Consolidated Communications' CEO Discusses Q1 2013 Results - Earnings Call Transcript

Consolidated Communications Holdings Inc. (NASDAQ:CNSL)

Q1 2013 Results Earnings Call

May 9, 2013 11:00 AM ET

Executives

Matt Smith - Treasurer and Vice President, IR

Bob Currey - President and CEO

Steve Childers - Chief Financial Officer

Bob Udell - Chief Operating Officer

Analysts

Davis Hebert - Wells Fargo Securities

Barry Sine - Drexel Hamilton

Jennifer Fritzsche - Wells Fargo

Donna Jaegers - D.A. Davidson

Operator

Good day, ladies and gentlemen. And welcome to the Consolidated Communications Holdings First Quarter 2013 Results Conference Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions)

As a reminder, today’s conference is being recorded. I would now like to turn the conference over to your host, Matt Smith, Treasurer and Vice President of Investor Relations. Please begin.

Matt Smith

Thank you, Sean, and good morning, everyone. We appreciate you joining us today for our first quarter 2013 earnings call. At the conclusion of the prepared remarks, we will open the call up for questions. Joining me on the call today are Bob Currey, President and Chief Executive Officer; Steve Childers, Chief Financial Officer; and Bob Udell, Chief Operating Officer.

Please review the Safe Harbor provisions in our press release and in our SEC filings for information about forward-looking statements and related risk factors. 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.

In addition, today’s discussion will include 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 Currey, who will provide an overview of our financial and operating results. Steve Childers will then provide a more detailed review of the financials. Bob?

Bob Currey

Thank you, Matt, and good morning, everyone. Thank you all for joining us today as we review our first quarter results. I’ll make a few comments about our performance in the quarter and then Steve will provide more detail on the financials.

We are off to a great start in 2013. We’re executing on our plan and delivering strong operating and financial results. We continue to see growth opportunities for the business and we are well-positioned to deliver on them. Our integration efforts with SureWest are going well and we are ahead of schedule on the synergies.

Now let me get into some of the specifics for the quarter. Revenue and adjusted EBITDA were $156.3 million and $74.1 million, respectively. On a pro forma basis, our core revenues increased 1.4% and adjusted EBITDA increased 13% versus the first quarter of 2012 and the dividend payout ratio was a solid 62.4%.

With respect to revenue, the SureWest transaction accelerated and significantly improved our diversification strategy, business and broadband revenues represents 74% of our total topline and federal subsidies are now down to only 5%.

Our broadband additions was strong in the quarter with 1,338 video add and 2,717 data adds. Our fiber centric network delivery speed that exceed current customer demands. We can deliver over 20 meg to 80% of our addressable home and over 50 meg to a third of them. We are in great shape to continue to grow our broadband customer base and increase ARPU.

On the commercial side, Ethernet continues to be the leading product and our offerings are very competitive. While businesses are still cautious and delaying some spend due to the lack of growth in the economy, but despite this we see new opportunities and have added commercial sales resources and increased our sales funnel with our success based capital strategies.

We’re expanding our fiber footprint with strategic opportunities that meet our financial threshold. Wireless backhaul continues to be a driver of growth in our carrier sales. Our 2,500-mile fiber route in Texas connects all the major cities in the states and the wireless traffic on this route is increasing. We signed agreements in the quarter for additional wireless sites outside of our footprint in both California and Illinois.

And finally, with respect to wireless our partnerships with Verizon have significant upside. We expect our cash distribution this year to be over 10% higher than the $29 million we received in 2012.

Now let me provide an update on our integration efforts. We mentioned last quarter that we had completed several of the system integrations, including the first phase of billing, the corporate, financial and back office system, and the call center platform. The remaining convergences are on schedule and will be completed between now and mid next year.

Given the past integration experience and the performance of the consolidated team are not surprised but I’m excited to announce the synergies are ahead of schedule. We achieved our first year target of $20 million of fourth quarter ahead of time. And we are in great shape to exceed the publicly announced $25 million annualized run rate target for June of next year.

So, with that, I will now turn the call over to Steve for some more detailed financial review.

Steve Childers

Thanks, Bob. Good morning to everyone. This morning, I will review our first quarter financial performance and then discuss 2013 full year guidance. Revenue for the quarter was $156.3 million, which on a pro forma basis was flat year-over-year, but represented an increase of 1.4% when excluding a $2.1 million decline in non-core prison services revenue related to the contract we lost with the State of Illinois.

As a remainder, we lost the contract last year in a bid process and over the course of the first quarter all these remaining state prison sites were transferred to a new provider. The 1.4% increase in core revenue is primarily driven by continued growth in our data and internet services, as well as our commercial and wireless backhaul areas. These increases were partially offset by continued decline in our voice-related services.

Total operating expenses exclusive of depreciation and amortization were $92.8 million compared to $101.2 million on a pro forma basis for the same period last year. The $8.4 million decrease was primarily due to continued success and achieving synergy cost savings and once transaction cost associated with the SureWest acquisition, as well as the cost tied to the loss of the prison contract.

Net interest expense for the quarter was $24.6 million, compared to $14.6 million for the same period of 2012. The increase was mainly driven by $8.2 million an expenses related to senior notes we issued in May of last year and part due to fourth quarter 2012 refinancing of our term debt.

At the end of the quarter we had $330 million of swaps mature that had a weighted average rate of 2.9%. We replaced $75 million of these at a rate of 1% and what the remaining portion wrote is variable rate of LIBOR.

As a result of these actions, starting in the second quarter, we expect our cash interest expense to improve by over $1 million per quarter. As a reminder, other than the 1% annual amortization of our term debt, we have no debt maturities until December 31, 2017 or for almost five years.

Other income net was $8.7 million, compared to $6.5 million for the same period last year. For the quarter, we recognized $8.1 million in cash distributions from our wireless partnerships as compared to $6.2 million for the first quarter of 2012.

Now moving on to net income and earnings per share. In the quarter, our adjusted net income and earnings per share were $8.2 million and $0.21, respectively. As outlined in the table on our earnings release, the adjustments are for acquisition and service-related costs, as well as non-cash stock compensation. This compares an adjusted net income of $5.2 million and an adjusted EPS of $0.18 for the same period 2012.

Adjusted EBITDA on a pro forma basis increased by $8.5 million or 13% to $74.1 million, as compared to $65.6 million for the same period last year. The year-over-year increase was driven by combination of organic growth and OpEx synergies achievement with SureWest.

Capital expenditures for the quarter were $27.5 million and included $700,000 in integration related capital.

From a liquidity standpoint, we ended the quarter with our $15 million revolver fully available an $8.6 million in cash on hand. For the quarter, our total net leverage ratio as calculated in our earnings release improved to 4.25 times to 1.

All leverage and coverage ratios were well within compliance levels of the credit facility and for senior notes. Cash available to pay dividends was $24.7 million, resulting in a solid dividend payout ratio of 62.4%.

Now, let me reiterate our guidance for 2013. First, capital expenditures are expected to be in the range of $100 million to $110 million. Included in our 2013 guidance is $4 million for non-recurring integration projects.

Cash interest expense is expected to be in the range of $80 million to $85 million, and cash income taxes are expected to be in a range of $1 million to $3 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 August 1, 2013 to shareholders of record on July 15th, 2013.

I’ll now turn the call back over to Bob for closing remarks.

Bob Currey

So in summary, we kicked off the year with a strong quarter and are well-positioned for the rest of 2013 and beyond. We are investing in the business for growth and providing great service to our customers. We are moving ahead of our plans with our synergy efforts, and we continue to deliver results that provide significant value for our shareholders.

And with that Sean, I’d like open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question comes from Davis Hebert with Wells Fargo Securities. Please go ahead with your question.

Davis Hebert - Wells Fargo Securities

Good morning, guys. Thanks for taking the questions. Your broadband penetration has consistently been around 30%. Do you have any longer-term target in mind, where you’d like to see that penetration go?

Bob Currey

Hey, David. Good morning. Thanks for the question. Yeah, our sort of mid-term target is 40%. We have markets that are up in the 40% range or above it. And there is absolutely no reason that we shouldn’t be able to penetrate to that level over the near term.

Davis Hebert - Wells Fargo Securities

Okay. And you mentioned a couple of markets where you are securing some add-on footprint, videos, backhaul contract. Can you talk about the difference in economics for some of those contracts as opposed to some of the ones that are on that?

Bob Udell

This is Bob Udell. The difference really doesn’t exist in terms of how we look at it within footprint, or out of our historical ILEC footprint. We really look at each of them on a return on cash basis. And so if it gives us an opportunity to extend our fiber footprint to places where we haven’t gone before or we have type 2 type services with CLEC type customers, it makes that much more attractive to us.

Davis Hebert - Wells Fargo Securities

Okay. Great. And then, turning to the capital structure, obviously with the markets doing very well, the debt markets in particular, is there any opportunity for you to look at that term loan pricing, or has that 101 soft call protections?

Steve Childers

Hey, David. This is Steve. With respect to the capital structure, I mean as you probably remember, we did do a refinancing at the end of -- in December that extended our 2014 trench out to 2018. So again, right now we feel -- from a maturity standpoint, we feel really good but no term debt maturities, so at least 2017. But to your point, the markets have remained very strong. We are continuing to monitor sort of what the payback would be against that 101 soft call and we haven’t made a decision yet. But we are obviously monitoring the markets very closely.

Davis Hebert - Wells Fargo Securities

Okay. And then last one for me. As you think about your target leverage, are we still kind of thinking about the mid-3s? I think that’s one number that you guys had mentioned in the past.

Steve Childers

Yeah. As we announced today, we are 4.25 at the end of the quarter, definitely getting into the mid-3s would be -- is the ultimate target. Certainly getting below four is -- we think is really is on the right path. So three, four years from now, we should be in the mid-3s.

Davis Hebert - Wells Fargo Securities

Okay. Great. Thanks again for taking the questions.

Operator

Our next question comes from Barry Sine with Drexel Hamilton. Please go ahead with your question.

Barry Sine - Drexel Hamilton

Good morning, gentlemen. Couple of questions if you don’t mind. First of all, on the video business, SureWest had some relatively newer markets where they build add more recently. I wonder if you kind of talk about how you’re doing in terms of getting some of your newer markets up into the company wide penetration levels.

Bob Udell

Yeah, Barry, Bob Udell. Nice to hear your voice. We are seeing across our footprint, but just to give you a feel for where we are across the company right now. We are at about 20% little over penetration. And some of the earlier fiber set areas in California for example and even in Kansas City, we are in the high 30% penetration range.

So we see no reason why we couldn’t see that type of penetration, especially with the robustness of the product and the additional bundling adds that we are experimenting with and having the success with in conjunction to using multiple sales channels and exporting the door-to-door sales that we are finding very productive. So, I think that’s a reasonable target.

Barry Sine - Drexel Hamilton

And you still kind of holding off in terms of, I mean, do market expansion in the Kansas City and Sacramento markets and just selling into what you already have?

Bob Udell

For this year that’s fair to say. But I think really our emphasis around the three customer groups that we target. We are leveraging a commercial or a carrier wireless backhaul opportunity as I mentioned in earlier question to the extent of our network reach. And I would add that activity as well as additional streets being built out in existing neighborhoods have cause us to add over 5,000 homes alone in the first quarter. So we are not turning our back on residential growth, but we still have some early -- some over penetrated areas that we want to see higher penetration and before we add additional homes passed, we are going to use multiple customer groups to drive our expansion for a good return.

Barry Sine - Drexel Hamilton

And then speaking of those other customer groups on the business side you mentioned that you are increasing the sales force. And I know that was one of the key revenue synergies you are expecting out of the SureWest acquisition, stepping up the marketing efforts for small businesses in Kansas City and Sacramento. Is that purely related to that? Are you growing the sales force in your legacy consolidated markets? And if you could give us an update in how that new marketing effort in your recently acquired markets is going on the business side?

Bob Currey

We are increasing our team size across the business. Larger scale gives us a little more flexibility in capital allocation. And as we had mentioned in Bon and Steve’s remarks, we feel real good about our focus on success-based projects and return on those. We’ve seen just in the Metro Ethernet area, a revenue growth of 5% quarter-over-quarter or little over 30% year-over-year. And the connections continue to be a good foundation for adding additional sticky products on top of it like, data center and some hosting activities. The sales team company wide is exceeding 60 reps now and we are continuing to add to that as we see the market opportunity justifying it.

Barry Sine - Drexel Hamilton

But where were you a year go in terms of reps?

Bob Currey

On a pro forma basis in the high 40s.

Barry Sine - Drexel Hamilton

And then just last question is on -- you’ve been acquisitive over the years and you are well along in terms of integrating your last acquisition. What do you guys see out there on the horizon? It’s probably a little bit soon perhaps for us to see in terms of major acquisition. But what are you seeing as you look out on the horizon for your potential like deal?

Bob Currey

Yeah, there is nothing eminent out there currently, Barry. I think, you said it well. We are well on our way. Although, we still have our head down and our focus is on finishing the SureWest transaction.

But if we saw something that was attractive and we have very specific criteria on de-levering accretive integration ability and growth, we’d be all over it. We’d be talking to them but nothing out there eminent at the current time.

Barry Sine - Drexel Hamilton

Okay. Thank you, gentlemen.

Operator

Our next question comes from Alex (inaudible) of Raymond James. Please go ahead with your question.

Unidentified Analyst

Hi. Thanks for taking the question. Just quick question on Google Fiber, now that they announced their overlaps in some of your markets in Kansas City. Can you just talk about how many homes you have in (inaudible) market? And what kind of speeds you are offering there? Thank you.

Bob Currey

Yeah. Thanks for the question. We paid attention to Google’s announcement and take note wherein every time they make an announcement or share something publicly just like rest of the world does. In (inaudible), we’ve got roughly 25,000 homes but their overlap on us is fairly small in the 3,000 range. They recently announced Shawnee. And we’ve got roughly 30,000 homes passed and the overlap there is somewhere in the 2,000 home rings.

So it’s like anything else competitive pressure, exciting. It causes us to continue to evaluate our product. So our contemplate of sales approach to our consumer base has served us very well. Our product mix has been robust. We have available 50 meg product away down to 1 meg and only about 2% of our customers there demand 50 meg.

And so we were watching carefully to stay right in front of demand and our position to make the necessary investments to match our customer speed requirement in the fiber dense network that we have especially in Kansas gives us a great position to do that. So that’s really right now our position with our approach to the market in Kansas.

Unidentified Analyst

And then just as a quick follow-up. You haven’t been actively building these markets for couple of years now, is that correct? And then is there -- have you seen any other competitive response from AT&T or Time Warner Cable across the Greater Kansas city market in response to Google fiber as well?

Bob Currey

I think the good response has been -- let me go back to your first comment. We have been building as recently through fourth quarter of last year additional homes as passed. And we’ve only recently soften that focus on because we think we should penetrate deeper the addressable homes before we add new developments or new talents. But we are constantly looking at that as an option on our investment strategy. But again, it’s got to meet our needs to serve multiple customer groups.

The normal response from a competitor perspective has been gift cards and promotional activities, but you’ve got to remember Google announced probably 18 months ago roughly and has least reportedly a couple of hundred customers connected. And so it’s an evolving opportunity and competitive threat that we’re all watching closely. And I think the key is that we stay in front of our customer’s demand and leverage the real strong service relationship that our folks in Kansas have had with our customer base there.

You know one thing that’s been a positive is, as you know, Google did some aggressive pole attachment and write away agreements in Kansas City. And AT&T and Time Warner especially have been opting into those agreements. We’re working on that as well and so that helps the industry versus plays out as a negative.

Unidentified Analyst

Great. Thank you.

Operator

(Operator Instructions) Our next question comes from Jennifer Fritzsche with Wells Fargo. Please go ahead with your question.

Jennifer Fritzsche - Wells Fargo

Great. Thank you. Just I wanted to hone-in in the wireless JVs and I apologize if you said that. Can you remind us how many are already upgraded to LTE and do you expect CapEx levels to remain elevated there as Verizon takes on LTE kind of in-sell initiative?

And then just following-up on the earlier questions, Bob, realizing it’s still early to think about acquisitions. But if you were to pursue that path, is it fair to say you would look for something tangent to your current three kind of clusters? Thanks very much.

Steve Childers

Hey, Jennifer. Good morning. This is Steve, I’ll take the first part and Bob will take the more strategic question there. With respect -- with respect to the wireless JVs, we have five partnerships, two in Texas, three in PA. Four of the five have already completed their LTE 4G build out. Those more on the RSAs and Texas is kind of in the last stages of that. So we think that is marginally behind us and again we are -- our view is that we are still going to generate about at least 10% more in cash distribution in 2013 than what we saw over 2012.

Jennifer Fritzsche - Wells Fargo

Thanks, Steve.

Bob Currey

Yeah. On the acquisition question Jennifer, absolutely if it’s contiguous or near our existing properties that’s another benefit. But that would not be necessarily a limiting factor. I never wanted to go to California either but when the opportunity for California and Kansas City, the growth properties, some of the strength that we bring to the table made sense for us. We look at that.

But it would have to be of substantial size to move the needle. It would have to be more than just an ILEC property, would have to have characteristics that we can upgrade, offer our triple-play and other cluster of products and services that we offer.

Jennifer Fritzsche - Wells Fargo

Perfect. Thank you, Bob.

Operator

Our next question comes from Donna Jaegers with D.A. Davidson. Please go ahead with your question.

Donna Jaegers - D.A. Davidson

Hi, guys. Sorry, I joined the call late. So I don’t know if you gave any color. Obviously your business lines are down 4%, business connections are down 3.6%. Did you give any color on what’s going on with business revenues?

Bob Udell

Hi, Donna. This is Bob Udell. Thanks for the question. You know that’s a natural thing when you have a base moving to Metro-E like platform. As they economize their number of voice channels to be fractioned across their employee base, you move few large customers like that. And you are going to see a step back in total connection. So I think that’s kind of ebb and flow as we convert more of those customers.

I think the thing to pay attention to is what’s happening on the revenue stream. And we’ve continued to see some great growth in that product line with the Metro-E platform being a basis for adding VoIP on top of it, the data center feature, cloud type services, things like that.

Donna Jaegers - D.A. Davidson

So this is the second time you mentioned data center capabilities. I wasn’t aware that you guys had any sort of data center capabilities. What exactly are you offering your customers there?

Bob Udell

We offer it as a complement to our network services. We won’t lead with data center, but we’ve got space in all of our major markets, Kansas, Texas, California, Pennsylvania, Illinois. And it’s a core location for some of our smaller customers. It’s a backup alternative for some of our larger customers. And we just sounded to be a complement, but not our lead product.

Donna Jaegers - D.A. Davidson

And that would be colocation services or do you actually offer Cloud?

Bob Udell

Both.

Donna Jaegers - D.A. Davidson

Okay. All right. Thanks.

Operator

I’m not showing any other questions at this time, gentlemen.

Matt Smith

Thanks again for joining us today and for you continued interest and support of Consolidated. We hope you will join us again next quarter. Thanks and have a great day.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the conference. You may now disconnect. Good day.

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