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Consolidated Communications Inc. (NASDAQ:CNSL)

Q4 2007 Earnings Call.

March 6, 2008; 11:00am ET

Executives

Steve Jones - Vice President, Investor Relations

Bob Currey - President and Chief Executive Officer

Steve Childers - Chief Financial Officer

Analysts

Patrick Ryan - Lehman Brothers

Jonathan Chaplin - JP Morgan

Chris Larsen – Credit Suisse

Frank Louthan - Raymond James

Operator

Welcome to the Consolidated Communications Fourth Quarter Earnings Conference Call. (Operator Instructions) I’d now like to turn the conference over to Mr. Steve Jones, Vice President, Investor Relations. Please go ahead sir.

Stephen Jones

Thank you Luan and good morning to everyone and thank you for joining us today for Consolidated Communications fourth quarter 2007 earnings conference call. As Luan said I am Steve Jones, Vice President, Investor Relations and with us on the call today are Bob Currey, President and Chief Executive Officer and Steve Childers, Chief Financial Officer.

After the prepared remarks, we will conduct a question-and-answer session. I will now review the safe harbor provisions of this call and then turn it over to Bob. This call may contain forward-looking statements within the context 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 numbers to the nearest GAAP equivalent.

I will now turn the call over to Bob who will provide you an overview of our financial and operating results. Steve Childers will then provide a more detailed review of our fourth quarter financials and Bob will conclude the prepared remarks with an update on our Pennsylvania activities. Bob?

Bob Currey

Thank you, Steve. We are excited to be on the call from our Gibsonia, Pennsylvania office and to have an opportunity to update you on our business.

We had a very productive and exciting fourth quarter. Not only did we close the North Pittsburgh transaction but I'm pleased to report that the existing business continues to generate both solid operating and financial results and connection growth remains strong.

I know you have heard me say it before but we continue to successfully execute on our strategy of providing high quality broadband and VoIP services in our Illinois and Texas markets and are looking forward to extending this strategy into Pennsylvania. Our focus continues to be on generating strong sustainable cash flow to support the dividend by growing revenue per customer, improving our operating efficiency and maintaining a disciplined capital expenditure philosophy.

Regarding the quarter, I will start with a brief overview of Texas and Illinois financial results and then review the operating metrics. Due to the timing of the closing of this transaction, our results for 2007 obviously do not include North Pittsburgh.

The financial results for the fourth quarter were strong. Revenue and adjusted EBITDA were $85 million and $37 million respectively. The dividend payout ratio was 71% for the quarter and a very comfortable 75.9% for the year.

We delivered solid operating metrics and again sequentially grew total connections in the quarter. In terms of DSL we had another phenomenal quarter. We added over 4,000 new DSL subscribers bringing the total subscriber base to over 66,000. Contributing to that success was our decision to offer a stand-alone DSL product. We don’t mass market this product but we use it only in targeted situations such as wireless only households. Those customers have proven very receptive to our DSL offering and we are confident we can continue to make well targeted gains. We like this opportunity because it allows us to win back customers we have lost over the years and to utilize facilities that we have already installed. We believe it’s critically important to establish and retain this important connection with the customer. Not only does it allow us to leverage existing facilities but it provides the opportunity to layer on our additional products such as IPTV.

We increased IPTV subs in the quarter by 1,200 bringing the total subscriber base to over 12,000. Our HD offering continues to be well received. The picture quality is great and the channel lineup continues to meet the needs of our customers. We will be adding a minimum of six new HD channels to the lineup in the second quarter of this year making our HD programming even more compelling. At the end of the fourth quarter almost 1600 customers have signed up for our HD representing approximately 13% penetration of the IPTV households.

As previously mentioned we had planned to launch DVR this month. However due to a problem with the software upgrade required to enable the DVR service we have decided to delay the launch one month until April. While the problem has been resolved, the additional time will ensure that our customers receive the experience they have come to expect from consolidate. Regarding Pennsylvania we will also launch IPTV service at the end of April. This means out of the gate we will offer our full product suite including DVR, HD, video on demand and over 200 all digital channels. I am extremely proud of the team and their ability to launch this product so quickly after closing the transaction. We are excited to introduce this in Pennsylvania and we will be passing 12,000 homes at launch representing approximately 25% of the Islet footprint. We would expect the Pennsylvania number to grow steadily to 17,000 homes by the end of 2008. We continue to be excited with this product and expect total IPTV customers to grow by approximately 50% in 2008.

Our access lines were impacted this quarter by the completion of phase three, our final phase of our billing integration. As part of the standard implementation process, we suspended billing treatment for approximately 30 days. This was done to stabilize the billing records and help ensure a smooth cut over. The end result was to push approximately 500 disconnects from the third quarter into the fourth.

There is also been a lot of talk recently about the economy and the impact it is having on various telecommunication service providers. From our perspective we have seen only a modest impact on our business. We benefit from serving diverse markets overall and suburban. Our historical tells us that these markets don’t yield the full effect of year market upswings or market down turns. To date we have not seen the significant impact that some other parts of the country have experience.

On the competitive front there is nothing new to report. As I have said every quarter, we continue to expect additional entrance any day although at present no new cable companies have launched the voice product in our markets. I will now turn the call over to Steve for a financial review.

Steven Childers

Thanks Bob and good morning to everyone. As Bob mentioned we are very pleased with both our fourth quarter and year end financial results. This morning I’ll review our quarterly financial performance and then provide 2008 guidance. Bob will then briefly review the results from Pennsylvania, so my comments will primarily be focused on Illinois and Texas. Revenue for the quarter was $85 million, an increase of $3.3 million over the fourth quarter of 2006. This increase was primarily driven by increases in data and internet revenue, other operations revenue and subsidies.

Data and internet revenue was principle attributable to the growth in DSL and IPTV subscribers, while the increase in other operations revenue was primarily driven by 900,000 increase in customer premise equipment or CPE sales in our commercial segment. Impacting subsidies with an increase in prior periods settlements in the fourth quarter of 2007, we received an 840,000 draw primarily associated with the updates for our 2006 ICLS cost studies. This was approximately 360,000 more than we received from comparable adjustments in 2006.

Total operating expenses for the quarter was 67.5 million, a decrease of approximately 9.4 million compared to the fourth quarter of 2006. The fourth quarter of 2006 reflected a 11.2 million non-cash impairment charge while the fourth quarter of 2007 reflects approximately 800,000 in incremental CPE cost, increased IPTV cost associated with serving on the larger subscriber base and increase cost incurred in support of the incremental other operations revenue and approximately $200,000 in integration expense that is associated with the North Pittsburg transaction. These increases were partially offset by 800,000 in tax refunds and through outs associated with property taxes and the Texas capital tax recognized in the quarter.

Net interest expense for the quarter was 22.1 million, an increase of 10.5 million compared to the fourth quarter of 2006. This increase was driven by the write off differed financing cost associated with the early repayment of our previous credit facility. Income tax expense for the quarter was a benefit of 2.1 million driven primarily with a pretax loss and 862,000 associated through resetting of our state differed tax rate after giving effect to prelimerate purchase account for the North Pittsburg transaction. Accordingly net loss for the fourth quarter of 2007 was 1 million compared to a loss of 500,000 for the same period last year.

Net loss per common share for the fourth quarter of 2007 was $0.04 compared to $0.02 for the same period last year. However we believe that it is appropriate to look at income per share on an adjusted basis. As detailed on the adjusted net income per share schedule in the earnings release, our adjusted number was $0.20 per share in the fourth quarter of 2007 compared to $0.21 in the fourth quarter of 2006. Consistent with our expectation adjusted EBITDA for the fourth quarter was 37 million compared to 35.7 million for the same period last year.

Capital expenditures were on plan at 8.8 million in the fourth quarter of 2007 and $33.5 million for the full year. From the liquidity standpoint, we ended the quarter with $34.3 million in cash and our new $50 million revolver remains fully available to us. All of our coverage ratios were well within the compliance levels of the new credit facility. In regards with our capital structure we did close and fund on the North Pitt transaction of December 31; accordingly our year-end balance sheet reflects $296 million in incremental bank borrowings taking our term debt to $760 million. As announced last week on April 1, we will redeem the remaining $130 million of our 9.75% senior notes by using available cash and only drawing approximately $120 million of the $140 million delayed term loan.

By replacing our high coupon bonds with bank debt de-levering by approximately $10 million our capital structure after April 1, will show $880 million in term loan debt and a weighted average cost at 7.1%. As a result of this transaction, we project to save approximately $4 million in annualized cash and interest cost. With the fourth quarter of 2007, our net leverage ratio as calculated in our earnings release was 4.6 times to 1. Please note the schedule reflects both the ProForma LTM and adjusted EBITDA calculations and our new capital structure. Cash available to pay dividends or CAPD was a strong $14.1 million for the quarter yielding a 71% dividend payout ratio.

Now I would like to spend a few minutes to provide our 2008 guidance which reflects our expectations for all three states. Consistent with 2007 we will provide guidance on capital expenditures, cash interest and cash taxes.

Capital expenditures for the full year are expected to be in the range of $46.5 million to $49.5 million including $2 million in integration CapEx. Cash interest expense is expected to be in the range of $64 million to $67 million and cash income taxes are expected to be in the range of $15 million to $18 million.

And finally with respect to our dividend, our Board of Directors has taken the following actions: first, it has declared the next quarterly dividend of approximately $0.39 per common share payable on May 1, 2008 to shareholders of record on April 15. Second, the Board has indicated its intention to continue paying the quarterly dividend in its current level throughout 2008.

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

Bob Currey

Thanks Steve. We are excited to have completed the North Pittsburgh transaction and to welcome the Pennsylvania employees to the consolidated team. Because of the closing date North Pitt will not be reporting separately, so we would like to share these results.

Revenue for the fourth quarter and full year of 2007 was $23 million and $95.7 million respectively. Adjusted EBITDA for the fourth quarter was 11.3 and full year 43.2. These results reflect pre-acquisition operations and are not indicative of what the business will achieve as part of consolidated.

Integration activities are well underway. As mentioned previously we are using the same playbook and project management team we used when we successfully integrated the Texas assets. We have identified multiple integration projects and for each have established timelines, deliverables, and budgets. Work has begun on the majority of them with the priority placed on those with the highest payoff. This is a very familiar territory for us and we are glad to be out of the planning phase and onto execution.

In terms of an integration update, we completed the financial system consolidation a full 90 days ahead of schedule and North Pittsburgh’s general ledger, payroll, financial reporting and HR were converted to our PeopleSoft ERP System effective with December 31 close. After the first 60 days of operations and based on our early start and the progress we have made, we are confident we will meet our $7 million in projected first year synergies.

So in summary the business performed very well in 2007 and we are excited going into the New Year. We have a great team that is made stronger by the addition of the Pennsylvania employees. Our strong service proposition, current and future product enhancements and churn management programs position us well in the markets we serve.

So with that summary, operator Luan, I would now like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Patrick Ryan with Lehman Brothers.

Patrick Ryan - Lehman Brothers

Good morning guys and thanks for taking the question. Just a quick remainder the synergy estimate for NPSI, I think it was a $11 million run rate after preferred share. That’s the question one. The second question is in terms of when you look at leverage up to 3.6, where is our target for that? By the end of the year or once things fully, the synergies in there and then also in terms of pay out ratio, what were your expectations for ’08 and the longer term. Thanks.

Steven Childers

Hey Patrick it’s Steve Childers, thank you for the questions. May be I will take the leverage question first. We’re obviously closing in 4.6 times as of today, we will give effect to the first year synergy. I will talk about in a second. That will be roughly $7 million, we really look at it as already being at 4.4 times, but we know we are going to deliver on those synergies. I think the target leverage ratio for us -- I am not going to give a timeline for this but our target is to get back to the four times or sub four times to build additional capacity for acquisitions down the road. In regards to the synergy estimated is 7.7 million for this year and we would expect in 2009 with the 11 or roughly 11 to 11.5 million in the second year going to the third year and the payout ratio, I think if – we are not going to give guidance on the payout ratio, but I think if you look where we ended this year is probably a good proxy for what our expectations are.

Patrick Ryan - Lehman Brothers

Great, thanks a lot.

Operator

Your next question comes from Jonathan Chaplin with JP Morgan.

Jonathan Chaplin - JP Morgan

Good morning it’s actually Dave, I’m fitting in for Jonathan. Had two quick questions, first of all on CapEx. Can you help us just a walk through the different components of how you get from the CapEx this year to your guidance of next year including kind of what’s core MPSI, what is the core consolidated portion and the synergies that you are expecting coming in there and obviously there is the $2 million of integration expenses that you highlighted in the press release as well, so that’s the first component and second one on subsidies sequentially they were up quite a bit this quarter wondering if there was bit of a timing issue because in the third quarter things seem to be a little bit lighter than normal and going back historically the fourth quarter seems to have increased a little bit, so I was just wondering if this quarter it was a timing issue, if there was something else going on that you can help flush out.

Bob Currey

Okay hey Dave, good morning this is Bob. I will take the CapEx question and Steve will handle the subsidy. On the CapEx if you look historically we have run at right at $33 million a year and consolidated Illinois and Texas combined and we think that’s a good proxy for going forward. North Pitt, the last two years has run approximately $16 million. We’ve given guidance that that will be $13 million this year and then improving in the out years, so when you add in the 33 the 13 and then the $2 million mostly associated with IT projects for just this year on the integrations, that’s why that adds up to 48, right in the sweet spot in between the guidance that Steve gave earlier.

Steven Childers

And Dave with respect to the subsidies you are correct and then fourth quarter is about 600,000 higher than third quarter. Remember we had a true up in the third quarter a negative settlement with -- on our ICLS like cost fund, or roughly $2.1 million which we talked about in the third quarter. At this time we readjusted some our 2006 cost study based on some new allocation procedures and had a positive draw of roughly 840,000 in the fourth quarter, but over time as we continue to improve our cost structure we would actually expect to see subsidies have a modest decline over time.

Jonathan Chaplin - JP Morgan

Just a follow up on the CapEx, so is there any synergy based on that because I think those numbers that we’ve drawn at, that doesn’t have any sort of synergies and I though I recall that we were expecting some modest synergy accretion from the deal or may be that’s the $16 to $13 million you had referred to earlier.

Steven Childers

Hey Dave this is Steve, let me try that one. When we announced the deal in July 2, we gave -- we basically said that there will be CapEx synergy of $3 million to $6 million and again I think it goes right back to what Bob said. Our expectation and the way that we are looking at that is CNSL, legacy CNSL’s run consistently about $33 million and as he said the run rate, the spin rate for North Pittsburg has been $16 million in each of the last two years, so we are actually baking in $3 million of the synergies into this first year operation.

Jonathan Chaplin - JP Morgan

Okay perfect and then just a follow again on the subsidies right. When I looked at the last year even adjusting for the draws both in the third and fourth quarter they were kind of running pretty close in the 12/1 to 12/4 range, so can you just help me understand with the fourth quarter -- why it seems to be so much higher than that because even this year you have been running at the 10.1 to a 11.6 after adjusting for all the one time screw up.

Bob Currey

The run rate going into the fourth quarter might be a little higher than normal. Again we had the 840,000 sort of out of period somewhere including in the number. So that would give you at 12/1, that would you...

Jonathan Chaplin - JP Morgan

Think at the 12/4 number.

Bob Currey

12/4 so we are still maybe about 300,000 higher than what your number is. Well I have to take a look at that. That I can’t -- that one I am a little surprised in the run rate number there.

Jonathan Chaplin - JP Morgan

Okay, that’s fair. Thanks guys.

Operator

Your next question comes from Chris Larsen with Credit Suisse.

Chris Larsen – Credit Suisse

Hi and thanks for taking my question. Couple of them; first on the dividends for ’08 you said that the pay out ratio would be similar to ’07 give a essence for what percent would be qualified and then you made a comment about the -- you expect some cable VoIP overlap soon. How -- which level cable VoIP you think you will get and then I don’t know if you -- when you said you are not seeing any today whether you were including North Pittsburg in that, if you can just clarify if you are seeing any North Pittsburg and if you expect it there and then just to follow on that last question for the USF payments in ’08 -- in ’07, what are your expectations? I know you said it’s coming down a little bit over time but it sounds almost as if ’08 would be relatively flat to ’07 is that a fair assumption, thanks.

Steven Childers

Hey Chris, thank you for the question. Let me take the -- we will take them in the order that you ask and with the respect to the dividend and the characterization and the tax treatment; for the dividend we ended up this year based on our final EMP study of basically coming out with 20% of that being a return of capital and the 80% being qualifying dividend. Again, it’s pretty hard to project what that number is going to be in a normal state particularly with giving effect the transaction. We really won't know the final answer until 2009. We are part of down the road with our tax. Look at 2008 tax results, but based on our early estimates that’s all they are for right now, is that we would use the 2008 or 2007 final number of 20% return on capital as a proxy.

Bob Currey

Yeah, regarding -– Chris, Bob, regarding the cable competition, maybe just a brief recap. We have had cable competition from Mediacom in Illinois for over a year now and my comment about -- we have said that on every call, we had expected cable competition in all of our markets for a couple of years and that’s why we have been focused on delivering our broadband, our IPTV and a quality experience for them. We had Interconnection agreement signed in Texas but they haven’t launched their VoIP product yet there but we expect it any time. Regarding North Pitt, Armstrong is the local cable company covering most of the territory. They have launched a product over a year ago also and Comcast has a small piece of the property. They have not launched as yet but again we expect all of them to launch at any day, any quarter but again as I said we have been saying that for a long time and I expected and but it hasn’t happen and hopefully they delay it some more.

Steven Childers

Because the final – Steve; the final part of your question was sort of the trajectory or trend line on subsidies. Again, we would expect in our models because of our focus on continued cost reductions which we recover on the subsidy pools, we continue to see in our models, we have subsidy going down slightly year-over-year. I mean if you -- I guess in your model if you kept that flat for 2007 or maybe a similar decline at 2007 or 2006, I think you’d be in the range.

Chris Larsen – Credit Suisse

Alright, thanks a lot. Anything going on with access rates that we should -- just on that same subject. Is there anything we should think about other than your minutes of use and lines, but anything on the permitted rates that might -- we need to think about?

Bob Currey

They are pretty steady and static right where they are. Minor dips but that’s it.

Chris Larsen – Credit Suisse

And no crop ups of traffic seems to be going back -- getting back under control industry-wide.

Bob Currey

That’s true. In fact we led some efforts there a couple of years ago, but the contributors to that, we have narrowed greatly and they know when you are out there monitoring it. So it’s -- we are on guard and I think we have taken most of that off of our network.

Chris Larsen – Credit Suisse

That’s great, thank you.

Operator

(Operator Instructions) Your next question comes from Frank Louthan with Raymond James.

Frank Louthan - Raymond James

Great, thanks. Just not part too much in the subsidy issue, but generally you see subsidy drops in the second and fourth quarter and assuming that most of your peers tend to assume you accrue for these things conservatively like most of your peers, should we as remodeling that look for a little bit more positive seasonality in those two quarters and is that kind of how we should think about it going forward and was there anything and then as far as the trending downward in that dissimulated on a two year look back, so to the extent that you continue to make cost improvements, is that really what’s driving some of the downward subsidies that I guess would be a positive line loss to this as well and then if you can comment a little bit on the videos side you said that you have about 13% penetration of HD what percentage of your new customers are taking HD and do you think that’s going to increase materially when you have both the HD and the DVR to market together, thanks.

Frank Louthan - Raymond James

Hi Frank, this is Steve Childers thanks for the question and be on the call and the response to the subsidy quotient, we actually -- we have our true ups and it’s usually in the third quarter. Are you referring second and fourth quarter? We usually file all our revised cost studies in 2006 and make the -- in the third quarter and make the appropriate change at that time. Having -- revising those cost studies in the fourth quarter again as a result of the work done in third quarter we saw a couple of things that we wanted to change in terms of allocation of cost and on the investment side as loss operating expense and thought it was the appropriate thing to do, so that’s what happened in the fourth quarter. Again for trending it I would -- and you’re exactly right that it is a two year look back and again I think if we have any seasonality or true up it will generally happened in the third quarter.

Bob Currey

Frank, I will handle the AHD question. We are just piling on it just to reinforce. It is around as you have stated, it’s around cost reductions. We have reduced over 300 employees from over 1,400 to less than a 1,100 over the last couple of years and also focused on other corporate overhead legal, stocks implementation is behind us, etcetera so it’s a steady nice downward ramp in cost which obviously are the basis for some of your subsidy reduction. Regarding HD, we did take 13%. The national average for HD is roughly 20%; that’s about what we are seeing with new customers, but remember we launched this after we were up and running with 6,000 or 7,000 IPTV customers. So, we are back selling into that base and we would expect roughly the same kind of take rate. We have also said on this call before though that the product is certainly going to be more of a requirement to compete in the Texas market, not as much though in Illinois but heading that way actually in Illinois. It’s a very desirable product and I would point out in Illinois where we have been launched for over two years now the IPTV penetration -- you commented on penetration; penetration in Illinois is 23%. So we are very pleased with how the penetration ramps year over year as you have been out in the market for a while.

Frank Louthan - Raymond James

Okay great and you said that you would pass about 17,000 homes in Pennsylvania markets by the end of ’08. What sort of alternative availability do you think you will see in that market as far as the availability for IPTV?

Bob Currey

You quoted it right Frank. By the end of the year we will be at 17 and by the end of ’09 we would project that that number will about double into the low 34, 35 range and as we -- we have only been running this property for 60 days and we had some of their forecast and we’ll fine tune that but I think you are spot on at 17 and think about that doubling next year. That’s what we are projecting at this point.

Frank Louthan - Raymond James

Okay and just one last question. You said you have already done the -- you did the conversion on the systems, is that all systems you need to convert in Pennsylvania and have there been any glitches, did you do a flash cut, are you running in parallel and if you did a flash cut, how long -- are you seeing anything that you need to adjust, is there anything we should be concerned about as far as how that system conversion went?

Bob Currey

Frank, great question. Let me start with the first part. It is not the only system. There are multiple systems that are also projects identified and those cuts will take place, most of them in the next six months but there is a conversion schedule that goes on for 18 months but the bulk of the work will be done before the end of the third quarter this year. We were grateful that after they had their shareholders vote in early November that we were allowed to get in here and start doing some planning. So we were thrilled that they allowed us to make some plan and to convert upon the closing, to convert all the financial systems that I identified earlier. So as far as glitches, at this point, the due diligence that we did last summer has just been confirmed. We are finding about what we thought we would find and very confident that we will hit the $7 million and a run rate of $11 million on OpEx synergies by the end of the year.

Frank Louthan - Raymond James

Okay, great. Thank you very much.

Bob Currey

You are welcome.

Operator

(Operator Instructions) There are no further questions at this time. I will now turn the call back to Bob Currey for any closing remarks.

Bob Currey

Thank you Luan and I want to thank all of you again for joining us today and for your continued interest and support to Consolidated Communications. As I hope you can understand from this call we are excited about our current position and opportunities and look forward to updating you again on our progress next quarter. Thank you and have a great day.

Operator

Ladies and gentlemen, that concludes your conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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