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CenturyLink, Inc. (NYSE:CTL)

Q2 2012 Earnings Call

August 8, 2012, 05:00 pm ET

Executives

Tony Davis - VP, Investor Relations

Glen Post - President & CEO

Stewart Ewing - EVP, CFO & Assistant Secretary

Karen Puckett - EVP & COO

Jim Ousley - CEO, Savvis & President, Enterprise Markets Group

Analysts

Simon Flannery - Morgan Stanley

Frank Louthan - Raymond James

Chris King - Stifel Nicolaus

Scott Goldman - Goldman Sachs

Operator

Good day ladies and gentlemen, and welcome to CenturyLink second quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the conference over to Mr. Tony Davis, Vice President of Investor Relations. Mr. Davis you may begin.

Tony Davis

Thank you, [Zaid]. Good afternoon, everyone, and welcome to our call today to discuss CenturyLink’s second quarter 2012 results released earlier this afternoon. Let me begin by saying I apologize we got the release out a little later than we have planned; had a little glitch in the release process and we will certainly strive to get it out sooner next quarter. So thank you for your patience and understanding in that. The slide presentation we will be reviewing during the prepared remarks portion of today's call is available in the Investor Relations Section of our corporate website at ir.centurylink.com. At the conclusion of our prepared remarks today, we will open the call for a Q&A.

On slide two you’ll find our Safe Harbor language. We will be making certain forward-looking statements today particularly as they pertain to guidance for third quarter and full-year 2012; the integration of Qwest and Savvis and other outlooks in our business.

We ask that you review our disclosure found on this slide as well as in our press release and in our SEC filings which describes factors that could cause our actual results to differ materially from those projected by us in are forward-looking statements.

We ask that you also note that our earnings release issued earlier this afternoon and the slide presentation and remarks made during this call contains certain non-GAAP financial measures. Reconciliations between the non-GAAP financial measures and the GAAP financial measures are available in our earnings release and on our website at www.centurylink.com.

As you turn to slide three, your host on today’s call is Glen Post, Chief Executive Officer and President of CenturyLink. Joining Glen will be Stewart Ewing, CenturyLink’s Chief Financial Officer and also available during the question-and-answer period of today's call will be Karen Puckett, CenturyLink’s Chief Operating Officer who leads our Regional Markets Group, Bill Cheek, President of our Wholesale Markets Group and Jim Ousley, Chief Executive Officer of our Savvis and President of our Enterprise Markets Group.

Our call today will be available for telephone replay through August 15, 2012 and accessible by webcast through August 30, 2012. Anyone listening to a taped or webcast replay or reading a written transcript of this call, should note that all information presented is current only as of August 8, 2012, and should be considered valid only as of this date regardless of the date heard or reviewed.

As we move to slide four, I will now turn the call over to your host today, Glen Post. Glen?

Glen Post

Thank you, Tony. Good afternoon everyone and thank you for joining us today as we discuss CenturyLink’s second quarter 2012 results and guidance for the third quarter and full year 2012 as we provide an update as well about our business.

During the second quarter CenturyLink achieved solid results and we continue to make good progress on a number of fronts. As announced previously, we restructured operating groups during the second quarter. We completed the reorganization successfully with minimal disruption of our business operations; we are pleased with the results of that restructuring.

Our national and international legacy Business Markets Group, BMG customers, our Savvis customers and Federal Government customers are now served by new Enterprise Markets Group or EMG, and our end region large business customers and state and local government customers are now served by our Regional Markets Group, RMG. We believe this restructuring strengthens our ability to better serve our business and government customers locally, nationally and internationally.

We also continue to make good progress with integration of Qwest and Savvis and remain on-track to meet our synergy targets for these transactions. Our operating group restructuring is just one example of how we continue to further integrate these acquisitions in to CenturyLink.

Additionally, we continue to see solid bookings in our enterprise business segment and we continue to map integrated network, co-location, managed hosting and cloud services and we continue to invest in additional data center capacity to position us to drive further growth from these services in the months ahead.

With our fiber-to-the-tower initiative we continue to make excellent progress in completing power builds and enabling high bandwidth Ethernet data services to support the growing demand for wireless data backhaul capacity.

As we have previously discussed, while this transition rather than from traditional copper based data services to fiber based data connectivity create some near term revenue pressure, we are confident our investments in fiber-to-the-tower will generate good returns and provide solid revenue growth over the seven to 10 year lives of these agreements.

Finally, we remain on schedule and launched Prism TV services in our first legacy Qwest market later this year and also on schedule to launch our (inaudible) managed hosting and cloud services platform for businesses in the fourth quarter of this year.

Now turning to slide five. During the quarter, we made good progress in improving our topline revenue trend. We generated revenue of $4.61 billion or 1.2% year-over-year decline comparing favorably to the 3.8% decline and the 2.7% decline for proforma second quarter 2011 and first quarter of 2012 respectively. Excluding data integration revenues which widely fluctuate from quarter-to-quarter, the annual revenue decline in second quarter was 1.7%.

For full year 2012, we remain on-track to reduce our annual revenue rate of decline to the 1.5% to 2.5% range. The integration of Qwest and Savvis remain on-track and we will continue to leverage these assets to strengthen our competitive position throughout our operating areas.

As well at the end of the second quarter, we achieved an annual synergy run-rate in excess of $380 million related to the Qwest integration. We continue to expect to end 2012 at an annual synergy run rate of $465 million related to Qwest. Also in the second quarter, we delivered further access line loss improvement and subscriber growth in broadband and Prism TV services.

We continue to scale our Prism TV service in the eight markets where it is available today and are progressing on our plans to roll Prism out in the first leg of Qwest market later this year. We remain focused on delivering advanced communications solutions and data hosting services to businesses as key factors of improving our topline revenue trend.

As of the second quarter business customers drive more than 60% of our total operating revenues and during the quarter, we generated strong strategic data growth from our business customers in both RMG and EMG.

Moving to slide six I’ll provide a few highlights regarding our key strategic initiatives. As we have outlined we are focused on continued investment in broadband expansion and enhancement. Prism TV, fiber-to-the-tower and managed hosting and cloud computing services; our second quarter results reflects the solid progress we are making in these key initiatives. Starting with broadband expansion enhancement, we continue to make significant investments and during the second quarter we had over 18,000 high speed Internet subscribers. We saw some weakness in demand, but second quarter is a seasonally weak quarter as we have significant presence in two snow bird states Florida and Arizona.

Our customer retention efforts and the growth benefits of bundling broadband with other products and services resulted in the continued decline of the rate of access line loss in our business improving with 7.4% in the second quarter 2011 to 6.1% at second quarter of 2012.

We expanded our Fiber-To-The-Node [FTTN] infrastructure to an additional 215,000 living units during the quarter and now passed nearly 6.6 million living units with Fiber-To-The-Node and we expect to pass approximately 7 million living units by end of this year. As a result, our network investment enhancements, broadband speed availability has also continued to improve.

Nearly 70% of enabled access lines now receive speeds of 6 megabits or higher and more than 55% of our enabled lines receive 10 megabits or higher and 27% have speeds of 20 megabits or higher. We expect to continue to make investments in our network to deliver competitive broadband products and services across our markets.

Turning to slide seven; our Prism TV service represents a very compelling entertainment alternative to Cable TV service in the eight markets of where it’s currently available and it continues to perform well for us. We added over 9,000 Prism TV subscribers during the second quarter into period with over 94,000 subscribers.

The new customers we've added over the past 12 months, approximately 50% are new customer to CenturyLink. We now have a penetration rate of over 9% across the eight markets in which the service is now available. In addition, we continue to enhance our IPTV experience by introducing new functionality and applications.

This quarter we launched our (inaudible) application allowing our customers to aggregate multiple channels on one screen and new TV applications as well, including Facebook, Picasa, Weather Channel, Yahoo! Sports and others that we've enabled this quarter. Prism TV continues to have a positive impact on churn and line loss trends and we experienced a greater than 90% broadband pull-through rate with our Prism TV sales to new customers.

Approximately 65% of Prism customers have a triple play bundle with CenturyLink and the ARPU by the way is between $165 to $170, a really strong average revenue per customer with our Prism bundles. We continue to see an annualized 350 to 400 basis point improvement in churn for customers taking our Prism product. We remain focused on expanding our Prism TV enabled footprint in driving additional subscriber growth and we are on-track to launch Prism TV again in our first Qwest market in the coming months.

And turning on to slide eight, our third key strategic initiative is investing in fiber builds there are many towers in our service areas economically feasible. Now these initiatives supports anticipates long term growth in data transport both of which is driven by wireless data traffic expanse our addressable customer footprint by enabling fiber access points to other strategic locations were viable along these routes.

During the second quarter we completed approximately 1,350 fiber builds this is in line with expectations and we continue to anticipate completing 4,000 to 5,000 builds in 2012 as fiber-to-the-tower construction season ramp up through the remainder of the year.

We believe our fiber-to-the-tower program have solidify our wholesale special access revenue for the long-term and assist in stabilizing our revenue trend. As we discussed with you before we do expect some near term revenue compression as our wireless wholesale customers' transition from copper-based DS1s backhaul facilities to fiber based Ethernet services. And we believe they continue the acceleration in wireless data consumption will drive increases in Ethernet service revenue will offset any revenue compression within a reasonable period of time and provide solid growth over the seven or 10 year lives of the associated contracts.

Moving on slide nine, we continue to invest in Managed hosting and cloud service to increase data center capacity as well as expand our product portfolio to meet customer needs and expand our market opportunity. During the quarter we announced our 2012 plan data center expansion in seven markets four of which were online in the second quarter. And we also lost our Savvis Symphony Virtual Private Data Center product cloud solution in (inaudible) and all these service in five locations across three continents. We continue to focus on leveraging multiple sales channels to drive further growth in data hosting services and at the end of the second quarter we are seeing significant growth in potential sales of hosting products within the EMG network and RMG segments.

And in the months ahead, we will focus on allowing hosting product offerings and solutions bundles with existing RMG and EMG network client as we see that demand continuing to grow. We ended the second quarter with 50 datacenters in North America, Europe and Asia with total salable force of about 1.4 million square feet. On July 31, we announced the acquisition of certain assets Ciber’s Global IT Outsourcing or ITO business. The addition of these assets will complement Savvis existing ITOs assets by expanding their capabilities for application management services and help desk support.

And now on slide 10 and a summary I am pleased with our second quarter financial results. We continue to improve our top line revenue trend. Our employees did a good job of containing costs and we've generated solid cash flows during the quarter.

We reduced our access line losses by 22% compared to proforma second quarter of 2011 and we grew high speed internet and Prism customer bases during the quarter. We also made solid progress in our key strategic initiatives that we believe positions us well to continue to improve our top line revenue trend in the months ahead.

Let me now turn the call over to Stewart for an in-depth look at our financial results.

Stewart Ewing

Thank you, Glen. I'll spend the next few minutes reviewing the financial highlights from the second quarter and then I'll provide a brief liability management update and then conclude my remarks with an overview of the third quarter and full year 2012 guidance we included in our earnings release issued earlier this afternoon.

Now turning to slide 12 first, in order to provide more relevant comparisons, I will be reviewing the financial results on a pro forma basis as if Savvis was fully included in the results of all periods. I will also be reviewing the results excluding special items as outlined in the earnings release and associated financial schedules. With that let's turn to our results for the second quarter.

As you can see, we generated strong operating revenues and solid cash flows. Operating revenues were $4.6 billion on a consolidated basis exceed in our guidance for the quarter and represent a 1.2% decline from pro forma second quarter 2011 operating revenues.

This also represents a solid improvement from the 3.8% revenue annual decline in the year ago period. Excluding data integration revenue, the year-over-year decline in revenue is 1.7%. Strategic revenue in the quarter increased to 45% of total revenue from 43% in pro forma second quarter a year ago due to growth in strategic products such as high-speed internet, data services, Prism TV and Managed hosting services.

Adjusted diluted earnings per share for the second quarter was $0.65 exceeding guidance by driven primarily by higher growth and strategic revenue than anticipated and a one-time adjustments to depreciation expense. As we discussed on prior earnings calls, adjusted diluted EPS excludes special items as certain non-cash purchase accounting adjustments.

Total cash operating expenses increased modestly from pro forma second quarter a year ago to second quarter 2012 with synergy achievement and other cost reductions partially offset by continued investments in our key strategic initiatives as well as other related revenue growth.

We generated solid operating cash flow of approximately $1.9 billion for the second quarter and achieved an operating cash flow margin of 41.2%. Additionally, we generated $779 million of free cash flow during the quarter which is defined as operating cash flow less cash taxes paid, interest, cash interest as well as capital expenditures and an additional adjustments to other income.

Our strong cash flows continue to provide us the financial strength and flexibility to meet the business objectives and drive long-term shareholder value. As a result, our operating group restructured that Glen discussed earlier, the segment financial information has been realigned this quarter to support this new operating structure.

We have also provided a supplemental financial schedule this quarter that provides restated historical quarterly segment financial information retroactive to first quarter 2011. The four segments are defined as follows, regional markets group is reported as one segment and includes region market groups, financial information as previously reported along with revenues and related direct and allocated costs associated with the in region large business customers and state and local government customers transferred through the region markets group from legacy business markets group.

In appliance markets group is operated and reported as two segments, first the network services segment includes the network services revenues and related direct and allocated cost associated with the national and international business markets grew customers and federal government customers transferred to EMG from BMG along with Savvis operating group's network services customers.

Second, the data hosting services segment includes Colocation and Managed Hosting and Cloud services revenues and related direct and allocated cost associated with the national and international business markets group customers and federal government customers transferred to the EMG group from legacy BMG group along with Savvis operating groups, data hosting services customers.

Wholesale market groups is reported as one segment and includes the wholesale market groups, financial information as previously provided along with revenues and the related direct and allocated costs associated with the Savvis operating group wholesale customers that we transferred by Savvis.

Now turning to slide 13, I will begin the operating segment’s discussion today with our regional markets group. Regional markets group generated $2.48 billion in operating revenues which represents a decrease of 2.6% over pro forma second quarter a year ago. Strategic revenues grew to $894 million in the quarter up 5.8% pro forma year-over-year excluding the impact of product line revenue, strategic revenues grew approximately 7%.

Legacy services revenues for the segment declined to $122 million or 7.5% from pro forma second quarter 2011 due primarily to a continuing decline in revenues related to access lines. Our expanse reductions for the second quarter compared to the previous year were mainly driven by lower employee related costs, professional fees and marketing and advertising costs which were partially offset by higher Prism TV and data integration expenses.

Moving to slide 14, our wholesale markets group generated $944 million in operating revenue, a decrease of 4.1% from pro forma second quarter 2011. This decline was a result of wireless and other wholesale carrier bandwidth revenue growth being more than offset by the continued decline in access and long distance revenues.

Strategic revenues for WMG grew 2.1% to $572 million from pro forma second quarter 2011, primarily driven by continued strong data transport demand from wireless providers.

WMG’s legacy revenues declined by 12.3% to $372 million, reflecting the continued decline in access and long distance revenues. WMG’s operating expenses for the quarter were $286 million or 6.8% below the pro forma period from a year ago.

Moving to slide 15, EMG network services segment generated $648 million in operating revenues during the second quarter which represented an increase of 2% from pro forma second quarter 2011.

The second quarter represented the second consecutive quarter of sequential growth in recurring revenues for the network services segment. Second quarter strategic revenues for EMG network services increased by $9 million or 2.8% to $333 million from pro forma second quarter 2011, driven primarily by strength in high bandwidth services, such as MPLS, Ethernet and DWDM. Excluding private line services, strategic revenue grew nearly 7% from the pro forma year ago period.

Legacy revenue for EMG network services declined by $8 million from pro forma second quarter 2011 due primarily to declines in local and legacy WAN services while data integration revenues increased $12 million or 14% due to higher equipment sales and professional services revenues from government and enterprise customers. Our total segment expenses in EMG network services were virtually flat from a same period a year ago.

Now turning to slide 16. In our EMG Data Hosting Services segment, which is primarily legacy Savvis operations. This segment generated $277 million in operating revenues representing an increase of 6.5% from pro forma second quarter 2011 revenues of $260 million. There is an additional $45 million of data hosting revenues reflected in other segments. We expect to provide a schedule that will reflect total data hosting revenues across this company on our website early next week. This growth came primarily from year-over-year increases of 4.7% in collection revenues and 11.5% in managed hosting and cloud services revenues and a modest increase in network services revenues.

Strong bookings in data hosting services in the prior two quarters helped drive this revenue growth in the second quarter. A solid pipeline and additional capacity will support continued revenue growth in the second half of 2012. EMG data hosting operating expenses were $211 million in the second quarter compared to $196 million from pro forma second quarter 2011. This increase of 7.7% is driven by an added headcount in operations and sales and marketing staff to support revenue growth.

As reflected in slide 17, we continue to make good progress on our liability management plans. In 2011 we set a target to repay $1.5 billion to $2 billion of gross debt from pro forma basis as of December 31, 2010 over the two-year period ending December 31, 2012.

We remain on track to reach this goal as we've accomplished approximately $1.5 billion of our target excluding debt financings year-to-date for July. If you consider year-to-date refinancings including the associated premiums incurred to call data associated with the refinancings we've accomplished about $1.1 billion of our target. Recent liability management actions have extended to weighted average maturity of our debt by approximately two years and slightly decreased our weighted average interest rate.

The chart reflects the change in annual debt maturities and as you can see these recent actions positions CenturyLink well from a debt maturity standpoint through 2017. Maturities over the five year period of 2013 through 2017 have declined over 35% from $9 billion to $5.6 billion making the annual maturities over that period very manageable.

As a result of the refinancing and debt reductions over the last several months, we currently expect interest expense to decline modestly each quarter through the remainder of 2012. The Pension Relief Act passed as part of the highway bill in June reduced our required pension contributions by approximately $1 billion over the next three years.

We currently expect our required contribution to be $100 million in 2013. This compares with an unexpected contribution of about $500 million in 2013 prior to the passage of the legislation.

Slide 18 addresses our third quarter and full year 2012 guidance. CenturyLink expects growth and strategic revenue in the third quarter. However we also expect third quarter 2012 revenues to be negatively impacted by the decline in access revenues as a result of the implementation of the FCC’s USF/SEC transformational order and the reduction effective July 1, 2012 in monthly universal service contribution rate assessed to end users, which will be partially offset by the implementation of Access Recovery Charges in accordance with the order. The total negative revenue impact of these three items on the third quarter compared with the second quarter will be about $25 million.

Operating expenses are also anticipated to increase in the third quarter of 2012 as compared to second quarter of 2012 due to the normal seasonality of outside plant maintenance and utility costs which we believe approximates an additional $50 million, increased data center operating costs as a result of some of the expansions that we’ve done in our data hosting area; and higher depreciation and amortization of approximately $20 million which will be partially offset by other operating efficiencies.

For the third quarter of 2012, CenturyLink projects total operating revenues of $4.54 billion to $4.59 billion and operating cash flow between $1.82 billion and $1.86 billion. Adjusted diluted EPS is expected to be $0.54 to $0.59. The company expects fourth quarter 2012 operating revenues and operating cash flow to increase compared to third quarter 2012 due to anticipated continued growth in strategic revenues and lower outside plant maintenance and utility marketing costs.

Slide 19 reflects our full-year 2012 guidance. Our operating revenue, we expect it to be $18.3 billion to $18.4 billion which is consistent with the guidance that we gave last quarter or actually it's up a $100 million on the lower end. Our operating cash flow from $7.5 billion to $7.65 billion, adjusted diluted EPS from $2.45 to $2.55, capital expenditures from $2.7 billion to $2.8 billion and free cash flow from $3.25 billion to $3.4 billion. In essence we've tightened our ranges and increased the midpoints of our guidance by moving the bottom of our ranges up to reflect our year-to-date performance

Turning to Slide 20, in summary we are investing to drive growth in our strategic initiatives that we believe will result in continued improvement of our top line revenue trend. We continue to believe a solid balance sheet is important to have financial flexibility and feel confident about our cash flow generate-ability which allows CenturyLink to return meaningful cash to our shareholders.

That concludes our prepared remarks for you today. So, at this time I'll ask the operator to provide instructions for the Q&A portion of our call.

Question-and-Answer Session

Operator

(Operator Instructions) and our first question comes from Simon Flannery [Morgan Stanley].

Simon Flannery - Morgan Stanley

You mentioned the pension impact. Can you give us an update on the labor negotiations with the contract up in October and what you are hoping to achieve from those. Also noted that you were doing some metro fiber builds in Charlotte. Perhaps you can provide a little bit more color on how extensive those metro deployments are and are we going to see more of those over time and what’s the sort of the payback on some of those projects?

Glen Post

Yes, Simon. Regarding the union negotiations, we are not going to really discuss any specifics at this time, but we could be looking for ways to really better align our cost of revenue sources. That will be our primary objective.

The Qwest contract expires October 6th. We’ll be well prepared for the possibility of a strike, but we remain really cautiously optimistic that we will be able to reach agreement with the CWA and IBEW. We will negotiate in good faith and expect the CWA and IBEW leaders do the same.

However, you just never know until the negotiations are over as we have seen this past week with AT&T sort of things happening there. But we're cautiously optimistic and have begun preliminary discussions with them.

Stewart Ewing

And Simon, on the metro fiber build at Charlotte, I am not familiar with that one. (Inaudible) build I know that we do, we are building to customers as we pickup additional customers and it makes sense from an economic standpoint.

Simon Flannery - Morgan Stanley

So there is no real change in your mix of CapEx?

Stewart Ewing

No, there is no real change. I mean we are doing some data center builds. We are building in some data centers that we have not been built into previously. We are also in conjunction with Savvis doing some work there to basically integrate their network with our network and give some redundancy to some of the data centers that Savvis has. So, we are doing some things like that, but there is no real specific change in our CapEx budget or philosophy there.

Operator

Our next question comes from Frank Louthan [Raymond James]

Frank Louthan - Raymond James

Can you give us an idea on the enterprise side, so what percentage of new RFPs and things are incorporating more to the Savvis type products versus the more traditional voice and data products.

And looking at your fiber-to-the-tower expansion there, are there any fiber-to-the-tower builds that you are seeing that are uneconomic, that you're walking away from or you are pretty much going after everything that comes up?

Glen Post

Frank, I'll get the last one first. With respect to fiber-to-the-tower, we are walking away from some of the builds that aren’t economic for us. It's really very, very insignificant I think and I mean generally if we can't build a tower, no one else can either.

And we are not seeing a lot of people build in our markets that we're aware of from the standpoint of the towers that we wouldn’t be willing to build to. So with the agreements that we have with major carriers and some of the smaller carriers as well, we feel very good about our ability to be able to capture the revenue that would otherwise be cannibalized from the wireless providers.

Stewart Ewing

Frank, I'll make a brief comment about the (inaudible) to talk to more about your question about the RFPs. I don’t have the RFP percentages, but I just know in our dealing with customers and the request we are receiving from our large customers, I would say that the vast majority are talking about the Savvis type or the cloud hosting products that I talk with. And that as I talk with our sales folks around the country and they are very interested; some long sales cycles here, but a lot of interest. And Jim, you want to --

Jim Ousley

Frank, I would just reinforce that now with the combination of the old BMG enterprise sales force working together, virtually every one of our major enterprise CenturyLink customers are now interested in talking about Savvis products. So we are not seeing a big change in the RFP type alignment; but clearly every major customer is now talking about Savvis products and vice-versa. The Savvis enterprise customers are requesting information on CenturyLink capabilities, so we are going to see leverage from it, no question about it.

Operator

Thank you. Our next question comes from David Barden [Bank of America-Merrill Lynch].

Unidentified Analyst

Hey guys, this is Julia (inaudible) for Dave. Thanks for taking the question. I guess just on synergies and so where they are coming in this year; is it more sort of fourth quarter weighted or are we going to see some in the third quarter; may be just some detail on kind of exactly where those synergies are coming from? And then just a side note, you guys put in the supplemental breakdown of Savvis; are going to continue to give that going forward? Thanks.

Glen Post

So we ended the quarter at a run rate of about $380 million, so we still expect ending the year about $465 million or so. We will see incremental synergies in the third quarter and then we will see some other incremental synergies in the fourth quarter as well. So I would say if you are doing a model basically spread evenly and you will be in a pretty good shape. Also we will continue to breakout Savvis as we did this quarter and the rest of the year.

And we're probably going to do more than just bringing Savvis out; I think we're going to provide you with a schedule. We have data hosting. Our segments are really more about customers. So we have customers, the Wholesale Group and the RMG Group that also have hosting services and we are basically going to provide you a schedule of all of the hosting revenue across the company, so we’ll get that hopefully on the website next week or so.

Operator

Thank you. Our next question comes from [Nicole Black]

Unidentified Analyst

Stewart, I was hoping you could clarify the comment you made about the $1.5 billion debt reduction excluding debt refinancing, we look at that does not net out the $2 billion of bond issuance that CenturyLink did in March of the $900 million of bond issuance that Qwest Corp. has done this year?

Stewart Ewing

So basically, when we first look at the debt pay downs that we will do; we didn’t know what refinancings we will do. So we basically looked at the maturities that were coming up as well as the other debt that was going to be coming due. The debt was going to be coming due plus other debt that I am not able to recall. And we were going to get to $1.5 billion to $2 billion.

The $1.5 billion really includes everything that we have paid off to-date that was a scheduled maturity or something that we could call early. The other the $1.1 billion really takes into consideration all the refinancings that we did and the associated premiums that we had to pay as well.

So we paid about $350 million to $400 million of premiums associated with the debt that we called associated with the refinancings that allowed us to really get our maturity towers to where we needed to get them for the next five years.

Unidentified Analyst

Does that mean $1.1 billion is how much you have accomplished against the $1.5 billion to $2 billion goal?

Glen Post

If you look at it that way then basically we will probably get towards the lower end of the range maybe $1.4 billion or $1.5 billion or so because we have got a $319 million maturity that comes up August 15th that we expect to pay off and put it in credit facility, but we’ll ultimately pay that off. If not by the end of fourth quarter or sometime during the first quarter; if you count the premiums that we had to pay and in fact then we’ll get closer to the $2 billion.

So that’s a way to look at it. The way to look at it really is we’ll get kind of towards the bottom end if you look at net debt more or less; if you look at the debt including the premiums that we had to pay then basically we’ll be closer to the top-end of the range.

Unidentified Analyst

And then at your Analyst Day I believe you cited that your leverage target of 2 to 2.5 range; do you have a timeframe associated with that?

Glen Post

Yeah, we really don’t; I mean our leverage with leases was about 2.8 times trailing 12 months and in the third quarter probably about 2.7 times or so to exclude leases and our target is more or less in that range, but not any specified period of time to get to there.

Unidentified Analyst

And the ratings agencies do count leases in their calculations, correct?

Glen Post

Yeah, they do and of course Moody’s has in their calculation and their target for us is to get down to 3 times and we are a little bit over 3 times now based on the target that they have for our rating.

Operator

Thank you. And our next question comes from Chris King [Stifel Nicolaus].

Chris King - Stifel Nicolaus

I just wanted to follow-up a little bit on the regulatory issues that are impacting you in the third quarter to the tune of $25 million or so. And realizing there is a lot that’s yet to be decided at the SEC level in terms of timing up of step downs and subsequent recovery mechanisms. Just was wondering if we could get your quick thoughts on kind of how you see that at least at this stage playing out over 2013 and as they say, right now you guys expecting to see another kind of $25 million step down in the middle of 2013, is that kind of your internal plans for right now and then secondly just wanted to get any of your latest thoughts regarding special access, I guess re-regulation at the (inaudible) and where that currently stands in your mind? Thanks.

Glen Post

So Chris the $25 million inclusive of $15 million step down in the USF contribution right, you know that will result in reduced revenue but it also results in reduced expense for us as well the way we account for. The access reform on a net basis, if you take the access charges that reduction which is I remember right about $30 million, $27 million, $30 million and you net that with the increase that we can flow through to our customers, it nets to about $10 million negative in the third quarter and of course that will recur, it will be flat in the fourth quarter. So next July, we will see another step down really don’t know how much at this point and then we're in the process of building on our 2013 performance to go over with board and we will have that done by the mid-September so timeline but wouldn’t expect anything more significant in the step down than we saw this year.

Chris King - Stifel Nicolaus

Thanks. And on the special access?

Glen Post

Yeah, basically, I mean, you know, we provided additional information to the SEC we know that this is something that’s on their agenda to look at over time, I mean its been there for long time, I mean at this time there is plenty of competition in special access market so we don’t really foresee any re-regulation of special access, I mean that would really be the long shot if that were to happen, its probably not in the near term.

Operator

Our next question comes from Scott Goldman [Goldman Sachs].

Scott Goldman - Goldman Sachs

I wonder if you can may be talk a little about the revenue trajectory you guys highlighted in the $25 million impact in the third quarter but the trajectory would suggest the second half it should be about 1.2% decline and may be even little bit worse presumably in part due to 25 million with potential, possibly even sequential step up in the fourth quarter I just wonder if you guys can just kind of way out the trajectory for revenue and what some of the drivers there in the (inaudible) as well?

Stewart Ewing

So if you look at the fourth quarter probably there will be about 6% decline, 1.6% decline from the year ago.

Scott Goldman - Goldman Sachs

Is it 1.6%?

Stewart Ewing

Yeah, about 1.6% probably.

Scott Goldman - Goldman Sachs

I assume part of that just a tougher comp from the year ago quarter?

Glen Post

Yeah.

Scott Goldman - Goldman Sachs

And so I mean if your say 1.2 now obviously a tougher comp, how do you think about the trajectory over revenue going into 2013 in your ability to possibly even grow revenue on a sequential basis.

Glen Post

Yeah, we are getting closer than before and if you take our last six quarters or eight quarters and just plow them out you can see that we make really good progress in terms of getting the hopefully flattening out revenue and starting to grow revenue, you know we mentioned in our EMG network segment to exclude the CPE type revenue basically that fluctuates you know we've seen our second quarter of sequential growth so we are getting close, I mean we are not ready to put a stake in the ground and say its 2013 or some time in 2013 or 2014 but we are definitely moving closer and we would expect our revenue decline in ’13 to be lower than the decline that we end up with in 2012 because we expect continued growth in the network area, we are having good success with the local model that we have put in place in the markets where we are the primary telephone company and we are seeing improved growth we think in the second half of this year with respect to the data hosting revenues. So I mean if we think that’s setting it pretty well.

Scott Goldman - Goldman Sachs

And then just to follow-up on your commentary about the network segment I thought you know I was looking at the proforma information you put out, looks like a nice step up on the year-over-year improvement in strategic services, but in equally good step down actually and the rate of decline in the legacy services so maybe you can talk a little bit about what's driving that and just what your expectations are for data integration for the back half of the year.

Glen Post

Data integration is hard to say, I mean we've got a number of deals in the pipeline but it's hard to say when they might close, that gets pushed from time to time and quarter to quarter.

In terms of the strategic revenue, I mean we are seeing s good growth there. We are seeing good opportunities with larger business customers that have asked us to take a look at being a participant in providing services to them or taking over one of the other larger carriers or MPLS. And Ethernet growth is really strong and we expect it to continue to be strong during the rest of the year.

And some of that revenue growth is actually cannibalizing some of the other revenues that we have, some of the legacy revenues that we have.

Operator

Thank you. Our next question comes from Michael (inaudible).

Unidentified Analyst

Just looking at the Prism TV adds in the quarter, they are maybe little bit lighter than I would have expected given how new you guys are in that business. I was just wondering if you could talk about anything in the competitive environment that you are seeing or if there are any changes that you guys are anticipating making in terms of maybe promoting the service or anything else that you might be thinking or planning to jump start growth in Prism adds as you go forward?

Karen Puckett

In terms of the Prism TV, I mean in general second quarter has weak seasonality and high speed and in Prism and when I look at overall, we're happy with our inward. From a competitive standpoint, we continue to get really good comments from our customers and depending on which market at least 50% of our customers are new to our company and so it is a big inward driver for us. As we expand we'll continue work on just a distribution of the inwards, but not any competitive issues. In fact we are very pleased with the performance of (inaudible) right now.

Glen Post

And we do expect to increase some of the advertising in some of these markets in the last half of the year as well Michael.

Operator

Our next question comes from [Brian Turner].

Unidentified Analyst

Just one quick for me. Can you give us any color on potential conversations you have had with the rating agencies as you look forward towards the end of the year and into 2013. Specifically have they provided any granularity around the criteria they might be looking for in order to maintain or stabilize the current ratings?

Glen Post

Yes Brian well we are not investment grade at S&P. So we are finding their terms of the writing that we have today and wouldn’t expect to get an upgrade there until we can show that we can stabilize revenue and start growing cash flow again.

With respect to Moody’s and Fitch, on Moody’s we have had conversations with them. They are target more or less to take the negative outlook of the parent company is to -- is basically for them to be able to see that we can get down to three times debt to EBITDA based on their calculation and they are willing to give us some time to do that and they understand where we are. We have a conversation with them each quarter and we have face to face visits a couple of times a year.

We expect to be able to give them our 2013 projections probably sometime after we meet with our Board in September. And again I think they want to be able to see clearly that we can get down to three times leverage on their basis in order to remove the negative outlook. With Fitch, the dividend payout ratio is more of what they look at and it's about 55% which is in line with where we are.

I think they are willing to potentially give us a little flexibility, if we need to make other investments that they can see are strategic investments from the standpoint of driving revenue in the future or preserving revenue. And example of that is fiber-to-the-tower. So, that's kind of where we are at the agencies.

Operator

Thank you. That does conclude our question-and-answer session for today. I would now like to turn the conference back over to Mr. Glen Post for any closing remarks.

Glen Post

Thank you, (inaudible). We are pleased with the continued progress we made during the second quarter for stabilizing topline revenues in our business. And we believe our continued investment in what we see as key strategic opportunities will help us continue to drive growth, both near term and long term.

Our strategic revenues continue to grow nicely and our guidance reflects our expectations that our revenues from strategic services will continue to grow in the months ahead. We also remain focused to ensuring that our operating costs are in line with our revenue mix and on achieving our operating expense synergy targets for the successful completion of the Qwest and Savvis integrations.

Additionally, the expansion of our Prism TV service and launch of managed hosting and cloud services for small and medium-sized businesses and customers. Later this year, we will further strengthen our product portfolio and provide us additional revenue and growth opportunity as we look into 2013. Thank you for joining our call today and we look forward to speaking with you in the weeks ahead.

Operator

Ladies and gentlemen thank you for participating in today’s conference. This concludes our program for today. You may all disconnect and have a wonderful day. Thank you.

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