EarthLink Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: EarthLink, Inc. (ELNK)
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EarthLink (NASDAQ:ELNK) Q3 2013 Earnings Call November 5, 2013 8:30 AM ET


Louis Alterman

Rolla P. Huff - Chairman of The Board, Chief Executive Officer and President

Bradley A. Ferguson - Chief Financial Officer and Executive Vice President


Michael Crawford - B. Riley Caris, Research Division

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

Barry McCarver - Stephens Inc., Research Division

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Scott H. Kessler - S&P Capital IQ Equity Research


Good morning. My name is Vanessa, and I will be your conference operator today. At this time, I would like to welcome everyone to EarthLink's Third Quarter 2013 Earnings Call. [Operator Instructions]

I will now turn the conference over to Louis Alterman, Senior Vice President of Finance for EarthLink. Please go ahead, sir.

Louis Alterman

Thanks, and welcome to our call. During today's call, we will refer to earnings slides that are available free to view in the Investor Relations section of our website at

Following our comments, there will be an opportunity for questions.

Before we continue, I'd like to point out that certain statements contained in our earnings release and on this conference call are forward-looking statements, rather than historical facts that are subject to risks and uncertainties that could cause actual results to differ materially from those described.

With respect to such forward-looking statements, the company seeks the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks include a variety of factors, including competitive developments and risk factors listed in the company's SEC reports and public releases. Those lists are intended to identify certain principal factors that could cause actual result to differ materially from those described in the forward-looking statements, but are not intended to represent a complete list of all risks and uncertainties inherent to the company's business.

In an effort to provide useful information to investors, our comments today also include non-GAAP financial measures. For details on these measures, including why we use them and a reconciliation to the most comparable GAAP measures, please refer to our earnings release and the Form 8-K that has been furnished to the SEC, both of which are available on our website at

After Rolla's opening comments, Brad Ferguson, our Chief Financial Officer, will discuss the quarter's financial results.

Now I'd like to hand things over to Rolla Huff, our Chairman and CEO.

Rolla P. Huff

Thanks, Louis, and good morning to everyone joining us on the call. We were encouraged by our continued overall progress in the third quarter. Sales bookings were well above historical levels and rep productivity continues to be high.

As we expected, business churn peaked in July, then began to decline in August and approached more normal levels in September.

As we passed several important milestones in our integration efforts this quarter, we will now leverage some of our new capabilities to begin a substantial project to reduce the cost structure of our access network and drive greater provisioning efficiency in 2014 and beyond.

And finally, we were able to drive several favorable settlements, including a more positive outcome in the USAC audit than we had originally anticipated last year.

I'll go more into depth in each of these items I just mentioned, and then I'll hand it over to Brad to dive deeper into the quarterly results and full year guidance.

I'll begin on Page 2 with new customer bookings, where we had a strong third quarter. The sequential comparisons will of course continue to be lumpy as we move upmarket as we've described in the past. But I think the important thing is that we continue to maintain booking levels significantly above 2012 production.

In Q3, we booked over $88 million in total contract value. Year-to-date, through September, we've booked $265 million in total contract value, or over $10 million in monthly recurring revenue. This is more than 5% above where we were last year at this time on approximately half the number of sales reps.

As you can see from the mix information on the bottom half of the page, 64% of our bookings in Q3 came from our growth products in carrier business.

Legacy CLEC sales are now down to 36% of the total, whereas 1.5 years ago, they comprised the vast majority of our new bookings.

We see substantial customer demand for the new platform we've invested in, and expect our reps will continue to sell proportionately more of our next-generation products and services.

Now, all of this translates into rep productivity that continues to be meaningfully higher relative to prior periods, as shown on Page 3.

Including our carrier business, our sales reps produced at a rate of $4,600 of new MRR per rep per month on average in Q3, which is above level seen in Q2 and nearly double the levels we saw throughout 2012.

As we've talked about before, it's not just the makeup of our product set that changed, but the makeup of our salesforce as well. EarthLink reps today are more proficient and solution selling, are used to carrying higher quotas and have the technical know-how to educate our customers on the benefits of moving to the cloud or transitioning to cloud-based IP voice technology.

The ability to offer and sell technology-based solutions at the enterprise level has been at the core of the EarthLink transformation.

We continue to invest some of the savings from our reduced salesforce into online demand creation. In the third quarter, digital advertising resulted in $31 million impressions, and we posted improvements north of 50% over last quarter's click-through rate.

In the third quarter, our search engine marketing efforts resulted in $144,000 in MRR bookings, or $1.7 million in new annualized revenue.

And importantly, we have another $800,000 of MRR or nearly $10 million of annualized revenue in our pipeline being worked.

Not only are we selling more and doing so with fewer sales reps, but we continue to move upmarket at a very fast cliff. In our retail business, the average deal size for new bookings in the third quarter of 2013 was 29% higher than it was at the end of last year.

The dollar amount of new bookings that is for transactions with $10,000 or more of MRR, is up 67% over the same time period and continues to improve as our broad suite of products increasingly allows us to compete for more complex deals.

There are a couple of important financial impacts from the larger, more complex sales. Once they're installed, these customers tend to be stickier and churn at much lower rates than smaller customers.

I'll have more to say about this in a minute.

Also, without question, the installation cycles for large enterprise wins are longer, usually because of just the sheer magnitude of the rollout projects. Rolling out a complex network with 50 -- 1000, 1,000 or more locations can take up to 18 months depending on the type of solution, the number of locations that require new construction, et cetera. But these are extremely valuable customers for our new business model. We're able to grow as the customer grows, as well as sell our IT services into these types of customers.

As a result of selling more large, multilocation deals, our backlog of deals that have been sold but not yet installed has grown by over 27% this year. It grew 19% sequentially just this quarter and now represents approximately $100 million of total contract value. Our continued strong sales execution and growing backlog of signed business gives us the confidence in our ability to create long-term, sustainable growth in this business.

I'd like to spend a few minutes now talking about churn, beginning on Page 4. As we discussed last quarter, churn on the lower-end of our retail business, typically small, single-location customers using legacy products and technology, increased in Q2, causing overall churn in our business segment to rise to 1.8%. The bulk of the churn change was caused by an increase in the number of customers coming out of contract over the summer. We said at the end of Q2 that we expected churn to remain elevated for a couple of months and then begin to return to historical levels, and that is what we're seeing.

For the full third quarter, churn in our retail segment, shown at the top right of the page, improved by about 10 basis points over Q2. But more importantly, if we zoom in on the monthly results, by September, churn was down 50 basis points from the July peak and getting closer to historical levels.

We anticipate continued, intense competition for small business customers from the cable industry to be sure. To better compete in this environment, we've resegmented our base internally so we can focus on the customers that are most vulnerable. With our integration activity now producing better information, we know we'll get smarter about the type of offer that is optimal for the various types of customers in this base.

We believe we can retain many of these customers, either by offering a bundle that includes Hosted Voice over IP and some of our IT services, or by offering Ethernet services, which we're quickly deploying. It will remain a fiercely competitive market at the low end, but we're executing a plan to defend our single-location customer base.

And thinking about not just the legacy products, but about the business as a whole, our average deal size will continue to grow, and the new customers will be larger, more complex and with multiple locations. These customers have a much lower churn profile because they're not as price-sensitive, and the cable companies are much less likely to be able to serve a customer with multiple locations across the country.

We're confident that our churn profile will continue to improve as we move upmarket, and these larger enterprise customers comprise an increasing proportion of our revenue base.

Focusing on the bottom right of the page. We expect new sales and churn in our wholesale business to be lumpy, just by the nature of that business. It usually bounces around between 1% and 1.5% per month. At the beginning of this quarter, we, along with several of our industry peers, felt the impact of Sprint turning off their legacy Nextel network. This was a churn event that we suspected would happen eventually, but of course, in our industry, it's difficult to predict the precise timing of things like this within years, much less quarters.

The impact to us was around $350,000 of revenue per month, or a little over $2 million for the second half of 2013. We're not aware of any other pending disconnects of this size, and we expect wholesale churn to generally remain in the low-1s.

On Page 5, you can see the consumer churn followed its normal seasonal pattern, ticking up 10 basis points over Q2 due to the typical volume of summer broadband movers, but remaining 20 basis points lower than a year ago.

Consumer churn has fallen substantially over time, and we expect that it continue to improve.

Turning to Page 6. I'd like to spend a couple of minutes updating you on some keep capabilities that are enabling our salesforce to produce, and that should provide a better operating leverage in the future. First, as you know, last quarter, we completed the rollout of our 5 next-generation data centers. In the third quarter, our IT service bookings were up 113% over the year-ago quarter. We've hired new sales teams in key Tier 1 markets with a focus around the data centers.

As I've mentioned, the new sales talent we're hiring are accustomed to carrying much higher quotas, and they come to us with quality business relationships in the types of customers we're now targeting.

The teams we've recently put in place in Chicago, Dallas, Los Angeles and other new markets are still in the ramp period, but to date, we've already sold $2.7 million of annualized revenue on the new CloudStacks. We filled up just about 10% of the capacity of the equipment in these data centers and have substantial headroom as we increase new customer additions from here.

We completed the CenterBeam acquisition early in the quarter and have made tremendous progress getting these products into the marketplace. We now have CenterBeam's suite of products, including leading 365 and endpoint management capabilities rebranded, loaded in our product catalogs and in the hands of our full salesforce. With these new products, we're in an increasingly strong position to cross-sell IT services into our existing customer base. In fact, in Q3, IT service sales, to the base, were up tenfold over last year.

We're now nearing the finish line on our fiber network expansion project, with the project being over 90% complete and one new route bill remaining in Texas. As a result of the expansion project and from continued demand for unique routes across our footprint, we've booked $1.8 million in carrier MRR year-to-date, and that's double the $900,000 in MRR that we had booked through the first 3 quarters of 2012.

The virtuous cycle that I've described the past quarter or 2, continues to grow in strength, and that's the product capabilities, the better markets, the new talent we can attract and bigger customers who can become references. All these factors are in the early stages, but are already helping us to drive higher sales momentum.

Putting all of these together, as you can see on Page 7, our total company year-over-year revenue declines remained about flat this quarter. The Sprint Nextel disconnect I referenced earlier occurred in July, which caused $1 million impact to the quarter.

Additionally, the retail churn increase occurred throughout Q2, as opposed to just at the very beginning, so it had larger impact on the Q3 P&L.

We'll continue to feel the impact of the summer churn in Q4, along with our typical seasonal revenue pattern, which includes lower business activity and usage, but the long-term trend is clearly improving.

Total company revenue declines have improved 130 basis points from where they were a year ago and are half of what they were 2 years ago.

Before I hand it over to Brad, I'd like to briefly touch on some key operational initiatives that are important to our ability to drive better operating leverage in the future. We continue to make progress on the integration of our core system platforms. I told you last quarter that we had divided the remaining integration activities into manageable chunks, and that strategy is working well.

As I mentioned on the prior slide, we continued our integration activities around our ITS business by enhancing our ITS OSS platform to provide our newly acquired CenterBeam product capabilities to our nationwide sales team.

In parallel, we've completed the integration of our sales system for both our network and ITS products and services.

On deck for November is a major systems release that will consolidate our care, repair and customer management platforms. That's going to be a big one. This release will be a critical step to improve the cost and quality of how we manage and care for our customers.

Our vision of a single pane of glass control structure technology that we've previously shared with you at Investor Day, is now in beta version and we expect to go to general customer availability in mid-Q1 of 2014. We're tremendously excited about this capability as we think it's a real differentiator for us.

Also in Q1, we'll deliver our new order management platform for our nationwide EarthLink complete product line. This will be the last major piece of heavy lifting associated with our 2 large network acquisition integrations, and once the platform is delivered, we'll then begin to selectively consolidate high growth customers and products of legacy order systems.

But this is only the start of getting our business to where we want it to be from a performance and margin perspective. The next phase will then be to leverage the new OSS platforms to begin optimizing our business. We intend to make procuring cost-effective network access, a core competency at EarthLink and to drive more cost efficient access purchasing decisions. We're in the early phases of planning these efforts. In some cases, there may be upfront cost to groom or migrate traffic to better access methods, but the payback should be very, very attractive. The result should be access cost that are not only lower, but also, in many cases, more variable, which will be important for the legacy portions of our business that are declining.

We also intend to leverage the better systems environment to get more efficient throughout our business and begin to more meaningfully impact SG&A trend lines.

Combined, we believe there are tens of millions of dollars of opportunity to cost-optimize our business that we can begin to recognize in 2014 and 2015.

Every time I talk to employees or to investors, I remind them that we're managing a very complex transformation, but the progress we've made in rolling out a leading-edge service portfolio and distribution strategy over the past 36 months has been substantial. We've built $180 million retail growth business that's accelerating in growth. I fundamentally believe that this growth business is going to drive the value-creation in our equity and I remain highly encouraged by the demand for our next-generation services in the marketplace.

Now I'll turn it over to Brad to dive deeper into our financial results and guidance. Brad?

Bradley A. Ferguson

Thanks, Rolla. I'll begin on Page 8. For the third quarter of 2013, we reported revenue of $309 million and adjusted EBITDA of $56 million.

Included in adjusted EBITDA, were several settlements, which, in aggregate, resulted in a net favorable $7 million.

We're working on several large items and we're aiming for mid-single digit millions of favorable settlements in the second half of the year, which we contemplated when providing our guidance last quarter. However, we were able to do slightly better than this and pull forward the benefit to the third quarter.

The bulk of the favorability was within cost of revenue, driven by a reduction in the USAC auto reserve, the majority of which was originally recorded in the second quarter of 2012.

As we said in the past, the nature of our business is lumpy, and we should expect that we'll continue to have these types of items in the future.

For the quarter, we generated unlevered free cash flow of $23 million, down from $25 million in the second quarter.

We reported a net loss of $11 million flat to the second quarter.

Turning to Page 9, which contains the components of our revenue. We continue to encourage our investors to use this slide and the revenue trajectory page, Slide 7, as guidepost when modeling 2013 and 2014 revenues.

In the third quarter, our retail growth products comprised 14.5% of total company revenues, up from 12.5% last quarter, with approximately $180 million on an annualized run-rate basis.

Compared to Q3 of last year, our retail growth products revenue stream grew 32%.

Organic growth for these products suggesting out the benefit from the CenterBeam acquisition is still expected to be at or above 20%.

Our wholesale business generated $36 million of revenue in the third quarter, down from the prior quarter as a result of the Nextel churn, as well as the expected step-down in inter-carrier compensation rates in July of this year, which had an approximately $1 million impact in Q3.

Over time, as we get past the comparisons to historical periods that include the Nextel revenues, we should be able to grow our wholesale revenue business in the low-single digits as we capitalize more on our unique routes within our footprint.

Our total growth business, including wholesale, which represented $284 million of revenue in 2012, has scaled so far this year to a run rate of $324 million. It now represents 26% of our total company revenue.

As Rolla mentioned, the timing of when we close and install large deals, we'll not be evenly distributed from quarter-to-quarter, and the larger deals tend to have the longest installation intervals.

Regardless of how the quarterly fluctuations play out, the overall trend for our growth products is strengthening.

Focusing on the legacy CLEC part of the business. In the third quarter, these products comprised 52% of total company revenues, down from 55% last year.

We said last quarter that we expected low-teen percentage decline in the second half of the year and that is what we continue to expect.

Over the longer term, we expect these revenue declines -- we expect the revenue declines in the segment to attenuate as we have a more compelling bundle of services to offer. It's also important to note that about half of the customers who are purchasing these legacy products today possess dimensions of their business that would make them logical targets for our growth products and we have organized ourselves internally to address that opportunity.

In the meantime, as Rolla mentioned, we are focused on aggressively managing the costs around this part of our business.

Our consumer business continues to perform well. Year-over-year declines were 13%, and the pace of decline continues to decelerate. We expect consumer revenue to be slightly better than we originally guided earlier this year.

The key sources and uses of cash are outlined on Page 10. We ended the third quarter with $116 million of cash and marketable securities. During the quarter, we utilized $33 million for capital expenditures, down slightly from $34 million in the second quarter.

Of the $45 million commitment that we outlined late last year for the fiber and data center projects, we now have spent a cumulative $41 million.

The remaining capital will trickle in as we complete these projects.

We used $25.5 million on the purchase of CenterBeam, including $2.5 million of transaction and severance costs.

Outside of CenterBeam, we spent approximately $9 million on integration and severance cost. During the quarter, we issued $5 million of dividends and we used $6 million to repurchase common stock at an average price of $5 per share.

We continue to consider opportunistic share buybacks within the balance of the restricted payments portions of our bond indentures, which currently has its limit to around $24 million.

Moving on to the balance sheet on Page 11. We have $600 million of gross debt outstanding, which equates to just over 2x net leverage.

I'd like to briefly provide an update on our corporate structure. In the past several years, we have undertaken an internal reorganization to align and reduce the number of our subsidiaries. We are now considering an additional internal reorganization, which would further reduce the number of our subsidiaries. We would also establish a holding company with no operations as a publicly traded parent company with EarthLink Inc. as a wholly own subsidiary. We expect this would have no impact on our leverage requirements and other financial covenants.

The whole co. would become the primary obligor on EarthLink's outstanding debt obligations, and EarthLink would become a guarantor in restricted subsidiary.

We would not anticipate this to drive a change in our current dividend practice and equity holders would remain shareholders in the same amounts and percentages as they were prior to the reorganization.

There are several benefits to the reorganization, including enabling us to reduce our ongoing audit tax, regulatory and corporate expenses; more efficient use of state NOLs; and it allows us to manage the business more efficiently with a streamlined structure.

To be clear, we're not considering this reorganization in connection with any contemplated transaction. The reason we're talking about it now is because we're making a number of required public state regulatory filings, so we wanted to take this opportunity to provide some context.

Now I'll discuss some of the operating results and metrics in more detail, beginning on Page 12.

Of our $309 million of total revenue in the third quarter of 2013, business services comprised 78%. Our total cost of revenue was $145 million in the third quarter of 2013. Normalizing for settlements, our gross margin rate is between 50% and 51%.

In the consumer segment, net subscriber losses were 42,000 compared to 40,000 last quarter and 53,000 in the third quarter of 2012. Total consumer churn was 2.2%.

Seasonality does impact some of the quarterly trends with Q3 typically being higher. But consumer churn has been steadily and predictably decreasing for 6 years and we expect this trend to continue.

Approximately 70% of our consumer subscribers have been -- have now been with us for 5 years or more, and these customers' churn rates are down in the 1s.

Total selling, general and administrative expenses were $109 million for the third quarter, up sequentially as a result of the CenterBeam acquisition, which, as a reminder, was EBITDA neutral at the time of acquisition.

Now for the updated financial outlook for 2013 on Page 13.

As we discussed earlier, we continue to have strong new bookings and the revenue from these customers will favorably impact future periods once installed. We also had higher churn over the late spring and summer, which has a more immediate impact on our P&L.

For the full-year 2013, we're adjusting our revenue guidance range to $1.240 billion to $1.245 billion. This is within, but at the lower end of the original guidance range we issued at the beginning of the year.

We're also raising our adjusted EBITDA expectations to a range of $222 million to $227 million. This is an $8 million increase at the bottom end of our previously issued guidance range and a $12 million increase to the bottom end of our originally issued guidance at the beginning of the year.

The lower revenue run rate, I just mentioned, applied some pressure to adjusted EBITDA, but for 2013, this is offset by the favorable impact of settlements we discussed earlier in the call.

We're projecting a net loss of $282 million to $280 million. This includes an approximately 13% tax rate, which, for 2013, differs from the approximate 38% rate that we typically book, primarily due to the impairment of nondeductible goodwill.

A reconciliation of our adjusted EBITDA guidance to the nearest GAAP measure, along with the various components below EBITDA, such as amortization, depreciation and interest expense, is provided for your reference on Page 18.

We're reducing the top end of our previous CapEx guidance by $5 million to a range of $140 million to $150 million.

As you know, this year included investments in fiber and data center assets.

Going forward, absent large opportunities that would come with these -- with the incremental revenue, we expect to return to our normal CapEx spend rate, which equates approximately $125 million to $135 million annually.

With that, operator, let's open up the lines for questions.

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Mike Crawford from B. Riley.

Michael Crawford - B. Riley Caris, Research Division

With your new more productive sales reps and the larger deals you're pursuing, where do you stand on the longer lead time associated with these deals, as well as with getting new hires up to speed?

Rolla P. Huff

So Mike, it's -- we're now starting to see the bookings, some of these larger deals that we talked about. So a year ago, we were talking about longer lead times in terms of getting the deals, now we're starting to get the deals and because of the complexity that the install times are moving out. But we're seeing -- I think we'll expect to see a more regular cadence of solid bookings because we've gone through that period of changing the sales motion. The part of the salesforce that you're referring to are in the new markets and they're really in the final stages of the ramp periods. They're -- the funnels that they've developed look solid. So we feel good that they'll move up the productivity curve just like the rest of our salesforce has.

Michael Crawford - B. Riley Caris, Research Division

Okay, thanks Rolla. And then in terms of that 27% growth in the backlog deals that are not yet installed, what are the primary bottlenecks there? Do you expect that number to increase or decrease over time?

Rolla P. Huff

Well, I don't know that I would call it a bottleneck as much as when you're rolling out 1,000-node network, the customer can't -- I mean, the customer's not even able to turn them up quickly. You've got to remember that as we've really moved from selling single T1s primarily, which you can provision in 45 days, to selling much more complex solutions that take months and quarters to provision. But just like the sales motion, as we move through this time period, we expect a more regular cadence of provisioning, too. So I hope our backlog continues to build that will tell me that we're continuing to scale our sales.

Michael Crawford - B. Riley Caris, Research Division

Okay. And final question, do you find yourself increasingly focused on the small box retailers, where it seems you're most competitive?

Rolla P. Huff

That is where we're most competitive and those -- that represents some of our largest deals. But we've done a couple of very large deals with financial institutions over the last 6 or 8 months that are hundreds of thousands of dollars of MRR. So -- but clearly, small box retail, we've got a unique offering for that market segment.


Your next question comes from the line of Donna Jaegers from D.A. Davidson.

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

These new contracts that you're signing, what's the average contract life on them? 3 years?

Rolla P. Huff

3 to 5 years.

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

Okay. And on the search engine optimization numbers that you threw out, granted it's from a standing start, so it looks good versus 0, but still a very, very small part of your sales. What's the prospect to really dial that up and really improve that?

Rolla P. Huff

We're putting a lot of focus on it, Donna. We're seeing our inside sales motion, which is primarily fed by that marketing activity, continuing to scale their sales. So I expect that we'll continue to feed that distribution channel and we're seeing great productivity from it.

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

Okay. And then you talked a lot about your -- the new initiative to try to trim access costs going forward. Obviously, AT&T and Verizon are also trying to get out of selling special access or at least link -- shorten the terms that they're selling them in. How does that -- how much special access do you guys use? What's your typical access methodology? Can talk to that a little more?

Rolla P. Huff

We -- so we'll oftentimes initially provision a customer on special access and then come back around later and groom them to a UNI. This is where our colos tend to be more valuable because we have the ability to groom them off. But I think what you will see us evolve to over the next 3 or 4 quarters is not selling specific access types, but rather selling bandwidth and a solution and then giving ourselves the ability to provision that bandwidth over everything from, not just special access in UNI, but cable, wireless. So we think that we're differentiated that way, and that's why, in my remarks, I've mentioned that I want that to be a core competency of our company because it differentiates us and I think we'll be able to bring our access cost down meaningfully from where they are right now.

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

Okay. And then just one last question then I'll get back in the queue. The business gross margins going forward, Brad, I think you mentioned 51% as a more normalized pace, but I think that was total. Where do you see the business margins going?

Bradley A. Ferguson

Yes, that's the total company at the 50% to 51% level. I think for the business services down in higher 40s, and certainly -- as we sell these bigger deals and you've got some things off net that will put some pressure on the margins, but as Rolla talked about, we're doing a lot of things to kind of take the cost preference and improvement. The IT services have higher gross margins, so I mean, I think, the business side in that kind of higher-40 range is kind of what we're looking at in the near term.

Rolla P. Huff

And Donna, I would just point out that as we get to a richer mix of Ethernet over copper, which is where this -- this is where we're going for sure, we think that will have a positive impact on margins.

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

I'll squeeze in one more question if I can. On M&A, there were some rumors during the quarter that the company was being shopped around. Can you talk a little bit about what you're -- are you happy with the progress that you are making? And continue to -- what's your outlook for remaining independent?

Rolla P. Huff

That we were being shopped around?

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

Yes. That was the rumor.

Rolla P. Huff

Gosh, nobody told me in on that. But look, we're continuing to stay heads down and try to drive the business. And we know that the more we improve the business, when that day comes, we'll be worth more. So -- but I'm not shopping the company around.


Your next question comes from the line of Barry McCarver from Stephens.

Barry McCarver - Stephens Inc., Research Division

Can you share with us what CenterBeam contributed to revenue in the quarter?

Bradley A. Ferguson

Yes. It's around mid-single digits, $4 million or so.

Barry McCarver - Stephens Inc., Research Division

Okay. And you said it was basically EBITDA neutral?

Bradley A. Ferguson


Barry McCarver - Stephens Inc., Research Division

Is there opportunity that, that starts to contribute during the fourth quarter?

Rolla P. Huff

Yes, definitely. We're seeing a lot of quoting activity around the endpoint management and 365-plus product offerings. It's a natural, frankly, to sell into our base. And it comes with pretty solid gross margins. So we're really happy with that platform.

Barry McCarver - Stephens Inc., Research Division

Great. And then continuing the discussion about the larger customers, larger contracts, can you kind of give us an idea of what the monthly recurring revenue might be? I guess, sort of at the low-end of what you would consider a large customer? And then secondly, do you find yourself competing with the new group of peers for this larger customers? And who would that be?

Rolla P. Huff

Sure. So the range that, I guess, we talk about is over $10,000 a month of recurring revenue. And remember, that is oftentimes the first revenue relationship that we get that it starts at $10,000 a month. But importantly, customers that are $10,000, and, I guess, the upper-end of the range is $800,000 or $900,000, we've done in the last 2 years. We've landed customers like that. Importantly, those types of customers are generally adding locations, so they're -- to the extent that they're growing, we're growing with them. And then beyond that, there are much more natural fits for our IT service portfolio. So we're generally competing with the AT&Ts and CenturyLinks. People that have similar -- people that have similar footprints.

Barry McCarver - Stephens Inc., Research Division

Okay. And then you mentioned the migration to that the order platform, beginning in the first quarter of next year, along with some further optimization. Kind of your thoughts what margins now look like with some of these projects being completed as we get into 2014. Not looking for specific guidance; just kind of wondering the trajectory there.

Rolla P. Huff

Well, I think it's going to be a balance. To the extent that we're still declining, we're losing the advantage of higher scale, so that puts a downward pressure on the margins. But I think we'll more than offset that. I expect to more than offset that in 2014 and '15 as we begin to optimize our network infrastructure and variabilize more of it. So we're going to try to take a page out of the EarthLink consumer platform and really focus on variabilizing as much of the cost structure as we can.

Bradley A. Ferguson

And other things, which would help, are like our CloudStacks, for instance. It's like we've made the investments, we've got some costs that are really fixed for supporting that, but we're at 10% capacity on utilizing in those investments. So those other things we should be able to get some help on the margin side.

Rolla P. Huff

Yes. As we mentioned, we're only -- we've only consumed about 10% of the capacity, so every dollar of revenue that we put on those CloudStacks, incrementally have much stronger margins.


Your next question comes from the line of Barry Sine from Drexel Hamilton.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

The first couple of slides in the deck are pretty impressive in terms of the sales momentum. Could you get a little more granular and talk to us about what are the best-selling products? What's really driving that sales growth from a product perspective?

Rolla P. Huff

Sure. I think the thing that makes us unique and we talked about little bit on the small box market, but any customer that has a distributed footprint, we give them a great opportunity to cut -- put together a private, customized network that, on top of it, gives them optionality around the whole suite of IT services. And so we just landed a reasonably large deal. I think it was something like $40,000 or $50,000 a month. We got that MPLS network, but the reason we got the deal was that we gave them, they believe, the best optionality around taking more cost out of their business by moving some of their things, whether it's technical support or hosted exchange services, Hosted Voice services. We really give them the ability to move there quickly because as we've said so many times, anybody that's an MPLS customer with us has nodes on their network already that are data centers that have this portfolio of products. And now, and I'll be anxious for -- to start to show you folks how the vision became a reality, the myLink portal, and I think you can expect to hear that be rebranded. But that single pane of glass that opens all of these things up to a customers, we think, is going to be extraordinarily unique in the industry.

Barry M. Sine - Drexel Hamilton, LLC, Research Division

Okay. And then as we think about the fourth quarter and the sales momentum, as you're increasingly exposed to the retail sector, is that a sector where sales slowdown because of their seasonality? In the fourth quarter, we might see a little lower bookings in fourth quarter?

Rolla P. Huff

Yes. Generally, the retail sector, in particular, sort of goes into lockdown-mode in the fourth quarter because they're -- it is their seasonally best quarter for sales into their business. So that generally consumes a lot of their time. Now having said that, we've got a lot of deals that have been in the works. So the way I would expect to see here -- see it roll out is that we should have a strong early months in the fourth quarter, and then it'll drop off in December as people are just really focused on the holiday season.

Bradley A. Ferguson

Similar thing, Barry, on installs. I mean, it will lock down, probably, after October, there is going to be lock down on the retail side.

Rolla P. Huff

That's right.


Your last question comes from the line of Scott Kessler from S&P Capital.

Scott H. Kessler - S&P Capital IQ Equity Research

I'm actually kind of surprised guys that you haven't gotten, I think, a single question related to, I guess, the last part of your press release and the comments that you made related to the formation of the holding company. I'm wondering if you could talk about things like what's going to determine whether you decide to move forward? What kind of potential timetable we're talking about here? And maybe give us some details on the potential financial impact that you alluded to.

Bradley A. Ferguson

Yes. I mean, it's -- they're not huge benefits, but it's certainly a structure that makes more sense, gives you more flexibility down the road. The benefits in terms of cost, I mean, it's probably a couple of hundred thousand dollars of savings, but this is the process you have to go through to unlock those and it just makes sense to do it. In terms of timing, there's a regulatory approval process, which, again, we don't expect that will be much resistance to doing that. I mean, there is our notes specifically called out the flexibility to do this, and the noteholder, as we talked about noteholders and equity holders, this is a neutral transaction. So really, it could happen at the end of this year, so in a couple of months, latest Q1. So that's the timeline.

Rolla P. Huff

Yes, I just want to emphasize that nobody should read into this as we're doing this in anticipation of something else that we want to do. It's not that way at all. But we've been working for the last 2 years, frankly, to rationalize the incredibly complex structures that we bought. Because you can just imagine with buying these 2 big CLECs that themselves were roll-ups that the structures were just off the charts complex. And our -- the finance team and our general council have been working hard to get those rationalized and this is really sort of the final step of that. But I don't want anybody to connect this to something having to do with the future event or transaction that we're contemplating. That's just not the case.

Scott H. Kessler - S&P Capital IQ Equity Research

Right. And just a follow-up. So is the best way to think about this, essentially, as an effort to kind of conclude the process of rationalization and simplification related to a number of acquisitions that you've made in disparate assets and operations, isn't that really what's going on?

Rolla P. Huff

That's exactly what it is.

Bradley A. Ferguson

We still have 40-something legal entities, so there are some more things we can do. But again, this is just an important step along the way, and get you to or help to have more than that. We're approaching triple digits, so we've made a lot of effort to kind of pare it down, and this is just again, another key step along the way, but we are on the back half of the things for sure.

Rolla P. Huff

Well, I'd like to thank everybody for listening to the call today and for your continued support. I'm clearly excited about the continued demand for our new product platform and look forward to catching up with everyone, again in the next few months. So take care.


This does conclude today's conference call. You may now disconnect.

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