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Consolidated Communications Holdings, Inc. (NASDAQ:CNSL)

Q2 2010 Earnings Call

August 05, 2010 11:00 a.m. ET

Executives

Noel Ryan - Director, IR

Mark Cox - EVP & CFO

Uzi Yemin - President & CEO

Fred Green - President & COO

Executives

Matt Smith - Director, IR

Bob Currey - President & CEO

Steve Childers - CFO

Analysts

Gray Powell - Wells Fargo Securities

Frank Louthan - Raymond James

Dave Coleman - RBC Capital Markets

Barry Sine - CapStone Investments

Donna Jaegers - D.A. Davidson

Operator

Good day ladies and gentlemen and welcome to the Consolidated Communications Holdings Inc, Second Quarter 2010 results Conference Call, (Operator Instructions). As a reminder this conference call is being recorded.

I would now like to introduce your host for today's conference Matt Smith, Treasurer and Director of Investor Relations, sir you may begin.

Matt Smith

Thank you Devin and good morning everyone, welcome to our second quarter 2010 earnings call to review the company's results that were released this morning. Joining me on the call today are Bob Currey, President, Chief Executive Officer and Steve Childers, Chief Financial Officer.

After the prepared remarks we'll conduct a question and answer session. I will now review the safe harbor provisions of the call and hen 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 and good morning everyone. We appreciate you joining us today as we review our results for the quarter. As is our normal practice, I will start with a high level financial and operating high lights and then Steve will provide a detailed review of the financials.

Second quarter of 2010 was another solid quarter for us revenue was 95.7 million and adjusted EBITDA 46 million. As we mentioned last quarter, the sale of our telemarketing business and the ongoing process to close our operator services unit will lower revenue, but be neutral to EBIDTA, when excluding the 1.8 million of the revenue reduction attributable to these businesses our overall revenue declined by less than 1% on a sequential basis.

With respect to our dividend, we continue to deliver a solid and secure return to our share holders as demonstrated by our pay out ratio, 70.6 for this quarter and 67.2% year-to-date.

Operationally, we continue to perform well despite the competitive and economic pressures, we increased our total connections for the third consecutive quarter and delivered growth of 4,150 connections year-over-year. This growth is lead by our broadband products, which fortify our competitive position in all three states.

We increased our broadband connections by 2,500 in the quarter, in what has historically been our softest quarter. This brings our total broadband customers to a 130,000 which represents a year-over-year increase of 12%. Our industry leading DSL penetration which is currently at 43% provide peer pricing points at various speeds as high as 20 megabits.

We have been successful in adding our IPTV service to our DSL customer base and the combination of our larger DSL penetration with our bundle pricing advantage provides us with substantial growth opportunities.

Currently, we penetrate 13% of the 198,000 homes that we pass with our IPTV service. We're driving higher ARPU through modest price increases and more importantly, through up selling HD and DVR as well as more video on demand programming. We see upside in this ARPU drivers as well.

With respect to access lines, we had another strong quarter. Our ILEC lines decreased by 2,400 or 1%. This brought our line loss rate for the last 12 months down to 4.8% compared to the 8% rate at this time last year. And this is the lowest rate we've had since the end of 2007 before our North Pittsburgh acquisition and positions us as one of the best in the industry. We feel this is the direct result of our success in providing attractive product bundles coupled with exceptional service.

Specific to the Pennsylvania CLEC business, this is the third quarter in a row that we have increased access line equivalents. And the key driver of this success is tied to our commercial, Metro-Ethernet data product, which can be either fiber or copper base.

The copper-based product was another positive that came out of our North Pittsburgh acquisition and we have been able to replicate it in our Illinois and Texas markets. We have increased the number of Metro E-circuits by 25% over the last year.

From a competitive standpoint, pricing continues to be rational with a variety of aggressive promotional offering, leading the acquisition battle. We're delivering the best products and services at a competitive price and continue to remain flexible with our marketing and promotional plans.

So, with those comments, I would now turn the call over to Steve for a financial review.

Steve Childers

Thanks Bob and good morning to everyone. This morning I will review our results and then update our 2010 guidance. Overall, we're pleased to report another solid quarter of financial results. Operating revenues for the second quarter was 95.7 million compared to 102 million for the same period of 2009. Of the 6.3 million period-over-period decline, approximately one-half was attributable to some of our telemarketing business in the first quarter of this year and the ongoing process that pay down our operator services division.

The 3.1 million revenue reduction from this business unit is neutral to earning. The remaining year-over-year fluctuation in our ongoing revenue streams consisted of the following. World calling, long distance and network access revenue were down by 3 million primarily due to lower access line. Subsidy revenue declined by 1.6 million, also as a result of access lines but impacted more or so by the increase in the Federal High Cost Fund, National Average Cost per Loop.

While National Average Cost per Loop is going up, our costs are going down.

Finally, revenues from broadband growth product increased by $2 million as seen in our data and the internet revenue.

Total operating expenses, exclusive of deprecation and amortization were 57 million compared to $62.2 million for the same period last year. The second quarter of 2009 included $1.8 million in integration and severance expenses as well as 2.7 in expenses from our telemarketing operations which as mentioned previously were sold in the first quarter of 2010.

Based on the 32% year-over-year growth in IPTV subscribers and the July 2009 re-launched of the video product, we incurred approximately 1.4 million, an increase programming video equipment cost. The remaining 2.1 million of saving are primarily due to cost structure improvements implemented throughout last year.

Net interest expense for the quarter decreased by 1.5 million to 13 million compared to the same period 2009, the improvement was driven by 67 basis point decline in our weighted average cost of debt, which was 5.61% throughout the second quarter.

Other income, net was 6.6 million, compared to 8.5 million for same period last year. For the quarter, we recognized 7.1 million of our pro rata share of earnings from our wireless partnerships which generated 6.6 million in cash distributions. In addition, we recognized 800,000 in losses from the disposal of assets primarily related to the sale of a building in our Butler, Pennsylvania market. Also in the second quarter of 2009, we posted a 1.8 million non-cash benefit for the resolution of an access dispute.

Weighing all these factors on a GAAP basis for the quarter, net income was 7 million and net income for common share was $0.24 per share, this compares to 7.5 million in net income, an income per share of $0.25 for the same quarter last year.

As detailed on the adjusted net income per share schedule in the earnings release, adjusted net income per share was $0.28 in the current quarter compared to $0.27 in the second quarter of last year.

Adjusted EBITDA was 46 million compared to 48.1 million in the same period last year. As I mentioned the second quarter of 2009 included a 1.8 million non-cash benefit from access dispute from it that was included in adjusted EBITDA. We are excluding that from our resolves, adjusted EBITDA was basically flat year-over-year. Capital expenditures for the quarter were $10.9 million.

From liquidity standpoint, our cash in the balance sheet during the quarter was 53.6 million which is an increase of 33.5 million compared to the same period last year. In addition, our $50 million revolver remained undrawn and we have no debt maturities until December 2014.

For the quarter, our total net leverage ratio as calculated in our earnings release was 4.38 times to 1. Our leverage and coverage ratios were well within compliance levels of the credit facility. Cash available to pay dividends was 16.4 million compared to 21.6 million in the same period of 2009, resulting in a very comfortable dividend payout ratio of 70.6%.

Now let me reaffirm all your guidance for 2010 CapEx, cash income taxes and then provide an updates our cash interest. Capital expenditures continued to be expected to be in the range of 40 million to 42 million. And cash income taxes guidance and change is expected to be in the range of 21 million to 23 million. Cash interest expense is now expected to be in the range of 49.5 million to 51.5 million which improves the midpoint of our previous guidance of 51 to 54 million by a $2 million.

With respect for our dividend, our board directors have declared the next quarterly dividend of approximately $0.39 per common share, playable on November 1st, 2010, the shareholders in record on October 15th, 2010.

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

Bob Currey

Thank you Steve, in summery we're pleased with our results for the quarter and all of our accomplishment so far this year. Our dedicated team continues to work hard to provide the best products and services to our customers and efficiently manage our expenses.

Together these actions result in strong and sustainable cash flows and support of our dividend and finally before we go to the Q&A, I have one other comment, on one last item.

Within the next few days, you'll see a filing that reflects a planed change in the Lumpkin family ownership structure. Since Mr. Lumpkin is the largest shareholder of Consolidated and the Chairman of the board, I thought it was important for you to understand the structure changes incurring.

These changes do not reflect any sale of consolidated stock by Mr. Lumpkin. Currently 14.2% of our outstanding shares are held in Central Illinois Telephone LLC or CIT for direct or indirect benefits of members of the Lumpkin Family. CIT was set up at the time of our IPL and its structure gives Mr. Lumpkin sole voting rights over the consolidated shares that it holds.

In order to permit state planning and financial flexibility for several members of the family, some of the CIT shares will be distributed out to family members or entities maintained for there benefits. After these transfers Mr. Lumpkin will remain our largest shareholder and voting power with respect to approximately 10.3% of the company's total outstanding stock.

This change in ownership structure is quiet similar to the one we notified you of last year, that involved other members of the Lumpkin Family.

So with that Devin I would like to open it up for questions.

Question-and-Answer Session

Operator

.

Thank you. (Operator Instructions). Our first question comes from Gray Powell of Wells Fargo Securities.

Gray Powell - Wells Fargo Securities

Guys thanks for taking the question, just a few. So access line trends continue to look pretty good, how much of the improvement would you say is due to the economy versus company specific initiatives, plus you've been running at a low 4% loss rate for the last two quarters. Do you think that level is the sustainable going forward?

Bob Currey

Good morning, Gray and thanks for the call. We're very pleased with the second quarter performance which did match our first quarter percent loss. It's more our internal efforts than the economy, we frankly aren't saying much on the -- particularly on the residential side we've seen a little stabilizing, at least the outs on the business have been mitigated and we're starting to see a little up tick there, but there is still tremendous pressure on he residential side as a result of the economy.

As far as going forward, in complete candor with you. We're ahead of some of our internal projections. We love to stay at this level or even be better obviously. But, our near-term target was in the 5% range. So, we're quite satisfied and we're going to do everything we can to keep that right where it is.

Grey Powell - Wells Fargo Securities

Okay. That's very helpful. And I guess, it does appear that broadband growth just for the industry in general, flowed in Q2. How should we think about trends in Q3 and should we expect just sort of the typical seasonal uptick that you've seen in prior years?

Bob Currey

Hello, you're spot on, identifying the second quarter as historically it would always be the softest quarter of the year. So, we would expect to see an improvement in the third quarter. From a broadband perspective, bifurcating that on our DSL, we're at 43% penetration rate and we still see opportunities above that 43%, particularly back to subscribers who no longer have our access lines. So, we've got a base to go out there I remind, but I want you to be aware that as those penetration rates rise, the low hanging is gone. The flip side of that, however, is on the IPTV. We are able to pull some of those broadband-only customers and attract them into our bundle with the value and the pricing of our bundle. So, we see upside opportunities from that standpoint.

Grey Powell - Wells Fargo Securities

Okay. And that makes a lot sense. And then one final question, I know you want to break out too many specifics on your IPTV economics. Can you give us a sense as to whether it's breakeven on an EBITDA basis today? And then just one of your longer-term targets for the business in terms of margins and penetrations? Thanks.

Steve Childers

Hey, Gray. Thanks for the question. This is Steve and I'll try that one. As we look at video and again, where the numbers aren't good, we're going to talk about are basically measuring on a stand along product basis. We still think it's the right strategic initiative to have videos as part of our triple play offering, as Bob just said, and having that offering, we think, has minimized access line losses as well as to have an increase throughput for our broadband product. So, when we talk about margins on all-end basis, it will be dilutive currently. We think, overtime, our 13% penetration, and we still think there is still a lot of upside. I think we've talked publicly in the past about getting the 30% penetration across all markets. We still think that's doable. We think a 30-40% gross margin on the product is doable. And we have a lot of opportunity, particularly with the re-launch that we just -- it's actually started last year, going from a Gateway set-top box saw a single stream -- we're actually seeing less than ARPU. People buying more of the single stream set-top boxes and are driving more HD content, DVR. We're seeing a nice increase on video-on-demand product. And then on the cost side of the relaunch, we're also able to really improve the customer experience because we're not having to reuse as much of the coaxial cable on the house and do as much of the wire. Installation time is quicker than the CP processes is. So, we think we have a lot of things going on in direction but we still have a lot more. We're trying to balance customer acquisition and retention with profitability going forward.

Grey Powell - Wells Fargo Securities

Okay, great. Thank you very much.

Operator

Your next question comes from Frank Louthan of Raymond James.

Frank Louthan - Raymond James

Great, thank you. On the IPTV I mean ended some a fairly low penetration for a while, I mean 13% penetration generally competitive video products have been able to easily capture north to 20% and in some case north of 30%, I mean what do you think we need to do to try and get that penetration up and is it product set issue that you need that you have what do you need to there from capital investment or is it a marketing initiatives, what are your thoughts on the process of increasing net to more of an industry kind of level of penetration?

Bob Currey

Frank, I'm going to start call you Frank Al because everybody has a little trouble with that last name but thanks for the question. First of all, we have some markets, Frank, the early markets that are very close to 30% and we think that should be the targeted range. We're stepping up, let me describe it as a two-pronged project that we're doing.

One is on the churn. Churn, we've seen a little bit of an uptick in churn and so we've stepped our churn mitigation efforts on the front end, we're working with people on terms that lower the non-pays reduced the non-pays and very actively going back in before contracts expired, people under one-year, two-year contract but probably the most important thing that we've done is over the last year, we've developed a comprehensive marketing database and it's allowing us to map our customers to better target customers to the high-value profitable customers.

We need to balance growth versus profitability. This new database gives us so much better look and different slices of our customers while income aged, propensity of the churn, propensity to buy additional products and sort of these. So not only does it assist us in our target marketing but it also allows us most importantly to measure the result of those activities.

So it's a combination things as I said in my introductory comments, I think the 100,000 DSL customers that we have gives us a tremendous opportunity to go back with our product. I also mentioned in the past that when we launched this product, we really want competitive, we didn't have HD, we didn't have DVR, we didn't have VOD, a recent example of the video-on-demand product, we were running about a dollar per subscriber.

Three-four months ago, we increased that product, offering more channels, we introduced the barker channel that shows the new titles that are available and we (inaudible) that just in four or five months from barker sub up to $3 a sub.

So I think product enhancement marketing, database and churn efforts give us a tremendous opportunity to grow that product.

Frank Louthan - Raymond James

So what was churn running and has that come down materially and then do you think that there's a reeducation process you need to go through? Do you think that there - some of the initial - the initial product launch people still have that impression that you have an inferior product when in fact you've gotten it up to par? I mean what do you think is sort of the issue there?

Bob Currey

Well, I don't -- I'll take the latter part of that, I don't think that they had an opinion that we had an inferior product. There were people who would not take our product because we didn't have DVR or you were limited to only one HD channel and we didn't have the 50 HD channels that we had today so there wasn't variety, but again back in those talks in the past about bonding and deploying fiber beeper, they can get three simultaneous HD channels today, so I don't think it was perceived as inferior as much as we probably weren't just proud of our product as we needed to be.

Also talked about some interoperability issues, trying to get all the vendors working together, we've had tremendous progress in -- working on that issue and in fact in test mode, in a couple of hundred homes today, we've not introduced a new set-top and a gateway in to the home by a second vendor and you get the second vendor, you not only get the price competition, but you also get quality -- a lot more focus on the quality.

Specifically, to your first question about the churn, there was an uptick in churn. About 20 to 25% I would say Frank and a lot of it, when we do our studies and ask why, it was around -- the highest category is moving people moving out of the territory, there was not a lot of service churn and it was non-pay and that's why we're working with the customers on the non-pay issue.

We don't have a bad debt problem, we manage that very, very closely but we have seen the pressure of the economy and the job losses impact our IPTV product.

Long winded answer, I hope I got to all of them, sorry to ramble on so long.

Frank Louthan - Raymond James

No, that's helpful, just two -- quickly a follow up, what are CPE costs running now per subscriber versus 12 day - 2 months ago, or how much -- how is that pricing competition vendors helping you and then of the 43% of customers that you have broadband penetration, how many of those are broadband only, that you could circle back with an IPTV marketing product as well, thanks.

Bob Currey

On the pricing, Frank, you know the old in-home all in was $550 in that range. The new one, the flexibility with the re-launch that gives us an opportunity, on average it's still around 500 but the benefit is, you can tailor it to the need of the customer and all in the home if you include HD capability and DVR capability, it's roughly $250, it's $70 for the Ruckus device in the set-top of approximately $130.

So then your adding on as want more functionality, more DVR, more HD. It gets back up close to the $500 range if you got three sets and a -- a minimum of three sets and your taking HD.

Regarding the question on the DSL, I'll call it naked Frank, I think your question was how many DSL subscribers take no other service, IPTV or voice; it's about 10% of our DSL subscribers or roughly 12,000.

Frank Louthan - Raymond James

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Dave Coleman of RBC Capital Markets.

Dave Coleman - RBC Capital Markets

Thank you. Steve, I was just wondering if you could, I guess, explain the reduction in interest rate -- I am sorry interest expense. That's astute to hedges rolling off in the second half of the year. And then just to follow on to that, what's the expectation is for additional interest rate hedges to expire in 2010 and '11, what your strategy is whether to hedge more of your credit facility or just let it float? And then just on the wireless JVs, I am just wondering if you have any insight as to where things stands as far LTE rollout in those markets and how much of a drag that's been on the contribution to partnership income. Thank you.

Steve Childers

Good day. This is Steve. And thanks for your question and you may have to prompt me here on this. Let me start with the wireless, first. First of all, for the quarter, on a year-to-date basis, we received a cash distribution from the five partnerships of just a little bit over 13 million for the first six months. That compares to a total of 22.4 for all of last year. Those distributions -- they are all in different phases of their rollout and data, build outs and everything. But our contribution or distribution to us always net of CapEx after they've already made those investments. And again, we're one of the partners.

We're not helping them manage the business. But the insight that we have. We might expect based on the accelerated distributions for the first half of the year. We might expect some modest reduction over the last half. We hope the gross continues at the same pace. But we definitely expect more than what we have received last year. So, I guess, that answers your question as we're seeing a lot of reduction of impact on the cash distribution to us because of the rollout of Verizon data products in those markets.

With respect to your hedges, the question on the interest rate reduction, we did show a nice reduction in interest expense for the quarter. That was because again, just the un-hedged rate or the variable rate continues to drop as well as the impact on hedges. Historically, we've been at 70-75% or maybe a little bit more in a hedge position.

We have had some of those roll-off at the end of last year. Actually, as you all see, we have filed our Q probably on Friday that we did and to a forward-looking swap at the end of the year for 175 million that rolled off, again a very attractive rate to hedge that. And we're also looking at hedges that roll-off for about 200 million at the end of 2011.

We actually entered into interest rate hedge at the end of July or in the Middle of July for 100 million of that and again we just are continuing to explore and monitor rates and see where we end up on that.

Because our effective hedge rate today is probably a little -- probably 4% plus. Even the forward-looking hedge rates today are 0.5 or whatever. So, very attractive rates today and will continue to monitor the market.

Dave Coleman - RBC Capital Markets

Okay. Great, and then just going back to the wireless JVs. Any sense as to how much the LTE spend has been in those markets and if that 13 million of distributions that you've received, what would that you have been without an LTE spend this year?

Bob Currey

Dave, we don't have that information, but we were told when they gave us the forecast at the beginning of the year that their projection of dividends included the LTE build outs that were planned for this year. So I think that's why Steve is so confident about the distributions that we've received and what we'd expect to receive in the last half of the year.

Dave Coleman - RBC Capital Markets

Okay, great. Thank you.

Operator

(Operators Instruction). Our next question comes from Barry Sine of CapStone Investments.

Barry Sine - CapStone Investments

Good morning, gentlemen. First, I guess this question is for Bob. Questions surrounding the dividend, obviously, I guess 149 days from now, the top dividend tax rate jumps from 15% to 43%, so, the question is the Board looking at that and if that stays, if there's no change in that current policy. Is the Board prepared to do something fairly dramatic so around the dividend like eliminate the dividend and move to share buybacks of debt reduction. What's you're thinking in terms of reacting to higher dividend tax rates? And then my other question would be if we can just get an update on terms of what the status of the economic activity surrounding the future product in Mattoon, thank you.

Bob Currey

Thank you Barry and good morning to you all sales. There's still so much uncertainty about what's going to happen with the tax changes. In the upcoming election, this morning that at least the TV stations all is looking tons of discussing about extending or not extending element, when you're going do this such or so. You know I think there's distance -- there's so much uncertainty about what the ultimate changes would be. Specifically to our dividend thought, our Board makes the decision on dividend strategy but we don't expect, I don't expect any change in that kind of strategy and we're just as committed to our dividend regardless of the potential impact of rate changes.

Regarding FutureGen, BOE has publicly announced that it supports that effort with a $1.1 billion in financing and we continue to expect an announcement any day and as we've told you in the past. This is the first coal-fueled, near-zero emissions power plant and its shovel-ready which of course the administration talked about they wanted those kinds of job. It's estimated that it will produce 3,000 construction yards. So if there's a shovel-ready tarp project that's slated to be funded, this is one and we remained optimistic.

Barry Sine - CapStone Investments

Okay, thank you.

Operator

Thank you. Our next question comes from Donna Jaegers of D.A. Davidson.

Donna Jaegers - D.A. Davidson

Hey, guys. Bob, I just got a question on the regulatory scene since you're fairly plugged in on that. What do you - can you talk a little about vouchers bill USF reform and what you see the FCC really - how you see them moving forward and the timing?

Bob Currey

Well, yeah. Good morning, Donna. I wish I knew instead of just speculating but let me attempt to answer you that. There's still -- it's probably even more confusing and hard to predict than the answer I just gave on taxes. There are so many unknowns before we get to a final outcome. I think that November elections will have a big impact on that, but with all that said we are involved, we support the reform, we wish that the SEC and hope the SEC would act on some of the things that they say they could act on without comprehensive legislation.

Phantom traffic, voice being included in the broadband support of new pools, voice costs and limiting the wireless sector, with all that said though we still continue to support the reform, we hope that it happens, but my best guess would be mid to late 2011 before we see anything and then under the current structure, the transactional periods that are being talked about, while we would have some exposure, we think with those transactional periods and our ability to influence it and make it a better bill that we would be able to manage our exposure and adapt our business model.

Donna Jaegers - D.A. Davidson

Great and then just, you mentioned earlier on the cable competition, you didn't see anything irrigational. Are you saying, your cable competitors rolling docks in your service areas and marketing aggressively on the on those higher speeds?

Bob Currey

Yes, they are doing both, I think -- but we've had this -- you know they've tried to make the speed issue since day one and we've been able to negate that. We go all the way up, we've got a 20Meg product, we have a 100 people taking it.

Our customers are very happy with our three and six tire products, but we have the ability to go higher. What they are generally doing, they're advertising it and -- but there really isn't any special pricing, everybody's still generally around the $100 for the tripe play, they play a little game with the fine print, there's always a great headline price and then if you read the fine print they have the ability to modify the price during the terms of the contract etc.

So it's the same, maybe a little bit more with the DOCSIS, but we're -- we think we're in good shape to compete with the product offerings that we currently have at the price points we have them.

Donna Jaegers - D.A. Davidson

Good, thanks Bob.

Operator

Thank you, I'm showing no further questions at this time sir.

Bob Currey

Well thank you Devin and thank all of you for joining us today and for your continued interest and support to Consolidated Communications, we hope to talk to you and that you'll join us again next quarter, thanks and have a great day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference, this concludes the program, you many all now disconnect.

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