Consolidated Communications Holdings Inc (CNSL) 2007 Q4 法說會逐字稿

Welcome to Consolidated Communications fourth quarter earnings conference call.

At this time, all participants are in a listen-only mode.

Following management's prepared remarks, we'll hold a Q&A session.

(OPERATOR INSTRUCTIONS)

As a reminder, this conference is being recorded today, March 6, 2008.

I would now like to turn the conference over to Mr.

Steve Jones, Vice President, Investor Relations.

Please go ahead, sir.

Thank you, Luanne, and good morning to everyone and thank you for joining us today for Consolidated Communications' fourth quarter 2007 earnings conference call.

As Luanne said, I'm Steve Jones, Vice President, Investor Relations, and with us on the call today are Bob Currey, President and Chief Executive Officer, and Steve Childers, Chief Financial Officer.

After the prepared remarks, we will conduct a question and answer session.

I will now review the Safe Harbor provisions of this call and then turn it over to Bob.

This call may contain forward-looking statements within the context of the federal securities laws.

Such forward-looking statements reflect, among other things, management's current expectations, plans and strategies and anticipated financial results, all of which are subject to known and unknown risks, uncertainties and factors that may cause the actual results to differ materially from those expressed or implied by these forward-looking statements.

Please see our public filings with the Securities and Exchange Commission for more information about forward-looking statements and related risk factors.

In addition, during this call we will discuss certain non-GAAP financial measures.

Our earnings release for this quarter's results, which has been posted to the Investor Relations section of our website, contains reconciliations of these numbers to 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 our fourth quarter financials and Bob will conclude the prepared remarks with an update on our Pennsylvania activities.

Bob?

Thank you, Steve.

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

We had a very productive and exciting fourth quarter.

Not only did we close the North Pittsburgh transaction, but I'm pleased to report the existing business continues to generate both solid operating and financial results and connection growth remains strong.

I know you have heard me say it before, but we continue to successfully execute on our strategy of providing high-quality broadband and voice services in our Illinois and Texas markets, and are looking forward to extending this strategy into Pennsylvania.

Our focus continues to be on generating strong, sustainable cash flow to support the dividend by growing revenue per customer, improving our operating efficiency and maintaining a disciplined capital expenditure philosophy.

Regarding the quarter, I'll start with a brief overview of Texas and Illinois financial results and then review the operating metrics.

Due to the timing of the closing of this transaction, our results for 2007 obviously do not include North Pittsburgh's.

The financial results for the fourth quarter were strong.

Revenue and adjusted EBITDA were $85 million and $37 million, respectively.

The dividend payout ratio was 71% for the quarter and a very comfortable 75.9% for the year.

We delivered solid operating metrics and again sequentially grew total connections in the quarter.

In terms of DSL, we had another phenomenal quarter.

We added over 4,000 new DSL subscribers, bringing the total subscriber base to over 66,000 customers.

Contributing to that success was our decision to offer a standalone DSL product.

We don't mass market this product, but we use it only in targeted situations, such as wireless-only households.

Those customers have proven very receptive to our DSL offering and we are confident we can continue to make well-targeted gains.

We like this opportunity because it allows us to win back customers we've lost over the years and to utilize facilities that we have already installed.

We believe it's critically important to establish and retain this support and connection with the customer.

Not only does it allow us to leverage existing facilities, but it provides the opportunity to layer on our additional products, such as IPTV.

We increased IPTV subs in the quarter by 1,200 customers, bringing the total subscriber base to over 12,000 customers.

Our HD offering continues to be well received.

The picture quality is great and the channel lineup continues to meet the needs of our customers.

We will be adding a minimum of six new HD channels to the lineup in the second quarter of this year, making our HD programming even more compelling.

At the end of the fourth quarter, almost 1,600 customers have signed up for our HD, representing approximately 13% penetration of the IPTV households.

As previously mentioned, we had planned to launch DVR this month.

However, due to a problem with the software upgrade required to enable the DVR service, we decided to delay the launch one month until April.

While the problem has been resolved, the additional time will ensure that our customers receive the experience they have come to expect from Consolidated.

Regarding Pennsylvania, we will also launch IPTV service at the end of April.

This means, out of the gate, we will over our full product suite, including DVR, HD, video-on-demand and over 200 all-digital channels.

I'm extremely proud of the team and their ability to launch this product so quickly after closing the transaction.

We're excited to introduce this in Pennsylvania and we will be passing 12,000 homes at launch, representing approximately 25% of the ILEC footprint.

We would expect the Pennsylvania number to grow steadily to 17,000 homes by the end of 2008.

We continue to be excited with this product and expect total IPTV customers to grow by approximately 50% in 2008.

Our access lines were impacted this quarter by completion of phase three, our final phase of our billing integration.

As part of the standard implementation process, we suspended billing treatment for approximately 30 days.

This was done to stabilize the billing records and help ensure a smooth cutover.

The end result was to push approximately 500 disconnects from the third quarter into the fourth.

There's also been a lot of talk recently about the economy and the impact it is having on the various telecommunication service providers.

From our perspective, we have seen only a modest impact on our business.

We benefit from serving diverse markets, both rural and suburban.

Our historical experience tells us that these markets don't feel the full effect of either market upswings or market downturns.

To date, we have not seen the significant impact that some other parts of the country have experienced.

On a competitive front, there's nothing new to report.

As I have said every quarter, we continue to expect additional entrants any day, although at present, no new cable companies have launched a voice product in our markets.

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

Thanks, Bob, and good morning to everyone.

As Bob mentioned, we are very pleased with both our fourth quarter and year-end financial results.

This morning, I'll review our quarterly financial performance and then provide 2008 guidance.

Bob will then briefly review the results from Pennsylvania so my comments will primarily be focused on Illinois and Texas.

Revenue for the quarter was $85 million, an increase of $3.3 million over the fourth quarter of 2006.

This increase was primarily driven by increases in data and Internet revenue, other operations revenue and subsidies.

Data and Internet revenue was principally attributable to the growth in DSL and IPTV subscribers, while the increase in other operations revenue is primarily driven by [$900,000] increase in customer premise equipment, or CPE sales, in our commercial segment.

Impacting subsidies was an increase in prior-period settlements.

In the fourth quarter of 2007, we received an $840,000 draw, primarily associated with the updates to our 2006 ICLS cost studies.

This was approximately $360,000 more than we received from comparable adjustments for 2006.

Total operating expenses for the quarter were $67.5 million, a decrease of approximately $9.4 million compared to the fourth quarter of 2006.

The fourth quarter of 2006 reflected an $11.2 million non-cash impairment charge, while the fourth quarter of 2007 reflects approximately $800,000 in incremental CPE cost, increased IPTV cost associated with serving a larger subscriber base and increased cost incurred in support of the incremental other operations revenue, and approximately $200,000 in integration expense associated with the North Pittsburgh transaction.

These increases were partially offset by $800,000 in tax refunds and true ups associated with property taxes and the Texas capital tax recognized in the quarter.

Net interest expense for the quarter was $22.1 million, an increase of $10.5 million compared to the fourth quarter of 2006.

This increase was driven by the write-off deferred financing cost associated with the early repayment of our previous credit facility.

Income tax expense for the quarter was a benefit of $2.1 million, driven primarily by the pre-tax loss and $862,000 associated for resetting of our state-deferred tax rates after giving effect to preliminary purchase for the North Pittsburgh transaction.

Accordingly, net loss for the fourth quarter of 2007 was $1 million compared to a loss of $500,000 for the same period last year.

Net loss per common share for the fourth quarter of 2007 was $0.04 compared to $0.02 for the same period last year.

However, we believe that it is appropriate to look at income per share on an adjusted basis.

As detailed on the adjusted net income per share schedule in the earnings release, our adjusted number was $0.20 per share in the fourth quarter of 2007 compared to $0.21 in the fourth quarter of 2006.

Consistent with our expectations, adjusted EBITDA for the fourth quarter was $37 million compared to $35.7 million for the same period last year.

Capital expenditures were on plan at $8.8 million in the fourth quarter of 2007 and $33.5 million for the full year.

From 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 of the levels of the new credit facility.

In regards to our capital structure, we did close and fund on the North Pittsburgh transaction of December 31st.

Accordingly, our year-end balance sheet reflects $296 million in incremental bank borrowing, taking our term debt to $760 million.

As announced last week, on April 1st, we will redeem the remaining $130 million of our 9.75% senior notes by using available cash and only drawing approximately $120 million of the $140 million delayed term loan.

By replacing our high coupon bonds with bank debt and de-levering by approximately $10 million, our capital structure after April 1 will show $880 million in term loan debt at a weighted average cost of 7.1%.

As a result of this transaction, we project to save approximately $4 million in annualized cash interest cost.

For the fourth quarter 2007, our net leverage ratio, as calculated in our earnings release, was 4.6 times to 1 times.

Please note the schedule reflects both a pro forma LTM adjusted EBITDA calculation and our new capital structure.

Cash available to pay dividends, or CAPD, was a strong $14.1 million for the quarter, yielding a 71% dividend payout ratio.

Now, I'd like to spend a few minutes to provide our 2008 guidance, which reflects our expectations for all three states.

Consistent with 2007, we will provide guidance on capital expenditures, cash interest and cash taxes.

Capital expenditures for the full year are expected to be in the range of $46.5 million to $49.5 million, including $2 million in integration CapEx.

Cash interest expense is expected to be in the range of $64 million to $67 million.

And cash income taxes are expected to be in the range of $15 million to $18 million.

And finally, with respect to our dividend, our Board of Directors has taken the following actions.

First, it is declared the next quarterly dividend of approximately $0.39 per common share, payable on May 1st, 2008 to shareholders of record on April 15th.

Second, the Board has indicated its intention to continue paying the quarterly dividend at its current level throughout 2008.

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

Thanks, Steve.

We're excited to have completed the North Pittsburgh transaction and to welcome Pennsylvania employees to the Consolidated team.

Because of the closing date, North Pitt will not be reporting separately so we would like to share these results.

Revenue for the fourth quarter and full year of 2007 was $23 million and $95.7 million, respectively.

Adjusted EBITDA for the fourth quarter was $11.3 million and full year, $43.2 million.

These results reflect pre-acquisition operation and are not indicative of what the business will achieve as part of Consolidated.

Integration activities are well underway.

As mentioned previously, we are using the same playbook and project management team we used when we successfully integrated the Texas asset.

We have identified multiple integration projects and for each, have established timelines, deliverables and budgets.

Work has begun on the majority of them with the priority placed on those with the highest payoff.

This is a very familiar territory for us and we are glad to be out of the planning phase and onto execution.

In terms of an integration update, we completed the financial system consolidation a full 90 days ahead of schedule and North Pittsburgh's general ledger, payroll, financial reporting and HR were converted to our PeopleSoft ERP system, effective with the December 31st close.

After the first 60 days of operation and based on our early start and the progress we have made, we are confident we will meet our $7 million in projected first-year synergies.

So in summary, the business performed very well in 2007 and we are excited going into the new year.

We have a great team that is made stronger by the addition of the Pennsylvania employees.

Our strong service proposition, current and future product enhancements and churn management programs position us well in the markets we serve.

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

(OPERATOR INSTRUCTIONS).

Your first question comes from Patrick Rien with Lehman Brothers.

Good morning, guys, and thanks for taking the question.

Just a quick reminder.

The synergy estimate for NTSI, I think it was $11 million run rate after the first year.

That's question one.

The second question is in terms of when you look at leverage, like your [3.6 times], where is a target for that?

By the end of the year or once things fully get all the synergies in there.

And then, also in terms of payout ratio, what are your expectations for '08 and then longer term?

Thanks.

Hey, Patrick.

It's Steve Childers.

Thank you for the questions.

Maybe I'll take the leverage question first.

We're obviously closing on a 4.6 times as of today.

You give effect to the first year synergies, which I'll talk about in a second, of being roughly $7 million.

We really look at it as already being at 4.4 times because we know we're going to deliver on those synergies.

I think the target leverage ratio for us, and I'm not going to give a timeline for this, but our target is to get back to 4 times or sub 4 times to build additional capacity for acquisitions down the road.

In regards to the synergy estimate, it is $7.0 million for this year and we would expect in 2009 it would be roughly $11 million to $11.5 million in the second year going into third year.

And the payout ratio, I think, again, we're not going to give guidance on the payout ratio, but I think if you look where we ended this year, it's probably a good proxy for what our expectations are.

Great.

Thanks a lot.

Your next question comes from Jonathan Chaplin with JP Morgan.

Good morning.

It's actually [Dave Stiebel] sitting in for Jonathan.

I had two quick questions.

First of all, on CapEx, could you help us just walk through the different components of how you get from the CapEx this year to your guidance of next year, including what's core and PSI, what is the core consolidated portion and the synergies that you're expecting to come in there?

And obviously, there's the $2 million of integration expenses that you highlighted in the press release, as well.

So that's the first component.

And the second one, on subsidies, sequentially, they were up quite a bit this quarter.

I'm wondering if there was a bit of a timing issue because in the third quarter, things seemed to be a little bit lighter than normal.

And going back, historically, the fourth quarter seems to have increased a little bit.

So I was just wondering if this quarter, if it was a timing issue, if there was something else going on that you could help flush out?

Okay.

Hey, Dave.

Good morning.

This is Bob.

I'll take the CapEx question and Steve will handle the subsidy.

On the CapEx, if you look, historically, we have run right at $33 million a year in consolidated Illinois and Texas combined.

And we think that's a good proxy for going forward.

North Pitt, the last two years, has run approximately $16 million.

We've given guidance that that will be $13 million this year and then improving in the out years.

So when you add in the $33 million, the $13 million and then the $2 million most associated with IT projects for just this year on the integration, that's why that adds up to $48 million right in the sweet spot in between the guidance that Steve gave earlier.

And, Dave, with respect to the subsidies, you are correct in the fourth quarter is about $600,000 higher than third quarter.

If you remember, we had a true up in the third quarter, a negative settlement on our ICLS side cost fund, or roughly $2.1 million, which we talked about, in the third quarter.

This time, we readjusted some of our 2006 cost study based on some new allocation procedures and had a positive draw of roughly $840,000 in the fourth quarter.

But over time, as we continue to improve our cost structure, we will actually expect to see subsidies have a modest decline over time.

Okay.

Just a follow up on the CapEx.

So is there any synergy baked in there?

Because I think those numbers that we've drawn out, that doesn't have any synergies and I thought I recall that we were expecting some modest synergy accretion from the deal.

Or maybe that's the $16 million or $13 million that you had referred to earlier.

Hey, Dave.

This is Steve.

Let me try that one.

When we announced the deal on July 2nd, we basically said that there would be CapEx synergy of $3 million to $6 million.

And again, I think it goes right back to what Bob said.

Our expectation and the way that we were looking at that is that CNSL, legacy CNSL has run consistently about $33 million.

And as he said, the run rate, or the spin rate, for North Pittsburgh has been $16 million in each of the last two years.

So we're actually baking in $3 million of synergies into this first year of operation.

Okay, perfect.

And then just a follow up again on the subsidies.

When I looked at it last year, even adjusting for the draws both in the third and fourth quarter, they were running pretty close to $12 million, on the $12.4 million range.

So can you just help me understand why the fourth quarter, why it seemed to be so much higher than that?

Because even this year, you've been running at the $10.1 million to $11.6 million after adjusting for all the one-time screw ups.

The run rate going into the fourth quarter might be a little than normal.

Again, we had the $840,000 out-of-period settlement included in that number so that would get you at about --

I think that's the $12.4 million number.

$12.4 million so we're still maybe about $300,000 higher than what your number is.

We'll have to take a look at that.

That one, I'm a little surprised in the run rate number there.

Okay.

Thanks, guys.

Your next question comes from Chris Larsen with Credit Suisse.

Hi.

Thanks for taking my question.

I had a couple of them.

First, on the dividends for '08, you said that the payout ratio would be similar to '07.

Do you have a sense for what percent would be qualified?

And then, you made a comment you expect some cable VoIP overlap soon.

What level of cable VoIP do you think you'll get?

And then, I don't know if you, when you said you're not seeing any today, whether you were included North Pittsburgh in that.

If you could just clarify if you're seeing any North Pittsburgh and if you expect it there.

And then, just to follow on that last question, for the USF payments in '08, in '07, what is your expectations?

I know you said coming down a little bit over time but it sounds almost as if '08 would be relatively flat to '07.

Is that a fair assumption?

Thanks.

Hey, Chris.

Thank you for the question.

Let me take the -- we'll take them in the order that you asked them.

With respect to the dividend and the characterization and the tax treatment, for the dividend, we ended up this year based on our final EMP study of basically coming out with 20% of that being return of capital and the 80% being a qualifying dividend.

Again, it's pretty hard to project what that number is going to be in a normal state, particularly with giving effect to the transaction.

We really won't know the final answer until 2009 when we're farther down the road, looking at our 2008 tax results.

But based on our early estimate, that's all they are for right now, is that we would use the 2007 final number of 20% return on capital as a proxy.

Chris, Bob.

Regarding the cable competition, maybe just a brief recap.

We've had cable competition from Mediacom in Illinois for over a year now and my comment about, we've said it on every call, we have expected cable competition in all of our markets for a couple of years.

And that's why we've been focused on delivering our broadband, our IPTV, and a quality experience for them.

We have interconnection agreements signed in Texas but they haven't launched their VoIP product yet there, but we expect it any time.

Regarding North Pitt, Armstrong is the local cable company, covering most of the territory, they launched a product over a year ago also and Comcast has a small piece of the property.

They have not launched as of yet.

But again, we expect all of them to launch at any day, any quarter.

But again, as I said, we've been saying that for a long time and I expect it but it hasn't happened and hopefully, they delay it some more.

Hey, Chris.

Steve.

The final part of your question was the trajectory or trend line on subsidies.

Again, we would expect, in our models, because where our focus on continued cost reductions, which you recover on on the subsidy pools, we continue to see, in our models, we have subsidy going down slightly, year over year.

So I mean if you, I guess, in your model, if you kept it flat to 2007 or maybe a similar decline that we had in 2007 to 2006, I think you'd be in the range.

Alright.

Thanks a lot.

Anything going on with access rates that we should, just on that same subject, is there anything we should be thinking about other than minutes of use and lines, but anything on the permanent rates that might we need to think about?

No.

They're pretty steady and static right where they are.

Minor (inaudible), but that's it.

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

That's true.

In fact, we led some efforts there a couple years ago and the contributors to that, we have narrowed greatly and they know when you're out there monitoring it.

So it's -- we're on guard and think we've taken most of that off of our network.

That's great.

Thank you.

(OPERATOR INSTRUCTIONS).

Your next question comes from Frank Louthan with Raymond James.

Great, thanks.

Just not to harp too much on the subsidy issue, but generally you see subsidy true ups in the second and the fourth quarter and assuming that most of your peers tend to, I assume you accrue for these things conservatively like most of your peers, should we, if remodeling that, look for a little bit more positive seasonality in those two quarters?

And is that how we should think about it going forward?

And was there anything, and then as far as it trending downward, assuming it's weighted on a two-year look back, so to the extent you continue to make cost improvements, is that really what's driving some of the downward subsidies?

That and I guess, possibly line losses, as well.

And then if you can comment a little bit on the video side.

You said that you have about 13% penetration with HD.

What percentage of your new customers are taking HD and do you think that's going to increase materially when you have both the HD and the DVR to market together?

Thanks.

Hey, Frank.

This is Steve Childers.

Thanks for the question and being on the call.

And the response to the subsidy questions, we actually are, when we have our true ups, it's usually in the third quarter.

You referenced second and fourth quarter.

We usually file all of our revised cost studies in the third quarter and make the appropriate change at that time.

Revising those cost studies in the fourth quarter, again, as a result of the work done in the third quarter, we saw a couple of things that we wanted to change in terms of allocation of cost on the investment side, as well as operating expense, and thought it was the appropriate thing to do.

So that's what happened in the fourth quarter.

Again, if you're trending it, and you're exactly right.

It is a two-year look back and again, I think if we have any seasonality or true up, it will generally happen in the third quarter.

Yes, Frank.

I'll handle the HD question but just piling on it, just to reinforce, it is around, as you stated, it's around cost reductions.

We have reduced over 300 employees from over 1,400 employees to less than 1,100 employees over the last couple of years and also focused on other corporate overheads, legal, SOX implementation is behind us, etc.

So it's a steady, nice, downward ramp in cost, which, obviously, are the basis for some of your subsidy reduction.

Regarding HD, we did say 13%.

The national average for HD is roughly 20%.

That's about what we're seeing with new customers.

But remember, we launched this after we were up and running with 6,000 IPTV customers or 7,000 IPTV customers.

So we're back-selling into that base and we would expect roughly the same take rate.

We've also said on this call before though that the product is certainly going to be more of a requirement to compete in the Texas market, not as much so in Illinois, but heading that way actually in Illinois.

It's a very desirable product.

And I would point out, in Illinois where we have been launched for over two years now, the IPTV penetration, you commented on penetration, penetration in Illinois is 23%.

So we're very pleased with how the penetration ramps, year over year, as you've been out in the market for awhile.

Okay, great.

And you said that you would pass about 17,000 homes in the Pennsylvania market by the end of '08.

What alternate availability do you think you'll see in that market as far as the availability for IPTV?

You quoted it right, Frank.

By the end of the year, we'll be at 17,000 homes and by the end of '09, we would project that that number will about double into the low 34,000 homes, 35,000 homes range.

And as we, we've only been running this property for 60 days and we had some of their forecast and we'll fine tune that but I think you're spot on at 17,000 homes and think about that doubling next year.

That's what we're projecting at this point.

Okay.

And then, just one last question.

You said you've already done the, you did a conversion on the systems.

Is that all the systems you needed to convert in Pennsylvania and have there been any glitches?

Did you go flash cut or are you running them parallel?

And if you did a flash cut, how long, are you seeing anything that you need to adjust?

Is there anything that we should be concerned about as far as how that system conversion went?

Frank, great question.

Let me start with the first part.

It is not the only system.

There are multiple systems that are also projects identified and those cuts will take place, most of them, in the next six months, but there's a conversion schedule that goes on for 18 months.

But the bulk of the work will be done before the end of the third quarter this year.

We were grateful that after they had their shareholder vote in early November that we were allowed to get in here and start doing some planning.

So we were thrilled that they allowed us to make some plans and to convert upon the closing to convert all the financial systems that I identified earlier.

So as far as glitches, at this point, the due diligence that we did last summer has just been confirmed.

We're finding about what we thought we would find and very confident that we will hit the $7 million and a run rate of $11 million on OpEx synergies by the end of the year.

Okay, great.

Thank you very much.

You're welcome.

(OPERATOR INSTRUCTIONS).

There are no further questions at this time.

I'll now turn the call back to Bob Currey for any closing remarks.

Thank you, Luanne, and I want to thank all of you, again, for joining us today and for your continued interest and support of Consolidated Communications.

As I hope you can understand from this call, we're excited about our current position and opportunities and look forward to updating you again on our progress next quarter.

Thank you and have a great day.

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

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