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Executives

Bob Gunderman - Senior Vice President of Financial Planning and Treasury

Jeffery R. Gardner - Chief Executive Officer, President and Director

Anthony W. Thomas - Chief Financial Officer

Brent K. Whittington - Chief Operating Officer

Analysts

Michael Rollins - Citigroup Inc, Research Division

Scott Goldman - Goldman Sachs Group Inc., Research Division

David W. Barden - BofA Merrill Lynch, Research Division

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

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

Timothy K. Horan - Oppenheimer & Co. Inc., Research Division

Batya Levi - UBS Investment Bank, Research Division

Derya Erdemli - JP Morgan Chase & Co, Research Division

Windstream (WIN) Q2 2012 Earnings Call August 9, 2012 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Windstream Second Quarter 2012 Communications Earnings Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded. I'd now like to turn the conference over to your host, Mr. Bob Gunderman, Senior Vice President of Financial Planning and Treasury. Please go ahead, sir.

Bob Gunderman

Good morning, everyone. We appreciate you joining us today to discuss Windstream's second quarter results. Before we get started, let me remind you that our earnings release, supplemental pro forma results and our second quarter earnings presentation are available on the Investor Relations section of our website. Today's discussion will include certain forward-looking statements. Please review the Safe Harbor language found in our press release and in our SEC filings, which describe factors that could cause our actual results to differ materially from those projected by us in our forward-looking statements. Today's discussion also includes certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measure are also available on the Investor Relations section of our website. We have provided supplemental pro forma financial results, including the PAETEC business for all periods shown. Given that Windstream and PAETEC had different operating metric disclosures, we are continuing to develop a unified approach and plan to introduce additional disclosures later this year.

At this time, we have continued to provide the business operating metrics for Legacy Windstream. In addition, we reclassified some minor revenue and expense items and adjusted the prior periods accordingly. We will make references to these pro forma results, including the year-over-year comparisons, during our call.

Participating in our call this morning are Jeff Gardner, President and Chief Executive Officer; Tony Thomas, Chief Financial Officer and Treasurer; and Brent Whittington, Chief Operating Officer.

At the end of our prepared remarks, we will take a few questions. With that, here's Jeff Gardner.

Jeffery R. Gardner

Thank you, and good morning, everyone. I'm going to begin by discussing the progress we are making on our strategic goals, Tony will review our financial performance and then Brent will discuss our operating results.

Beginning on Slide 4, the key takeaways that I would like to emphasize today are: First, we are confident in our strategy and our business is performing well. Our second quarter results were in line with our expectations, and we remain on track to achieve our 2012 plan. Next, we are driving profitable growth in our strategic areas of business and broadband through a combination of targeted acquisitions, our operational focus and success-based capital investments. At the same time, we continue to improve our cost structure.

2012 is a peak CapEx year, driven by unique opportunities to grow organically with success-based capital investments. And coincidentally, these investments occur in a year with very favorable tax treatment. As we move into 2013 and beyond, capital will decline, and we expect to also benefit from lower cash interest and growth in adjusted OIBDA. As a result, Windstream is positioned to deliver sustainable and growing free cash flow.

The dividend is a key component of our strategy. Yesterday, we declared our 25th consecutive dividend of $0.25 per quarter, and the cash generation capabilities of this business allow us to adequately invest in our network to support growth opportunities while paying the dividend well into the future.

Turning to Slide 5. Windstream's long-term strategy is straightforward: Improve revenue, aggressively manage expenses and pursue targeted acquisitions, all with the goal of increasing free cash flow per share and in turn, creating shareholder value. We have made substantial improvements in our revenue mix and financial trends over the past 6 years by executing this strategy, and we continue to make progress during the quarter.

Specifically, turning to Slide 6, our strategic growth areas account for 68% of Windstream's total revenue, and collectively, grew 2.5% year-over-year during second quarter. Business service revenue grew by 2%. Our business sales team is participating in many new sales opportunities as a result of our expanded network, robust product lineup and our personalized service, which has improved our competitive position. Consumer broadband service revenue grew by 4% year-over-year, a result of our focus on monetizing our industry-leading penetration by selling incremental broadband features and faster speeds. Additionally, we are investing capital in growth initiatives that further improve our financial profile and offer attractive returns.

Cost management is a core competency for Windstream, and we took steps in the second quarter to further improve our cost structure. We announced that we are restructuring our management organization to increase the efficiency of our decision-making and serve our customers more effectively. The reorganization is expected to yield $30 million to $40 million in annualized cost savings, primarily benefiting the fourth quarter. In addition, we expect to achieve $50 million in synergies in 2012 related to the PAETEC acquisition.

Our targeted acquisition strategy has strengthened Windstream. The power of a nationwide network is significantly enhancing our ability to win larger, multi-location enterprise deals, and our sophisticated product offerings and brand promise of personalized service are resonating very well. The PAETEC integration activities are on track, and we are making solid progress as a combined organization.

In summary, I am confident in our strategy and our ability to execute on our plans. We see a clear path of growing free cash flow per share which will support our dividend well into the future.

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

Anthony W. Thomas

Thanks, Jeff, and good morning. Turning to Slide 7 where the second quarter Windstream achieved total revenue of $1.54 billion, operating income of $239 million and earnings per share of $0.09. Our results include approximately $12 million in after-tax merger integration expense and $6 million in restructuring costs. Excluding these items, our adjusted EPS would have been $0.12 in the second quarter.

On Slide 8, Windstream generated pro forma revenue of $1.54 billion during the second quarter, a decrease of 1% year-over-year. Specifically, business service revenues grew by $18 million or 2%, consumer service revenues declined by $11 million or 3%. Wholesale revenues declined $29 million or 12% year-over-year, and total product sales increased by $14 million or 26%.

Within the business channel on Slide 9, data and integrated services grew by $28 million year-over-year or 8% due to growth in IP, next-generation data and data center services. Carrier revenue was up $7 million or 5% related to strong demand for increased capacity in wireless backhaul services. Business voice and long-distance revenues decreased by $20 million due to ongoing migrations from traditional voice services to integrated voice and data services. Importantly, our business team has been achieving their sales targets, and we are well positioned to deliver on our plan for the remainder of the year. Business product sales increased by $3 million or 8% as we saw an increase in enterprise-related product sales.

In the consumer channel, voice and long-distance revenue declined by $14 million or 7% due to fewer voice lines and declining feature packages. This was partially offset by growth in broadband revenues, which increased $4 million or 4%. With broadband penetration reaching 69% of primary consumer lines, we are focusing on improving customer ARPU by up-selling features, add-on services and faster broadband speeds.

Wholesale revenues declined by $12 million year-over-year, which was in line with our expectation. First, Switched Access revenues decreased by $28 million due to traditional declines related to fewer access line and to modifications we made to certain PAETEC wholesale products last quarter.

USF revenues increased by $4 million year-over-year driven by higher end-user pass-through surcharges. Wholesale voice and data revenue, which includes our traditional resell business, declined by $5 million due to fewer access lines and lower usage.

Sequentially, total service revenues decreased by $18 million or 1.2%. This was largely due to declines in the wholesale revenue related to changes to the PAETEC Switched Access products I just mentioned. As a reminder, we had $10 million in revenues related to these products in the first quarter. We also had a sequential decline in business voice and long-distance revenue due to migration to integrated voice and data services. In addition, retail long-distance usage was higher in the first quarter and returned to a more consistent run rate during the second quarter.

In the consumer channel, revenue declined by $1 million sequentially, which was an improvement from the roughly $4 million trend we have experienced over the last few quarters.

On Slide 10, cash expenses improved by approximately $7 million or 1% year-over-year. Specifically, cost of services increased by $9 million due to network growth and interconnection costs; increased data center costs due to growth and expansion; and higher pass-through federal USF surcharges, which were partially offset by seasonal declines in payroll taxes and other benefit costs. Cost of products sold increased by $13 million, consistent with better product sales. SG&A expenses decreased $29 million or 11% due to $12 million in incremental deal synergies and other cost management initiatives.

Sequentially, cash expenses declined by $9 million or 1% related to incremental PAETEC synergies, declines in seasonal payroll taxes and other cost management initiatives, which were offset partially by an increase in seasonal operating expenses and higher product sales.

For the quarter, adjusted OIBDA was $596 million, a decrease of 2% year-over-year and our adjusted OIBDA margin was 39%. Sequentially, adjusted OIBDA increased by $2 million and the margin improved by 30 basis points.

Turning to Slide 11. During the quarter, we spent $267 million on capital expenditures, which included $70 million on fiber-to-the-tower investments and roughly $7 million on broadband deployment related to stimulus projects. In addition, we spent $9 million of integration capital related to network optimization opportunities, which are part of our PAETEC integration plans.

In the fourth quarter of 2011, the FCC established an interim $300 million Phase 1 Connect America Fund to further assist price cap carriers in deploying broadband to unserved locations of which Windstream was eligible for up to $60 million. Given the framework to accept the support, combined with our already high broadband addressability, very few opportunities met our investment criteria. We accepted roughly $700,000 of the support under the current framework and also filed a waiver seeking to modify certain requirements, which would enable us to accept all of the funds and expand our broadband footprint.

Adjusted free cash flow was $135 million during the second quarter, which was down $91 million year-over-year, while actual adjusted OIBDA grew by $86 million with the addition of PAETEC. This was offset by higher CapEx of $96 million and an increase in cash interest of $79 million, which was largely due to a shift in the timing of our interest payments due to our refinancing activities. Now the majority of our interest payments fall within the second and fourth quarters whereas last year, the bulk of those payments were in the first and third quarters. For the first 6 months 2012, we generated $487 million in adjusted free cash flow and paid out $294 million in dividends. During the second quarter, working capital was a $15 million source of cash.

Turning to Slide 12, we strengthened the balance sheet by amending our credit agreement in order to raise $900 million of additional proceeds, which we used to fully repay our outstanding revolver balance and create sufficient liquidity to refinance 2013 debt maturities. This transaction did not change our net leverage ratio and allows us to repay the 2013 debt maturities without further need to access the debt markets.

We ended the quarter with net leverage of 3.66x adjusted OIBDA. We remain committed to reducing net leverage to 3.2x to 3.4x adjusted OIBDA, and we'll make significant progress towards this goal next year as we permanently pay down a portion of the 2013 maturities, which will allow us to reach the top end of our targeted leverage ratio by the end of 2013.

Turning to Slide 13, our plan for 2012 remains on track. For the remainder of the year, we expect to see sequential improvement in revenue and adjusted OIBDA, particularly in the fourth quarter related to enterprise sales success to date, incremental fiber installations, additional PAETEC synergies and the cost savings related to our ongoing reorganization efforts. Importantly, improvements that we expect in the back half of the year are based on activities that are well underway, and we are comfortable that we will achieve the low end -- the lower end of the revenue-adjusted OIBDA guidance range that we provided in February.

As we look to 2013 and beyond on Slide 14, we expect strong performance to drive growth in the business channel and continued stability in the consumer channel which, combined with the cost-saving initiatives, should lead to adjusted OIBDA growth. This, together with significant reductions in capital spending and lower cash interest, positioned us very well to sustain our dividend, deleverage the balance sheet and consider additional shareholder-friendly activities even with the expectation of higher cash taxes.

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

Brent K. Whittington

Thanks, Tony, and good morning, everyone. Turning to Slide 15. During the second quarter, business sales momentum remained strong, and our core services performed very well. We completed the rebranding efforts in the PAETEC markets and are seeing many benefits to operating as a combined company. We are successfully competing for large enterprise business customers and seeing positive results from our advanced service capabilities and personalized service.

We are differentiating Windstream by providing an integrated sales approach, which includes the collaboration of network engineers and dedicated product and data center specialists to customize solutions for business customers. We are equally focused on small business customers and are differentiating Windstream by offering innovative bundles that combine web hosting, design and maintenance with a full suite of voice and broadband services. We're seeing increased demand for data center co-location, cloud, and managed services from both large and small business customers. The carrier business continues to grow nicely, driven by growing customer bandwidth needs and wireless backhaul.

On Slide 16, consumer voice lines declined by approximately 24,000 in the second quarter and represented a 4.4% decline in total customers year-over-year. We had a net loss of high-speed Internet customers of 4,600, in part due to our high penetration of 69% of primary residential customers. We rebranded our consumer offerings in March to provide an innovative entertainment bundle with our voice and high-speed Internet service and the Roku device, allowing customers to enhance their pay TV experience by streaming video content over the Internet. While this promotion draws better customer ARPU and enhances the utility of the broadband connection, the higher price point and traditional second quarter seasonality pressures contributed to slower sales. In the third quarter, we introduced revised pricing in order to increase sales trends.

Turning to Slide 17, the PAETEC integration is proceeding in line with our expectations. As a reminder, we have integrated all functional workgroups and corporate systems and are operating as a combined sales and operations organization. The team is leveraging our full suite of products and services across a much larger customer base, and our nationwide network is providing increased sales opportunities, particularly to multi-location enterprises.

The PAETEC billing conversion activities are underway and remain on track. We are very pleased with the milestones we have reached thus far and remain confident in our ability to achieve the targeted synergies and successfully integrate PAETEC.

On Slide 18, we are making great progress on our capital initiatives planned for this year. To date, we completed fiber to over 1,500 towers and have around 2,100 towers currently under construction that we expect to complete in the next 12 months. As a reminder, we expect to reach between 4,000 and 5,000 towers both in and out of our ILEC footprint by the end of 2013, which will conclude the majority of our fiber-to-the-tower investments. We are also making investments in our broadband network to improve capacity and work is continuing on the broadband stimulus projects, which should add roughly 75,000 new addressable lines upon completion and provide a nice opportunity to further increase our broadband penetration.

While our capital spend has elevated this year, beginning next year, we expect CapEx intensity to decline to a more normalized level of 11% to 13% of revenues as our fiber-to-the-tower and stimulus projects wind down.

Thanks for your time this morning. We'll now take a few of your questions. Ali, please review the instructions and open the call up to questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Michael Rollins of Citi.

Michael Rollins - Citigroup Inc, Research Division

Was just curious if you could talk a little bit more about the business service revenue. There was growth year-over-year, but some sequential downtick there. And I was just wondering if you can give us a little more color what you're seeing with the business environment. Are you seeing any change in the funnel or the sales cycle? That would be great.

Brent K. Whittington

Michael, this is Brent, I'll take that. And I mean, overall, we're not seeing any trends that would cause us concern. From a sales perspective, our team had a great quarter as they did in the first. And what we're seeing in terms of momentum is good, no negative customer or revenue churn trends that I'd say caused any concern. That 2% increase in business revenues year-over-year was slower sequentially than what we saw in Q1. When you start really looking through the details of that, most all the revenue trends look consistent with what you'd expect, but voice and LD is really where we saw a sequential decline of about $10 million in the second quarter. We kind of talked about it in the call because in Q1, what we really saw at that point was accelerated usage revenues that frankly just didn't continue in Q2. We saw Q2 trends revert back to what we'd seen really in the Q3, Q4 time frame of last year. Not totally surprising, but that's really the biggest driver there. When you're talking about a difference between a 2% and a 3% growth, it's those little $3 million and $5 million swings that make a difference. And that's the big driver there, Michael.

Michael Rollins - Citigroup Inc, Research Division

And should we see -- is this the new pace that we should expect for a few quarters, this 2% level, or is there room based on what you're seeing in the funnel and your pipeline for that 2% to accelerate year-over-year as we move through the next few quarters?

Brent K. Whittington

Yes, Michael, we'd expect the 2% to accelerate. So I think 2% is a little lighter than we've seen. If you look at with the way our revenue growth was trending those previous 4 quarters, 2% is more than what we saw in probably Q2 and Q3 of last year. What we're seeing in the sales funnel once we get that stuff installed, we feel confident those revenue trends can improve.

Operator

Our next question comes from Scott Goldman of Goldman Sachs.

Scott Goldman - Goldman Sachs Group Inc., Research Division

I guess, in part a follow-up on that first question, but looking a bit bigger picture into the guidance that you've said. So last quarter you said you expected an acceleration in business and consumer revenue trends in the back half of the year. I think if you look at what you've said today is expect sequential improvement in revenue and EBITDA, particularly in 4Q. So I just want to make sure I understand, are you expecting 3Q and 4Q revenue and EBITDA to be sort of above 2Q, and so we'll see sequential improvement each quarter from here on in or how to interpret that? And then, if you go back to the statement you made last quarter and piggybacking onto the last question, we had a growth of, I think, 3.2% in business services in 1Q and I think our expectation was that, that would improve in the back half of the year. Should we expect the improvement to come off of the 2% base or is that 3.2% business services revenue the base to grow off of?

Anthony W. Thomas

Scott, this is Tony. I think when you think about going -- looking at the back half of the year, we are expecting sequential improvement in both revenue and adjusted OIBDA, particularly business service revenues, as Brent just alluded to. So that's what we're focused on. And as I alluded to my prepared remarks, that's based off what we're seeing in the sales funnel, our incremental fiber installations, that's what's really going to drive the improvements in our top line. And then on adjusted OIBDA, we still have ongoing PAETEC synergies to realize, coupled with the management reorganization, plus just simply the day-to-day cost management activities that we have going around the company, and that's what gives us conviction that we're going to see that sequential improvement we need to see in the back half of the year. And as you -- and as I alluded to my prepared remarks, we do expect that to ramp in the back half. We expect adjusted OIBDA to grow in 3Q and improve upon that into 4Q.

Scott Goldman - Goldman Sachs Group Inc., Research Division

And then just to follow up on that. On the consumer side, would you expect that to -- the rates of decline there to improve in the back half of the year?

Anthony W. Thomas

We do expect to see some marginal improvement in the consumer revenue trends as well, Scott.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Okay, great. And then just secondly, broadband, can you talk a little bit -- you mentioned some comments about the losses in the quarter. Maybe talk about what you're seeing from a churn versus gross add perspective and what sort of traction you're seeing now from the merge campaign and how that -- how you think that could play out in terms of volumes in the back half of the year?

Brent K. Whittington

Scott, this is Brent, I mean, churn overall for us has been a good story this year. In the second quarter, there's a couple of things that are going on are worth explaining. First, seasonally, you tend to see slower sales in Q2 versus Q1, and that certainly was true for us. That slowdown was actually less on the gross add side than we saw a year ago, but the overall volume was down which, as much as anything, is a function of our penetration, where we're seeing the lower sales to our existing customers. So for us, merge was all about increasing our prospects and really changing the dynamics of the discussion away from speed to the value of the entertainment package. That's what merge really was about. We saw early momentum, it slowed. The timing of that launch coincided with what I would define as more aggressive pricing action by our competition, and that definitely had an impact. That, coupled with seasonality and just the size of our base, is really what caused us to be slightly negative there. But we've kind of thought for a while for us, given our penetration, it's not just about customer count, it's also about revenue growth. And so we've had and continue to have such a huge focus around those value-added services tied to that broadband product. And that's really what we're anchoring kind of the future growth of that franchise to, not just customer growth. I did talk about the customer growth opportunity that we'll see which is largely tied to the stimulus projects we have underway whereby whenever we're ultimately completed and we will have passed 75,000 incremental new prospects we can kind of add to our list, Scott.

Operator

Our next question comes from David Barden of Bank of America.

David W. Barden - BofA Merrill Lynch, Research Division

So just a couple, you can kind of see where the direction of things is going. So Tony, I think that you -- when you were reading the script, you were saying or reiterating the low end of guidance, then you corrected yourself and said the lower end. We're in the middle of third quarter. You guys are kind of reiterating a number for EBITDA that would be $2.43 billion or better. The consensus on the Street is actually 10s of millions below that, and it seems like if you're going to get to just very low end of the guidance number, you'd have to show up with kind of $620 million of EBITDA per quarter for the next 2 quarters in order to get there from where we were in the first half. So it's not just a slight acceleration, it's a pretty monumental acceleration. I mean obviously, the Street is skeptical that it can really be accomplished. So if you can kind of walk through the mechanics of where your conviction comes from that, that kind of acceleration is possible numerically, it would be really helpful. And then the second issue is going to be, as I think your average person probably doesn't understand the adjusted free cash flow, right. They're going to look at the cash flow statement and see that in the first half, you had operating cash flow of x, it was slightly higher than your CapEx and your dividends, and so the payout ratio looks like it's very, very high right now. Can you talk about how that is going to change in the second half? How does that dividend get more comfortable for you guys relative to the first half if I ignore the adjustments and just look at the cash flow statement?

Anthony W. Thomas

Great questions, David. And let me start with your guidance question. As I alluded to, the sequential improvements we need to see in the back half of the year are really being driven by an increase in business service revenue, as well as the cost saving initiatives. So when you look at the business service revenues, we looked into the funnel, we see what we have, as Brent alluded to, we know what we're going to install here now, we have that better visibility into that in the third quarter, as well as the -- on the carrier business, our fiber-to-the-tower pipeline, we also get better visibility into what that is going to yield in the third quarter and beyond. So it's really just looking into our sales funnel and the conviction we have around our sales organization in terms of being able to deliver results in the back half of the year. And then on the cost management side, we've already taken the actions necessary to achieve a lot of our cost savings. We've already identified specific expense reductions we expect to make with regard to PAETEC in the back half of the year, and we've also -- we are also ramping up our management reorganization efforts into third quarter. So we've taken those actions, we have clear visibility into those cost savings, and that's really where we obtain our conviction is based off what we see today. But obviously, we need to execute and we need to continue to execute well in the back half of the year for us to achieve the lower end of our guidance range. And then your question on cash flow. We do use the adjusted free cash flow model because it excludes certain, really, just a few things. The few things it excludes are merger integration expenses, which are costs we incur simply to integrate our acquisitions, and most of our costs here in the second quarter, as well as the first half of the year are related to PAETEC. And we do expect to continue to incur some M&I expenses in the back half of the year. And we're also -- we also exclude restructuring charges. And given the management reorganization that we're going through, we do expect to incur some onetime restructuring charges associated with that effort. And other item we exclude is working capital. But as we look to the back half of the year, I think there will be some pressure from M&I on the totality of the cash flows. But when you look beyond 2012 and into 2013, the M&I expense is significantly less, and we do not anticipate any significant restructuring expenses. So those are really discrete onetime items that are nonrecurring in nature. So I think ultimately, that's what gives us the confidence associated with the dividend payout ratio, plus just when we look into 2013, we're anticipating adjusted OIBDA growth. As we've talked a lot about, we expect the fiber-to-the-tower investments to start to weigh in, in '13 and we've taken some actions to improve our interest payments. I think, taken in totality, we're very comfortable with the cash flow generation capabilities of this company. And I think that'll be more easily seen in 2013 than it is in 2012 simply due to the merger integration expenses we're incurring this year.

David W. Barden - BofA Merrill Lynch, Research Division

And Tony, just the last thing, if I could, to follow up. So with respect to kind of the refinancings that we saw this quarter, there was a lot of movement in the revolver and the term loans, could you talk about why aren't we just going to the bond market, terming out some debt right now and just kind of cleaning the slate? Why did you take the approach that you took as opposed to just doing something more straightforward?

Anthony W. Thomas

No, David, I think we took the approach of going to the term loan market because, one, it was readily available and it's much more cost effective than the unsecured debt market. So when you look at the unsecured debt market, Windstream's debt yields are between 6% and 7% today, but in the term loan market, we were able to raise money at LIBOR plus 225 and LIBOR plus 300. So those are very attractive rates. And by -- as you alluded to, by raising this money, we've completely freed up our revolver, so we have $1.25 billion revolver with no draws on it. So as we look to our 2013 maturities, we are in a great position without having to go to the debt market today to completely pay off those debt maturities. So we are in a great spot. As we look into 2013, as we always do, we'll remain active in the capital markets and pick our times. But the real reason that I think we looked to the term loan market was simply we are looking for ways to continue to lower our cash interest, as well as be able to find very attractive capital, and I think that's what we accomplished.

Operator

Our next question comes from Frank Louthan of Raymond James.

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

A couple of the -- a couple of your peers have mentioned some impact in the third quarter from universal service rates change to the rate for the quarter. Can you give us an idea of what sort of impact that had? And you mentioned in the slides approaching some lower leverage levels, can you give us a time frame for when we should expect to see that, to see those materialize?

Jeffery R. Gardner

I'll take the first part, Frank. There was a slight increase in the USF factor that was passed on in the quarter. That's a pass-through, so it doesn't have a big impact as we talked about OIBDA. And as you know, with the rest of the USF revenue, they've remained frozen at 2011 levels while we've worked through this CAF 1 issue. As it relates to CAF 1, Tony made his comments in the prepared remarks around what we were taking from the CAF 1 fund, but we've also put forth the waiver and have been talking with the FCC on why it makes sense to grant that waiver so that we can get to more of our rural customers.

Anthony W. Thomas

And Frank, this is Tony. Could you repeat that second question to make sure I got that right?

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

Well, you mentioned on the slides and you've mentioned before about getting -- ultimately getting your lower levels of leverage. Do you have just a time frame on that and when we should expect to see that? I would assume it's just using free cash to pay down debt, but I mean, is that a 2013, 2015, what's kind of the time frame there?

Anthony W. Thomas

Yes, Frank, great question. Let me reiterate what we said in our prepared remarks. We do plan to use free cash flow to achieve the high end of our leverage goal which is 3.4x by the end of 2013, and we feel very comfortable we should be able to achieve that leverage target.

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

Okay, great. And then just one follow-up. Can you give us -- you mentioned, you're still seeing some of the impact, positive impacts can help the second half from the PAETEC and the management reorganization synergies. Can you give us an idea of where you are on a run-rate basis, on an annualized run rate basis for both of those items currently or at the -- either as of today or as of at the end of the second quarter?

Anthony W. Thomas

Yes, Frank, I think when we look at the management reorganization, we were targeting cost savings between $30 million and $40 million. And right now, we have already achieved approximately $25 million of that and remain confident we will achieve the rest of the -- we'll be able to step into the higher annual run rate savings target. So as we look into the back half of the year, that gives us a great deal of certainty. And in regards to the PAETEC synergies, we're roughly on an annualized run rate of $25 million to $30 million right now. But we have clear line of sight on the actions we're taking in the third quarter to achieve the remainder of that to ensure we receive -- we achieve the $50 million in annual run rate savings that we expect in 2012.

Operator

Our next question come from Donna Jaegers of D.A. Davidson.

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

Just on the business side, I was wondering if you have any incentives in place. Obviously, part of the play is you have a lot of assets underneath the PAETEC sales force. Are there any specific incentives in place for the sales force to really sell more on net to really improve your return on assets there? And also, could you call -- I don't know if you keep track of data center capital capacity utilization, but if you have a number there to give us.

Brent K. Whittington

Donna, this is Brent. I don't have a number on capacity utilization on data centers, and that's not something I think we're thinking about proposing at this point. I mean, we're still early in the buildout there. I'll tell you that the markets that are mature, we continue to add space, which has been great to see because of the sales success. And as we start new markets, we're pleased with the trends there. And I've talked a little bit last quarter actually about the new markets that we have started, one specifically here in Little Rock, and we have 2 others currently underway right now. In terms of business incentives, I mean the vast majority of our compensation's focused on revenue. And the good thing about that is using your own network allows you to really pursue much higher revenue opportunities more effectively than using third parties. So in that regard, we certainly think that we incent our sales team appropriately and we're making investments and can leverage our network assets. That's a major area of focus for us to make sure we do exactly what you pointed out, which is improve that return on investment. And the faster you convert and begin converting those assets to cash in terms of driving revenue, the better off your returns are and we certainly remain focused on that. But definitely an area for us to continue to try and improve as well. So a good question, Donna.

Operator

Our next question comes from Tim Horan of Oppenheimer.

Timothy K. Horan - Oppenheimer & Co. Inc., Research Division

Tony, maybe can you give us a little color on your confidence level of hitting the low end of guidance? And the reason I mention it is that at 50% confidence level, 75%, because if you hit the low end, your run rate at the end of the year and EBITDA should be around 41%, and presumably that EBITDA margin will improve next year. And I think you're -- that's probably 200 to 400 basis points above where the Street's kind of thinking for next year at this point. And then obviously, you have a lot of balls up in the air, and we don't have anywhere near the visibility that you have. And I think if that's going to be the case, it should be amazingly bullish for the business model.

Anthony W. Thomas

Tim, really, I think the previous comments I made, I'm going to stick with. And I'm probably not going to give a probability weighting to our achievement of our goals beyond the fact to tell you that this entire management team, the entire team as a whole at Windstream is entirely focused on executing on our strategy and our detailed plans so that we can achieve that low end of our guidance. We know how important it is to our investors and in signal sense [ph] and it's receiving the right level of emphasis within the company.

Timothy K. Horan - Oppenheimer & Co. Inc., Research Division

Great. And then lastly on the target leverage of the 3.4x, at what level -- let's say, it could get below 3x, can you start to see your interest rates kind of decline more to the 5% to 6% range like a lot of your peers are at from the 6% to 7% range, and would that be a priority? Or I think you were kind of hinting that stock buybacks would be kind of the better avenue for you. But just kind of trying to see how you balance the 2 between stock buybacks and getting the leverage down a little bit more.

Anthony W. Thomas

No, that's a great question, Tim. Our target leverage is 3.2x to 3.4x, and we're trying to achieve the high end of that leverage ratio by the end of 2013. And importantly, when you look at our weighted average cost of debt, it's quite attractive. Some of the folks in our peer group are investment-grade. Windstream's is a high-yield company, so not surprisingly we have a marginally higher cost of debt, but a still very attractive overall cost of debt for a high-yield company as evidenced by the fact that we just went to market and closed on a transaction yesterday raising $900 million. $300 million of that at LIBOR 2.25% and $600 million of that at LIBOR plus 300 and a 1% floor. So a very attractive access and availability of debt to Windstream. I think that's ultimately also a signal of confidence that our bond investors have in Windstream's ability to generate free cash flow over a long period of time. As you alluded to, after we achieve our leverage goals, we'll have opportunity to put that cash to work in other ways, and Windstream has historically pursued share buybacks. That would definitely be one thing we would consider in the future, as well as we've used our cash for M&A activity. Both are pieces of our puzzle. But right now here in the immediate term, we're focused on reducing our leverage and getting inside that target leverage ratio.

Operator

Our next question comes from Batya Levi of UBS.

Batya Levi - UBS Investment Bank, Research Division

A couple questions. First, can you please clarify your comments for sequential revenue growth throughout the second half? Say, CP was pretty lumpy, you've got a big benefit in the second quarter. So is that comment for service revenues to grow sequentially from here or for total revenues? And I wanted to ask about the Texas PUC, the rule that passed there. I believe you collect about $94 million of state funds and they're proposing to reduce it over a 4-year period starting in January '13. Can you talk about your view there? Will you be able to -- are there any offsets to that USF pressure?

Brent K. Whittington

Tony, I'll take the revenue question and let Jeff speak to the Texas PUC proceeding to kind of augment and restate my comments around revenues. We do expect to see revenue growth sequentially at both the service revenue and total revenue line from the second quarter into the third quarter and from 3Q into 4Q. And that's not surprising that we run basically a monthly recurring revenue model on our business service revenues with the exception of some long-distance usage trends that showed a little variability in the first quarter. If we achieve our monthly recurring revenue goals, that puts us in a very good position to go from 2Q into 3Q into 4Q. So as we look forward, that's really what's giving us our confidence and hopefully, that clarifies our view into revenues for the remainder of the year.

Jeffery R. Gardner

Right. And on Texas USF and the proceedings that are going on now, this has been a common thing where every 2 years, they take a look at the Texas USF. We've made a proposal with a couple other companies, and you need to remember that we're serving very rural customers in Texas. And these proceedings are underway. And you're right, there may be some modest reductions there, but those would be offset -- would be potentially offset with rate increases to our customers who are billing today in that state.

Operator

Our final question comes from the line of Phil Cusick of JPMorgan.

Derya Erdemli - JP Morgan Chase & Co, Research Division

This is Derya here for Phil. I was wondering if you can give us an update on your expected fiber-to-the-tower spending in second half and then the decline you expect for 2013? And also, how many sites do you have in territory? How many are wired for fiber today by Windstream and others, if you could get that?

Brent K. Whittington

This is Brent. Thanks for the question. So we're, I'd say, just over midway into our fiber-to-the-tower deployment. I talked a little bit about what we expect to happen through the back part of the year, where we still have about 2,100 towers under construction and the bulk of that will be completed late this year, mid-2013. As we look forward to next year and think about CapEx trends, in general, there's really 2 things that are happening next year. We do believe we should be substantially complete with the stimulus projects this year and then certainly making major progress in terms of our fiber-to-the-tower construction efforts this year as well. The wind down of those 2 things alone could frankly reduce our CapEx next year by almost $200 million. Those are 2 big things that are happening next year that'll make CapEx look different than 2012. And as we've talked about fiber-to-the-tower before, I mean, 60% to 70% of that effort is within our ILEC footprint. That effort was about retention, as well as growing that revenue stream because those deals are priced on a usage basis. The remaining part of that effort was all outside of our territory, which was a network expansion, and 100% of those revenues are incremental. And the combination of those 2 kind of parallel paths for us was about keeping that revenue trend in that mid-single-digit range we've experienced over the past 18 or so months of 5% to 7%, and that's really what we're targeting to make happen.

Derya Erdemli - JP Morgan Chase & Co, Research Division

And do you know about what percentage of in-territory towers are passed with fiber right now?

Brent K. Whittington

Yes, I mean, we don’t break it out in terms of -- we're just over 50% totally complete. I mean, we don’t really split the difference in terms of what's under construction between in and out. I mean, suffice it to say, given the transport needs of our wireless customers, their pressure is to deliver those services regardless of where those geographic markets are. They want it turned up as fast as we can. And it's typically a little faster build process in territory because we already have all the agreements in place to really get on the poles or bore undergrounds and all the permit issues, make that much simpler. So we're further ahead in territory than we are out for sure.

Derya Erdemli - JP Morgan Chase & Co, Research Division

Just a quick one more thing, if I could. Do you have any insight into cash taxes for 2013 that you could share with us?

Anthony W. Thomas

Yes, this is Tony. As we indicated, I think, previously, we're still expecting 2013 cash taxes to be around $250 million.

Jeffery R. Gardner

Thank you all for your questions today. In closing, like to say a few things. Our business and consumer channels delivered solid performance during the second quarter, and we remain on track to reach our goals we set for 2012. As we had many questions about the need to pick up activity in the second half, I'd like to, again, point out what Tony said in his prepared remarks, we have specific activities already underway to drive those performance improvements. We have confidence in our strategy which is working, as evidenced by improvement that we've seen in our financial results over the past several years driven by an improvement in our revenue mix, targeted acquisitions and cost management initiatives. Going forward, we believe we have the right assets in place to allow Windstream to execute on our growth strategy and generate sustainable and growing free cash flow in the future, and in turn increase shareholder value. Thank you, again, for joining us this morning and for your interest in Windstream. Have a great day.

Operator

Ladies and gentlemen, this does conclude today's conference. You may all disconnect, and have a wonderful day.

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