ITEM 2. MANAGEMENT’S DISCUSSIO
N AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The Securities and Exchange Commission (“SEC”) encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. Certain statements in this Quarterly Report on Form 10-Q, including those which relate to the impact on future revenue sources, pending and future regulatory orders, continued expansion of the telecommunications network and expected changes in the sources of our revenue and cost structure resulting from our entrance into new communications markets, are forward-looking statements and are made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. These forward-looking statements reflect, among other things, our current expectations, plans, strategies and anticipated financial results. There are a number of risks, uncertainties and conditions that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements. Many of these circumstances are beyond our ability to control or predict. Moreover, forward-looking statements necessarily involve assumptions on our part. These forward-looking statements generally are identified by the words “believe”, “expect”, “anticipate”, “estimate”, “project”, “intend”, “plan”, “should”, “may”, “will”, “would”, “will be”, “will continue” or similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of Consolidated Communications Holdings, Inc. and its subsidiaries (“Consolidated”, the “Company”, “we” or “our”) to be different from those expressed or implied in the forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements that appear throughout this report. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward–looking statements is included in our 2015 Annual Report on Form 10-K filed with the SEC. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under federal securities laws or the rules and regulations of the SEC, we disclaim any intention or obligation to update or revise publicly any forward-looking statements. You should not place undue reliance on forward-looking statements. Management’s Discussion and Analysis (“MD&A”) should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes to the financial statements (“Notes”) as of and for the quarter and nine months ended September 30, 2016 included in Item 1 of Part I of this Quarterly Report on Form 10-Q.
Throughout this MD&A, we refer to measures that are not measures of financial performance in accordance with accounting principles generally accepted in the United States (“US GAAP” or “GAAP”). We believe the use of these non-GAAP measures on a consolidated basis provides the reader with additional information that is useful in understanding our operating results and trends. These measures should be viewed in addition to, rather than as a substitute for, those measures prepared in accordance with GAAP. See the “Non-GAAP Measures” section below for a more detailed discussion on the use and calculation of these measures.
Overview
We are an integrated communications services company that operates as both an Incumbent Local Exchange Carrier (“ILEC”) and a Competitive Local Exchange Carrier (“CLEC”) dependent upon the territory served. We provide an array of services in consumer, commercial and carrier channels in 11 states, including local and long-distance service, high-speed broadband Internet access, video services, Voice over Internet Protocol (“VoIP”), custom calling features, private line services, carrier grade access services, network capacity services over our regional fiber optic networks, data center and managed services, directory publishing, equipment sales and services, and cloud services.
We generate the majority of our consolidated operating revenues primarily from subscriptions to our video, data and transport services (collectively “broadband services”) to business and residential customers. Commercial and carrier services provide the majority of our operating revenues and are expected to be the primary driver of our growth in the future. We continue to focus on commercial and broadband growth opportunities and are continually expanding our commercial product offerings for both small and large businesses in order to capitalize on technological advances in the industry. We can leverage our fiber optic networks and tailor our services for business customers by developing solutions to fit their specific needs. In addition, we recently launched a suite of cloud services and an enhanced hosted voice product, which increases efficiency and enables greater scalability and reliability for businesses. We anticipate future momentum
in commercial and carrier services as these new products gain traction as well as from the growing demand from customers for additional bandwidth and data-based services.
We market services to our residential customers either individually or as a bundled package. Our “triple play” bundle includes our data, video and voice services. As the market demands for bandwidth continue to increase as a result of consumer trends toward increased Internet usage, our continued focus is on enhancing product and service offerings, such as our progressively increasing consumer data speeds.
We offer data speeds of up to 1 Gbps in select markets.
Where 1 Gbps speeds are not yet offered, the maximum broadband speed is 100 Mbps, depending on the geographic market availability. As of September 30, 2016, approximately 28% of the homes in the areas we serve subscribe to our data service. Our exceptional consumer broadband speed allows us to continue to meet the needs of our customers and the demand for higher speeds resulting from the growing trend of over-the-top (“OTT”) content viewing. The availability of 1 Gbps data speed also complements our wireless home networking (“Wi-Fi”) that supports our TV Everywhere service and allows our subscribers to watch their favorite programs at home or away on a computer, smartphone or tablet.
The consumer’s growing acceptance of OTT video services either to augment their current viewing options or to entirely replace their video subscription may impact our future video subscriber base, which could result in a decline in video revenue as well as a reduction in video programing costs. Total video connections decreased 9% as of September 30, 2016 compared to the same period in 2015. We believe the trend in changing consumer viewing habits will continue to impact our business model and strategy of providing consumers the necessary broadband speed to facilitate OTT content viewing.
Operating revenues also continue to be impacted by the anticipated industry wide trend of a decline in voice services, access lines and related network access revenue. Many customers are choosing to subscribe to alternative communications services and competition for these subscribers continues to increase. Total voice connections decreased 5% as of September 30, 2016 compared to the same period in 2015. Competition from wireless providers, competitive local exchange carriers and, in some cases, cable television providers has increased in recent years in the markets we serve. We have been able to mitigate some of the access line losses through marketing initiatives and product offerings, such as our VoIP service.
As discussed in the “Regulatory Matters” section below, our operating revenues are also impacted by legislative or regulatory changes at the federal and state levels, which could reduce or eliminate the current subsidies revenue we receive. A number of proceedings and recent orders relate to universal service reform, intercarrier compensation and network access charges. There are various ongoing legal challenges to the orders that have been issued. As a result, it is not yet possible to fully determine the impact of the regulatory changes on our operations.
Significant Recent Developments
Acquisition
On April 18, 2016, we entered into a definitive agreement to acquire substantially all of the assets of Champaign Telephone Company, Inc. and its sister company, Big Broadband Services, LLC (collectively “CTC”), a private business communications provider in the Champaign-Urbana, IL area. The acquisition was completed on July 1, 2016. The aggregate purchase price, including customary working capital adjustments, consisted of cash consideration of $13.4 million, which was paid from our existing cash resources.
Divestiture
On May 3, 2016, we entered into a definitive agreement to sell all of the issued and outstanding stock of Consolidated Communications of Iowa Company (“CCIC”), formerly Heartland Telecommunications Company of Iowa. CCIC operates as an incumbent local exchange carrier providing telecommunications and data services to residential and business customers in 11 rural communities in northwest Iowa and surrounding areas. The sale was completed on September 1, 2016 for total cash proceeds of approximately $21.0 million, net of certain contractual adjustments, subject to a customary working capital adjustment. In May 2016, in connection with the expected sale, the carrying value of CCIC was reduced to its estimated fair value and we recognized an impairment loss of $0.6 million during the nine months ended September 30, 2016. During the quarter and nine months ended September 30, 2016, we recognized an additional loss on the sale of
$0.3 million. We recognized a taxable gain on the transaction resulting in current income tax expense of $7.2 million during the nine months ended September 30, 2016 to reflect the tax impact of the divestiture.
Restatement of Credit Agreement
On October 5, 2016, the Company and certain of its subsidiaries entered into a Restatement Agreement to amend and restate our existing credit agreement through a Third Amended and Restated Credit Agreement (the “Restated Credit Agreement”). Under the terms of the Restated Credit Agreement, the Company issued initial term loans in the aggregate amount of $900.0 million, with a maturity date of October 5, 2023, and used the proceeds in part to pay off the outstanding Term 4 loan in the amount of $885.0 million. The Company also obtained a revolving loan facility of $110.0 million, with a maturity date of October 5, 2021, to replace the existing $75.0 million revolving credit facility scheduled to mature in December 2018. The terms, conditions and covenants of the initial term loan facility are materially consistent with those of the existing Credit Agreement. The initial term loan facility has an interest rate of London Interbank Offered Rate (“LIBOR”) plus 3.00% with a 1.00% LIBOR floor and included an original issue discount of 0.25%. The refinancing is expected to save approximately $2.0 million per year in annual interest expense. In connection with entering into the Restated Credit Agreement, we expect to incur a loss on the extinguishment of debt of approximately $6.5 million during the quarter ended December 31, 2016.
Results of Operations
The following tables reflect our financial results on a consolidated basis and key operating metrics as of and for the quarters and nine months ended September 30, 2016 and 2015.
Financial Data
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Quarter Ended September 30,
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Nine Months Ended September 30,
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(
In millions, except for percentages)
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2016
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2015
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$
Change
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%
Change
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2016
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2015
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$
Change
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%
Change
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Operating Revenues
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Commercial and carrier:
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Data and transport services (includes VoIP)
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$
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49.7
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$
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47.2
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$
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2.5
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5
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%
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$
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147.4
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$
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139.5
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$
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7.9
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6
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%
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Voice services
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25.1
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25.5
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(0.4)
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(2)
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75.4
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77.8
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(2.4)
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(3)
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Other
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3.5
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3.2
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0.3
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9
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8.8
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8.6
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0.2
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2
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78.3
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75.9
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2.4
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3
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231.6
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225.9
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5.7
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3
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Consumer:
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Broadband (VoIP, data and video)
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51.4
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52.9
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(1.5)
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(3)
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159.1
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160.7
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(1.6)
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(1)
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Voice services
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13.7
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15.1
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(1.4)
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(9)
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42.2
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45.8
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(3.6)
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(8)
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65.1
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68.0
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(2.9)
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(4)
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201.3
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206.5
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(5.2)
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(3)
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Equipment sales and service
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17.7
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14.7
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3.0
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20
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37.8
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44.9
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(7.1)
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(16)
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Subsidies
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11.6
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13.9
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(2.3)
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(17)
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37.7
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42.8
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(5.1)
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(12)
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Network access
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15.6
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17.0
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(1.4)
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(8)
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48.7
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53.2
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(4.5)
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(8)
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Other products and services
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3.3
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4.4
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(1.1)
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(25)
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10.2
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14.2
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(4.0)
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(28)
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Total operating revenues
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191.6
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193.9
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(2.3)
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(1)
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567.3
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587.5
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(20.2)
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(3)
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Operating Expenses
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Cost of services and products
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85.6
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83.2
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2.4
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3
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246.1
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249.5
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(3.4)
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(1)
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Selling, general and administrative costs
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40.0
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51.0
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(11.0)
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(22)
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119.7
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136.7
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(17.0)
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(12)
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Loss on impairment
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—
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—
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—
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—
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0.6
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—
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0.6
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100
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Depreciation and amortization
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43.3
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46.1
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(2.8)
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(6)
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130.9
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133.3
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(2.4)
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(2)
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Total operating expenses
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168.9
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180.3
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(11.4)
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(6)
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497.3
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519.5
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(22.2)
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(4)
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Income from operations
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22.7
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13.6
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9.1
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67
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70.0
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68.0
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2.0
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3
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Interest expense, net
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(19.1)
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(19.2)
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0.1
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1
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(56.8)
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(60.3)
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3.5
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6
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Loss on extinguishment of debt
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—
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—
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—
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—
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—
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(41.2)
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41.2
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100
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Other income
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8.4
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10.5
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(2.1)
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(20)
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24.2
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25.8
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(1.6)
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(6)
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Income tax expense (benefit)
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5.0
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2.2
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2.8
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|
127
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22.3
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(2.3)
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24.6
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1,070
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Net income (loss)
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7.0
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2.7
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4.3
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159
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15.1
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|
|
(5.4)
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20.5
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|
380
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|
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Net income attributable to noncontrolling interest
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—
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0.1
|
|
|
(0.1)
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(100)
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0.2
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0.2
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—
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—
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Net income (loss) attributable to common shareholders
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$
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7.0
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$
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2.6
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$
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4.4
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169
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$
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14.9
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|
$
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(5.6)
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$
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20.5
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|
366
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Adjusted EBITDA
(1)
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$
|
77.1
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$
|
89.4
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$
|
(12.3)
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(14)
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%
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$
|
233.7
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$
|
249.4
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$
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(15.7)
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(6)
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%
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|
(1)
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|
A non-GAAP measure. See the “Non-GAAP Measures” section below for additional information and reconciliation to the most directly comparable GAAP measure.
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Key Operating Statistics
|
|
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|
|
As of September 30,
|
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|
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2016
|
|
2015
|
|
Change
|
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% Change
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Consumer customers
|
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257,106
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|
270,466
|
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(13,360)
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(5)
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%
|
|
|
|
|
|
|
|
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Voice connections
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462,232
|
|
488,037
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|
(25,805)
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|
(5)
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|
Data connections
|
|
470,474
|
|
452,265
|
|
18,209
|
|
4
|
|
Video connections
|
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108,816
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|
119,643
|
|
(10,827)
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(9)
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Total connections
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1,041,522
|
|
1,059,945
|
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(18,423)
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(2)
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%
|
Operating Revenues
Commercial and Carrier
Data and Transport Services
We provide a variety of business communication services to small, medium and large business customers, including many services over our advanced fiber network. The services we offer include scalable high speed broadband Internet access and VoIP phone services which range from basic service plans to virtual hosted systems. In addition to Internet and VoIP services, we also offer private line data services to businesses that include dedicated Internet access through our Metro Ethernet network. Wide Area Network (“WAN”) products include point-to-point and multi-point deployments from 2.5 Mbps to 10 Gbps to accommodate the growth patterns of our business customers. Data center and disaster recovery solutions provide a reliable and local colocation option for commercial customers. We also offer wholesale services to regional and national interexchange and wireless carriers, including cellular backhaul and other fiber transport solutions.
Data and transport services revenues increased $2.5 million and $7.9 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 primarily due to growth in data connections and a continued increase in VoIP, internet access and Metro Ethernet revenues. Fiber transport and cellular backhaul revenues also increased as network bandwidth demand for wireless data continues to escalate.
Voice Services
Voice services include basic local phone and long-distance service packages for business customers. The plans include options for voicemail, conference calling, linking multiple office locations and other custom calling features such as caller ID, call forwarding, speed dialing and call waiting. Services can be charged at a fixed monthly rate, a measured rate or can be bundled with selected services at a discounted rate.
Voice services revenues decreased $0.4 million and $2.4 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 primarily due to a 7% decline in access lines as commercial customers are increasingly choosing alternative technologies, including our own VoIP product, and the broad range of features that Internet based voice services can offer.
Consumer
Broadband Services
Broadband services include revenues from residential customers for subscriptions to our VoIP, data and video products. We offer high speed Internet access at speeds of up to 1 Gbps, depending on the nature of the network facilities that are available, the level of service selected and the location. Our VoIP digital phone service is also available in certain markets as an alternative to the traditional telephone line. Depending on geographic market availability, our video services range from limited basic service to advanced digital television, which includes several plans each with hundreds of local,
national and music channels including premium and pay-per-view channels as well as video on-demand service. Certain customers may also subscribe to our advanced video services, which consist of high-definition television, digital video recorders (“DVR”) and/or a whole home DVR.
Broadband services revenues decreased $1.5 million and $1.6 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 despite price increases for data and video services implemented in the first quarter of 2016. Total data and video connections decreased 4% and 11%, respectively, as of September 30, 2016 compared to the same period in 2015 as a result of increased competition as consumers are choosing to subscribe to alternative communications services particularly for video services. VoIP revenue also declined during the same periods due to a 10% decline in connections as more consumers continue to rely exclusively on wireless service.
Voice Services
We offer several different basic local phone service packages and long-distance calling plans, including unlimited flat-rate calling plans. The plans include options for voicemail and other custom calling features such as caller ID, call forwarding and call waiting. Voice services revenues decreased $1.4 million and $3.6 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 primarily due to a 10% decline in access lines. The number of local access lines in service directly affects the recurring revenues we generate from end users and continues to be impacted by the industry-wide decline in access lines. We expect to continue to experience modest erosion in voice connections due to competition from alternative technologies, including our own competing VoIP product.
Equipment Sales and Service
We are an accredited Master Level Unified Communications and Gold Certified Cisco Partner providing equipment solutions and support for business customers. As an equipment integrator, we offer network design, implementation and support services, including maintenance contracts, in order to provide integrated communication solutions for our customers. When an equipment sale involves multiple deliverables, revenues are allocated to each respective element based on relative selling price. Equipment sales and service revenues increased $3.0 million and decreased $7.1 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015. Equipment sales and services are non-recurring and changes in revenues can be attributed to the timing and volume of customer sales, which can vary each quarter and result in positive or negative fluctuations in our quarterly operating revenues and expenses.
Subsidies
Subsidies consist of both federal and state subsidies, which are designed to promote widely available, quality broadband services at affordable prices with higher data speeds in rural areas. Subsidies decreased $2.3 million and $5.1 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 primarily due to the transition to Connect America Fund (“CAF”) Phase II funding in 2015, the scheduled reduction in the annual CAF Phase II rate during the quarter ended September 30, 2016 and a decrease in state funding support for our Texas ILEC. See the “Regulatory Matters” section below for further discussion of the subsidies we receive.
Network Access Services
Network access services include interstate and intrastate switched access revenues, network special access services and end user access. Switched access revenues include access services to other communications carriers to terminate or originate long-distance calls on our network. Special access circuits provide dedicated lines and trunks to business customers and interexchange carriers. Network access revenues decreased $1.4 million and $4.5 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 primarily as a result of the continuing decline in minutes of use, voice connections and carrier circuits; however, a portion of the decrease can be attributed to carriers shifting to our fiber Metro Ethernet product, contributing to the growth in that area.
Other Products and Services
Other products and services include revenues from telephone directory publishing, video advertising and billing and support services. Other products and services revenues decreased $1.1 million and $4.0 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 primarily due to a decline in outside billing and support services revenue of $0.8 million and $2.9 million, respectively, as a result of the sale of our billing services company in late 2015. The remainder of the decrease in other products and services revenue for the quarter and nine months ended September 30, 2016 compared to the same periods in 2015 was due to a decline in telephone directory advertising revenues.
Operating Expenses
Cost of Services and Products
Cost of services and products increased $2.4 million and decreased $3.4 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015. Cost of goods sold related to equipment sales increased $2.3 million in the current quarter but declined $5.3 million year-to-date related to changes in non-recurring equipment sales, which can fluctuate each quarter as discussed above. Network access costs also increased due to growth in carrier and wireless backhaul services. However, video programming costs decreased as a result of a 9% decline in video connections, which was largely offset by an increase in programming costs per channel as costs continue to rise as a result of annual rate increases. The change in cost of services and products was also impacted by an increase in pension expense in the current year, but was offset in part by a reduction in incentive compensation in 2016.
Selling, General and Administrative Costs
Selling, general and administrative costs decreased $11.0 million and $17.0 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015. During the quarter ended September 30, 2015, an early retirement program was offered to a group of select employees who were 55 years of age or older and who had provided 15 or more years of service. The early retirement package was accepted by approximately 60 employees and, as a result, one-time severance costs of $7.2 million were incurred during the quarter ended September 30, 2015. The remaining decrease in selling, general and administrative costs was primarily due to a decline in employee-related costs from the reduction in headcount as part of the Company’s cost saving initiatives implemented in 2015 as well as a decrease in incentive compensation. Bad debt expense also decreased as a result of recoveries recognized in 2016 and increased reserves in the prior year periods. However, advertising expense increased due to additional radio advertising and marketing promotions in 2016.
Depreciation and Amortization
Depreciation and amortization expense decreased $2.8 million and $2.4 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015, primarily due certain circuit equipment, outside plant and software becoming fully depreciated in 2016, which was offset in part by ongoing capital expenditures related to network enhancements and success-based capital projects for consumer and commercial services.
Reclassifications
Certain amounts in our 2015 condensed consolidated financial statements have been reclassified to conform to the 2016 presentation, which consisted primarily of the reclassification of certain operating revenues from network access to commercial and carrier. The change in the classification of these revenues had no impact to total operating revenues as previously reported.
Regulatory Matters
Our revenues are subject to broad federal and/or state regulation, which include such telecommunications services as local telephone service, network access service and toll service and are derived from various sources, including:
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·
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business and residential subscribers of basic exchange services;
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·
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surcharges mandated by state commissions;
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·
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long-distance carriers for network access service;
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·
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competitive access providers and commercial enterprises for network access service; and
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·
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support payments from federal or state programs.
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The telecommunications industry is subject to extensive federal, state and local regulation. Under the Telecommunications Act of 1996, federal and state regulators share responsibility for implementing and enforcing statutes and regulations designed to encourage competition and to preserve and advance widely available, quality telephone service at affordable prices.
At the federal level, the Federal Communications Commission (“FCC”) generally exercises jurisdiction over facilities and services of local exchange carriers, such as our rural telephone companies, to the extent they are used to provide, originate or terminate interstate or international communications. The FCC has the authority to condition, modify, cancel, terminate or revoke our operating authority for failure to comply with applicable federal laws or FCC rules, regulations and policies. Fines or penalties also may be imposed for any of these violations.
State regulatory commissions generally exercise jurisdiction over carriers’ facilities and services to the extent they are used to provide, originate or terminate intrastate communications. In particular, state regulatory agencies have substantial oversight over interconnection and network access by competitors of our rural telephone companies. In addition, municipalities and other local government agencies regulate the public rights-of-way necessary to install and operate networks. State regulators can sanction our rural telephone companies or revoke our certifications if we violate relevant laws or regulations.
FCC Matters
In general, telecommunications service in rural areas is more costly to provide than service in urban areas. The lower customer density means that switching and other facilities serve fewer customers and loops are typically longer, requiring greater expenditures per customer to build and maintain. By supporting the high cost of operations in rural markets, Universal Service Fund (“USF”) subsidies promote widely available, quality broadband services at affordable prices and with improved data speeds in rural areas. Revenues from the federal and certain states’ USFs decreased $2.3 million and $5.1 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 primarily due to the transition to CAF Phase II funding in 2015, the scheduled reduction in the annual CAF Phase II rate in August 2016, and a decrease in state funding support for our Texas ILEC.
In order for an eligible telecommunications carrier (“ETC”) to receive high-cost support, the USF/Intercarrier Compensation (“ICC”) Transformation Order requires states to certify annually that USF support is used only for the provision, maintenance and upgrading of facilities and services for which the support is intended. States, in turn, require that ETCs file certifications with them as the basis for the state filings with the FCC. Failure to meet the annual data and certification deadlines can result in reduced support to the ETC based on the length of the delay in certification. For calendar year 2013, the California state certification was due to be filed with the FCC on or before October 1, 2012. We were notified in January 2013 that SureWest Communications (“SureWest”) did not submit the required certification to
the California Public Utilities Commission (“CPUC”) in time to be included in its October 1, 2012 submission to the FCC. In January 2013, we filed a certification with the CPUC and filed a petition with the FCC for a waiver of the filing deadline for the annual state certification. In February 2013, the CPUC filed a certification with the FCC with respect to SureWest. In October 2013, the Wireline Competition Bureau of the FCC denied our petition for a waiver of the annual certification deadline. In November 2013, we applied for a review of the decision made by the FCC staff by the full Commission. Management is optimistic that the Company may prevail in its application to the Commission and receive USF funding for the period January 1, 2013 through June 30, 2013 based on the change in SureWest’s USF filing status caused by the change in the ownership of SureWest, the lack of formal notice by the FCC regarding this change in filing status, the fact that SureWest had a previously filed certification of compliance in effect with the FCC for the two quarters for which USF was withheld and the FCC’s past practice of granting waivers to accept late filings in similar situations. However, due to the denial of our petition by the Wireline Competition Bureau and the uncertainty of the collectability of previously recognized revenues, in December 2013 we reversed $3.0 million of previously recognized revenues until such time that the Commission has the opportunity to reach a decision on our application for review.
Our recently acquired Enventis ILEC properties are cost-based rate of return companies. Historically, under FCC rules governing rate making, these ILECs were required to establish rates for their interstate telecommunications services based on projected demand usage for the various services. We projected our earnings through the use of annual cost separation studies, which utilized estimated total cost information and projected demand usage. Carriers were required to follow FCC rules in the preparation of these annual studies. We determined actual earnings from our interstate rates as actual volumes and costs became known. Effective January 1, 2015, our Enventis ILECs are treated as price cap companies for universal service purposes. In March 2015, we filed a petition for waiver to keep them as rate of return companies for switched and special access. The petition was granted in October 2015. We expect certain adjustments to take place over 24 months as a result of exiting the National Exchange Carrier Association (“NECA”) pool; however, we do not anticipate that they will be material to our condensed consolidated financial statements or results of operations.
An order adopted by the FCC in 2011 (the “Order”) will significantly impact the amount of support revenue we receive from the USF, CAF and ICC. The Order reformed core parts of the USF, broadly recast the existing ICC scheme, established the CAF to replace support revenues provided by the current USF and redirected support from voice services to broadband services. In 2012, CAF Phase I was implemented, which froze USF support to price cap carriers until the FCC implemented a broadband cost model to shift support from voice services to broadband services. The Order also modified the methodology used for ICC traffic exchanged between carriers. The initial phase of ICC reform was effective on July 1, 2012, beginning the transition of our terminating switched access rates to bill-and-keep over a seven year period, and as a result, we estimate that our network access revenue for 2016 will be reduced by as much as approximately $1.7 million.
In December 2014, the FCC released a report and order that addressed, among other things, the transition to CAF Phase II funding for price cap carriers and the acceptance criteria for CAF Phase II funding. For companies that accepted the CAF Phase II funding, there is a three year transition period in instances in which their CAF Phase I funding exceeds the CAF Phase II funding. If CAF Phase II funding exceeds CAF Phase I funding, the transitional support is waived and CAF Phase II funding begins immediately. Companies are required to commit to a statewide build out requirement to 10 Mbps downstream and 1 Mbps upstream in funded locations. We accepted the CAF Phase II funding in August 2015. The annual funding under CAF Phase I of $36.6 million will be replaced by annual funding under CAF Phase II of $13.9 million through 2020. In the state of Iowa, where CAF Phase II funding was greater than the CAF Phase I funding, the CAF Phase II funding was received with a retroactive payment back to January 1, 2015. For all other states, funding under CAF Phase II is less than funding under CAF Phase I. The acceptance of funding at the lower level will transition over a three year period, beginning in August 2015, at the rates of 75% of the CAF Phase I funding level in the first year, 50% in the second year and 25% in the third year. With the sale of CCIC in September 2016, we anticipate that the annual CAF Phase II funding will decrease to $11.5 million.
In March 2015, the FCC released its net neutrality order which applies to all wireline and wireless providers of broadband internet access services. The net neutrality order addresses several areas that will be regulated and others that are subject to forbearance. The regulation’s “bright line” rules disallow blocking, throttling and paid prioritization by internet service providers. The net neutrality order also requires providers to disclose certain information to consumers on rates, fees, data allowances and packet loss. Finally, it gives the FCC codified enforcement authority and it forbears on certain Title II
regulations. On June 12, 2015, the net neutrality order became effective and has not resulted in any significant changes to the services we provide our customers, nor has it had a material impact on our condensed consolidated financial position or results of operations.
State Matters
California
In an ongoing proceeding relating to the New Regulatory Framework, the CPUC adopted Decision 06-08-030 in 2006, which grants carriers broader pricing freedom in the provision of telecommunications services, bundling of services, promotions and customer contracts. This decision adopted a new regulatory framework, the Uniform Regulatory Framework (“URF”), which among other things (i) eliminates price regulation and allows full pricing flexibility for all new and retail services, (ii) allows new forms of bundles and promotional packages of telecommunication services, (iii) allocates all gains and losses from the sale of assets to shareholders and (iv) eliminates almost all elements of rate of return regulation, including the calculation of shareable earnings. In December 2010, the CPUC issued a ruling to initiate a new proceeding to assess whether, or to what extent, the level of competition in the telecommunications industry is sufficient to control prices for the four largest ILECs in the state. Subsequently, the CPUC issued a ruling temporarily deferring the proceeding. When the CPUC may open this proceeding is unclear and on hold at this time. The CPUC’s actions in this and future proceedings could lead to new rules and an increase in government regulation. The Company will continue to monitor this matter.
Pennsylvania
In 2011, the Pennsylvania Public Utilities Commission (“PAPUC”) issued an intrastate access reform order reducing intrastate access rates to interstate levels in a three-step process, which began in March 2012. With the release of the FCC order in November 2011, the PAPUC temporarily issued a stay. A final stay was issued in 2012 to implement the FCC ordered intrastate access rate changes. The PAPUC consumer affairs advocate is in favor of extending the funding through 2021. The PAPUC had indicated that it would address state universal funding in 2013, but delayed conducting a proceeding pending any state legislative activity. The Company will continue to monitor this matter.
Texas
The Texas Public Utilities Regulatory Act (“PURA”) directs the Public Utilities Commission of Texas (“PUCT”) to adopt and enforce rules requiring local exchange carriers to contribute to a state universal service fund that helps telecommunications providers offer basic local telecommunications service at reasonable rates in high-cost rural areas. The Texas Universal Service Fund is also used to reimburse telecommunications providers for revenues lost by providing lifeline service. Our Texas rural telephone companies receive disbursements from this fund.
Our Texas ILECs have historically received support from two state funds, the small and rural incumbent local exchange company plan High Cost Fund (“HCF”) and the High Cost Assistance Fund (“HCAF”). The HCF is a line-based fund used to keep local rates low. The rate is applied on all residential lines and up to five single business lines. The amount we receive from the HCAF is a frozen monthly amount that was originally developed to offset high intrastate toll rates.
In September 2011, the Texas state legislature passed Senate Bill No. 980/House Bill No. 2603 which, among other things, mandated the PUCT to review the USF and issue recommendations by January 1, 2013 with the intent to effectively reduce the size of the USF. This would be accomplished by implementing an urban floor to offset state funding reductions with a phase-in period of four years. The PUCT recommended that (i) frozen line counts be lifted effective September 1, 2013 and (ii) rural and urban local rate benchmarks be developed. The large company fund review was completed in September 2012 and the PUCT addressed the small fund participants in Docket 41097
Rate Rebalancing
(“Docket 41097”), as discussed below.
In June 2013, the Texas state legislature passed Senate Bill No. 583 (“SB 583”). The provisions of SB 583 were effective September 1, 2013 and froze HCF and HCAF support for the remainder of 2013. As of January 1, 2014, our annual $1.4 million HCAF support was eliminated and the frozen HCF support returned to funding on a per line basis. In July 2013,
the Company entered into a settlement agreement with the PUCT on Docket 41097, which was approved by the PUCT in August 2013. In accordance with the provisions of the settlement agreement, the HCF draw will be reduced by approximately $1.2 million annually over a four year period beginning June 1, 2014 through 2018. However, we have the ability to fully offset this reduction with increases to residential rates where market conditions allow.
In addition, the PUCT is required to develop a needs test for post-2017 funding and has held workshops on various proposals. The PUCT issued its recommendation to the Texas state commissioners in May 2014, which was approved in December 2014. The needs test allows for a one-time disaggregation of line rates from a per line flat rate, then a competitive test must be met to receive funding. The deadline for submission of the needs test is December 31, 2016. We expect to complete the needs test as required and file for continued funding by the 2016 deadline.
Other Regulatory Matters
We are also subject to a number of regulatory proceedings occurring at the federal and state levels that may have a material impact on our operations. The FCC and state commissions have authority to issue rules and regulations related to our business. A number of proceedings are pending or anticipated that are related to such telecommunications issues as competition, interconnection, access charges, intercarrier compensation, broadband deployment, consumer protection and universal service reform. Some proceedings may authorize new services to compete with our existing services. Proceedings that relate to our cable television operations include rulemakings on set top boxes, carriage of programming, industry consolidation and ways to promote additional competition. There are various on-going legal challenges to the scope or validity of FCC orders that have been issued. As a result, it is not yet possible to fully determine the impact of the related FCC rules and regulations on our operations.
Non-Operating Items
Other Income and Expense, Net
Interest expense, net of interest income, decreased $0.1 million and $3.5 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015 primarily due to a reduction in the interest rate for our outstanding senior notes. In June 2015, we issued an additional $300.0 million in 6.50% Senior Notes due 2022, which were used, in part, to redeem the then-remaining amount of our outstanding 10.875% Senior Notes due 2020. Interest expense was also reduced in 2016 from a decline in outstanding debt under our revolving credit facility as well as a decrease in interest expense related to our interest rate swap agreements.
In connection with the redemption in June 2015 of the remaining $227.2 million of the original aggregate principal amount of our 10.875% Senior Notes due 2020, we paid $261.9 million and recognized a loss on the extinguishment of debt of $41.2 million during the nine months ended September 30, 2015.
Other income decreased $2.1 million and $1.6 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015, primarily due to a decline in investment income from our wireless partnership interests. In addition, during the nine months ended September 30, 2015 an other-than-temporary impairment loss of $0.8 million was recognized as a result of the sale of our equity interest in Central Valley Independent Network, LLC in 2015.
Income Taxes
Income taxes increased $2.8 million and $24.6 million during the quarter and nine months ended September 30, 2016, respectively, compared to the same periods in 2015.
Our effective tax rate was
41.3
% and 44.7% for the quarters ended September 30, 2016 and 2015, respectively,
and 59.5% and 29.7% for the nine months ended September 30, 2016 and 2015, respectively. During the quarter ended June 30, 2016, the Company entered into a definitive agreement to sell all of the issued and outstanding stock of CCIC in a taxable transaction. Accounting Standards Codification 740-30-25-7 (“ASC 740”) requires a company to assess whether the excess of the reported amount of an investment in a domestic subsidiary for financial reporting purposes over the underlying tax basis is a taxable temporary difference. Prior to the quarter ended June 30, 2016, the Company had met the criteria under ASC 740 to not record the tax effects of the taxable temporary difference related to the investment in CCIC as the Company expected to recover its investment in a tax-free
manner. During the quarter ended June 30, 2016, the Company recorded a deferred tax liability and deferred tax expense of $7.5 million to reflect the taxable temporary difference related to the investment in CCIC. The transaction was completed during the quarter ended September 30, 2016. During the quarter ended September 30, 2016, the Company reclassified the deferred tax expense of $7.5 million recognized in the quarter ended June 30, 2016 to current tax expense and recorded an additional $0.3 million benefit to current tax expense. For the nine months ended September 30, 2016, this resulted in $7.2 million being recorded as current tax expense to reflect the tax impact of the transaction. During the quarter ended September 30, 2016, we recorded $0.4 million of deferred tax expense and a corresponding offset to the deferred tax asset related to an additional valuation allowance on $8.1 million state NOL carryforwards. We also recorded less than $0.1 million of tax benefit during the quarter ended September 30, 2016 to adjust our 2015 provision to match our 2015 returns compared to approximately $0.2 million of tax expense during the quarter ended September 30, 2015 to adjust our 2014 provision to match our 2014 returns. In addition, for the quarter and nine-month periods ended September 30, 2016 and 2015, the effective tax rate differed from the federal and state statutory rates due to non-deductible expenses and differences in allocable income for the Company’s state tax filings. Exclusive of these adjustments, our effective tax rate would have been approximately 39.2% and 41.7% for the quarters ended September 30, 2016 and 2015, respectively and 38.8% and 31.5% for the nine-month periods ended September 30, 2016 and 2015, respectively.
Non-GAAP Measures
In addition to the results reported in accordance with US GAAP, we also use certain non-GAAP measures such as EBITDA and adjusted EBITDA to evaluate operating performance and to facilitate the comparison of our historical results and trends. These financial measures are not measures of financial performance under US GAAP and should not be considered in isolation or as a substitute for net income as a measure of performance and net cash provided by operating activities as a measure of liquidity. They are not, on their own, necessarily indicative of cash available to fund cash needs as determined in accordance with GAAP. The calculation of these non-GAAP measures may not be comparable to similarly titled measures used by other companies. Reconciliations of these non-GAAP measures to the most directly comparable financial measures presented in accordance with GAAP are provided below.
EBITDA is defined as net earnings before interest expense, income taxes and depreciation and amortization. Adjusted EBITDA is comprised of EBITDA, adjusted for certain items as permitted or required under our credit facility as described in the reconciliations below. These measures are a common measure of operating performance in the telecommunications industry and are useful, with other data, as a means to evaluate our ability to fund our estimated uses of cash.
The following table is a reconciliation of net income (loss) to adjusted EBITDA for the quarters and nine months ended September 30, 2016 and 2015:
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Quarter Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
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(In thousands, unaudited)
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
Net income (loss)
|
|
$
|
7,089
|
|
$
|
2,745
|
|
$
|
15,148
|
|
$
|
(5,354)
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|
Add (subtract):
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|
|
|
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|
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|
|
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Interest expense, net of interest income
|
|
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19,075
|
|
|
19,174
|
|
|
56,827
|
|
|
60,277
|
|
Income tax expense (benefit)
|
|
|
4,991
|
|
|
2,220
|
|
|
22,287
|
|
|
(2,258)
|
|
Depreciation and amortization
|
|
|
43,224
|
|
|
46,057
|
|
|
130,855
|
|
|
133,264
|
|
EBITDA
|
|
|
74,379
|
|
|
70,196
|
|
|
225,117
|
|
|
185,929
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
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Adjustments to EBITDA:
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|
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|
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Other, net
(1)
|
|
|
(6,742)
|
|
|
(1,498)
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|
|
(17,263)
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|
|
(14,140)
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Investment distributions
(2)
|
|
|
8,638
|
|
|
19,996
|
|
|
23,218
|
|
|
34,162
|
|
Loss on extinguishment of debt
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
41,242
|
|
Non-cash, stock-based compensation
(3)
|
|
|
862
|
|
|
742
|
|
|
2,666
|
|
|
2,265
|
|
Adjusted EBITDA
|
|
$
|
77,137
|
|
$
|
89,436
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|
$
|
233,738
|
|
$
|
249,458
|
|
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(1)
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Includes the equity earnings from our investments, dividend income, income attributable to noncontrolling interests in subsidiaries, transaction related costs, including severance, and certain other miscellaneous items.
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(2)
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|
Includes all cash dividends and other cash distributions received from our investments.
|
|
(3)
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Represents compensation expenses in connection with the issuance of stock awards, which, because of the non-cash nature of these expenses, are excluded from adjusted EBITDA.
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Liquidity and Capital Resources
Outlook and Overview
Our operating requirements have historically been funded from cash flows generated from our business and borrowings under our credit facilities. We expect that our future operating requirements will continue to be funded from cash flows from operating activities, existing cash and cash equivalents and, if needed, borrowings under our revolving credit facility and our ability to obtain future external financing. We anticipate that we will continue to use a substantial portion of our cash flow to fund capital expenditures, meet scheduled payments of long-term debt, make dividend payments and invest in future business opportunities.
The following table summarizes our cash flows:
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|
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Nine Months Ended September 30,
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(In thousands)
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2016
|
|
2015
|
Cash flows provided by (used in):
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|
|
|
|
|
Operating activities
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|
$
|
173,591
|
|
$
|
167,637
|
Investing activities
|
|
|
(86,617)
|
|
|
(99,155)
|
Financing activities
|
|
|
(69,449)
|
|
|
(51,307)
|
Increase in cash and cash equivalents
|
|
$
|
17,525
|
|
$
|
17,175
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Cash Flows Provided by Operating Activities
Net cash provided by operating activities was $173.6 million during the nine-month period ended September 30, 2016, an increase of $6.0 million compared to the same period in 2015. Cash flows provided by operating activities increased primarily as a result of an increase in net income and changes in working capital primarily related to the timing in the payment of expenditures and an increase in advance billings related to equipment sales. In addition, net cash provided by operating activities during the nine months ended September 30, 2015 included the payment of various change-in-control and severance agreements as a result of the acquisition of Enventis in 2014. The increase was also attributed to a reduction in cash contributions to our defined benefit pension plan of $11.3 million during the first nine months of 2016 as compared to the same period in 2015. However, cash distributions received from our wireless partnerships decreased $10.9 million in 2016 due in part to a non-recurring cash distribution received for the sale of the partnership owned towers during the quarter ended Septermber 30, 2015.
Cash Flows Used In Investing Activities
Net cash used in investing activities was $86.6 million during the nine-month period ended September 30, 2016 and consisted primarily of cash used for capital expenditures and the acquisition of CTC and cash proceeds provided from the sale of CCIC.
Capital Expenditures
Capital expenditures continue to be our primary recurring investing activity and were $94.2 million during the nine-month period ended September 30, 2016, a decrease of $6.0 million compared to the same period in 2015. Capital expenditures for the remainder of 2016 are expected to be $32.0 million to $35.0 million, of which approximately 61% is planned for success-based capital projects for consumer and commercial initiatives. Capital expenditures for the remainder of 2016 and subsequent years will depend on various factors, including competition, changes in technology, regulatory changes and the timing in the deployment of new services. We expect to continue to invest in existing and new services and the
expansion of our fiber network in order to retain and acquire more customers through a broader set of products and an expanded network footprint.
Acquisitions and Dispositions
On July 1, 2016, we acquired substantially all of the assets of CTC, a private business communications provider in the Champaign-Urbana, IL area. The aggregate purchase price, including customary working capital adjustments, consisted of cash consideration of $13.4 million, which was paid from our existing cash resources.
On September 1, 2016, we completed the sale of all of the issued and outstanding stock of CCIC, our non-core, rural ILEC business located in northwest Iowa, for $20.9 million in cash, which is subject to a customary post closing working capital adjustment.
Cash Flows Provided by (Used In) Financing Activities
Net cash provided by (used in) financing activities consists primarily of our proceeds from and principal payments on long-term borrowings and the payment of dividends.
Long-term Debt
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”). As described below, the Credit Agreement was amended and restated on October 5, 2016. Prior to the restatement, the Credit Agreement consisted of a $75.0 million revolving credit facility and initial term loans in the aggregate amount of $910.0 million (“Term 4”). The Credit Agreement also included an incremental term loan facility which provided the ability to request 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 Consolidated Communications of Illinois 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. The Term 4 loan contained an original issuance discount of $4.6 million, which was being amortized over the term of the loan. The Term 4 loan required quarterly principal payments of $2.3 million and had an interest rate of London Interbank Offered Rate (“LIBOR”) plus 3.25% subject to a 1.00% LIBOR floor.
Prior to the restatement of the Credit Agreement, our revolving credit facility had 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 as of September 30, 2016, the borrowing margin for the three month period ending December 31, 2016 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. Interest is payable at least quarterly. As of September 30, 2016 and December 31, 2015, borrowings of $8.0 million and $10.0 million, respectively, were outstanding under the revolving credit facility. A stand-by letter of credit of $1.6 million, issued primarily in connection with the Company’s insurance coverage, was outstanding under our revolving credit facility as of September 30, 2016. The stand-by letter of credit is renewable annually and reduces the borrowing availability under the revolving credit facility. As of September 30, 2016, $65.4 million was available for borrowing under the revolving credit facility.
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.
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, 2016, 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, 2016, and including the $19.6 million dividend declared in August 2016 and paid on November 1, 2016, we had $263.2 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 or 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, 2016, our total net leverage ratio under the Credit Agreement was 4.38:1.00, and our interest coverage ratio was 4.09:1.00.
Restatement of Credit Agreement
On October 5, 2016, the Company and certain of its subsidiaries entered into a Restatement Agreement to amend and restate the existing Credit Agreement through a Third Amended and Restated Credit Agreement (the “Restated Credit Agreement”). Under the terms of the Restated Credit Agreement, the Company issued initial term loans in the aggregate amount of $900.0 million, with a maturity date of October 5, 2023 (subject to earlier maturity on March 31, 2022 if the Company’s unsecured Senior Notes due in October 2022 are repaid in full or redeemed in full on or prior to March 31, 2022), and used the proceeds in part to pay off the outstanding Term 4 loan in the amount of $885.0 million. The Company also obtained a revolving loan facility of $110.0 million, with a maturity date of October 5, 2021, to replace the existing $75.0 million revolving credit facility scheduled to mature in December 2018. The terms, conditions and covenants of the initial term loan facility are materially consistent with those of the existing Credit Agreement. The initial term loan facility has an interest rate of LIBOR plus 3.00% with a 1.00% LIBOR floor and included an original issue discount of 0.25%. The spread on the revolving credit facility consists of a range from 2.50% to 3.25% based upon our total net leverage ratio. The Company has the ability to borrow an additional $300.0 million of incremental term loans subject to certain terms and conditions and can borrow more than the $300.0 million provided that its senior secured leverage ratio would not exceed 3.00:1.00. In connection with entering into the Restated Credit Agreement, we expect to incur a loss on the extinguishment of debt of approximately $6.5 million during the quarter ended December 31, 2016.
6.50% Senior Notes due 2022
In September 2014, we completed an offering of $200.0 million aggregate principal amount of 6.50% Senior Notes due in October 2022 (the “Existing Notes”). The Existing Notes were priced at par, which resulted in total gross proceeds of $200.0 million. On June 8, 2015, we completed an additional offering of $300.0 million in aggregate principal amount of 6.50% Senior Notes due 2022 (the “New Notes” and together with the Existing Notes, the “Senior Notes”). The New Notes were issued as additional notes under the same indenture pursuant to which the Existing Notes were previously issued on September 18, 2014. The New Notes were priced at 98.26% of par with a yield to maturity of 6.80% and resulted in total gross proceeds of approximately $294.8 million, excluding accrued interest.
The Senior Notes mature on October 1, 2022 and interest is payable semi-annually on April 1 and October 1 of each year. Consolidated Communications, Inc. (“CCI”) is the primary obligor under the Senior Notes, and we and certain of our wholly‑owned subsidiaries have fully and unconditionally guaranteed the Senior Notes. The Senior Notes are senior unsecured obligations of the Company.
The net proceeds from the issuance of the New Notes were used, in part, to redeem the remaining $227.2 million of our original $300.0 million aggregate principal amount of 10.875% Senior Notes due 2020 (the “2020 Notes”). In connection with the redemption of the 2020 Notes, we paid $261.9 million and recognized a loss on the extinguishment of debt of $41.2 million during the nine months ended September 30, 2015.
Senior Notes Covenant Compliance
Subject to certain exceptions and qualifications, the indenture governing the Senior Notes contains customary covenants that, among other things, limits CCI’s and its restricted subsidiaries’ ability to: incur additional 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. The indenture also contains customary events of default.
Among other matters, the Senior Notes indenture provides that CCI may not pay dividends or make other restricted payments, as defined in the indenture, if its total net leverage ratio is 4.75:1.00 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 not yet reflected in historical results. As of September 30, 2016, this ratio was 4.51:1.00. If this ratio is met, dividends and other restricted payments may be made from cumulative consolidated cash flow since April 1, 2012, less 1.75 times fixed charges, less dividends and other restricted payments made since May 30, 2012. 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 $312.0 million have been paid since May 30, 2012, including the quarterly dividend declared in August 2016 and paid on November 1, 2016, there was $425.6 million of the $737.6 million of cumulative consolidated cash flow since May 30, 2012 available to pay dividends as of September 30, 2016. As of September 30, 2016, the Company was in compliance with all terms, conditions and covenants under the indenture governing the Senior Notes.
Capital Leases
We lease certain facilities and equipment under various capital leases which expire between 2016 and 2021. As of September 30, 2016, the present value of the minimum remaining lease commitments was approximately $17.1 million, of which $5.3 million was due and payable within the next twelve months.
The leases require total remaining rental payments of
$19.4 million as of September 30, 2016, of which $3.8 million will be paid to LATEL LLC, a related party entity.
Dividends
We paid $58.8 million and $58.6 million in dividend payments to shareholders during the nine-month periods ended September 30, 2016 and 2015, respectively. In August 2016, our board of directors declared a quarterly dividend of $0.38738 per common share, which is payable on November 1, 2016 to stockholders of record at the close of business on October 14, 2016. Our current annual dividend rate is approximately $1.55 per share.
The cash required to fund dividend payments is in addition to our other expected cash needs, which we expect to fund with cash flows from our operations. In addition, we expect we will have sufficient availability under our revolving credit facility to fund dividend payments in addition to any expected fluctuations in working capital and other cash needs, although we do not intend to borrow under this facility to pay dividends.
We believe that our dividend policy will limit, but not preclude, our ability to grow. If we continue paying dividends at the level currently anticipated under our dividend policy, we may not retain a sufficient amount of cash, and may need to seek refinancing to fund a material expansion of our business, including any significant acquisitions or to pursue growth opportunities requiring capital expenditures significantly beyond our current expectations. In addition, because we expect a significant portion of cash available will be distributed to holders of common stock under our dividend policy, our ability
to pursue any material expansion of our business will depend more than it otherwise would on our ability to obtain third-party financing.
Sufficiency of Cash Resources
The following table sets forth selected information regarding our financial condition.
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September 30,
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December 31,
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(In thousands, except for ratio)
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2016
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2015
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Cash and cash equivalents
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$
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33,403
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$
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15,878
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Working capital (deficit)
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(22,541)
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(17,892)
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Current ratio
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|
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0.85
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|
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0.88
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Our most significant uses of funds in the remainder of 2016 are expected to be for: (i) dividend payments of approximately $19.6 million; (ii) interest payments on our indebtedness of approximately $26.0 million and principal payments on debt of $2.3 million; and (iii) capital expenditures of between $32.0 million and $35.0 million. In the future our ability to use cash may be limited by our other expected uses of cash, including our dividend policy, and our ability to incur additional debt will be limited by our existing and future debt agreements.
We believe that cash flows from operating activities, together with our existing cash and borrowings available under our revolving credit facility, will be sufficient for at least the next twelve months to fund our current anticipated uses of cash. After that, our ability to fund these expected uses of cash and to comply with the financial covenants under our debt agreements will depend on the results of future operations, performance and cash flow. Our ability to fund these expected uses from the results of future operations will be subject to prevailing economic conditions and to financial, business, regulatory, legislative and other factors, many of which are beyond our control.
We may be unable to access the cash flows of our subsidiaries since certain of our subsidiaries are parties to credit or other borrowing agreements, or are subject to statutory or regulatory restrictions, that restrict the payment of dividends or making intercompany loans and investments, and those subsidiaries are likely to continue to be subject to such restrictions and prohibitions for the foreseeable future. In addition, future agreements that our subsidiaries may enter into governing the terms of indebtedness may restrict our subsidiaries’ ability to pay dividends or advance cash in any other manner to us.
To the extent that our business plans or projections change or prove to be inaccurate, we may require additional financing or require financing sooner than we currently anticipate. Sources of additional financing may include commercial bank borrowings, other strategic debt financing, sales of nonstrategic assets, vendor financing or the private or public sales of equity and debt securities. There can be no assurance that we will be able to generate sufficient cash flows from operations in the future, that anticipated revenue growth will be realized or that future borrowings or equity issuances will be available in amounts sufficient to provide adequate sources of cash to fund our expected uses of cash. Failure to obtain adequate financing, if necessary, could require us to significantly reduce our operations or level of capital expenditures which could have a material adverse effect on our financial condition and the results of operations.
Surety Bonds
In the ordinary course of business, we enter into surety, performance and similar bonds as required by certain jurisdictions in which we provide services. As of September 30, 2016, we had approximately $4.0 million of these bonds outstanding.
Defined Benefit Pension Plans
As required, we contribute to a qualified defined pension plan (the “Retirement Plan”) and non-qualified supplemental retirement plans (collectively the “Pension Plans”) and other post-retirement benefit plans, which provide retirement benefits to certain eligible employees. Contributions are intended to provide for benefits attributed to service to date. Our funding policy is to contribute annually an actuarially determined amount consistent with applicable federal income tax regulations.
The costs to maintain our Pension Plans and future funding requirements are affected by several factors including the expected return on investment of the assets held by the Pension Plan, changes in the discount rate used to calculate pension expense and the amortization of unrecognized gains and losses. Returns generated on Pension Plan assets have historically funded a significant portion of the benefits paid under the Pension Plans. We estimate the long-term rate of return of Pension Plan assets will be 7.75%. The Pension Plans invest in marketable equity securities which are exposed to changes in the financial markets. If the financial markets experience a downturn and returns fall below our estimate, we could be required to make a material contribution to the Pension Plan, which could adversely affect our cash flows from operations.
In 2016, we expect to make contributions totaling approximately $0.3 million to our non-qualified supplemental retirement plans and $4.0 million to our other post-retirement benefit plans, which represents a decline of $10.9 million from the total contributions made in 2015. We do not expect to contribute to our qualified defined pension plans in 2016. As of September 30, 2016, we have contributed $0.2 million and $2.4 million to our non-qualified supplemental retirement plans and our other post-retirement benefit plans, respectively. Our contribution amounts meet the minimum funding requirements as set forth in employee benefit and tax laws. See Note 9 to the Condensed Consolidated Financial Statements, included in this report in Part I – Item I “Financial Information” for a more detailed discussion regarding our pension and other post-retirement plans.
Income Taxes
The timing of cash payments for income taxes, which is governed by the Internal Revenue Service and other taxing jurisdictions, will differ from the timing of recording tax expense and deferred income taxes, which are reported in accordance with GAAP. For example, tax laws in effect regarding accelerated or “bonus” depreciation for tax reporting resulted in less cash payments than the GAAP tax expense. Acceleration of tax deductions could eventually result in situations where cash payments will exceed GAAP tax expense.
Regulatory Matters
As discussed in the “Regulatory Matters” section above, in December 2014, the FCC released a report and order that significantly impacts the amount of support revenue we receive from the USF, CAF and ICC by redirecting support from voice services to broadband services. Our annual funding under CAF Phase I of $36.6 million will be replaced by annual funding under CAF Phase II of $13.9 million through 2020. In the state of Iowa, where CAF Phase II funding was greater than the CAF Phase I funding, the CAF Phase II funding was received with a retroactive payment back to January 1, 2015. For all other states, funding under CAF Phase II is less than funding under CAF Phase I. The acceptance of funding at the lower level will transition over a three year period, beginning in August 2015, at the rates of 75% of the CAF Phase I funding level in the first year, 50% in the second year and 25% in the third year. With the sale of CCIC, we anticipate that the annual CAF Phase II funding will decrease to $11.5 million.
The Order also modifies the methodology used for ICC traffic exchanged between carriers. As a result of implementing the provisions of the Order, our network access revenue decreased approximately $0.5 million and $1.1 million during the quarter and nine months ended September 30, 2016 compared to the same period in 2015, respectively. Our anticipated decline in network access revenue through 2018 is $1.7 million, $2.0 million and $1.9 million in 2016, 2017 and 2018, respectively.
In accordance with the provisions of SB 583, as discussed in the “Regulatory Matters” section above, our annual $1.4 million Texas HCAF support was eliminated effective January 1, 2014. In addition, in accordance with the provisions of the settlement agreement reached with the PUCT, the HCF draw will be reduced by approximately $1.2 million annually over a four year period beginning June 1, 2014 through 2018. However, we have the ability to fully offset this reduction with increases to residential rates where market conditions allow.
Critical Accounting Estimates
Our condensed consolidated financial statements and accompanying notes are prepared in accordance with US GAAP. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates and assumptions are affected by management’s application of
accounting policies. Our judgments are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making estimates about the carrying values of assets and liabilities that are not readily apparent from other sources. For a full discussion of our accounting estimates and assumptions that we have identified as critical in the preparation of our condensed consolidated financial statements, refer to our 2015 Annual Report on Form 10-K filed with the SEC.
Recent Accounting Pronouncements
For information regarding the impact of certain recent accounting pronouncements, see Note 1 “Summary of Significant Accounting Policies” to the Condensed Consolidated Financial Statements, included in this report in Part I - Item I “Financial Information”.