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Consolidated Communications Inc. (NASDAQ:CNSL)

Q1 2008 Earnings Call

May 08, 2008, 11:00 am ET

Executives

Matt Smith - Director of Investor Relation

Steve Jones - Vice President of Human Resources

Bob Currey - President and Chief Executive Officer

Steve Childers - Chief Financial Officer

Analysts

Tom Sykes - Lehman Brothers

Jonathan Chaplin - JP Morgan

Frank Nelson - Raymond James

Charlie Smith - Fort Pitt Capital

Operator

Welcome to the Consolidated Communications First Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. Following management's prepared remarks we'll hold a question and answer session. (Operator Instructions). As a reminder, this conference is being recorded today May 8th, 2008. I would now like to turn the conference over to Kirsten Chapman. Please go ahead, ma'am.

Matt Smith - Director of Investor Relation

Good morning. This is Matt Smith. As previously announced, I am assuming the investor relations responsibilities while Steve Jones has become our Vice President of Human Resources. It is my pleasure to kick off the call today. Thank you for joining us for Consolidated Communications First Quarter 2008 Earnings Conference Call. 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 measures 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 first quarter financials and Bob?

Bob Currey - President and Chief Executive Officer

Thank you, Matt and thank you all for joining us today. As a reminder, due to the timing of closing on the North Pittsburgh transaction this is our first quarter reporting results for our Pennsylvania operations and we are delighted with both our progress in Pennsylvania and our overall results.

We had another strong quarter and are firing on all cylinders. Our operating metrics were solid. Both revenue and adjusted EBITDA were strong and the Pennsylvania integration is ahead of schedule. We continue to successfully execute on our strategy of providing high-quality broadband and voice services. We're focused on generating strong sustainable cash flow to support the dividend while continuing to invest in the long term growth of our business.

Regarding the quarter, I'd like to start with a brief overview of our consolidated financial results and then review our operating metrics. Financial results for the first quarter were very strong. Revenue and adjusted EBITDA were $105.4 million and $49.2million, respectively. The dividend payout ratio was a solid 72.2% for the quarter.

Overall, 2008 is off to a great start from a financial perspective. Now, on to our operational results. Before I review the detail of the operating metrics, I should note a couple of non-revenue impacting changes to the total connection schedule. First, as detailed in the schedule in the earnings release this morning we are now including Pennsylvania ILEC access lines, Pennsylvania CLEC access line equivalents and ILEC VoIP lines in our total connection count. And second, to be consistent with our legacy markets, we're now reflecting Pennsylvania PRR circuits as 23 lines for the ILEC access line count and have presented these in the earnings release on a comparable basis for both 2006 and 2007.

Now regarding our operating results, in terms of DSL we're off to a great start for the year. We added 3,000 new ILEC DSL subscribers bringing the total base to over 84,000.

Our marketing team continues to produce solid DSL net adds. And we are pleased to report that we launched our DVR service last week. We're excited to finally offer this product as it completes our current IPTV suite. This gives us a very competitive video offering and when coupled with voice and data provides for a strong triple play. Also, last week, we introduced IPTV service in Pennsylvania.

I am proud of the team for getting this product to market so quickly after closing. We launched with our full IPTV product suite including DVR, HD, Video-on-Demand and over 200 all digital channels. At last week's launch we passed approximately 12,000 homes representing about 25% of the Pennsylvania ILEC footprint. We expect this number to grow to 17,000 homes by the end of the year and from a competitive standpoint being able to offer the triple play is a significant step forward.

As we stated on the last call, DVR was delayed until April in order to ensure a high-quality customer experience. For the quarter we posted IPTV growth of 800 bringing the total subscriber base to over 13,000. I mentioned earlier that we added ILEC VoIP lines to our total connection count and I'm pleased to report the product grew by nearly 500 lines in this quarter.

As mentioned on prior calls, we target this product towards small to medium size businesses and as of the end of the quarter we had over 2900 ILEC VoIP lines in service. And finally regarding access lines, our Pennsylvania market continues to have a line loss at a pace greater than our Illinois and Texas markets. We are excited about the new Pennsylvania triple play bundle and expect it to have a positive impact on access line and broadband performance. For the CLEC business, we grew access line equivalents by 2800 this quarter.

A key contributor to that increase was the sale and installation of a large multi-facility healthcare organization. In terms of our Pennsylvania integration, we're very pleased with the progress. Thrilled with the valuable contribution and support of the Pennsylvania Employee Group and we remain very confident in our plan. All projects are on or ahead of schedule and are on budget.

To date, we have completed the following major integration projects. Corporate rebranding, the conversion of the financial and HR systems. We are now internally hosting and operating the ILEC billing system and the integration of the carrier billing system into our platform. Additionally, all of the former North Pittsburgh executives were out of the business by the end of January. So in summary, we've already taken action to realize approximately 4 million of the 7 million in projected year one synergy savings.

On the competitive front, as anticipated, Suddenlink launched its cable VoIP products several weeks ago in parts of our Conroe and Lufkin, Texas markets. Cable VoIP now overlaps approximately 54% of our territory in Texas and approximately 62% of all of our markets combined.

On a final note, there has been some exciting economic activity that will result in employment growth in our markets. In Pennsylvania, Westinghouse is consolidating its nuclear division in Cranberry Woods which is reported to bring as many as 3000 employees to our service area. Construction has already begun on this project and last month we sold them the first PIRI for this complex. And in Texas, KBR, a large engineering construction company has reported it will be building a 900,000 square foot facility in Katie that will centralize approximately 4500 employees in the middle of our Katie market. They plan to break ground on this project by the end of the year.

So with that, I will now turn the call over to Steve for our financial review.

Steve Childers – Chief Financial Officer

Thanks Bob. Good morning to everyone. As Bob mentioned, we are very pleased with our first quarter results. This morning, I will review our quarterly financial performance and then update you on 2008 guidance. Operating revenue for the first quarter of 2008 increased 22.4% to 105.4 million, compared to 83 million in the first quarter of 2007. The increase is primarily due to 24 million in revenue generated by our new Pennsylvania operations. Excluding the contribution from the North Pittsburgh acquisition, operating revenues were 81.5 million for a quarter-over-quarter decline of 1.5 million.

Contributing to this decrease was the following factors. A decline in network access revenue primarily driven the by receipt of 1.2 million carrier billing settlements recognized in the first quarter of 2007 and a decline in local calling services associated with the reduction in access lines. This was partially offset by additional data and Internet revenue attributable to the continued growth in DSL and IPTV subscribers.

Total operating expenses exclusive of depreciation and amortization for the first quarter of 2008 were 62 million compared to 47.9 million in the first quarter of 2007. The increase was primarily due to inclusion of 14.3 million in cost to sales and SG&A expenses associated with our new Pennsylvania operations which were in line with our expectation.

Also, our first quarter2008 total operating expense includes approximately $1 million in integration and severance expense, which qualifies as an add back to adjusted EBITDA under the terms of our credit agreement.

Depreciation and amortization for the quarter was 22.9 million, an increase of 6.3 million compared to the first quarter of 2007.

As a result of the North Pittsburgh acquisition and the related fair value study, in the quarter we recognized 7 million in appreciation on the fixed assets acquired and the amortization of the customer lists from North Pitt.

Net interest expense for the quarter was 18.1 million, an increase of 6.7 million compared with the first quarter of 2007. The increase was primarily driven by the incremental debt and terms of the new credit facility associated with the North Pittsburgh acquisition.

Other income of 4.1 million represented an increase of 2.8 million compared to the same period last year. As part of the North Pittsburgh transaction, we acquired limited interests in three additional wireless partnerships. These new investments contributed approximately 3 million in the quarter.

Weighing all these factors, net income for the first quarter of 2008 was 3.7 million compared to net income of 4.6 million for the same period last year. Net income per common share for the first quarter of 2008 was $0.13 compared to $0.18 for the same period last year. However, we believe 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 $0.16 per share in the first quarter of 2008.

Adjusted EBITDA for the first quarter was 49.2 million, compared to 37.2 million for the same period last year. The primary driver of the 12 million or 32% increase was the inclusion of the results from our North Pennsylvania property.

Capital expenditures were 13.3 million in the first quarter of 2008 and we fully expect to be in our guidance range at year end. Our Q1 CapEx spend includes approximately 400,000 associated with our integration efforts.

From a 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 compliance levels of the new credit facility.

In regards to the capital structure, we did close and fund the North Pittsburgh transaction at 1231, 2007. As announced on April 1st we did redeem the remaining $130 million of our 9.75 senior notes.

By using available cash and only drawing $120 million under the $140 million for late term loan we were able to replace our high coupon bonds with bank debt at a weighted average cost of 7.1% and reduce gross debt by $10 million. As a result of this transaction, we'll save approximately $4 million in annualized cash interest costs.

Also as a result of this transaction in the second quarter, we will recognize a $9 million charge to earnings which consists of a $6.3 million bond redemption penalty associated with the redemption and a write-off of approximately $2.7 million in deferred financing costs. This will favorably impact our guidance on cash taxes which we will discuss in a minute.

For the first quarter of 2008 our total net leverage ratio as calculated in the earnings release was 4.6 times to 1. Please note, the schedule reflects both the pro forma LTM adjusted EBITDA calculation and our new capital structure.

Cash available to pay dividends or CAPD was a strong 15.7million for the quarter yielding a comfortable 72.2% dividend payout ratio.

Now I'd like to provide our 2008 guidance. Capital expenditures for the full year remain unchanged in the range of 46.5 million to 49.5 million including $2 million in integration CapEx. Cash interest expense remains unchanged at 64 million to 67 million and with respect to cash income taxes do to the 9 million charge to earnings as a result of the bond redemption as previously discussed adjusting our guidance down from the previous range of $15 million to $18 million -- down to a new range of $12 million to $13 million. And finally with respect to our dividend, our Board of Directors has declared the next quarterly divided of approximately $0.39 per common share payable on August 1st, 2008 to shareholders of record on July 15th, 2008. With that, I'll now turn the call back over to Bob for closing remarks.

Bob Currey – President and Chief Executive Officer

In summary, the business performed well in the quarter and we're off to a great start in 2008. We're excited about our growth opportunities including the launch of IPTV in Pennsylvania, the addition of the DVR product in all three states and the major commercial developments underway in our communities. We continue to believe we are well positioned in our markets and look forward to the future. And with that, Allison, I'd like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from Tom Sykes with Lehman Brothers.

Tom Sykes

Yeah, thanks for taking the question. I've got two if I could. The first is it looks like the North Pittsburgh access line declines looking at it the old way. The year-over-year decline on a percentage basis and an absolute basis improved quite a bit and I was wondering how much you attribute that to what you've done so far in the market and how much you would just attribute to natural sort of leveling out of cable VoIP impact and to the extent that you haven't done a lot so far how whether or not you're excited about your ability to bring down those -- that loss rate even more. And then second question. On IPTV, can you sort of give us a flavor for how much the net adds on IPTV were impacted by the delay of the DVR? I mean did you slow down marketing at all so that you could ramp up once the DVR became available? Thanks.

Bob Currey

Good morning Tom thanks for the questions. Regarding North Pitt, I would say it's more to the latter that you said. Cable VoIP having peaked and not so much what we've done there. We're excited to be launching the triple play. We've been taking a lot of incoming scuds from Armstrong. They've known since last July we're coming and they've shot every weapon they've had at us and so we're not disappointed with where it is but I would tell you it's way too early for us to take any credit for that improvement. That would be more the peak and it's turned down and while we've done some things, I think that will bear its fruit in future quarters.

Regarding IPTV, the thing we did -- we didn't -- I wouldn't say we stopped everything because we still grew 800 but we knew -- we need particularly as we've discussed in the past we needed DVR in Texas so we slowed down there to launch to make sure that we were ready with the DVR product and obviously we couldn't launch in Pittsburgh. We wanted to wait until we had the full suite and launch with DRV. In Illinois, we're up over 20% market penetration and the DVR product will open some more up for us, but frankly in Illinois we've come up the ramp pretty quickly and we're not passing any new homes or haven't in the last couple of quarters. So we're sort of reaching a point where the growth in Illinois is not going to be as steep as it was.

Tom Sykes

Okay, great thank you very much.

Operator

Your next question is from Jonathan Chaplin with JP Morgan.

Jonathan Chaplin

Good morning guys. I'm wondering if you can dig into the synergies a little bit. So -- the of the $4 million it sounds like you put projects in place already that are going to capture $4 million in savings of the $7 million I'm wondering how much in actual worldwide synergies showed up in the first quarter number? Is it a break up of that $4 million or is it something less? And then given that your 4 million of 7 million totals after one quarter, isn't it likely that you're going to overshoot the 7 million -- your 7 million expectation or is it just a large part of the synergies you are able to capture very quickly? And on this -- from the 3 million that came in from the NPSI partnerships. Is that a sustainable level or was there something one-time in the amount of EBITDA contribution from those assets this quarter? Thanks guys.

Bob Currey

Yes, okay, Jonathan. Let me take the first two and then I'll let Steve handle the one on the wireless partnerships. As far as 4 million, yes. You can categorize it properly. It's stuff that we captured early. We were able to get in there after they completed their shareholder vote in November so we got a head start and we're able to get some things done in the first quarter. Albeit some of it was late in the first quarter. So I would estimate to your question about how much did we actually save in the first quarter? It's probably 500,000 to 600,000 but it's a run rate -- on a run rate basis. It will equate to the 4 million on an annualized basis. As far as how far we'll over shoot the 7 million, I think it's a little too early for me to predict on that at this point. I'm very confident on the 7 and think there's some upside there but it would be premature for me to make a statement at this time and Steve on the wireless?

Steve Childers

Sure. Hey, Jon thanks for the question. Relative to the North Pittsburgh wireless partnerships again, as I said on earlier in my remarks we acquired three new interests -- limited partner interests in the three new investments. Those through off about $3.3 million of cash for the first quarter and there's probably $500,000 to $600,000 a little bit higher than what our internal model or expectation was. Those same partnerships through off $9 million in cash last year. We kind of expect to have the same run rate. Again, although we're very excited to be in those investments the way those individual partnerships are growing. They completely overlay our ILEC footprint and surround our CLEC footprint. So I think we actually have a little bit of a wire supply and happy to have the contribution from those businesses. So all in from wireless partnerships we probably have about $15 million in cash distributions for the year from those and we do think we'll deliver on those numbers for this year.

Jonathan Chaplin

Great. And if I could just follow up on - perhaps comment on synergy realization. It seems that you get a decent step up then on synergy realization in 2Q. As far as synergies that you capture in 1Q, so it seems like margin should continue to come up from 1Q to 2Q. Is that fair?

Bob Currey

Yes. There's -- I want to be cautious again here to Jonathan because as you know a lot of things move around from quarter to quarter but clearly some of the synergy things that happen late in the first quarter will carry over into the second quarter. We'll get the benefit of those on a run rate basis.

Steve Childers

Hey, Jonathan I agree with what Bob said. I just want to be cautious to. I think from -- we're ahead on our headcount from a run rate expense savings so from an operational point of view we'll continue to see margin expansion that way. We also want to go back to the earlier discussion on the wireless partnerships. Again, I would classify maybe 500,000 of that being higher than expected going into Q2.

Jonathan Chaplin

Okay, thanks a lot guys.

Operator

(Operator Instructions) Your next question is from Frank Nelson Raymond James.

Frank Nelson

Great. Thank you. On the ILEC VoIP line can you give us a little more color on that? What exactly -- how exactly are you marketing that? Is that sort of a win back opportunity? Are you generally replacing cooper loops with VoIP lines and what's sort of the advantage to the customer there? And then on the billing systems, when exactly did you cut over the billing system from North Pittsburgh and can you -- have you been through a full billing cycle yet and then did you do a flash cut or run parallel systems for one cycle or so? Can you give some update on that? Thanks.

Bob Currey

Yeah, Frank, regarding the VoIP. It's T1 delivered. It's a product that we're focused on to small and medium size business It's a hosted VoIP product. It really is just -- and is primarily in Texas and Pennsylvania today. So it's just a substitute product for the -- a PBX or key system small business type focus and it's been well received in the marketplace. The other interesting thing about it is we're getting term with it too Frank. We're getting a three -- most of the customers are taking five-year term so we're locking up some revenue. The ARPUs about the same as a key system so we're pleased with the exception -- or with the acceptance of the product. Regarding the billing question on when we cut it.

Steve Childers

Hey, Frank this is Steve. I'll take the billing question and I'll break it into a couple of parts. Number one, the system that's fully integrated onto our platforms is our caterer access billing. We cut that over at the end of March. We did a complete test. A couple of bill cycles and again absolutely no issues of flawless cut. We're very excited to have that behind us. The other two billing systems, the ILEC billing system was really hosted by Armstrong and basically all we've done on that to set the path forward for future integration on to our consolidated billing platform is we move the hosting relationship from Armstrong to our consolidated systems. So nothing has really changed with respect to the billing system. We have control of the data and processing and our competitor no longer has that information. And then the CLEC was kind of a -- is a stand-alone billing project right now and nothing has changed relative to that. Does that answer the question?

Frank Nelson

Yes, that's great, thank you very much, thanks.

Operator

(Operator Instructions). Your next question is from Charlie Smith Fort Pitt Capital. Charlie your line is open. I apologize. That question has been withdrawn. (Operator Instructions) Next question is from Charlie Smith Fort Pitt Capital.

Charlie Smith

Yeas good morning, can you hear me now?

Bob Currey

Yes.

Charlie Smith

Good. I'm wondering if the SEC votes to tax the USF at March levels. What effect that may have on your subsidy line going forward?

Bob Currey

Well, first of all Charlie we strongly support what the SEC did as far as capping the ETCs. That's been where the tremendous growth in the fund and has put the political pressure on doing something with the fund. We have modeled a slight decrease year-over-year. Well we've seen it year-over-year the last two or three years and we projected that will happen into the future. Modest in our projections, in our plans. So we're pleased with the progress and hope that they continue and have some time now to do comprehensive reform.

Charlie Smith

Okay, thanks.

Operator

At this time, there are no further questions. I will now turn the call over to Bob Currey for any closing remarks.

Bob Currey

Thank you, Allison and thank all of you for joining us today and for your continued interest in and support of Consolidated Communications. As I said earlier, I'm excited about our expanded team, our markets and our competitive position. And with that again, 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 line.

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