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TW Telecom (NASDAQ:TWTC)

Q3 2012 Earnings Call

November 06, 2012 11:00 am ET

Executives

Carole Curtin

Larissa L. Herda - Chairman, Chief Executive Officer and President

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

Analysts

Simon Flannery - Morgan Stanley, Research Division

Colby Synesael - Cowen and Company, LLC, Research Division

Michael J. Funk - BofA Merrill Lynch, Research Division

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

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

Michael Rollins - Citigroup Inc, Research Division

Brett Feldman - Deutsche Bank AG, Research Division

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

Thomas O. Seitz - Jefferies & Company, Inc., Research Division

Operator

Good morning, and welcome to tw telecom's Third Quarter 2012 Conference Call. Today's call is being recorded. With us from the company is Chairman, Chief Executive Officer and President, Ms. Larissa Herda; and Executive Vice President and Chief Financial Officer, Mr. Mark Peters. At this time, I will turn the call over to Carole Curtin, Vice President of Investor Relations. Please go ahead.

Carole Curtin

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

Before we start, I would like to draw your attention to our Safe Harbor statement included in our supplemental materials, which you can find on our website.

Information in our quarterly earnings materials and our discussion today contain statements about expected future events and financial results that are forward-looking, and are subject to risks and uncertainties. A discussion of factors that may cause our results to differ materially from our expectations is contained in our filings with the SEC under Risk Factors and elsewhere available on our website. I'd also like to point out that our earnings materials and discussion contain certain non-GAAP financial measures. You can find reconciliations between the non-GAAP and GAAP financial measures in the materials on our website.

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

Larissa L. Herda

Thanks, Carol. Hi, everyone, and thank you for joining us today. Before I get started with our earnings discussion, I just wanted to comment on the storm. We have many family, friends, employees, customers and investors who have been impacted by the storm this past week, and our hearts go out to everyone. Thankfully, all of our employees are safe and like many employees at other telecom network providers, they continue to work very hard for our customers.

We prepared well for the storm and we probably had a little bit of luck, too. Overall, thus far, we've been very fortunate as our entire East Coast network has experienced only modest service disruptions. Our teams continue to be mobilized to ensure our impacted customers' networks are restored as quickly as possible, and we believe that revenue and cost impact, for now, appear to be low.

And I just wanted to thank all of our employees for their incredible dedication and professionalism throughout this disaster. As always, I'm in awe of our team, who will stop at nothing for our customers, and others in their communities that are in need.

So now getting back to earnings. We delivered our 32nd consecutive quarter of revenue growth along with strong margins and cash flow, underscoring our ongoing long-term consistent performance.

Today, I want to take some time to talk about what we've been seeing in the marketplace, as well as update you on our progress with some very differentiated new products and capabilities.

But first, let me start with the enterprise market.

For the past 3 or 4 months, we've all been hearing some mixed signals from others in the telecoms sector regarding the enterprise space. So let me turn to our own operations and share what we've been seeing.

Our business remains in a great market position, and our new product opportunities are very exciting. We continue to roll out our Intelligent Network with ongoing leadership in the Ethernet space, including the launch of a new, differentiated and compelling Ethernet offering. We also achieved solid overall comprehensive results for the quarter, including 7.1% year-over-year revenue growth driven by our data and Internet revenue, which grew at a higher rate this quarter than the last 2 quarters, as data and Internet now represent 51% of our total revenue.

In addition for the quarter, we delivered a 37% modified EBITDA margin, 8.5% sequential growth in net income and 44% growth year-over-year as well as a 10% levered free cash flow margin. Our customer metrics remain healthy as our revenue churn was low, and we continue to grow our customer base. So a solid quarter for overall financial results, including ongoing revenue growth, strong modified EBITDA margin, coupled with substantial cash production.

Turning to our sales trends. Sales were lower this quarter primarily in September, coming off a very strong second quarter and they strengthened as we started the fourth quarter with strong October sales, a solid sales funnel and a lot of customer interest in our new products. So we've seen fluctuations in our sales trends throughout the year, but continued to see a strong funnel of ongoing opportunities as we introduced new and differentiated solutions.

So let me now touch on our sales force. As we mentioned before, throughout the past year, we transitioned more of our sales talent to move upmarket, to focus on the growing opportunities to address larger enterprises with our evolving product portfolio. This contributed to a slight contraction in our sales force compared to this time last year, but allowed us to put the right talent in the right places, and we're ready to grow that group again. So you can expect to see us increase our direct sales force over the next year. In addition, our success with our indirect sales force -- given our success with our indirect sales force, we expect to grow that sales channel as well, to help achieve greater local coverage in each of our local markets. We believe these additional resources will help leverage our new product capabilities to further penetrate our market.

So now I'd like to turn to the competitive landscape and our differentiated position. We believe that innovative technologies can provide the potential for new demand from rapidly expanding cloud adoption, as well as the opportunity to take share. Therefore, we are leveraging the power of combining our Ethernet managed services and Intelligent Network capabilities, creating new products like our Dynamic Capacity and our one-to-many Ethernet offerings. These products are designed to help customers run their businesses more effectively by delivering flexibility and operating efficiencies, which is why customers are so excited about these solutions, and why we believe we're positioned so well in the marketplace.

So it's steady as she goes as we remain focused on innovation and differentiation. With that, I will now turn the call over to Mark to take you through the quarterly results.

Mark A. Peters

Thanks, Larissa. We achieved another solid quarter of comprehensive results including strong margins and cash flow. At the same time, we invested for future growth, executed on delivering new product capabilities and accessed the strong debt markets.

Let me start with a quick overview of revenue for the quarter. We grew revenue 7.1% year-over-year and 1.2% sequentially. As we told you last quarter, we absorbed the impact of some expected regulatory and tax rate decrease that dampened the total revenue growth a bit. At the same time, our data and Internet services continue to grow at a higher sequential rate this quarter than the last 2 quarters, and represented over half of our total revenue at the end of the quarter.

Keep in mind the strength of our data and Internet revenue this quarter is before the benefit of any meaningful contribution from our new products, which we just started to offer this summer.

Demonstrating the strength of our customer relationships and stickiness of our products, we also delivered another quarter of low revenue churn, the benefit of which was reduced by the impact of sequential increase in repricing for customers renewing their contract.

Turning to our revenue by line of business, here are a few highlights: data and Internet services represented 51% of revenue, and grew 3.7% sequentially compared to 3.2% last quarter, and 3% in the first quarter. This accelerating growth is primarily due to the strength of our strategic Ethernet and VPN-based products, partially offset by churn and repricing, with the enterprise customers accounting for about 90% of this revenue. Voice services represent 25% of revenue and was unchanged compared to the prior quarter, reflecting both increased sales of Converged Services offset by churn and a rate reduction for certain taxes and fees that we discussed last quarter, with the enterprise customers representing about 98% of this revenue.

Network services represented 22% of revenue, and declined 2.1% sequentially this quarter, primarily due to churn as well as customers transitioning to Ethernet services, and repricing for contract renewals, which outpaced new sales in this category. Carrier customers represent about 60% of this revenue with enterprises comprising the balance. Intercarrier compensation represented 2% of revenue and sequentially declined to 6.9% primarily due to mandated FCC rate reductions that we started discussing with you a couple of quarters ago.

Turning to our margin, they remain strong. Operating cost increased sequentially, primarily as a result of revenue growth and include increased network access costs, as well as seasonally higher maintenance and utility cost, somewhat offset by a reduction in taxes and fees due to the rate change. For the quarter, we delivered a 57.8% modified gross margin and a 37% modified EBITDA margin. Year-to-date, our growth operating margin is comparable to last year and our modified EBITDA margin expanded by 40 basis points.

Turning to the bottom line, we grew net income 8.5% sequentially, and 44% year-over-year for both the quarter and on a year-to-date basis. At the same time, we delivered a levered free cash flow margin of just over 10% for both the quarter and year-to-date.

Next, I'll move to CapEx, which, as a percentage of revenue, remained under 23%, both on a quarterly and year-to-date basis. Looking at the fourth quarter, we expect CapEx to increase primarily related to the timing of success-based and strategic investments, including network expansion and other infrastructure projects. We continue to expect our full year 2012 CapEx to be at the low end of our original guidance range of $345 million to $355 million, with the majority tied to short- to medium-term success-based opportunities.

Next, let me turn to our recent financing activity -- events. As a component of our use of cash this quarter and August we extinguished $101.5 million of our Term Loan B that had a January 2013 maturity date. In addition, on October 2, we completed the private debt financing for $480 million of senior notes. This financing was completed at a very advantageous rate of 5.375% per 10 year senior notes priced at par. We executed this financing in anticipation of the fact that our convertible debt is both at put and call option next April. To the extent we don't use these proceeds for any convertible debt obligation, we'll use it for general corporate purposes. These 2 financing activities position us well for any near-term debt obligations and ladder our maturities nicely over the next 10 years. Our balance sheet remains strong and we ended the quarter with nearly $460 million in cash equivalents and short-term investments, which is prior to the proceeds received from our financing.

In closing, this is another solid quarter and another important step in position -- positioning for the future as we executed on delivering new product and services to drive future revenue growth, continue to reposition our sales team to align with our evolving product portfolio and roadmap and further strengthen balance sheet to enable our continued, consistent growth and expansion. We strategically positioned our business and expect to continue to invest for differentiation, efficiency, and strong comprehensive financial results, including focusing on moving the needle on revenue growth. While we could use some help from the economy, we believe we're well-positioned with some compelling new services that will help us to continue to take market share and contribute to growing strong cash -- generating strong cash flow, growing our return on invested capital and maintaining a strong balance sheet.

And with that, I'll turn the call back to Larissa for more on the profits.

Larissa L. Herda

Thanks, Mark. I want to spend some time today on our ongoing journey of innovation to position us for new market opportunities. We've made significant progress with our new products this year, setting us up for ongoing differentiation to further drive our long, consistent record of strong, comprehensive results.

Today I'll touch on 2 key areas of innovation, including: first, our rollout in October of our newest Ethernet service, which we call our one-to-many connectivity; and second, progress on the launch of Dynamic Capacity or Phase 2 of the Intelligent Network.

First, let me start with our newest Ethernet service that we refer to as one-to-many Ethernet connectivity. For infrastructure customers that don't have their own network everywhere they need to go, they can now access just one of our locations and be connected via Ethernet to any building or data center in our national service area. And therefore, they can avoid capital investments, reduced operating costs and more easily manage their businesses operationally, making this solution very attractive.

We have the unique capability to do this because of the national platform and integrated back office we've built, combined with our very robust Ethernet solutions, which allow us to deliver a logical service that leverages the physical network we've already established. I'm pleased to announce that we've launched this new Ethernet solution in October, which is one of the first deployments of this type. We're focusing on international carriers as one of the first customer groups for this offering. We've targeted 25 of the largest global carriers, about 1/3 of which have signed new master service agreements with us, some of which we've sold services to already, with several of those deals being recently installed. We believe this product offering is extremely attractive to this customer base and is allowing us to leapfrog over the competition as we deployed new Ethernet services.

Also, given our domestic focus, unlike other providers, we do not compete with these global carriers for their international customers, which helps to position us as well. These 25 carriers alone generate nearly $1 trillion in global annual revenue. So these are very large companies who have significant U.S.-based network requirements driven by their enterprise customers. And we're looking to get a slice of these opportunities with our new capability.

Our strategy with our one-to-many Ethernet solution is to connect international carriers and their customers to our Ethernet highway in the U.S. We're delivering a single large bandwidth interface, which we can scale from 1 to 10 gigs easily. The efficiency of this solution is that it enables these carriers to divide its Ethernet capacity into flexible increments, which gives them the capability to meet their underlying customer demand. This is a unique solution and, again, speaks to our innovation and leadership in this space.

Next, let me turn to an update on Phase 2 of our Intelligent Network, which includes our new Dynamic Capacity service. Our Intelligent Network technology is critical to enabling new and innovative ways for customers to grow and serve their businesses, including leveraging cloud technology. Enterprise CIOs want the flexibility to consume new applications real time. They're experiencing an increasing proliferation of on-demand applications for their mission-critical needs, which require a secure, reliable network connection. These CIOs want to leverage their fixed network with the flexibility to consume and manage constantly changing, best-in-class applications, which are now being sold in a compelling new consumption model, by the slice, by the hour, or by the compute cycle. With Dynamic Capacity, our Intelligent Network enables enterprises to increase bandwidth real-time, allowing them to better react to traffic spikes, bandwidth-hungry applications, and both planned and unforeseen events, and also to leverage cloud capabilities and data center services much more effectively.

In August, we launched our Dynamic Capacity service to all 75 markets. Our sales engineers and account executives are partnering and working with customers and they are encountering a lot of enthusiasm. We find that innovation in network capabilities drive innovation by our customers. While it's still early, our teams are not only validating our expectations about this product, but they're learning every day about new ideas customers have for using this capability and how this solution fits into their network and operations.

Our offering is focused on 3 opportunities: the first is for existing customers, who already have our most advanced Ethernet capabilities, who can quickly subscribe and then be able to flex up their bandwidth in a matter of seconds. The next is when these same existing customers identify a new application that requires incremental Ethernet and Dynamic Capacity services. And our third opportunity is to open more doors and close more deals as we attract new customers with this powerful new service as well as other core products. And by the way, we started to see this happen. Our sales team tells us that Dynamic Capacity has raised their visibility and is starting to get us appointments with customers we had never before would've had access to.

An interesting trend to-date is that customers' initial Ethernet purchases for the fixed bandwidth element are the same or slightly greater than prior Ethernet purchases. This is true for both new and existing customers. For example, the vast majority of our initial Dynamic Capacity sales are driving an entirely new Ethernet circuit. Although we're early in this process, we believe this reinforces that application proliferation for enterprises as having a favorable impact on the need for real-time flexibility and overall network demand. Now keep in mind, we're talking about a small group of customers so far, but we're pleased with our initial results.

We're also seeing 3 key purchasing reasons with our initial sales, including: first, customers need this unique capability to flex up their bandwidth for a variety of business demand, from business continuity and disaster recovery to data replication. Second, they're responding to this product's innovation and flexibility by using it to temporarily expand bandwidth to test new applications, which are quickly expanding in today's enterprise environment. And third, they are buying the solution as an insurance policy to obtain future bandwidth flexibility as needed while managing fixed costs, which will help us continue to take share as customers view Dynamic Capacity as protection they need to have.

Many of our new customer wins for Dynamic Capacity solutions are between the enterprise and the data center or between 2 data centers, which positions us well as the market continues its rapid adoption of cloud-based services. Here are 3 recent sales of Dynamic Capacity to give you a flavor of how customers are using this service. These sales will highlight our overall solutions flexibility to enable enterprises to work in different data center environments, including a third-party data center, in our own co-location facility and also a customer private data center.

So first, our first customer example is a medium-sized insurance and financial planning company. This company had a long-standing reliance on a legacy in-house, taped backup system. And yes, you would be surprised on how many companies still do. We consulted with the customer on how our network could enable a new online backup solution, hosted at a third-party data center, which is just 1 of over 350 data centers already connected to our network. To accomplish this, we designed an E-Line and Dynamic Capacity connection to connect their headquarter's location to the data center. Given this was a brand-new application, the customer was challenged by determining how to optimally configure both the network and application as well as determining their future bandwidth needs. We were able to sell this deal due to our consultative service, Dynamic Capacity capabilities, and connectivity to third-party data centers that enabled the solution with the flexibility to meet their backup needs.

Our second example is a company headquartered in Minnesota providing video surveillance solutions to businesses throughout the United States, with multiple locations connected by our managed service solutions, including a presence in one of our co-location facilities. We consulted with the customer to determine a plan to increase their business and network resiliency by relying more heavily on tw telecom's co-location facility. The customer needed to establish data backup over the wide area network in their new private cloud environment as they were uncertain of the bandwidth requirement. As a result, we sold this customer a new E-Line service with Dynamic Capacity between their headquarters and our co-location facility which, again, was the right solution to help them adjust their bandwidth as needed.

Our third example is an enterprise customer that supplies outsourced IT support for a large statewide university with multiple campuses. Their current network is made up of multiple providers and technologies, but what we brought to the table was the value of tw telecom's Intelligent Network to help shape the future strategy for their network. Initially, our Ethernet E-Line services connected 3 sites, including their primary private data center and 2 other key locations. The important applications for this customer included hosting a Cisco CallManager, videoconferencing and various file and e-mail services -- servers in their data center. Their challenge was that every campus location across the state required access to these applications, and those applications all have peak bandwidth performance needs. Our Intelligent Network resulted in achieving a larger piece of their network spend due to the troubleshooting visibility of enhanced management and the flexibility of Dynamic Capacity to increase the network performance for their end-users.

So I hope those customer examples give you a flavor of our opportunities. You may have noticed that these customer wins involve our consultative capabilities, which is really changing the conversation with the customer to a more strategic relationship. We're pleased with the early progress of our Dynamic Capacity launch. We're seeing sales -- the sales funnel for this product grow, and we're closing deals, which sets up our advanced Ethernet portfolio for continued growth in 2013.

So before I leave the Intelligent Network, I want to share some additional functionality we will be adding to our enhanced management product in the fourth quarter. Today, one of the enterprise's challenges is juggling many variables, including the fact that different applications require different networking requirements with different operating tolerances. Therefore, we are going to provide customers additional visibility by allowing them to set threshold alerts and alarms specific to their network services. So they are proactively notified when the network is approaching conditions that may impact their applications environment. This functionality allows customers to set optimal network configurations in support of specific applications, all without requiring them to spend more for additional hardware, tools or other resources. This new feature represents another aspect of our innovation to make customers' businesses run faster, better and easier and, we believe, will be another driver of Dynamic Capacity as customers respond to these alarms by flexing up the bandwidth when needed.

I want to close my comments by saying we believe our business is in a great position with a lot of new innovation to drive our data and Internet growth engine. Our future is bright and our capabilities are powerful. While we could be helped by a stronger economy, we believe we're on the right path and expect to continue to grow our business as we always do: by adapting, being nimble and being innovative. Remember, we championed the Ethernet a decade ago. We're leading the Intelligent Network today, and we're designing Ethernet innovation for tomorrow as we continue to focus on serving our customers' changing networking needs, which has always been a winning combination for us.

Operator, with that, we will take questions.

Question-and-Answer Session

Operator

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

Simon Flannery - Morgan Stanley, Research Division

I wonder if we could talk about the booking patterns in September. You don't often call that sort of month by month, but was -- is this something that's likely to have a significant impact on the sequential revenue trends in Q4, or was it just you wanted to give more color around the sort of the ups and downs of that process? And related to that, you mentioned repricing in your commentary a couple of times. Again, is this something that's consistent with prior trends? Are you starting to see more pricing pressure, either from competition or from customer demands?

Larissa L. Herda

So on the booking patterns, we had indicated that we had a record second quarter on bookings and the third quarter was not a record. It was down a bit. We generally have seasonal Julys. We had a great August. In fact, it was actually a record August. And then, September was looking really good until the last week, and then things suddenly slowed down. So we weren't really sure, at the time, why that was happening. We have obviously been hearing a lot of noise in the marketplace about customers delaying their sales, but that didn't show up in October. So I don’t think that's what it was; I think it was more the fluctuations. But with September being a little bit lower, it just caused the second quarter to be -- to be lower sequentially -- I mean, the third quarter to be lower sequentially than the second quarter. So we just felt that we needed to call that out and let investors know we like to be proactive with those types of communications. Hard to say what the impact will be. If October is an example of the fourth quarter then, the answer is I don't see it -- 1 month really impacting our results. But there's always variability in quarters and in different months -- in months in the quarter and September should've been higher than it was, so that was really the main point. And repricing, we always say that. I think that's a standard language that's been in our script for years, and it's been about the same.

Mark A. Peters

But the trend came down, again, nicely, to a very low level, but it's a little bit offset by a little bit increase in the repricing. So we just wanted to give a balanced view of what was going on.

Simon Flannery - Morgan Stanley, Research Division

And is that competition or is that just customer, kind of, really pushing harder?

Larissa L. Herda

It's really business as usual. You just -- I mean, it's -- you're always repricing services when contracts are coming up for bid. We usually help to mitigate that by selling customers more services. And generally, what happens before that customer's contract come up for bid is we're in there again selling other services to them and kind of upping the whole contract for a higher price. So we just had some impacts in the quarter that offset the lower churn.

Operator

We'll take our next question from Colby Synesael from Cowen and Company.

Colby Synesael - Cowen and Company, LLC, Research Division

Two questions, if I may. The first one is talking about the ramp in the sales force. Just curious if you're planning on simply filling in what you've lost. I think you lost and has cut 20 sales people over the last year, or do you expect to go well beyond that and what the potential impact on margins could be tied to that? And then my second question has to do with the CapEx. I realized you reaffirmed that you're going to be towards the lower end of the guidance, but even with that, it seems like you're going to see a significant increase in the fourth quarter, I think over $100 million. Just curious if you can give just a little bit more specifics around what that's going to be used for? I know you said timing and strategic, but just a little bit more color would be helpful.

Larissa L. Herda

Yes, I'll talk about sales and Mark can talk about the CapEx. We're going to increase our sales force. We went through the year -- and we've talked about this before -- we went through the year and what we've been finding is, with our new product capabilities, is that we seem to be attracting larger customers. And so rather than have sales people spending time on the smaller end customers, where there isn't typically as much differentiation to be had, we've been wanting to move the sales force up. And you have to do that gratefully because you can't just suddenly do it or it can really disrupt your sales organization. So we've been really doing it thoughtfully and trying to make sure that we're making the right moves in the sales organization. We have a really good sales organization and the last thing you want to do is anything that's disruptive to them. So -- and we also have added, obviously, over the past couple of years, we've added the ultimate channel to that mix. And so when you combine it, we have more feed on the Street right now, and we want to add more of our own feed as well and then, we're going to -- we've had a great success with the ultimate channel group, so I think we're going to open that one up quite a bit. Because we've got our rhythm going and I think that we figured out a strategy that works well where they are more of an incremental addition to our sales organization, and they're not eating into what our direct sales force is doing. And so I think we figured out that magical mix of activity there that allows that to happen. So we will increase the size of the sales force that we have today. We're not going to talk about exactly what that is, because you kind of feel that out as the time goes on. We have a fairly good idea of where we want to put those heads, and they're going to focus on larger customers. And as far as the margins are concerned, I think we'll be adding people over time, and obviously, you churn out people, so I think it will be a smoother transition as the year goes on.

Mark A. Peters

And on the CapEx, it's really a lot of the projects we had, timing of some of the CapEx that's got pushed into the fourth quarter from network expansion, reach expansion; they're culminating in the fourth quarter. Some other infrastructure-type investments that are kind of just getting bunched up in the fourth quarter. So short- to medium-term success based in many cases, except for the network expansions, we're expanding our network reach into more territory within our existing markets. So that's what a lot of fluctuation going into the fourth quarter and increase will be. And as well as connecting up new customer locations with customer projects. So clearly, to get to the guidance that's going to be a bit of a chunk of CapEx in the fourth quarter if we can get, again, all these projects completed before the end of the year.

Operator

We'll take our next question from Michael Funk with Bank of America.

Michael J. Funk - BofA Merrill Lynch, Research Division

A couple quick questions. Larissa, maybe you can explain to us how you think about the competitive and financial benefits and risks of combining with another company? Maybe you can break it down further, if you could, tell us about combining with an [indiscernible] versus a cable company. Obviously, there were -- maybe some network benefits and headcount reduction benefits as well. Well, obviously some execution, and maybe even competitive risks there as well. And then second, maybe you can explain to us how you're partnering with other companies in developing ecosystem of partners to help keep you one step ahead with competition with regard to the services you're delivering to your customers?

Larissa L. Herda

Oh, Michael.

Michael J. Funk - BofA Merrill Lynch, Research Division

Is that too much for you?

Larissa L. Herda

So I'm not going to make a comment. I'm not -- I guess someone had to ask the question. But I'm not going to comment on all those things. There are obviously -- there's a lot of thoughts that various different people have on these things. We've built a really nice company. We have probably one of the best operational organizations that are out there. We know how to acquire companies and we integrate really well. I guess if someone was -- someday interested in acquiring us, they would find a very clean organization. So I'm not really sure how to even comment on risks for those types of activities. This is a well-run machine, so if somebody wanted to use this as a growth engine, it would be a very positive addition to anybody's portfolio. Could you repeat the question on the ecosystem? Because I kind of lost you.

Michael J. Funk - BofA Merrill Lynch, Research Division

Yes, I didn't mean to keep you too focused on the first one. The second one is more about your product offering. Obviously you try to stay ahead of the competition within the products that you're offering. And one of the things further down the road in how you're partnering with other companies, either technology or telecom companies, to continue to deliver advanced services to customers, help us think about TW Telecom 12, 24 months out from now?

Larissa L. Herda

Yes. It's a -- that's a great question. Makes up for the first one. So the ecosystem is something that we are -- we're very interested in playing in, and we're doing a really good job setting us up for it. We're connected to many data center locations where enterprises are placing a lot of their applications, and a lot of them are connected to, and we believe that the Cloud, for instance, is nothing without the network. And customers are looking for dedicated connectivity for the various different applications because they have a lot of their mission and more and more mission-critical applications are going into these third-party data centers. And so, when you combine this network connectivity that we have where we have all of these enterprise buildings, we have all of these data centers. And then on top of that, we're finding that all of these application providers are looking for a partner that isn't competing with them. And we're not. And most of the other large carriers are. And so, we're finding this really unique, interesting partnerships that are being developed as a result of our really neutral status that we have as a network provider. And when you combine that with the capabilities of the Intelligent Network, and their ability to dynamically manage their applications environment into these data centers, it's very powerful. I mean, you get to the heart -- with your question, you really get to the heart of the future for us, and that is this involvement in the ecosystem, and enabling all of these applications and making it easy for customers to deal with this just myriad of complexity that they have. We have the -- we have the network and we have the operational capabilities and we have the product portfolio for that, and we're constantly evolving it. We're getting tremendous input from customers on what we've been doing and they're very excited about it. So yes, that -- I see that partnership continuing with all these various different elements within the ecosystem.

Operator

We'll take our next question from Frank Louthan with Raymond James.

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

Can you -- tell us, do you expect to see any margin impact from SEC's action on special access, how you see that helping? And then can you give us an idea about the effort to sell into the existing buildings, how that's progressing? I apologize if you have commented on that earlier, that I've missed it.

Larissa L. Herda

Yes. No. I haven't commented on that earlier. I think it's too soon to say what the SEC is going to do with special access. Our hope and desire is that the pricing in areas that are noncompetitive, where there is no other option for special access services, becomes more reasonable. We also are hoping that we're not being tied to non-anticompetitive contracts that require us to constantly buy more and more and more. The fact that they suspended pricing flexibility for the incumbents, I think, is very positive. Could have -- if they hadn't done that, you would've seen, at least one incumbent that was -- that already put out their notice that they were going to increase prices in the same area they had increased prices 11 months earlier. So we would have seen some negative margin impacts there. So that stopped the bleeding in that respect. So I think that the move was right, and what I like is that they're very data-driven. And we believe that when you're data-driven and you're looking at facts, that the facts will speak for themselves. And that they will result in some better, we think, thoughtful regulation around these services that are monopoly services. So I guess you can say that the margin impact on this recent suspension of pricing flexibility was positive. With regard to our efforts in our existing buildings, that's an ongoing process and we continue to make progress there. We've never really given any statistics out on that, but I think the fact that our margins continued to be strong, and we're selling more services that are off-net because we're selling bigger networks with more type 2 components, I think, is a very good indication of our very strong on-net sales that we continue to make. So I think it's creating a good balance in our business.

Mark A. Peters

Yes. I mean we're clearly -- everybody is focused on the effort in the business. And it's also -- this is further reflected as you can see the continued expansion of our return on invested capital, that we keep really using the infrastructure in place to continue to serve the customers.

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

Okay. So with that, I mean, at what point will you be able to give us some sort of statistics on success or a number of where you were as far as multi-tenant buildings versus where that's grown? I mean, I see where the margins are fairly strong, that's been the case for a while. I'm just curious, is that something that you can give us an update on in the future?

Larissa L. Herda

Yes. Probably not. It's -- we're probably going to just continue to -- you'll continue to see the performance show up in our overall financial results.

Operator

We'll take our next question from Tim Horan with Oppenheimer.

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

Larissa, do you think the storm is having any impact on customers, maybe, who wanted to move to the Cloud a little faster for disaster recovery? And could it have any real impact on your sales in the quarter?

Larissa L. Herda

Well, I think it's probably overall too soon to tell. But I can tell you that we have -- because of our network resiliency, we've been very fortunate, as I said earlier. And we have been turning up a lot of -- a number of key emergency services for customers that some customers, who weren't our customers before -- we had a situation in one of the exchanges where this customer had service up with us. And I guess some of the other customers in the exchange, whatever providers they happen to be using, we're not up. So they were able -- we were able to turn up some services for them or we're in the process of turning up the services for them. So I think that all the providers are working really hard, and everybody's working together. We've just been, I think, just, sometimes you get lucky, as I've said in the beginning of my script. And I think what happens in these types of disasters is companies realize that diversity is really important, and diversity of carriers is really important. And knowing where those carriers are connected and where the points of connection are in common is really important. And so, I think, we're helpful to customers in increasing their disaster recovery profile as a diverse carrier. So I think in that regard, yes, we'll probably see some continued activity in that regard. Our Dynamic Capacity product is something that customers use a lot for disaster. We think -- and they're starting talking to us about using a lot for disaster recovery -- it fits right into that category because what they can do is if they lose a service in one location, they can reroute to a circuit that we have in another location, and send the traffic immediately, increase their bandwidth very quickly. So it fits right into that discussion of maintaining services during various different incidences. So with regard to the Cloud, it's possible that you may see -- I think people have already been moving in that direction, so I'm not sure if will it accelerate it or not. But diversity is very important to the sustainability of networks. And I think having competition, having multiple competitors who can provide different services from different locations, has proven to be extremely effective for businesses that use that strategy.

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

And then just a quick follow-up on the September comment. I mean, you have a lot of change in the sales force, a lot of new products out there. Do you think this was more driven by the economy or was it a little bit more driven by your own product cycle and your own company cycle internally?

Larissa L. Herda

Tim, I don’t want to blame the economy for anything. Obviously, we would love to have a better economy. But we're a share taker, and so there's a lot of share for us to take. And yes, maybe there is some customers that are worried about the fiscal cliff, and so they don't think our politicians will actually come together, which is obviously a concern. And maybe there are some that delay their decisions. That's possible. I can't point to that. I mean, you could point to the fact that September is an unusually short month, too. So, I mean, there's a lot of different things. It was something that really showed up in the last week of the month. And then it popped back up in October, so it's possible that the averages will turn out to be fine. But we like to let investors know when we see something that's unusual. And it was unusual for September to be a little bit down. So I don't think it's anything to lose sleep over, especially when October numbers came in, we were very excited to know that they were -- that they bounced back up again. Because that tells us it really probably wasn't the economy and it probably wasn't a sales cycle either; it was probably just a fluctuation.

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

And I'm sorry last, last one. If the fiscal cliff does happen next year or GDP for the country is down 1% or 2%, or whatever happens, how impactful would that be on your margin trends at this point?

Larissa L. Herda

If -- I'm sorry, if they fall off the cliff?

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

Well, yes. Let's say we go into recession next year, what do you think would happen to your margin at this point?

Mark A. Peters

Yes. It's hard to say. I mean, If you look at -- you have to look at the extremes. So when we look at the extreme of the Great Recession, we took a hit on the top line, and we still grew nicely at 4.5% at our worst top line growth. And we continue, throughout that time frame, we continued to expand margins. So I mean, growth and growing density within our markets is largely what drives our margin expansion. You won't see us, as in the Great Recession, you wouldn't see us pulling back and changing our strategy because of the recession. So would there be a bit of a margin hit if we have salespeople, if the growth wasn't as strong because of a big hit to the GDP? Maybe. It's still hard to speculate on the different variables, though. We're a very strong, consistent recurring revenue business. And again, not to predict it, but we've been able to weather the worst and a lot of bad stuff and -- very nicely.

Larissa L. Herda

Yes. Actually that annuity revenue stream is a wonderful thing because it supports you during even the tough times.

Operator

We'll take our next question from Michael Rollins with Citi.

Michael Rollins - Citigroup Inc, Research Division

Just curious, if I think back to late last year, early this year, it seems like the company was making a larger effort to repurchase shares and to maybe slow the rate of deleveraging in the business when you combine that with the investments that you're making. Investments now can be at the low end of your CapEx guidance range; you're generating free cash flow. Can you talk about why the company has decided not to buyback stock over the last 6 months, and maybe what your outlook is for possible buybacks or use of cash going forward?

Mark A. Peters

Sure. We've always said that we'll be optimistic and patient as we execute our stock buyback program. And that's very much -- they're very much in line with our shareholders. They like the approach that we've taken, that we're not rushing in doing anything. And you're going to really likely see us much more active in the times of market weakness and less so when the market's strong. So that's really what kind of played into when you thought -- take a bit of a pause throughout the summer time. But we're very much committed to the buyback program as we look forward and -- so you can expect us to be -- to continue to execute the program kind of within those parameters.

Michael Rollins - Citigroup Inc, Research Division

And can you remind us what your target leverage ratios are? What you aspire for the company to be operating at?

Mark A. Peters

We haven't published a specific leverage ratio target because, for us, it can be very situational. So we're in a very good place today with our leverage ratio than -- it gives us the flexibility to stay in the course like we did during the recession. And then kind of as we talked on the previous question, if something bad happens to the economy next year, we can keep investing and keep differentiating and continue to position ourself in our space to continue to grow the business. And by doing -- being able to do that during the Great Recession where others couldn't, I believe, allowed us to grow -- return to growth -- a higher growth rate much faster versus having to seize up the business, stop the momentum and then restart it again, because that takes a lot of time and it's very disruptive internally and with the customers and the development cycle, et cetera. So having the relatively low leverage ratio that we have gave us that capability. Now if we thought strategic opportunity -- though you can look at our history, we're patient and disciplined in this front -- but if for some reason, we found an opportunity to invest, to expand our reach, to expand and invest -- make a big investment in some place, we have the capability and the growth to take that leverage ratio up and do it while at the same time staying the course on our organic growth and continuing to stock buyback programs. So having the strength of our balance sheet, and coupled with our cash flow, gives us the ability to not have to choose between good alternatives but to ultimately do multiple good things as they present themselves.

Operator

We'll take our next question from Brett Feldman with Deutsche Bank.

Brett Feldman - Deutsche Bank AG, Research Division

You reiterated that your CapEx is likely to come in at the low end of the range. And historically, the large majority of your CapEx is success based. I'm just wondering if we could get a little more color on that? Is it just really some of the timing factors that you outlined during your remarks? Did you maybe see a little less demand so far this year than you thought? And if it is a timing stuff, we've heard a lot of carriers and other enterprise writers [ph] talking about timing. Why do you think that is? Do you think it's mostly a macroeconomic issue? Do you feel like people just wait until the end of the year to sort of blow out their budgets? Or you find that there is a genuine slowing down of the selling process right now?

Mark A. Peters

Yes. There are several things when we look out our CapEx for the year. And we expand a little bit more on them last quarter than we did this quarter. When we look at the whole year and our capital intensity, I mean, some of it is a timing of projects that we've -- some network expansions that, just quite honestly, we expected to be done a little sooner in the year, and they're kind of bunching up toward the end of the year, and some other projects like that.

Larissa L. Herda

Some of those are inhibited by things like right-of-way, and just things that happen when you're building a network that may move it out a quarter or so.

Mark A. Peters

So not tied to sales, directly to sales, like tied specifically to a customer. We're -- we've continually gotten better as we look at our internal processes and our inventory processes and deployment and re-use of infrastructure. So we've actually saved meaningful dollars this year as we've -- as we continually centralize how we order and purchase and manage and deploy our assets into the network, both infrastructure and customer prem equipment. And that's actually built into our ability to come in at the lower end of our guidance. From a standpoint of a customer sales, it's not that -- we're not tying it specifically to slowing of sales, or per sale cycle, anything there. I mean we do continually do bigger and bigger and more complex customer deployments, and they do take longer to deploy. So I can't say that that's a big piece of pushing into the fourth quarter, but there was always a little bit of them timing of when a project is completed, whether our deployment or our customers are being ready at their location. So there's a lot of different components in our capital -- improvement in our capital, intensity capital efficiency this year that all come together to the lower percentages here relative to the last couple of years.

Brett Feldman - Deutsche Bank AG, Research Division

And just a follow-up. Maybe I'm wrong here, but I remember I think it was last year, you had more non-success base CapEx spend when you got a lot of infrastructure projects. Is that correct that, that's gone down in 2012?

Mark A. Peters

No, I wouldn't say anything specific there. I mean, last year, we did deploy some of the products infrastructure that we've put into place that we deployed, that served into, I guess, we can put that into the category as a non-success based product or putting infrastructure in place and the next gen equipment. And we've been doing that over a couple of years but we did some of that last year but it did not repeat itself this year. So yes, thanks for reminding me that, we talked a bit about that last quarter as well.

Brett Feldman - Deutsche Bank AG, Research Division

Just thinking a little ahead here, in terms of 2013. I know you haven't given guidance yet but are you planning any type of sort of one off projects that we should start thinking about now? Are you going to kind of be in your normal, mostly success to cap base model?

Mark A. Peters

And we'll talk about that next quarter when we normally do the -- as we talk about, kind of, CapEx guidance for the next year so I don’t want to jump the gun this quarter and talk about that.

Operator

We'll take our next question from Donna Jaegers with D.A. Davidson.

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

On the wholesale, your one-to-many ethernet product, can you talk -- you're selling to big customers. These are big chunky buys. Can you give us a little more color on what sort of the typical contract amount might be on these?

Larissa L. Herda

Yes. No, I can't give you any typical color at this point. We haven't communicated that. They're going to be buying -- generally what they're going to do is they're going to is buy a like a hub type of facility from us and so they've been buying entrance facilities from us and then the -- kind of the circuits come. And different carriers of different arrangements. So I really don't want to talk about them because that's competitive information. Some of them want to pay for the entrance facility and have a lower-cost on the individual circuits coming off of them. Some of them want to not pay for the entrance facility and pay a higher cost on it. So it's all different. But I think the key with that product, as I think you understand, is that now these carriers really only have to meet us in one place and then we can take them anywhere, and that -- because ethernet is still a bit of a bare to interconnect with a lot of different carriers in every single market. So this takes all of that out of the equation and we can handle all their services for them to any of our 75 markets. So that's pretty powerful, and it saves them enormous amount of capital expense and operating expense.

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

Okay, and then maybe just a follow-up, maybe one that you can answer a little more. On your -- the direction in margins going forward, obviously there's a caller out there saying that someone thinks that you're margins are going to be down going forward. But we still -- the new products that you're introducing, the Intelligent Network product and then this wholesale ethernet, those should be higher margins than the average, right?

Larissa L. Herda

Yes. I mean...

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

And so, unless you guys...

Larissa L. Herda

It's actually -- with the Dynamic Capacity, I mean, it's really on top of -- it's all on net, and so that's high time margin, and then it's incremental revenue on top of our already-high margin ethernet services. So it's a beautiful addition to margins when they use it, right? So we'll see how that goes.

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

Okay so then the other 2 things...

Larissa L. Herda

The one-to-many is on-net, but eventually, what we'll be doing Type 2 as well. So it will just depend on how much Type 2 we do for them. But it's also a very -- the on-net portion, obviously, is a very high-margin service.

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

Okay, so then the other -- go ahead, sorry.

Mark A. Peters

Yes. I'm sorry. So the underlying mix doesn't really change with these products because it helps us with some more of the underlying, but then I also said you layer on the Dynamic Capacity, and that's all margin. And so, I don't see the products changing, being the Cloud of the change in the mix.

Larissa L. Herda

I mean, if we add a bunch of salespeople but nobody produces, but you know what happens to that is that it smooths out because then they start to produce. So that eventually you're selling a lot more -- you have a lot more high-margin revenue that you're bringing in. And they're focusing on bigger customers, and the bigger customers primarily buy on-net services from us, I mean they buy a lot of on-net services from us. And so...

Mark A. Peters

And they're very sticky. I mean, the bigger the customer, the more differentiated products. Those are stickiest and that -- and those are the ones, I mean, quite honestly when we talk about repricing earlier. The more differentiated the product offering, the less of that you have over time, too. So I mean that's -- it's I think all very complementary to our strategy. But to expand the margins, as we've said over and over again, is really to build in further density within our existing markets. And so gradually, that is what we would expect to help us expand the margins over time.

Larissa L. Herda

And that's by adding more salespeople, that's what we're doing, is moving -- exactly moving the dial on that strategy, and that's increasing the penetration in those markets because that's what drives our margin growth long-term.

Larissa L. Herda

Looks like we have -- we're a little bit over on time but we're going to take one more question.

Operator

All right. We'll take our last question from Tom Seitz with Jefferies.

Thomas O. Seitz - Jefferies & Company, Inc., Research Division

Larissa, I think this one's for you. You like to say, I think you even said it in this call, that people forget that there is no Cloud without the network. Where do you think CIOs are with accepting that premise? Is there 100% agreement with that or do you find that there's a willingness to go out and just use the cheapest bandwidth and set up their initial Clouds and that maybe it takes moving mission-critical apps for them to care about the absolute reliability of the network. Can you just talk generally about that real quick?

Larissa L. Herda

I think -- depending on the CIO, I think most CIOs understand that the Internet just is not good for mission-critical applications. And it's fine for certain types of distributed applications like salesforce.com, for instance. You couldn't do it without the Internet because you've got -- you have a salesperson who may be in a coffee shop one day and then they're in a -- they're in their -- they're at home another day and they're somewhere else another day, and then they're on the road. So those types of applications are -- function extremely well and probably only because you have the Internet as an access methodology. But CIOs absolutely understand that they can't put their mission-critical applications over the Internet. And by the way, the Internet is also a network, right? So the Internet usually does require -- I mean we sell a lot of Internet services -- it does require a physical network infrastructure to go somewhere, generally into a data center. So it's not without positive network implications as well. But with regard to the Cloud -- and I think that CIOs are absolutely getting it, and they understand that they need to have dedicated network services because they can't put a lot of these mission-critical apps over the Internet. The Internet goes down, the Internet has latency, there's no guarantee and, yes, it's a fairly robust entity because there's so many companies that we have that have combined to create the Internet, us being one of them. But CIOs also want visibility outside the -- that they want visibility to their network. And they want -- and to do that, they really need to have a dedicated infrastructure for that. So yes, I think they get it, I think more and more are getting it. The smaller the business, I think more likely they are to rely on Internet connectivity. But the customers that we sell to have significant mission-critical apps. And they need that dedicated network.

All right, everybody. Well, thank you for taking the extra time with us and for your support of TW Telecom. I hope you all have a good day. Thanks.

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