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CNSL > SEC Filings for CNSL > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for CONSOLIDATED COMMUNICATIONS HOLDINGS, INC.

Form 10-Q for CONSOLIDATED COMMUNICATIONS HOLDINGS, INC.


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Certain statements included in this report, including that which relates to the impact on future revenue sources, pending and future regulatory orders, continued expansion of the telecommunications network and expected changes in the sources of our revenue and cost structure resulting from our entrance into new communications markets, are forward-looking statements and are made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. These forward looking statements generally are identified by the words "believe", "expect", "anticipate", "estimate", "intend", "should", "may", "will", "would", "will be", "will continue" or similar expressions. Such forward looking statements involve known and unknown risks, the impact of current economic conditions, uncertainties and other factors that may cause actual results, performance or achievements of Consolidated Communications Holdings, Inc. ("Consolidated", the "Company", "we" or "our") to be different from those expressed or implied in the forward-looking statements. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in our 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC"). We disclaim any intention or obligation to update or revise publicly any forward-looking statements. Management's Discussion and Analysis ("MD&A") should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes to the financial statements ("Notes") as of and for the nine months ended September 30, 2012 included in Item 1 of this Quarterly Report on Form 10-Q.

Throughout MD&A, we refer to measures that are not a measure of financial performance in accordance with United States generally accepted accounting principles ("US GAAP" or "GAAP"). We believe the use of these non-GAAP measures on a consolidated and segment basis provides the reader with additional information that is useful in understanding our operating results and trends. These measures should be viewed in addition to, rather than as a substitute for, those measures prepared in accordance with GAAP. See the Non-GAAP Measures section below for a more detailed discussion on the use and calculation of these measures.

Significant Recent Development

On July 2, 2012, we completed the merger with SureWest Communications ("SureWest"), which resulted in the acquisition of 100% of all the outstanding shares of SureWest for $23.00 per share in a cash and stock transaction. The acquisition of SureWest provides additional diversification of the Company's revenues and cash flows both geographically and by service type, which offers a platform for future growth and is expected to generate operational and capital cost synergies. SureWest provides a wide range of telecommunications, digital video, Internet, data and other facilities-based communications services in Northern California, primarily in the greater Sacramento region, and in the greater Kansas City, Kansas and Missouri areas. For the year ended December 31, 2011, SureWest reported $248.1 million in total operating revenues. For the six months ended June 30, 2012, SureWest generated $127.9 million in operating revenues. The total purchase price of $550.8 million, consisted of cash and assumed debt of $402.4 million and 9,965,983 shares of the Company's common stock valued at the Company's opening stock price on July 2, 2012 of $14.89, which totaled $148.4 million. The cash portion of the merger consideration and the funds required to repay SureWest outstanding debt was financed with the sale of $300.0 million in aggregate principal amount of 10.875% Senior Notes due 2020 ("Senior Notes"). The Company also used cash on hand and approximately $35.0 million in borrowings from its revolving credit facility. Because the acquisition closed on July 2, 2012, the Company's financial information does not include any of the results of operations from SureWest prior to the acquisition date. The financial results of SureWest are included in the Telephone Operations segment as of the date of the acquisition.

Overview

We are an established telecommunications services company providing a wide range of services to residential and business customers in Illinois, Texas, Pennsylvania, California, Kansas and Missouri. We offer a wide range of telecommunications services, including local and long-distance service, high-speed broadband Internet access, video services, digital telephone service ("VOIP"), custom calling features, private line services, carrier grade access services, network capacity services over our regional fiber optic networks, directory publishing and Competitive Local Exchange Carrier ("CLEC") services. We also operate two non-core complementary businesses, prison services and equipment sales. We classify our operations into two reportable business segments: Telephone Operations and Other Operations.


Table of Contents

Telephone Operations Segment

Our Telephone Operations segment generated approximately 93% of our consolidated operating revenues during the nine-month period ended September 30, 2012, primarily from subscriptions to our voice, video and data services ("broadband services") to residential and business customers. Revenues in the Telephone Operations segment increased $62.6 million during the nine months ended September 30, 2012 compared to the same period in 2011, primarily from the SureWest acquisition and growth in data, video and Internet connections. We expect our broadband service revenues to continue to grow as consumer and business demands for data based services increase.

We market our services to residential and business customers, either individually or as a bundled package. Our "triple play" bundle includes telephone service, data service and video service. As of September 30, 2012, our video service was available to approximately 520,000 homes in Illinois, Texas, Pennsylvania, California, Kansas and Missouri markets. As of September 30, 2012, approximately 20% of the homes in the areas we serve subscribe to our video service. Data and Internet connections continue to increase as a result of enhanced product and service offerings, such as our VOIP service and data speeds of up to 50 megabits per second, depending on the geographic market availability.

The increase in Telephone Operations revenues during the nine months ended September 30, 2012 was offset by an anticipated industry wide trend of a decline in access lines and related use of services. Many customers are choosing to subscribe to alternative communications services and competition for these subscribers continues to increase. Competition from wireless providers, competitive local exchange carriers and in some cases cable television providers has increased in recent years in the markets we serve. We have been able to mitigate some of the access line losses through marketing initiatives and product offerings, such as our VOIP service.

Other Operations Segment

Our Other Operations segment is comprised of non-core business activities including prison services and business systems. Prison services, which only operates primarily in Illinois, provides local and long-distance telephone service and automated calling service for correctional facilities. Business systems sells and supports telecommunications equipment to business customers in Texas and Illinois.

Consolidated Results of Operations

The following tables reflect our financial results on a consolidated basis and key operating metrics as of and for the quarters and nine-month periods ended September 30, 2012 and 2011.

                                 Financial Data



                                   Quarter Ended September 30,                     Nine Months Ended September 30,
                                                      $           %                                       $           %
(In millions, except
for percentages)            2012        2011       Change       Change         2012         2011        Change      Change
Revenue
Telephone operations     $  149.5     $  84.7     $  64.8         77  %    $   319.6      $ 257.0     $   62.6        24  %
Other operations              7.5         7.8        (0.3 )       (4 )          23.8         23.6          0.2         1
Total operating
revenue                     157.0        92.5        64.5         70           343.4        280.6         62.8        22
Expenses
Telephone operations         88.3        48.3        40.0         83           185.8        143.6         42.2        29
Other operations              6.8         6.7         0.1          1            21.2         21.3         (0.1 )      (0 )
Transaction/Debt
refinancing costs            14.5         0.1        14.4     14,400            19.9          2.6         17.3       665
Depreciation and
amortization                 37.3        22.2        15.1         68            81.3         66.3         15.0        23
Total operating
expense                     146.9        77.3        69.6         90           308.2        233.8         74.4        32
Income from
operations                   10.1        15.2        (5.1 )      (34 )          35.2         46.8        (11.6 )     (25 )
Interest expense,
net                         (20.6 )     (13.4 )      (7.2 )      (54 )         (52.1 )      (37.8 )      (14.3 )     (38 )
Other income                  8.4         6.9         1.5         22            21.8         20.4          1.4         7
Income tax (benefit)
expense                      (1.9 )       2.7        (4.6 )     (170 )           0.3         10.4        (10.1 )     (97 )
Net (loss) income            (0.2 )       6.0        (6.2 )     (103 )           4.6         19.0        (14.4 )     (76 )
Net income
attributable to
noncontrolling
interest                      0.1         0.2        (0.1 )      (50 )           0.4          0.5         (0.1 )     (20 )
Net (loss) income
attributable to
common stockholders      $   (0.3 )   $   5.8     $  (6.1 )     (105 )     $     4.2      $  18.5     $  (14.3 )     (77 )

Adjusted EBITDA (1)      $   70.9     $  46.3     $  24.6         53  %    $   162.0      $ 141.1     $   20.9        15 %

(1) A non-GAAP measure. See the Non-GAAP Measures section below for additional information and reconciliation to the most directly comparable GAAP measure.


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                            Key Operating Statistics



                                                 As of September 30,
                                      2012        2011       Change     % Change
ILEC access lines
Residential                         155,274     138,090      17,184          12 %
Business                            115,686      92,161      23,525          26
Total                               270,960     230,251      40,709          18

Voice connections (1)
Residential                          80,097       2,502      77,595       3,101
Business                             51,360      52,668      (1,308 )       (2)
Total                               131,457      55,170      76,287         138

Data and internet connections (2)   246,817     132,084     114,733          87
Video connections (2)               105,202      32,981      72,221         219
Total connections                   754,436     450,486     303,950          67

(1)Voice connections include voice lines outside the Incumbent Local Exchange Carrier ("ILEC") service areas and Voice-over-IP inside the ILEC service areas.

(2)These connections include both residential and business (excluding SureWest business metrics) for services both inside and outside the ILEC service areas.

Consolidated Overview

The comparability of our consolidated results of operations and key operating statistics was impacted by the SureWest acquisition, which closed on July 2, 2012, as described above. SureWest's results are included in our consolidated financial statements as of the date of the acquisition. We also incurred transaction costs directly related to the SureWest acquisition in 2012 which directly impacted net income for the quarter and nine months ended September 30, 2012. During the nine months ended September 30, 2012, we incurred $19.9 million in expense related to the acquisition, which included accrued change-in-control payments to former members of the SureWest management team of $8.7 million which are expected to be paid during the six months ended June 30, 2013. We also incurred additional interest costs of $16.8 million, which included $11.1 million of interest incurred on the Senior Notes obtained for the SureWest acquisition, $4.2 million of amortization of fees related to securing the bridge loan commitment to finance the SureWest acquisition, and $1.5 million of interest related to ticking fees associated with the bridge loan financing.

Consolidated operating revenue increased $64.5 million and $62.8 million during the quarter and nine months ended September 30, 2012, respectively, due to the SureWest acquisition. The SureWest operations accounted for $66.4 million of the quarterly and year-to-date increases in operating revenues. The acquisition of SureWest provides additional diversification of the Company's revenues and cash flows both geographically and by service type. Excluding the addition of the operations for SureWest, consolidated operating revenues decreased $1.9 million and $3.6 million for the quarter and nine months ended September 30, 2012, respectively. Revenues related to our traditional wireline telephone business decreased due to the continued decline in access lines, but was partially offset by an increase in video, data and Internet revenue as we continue to grow our broadband services. The decline in access lines continues to moderate and was offset by growth in our broadband connections. The SureWest operations accounted for 298,656 of the total connections at September 30, 2012.

Our operating revenues are also impacted by legislative or regulatory changes at the federal and state levels, which could reduce or eliminate the current subsidies and revenues we receive. A number of proceedings and recent orders relate to universal service reform, intercarrier compensation and network access charges. There are various ongoing legal challenges to the orders that have been issued. As a result, it is not yet possible to determine fully the impact of the regulatory changes on our operations.

Operating expenses increased $69.6 million and $74.4 million during the quarter and nine months ended September 30, 2012, respectively, due to the acquisition of SureWest and the transaction costs directly related to the acquisition as described above. The SureWest operations accounted for $58.7 million of the quarter and year-to-date increases and transaction costs increased $14.4 million and $17.3 million for the quarter and nine months ended September 30, 2012, respectively.


Table of Contents

Operating revenues and expenses by segment are discussed below.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year's presentation. These reclassifications had no effect on total stockholders' equity, total revenue, income from operations or net (loss) income.

During the third quarter of 2012, inventories have been reclassified from current assets to property, plant and equipment on the condensed consolidated balance sheets. Inventories consist primarily of network construction materials and supplies that when issued are capitalized as part of new customer installations and the construction of the network. The change in classification of inventories impacts the calculation of certain financial ratios. Prior period calculations have been revised to conform to the current year presentation.

In addition, the calculation of certain key operating statistics was revised during the third quarter of 2012 to reflect a new methodology for the combined entity of Consolidated and SureWest. Accordingly, prior period operating statistics have been revised to conform to the current practice.

Segment Results of Operations



                              Telephone Operations



                                                     Quarter Ended September 30,                      Nine Months Ended September 30,
                                                                        $           %                                       $            %
(In millions, except for percentages)         2012        2011       Change       Change        2012          2011        Change       Change
Revenue
Local calling services                      $  27.1     $  20.7     $   6.4         31  %    $   66.7       $  63.8     $    2.9          5  %
Network access services                        29.5        19.8         9.7         49           68.9          60.5          8.4         14
Subsidies                                      12.7        11.2         1.5         13           35.4          33.9          1.5          4
Long-distance services                          5.4         3.8         1.6         42           12.4          12.2          0.2          2
Video, Data and Internet services              65.1        20.9        44.2        211          109.8          61.5         48.3         79
Other services                                  9.7         8.3         1.4         17           26.4          25.1          1.3          5
Total operating revenue                       149.5        84.7        64.8         77          319.6         257.0         62.6         24
Expenses
Cost of services and products                  54.1        28.3        25.8         91          115.0          87.0         28.0         32
Selling, general and administrative costs      34.2        20.0        14.2         71           70.8          56.6         14.2         25
Financing and other transaction costs          14.5         0.1        14.4     14,400           19.9           2.6         17.3        665
Depreciation and amortization                  37.1        22.0        15.1         69           80.7          65.7         15.0         23
Total operating expense                       139.9        70.4        69.5         99          286.4         211.9         74.5         35
Income from operations                      $   9.6     $  14.3     $  (4.7 )     (33)       $   33.2       $  45.1     $  (11.9 )      (26 )

Telephone Operations Operating Revenue

Local Calling Services

We offer several different basic local phone service packages for residential and business customers. The plans include options for voicemail and other custom calling features such as caller ID, call forwarding and call waiting. Local calling services revenue increased $6.4 million and $2.9 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011 primarily due to the acquisition of SureWest. Excluding the addition of SureWest revenues, local calling services decreased $2.3 million and $5.8 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011 primarily due to a 3% decline in local access lines. The number of local access lines in service directly affects the recurring revenue we generate from end users and continues to be impacted by the industry-wide decline in access lines. We expect to continue to experience modest erosion in access lines due to market forces and through our own competing VoIP product.


Table of Contents

Network Access Services

Network access service revenues include interstate and intrastate switched access revenue and network special access services. Network access services revenue increased $9.7 million and $8.4 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011 primarily as a result of the acquisition of SureWest, which accounted for $10.9 million of the quarter and year-to-date increases. Excluding the addition of the SureWest revenues, network access services decreased $1.2 million and $2.5 million for the quarter and nine months ended September 30, 2012, respectively compared to the same periods in 2011 primarily due to a decline in switched access minutes of use. These decreases were partially offset by higher special access and federal universal service revenues.

Subsidies

Subsides consist of federal and state subsidies designed to promote widely available, quality telephone service at affordable prices in rural areas. Subsidy revenues increased $1.5 million for both the quarter and nine months ended September 30, 2012 compared to the same periods in 2011 primarily as a result of the acquisition of SureWest and the addition of revenues from the Connect America Fund in 2012.

Long-Distance Services

We offer a variety of long-distance calling plans, including unlimited flat-rate calling plans, to residential and business customers. Long-distance services revenue increased $1.6 million and $0.2 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011 primarily due to the acquisition of SureWest. Excluding the addition of SureWest revenues, long distance services decreased $0.4 million and $1.8 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011. The decrease in long distance revenue is primarily due to the decline in access lines as described above and the shift in customers moving to unlimited long-distance plans.

Video, Data and Internet Services

Video, data and Internet services include revenue from residential and business customers for subscriptions to our voice, video and data products. We offer high speed Internet access at speeds of up to 50 Mbps, depending on the nature of the network facilities that are available, the level of service selected and the location. We also offer a variety of data connectivity services in select markets, including Metro Ethernet services over our copper and fiber-based networks, wireless backhaul services, virtual hosting services and collocation services. Our VoIP digital phone service is also available in certain markets as an alternative to the traditional telephone line. Depending on geographic market availability, our video services range from limited basic service to advanced digital television, which includes several plans each with hundreds of local, national and music channels including premium and pay-per-view channels as well as video on demand service. Certain subscribers may also subscribe to our advanced video services, which consist of high-definition television, digital video recorders ("DVR") and/or a whole home DVR.

Video, data and Internet revenue increased $44.2 million and $48.3 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011 primarily as a result of the acquisition of SureWest, which accounted for $41.8 million of the quarter and year-to-date increases. The increase in revenue was also due to the continued growth in data and video connections, which increased 8% and 11%, respectively, as of September 30, 2012. Video, data and Internet revenue comprised 41% of our quarterly consolidated revenues at September 30, 2012, as compared to 23% at September 30, 2011. We expect video, data and Internet service revenue to continue to grow as the consumer and business demand for data based services continues to increase.

Other Services

Other services include revenues from telephone directory publishing, wholesale transport services, billing and collection services and inside wiring service and maintenance. Other services revenue increased $1.4 million and $1.3 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011. The increase in other services revenue was primarily due to the acquisition of SureWest and an increase in transport services, which was offset in part by a decline in directory publishing revenues.


Table of Contents

Telephone Operations Operating Expenses

Cost of Services and Products

Cost of services and products increased $25.8 million and $28.0 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011 primarily as a result of the addition of the SureWest operations as well as higher costs associated with video programming. Video programming costs continue to increase due to the growth in video connections and an increase in costs per program channel. During the quarter ended September 30, 2012, the increase in video programming costs was offset in part by a reduction in pension costs.

Selling, General and Administrative Costs

Selling, general and administrative costs increased $14.2 million during the quarter and nine months ended September 30, 2012 compared to the same periods in 2011. Excluding the addition of the operations for SureWest, which accounted for $15.5 million of the quarter and nine-month period increase, selling, general and administrative costs decreased $1.3 million for the current year periods due to a reduction in bad debt expense, utility costs and legal expenses.

Transaction/Debt refinancing costs

In connection with the acquisition of SureWest, we incurred $14.5 million and $19.9 million of transaction related fees which were recognized as a financing and other transaction costs during the quarter and nine months ended September 30, 2012, respectively. In the second quarter of 2011, we amended our credit agreement and incurred fees of $2.6 million, which were recognized as a financing cost during 2011.

Depreciation and Amortization

Depreciation and amortization expense increased $15.1 million and $15.0 million during the quarter and nine months ended September 30, 2012, respectively, compared to the same periods in 2011 primarily as a result of the acquisition of SureWest.

                                Other Operations



                                                       Quarter Ended September 30,                         Nine Months Ended September 30,
                                                                           $            %                                           $            %
(In millions, except for percentages)          2012         2011        Change       Change          2012            2011         Change      Change
Revenue                                      $   7.5      $   7.8      $   (0.3 )     (4)  %     $       23.8      $   23.6      $   0.2         1  %
Expenses
Cost of services and products                    5.4          5.5          (0.1 )     (2)                16.9          16.9            -         0
. . .
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