Consolidated Communications Holdings, Inc. - Quarter Report: 2013 June (Form 10-Q)

Table of Contents

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2013

 

or

 

[     ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 000-51446

 

 

CONSOLIDATED COMMUNICATIONS HOLDINGS, INC.

 (Exact name of registrant as specified in its charter)

 

 

   (217) 235-3311   

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes    X            No       

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes    X             No       

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer           Accelerated filer   X  

 

Non-accelerated filer       (Do not check if a smaller reporting company)Smaller reporting company      

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes                 No   X

 

On July 26, 2013, the registrant had 40,111,518 shares of Common Stock outstanding.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42
Item 4.	Controls and Procedures	42
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	44
Item 6.	Exhibits	46
SIGNATURES		47

 

Table of Contents

 

PART I – FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

CONSOLIDATED COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited; Amounts in thousands except per share amounts)

 

 

		Quarter Ended June 30,						Six Months Ended June 30,
		2013			2012			2013			2012
Net revenues		$	151,320		$	86,557		$	302,848		$	173,008
Operating expense:
Cost of services and products (exclusive of depreciation and amortization)		55,942			32,019			110,994			63,073
Selling, general and administrative expenses		33,544			19,121			66,670			37,804
Financing and other transaction costs		178			562			357			5,384
Depreciation and amortization		34,709			21,708			69,550			43,682
Income from operations		26,947			13,147			55,277			23,065
Other income (expense):
Interest expense, net of interest income		(20,697)			(16,893)			(45,297)			(31,493		)
Investment income		8,693			6,762			17,477			13,228
Other, net		82			185			(25)			199
Income from continuing operations before income taxes		15,025			3,201			27,432			4,999
Income tax expense		5,465			880			11,014			1,501
Income from continuing operations		9,560			2,321			16,418			3,498
(Loss) income from discontinued operations, net of tax		(272)			585			(248)			1,292
Net income		9,288			2,906			16,170			4,790
Less: net income attributable to noncontrolling interest		94			120			193			245
Net income attributable to common shareholders		$	9,194		$	2,786		$	15,977		$	4,545
Net income per common share - basic and diluted
Income from continuing operations		$	0.23		$	0.07		$	0.40		$	0.11
(Loss) income from discontinued operations, net of tax		(0.01)			0.02			(0.01)			0.04
Net income per basic and diluted common share attributable to common shareholders		$	0.22		$	0.09		$	0.39		$	0.15
Dividends declared per common share		$	0.38		$	0.38		$	0.77		$	0.77

 

See accompanying notes.

 

1

Table of Contents

 

CONSOLIDATED COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited; Amounts in thousands)

 

 

		Quarter Ended June 30,						Six Months Ended June 30,
		2013			2012			2013			2012
Net income		$	9,288		$	2,906		$	16,170		$	4,790
Pension and post-retirement obligations:
Amortization of actuarial losses and prior service cost to earnings, net of tax		474			448			948			897
Derivative instruments designated as cash flow hedges:
Change in fair value of derivatives, net of tax		719			589			1,138			1,584
Reclassification of realized (gain) loss to earnings, net of tax		-			(8)			1,839			-
Comprehensive income		10,481			3,935			20,095			7,271
Less: comprehensive income attributable to noncontrolling interest		94			120			193			245
Total comprehensive income attributable to common shareholders		$	10,387		$	3,815		$	19,902		$	7,026

 

See accompanying notes.

 

2

Table of Contents

 

CONSOLIDATED COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; Amounts in thousands except share and per share amounts)

 

		June 30,			December 31,
		2013			2012
ASSETS
Current assets:
Cash and cash equivalents		$	3,520		$	17,854
Accounts receivable, net		56,527			57,957
Income tax receivable		1,954			12,020
Deferred income taxes		8,984			8,984
Prepaid expenses and other current assets		13,761			11,269
Assets of discontinued operations		714			1,772
Total current assets		85,460			109,856
Property, plant and equipment, net		895,597			907,672
Investments		111,800			109,750
Goodwill		603,446			603,446
Other intangible assets		44,994			49,530
Deferred debt issuance costs, net and other assets		15,992			13,800
Total assets		$	1,757,289		$	1,794,054
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	7,630		$	14,954
Advance billings and customer deposits		26,485			27,654
Dividends payable		15,538			15,463
Accrued compensation		19,445			21,912
Accrued expense		33,755			47,225
Current portion of long-term debt and capital lease obligations		9,849			9,596
Current portion of derivative liability		371			3,164
Liabilities of discontinued operations		254			4,209
Total current liabilities		113,327			144,177
Long-term debt and capital lease obligations		1,214,404			1,208,248
Deferred income taxes		140,320			138,068
Pension and other postretirement obligations		149,672			156,710
Other long-term liabilities		12,989			10,746
Total liabilities		1,630,712			1,657,949
Commitments and contingencies
Shareholders’ equity:
Common stock, par value $0.01 per share; 100,000,000 shares authorized, 40,111,518 and 39,877,998, shares outstanding as of June 30, 2013 and December 31, 2012, respectively		401			399
Additional paid-in capital		163,668			177,315
Retained earnings		-			-
Accumulated other comprehensive loss, net		(41,859)			(45,784		)
Noncontrolling interest		4,367			4,175
Total shareholders’ equity		126,577			136,105
Total liabilities and shareholders’ equity		$	1,757,289		$	1,794,054

 

See accompanying notes.

 

3

Table of Contents

 

CONSOLIDATED COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; amounts in thousands)

 

		Six Months Ended June 30,
		2013			2012
Net cash provided by continuing operations		$	67,346		$	49,228
Net cash (used in) provided by discontinued operations		(3,097)			912
Net cash provided by operating activities		64,249			50,140
Cash flows from investing activities:
Purchases of property, plant and equipment, net		(52,623)			(20,715		)
Restricted cash for acquisition of SureWest		-			(298,035		)
Other		(81)			(286		)
Net cash used in continuing operations		(52,704)			(319,036		)
Net cash used in discontinued operations		(48)			(97		)
Net cash used in investing activities		(52,752)			(319,133		)
Cash flows from financing activities:
Proceeds on bond offering		-			298,055
Restricted cash on bond offering		-			(17,047		)
Proceeds from the issuance of long-term debt		49,000			-
Payment of capital lease obligation		(224)			(92		)
Payment on long-term debt		(43,620)			(4,400		)
Payment of financing costs		-			(5,070		)
Dividends on common stock		(30,987)			(23,173		)
Net cash used in financing activities		(25,831)			248,273
Decrease in cash and cash equivalents		(14,334)			(20,720		)
Cash and cash equivalents at beginning of period		17,854			105,704
Cash and cash equivalents at end of period		$	3,520		$	84,984

 

See accompanying notes.

 

4

Table of Contents

 

CONSOLIDATED COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

1.              SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Business and Basis of Accounting

 

Consolidated Communications Holdings, Inc. (the “Company”, “we” or “our”) is a holding company with operating subsidiaries (collectively “Consolidated”) that provide communications services to residential and business customers in Illinois, Texas, Pennsylvania, California, Kansas and Missouri.

 

We offer a wide range of telecommunications services to residential and business customers in the areas we serve. Our telecommunications services include 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, Competitive Local Exchange Carrier (“CLEC”) services and equipment sales.  As of June 30, 2013, we had approximately 263 thousand access lines, 126 thousand voice connections, 251 thousand data and Internet connections and 109 thousand video connections.

 

We historically operated our business as two separate reportable segments: Telephone Operations and Other Operations.  Based on recent changes in our business structure, as of the quarter ended June 30, 2013 we concluded that we operate our business as one reportable segment. See the Recent Business Developments section below for a more detailed discussion regarding the circumstances that resulted in the change to our segment reporting.

 

In the opinion of management, the accompanying condensed consolidated balance sheets and related consolidated statements of income, comprehensive income and cash flows include all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States (“U.S. GAAP” or “GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such SEC rules and regulations and accounting principles applicable for interim periods. Events subsequent to the balance sheet date have been evaluated for inclusion in the accompanying condensed consolidated financial statements through the date of issuance.  Management believes that the disclosures made are adequate to make the information presented not misleading. Interim results are not necessarily indicative of results for a full year.  The information presented in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and the accompanying notes to the financial statements (“Notes”) thereto included in our 2012 Annual Report on Form 10-K filed with the SEC.

 

Recent Business Developments

 

SureWest Merger

 

We completed the acquisition of SureWest Communications on July 2, 2012.  SureWest Communications results of operations are included within our results following the acquisition date.  For a more complete discussion of the transaction, refer to Note 2.

 

Segment Reporting

 

Historically, we have classified our operations into two separate reportable business segments: Telephone Operations and Other Operations.  Our Telephone Operations consisted of a wide range of telecommunications services to residential and business customers, including local and long-distance service, high-speed broadband Internet access, video services, VOIP services, custom calling features, private line services, carrier access services, network capacity services over a regional fiber optic network, mobile services and directory publishing.  Our Other Operations segment operated two complementary non-core businesses including telephone services to state and county correctional facilities (“Prison Services”) and equipment sales.  As discussed below, our contract to provide telephone services to correctional facilities operated by the Illinois Department of Corrections was not renewed and the process of transitioning these services to another service provider was completed during the quarter ended March 31, 2013.  During the quarter ended June 30, 2013, upon establishing a plan to sell certain assets related to the Prison Services business, we classified the assets

 

5

Table of Contents

 

and operations as a discontinued operation.  Prison Services comprised nearly all of the Other Operations segment revenue and results of operations.  Consequently, with the cessation of our Prison Services business and based on the segment accounting guidance, the Company has concluded that it operates as one segment as of the quarter ended June 30, 2013. As required by the authoritative guidance for segment presentation, segment results of operations have been retrospectively adjusted to reflect this change for all periods presented.

 

Prison Services Contract

 

We previously provided telephone service to inmates incarcerated at facilities operated by the Illinois Department of Corrections and to certain county jails.  On June 27, 2012, the Illinois Department of Central Management Services announced its intent to replace us as the provider of those services with a competitor. Although we challenged our competitor’s bid and the State’s decision to accept that bid in a variety of different forums, during the quarter ended March 31, 2013, the process of transitioning these services to another service provider was completed. All related assets have been assessed for recoverability in light of this change and we determined that no impairment was necessary. During 2012, the prison services contract comprised 5% of consolidated operating revenues and approximately 2% of consolidated operating income, excluding financing and other transaction fees.

 

Discontinued Operations

 

During the quarter ended June 30, 2013, the Company established a plan to sell certain assets related to the Prison Services business.  We expect the plan to be completed by the end of the third quarter of 2013.  In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 205-20, “Discontinued Operations”, the financial results of these prison services operations have been classified as discontinued operations and are presented in a separate line on the condensed consolidated statements of income for all periods presented.  The related prison services assets have been classified on the condensed consolidated balance sheets as assets of discontinued operations for all periods presented.  For a more complete discussion of the transaction, refer to Note 2.

 

Reclassifications

 

Certain amounts in our 2012 condensed consolidated financial statements have been reclassified to conform to the presentation of our 2013 condensed consolidated financial statements, which consists primarily of the effects of reclassifications from the presentation of prison services as a discontinued operation and the finalization of purchase accounting for the SureWest acquisition.

 

Recent Accounting Pronouncements

 

Effective January 1, 2013, we adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update No. 2012-02 (“ASU 2012-02”), Testing Indefinite-Lived Intangible Assets for Impairment. ASU 2012-02 permits an entity to perform an initial assessment of qualitative factors to determine whether it is more likely than not that a non-goodwill indefinite-lived intangible asset is impaired and thus whether it is necessary to calculate the asset’s fair value for the purpose of comparing it with the asset’s carrying amount. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.

 

Effective January 1, 2013, we adopted Accounting Standards Update No. 2013-02 (“ASU 2013-02”), Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which establishes new requirements for disclosing reclassifications of items out of accumulated other comprehensive income (“OCI”). ASU 2013-2 requires disclosures for the (i) changes in components of accumulated OCI, (ii) effects on individual line items in net income for each item of accumulated OCI that is reclassified in its entirety to net income, and (iii) cross references to other disclosures that provide additional details for OCI items that are not reclassified in their entirety to net income. For public companies, amendments are effective prospectively for reporting periods beginning after December 15, 2012, with early adoption permitted. In accordance with the provisions of this guidance, disclosures related to accumulated OCI can be found in Note 8.

 

6

Table of Contents

 

2.     ACQUISITION AND DISPOSITIONS

 

Merger With SureWest Communications

 

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.  SureWest provides telecommunications services in Northern California, primarily in the greater Sacramento region, and in the greater Kansas City, Kansas and Missouri areas. 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. We acquired SureWest to provide additional diversification of our revenues and cash flows.

 

Subsequent to the merger, the financial results of SureWest operations have been included in our condensed consolidated statement of income.  During the quarter and six months ended June 30, 2013, we paid change-in-control obligations to former members of the SureWest management team of $0.8 million and $7.9 million, respectively, that were previously accrued.  At June 30, 2013, unpaid obligations under the change-in-control agreements were $0.3 million, which are expected to be paid during the three months ended September 30, 2013.

 

The acquisition of SureWest has been accounted for using the acquisition method in accordance with the FASB’s ASC Topic 805, Business Combinations.  Accordingly, the net assets acquired were recorded at their estimated fair values at July 2, 2012.  These values were derived from a purchase price allocation, which was finalized during the quarter ended June 30, 2013 with the completion of various tax analysis and adjustments.

 

The following table summarizes the final purchase price allocation:

 

		(In thousands)
Current assets		$	47,073
Property, plant and equipment		591,818
Goodwill		84,016
Other intangible assets		3,600
Other long-term assets		4,861
Total assets acquired		731,368
Current liabilities		53,566
Pension and other post-retirement obligations		55,916
Deferred income taxes		66,976
Other long-term liabilities		4,114
Total liabilities assumed		180,572
Net assets acquired		$	550,796

 

As noted above, during the quarter ended June 30, 2013, the Company recorded tax related adjustments to the preliminary purchase price allocation which decreased deferred income taxes by $1.3 million, increased current assets by $0.2 million and decreased goodwill by $1.5 million.  As of June 30, 2013, the Company has completed its accounting for the acquisition of SureWest.  These adjustments were retrospectively applied on the balance sheet to reflect the appropriate balances as of July 2, 2012.  There was no impact to the income statement for the twelve months ended December 31, 2012.

 

Unaudited Pro Forma Results

 

The following unaudited pro forma information presents our results of operations as if the acquisition of SureWest occurred on January 1, 2011.  The adjustments to arrive at the pro forma information below include additional depreciation and amortization expense for the fair value increases to property plant and equipment, software and customer relationships.  Interest expense was increased to reflect the additional debt acquired to finance a portion of the acquisition price.  Shares used in the calculation of basic and diluted earnings per share were adjusted to reflect the additional shares of common stock issued to fund a portion of the acquisition price. The pro forma information below does not purport to present the actual results that would have resulted if the acquisition had in fact occurred at the beginning of the fiscal periods presented, nor does the information project results for any future period.

 

7

Table of Contents

 

		Quarter Ended			Six Months Ended
(In thousands, except per share amounts)		June 30, 2012			June 30, 2012
Operating revenues		$	151,563		$	300,910
Income from operations		$	12,037		$	26,113
Loss from continuing operations		$	(1,659)		$	(761	)
Discontinued operations, net of tax		$	585		$	1,292
Net (loss) income		$	(1,074)		$	531
Less: income attributable to noncontrolling interest		120			245
Net (loss) income attributable to common shareholders		$	(1,194)		$	286
Net income per common share - basic and diluted
Loss from continuing operations		$	(0.04)		$	(0.02	)
Discontinued operations, net of tax		0.01			0.03
Net (loss) income per basic and diluted common share attributable to common shareholders		$	(0.03)		$	0.01

 

Discontinued Operations

 

During the quarter ended June 30, 2013, the Company established a plan to sell certain assets related to the Prison Services business.  We expect the plan to be completed by the end of the third quarter of 2013. The financial results of the operations for prison services, which were previously reported in the Other Operations segment, have been reported as a discontinued operation in our condensed consolidated financial statements for all periods presented.

 

As of June 30, 2013 and December 31, 2012, the major classes of the prison services assets and liabilities included in discontinued operations were as follows:

 

(In thousands)		June 30, 2013			December 31, 2012
Accounts receivable, net		$	60		$	625
Deferred income taxes		583			583
Property, plant and equipment, net		71			564
Total assets		$	714		$	1,772
Accounts payable		$	-		$	13
Advance billings and customer deposits		165			938
Accrued expense		89			3,258
Total liabilities		$	254		$	4,209

 

The following table summarizes the financial information for the prison services operations for the quarters and six months ended June 30, 2013 and 2012:

 

		Quarter Ended June 30,						Six Months Ended June 30,
(In thousands)		2013			2012			2013			2012
Operating revenues		$	482		$	6,448		$	5,249		$	13,361
Operating expenses including depreciation and amortization		878			5,543			5,577			11,361
(Loss) income from operations		(396)			905			(328)			2,000
Income tax (benefit) expense		(124)			320			(80)			708
(Loss) income from discontinued operations		$	(272)		$	585		$	(248)		$	1,292

 

8

Table of Contents

 

3.  EARNINGS PER SHARE

 

The computation of basic and diluted earnings per share attributable to common shareholders computed using the two-class method is as follows:

 

		Quarter Ended						Six Months Ended
		June 30,						June 30,
(In thousands, except per share amounts)		2013			2012			2013			2012
Income from continuing operations		$	9,560		$	2,321		$	16,418		$	3,498
Less: net income attributable to noncontrolling interest		94			120			193			245
Income attributable to common shareholders before allocation of earnings to participating securities		9,466			2,201			16,225			3,253
Less: earnings allocated to participating securities		131			95			263			160
Income from continuing operations attributable to common shareholders		9,335			2,106			15,962			3,093
Net income (loss) from discontinued operations		(272)			585			(248)			1,292
Net income attributable to common shareholders		$	9,063		$	2,691		$	15,714		$	4,385
Weighted-average number of common shares outstanding		39,755			29,689			39,755			29,689
Basic and diluted earnings per common share:
Income from continuing operations		$	0.23		$	0.07		$	0.40		$	0.11
Income (loss) from discontinued operations, net of tax		(0.01)			0.02			(0.01)			0.04
Net income per common share attributable to common shareholders		$	0.22		$	0.09		$	0.39		$	0.15

 

Diluted earnings per common share attributable to common shareholders for the three and six months ended June 30, 2013 excludes 0.4 million shares and 0.2 million shares, respectively, of potential common securities related to our share-based compensation plan, because the inclusion of the potential common shares would have had an antidilutive effect.  For the three and six months ended June 30, 2012, diluted earnings per share excluded 0.3 million potential common shares.

 

4.  INVESTMENTS

 

Our investments are as follows:

 

		June 30,			December 31,
(In thousands)		2013			2012
Cash surrender value of life insurance policies		$	2,115		$	2,045
Cost method investments:
GTE Mobilnet of South Texas Limited Partnership (2.34% interest)		21,450			21,450
Pittsburgh SMSA Limited Partnership (3.60% interest)		22,950			22,950
CoBank, ACB Stock		5,028			5,023
Other		430			430
Equity method investments:
GTE Mobilnet of Texas RSA #17 Limited Partnership (20.51% interest)		26,543			25,695
Pennsylvania RSA 6(I) Limited Partnership (16.6725% interest)		7,434			7,286
Pennsylvania RSA 6(II) Limited Partnership (23.67% interest)		24,186			23,338
CVIN, LLC (13.43% interest)		1,664			1,533
Totals		$	111,800		$	109,750

 

Cost Method

 

We own 2.34% of GTE Mobilnet of South Texas Limited Partnership (the “Mobilnet South Partnership”).  The principal activity of the Mobilnet South Partnership is providing cellular service in the Houston, Galveston, and Beaumont, Texas metropolitan areas.  We also own 3.60% of Pittsburgh SMSA Limited Partnership (“Pittsburgh SMSA”), which provides cellular service in and around the Pittsburgh metropolitan area.  Because of our limited influence over these partnerships, we use the cost method to account for both of these investments.  It is not practicable to estimate fair value of these investments.  We did not evaluate any of the investments for impairment

 

9

Table of Contents

 

during the quarters or six months ended June 30, 2013 or 2012 as no factors indicating impairment existed.  For the three months ended June 30, 2013 and 2012, we received cash distributions from these partnerships totaling $3.8 million and $3.0 million, respectively. For the six months ended June 30, 2013 and 2012, we received cash distributions from these partnerships totaling $7.8 million and $5.5 million, respectively.

 

CoBank, ACB (“CoBank”) is a cooperative bank owned by its customers.  On an annual basis, CoBank distributes patronage in the form of cash and stock in the cooperative based on the Company’s outstanding loan balance with CoBank, which has traditionally been a significant lender in the Company’s credit facility.  The investment in CoBank represents the accumulation of the equity patronage paid by CoBank to the Company.

 

Equity Method

 

We own 20.51% of GTE Mobilnet of Texas RSA #17 Limited Partnership (“RSA #17”), 16.6725% of Pennsylvania RSA 6(I) Limited Partnership (“RSA 6(I)”) and 23.67% of Pennsylvania RSA 6(II) Limited Partnership (“RSA 6(II)”).  RSA #17 provides cellular service to a limited rural area in Texas.  RSA 6 (I) and RSA 6 (II) provide cellular service in and around our Pennsylvania service territory.  Because we have significant influence over the operating and financial policies of these three entities, we account for the investments using the equity method.  For the three months ended June 30, 2013 and 2012, we received cash distributions from these partnerships totaling $3.9 million and $2.9 million, respectively. For the six months ended June 30, 2013 and 2012, we received cash distributions from these partnerships totaling $8.0 million and $6.5 million, respectively.

 

We have a 13.43% interest in Central Valley Independent Network, LLC (“CVIN”), a joint enterprise comprised of affiliates of several independent telephone companies located in central and northern California. CVIN provides network services and oversees a broadband infrastructure project designed to expand and improve the availability of network services to counties in central California.  Because we have significant influence over the operating and financial policies of this entity, we account for this investment using the equity method.  During the six months ended June 30, 2013, we made additional capital investments of $0.1 million in this partnership.  We did not receive any distributions from this partnership during the quarters or six months ended June 30, 2013 and 2012.

 

The combined unaudited results of operations and financial position of our three equity investments in the cellular limited partnerships are summarized below:

 

		Quarter Ended						Six Months
		June 30,						Ended June 30,
(In thousands)		2013			2012			2013			2012
Total revenues		$	79,342		$	73,555		$	156,061		$	145,890
Income from operations		24,914			22,235			48,888			41,927
Net income before taxes		24,926			22,247			48,911			41,956
Net income		24,926			22,143			48,911			41,748

 

		June 30,			December 31,
(In thousands)		2013			2012
Current assets		$	58,650		$	49,982
Non-current assets		81,826			79,529
Current liabilities		15,798			15,417
Non-current liabilities		1,492			1,351
Partnership equity		123,186			112,734

 

5.              FAIR VALUE MEASUREMENTS

 

Our derivative instruments related to interest rate swap agreements are required to be measured at fair value on a recurring basis.  The fair values of the interest rate swaps are determined using valuation models which rely on the expected London Interbank Offered Rate (“LIBOR”) based yield curve and estimates of counterparty and Consolidated’s non-performance risk as the most significant inputs.  Because each of these inputs are directly observable or can be corroborated by observable market data, we have categorized these interest rate swaps as Level 2 within the fair value hierarchy. See Note 7 for further discussion regarding our interest rate swap agreements.

 

10

Table of Contents

 

Our interest rate swap liabilities measured at fair value on a recurring basis and subject to disclosure requirements at June 30, 2013 and December 31, 2012 were as follows:

 

					As of June 30, 2013
					Quoted Prices In Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
(In thousands)		Total			(Level 1)			(Level 2)			(Level 3)
Current interest rate swap liabilities		$	(371)		$	–		$	(371)		$	–
Long-term interest rate swap liabilities		(2,779)			–			(2,779)			–
Totals		$	(3,150)		$	–		$	(3,150)		$	–

 

 

					As of December 31, 2012
					Quoted Prices In Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
(In thousands)		Total			(Level 1)			(Level 2)			(Level 3)
Current interest rate swap liabilities		$	(3,164)		$	–		$	(3,164)		$	–
Long-term interest rate swap liabilities		(3,919)			–			(3,919)			–
Totals		$	(7,083)		$	–		$	(7,083)		$	–

 

The change in the fair value of the derivatives is primarily a result of a change in market expectations for future interest rates and the expiration of certain instruments during the six months ended June 30, 2013.

 

We have not elected the fair value option for any of our financial assets or liabilities.  The carrying value of other financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities approximate fair value due to their short maturities or variable-rate nature of the respective balances.  The following table presents the other financial instruments that are not carried at fair value but which require fair value disclosure as of June 30, 2013 and December 31, 2012.

 

		As of June 30, 2013						As of December 31, 2012
(In thousands)		Carrying Value			Fair Value			Carrying Value			Fair Value
Investments, equity basis		$	59,827		n/a			$	57,852		n/a
Investments, at cost		$	49,858		n/a			$	49,853		n/a
Long-term debt		$	1,218,839		$	1,268,870		$	1,213,000		$	1,231,355

 

Cost & Equity Method Investments

 

Our investments at June 30, 2013 and December 31, 2012 accounted for under both the equity and cost methods consists primarily of minority positions in various cellular telephone limited partnerships and our investment in CoBank.  These investments are recorded using either the equity or cost methods. It is impracticable to determine fair value of these investments.

 

Long-term Debt

 

The fair value of our long-term debt was estimated using a discounted cash flow analyses based on incremental borrowing rates for similar types of borrowing arrangements.  We have categorized the long-term debt as Level 2 within the fair value hierarchy.

 

11

Table of Contents

 

6.     LONG-TERM DEBT

 

Long-term debt, presented net of unamortized discounts, consisted of the following:

 

		June 30,			December 31,
(In thousands)		2013			2012
Senior secured credit facility:
Term Loan 2		$	402,916		$	404,961
Term Loan 3, net of discount of $4,714 and $5,088 at June 30, 2013 and December 31, 2012, respectively		507,711			509,912
Revolving loan		10,000			-
Senior notes, net of discount of $1,788 and $1,873 at June 30, 2013 and December 31, 2012, respectively		298,212			298,127
Capital leases		5,414			4,844
		1,224,253			1,217,844
Less: current portion of long-term debt and capital leases		(9,849)			(9,596)
Total long-term debt		$	1,214,404		$	1,208,248

 

Credit Agreement

 

The Company, through certain of its wholly owned subsidiaries, has an outstanding credit agreement with several financial institutions, which consists of a $50.0 million revolving credit facility and outstanding term loans of $910.6 million at June 30, 2013.  The credit facility also includes an incremental term loan facility which provides the ability to borrow up to $300.0 million of incremental term loans.  As of June 30, 2013, $10.0 million was outstanding under the revolving credit facility.  No amounts were outstanding under the revolving credit facility at December 31, 2012. Borrowings under the senior secured credit facility are secured by substantially all of the assets of the Company, with the exception of Illinois Consolidated Telephone Company and our majority-owned subsidiary, East Texas Fiber Line Incorporated.

 

Our term loans under the credit facility, as amended, were issued in separate tranches, resulting in different maturity dates and interest rate margins for each term loan.  The second term loan (“Term 2”) consists of an original aggregate principal amount of $409.1 million, matures on December 31, 2017 and currently has an applicable margin (at our election) equal to either 4.00% for a LIBOR-based term loan or 3.00% for an alternative base rate term loan.  The Term 2 loan requires $1.0 million in quarterly principal payments, which began on March 31, 2012.  The third term loan (“Term 3”) consists of an original aggregate principal amount of $515.0 million, with a maturity date of December 31, 2018.  The Term 3 loan requires quarterly principal payments of $1.3 million which commenced March 31, 2013 and has an applicable margin (at our election) equal to either 4.00% for a LIBOR-based term loan or 3.00% for an alternative base rate term loan subject to a 1.25% LIBOR floor. The Term 3 loan contains an original issuance discount of $5.2 million, which is being amortized over the term of the loan.

 

Our revolving credit facility has a maturity date of June 8, 2016 and an applicable margin (at our election) of between 2.75% and 3.50% for LIBOR-based borrowings and between 1.75% and 2.50% for alternative base rate borrowings, depending on our leverage ratio.  Based on our leverage ratio at June 30, 2013, the borrowing margin for the next three month period ending September 30, 2013 will be at a weighted-average margin of 3.25% for a LIBOR-based loan or 2.25% for an alternative base rate loan.  The applicable borrowing margin for the revolving credit facility is adjusted quarterly to reflect the leverage ratio from the prior quarter-end. As of June 30, 2013, $10.0 million was outstanding under the revolving credit facility. There were no borrowings or letters of credit outstanding under the revolving credit facility at December 31, 2012.

 

The weighted-average interest rate on outstanding borrowings under our credit agreement was 4.77% and 4.79% at June 30, 2013 and December 31, 2012, respectively.  Interest is payable at least quarterly.

 

Net proceeds from asset sales exceeding certain thresholds, to the extent not reinvested, are required to be used to repay loans outstanding under the credit agreement.

 

12

Table of Contents

 

Credit Agreement Covenant Compliance

 

The credit agreement contains various provisions and covenants, including, among other items, restrictions on the ability to pay dividends, incur additional indebtedness, and issue capital stock.  We have agreed to maintain certain financial ratios, including interest coverage and total net leverage ratios, all as defined in the credit agreement.  As of June 30, 2013, we were in compliance with the credit agreement covenants.

 

Effective February 17, 2012, we amended our credit facility to provide us with the ability to incur indebtedness necessary to finance the acquisition of SureWest, which enabled us to issue the unsecured Senior Notes (“Senior Notes”), as described below.  In connection with the amendment, fees of $3.5 million were recognized as financing and other transaction costs during the six months ended June 30, 2012.

 

In general, our credit agreement restricts our ability to pay dividends to the amount of our Available Cash as defined in our credit agreement. As of June 30, 2013, and including the $15.5 million dividend declared in May 2013 and paid on August 1, 2013, we had $194.2 million in dividend availability under the credit facility covenant.

 

Under our credit agreement, if our total net leverage ratio (as defined in the credit agreement), as of the end of any fiscal quarter, is greater than 5.10:1.00, we will be required to suspend dividends on our common stock unless otherwise permitted by an exception for dividends that may be paid from the portion of proceeds of any sale of equity not used to fund acquisitions, or make other investments.  During any dividend suspension period, we will be required to repay debt in an amount equal to 50.0% of any increase in Available Cash, among other things.  In addition, we will not be permitted to pay dividends if an event of default under the credit agreement has occurred and is continuing.  Among other things, it will be an event of default if our total net leverage ratio and interest coverage ratio as of the end of any fiscal quarter is greater than 5.25:1.00 and less than 2.25:1.00, respectively.  As of June 30, 2013, our total net leverage ratio under the credit agreement was 4.26:1.00, and our interest coverage ratio was 3.32:1.00.

 

Senior Notes

 

On May 30, 2012, we completed an offering of $300.0 million aggregate principal amount of 10.875% unsecured Senior Notes, due 2020 through our wholly-owned subsidiary, Consolidated Communications Finance Co. (“Finance Co.”) for the acquisition of SureWest.  The Senior Notes will mature on June 1, 2020 and earn interest at a rate of 10.875% per year, payable semi-annually in arrears on June 1 and December 1 of each year, commencing on December 1, 2012.  The Senior Notes were sold in the United States to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933 (the “Securities Act”) and outside the United States in compliance with Regulation S under the Securities Act.  In addition, some of the Senior Notes were sold to certain “accredited investors” (as defined in Rule 501 under the Securities Act).  The Senior Notes were sold to investors at a price equal to 99.345% of the principal amount thereof, for a yield to maturity of 11.00%.  This discount is being amortized over the term of the Senior Notes.  The proceeds of the sale of the Senior Notes were held in an escrow account prior to the closing of the SureWest transaction.  Upon closing of the SureWest acquisition on July 2, 2012, Finance Co. merged with and into our wholly-owned subsidiary Consolidated Communications, Inc., which assumed the Senior Notes, and we and certain of our subsidiaries fully and unconditionally guaranteed the Senior Notes.  On August 3, 2012, SureWest and its subsidiaries guaranteed the Senior Notes.

 

During the quarter ended June 30, 2013, we completed an exchange offer to issue registered notes (“Exchange Notes”) for $287.3 million of the original Senior Notes.  The terms of the Exchange Notes are substantially identical to the Senior Notes, except that the Exchange Notes are registered under the Securities Act and the transfer restrictions and registration rights applicable to the Senior Notes do not apply to the Exchange Notes.  The exchange offer did not impact the aggregate principal amount or the remaining terms of the Senior Notes outstanding.

 

Senior Notes Covenant Compliance

 

The indenture governing the Senior Notes contains customary covenants for high yield notes, which limits Consolidated Communications, Inc.’s and its restricted subsidiaries’ ability to: incur debt or issue certain preferred stock; pay dividends or make other distributions on capital stock or prepay subordinated indebtedness; purchase or redeem any equity interests; make investments; create liens; sell assets; enter into agreements that restrict dividends or other payments by restricted subsidiaries; consolidate, merge or transfer all or substantially all of its assets; engage in transactions with its affiliates; or enter into any sale and leaseback transactions.

 

13

Table of Contents

 

Among other matters, the Senior Notes indenture provides that Consolidated Communications, Inc. may not pay dividends or make other “restricted payments” to the Company if its total net leverage ratio is 4.25:1.00 or greater.  At June 30, 2013, this ratio, which is calculated differently than the comparable ratio under the credit agreement, was 4.00:1.00.  If this ratio is met, dividends and other restricted payments may be made from cumulative consolidated cash flow since the date the Senior Notes were issued, less 1.75 times fixed charges, less dividends and other restricted payments made since the date the Senior Notes were issued.  Dividends may be paid and other restricted payments may also be made from a “basket” of $50.0 million, none of which has been used to date, and pursuant to other exceptions identified in the Senior Notes indenture. Since dividends of $77.5 million have been paid since May 30, 2012, at June 30, 2013 there was $115.2 million of the $192.7 million of cumulative consolidated cash flow since May 30, 2012 available to pay dividends.

 

Bridge Loan Facility

 

In connection with the acquisition of SureWest, in February 2012 the Company received committed financing for a total of $350.0 million to fund the cash portion of the anticipated transaction, to refinance SureWest’s debt and to pay for certain transaction costs. The financing package included a $350.0 million Senior Unsecured Bridge Loan Facility (“Bridge Facility”). As anticipated, permanent financing for the SureWest acquisition was funded by our Senior Note offering, as described above.  As a result, the $4.2 million commitment fee incurred for the Bridge Facility was capitalized as deferred debt issuance costs in February 2012 and was amortized over the expected life of the Bridge Facility, which was four months.

 

Capital Leases

 

As of June 30, 2013, we had seven capital leases which expire between 2015 and 2021.  As of June 30, 2013, the present value of the minimum remaining lease commitments was approximately $5.4 million, of which $0.6 million was due and payable within the next twelve months.  The leases require total remaining rental payments of $8.5 million as of June 30, 2013, of which $6.1 million will be paid to LATEL LLC, a related party entity.

 

During the quarter ended June 30, 2013, we acquired equipment of $0.8 million through capital lease agreements, which represents a noncash investing activity.

 

7.     DERIVATIVE FINANCIAL INSTRUMENTS

 

We use derivative financial instruments to manage our exposure to the risks associated with fluctuations in interest rates. Our interest rate swap agreements effectively convert a portion of our floating-rate debt to a fixed-rate basis, thereby reducing the impact of interest rate changes on future cash interest payments.  Derivative financial instruments are recorded at fair value in our condensed consolidated balance sheet.  Certain of our interest rate swaps are designated as cash flow hedges of our expected future interest payments.  For derivative instruments designated as a cash flow hedge, the effective portion of the change in the fair value is recognized as a component of accumulated other comprehensive income (loss) (“AOCI”) and is recognized as an adjustment to earnings over the period in which the hedged item impacts earnings. When an interest rate swap agreement terminates, any resulting gain or loss is recognized over the shorter of the remaining original term of the hedging instrument or the remaining life of the underlying debt obligation.  If a derivative instrument is de-designated, the remaining gain or loss in AOCI on the date of de-designation is amortized to earnings over the remaining term of the hedging instrument. For derivative financial instruments that are not designated as a hedge, changes in fair value are recognized on a current basis in earnings.  The ineffective portion of the change in fair value of any hedging derivative is recognized immediately in earnings.  Cash flows from hedging activities are classified under the same category as the cash flows from the hedged items in our consolidated statement of cash flows.

 

The following interest rate swaps were outstanding at June 30, 2013:

 

(In thousands)		Notional Amount			2013 Balance Sheet Location		Fair Value
Cash Flow Hedges:
Fixed to 1-month floating LIBOR		$	275,000		Other long-term liabilities		$	(2,779)
Fixed to 1-month floating LIBOR		100,000			Current portion of derivative liability		(371)
Total Fair Values							$	(3,150)

 

14

Table of Contents

 

The following interest rate swaps were outstanding at December 31, 2012:

 

(In thousands)		Notional Amount			2012 Balance Sheet Location		Fair Value
Cash Flow Hedges:
Fixed to 1-month floating LIBOR		$	200,000		Other long-term liabilities		$	(2,758)
Fixed to 1-month floating LIBOR		100,000			Current portion of derivative liability		(1,069)
Forward starting fixed to
1-month floating LIBOR		75,000			Other long-term liabilities		(1,161)
De-designated Hedges:
Fixed to 3-month floating LIBOR		130,000			Current portion of derivative liability		(1,300)
3-month floating LIBOR minus spread to 1-month floating LIBOR		130,000			Current portion of derivative liability		(16)
Fixed to 1-month floating LIBOR		200,000			Current portion of derivative liability		(779)
Total Fair Values							$	(7,083)

 

At June 30, 2013 and December 31, 2012, the interest rate on approximately 41% and 69%, respectively, of our outstanding debt under the term loan credit facility was fixed through the use of interest rate swaps.

 

As of June 30, 2013, the counterparties to our various swaps are four major U.S. and European banks.  None of the swap agreements provide for either us or the counterparties to post collateral nor do the agreements include any covenants related to the financial condition of Consolidated or the counterparties.  The swaps of any counterparty that is a “Lender” as defined in our credit facility are secured along with the other creditors under the credit facility.  Each of the swap agreements provides that in the event of a bankruptcy filing by either Consolidated or the counterparty, any amounts owed between the two parties would be offset in order to determine the net amount due between parties.  This provision allows us to partially mitigate the risk of non-performance by a counterparty.

 

On December 4, 2012, $660.0 million notional interest rate swaps designated as cash flow hedges were de-designated in connection with an amendment to our credit agreement.  Prior to the de-designation, the effective portion of the change in fair value of these interest rate swaps were recognized in AOCI.  The balance of the unrealized loss included in AOCI as of the date the swaps were de-designated was amortized to earnings over the remaining term of the swap agreements.  On December 31, 2012, $200.0 million notional interest rate swap agreements expired and the remainder expired on March 31, 2013.  Subsequent to December 4, 2012, changes in fair value of the de-designated swaps were recognized in earnings.  During the six months ended June 30, 2013, a gain of $2.1 million was recognized as a reduction to interest expense for the change in fair value of the de-designated swaps.

 

Information regarding our cash flow hedge transactions is as follows:

 

		Quarter Ended						Six Months Ended
		June 30,						June 30,
(In thousands)		2013			2012			2013			2012
Gain recognized in AOCI, pretax		$	1,161		$	932		$	1,838		$	2,508
Deferred losses reclassed from AOCI to interest expense		$	-		$	13		$	(2,912)		$	1
Gain arising from ineffectiveness reducing interest expense		$	-		$	15		$	-		$	31

 

		June 30,			December 31,
(In thousands, except months)		2013			2012
Aggregate notional value of current derivatives outstanding		$	375,000		$	630,000
Aggregate notional value of forward derivatives outstanding		$	-		$	75,000
Period through which derivative positions currently exist		March 2016			March 2016
Fair value of derivatives		$	(3,150)		$	(7,083)
Deferred losses included in AOCI (pretax)		$	3,149		$	7,899
Losses included in AOCI to be recognized in the next 12 months		$	-		$	2,912
Number of months over which loss in AOCI is to be recognized		N/A			3

 

15