network to create what we believe will be an enhanced competitive position to provide customers greater capabilities and services. I believe the communications to date by both organizations have addressed the deal announcement, therefore, today, we'd like to review our quarterly results and key growth initiatives.

I'm pleased to share our strong results for the second quarter as we grew revenue at an accelerated growth rate achieving our highest year-over-year growth rate in more than 2 years. We expanded our levered free cash flow even after absorbing CapEx for our strategic market expansion and we delivered a strong EBITDA margin. In fact, it expanded 40 basis points sequentially when you exclude the merger-related costs for the quarter. So any way you look at it, this was a terrific quarter.

Turning to a few financial highlights. We continue to gain traction with our new products, expanded sales force and strategic market expansion, and our results are showing the success of these growth initiatives. For the quarter, we grew revenue 2.8% sequentially and 7.8% year-over-year as we accelerated our already strong growth rate. In addition, we delivered a 33.9% Modified EBITDA margin, excluding the merger transaction cost incurred during the quarter.

The second quarter was a productive one as we achieved strong financial results, delivered excellent operational execution and announced a strategic business combination. In a moment, John Blount will update you on our market expansion progress and the momentum with our new products and services.

Additionally, as you probably know, last week, Level 3 announced its post-closing executive team. I was very pleased to see that John Blount, along with Harold Keith, our current Senior Vice President of Information and Network Technologies will be members of Level 3's new executive team to help lead this new organization. I'm personally very excited that both John and Harold will be part of the combined company. Both have been great partners to me and I know they will be strong leaders for Jeff as they all work together with the rest of the new leadership team to drive exceptional execution for Level 3.

I'll now turn the call over to Mark Peters to discuss our financial highlights for the quarter and I'll be back later with some closing comments. Mark?

Mark A. Peters

Thanks, Larissa. We delivered another strong performance this quarter, including strong revenue growth, continued strength in our bookings or sales, a healthy Modified EBITDA margin and ongoing cash generation and balance sheet strength.

Let me touch on each of these. As Larissa mentioned, for the quarter, we accelerated revenue growth to 7.8% year-over-year, which is up 90 basis points from the same period last year. Our revenue reflects our 39th consecutive quarter of sequential growth, which speaks to our strong performance, the consistency of our business, and effectiveness of our model. Our bookings or sales demonstrated ongoing strength as we grew bookings for the quarter, both year-over-year and sequentially. Both our revenue and our bookings growth reflect the success of our growth initiative, our ongoing customer service excellence and our enterprise and solutions expertise.

Modified EBITDA margin was 33% for the quarter. When excluding the merger-related transaction cost of approximately $4.1 million, the Modified EBITDA margin was 33.9% as compared to 33.5% last quarter, a 40-basis-point expansion.

Our levered free cash flow in the second quarter increased sequentially and year-over-year as we continue to see the benefits of our targeted growth investments as well as lower capital spending in the quarter. In fact, when excluding the strategic market expansion CapEx and merger costs, our year-to-date levered free cash flow increased 29% year-over-year.

Based on our strong business trends, we remain confident in our previous outlook for revenue and Modified EBITDA margin, which included our expectation that our 2014 revenue growth rate will be greater than that of 2013 and our Modified EBITDA margin, excluding merger-related costs, will begin to expand toward the end of the year as result of anticipated higher revenue growth.

Turning to CapEx. Our spending for the quarter decreased sequentially and year-over-year, primarily due to efficiency gains, favorable equipment pricing and the timing of projects. We reduced our 2014 CapEx guidance from a range of $440 million to $460 million to a new range of $420 million to $440 million, which includes our strategic market expansion. The largest component of this $20 million reduction in the range is a $15 million reduction in CapEx for our strategic market expansion that reflects greater volume discount of equipment purchases and more efficient integration of the network than originally forecast.

The balance of the reduced guidance reflects continuous improvements in inventory management, automation and equipment redeployment, as well as the ability to use our infrastructure to deliver product enhancements more economically. We're pleased to achieve these savings and execute so well operationally, as we're always focused on ongoing improvement, including increasing cash flow contribution.

Moving to the balance sheet. We continue to generate cash, driven by increased Modified EBITDA and lower capital spending for the quarter. We also suspended our stock repurchase program in light of the merger. We ended the quarter with a continued strong balance sheet, including an increase of more than $8 million in cash equivalents and short-term investments.

Summing up the quarter, we delivered strong comprehensive financial results as we accelerated our revenue growth, delivered higher Modified EBITDA and grew levered free cash flow. We also achieved ongoing strong bookings or sales and we maintained our balance sheet strength and grew our cash balances.

So I'll now hand the call over to John for a bit more color on our growth initiatives. John?

John T. Blount

Thanks, Mark. I want to touch on 2 key areas, including our ongoing momentum with new products and services and our strategic market expansion progress. Let me start with some details on the momentum with our new products and services, which remains a key priority and major growth initiative for us.

We continue to invest and upsell our existing customers due to our innovative strategy. Across the portfolio, we're experiencing strong results, driven by product capability, flexibility and a great service experience. Several of the product drivers include: Combining Ethernet and Internet services with our Intelligent Network, utilizing our E-Access service for National Ethernet footprint for carriers and capitalizing on our data networks to deliver enterprise-wide SIP services.

Each of these solutions contributes to the expanding growth rate of the overall portfolio and addresses a large market opportunity. For instance, we recently expanded our Dynamic Capacity capability to our Internet portfolio and we've seen great response to our marketing programs, resulting in strong initial sales of this new service. Let me share a few examples of how enterprises are using this capability.

Our customers in the hospitality sector see the advantage of scheduling and flexing up their Internet bandwidth during peak occurrences, including an event or trade show. This provides attendees the best online experience and the hotel, the benefit of knowing exactly what their incremental cost will be during a specific period. Another example is our customer, Zywave, a Software-as-a-Service company that provides services for independent insurance brokers and financial planners, including agency management, data analysis, compliance, risk management and video conferencing to name a few. Zywave purchased our Dynamic Capacity for their Internet services to support video applications for their customers, as well as other services with future variable bandwidth needs. So some great early response to this recently launched capability.

Next, let me turn to the progress with our Constellation Platform. Even though we're still in the development stage, we're already capitalizing on this innovation. Our customers see the value of our future vision and they're benefiting from the building blocks of this development, including new service capabilities like eLynk. eLynk is a virtualized Ethernet connection, allowing customers better management and flexibility for their networks as they move from physical to logical connectivity, making their businesses run better, faster and easier. As a result, our eLynk platform is creating new solutions today to help run enterprises' businesses while driving new revenue for us.

We've talked to you in the past about several key partnerships that leverage our software-driven network and integrates the network to the application using our eLynk platform. As a reminder, this includes public solutions and partnerships for infrastructure-as-a-service, virtualization, software recovery solutions and big data, some of the hottest IT solutions today. We've also announced key partnerships with data centers, who are important players in cloud adoption.

However, our opportunities go beyond the public solutions, extending to private solutions for companies like hospitals, software companies, retail businesses and technology incubators to name a few, who can all benefit from our advanced solutions. A great example of this is a large medical system that is a customer of ours that plans to use our eLynk platform to easily connect and integrate all their labs and clinic partners.

In summary, we continue to further develop our partner strategies, as well as address ongoing private enterprise solutions, which we believe will help drive sales as we continue to advance our Constellation Platform.

Let me now touch on our strategic market expansion. Year-to-date, we've activated 16 of our 33 or about half of our target market expansions. And we expect to activate the remaining expansion markets by year end. So continued solid progress, which is in line with our expectations. As we've previously communicated, we expect sales from our strategic market expansion to gradually build this year, which is already occurring, with revenue contribution primarily beginning in 2015.

And finally, I'd like to provide some color on the integration planning with Level 3. I've had the opportunity to work as the co-leader of this process and I'm pleased to share that we've established an integration team with representatives of both companies. The team is building a comprehensive plan, and we're off to a great start.

With that, I'll turn the call back to Larissa for some closing comments.

Larissa L. Herda

Thanks, John. Before we turn to Q&A, I want to share that our team is highly focused on executing our financial and operational goals through the merger closing in order to achieve a strong hand off of our operations to the new organization. As a heads-up, we're going to defer any questions related to the merger to Level 3.

So with that, we'll now take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Simon Flannery of Morgan Stanley.

Simon Flannery - Morgan Stanley, Research Division

John, I was wondering if you could just touch a little bit on where you are in terms of the staffing of the new markets, in particular, and how that cost is going to build. And in particular, the 5 new markets, what the status of that is? And then, Larissa, I don't know if this is prohibited or not, but if you had any feedback on what customer response to the transaction and employee response, how are people thinking about the opportunities, have you heard any feedback at this point?

John T. Blount

So, as you know, we've got expansions in our existing markets, as well as we've got new markets. And as we've talked before, in the expansions of the existing markets, for us, it's business as usual as we expand those teams to address the new market opportunities that the fiber expansion presents for us. So that's going along quite well as we add to our existing teams and we're just beginning the front-end of the staffing for the new markets as those start to turn up. But there's good talent that's out there. We're finding that we're able to attract good talent and so we're excited about the opportunities that these new expansion markets represent.

Larissa L. Herda

And Simon, sure, I can give you some color on customer response. As you can imagine, our salespeople are very excited. They get it that they're going to have more products to sell, more opportunities to make money. They're -- we've never had global capabilities before. I mean, we've had connections to be able to complete some circuits for customers internationally, but having the long haul network, the global capabilities, the expanded product portfolio for salespeople, that's excited. And that translates into obviously really exciting conversations with customers because they talk to our existing customers and tell them all the things that we're going to be able to do that customers have wanted us to do, but we never had the capability before. Obviously, customers are very excited about that. We had been finding that a lot of our customers don't know who Level 3 is because our sweet spot is really middle market customers. That's not been their focus. And so as our salespeople go out there and talk to a lot of these customers, they're pretty excited about learning that they will be, again, be able to sell more services to them. So overall, we've had a very positive response.

Operator

[Operator Instructions] We'll move next to Colby Synesael of Cowen.

Colby Synesael - Cowen and Company, LLC, Research Division

First off, congratulations on the deal and I have enjoyed covering you and wish all of you the best of luck. Second off, just coming to my questions, curious if the deal itself has actually impacted any sales momentum or you could foresee the deal announcement impacting sales momentum? And then my second question, just, I guess, more high-level, Larissa, I think in the past you talked about how this can become -- it could ultimately reach 10% type growth at some forward date, although no time period has been given. Based on the momentum you are seeing in the company, excluding the deal, do you think that, that is still an achievable possibility for this company if the deal is not happening?

Larissa L. Herda

Would have, could have, whenever. Well, first of all, Colby, thank you for your kind comments. We've enjoyed working with all of you as well. So we are not seeing an impact on momentum in the sales organization. We've made sure to keep the sales people very focused by giving them some kickers for sales and installs that are made over the next several months through into next year. And again, salespeople see dollar signs, they get very excited. And so we would -- we have had a good feedback from our regional vice presidents on our call that we had with them. Those are the people who run the sales operations and -- from a sales perspective. And they have been feeling very good about the momentum, the funnel looks good. It continues to be good. So I can't comment on the future and what could happen and certainly, couldn't comment on where revenue could go if we were a standalone company, anymore. I will say that, obviously, if you look at our results from this quarter, with the kind of growth rate that we're at today and the momentum that we have in the business, it bodes well and I think that we're handing out -- we will -- our plan is to hand over a very strong company. I think our growth initiatives that we put in place, they're clearly impacting the business in a positive way. So the timing is very good. We still aren't seeing revenue yet from the market expansions, but we didn't expect to until really 2015. But all of those initiatives are right on target. We're already seeing sales, probably a little earlier than we had talked about to the market. So the good news is those take time to install because we're putting new buildings on in those markets, so there's construction schedules. So again, we'll start to see revenue show up from the market expansions in 2015, maybe a little sooner, we'll see. But at the end of the day, I think we've delivered -- consistently delivered. I mean, you guys have watched us for many years, quarter after quarter, strong revenue growth, strong financial overall, comprehensive results, and that's what we're focused on right now. We're focused on delivering on everything that we have said that we were going to deliver and handing over to the combined company a really good growth engine and a good cash flow generator for the future.

Operator

Our next question comes from Brian Hawthorne of Stephens.

Brian Hawthorne

Just one quick one. As you've moved out into these new markets, can you talk about pricing or what your kind of expectations are for that?

Larissa L. Herda

For the new markets?

Brian Hawthorne

Yes.

Larissa L. Herda

We don't -- the same as our other markets, we don't really see any -- every market has a little bit of a different competitive situation in it, but we're not seeing anything that we haven't expected in those markets. So steady as she goes with regard to pricing. Remember, we're offering -- I think, it was an interesting comment on our call with our regional and national sales organization leaders, and that was that our people, our salespeople are really, really starting to do a much better job in differentiating our product portfolio from other carriers that are out there. What we're selling is very different. Things like Dynamic Capacity and eLynk and just the overall vision of where we're going, and that is creating a lot of excitement with customers, they like to see that kind of a vision of the future. And I think that as we go into these new markets, they've never seen us before, so it's pretty exciting for salespeople in those markets. So I think that pricing is going to be what it's going to be. It's a very competitive market. I mean, let's face it, you've got big incumbent carriers with a lot of money who are out there competing as hard as they can for business. You have -- in each market, you have other competitors, too, that have a lot of strengths as well. And a lot of them are building fiber. So it's a very -- there's a lot of competition in the marketplace. We've obviously always been able to figure out how to be maybe a little bit smarter than some of them because it's obviously showing up in our ability to grow when others seem to have a problem with that. So we expect the same in the new markets as well.

Operator

We'll take our next question from the side of Mike McCormack of Jefferies.

Michael McCormack - Jefferies LLC, Research Division

Just a quick comment, Larissa, and echoing the comments earlier about the good luck to you all. Congratulations. But thinking about Level 3, obviously with Global Crossing gaining some momentum and I think the integration process went fairly well, but what were you seeing in the market from that combined entity as far as its competitiveness? Were they becoming a bigger problem even though the segmentation might be a little bit different? And then maybe an add-on to that would be any sort of intercompany churn of customers or revenue?

Larissa L. Herda

I can't comment on anything to do with Level 3's performance or their competitive position in the marketplace. I think Global Crossings was a global company, so it's a very different business from ours. Not even -- I mean, I never -- we didn't really ever see them in the United States. So their focus has been on different customer segment and they're global. We're domestic U.S., and so there's a -- and very focused on metro, local customers, local relationships. They're very complementary businesses, the 2 businesses. And our strength, they didn't have the strength that we have. That's one of the reasons why they decided that they needed us because to provide -- to compete more effectively against companies that have all those things. So I feel that's really the only comments I can make on that.

Operator

[Operator Instructions] Our next question comes from Frank Louthan of Raymond James.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Can you give us a sense of kind of what the sales channel reaction has been post the announcement? And the success you've mentioned in some of the newer markets, is that tied to having sales channel partners already on the ground there? How should we think about how that's progressing?

Larissa L. Herda

Do you mean alternate channels or our sales. Because I answered the question on the salespeople a little earlier and their response.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Well, I apologize for missing that.

Larissa L. Herda

Okay, I'll just repeat it. That's okay. No problem repeating it. I just want to make sure I understood the question you were asking. So generally, our salespeople have been very excited about having new products to sell. We have a lot of customers, over the years, who have asked us to do more and more and more, but we've had -- I mean, we do a great job with what we have. You play with the cards that you're dealt and that you create and that you grow, but we didn't have a global footprint and we didn't have a national fiber footprint. We have some regional fiber, but -- and so having those additional capabilities in the new products, a lot of the products that Level 3 will be bringing to the table for these sales folks is going to be very exciting for them. So they get it, they understand that there is some really great exciting opportunities. They'll be able to sell more to their customers instead of being more of a niche provider in a lot of areas. They'll hopefully be able to get more of their spend. And so it's a very good response from the salespeople. Does that answer your question?

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

And on the alternate side, are they -- is that what's helping you to have success in some of the newer markets more quickly? Or are they grasping onto this? Have you seen them sort of embrace the transaction or step away? How does that work?

Larissa L. Herda

Yes, both companies have relationships with alternate providers. So I would anticipate that those programs -- I can't speak for the future, but they have been successful programs for both companies. So I'm sure they'll meld those together and figure out how they want to go forward in the marketplace. But we've received good feedback from our partners as well.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Can you comment on the Constellation project, any change in the intensity of that investment?

Larissa L. Herda

No change. We continue to move forward with it. Everything that we're doing, we are moving forward as a standalone company. We are moving forward with our initiatives. These are all important futures. And so we're -- as John talked about earlier on the call, one of the products that we deployed is a result of our Constellation investment that's called eLynk, and we've been very effectively deploying that and selling it to customers. It's been exciting for them. And so, you're already kind of seeing elements of the Constellation platform just because it's a foundational platform and there's other things that we're doing with it, so we're starting to see results there.

Operator

[Operator Instructions]

Larissa L. Herda

I think we're done with questions. We don't seem to have anyone else in line. It's probably one of our shortest calls understandably. I just want to close with that last question and say that we're very proud of our long-term performance, including this quarter's strong results. We're excited by the future combination of the 2 companies and we appreciate all of your interest and support over the years. Thank you, and have a great day.

Operator

That concludes our program. Thank you for joining us. You may now disconnect your lines and, everyone, have a great day.

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