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Consolidated Communications Holdings Inc. (NASDAQ:CNSL)

Q3 2007 Earnings Call

November 8, 2007 11:00 a.m. ET

Executives

Steve Jones - VP of IR

Bob Currey - President and CEO

Steve Childers - CFO

Analysts

Patrick Ryan - Lehman Brothers

Jonathan Chaplin - JP Morgan

Robert Simmons - Oppenheimer

Operator

Welcome to the Consolidated Communications' Third QuarterEarnings Call. At this time, all participants are in a listen-only mode.Following management's prepared remarks, we will hold a Q&A session.(Operator Instructions) As a reminder, this conference is being recorded,November 8, 2007.

I would now like to turn the conference over to Steve Jones.Please, go ahead sir.

Steve Jones

Thank you, Kate, and good morning. And thank you to all ofyou for joining us today on Consolidated Communications Third Quarter 2007 EarningsCall. I'm Steve Jones, Vice President of Investor Relations, and with us on thecall today are Bob Currey, President and Chief Executive Officer, and SteveChilders, Chief Financial Officer. After the prepared remarks, we will conducta question-and-answer session.

I will now review the Safe Harborprovisions of this call. This call may contain forward-looking statementswithin the meaning of the federal securities laws. Such forward-lookingstatements reflect, among other things, management's current expectations,plans and strategies and anticipated financial results, all of which aresubject to known and unknown risks, uncertainties, and factors that may causethe actual results to differ materially from those expressed or implied bythese forward-looking statements.

Please see our public filings with the Securities andExchange Commission for more information about forward-looking statements andrelated to risk factors. In addition, during this call, we will discuss certainnon-GAAP financial measures, our earnings release for this quarter's resultswhich has been posted to the investor relation section of our website, containsreconciliations of these measures to the nearest GAAP equivalent.

And now, the proxy solicitation.

This material is not a substitute for the prospectus andproxy statement Consolidated Communications Holdings and North PittsburghSystems filed with the Securities and Exchange Commission, which was mailed toNorth Pittsburgh Systems' shareholders on October 12, 2007. Investors are urgedto read this prospectus and proxy statement, which contains importantinformation, including detailed risk factors.

The prospectus and proxy statement and other documents whichwere filed by Consolidated Communications Holdings and North Pittsburgh Systemswith the Securities and Exchange Commission are available free of charge at theSEC's website, or by directing a request to either Company.

This communication shall not constitute an offer to sell orthe solicitation of an offer to buy securities, nor shall there be any sale ofsecurities in any jurisdiction in which such offer, solicitation or sale wouldbe unlawful prior to registration or qualification under the securities laws ofthat jurisdiction.

Consolidated Communications Holdings and North PittsburghSystems and certain of their respective directors, executive officers, andother members of management and employees are participants in the solicitationof proxies in connection with this proposed transaction. Information about thedirectors and executive officers of Consolidated Communications is set forth inthe proxy statement filed in connection with its 2007 Annual Meeting.

Information about the directors and executive officers of NorthPittsburgh Systems is set forth in the perspective's proxy statements in theCompany's annual report on Form-10K for the year ended December 31, 2006, asamended.

Investors may obtain additional information regarding the interestsof such participants in the proposed transactions by reading the prospectus andproxy statement.

I will now turn the call over to Bob, who will provide anoverview of our financial and operating results. Steve Childers will thenprovide a more detailed review of our third quarter financials, and Bob thenwill conclude the prepared remarks with an update on the North Pittsburgh transaction. Bob?

Bob Currey

Thank you, Steve, and thank all of you for joining us today.I am pleased to report that we had another solid quarter. The existing businesscontinues to perform well and the North Pitt acquisition is on track to closein the fourth quarter, or at the latest early in 2008.

We continue to successfully execute on our strategy ofproviding high-quality broadband and voice services, thus generating strongsustainable cash flow to support our dividend.

This is achieved by growing revenue per customer, improvingoperating efficiency and maintaining our disciplined capital expenditurephilosophy.

With regards to the quarter, I will start with a briefoverview of the financial results and then talk about the strong operatingmetrics.

Our results for the third quarter were solid. Revenue andadjusted EBITDA were $80.3 million and $33.5 million respectively. Results thisquarter were impacted by a prior period subsidy settlement. The net settlementamount resulted in $2.1 million reduction in both revenue and adjusted EBITDA.

The dividend pay out ratio for the quarter was 92.6%including the subsidy true-up, and 77.4% without it. Even with the impact ofthe true-up, we are at a comfortable 77.7% year-to-date pay out ratio.

We delivered strong operating metrics. Growing connectionsby 4,000 this quarter, and we have now surpassed 300,000 total connections.

In terms of DSL, I would describe it as a phenomenalquarter. We added over 4,300 new DSL subscribers, bringing the total subscriberbase to almost 63,000. This represents our strongest third quarter ever, andbrings our penetration of primary residential lines to 38.6%.

For the quarter, we also added 1,500 IPTV customers acrossboth states, bringing the total subscriber base to just over 11,000.

In August, with the launch of Illinois we completed the high definitionroll out, and now offer a competitive HD channel line up in both states. Thepicture quality is great and the customer reaction continues to be verypositive. To date, 750 customers have signed up for HD, representing a 7%penetration of our IPTV households.

In the past I've talked about our ability to tailorprogramming to meet the needs of our subscribers. Another example of that isthe Big 10 network. We offer it in Illinoisand it is not offered by our cable competitors. We believe that being able toreact to market demand is, key in helping to differentiate us in themarketplace and gain market share.

Regarding DVR, we continue to test the product and are stilltargeting a fourth quarter launch in all markets. Combining HD with DVR willfurther strengthen our IPTV platform, and when coupled with voice on dataprovide a very compelling triple play value proposition.

DSL and IPTV are sticky, and have been drivers of the growthof connections and revenue per customer. Approximately 90% of our IPTVcustomers take our full triple play offering, making us the leading triple playprovider in our markets.

As I previously mentioned, we also offer a hosted VoIPproduct in Texas,targeted towards small and medium size business. We continued to be pleasedwith the subscriber growth. We added 350 seats in the third quarter, bringingthe total number to just over 2,200. I would add that these seat counts thatare associated with this product has more than doubled in the last 12 monthsand that it is not included in our total connection counts.

On the competitive front, although we continue to expectadditional entrance, no new cable companies launched the voice product in ourmarkets during this quarter.

And finally, I am pleased to report that we've successfullycompleted Phase III, our last phase of our billing integration. This completesthe Illinois and Texas billing project. I appreciate all thehard work put forth by the billing teams. After briefly catching their breath,they have now turned their attention to finalizing the integration plan for North Pittsburgh and will focus their attention onconverting those systems to Consolidated's platforms.

I'll now turn the call over to Steve Childers for ourfinancial review.

Steve Childers

Thanks, Bob, and good morning to everyone. As Bob mentioned,we are pleased with both our third quarter and year-to-date results. Thismorning, I'll review our quarterly financial performance and then update 2007guidance.

Revenue for the quarter was $80.3 million, which isconsistent with the third quarter of 2006. As anticipated, third quarterrevenues were negatively impacted by prior period ICLS subsidy settlement. Thesettlement was associated with 2006 time period, and resulted in a net $2.1million reduction in revenue compared to the third quarter of last year,resulting in a 900,000 negative variance.

Also reflected in the net subsidy settlement this quarterwas the impact of an update to our 2007 ICLS cost studies. This resulted in$398,000 positive adjustment in the quarter, of which $265,000 related to thefirst half of 2007.

Additionally, revenues from local calling services weredown, primarily due to the reduction in local access lines. While the $2million increase in data and internet revenue was driven by growth in broadbandcustomers.

Total operating expenses for the quarter were $65.8 million,an increase of approximately $1 million compared to the third quarter of 2006.This increase was driven by $600,000 in incremental non-cash compensationassociated with restricted share plan, $400,000 weather related overtime, and$600,000 associated with the resolution of a vendor disputes reflected in bothperiods. These were partially offset by $600,000 in reduction in depreciationand amortization.

We would expect fourth quarter expense levels to beconsistent to slightly below those of the third quarter although it could beslightly impacted by the timing of the integration cost with respect to North Pittsburgh.

Net interest expense for the quarter was $11.9 million, anincrease of $700,000 compared to the third quarter of 2006. This increase wasdriven by increased borrowings associated with July 2006 share repurchase, andnew interest rate swap agreements that were initiated to both, replace existingagreements that expired and to increase our overall hedged position.

Consolidated term debt is now approximately 99% hedged, withan average annual interest rate of 66.6%. Income tax expense for the quarterwas $2 million reflecting a decrease of $1.9, compared to the third quarter of2006. The decline was driven by a difference in pretax income, and by the factthat the third of 2006 included $800,000 in additional tax expense associatedwith the finalizing and filing in 2005 federal return.

Accordingly, net income for the third quarter of 2007 was$2.3 million, compared to $2 million for the same period last year. Net incomefor common share for the third quarter of 2007 was $0.9, compared to $0.7 forthe same period last year. However, we believe it is appropriate to look at thirdquarter income per share on an adjusted basis. As detailed on the adjusted netincome per share schedule in the earnings release, our adjusted number was $0.14per share.

After adding back the anticipated subsidy settlement,adjusted EBITDA would have been $35.6 million, which was consistent with ourexpectations.

Capital expenditures were on plan at $8 million in the thirdquarter of 2007. From the liquidity standpoint, we ended the quarter with $24.4million in cash and cash equivalents, and our $30 million evolver remains fullyavailable to us.

For the third quarter of 2007,our total net leverage ratio as calculated in our earnings release was fourtimes to one. All of our coverage ratios were well with the compliance levelsof our credit facility.

Cash available to pay dividendsor CAPD was $10.9 million for the quarter, yielding a 92.6% dividend payoutratio. Excluding the prior period subsidy settlements and the run rate payoutratio, was 77.4% for the quarter.

Now, I'd like to update our 2007guidance.

Capital expenditures for the fullyear are expected to be in the range of $32.5 million to $33.5 million. Cashinterest expense is expected to be in a range of $44 million to $44.5 million,and cash income taxes are expected to be in the range of $13 million to $14million.

With respect to our dividend, ourBoard of Directors has declared the next quarterly dividend of approximately$0.39 per common share payable on February 1, 2008 to shareholders of record onJanuary 15, 2008.

I will now turn the call backover to Bob for an update on the North Pittsburghand closing remarks.

Bob Currey

Thanks Steve. We continue to bevery excited about our North Pittsburghtransaction. It adds attractive markets to our portfolio, it has a strongnetwork that will be leveraged to increase broadband penetration and launchIPTV, and it's expected to be cash flow accretive in the first full year ofoperations. In terms of an update, the North Pittsburghshareholder meetings will be held on Tuesday, November 13. The regulatoryapproval process is nearing completion, and the integration planning is wellunderway.

From a regulatory approval perspective, the FTC has grantedearly termination of Hart-Scott-Rodino waiting period. The FTC has approvedboth our international and domestic 214 applications. We are very close tocompleting the process with the Pennsylvania PUC. We have successfullyconcluded discussions with all the interveners and expect to be on the December6th PUC open meeting docket.

Assuming PUC approval in December, we would be in a positionto close in the fourth quarter, or at the latest in early 2008. In terms ofintegration, the planning process is underway and doing very well. This is avery familiar territory for us. We are using the same playbook that has provensuccessful on our prior integrations. There have been detailed planningsessions between the various process owners from both companies. And, incollaboration with North Pitt management team, several integration projectshave been fast tracked.

I will mention two key projects; one, IPTV deployment, andthe migration of the financial system from J.D. Edwards to our PeopleSoft.Project teams have the name for both efforts, and the implementation processhas begun. We are anxious to get going, and will be well prepared to hit theground running once the transaction closes.

As mentioned on this call and previous ones, we have spentthe last several months working with the North Pitt team on completing thedetailed integration plans, having discussions internally on organizationalstructure and validating our synergy assumptions. As a result of all of this,we're pleased to report that nothing has changed with regard to our synergyestimates.

We are very confident that we will achieve both the OpEx andthe CapEx targets previously provided. If you are not aware, North Pittsburgh also released their earnings this morning. Then you mayrefer to their press release for the specifics on the quarter.

Although third quarter access line loss was higher than the secondquarter, their results were in line with our expectations. In advance of thetransaction closing, the incoming cable providers have increased theirpromotional activities. We expected this and this is one of the reasons we'vefast tracking IPTV.

Lastly, regarding the financing for the transaction, bothMoody's and S&P recently affirmed their existing ratings for us. We intendto launch the bank deal on Wednesday of next week, and expect to be in positionto close and fund the acquisition and financing transactions shortly afterreceiving the Pennsylvania PUC approval.

So, in summary, we are pleased with our performance thispast quarter. We are excited with both how the current business is performingand the opportunities presented by the North Pitt transaction. We look forwardto continuing our focus on our customers with both great service and greatproducts.

And with that summary, Kate I would like to open it up forquestions.

Question-and-AnswerSession

Operator

(Operator Instructions) Your fist question is from PatrickRyan from Lehman Brothers.

Patrick Ryan - LehmanBrothers

Good morning and thanks for taking the question. I just wantto talk a little bit about the IPTV potential over North Pittsburgh. I am wondering if you can maybe give us an idea ofwhen you expect to launch that product, and maybe when marketing would begin?And then an idea of what percent of lines will actually be able to get thatproduct? Thanks.

Bob Currey

Yeah. Good morning, Patrick. We planned, as I mentioned withthe fast tracking of that project. We plan on launching as soon as possible. Ican't give you a specific date today, except to tell you that all of theplanning is well along. The engineering is done and completed. The marketingprograms are ready to launch, and as soon as this transaction closes, we willlaunch pretty quickly after that date. As far as the second part of yourquestion, the size of the Pittsburghmarket, we'll launch with approximately 80% coverage right from the get going.

Patrick Ryan - LehmanBrothers

Okay. And just one quick follow-up, will you also belaunching HD and DVR in that market at the same time?

Bob Currey

Yes, we will. We'll have the same HD and DVR products acrossall of our markets.

Patrick Ryan - LehmanBrothers

Great, thanks a lot.

Bob Currey

You're welcome.

Operator

Your next question is from Jonathan Chaplin from J.P.Morgan.

Jonathan Chaplin - J.P.Morgan.

Good morning, guys. So, DSL and access line, both came inquite a lot better than we expected, and they really bug trends we've seen,pretty much across the industry this quarter. I'm wondering if you can give ussome insights, into what you're doing on the DSL front. That it's driving thegrowth that you're seeing at the moment. I mean, it's particularly impressivegiven how high, I think you probably have the highest DSL penetration acrossthe group already, and still you're growing at a faster rate. And I amwondering if you have any insight into the impact that DSL penetration ishaving on access lines. I'm wondering if it's the high DSL penetration that'sresulting in better than to peer access line trends as well? Thank you.

Bob Currey

Good morning, Jonathan.

Jonathan Chaplin - JPMorgan.

Hey, Bob.

Bob Currey

Thanks for that multi part question here. Let me see I'vegot them all. The first part, as far as, what are we doing with DSL, nothingdifferent than we have in the past. We have maintained the pricing. If theytake a longer term contract, we do discount the product. But it's more of thesame, just offering a value proposition. Good word of mouth in our community isabout the value of the product. And I would also add that the value of thetriple play has certainly contributed to our DSL success.

Regarding access lines losses, we are strong believers thatthe bundle is sticky. That IPTV does add to that bundle. We are up to the11,000 customers. We definitely see less churn with the more products that ourcustomers take. And at the end of the day, it is the value of the bundle thatis the attraction that is responsible for our access line losses to-date.

Jonathan Chaplin - JPMorgan

So Bob, if I could just follow-up on your DSL comment. Is itthe availability of video in a greater portion of your footprint that resultedin record net adds or record third quarter net adds this time around? You thinkthat's the biggest contributor to the increase in growth that you are seeing?

Bob Currey

No not at all, because we didn’t even expand the homespassed of IPTV in this quarter, Jonathan. They are basically, where they aregoing to be for the remainder of this year. So, that wouldn’t be a contributor.It's just again, the value of the product, I will give my marketing and salesteam a lot of credit. A very focused and a compelling product, and we havelaunched a naked product. I announced that on the last call it hasn’t acquireda lot of new customers at this point, and we charge a $5 premium for it. But ithas worked particularly in the college environment, the off-campus studenthousing. So, it's really just more the same, second quarter was good, butseasonal, and the third quarter bounced back up to where we had expected to be.

Jonathan Chaplin - JPMorgan

That's great. Thank you very much.

Operator

Your next question is from Robert Simmons from Oppenheimer.

Robert Simmons -Oppenheimer

Hi, guys. I had two questions. One is you said that youactually are passing more homes this year, but what are your expectations for’08 and ’09 in your urban markets?

Bob Currey

Yeah, thanks for the call, Robert. The plan is to addroughly 30,000 homes next year and 20 in ’09.

Robert Simmons -Oppenheimer

Okay, that's great. Thanks. And the other things is, can youtalk more about the subsidy true-up a bit, explain a little more how thatworks?

Steve Childers

Hi, Rob. This is Steve Childers. Thanks for your question.The true-up is basically, in this third quarter was kind of back review thanwhat we actually recognized in the third quarter. We recorded a $2.1 millionnet ICLS, or interstate common line support true-up, $2.4 million of thatactually was attributable to 2006. And then based on that -- and that wastrigged by the filing of our final cost studies in July of this year,representing 2006, which basically trued-up our expenses in the rate days, mathcategorization of investment for that time period. At the same, we also reviseour 2007 projection for ICLS revenue requirements and that generated a positivetrue-up of roughly $398,000 that was booked in the quarter, $265,000 of thatwas attributable to the first half of this year, $133,000 was attributable inthe third quarter and should in our run rate going into fourth quarter.

Robert Simmons -Oppenheimer

Alright, got you. Thank you very much.

Steven Childers

Okay.

Operator

(Operator Instructions) Your next question is from ChrisLarsen from Credit Suisse.

Unidentified Analyst

Hi, this is Brad for Chris. I just had a real quick questionon your level of cable VoIP competition now. I know it's really low in Texas, Illinois.But, I was wondering if you could just remind us where it's at, where do youthink its going, and then you mentioned in the Pittsburgh properties that it’s ramping up,if you could just kind of compare the two markets and sort of where you seethat going as well?

Bob Currey

Yeah, Brad. Mediacom in Illinois, which covers about 60% of theterritory, is the only cable company that has launched a VoIP product. We'veseen VoIP competition from the Vonage's and others. But as far as the cablecompetitors, it's only been Mediacom up till this point.

Unidentified Analyst

Okay, and then in Pittsburgh?

Bob Currey

In Pittsburghthey have a launched both cable companies up there, Armstrong and Comcast, haveboth launched a VoIP product.

Unidentified Analyst

Okay. And you don't have any idea how many percent of linesthat it covers or is it all of them?

Bob Currey

I think it's everything. It would be ubiquitous to the wholeterritory.

Unidentified Analyst

Okay, thank you.

Bob Currey

You're welcome.

Operator

(Operator Instructions) There are no further questions atthis time. Please proceed with your presentation or any closing remarks.

Bob Currey

Well, thank you, Kate. And now, I thank all of you forjoining us today, and for your continued interest and support of Consolidated.As you heard today, we remain excited about our current position andopportunities and look forward to updating you in the future. Thanks, and havea great day.

Operator

Ladies and gentlemen, that concludes your conference fortoday. We thank you for your participation, and ask that you please disconnectyour lines. Thank you.

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