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WSTC > SEC Filings for WSTC > Form 10-Q on 29-Apr-2013All Recent SEC Filings

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Form 10-Q for WEST CORP


29-Apr-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Condensed Consolidated Financial Statements (unaudited) and the Notes thereto.

Business Overview

We are a leading provider of technology-driven, communication services. We offer a broad portfolio of services, including conferencing and collaboration, unified communications, alerts and notifications, emergency communications, business process outsourcing and telephony / interconnect services. The scale and processing capacity of our proprietary technology platforms, combined with our expertise in managing voice and data transactions, enable us to provide reliable, high-quality, mission-critical communications designed to maximize return on investment for our clients. Our clients include Fortune 1000 companies, along with small and medium enterprises in a variety of industries, including telecommunications, retail, financial services, public safety, technology and healthcare. We have sales and operations in the United States, Canada, Europe, the Middle East, Asia-Pacific, Latin America and South America.


Table of Contents

Since our founding in 1986, we have invested significantly to expand our technology platforms and develop our operational processes to meet the complex and changing communications needs of our clients. We have evolved our business mix from labor-intensive communication services to predominantly diversified and platform-based, technology-driven voice and data services.

Investing in technology and developing specialized expertise in the industries we serve are critical components to our strategy of enhancing our services and our value proposition. In 2012, we managed approximately 28 billion telephony minutes and approximately 134 million conference calls, facilitated over 260 million 9-1-1 calls, and delivered over 1.2 billion notification calls and data messages. With approximately 730,000 telephony ports to handle conference calls, 9-1-1 public safety calls, alerts and notifications and customer service at March 31, 2013, we believe our platforms provide scale and flexibility to handle greater transaction volume than our competitors, offer superior service and develop new offerings. These ports include approximately 425,000 IP ports, which we believe provide us with the only large-scale proprietary IP-based global conferencing platform deployed and in use today. Our technology-driven platforms allow us to provide a broad range of complementary platform and agent-based service offerings to our diverse client base.

Financial Operations Overview

Revenue

In our Unified Communications segment, our conferencing and collaboration services, event services and IP-based unified communication solutions are generally billed on a per participant minute or per seat basis and our alerts and notifications services are generally billed on a per message or per minute basis. Billing rates for these services vary depending on participant geographic location, type of service (such as audio, video or web conferencing) and type of message (such as voice, text, email or fax). We also charge clients for additional features, such as conference call recording, transcription services or professional services. Since we entered the conferencing services business, the average rate per minute that we charge has declined while total minutes sold has increased. This is consistent with industry trends. We expect this trend to continue for the foreseeable future.

In our Communication Services segment, our emergency communications solutions are generally billed per month based on the number of billing telephone numbers or cell towers covered under each client contract. We also bill monthly for our premise-based database solution. In addition, we bill for sales, installation and maintenance of our communication equipment technology solutions. Our platform-based and agent-based customer service solutions are generally billed on a per minute or per hour basis. We are generally paid on a contingent fee basis for our receivables management and overpayment identification and recovery services as well as for certain other agent-based services. Our telephony / interconnect services are generally billed based on usage of toll-free origination services.

Cost of Services

The principal component of cost of services for our Unified Communications segment is our variable telephone expense. Significant components of our cost of services in this segment also include labor expense, primarily related to commissions for our sales force. Because the services we provide in this segment are largely platform-based, labor expense is less significant than the labor expense we experience in our Communication Services segment.

The principal component of cost of services for our Communication Services segment is labor expense. Labor expense in costs of services primarily reflects compensation and benefits for the agents providing our agent-based services, but also includes compensation for personnel dedicated to emergency communications database management, manufacturing and development of our premise-based public safety solution as well as commissions for our sales professionals. We generally pay commissions to sales professionals on both new sales and incremental revenue generated from existing clients. Significant components of our cost of services in this segment also include variable telephone expense.


Table of Contents

Selling, General and Administrative Expenses

The principal component of our selling, general and administrative expenses ("SG&A") is salary and benefits for our sales force, client support staff, technology and development personnel, senior management and other personnel involved in business support functions. SG&A also includes certain fixed telephone costs as well as other expenses that support the ongoing operation of our business, such as facilities costs, certain service contract costs, equipment depreciation and maintenance, impairment charges and amortization of finite-lived intangible assets.

Key Drivers Affecting Our Results of Operations

Factors Related to Our Indebtedness.

On March 27, 2013, we completed an initial public offering ("IPO") of 21,275,000 shares of common stock of the Company, par value $0.001 per share, registered pursuant to a Registration Statement on Form S-1 (File No. 333-162292). Proceeds received from the offering, net of the underwriter's discount were $401.0 million. The Company paid $1.0 million in Sponsor Management fees in the first quarter of 2013 and expects to pay an additional $24.0 million to an investor group led by Thomas H. Lee Partners, L.P. and Quadrangle Group LLC pursuant to that certain Management Agreement, dated October 24, 2006, and that certain Management Letter Agreement, dated March 8, 2013. The Management Agreement terminated in accordance with its terms immediately prior to completion of the IPO.

On March 27, 2013, the Company instructed the trustee for the Company's 11% senior subordinated notes due 2016, to deliver a notice of redemption to the holders of all of the outstanding $450.0 million principal amount of senior subordinated notes. The redemption date is April 26, 2013 at a redemption price equal to 103.667% of the principal amount of the senior subordinated notes. During the three months ended March 31, 2013, the Company recorded the $16.5 million subordinated debt call premium as a non-operating expense. In addition, the Company will pay accrued and unpaid interest on the redeemed senior subordinated notes up to April 26, 2013. Following this redemption, none of the senior subordinated notes will remain outstanding.

On February 20, 2013, West, certain domestic subsidiaries of West, as subsidiary borrowers, Wells Fargo Bank, National Association ("Wells Fargo"), as administrative agent, and the various lenders party thereto modified the Company's senior secured credit facilities ("Senior Secured Credit Facilities") by entering into Amendment No. 3 to Amended and Restated Credit Agreement (the "Third Amendment"), amending the Company's Amended and Restated Credit Agreement, dated as of October 5, 2010, by and among West, Wells Fargo, as administrative agent, and the various lenders party thereto, as lenders (as previously amended by Amendment No. 1 to Amended and Restated Credit Agreement, dated as of August 15, 2012, Amendment No. 2 to Amended and Restated Credit Agreement, dated as of October 24, 2012, and the Third Amendment, the "Amended Credit Agreement").

The Amended Credit Agreement provides for a reduction in the applicable margins and interest rate floors of all term loans, extends the maturity of a portion of the term loans due July 2016 to June 2018; and adds a further step down to the applicable margins of all term loans upon satisfaction of certain conditions. As of the effective date of the Third Amendment, the Company had outstanding the following senior secured term loans:

Term loans in an aggregate principal amount of approximately $2.1 billion (the "2018 Maturity Term Loans"). The 2018 Maturity Term Loans will mature on June 30, 2018, and the interest rate margins applicable to the 2018 Maturity Term Loans are 3.25%, for LIBOR rate loans, and 2.25%, for base rate loans; and

Term loans in an aggregate principal amount of approximately $317.7 million (the "2016 Maturity Term Loans"; and, together with the 2018 Maturity Term Loans, the "Term Loans"). The 2016 Maturity Term Loans will mature on July 15, 2016, and the interest rate margins applicable to the 2016 Maturity Term Loans are 2.75%, for LIBOR rate loans, and 1.75%, for base rate loans.

The Amended Credit Agreement also provides for interest rate floors applicable to the Term Loans. The interest rate floors are 1.00%, for LIBOR rate loans, and 2.00%, for base rate loans. The Term Loans are subject to an additional step down to the applicable margins by 0.50% conditioned upon completion by the Company of an IPO and the Company attaining and maintaining a total leverage ratio less than or equal to 4.75:1.00.


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Evolution to Predominately Platform-based Solutions Business. We have evolved into a diversified and platform-based technology-driven service provider. Since 2005, our revenue from platform-based services has grown from 37% of total revenue to 73% for the three months ended March 31, 2013 and our operating income from platform-based services has grown from 53% of total operating income to 95% over the same period. As in the past, we will continue to seek and invest in higher margin businesses, irrespective of whether the associated services are delivered to our customers through an agent-based or a platform-based environment. We expect our platform-based service lines to grow at a faster pace than agent-based services and as a result will continue to increase as a percentage of our total revenue. However, many of our customers require an integrated service offering that incorporates both agent-based and platform-based services-for example, an automated voice response system with the option for the client's customer to speak to an agent. Accordingly, we expect agent-based services will continue to represent a meaningful portion of our service offerings for the foreseeable future.

Acquisition Activities. Identifying and successfully integrating acquisitions of value-added service providers has been a key component of our business strategy. We will continue to seek opportunities to expand our suite of communication services across industries, geographies and end-markets. While we expect this will occur primarily through organic growth, we have and will continue to acquire assets and businesses that strengthen our value proposition to clients and drive value to us. We have developed an internal capability to source, evaluate and integrate acquisitions that we believe has created value for shareholders. Since 2005, we have invested approximately $2.0 billion in strategic acquisitions. We believe there are acquisition candidates that will enable us to expand our capabilities and markets and intend to continue to evaluate acquisitions in a disciplined manner and pursue those that provide attractive opportunities to enhance our growth and profitability.

Key Factors Related to Cash Flows

We expect to generate $180-$220 million in free cash flow, cash flows from operations less capital expenditures, in 2013. Our expectation is to return some portion of our free cash flow to shareholders each year through a regular quarterly dividend. We expect to use the remaining free cash flow to reduce leverage and fund acquisitions to accelerate growth. Our goal is to reduce net leverage to less than 4x adjusted EBITDA in less than 24 months through free cash flow generation and EBITDA growth.

Our pro forma adjusted interest expense for the first quarter of 2013 was $46.4 million compared to actual interest expense of $72.9 million. Pro forma adjusted interest reflects the impact of lower debt balances and lower interest rates post IPO. Approximately $12.4 million of the pro forma adjustment relates to the savings expected for the full quarter from the anticipated redemption of the $450 million senior subordinated notes and the remaining amount relates to the savings for the full quarter associated with the pricing of amendment number three to our senior secured term loan facilities as if these transactions had been completed January 1, 2013. The amendment of the $2.4 billion senior secured term loan facilities was completed on February 20, 2013. This amendment will reduce our annual cash interest expense run rate by $47 million and extend the maturity of $1.1 billion of term loans to June 2018.

On March 27, 2013, we instructed the Bank of New York Mellon Trust Company, N.A., as trustee to deliver a notice of redemption to the holders of the outstanding $450.0 million principal amount of the senior subordinated notes. The redemption price was 103.667% of the principal amount of the senior subordinated notes. The redemption date for the senior subordinated notes was April 26, 2013. This redemption will reduce our annual cash interest expense run rate by $49.5 million.

The completion or our senior term loan amendment on February 20, 2013, and redemption of the senior subordinated notes on April 26, 2013, provides us with annual run rate interest savings of $96.5 million and further benefits the Company with an improved capital structure, reduced leverage and greater overall financial flexibility.

Overview of 2013 Results

The following overview highlights the areas we believe are important in understanding our results of operations for the three months ended March 31, 2013. This summary is not intended as a substitute for the detail provided elsewhere in this quarterly report, or for our consolidated financial statements and notes thereto included elsewhere in this quarterly report.

Our revenue increased $21.2 million, or 3.3% during the three months ended March 31, 2013 compared to revenue during the three months ended March 31, 2012.

Our operating income decreased $21.0 million, or 18.3%, during the three months ended March 31, 2013 compared to operating income during the three months ended March 31, 2012. This decrease in operating income is primarily the result of $28.0 million of expenses recorded in connection with our IPO.

On February 20, 2013, we amended our senior secured term loan facilities. The Amended Credit Agreement provides for a reduction in the applicable margins and interest rate floors of all term loans, extends the maturity of a portion of the term loans due July 2016 to June 2018; and adds a further step down to the applicable margins of all term loans upon satisfaction of certain conditions.

On March 8, 2013, we completed a 1-for-8 reverse stock split and amended our Amended and Restated Certificate of Incorporation by filing an amendment with the Delaware Secretary of State. We also adjusted the share amounts under our Executive Incentive Plan and Nonqualified Deferred Compensation Plan as a result of the 1-for-8 reverse stock split.

On March 27, 2013, we completed our IPO of 21,275,000 shares of common stock of the Company. Proceeds from the offering, net of the underwriting discounts and commissions were $401.0 million.

On March 27, 2013, we instructed the trustee to deliver a 30 day notice of redemption to redeem $450.0 million 11% senior subordinated notes. The redemption price is 103.667% of the principal amount of the senior subordinated notes.


Table of Contents

Results of Operations

Comparison of the Three Months Ended March 31, 2013 and 2012

Revenue: Total revenue for the three months ended March 31, 2013 increased approximately $21.2 million, or 3.3%, to $660.2 million from $639.1 million for the three months ended March 31, 2012. This increase during the three months ended March 31, 2013 included acquisition revenue of $22.4 million from the acquisition of HyperCube LLC ("HyperCube"), compared to $1.6 million for the three months ended March 31, 2012. The HyperCube acquisition closed on March 23, 2012 and its results have been included in the Communication Services segment since that date.

For the three months ended March 31, 2013 and 2012, our largest 100 clients represented 54% and 55% of total revenue, respectively.

Revenue by business segment:

                                                  For the three months ended March 31,
                                                      % of Total                       % of Total
                                        2013           Revenue           2012           Revenue          Change        % Change
Revenue in thousands:
Unified Communications                $ 367,568              55.7 %    $ 359,647              56.3 %    $  7,921             2.2 %
Communication Services                  296,451              44.9 %      281,737              44.1 %      14,714             5.2 %
Intersegment eliminations                (3,795 )            -0.6 %       (2,322 )            -0.4 %      (1,473 )          63.4 %

Total                                 $ 660,224             100.0 %    $ 639,062             100.0 %    $ 21,162             3.3 %

For the three months ended March 31, 2013, Unified Communications revenue increased $7.9 million, or 2.2%, to $367.6 million from $359.6 million for the three months ended March 31, 2012. The increase in revenue for the three months ended March 31, 2013 was entirely organic. The increase was attributable primarily to the addition of new customers as well as an increase in usage of our web and audio-based conferencing services by our existing customers. Revenue attributable to increased usage and new customer usage was partially offset by a decline in the rates charged to existing customers for those services. The volume of minutes used for our reservationless conferencing services, which accounts for the majority of our conferencing revenue, grew approximately 5.6%, for the three months ended March 31, 2013 over the three months ended March 31, 2012. When adjusted for the same number of business days in the first three months of 2013 compared to the first three months of 2012, reservationless volume of minutes grew 10%. For the three months ended March 31, 2013, the average rate per minute for reservationless services declined by approximately 6.1%. Since we entered the conferencing services business, the average rate per minute that we charge has declined while total minutes sold has increased. This is consistent with industry trends which we expect to continue for the foreseeable future. Our Unified Communications international revenue grew to $117.1 million, an increase of 2.5% over the three months ended March 31, 2012.

For the three months ended March 31, 2013, Communication Services revenue increased $14.7 million, or 5.2%, to $296.5 million from $281.7 million for the three months ended March 31, 2012. The increase for the three months ended March 31, 2013 included acquisition revenue of $22.4 million from the HyperCube acquisition, compared to $1.6 million for the three months ended March 31, 2012. Revenue from agent-based services for the three months ended March 31, 2013, decreased $11.4 million compared with the three months ended March 31, 2012 including a $5.2 million decline in direct response revenue. Revenue from platform-based services within Communication Services increased $26.1 million compared with the three months ended March 31, 2012.

Cost of services: Cost of services consists of direct labor, telephone expense, commissions and other costs directly related to providing services to our clients. Cost of services increased approximately $17.4 million, or 6.0%, in the three months ended March 31, 2013, to $309.1 million, from $291.7 million for the three months ended March 31, 2012. As a percentage of revenue, cost of services increased to 46.8% in the three months ended March 31, 2013 compared to 45.6% for the three months ended March 31, 2012.


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Cost of services by business segment:

                                                  For the three months ended March 31,
                                       2013          % of Revenue         2012          % of Revenue        Change       % Change
Cost of services in thousands:
Unified Communications              $  157,106                42.7 %    $ 148,740                41.4 %    $  8,366            5.6 %
Communication Services                 155,391                52.4 %      144,742                51.4 %      10,649            7.4 %
Intersegment eliminations               (3,430 )                NM         (1,780 )                NM        (1,650 )           NM

Total                               $  309,067                46.8 %    $ 291,702                45.6 %    $ 17,365            6.0 %

NM- Not meaningful

Unified Communications cost of services for the three months ended March 31, 2013 increased $8.4 million, or 5.6%, to $157.1 million from $148.7 million for the three months ended March 31, 2012. The increase is primarily driven by increased service volume. As a percentage of this segment's revenue, Unified Communications cost of services increased to 42.7% for the three months ended March 31, 2013 from 41.4% for the three months ended March 31, 2012. The increase in cost of services as a percentage of revenue is due primarily to changes in the product mix, geographic mix and declines in the average rate per minute for reservationless services.

Communication Services cost of services increased $10.6 million, or 7.4%, for the three months ended March 31, 2013 to $155.4 million from $144.7 million for the three months ended March 31, 2012. The increase in cost of services for the three months ended March 31, 2013 was primarily the result of $12.6 million of incremental cost of services from the HyperCube acquisition. As a percentage of this segment's revenue, Communication Services cost of services increased to 52.4% for the three months ended March 31, 2013 from 51.4%, for the three months ended March 31, 2012. This increase in cost of services as a percentage of this segment's revenue is due to the impact of the HyperCube acquisition.

Selling, general and administrative ("SG&A") expenses: SG&A expenses increased by approximately $24.7 million, or 10.6%, to $257.9 million for the three months ended March 31, 2013 from $233.1 million for the three months ended March 31, 2012. SG&A expenses in the first quarter of 2013 included $25.0 million for Sponsor management fees and related termination of the management agreement in connection with the IPO and $3.0 million of IPO related bonuses. As a percentage of revenue, SG&A expenses increased to 39.1% for the three months ended March 31, 2013 from 36.5% for the three months ended March 31, 2012. The Sponsor management fee, related termination of the management agreement and IPO related bonuses had a 4.3% impact on SG&A expenses as a percentage of revenue. During the three months ended March 31, 2012, SG&A expenses included $5.3 million for an asset impairment and site closure expenses.

Selling, general and administrative expenses by business segment:

                                                  For the three months ended March 31,
                                       2013          % of Revenue         2012          % of Revenue        Change       % Change
Selling, general and
administrative expenses in
thousands:
Unified Communications              $  132,598                36.1 %    $ 113,770                31.6 %    $ 18,828           16.5 %
Communication Services                 125,635                42.4 %      119,889                42.6 %       5,746            4.8 %
Intersegment eliminations                 (366 )                NM           (541 )                NM           175             NM

Total                               $  257,867                39.1 %    $ 233,118                36.5 %    $ 24,749           10.6 %

NM- Not meaningful

Unified Communications SG&A expenses for the three months ended March 31, 2013 increased $18.8 million, or 16.5%, to $132.6 million from $113.8 million for the three months ended March 31, 2012. As a percentage of this segment's revenue, Unified Communications SG&A expenses was 36.1% for the three months ended March 31, 2013 compared to 31.6% for the three months ended March 31, 2012. The Sponsor management fee, related termination of the management agreement and IPO related bonuses allocated to Unified Communications was $17.7 million. The Sponsor management fee, related termination of the management agreement and IPO related bonuses had a 4.8% impact on SG&A expenses as a percentage of revenue for Unified Communications.


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Communication Services SG&A expenses increased $5.7 million, or 4.8%, to $125.6 million for the three months ended March 31, 2013 from $119.9 million for the three months ended March 31, 2012. Incremental SG&A expenses from an acquired entity were $6.6 million. As a percentage of this segment's revenue, Communication Services SG&A expenses decreased to 42.4% for the three months ended March 31, 2013 from 42.6% for the three months ended March 31, 2012. The Sponsor management fee, related termination of the management agreement and IPO related bonuses allocated to Communication Services was $10.3 million. The Sponsor management fee, related termination of the management agreement and IPO related bonuses had a 3.5% impact on SG&A expenses as a percentage of revenue for Communication Services. During the three months ended March 31, 2012 SG&A expenses in Communication Services included $4.8 million for an asset impairment and site closure expenses.

Operating income: Operating income decreased $21.0 million, or 18.3%, to $93.3 million for the three months ended March 31, 2013 from $114.2 million for the three months ended March 31, 2012. As a percentage of revenue, operating income decreased to 14.1% for the three months ended March 31, 2013 from 17.9% for the three months ended March 31, 2012. This decrease in operating income included the Sponsor management fee, related termination of the management agreement and . . .

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