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Consolidated Communications Holdings, Inc. (NASDAQ:CNSL)

Q3 2012 Earnings Call

November 1, 2012 11:00 AM ET

Executives

Matt Smith – Treasure and Director, IR

Bob Currey – President and CEO

Steve Childers – SVP and CFO

Bob Udell – SVP and COO

Analysts

Frank Louthan – Raymond James

Jennifer Fritzsche – Wells Fargo

Donna Jaegers – DA Davidson

Steve Blinn – Morgan Stanley

Operator

Good day, ladies and gentlemen and welcome to the Consolidated Communications Holdings Third Quarter 2012 Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator instructions) As a reminder, this call may be recorded.

I would now like to introduce your host for today’s conference, Matt Smith, Treasurer and Director of Investor Relations. Sir, you may begin.

Matt Smith

Thank you, Sam, and good morning, everyone. We appreciate you joining us today for our third quarter 2012 earnings call. At the conclusion of the prepared remarks, we will open the call up for questions. Joining me on the call today are Bob Currey, President and Chief Executive Officer; and Steve Childers, Chief Financial Officer. Also available during the question-and-answer session is Bob Udell, our Chief Operating Officer.

Please review the Safe Harbor provisions in our press release in our SEC filings for information about forward-looking statements and related risk factors. This call may contain forward-looking statements within the meaning 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.

In addition, today’s discussion will include 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 their nearest GAAP equivalent.

I will now turn the call over to Bob, who will provide an overview of our third quarter results and an update to our integration progress. Steve Childers will then provide a more detailed review of the financials. Bob?

Bob Currey

Thank you, Matt, and good morning, everyone. I appreciate you joining us today. Let me begin by making a few comments about our overall results for the quarter and then provide an update on our SureWest integration progress. This is the first quarter of reporting for the combined company and we are very pleased with how the business performed.

On a pro forma basis, both revenue and adjusted EBITDA increased year-over-year with revenue growing around 1% and adjusted EBITDA by 6.5%. These results reflect our successful strategy of improving a top line operating efficient rate and meeting cost synergy targets.

On the top line, we continued our diversification with business and broadband now representing 73% of our total revenues. We also delivered substantial synergies throughout the quarter and continued our cost structure improvements.

At the close of the SureWest acquisition on July 2, we realized $10 million of annualized operating expense synergies and an additional $2 million throughout the quarter. These operating expense synergies are right on our plan and have us on pace to meet or exceed the targets we set of $20 million annually at the end of the first year after close and $25 million at the end of the second.

In addition, we now expect to achieve the high end of our targeted $5 million to $10 million of CapEx synergies. And those will be achieved in the 2013 calendar year. The strong financial results in the quarter allowed us to deliver a comfortable dividend payout ratio of 67.2%. We distributed $15.5 million in dividends to our shareholders in the third quarter and on Monday our Board of Directors declared our 30th consecutive quarterly dividend to be distributed to shareholders on February 1, our record holders as of January 15.

Now moving on to our operating results for the quarter, we delivered strong growth in our broadband subscribers of 6,500. We added 4,100 data in Internet connections and 2,400 video connections. On the residential side, we are now penetrated at 30.2% for Internet marketable homes and 20.2% for video marketable homes. And while these are solid penetration levels, we have significant upside opportunity to drive these higher in addition to increasing ARPU with faster speeds and video tier upgrade.

On the Internet side, we are now offering our customers a multitude of speed between one and 50 megs at different price points providing more options to the consumer and additional upgrade opportunities, with video we rolled out Whole Home DVR in certain markets during the quarter where it had not already launched, we are no longer at a competitive disadvantage in those markets and we expect this to help to drive higher penetration and ARPU. With respect to ILEC access lines our legacy business continued our best-in-class performance.

With the last 12 month line losses down to 3%, on a combined basis with legacy consolidated and SureWest. The access line losses were 4.8% over last year but just as we did when we acquired our North Pittsburgh properties back in 2008 we are using or bundling in sales approach in the California ILEC and expect to improve on our pro forma access line retention. In total net of our broadband growth and voice losses we increased overall connections by 1,500 in the quarter. Delivering on our strategy of growing broadband in excess of voice occurrence.

Now moving on to our enterprise and carrier channels, the momentum continues to move forward and our network is in great shape to deliver the advanced communications and technology solutions that are in demand. Capacity needs on the wireless side are still increasing, as data consumption is exploding. We are benefiting from wireless data on both the network side and through our five Verizon partnerships.

And finally before I turn the call over to Steve, let me provide a brief update on our progress with SureWest. We have a lot of people working very hard on our integration efforts and I would like to publically recognize them for all of their hard work. All of our integration efforts are on plan and I am happy to report that in October, we achieved our first major milestone with the completion of the first step of our billing and back-office integration.

The Kansas City customer base was converted into the existing systems and processes with the California customers. This allows the legacy show us business to operate more efficiently. And with respect to corporate systems, including accounting, payroll, supply chain and HR applications this migration is also on plan and will be completed at year-end 2012.

Our next major step is to combine all customers into one companywide system, which will result in a more standardized internal process, further operational alignment and a better customer experience. Overall I am very pleased with the first quarter of combined operations. The results were strong in both synergies and integration are on target. I am confident in our strategy and our ability to execute on our plans.

And with those comments, I’ll now turn the call over to Steve for the financial review.

Steve Childers

Thanks, Bob and good morning to everyone. This morning, I will review our quarterly financial performance and reiterate our 2012 pro forma financial guidance. But before I do that, let me call your attention to the last table in our press release. To assist with your modeling and stringing analysis, we have presented a table of operating metrics that includes the current quarter as well as the four prior quarters on a pro forma basis.

I’d also like to point out, that the CLEC access line equivalents counts that consolidated traditional reported are now separated and included in each of the appropriate voice and data categories. We believe this presentation of our metrics provides the most useful format for you to evaluate major our success: going forward. With respect to our solid financials in the quarter operating revenues were a $157 million which represent an increase of $1.3 million or 0.8% over the third quarter last year on a pro forma basis. Increases in data, video and back office services were partially offset by declines in voice services in own carrier access.

Total operating expenses exclusive of Depreciation and Amortization were $109.7 million compared to $98.5 million on a pro forma basis for the same period last year the increases primarily due to $14.5 million of transaction costs related to the SureWest acquisition. Also the costs associated with our growth in revenue were partially offset by our savings and synergy initiatives. Net interest expense for the quarter was $20.6 million compared to $13.4 million in the third quarter of 2011. Compared to last year, we incurred an additional $8.4 million of interest expense related to senior notes issued to help fund the SureWest acquisition. This was partially offset by lower costs on our interest rates swap agreement.

Other income net was $8.5 million and in the quarter we received $7.7 million in cash distributions from our Verizon wireless partnerships compared to $6.9 million in distributions for the third quarter of 2011. All these factors on a GAAP basis for the third quarter 2012 we had a net loss of $300,000 and a net loss per common shares of $0.01 compared to the net income of $5.8 million and net income per common shares of $0.19 for the third quarter of 2011.

As detailed in the adjusted net income per shares schedule in the earnings release after adjusting for the financing and transaction costs related to the acquisition of SureWest our adjusted net income and adjusted net income per share in the third quarter of 2012 were $11.2 million and $0.28 cents respectively.

Adjusted EBITDA was $70.9 million in the quarter which is an increase of $4.3 million were up 6.5% from $65.7 million on pro forma basis for the same period last year. Capital expenditures for the quarter were $28.3 million. On a year-to-date basis pro forma capital expenditures were $88 million. We will be within our guidance of $107 million to $113 million which means the fourth quarter will be in the range of $22 million to $27 million.

From the liquidity standpoint we ended the quarter with $24.8 million in cash from the balance sheet and we have 15 million available on our revolver. For the quarter our total net leverage ratio as calculated in our earnings release was 4.38 times to 1, giving forward steps for $25 million of targeted – net of the estimated $3 million to $4 million realized in the quarter that leverage would be approximately four times to one. Cash available to pay dividends was $23 million resulting in a dividend payout ratio of 67.2%.

Now for guidance, we are reiterating the pro forma guidance we provided last quarter for the full year 2012. Capital expenditures for the combined company are expected to be in the range of $110 million to $115 million as compared to $115.1 million in 2011.

Cash interest costs are expected to be in the range of $63 million to $67 million as compared to $59.7 million last year. And finally cash income taxes are expected to be in the range of $5 million to $6 million as compared to $7.8 million in 2011.

With respect to our dividend, our Board of Directors has declared the next quarterly dividend of approximately $0.39 per common share payable on February 1, 2013 to shareholders of record on January 15, 2013. With that I will now turn the call back over to Bob for closing remarks.

Bob Currey

So in summary there are lot of employees working really hard to deliver the kind of results we did this quarter, while successfully integrating the two companies. I am very proud of our employees and excited about the opportunities we have before us. We are well positioned to continue to deliver on our strategy and drive shareholder value to a combination of growth and a strong dividend. And with that Sam, I would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Frank Louthan of Raymond James. Your line is now opened.

Frank Louthan – Raymond James

Thank you on the video ads can you give us an idea of what sort of the split is between the customers that you’re adding on your on the Coax and fiber parts with the network versus the copper and then can you give us an update on the lot of conversation about what Google is doing in Kansas City you’re in that market as well can you give us an update there about your current and expected exposure to what they’re doing and how you see that impacting the competitive business there?

Bob Udell

Yeah, Frank, Bob Udell, can you hear me.

Frank Louthan – Raymond James

Yeah, Bob how you are doing?

Bob Udell

Good, how are you? Hey, as far as the split between copper and fiber we really have the benefit of a diversity of markets that’s beating the growth and giving us the good third quarter as well as a seasonality of the third quarter always being a bit better than the second when you look at the split of fiber and copper, it really somewhat follows the distributions of that network across our customer base; there is no great hedge on the fiber growth in next quarter.

But we do historically see a better take rates in fiber neighborhoods because of the faster speeds and certainly the ability to have a more HD in those offerings. But I can’t say that one is dominating, I wouldn’t say that our Kansas City market was a bit stronger this quarter and that’s just to do with some of our marketing strategies that we brought to market after the close.

On your next question regarding Google, remember that in Kansas City although they’ve announced and we’re seeing them putting up cables and fiber on the post, we’re not overlapping than in any of our residential developments and we feel still very confident in the depth of our product, the speeds of our data, we’re in conversations. The good news with this is we are in conversations with all the cities in which we do service, provide services because they’re interested in what our future plans are and we got a real robust fiber network in that market.

So with no overlaps with the attention that the markets getting it’s really brought us a couple of positives in terms of continuing dialog with the cities we serve, our good service reputation and in fact we’re looking at MSN most favorite opt in opportunities with the cable attachment or pole attachment agreements that they have in Kansas City so where we can extend that to our business reach, we’ll benefit from that.

Frank Louthan – Raymond James

Okay, great. And then can you just over the long term giving an idea of your prioritizing use of cash seem to debt repayment or dividend increases and comment on the safety of the dividend at this point?

Bob Currey

Well, Frank, the predictability and visibility of the dividend is the highest priority here. As we’ve guided, the CapEx is still very healthy in the 110,000 to 115,000 and that will be in the high of the 5 to 10 down next year and probably this same kind of reduction in 2014. So our focus is on managing the growth opportunities that present themselves, but maintaining that healthy dividend payout ratio. There is no plans to do anything with the dividend that’s sacred and secure and we’re focused on reducing our net leverage overtime.

Frank Louthan – Raymond James

Okay. So what’s the lower – improvements in the CapEx and so forth in the next couple of years, so we are seeing that’s kind of just either build some cash in the balance sheet or otherwise go to a lower net debt ratio?

Bob Currey

Absolutely, and on the caveat, I would add to that. If there were some just fantastic growth opportunity, we’re not going to turn down some backhaul fiber opportunities with we’re just very attractive return opportunities. We would look at those, but I think you’re perfectively fine modeling the numbers that I just laid out.

Frank Louthan – Raymond James

Okay, great. Thank you.

Operator

Thank you. Our next question comes from Jennifer Fritzsche of Wells Fargo. Your line is now open.

Jennifer Fritzsche – Wells Fargo

Apologize if you mentioned this and I missed the beginning, but just if you could talk a little bit about the Verizon wireless joint ventures and any sort of outlook you might have related to the direction of CapEx. I know you can’t offer specific color to that, with most of those – those behind these markets, and just wondering directionally of our CapEx in 2013. And then separately, Bob, if I could just held on that one point about growth opportunities you made to Frank, I mean, I would assume that these would involve like more fiber-centric assets then typical RLEC assets. Is that a correct assumption?

Bob Currey

Yes, it is Jennifer, let me start with that and then Steve can talk to your question on the – Verizon wireless partnerships. Yes to spot-on as we’ve transitioned ourselves to a broadband company and not a voice ILEC business, that’s where those opportunities would go. Back to the question – the earlier question that Frank ask also about where is the growth coming on the video side.

The only real homes that we’re adding are fiber whether that’s in Texas, in Greenfield or legacy consolidated and most of that growth in the past year of new homes has been in Kansas City. So while Bob, made the point a good point that there is really the product is basically as good on either on those fiber or copper height or coax facilities. Our growth in new homes is in the fiber arena so you’ll probably see a disproportionate share of the growth go to fiber for that reason alone. So, Steve on the wireless partnerships?

Steve Childers

Sure, hey Jennifer, thanks for the question and on the Verizon again I’m sure – I’m not sure here is the remarks during the call but just a restate for the wireless distributions for the third quarter we receive $7.7 million from Verizon.

As we’ve talked in the past the last half of the year is always stronger than what the first half, it was 7.7 for third quarter is up compared to 6.9 for the same period last year. And since you asked the question on an outlook basis we have just received notification of what all of our distributions are going to be for fourth quarter and we will – on the next call we will be reporting that we have $9.4 million in distribution for the fourth quarter, our highest quarter ever.

So, that will be great way to end the year, but then also to kind of your question going to 2013 relative to time in CapEx, again as we’ve talked in the past the Metro markets for the LTE build out are complete both in Pittsburgh and Houston. We’re still kind of moving through the RSA the three RSAs that we have. Regarding our plan, our thoughts, our – that all things being equal, the growth in the metro market should kind of offset any decline if any on the rural markets. But I also would remind you that some of our distributions are a little bit lumpy based on the timing of when they have the iPhone launches so we would expect our first quarter distribution for 2013 to be impacted by the iPhone 5 launch that we had in the fourth quarter of this year.

Jennifer Fritzsche – Wells Fargo

Great, thank you, Bob.

Operator

Thank you. Our next question comes from Donna Jaegers of DA Davidson. Your line is now opened.

Donna Jaegers – DA Davidson

Hi, guys. Hey, thanks and congratulations on a good quarter. I’m sure you guys putting a lot of work with the integration. Can you give us a little more detail on the wireless backhaul, any sort of color on number of contracts signed, or revenues from those contracts so far?

Bob Udell

Yeah, Donna, this is Bob Udell. With respect to new in the third quarter, we’ve added roughly a $130,000 in new monthly revenue and I think 220 around 225 new circuits. So we continue to see demand both with existing contracts and opportunity for new sites and I won’t give the specific number on right on top of mine but we’re building out new sites as we speak.

Donna Jaegers – DA Davidson

Good and then on the CLEC operations obviously SureWest had lot of good fiber plant in the Sacramento market but you’re facing a pretty sluggish economy out there can you give us any color on what you do and try to add a little more energy – energize the Sacramento CLEC operations?

Bob Currey

Yes, we’d be glad too, the benefit of our portfolio markets now is that we have a diversity of markets specific to Sacramento and California while we actually expected the sluggishness of real estate there to hamper any growth. We’ve seen a more robust take rate on our new Metro E product platform which is really the basis for the business bundle that we specialize or tailor to the size of the business and so with that standardization or that marketing focus on that product some investments we’re making on the VOIP switch and features that we can layer on to that Metro E path. We’re actually seeing a better take rate in California than we would have expected that close.

Donna Jaegers – DA Davidson

Okay. And then a more longer term question for Bob Currey, obviously the regulatory reform has hit a lot of the smaller independently owned telecom carriers harder with the drop in access charges and universal service fund changes looking ahead. What’s your view longer term on M&A, will that create more opportunities for you to just sort of scoop up contingent operations that are close by geographically, are you interested in that? I know you are still digesting SureWest, so probably nothing in the near-term but just sort of a longer-term outlook?

Bob Currey

Don, we would certainly be interested in opportunities where they make sense, and by that I mean perhaps geographically, certainly value wise that continues to diversify us into a broadband and commercial company and away from ILEC voice, we wouldn’t be real excited about a small voice ILEC in a state that we already, or where we don’t already operate.

I think the regulatory reforms certainly and particularly the uncertainty to some of the next phases of it because cost models and other guidance have not been developed yet from the FCC. I think that will contribute to some nervousness on some providers, but there is also that the technological risk, the need for scale and scope today that will also I think enhance the opportunity for some of us who want to be consolidate.

So we’ll be opportunistic as you point out, where heads down right now focused on SureWest, but still maintaining relationships and contacts and we’d be interested in talking to somebody that was looking for an exit.

Donna Jaegers – DA Davidson

Okay, thanks, Bob.

Bob Currey

You’re welcome.

Operator

Thank you. (Operator Instructions). Our next question comes from Steve Blinn of Morgan Stanley. Your line is now opened.

Steve Blinn – Morgan Stanley

Good morning, I think most of my questions have been answered but I just had one more – how much in severance and integration expense do you figure still to come maybe in the fourth quarter or beyond? I know there is a fair amount here in the third quarter but can you give us an idea about how much is left? Thank you.

Steve Childers

Steve, it is Steve Childers. There is probably another $6 million to $7 million that as we move through our – I mean there is some costs that will be paid we’ve already accrued for, they reflect in our purchase accounting. But in terms of other severance costs, other integration related costs I would say below, somewhere between $5 million and $10 million, I guess, and particularly in some factor in severance than what we would be treating as add backs for software integration, some of the licensing and things like that. But again that’s a cash spend that is and to the degree that it’s our adjusted EBITDA calculation. We would be taking that as an add back and to the covenants with credit agreement.

Steve Blinn – Morgan Stanley

Okay, great. Thank you.

Operator

Thank you. Our next question is a follow-up from Donna Jaegers of D.A. Davidson. Your line is now open.

Donna Jaegers – DA Davidson

Hey Steve, just a quick question on depreciation going forward, it looks like you guys wrote down some of the SureWest assets; is this a good level going forward for depreciation expense?

Steve Childers

Donna, that’s a really good question, as you’ll see when we filed our 10-Q, we have not finalized the valuation study and all the purchase accounting related to the SureWest acquisition. So we’re still working how the purchase price, was allocated, so for right now I would, that’s the best number that we have factoring in visions going forward. And we hope to add the valuation, and finalize and we didn’t expected to be any, no tremendous shifts, but it could change a little bit.

Donna Jaegers – DA Davidson

Okay, thanks a lot.

Operator

Thank you. And at this time, I’m not showing any further questions from the phone lines. I would like to turn the call back to management for any further remarks.

Bob Currey

Well, Shawn, thank you, and thanks for all of you for joining us today and for your continued interest and support of Consolidated. We hope you will join us again next quarter and thanks again and have a great day.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.

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