Consolidated Communications Holdings
Consolidated Communications Holdings, Inc. (Form: 10-Q, Received: 05/07/2010 13:23:20)

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

for the quarterly period ended March 31, 2010

 

 

OR

 

 

o

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

for the transition period from                to                .

 

COMMISSION FILE NUMBER 000-51446

 

CONSOLIDATED COMMUNICATIONS HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

02-0636095

(State or other jurisdiction of

 

(IRS Employer Identification No.)

incorporation or organization)

 

 

 

121 South 17 th  Street

 

 

Mattoon, Illinois

 

61938-3987

(Address of Principal Executive Offices)

 

(Zip Code)

 

(217) 235-3311

(Registrant’s Telephone Number, including Area Code)

 

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

YES  x    NO  o

 

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

YES  o    NO  o

 

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

 

Large accelerated filer   o

 

Accelerated filer   x

 

 

 

Non-accelerated filer   o

 

Smaller reporting company   o

(Do not check if a smaller reporting company)

 

 

 

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

YES  o    NO  x

 

Indicate the number of shares outstanding of each class of Common Stock, as of the latest practicable date

 

Class

 

Outstanding as of May 5, 2010

Common Stock, $0.01 Par Value

 

29,822,604 Shares

 

 

 



Table of Contents

 

FORM 10-Q

 

QUARTERLY REPORT

 

TABLE OF CONTENTS

 

 

 

Page No.

 

 

 

PART I

 

 

 

Item 1.

Financial Statements

 

 

Condensed Consolidated Statements of Operations (Unaudited) - Three month periods ended March 31, 2010 and 2009

1

 

Condensed Consolidated Balance Sheets – March 31, 2010 (Unaudited) and December 31, 2009

2

 

Condensed Consolidated Statement of Changes in Stockholders’ Equity (Unaudited) – Three months ended March 31, 2010

3

 

Condensed Consolidated Statements of Cash Flows (Unaudited) - Three month periods ended March 31, 2010 and 2009

4

 

Notes to Unaudited Condensed Consolidated Financial Statements

5

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

31

 

 

 

Item 4.

Controls and Procedures

31

 

 

 

PART II

 

 

 

Item 1.

Legal Proceedings

32

 

 

 

Item 1A.

Risk Factors

32

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

32

 

 

 

Item 3.

Defaults Upon Senior Securities

32

 

 

 

Item 4.

[Removed and Reserved]

32

 

 

 

Item 5.

Other Information

32

 

 

 

Item 6.

Exhibits

33

 



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Consolidated Communications Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited)

 

 

 

Three Months Ended March 31,

 

(In thousands except per share amounts)

 

2010

 

2009

 

 

 

 

 

 

 

Net revenues

 

$

98,302

 

$

101,710

 

Operating expense:

 

 

 

 

 

Cost of services and products (exclusive of depreciation and amortization shown separately below)

 

35,940

 

36,100

 

Selling, general and administrative expenses

 

22,803

 

27,877

 

Depreciation and amortization

 

21,542

 

21,677

 

Operating income

 

18,017

 

16,056

 

Other income (expense):

 

 

 

 

 

Interest income

 

16

 

22

 

Interest expense

 

(12,921

)

(14,492

)

Investment income

 

6,302

 

5,048

 

Other, net

 

64

 

(551

)

Income before income taxes

 

11,478

 

6,083

 

Income tax expense

 

4,427

 

2,386

 

Net income

 

7,051

 

3,697

 

Less: net income attributable to noncontrolling interest

 

131

 

407

 

Net income attributable to common stockholders

 

$

6,920

 

$

3,290

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per common share—basic

 

$

0.23

 

$

0.11

 

 

 

 

 

 

 

Net income per common share—diluted

 

$

0.23

 

$

0.11

 

 

 

 

 

 

 

Cash dividends per common share

 

$

0.39

 

$

0.39

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

Consolidated Communications Holdings, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

(In thousands except share and per share amounts)

 

March 31,
2010
(Unaudited)

 

December 31,
2009

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and equivalents

 

$

44,339

 

$

42,758

 

Accounts receivable, net of allowance for doubtful accounts of $1,894 in 2010 and $1,796 in 2009

 

42,635

 

42,125

 

Inventories

 

7,582

 

6,874

 

Deferred income taxes

 

5,970

 

5,970

 

Prepaid expenses and other current assets

 

8,770

 

6,639

 

Total current assets

 

109,296

 

104,366

 

 

 

 

 

 

 

Property, plant and equipment, net

 

371,622

 

377,200

 

Investments

 

97,912

 

98,748

 

Goodwill

 

520,562

 

520,562

 

Customer lists, net

 

96,553

 

102,088

 

Tradenames

 

13,446

 

13,446

 

Deferred debt issuance costs, net and other assets

 

6,243

 

6,633

 

Total assets

 

$

1,215,634

 

$

1,223,043

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

12,530

 

$

13,482

 

Advance billings and customer deposits

 

22,731

 

20,025

 

Dividends payable

 

11,553

 

11,476

 

Accrued expense

 

20,410

 

26,268

 

Current portion of capital lease obligations

 

103

 

344

 

Current portion of derivative liability

 

4,926

 

6,074

 

Current portion of pension and postretirement benefit obligations

 

2,908

 

2,908

 

Total current liabilities

 

75,161

 

80,577

 

Senior secured long-term debt

 

880,000

 

880,000

 

Deferred income taxes

 

74,791

 

74,711

 

Pension and other postretirement obligations

 

80,985

 

80,298

 

Other long-term liabilities

 

27,835

 

26,740

 

Total liabilities

 

1,138,772

 

1,142,326

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, par value $0.01 per share; 100,000,000 shares authorized, 29,822,604 and 29,608,653, shares outstanding as of March 31, 2010 and December 31, 2009, respectively

 

298

 

296

 

Additional paid-in capital

 

105,621

 

109,746

 

Retained earnings

 

 

 

Accumulated other comprehensive loss, net

 

(35,403

)

(35,540

)

Noncontrolling interest

 

6,346

 

6,215

 

Total stockholders’ equity

 

76,862

 

80,717

 

Total liabilities and stockholders’ equity

 

$

1,215,634

 

$

1,223,043

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

Consolidated Communications Holdings, Inc. and Subsidiaries

Consolidated Statement of Changes in Stockholders’ Equity

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Common Stock

 

Additional Paid in

 

Retained

 

Other Comprehensive

 

Non-controlling

 

 

 

(In thousands, except share amounts)

 

Shares

 

Amount

 

Capital

 

Earnings

 

Loss, net

 

Interest

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance - December 31, 2009

 

29,608,653

 

$

296

 

$

109,746

 

$

 

$

(35,540

)

$

6,215

 

$

80,717

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends on common stock

 

 

 

(4,626

)

(6,920

)

 

 

(11,546

)

Shares issued under employee plan, net of forfeitures

 

213,951

 

2

 

(2

)

 

 

 

 

Non-cash, stock-based compensation

 

 

 

503

 

 

 

 

503

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

6,920

 

 

131

 

7,051

 

Change in prior service cost and net loss, net of tax of $26

 

 

 

 

 

47

 

 

47

 

Change in fair value of cash flow hedges, net of tax of $54

 

 

 

 

 

90

 

 

90

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

7,188

 

Balance - March 31, 2010

 

29,822,604

 

$

298

 

$

105,621

 

$

 

$

(35,403

)

$

6,346

 

$

76,862

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

Consolidated Communications Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Three-months ended March 31,

 

(In thousands)

 

2010

 

2009

 

Operating Activities

 

 

 

 

 

Net income

 

$

7,051

 

$

3,697

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

21,542

 

21,677

 

Deferred income taxes

 

80

 

(1,944

)

Loss on disposal of assets

 

4

 

 

Cash distributions from wireless partnerships in excess of earnings

 

705

 

169

 

Stock-based compensation expense

 

503

 

433

 

Amortization of deferred financing costs

 

324

 

332

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(510

)

(797

)

Inventories

 

(708

)

109

 

Other assets

 

(2,126

)

974

 

Accounts payable

 

(952

)

(2,183

)

Accrued expenses and other liabilities

 

(2,124

)

(3,113

)

Net cash provided by operating activities

 

23,789

 

19,354

 

Investing Activities

 

 

 

 

 

Additions to property, plant and equipment, net

 

(10,935

)

(10,157

)

Proceeds from the sale of investments

 

514

 

300

 

Net cash used for investing activities

 

(10,421

)

(9.857

)

Financing Activities

 

 

 

 

 

Payment of capital lease obligation

 

(241

)

(224

)

Repurchase and retirement of common stock

 

 

(9

)

Dividends on common stock

 

(11,546

)

(11,388

)

Net cash used for financing activities

 

(11,787

)

(11,621

)

Net increase (decrease) in cash and equivalents

 

1,581

 

(2,124

)

Cash and equivalents at beginning of year

 

42,758

 

15,471

 

Cash and equivalents at end of year

 

$

44,339

 

$

13,347

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Consolidated Communications Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

1.             Nature of Operations

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Consolidated Communications Holdings, Inc. and its subsidiaries, which are collectively referred to as “Consolidated”,  the “Company”, “we”, “our” or “us”, unless the context otherwise requires.  All significant intercompany transactions have been eliminated in consolidation.

 

We have prepared the unaudited condensed consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations, although we believe that the disclosures are adequate to make the information presented not misleading.  These financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009.

 

The accompanying unaudited condensed consolidated financial statements presented herewith reflect all adjustments (consisting of only normal and recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of the results of operations for the three month periods ended March 31, 2010 and 2009.  The results of operations for interim periods are not necessarily indicative of results to be expected for an entire year.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ materially from those estimates.

 

As of March 31, 2010, the Company’s Summary of Critical Accounting Policies for the year ended December 31, 2009, which are detailed in the Company’s Annual Report on Form 10-K, have not changed.

 

The Company has evaluated subsequent events and transactions for potential recognition or disclosure in the financial statements through the day the financial statements are issued.

 

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

 

2.                                       Recent Accounting Pronouncements

 

Effective January 1, 2010, we adopted the Financial Accounting Standards Board’s (“FASB”) updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of the Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers.  In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number).  The updated guidance also requires that an entity provide fair value

 

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measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring Level 2 and Level 3 fair value measurements.  The guidance was effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010.  Therefore, we have not yet adopted the guidance with respect to the roll forward activity in Level 3 fair value measurements.  We have updated our disclosures to comply with the updated guidance.  Adoption of the updated guidance did not have an impact on our consolidated results of operations or financial condition.

 

3.             Prepaid and other current assets

 

Prepaid and other current assets are as follows:

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

Prepaid maintenance

 

$

2,732

 

$

3,152

 

Prepaid taxes

 

1,640

 

43

 

Deferred charges

 

1,025

 

718

 

Prepaid insurance

 

685

 

471

 

Prepaid expense - other

 

2,569

 

2,200

 

Current portion of swap assets

 

44

 

 

Other current assets

 

75

 

55

 

Total

 

$

8,770

 

$

6,639

 

 

4.             Property, plant and equipment

 

Property, plant and equipment are as follows:

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

Land and buildings

 

$

66,703

 

$

66,700

 

Network and outside plant facilities

 

836,351

 

833,879

 

Furniture, fixtures and equipment

 

80,415

 

80,315

 

Assets under capital lease

 

5,144

 

5,144

 

Less: accumulated depreciation

 

(631,104

)

(617,141

)

 

 

357,509

 

368,897

 

Construction in progress

 

14,113

 

8,303

 

Totals

 

$

371,622

 

$

377,200

 

 

Depreciation expense totaled $16.0 million and $16.1 million for the three month periods ended March 31, 2010 and 2009, respectively.

 

7.             Investments

 

We own 2.34% of GTE Mobilnet of South Texas Limited Partnership (the “Mobilnet South Partnership”).  The principal activity of the Mobilnet South Partnership is providing cellular service in the Houston, Galveston, and Beaumont, Texas metropolitan areas.  We also own 3.60% of Pittsburgh SMSA Limited Partnership (“Pittsburgh SMSA”), which provides cellular service in and around the Pittsburgh metropolitan area.  Because of our limited influence over these partnerships, we use the cost method to account for both of these investments.  For the three months ended March 31, 2010 and

 

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Table of Contents

 

2009, we received cash distributions from these partnerships totaling $3.0 million and $2.4 million, respectively.

 

We also own 17.02% of GTE Mobilnet of Texas RSA #17 Limited Partnership (“RSA 17”), 16.6725% of Pennsylvania RSA 6(I) Limited Partnership (“RSA 6(I)”), and 23.67% of Pennsylvania RSA 6(II) Limited Partnership (“RSA 6(II)”).  RSA #17 provides cellular service to a limited rural area in Texas.  RSA 6(I) and RSA 6(II) provide cellular service in and around our Pennsylvania service territory.  In addition, we have a 50% ownership interest in Boulevard Communications LLP, a competitive access provider in western Pennsylvania.  Because we have some influence over the operating and financial policies of these four entities, we account for the investments using the equity method.  For the three months ended March 31, 2010 and 2009, we received cash distributions from these partnerships totaling $3.9 million and $2.7 million, respectively.

 

Our investments are as follows:

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

Cash surrender value of life insurance policies

 

$

1,605

 

$

1,797

 

Cost method investments:

 

 

 

 

 

GTE Mobilnet of South Texas Limited Partnership (2.34%)

 

21,450

 

21,450

 

Pittsburgh SMSA Limited Partnership (3.60%)

 

22,950

 

22,950

 

CoBank, ACB Stock

 

2,963

 

2,902

 

Other

 

60

 

60

 

Equity method investments:

 

 

 

 

 

GTE Mobilnet of Texas RSA #17 Limited Partnership (17.02% interest)

 

18,900

 

19,080

 

Pennsylvania RSA 6(I) Limited Partnership (16.6725% interest)

 

6,977

 

7,301

 

Pennsylvania RSA 6(II) Limited Partnership (23.67% interest)

 

22,850

 

23,049

 

Boulevard Communications, LLP (50% interest)

 

157

 

159

 

Total

 

$

97,912

 

$

98,748

 

 

CoBank is a cooperative bank owned by its customers.  Annually, CoBank distributes patronage in the form of cash and stock in the cooperative based on the Company’s outstanding loan balance with CoBank, who has traditionally been a significant lender in the Company’s credit facility.   The investment in CoBank represents the accumulation of the equity patronage paid by CoBank to the Company.

 

Because the income from our investment in Pennsylvania RSA 6(II) for the first quarter of 2010 exceeds 10% of our pretax income, below is a summary of unaudited summarized income statement information of Pennsylvania RSA 6(II):

 

 

 

Three months ended March 31,

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Total revenues

 

$

28,973

 

$

27,707

 

Income from operations

 

7,871

 

6,384

 

Net income before taxes

 

8,045

 

6,520

 

Net income

 

8,045

 

6,520

 

 

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8.             Fair Value Measurements

 

The Company’s derivative instruments related to interest rate swap agreements are required to be measured at fair value on a recurring basis.  The fair values of the interest rate swaps are determined using an internal valuation model which relies on the expected LIBOR based yield curve and estimates of counterparty and Consolidated’s non-performance risk as the most significant inputs.  Because each of these inputs are directly observable or can be corroborated by observable market data, we have categorized these interest rate swaps as Level 2 within the fair value hierarchy.

 

The Company’s swap assets and liabilities measured at fair value on a recurring basis subject to disclosure requirements at March 31, 2010 were as follows:

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

(In thousands)

 

March 31, 2010

 

Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Current interest rate swap assets

 

$

44

 

 

44

 

 

Long-term interest rate swap assets

 

52

 

 

52

 

 

Current interest rate swap liabilities

 

(4,926

)

 

(4,926

)

 

Long-term interest rate swap liabilities

 

(27,233

)

 

(27,233

)

 

Totals

 

$

(32,063

)

$

 

$

(32,063

)

$

 

 

The change in the fair value of the derivatives is primarily a result of a change in market expectations for future interest rates.

 

We have not elected the fair value option for any of our financial assets or liabilities.  The carrying value of other financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities approximate fair value due to their short maturities or variable-rate nature of the respective balances.  The following table presents the other financial instruments that are not carried at fair value but which require fair value disclosure as of March 31, 2010 and December 31, 2009.

 

 

 

As of March 31, 2010

 

As of December 31, 2009

 

(In thousands)

 

Carrying Value

 

Fair Value

 

Carrying Value

 

Fair Value

 

Investments, equity basis

 

$

48,884

 

n/a

 

$

49,589

 

n/a

 

Investments, at cost

 

$

47,423

 

n/a

 

$

47,362

 

n/a

 

Long-term debt

 

$

880,000

 

$

880,000

 

$

880,000

 

$

880,000

 

 

The Company’s investments at March 31, 2010 and December 31, 2009 accounted for under both the equity and cost methods consist of minority positions in various cellular telephone limited partnerships.  These investments are recorded using either the equity or cost methods, and it is not practical to estimate a fair value for these non-publicly traded entities.

 

Our long-term debt allows us to select a one month LIBOR repricing option, which we have elected.  As such, the fair value of this debt approximates its carrying value.

 

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9.             Goodwill and Other Intangible Assets

 

In accordance with the applicable accounting guidance, goodwill and tradenames are not amortized but are subject to impairment testing—no less than annually or more frequently if circumstances indicate potential impairment.

 

The following table presents the carrying amount of goodwill by segment:

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

Telephone Operations

 

$

519,541

 

$

519,541

 

Other Operations

 

1,021

 

1,021

 

Totals

 

$

520,562

 

$

520,562

 

 

Our most valuable tradename is the federally registered mark CONSOLIDATED, which is used in association with our telephone communication services and is a design of interlocking circles.  The Company’s corporate branding strategy leverages a CONSOLIDATED naming structure.  All of the Company’s business units and several of our products and services incorporate the CONSOLIDATED name.  These tradenames are indefinitely renewable intangibles.  The carrying value of the tradenames was $13.4 million at both March 31, 2010 and December 31, 2009.

 

The Company’s customer lists consist of an established base of customers that subscribe to its services.  The carrying amount of customer lists is as follows:

 

 

 

Telephone Operations

 

Other Operations

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

 

 

 

 

Gross carrying amount

 

$

193,124

 

$

193,124

 

$

11,712

 

$

11,712

 

Less: accumulated amortization

 

(97,783

)

(92,358

)

(10,500

)

(10,390

)

Net carrying amount

 

$

95,341

 

$

100,766

 

$

1,212

 

$

1,322

 

 

Amortization associated with customer lists totaled approximately $5.5 million in each of the three month periods ended March 31, 2010 and 2009.

 

10.          Deferred Debt Issuance Costs, Net and Other Assets

 

Deferred financing costs, net and other assets are as follows:

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

Deferred debt issuance costs, net

 

$

6,140

 

$

6,464

 

Long-term swap assets

 

52

 

 

Other assets

 

51

 

169

 

Total

 

$

6,243

 

$

6,633

 

 

Deferred debt issuance costs are subject to amortization.  Remaining deferred debt issuance costs of $6.1 million at March 31, 2010 related to our secured credit facility will be amortized utilizing a method which approximates the effective interest method over the remaining life of 4.75 years, resulting in amortization expense of $1.3 million yearly unless the facility is extinguished earlier.

 

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11.          Accrued Expenses

 

Accrued expenses are as follows:

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

Salaries and employee benefits

 

$

10,242

 

$

11,727

 

Taxes payable

 

2,774

 

7,766

 

Accrued interest

 

1,314

 

1,177

 

Other accrued expenses

 

6,080

 

5,598

 

Total accrued expenses

 

$

20,410

 

$

26,268

 

 

12.          Debt

 

Long-term debt consists of the following:

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

 

 

 

 

 

 

Senior secured credit facility - revolving loan

 

$

 

$

 

Senior secured credit facility - term loan

 

880,000

 

880,000

 

Obligations under capital lease

 

103

 

344

 

 

 

880,103

 

880,344

 

Less: current portion

 

(103

)

(344

)

Total long-term debt

 

$

880,000

 

$

880,000

 

 

Credit Agreement
 

The Company, through certain of its wholly owned subsidiaries, has outstanding a credit agreement with several financial institutions, which consists of a $50 million revolving credit facility (including a $10 million sub-limit for letters of credit) and a $880 million term loan facility.  Borrowings under the credit facility are secured by substantially all of the assets of the Company with the exception of Illinois Consolidated Telephone Company.  The term loan requires no principal reductions prior to maturity and thus matures in full on December 31, 2014.  The revolving credit facility matures on December 31, 2013.  There were no borrowings outstanding under the revolving credit facility as of March 31, 2010.

 

At our election, borrowings under the credit facilities bear interest at a rate equal to an applicable margin plus either a “base rate” or LIBOR.  As of March 31, 2010, the applicable margin for interest rates was 2.50% per year for the LIBOR-based term loans and 1.50% for alternative base rate loans.  The applicable margin for our $880 million term loan is fixed for the duration of the loan.  The applicable margin for borrowings on the revolving credit facility is determined via a pricing grid.  Based on our leverage ratio of 4.67:1 at March 31, 2010, borrowings under the revolving credit facility will be priced at a margin of 2.50% for LIBOR-based borrowings and 1.50% for alternative base rate borrowings for the three month period ending June 30, 2010.  The applicable borrowing margin for the revolving credit facility is adjusted quarterly to reflect the leverage ratio from the prior quarter-end.

 

The weighted-average interest rate incurred on our credit facilities during the three month periods ended March 31, 2010 and 2009, including amounts paid on our interest rate swap agreements

 

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and the applicable margin, was 5.57% and 6.31% per annum, respectively.  Interest is payable at least quarterly.

 

The credit agreement contains various provisions and covenants, including, among other items, restrictions on the ability to pay dividends, incur additional indebtedness, issue capital stock, and commit to future capital expenditures.  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 March 31, 2010, we were in compliance with the credit agreement covenants.

 

13.                                Derivatives

 

In order to manage the risk associated with changes in interest rates, we maintain interest rate swap agreements that effectively convert a portion of our floating-rate debt to a fixed-rate basis, thereby reducing the impact of interest rate changes on future cash interest payments.  We account for these transactions as cash flow hedges under the FASB’s Accounting Standards Codification Topic 815 (“ASC 815”), Derivatives and Hedging .  The swaps are designated as cash flow hedges of our expected future interest payments.  In a cash flow hedge, the effective portion of the change in the fair value of the hedging derivative is recorded in accumulated other comprehensive loss and is subsequently reclassified into earnings during the same period in which the hedged item affects earnings.  The change in fair value of any ineffective portion of the hedging derivative is recognized immediately in earnings.

 

Under our interest rate swap agreements, we receive 3-month LIBOR based interest payments from the swap counterparties and pay a fixed rate.  In addition, we make 3-month LIBOR-based payments, less a fixed percentage to a basis swap counterparty and receive 1-month LIBOR.  The combination effectively hedges the interest payments based on 1-month LIBOR resets on our credit facility.  The net effect of the swaps is that we pay a weighted average fixed rate of 4.42% to our swap counterparties on $605 million of notional amount and receive 1-month LIBOR less a fixed percentage, which amounted to 0.06% for the first quarter of 2010.  At both March 31, 2010 and December 31, 2009, interest on 68.75% of our outstanding debt was fixed through the use of interest rate swap agreements.

 

The counterparties to our various swaps are 5 major U.S. and European banks.  None of the swap agreements provide for either Consolidated or the counterparties to post collateral nor do the agreements include any covenants related to the financial condition of Consolidated or the counterparties.  The swaps of any counterparty that is a “Lender” as defined in our credit facility are secured along with the other creditors under the credit facility.  Each of the swap agreements provides that in the event of a bankruptcy filing by either Consolidated or the counterparty, any amounts owed between the two parties would be offset in order to determine the net amount due between parties.  This provision allows us to partially mitigate the risk of non-performance by a counterparty.

 

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We report the gross fair value of our derivatives in:  (i) Prepaid expenses and other current assets, (ii) Deferred debt issuance costs, net and other assets, (iii) Current portion of derivative liability, and (iv) Other long-term liabilities on our Condensed Consolidated Balance Sheets.  The table below shows the balance sheet classification and fair value of our interest rate swaps designated as hedging instruments under ASC 815:

 

 

 

Fair Value

 

 

 

March 31,

 

December 31,

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Prepaid expenses and other current assets

 

$

44

 

$

 

Deferred debt issuance costs, net and other assets

 

52

 

 

Current portion of derivative liability

 

(4,926

)

(6,074

)

Other long-term liabilities

 

(27,233

)

(26,105

)

 

Information regarding our cash flow hedge transactions is as follows:

 

 

 

For the Three Months Ended March 31,

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Loss (gain) arising from ineffectiveness included in interest expense

 

$

29

 

$

(22

)

Losses reclassed from accumulated other comprehensive loss (“OCI”) to interest expense

 

$

1,582

 

$

2,855

 

 

 

 

March 31,

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Aggregate notional value of derivatives outstanding

 

$

605,000

 

$

740,000

 

Period through which derivative positions currently exist

 

March 2013

 

March 2013

 

Loss in fair value of derivatives

 

$

32,063

 

$

46,083

 

Deferred losses included in OCI (pretax)

 

$

31,747

 

$

45,711

 

Losses included in OCI to be recognized in the next 12 months

 

$

3,643

 

$

9,777

 

Number of months over which loss in OCI is to be recognized

 

36

 

48

 

 

14.          Interest Expense

 

The following table summarizes interest expense:

 

 

 

For the Three Months Ended
March 31,

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Interest expense — credit facility

 

$

6,020

 

$

6,502

 

Payments on swap liabilities, net

 

6,246

 

7,355

 

Other interest

 

363

 

354

 

Amortization of deferred financing fees

 

323

 

319

 

Capitalized interest

 

(31

)

(38

)

Total interest expense

 

$

12,921

 

$

14,492

 

 

15.          Retirement and Pension Plans

 

We have 401(k) plans covering substantially all of our employees.  We recognized expense with respect to these plans of $0.7 million for each of the three month periods ended March 31, 2010 and 2009.  Contributions made under our defined contribution plans include a match, at the Company’s discretion, of employee salaries contributed to the plans.

 

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Qualified Retirement Plan

 

We sponsor a defined-benefit pension plan (“Retirement Plan”) that is non-contributory covering substantially all of our hourly employees who fulfill minimum age and service requirements.  Certain salaried employees are also covered by the Retirement Plan, although these benefits have previously been frozen.

 

The following table summarizes the components of net periodic pension cost for the qualified retirement plan for the three months ended March 31:

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Service cost

 

$

467

 

$

527

 

Interest cost

 

2,784

 

2,775

 

Expected return on plan assets

 

(2,546

)

(2,355

)

Net amortization loss

 

189

 

668

 

Prior service credit amortization

 

(11

)

(10

)

Net periodic pension cost

 

$

883

 

$

1,605

 

 

Non-qualified Pension Plan

 

The Company also has non-qualified supplemental pension plans (“Restoration Plans”), which we acquired as part of our North Pittsburgh Systems, Inc. (“North Pittsburgh”) and TXU Communications Venture Company (“TXUCV”) acquisitions.  The Restoration Plans covers certain former employees of our North Pittsburgh and TXUCV operations.  The Restoration Plans restore benefits that were precluded under the Retirement Plan by Internal Revenue Service limits on compensation and benefits applicable to qualified pension plans, and by the exclusion of bonus compensation from the Retirement Plan’s definition of earnings.  The Restoration Plans are unfunded and have no assets, and benefits paid under the Restoration Plans come from the general operating funds of the Company.

 

The following table summarizes the components of net periodic pension cost for the Restoration Plans for the three months ended March 31:

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Service cost

 

$

 

$

 

Interest cost

 

15

 

14

 

Net amortization loss

 

8

 

8

 

Net periodic pension cost

 

$

23

 

$

22

 

 

Other Non-qualified Deferred Compensation Agreements

 

We also are liable for deferred compensation agreements with former members of the board of directors and certain other former employees of a subsidiary of TXUCV, which was acquired in 2004.  The benefits are payable for up to the life of the participant and may begin as early as age 65 or upon the death of the participant.  Participants accrue no new benefits as these plans had previously been frozen by TXUCV’s predecessor company prior to our acquisition of TXUCV.  Payments related to the deferred compensation agreements totaled approximately $0.1 million for the three-month periods ended March 31, 2010 and 2009.  The net present value of the remaining obligations was approximately

 

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$3.0 million at March 31, 2010 and $3.1 million at December 31, 2009, and is included in pension and postretirement benefit obligations in the accompanying balance sheets.

 

We also maintain 40 life insurance policies on certain of the participating former directors and employees.  We did not recognize any proceeds in other income for the three-month periods ended March 31, 2010 or 2009 due to the receipt of life insurance proceeds.  The excess of the cash surrender value of the remaining life insurance policies over the notes payable balances related to these policies is determined by an independent consultant, and totaled $1.6 million at March 31, 2010 and $1.8 million at December 31, 2009.  These amounts are included in investments in the accompanying balance sheets.  Cash principal payments for the policies and any proceeds from the policies are classified as operating activities in the statements of cash flows.

 

16.          Postretirement Benefit Obligation

 

We sponsor a healthcare plan and life insurance plan that provides postretirement medical benefits and life insurance to certain groups of retired employees.  Retirees share in the cost of healthcare benefits, making contributions that are adjusted periodically—either based upon collective bargaining agreements or because total costs of the program have changed.  We generally pay the covered expenses for retiree health benefits as they are incurred.  Postretirement life insurance benefits are fully insured.  Our postretirement plan is unfunded and has no assets, and the benefits paid under the postretirement plan come from the general operating funds of the Company.

 

The following table summarizes the components of the net periodic costs for postretirement benefits for the three months ended March 31:

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Service cost

 

$

206

 

$

217

 

Interest cost

 

530

 

579

 

Net prior service cost amortization

 

(112

)

(241

)

Net amortization gain

 

 

(5

)

Net periodic postretirement benefit cost

 

$

624

 

$

550

 

 

In March 2010, President Obama signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (the “Acts”).  Based on the our analyses to date, we do not currently believe the provisions within the Acts will result in a material remeasurement of our postretirement health care liabilities.  We will continue to assess the accounting implications of the Acts as related regulations and interpretations of the Acts become available.  The actual extent of impact cannot be actuarially determined until related regulations are promulgated under the Acts and additional interpretations of the Acts become available.  Provisions within the Acts for which financial impacts to our postretirement health care liabilities are possible, but not currently determinable, include application of the excise tax on high-cost employer coverage.  We do not expect the other provisions within the Acts to materially impact our postretirement health care liabilities or results of operations.

 

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17.          Stock-based Compensation Plans

 

Pretax stock-based compensation expense for the three month periods ended March 31 was as follows:

 

(In millions)

 

2010

 

2009

 

 

 

 

 

 

 

Restricted stock

 

$

0.3

 

$

0.3

 

Performance shares

 

0.2

 

0.1

 

Total

 

$

0.5

 

$

0.4

 

 

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

 

As of March 31, 2010, we had not yet recognized compensation expense on the following non-vested awards.

 

(In millions)

 

Non-recognized
Compensation

 

Average Remaining
Recognition Period
(years)

 

 

 

 

 

 

 

Restricted stock

 

$

2.8

 

1.8

 

Performance shares

 

2.2

 

1.6

 

Total

 

$

5.0

 

1.7

 

 

The following table summarizes unvested restricted stock awards outstanding and changes during the three months ended March 31:

 

 

 

2010

 

2009

 

 

 

# of 
Shares

 

Price(1)

 

# of 
Shares

 

Price(1)

 

Non-vested restricted shares outstanding — January 1

 

82,375

 

$

12.08

 

74,391

 

$

16.62

 

Shares granted

 

115,949

 

18.65

 

96,447

 

9.05

 

Shares vested

 

(3,000

)

13.00

 

(6,000

)

13.45

 

Non-vested restricted shares outstanding — March 31

 

195,324

 

$

15.97

 

164,838

 

$

12.31

 

 


(1)            Represents the weighted—average fair value on date of grant.

 

The following table summarizes unvested performance share-based restricted stock awards outstanding and changes during the three months ended March 31:

 

 

 

2010

 

2009

 

 

 

# of
Shares

 

Price(1)

 

# of
Shares

 

Price(1)

 

 

 

 

 

 

 

 

 

 

 

Non-vested performance shares outstanding — January 1

 

46,578

 

$

11.72

 

31,137

 

$

15.68

 

Shares granted

 

98,002

 

18.65

 

61,544

 

9.05

 

Shares vested

 

 

 

(1,202

)

13.42

 

Non-vested performance shares outstanding — March 31

 

144,580

 

$

16.42

 

91,479

 

$

11.25

 

 


(1)           Represents the weighted—average fair value on date of grant.

 

18.          Income Taxes

 

There have been no changes to the balance of our unrecognized tax benefits reported at December 31, 2009.  As of March 31, 2010 and December 31, 2009, the amount of unrecognized tax benefits was $5.7 million.  The total amount of unrecognized benefits that, if recognized, would affect the effective tax rate is $5.7 million.  A decrease in unrecognized tax benefits of $5.4 million and $1.2

 

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million of related accrued interest is expected in the third quarter of 2010 due to the expiration of the federal statute of limitation.  This decrease will significantly reduce our effective tax rate.

 

Our practice is to recognize interest and penalties related to income tax matters in interest expense and general and administrative expense, respectively.  We had $1.2 million of interest and penalties relating to unrecognized tax benefits recorded as of March 31, 2010, of which $0.1 million was recorded during the three months ended March 31, 2010 and 2009.

 

The only periods subject to examination for our federal return are years 2006 through 2008.  The periods subject to examination for our state returns are years 2005 through 2008.  We are not currently under examination by either federal or state taxing authorities.

 

Our effective tax rate was 38.6% and 39.2%, for the three months ended March 31, 2010 and 2009, respectively.  The effective tax rate differs from the federal and state statutory rates primarily due to non-deductible expenses.

 

During the quarter ended March 31, 2009 we settled an IRS exam covering years 2005 through 2007.  As a result, we recorded additional income tax expense of $78 thousand.

 

19.          Accumulated Other Comprehensive Loss, Net

 

Accumulated other comprehensive loss, net is comprised of the following components at March 31, 2010 and December 31, 2009:

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Fair value of cash flow hedges

 

$

(31,747

)

$

(31,891

)

Prior service credits and net losses on postretirement plans

 

(24,155

)

(24,229

)

 

 

(55,902

)

(56,120

)

Deferred taxes

 

20,499

 

20,580

 

Totals

 

$

(35,403

)

$

(35,540

)

 

20.          Environmental Remediation Liabilities

 

Environmental remediation liabilities were $0.3 million at March 31, 2010 and December 31, 2009, and are included in other liabilities.  These liabilities relate to anticipated remediation and monitoring costs with respect to two small vacant sites and are undiscounted.  The Company believes the amount accrued is adequate to cover the remaining anticipated costs of remediation.

 

21.          Litigation and Contingencies

 

On April 15, 2008, Salsgiver Inc., a Pennsylvania-based telecommunications company, and certain of its affiliates filed a lawsuit against us and our subsidiaries North Pittsburgh Telephone Company and North Pittsburgh Systems Inc. in the Court of Common Pleas of Allegheny County, Pennsylvania, alleging that we have prevented Salsgiver from connecting their fiber optic cables to our utility poles.  Salsgiver seeks compensatory and punitive damages as the result of alleged lost projected profits, damage to its business reputation, and other costs.  It claims to have sustained losses of approximately $125 million, but does not request a specific dollar amount in damages.  We believe that these claims are without merit and that the alleged damages are completely unfounded.  We intend to defend against these claims vigorously.  In the third quarter of 2008, we filed preliminary objections and responses to Salsgiver’s complaint.  However, the court ruled against our preliminary objections.  On November 3, 2008, we responded to Salsgiver’s amended complaint and filed a counter-claim for

 

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trespass, alleging that Salsgiver attached cables to our poles without an authorized agreement and in an unsafe manner.  We are currently in the discovery and deposition stage.  In addition, we have asked the FCC Enforcement Bureau to address Salsgiver’s unauthorized pole attachments and safety violations on those attachments.  We believe that these are violations of an FCC order regarding Salsgiver’s complaint against us. We do not believe that these claims will have a material adverse impact on our financial results.

 

We are from time to time involved in various other legal proceedings and regulatory actions arising out of our operations.  We do not believe that any of these, individually or in the aggregate, would have a material adverse effect upon our business, operating results or financial condition.

 

22.          Net Income per Common Share

 

The following illustrates the earnings allocation method as required by the FASB’s authoritative guidance on the treatment of participating securities in the calculation of earnings per share which we utilize in the calculation of basic and diluted earnings per share.

 

(In thousands, except per share amounts)

 

2010

 

2009

 

 

 

 

 

 

 

Basic Earnings Per Share Using Two-class Method:

 

 

 

 

 

Net income

 

$

7,051

 

$

3,697

 

Less: net income attributable to noncontrolling interest

 

131

 

407

 

Net income attributable to common shareholders before allocation of earnings to participating securities

 

6,920

 

3,290

 

Less: earnings allocated to participating securities

 

43

 

35

 

Net income attributable to common stockholders

 

$

6,877

 

$

3,255

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding

 

29,483

 

29,386

 

 

 

 

 

 

 

Net income per common share attributable to common stockholders - basic

 

$

0.23

 

$

0.11

 

 

 

 

 

 

 

Diluted Earnings Per Share Using Two-class Method:

 

 

 

 

 

Net income

 

$

7,051

 

$

3,697

 

Less: net income attributable to noncontrolling interest

 

131

 

407

 

Net income attributable to common shareholders before allocation of earnings to participating securities

 

6,920

 

3,290

 

Less: earnings allocated to participating securities

 

43

 

35

 

Net income attributable to common stockholders

 

$

6,877

 

$

3,255

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding

 

29,483

 

29,386

 

 

 

 

 

 

 

Net income per common share attributable to common stockholders - diluted

 

$

0.23

 

$

0.11

 

 

We had additional potential dilutive securities including unvested restricted shares and performance shares outstanding representing 0.3 million and 0.2 million common shares that were not included in the computation of potentially dilutive securities at March 31, 2010 and 2009, respectively, because they were anti-dilutive or the achievement of performance conditions had not been met at the end of the period.

 

23.          Business Segments

 

The Company is viewed and managed as two separate, but highly integrated, reportable business segments: “Telephone Operations” and “Other Operations.”  Telephone Operations consists of

 

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a wide range of telecommunications services, including local and long-distance service, VOIP service, custom calling features, private line services, dial-up and DSL Internet access, IPTV, carrier access services, network capacity services over a regional fiber optic network, mobile services and directory publishing.  The Company also operates a number of complementary non-core businesses that comprise “Other Operations,” including telephone services to county jails and state prisons, equipment sales and operator services.  Management evaluates the performance of these business segments based upon net revenue, operating income, and income before extraordinary items.

 

 

 

Three Months Ended
March 31,

 

(In thousands)

 

2010

 

2009

 

 

 

 

 

 

 

Telephone operations

 

$

88,783

 

$

91,695

 

Other operations

 

9,519

 

10,015

 

Total net revenue

 

98,302

 

101,710

 

 

 

 

 

 

 

Operating expense – telephone operations

 

49,974

 

54,308

 

Operating expense – other operations

 

8,769

 

9,669

 

Total operating expense

 

58,743

 

63,977

 

 

 

 

 

 

 

Depreciation and amortization expense – telephone operations

 

21,326

 

21,359

 

Depreciation and amortization expense – other operations

 

216

 

318

 

Total depreciation expense

 

21,542

 

21,677

 

 

 

 

 

 

 

Operating income – telephone operations

 

17,483

 

16,028

 

Operating income - other operations

 

534

 

28

 

Total operating income

 

18,017

 

16,056

 

 

 

 

 

 

 

Interest income

 

16

 

22

 

Interest expense

 

(12,921

)

(14,492

)

Investment income

 

6,302

 

5,048

 

Other, net

 

64

 

(551

)

Income before taxes

 

$

11,478

 

$

6,083

 

 

 

 

 

 

 

Capital expenditures:

 

 

 

 

 

Telephone operations

 

$

10,912

 

$

10,155

 

Other operations

 

23

 

2

 

Total

 

$

10,935

 

$

10,157

 

 

 

 

March 31,

 

December 31,

 

 

 

2010

 

2009

 

Goodwill:

 

 

 

 

 

Telephone operations

 

$

519,541

 

$

519,541

 

Other operations

 

1,021

 

1,021

 

Total

 

$

520,562

 

$

520,562

 

 

 

 

 

 

 

Total assets:

 

 

 

 

 

Telephone operations (1)

 

$

1,204,602

 

$

1,210,765

 

Other operations

 

11,032

 

12,278

 

Total

 

$

1,215,634

 

$

1,223,043

 

 


(1)  Included within the telephone operations segment assets are our equity method investments totaling $48.9 million and $49.6 million at March 31, 2010 and December 31, 2009, respectively.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion of our consolidated operating results and financial condition for the three month periods ended March 31, 2010 and 2009 should be read in conjunction with the consolidated financial statements and related notes contained elsewhere in this report.

 

“Consolidated Communications” or the “Company” refers to Consolidated Communications Holdings, Inc. alone or with its wholly owned subsidiaries as the context requires.  When this report uses the words “we,” “our,” or “us,” they refer to the Company and its subsidiaries.

 

Forward-Looking Statements

 

Any statements contained in this Report that are not statements of historical fact, including statements about our beliefs and expectations, are forward-looking statements and should be evaluated as such. The words “anticipates”, “believes”, “expects”, “intends”, “plans”, “estimates”, “targets”, “projects”, “should”, “may”, “will” and similar words and expressions are intended to identify forward-looking statements.  These forward-looking statements are contained throughout this Report, including, but not limited to, statements found in this Part I — Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, Part I — Item 3 — “Quantitative and Qualitative Disclosures about Market Risk” and Part II — Item 1 — “Legal Proceedings”.  Such forward-looking statements reflect, among other things, our current expectations, plans, strategies, and anticipated financial results and involve a number of known and unknown risks, uncertainties, and factors that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements, including but not limited to:

 

·                   various risks to stockholders of not receiving dividends and risks to our ability to pursue growth opportunities if we continue to pay dividends according to our current dividend policy;

·                   the current volatility in economic conditions and the financial markets;

·                   adverse changes in the value of assets or obligations associated with our employee benefit plans;

·                   various risks to the price and volatility of our common stock;

·                   our substantial amount of debt and our ability to incur additional debt in the future;

·                   our need for a significant amount of cash to service and repay our debt and to pay dividends on our common stock;

·                   restrictions contained in our debt agreements that limit the discretion of our management in operating our business;

·                   the ability to refinance our existing debt as necessary;

·                   rapid development and introduction of new technologies and intense competition in the telecommunications industry;

·                   risks associated with our possible pursuit of future acquisitions;

·                   the length and severity of weakened economic conditions in our service areas in Illinois, Texas and Pennsylvania;

·                   system failures;

·                   loss of large customers or government contracts;

·                   risks associated with the rights-of-way for our network;

·                   disruptions in our relationship with third party vendors;

·                   loss of key management personnel and the inability to attract and retain highly qualified management and personnel in the future;

 

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·                   changes in the extensive governmental legislation and regulations governing telecommunications providers, the provision of telecommunications services and access charges and  subsidies, which are a material part of our revenues;

·                   telecommunications carriers disputing and/or avoiding their obligations to pay network access charges for use of our network;

·                   high costs of regulatory compliance;

·                   the competitive impact of legislation and regulatory changes in the telecommunications industry;

·                   liability and compliance costs regarding environmental regulations; and

·                   the additional risk factors outlined in Part I — Item 1A — “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, and the other documents that we file with the SEC from time to time that could cause our actual results to differ from our current expectations and from the forward-looking statements discussed in this Report.

 

Many of these risks are beyond our ability to control or predict.  All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this Report.  Because of these risks, uncertainties, and assumptions, you should not place undue reliance on these forward-looking statements.  Furthermore, forward-looking statements speak only as of the date they are made.   Except as required under the federal securities laws or the rules and regulations of the SEC, we do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise.

 

Overview

 

We are an established rural local exchange company that provides communications services to residential and business customers in Illinois, Texas, and Pennsylvania. We offer a wide range of telecommunications services, including local and long-distance service, digital telephone (“VOIP”), custom calling features, private line services, dial-up and high-speed broadband Internet access (“DSL”), internet protocol digital television (“IPTV”), carrier access services, network capacity services over our regional fiber optic network, directory publishing and competitive local exchange carrier (“CLEC”) calling services.  We also operate a number of non-core complementary businesses, including providing telephone services to county jails and state prisons and equipment sales.

 

Executive Summary

 

We generated net income attributable to common stockholders of $6.9 million, or $0.23 per diluted share in the first three months of 2010, as compared to net income attributable to common stockholders of $3.3 million, or $0.11 per diluted share, in the first three months of 2009.  Net income in the first three months of 2010 benefited from increased earnings from our wireless partnerships and significantly lower operating expenses.  Operating expenses declined principally due to lower salary and benefit expenses as a result of workforce reductions taken at the end of the first quarter of 2009, lower pension expense and professional fees, and lower integration and restructuring costs.  Operating expenses in the first quarter of 2010 were higher due to increased video programming costs.  Operating expenses in the first quarter of 2009 were higher due to $2.4 million of integration and restructuring expense for which we are receiving cost savings on an ongoing basis.

 

Revenue in the first quarter of 2010 decreased to $98.3 million as compared to $101.7 million in the first quarter of 2009.  Decreased revenue in the first three months of 2010 resulted primarily from local access line loss, offset partially by increases in DSL and IPTV subscriptions.

 

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We completed the sale of our telemarketing business late in the first quarter of 2010, the assets and revenues of which were immaterial to our overall results of operations.

 

General

 

The following general factors should be considered in analyzing our results of operations:

 

Revenues

 

Telephone Operations and Other Operations.   Our revenues are derived primarily from the sale of voice and data communication services to residential and business customers in our rural telephone companies’ service areas.  Because we operate primarily in rural service areas, we do not anticipate significant growth in revenues in our Telephone Operations segment except through acquisitions.  However, we do expect relatively consistent cash flow from year to year because of stable customer demand, and a generally supportive regulatory environment.

 

Local access lines and bundled services. An “access line” is the telephone line connecting a home or business to the public switched telephone network.  The number of local access lines in service directly affects the monthly recurring revenue we generate from end users, the amount of traffic on our network, the access charges we receive from other carriers, the federal and state subsidies we receive, and most other revenue streams.  We had 244,696, 247,235 and 259,787 local access lines, respectively, in service as of March 31, 2010, December 31, 2009 and March 31, 2009.

 

Most wireline telephone companies have experienced a loss of local access lines due to challenging economic conditions and increased competition from wireless providers, competitive local exchange carriers and, in some cases, cable television operators.  We have not been immune to these conditions.  Cable competitors in all of our markets offer a competing voice product.  We estimate that cable companies offer voice service to all of their addressable customers, covering 85% of our entire service territory.

 

In addition, since we began to more aggressively promote our VOIP service, we estimate that approximately one-half of our VOIP telephone subscriber additions are switching from one of our traditional access lines.  We expect to continue to experience modest erosion in access lines both due to market forces and through our own cannibalization.

 

We have been able in some instances to offset the decline in local access lines with increased average revenue per access line by:

 

·                   Aggressively promoting DSL service, including selling DSL as a stand-alone offering;

·                   Value bundling services, such as DSL or IPTV, with a combination of local service and custom calling features;

·                   Maintaining excellent customer service standards; and

·                   Keeping a strong local presence in the communities we serve.

 

We have implemented a number of initiatives to gain new local access lines and retain existing lines by making bundled service packages more attractive (for example, by adding unlimited long-distance) and by announcing special promotions, like discounted second lines.  We also market a “triple play” bundle, which includes local telephone service, DSL, and IPTV.  As of March 31, 2010, IPTV was available to approximately 194,000 homes in our markets.  Our IPTV subscriber base continues to

 

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grow and totaled 24,898, 23,127 and 18,207 subscribers at March 31, 2010, December 31, 2009 and March 31, 2009, respectively.

 

We also continue to experience growth in the number of DSL subscribers we serve.  We had 102,132, 100,122 and 94,554 DSL lines in service as of March 31, 2010, December 31, 2009 and March 31, 2009, respectively.  Currently over 95% of our rural telephone companies’ local access lines are DSL-capable.

 

In addition to our access line, DSL and video initiatives, we intend to continue to integrate best practices across our markets. We also continue to look for ways to enhance current products and introduce new services to ensure that we remain competitive and continue to meet our customers’ needs. These initiatives have included:

 

·                   Hosted VOIP service in all of our markets to meet the needs of small- to medium-sized business customers that want robust functionality without having to purchase a traditional key or PBX phone system;

·                   VOIP service for residential customers, which is being offered to our customers as a growth opportunity and as an alternative to the traditional phone line for customers who are considering a switch to a cable competitor.  Since we began to more aggressively promote our VOIP service in situations in which we are attempting to save or win back customers, we estimate that the product has allowed us to reduce our residential customer loss by 10%;

·                   DSL service—even to users who do not have our access line—which expands our customer base and creates additional revenue-generating opportunities;

·                   Metro-Ethernet services delivered over our copper infrastructure with speeds of 25 mbps to 40 mbps;

·                   DSL product with speeds up to 20 mbps for those customers desiring greater Internet speed; and

·                   High definition video service and digital video recorders in all of our IPTV markets.

 

These efforts may mitigate the financial impact of any access line loss we experience.

 

As noted above, we also utilize service bundles to generate revenue and retain customers.  Our service bundles totaled 56,522, 56,856 and 41,415 at March 31, 2010, December 31, 2009 and March 31, 2009, respectively.

 

Expenses

 

Our primary operating expenses consist of the cost of services; selling, general and administrative expenses; and depreciation and amortization expenses.

 

Cost of services and products.   Our cost of services includes the following:

 

·                   Operating expenses relating to plant costs, including those related to the network and general support costs, central office switching and transmission costs, and cable and wire facilities;

·                   General plant costs, such as testing, provisioning, network, administration, power, and engineering; and

·                   The cost of transport and termination of long-distance and private lines outside our rural telephone companies’ service area.

·                   Video programming costs

 

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We have agreements with various carriers to provide long-distance transport and termination services.   We believe we will meet all of our commitments in these agreements and will be able to procure services for periods after our current agreements expire.  We do not expect any material adverse effects from any changes in any new service contract.

 

Selling, general and administrative expenses Selling, general and administrative expenses include expenses associated with customer care; billing and other operating support systems; and corporate expenses, such as professional service fees and non-cash, stock-based compensation.

 

Our operating support and back-office systems enter, schedule, provision, and track customer orders; test services and interface with trouble management; and operate inventory, billing, collections, and customer care service systems for the local access lines in our operations.  We have migrated most key business processes onto a single company-wide system and platform.  We hope to improve profitability by reducing individual company costs through centralizing, standardizing, and sharing best practices.  We incurred $2.4 million of integration and restructuring expenses during the first three months of 2009 related to moving the North Pittsburgh accounting, payroll and ILEC billings functions to our existing legacy systems.

 

Depreciation and amortization expenses.   The provision for depreciation on property and equipment is recorded using the straight-line method based upon the following useful lives:

 

Years

 

 

 

Buildings

 

18 - 40

 

Network and outside plant facilities

 

3 - 50

 

Furniture, fixtures and equipment

 

3 - 15

 

Capital Leases

 

11

 

 

Amortization expenses are recognized primarily for our intangible assets considered to have finite useful lives on a straight-line basis. In accordance with the applicable authoritative guidance, goodwill and intangible assets that have indefinite useful lives are not amortized but rather are tested at least annually for impairment.  Because tradenames have been determined to have indefinite lives, they are not amortized.  Customer relationships are amortized over their useful life.  The net carrying value of customer lists at March 31, 2010 is being amortized at a weighted-average life of approximately 3.2 years.

 

Results of Operations

 

Segments

 

We have two reportable business segments, Telephone Operations and Other Operations.  The results of operations discussed below reflect our consolidated results.

 

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For the Three Months Ended March 31, 2010  Compared to March 31, 2009

 

The following summarizes our revenues and operating expenses on a consolidated basis for the three months ended March 31, 2010 and 2009:

 

 

 

2010

 

2009

 

(In millions, except for percentages)

 

$

 

%

 

$

 

%

 

Revenue

 

 

 

 

 

 

 

 

 

Telephone operations

 

 

 

 

 

 

 

 

 

Local calling services

 

$

23.8

 

24.2

 

$

24.7

 

24.3

 

Network access services

 

21.2

 

21.6

 

22.0

 

21.6

 

Subsidies

 

12.2

 

12.4

 

14.1

 

13.9

 

Long-distance services

 

4.6

 

4.7

 

5.5

 

5.4

 

Data and Internet services

 

18.0

 

18.3

 

16.4

 

16.1

 

Other services

 

9.0

 

9.1

 

9.0

 

8.9

 

Total telephone operations

 

88.8

 

90.3

 

91.7

 

90.2

 

Other operations

 

9.5

 

9.7

 

10.0

 

9.8

 

 

 

 

 

 

 

 

 

 

 

Total operating revenue

 

98.3

 

100.0

 

101.7

 

100.0

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Telephone operations

 

50.0

 

50.9

 

54.3

 

53.4

 

Other operations

 

8.8

 

8.9

 

9.7

 

9.5

 

Depreciation and amortization

 

21.5

 

21.9

 

21.6

 

21.3

 

Total operating expense

 

80.3

 

81.7

 

85.6

 

84.2

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

18.0

 

18.3

 

16.1

 

15.8

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

12.9

 

13.1

 

14.5

 

14.2

 

Other income

 

6.3

 

6.4

 

4.5

 

4.4

 

Income tax expense

 

4.4

 

4.5

 

2.4

 

2.4

 

 

 

 

 

 

 

 

 

 

 

Net income

 

7.0

 

7.1

 

3.7

 

3.6

 

Net income attributable to noncontrolling interest

 

0.1

 

0.1

 

0.4

 

0.4

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common stockholders

 

$

6.9

 

7.0

 

$

3.3

 

3.2

 

 

Revenue

 

Revenue in the first three months of 2010 declined by $3.4 million, or 3.3%, to $98.3 million from $101.7 million in the first three months of 2009.  Overall, the decline in revenue was principally the result of year-over-year declines in the number of access lines, which impacted revenue for local calling services, network access services, subsidies and long-distance services, as well as from the sale in the first quarter of 2010 of our telemarketing business.  Access line loss continues to moderate and is being partially offset by growth in our number of broadband connections.  VOIP, DSL and IPTV connections all increased during the first three months of 2010 as compared to 2009.  Connections by type are as follows:

 

 

 

March 31,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Residential access lines in service

 

144,855

 

156,935

 

Business access lines in service

 

99,841

 

102,852

 

Total local access lines in service

 

244,696

 

259,787

 

 

 

 

 

 

 

IPTV subscribers

 

24,898

 

18,207

 

ILEC DSL subscribers

 

102,132

 

94,554

 

Total broadband connections

 

127,030

 

112,761

 

 

 

 

 

 

 

VOIP subscribers

 

8,529

 

7,141

 

CLEC access line equivalents (1)

 

73,413

 

73,737

 

 

 

 

 

 

 

Total connections

 

453,668

 

453,426

 

 

 

 

 

 

 

Long-distance lines (2)

 

170,765

 

165,892

 

Dial-up subscribers

 

2,205

 

3,612

 

 


(1)  CLEC access line equivalents represent a combination of voice services and data circuits.  The calculations represent a conversion of data circuits to an access line basis.  Equivalents are calculated by converting data circuits (basic rate interface, primary rate interface, DSL, DS-1, DS-3 and Ethernet) and SONET-based (optical) services (OC-3 and OC-48) to the equivalent of an access line.

 

(2) Reflects the inclusion of long-distance service provided as part of our VOIP offering while excluding CLEC long-distance subscribers.

 

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Telephone Operations Revenue

 

Local calling services revenue decreased by $0.9 million, or 3.6%, to $23.8 million in the first three months of 2010 compared to $24.7 million in the first three months of 2009.  The decrease is primarily due to the decline in local access lines.

 

Network access services revenue decreased by $0.8 million, or 3.6%, to $21.2 million in the first three months of 2010 compared to $22.0 million in the first three months of 2009.  The decrease is primarily due to a decline in switched access minutes of use, and to a lesser extent, a decline in special access revenue.

 

Subsidy revenue decreased by $1.9 million, or 13.5%, to $12.2 million in the first three months of 2010 compared to $14.1 million in the first three months of 2009.  The decrease is principally the result of an increase in the national average cost per loop component of the federal high cost fund as well as access line erosion.

 

Long-distance services revenue decreased by $0.9 million, or 16.4%, to $4.6 million in the first three months of 2010 as compared to $5.5 million in the first three months of 2009.  The decrease is primarily due to a decline in billable minutes, primarily due to customers moving to unlimited long-distance plans.

 

Data and Internet revenue increased by $1.6 million, or 9.8%, to $18.0 million in the first three months of 2010 as compared to $16.4 million in the first three months of 2009.  The increase is primarily due to an increase in the number of DSL and IPTV subscribers.

 

Other services revenue was flat, at $9.0 million in the first three months of both 2010 and 2009.

 

Other Operations Revenue

 

Other Operations revenue decreased by $0.5 million, or 5.0%, to $9.5 million in the first three months of 2010 as compared to $10.0 million in the first three months of 2009.  Declines in revenue resulting from the sale of our telemarketing business and from a decrease in incoming calls in our operator services business was offset by increases in our prison systems and equipment sales businesses.

 

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Operating Expenses

 

Operating expenses decreased in the first three months of 2010 by $5.2 million, or 8.1%, to $58.8 million as compared to $64.0 million in the first three months of 2009.  Reductions in operating expenses by segment are discussed below.

 

Telephone Operations Operating Expenses

 

Operating expenses for Telephone Operations decreased by $4.3 million, or 7.9%, to $50.0 million in the first three months of 2010 as compared to $54.3 million in the first three months of 2009.  The overall decrease in operating expenses was principally driven by a reduction in salaries and benefits as a result of a workforce reduction implemented late in the first quarter of 2009, lower pension expense and professional fees, and lower integration and restructuring costs.  These were offset somewhat by higher video programming fees.

 

Other Operations Operating Expenses

 

Operating expenses for Other Operations decreased by $0.9 million, or 9.3%, to $8.8 million in the first three months of 2010 as compared to $9.7 million in the first three months of 2009.  Operating expenses in our other Operations Segment declined as a result of lower costs related to the disposition of our telemarketing business.

 

Depreciation and Amortization

 

Depreciation and amortization expense was flat, totaling $21.5 million for the first three months of 2010 as compared to $21.6 million for the first three months of 2009.

 

Interest Expense, Net

 

Interest expense, net of interest income, declined by $1.6 million, or 11.0%, to $12.9 million for the first three moths of 2010 as compared to $14.5 million for the first three months of 2009.  Interest expense in the first quarter of 2010 benefited from the expiration of $135 million of floating to fixed interest rate swaps during 2009, as the fixed rates paid on the swaps were at a significantly higher rate than the LIBOR rates we received in return.  Interest expense also benefited in the first quarter of 2010 from lower interest rates in general.

 

Other Income (Expense)

 

Other income increased $1.8 million to $6.3 million in the first three months of 2010 compared to $4.5 million in the first three months of 2009.  The increase was principally due to improved earnings from our wireless partnership interests.

 

Income Taxes

 

Our provision for income taxes was $4.4 million in 2010 compared to $2.4 million in 2009.  Our effective tax rate was 38.6% for the three months ended March 31, 2010 compared to 39.2% for the three months ended March 31, 2009.  Our effective tax rate differs from the federal and state statutory rates primarily due to non-deductible expenses.

 

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Net Income Attributable to Noncontrolling Interest

 

The net income attributable to noncontrolling interest totaled $0.1 million in the first three months of 2010 versus $0.4 million in the first three months of 2009.  The income for our East Texas Fiber Line, Inc. subsidiary (a joint venture owned 63% by the Company and 37% by Eastex Celco) declined slightly period over period.

 

Liquidity and Capital Resources

 

Outlook and Overview

 

The following table sets forth selected information concerning our financial condition.

 

(In thousands)

 

March 31,
2010

 

December 31,
2009

 

Cash and cash equivalents

 

$

44,339

 

$

42,758

 

Working capital

 

34,135

 

23,789

 

Total debt

 

880,103

 

880,344

 

Current ratio

 

1.45

 

1.30

 

 

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 generated from our business and, if needed, from borrowings under our revolving credit facility.

 

As a general matter, we expect that our liquidity needs for the remainder of 2010 will arise primarily from: (i) dividend payments of between $33.0 million and $34.0 million; (ii) interest payments on our indebtedness of between $38.0 million and $41.0 million; (iii) capital expenditures of between $29.0 million and $31.0 million; (iv) cash income tax payments; (v) pension, 401(k) and other post retirement contributions of approximately $4.0 million; and (vi) certain other costs.  In addition, we may use cash and incur additional debt to fund selective acquisitions.  However, 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 approximately the next twelve months to fund our currently 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 do so 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 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

 

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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.

 

As discussed below, our term loan has been fully funded at a fixed spread above LIBOR and we have $50 million available under our revolving credit facility.   Based on our discussion with banks participating in the bank group, we expect that the funds will be available under the revolving credit facility if necessary.

 

Sources of Liquidity

 

Our current principal sources of liquidity are cash, cash equivalents, working capital, cash available under our secured revolving credit facility, and cash provided by operations.

 

Cash and cash equivalents .  For the first quarter of 2010, cash and cash equivalents increased by $1.5 million.

 

Cash provided by operations .  Net cash provided by operating activities in the first quarter of 2010 was $23.8 million, as compared to cash provided by operating activities of $19.4 million in the first quarter of 2009.  Cash provided by operations in 2010 increased primarily as a result of increased cash provided from our wireless partnerships, and improved operating performance.

 

Working capital .  Our net working capital position increased $10.2 million in the first quarter of 2010 over the fourth quarter of 2009 as a result of improved cash provided from operations.

 

Cash available under our secured revolving credit facility .  At March 31, 2010, we had no borrowings outstanding under our secured revolving credit facility and $50 million of availability.

 

Uses of Liquidity

 

Our principal uses of liquidity are dividend payments, interest expense and other payments on our debt, capital expenditures and payments made to fund our pension and other postretirement obligations.

 

Dividend payments .  During the first quarter of 2010, we used $11.5 million of cash to make dividend payments to shareholders.  During the first quarter of 2009, we used $11.4 million of cash to make dividend payments to shareholders.  Our current quarterly dividend rate is approximately $0.39 per share.

 

Interest and other payments related to outstanding debt .  During the first quarter of 2010, we used $12.3 million of cash to make required interest payments on our outstanding debt.  We also used $0.2 million of cash in the first quarter of 2010 to reduce our capital lease obligations.

 

Pension and postretirement obligations .  In the first quarter of 2010, we used $1.5 million of cash to fund pension, 401(k) and other postretirement obligations.

 

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Capital expenditures .  During the first quarter of 2010, we spent approximately $10.9 million on capital projects.

 

Debt

 

The following table summarizes our indebtedness as of March 31, 2010:

 

(In thousands)

 

Balance

 

Maturity Date

 

Rate (1)

 

 

 

 

 

 

 

Capital lease

 

$

103

 

April 12, 2010

 

7.4%

Revolving credit facility

 

 

December 31, 2013

 

LIBOR plus 2.50%

Term loan

 

$

880,000

 

December 31, 2014

 

LIBOR plus 2.50%

 


(1)           As of March 31, 2010, the 1-month LIBOR rate in effect on our borrowings was 0.23%.