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Consolidated Communications Holdings Inc. (NASDAQ:CNSL)

Q2 2013 Earnings Call

August 8, 2013 11:00 AM ET

Executives

Matt Smith – Treasurer and VP of Finance

Bob Currey – President and CEO

Steve Childers – SVP and CFO

Bob Udell – SVP and COO

Analysts

Frank Louthan – Raymond James

Jennifer Fritzsche – Wells Fargo

Aaron Lee – Park West

Operator

Good day ladies and gentlemen, and welcome to your Consolidated Communications Holdings Incorporated Second Quarter 2013 Results Conference Call. At this time, all participants will be in a listen-only mode. But later, there will be a question-and-answer session, and instructions will be given at that time.

If anyone should require audio assistance, you can press star, then zero, and an audio operator will assist you. And as a reminder, today’s conference is being recorded. And now, I would like to introduce your host for today, Matt Smith. Matt, please go ahead.

Matt Smith

Thank you, John, and good morning everyone. We appreciate you joining us today for our second 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 in 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

Thanks, Matt, and good morning, everyone. We appreciate you joining us today. I’ll make a few comments about our performance in the quarter, and then Steve will provide more detail on the financials.

We delivered solid results in the quarter, and continued to improve our strategic position.

We are consistently enhancing and expanding our product and service levels, deploying fiber, and shortening loops and diversifying our revenues with a focus on broadband.

We’re investing for growth, and delivering on our synergies for the SureWest acquisition.

And I’m pleased with how we have performed and the steps we are taking for the future.

Now, let me get into some of the specifics for the quarter.

For continuing operations, revenue and adjusted EBITDA were 151.3 million and 71.8 million respectively. Revenue from data and video, increased by 4.5 million, or 7.1% on a year-over-year basis.

Adjusted EBITDA increased by 8.2 million or 12.9% compared to the pro forma quarter, second quarter of last year. And we had another strong dividend payout ratio of 60.9%.

In what is historically a seasonally soft quarter, we delivered broadband adds of 2,564 with 1,608 from video and 956 from data.

Our network across the footprint is in great shape, and we can deliver 20 meg or more to 80% of our marketable homes. We extended fiber to nearly 1,500 additional homes during the quarter, and we now serve 42% of our marketable homes with direct fiber, or hybrid fiber coax.

We have the capability to deliver speeds from 100 meg to 1 gig on much of these networks, should demand warrant such speeds. If our customer requirements move in that direction, we’re prepared to offer such services.

On the commercial side, we continue to see solid demand for our metro Ethernet services and hosted VOIP platform, as well as with our data centers. The additional sales reps that we have added, and are adding to capitalize on these opportunities, are beginning to pay dividends, and we should expect to see additional incremental growth from this investment over time.

Wireless backhaul continues to be a key driver of growth in our carrier sales. We had one of our best quarters ever with contracts for 79 new towers increasing our total number of towers under contract to 776.

In addition, with respect to wireless, we had another strong quarter of cash distributions from our five Verizon partnerships. In total, we received 7.7 million in the quarter, representing an increase over the same period of last year, by 1.8 million or 30% growth.

Now, let me provide an update on our SureWest integration efforts. All of the major systems and work group consolidations had been either integrated, or are in the process.

We have taken a phased approach to the conversion of the billing system. The first phase that we complete in October of last year, was putting both California and Kansas City on the same platform, resulting in improved processes and creating efficiencies.

The next phase will be completed in January of 2014 and will provide a new user interface for our customer service and sales groups.

Benefits, including more intelligent and efficient order entry system, a complete view of the customer on one screen, and sharing of calls between call centers. All of which deliver a better service experience for our customers.

The final phase of billing integration will complete in the third quarter of 2014 and all plans are on schedule.

At that time, the SureWest billing system will be integrated, and all teams will be functioning with common, more efficient processes.

And with respect to synergies, at the end of the quarter, we achieved an annualized run rate of 22 million which represents a 10% over achievement of the original first year target.

We fully expect to exceed our second year target of 25 million annualized run rate by June of next year.

And the

And then finally before I turn the call over to Steve, let me provide an update on some regulatory changes in our Texas market as you may have heard about.

The state’s legislature recently passed a bill to partially reduce disbursement levels or universal service funding over a transitioning period of four years.

To offset these reductions, we have the ability to increase our residential rates or competition allows, and we expect the overall change to have a minimal financial impact.

The revenue shift from subsidies to local, will start in 2014 with no change this year.

So with that, I’ll now turn the call over to Steve for a detailed financial review.

Steve Childers

Thank you, Bob, and good morning to everyone. I’ll review our second quarter financials and then we will confirm 2013 full year guidance.

But before I get into the results for the quarter, I want to discuss the change in our reporting segments and the treatment of our prison services business unit as discontinued operations in this quarter.

Previously, we had two reporting segment, telephone operations for core business and other operations for our ancillary businesses. Since 2010, we have sold or closed all the none core lines of business with the exception of prison services.

As previously discussed and disclosed, we lost state of Illinois contract for inmate services in a competitive bid process during 2012, and all the sites were transitioned to the new provider by the end of the first quarter of 2013.

Primarily driven by the loss of this contract, effective with this second quarter, we are now treating the results for the prison service as discontinued operations.

Additionally on a go forward basis, we will manage our continuing core operations and report result as a single segment.

These reporting changes are then reflected for all period presented in our earnings release, and for what you will see in our 10-K or 10-Q filing which we expect to file later today.

Now, let me get into the details. As Bob mentioned, we did have solid performance for the quarter. Revenue for continuing operations was 151.3 million, compared to 151.6 million on a pro forma basis for the second quarter of 2012.

We recognize growth of over 7% in our data and video services as wireless continued growth in our commercial and wireless backhaul areas.

These increases were offset by continued declines in our legacy voice related services.

Full operating expenses for continue operations exclusive depreciation on amortization, were 89.7 million and were down 10.4 million compared to the same period last year on a pro forma basis.

The 10% operating expense reduction was primarily due to continued success in achieving synergy cost savings as well as incurring less severance integration and transaction cost related to the SureWest acquisition.

Net interest expense for the quarter was 20.7 million compared to 16.9 million for the same period of 2012. The increase was mainly driven by the 5.3 million in incremental interest expense on the senior notes we issued in May of last year, and in part, due to our fourth quarter 2012 refinancing of our term debt.

Increase was partially offset by 2.6 million of fees recognized in the second quarter of last year tied to our bridge financing for SureWest and also on a lower cost on our swaps in the current quarter as older high cost interest rate as this matures since second quarter of 2012.

Other income net was 8.8 million compared to 6.9 million to the same period last year. For the quarter, we recognize 7.7 million cash distributions from our wireless partnerships as compared to 5.9 million for the second quarter 2012.

Moving on to net income and earnings per share, in the quarter, our adjusted net income and earnings per share as presented in our earnings release, were 10.7 million and $0.27 per share respectively.

The adjustments are for transaction and service related – severance related cost as well as non-cash stock compensation. This compares to an adjusted net income of 5.5 million and adjusted earnings per share of $0.19 for the same period of 2012.

Adjusted EBITDA for the quarter was 71.8 million and on a pro forma basis increased by 8.2 million or 12.9% compared to the same period last year.

The year-over-year increase was driven by combination of organic growth and OpEx synergy achievement with SureWest.

Capital expenditures for the quarter were 25.1 million and are 52.6 million year-to-date with over 60% being success based.

From a liquidity standpoint, we ended the quarter with 40 million of the revolver available, and 3.5 million cash on hand.

For the quarter, our total net leverage ratio as calculated in our earnings release improved 4.23 times to one, all leverage and coverage ratios were well within compliance levels of the credit facility and our senior notes.

Cash available to pay dividends was 25.5 million resulting on a strong dividend payout ratio of 60.9%.

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

Cash interest expense is still expected to be in the range of 80 million to 85 million and cash income taxes are still expected to be in the 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 November 1, 2013 to shareholders of record on October 15, 2013.

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

Bob Currey

So in summary, the second quarter was a consistent one with year-over-year adjusted EBITDA growth of 13% and a very comfortable dividend payout ratio. We will continue our strategic focus on providing the best products and services in our markets, investing in the business for growth, exceeding our original synergy targets, and delivering results that provide significant value for our shareholders.

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

Question-and-Answer Session

Operator

(Operator instructions) So we’ll take our first question from Frank Louthan from Raymond James. Frank, please go ahead.

Frank Louthan – Raymond James

Great, thank you. Can you give us some color on the broadband adds, it’s a little bit weaker in what were relative to – better than expected video subs, anything on the trend there that we should be thinking about?

And then how are you thinking about M&A going forward? You made good acquisitions in the past. Are you still a better buyer out there? Are you seeing any properties that look interesting? How should we think about your – M&A going forward?

Bob Udell

Yes, Frank, this is Bob Udell. Thanks for the question. The quarter really was an okay quarter of broadband adds and what you refer to as seasonally a soft quarter.

The success in each market can fluctuate based on what promotions we have going on. We’ve been investing in a few platform migrations and upgrades in the west, our east markets, specially Texas, with the economy doing very well there, was probably the most robust.

And overall, we’re pretty comfortable with second quarter, but of course would have higher expectations for third quarter.

Bob Currey

Yes, Frank. And regarding the M&A, you know, scale is important in this business and you’re well aware of that. But not a lot has changed. Our major focus is still on continuing the successful integration of SureWest. Obviously maintaining relationships with potential partners, and we’re on I think every banker’s list, we get books of anything that people are actually considering selling.

But right now, integration is our main focus. We’ll continue to look. It doesn’t have to – obviously SureWest wasn’t really in the Parallax sweet spot, so we’d look outside necessarily at Arlak [ph], but the main ingredients for any deal you know, continue to be to improve our leverage profile, be accretive, easily integrated, and the networking plant having been invested so that we can offer at least a double play, if not a triple play product. So we’ll keep looking.

Frank Louthan – Raymond James

Okay. Thank you very much.

Operator

Thank you. So we’ll take our next question from Jennifer Fritzsche from Wells Fargo. Jennifer, please go ahead.

Jennifer Fritzsche – Wells Fargo

Great. Thank you for taking the question. Good quarter. I just wanted to hone in a little bit on taxes. Bob, you mentioned the ability to raise the slick rate where competitive pressures allow.

Can you talk a little bit about the completion you’re seeing in these affected markets, like do you believe that that higher subscriber line charge could be implemented without much disruption?

Bob Udell

Jennifer, thanks for the question. This is Bob Udell. There is room in our bundles for pricing flexibility. In terms of the voice as a standalone product, we’ve been in Texas operating a voice over internet or VOIP alternative that’s feature rich [ph]. And really our Metro Ethernet play there and given us a great upside opportunity in luring on new services. So in the micro data center service or cloud computing that we’re in the process of going out.

So specifically on voice alone, those customers are a very small segment of our installed base there at these gigs [ph]. And the focus in converting them to broadband really leaves us a lot of pricing flexibility. And when we’re talking about the voice component alone, that’s a couple of bucks. And we think we’ve got real flexibility there.

On the consumer side, we’ve been deemphasizing the standalone access line and also moving towards a bundled offering. So the same theory applies there. And in the aggregate with the bundle, you’d be talking less than a dollar or a couple dollars at max depending on where we settle out with the regulatory process at a State and Federal level.

Jennifer Fritzsche – Wells Fargo

Great. Thank you, Bob.

Operator

Okay. Thank you. And we’ll take our next question from Aaron Lee [ph] – Park West. Aaron, please go ahead.

Aaron Lee – Park West

Hi, good morning. Thanks for taking my question. Just to continue with Texas; is there a way for us to think about the quantitative impact of the subsidy changes over the next year, two years, three years? And I have a follow up as well.

Bob Currey

Yes, Aaron, let me give you some specifics on that. There’s actually two funds that we get support from in Texas, a high cost fund and a high cost assistance fund. The high cost assistance fund that we receive will be eliminated January 1, 2014, and that’s $1.4 million per year.

The high cost fund, the other one that we receive support from is being reduced by approximately one-third over a four-year period. So beginning in 2014, we will loss $1.2 million per year over the next four years.

And so, there will be fund fluctuation in that based on our access earning [ph] performance. But that’s a general guideline for you to use in your modeling. But as was previously stated, we also have the opportunity to raise residential rate. And in Texas, we have some historically very low rate which under the Federal program, we have to meet minimum. So in some cases, we’re being required to raise rates otherwise we lose subsidy at the Federal level.

So we think the funding decline will be minimal financial impact as we migrate. And when we were negotiating this settlement, we always wanted a transition period. And we’re great full to have four years to adjust our business model rather than something abrupt.

Aaron Lee – Park West

Got it. That’s helpful. And my follow up just relates to the Federal side of the equation. Is there a way we should think about the impact of the SEC’s push for transition from subsidies for rural voice [ph] to more focus on broadband subsidies? And how that might impact your subsidies line going forward as well?

Bob Currey

Well, I wish I could give you the kind of detail that I just gave you on the Texas fund. But a couple of comments, maybe that would be helpful. And you didn’t comment on the inter-carrier comp side and we’re in the second year of that. Those numbers are known, they’re manageable, it won’t have a big impact on us.

On the CAF 1 and the CAF 2, we didn’t take any money in CAF 1. We don’t know all of the rules yet on CAF 2. We’re evaluating by senses block [ph]. But I will tell you the fact that we can already serve broadband to 98% of our access lines, I think the opportunity for us on CAF 2 will be limited.

We’ll obviously look at it, that 2% that we don’t serve. But some of the rules and where it’s been economic we’ve built in the past and we would have built. But again, once the rules are fully understood and implemented, we’ll be able to give you some more detail like I did on Texas.

Aaron Lee – Park West

Great. Thank you.

Operator

Okay. Thank you, ladies and gentlemen. I’m showing no further questions in the queue at this time. So I would like to turn the call back to Bob Currey, for any concluding remarks.

Bob Currey

Yes, thank you John [ph]. And thanks all of you for joining us today, and for your continued interest and support in Consolidated. We hope you’ll join us again next quarter. Thank you, and have a great day.

Operator

Okay. Ladies and gentlemen, this does concludes your conference. You may now disconnect, and have a great day.

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