Lumos Networks' (LMOS) CEO Tim Biltz on Q2 2014 Results - Earnings Call Transcript

Aug. 8.14 | About: Lumos Networks (LMOS)

Lumos Networks Corp. (NASDAQ:LMOS)

Q2 2014 Earnings Conference Call

August 7, 2014 9:30 AM ET

Executives

William G. Davis, Jr. – Vice President-Investor Relations and Chief of Staff

Timothy G. Biltz – President and Chief Executive Officer

Johan G. Broekhuysen – Interim Chief Financial Officer, Chief Accounting Officer and Corporate Controller

Analysts

Colby A. Synesael – Cowen & Co. LLC

Donna M. Jaegers – D. A. Davidson & Co.

Jennifer M. Fritzsche – Wells Fargo Securities LLC

Operator

Good day, and welcome to the Lumos Networks Second Quarter 2014 Earnings Conference Call and Webcast. All participants will be in listen-only mode. After today’s presentation there will be an opportunity to ask questions. (Operator instructions) Please also note this event is being recorded. I would now like to turn the conference over to Mr. Will Davis, Director of Investor Relations. Please go ahead, sir.

William G. Davis, Jr.

Thank you and good morning. This is Will Davis, Vice President of Investor Relations and Chief of Staff for Lumos Networks Corporation. Welcome to Lumos Networks’ Second quarter 2014 earnings conference call. The topics for today's call include remarks by Tim Biltz, our CEO and our financial results update by, Johan Broekhuysen, our Interim CFO.

We ask the questions on this call be from current investors or analysts, and that any media questions be directed to Jim Nester, Lumos Networks Director of Marketing Operations.

Before we continue, I would like to point out that certain of the statements made on this conference call are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those described. Please refer to the special note from the Company regarding forward-looking statements in our second quarter 2014 earnings press release issued last evening.

In an effort to provide useful information to investors, our comments today include only non-GAAP financial measures. For details on these measures, including reconciliations to the most comparable GAAP measures, please refer to our second quarter 2014 earnings press release and to information posted on the company's Investor Relations website.

With that, I will now turn the call over to Tim.

Timothy G. Biltz

Thank you Will, and good morning, everyone, and thank you for joining our call. Last night we issued a press release with our unaudited financial results for the second quarter 2014, and our financial outlook for the full year of 2014 in which we maintained our annual guidance of approximately $200 million in revenue and approximately $90 million in EBITDA. Before I discuss our operating results, I would like to touch on a few non-operating items. Johan Broekhuysen, who many of you have met over the past several months, has continued to perform very admirably as our Interim CFO. Our official search for a permanent CFO is still ongoing, and while I'm not in a position to name the permanent CFO, I can say I've been quite pleased and the Company has been well-served, with Johan's performance.

On July 29, we issued a press release indicating that Michael Huber has resigned from the Lumos Board, effective immediately, and that James Hyde had tendered his resignation to leave the Board by the end of this third quarter of 2014. I would like to thank both of them for their years of valuable work on our Board. We are indebted to their management of the spinoff from nTelos, and their support in our efforts to transform Lumos into a fiber infrastructure player.

I would also like to introduce two new board members, Brian Rosenberg who is President of Macalester College for the past 10-plus years. Brian will bring a fresh, logical, and unique perspective to our business, and he carries substantial strategic and operational experience with him. His insights and working knowledge of the educational and healthcare industry should be quite helpful to us serving and growing these critical vertical market segments. Mike Sicoli, who served as CEO of Sidera Networks before its acquisition by Lightower in April of 2013, has also joined our Board. Prior to his leadership at Sidera, Mike was CFO of RCN from 2005 to 2010, and led their aggressive business transformation ultimately resulting in a go-private deal with their assets which created Sidera.

I believe we will be well-served by Mike's fiber industry experience, and his experience in creating shareholder value with fiber infrastructure investments. While Johan and I will discuss our second quarter results in some detail, the majority of my comments today will revolve around the strategy to aggressively invest in valuable fiber infrastructure within our expanding footprint and the specific steps we are taking to build a backlog of high-quality, long-term carrier and enterprise fiber contracts attached to this network. We believe that long- term predictable revenue streams will be the key catalyst in creating shareholder value.

The historically low interest rate environment and the current tax policy, namely the extension of the Bonus Depreciation, have created an advantageous environment well-suited for Lumos and our aggressive transformation. Now onto the second quarter results, revenues of $50.1 million were up very slightly from the prior quarter and adjusted EBITDA of $22.7 million grew nearly 1% sequentially. Data revenue comprised of our FTTC enterprise and transport segments grew over 2% sequentially, up to $26.7 million, and constitutes over 53% of our total business, up from 49% in the prior year period.

We remain focused on delivering approximately $106 million in data revenue in 2014, up about 2% year-over-year. Adjusted EBITDA margins within the data segment surpass 50% in the second quarter, up 150 basis points sequentially. Adjusted EBITDA in our data segment was over $13 million in the second quarter, which would represent a $54 million annualized run rate. Our long-term adjusted EBITDA margin target for our data business remains 60%. We believe that we can reach this target through increased scale of our fiber business, by adding long term on-net fiber contracts with gross margins in or above 85%.

Other pure-play fiber companies have obtained EBITDA margins in this range, and we will strive to replicate their success. Within data, FTTC revenue was over $5 million this quarter for the first time, up over 8% sequentially and up 59% from prior year period. We believe that the fiber-to-the-cell revenue will surpass $20 million in 2014 up over 40% year-over-year. This represents a seed change in our revenue mix. As recently as the first quarter of 2013, our RLEC access revenue was nearly two and a half times as large as our FTTC revenue. But now, they are roughly the same size.

We ended the second quarter with 673 fiber-to-the-cell unique installed sites on our network, up 45% from the prior year period. We installed 40 unique towers in the second quarter, up strongly sequentially, and we remain on track and confirm our 825 by year-end. Our long-term target remains 1500 unique towers on our network. If we take a closer look at our FTTC circuit or tenant count, we currently have 1.3 tenants per unique tower which translates to 870 total circuits or connections at the end of the second quarter on our network.

We have approximately 1,270 total circuits under contract, meaning they've either been installed or they are in the backlog waiting to be installed. Nearly 1,000 of those 1,270 are unique sites. Our long-term target is to have 1,500 unique sites and 2,250 total FTTC circuits or connections on our network. Therefore, we have about 56% of our total long-term FTTC contract circuits under contract as of June 30. The additional tenants to each tower are simply great for the business model, because the installation process is faster and it certainly accelerates the return on our invested capital.

Our long-term target of $70 million in annual FTTC revenues assumed 2,250 circuits billing on average $2,500 to $2,600 per month at maturity. We maintain our target for 500 to 700 new circuits signed in 2014. If we reach that target, we could end 2014 well over two-thirds of our total long-term circuit contracts under contract. The ramp of the LTE rollouts in our network is in a steep part of the growth curve and our pipeline for FTTC sites has never been larger.

I'm also pleased to be able to raise significantly the number of total towers in our addressable market, from 4,100 towers within 5 miles of our fiber to 5,400 towers within three miles. This is due to a combination of reasons, both the growth of our fiber footprint, the continued pace of tower builds, and a more thorough market review and data sources. I expect these numbers will continue to rise over time and this gives me further confidence we can reach our long-term FTC targets. All of you have undoubtedly heard me talk at length about Project Ark, a dedicated, all-IP overlay network built for out FTTC customer traffic.

This initiative remains a mission-critical part of our FTTC business. I'm thrilled to confirm that the Ark is on target for completion in the third quarter, and the routing of FTC traffic onto the Ark will begin in the fourth quarter. The Ark will allow for a fully-redundant FTTC transmission and provides the highest level of carrier-grade Ethernet services that our customers require.

Our transport segment grew 3% sequentially, as we avoided further material unforeseen TDM churn. Our transport revenue declined $1 million sequentially in the first quarter of 2014 as our carrier customers groomed some of these legacy TDM circuits, largely DS1s and 3s. We continue to believe that our transport revenue will decline in the range of 8% to 10% in 2014 as carriers continue to groom their network of legacy TDM circuits in favor of the more efficient Ethernet product offerings.

As we have noted before, we are not losing these circuits directly to competition, rather, they're simply disappearing as networks evolve the IP. In 2012, our DS1 DS3 revenue within our transport business was around $28 million, and by the end of 2014 that run rate will have been cut roughly in half. So, we have taken a lot of the pain already in this segment. Our enterprise revenues declined sequentially in the range of 1%, as previously disclosed known churn events began to flow through the P&L.

We believe that we are taking the necessary steps to change the trajectory of this business. Given that our business is based on the reoccurring revenue stream model, we are unlikely to show year-over-year enterprise growth until 2015. A declining revenue base in our enterprise business is not acceptable, and we are very focused on renewing growth in this critical segment. In order to have a world-class fiber bandwidth infrastructure business, we need to have a vibrant enterprise business. So, how do we get there?

In the second quarter, we hired Glenn Lytle as VP of our enterprise business. Glenn had tremendous success at Comcast Business Services building a large enterprise book, in many of our overlapping markets, particularly Virginia and Pennsylvania. He brings a whole new level of detail and focus on account management. Additionally, he has accelerated our focus on enhancing our enterprise renewal program and the results have been dramatic. In the second quarter, the average contract length of our enterprise renewals increased sequentially by nearly one year, from 33 months to 43 months.

This is a tremendous accomplishment, and demonstrates the ability our sales force has to sign an increasing number of five-year contracts. In the first half of 2014, we renewed approximately 9% of our enterprise base and one of Glenn's key goals is to accelerate this pace in the coming quarters. I also expect that Glenn will orchestrate further substantial strategic changes within his enterprise business over the coming months. We believe that the total blended contract length of our fiber data business will be a critical metric to disclose, because it can demonstrate the predictable cash flows of this business.

In the future, we believe that this blended rate will likely increase as FTC grows as a portion of our data revenue, and as we continue to focus on signing enterprise customers to longer-term contracts. Two other key areas of our enterprise business are data center connectivity and our edge-out markets, particularly Richmond. Our monthly sales productivity in Richmond is materially better than that of our overall footprint, and we expect that trend to continue. On an annualized basis, our Richmond bookings in direct enterprise and transport is around $4.2 million in annual revenue, and we have a list of great enterprise accounts like HCA, VCU Medical to go along with the data center connectivities to into Peak 10 and QTS.

We believe that continued data center connectivity in our footprint will help drive increased enterprise sales as our customers increasingly look to us to provide them with secure bandwidth options to key data center destinations with diversity. One of the true bright spots in our enterprise business is our carrier or partner end user channel. In the second quarter, our sales bookings in this segment exceeded $60,000 of MRC, up over 75% sequentially and represents now more than 25% of total enterprise sales bookings.

We continue to believe that this segment will constitute a growing portion of our enterprise sales bookings and could reach 50% of enterprise sales in the long term. To review this program quickly, we have signed MSAs with nearly all the key national and regional broadband operators and MSOs. An example, say one of these partners has a national retail chain as a customer who has locations in our footprint and close proximity to our fiber. In an example like this, our MSA partner would lease access onto our network to extend connectivity to that site as a Type 2 service. This typically is a win-win for both.

We're able to monetize our unique footprint with incremental revenue on our network to a customer we would unlikely have ever sold directly, and our partners can avoid incremental capital costs. To further enhance this channel's productivity, in June we sent out our near-net list of 15,000 buildings within a half mile of our fiber to our MSA partners, and we are now in the interface stage of finding mutual opportunities. Over time, as our network intelligence accelerates and our partnerships expand, we expect that near-net building list to grow substantially.

It is our belief that getting the near-net list into the hands of our partners will significantly broaden the potential of this distribution channel. In the last year, we have grown our carrier end user team from 1 to 5 executives, due to the anticipation of the increased demand, and this strategy is working. Our two most recent hires came to Lumos from pure-play fiber companies to pursue Federal government business, MSOs, and international telecom players. And we're off to a strong start in the third quarter with carrier end-user sales.

In the second quarter, we continued the strong pace of the build out of our fiber infrastructure. We installed 40 fiber-to-the-cell, we added 81 miles of fiber, and now have 7,548 route miles of fiber in our footprint. This count does not include the 53 mile long-haul network that we completed between Richmond and Charlottesville, Virginia, in the month of June. We will add these miles to the third quarter total.

This long-haul route will significantly reduce Type 2 lease causes and represent a truly unique route in our footprint. Our long-haul route between Richmond and Ashburn, Virginia, the data center capital of the world, is scheduled for completion in the fourth quarter. We believe these important routes will add significant value to our business as it reduced costs and brings our network within range of new towers, enterprises, and data centers. We added fiber connectivity to the Peak 10 data center in Richmond, Virginia, which marked our 14th commercial data center connection.

We put out two press releases last night with more good news on the data centers, announcing fiber connectivity to QTS, a major Richmond data center, and the signing of a contract to bring fiber connectivity to a newly-constructed data center operated by DC Corp. When fiber is connected to DC Corp facility later this quarter, we will have connections to 16 commercial data centers, well on our way to achieving our target of 20 connections by the end of 2014.

Our partnership momentum with national data center carriers and leaders like Peak 10, QTS, Iron Mountain, Terremark, and DC Corp, and continues to build our enterprise customers as they are increasingly asking us to provide them with safe, reliable and diverse high-speed connectivity to data centers. We view data centers as large multi-tenant on-net locations to help us scale our data business. We are still significantly under-exposed to data centers, but we have made significant progress to bridge that gap and a roadmap to continue to expand in 2015 and 2016.

In the second quarter, we added 33 on-net buildings to our network and now have 1,420. In the past year, we have added 147 lit buildings. Note these buildings are where we provide fiber all the way to the location, providing the last mile access. Both we and our customers prefer this method, as we can control the network and service quality while maintaining gross margins north of 80%. This is a clear example of how incremental fiber builds can drive margin and value.

Now turning to our overall sales outlook, we maintain our target for total data sales of between $2.4 million and $2.8 million in 2014, which represents an annual increase range of between 30% and 50%. Based on our sales pipeline, we continue to believe that we can and will finish within that range.

In our view, the fact that the vast majority of these sales are Ethernet and on long-term sales contracts is as nearly relevant as the total aggregate sales number. We continue to focus on keeping our operating expenses flat in 2014 versus 2013. however, as I’ve said in the past, we will continue to manage the business in the best interest of our customers and our capabilities to deliver high levels of services. We plan to invest in sales, engineering and IT talent, while we accelerate our fiber revenue, while continuing to shift costs from our legacy product lines. We are in a scale game, and we need to continue to invest in our network and our people to grow and provide world-class services to our customers.

To this end, we’ve hired a number of key personnel within Craig Drinkhall’s CTO organization with significant fiber and IP experience. These critical hires – these hires are critical in order to scale our network with increased sophistication and accelerating bandwidth demands.

We’ve made further headway in our conversion to our state-of-the-art Oracle back office system. We continue to believe that most of the benefit will be felt in the out years, but we are already reaping some increased efficiencies in financial reporting and in the enhancement of customer data intelligence.

In closing, I think it’s worth noting a few of the positive trends in the industry that we believe are validating our thesis to build valuable fiber infrastructure assets, underpinned by long-term fiber contracts. The merger of TW Telecom and Level 3 demonstrates the value of fiber assets operated by a skilled management team, combined with attractive customer base.

Additionally, it wasn’t lost on us that Zao outlined in the first three pages of its S1, many of the same fiber network metrics that we are striving for – lit buildings, connected data centers, FTT cites, fiber miles, and the value of revenue under contract.

Now before I turn the call over to Johan for more detail about our financial results and our guidance, I would like to thank all of our customers, employees and shareholders for their continued support and confidence in our transformation. Thank you. Johan?

Johan G. Broekhuysen

Thank you, Tim and good morning, everyone. This morning, I would like to provide you with a financial overview of Lumos Networks business. This overview should be considered along with the more detailed financial information available in our Q2 2014 10-Q, filed with the SEC last night, and the press release that was also issued. I will cover three topics today, provide a financial outlook for the full year of 2014, provide Q2 2014 financial results, and give a brief project management office update on our current projects.

As Tim mentioned in his remarks, we are maintaining our annual financial guidance of approximately $200 million in revenue and $90 million in EBITDA for the financial year. We believe we will spend approximately $75 million in CapEx in 2014, and end the year with approximately $32 million in cash and marketable securities, which is slightly higher than prior quarter guidance, and this is due to the improved cash position as a result of improved tax compliance.

Q2 financial results. Revenues for the second quarter of 2014 were $50.1 million, which is $75,000 higher than the first quarter and $2.1 million lower than Q2 a year ago. For the six months ended June 2014, revenues are $100.25 million, or $4.5 million lower than the same period a year ago. Our data segment revenues for the second quarter were $26.7 million, which is $570,000 higher than the first quarter and $1 million lower than Q2 a year ago.

For the six months ended June 2014, data revenues of [Technical Difficulty] $1.7 million higher than the same period a year ago. Our R&SB segment had revenues of $18.3 million for the second quarter, which is $357,000 lower than the first quarter and $2.1 million than Q2 a year ago.

For the six months ended June 2014, R&SB segment revenues were $36.9 million, or $4.5 million lower than the same period in the prior year. RLEC access revenues were $51 million – $5.1 million; I beg your pardon, in the second quarter of 2014, or $138,000 lower than the first quarter and $984,000 lower than Q2 a year ago.

For the six months ended June 2014, RLEC access revenues were $10.4 million, which is $1.7 million lower than the same period a year ago. We continue to see churn in our data segment, particularly in our TDM transport product service offerings, and to a lesser extent in some of our enterprise product lines that are mature and are also TDM-based services. While churn rates in our transport business in Q2 returned historical rates, we cannot guarantee that this will be the case for the remainder of 2014.

The churn in our transport and enterprise TDM services is primarily being offset by the significant growth generated by our fiber-to-the-cell business, which typically has 5 to 10-year contractual terms. In addition to selling Ethernet-based services to new enterprise customers in our network footprint, we have initiated retention programs to convert existing monthly customer contracts into three-year or longer contracts by offering additional bandwidth with a little or no incremental cost to the customer or the company.

These retention programs have not yet been in place long enough to be certain they are effective, but early signs are positive. We are also focusing on our data center strategy to be more competitive in our enterprise offerings, as demand by enterprise is to be directly-connected to data center growth.

Our R&SB segment continues to see annualized declines in the 10% to 15% range, primarily due to residential wireless substitution, technology changes and product replacement by competitive voice service offerings from cable operators in our market. Diego Anderson, our R&SB GM, has successfully completed the upgrading of our IPTV offerings to improve the customer video experience.

In addition, Diego has added a small team of sales professionals to pursue the sale of services to small businesses within a quarter mile of Lumos fiber in the Lumos legacy markets that have been underserved by the company in the past, as we focused on the rapidly-shifting revenue stream, the custom Ethernet offerings for enterprises with greater than 750 MRC. We are hopeful that with targeted retention incentives and our new sales efforts being introduced at the R&SB medium and small enterprise customers; we can lower current churn rates in the R&SB segment.

Adjusted EBITDA for Q2 2014 was $22.7 million, up $157,000 from Q1 2014 and down $1.8 million from Q2 a year ago. Adjusted EBITDA for the six months ended June 2014 was $45.29 million, which is $3.9 million lower than the same period a year ago. The higher EBITDA Q2 versus Q1 was primarily due to lower cost of revenues resulting from the decline in Type 2 legacy voice customers in the CLEC territories, partially offset by operating expense increases.

The increase in operating expenses in the second quarter were primarily labor costs as we recruited and hired more employees in the CT organization to stop the NOC and fill other needed IP engineering roles. Compared to Q2, 2013, adjusted EBITDA was down $1.8 million due to revenue declines of $2.1 million, primarily in our legacy voice business.

It is worth noting that our operating expenses, Q2 2014 versus Q2 2013 are flat, showing me we have been successful thus far in shifting resources from our R&SB business to our data business without incremental increases in OpEx. The $3.9 million decline in EBITDA for the six-month period versus the same period a year ago is primarily attributable to the $4.5 million revenue decline partially offset by lower cost of revenue, the result of declines in voice subscribers, primarily in the CLEC territories. Again, it is worth noting that for the first six months in 2014, we’ve managed to successfully transition resources from the R&SB business to the data business, essentially keeping OpEx flat.

Let me take a brief moment to comment on our recent announcement within the industry that certain industry assets were spun off into a publicly-traded REIT. This is a bold and interesting move that could assist in unlocking a latent enterprise value within the industry, and we will be working to understand to worth any value we could unlock were we to do a similar type of transaction. I would like to be clear though, that all capital structures are different and REITs, like all trusts, are regulated by the IRS. Accordingly, this structure may not be appropriate for Lumos. Needless to say, there’s more work to be done.

Project management office update. As Tim mentioned, we’re on track for Project Ark and Project Stingray, which are both directed at creating greater resiliency and redundancy in our networks.

Project Ark will create a fully-redundant carrier Ethernet grade network that will be dedicated to carrying fiber-to-the-cell and carrier traffic across our network, and we expect to migrate our first carrier customers onto the Ark in late Q3 and early Q4 this year.

Project Stingray is primarily intended to create improved resiliency in the rest of our network. Project Accelerate is the internal project to upgrade or replace many of our legacy internal systems with the Oracle Stack, which we acquired in 2013. We went live with Oracle EBS Financial Systems in April, and it continues to perform well for us with productivity gains and improved transparency in the financial reporting function.

In addition, we placed MetaSolv into production in late April, and the implemented functionality appears to be working as configured. We continue to optimize some of the configuration and adapt our processes within certain service delivery areas of the company to ensure successful service provisioning to customers across the spectrum of services that we offer.

We believe that with the ongoing incremental improvements and continued system optimization, we will create a scalable, robust service delivery system that ultimately will improve productivity and scalability within the organization through greater efficiency, accuracy and transparency.

Phase 2 of Project Accelerate is slated to begin in Q3 of 2014, and will begin the effort to design and migrate to the Oracle CRM and BRM platforms. This transformation is expected to be completed sometime in late 2015.

That concludes my prepared remarks. Operator, we will now take questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Colby Synesael of Cowen. Please go ahead.

Colby A. Synesael – Cowen & Co. LLC

Great, thank you. A few questions. So, I know you just commented on what Windstream was doing in terms of spinning off assets, but just curious, do you think as a smaller company going through that same process would be easier or more difficult for you? And related to that, but I guess separate, would you consider selling your legacy ILEC assets, and effectively keeping the fiber infrastructure, which you’ve been focusing on? Is that something you would consider? Is that even possible? And then I guess just another question as it relates to just fiber backhaul. We’ve been hearing that a lot of providers, in particular, Verizon, increasingly focusing on signing dark fiber deals as opposed to lit. As some of your customers that you’ve already signed make that transition, is that more of an opportunity in terms of financially speaking, or is that more of a risk for you guys? Thanks.

Timothy G. Biltz

I’ll take the FTC and if you want I’ll let you speak to the – and then I’ll give my thoughts on a little bit of the REIT as well. A couple questions in there. let me deal with the spin of the RLAC or the selling of the RLAC assets. What I would say is, it’s very – scale’s an issue for us today, so it’s unlikely we would sell those assets off in any short period of time, I think.

Over time, that certainly would be an option, and potentially, the REIT structure may assist in that. I don’t know, it’s too early. On the dark fiber contract, we sat down with our customers and discussed all ranges. So, we’re not opposed to dark fiber, and as a matter of fact, the long-term reoccurring nature of dark fiber and the ability to receive capital up front, to put that capital in the ground, we think is fine.

We’ve already proposed with services, to what we call a managed service; to some people refer to it as a dim, to a transition to dark. I would say those – it’s both a risk and an opportunity, whenever a customer changes a service, but we at this point, have seen no, zero, requests or desires to put dark fiber or to have signed it in our footprint. All of ours are lit, most of those are as Johan mentioned, five, seven and 10-year contracts, with the majority being in the seven to 10-year contract range. So, we’ll face it and we are bidding and proposing on some dark fiber, but I would say it would be outside of our traditional footprint is where we have most of the experience.

Johan G. Broekhuysen

Colby, on the REIT, I really only really only have two thoughts at this time. One is, I think it’s an interesting move for the industry. It creates additional opportunity to unlock value, so I think probably as an industry it’s a plus. In terms of specific to Lumos, I think there’s a lot – there are a lot of regulation around a REIT, and understanding how that would play into our strategic go-forward plans is critical. So, until we do all that work, it’s really too early to say whether we’ll benefit or not, but it’s another option, it’s a new option, and that makes it interesting.

Colby A. Synesael – Cowen & Co. LLC

It sounds like you guys really will do at least some work on this to actually see if it makes sense for you, opposed to simply observing what Windstream’s doing?

Timothy G. Biltz

Well, I wouldn’t say we’d take it too far down the – we’ll do work, we’ve already talked to bankers, we’ve already been briefed by the people that were involved in that process. There’s a lot of work for Windstream to get that effective. It would not be the highest priority of our time in the next six months. We want to make sure our capital structure is both efficient, but also effective for what we’re trying to execute on, and I’m not so sure that would be – but we’ll study it, but I would move so far as to say we’ll do significant work.

Colby A. Synesael – Cowen & Co. LLC

Okay, all right. Thank you

Timothy G. Biltz

Yes.

Operator

(Operator Instructions) Our next question comes from Donna Jaegers of D.A. Davidson. Please go ahead.

Donna M. Jaegers – D. A. Davidson & Co.

Hi guys, good quarter. On the – sort of an off-the-wall question, Dish and nTelos are trialing fixed broadband in nTelos’ service area. Does that overlap with your ILEC property, and what are you seeing so far? I think they just started it up about a month ago.

Timothy G. Biltz

The reality is they are doing it in our footprint, we obviously supply a lot of FTC services to nTelos. And I don’t know that we – I’d have to ask Diego if we’ve lost any customers to them. I don’t see it as a threat to our fundamental business. As a matter of fact, I see as one of our large customers is buying more bandwidth on the wholesale side to FTC.

There’s lots of those service areas that are quite rural, where wireless bandwidth is the most efficient way to get it there. So, in our ILEC territory, our line loss is still only 5%, 6% range, and our video product is actually growing in that 6% to 8% range, and our broadband is growing in our RLEC. So, we haven’t seen any real impact, but we also don’t see it as a big threat. We see it as servicing our customer. We want nTelos to get their 4G into market as fast as possible.

Donna M. Jaegers – D. A. Davidson & Co.

Okay. and then with Diego’s appointment to managing the ILEC properties, can you give any more color on obviously, Johan mentioned that you guys were sort of transferring expenses. You’re adding expenses on the competitive operations, trying to trim them on the ILEC. Any other color on Diego’s goals for the ILEC properties?

Timothy G. Biltz

To minimize the rate of decline for sure, increased penetration of our broadband as Johan laid out, I think we’ve underpenetrated our broadband sales, just medium and small businesses, in the ILEC territory. There’s not a lot we can do for that group in the CLEC territory and do it wisely, so that's where most of the costs are coming out. And we're actually increasing some of the investment in the ILEC footprint. So, there's even a shift of costs within the segment itself. So new salespeople, a couple talented folks, we're weighing out some new technologies in the ILEC that are efficient that will allow us to increase our bandwidth speed within the ILEC.

I think Johan mentioned we have upgraded the IPTV network to take additional capacity. We are finishing an RUS project in Covington, which I think will pass another 800 or 900 homes in the next year. He's rolling out VDSL to increase those speeds in the ILEC. So, he's got a lot of initiatives and projects, and it's been a great, should've done it two years ago, is my fault. But having said all that, we're actually – we're not asking him to turn the company around, we're just trying to moderate and make that business more efficient and profitable. But the real growth is still going to come from Ethernet to the large enterprise and carrier customers, and that's where the majority of the capital is going.

Donna M. Jaegers – D. A. Davidson & Co.

Right, and then just another question on regulation. On the inter-carrier reform, as that shifts to interstate instead of intrastate, does that open up more or less risk for you guys? I think it's a smaller step down than what you faced in the past. And then, any read on the Universal Service Fund and CAF2? As far as any potential for you guys to – any risk there, or any potential to pick up new revenues?

Timothy G. Biltz

Well, I wouldn’t say we’re picking up new revenues, but what I would say is, we certainly have the stuff down and Johan, you jump in and maybe the specifics if you have them. But we still believe our access will decline in that 5% to 7% range. I think that the regulatory structures and the mechanisms to recover those funds in a step-down fashion through the CAF, the charges to the customers, and the like. I think it's firmly in place and we see it, we feel comfortable with that, and there'll be some down-tick in access based on the recent rates but not significant at all.

Johan G. Broekhuysen

Yeah, so Donna, we did implement the new rate structure, the new tariffs in July, as required. Most of those revenues as you rightly pointed out are protected through the CAF, and other mechanisms. So to Tim's point, we'll continue to see 5%, 7%, maybe 8% decline in that space, which is expected given that the step down on the CAF is 5% a year and then there's some long distance that's associated with those customers and their tariff. So, the reform will continue, and we'll continue to be protected by CAF.

Donna M. Jaegers – D. A. Davidson & Co.

Okay that’s great, thanks guys.

Timothy G. Biltz

Thank you.

Johan G. Broekhuysen

Thanks Donna.

Operator

(Operator Instructions) Our next question comes Jennifer Fritzsche of Wells Fargo. Please go ahead.

Jennifer M. Fritzsche – Wells Fargo Securities LLC

Great, thank you for taking the question. Just a few, if I may. On the fiber-to-the-tower opportunity, I know you define it as 5,400 given the towers within the network, in your footprint, rather. Can you talk about how many, your best guess, already have fiber laid to them so when – I'm just thinking when those contracts come up for renewal, what the opportunity is for you all? And then regarding nTelos, now that they have the agreement with Sprint behind them, I just was wondering if you've seen greater activity there in the rollout of their fiber-to-the-towers. And then finally, I just wanted to ask about the competitive environment, what you're seeing from cable. And could you talk about how much ZAO is overlapping with your business in your footprint? Thanks very much.

Timothy G. Biltz

On the FTC, we do not have a solid number although we're spending time trying to figure that number out, and that's one of the results of this larger footprint is the result of that more in-depth work. I have my estimates of what I think it is and it’s – is it a fair number. We’ve already accomplished a significant amount with a 1000 uniques under contract. So I would say in that probably a third of those. We represent a third of the stuff that's been issued in our territory so there's probably another 2,000 towers that have access, and so maybe another 2,500 that don't would be my guess. I don't have the firm data for that, when we're trying to get that data. Concentrations are higher in Pittsburgh and Richmond obviously then they would be in West Virginia and more rural Virginia. So, we feel comfortable, we also see a lot of new sites going up that start at zero, there's no fiber to those sites that are coming in. That's FTC.

On the issue of general competition, I would say it's – we compete not so much – we do compete with the MSO and the MSOs are very difficult to win if they're on that. Our business is truly based on building custom networks that leverage our footprint relative to the customer's needs. So, it does, by definition, bring down the market size of who we target. And the flip side of that is our carrier-end strategy because our network is unique. We prefer people not to over-build it. We provide it available to them through the carrier end user, and the near-net list.

And so as I said in my comments, we have seen that business increase significantly each of the last couple quarters, and we expect the third quarter to be up as we partner with our competitors if you will. So it’s competitive out there, but not any more so than it was before, and I think we become better at working with our competitors to provide them access. ZAO, we see ZAO primarily in the large markets, and the southern tier of our market. But I would say our – when we think about our big competitors, we see more – the cable operators and the incumbent ILEC.

Johan G. Broekhuysen

Jen, I would just add a little bit of color to your fiber-to-the-cell question. When we cut our addressable market about 18 months ago, the number was 4,100 addressable towers within 5 miles this is now 5,400 towers within 3 miles. So it’s probably a more realistic picture of what we would actually build to. I think that's a combination of A) We’ve added significant mileage since then, and the industry continues to add towers as Tim mentioned. It looks like the industry may add more towers this year than in the last couple of years. And then too, I think when you're looking at what is our addressable market, another way to look at it is just by operator. If you look at some of the significant wireless operators nationally really have not started to roll out LTE in all markets. Some have, but some haven't. So, that’s another way to kind of look at the fact that we're still in early innings for LTE rollout in our footprint.

Timothy G. Biltz

So we see to that point, you asked specifically Jennifer about nTelos and the answer is yes. Clearly, it was very important for them to get their strategic alliance renewed with Sprint, and they have clarity of what they want to do, where they want to go, and our team is working with them. Clearly, we can’t provide all their services because our footprint doesn’t line up a 100%, but we would expect or hope that we would be competitive in a large number of those sites, and that would be beneficial.

We also, I think we mentioned in the last call that T-Mobile remains very active, and moving in this footprint, and we have a very good relationship with them and have booked a significant amount of business with them. I think we've also said that Sprint, well, most of their footprint in our area has either been covered by Shentel or nTelos, as we've gone into Richmond and Pittsburgh and other markets we're starting to see significant discussion about clear wire perspective in the 2.5 spectrum. So, from our backlog, I can't say we're going to win it all but from the business that we're quoting and we've never seen FTC larger now.

Jennifer M. Fritzsche – Wells Fargo Securities LLC

Thank you very much.

Timothy G. Biltz

Thank you.

Operator

Thank you. This concludes our question-and-answer session. I would now like to turn the conference over to Mr. Will Davis for any closing remarks.

William G. Davis, Jr.

As a reminder, a replay of this call and an archive of the audio webcast will be available. Please refer to our Investor Relations website for details. Thank you again, for joining us this morning. This concludes our call.

Operator

Thank you very much sir, the conference is now concluded and we thank you all for attending today’s presentation. You may now disconnect and have a wonderful day.

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