Consolidated Communications Holdings Inc (CNSL) 2006 Q3 法說會逐字稿

Welcome to the Consolidated Communications Third Quarter Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

As a reminder this conference is being recorded, Wednesday, November 8, 2006.

I would now like to turn the conference over to Mr. Steve Jones, Vice President of Investor Relations.

Please go ahead, sir.

Good morning and thank you for joining us today for Consolidated Communications Third Quarter, 2006 Earnings Conference Call.

As Nicole mentioned, I'm Steve Jones, Vice President, Investor Relations, and with us today on the call 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 risks.

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 their nearest GAAP equivalent.

I will now turn the call over to Bob.

Thank you, Steve, and thank you all for joining us today.

Once again, I am pleased to report we are executing well against our plan.

This quarter, we accomplished quite a bit operationally and posted strong financial results.

Our goal is to provide high-quality broadband and voice services, generate strong sustainable cash flow, and support the dividend.

Our strategies for long-term success continue to be growing revenue for customers, improve operating efficiencies, maintain a disciplined CapEx philosophy, and selectively pursue acquisitions.

Before commenting on our operational execution, let me provide a brief financial overview.

Steve Childers will go into greater detail a bit later.

Overall, we are very pleased with the financial results for the quarter.

Revenue was solid at 80.3 million.

We continue to realize margin improvement as we drive cost out of our business, and adjusted EBITDA was strong at 34.8 million.

The dividend payout ratio for the quarter was 75.9%.

Including this quarter's results, we have generated cumulative available cash under our credit agreement of approximately 21.2 million, and we paid out 11.5 million in dividends in the third quarter.

I would note that beginning in the fourth quarter of '06, due to the Providence equity share repurchase, our dividend will decrease to 10 million quarterly.

Now, let me talk a bit about some of our operational objectives and achievements during the quarter.

Sequentially, we grew total connections in excess of 1,600 in the quarter and are now up over 7,600 for the year and surpassed 290,000 in total.

Our robust products offerings, bundling strategy and a focus on customer service have favorably impacted line loss.

Access lines were down approximately 2,900 when compared to the second quarter of this year, but 780 were due to a non-recurring access line reclassification.

This reclassification was due to a company initiated review with our phase two billing integration project, and had no impact on current or future revenues.

After adjusting for this non-recurring event, our annualized year-to-date line loss, excluding the one-time reclassification, is 2.9%.

In terms of DSL, we had another outstanding quarter, surpassing the same quarter performance we achieved for the past two years, we added over 3,400 new DSL subscribers.

This brings our total subscriber count to 49,360 and represents a 7.4% increase compared to the second quarter of '06, and a 37% increase compared to third quarter of '05.

For the year, we've added over 10,000 new subscribers, bringing our penetration of primary residential lines to 28.7%.

Regarding IPTV, we had another strong quarter in Illinois and as we announced at the end of August, we're excited to have launched the product in Texas.

First in Illinois, we again added over 1,000 customers, bringing the total subscriber base to over 5,500.

We continue to see strong and steady demand for this product.

Additionally, we increased the size of the market we serve.

We added 8,000 homes in the quarter, bringing the total homes passed to 35,000.

The build out is on time and on budget.

I would also like to highlight that our average penetration rate now tops 24% in the three original markets that we launched in 2005.

To us, this indicates strong customer demand for our IPTV product and triple play offerings.

Even more significant of the approximately 5,500 IPTV customers, 89% take our triple play offering of voice, video and data.

Second in Texas, as we previously announced, we launched our IPTV product at the end of August, initially passing 37,000 homes.

Just as we did with the IPTV rollout in Illinois last year, we are taking a measured approach to the launch to insure that the network and back office processes are well tested.

We learned with the Illinois rollout that word of mouth can be the single greatest stimulant for demand, so it is critical we insure the customer experience is positive.

We have applied all the lessons learned from our prior Illinois launch.

The video network is performing very well, the number of trouble reports is at an all-time low, and first call resolution that avoids a [truck] roll is at an all-time high.

Training is completed for all frontline personnel and we feel confident our initial customers will have a great experience with Consolidated's IPTV service and we'll pass that news along to friends and family.

Let me briefly update you on our video on demand product.

As I mentioned on last quarter's call, we completed our conversion to a new vendor in the second quarter, and now offer 1,000 hours of content.

In Illinois, the customer feedback has been very positive, and we have experienced a 47% increase in video on demand usage.

DSL and IPTV, along with our other products, have been key drivers of the 19.7% year-over-year increase in our service bundles.

We believe the increased value of a bundle of product offerings, supported by superior customer service, will drive revenue and increase customer satisfaction and importantly, retention.

Along with growing revenue per customer, we continue to improve our cost structure.

As planned, we completed phase two of our billing integration project in August.

I am very pleased to report the project came in on time, under budget, and with the desired customer enhancements.

As a brief reminder, both Texas and Illinois utilized the same billing system software, although they were on different releases.

We have now successfully migrated our Texas customers to our enhanced billing software.

Phase three, the final phase, will integrate our Illinois customers and we expect that to complete in mid 2007.

As I mentioned on last quarter's call, completion of phase two allowed us to consolidate call centers and related work groups while providing a more consistent and efficient service delivery.

We have completed this consolidation.

This alone yielded a network force reduction of 24 with an anticipated expense savings of $1 million annually.

On the competitive front, as I also mentioned on our second quarter call, Mediacom launched its voice product in the Eastern part of Illinois in the second quarter.

We believe our triple play offering compares well to Mediacom's and are pleased that our quarterly line loss, net of the non-recurring items, is lower than the same period last year despite the Mediacom launch.

On the M&A front, we continue -- we recognize that there has been activity in the sector recently and we continue to also monitor acquisition opportunities.

As I said in the past, we don't have to do anything, but we do have M&A and integration experience and if we found an opportunity that made sense for Consolidated, we would pursue it.

Let me now turn the call over to Steve Childers, our CFO, for a financial review.

Thanks Bob and good morning to everyone.

As Bob mentioned, we are very pleased with our third quarter and year-to-date financial results.

This morning I will review our quarterly financial results and confirm our 2006 guidance.

Revenue for the quarter was 80.3 million, which reflects a $1.9 million decrease compared to 82.2 million in the third quarter of 2005.

This was primarily attributable to the client prior period subsidy settlements.

Subsidy revenue declined in total by 3.7 million, which included a $2.7 million decrease in prior period subsidy settlements.

In the third quarter of 2005, we received a total of approximately 1.5 million prior period receipts from the Federal Interstate Common Line Fund, and the Texas High Cost Support Funds.

For the third quarter of 2006, there was not a comparable Texas High Cost Fund receipt and the annual Interstate Common Line adjustment resulted in the company refunding 1.2 million.

Another factor driving the decline were increases in the national average [lube] cost and their impact on universal service fund draws.

Local calling service revenue decreased by 700,000 due primarily to the reduction of local access lines.

These period-over-period decreases were partially offset by an increase in data and Internet service revenue of 1.5 million, driven by the growth in our DSL and IPTV products.

The increase in network access revenue of one million was driven primarily by increased demand for special access circuits and back billings associated with completion of internal circuit audit.

Total operating expenses for the third quarter of 2006 were 64.9 million, which reflect a 10.4 million decrease compared to 75.3 million in the third quarter of 2005.

The overall decrease in operating expense was attributable to our ongoing cost reduction initiatives and the recognition in the third quarter, 2005, of 6.6 million in additional non-cash compensation expense related to [vesting] obligations associated with our restricted share plan at the time of the IPO, as well as 2.2 million of incremental litigation costs.

In addition, affecting results in this quarter was a legal settlement associated with a dispute involving a landlord of the former TXU Communications headquarters facility in Irving, Texas.

This dispute related to obligations associated with a lease signed in 2001 on this facility.

As a result, we recorded a $500,000 charge to earnings to cover this settlement.

Although we felt the suit against us was without merit, we chose to settle to avoid continued litigation expense.

As a result, income from operations was 15.5 million for the third quarter of 2006, which reflects an 8.6 million increase compared to 6.9 million in the third quarter of 2005.

Net interest expense for the quarter was 11.2 million compared to 19.8 million for the same period last year.

The decline was primarily driven by the redemption of 65 million of our senior notes in the third quarter of 2005.

In connection with the redemption, we incurred a bond redemption premium of 6.3 million, and also recognized the related deferred financing write off of $2.3 million.

Income tax expense for the third quarter of 2006 was 3.9 million, compared to a tax benefit of 1.3 million for the same period last year.

The increase was primarily due to the significant change in pretax income.

In addition, we recognized approximately $800,000 in incremental tax expense in the quarter associated with finalizing and filing our 2005 consolidated federal tax return and amending our 2003 and 2004 federal returns for our Texas operations.

Accordingly, net income for the third quarter of 2006 was 2 million, compared to a loss of 10.2 million for the same period last year.

Net income per common share for the third quarter of 2006 was $0.07.

However, we believe it is appropriate to look at the third quarter income per share on a normalized basis.

Excluding non-cash stock compensation expense, adjustments in income tax expense, as previously discussed, as well as [bill] integration, severance and startup costs for Sarbanes-Oxley, net income per share would have been $0.15 per share, a reconciliation of which is provided in the press release.

Adjusted EBITDA was 34.8 million for the quarter compared to 33.1 million for the same period last year, reflecting an increase of 1.7 million.

Adjusted EBITDA margin for the quarter, for the third quarter of 2006, was 43.3% compared to 40.2% for the same period last year.

After adjusting for the change in prior period subsidies and litigation costs, the adjusted EBITDA margin was 44.8% compared to 42.5% for the third quarter of 2005.

This represents an over 200 basis point increase in margin.

The increases in both adjusted EBITDA and in adjusted EBITDA margin were attributable to increases in revenue, improvements in operating efficiencies, and incremental cash distributions from our sell partnership investments and after accounting for the change in prior period subsidy settlements and litigation costs.

As planned, capital expenditures were 7.8 million in the third quarter of 2006.

We ended the quarter with 19.9 million in cash on the balance sheet and over $30 million in our -- and our $30 million revolving credit facility remains fully available to us.

For the third quarter of 2006, our total net leverage ratio as calculated in our earnings release was 4.1 times to one.

The increase over the second quarter -- the increased leverage over the second quarter of 2006 was driven by a modest increase in term borrowing associated with the Providence share repurchase.

All coverage ratios were well within compliance levels of our credit facility.

Cash available to pay dividends or CAPD was 15.2 million in the third quarter of 2006, yielding a 75.9% payout ratio.

And now I would like to reiterate our 2006 guidance provided on our second quarter call.

Capital expenditures are not -- are expected not to exceed 33 million.

Annual cash interest is expected to be in the range of 40 million to 41 million.

Cash income taxes are projected to be in the range of 7 million to 8 million.

Also, consistent with prior quarters and our stated dividend policy, our board of directors on Monday declared our next quarterly dividend of approximately $0.39 per common share payable on February 1, 2007, to shareholders of record on January 15, 2007.

With that, I'll now turn the call back to Bob.

Thank you, Steve.

In summary, I could not be more proud of the company's performance this quarter.

We accomplished many things, including the successful completion of phase two of billing integration, the consolidation of three call centers, and the launch of our IPTV product in Texas, all while growing total connections and posting strong financial results.

We continue to focus on providing high-quality broadband and voice services while generating strong, sustainable cash flow.

I'm pleased with the completion of phase two of billing and delighted with both our DSL and IPTV results.

We are well positioned for margin improvement, a strong finish in '06, and to hit the ground running in 2007.

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

Nicole, would you take some questions?

[OPERATOR INSTRUCTIONS]

Your first question comes from Jonathan Chaplin with JP Morgan.

Good morning, thanks, great quarter guys.

Two quick questions if I may, firstly on EBITDA margins.

I'm wondering how much of a benefit you got from the 24 heads that were eliminated this quarter or if all of that benefit really only comes next quarter?

And then following on from that, what opportunities are there for margin expansion between now and mid '07 when you complete the last phase of the billing conversions?

Or does the next sort of leg of margin expansion only come close to completion of that project?

Thanks.

Thank you Jonathan, good morning.

On the first part of that question, the recent reduction of 24, the estimated annual savings of $1 million, we haven't -- there's not been any of that achieved yet.

Those folks just left the payroll and so you'll see those going forward.

You haven't seen those in the third quarter results.

Regarding the opportunities, I'll paraphrase it and if I missed your question, come back.

But I'll paraphrase it [a bit].

The trends going forward, as Steve noted, we've had a 230 bps improvement in our margin performance.

We see that trend continuing over the next year.

Some of that will come with phase three of billing and some of that will just come from the recently completed call center consolidations, along with some of the other benefits that we've achieved with migrating to common systems and common platforms and improving our operating performance.

So we're excited about the opportunities that we have to continue our margin improvement over the near term.

Excellent.

If I could just follow up on that?

Do you expect to get that incremental 200 bps sort of evenly over the quarters of '07, or will it be sort of more backend loaded following the completion of billing?

Yes, Jonathan, it won't be arithmetic.

It will be a bit bumpy, but it certainly won't all come just with the completion of phase three.

There will be some benefits that come with phase three, but we should be able to show improvement throughout the year.

It won't all be tied in coming in the mid year when we complete the billing integration, phase three.

Excellent.

Thank you, very much.

I would caution too, we're launching Texas video and that is EBITDA dilutive in the short term, so just like Illinois, it's the right thing to do for all of the strategic reasons and over time, it will be a nice contributor to our EBITDA growth.

But in the short term, that is a negative.

Your next question comes from Patrick Rien with Lehman Brothers.

Good morning guys and thanks for taking the questions.

I just had a quick question around the competitive landscape, around your Texas markets.

I know you mentioned Time Warner and Cox in the area, and I was just wondering if you'd seen any sort of pre-launch for VoIP service down there?

No, we really haven't.

You're getting the general advertising, some billboards that overhangs the market, but nothing specific from any of the competitors in Texas at this point.

Excellent.

And then just one follow-up on Mediacom in Eastern Illinois, any increase in them going back and winning back customers, or increasing their marketing effort?

No, not really.

As I noted in my introductory comments, if you take out the one-time audit period adjustment, we're actually slightly better on line loss year-to-date in '06 as compared to '05, and that's with the Mediacom launch.

So we feel that our product offerings are very competitive.

I would also add that we recently put together a win back program with some feet on the street in Illinois and we've had some early success with 24 of those migrating back.

So it's early, it's an early indicator, but clearly, we don't -- we're not going to stand still and do nothing with those launches.

We're going to respond.

Great.

And just one last question on that.

Any idea what the coverage I guess is of Mediacom in those markets or your Illinois access lines?

Well, Mediacom covers about almost 60% of the Illinois territory, Charter being the rest, and overall, it's 16% of our total company lines.

Great, thanks a lot guys.

[OPERATOR INSTRUCTIONS]

Your next question comes from Michael Rollins with Citigroup.

Hi, good morning, just a couple of questions.

The first one is can you just give us a sense of as you look at the subsidies in 2007, I think you touched on this a little bit earlier in your comments around some of the adjustments in the third quarter, what kind of net change should we see in subsidies over the next 12-to-24 months as you get rid of a lot of just the true-ups back and forth that have been happening over the last couple of years?

And then just a second question, just very briefly, I'm just curious as you look at the IPTV success that you've had in Illinois, how are you finding the scalability of the systems?

And what are the things that you've been positively surprised by and maybe those things that were either a little bit more challenging or required a little bit more work than what you previously would have expected?

Thanks.

Hey Mike, this is Steve.

I'll take the first part of your question and Bob will take the IPTV related question.

With respect to subsidies, we did call out the 1.2 million negative draw or refund back to the pool in the third quarter.

Obviously we don't expect to incur that in the fourth quarter, and in our model, we have -- based on all of our cost reduction efforts, we have projected a slight decrease in subsidies -- a very modest decrease in subsidies over the next 12 months.

Michael, and good morning, thanks for joining the call.

On the scalability, we've had no scalability issues.

We've been very pleased with that.

Surprises, we had -- in the early days, a year and a half ago, we had interoperability issues with the different vendors.

Those have been solved well over a year ago, and we're very happy with that.

We had a little bump with the gateways to the home, the manufacturing issue that we talked about on the last call where the supplier was doing it in India and he has since brought that back to San Diego.

Those are behind us.

And then I think the positive things coming down the road are HD and DVR that will add some revenue enhancing, ARPU enhancing opportunities to our network or to our customer base as did the VOD vendor change that we made in the last quarter.

So net-net, we're thrilled with the way the network is performing, the vendors are responding.

I guess the last positive -- just from a personal standpoint, the picture still just blows me away [at yield].

You'd think that it was an HD product, when you compare it to what they've been getting, at least here in Illinois from Mediacom.

Thank you, very much.

[OPERATOR INSTRUCTIONS]

There are no further questions at this time.

Mr. Jones, you may proceed with your presentation or any closing remarks.

Yes, well, thank you Nicole, and I thank all of you for joining us today and for your continued interest and support of our company.

As you can tell by the call, we remain excited about our current position and the opportunities.

We look forward to updating you on that progress.

In terms of upcoming events, we will be presenting at the Credit Suisse Media and Telecom Conference on December 5th in New York, and at Citigroup's Global Entertainment, Media and Telecom Conference in January in Las Vegas.

And I look forward to seeing some of you at those events.

Thanks for joining us and have a great day.

Ladies and gentlemen, that concludes your conference call for today.

We thank you for your participation and ask that you please disconnect your lines.