Consolidated Communications Holdings, Inc. - Quarter Report: 2014 September (Form 10-Q)

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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 September 30, 2014

 

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 October 27, 2014, the registrant had 50,433,553 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	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42
Item 4.	Controls and Procedures	43
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	44
Item 6.	Exhibits	46
SIGNATURES		47

 

 

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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 September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Net revenues		$	149,040			$	150,773			$	449,724			$	453,621
Operating expense:
Cost of services and products (exclusive of depreciation and amortization)		56,435				55,780				167,653				166,774
Selling, general and administrative expenses		32,659				33,715				97,945				100,385
Financing and other transaction costs		729				355				1,995				712
Depreciation and amortization		34,968				34,756				106,515				104,306
Income from operations		24,249				26,167				75,616				81,444
Other income (expense):
Interest expense, net of interest income		(20,721		)		(20,632		)		(60,280		)		(65,929)
Investment income		8,315				9,687				25,964				27,164
Other, net		293				(687		)		(862		)		(712)
Income from continuing operations before income taxes		12,136				14,535				40,438				41,967
Income tax expense		4,387				4,205				14,380				15,219
Income from continuing operations		7,749				10,330				26,058				26,748
Discontinued operations, net of tax:
Income (loss) from discontinued operations, net of tax		-				92				-				(156)
Gain on sale of discontinued operations, net of tax		-				1,333				-				1,333
Total discontinued operations		-				1,425				-				1,177
Net income		7,749				11,755				26,058				27,925
Less: net income attributable to noncontrolling interest		107				61				285				254
Net income attributable to common shareholders		$	7,642			$	11,694			$	25,773			$	27,671
Net income per common share - basic and diluted
Income from continuing operations		$	0.19			$	0.26			$	0.63			$	0.65
Discontinued operations, net of tax		-				0.03				-				0.03
Net income per basic and diluted common share attributable to common shareholders		$	0.19			$	0.29			$	0.63			$	0.68
Dividends declared per common share		$	0.39			$	0.39			$	1.16			$	1.16

 

See accompanying notes.

 

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CONSOLIDATED COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited; Amounts in thousands)

 

 

		Quarter Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Net income		$	7,749			$	11,755			$	26,058			$	27,925
Pension and post-retirement obligations:
Amortization of actuarial (gains) losses and prior service credit to earnings, net of tax		(136		)		433				(408		)		1,381
Derivative instruments designated as cash flow hedges:
Change in fair value of derivatives, net of tax		-				(417		)		-				(285		)
Reclassification of realized loss to earnings, net of tax		290				566				1,001				3,411
Comprehensive income		7,903				12,337				26,651				32,432
Less: comprehensive income attributable to noncontrolling interest		107				61				285				254
Total comprehensive income attributable to common shareholders		$	7,796			$	12,276			$	26,366			$	32,178

 

See accompanying notes.

 

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CONSOLIDATED COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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

 

		September 30,				December 31,
		2014				2013
ASSETS
Current assets:
Cash and cash equivalents		$	4,890			$	5,551
Restricted cash		204,803				-
Accounts receivable, net		51,388				52,033
Income tax receivable		804				9,796
Deferred income taxes		8,905				7,960
Prepaid expenses and other current assets		13,756				12,380
Total current assets		284,546				87,720
Property, plant and equipment, net		859,620				885,362
Investments		113,594				113,099
Goodwill		603,446				603,446
Other intangible assets		33,018				40,084
Deferred debt issuance costs, net and other assets		19,231				17,667
Total assets		$	1,913,455			$	1,747,378
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	4,991			$	4,885
Advance billings and customer deposits		23,512				25,934
Dividends payable		15,607				15,520
Accrued compensation		17,534				22,252
Accrued interest		12,433				3,524
Accrued expense		33,008				35,173
Current portion of long-term debt and capital lease obligations		9,809				9,751
Current portion of derivative liability		877				660
Total current liabilities		117,771				117,699
Long-term debt and capital lease obligations		1,407,354				1,212,134
Deferred income taxes		180,204				179,859
Pension and other postretirement obligations		60,822				75,754
Other long-term liabilities		12,463				9,593
Total liabilities		1,778,614				1,595,039
Commitments and contingencies
Shareholders’ equity:
Common stock, par value $0.01 per share; 100,000,000 shares authorized, 40,289,154 and 40,065,246 shares outstanding as of September 30, 2014 and December 31, 2013, respectively		403				401
Additional paid-in capital		130,055				148,433
Retained earnings		-				-
Accumulated other comprehensive loss, net		(407		)		(1,000		)
Noncontrolling interest		4,790				4,505
Total shareholders’ equity		134,841				152,339
Total liabilities and shareholders’ equity		$	1,913,455			$	1,747,378

 

See accompanying notes.

 

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CONSOLIDATED COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; amounts in thousands)

 

 

		Nine Months Ended September 30,
		2014				2013
Net cash provided by continuing operations		$	133,364			$	124,053
Net cash used in discontinued operations		-				(3,412		)
Net cash provided by operating activities		133,364				120,641
Cash flows from investing activities:
Purchases of property, plant and equipment, net		(76,038		)		(80,584		)
Proceeds from sale of assets		1,563				111
Restricted cash related to acquisition		(149,917		)		-
Other		-				(238		)
Net cash used in continuing operations		(224,392		)		(80,711		)
Net cash provided by discontinued operations		-				2,331
Net cash used in investing activities		(224,392		)		(78,380		)
Cash flows from financing activities:
Proceeds from bond offering		200,000				-
Restricted cash on bond offering		(54,886		)		-
Proceeds from the issuance of long-term debt		28,000				57,000
Payment of capital lease obligation		(481		)		(368		)
Payment on long-term debt		(32,825		)		(63,930		)
Payment of financing costs		(2,707		)		-
Dividends on common stock		(46,734		)		(46,526		)
Net cash provided by (used in) financing activities		90,367				(53,824		)
Decrease in cash and cash equivalents		(661		)		(11,563		)
Cash and cash equivalents at beginning of period		5,551				17,854
Cash and cash equivalents at end of period		$	4,890			$	6,291

 

See accompanying notes.

 

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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 September 30, 2014, we had approximately 245 thousand access lines, 119 thousand voice connections, 261 thousand data and Internet connections and 111 thousand video connections.

 

In the opinion of management, the accompanying condensed consolidated balance sheets and related condensed 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 thereto included in our 2013 Annual Report on Form 10-K filed with the SEC.

 

Recent Business Developments

 

Enventis Merger

 

On June 29, 2014, we entered into an agreement and plan of merger with Enventis Corporation, a Minnesota corporation (“Enventis”), to acquire all the issued and outstanding shares of Enventis in exchange for shares of our common stock and cash in lieu of fractional shares. On October 16, 2014, the merger was completed and Enventis became a wholly owned subsidiary of the Company. For a more complete discussion of the transaction, refer to Note 2.

 

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.

 

Discontinued Operations

 

On September 13, 2013, we completed the sale of the assets and contractual rights used to provide communications services to inmates in thirteen county jails located in Illinois for a total purchase price of $2.5 million. In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 205-20, “Discontinued Operations”, the financial results of the Prison Services business

 

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have been reported as a discontinued operation in our condensed consolidated financial statements for all periods presented. For a more complete discussion of the transaction, refer to Note 2.

 

Recent Accounting Pronouncements

 

In August 2014, FASB issued the Accounting Standards Update No. 2014-15 (“ASU 2014-15”), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 requires management to evaluate for each annual and interim reporting period whether conditions or events give rise to substantial doubt that an entity has the ability to continue as a going concern within one year following issuance of the financial statements and requires specific disclosures regarding the conditions or events leading to substantial doubt. The new guidance is effective for annual and interim periods ending after December 15, 2016, with early adoption permitted. We are currently evaluating the impact this update will have on our condensed consolidated financial statements.

 

In June 2014, FASB issued the Accounting Standards Update No. 2014-12 (“ASU 2014-12”), Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 provides guidance requiring a performance target that could be achieved after the requisite service period has ended to be treated as a performance condition affecting vesting of the award and therefore not reflected in estimating the fair value of the award at the date of grant. The amended guidance is effective for annual and interim periods beginning on or after December 15, 2015, with early adoption permitted. We are currently evaluating the impact this update will have on our condensed consolidated financial statements.

 

In May 2014, FASB issued the Accounting Standards Update No. 2014-09 (“ASU 2014-09”), Revenue from Contracts with Customers (Topic 606). ASU 2014-09 provides new, globally applicable converged guidance concerning recognition and measurement of revenue. As a result, significant additional disclosures are required about nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance is effective for annual and interim periods beginning on or after December 15, 2016. Companies are allowed to transition using either the modified retrospective or full retrospective adoption method. If full retrospective adoption is chosen, three years of financial information must be presented in accordance with the new standard as well as summarized financial data for five years. We are currently evaluating the impact this update will have on our condensed consolidated financial statements as well as the transition method we will use.

 

In April 2014, FASB issued the Accounting Standards Update No. 2014-08 (“ASU 2014-08”), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 revises the definition of a discontinued operation to limit the circumstances under which a disposal or classification as held for sale qualifies for presentation as a discontinued operation. Amendments in this ASU require expanded disclosures concerning a discontinued operation and the disposal of an individually-material component of an entity not qualifying as a discontinued operation. ASU 2014-08 is effective for annual and interim periods beginning on or after December 15, 2014 and should be applied prospectively, with early adoption permitted.

 

Effective January 1, 2014, we adopted Accounting Standards Update No. 2013-11 (“ASU 2013-11”), Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 provides guidance concerning the balance sheet presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward is present. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.

 

2. ACQUISITION AND DISPOSITIONS

 

Merger with Enventis Corporation

 

On June 29, 2014, we entered into an agreement and plan of merger (the “Merger Agreement”) with Sky Merger Sub Inc., a newly formed Minnesota corporation and wholly-owned subsidiary of the Company, and Enventis, to acquire all the issued and outstanding shares of Enventis in exchange for shares of our common stock and cash in lieu of fractional shares. Enventis is an advanced communications provider, which services business and residential customers primarily in the upper Midwest. On October 16, 2014, the acquisition of Enventis was completed, and as a result, Enventis became a wholly-owned subsidiary of the Company. The acquisition reflects our strategy to diversify revenue and cash flows amongst multiple products and to expand our network to new markets.

 

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At the effective time of the merger, each share of common stock, no par value, of Enventis owned immediately prior to the effective time of the merger converted into and became the right to receive 0.7402 shares of common stock, par value of $0.01 per share, of our common stock plus cash in lieu of fractional shares, as set forth in the Merger Agreement. Based on the closing price of our common stock on the date preceding the merger, the total value of the purchase consideration to be exchanged is approximately $257.7 million, excluding the assumption of debt of approximately $149.9 million. On the date of the merger, we issued an approximate aggregate total of 10.1 million shares of our common stock to the former Enventis shareholders.

 

The acquisition will be accounted for in accordance with the acquisition method of accounting for business combinations. The tangible and intangible assets acquired and liabilities assumed will be recorded at their estimated fair values as of the date of the acquisition. The results of operations of Enventis will be reported in our consolidated financial statements beginning as of the effective date of the acquisition. Due to the limited time between the acquisition date and this filing, the initial accounting for the business combination and the valuation of the assets acquired and liabilities assumed has not been completed, including the measurement of certain intangible assets and goodwill and the preparation of supplemental pro forma information. We have not included pro forma revenue or earnings information of the combined entity as the information required to determine any pro forma adjustments is not available as of the date of this filing.

 

Upon closing of the Enventis acquisition or shortly thereafter, various triggering events occurred which will result in the payment of various change in control payments and other contingent payments to certain Enventis employees. The estimated cash payments under these agreements will be approximately $7.0 million and are expected to be paid in the second quarter of 2015.

 

Transaction costs related to the acquisition of Enventis were $0.7 million and $1.7 million during the quarter and nine months ended September 30, 2014, respectively, which are included in financing and other transaction costs in the condensed consolidated statements of income.

 

Discontinued Operations

 

In September 2013, we completed the sale of the assets and contractual rights of our Prison Services business for a total cash purchase price of $2.5 million, which included the settlement of any pending legal matters. 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.

 

The following table summarizes the financial information for the Prison Services operations for the quarter and nine months ended September 30, 2013:

 

		Quarter Ended				Nine Months Ended
(In thousands)		September 30, 2013				September 30, 2013
Operating revenues		$	373			$	5,622
Operating expenses including depreciation and amortization		306				5,883
Income (loss) from operations		67				(261		)
Income tax benefit		(25		)		(105		)
Income (loss) from discontinued operations		$	92			$	(156	)
Gain on sale of discontinued operations, net of tax		$	1,333			$	1,333

 

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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						Nine Months Ended
		September 30,						September 30,
(In thousands, except per share amounts)		2014			2013			2014			2013
Income from continuing operations		$	7,749		$	10,330		$	26,058		$	26,748
Less: net income attributable to noncontrolling interest		107			61			285			254
Income attributable to common shareholders before allocation of earnings to participating securities		7,642			10,269			25,773			26,494
Less: earnings allocated to participating securities		153			131			459			394
Income from continuing operations attributable to common shareholders		7,489			10,138			25,314			26,100
Net income from discontinued operations		-			1,425			-			1,177
Net income attributable to common shareholders		$	7,489		$	11,563		$	25,314		$	27,277
Weighted-average number of common shares outstanding		39,877			39,755			39,877			39,755
Basic and diluted earnings per common share:
Income from continuing operations		$	0.19		$	0.26		$	0.63		$	0.65
Income from discontinued operations, net of tax		-			0.03			-			0.03
Net income per common share attributable to common shareholders		$	0.19		$	0.29		$	0.63		$	0.68

 

Diluted earnings per common share attributable to common shareholders for the quarter and nine months ended September 30, 2014 excludes 0.4 million shares of potential common shares that could be issued under our share-based compensation plan, because the inclusion of the potential common shares would have had an antidilutive effect. For the quarter and nine months ended September 30, 2013, diluted earnings per share excluded 0.4 million and 0.3 million potential common shares, respectively.

 

4. INVESTMENTS

 

Our investments are as follows:

 

		September 30,			December 31,
(In thousands)		2014			2013
Cash surrender value of life insurance policies		$	1,898		$	2,183
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		5,107			5,112
Other		200			200
Equity method investments:
GTE Mobilnet of Texas RSA #17 Limited Partnership (20.51% interest)		28,020			27,467
Pennsylvania RSA 6(I) Limited Partnership (16.67% interest)		7,448			7,696
Pennsylvania RSA 6(II) Limited Partnership (23.67% interest)		24,585			24,105
CVIN, LLC (12.09% interest)		1,936			1,936
Totals		$	113,594		$	113,099

 

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 practical to estimate fair value of these investments. We did not evaluate any of the investments for impairment during the quarters or nine months ended September 30, 2014 or 2013 as no factors indicating impairment existed. For the quarters ended September 30, 2014 and 2013, we received cash distributions from these partnerships totaling $3.8 million and $4.3 million, respectively. For the nine months ended September 30, 2014 and 2013, we received cash distributions from these partnerships totaling $11.1 million and $12.1 million, respectively.

 

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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”), 16.67% 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 quarters ended September 30, 2014 and 2013, we received cash distributions from these partnerships totaling $3.8 million and $4.2 million, respectively. For the nine months ended September 30, 2014 and 2013, we received cash distributions from these partnerships totaling $14.2 million and $12.2 million, respectively.

 

We have a 12.09% 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 quarter and nine months ended September 30, 2013, we made additional capital investments of $0.1 million and $0.2 million, respectively, in this partnership. We did not receive any distributions from this partnership during the quarters or nine months ended September 30, 2014 and 2013.

 

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

 

		Quarter Ended						Nine Months
		September 30,						Ended September 30,
(In thousands)		2014(1)			2013			2014(2)			2013
Total revenues		$	69,219		$	82,394		$	233,263		$	238,455
Income from operations		18,473			25,874			67,779			74,762
Net income before taxes		24,273			25,896			73,635			74,808
Net income		24,273			25,896			73,635			74,808

 

		September 30,			December 31,
(In thousands)		2014(3)			2013
Current assets		$	56,915		$	54,837
Non-current assets		92,414			87,968
Current liabilities		14,816			15,221
Non-current liabilities		3,001			1,786
Partnership equity		131,512			125,799

 

(1) Quarter ended September 30, 2014 excludes total revenue and income from operations of RSA 6(I), as the information was not available at the time of this filing; however estimated net income before taxes and net income are included.

 

(2) Nine months ended September 30, 2014 excludes total revenue and income from operations of RSA 6(I) for the quarter ended September 30, 2014, as the information was not available at the time of this filing; however, estimated net income before taxes and net income are included.

 

(3) Financial position as of September 30, 2014 for RSA 6(I) is as of June 30, 2014, which was the most recent available data at the time of this filing.

 

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.

 

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Our interest rate swap liabilities measured at fair value on a recurring basis and subject to disclosure requirements at September 30, 2014 and December 31, 2013 were as follows:

 

					As of September 30, 2014
					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		$	(877)		$	–		$	(877)		$	–
Long-term interest rate swap liabilities		(583)				–		(583)				–
Total		$	(1,460)		$	–		$	(1,460)		$	–

 

					As of December 31, 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		$	(660)		$	–		$	(660)		$	–
Long-term interest rate swap liabilities		(1,959)			–			(1,959)			–
Total		$	(2,619)		$	–		$	(2,619)		$	–

 

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 September 30, 2014 and December 31, 2013.

 

		As of September 30, 2014						As of December 31, 2013
(In thousands)		Carrying Value			Fair Value			Carrying Value			Fair Value
Investments, equity basis		$	61,989		n/a			$	61,204		n/a
Investments, at cost		$	49,707		n/a			$	49,712		n/a
Long-term debt		$	1,412,522		$	1,456,281		$	1,216,764		$	1,261,508

 

Cost & Equity Method Investments

 

Our investments at September 30, 2014 and December 31, 2013 accounted for under both the equity and cost methods consisted 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.

 

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6.              LONG-TERM DEBT

 

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

 

		September 30,			December 31,
(In thousands)		2014			2013
Senior secured credit facility:
Term Loan 4, net of discount of $4,096 and $4,537 at September 30, 2014 and December 31, 2013, respectively		$	899,079		$	905,463
Revolving loan		15,000			13,000
10.875% Senior notes due 2020, net of discount of $1,557 and $1,699 at September 30, 2014 and December 31, 2013, respectively		298,443			298,301
6.50% Senior notes due 2022		200,000			-
Capital leases		4,641			5,121
		1,417,163			1,221,885
Less: current portion of long-term debt and capital leases		(9,809)			(9,751)
Total long-term debt		$	1,407,354		$	1,212,134

 

Credit Agreement

 

In December 2013, the Company, through certain of its wholly owned subsidiaries, entered into a Second Amended and Restated Credit Agreement with various financial institutions (the “Credit Agreement”) to replace the Company’s previously amended credit agreement. The Credit Agreement consists of a $75.0 million revolving credit facility and initial term loans in the aggregate amount of $910.0 million (“Term 4”). The proceeds from the Credit Agreement were used to repay the outstanding term loans from the previous agreement in its entirety. The Credit Agreement also includes an incremental term loan facility which provides the ability to borrow up to $300.0 million of incremental term loans subject to certain terms and conditions. Borrowings under the senior secured credit facility are secured by substantially all of the assets of the Company and its subsidiaries, with the exception of Illinois Consolidated Telephone Company and our majority-owned subsidiary, East Texas Fiber Line Incorporated.

 

The Term 4 loan was issued in an original aggregate principal amount of $910.0 million with a maturity date of December 23, 2020, but is subject to earlier maturity on December 31, 2019 if the Company’s unsecured Senior Notes due in 2020 are not repaid or redeemed in full by December 31, 2019. The Term 4 loan contains an original issuance discount of $4.6 million, which is being amortized over the term of the loan. The Term 4 loan requires quarterly principal payments of $2.3 million, which commenced March 31, 2014, and has an interest rate of LIBOR plus 3.25% subject to a 1.00% LIBOR floor.

 

Our revolving credit facility has a maturity date of December 23, 2018 and an applicable margin (at our election) of between 2.50% and 3.25% for LIBOR-based borrowings or between 1.50% and 2.25% for alternate base rate borrowings, depending on our leverage ratio. Based on our leverage ratio at September 30, 2014, the borrowing margin for the next three month period ending December 31, 2014 will be at a weighted-average margin of 3.00% for a LIBOR-based loan or 2.00% for an alternate 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 September 30, 2014 and December 31, 2013, borrowings of $15.0 million and $13.0 million, respectively, were outstanding under the revolving credit facility. A stand-by letter of credit of $0.9 million, issued in connection with the Company’s insurance coverage, was outstanding under our revolving credit facility as of September 30, 2014. The stand-by letter of credit is renewable annually and reduces the borrowing availability under the revolving credit facility.

 

The weighted-average interest rate on outstanding borrowings under our credit facility was 4.23% at September 30, 2014 and December 31, 2013. 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.

 

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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 September 30, 2014, we were in compliance with the Credit Agreement covenants.

 

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 September 30, 2014, we had $230.4 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 September 30, 2014, our total net leverage ratio under the Credit Agreement was 4.35:1.00, and our interest coverage ratio was 3.51:1.00.

 

Senior Notes

 

6.50% Senior Notes

 

On September 18, 2014, Consolidated Communications Finance II Co., a wholly–owned subsidiary of the Company completed an offering of $200.0 million aggregate principal amount of 6.50% senior notes due in 2022 (the “2022 Notes”). Interest on the 2022 Notes is payable semi-annually on April 1 and October 1, commencing on April 1, 2015. The 2022 Notes were priced at par, which resulted in total gross proceeds of $200.0 million.

 

The proceeds from the sale of the 2022 Notes with interest payable through January 31, 2015 were held in an escrow account pending the completion of the Enventis acquisition. At September 30, 2014, restricted cash consisted of the $200.0 million of gross proceeds from the issuance of the 2022 Notes plus $4.8 million of interest held in the escrow account.

 

Upon closing of the Enventis acquisition, the obligations under the 2022 Notes were assumed by Consolidated Communications, Inc. (“CCI”) and were guaranteed by the Company and certain of its wholly-owned subsidiaries. On October 16, 2014, the net proceeds from the issuance of the 2022 Notes were released from escrow and used to finance the acquisition of Enventis including related fees and expenses, to repay the existing indebtedness of Enventis and to repurchase a portion of our 10.875% Senior Notes due 2020, as described below.

 

A portion of the 2022 Notes were sold to a trust, the beneficiary of which is a member of the Company’s Board of Directors (“related party”). The related party purchased $5.0 million of the 2022 Notes on the same terms available to other investors.

 

10.875% 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 (the “2020 Notes”). The 2020 Notes 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 2020 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 2020 Notes. CCI is the primary obligor under the 2020 Notes, and we and certain of our subsidiaries have fully and unconditionally guaranteed the 2020 Notes.

 

In 2013, we completed an exchange offer to issue registered notes (“Exchange Notes”) for $287.3 million of the original 2020 Notes. The terms of the Exchange Notes are substantially identical to the 2020 Notes, except that the Exchange Notes are registered under the Securities Act of 1933 and the transfer restrictions and registration rights applicable to the 2020 Notes do not apply to the Exchange Notes. The exchange offer did not impact the aggregate principal amount or the remaining terms of the 2020 Notes outstanding.

 

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On October 16, 2014, we redeemed $46.8 million of the original aggregate principal amount of the 2020 Notes at a price of 116.75%, plus accrued and unpaid interest.  In connection with the repurchase of the 2020 Notes, we paid $56.5 million and recognized a loss of approximately $9.4 million on the partial extinguishment of debt during the fourth quarter ended December 31, 2014.

 

Senior Notes Covenant Compliance

 

The indenture governing the 2020 Notes contains customary covenants for high yield notes, which limits CCI’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.

 

Among other matters, the 2020 Notes indenture provides that CCI may not pay dividends or make other “restricted payments” to the Company if its total net leverage ratio is 4.50:1.00 or greater.  This ratio is calculated differently than the comparable ratio under the Credit Agreement; among other differences, it takes into account, on a pro forma basis, synergies expected to be achieved as a result of certain acquisitions but not yet reflected in historical results.  At September 30, 2014, this ratio was 4.38:1.00.  If this ratio is met, dividends and other restricted payments may be made from cumulative consolidated cash flow since the date the 2020 Notes were issued, less 1.75 times fixed charges, less dividends and other restricted payments made since the date the 2020 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 indenture.  Since dividends of $139.7 million have been paid since May 30, 2012, at September 30, 2014 there was $231.5 million of the $371.2 million of cumulative consolidated cash flow since May 30, 2012 available to pay dividends, exclusive of the quarterly dividend declared in July 2014 and payable on November 1, 2014.

 

On March 19, 2014, CCI commenced a solicitation of consents from the eligible holders of the 2020 Notes in order to amend the indenture governing the 2020 Notes to (i) modify CCI’s Consolidated Leverage Ratio (as defined in the indenture governing the 2020 Notes) level required before CCI (subject to certain other conditions specified in the indenture) can make Restricted Payments (as defined in the indenture) otherwise available under the consolidated cash flow builder basket from 4.25:1.00 to 4.50:1.00 and (ii) modify the size of a permitted lien basket for liens securing Indebtedness (as defined in the indenture) by amending the multiplier for CCI’s Consolidated Cash Flow (as defined in the indenture) in the calculation of such permitted lien basket from 2.50 to 2.75.  On April 1, 2014, the required consent of the holders of the 2020 Notes was obtained and the consent solicitation expired, and we entered into a supplemental indenture effecting the proposed amendments as provided in the consent solicitation.  The amendment to the indenture with respect to modifying the size of a permitted lien basket for liens securing Indebtedness modified such provision in the indenture so that it would be the same as the equivalent provision in our Credit Agreement.  In connection with entering into the supplemental indenture, consent fees of $2.5 million paid to the holders of the 2020 Notes who validly consented to the proposed amendment were capitalized during the quarter ended June 30, 2014 as deferred debt issuance costs and amortized over the remaining term of the 2020 Notes.  Solicitation fees of $0.5 million were recognized as other expense in the condensed consolidated statements of income during the nine months ended September 30, 2014.

 

The indenture governing the 2022 Notes contains substantially the same covenants as the indenture governing the 2020 notes, except that the indenture governing the 2022 Notes provides that CCI may not pay dividends or make other “restricted payments” to the Company if its total net leverage ratio is 4.75:1.00 or greater.

 

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Bridge Loan Facility

 

In connection with the acquisition of Enventis, the Company entered into a $140.0 million senior unsecured bridge loan facility (“Bridge Facility”) on June 29, 2014 in order to fund the anticipated acquisition including the related fees and expenses and to repay the existing indebtedness of Enventis.  As anticipated, financing for the Enventis acquisition was completed through the 2022 Note offering, as described above, replacing the Bridge Facility on the closing date of the acquisition.  No amounts were drawn or funded under the Bridge Facility prior to replacement.  In connection with entering into the Bridge Facility, commitment fees of $1.4 million were capitalized during the quarter ended June 30, 2014 as deferred debt issuance costs and amortized over the expected life of the Bridge Facility through October 2014.

 

Capital Leases

 

As of September 30, 2014, we had seven capital leases which expire between 2015 and 2021.  As of September 30, 2014, the present value of the minimum remaining lease commitments was approximately $4.6 million, of which $0.7 million was due and payable within the next twelve months.  The leases require total remaining rental payments of $6.9 million as of September 30, 2014, of which $5.2 million will be paid to LATEL LLC, a related party entity.

 

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.  We may designate certain of our interest rate swaps 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, including those that have been de-designated, 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 condensed consolidated statement of cash flows.

 

The following interest rate swaps were outstanding at September 30, 2014:

 

(In thousands)		Notional Amount			2014 Balance Sheet Location		Fair Value
De-designated Hedges:
Fixed to 1-month floating LIBOR		$	50,000		Other long-term liabilities		$	(465)
Fixed to 1-month floating LIBOR		225,000			Current portion of derivative liability		(877)
Fixed to 1-month floating LIBOR (with floor)		50,000			Other long-term liabilities		(118)
Total Fair Values							$	(1,460)

 

The following interest rate swaps were outstanding at December 31, 2013:

 

(In thousands)		Notional Amount			2013 Balance Sheet Location		Fair Value
De-designated Hedges:
Fixed to 1-month floating LIBOR		$	175,000		Other long-term liabilities		$	(1,897)
Fixed to 1-month floating LIBOR		100,000			Current portion of derivative liability		(660)
Fixed to 1-month floating LIBOR (with floor)		50,000			Other long-term liabilities		(62)
Total Fair Values							$	(2,619)

 

As of September 30, 2014, 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

 

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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.

 

In December 2013, $325.0 million notional interest rate swaps previously designated as cash flow hedges were de-designated as a result of the amendment to our Credit Agreement on December 23, 2013 as discussed in Note 6.  The interest rate swap agreements mature on various dates through September 2016.  Prior to de-designation, the effective portion of the change in fair value of the 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 is amortized to earnings over the remaining term of the swap agreements.  Subsequent to the de-designation of the interest rate swaps, changes in fair value of the de-designated swaps are immediately recognized in earnings as interest expense.  During the quarter and nine months ended September 30, 2014, a gain of $0.7 million and $1.2 million, respectively, was recognized as a reduction to interest expense for the change in fair value of the de-designated swaps.

 

In December 2012, interest rate swaps with an aggregate notional value of $660.0 million were de-designated as cash flow hedges in connection with the amendment to our previous credit agreement on December 4, 2012.  Of these agreements, $200.0 million notional interest rate swap agreements expired on December 31, 2012 and the remainder expired on March 31, 2013.  During the nine months ended September 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.

 

At September 30, 2014 and December 31, 2013, the pre-tax deferred losses related to our interest rate swap agreements included in AOCI were $1.0 million and $2.6 million, respectively.  The estimated amount of losses included in AOCI as of September 30, 2014 that will be recognized in earnings in the next twelve months is approximately $1.0 million.

 

Information regarding our cash flow hedge transactions is as follows:

 

		Quarter Ended						Nine Months Ended
		September 30,						September 30,
(In thousands)		2014			2013			2014			2013
Gain recognized in AOCI, pretax		$	-		$	(673)		$	-		$	(460)
Deferred losses reclassed from AOCI to interest expense		$	(468)		$	(913)		$	(1,616)		$	(5,450)

 

8.     EQUITY

 

Share-Based Compensation

 

The following table summarizes total compensation costs recognized for share-based payments during the quarters and nine month periods ended September 30, 2014 and 2013:

 

		Quarter Ended						Nine Months
		September 30,						Ended September 30,
(In thousands)		2014			2013			2014			2013
Restricted stock		$	531		$	466		$	1,575		$	1,383
Performance shares		417			328			1,097			851
Total		$	948		$	794		$	2,672		$	2,234

 

 

Stock-based compensation expense is included in “selling, general and administrative expenses” in the accompanying statements of income.

 

As of September 30, 2014, total unrecognized compensation costs related to nonvested Restricted Stock Awards (“RSAs”) and Performance Share Awards (“PSAs”) was $5.2 million and will be recognized over a weighted-average period of approximately 1.2 years.

 

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The following table summarizes the RSA and PSA activity for the nine month period ended September 30, 2014:

 

		RSAs					PSAs
		Shares		Weighted Average Grant Date Fair Value			Shares		Weighted Average Grant Date Fair Value
Non-vested shares outstanding - January 1, 2014		123,501		$	17.32		64,266		$	17.96
Shares granted		132,781		$	19.74		91,127		$	17.13
Non-vested shares outstanding - September 30, 2014		256,282					155,393

 

Accumulated Other Comprehensive Income

 

The following table summarizes the changes in accumulated other comprehensive loss, net of tax, by component for the nine month period ended September 30, 2014:

 

		Pension and
		Post-Retirement			Derivative
(In thousands)		Obligations			Instruments			Total
Balance at December 31, 2013		$	643		$	(1,643)		$	(1,000)
Amounts reclassified from accumulated other comprehensive income		(408)			1,001			593
Net current period other comprehensive income		(408)			1,001			593
Balance at September 30, 2014		$	235		$	(642)		$	(407)

 

The following table summarizes reclassifications from accumulated other comprehensive loss during the quarters and nine month periods ended September 30, 2014 and 2013:

 

		Amount Reclassified from AOCI
		Quarter Ended September 30,						Nine Months Ended September 30,						Affected Line Item in the
(In thousands)		2014			2013			2014			2013			Statement of Income
Amortization of pension and post-retirement items:
Prior service credit		$	80		$	247		$	239		$	478		(a)
Actuarial gain (loss)		142			(957)			426			(2,739)			(a)
		222			(710)			665			(2,261)			Total before tax
		(86)			277			(257)			880			Tax (expense) benefit
		$	136		$	(433)		$	408		$	(1,381)		Net of tax
Loss on cash flow hedges:
Interest rate derivatives		$	(468)		$	(913)		$	(1,616)		$	(5,450)		Interest expense
		178			347			615			2,039			Tax benefit
		$	(290)		$	(566)		$	(1,001)		$	(3,411)		Net of tax

 

(a)         These items are included in the components of net periodic benefit cost for our pension and post-retirement benefit plans.  See Note 9 for additional details.

 

9.              PENSION PLAN AND OTHER POST-RETIREMENT BENEFITS

 

Defined Benefit Plans

 

We sponsor a qualified defined benefit pension plan (“Retirement Plan”) that is non-contributory covering certain of our hourly employees who fulfill minimum age and service requirements.  Certain salaried employees are also covered by the Retirement Plan, although these benefits have previously been frozen.  In April 2013, the Retirement Plan was amended for certain employees under collective bargaining agreements to among other things: (i) change the benefit formula to a cash balance account as of May 1, 2013 and (ii) freeze entrance into the Retirement Plan so that no person is eligible to become a participant on or following May 1, 2013.  As of May 2013, all employees under collective bargaining agreements that include a defined benefit plan are on a cash balance plan.

 

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