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Consolidated Communications Holdings, Inc. (NASDAQ:CNSL)

Q2 2008 Earnings Call

August 7, 2008 11:00 am ET

Executives

Matt Smith – Director of Investor Relations

Robert Currey – President, Chief Executive Officer

Steve Childers – Chief Financial Officer

Analysts

Patrick Rien – Lehman Brothers

Frank Louthan – Raymond James

Michael Nelson – Stanford Group

Gray Powell – Wachovia

Chris Larson – Credit Suisse

Operator

Welcome to the Consolidated Communications second quarter earnings call. (Operator Instructions) I would now like to turn the conference over to Matt Smith of Consolidated Communications.

Matt Smith

I'm Matt Smith, Director of 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'll 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 meaning of the Federal Securities laws. Such forward-looking statements reflect among other things managements current expectation, 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 web site contains reconciliations of these measures to their nearest GAAP equivalent. I will now turn the call over to Bob who will provide an overview of our financial and operating results. Steve Childers will then provide a more detailed review of the second quarter financials.

Robert Currey

Our results for the second quarter were very strong. Revenue, adjusted EBITDA and cash available for dividends were all solid, and our Pennsylvania integration continues to be ahead of schedule. As anticipated, the cable competitors launched voice services in our Texas markets during the quarter. We have taken the necessary steps to be well positioned to compete with our Triple Play bundle, industry leading DSL penetration and our consumer VOIP offering.

Now let me review some of the details for the quarter. Revenue and adjusted EBITDA were $106.4 million and $48.3 million respectively. The dividend payout ratio improved to 68.4%. As for our metrics, we celebrated a key milestone this quarter by breaking 100,000 mark for broadband connections. We continue to deliver solid broadband growth with DSL and IP TV increasing by a combined 3.4% over last quarter.

Considering that the second quarter is historically a seasonal challenge, we are pleased to report DSL net adds were comparable with the second quarter performance over the last two years, rising by approximately 2,300 subs or 2.7% sequentially, while IP TV showed good growth at approximately 1,100 or 8.3% sequentially.

Both our DVR and Pennsylvania IP TV launches in late April have shown positive traction and we like the prospects for these products going forward. Our take rate on DVR and HD across all markets is up to 6% and 13% respectively. Our VOIP offering is proving to be a substantial growth opportunity and a desirable alternative from a technology and value perspective for some of our customers.

We added nearly 1,200 lines in the quarter which is split between new customers and existing customers. While this does in some cases cannibalize access lines, we are saving a customer by offering this alternative and it is another way that we successfully compete head to head with the cable providers.

Finally, regarding access lines; as we announced on our last call, Sunlake launched its voice service in our Texas markets early in the second quarter and Comcast followed later in the quarter. As expected, this caused a spike in our access line loss for the quarter. In our estimate, this means cable providers and their voice services are now virtually 100% launched in all three of our states. We have been preparing for this challenge for years and with our full product suite, we are uniquely positioned to compete and win.

In our Pennsylvania operations we have seen [inaudible] line loss trends stabilize at an annualized 6.5% for the second quarter compared to 10% last year at this time. For the [C-lack] suite we grew access line equivalents by approximately 900 in the quarter, giving us an increase of over 5% year to date.

Now in terms of the Pennsylvania integration, we continue to be very pleased with our progress and are confident in our synergies and overall plan. We have been able to utilize same playbook and leverage the experience game from integrating the Texas properties which was a much larger transaction that tripled the size of our company. As we mentioned on our last call, we have already completed the integration of our financial systems, carrier access billing system and move the I-link billing system in house from a third party which enables our internal technical staff to fully support the systems. We have successfully completed 20 bill cycles between the I-link and access billing systems.

So in summary, we're confident we will exceed our original projections of $7 million and have already taken action to realize approximately $5.5 million in annualized savings.

Now, let me touch on the economy. Although the economy in general is in a challenging period, we like our unique blend of rural and growth markets as they have helped insulate us from major downturns. To date, we have not seen any major impact on our business on the economy. In fact, before I turn the call over to Steve, I want to provide an update on some of the commercial growth activity we talked about last quarter.

First, Westinghouse is consolidating its nuclear division in our Cranberry, Pennsylvania territory with plans to bring as many as 3,000 jobs to the area. Construction is well under way and we have already installed some services to support their construction efforts. Secondly, KBR continues to be on track to build a 900,000 square foot facility in our Katy, Texas market with construction beginning by year end. This will centralize about 4,500 jobs in our market. We are focused on both of these outstanding opportunities.

I will now turn the call over to Steve Childers for the financial review.

Steve Childers

We again delivered strong results for the second quarter. This morning, I'll review our quarterly financial performance and then update our 2008 guidance.

Operating revenue for the second quarter of 2008 increased 24% to $106.4 million compared to $80.9 million in the second quarter of 2007. The increase is primarily due to $24 million in revenue generated by our new Pennsylvania operations. Excluding the contributions of the north Pittsburg acquisition, operating revenues were $82.4 million for a quarter over quarter increase of $1.5 million. Contributing to the increase were the following factors: data and internet revenue was up $2.1 million primarily due to growth in DSL, IP TV and voice subscribers. This was partially offset by a decline in local calling services associated with the reduction in access lines.

Total operating expenses exclusive of depreciation and amortization for the second quarter of 2008 were $63 million compared to $48.1 million in the second quarter of 2007. The increase is due to the recognition of $14.3 million in cost of sales and SG&A expenses associated with our new Pennsylvania operations which were in line with our expectations.

Also, our second quarter of 2008 total operating expenses includes approximately $1 million of integration and severance expense which qualifies as an add back to adjusted EBITDA under the terms of our credit agreement.

Depreciation and amortization expense for the quarter was $22.4 million, an increase of $5.7 million compared to the second quarter of 2007. This increase was driven by our north Pittsburg acquisition.

Net interest expense for the quarter was $16 million, an increase of $4.5 million compared to the second quarter of 2007. This increase was due to the incremental debt in terms of new credit facility associated with the north Pittsburg acquisition, net of the interest savings associated with the April 1 redemption of the remaining $130 million of our 9 3/4 senior notes. As a result of the redemption in the quarter we recognized a $9.2 million loss in extinguishment of debt. This charge consists of $6.3 million redemption penalty and the write off of $2.9 million in previously deferred financing costs.

By using available cash and only drawing $120 million under our $140 million delayed term loan, we were able to replace our high coupon notes with bank debt and a weighted average cost of 7%, and reduced gross debt by $10 million. As a result of this transaction, we will save approximately $4 million in annualized cash interest costs.

Other income of $4.6 million increased $2.8 million compared to the same period last year. As part of the north Pittsburg transaction, we acquired limited interest in three additional Verizon wireless partnerships. These investments contributed approximately $2.9 million in the quarter.

Weighing all these factors, net income for the second quarter of 2008 was $180,000 compared to net income of $5.5 million for the same period last year, while net income per common share was $0.01 and $0.21 respectively. 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 on the earnings release, our adjusted net income was $6.4 million and adjusted net income per share was $0.22 per share in the second quarter of 2008 compared to $4.9 million and $0.19 per share respectively in the second quarter of 2007.

Adjusted EBITDA for the second quarter was $48.3 million compared to $36.1 million for the same period last year. The primary driver of $12.2 million, or 34% increase was inclusion of results from our Pennsylvania property.

Capital expenditures were $13 million in the second quarter of 2008 and our year to date CapEx spend is $26.3 million. The accelerated spending rate for the first half of the year was driven by integration related CapEx and network additions necessary for the video build out in Pennsylvania. As we'll discuss we'll review guidance for 2008 capital spending will not exceed $48 million.

From a liquidity standpoint, we ended the quarter with $10.4 million in cash and our new $50 million revolver remains undrawn. For the second quarter of 2008, our total net leverage to ratio as calculated in our earnings release was 4.6 times to 1. Please note that the schedule reflects both the pro forma LTM adjusted EBITDA calculation and our new capital structure. Our leverage in all other coverage ratios were well within compliance levels in the new credit facility. Cash available to pay dividends or CAPD was a strong $16.6 million for the quarter, yielding a comfortable 68.4% dividend payout ratio.

Now I'd like to update you on our 2008 guidance. First, with respect to capital expenditures as just discussed, we are lowering the top end of the range from $49.5 million to $48 million. As a result, our new full year guidance range is $46.5 million to $48 million including $2 million in integration CapEx.

Cash interest expense remains unchanged at $64 million to $67 million, and full year cash income taxes remain in the range of $12 million to $15 million. As a reminder, on our first quarter earnings call, we lowered our guidance in cash taxes from $15 million to $18 million to a new range due to tax effect with a $9.2 million loss of redemption of debt associated with calling our senior notes.

And finally, with respect to our dividend, our Board of Directors has declared the next quarterly dividend of approximately $0.39 per common share payable on November 1, 2008 to shareholders of record on October 15. With that, I'll now turn it over to Bob for closing remarks.

Robert Currey

In summary, the business performed very well in the quarter. We're excited about our growth opportunities with our broadband and VOIP products in all of our markets and the major commercial development underway in our communities. We continue to believe we are well positioned in the markets we serve and look forward to the future.

With that, I'd like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Patrick Rain – Lehman Brothers

Patrick Rien – Lehman Brothers

On the synergies, it looks like you're probably on track to beat the $7 million guidance you gave this year. Does that mean you're pulling some of the synergies from next year into this year or do you think you'll also potentially see $11 million next year? And also, on the DSL ads, I was wondering if you had some promotions going on and how you're feeling there so far through the quarter.

Robert Currey

Regarding the synergies, the 5.5, that's just a jump on the $7 million of this year so it is not bringing forward the $11 million for next year. We're confident that we will exceed the $7 million this year and that we'll meet or exceed the $11 million next year.

Regarding DSL, we have a strategy of constant promotions refreshing each quarter, but nothing out of the ordinary. It's our normal refreshing along the way. In ads we announced before, we launched an extended reach where we're taking it beyond the limitation, giving somebody a broadband product but maybe not the full 10 meg or 6 meg, and that's been very successful for us, but other than that, no unique or aggressive promotion activity.

Patrick Rien – Lehman Brothers

The DVR box – how do you price that for customers that are already IT TV subscribers and do they sign new contracts or do you subsidize that? What's the hit on that when you go out and switch it out?

Robert Currey

We price it at $12.95 if you're not in a bundle, and if it's in a bundle it drops to $7.95, and there's no contract.

Operator

Your next question comes from Frank Louthan – Raymond James.

Frank Louthan – Raymond James

Any change in long distance calling patterns, minutes of use shifting in June or going into July that we've seen there? Can you give us an update on what you think the outlook for the facility in Pennsylvania? Do you think you'll be able to ramp the growth a little more? Is that still going pretty steady?

Robert Currey

On the LD, there's really no major shift and in fact, we had a slight up tick in the percent take of our LD product. We're at an all time high as far as penetration. But as you know, there's been pressure on price and usage, but it's as predicted, no major change.

Regarding the [C-lack] we're very, as we've announced in the past, we're very pleased with the results of the [C-lack] operation in Pittsburg. We think that north Pitt was doing that very well. We like the growth and we see it kind of steady. We've grown over 5% year to date and we think that's a good number to look at going forward.

Frank Louthan – Raymond James

The other income line, with the wireless partnerships, is that a good run rate that we should be thinking about going forward? Can you give us an idea on the consumer board side, how are you positioning that and how do you market that product to customers currently?

Steve Childers

I think that the second quarter what you see in the financials for the second quarter probably is a good run rate from an equity basis and the way we're looking at earnings. I would remind you that according to the credit agreement that we have, and we made for adjusted EBITDA, we are backing up the equity earnings and adding the cash distributions to those partnerships in there. And relative to the cash distributions, we are probably about $700,000 higher in the first quarter than we were compared to the second quarter. I think the second quarter is representative both on a run rate basis for the cash distributions and the equity earnings from those partnerships.

Robert Currey

Regarding your question on VOIP, as we said, we launched it in Texas first and in certain markets in Texas it has become a primary offer for us. But it's always stimulated with the bundle. The focus in on the bundle and they get a nice price break if it's taken in conjunction with the bundle. In Illinois where we just started with it, it's strictly been a win back, retention, save product for us in Illinois, and that will change over time as it will in Pennsylvania.

Operator

Your next question comes from Michael Nelson – Stanford Group.

Michael Nelson – Stanford Group

Could you provide us with some color on how well your IP TV service has been received in Pennsylvania and are you seeing the same types of trends or anything different in that market?

Robert Currey

We're pleased with finally getting the product launched, actually very quickly, four months after closing. And just in context, even though we launched it over 13,000 homes or 12,000 homes, we didn't launch all those day one. We launched that over a period of the quarter, so we're now out selling in all those homes. We've been very pleased with the subscriber growth during this initial period and the customer acceptance.

Each market has different characteristics, so it's not particularly valuable to compare the launch metrics like when we launched in Illinois almost three years ago. But as far as expectations, I would say that it was in line or slightly better with our expectations. We expect to see good growth in the near term, and then over time it starts to moderate. Obviously for competitive reasons, particularly with the aggressive competitor there, we've decided not to disclose how many of the new IP additions from that market.

But the network and the team are doing very well for just taking over that property at the beginning of the year, and we're excited, and the employees are very excited to have a competitive offering out there to compete with a very aggressive cable company.

Michael Nelson – Stanford Group

Regarding potential M&A, obviously lots of talk in the industry. You guys seem to be doing a great job integrating the north Pittsburg property and as you complete that integration, I'm wondering if you see any other attractive assets out there and do you feel like you have the balance sheet and bend with the targeted additional acquisitions at this point?

Robert Currey

We're not going to comment specifically on any specific companies. We do view ourselves as a consolidator. I think over the last three that we've done, we've proven that we can do them very well. We're always looking, but our focus is on executing, finishing this Pittsburg, even though we're well ahead and very confident that it will go well.

Our focus is on de-levering, executing against our business plan, integration, get the synergies and de-lever. At the same time, we'll have our eye open and be opportunistic should something come on the market. Obviously the financial markets need to improve, but we will be in a good position should something that makes sense for us come on the market.

Operator

Your next question comes from Gray Powell – Wachovia.

Gray Powell – Wachovia

How should we think about overall access line trends with the expansion of your IP TV product in north Pittsburg, and does the increased competition in Texas offset the gains that you're making in Pennsylvania? Do you see further opportunity for improvements in the north Pittsburg territory?

Robert Currey

Regarding the competition, we've been expecting it and commenting on these calls for a number of years that we'd get the launch in Texas. It's happened. You know some of this history. What happens is, you get that initial spike. You have it for two or three quarters and then it moderates. We think we're well positioned because even though we don't have coverage 100% with our IP TV product in Texas, we've been out in the market. We're known.

I think also our high DSL penetration also serves as a nice barrier to competition. So we feel like we're very well positioned to compete in Texas. We'll work our way through the spike of the next couple of quarters.

Regarding PA, absolutely we see upside there. We've seen in just a short period of time with the launch of our IP TV product some excitement around that. It's a word of mouth product, getting out into the community and so we would be disappointed if we didn't continue to make progress both on the line loss and on total connection growth in not only Pittsburg but across our three state operation.

Gray Powell – Wachovia

On you IP TV efforts, it seems like relative to my model that you may be pulled in for the expansion to Q3 this year into Q2? Can you talk about what you expect to do for the rest of the year and give us a sense of the operating expenses and CapEx associated with the IP TV expansion in 2008?

Robert Currey

Could you clarify the question on the expansion? Are you asking if we're covering more territory?

Gray Powell – Wachovia

If you're at about 130,000 homes just passed roughly speaking, what you expect to cover the rest of the year?

Robert Currey

Except for Pennsylvania, we will expand the market in PA. Between now and the end of the year we'll add a minimum of 4,000 to 5,000 past in PA. And there's some minor little tuck ins, but it really doesn't move the needle in Texas or Illinois as far as homes past.

Steve Childers

What we're really, I don't want to say waiting for, but bonding which we're testing in the laboratories now and supposedly will be commercially available later this year. We're not counting on it quite that early, but that's what we're waiting for. We can much more economically pass homes when we get the bonding. We've sort of gotten the low hanging fruit with our initial launches and the bonding will open up significantly more homes.

Operator

Your next question comes from Chris Larson – Credit Suisse.

Chris Larson – Credit Suisse

You said 100% cable VOIP launch and I just wanted to clarify. Was that 100% of your territory has competition from cable VOIP or that 100% of what's going to happen has been launched. And as you look at how that competition is going to play out, are you thinking one to two quarters is the big rush of people that are excited to change and that begins to stabilize out after that, like what we've seen in some of the other carriers? How are you thinking about the level of access line losses with the cable competition?

And lastly, you just mentioned something about the bonding and it got me to thinking that you could dramatically increase obviously you data rates with DSL bonding, and are you considering selling bonded DSL service so that you can sell higher data rates just as pure data to your customers? It seems like at least in some of the other territories, cable is doing well because they have the higher data rates.

Robert Currey

As far as the 100%, it was the later of the explanations that you gave. It's launched by all of the cable companies in the areas where they can provide service, ie: parts of their territory they haven't built long loops, so it's roughly 85% of our serving territory. But all the companies that overlap us in service have launched their VOIP product. That's what I meant by the 100%.

To the competition question and the spike, in general and what we've seen from media com, you get that a couple of quarters, maybe three and it starts to moderate. In some places, some of the companies we've followed, it's gone on longer than that. Again, my comment about IP TV and DSL, we think we will moderate that fairly quickly. You get the early adaptors that change and then it levels off, and then your products and the quality of your service etc., then starts to differentiate how well you compete.

Regarding bonding, yes, it does open up some opportunities. However, we currently can get 10 meg to about 80% of our DSL subscribers, so at this point, we really don't need, there's very little need beyond a 10 meg product. But bonding will open up that should we need additional speed going forward.

It obviously also extends the loops. You can get much more distance. It's a trade off as you are well aware of whether its band width or the length of the loop, but it certainly will take our coverage from roughly 95% today to perhaps closer to 100% if not 100%.

Operator

There are no further questions.

Robert Currey

Thank all of you today for joining us and for you continued interest and support of Consolidation Communications. Thanks and have a great day.

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Source: Consolidated Communications Holdings, Inc. Q2 2008 Earnings Call Transcript
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