Welcome to the Consolidated Communications third quarter earnings conference call. At this time all participants are in a listen-only mode. Following management’s prepared remarks, we’ll hold a Q-and-A session. (Operator Instructions) As a reminder, this conference is being recorded Thursday, November 6, 2008.
I would now like to turn the conference over to Mr. Matt Smith, Director of Investor Relations. Mr. Smith, please go ahead.
Thank you Nicole and good morning everyone. We appreciate you joining us for this third quarter 2008 earnings conference call. With me on the call today are Bob Currey, President and Chief Executive Officer and Steve Childers, Chief Financial Officer. After the prepared remarks we will conduct a question-and-answer session.
I will now review the Safe Harbor provisions of this call and then turn it over to Bob. This call may contain forward-looking statements within the meaning of the federal securities laws. Such forward-looking statements reflect among other things, management’s current expectations, plans and strategies, and anticipated financial results, all of which are subject to known and unknown risks, uncertainties and factors that may cause the actual results to differ materially from those expressed or implied by these forward-looking statements.
Please see our public filings with the Securities and Exchange Commission for more information about forward-looking statements and related risk factors. In addition, during this call we will discuss certain non-GAAP financial measures. Our earnings release for this quarter’s results which has been posted to the Investor Relations section of our website contains reconciliations of these measures to their nearest GAAP equivalent.
I will now turn the call over to Bob, who will provide an overview of our financial and operating results. Steve Childers will then provide a more detailed review of the third quarter financials. Bob.
Thank you, Matt, and thank you all for joining us today. I am pleased to once again report solid financial results and total connection growth despite some challenges related to Hurricane Ike and the economy.
Both adjusted EBITDA and cash available for dividends were in line with our expectations. The Pennsylvania integration continues to be ahead of schedule and ahead of budget. I am particularly pleased with the reception to our triple play bundle in Pennsylvania, helping drive the access line loss there to its lowest level in two years. In fact, IPTV has had the fastest start over the first six months than in any of our past launches.
Let me talk a moment about the hurricane. Although our Texas markets were hit the hardest by the storm, it tracked through all of our markets and even caused substantial power outages in Pennsylvania. We were fortunate to have limited structural damage and we proactively suspended our marketing and installation activities to focus on service restoral. Our employees showed a relentless commitment to our customers and I could not be more proud of their efforts.
Our revenue for the quarter was $103.8 million. Excluding the expense impact from Hurricane Ike, adjusted EBITDA was $47.4 million and the dividend payout ratio was a strong 66.7%. Steve will discuss the detailed financials, as well as the impacts from the hurricane later on this call.
From an operational view, we grew total connections sequentially in the quarter and 6,600 or 1.5%, year-over-year. We continue to deliver strong broadband growth with our industry leading DSL and IPTV increasing by nearly 4% over last quarter and 19% year-over-year.
DSL lines and service increased by 2,600 or 3% over the second quarter and IPTV increased by 1,300 or 9.5% sequentially, even though we shut down our marketing and installation activities for two to three weeks in Texas, our largest market.
As you know, we introduced our DVR product in April and the penetration rate on that product has more than doubled to 13% over the last quarter. The DVR does bolster the product line and aids in ARPU growth.
We added nearly 1,700 ILEC VOIP lines in the quarter which is split between new and existing customers. Approximately 1,300 of the growth in lines were for residential customers. The product offering is both, customer retention and a strong growth opportunity for us.
As we mentioned last quarter, while in some cases this does cannibalize traditional voice services. It supports attractive margins and retains the customer by offering a product that they want. It is yet another way that we compete with the cable providers.
Regarding access lines, as we announced on our last quarter’s call, both Suddenlink and Comcast launched their voice service in our Texas markets in the second quarter, as did NewWave Communications in the Western Illinois market. The third quarter was the first full quarter after the launches and as expected, we felt it.
On the other hand, our Pennsylvania markets have continued to experience improved ILEC line loss trends. The line loss during the third quarter alone for Pennsylvania was 0.008% or when annualized 3.2%. The year-over-year rate was 5.4%, which is the lowest level in more than two years.
This continued improvement is just another example of our demonstrated ability to respond to the competition with our diversified and customer driven product set. For the Pennsylvania CLEC business, we had another strong quarter, growing access line equivalents by approximately 1,000 giving us a 6.7% year-to-date increase.
Now let me provide an update on the Pennsylvania integration. We continue to be very pleased with our progress. We will exceed our synergy target of $7 million for the first year and all projects will be done on time and on budget. Our team has a proven track record of successfully integrating companies. With approximately 65% of our integration projects complete, we expect to be finished by June of next year.
Before I turn the call over to Steve, let me comment on two other items: (1) the recent proposed FCC action on inter-carrier comp and (2) the economy. As I’m sure you’re aware, the FCC chairman’s recent proposal was an attempt at broad reform on inter-carrier comp and USF. As I’m sure you are aware, the FCC chairman’s recent proposal was an attempt at broad reform.
While we applaud the FCC’s bold move to address the broader issues, we along with many of our RLEC peers and the national associations that represent us, requested an appropriate review and comment period which ultimately the other four commissioners supported.
As you probably heard on Monday of this week, the FCC delayed addressing broad reform due to concerns expressed by us and others and now plans to follow an appropriate process, fitting with the scale and scope of this effort. We will stay involved in working with the commissioners and the FCC staff to develop a solution that can support continued investment in rural America.
As for the economy, we think our unique market mix, led by agriculture and energy sectors provide a measure of stability during tough times. We are encouraged by continual residential and commercial developments, primarily in our Pennsylvania and Texas markets. Nevertheless, we do anticipate growing pressure from the slowing economy and are monitoring sales and service trends and bad debt non-pay metrics very closely. To-date, we have not experienced measurable negative impacts in these areas.
I will now turn the call over to Steve for the financial review.
Thanks Bob and good morning to everyone. As Bob mentioned we again delivered solid results for the third quarter. This morning, I’ll review our quarterly financial performance and then update our 2008 guidance. Operating revenue for the third quarter of 2008 increased 29.3% to $103.8 million, compared to $80.3 million in the third quarter of 2007.
The increase is primarily due to the $23.8 million in revenue generated by our Pennsylvania operations. Excluding contribution from the North Pittsburgh acquisition, our operating revenues were essentially flat at $80 million. The declines in local calling services and network access were offset by growth in our DSL, IPTV, and VOIP business.
Total operating expenses, exclusive of depreciation and amortization for the third quarter of 2008 were $63.9 million compared to $49.5 million in the third quarter of 2007. The increase is primarily due to the recognition of $14.2 million in cost of sales and SG&A expense associated with our Pennsylvania operations, which were in line with our expectations.
Our third quarter of 2008 total operating expense includes approximately $1.1 million of integration and service expense which qualifies in add back to adjusted EBITDA under the terms of our credit agreement.
Also, due to the hurricane service restoral efforts, which we incurred approximately $1.2 million in incremental cost from overtime contractor and vendor costs are included in our cost of sales during the third quarter.
Depreciation and amortization expense for the quarter was $22.8 million, an increase of $6.4 million compared to the third quarter of 2007. The increase was primarily attributable to the North Pittsburgh acquisition. Net interest expense for the quarter was $13.6 million, an increase of $1.7 million, compared to the third quarter of 2007.
First, interest expense increased $4.2 million due to the incremental debt and terms of the new credit facility associated with the North Pittsburgh acquisition. Also included in the quarter was a $2.5 million non-cash benefit associated with hedge accounting, related to new interest rate basis swaps that we entered into on September 4, 2008. We expect the basis swaps will yield approximately $1.5 million in cash interest savings over the life of our interest rate hedge agreements.
Other income of $5.8 million increased $1.7 million compared to the same period last year. As part of the North Pittsburgh transaction, we acquired limited interest in three additional Verizon wireless partnerships. These investments contributed approximately $3.7 million in the quarter.
Weighing all the factors, net income for the third quarter of 2008 was $5 million, compared to net income of $2.3 million for the same period last year, while net income per common share was $0.17 compared to $0.09 for the same period in 2007.
We believe it is appropriate to look at net income per share on an adjusted basis. As detailed on an adjusted net income per share schedule in the earnings release, our adjusted net income was $4.7 million and adjusted income per share was $0.16 per share in the third quarter of 2008 compared to $3.7 million and $0.14 per share respectively in the third quarter of 2007. Additionally, third quarter 2008 operating expenses associated with Hurricane Ike diluted net income per share by $0.02 per share.
Adjusted EBITDA for the third quarter was $47.4 million when excluding the incremental expenses related to Hurricane Ike, compared to $33.5 million for the same period last year. The primary driver of the $13.9 million or 41.5% increase was the inclusion of our Pennsylvania property. Capital expenditures were $10.8 million in the third quarter of 2008 and our year-to-date CapEx spend is $37.1 million.
From a liquidity standpoint, we ended the quarter with $12.4 million cash and our $50 million revolver remains undrawn. As a reminder, all borrowings under the credit facility have been executed and we have no debt maturities until December of 2014 over the term in the credit facility. Also at the end of the third quarter, approximately 90% of our term debt was assessable fixed as a result of interest rate or cash flow hedges and our overall cost of debt was 6.9%.
For the third quarter of 2008, our total net leverage ratio as calculated in our earnings release, decreased 4.5:1. Please note that the schedule reflects a pro forma LTM adjusted EBITDA calculation. Our leverage and coverage ratios were well within compliance levels of credit facility.
Cash available to pay dividends or CAPD was a strong $15.8 million for the quarter. The dividend payout ratio was 71.7% and would have been 66.7% after giving effect of the incremental storm related expenses.
Now I’d like to update you on our 2008 guidance. First, capital expenditures are not expected to exceed $48 million including $2 million in integration CapEx. Second, cash interest expense is now expected to be in the range of $65 million to $65.5 million and finally, full year cash income taxes are now expected to be in the range of $13 million to $14 million.
With respect to our dividend, our Board of Directors has declared the next quarterly dividend of approximately $0.39 per common share payable on February 1, 2009, to shareholders of record on January 15, 2009.
With that I will now turn the call back over to Bob for closing remarks.
Thank you, Steve. In summary, we have a proven track record of executing and integrating our strategy, which supported solid results this quarter despite some challenging factors.
As we have stated in the past, our strategy continues to be providing high quality broadband and voice services; generating strong, sustainable cash flow to support our dividend. We have and will continue to focus on growing revenue per customer, improving our operating efficiencies, and maintaining our disciplined CapEx philosophy.
The Pennsylvania integration is going very well and our recently launched triple play in that market is experiencing nice traction. Along with the unique mix of markets we serve, we are a leader of broadband penetration and this positions us well.
We continue to be excited about our growth opportunities with our broadband and VOIP products, as well as the continued development in our communities.
With that Nicole, I’d like to open it up for questions.
(Operator Instructions) Your first question comes from Michael Nelson - Stanford Group.
Michael Nelson - Stanford Group
Actually, two questions if I may. The first, regarding your IPTV service, which does appear to be gaining some traction. I mean, could you give us an update on some of the new products, like the DVR and video-on-demand, if you expect them to further stimulate demand? Also, could you comment on what you’re seeing from your IPTV vendors on pricing; if that continues to come down significantly and the scalability of the product?
Then if I may, second on the regulatory environment, which I appreciate the opening comments. I understand the FCC released their comment, the draft inter-carrier compensation and universal service reform order that they debated last week. I’m wondering if you could comment on that at this point. Do you expect any changes in the next six, 12 months, or so and is there any way of quantifying the amount or a percent of revenue you receive from terminating traffic? Thanks.
Let me take them in the order in which you asked them. First of all, on the DVR as I commented, we love that product and of course it’s required for a lot of customers to even consider your TV offering and from last quarter, it jumped. We launched it in late April, early May and it jumped from 5% penetration in the second quarter to 13% this quarter.
As far as some other enhancements, we’ve added ten HD channels this past three, four months and we’re now up to just over 20 HD channels and there’s also some new programming with DSL over a portal and HD with IPTV. So we’re excited about what’s happening there.
As far as pricing, the vendor pricing continues to improve, not fast enough for us, but clearly the price is coming down, and there is some hope that some new vendors are also entering the equipment business. The pressure there of course has been on the programming and that continues to go up and that’s a challenge to keep a competitive rate while your programmers are raising their rates.
Regarding your second question on inter-carrier access reform, let me comment on the original order that was deferred last Monday. Obviously, we were involved along with many of our peers. I personally spent three different trips into Washington over the last two weeks, meeting with FCC chairman and commissioners. We were pleased that the vote was taken off the agenda and believe that there will be a much more opened discussion about reform that will benefit both the consumers and the entire industry, not just the big guys as was going to happen if that order had passed.
There’s no debate that reform is needed and we’re eager to contribute in that development of a long-term solution. Unfortunately, that order that was pulled was 167 pages and it was only with limited information. We never really had enough time to look at the whole order, so it’s difficult to quantify the impacts, but it was not good, I can tell you that and it definitely would have been a loser for rural America’s consumers.
Regarding your comment about last night, the order released and it was released late last night, approved and released. They dealt with the court ordered November 5 remand on dial-up ISP traffic. Had they stopped there, that would have been great, but they combined it with an additional order which rejected the 2007 joint board recommendation on universal service and they’ve put out another proposed rulemaking on comprehensive inter-carrier comp reform.
They’ve set a schedule pretty quick to try to get this thing reviewed and perhaps on the next scheduled commission meeting currently set for December 18. There’s some things in there that we like to keep as appropriately addressing, not burdening customers with rate increases, addressing phantom traffic and traffic pumping or traffic stimulation, eliminating the identical rural support and really trying to get broadband into the future for universal service.
Unfortunately, just like the comment I made about last Monday, this order is 430 pages in length. It was released last night. We’re all over it, along with some of my peers and industry groups, but it really would be premature for me to comment on its impact to us until we really get a chance to wade through the 430 pages.
A very long answer to your very short question, but it’s a very complex subject and very important to not only our industry and our segment, but I think to the economy in general.
Your final question comes from Patrick Rien - Barclays Capital.
Patrick Rien - Barclays Capital
I was trying to look at access line loss a little bit. Illinois, Texas was 7.4% this quarter, 5.5% last quarter. Is it possible to break down where you’ve seen the most line loss between those two markets, and then on top of that, where you’re seeing it. Is it from wireless substitution of the new cable or VOIP providers in Texas or is it a reduction in people moving into new homes? So, not necessarily a disconnect issue, but a new add issue. Thanks.
Good morning, Patrick; Bob. I’ll take that one. Most of the line loss is in Texas. It’s our largest market and as I mentioned in my introductory comments, Comcast and Suddenlink both launched late in the second quarter, so this is the first full quarter. It’s about what you expect. It’s the spike that we’ve seen in not only in our other markets, but others have experienced; we expect a couple quarters of that and then hopefully it mitigates.
Regarding where is it coming from? I would tell you it’s close to 50/50 split with still some wireless substitution, some of the economically challenged customers, as they try to adjust their budgets; there may be some access line loss there. Clearly, it’s a combination of the last point you made though, that inward movement is certainly down and people are moving and not moving back in as fast and then half of it is estimated, but half of it is coming from the cable launch of their VOIP product.
I would add though that some of that was also as I commented, we’re cannibalizing a bit of ours with our residential VOIP products. We added 1,300 residential VOIP this quarter, so some of that is our own cannibalization, but again, there’s nice margins, there’s term with that and we’ll take that rather than lose the customer to the cable competitor.
Patrick Rien - Barclays Capital
Then just one follow up if possible. It looks like you added 600 business subs this quarter after I think two quarters of losses. Was that a one time event or did you implement a new sales strategy?
In some of our markets, we have seen business line growth but there was also a re-class there Patrick of some lines that were counted as company lines that should have been business lines and so there’s a piece of that in there.
Patrick Rien - Barclays Capital
Okay and then how about an update on Westinghouse and North Pitt and KBR in your Houston properties; are they still building out there?
They sure are. It’s going nicely, it’s on schedule, and in fact we’ve sold them some additional services out there, so we’re happy with what’s happening in that Cranberry area, north of our headquarters there in Gibsonia.
(Operator Instructions) There are no further questions at this time. I will now turn the call back over to Mr. Bob Udell for any closing remarks.
Nicole, that’s Bob Currey, but that’s okay. Thank you again for joining us today and for your continued interest and support of our company. Thanks and have a great day.
Ladies and gentlemen, this concludes our conference call for today. We thank you for your participation and ask that you please disconnect your line.
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