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Executives

Matthew Smith – Treasurer and Director, Finance

Bob Currey – President and CEO

Steve Childers – SVP and CFO

Analysts

Barry Sine – Capstone Investments

Gray Powell – Wells Fargo Securities

Michael Nelson – Soleil Securities

Donna Jaegers – D.A. Davidson

Dennis Weaver [ph] – Maverick Industry [ph]

Frank Louthan – Raymond James

Consolidated Communications Holdings, Inc. (CNSL) Q3 2009 Earnings Call Transcript November 5, 2009 11:00 AM ET

Operator

Good morning. My name is Demetris and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2009 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions) Thank you.

Mr. Smith, you may begin the conference.

Matthew Smith

Thank you, Demetris, and good morning everyone. I am Matt Smith, Treasurer and Director of Finance. And with me on the call today are Bob Currey, President and Chief Executive Officer, and Steve Childers, Chief Financial Officer. Thank you for joining us on this third quarter 2009 earnings call. After their prepared remarks, we'll conduct a question-and-answer session.

I will now review the Safe Harbor provisions of the 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 financials.

Bob?

Bob Currey

Thanks, Matt. Good morning to all of you and thanks for joining us today. The third quarter was a strong quarter both financially and operationally, especially considering the competitive and economic challenges that exist today. We delivered our best ever IPTV growth with 1800 subscriber additions, a solid DSL increase of 2100, and our best access line results since the first quarter of 2008. Our cash available for dividends of 19.9 million and payout ratio of 58.1 continued to provide a comfortable cushion for our dividend. Additionally, our pair bonding rollout is proceeding as planned and the market response is very positive.

Revenue for the period was 101.6 million and adjusted EBITDA was 47.3 million. When you exclude the non-cash benefit of 1.8 million related to the access dispute resolution in the second quarter, adjusted EBITDA increased by $1 million sequentially. This improvement is directly related to the cost savings initiatives that we implemented in the first half of the year. Steve will discuss the financials in more detail later in this call.

In regard to our operating results, customer demand for our broadband products continues to be very strong in all of our markets. Our IPTV service had strong growth with the 1800 subscriber adds resulting in a 9.1% increase for the quarter and 39.2% for the last 12 months. The solid DSL increase of 2100 lines resulted in a 2.2% growth for the quarter and 9.7% over the last 12 months. During the quarter, we also added nearly 700 ILEC VoIP lines bringing that total subscriber account to 8600.

Access lines declined by 1.7% in the quarter which was the lowest quarterly loss since the cable competitive launches five quarters ago. The trend is exactly what we anticipated. We do not expect to experience a sustained spike again and the improvement should continue. As we discussed on last quarter's calls, the pair bonding technology deployment is well underway. It allowed us to pass an additional 18,000 homes with our IPTV product during the quarter and we will pass another 18,000 homes in the fourth quarter. The market is responding well to both the IPTV expansion and the additional bandwidth available to broadband customers.

In addition, we are very excited about a new wireless device tied to our IPTV service. This new technology along with pair bonding gives us the ability to better size the capacity needs of each and every customer with a quicker install resulting in an overall reduction of cost. In nearly every new installation, we are using this in home wireless device along with individual set top boxes to scale the service to the number of TVs, HD streams, and DVR boxes that our customers desire. Through this technology, it can all be done with limited wiring, providing a more efficient and importantly a more friendly customer installation. Again, the response from our customers has been excellent.

Before I turn it over to Steve, let me update you on the commercial developments that we have also discussed on our past calls. In our Cranberry, Pennsylvania market, the Westinghouse project has nearly completed its facilities construction and about half of the planned 3000 employees have moved in. The remaining half are scheduled to move in stages over the next six months. We are providing a diverse set of services to these new facilities and they're already one of our top three commercial accounts in Pennsylvania.

In Mattoon, Illinois, the FutureGen clean coal project is proceeding well. With the Department of Energy commitment of $1.1 billion for the project, it could break ground in 2010. And in Katy, Texas, KBR is still working toward construction of a 900,000 square-foot facility which is expected to centralized their 4500 employees in the Houston area. The project is still delayed for financing but discussions are ongoing. We continue to monitor these exciting projects closely and are actively engaged with all parties.

So with that, let me turn it over to Steve for the financial review.

Steve Childers

Thanks, Bob, and good morning to everyone. This morning, I will review our quarterly financial performance and then confirm 2009 guidance. As Bob said, we are very pleased with the strong results in the quarter. Operating revenues for the third quarter of 2009 was 101.6 million compared to 103.8 million for the same period of 2008. Local services revenue declined by 1.7 million primarily due to continued access line erosion. Network access revenue was down 2.4 million due to line loss and lower minutes of use. Data and Internet revenue increased by 800,000 due to the growth of IPTV DSL and our VoIP services.

Total operating expenses exclusive of depreciation and amortization for the quarter were 61.8 million compared to 64 million for the same period last year. The current quarter included 1.3 million of incremental pension costs as well as $400,000 in incremental integration severance expense while the third quarter of last year included 1.2 million in hurricane Ike service restore cost. When excluding these items, our operating expenses declined by 2.7 million year-over-year. The continued cost structure improvement is the result of leveraging our systems integration work for our Pennsylvania operations and being able to consolidate and reduce work groups.

In our previous 2009 update call, we announced that as a result of these efforts, we have been able to achieve 5.8 million in annualized cost structure improvements. In this quarter, we took actions to begin consolidating additional back-office and service functions. This resulted in a charge of $812,000 in severance that qualified as an add back to adjusted EBITDA under the terms of our credit agreement. We expect these third-quarter actions to generate approximately $1 million of annualized savings.

Net interest expense for the quarter was 14.8 million compared to 13.6 million in the same quarter last year. In the third quarter of 2008, we recognized a non-cash benefit of 2.5 million due to the ineffectiveness of our interest rate swaps. Normalizing for this benefit, interest expense decreased 1.3 million in the quarter driven by 60 basis points improvement in our weighted average cost of debt. Other income was 6.1 million compared to 5.9 million for the same period of last year. For the quarter, we recognized 5.8 million in cash distributions from our wireless partnerships compared to 4.8 million for the third quarter of 2008.

Weighing all these factors, net income increased 2.1 million to 7.1 million compared to 5 million in the same quarter last year. Net income per common share increased $0.07 to $0.24 compared to $0.17 for the same period in 2008. 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, our adjusted net income was 8.6 million and adjusted net income per share was $0.29 compared to 4.7 and $0.16 per share in the third quarter of 2008.

Adjusted EBITDA was 47.3 million compared to 46.2 million for the same period last year. Capital expenditure for the quarter were 10.6 million. And from a liquidity standpoint, we ended the quarter with 31.9 million and our $15 million revolver remained undrawn. As a reminder we have no debt maturities until December of 2014. Also at September 30, 60 million of our interest rate hedges expired, which decreased our hedge position on term debt from 84% down to 77% and also lowered the overall cost of debt from 6.26% to 5.96% going into the fourth quarter.

For the fourth quarter, our total net leverage ratio as calculated in our earnings release was 4.5 times to one. Our leverage and coverage ratios were well within compliance levels of the credit facility. Cash available to pay dividends or CAPD increased by 4 million over the same period in 2008 resulting in a very strong dividend payout ratio of 58.1%.

Now I would like to reaffirm to you our 2009 guidance for CapEx, cash interest and cash income taxes. First, capital expenditures are expected to be 41 to 42 million. Cash interest expense is expected to be in the range of 56 million to 57.5 million. Full year cash income taxes are expected to be in the range of 9 million to 11 million. Our 2009 tax projections do take into consideration bonus depreciation allowed under the stimulus bill. With respect to our dividend, our Board of Directors has declared the next quarterly dividend of approximately $0.39 per common share payable on the February 1, 2010, to shareholders of record on January 15, 2010.

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

Bob Currey

In summary, we had another great quarter. We continue to produce strong cash available for dividends and a comfortable payout ratio. We continue to utilize the newest technologies that offer the best products and services and we're excited about the commercial opportunities in our markets, all of which help us to continue to create positive shareholder value.

But finally, before we go to the Q&A, let me comment on one last item. Within the next few days, you will see a filing that reflects a planned change in the Lumpkin family ownership structure. Since Mr. Lumpkin is the largest shareholder of Consolidated Communications and Chairman of our Board, I thought it was important for you to understand the structural changes occurring. This is not a sale of Consolidated stock by Mr. Lumpkin or his family. It is just a distribution of shares.

Currently the Lumpkin family owns approximately 19.2% of the outstanding shares of Consolidated, individually or through various entities for their benefit. The shares are held in Central Illinois Telephone, Llc. This entity was established in 2002 and its structure gives Mr. Lumpkin sole voting rights over the Consolidated shares that it holds. In order to permit state planning and financial facility within the family, some of the Central Illinois Telephone owned shares will be distributed out to family members or entities maintained for their benefit. But after these transfers, Mr. Lumpkin will still be our largest shareholder and chairman as well as having sole voting power with respect to the approximately 14.2% of the company's total outstanding stock.

With that, Demetris, I would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Barry Sine, Capstone Investments.

Barry Sine – Capstone Investments

Hi, gentlemen. Very nice quarter.

Bob Currey

Thank you, Barry.

Barry Sine – Capstone Investments

Three questions if I might. The first one on two revenue line items, both long-distance and access, I know you talked about them briefly in the prepared remarks, they were a little bit lower than I was looking for and it looked a little bit lower than what we had seen trendwise. Can you give us a little bit more color and flavor of both of those revenue line items?

Steve Childers

Yes, Barry. This is Steve. On network access, for the quarter, it was down roughly 2.4 million and a little bit wider maybe than what the access line loss was, so the combination there was into the second quarter, we had roughly 300,000 to $400,000 in positive carrier settlements. Not only do we not have those same settlements in the third quarter, we actually had a couple of net settlements going the other way and then the rest of it is basically just continued line loss and declining minutes of use.

And then on long-distance, again I think, there's not really been a lot of pricing movement on it. It is just a reflection of the line. Well there's two things, a reflection on the line loss and people moving to, people moving to our more unlimited package and things like that. So the gap is probably a little bit wider quarter over quarter that you might expect. But I also think that with respect to our recent billing integration from our PA system, that we are probably – may be getting a better classification of some things previously classified in long-distance (inaudible) might have a little bit things – little bit of a bucket thing going forward now that we have got the systems integrator.

Barry Sine – Capstone Investments

If somebody is on unlimited package, do you still book a portion of that revenue in the long-distance category?

Steve Childers

Yes.

Barry Sine – Capstone Investments

Okay. And then, my second question in terms of what you're doing with homes passed, the increases there, and what you are expecting to do with pair bonding, it is a pretty significant increase in your addressable market. During the third quarter I think you said about 18,000 new homes came on board. When in the quarter did they come on board, was that early in the quarter, do we get the full impact from a marketing standpoint? And then the same question with respect to the fourth quarter, will it come on early in the quarter, late in the quarter?

Bob Currey

They are added incrementally, Barry. I can't tell you that it is arithmetic throughout the quarter but it is. It is spread throughout the quarter and that will be the same case in the fourth quarter. There is two components, part of that – one is the construction budget and the planned spending, and then our marketing program. So they are brought online in conjunction with the planned construction and the marketing demand.

Barry Sine – Capstone Investments

When you say that you have added homes passed, does that mean that they are constructed, or that they are constructed and being marketed too?

Bob Currey

Well, once they're past, they are constructed and they are being marketed too.

Barry Sine – Capstone Investments

Last question, North Pittsburgh acquisition is fully integrated, things are going well there. You are also building up a pretty nice cash balance, what is your current thinking in regards to another one of those similar type of acquisitions?

Bob Currey

Well, to the first part of your question, the integration is completed. As far as systems and processes, there is still some minor tweaking and still some cost reductions that are planned this quarter. As far as I guess your last question sort of to the M&A area, we would love to do another North Pittsburgh. As we've said in the past, we would consider ourselves acquisitive. As you know the financial markets have not allowed any activity there, but where we would certainly entertain and we're constantly looking at potential growth opportunities.

Barry Sine – Capstone Investments

Okay, thank you.

Bob Currey

Thank you. Have a good day.

Operator

Your next question comes from the line of Gray Powell with Wells Fargo Securities.

Gray Powell – Wells Fargo Securities

Hi guys. Thanks for taking the questions. I just have a few here. I guess first off, your line losses saw a very good sequential improvement in Q3. Should we think about absolute loss levels staying in the low 4000 range or do you think there is room to bring that down even more?

Bob Currey

Well, as I said, I think the spikes are behind us and with the programs that we are implementing, the marketing activity that is going on, we expect that to continue to improve.

Gray Powell – Wells Fargo Securities

Okay. And then you just talked about how you are pretty close to wrapping up the cost synergies associated with the North Pittsburgh acquisition, and it sounds like you completed some other initiatives this year. Do you see any other significant opportunities to reduce cost and then should we think about EBITDA margin staying in this mid-to high 40% range or is there opportunity to defer them to improve margins?

Bob Currey

Well, I think there is always an opportunity. We are looking constantly for opportunities to improve margins. There as I said – Gray, there is some opportunities out there still within the North Pitt but we're constantly looking and with some of the CapEx that we deploy in our network and our back-office, there are some opportunities that we're looking at t continue to take costs out of the business.

Gray Powell – Wells Fargo Securities

Okay, great. And then just last question, your dividend payout ratios, now it is under 60%. Should we think about you using your excess free cash flow to reduce leverage going further, just going forward? And then along those lines, by my math, leverage is down from 5.3 times a year ago to 4.5 times today, do you see leverage getting below four times next year?

Steve Childers

Well, Gray, this is Steve. I think that in terms of thinking about the payout ratio being around 60%, we will use excess cash to continue to delever as we have in the past few quarters. I think the answer to that is yes, absent a transaction coming up, M&A deal potentially. But other than that, we will continue to focus on improving the payout ratio, improving the leverage ratio. And as you noted, we have demonstrated improved ability to be able to improve the leverage the last few quarters and we would expect that to continue. Four is still the target, I'm not sure we will be there by the end of next year, but that is certainly the goal.

Gray Powell – Wells Fargo Securities

Okay, great. Thank you very much.

Operator

Your next question comes from the line of Michael Nelson with Soleil Securities.

Michael Nelson – Soleil Securities

Hi. Thanks a lot. I appreciate taking the questions and congratulations on the solid quarter. You know you're really showing some nice improvements on access line trends and I'm wondering if you could provide some color on some of the puts and takes to the improved performance? Specifically I am wondering how impactful the expansion of IP TV has been as well as the competitive pressures that maybe abating in residential relocation activities? Thanks.

Bob Currey

Yes, thank you Michael. I don't think the competitive market has abated. There is still – there is not any major changes, but you know it is a war out there and I'm not ready to say or declared victory. The cable guys and the wireless guys are effective competitors. With that said though, we think we have got the right product set. IPTV does pull through certainly broadband, DSL, and we're starting to see, and it is not a big enough number yet to have a party with, but we are starting to see port outs or port ins come back the other way from some of our cable competitors. So that is a good sign.

I think the other bigger component for us though is aggressively putting our voice product back into the bundle. You know we are calling people that – who don't have our service now. We are calling people who only have our broadband product what we refer to as naked DSL, and so we have got some different strategies to try to get that voice line, if we can, back into the bottle and at least keep and establish the contact and relationship with that customer.

Michael Nelson – Soleil Securities

Great, that is very helpful. I appreciate it. Thanks. Good luck, guys.

Bob Currey

Thanks, Michael.

Operator

Your next question comes from the line of Donna Jaegers from D.A. Davidson.

Donna Jaegers – D.A. Davidson

Hi, guys. Thanks for taking the question. A few of them if you would. The tax rate dropped to 25.5%, can you sort of explain what was going on with that?

Steve Childers

Yes. Donna, this is Steve. In the quarter, we had some normal adjustments this time that we have every time this year. We finalized our –- the previous year tax returns and actually trued up the provision to the return. So there was probably seven or eight hundred thousand dollars kind of flowing through that way that were favorable throughout to us.

Donna Jaegers – D.A. Davidson

Okay. And then the IPTV adds, you had 1800, is that applicable over – I'm sure that is over your whole footprint but otherwise it looks pretty impressive over just the new increase in footprint. So can you talk a little bit about penetration rates that you're seeing with the new rollout of 18,000 homes?

Bob Currey

Donna, Bob. I'm not sure I followed the question. Is it spread out over our total three state territory, the answer is yes. There is homes we have passed homes in all three states, roughly in proportion to the access lines in that state.

Donna Jaegers – D.A. Davidson

So, the question is, and excuse me, I have been listened to too many earnings calls late into the evening, but the question was, on the 18,000 new lines that you rolled out with pair bonding, what sort of penetration are you getting in approaching those customers with IPTV? Or is it too soon, to too early to have any stats on that?

Bob Currey

There probably is a stat, but you got me. I have a follow-up with you Donna. I don't have that at my disposal right now. I'm sorry. I've know they are spread. We have had a little more success this quarter in Texas. But other than that, my guess is they are spread, but don't hold me to that. Let me get back to you with the precise answer to you.

Donna Jaegers – D.A. Davidson

Okay, I'll follow-up on that. Can you just talk a little bit about are you running any promotions now on IPTV or is that 1800 just sort of through word-of-mouth?

Bob Currey

No. We're running some promotions, we always are. There is no dramatic change. I will tell you though the pair bonding has been word-of-mouth because we've had some customers both running our IPTV service or our DSL service that we could not serve. And so they have heard from their neighbors or someone that that service is available. So the word-of-mouth has gotten out. We are very encouraged with that.

Donna Jaegers – D.A. Davidson

Okay. And then just the payment that you guys got from your cellular partnerships was a little larger than it has been in the past? What is your visibility on – is it going to stay at that level or will it drop back to a more normalized sort of 4 million a quarter level?

Bob Currey

Well, Donna, this is Steve. Last year, we received 17.5 million in total. We are running at a higher rate in that for 2009. And generally the distributions are fairly consistent although the second quarter is generally a little bit lower than what we expect for the other three quarters of the year. So I would expect fourth-quarter distribution to look very similar to what we received in the third quarter.

Donna Jaegers – D.A. Davidson

Okay, great. Thanks guys.

Operator

(Operator instructions) Your next question comes from the line of Dennis Weaver [ph] from Maverick Industry [ph].

Dennis Weaver – Maverick Industry

Hello?

Bob Currey

Hi, Dennis.

Dennis Weaver – Maverick Industry

Oh, hi. I got confused. Just a real quick question. Do you expect your S&P rating to increase in the near future?

Steve Childers

This is Steve. We just actually met with S&P and had a call with them the last couple of weeks. I think – I don't think there will be any ratings action at this time. We hope that as we continue to deliver great results and build cash, start paying back some of debt, that they will consider improving the rating, but I think it'll be just as it is for right now.

Dennis Weaver – Maverick Industry

Okay, thank you.

Steve Childers

You bet.

Operator

Your next question comes from the line of (inaudible) from Raymond James.

Frank Louthan – Raymond James

Hi, guys. It is actually Frank. Just real quick, looking at your the wireless box for IPTV, could you give us a little more discussion on that? What is the overall cost savings? Is it specifically just on the wiring or is the box cheaper and this can be the standard going forward? And then if you can also give us a little update on your thoughts and uses of cash, would you be inclined to do a buyback here, why or why not? Thanks.

Bob Currey

Good morning, Frank. I'll take the first one and Steve can take the second one. Just (inaudible) more worry than you question would warrant, but the wireless, what we're doing is, what we're calling our video relaunch, there is actually three technologies involved. And what they allow us to do, the three are bonding the pair bonding, a Ruckus Wireless device, and a new single set top box. And before I get to the cost, let we just described what it allows us to do. In a single apartment, one bedroom, somebody wants one telephone, one TV, we can now put that in with a $70 plus modem cost, we don't have to run a gateway which was running us nearly $600. So it gives us the flexibility to go into the single bedroom home, one TV, low-cost customer benefits. We save money. The wiring is very quick, et cetera.

Let's jump to the opposite extreme now where you have a home five or six TVs. We then run one Cat 5 to one TV, install the Ruckus Wireless device, and then the rest of the house is served from the Ruckus device, which does two things. One again a customer friendly install, they are not fitting there through a three or four hour install, these are taking about an hour. And secondly as we upsell them, they want additional HD streams, they want DVR, it's come down to the office, pick it ,up and take it home, plug it in. It is not a truck roll for us. So it is an incremental up sale, an incremental install.

Now, for your cost question, the old gateway into the home which had all the built-in features was roughly $600. And we're doing this per home roughly just over $200. So at the low end, we are saving quite a bit of money. At the high-end, it might cost us more, but it is built into the pricing plans, and we incrementally up sell, and add to the functions and features, that that customer wants, gives us much more flexibility than we had under the gateway when we were restricted to three streams into the home, I could now give somebody ten standard definition channels into the home over the 20 to 30 meg whichever we're providing. And all of that without wiring, one Cat 5 to one TV.

I hope that got it probably like – I've said more that you wanted, Frank. Steve, maybe on the use of cash?

Steve Childers

Frank, this is Steve. And to your question, we're fortunate to build quite a bit of cash in the third quarter for the earlier question and conversation of leverage ratios are showing some improvement quarter over quarter. So I think for right now, as we can look at where we are positioned, we look at the balance sheet, we'd obviously love to be able to recast the capital structure in conjunction with a acquisition down the road. So my preferred use of cash would be to go against an acquisition. But absent that not happening, I think right now, we are going to continue to try to balance the payout ratio and leverage and focus on delivering in the short-term. And from time to time we talk about the share repurchases, to have discussions with the Board, relative to that, but based on our limited flow, our desire right now is to focus on delevering.

Frank Louthan – Raymond James

And on acquisitions, we saw sort of a break in the trend here with Windstream acquiring a CLEC. Are CLEC properties attractive to you, is that something that you would consider as part of an acquisition, a pure play CLEC in your territories or would you just be looking at staying with the rural ILEC focus?

Bob Currey

Well, Frank, I think you are aware, we do have a CLEC in Pennsylvania and we like that very much. That is a great business model. We were – my team is blessed with a lot of CLEC experience. We launched residential and business over 10 years ago in Illinois. We like that. We like that business. So would we look at a CLEC? Yes, particularly where it surrounds our territory, makes some sense. We would certainly entertain a look at it. But we kind of like this smart build that we are doing in PA and also in Texas. We have gotten an edge out strategy in both Texas and Illinois where our IP network allows us to do is some smart things near territory and edge out that way. So it would be on the table. I would tell you though it would be – would have to make some sense and it would have to be near or complementary to our existing territory.

Frank Louthan – Raymond James

Great, thank you very much.

Bob Currey

Thank you, Frank.

Operator

There are no further questions at this time. I would like to turn the call over to Mr. Currey.

Bob Currey

Thank you. And thank you again for joining us today and for your continued interest and support of Consolidated.

Before I end the call though, I would like to publicly thank all the people that I work with for their accomplishments during this very challenging year. It is easy for me to get on these calls and discuss how well we service our customers as well as the financial and operating gains from consolidation and cost reductions. But I recognize it's the hard work, creativity, and energy of all of our employees in Illinois and Pennsylvania and Texas that make these things possible. So again thank you for joining us. Have a great day.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Consolidated Communications Holdings, Inc. Q3 2009 Earnings Call Transcript
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