Citizens Communications Q3 2007 Earnings Call Transcript

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Citizens Communications (CZN) Q3 2007 Earnings Call November 6, 0000 3:00 AM ET

Operator

Good day, everyone, and welcome to the CitizensCommunications third quarter conference call. This call is being recorded. Atthis time, I would like to turn the call over to Mr. David Whitehouse. Mr.Whitehouse, please go ahead, sir.

David Whitehouse

Thank you, James. Good morning. The purpose of this call isto discuss 2007 third quarter results for Citizens Communications, which werereleased this morning. If anyone needs a copy of the materials, please contactLisa Lombardo at 203-614-5064. We anticipate the Form 10-Q will be filed laterthis week.

On today’s call are Maggie Wilderotter, Chairman and ChiefExecutive Officer; and Don Shassian, Chief Financial Officer.

During this call, we’ll be making certain forward-lookingstatements, in particular on matters related to 2007 results and estimates.Please review the Safe Harbor language found on our press release and SECfilings.

On this call, we’ll be discussing GAAP and non-GAAPfinancial measures as defined under SEC rules. In our earnings release and onour website, czn.com, we have provided a reconciliation of non-GAAP financialmeasures to the most directly comparable financial measures calculated andpresented in accordance with GAAP. Please refer to this material during ourdiscussion.

I will now turn the call over to Maggie.

Maggie Wilderotter

Thanks, David. Good morning, everyone thank you for joiningus. Citizens Communications had a solid third quarter of 2007. Revenues for thequarter were $575.8 million, our operating margin normalized after excluding a$12.1 million severance charge, was 54.9% due to increased expense control, andcapital expenditures for the quarter were $90.9 million. Capital spending istraditionally higher in the second half of the year as we are able to completemany projects with favorable weather conditions.

All of these factors resulted in free cash flow generationof $118.9 million. We have achieved a dividend payout ratio of 60% for thefirst three quarters of the year. Don Shassian will elaborate on the financialsfor the quarter, including details of our commonwealth acquisition synergiesand our closing of the Global Valley acquisition.

Global Valley is a great tuck-in acquisition for us. The15,000 access line operation is located in four markets in Northern California,specifically in the Patterson and Livingstone areas of the Central Valley andcontiguous with our Elk Grove and Susanville markets. These properties continueto have access line growth.

We received approval from all regulatory entities, includingthe California Public Utilities Commission, in less than four months, whichenabled us to close on October 31st. We had anticipated a six- to nine-monthregulatory approval process so we are very pleased to close Global Valley injust three-and-a-half months from announcement.

This acquisition is cash flow accretive on day one. Thereare some small operational and system synergies that we will leverage, but wealso believe we can grow revenues in these markets by layering in our digitalphone product, our dish network triple play product, and our commercialbundles. Our west region is managing the integration effort.

During the quarter, we have made great progress integratingour Pennsylvania properties. Since we closed on the commonwealth transaction inearly March, we have streamlined the organization structure, removed[inaudible] management, consolidated sales teams for the ILEC, the CLEC, andthe equipment sales into one core team, have sold a large portion of theequipment business to Share Technologies, and completed all system conversions,including financial, human resources, and billing.

We completed our billing conversion ahead of schedule inSeptember so we would be prepared to off all of our fourth quarter promotionsthroughout the Pennsylvania properties. We are well on our way in achieving the$30 million in reoccurring annual synergies.

During the quarter, our high-speed data customers increasedto 497,241. Our company wide average revenue per high-speed customer continuesto be over $40, and residential broadband penetration increased to 30%. Ourtotal net adds were 17,900, up over the previous two quarters. We were verysuccessful with a dial-up conversion program and we converted 7,855 dial-upcustomers to broadband during the quarter.

Once again, we were surgical in our Q3 promotions andoffers. We focused on dial-up conversions and a jump start program in marketswhere we turned on new high-speed elements in neighborhoods.

In addition, we used aggressive price points in a few keymarkets [with] cable launch telephone service. We did not run any new massmarket promotions during the third quarter.

Even with this segmented approach to promotions, our averagedaily high-speed sales were the highest of all three quarters this year. Wewere up 6% over Q1 high-speed adds and 20% higher than Q2 performance.

Our digital phone offer continued to gain strength in thethird quarter. This national product bundle, which we rolled out in the fourthquarter of 2006, includes local and either unlimited national long distance orunlimited statewide calling. There are four key features included in thispackage and the customer receives digital phone for a very competitive monthlyprice. We now have 277,559 residential customers, or 19% penetration on thisbundle in less than a year.

In mid-September, we have now launched a business digitalphone package for our small and Soho customers. We have started to aggressivelypromote this package throughout our markets this quarter.

We believe digital phone is a strategic weapon in themarketplace to fight against access line losses to competitive alternatives,like cable phone offerings or wireless.

Access line losses for the quarter were 42,100. While thisnumber was higher than the previous quarter, there are several factors for thisincrease. First, we converted dial-up customers to broadband. Second, we arenot seeing any material increase in access line losses to competition in ourmarkets, but we have seen the decline in access line growth adds. One of thefactors is a slowdown in housing sales in our Arizona and California markets,along with mortgage foreclosure issues in several states.

In addition, we did clean up company used lines this quarterand we also implemented a rate increase for certain customers in Rochester, sowe had anticipated a spike in access line losses resulting from this increase.That spike had settled down in September but it did affect the overall numbersfor the quarter.

We continue to have a priority focus with may initiativesunderway to help improve our net access lines.

Finally, on the product front, dish sales remained strong.Our total customers with dish is now 86,400, with approximately 33,500 salesthus far this year. In partnership with EchoStar, our Q3 offers included a DVDpackage and a high definition package.

I want to touch on the fourth quarter promotions that we arerunning in our markets. As many of you know, the fourth quarter is a big retailquarter for our industry and key promotions give us the opportunity to takeadvantage of this selling season.

We were very pleased with our two aggressive offers lastyear, a free Dell PC offer and a free year of DISH network. We have seen a goodpayback on these offers and strong retention of these customers.

This year, we did some further analysis on PC ownership inour markets. Nationally, 78% of households own a PC. In our footprint, thatnumber is 63%. Through several sources, we were able to estimate PC ownershipat the market cluster level. We have launched a free Dell PC offer in thosemarkets in our footprint that have 65% or less PC penetration.

In many of our markets, close to 40% of our customers do notown a PC. We are bundling digital phone, high speed, and the free PC inexchange for a two-year commitment for new customers and a three-yearcommitment for existing customers.

In the markets with more than 65% PC penetration, we areoffering a free year of the DISH family package and free local channels inexchange for a new customer signing up for a two-year commitment to ourConnection Triple Play bundle and a three-year commitment for existingcustomers on the Triple play.

We also have a high-speed offer in these markets thatincludes a free digital camera and a $50 gift certificate for an online photoservice. All three promotions were launched October 1st and we are seeingstrong results thus far.

I want to reiterate that our philosophy is to use promotionsto push market share for both high speed and video. We find that churn isreduced with multiple products in our bundles. We also protect our reoccurringrevenue stream when we utilize aspirational gifts as our offer versus justlowering monthly prices. As I mentioned, our average high speed revenue peruser remains over $40 per customer.

On the operations front, we completed our call centerconsolidation in the third quarter. We closed two call centers in Rochester,New York and Kingman, Arizona. I am pleased that we were able to keep 85 of ourseasoned reps in these two centers through our work-at-home program. Our Delan,Florida; Burnsville, Minnesota; and Dallas, Pennsylvania call centers arehandling all of our customer service calls and they share a universal queuewith our 180 work-at-home representatives.

As I mentioned last quarter, work-at-home now representsabout 20% of our customer service workforce. Their numbers are also impressive.The work-at-home team has the highest revenue per call and the lowest averagehandle time.

During the third quarter, we successfully ratified four keylabor contracts, including our two contracts in Rochester, New York. To date,we have ratified 14 contracts this year, covering over 1,500 employees. Thesecontracts provide needed operational flexibility and expense savings over thethree- or four-year terms of these agreements. We still have one remainingcontract to negotiate this year.

The national moves and transfers program continues to gainmomentum. In Q3, AT&T launched their first market in the program. All ofVerizon’s markets are now launched, as well as markets with Quest, Embark,Century Tel, and Windstream. The remaining companies and market expansion willcontinue in Q4.

All of us are committed to a cohesive program managementapproach in 2008, so we can ramp this channel and leverage it for new customeradditions.

Shifting over to new products, here is the latest update onour wireless data launches. We are up and running in nine municipalities, withfive anchor tenants and 20 hot spots. We turned on service in Burnsville,Minnesota; Fort Dodge, Iowa; and Wilkes-Barre, Pennsylvania.

We added two colleges and one city as anchor tenants duringthe third quarter: Blackburn College in Shepardstown, West Virginia; WilkesUniversity, and the City of Wilkes-Barre, both in Pennsylvania.

We are also actively building four more municipalities forlaunch in Q4: Elk Grove, California; The City of Rochester; Pittsford, NewYork; and Griese, New York. We plan to launch six more key anchor tenants inthe fourth quarter, including King’s College in Pennsylvania and several hotelsin our markets.

Our strategy for wireless data is to supplement ourcustomers for both consumer and business high-speed offerings with WiFi in keymarkets. We also get to create three new data revenue streams; subscriptionrevenues from existing customers, casual use revenue from hour and day passes,and anchor tenant monthly reoccurring revenues.

We will have 13 municipalities built by the end of this yearwith a dozen anchor tenants and close to 40 hot spots.

Here now is Don Shassian, our Chief Financial Officer, togive you the financial overview of the 2007 third quarter.

Donald R. Shassian

Thank you, Maggie and thank you, everybody, for joining usthis morning. Before I get into a discussion of the quarterly highlights, Iwould like to remind everyone that we closed the Commonwealth Telephonetransaction on March 8 and accordingly, have consolidated the results ofCommonwealth, or as we call it our new Pennsylvania property, since March 8.

In order to facilitate our investors’ insight to andunderstanding of the impact that our new Pennsylvania property had on ourquarterly financial and operational results, we have once again attached to ourpress release additional schedules that break out the legacy Citizens financialnumbers and operating metrics from the new Pennsylvania property numbers.

We had another solid quarter with strong revenues, EBITDA, oroperating cash flow, and free cash flow. Quarterly revenues of $575.8 millionwere up 13.5% and included $80.5 million from our new Pennsylvania property.Excluding that increase, our quarterly revenues were $495.3 million,essentially flat when compared with our second quarter of this year. Excludingour Pennsylvania property, third quarter revenues were below last year’s thirdquarter, primarily due to lower subsidy revenue.

Our reported EBITDA margin was 52.8% for the quarter;however, our normalized EBITDA, after excluding a $12.1 million charge fortermination and severance costs, was 54.9%.

Free cash flow was $118.9 million for the quarter. Ourdividend payout ratio for the quarter was 70% and the business generated $35.6million in cash in excess of our dividends for the quarter.

For the nine months ended September 30, our free cash flowwas $422.7 million. Our dividend payout ratio was 60%, and the business hasgenerated $168.6 million of cash in excess of our dividends.

During the third quarter and into November, we accomplisheda number of financial related initiatives. First, during the quarter werepurchased 10.5 million shares for $148.4 million, which brought the totalrepurchase program through September 30 to 15.1 million shares for $219.1million, which was approximately 88% of our $250 million authorized program. Wecompleted the remainder of this program in mid-October.

Secondly, during the quarter we retired approximately $31million in industrial revenue bonds and [rural] utilization debt. As you know,our next significant debt obligation on our maturity ladder is not until 2011.

Third, on October 31, we closed on our acquisition of GlobalValley Networks for $62 million in cash. Global Valley has approximately 15,000access lines and operates in the towns of Patterson, Livingstone, San Antonio,and Guinda in Northern California. It is a great property providing excellentcustomer service to a geographic area that has had 3% to 5% access line growththe past two years. It has solid EBITDA margins and the purchase pricerepresents 7.5 times multiple of trailing EBITDA.

Fourth, in July we sold a portion of the equipment businessthat we acquired in the Commonwealth transaction. This was a sale of customercontracts in the southern and southeastern portions of Pennsylvania, while westill retain all of the customer contracts in Wilkes-Barre, Scranton, and Lehigh Valley areas. The sales price equates to one timesrecurring revenue and was less than $2 million.

Now let’s discuss Q3 results. Our revenue for the quarterwas up 13.5% compared to last year’s third quarter. Our Pennsylvania property’srevenue in the third quarter was $80.5 million, which was slightly below lastquarter due to some switched access disputes and the sale of a portion of theCPE business I just mentioned.

Excluding the impact of our new Pennsylvania property, ourrevenue decreased $11.9 million, or 2.4% from third quarter 2006, but was flaton a sequential basis. We continue to experience strong growth in data and non-switchaccess revenues, offset by reductions in federal and state subsidies and localrevenue.

Our average revenue per access line for the quarter was$77.31, which is up 1% over last quarter. Excluding our new Pennsylvaniaproperty, our quarterly average revenue per line on a monthly basis was $80.37,up 3.3% over last year’s third quarter ARPU.

Quarterly data and Internet revenue of $133.9 million was up22.6% over last year’s third quarter. Data and Internet revenue from our newPennsylvania property was $11.5 million, which is up over last quarter.Excluding the new Pennsylvania property, our third quarter data and Internetrevenues of $122.4 million increased $13.1 million, or 12% compared to lastyear, due to a higher volume of high-speed Internet customers and high capacitycircuits like DS1s and DS3s.

On a sequential basis, our data and Internet revenue was up$1 million, again on higher volumes.

Local service and enhanced services revenue of $231.2million was up 13.9% compared to last year’s third quarter. Local revenues fromour Pennsylvania property was $36.2 million, essentially flat with lastquarter. Excluding the new Pennsylvania property, our third quarter localservices revenue of $195 million decreased $8 million as compared to the thirdquarter of 2006, primarily due to the loss of access lines. On a sequentialbasis, our local revenue was down $1.2 million on fewer lines.

Access service revenue of $113.1 million was up 7.8% overlast year’s third quarter. Access revenue from our Pennsylvania property was$20.3 million, which is down sequentially $2.4 million due to some carrieraccess disputes.

Excluding the new Pennsylvania property, our third quarteraccess service revenue of $92.9 million decreased $12.1 million as compared tothird quarter of ’06. That decline was driven primarily by lower subsidy and toa less extent, lower switch minutes of use.

On a sequential basis, our access revenues increased $2.1million, primarily due to the fact that last quarter had an unfavorable true-upresulting from local switching support fund.

Other revenue of $21.4 million was down 5.2% compared tolast year’s third quarter. Other revenue from our Pennsylvania property was$3.9 million, which is below the prior quarter due to the sale of a portion ofthe CPE business. Excluding the new Pennsylvania property, our third quarterother revenue of $17.5 million decreased by $5.1 million compared to lastyear’s third quarter, driven by higher un-collectibles, our free TV promotioncredits in certain markets, and a decrease in roaming minutes associated withour Mojave wireless partnership.

On a sequential basis, our other revenue was down $2.6million, driven by higher un-collectibles and a decrease in roaming minutesassociated with our Mojave wireless partnership.

As Maggie mentioned, we increased our Q3 marketingactivities, incorporating some additional promotions and incentives. The resultfor the quarter was the following: 17,900 new high-speed net adds; 27,800 newnet bundles; 5,400 new net video customers; 55,400 new digital phone andunlimited state calling customers.

With respect to high speed, we added 17,900 high-speed datacustomers during the quarter, which brought us to approximately 497,200high-speed Internet customers at September 30. Our high-speed penetration rateis 20.2% on total access lines and our residential high-speed penetration isapproximately 30%. Both of these numbers are slightly diluted by thePennsylvania property, whose penetration rate on total access lines is 13.3%and on residences is 27.3%.

We are making good progress in increasing the high-speedpenetration in Pennsylvania as our product mix, pricing distribution channels,and overall marketing are demonstrating strong results.

Most importantly, as Maggie mentioned, our ARPU forhigh-speed remains above $40 per month per customer.

During the quarter, we added 27,800 new bundle customers,which brought our total bundle customers to 620,800 at September 30.Penetration rate for our bundles is 25.2% of total access lines. This rate isalso diluted by our Pennsylvania property, whose bundle penetration rate isonly 14.8%, but is growing quite nicely as we introduce our bundle packages,specifically digital phone. We have achieved nearly 18,000 Pennsylvania customerssigning up for this unlimited national voice product bundle.

During the quarter, we added 5,400 new video customers,which brought our total video customer base to 86,400 at September 30. Theresidential penetration rate for video is 5.8%.

Our access line losses were 42,100 during the third quarterof this year, which is up 7,300 compared to second quarter. On an annual basis,our access line losses were 5.1%. Primary residential line loss for the companywas 32,000, which is up approximately 4,500 compared to last quarter. Oursecond line residential losses were 4,900, which is up 500 over last quarter aswe continue to aggressively promote our dial-up to broadband program. Businessline losses for the company for the third quarter were 5,200.

In addition to seasonality losses that we experience as someof the vacation locations in our properties, we also had a spike in line lossesin Rochester after a planned primary line rate increase and we have continuedto experience some line losses based on housing vacancies and a stagnant realestate market in California and Arizona.

From a competitive viewpoint, 57% of our access lines are inareas where alternative wireline voice providers, or VOIP, are available. Thatis slightly up compared to last quarter as Comcast has rolled out voice in ourElk Grove, California market and Time Warner has rolled out voice in the oldAdelphia properties in New Yorkstate.

On the expense side, we continue to demonstrate veryeffective cost management. Our reported EBITDA margin for the quarter was 52.8%.As we disclosed in a press release on October 3, we recorded a $12.1 millioncharge for severance and other termination costs related to our call centerstrategy, early retirement for some field operations personnel, and some othermatters. Excluding this charge, our normalized EBITDA would have been $316.1million and our margin would have been 54.9%. Our Pennsylvania property’sEBITDA margin for the quarter was 56.8% when excluding our corporateallocations.

Excluding all charges for severance and termination costsand excluding integration costs from our acquisition, our other operatingexpenses had decreased nearly $8 million as compared to last year’s thirdquarter and over $11 million when comparing the first nine months of ’07 to’06.

With regard to the CT integration, our financial systemswere installed for the Pennsylvania property effective July 1 and our billingsystems were converted in September. Through the third quarter, we haveachieved over $21 million in annualized cost savings. Our previously announcedestimated annual synergy target of $30 million to be achieved in three years ison plan and we are confident that we will achieve these savings as originallydisclosed.

Our capital expenditures in the second quarter were $90.9million, which is up compared to second quarter and includes $11.3 millionrelated to our new Pennsylvania properties. Our capital expenditures throughSeptember were $202.6 million, including $24.2 million pertaining to the newPennsylvania properties. Our capital spending will continue to ramp through thefourth quarter. Our spending continues to be focused on initiatives whichutilize a return on investment criteria and our focus on our growthopportunities and our competitive position in the marketplace.

As for 2007 expectations, we continue to believe that ourcapital expenditures will be between $315 million and $325 million, and ourfree cash flow will be between $500 million and $520 million.

You will note that our cash taxes through the third quarterwere $53.7 million, and after completing the filing of our new Pennsylvaniaproperty’s 2006 tax return and our Citizens 2006 tax return, we estimate thatour cash taxes for 2007 will approximately $60 million.

In closing, we have a very positive outlook for the futureperformance of our business and its ability to generate free cash flow. Theintegration of our new Pennsylvania property is going great. We expect to beable to keep our annual dividend payout ratio below 70% even when we become afull cash taxpayer in 2009 while maintaining a reasonable level of leverage.

Thank you for your interest. Operator, I would ask you toplease open this up to questions.

Question-and-AnswerSession

Operator

(Operator Instructions) We’ll take our first question from Tom Sykeswith Lehman Brothers.

Tom Sykes - LehmanBrothers

Thanks for taking the question. Can you tell us where youare at with respect to offering a home zone like box for video service,integrating the ability to download information from the Internet and then playit over on your DBS offering?

On top of where the equipment is at, can you tell us ifthere are any sort of changes to how you might contemplate the revenuearrangement with DISH if you do proceed with such a box? Thanks.

Maggie Wilderotter

Let me take a shot at the home zone product. We are indiscussions with EchoStar about the home zone box. They are doing a newgeneration of this box, which is something we’re waiting for. We believe thatbox will be ready around the first part of 2008, and then we will start to testthat box.

We are very excited about it. We think it’s a greatopportunity for us to be able to deliver in the home both linear televisionfrom the DISH network as well as streaming video and content from the broadbandnetwork. And by having one box with one user interface, it makes it very easyfor the customer to use that television set as an appliance for bothcapabilities.

We have not gotten into all of the revenue back and forthwith EchoStar, but in preliminary discussions with them, if there is content wewant to put up, we would be able to collect dollars on that content. I think EchoStarwill also probably make certain content available from a broadband perspectiveand then we would talk about how the revenues work from there.

In addition, we’ve also been part of an ancillary team toAT&T on their home zone launch, and we have several of the home zone boxes inour lab in Elk Grove that we are testing as we speak, so we really do believethat with our network build in that three to six meg range, there’s plenty ofcapability to offer this type of a combo box in many of our markets in 2008.

We’re hoping it’s going to be third or fourth quarter ofnext year but it really just depends on when the new box comes out.

Tom Sykes - LehmanBrothers

Thank you very much.

Operator

We’ll take our next question from Chris Larsen with CreditSuisse.

Chris Larsen - CreditSuisse

Thanks. Two questions, if you don’t mind; you talked alittle bit about the business access lines you lost. Can you talk about who youare losing those to? I imagine there’s not a lot of wireless substitution goingon there.

Second, Don, do you have a sense for where cash taxes mightbe in ’08 as opposed to ’07? Thanks.

Donald R. Shassian

Chris, on business line losses, the increase -- we had anincrease in business line losses this quarter over last quarter and it actuallywas not so much on the competitive side. There was one major ISP in thePennsylvania CLEC that we lost. We knew that was going to happen many, manymonths ago. And we also had fewer CLEC adds in the Pennsylvaniaproperty as we have refined our approach on that CLEC property. As you mayrecall, we’re looking to really own the geographic build that exists, nottrying to expand that geographic build, so we’re trying to focus on customersin that area and really not reaching out further. So we are trying to harvestit a little bit better than it was before, utilizing the CapEx investments.

So the decrease was some fewer adds -- out of the 2,400increased losses of business, 1,600 were on the CLEC side, on the Pennsylvaniaside, and another 800 who truly was us doing it to ourselves. There’s some own-- our own official accounts lines used for internal purposes that we cleanedup and groomed and took away, so we really didn’t see an increase in businessline losses during the quarter coming from competition.

On the cash taxes, Chris, ’08, the guidance I’ve given outpreviously of 30% effective tax rate on a cash basis is still a good targetednumber.

Chris Larsen - CreditSuisse

Thanks a lot, Don, appreciate it.

Operator

Our next question comes from Jonathon Chaplin with J.P.Morgan.

Jonathon Chaplin -J.P. Morgan

Thanks. I’m wondering if you could just remind us what thesubscriber acquisition costs are for the PC and DISH offers and how thosecompare to your typical subscriber acquisition costs. And then I’m wondering ifyou could just give us an idea of how much you realize in synergies, if any,from the CT acquisition this quarter. I’m just wondering how much of the marginincrease you saw came from synergy realization.

And then forgive me if you mentioned this earlier on thecall, but now that the share repurchase program is done, when should we expectan announcement on when you re-up that or uses of cash for next year? Thankyou.

Maggie Wilderotter

What I’ll do, Jonathon, is I’ll talk about the subscriberacquisition costs and the share repurchase and I’ll have Don actually talk alittle bit about the synergies for the quarter based upon Commonwealth.

We have not disclosed our subscriber acquisition costs withregard to this quarter, or really any time when we do these big promotions. ButI will say this, the payback is less than a year and that’s really what we lookat, is an analysis of how much does it costs to acquire that customer, what arethe revenues we’re getting from that customer, and then what is the paybackoverall. So we used the exact same analysis last year and again, we had lessthan a year payback on these offers and it’s exactly the same, actually just alittle bit better this year because of the mix of products that we are actuallyputting into the marketplace.

On the share repurchase, yes, we did just complete it. Wewill be evaluating share repurchase with our board of directors. We continuallydo that. Usually when we have those discussions, it’s in the February timeframebut it’s on the docket to discuss at the next board meeting that we have.

Donald R. Shassian

Jonathan, with regard to the Commonwealth synergies, lastquarter I mentioned that we had achieved $12 million annualized synergies.We’ve now achieved about $21 million annualized synergies.

The increase from quarter to quarter, most of that happenedat the end of -- middle and end of September after we completed our billingsystem conversions, so if you are looking at it for the quarter in terms ofoperating results, it’s probably about $3 million to $4 million, maybe a littlebit north of $4 million of expense synergies for the quarter that werereflected.

Jonathon Chaplin -J.P. Morgan

Thank you very much.

Operator

We’ll take our next question from Gaurav Jaitly from UBS.

Gaurav Jaitly - UBS

Great, thanks. Good morning. Just a couple of questions; Iwas hoping to actually get some more color on the line loss trends. It would bevery helpful actually if you could give us a sense of how much of theyear-over-year increase in access line losses, you know, of the 11,000year-over-year increase was related to California and Arizona from the housingimpact.

And then secondly, just following up on the last question,as we think about your priorities for use of cash, your leverage as of the endof the third quarter by my math is about 3.5 times, [but to think] at the highend of your target leverage, has there been any change in your thinking aboutyour leverage, your target leverage ratios and what you might do with your useof cash? Thank you.

Donald R. Shassian

Let me take the second question first, in terms of leverage.It’s about 3.5, that’s correct. We have cash on the balance sheet at the end ofthe quarter that is going to be used to complete the stock buy-back whichhappened in the first half of October as well as cash out on the Global Valleyacquisition, so leverage is about 3.5. I think it actually goes up a little bitto 3.6.

The thought process still is that we would like to getourselves to the 3.2, 3.3 zone, so our utilization of cash, we’ll continue tolook at on a very balanced approach of managing our leverage structure, as wellas returns for shareholders and evaluating reinvestments into the business.

But our view still would be that we would like to be in thezone of 3.2, 3.3, and continue to drive ourselves in that direction.

In terms of line losses in our western region, quarter toquarter it is really up about 2,000 additional line losses quarter to quarter,third quarter to third quarter. The increase that we’ve seen is primarily --the vast majority I think I would say is because of the housing andforeclosures. There’s about 1,200 that I think we’ve identified for thisquarter was an increase in housing vacancies as well as foreclosures in our Californiaand Mojave County, Arizonamarket.

Our Elk Grove, California market is in Sacramento County,which is one of the large counties in this country that has probably thelargest foreclosure rates in the country, and we’ve got a fair number ofvacancies we have to deal with.

That is the only markets, the California market and Arizona,where we are seeing any significant impact from the economy.

Maggie Wilderotter

And keep in mind too that when we talk about access linelosses, it’s really about gross adds. Our deactivations are doing very well. Asa matter of fact, we’re doing better year over year in terms of keeping thecustomers in markets but we have seen that softness in the housing market.

Gaurav Jaitly - UBS

Thank you. That’s very helpful. If I could just follow up,the 2,000, Don, that you talked about, year-over-year increase, how much wasthat in the second quarter, so we could just get a sense of the trend in thatnumber?

Donald R. Shassian

The increase over second quarter was about 2,000.

Gaurav Jaitly - UBS

So it was up 2,000 from second quarter ’07 to third quarter’07?

Donald R. Shassian

I’m sorry, no. The increase from Q2 to Q3 is about 1,200.

Maggie Wilderotter

It was 2,000 year over year.

Gaurav Jaitly - UBS

Great. Thank you. That’s very helpful.

Operator

We’ll take our next question from Jonathon Chaplin from J.P.Morgan.

Jonathon Chaplin -J.P. Morgan

Just a quick follow-up on that last question; could you giveus an idea of how many of your access lines are in the two markets that arereally affected by the slowdown in housing?

And then also, something that’s really interesting that cameout of the Embark call is they said new housing builds cost them about $1,500per home, so as housing slows down, they should see a reduction in CapEx. I’mwondering if there’s a similar impact in your markets. Thanks.

Donald R. Shassian

Percentage wise, let me just say the California and Arizonamarkets are well less than 20% of our total access lines.

Maggie Wilderotter

And Jonathon, if you think about it, the hot spots areprobably 10% of our access lines of that 20% footprint, so it’s not the entireCalifornia marketplace. It’s mostly in the Elk Grove area outside of Sacramentoand Mojave County.

Donald R. Shassian

And the issue on CapEx, the cost to build out into a newdevelopment, $1,500, could be as high as $1,800. It’s a ballpark good number.

What we are seeing is as developers come in though, and theyopen up trenches, instead of doing 500 home developments, they are paring itback down to 125, 150. So we are having a smaller potential investment in someof those developments but we are also looking at those and saying well, wait asecond -- do we really believe that this developer is really going to besuccessful in the next couple of years with how things may turn out, and is itmore efficient for us to maybe put a conduit in while the trenches are there,and therefore not have to really put in the fiber all the way through. Put aconduit in, it lowers our cost initially. Could increase it overall because wemight have to go back into that conduit a couple of times, but we may be ableto lower our CapEx a little bit in being more prudent as the builders arecoming out.

But we are still seeing, even in these markets where thereis a housing issue, we are still seeing developments being initiated, althoughthey are smaller developments and we are trying to tone down our CapExaccordingly to be more prudent with their builds.

Does that help, Jonathon?

Jonathon Chaplin -J.P. Morgan

It does, Don. So the CapEx guidance for this year hasn’tcome down, but is there a prospect if housing weakness continues into next yearthat we’re looking -- that this could translate into a lower level of CapEx fornext year?

Donald R. Shassian

It could but it’s not a huge number. I mean, it’s not -- ourCapEx guidance, a ballpark 320 for next year, we’re not saying it’s going tocome down from 320 to 280 or 250. It’s probably like a $10 million move is allit really could be.

Jonathon Chaplin -J.P. Morgan

Okay. Thank you very much.

Operator

Our next question comes from Michael McCormack with BearStearns.

Michael McCormack -Bear Stearns

Thanks, Don, for the increased cash flow disclosure thisquarter. A couple of things; first, on the -- I think Maggie mentioned someaggressive price points. Can you give us a sense for where you were havingthose aggressive price points, what they were and what the price points ofcable were in the market as well?

And secondly, just your thoughts on looking at flow sharebut also the current marketplace share of high-speed subscribers between cableand you guys would be great. Thanks.

Maggie Wilderotter

Mike, let me take a stab at it. As I said, we did someaggressive price plans in a couple select markets. We tested $19.99. We alsotested $24.99 and $29.99 as price points, and again they were for promotionalperiods of time.

And if you look at our pricing compared to the competition,in most cases we are very competitively priced and probably with a little bitof a premium over the cable competition in our markets, but not a significantamount, maybe within a $5 range. So we try to keep the price points verycompetitive to cable.

If you look at flow share from a share percentage, we dovery well in our markets against the cable guys. We truly are the leaders inproviding high-speed Internet service in all of our markets except forRochester, and we’ve actually been catching up in Rochester but when welaunched high-speed in Rochester back in early 2001, Time Warner had had aboutan 18-month head start on us, so they had taken a fair amount of share that wehad to catch up to. But we are holding our own in that market as well, but ifyou look at the rest of our rural properties, we are doing extremely wellagainst the competition.

Donald R. Shassian

Mike, one way I would look at it is 88% of our residentiallines are high-speed capable, and as Maggie mentioned earlier, PC penetrationis about 63, 65 -- 63%. So if you look at residential lines that are capablefor high-speed and with PCs, we believe we’ve got north of 50% of that market.And then, when you put the dial-up customer base which we have, which is about88,000 today, it puts us way north of 50 in a very strong position we believe in thatmarketplace.

Michael McCormack -Bear Stearns

Yeah, I guess just to get a sense for the opportunity on agoing forward basis, not knowing what the cable share is, it just makes it alittle more difficult.

Donald R. Shassian

Well, the key for us obviously is continue to increase thecapable lines, which is going to be moving maybe a little bit north but not toofar north, really try to put competitive offers to win back customers from thecable folks, and then to be able to increase the pie. Our PC promotion, as youknow, is really trying to increase that pie to drive that 63% PC penetration,which we feel last year we moved pretty significantly. We want to move thatagain this quarter.

Maggie Wilderotter

We probably moved it three to four points last year, Mike,so part of the challenge is you have to have a PC to have broadband be viablein the home.

Michael McCormack -Bear Stearns

Right. Don, I’m sorry, just to add one more on that; theone-time item, was there a cash impact this quarter?

Donald R. Shassian

That $12 million is going out fourth quarter.

Michael McCormack -Bear Stearns

Okay, so is there going to be a cash impact in Q4?

Donald R. Shassian

Cash will come out in Q4, yeah. It will be through the -- asyou are looking at that working capital statement, it will be coming out in Q4,yes.

Michael McCormack -Bear Stearns

Okay, so is that sort of a de facto, slight improvement inthe free cash flow forecast for the year?

Donald R. Shassian

No, there is a lot of balances there. We’ve got also this Q4promotion activities as well. We’ve got a number of moving pieces occurringhere.

Michael McCormack -Bear Stearns

Thanks, guys.

Operator

Our next question comes from Winston Lim from Goldman Sachs.

Winston Lim - GoldmanSachs

Good morning. In terms of the promotions, I just want to geta bit more granularity there. How many of the markets will have the free PCoffer and how many will have the free DISH offer, and how does that compareversus the last time? And maybe you can just remind us of how the costs will berecognized over the life of the contracts as well? Thanks.

Maggie Wilderotter

I’ll take the split on the share question, Winston, and I’lllet Don talk a little bit about how we are accounting for the costs.

If you look at our markets today, the split is almost 50-50.It’s about 70 markets where we are doing the free PC and about the same numberof markets where we are doing free TV and the camera offer.

And we are seeing, early results, we’re seeing a trend ofabout the same number of PCs in the October timeframe that we did when welaunched the free PC offer last year everywhere.

So again, we’ve gotten a lot more segmented on the offer. Weare getting a lot better take rates on the offer as well, because I think we’vereally hit the right kind of markets and the right customer segments withinthose markets.

Donald R. Shassian

The accounting that you will see going forward, the PC andcamera will hit our P&L in the fourth quarter based on the sales and theinstallations that occur during that quarter, so like last year’s fourthquarter, for all those PCs, there was a large fourth quarter charge for thecost of those PCs. We have something similar in Q4 for the PCs and camera.

On the TV promotion, that is booked as a contra to revenue.Essentially the payment that will be made to DISH network, we are making andthe customer is not reimbursing us for that, so it ends up being a contra torevenue each month over the 12-month period.

Winston Lim - GoldmanSachs

Thank you.

Operator

We’ll move on to our next question from Frank Louthan fromRaymond James.

Frank Louthan - RaymondJames

Great. Thank you. Could you give us an idea of what thefinancial impact was from the call center shutdowns in the third quarter? Isthat something we are going to see more fourth quarter and next year?

And then, give us an idea of how you are thinking about yourpricing on high-speed data. You mentioned this a little earlier. You said youwere doing some price promotions but I know over time, you’ve had thephilosophy of keeping the price higher but maybe having a little bit lowerpenetration overall, kind of maximizing the value, but how is that continuingto trend? What sort of impact do you think your higher pricing is having onyour line losses? And looking at the long-term lifetime value of an access linerelative to maybe maintaining a higher margin on the high-speed data in thenear-term, looking over the long-term -- what are your thoughts there? Havethings changed? Is that something you may be rethinking as far as you think youare going to need to lower your price to maintain access line losses? Thanks.

Maggie Wilderotter

Don, why don’t you take the first question with regard tothe call centers and I’ll take the question on the high-speed pricing.

Donald R. Shassian

Frank, on the call centers, we announced the charge thisquarter. It ends up being the end of the consolidation program. It is beingimplemented last month and a little bit more for the next -- into November assome of the people are still leaving and as we continue to integrate andenhance the very large call center that we’ve built now on Delan, Florida.

The savings from the program, if you look at our costs forour call center functions back in late 2005, before we initiated the program tothe cost for those same functions that we are going to have when this is allfinished in early ’08 is about a $9 million to $10 million annualized savingsfor us. It is somewhat of a headcount reduction. It is somewhat of a movementof people to a different wage scale. It is some productivity improvements andit is a very big fundamental operational move for us that we are going through.

We feel very pleased about the progress we are making but itis a very sizable savings that we are going to be harnessing the latter part ofthis year and then beginning of next year. It ends up being not as much savingsnecessarily built into this third quarter because the bulk of the changes areoccurring -- the final changes, which is really -- because you’ve hired anumber of people to be able to handle a call volume as you decrease somewhere else,those savings are coming off into the fourth quarter.

Maggie Wilderotter

Frank, on the high-speed Internet pricing strategy, we havehad a philosophy to sell value associated with high-speed. As I mentioned,doing more aspirational promotions with gifts and keeping our prices in theranges where they are today.

However, we do believe that growing high-speed market shareis critical to our business and because of that, what we’ve been doing istesting some different price points in the marketplace to see if the changes inpricing actually does drive share and if it does, to what extent does it driveshare?

And I think you’ll see us do more surgical type pricingpromotions throughout 2008 to sort of give us a sense where we have very highlycompetitive markets, can we drive share in a different way?

So it is something that we are focused on. We don’t believetoday that our access line losses are associated with having a high rate forhigh-speed, because we are, as Don said, the leaders in our market and wecontinue to drive I think good share in our markets.

But we are also cognizant that if there is a way to balancethat value, do some more aggressive price promotions and still accomplish thatprice value on the product and grow some share, that’s what we’re going to tryto do.

Frank Louthan -Raymond James

Okay, great. And what is the competitive situation where youstill have the higher price point? Is cable fairly rational? Are they followingyour pricing, or do you see them trying to undercut that if they have thatopportunity?

Maggie Wilderotter

Cable is pretty rational in our markets. We see themfollowing our price points instead of coming in and undercutting.

Where we have seen cable be more aggressive is usually inthat first 60 or 90 days when they launch phone in a market, and they’ll comeout with a bundled price that’s aggressive, but it’s the same basic price pointthat we have for our triple play in the marketplace.

Frank Louthan -Raymond James

Great. That’s very helpful. Thank you.

Operator

We’ll take our next question from David Barden from Banc ofAmerica.

Steven Douglas - Bancof America

This is Steven Douglas, actually. I have two quickquestions. First, some of your peers have talked about an increase in bad debtexpense this quarter and I was wondering if you guys had seen anything on thatfront.

And second, again on the buy-back, having completed it aheadof plan, is there anything to read into there, I guess besides maybeopportunistically buying or something like that? Thanks.

Donald R. Shassian

On the bad debt, as I mentioned in my prepared remarks, ourbad debt provision for this quarter did increase over last quarter by $2million. We did see a deterioration in aging occurring in the second quarter.Our write-offs have increased and there was a $2 million increase in thequarter. Say it’s economy driven, could say a variety of items but itdefinitely -- you do see in this industry an increase in un-collectibles whenthere is a softening in the economy.

With regard to the buy-back, there is nothing really bysignal there. We established that program as a 10B5 program, meaning weestablish it with an institution and we set parameters with them to begin with,and said that look, if the stock price during a day is between A and B, you canbuy back so many shares. Stock price goes up, you buy less; stock price goesdown, you buy more. And that way we are able to let it happen.

We, as an executive management and all of our managementdoes not have to be concerned about being in that market and making decisions.If we end up looking at acquisitions or anything else, we are able to have alittle bit more flexibility to run the business and not be trying to guess themarket.

So it was a program put in place and as the stock droppedlast quarter, it just accelerated itself and that’s what happened, so there isnothing else to read into that.

Steven Douglas - Bancof America

Thanks, guys.

David Whitehouse

James, I think we have time for one more question.

Operator

And we’ll take that question from David Janazzo with MerrillLynch.

David Janazzo -Merrill Lynch

Good morning. Maggie, you had ticked off a number of thewireless data program stats. Can you give us your thoughts on returns on thatinvestment? And then, we’ve seen a number of the WiFi projects not pan out. Whyare yours different?

Maggie Wilderotter

I’ll talk a little bit about why we think ours aredifferent. I know Don can pipe in on the returns.

Let me say this; one of the reasons why we believe that thisis different is because we have a nationwide data backbone, so the amount ofcapital that it takes for us to build these networks in our markets is aminimal amount of capital compared to someone who comes in from a greenfieldperspective and has to build a WiFi system, mesh system into a market. So weare leveraging a lot of our capital that we already have in these markets.

In addition to that, our strategy has been to get anchortenants to help pay back on that capital investment, to the casual users andthe ability for our customers to use these networks becomes incremental revenueon top of payback revenue. So our strategy in having multiple anchor tenants aswell as hot spots gives us a reoccurring revenue stream, a monthly reoccurringrevenue stream to pay back on that capital.

And we do have a pretty stringent, I would say, ROI processthat we go through in analyzing what markets we build, how we build them, andwhat the returns have to be on that capital.

Donald R. Shassian

Let me also -- some of the others that have announcedwireless data builds that were slowed down or shut down, their economic modelwas an advertising-based model. Ours really is a subscription-based model,whether it’s day pass, hourly day pass, weekly, monthly, or anchor, where we’vegot an institution or a business paying us a monthly fee for a fixed number ofusers. So it’s a different economic model.

The economics are different based on the customer that weare approaching. If it’s an anchor where we have a college or university thatis a multi-year contract that is subscribing for a fixed number of users,several hundred for five years, we build the network out and get a returnthat’s got a nice two-year payback.

If it is a hot spot where we are going to a business and areputting up something, a very cheap, inexpensive, depending on the day uses andcasual, it could be a little bit longer. It really depends on the flow anddepends on how many hot spots we can put into a geographic area of a downtowncommunity.

And then there’s a municipal build that obviously is reallydependent upon getting all those hot spots built out.

So on the short end, it’s an 18-month to two-year payback onsome. On others, we think it could be maybe a four-year payback. But the longerones are ones that are really unknowns, because right now we are seeing anincrease in the volume of takes on the casual day passes and we’re seeing somevery good increases and takes on the hot spots. So we feel like that four yearsmay be longer than maybe actually will pan out. But so far, we are seeing somevery interesting takes on these and very promising and it is a CapExexpenditure for us that is quite manageable within our total CapEx budget, tobe able to get a decent return, we feel.

Maggie Wilderotter

And if you look at the mix, we are going to have 13municipalities, as I mentioned, over a dozen anchors and 40 hotspots by the endof the year. And if you look at that mix from a payback perspective, it’sprobably two years to two-and-a-half years.

David Janazzo -Merrill Lynch

Thank you.

Operator

Mr. Whitehouse, I would like to turn the conference backover to you for any additional or closing remarks, sir.

Maggie Wilderotter

I’ll just close and say that our priorities for the fourthquarter of 2007 are about staying the course, a focus on a strong customerretention efforts as well as a strong focus on our employees, integrating ourCommonwealth and Global Valley acquisitions, improving and driving sales ofhigh-speed, video and packages, our service delivery, completing that, andmaximizing our financial returns.

So thank you again for joining us on the call and we do lookforward to speaking with you in February when we report our Q4 2007 earnings.

Operator

That does conclude today’s presentation. We thank you forjoining us. Have a wonderful day.

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