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Knology, Inc. (NASDAQ:KNOL)

Q3 2008 Earnings Call

November 5, 2008 at 10:00 am ET

Executives

Rodger L. Johnson - Chairman and Chief Executive Officer

M. Todd Holt - President

Bruce D. Herman - Chief Financial Officer

Analysts

David Joyce - Miller Tabak Co.

Frank Louthan - Raymond James

Jonathan Atkin - RBC Capital Markets

Travis McCourt - Morgan Keegan

Hamed Khorsand - BWS Financial

Barry Kaplan - Maple Tree Capital

Operator

Good morning and welcome to the Knology, Inc third quarter 2008 conference call. Today’s call is being recorded. At this time, all lines have been placed on mute to prevent any background noise and after the speaker’s remarks there will be a question-and-answer session. I would now like turn the call over to Mr. Bruce Herman, Knology’s Chief Financial Officer.

Bruce D. Herman

Thank you, Anthony. Good morning everyone and welcome to the Knology, Inc conference call. Joining me this morning are Rodger Johnson, our Chairman of the Board and Chief Executive Officer and Todd Holt, Knology’s President. Rodger will provide a state of the business review as well as cover some of the highlights of the third quarter. I will follow Rodger with a more detailed review of the quarterly financial and operating performance of the business.

But before Rodger gets started, let me offer a cautionary note regarding forward-looking statements. Some of the information we provide and discuss in this call is forward-looking information and is given in reliance on the Safe Harbor Provision by the Private Security Litigation Reform Act. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from these forward-looking statements due to certain factors including the risks and uncertainties discussed in Knology’s annual report on form 10-K for the fiscal year ended December 31, 2007 as well as other reports subsequently filed with the Securities and Exchange Commission. With that, Rodger will provide an overview of our business.

Rodger L. Johnson

Thanks Bruce and thanks to everyone for joining us this morning. I am happy to report that in spite of the economically challenged environment that our country has recently faced, Knology had a very good third quarter. We saw return to connection growth and delivered a net gain of almost 5000 RGUs versus the previous quarter. Our total connections are now in excess of 670,000 that is up by 30,000 from the third quarter of 2007. We also were able to grow our basic subscriber count by almost 1,500 during the period and the majority of those basic subscribers are also digital subscribers. It is worth noting that Knology grew its subscriber base when many other MSOs were actually losing basic subscribers.

In the third quarter of 2008, we delivered our highest ever revenue, $103.2 million and our highest ever EBITDA at $34.6 million. We have now increased revenues and EBITDA every quarter for 16 consecutive quarters and we have often remarked that our goal is to deliver consistent and reliable performance and this track record is evidence thereof. EBITDA margins expanded at 33.5% during the third quarter and are climbing ever closer to our mid-thirties percent target.

Additionally, during the quarter, we saw ARPU growth of $51.51, up from $48.87 a year ago. There is no doubt that we, like others are seeing some slowing in the economy but the vast majority of our markets have been very resilient thus far. We have seen a little softness in our two Florida markets and in our West Point, Georgia market. However, we are optimistic about the West Point market as we move into 2009 and the anticipated opening late in the year of the Kia automotive manufacturing facility and its various suppliers. The Florida markets, Panama City and Pinellas, will likely take a little longer to recover because of the overarching impact of real estate on their economies.

A positive note as we attempt to asses in the economic implications of the churn held constant for the quarter at the same level we experienced in the third quarter of 2007 and we have not seen an increase in our level of bad debt. We believe that consumers, particularly in our secondary and tertiary markets, view cable and high-speed internet as high-value, lower-cost sources for entertainment and information.

With the return of RGU growth in the quarter, we saw our overall RGU penetration grow to 73.1% and our digital penetration held constant at 48-plus percent of our video subscribers. Another piece of good news during the third quarter was the further realization of some of the synergies we anticipated with our PrairieWave and Graceba acquisitions. These are coming from operations where both PrairieWave markets and the Graceba markets are all making good progress. Synergies are also coming from overhead reduction and regulatory re-balancing and we are continuing to derive benefits as we have noted on previous earnings calls from the redundant call centers that we established following the PrairieWave acquisition.

Our business and commercial sales efforts showed a net gain of more than 1,700 RGUs during the quarter and business connections are up almost 19% from a year ago. We are beginning to see traction that we anticipated from the iPlex product that we announced during the second quarter. Customers seem to like the flexibility that SIP trunking provides relative to scale in their network needs as well as the cost advantages it affords. And obviously, we are seeing this both on the voice and, particularly, the data sides. Additionally, we have had some success during the quarter which Wireless Backhaul sales albeit very early in our efforts there. Finally, we have seen more sales with our lease-cost routing and IP-provisioning and rating products. So, the business side of the business, the commercial side, is still growing strong.

While we are talking some technology items, I should also mention that we increased our high-definition channels in all markets during the third quarter. In some cases, we added as many as ten channels to our market line-up. Our plans for 2009 call for adding at least another twenty HD channels in each of our markets. Similarly, we are continuing the expansion of our VOD capabilities and around the end of this year. We will be delivering VOD in all but two of our markets. We also anticipate that we will bid Docsis 3.0-enabled for about 20% of our customers by year-end. We plan to enable another 50% in 2009 and finish out the balance in 2010. And for those of you who are not familiar with Docsis 3.0, its deployment will allow us to substantially increase speeds for our high-speed internet customers. We will actually implement Docsis 3.0 on a market-by-market basis as the competitive situation dictates.

One other thing that we are very excited about was, during the third quarter, we completed a trial of a fill-in strategic investment, and by that I mean we built out a neighborhood in one of our existing markets where we already had an operating structure in place, meaning we already had the head end and the general manager and all the supporting staff. The incumbent MSO and satellite providers were already present in this neighborhood. We invested about $250,000 in building up facilities and plant to serve about 450 homes in this neighborhood. Within 90 days, following the completion of this build out, we had already achieved 81.5% RGU penetration, and this exceeded our target and reflected the fact that we took significant share away from the existing providers. Our bundle rate in this market is 2.8 RGUs per home and our projected IRR from this trial was approximately 55%. Obviously, we are assessing other similar opportunities throughout our footprint.

Before I pass the ball to Bruce and Todd, I will offer one last observation on the quarter. As I mentioned on our second quarter call, I made a decision not to push a new promotion in the market earlier this year until I saw the retention results from our late 2007 promotion. We have experienced excellent customer attention from both our triple play and double play enhanced bundles, and by that I mean we are not experiencing much more loss that our normal churn rate even after we increased prices to the rack rates. As a result, we began aggressively rolling out our 2008 promos during the third quarter and saw a corresponding increase in sales.

Twenty-twenty hindsight being what it was if we had known our retention rate was going to be as strong as it had been, we would have moved sooner than we did on our 2008 promotions. We actually paid the price for our decisions in the second quarter but I believe we got back on track in the third quarter. While the economic overhang will slow us somewhat, we anticipate that we will continue to grow both the residential and business subscriber bases going forward. As a matter of fact, we actually ended the third quarter with a strong installation backlog headed into the fourth quarter and we have seen churn decline consistent with our normal seasonal patterns.

I will turn it over now to Bruce and Todd. What Bruce will do is review the details of our performance, and then, Todd is going to address a couple of specific investor questions that we have received. So, Bruce?

Bruce D. Herman

Thank you, Rodger. Let me begin by reviewing the connections, RPU and churn numbers. We ended the third quarter with nearly 671,000 total connections, a 4.9% year-over-year increase, reflecting solid growth in both residential and business connections. Residential connections increased by 3% from a year ago, reflecting the suspended and then renewed marketing and promotional efforts that Rodger just discussed. Business connections continued to show encouraging momentum, increasing by a strong 19% from a year ago. Commercial connections now account for about 16% of total connections and approximately 20% of total revenue. Connections grew 4873 units from second quarter levels. This came primarily from a 3732 unit increase in our high-speed internet connections, along with the 1379 unit increase in video connections. Voice connections showed a slight decline of just 238 units. We are encouraged by these results and we continue to see positive momentum on both the residential and commercial markets going into the fourth quarter.

Along with growth in connections, we continue to see ongoing increases in average revenue per connection or RPU. Our overall RPU increased to $51.51 in the third quarter, up from $48.87 a year ago and $50.91 in the previous quarter. RPU also increased for all three services in the third quarter, reaching $62.33 for video, $47.85 for phone and $40.57 for the high-speed internet service. Our average revenue per customer increased to $122.62, up from $115.89 a year ago. These RPU figures reflect prices increases earlier in the year, continued growth in our commercial business and continued consumer demand for the high-end video services. Our deployment of the high-end HD-DVR box increased 66% over last year, and as of quarter end 27% of our video subscribers subscribed to an advanced service, up from 21% last year. About 57% of digital customers subscribed to an advanced service compared to 45% last year.

We are also encouraged that average monthly connection churn has remained in check in this tough economic environment. Churn was 2.8 in the third quarter, the same as a year ago and basically the same as the prior quarter. Notably, we have not seen a deterioration in churn caused by non-paying customers, a trend we monitor closely especially in the current economy.

Moving on to the financial performance, our revenue was $103.2 million for the third quarter, representing an 11.8% increase compared to the third quarter of last year and a sequential increase from $102.1 million in the second quarter of 2008. EBITDA for the third quarter was $34.6 million, a 20.6% increase compared to the same period last year. Our EBITDA margin increased to 33.5% this quarter, up from 31.1% EBITDA margin posted in the same period one year ago and 32.8% last quarter. Our gross margin percentage was 71%, in line with both a year ago and last quarter. Our GAAP operating income was $9.2 million in the third quarter, more than double a year ago and an increase of $1.6 million over the last quarter. Moving down to the net income line, we experienced a net loss of $2.8 million, or $0.08 per share in the third quarter, an improvement from the net loss of $4 million or $0.11 per share last quarter. We achieved $1.8 million net income a year ago but that was favorably impacted by an $8.3 million sale of the non-core phone directory business that we initially purchased as part of the Prairie Wave acquisition.

On the balance sheet, we ended the third quarter with $46.7 million in cash, up $9.1 million from the $37.6 million cash balance at the end of the second quarter. In addition to the cash we have on hand, we also maintain a $25 million revolver, none of which is currently drawn, and it continues to serve as liquidity cushion for the business. From a leverage perspective, we are about 4.4 times LQA EBITDA using gross debt, the same calculation on a net debt basis yield to leverage ratio of 4.1 times. Our interest coverage is 3.2 times, so we feel very good about where we are from a balance sheet, liquidity and leverage perspective. Our CapEx for the quarter came in at $10.2 million as we continue to monitor our spending closely. A net cash interest was $11 million, resulting in levered free cash flow for the quarter at a strong $13.4 million. For the first nine months of the year, we have generated $30.8 million of levered free cash flow. Now remember, we are required to use 50% of our excess free cash flow as defined by our credit facility to pay down principal in addition to the 1% annual amortization. The remaining cash flow will allow us to maintain a strong cash balance during these economic times and provide us with solid liquidity. Todd will comment on that a bit later. So, in summary, the third quarter was a good rebound from a soft second quarter when we were impacted by the marketing decisions earlier in the year as Rodger indicated. Early fourth quarter activity is very promising and we are looking forward to the remainder of 2008 and into 2009. Now, Todd has a fewer more comments before we open the call for Q and A.

M. Todd Holt

Thank you, Bruce. Based on the calls we have been receiving recently, I wanted to briefly comment on a couple of things that seem to be on the minds of the investors and potential investors these days. First, regarding our bank debt. In addition to the 1% yearly amortizations, which equaled about $6 million annually, we are required to pay down principal each year with 50% of our excess free cash flow as defined by our credit agreement. This payment will amount to somewhere in the $15 million range for calendar year 2008. And the payment is due within 90 days after year-end. We intend to make this payment as early as possible, in January 2009, to maximize the interest savings. Outside of the annual 1% and the excess free cash flow suite, the remaining balance of our bank debt matures out in June 2012, more than three and a half years away. At around four times levered on a net-debt basis and improving in each quarter as our cash balance and EBITDA increases along with the principal reduction, we feel very comfortable with our debt balance and capital structure. We also feel like it is prudent to maintain a bullet-proofed balance sheet in this uncertain economic environment. And we believe that our current cash balance, our healthy free cash flow position, the $25 million un-drawn revolver and our ability to chip away at the debt, provides a solid balance sheet.

We also get questions about our appetite for mergers and acquisitions. We have been successful over the past 18 months making very accretive acquisitions and integrating this business into Knology. One reason these acquisitions have worked so well for us is the disciplined approach we take in identifying the target, negotiating the terms, and integrating the businesses. We do believe that M&A will play a role in the future growth of Knology. However, we will not waver on our disciplined approach to acquisitions. And quite frankly, with the credit markets where they are today, as well as the valuation multiples where they are, it is a very difficult, if not an impossible environment, to consider M&A. So given the current market conditions, M&A is unlikely on a near-term basis, unless it was a very small transaction that met our disciplined standards and did not require us tapping the capital markets.

And lastly, let me comment on our outlook. Last quarter, we indicated that we expected the full year of 2008 results to be at the low end of our initial guidance. With a good third quarter behind us and a nice start to the fourth quarter, our view remains mostly the same. With revenue and free cash flow likely to come in at the low end of the range, CapEx will be below the $50 million mark, and EBITDA, as we have previously communicated, will be a little more challenging, looking like it will be probably be slightly below. So what this means is that, currently in our opinion, the street consensus reflects pretty reasonable numbers for our business. Although a little bit slower than initially planned out of the gates this year, this represents solid growth in the key financial metrics of the business with very robust free cash flow. All in all, pretty good results.

Anthony, this concludes our prepared remarks this morning and we would now like to open the line for questions.

Question-and-Answer Session

Operator

Your first question comes from David Joyce - Miller Tabak Co.

David Joyce – Miller Tabak Co.

Just have a little bit more color on what this retention rates were, in case I missed it. On earlier promotions, also, I was wondering if you are able to discuss what the current promotion returns are? And then finally, I wanted to see if there are any particular markets like, you did mention Pinellas and Panama, are these particularly challenging subscriber numbers and when do you think this might be turning around?

Rodger L. Johnson

Okay. Retention rates, promo pricing and any other markets. Okay. From a retention rate standpoint, David, I did not say this but we are right at about 70% retention since the inception early in 2007 of our enhanced triple play bundle package. If you were just to run out our normal churn rate over that period of time, we would be at 74.5% retention. So, there is less than 5% difference between our retention rates on triple plays as oppose to normal churn, even after we increased our prices to the rack rates. Similarly, if you look at the double play bundles, we are just under 55% retention. If you run out the normal churn rates for the time that those programs have been in existence, we would have seen 57.5% normal retention. Therefore, we are less than 3% off, even after returning to our normal rack rates. What that fundamentally says is the value of the promos is very, very solid for us on a go-forward basis. From a promo pricing standpoint, obviously we have got lots of different offers out in the market place depending on what the customer subscribes to. There have been $99 offers and $79 offers and $69 offers. And what we have always tried to do is structure those offers and compose the package reflecting what our cost of service would be so that we can maintain a high gross margin on those products, David, consistent with what we have tried to enjoy across the board in the business. So, there is no way I can give you one single answer but clearly, we are still pushing the double plays and the triple plays out in the marketplace in some composition. And how the markets are performing in economic environment, I candidly feel good once we got the gear back cranked up from a marketing standpoint. I do believe that we are seeing some softness in the valley which we have seen in the West Point, Georgia, area which we have seen for quite some time because of the shutting down of the textile mills, and the unemployment situation that exists here. But as I have repeatedly said, we are starting to see movement and a lot of activity surrounding the Kia plant opening or what have you. So, as I said I think that comes back in 2009. I do not know how to predict how long the economic cycle is going to be a factor in Florida. Real estate is the dominant issue there. We do see businesses closing and people being laid off and what have you. So, there is no way I can predict how far out in the future it is. But we are still seeing, at least, holding flat line on EBITDA performance and things of that nature. We are not seeing a big backslide or anything. It is just not growing. And the others markets, I think, are going to be fine. So, hopefully, that answers all three of your questions.

David Joyce – Miller Tabak Co.

Yes, I just have another question on the promotion pricing. In some larger markets, there is higher subscriber acquisition cost from offering free HD TVs and what have you to free new programming and premium channels, that sort of thing. Are you facing any exposure to that, any pressure from those kinds of offers?

Rodger L. Johnson

We really have not seen the free HDs and all that stuff. Clearly, people package premiums in at different times. We actually did that last year, if you will recall, and we were not satisfied with the results in terms of the implications that it had on margin. But we are not seeing anything out of the norm. It is a competitive marketplace. We see all kinds of promos and what have you but not the big giveaways. There was a time when we saw things like gas cards and things of that nature. But I do not see anything. Some of those national programs but…

M. Todd Holt

I have read the same thing, David, and see that occasionally but it looks like that a lot of that type of heavy promotional activity is geared towards [voice] markets, just a more competitive market. And as you know, we have very, very little [voice] exposure in our footprint and, I think, that is one reason that we do not see that type of promotional activity.

Operator

Your next question comes from Frank Louthan - Raymond James.

Frank Louthan – Raymond James

Great, thank you. Can you just remind us what, you said, the guidance may be a little bit below with the previous guidance was, can you remind us what that range was? Can you comment on how it should be thinking about ARPU trends going forward with the promotional activity, probably, if the economy, I would assume that, in some level of a heavier promotions that we have seen in the past, is probably the norm for the next few quarters. Can give us an idea on how we should be thinking about the ARPU and how that could impact that? Thanks.

M. Todd Holt

Thank you, Frank. On the guidance question, what we said was that we felt like where the consensus was, out in the environment now, with some pretty fair numbers and if you look at those, you are looking at about $410 million revenue and about $137 million EBITDA, somewhere between $43 million or $45 million of free cash flow. Our comment is that, currently, we felt like those are pretty reasonable numbers for our business right now, thinking about expectations for the full year. And in the second question, the ARPU trends, that the promos have some impact there, but quite frankly the trend as far as price increases driving all through up particularly in the first quarter and then the continued success we have selling to the business costumers that have the higher ARPUs, those two things certainly more than offset the promotional activity ARPUs, because remember, the promotional activity is just directed towards new connects. So, the base of the customers still get the price increases, and then with the business sales. So, with that, we actually would expect the ARPU trends maybe slightly lower less but we will certainly see first quarter lift and then continued lift through the year, based on that activity.

Operator

Your next question comes from Jonathan Atkin - RBC capital market.

Jonathan Atkin – RBC Capital Markets

Yes, I wonder if you can talk about just the about the macro environment as the recession continue into 2009? And as you look at things, is it fair to say that the impact will be felt in the commercial business more than a residential side? And then if you could maybe give us a little bit of review of how you look at the RGU trends, voice versus data versus video? Is it going to be directionally similar over the next several quarters?

Rodger L. Johnson

Let me take a crack at it and then Bruce and Todd, if they got anything to add. I think from a macro trend and I said this on the last call, we will all be having our heads in the sand if we did not recognize that there is some economic implication out there. You are saying on small businesses that they are closing their doors and what have you, and what we have to do there is redouble our efforts, I think, like SIP Trunking products that we put out, have been very well received and there are some price advantages to go with SIP, for those small businesses that buy that product. So, I think, there will be, in some softness out there, but I do not think it is going to be radical in our marketplaces. But please recognize that we acknowledge the economy is going to be a factor that has to be dealt with. I think what we will do is we will continue to grow both our business customer base and we will continue to grow our consumer customer base. We just might not grow them at the rates we have experienced in years gone by, as the way I look at the macro environment. From our RGU trend, I think we can consistently count on data to continue to be our fastest growing product. I think video is going to continue to grow because, like I said a while ago, I think the consumer out there views that as a low cost alternative for information and entertainment right now. So, again, maybe a little bit slower than in years gone by but still a growth environment. The one that, I think, is going to be the most challenging and I think Bruce mentioned we were down about 238 telephone subscribers. You read a lot of stuff out there about people going to a wireless replacement and giving up their landlines. Quite frankly, we are pleased because at 238 that means we had just about the same number of telephone lines as we removed. And when I listen to some of the others, in particular the Telco companies, they are losing a whole lot more of their landlines. So, we have been able to enjoy a little bit of a push as far as Telco activity. I think, Jonathan that is in large part because of the magnitude of bundling that we do. We are able to incorporate all those RGUs in to a single package. So, net macro environment is real from an economic stand point. We have to take that in consideration. I anticipate a little bit slower growth rate going forward. RGU trends still feel good about data; still feel good about the video, voice we have got to watch carefully.

Jonathan Atkin – RBC Capital Markets

And then, finally, on the residential side of the business that you could talk about, kind of, the competitors have done. When you gain a customer, is it more often that Telco or the incumbent cable operator that you are displacing?

Rodger L. Johnson

Actually, I would say that it is mostly the incumbent cable operator or its new movement into the communities, and the reason I say that is AT&T is not yet delivering a strong triple play alternative in our marketplaces. We do pick up just telephone RGUs off of the Telco’s and that is predominantly true on the business side, that is where a lot that where it is coming from because we have a products that fit that small and medium business market a little bit better than those guys do. But on the residential side, I think it is more new people moving in and also taking away from the incumbents.

Jonathan Atkin – RBC Capital Markets

On the commercial side for your net ads, what is the average number of lines per customer? If you have mentioned that before, I am sorry if I missed that.

Rodger L. Johnson

It is hard to say because we have very small, single line customers, but we also have customers that had significant number of RGUs. I think I looked at some data the other day, 33% roughly of our accounts are more than in five lines but we have got some that add up to 400 to 500 lines as we look at it. I think one of the comments too, when you look in RGUs and you try to track that against business, you have got to be careful going down that path. I know we just signed a deal in one of our markets with a major bank in that marketplace where it was about a $25,000 non-recurring charge on the front-end and $6500 a month and we got one RGU out of that deal, and I cannot remember it either, a three or a five-year contract, but it is going to be, the deal is worth $500,000 to us and we get to count one RGU. So, you kind of be a little bit careful with that, Jonathan.

Jonathan Atkin – RBC Capital Markets

Alright, thank you very much.

Operator

We will take our next question from Travis McCourt with Morgan Keegan.

Travis McCourt – Morgan Keegan

Hey guys, a few questions, you talked a little bit about the trends you expect near-term, I was wondering if you can talk a little bit about what you expect from CapEx, are you seeing any slowdown in HD-DVR upgrades. If you are, does that impact CapEx going forward? I did not hear you say the percentage of double play and triple play customers as a percentage of the base today? But if you have that, that would be great. And then also, any commentary strategically about wireless which after about 2 year hiatus, seems to be on the top of mind of a lot of cable companies right now.

Rodger L. Johnson

Travis, real quickly, on the bundle stats, the triple play has actually moved up a little bit and now is at 50 % of the customer base, take the full triple plays and then the double plays saw another 31%, so we are seeing that trend up positively. So, 81% of the customer base has taken some form of a bundle and obviously that helps us to manage the churn, and adjust that the high ARPU and the good EBITDA economics. So that continues to work in our favor. On the CapEx, you did ask about the trends there. For two years running now, we been on the similar level, high success-based CapEx. Generally, that profile will be maintained on go-forward basis. The way I think about it is the business is in a position to continue to generate very robust free cash flow and part of that equation is us spending our capital very efficiently and having good discipline there. So, that will certainly continue on a go-forward basis.

And then Travis, your question about wireless is very timely, I think. As I mentioned in my comments, we are playing in the world of wireless growth right now, through not only some direct contracts. We have got a number of proposals out right now for wireless back call, and we also have some partnering opportunities for wireless back call. So, we are going to be some kind of a left-handed beneficiary of the growth in that environment. I think, the more germane part of your question is, are going to get in to the wireless business ourselves? There is nothing that we see imminently out there that will cause to make that decision. But as we have said before, it is one that we constantly look at and we constantly evaluate, is that going to be meaningful. I think, as I have said before, I do not think it is a money maker for us but it may be necessary in some point in time from a defensive standpoint.

Travis McCourt – Morgan Keegan

Got you and then couple of follow-ups, is AT&T offering video in any of your markets at this point and any of BellSouth markets in or any expectations for that in 2009? And then the trial you referred to, in the prepared remarks, Rodger, I missed what exactly that was? Was that a fiber to the home trial?

Rodger L. Johnson

Ok. First of all, AT&T, the only video offering that they have had in our market thus far is through the satellite partnerships that they have had in times gone by, and it really has not been meaningful in terms of any kind of penetration in the marketplace. We have not seen any declarations of new verse coming into our markets or anything like that, at least on the time frame that we are looking at. And then the trial, quite frankly, we are really, really excited because the background there is when we originally built out our networks in some of this markets, and I am going back probably to the 2003 to 2004 time frame when capital is really, really tight, we did not completely finish the build out in the number of our marketplaces. So, there are neighborhoods that are kind of fill-in neighborhoods that are in the middle of footprint that we never ever put in the facilities and plan to deliver to that universe. But we have already got all the infrastructure and surrounding that. Our ring might lead to the front of our neighborhood but we just never ever carried the hybrid fiber coax actually into the neighborhood, and that is what we did, and that was on trial, we actually went in, carried that hybrid fiber coax to the homes in the neighborhood because what we wanted to see is, can we go in almost like we used to do, take share away from the incumbent, and when we found out, as I said, we had 81.5% penetration within 90 days after completion of the build. There are lots of opportunities like that and at 55% IRR, that is the kind of stuff that we got to think about on our own growth basis growing forward.

Operator

Your next question comes from Hamed Khorsand - BWS Financial.

Hamed Khorsand - BWS Financial

Good morning. My question was related to see how first nine months of this year has gone by and given you Q4 guidance is there any attention going to be put on paying down at aggressive manner or you just going to retain the cash.

M. Todd Holt

Hamed, you know as we said, probably before, we are not near-term going to be in a position to aggressively pay down the debt. Now remember, this is a four time our reasonable leverage in our opinion and the cost of debt is correct. Now, we certainly look forward in making our principal payments, the 1% amortization, and we can chip away at the leverage with the excess free cash flow. But given the current economic conditions where they are right now, I will just reiterate what we said earlier, we just think that it is prudent to maintain very good liquidity. So, the cash balance for this and revolver where it is, that gives us that type of liquidity, and quite frankly provides us that bullet-proof balance sheet that we talked about. So, no, based on the leverage and the cost of debt, we are not going drive to that cash balance way down by aggressively applying that cash towards debt repayment.

Rodger L. Johnson

I think the fact that we are going to be paying off the amortization and 50% of the defined free cash flow; those are pretty substantial payments that we are making, just as the matter of course. So, we are going to be reducing that debt just through the normal process that is in place.

Hamed Khorsand - BWS Financial

Do you have like an internal timeline set, so that we can see debt go down from $600 million level back to the $550 million level where it was last year.

M. Todd Holt

No, we do not have that specific calculation of when we would pay down the debt and to what magnitude we will pay down the debt. It is safe to say that if these market conditions continued for many quarters, and the cash continued to pile up on the balance sheet without a better view, then, obviously that puts up in a position to use more of that cash to pay down on debt. But that has yet to be seen what happens with these market conditions. But sure, if the capital markets stayed like they were, and the cash just really builds up, that allows us to consider paying down more debt.

Hamed Khorsand - BWS Financial

Ok, given that what you looking at in Q4, are we at the point in the business where we can see net income profitability or are we still not at 3 months out from that.

M. Todd Holt

I would think that while we are on the cost, on a monthly basis right now, we were on the cuff of net income, but I think it is probably safe to think that early part of next year, we generate positive EPS, and that is just another milestone for this business. I mean, we are generating that healthy EBITDA at this point. We have certainly crank the nut on the free cash flow, levered free cash flow, the GAAP operating income or we are seeing a nice lift on this in all of those metrics, and the key financial metric that will hit milestone on that positive EPS, so it is right around the corner. We are not getting ahead around ourselves and “guess-timate” exactly what month or quarter that is but it is safe to say, that early part of next year, we will be looking at the positive EPS on a run rate basis.

Rodger L. Johnson

Hamed, we are actually in the throes of our budget preparation process right now, and I think as we culminate that process, we will have a whole lot more visibility as far as the timing of something like that.

M. Todd Holt

Anthony, we can do one more question.

Operator

Your last question comes from Barry Kaplan - Maple Tree Capital.

Barry Kaplan- Maple Tree Capital

I just wanted to followup, Rodger, on your comments about the voice business, where you had a small decline sequentially in the telecom subscribers, and you seem in your comments almost a little bit conceding that you are not going to grow, that voice business going forward because of wireless. But I would have thought, with the bundle on the residential side and you are adding a lot of subscribers on the digital and some subscribers on the voice that the bundle would drag that up, plus having presumably, the commercial business is pretty much almost all bundled with voice and data, and you know on time when I gave a report this morning, and they added voice customers. So I guess my question, do you have this small ILEC business and the losses, is that where the primary difficulty is? And are you adding voice subscribers in the cable business? I just want to get a better of sense of why you are not more optimistic on your ability to add voice subscribers.

Rodger L. Johnson

You know, I am not un-optimistic as much as I am uncertain right now. And that uncertainty revolves around where this economy is going to go. I think, I would say yes we are going to continue to add more bundles and voice is going to be a component of those bundles. Yes, our business of voice and data sales is going to continue to grow. But what I do not know what we do not know right now is how much pressure the consumer is going to face. What we see things like, Barry, is a new MDU whereas we would have gone in and we say we have an exclusive MDU, and we would have gotten close to 100% of the video and 100% of the high-speed internet, and maybe 80% of the voice in times gone by, that would not have been a bad pattern for us to have. That video may still be close to a hundred, that data may still be close to a hundred, but the voice may be 40% or 50%. So, there is still growth in voice from a consumer standpoint. It is just how many people will decide that they want to concede and save money and just go with their wireless. I read in an article the other day that, I think they said 20% of the country now is wireless-only customers. They do not have landlines in their home anymore. So, if anything is kind of a hedge on my part is because of uncertainty out there about what is going to happen.

Barry Kaplan- Maple Tree Capital

Is the issue part, at least, proportionally in your RLEC business, where I would presume you have a presumably a pure loss, in other words, you would not be offsetting that?

Rodger L. Johnson

Well, our RLEC businesses are all triple play bundle businesses. So, they look like our broadband markets.

Barry Kaplan- Maple Tree Capital

If you are starting out with much higher penetration of…

Rodger L. Johnson

…of video. Excuse me, of voice. Yes.

Barry Kaplan- Maple Tree Capital

Yes.

Rodger L. Johnson

But I mean the activity that is out there right now is still triple play.

Barry Kaplan- Maple Tree Capital

Right.

Rodger L. Johnson

And also, Barry, one of the things in our business environment, you made a good comment that says we penetrate in business, sometimes it gets confusing to have the actual voice RGU count in there especially, as we provide things like SIP Trunking, matrix phone systems and things like that, and so, we may not be fully capturing the impact of the voice benefit on the RGU count.

Barry Kaplan- Maple Tree Capital

This is an IP product.

Rodger L. Johnson

That is exactly right. I mean, included in the revenue but just not on that particular metric.

Barry Kaplan- Maple Tree Capital

Alright.

Rodger L. Johnson

I think that is a big issue when you look at the count as well.

Barry Kaplan- Maple Tree Capital

Ok, fair enough.

Rodger L. Johnson

Ok?

Barry Kaplan- Maple Tree Capital

Yes. Thanks a lot.

Rodger L. Johnson

You know, I think we have hit pretty much the highlights here. If anybody has any individual questions, as we always say, please do not hesitate that we did not get to, as we say, please do not hesitate to call Todd or Bruce or myself. We will be happy to go through everything with you. We appreciate your support. Nobody has quickly enjoyed what is going in the market for the last few months here. But at the end of the day, our folks are right on running a good business and, I think, we are continuing to run our business, a good business. And we are optimistic about the future. Thank you.

Operator

That is all for today’s teleconference. Thank you for your participation. You may now disconnect your line.

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