Consolidated Communications Holdings
Consolidated Communications Holdings, Inc. (Form: 10-Q, Received: 05/04/2012 10:18:53)

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, 2012

 

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   x   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 1, 2012

Common Stock, $0.01 Par Value

 

29,951,282 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, 2012 and 2011

1

 

Condensed Consolidated Statements of Comprehensive Income (Unaudited) — Three month periods ended March 31, 2012 and 2011

2

 

Condensed Consolidated Balance Sheets — March 31, 2012 (Unaudited) and December 31, 2011

3

 

Condensed Consolidated Statement of Changes in Stockholders’ Equity (Unaudited) — Three months ended March 31, 2012

4

 

Condensed Consolidated Statements of Cash Flows (Unaudited) - Three month periods ended March 31, 2012 and 2011

5

 

Notes to Unaudited Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

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

24

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

37

 

 

 

Item 4.

Controls and Procedures

37

 

 

 

PART II

 

 

 

Item 1.

Legal Proceedings

39

 

 

 

Item 1A.

Risk Factors

40

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

40

 

 

 

Item 3.

Defaults Upon Senior Securities

40

 

 

 

Item 4.

Mine Safety Disclosures

41

 

 

 

Item 5.

Other Information

41

 

 

 

Item 6.

Exhibits

41

 



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)

 

2012

 

2011

 

 

 

 

 

 

 

Net revenues

 

$

93,364

 

$

95,441

 

Operating expense:

 

 

 

 

 

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

 

35,864

 

35,684

 

Selling, general and administrative expenses

 

19,528

 

20,699

 

Financing and other transaction costs

 

4,822

 

 

Depreciation and amortization

 

22,137

 

22,158

 

Operating income

 

11,013

 

16,900

 

Other income (expense):

 

 

 

 

 

Interest expense, net of interest income

 

(14,600

)

(11,939

)

Investment income

 

6,466

 

6,917

 

Other, net

 

14

 

227

 

Income before income taxes

 

2,893

 

12,105

 

Income tax expense

 

1,009

 

4,608

 

Net income

 

1,884

 

7,497

 

Less: net income attributable to noncontrolling interest

 

125

 

132

 

Net income attributable to common stockholders

 

$

1,759

 

$

7,365

 

 

 

 

 

 

 

Net income per common share—basic

 

$

0.06

 

$

0.25

 

 

 

 

 

 

 

Net income per common share—diluted

 

$

0.06

 

$

0.25

 

 

 

 

 

 

 

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 Statements of Comprehensive Income

(Unaudited)

 

 

 

Three months ended March 31,

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Net income

 

$

1,884

 

$

7,497

 

Change in prior service cost and net loss, net of tax of $272 and $287 for March 31, 2012 and 2011

 

449

 

492

 

Change in fair value of cash flow hedges, net of tax of $585 and $1,704 for March 31, 2012 and 2011

 

1,003

 

2,956

 

Comprehensive income

 

3,336

 

10,945

 

Less: comprehensive income attributable to noncontrolling interest

 

125

 

132

 

Total comprehensive income attributable to common stockholders

 

$

3,211

 

$

10,813

 

 

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

 

2



Table of Contents

 

Consolidated Communications Holdings, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

(In thousands, except share and per share amounts)

 

March 31,
2012

 

December 31,
2011

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

98,493

 

$

105,704

 

Accounts receivable, net of allowance for doubtful accounts of $2,747 in 2012 and $2,547 in 2011

 

34,169

 

35,492

 

Inventories

 

6,950

 

7,151

 

Income tax receivable

 

11,730

 

8,988

 

Deferred income taxes

 

4,825

 

4,825

 

Prepaid expenses and other current assets

 

9,563

 

6,170

 

Total current assets

 

165,730

 

168,330

 

 

 

 

 

 

 

Property, plant and equipment, net

 

326,550

 

332,046

 

Investments

 

98,559

 

98,069

 

Goodwill

 

520,562

 

520,562

 

Customer lists, net

 

52,276

 

57,811

 

Tradenames

 

12,347

 

12,347

 

Deferred debt issuance costs, net and other assets

 

8,719

 

4,904

 

Total assets

 

$

1,184,743

 

$

1,194,069

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

13,932

 

$

13,673

 

Advance billings and customer deposits

 

21,571

 

20,324

 

Dividends payable

 

11,602

 

11,571

 

Accrued expense

 

26,211

 

24,571

 

Current portion of senior secured term debt

 

8,800

 

8,800

 

Current portion of capital lease obligations

 

204

 

192

 

Current portion of derivative liability

 

11,149

 

3,580

 

Current portion of pension and postretirement benefit obligations

 

2,579

 

2,579

 

Total current liabilities

 

96,048

 

85,290

 

Long-term portion of capital lease obligation

 

4,462

 

4,519

 

Senior secured long-term debt

 

869,000

 

871,200

 

Deferred income taxes

 

78,184

 

77,327

 

Pension and other postretirement obligations

 

92,012

 

93,754

 

Other long-term liabilities

 

4,990

 

14,167

 

Total liabilities

 

1,144,696

 

1,146,257

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, par value $0.01 per share; 100,000,000 shares authorized, 29,951,282 and 29,869,512, shares outstanding as of March 31, 2012 and December 31, 2011, respectively

 

299

 

299

 

Additional paid-in capital

 

70,510

 

79,852

 

Retained earnings

 

 

 

Accumulated other comprehensive loss, net

 

(36,381

)

(37,833

)

Noncontrolling interest

 

5,619

 

5,494

 

Total stockholders’ equity

 

40,047

 

47,812

 

Total liabilities and stockholders’ equity

 

$

1,184,743

 

$

1,194,069

 

 

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 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, 2011

 

29,869,512

 

$

299

 

$

79,852

 

$

 

$

(37,833

)

$

5,494

 

$

47,812

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends on common stock

 

 

 

(9,843

)

(1,759

)

 

 

(11,602

)

Shares issued under employee plan, net of forfeitures

 

81,770

 

 

 

 

 

 

 

Non-cash, stock-based compensation

 

 

 

501

 

 

 

 

501

 

Comprehensive income

 

 

 

 

1,759

 

1,452

 

125

 

3,336

 

Balance - March 31, 2012

 

29,951,282

 

$

299

 

$

70,510

 

$

 

$

(36,381

)

$

5,619

 

$

40,047

 

 

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

 

4



Table of Contents

 

Consolidated Communications Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Three months ended March 31,

 

(In thousands)

 

2012

 

2011

 

Operating Activities

 

 

 

 

 

Net income

 

$

1,884

 

$

7,497

 

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

 

 

 

 

 

Depreciation and amortization

 

22,137

 

22,158

 

Deferred income taxes

 

 

298

 

Loss on disposal of assets

 

60

 

4

 

Cash distributions from wireless partnerships in excess of (less than) earnings

 

(374

)

2

 

Stock-based compensation expense

 

501

 

511

 

Amortization of deferred financing costs

 

3,463

 

324

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

1,323

 

2,727

 

Income tax receivable

 

(2,742

)

1,811

 

Inventories

 

201

 

(760

)

Other assets

 

(3,393

)

(1,646

)

Accounts payable

 

259

 

805

 

Accrued expenses and other liabilities

 

(519

)

(2,652

)

Net cash provided by operating activities

 

22,800

 

31,079

 

Investing Activities

 

 

 

 

 

Purchases of property, plant and equipment

 

(11,224

)

(10,043

)

Proceeds from the sale of assets

 

20

 

115

 

Other

 

92

 

 

Net cash used for investing activities

 

(11,112

)

(9,928

)

Financing Activities

 

 

 

 

 

Payment of capital lease obligation

 

(45

)

(34

)

Payment on long term debt

 

(2,200

)

 

Payment of financing cost

 

(5,083

)

 

Dividends on common stock

 

(11,571

)

(11,530

)

Net cash used for financing activities

 

(18,899

)

(11,564

)

Net increase/(decrease) in cash and equivalents

 

(7,211

)

9,587

 

Cash and equivalents at beginning of year

 

105,704

 

67,654

 

Cash and equivalents at end of period

 

$

98,493

 

$

77,241

 

 

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

Notes to Unaudited Condensed 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 in the United States 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, 2011.

 

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, 2012 and 2011.  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, 2012, the Company’s Summary of Critical Accounting Policies for the year ended December 31, 2011, which are detailed in the Company’s Annual Report on Form 10-K, have not changed.

 

Recent Accounting Pronouncements Applicable to the Company

 

Effective January 1, 2012, we adopted the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-04 (“ASU 2011-04”), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”).  This pronouncement was issued to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS.  ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements.  The adoption of this standard did not have a material impact on our consolidated financial statements.

 

Effective January 1, 2012, we adopted the FASB issued Accounting Standards Update No. 2011-05 (“ASU 2011-05”), Presentation of Comprehensive Income .  ASU 2011-05 requires an entity to either present components of net income and other comprehensive income in one continuous statement or in two separate but consecutive statements. Accordingly, we have presented net income and other comprehensive income in two consecutive statements.

 

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

 

2.                                     Agreement and Plan of Merger with SureWest Communications

 

On February 5, 2012, we entered into a definitive agreement to acquire all the outstanding shares of SureWest Communications (“SureWest”) for $23.00 per share in a cash and stock transaction with a total consideration of approximately $340.9 million, exclusive of debt, based on our February 3, 2012 closing stock price.  SureWest’s shareholders may elect to exchange each share of SureWest common stock for either $23.00 in cash or shares of Consolidated common stock having an equivalent value based on average trading prices for the 20-day period ending two days before the closing of the acquisition, subject to a collar so that there will be a maximum exchange ratio of 1.40565 shares of Consolidated common stock for each share of SureWest common stock and a minimum of 1.03896 shares of Consolidated common stock for each share of SureWest common stock. Overall elections are subject to proration so that 50% of the SureWest shares (treating equity award shares as outstanding shares) will be exchanged for cash and 50% for stock.  In order to preserve the tax-free nature of the transaction, the Agreement and Plan of Merger for the transaction also provides for a general consideration adjustment in certain circumstances.

 

The merger is subject to approval by SureWest shareholders, with a vote scheduled for June 12, 2012, approval by our stockholders of the issuance of our common stock to SureWest shareholders, with a vote scheduled for June 12, 2012, other regulatory approvals and customary closing conditions.  In April 2012, we and the regulated SureWest subsidiaries reached a settlement agreement with the advocacy groups Division of Ratepayer Advocates and The Utility Reform, which had previously filed protests with the Public Utilities Commission of the State of California (“California PUC”) concerning the SureWest acquisition and also filed a joint petition to the California PUC that requests it issue an order approving the settlement.  As a consequence, there is no longer any party in the California PUC proceeding opposing the proposed merger.  We anticipate closing on the SureWest transaction early in the third quarter of 2012.

 

3.                                     Prepaid and other current assets

 

Prepaid and other current assets are as follows:

 

(In thousands)

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Prepaid maintenance

 

$

3,021

 

$

1,980

 

Prepaid taxes

 

2,122

 

440

 

Deferred charges

 

770

 

784

 

Prepaid insurance

 

887

 

313

 

Prepaid expense - other

 

2,718

 

2,607

 

Other current assets

 

45

 

46

 

Total

 

$

9,563

 

$

6,170

 

 

4.                                     Property, plant and equipment

 

Property, plant and equipment are as follows:

 

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Table of Contents

 

(In thousands)

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Land and buildings

 

$

66,844

 

$

66,704

 

Network and outside plant facilities

 

900,651

 

897,140

 

Furniture, fixtures and equipment

 

72,925

 

73,185

 

Assets under capital lease

 

10,014

 

10,014

 

Less: accumulated depreciation

 

(734,877

)

(721,527

)

 

 

315,557

 

325,516

 

Construction in progress

 

10,993

 

6,530

 

Totals

 

$

326,550

 

$

332,046

 

 

Depreciation expense totaled $16.6 million for the three month periods ended March 31, 2012 and 2011, respectively.

 

5.                                     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.  It is not practicable to estimate fair value of these investments.  We did not evaluate any of the investments for impairment as no factors indicating impairment existed during the year.  For the three month periods ended March 31, 2012 and 2011, we received cash distributions from these partnerships totaling $2.6 million and $3.0 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.  Because we have some influence over the operating and financial policies of these three entities, we account for the investments using the equity method.  For the three month periods ended March 31, 2012 and 2011, we received cash distributions from these partnerships totaling $3.6 million and $3.9 million, respectively.

 

Our investments are as follows:

 

(In thousands)

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Cash surrender value of life insurance policies

 

$

2,124

 

$

1,978

 

Cost method investments:

 

 

 

 

 

GTE Mobilnet of South Texas Limited Partnership (2.34% interest)

 

21,450

 

21,450

 

Pittsburgh SMSA Limited Partnership (3.60% interest)

 

22,950

 

22,950

 

CoBank, ACB Stock

 

3,456

 

3,394

 

Other

 

15

 

15

 

Equity method investments:

 

 

 

 

 

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

 

19,540

 

19,422

 

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

 

7,010

 

7,063

 

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

 

22,014

 

21,797

 

Total

 

$

98,559

 

$

98,069

 

 

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Table of Contents

 

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.

 

Selective summarized financial information for the three equity method investments was as follows:

 

 

 

Three months ended March 31,

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Total revenues

 

$

72,336

 

$

69,063

 

Income from operations

 

19,692

 

20,165

 

Net income before taxes

 

19,710

 

20,192

 

Net income

 

19,605

 

20,092

 

 

 

 

March 31,

 

December 31,

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Current assets

 

$

44,761

 

$

44,739

 

Non-current assets

 

77,846

 

79,432

 

Current liabilities

 

12,899

 

14,523

 

Non-current liabilities

 

1,152

 

1,096

 

Partnership equity

 

108,557

 

108,552

 

 

6.                                     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 liabilities measured at fair value on a recurring basis subject to disclosure requirements at March 31, 2012 and December 31, 2011 were as follows:

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

(In thousands)

 

March 31, 2012

 

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 liabilities

 

$

(11,149

)

 

$

(11,149

)

 

Long-term interest rate swap liabilities

 

(3,228

)

 

(3,228

)

 

Totals

 

$

(14,377

)

$

 

$

(14,377

)

$

 

 

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Table of Contents

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

(In thousands)

 

December 31,
2011

 

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 liabilities

 

$

(3,580

)

 

$

(3,580

)

 

Long-term interest rate swap liabilities

 

(12,401

)

 

(12,401

)

 

Totals

 

$

(15,981

)

$

 

$

(15,981

)

$

 

 

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, 2012 and December 31, 2011.

 

 

 

As of March 31, 2012

 

As of December 31, 2011

 

(In thousands)

 

Carrying Value

 

Fair Value

 

Carrying Value

 

Fair Value

 

Investments, equity basis

 

$

48,564

 

n/a

 

$

48,282

 

n/a

 

Investments, at cost

 

$

47,871

 

n/a

 

$

47,809

 

n/a

 

Long-term debt

 

$

877,800

 

$

877,800

 

$

880,000

 

$

880,000

 

 

The Company’s investments at March 31, 2012 and December 31, 2011 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.

 

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.  Based upon the inputs of the LIBOR based yield curve, which can be corroborated by observable market data, we have categorized the long-term debt as Level 2 within the fair value hierarchy.

 

7.                                     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,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Telephone Operations

 

$

519,542

 

$

519,542

 

Other Operations

 

1,020

 

1,020

 

Totals

 

$

520,562

 

$

520,562

 

 

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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 indefinite lived intangibles.  The carrying value of the tradenames was $12.3 million at both March 31, 2012 and December 31, 2011.

 

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,
2012

 

December 31,
2011

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

 

 

 

 

Gross carrying amount

 

$

193,124

 

$

193,124

 

$

4,405

 

$

4,405

 

Less: accumulated amortization

 

(141,178

)

(135,754

)

(4,075

)

(3,964

)

Net carrying amount

 

$

51,946

 

$

57,370

 

$

330

 

$

441

 

 

Amortization associated with customer lists totaled approximately $5.5 million in each of the three month periods ended March 31, 2012 and 2011.

 

8.                                     Deferred Debt Issuance Costs, Net and Other Assets

 

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

 

(In thousands)

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Deferred debt issuance costs, net

 

$

8,646

 

$

4,833

 

Other assets

 

73

 

71

 

Total

 

$

8,719

 

$

4,904

 

 

Deferred debt issuance costs are subject to amortization.  Deferred debt issuance costs of $5.5 million at March 31, 2012 related to our secured credit facility will be amortized over the term of the corresponding debt.  The remaining $3.1 million deferred debt issuance costs relate to our bridge financing and will be amortized over the expected life of the bridge loan.

 

9.                                     Accrued Expenses

 

Accrued expenses are as follows:

 

(In thousands)

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Accrued salaries and employee benefits

 

$

7,495

 

$

10,235

 

Accrued financing fees

 

6,125

 

 

Taxes payable

 

1,954

 

4,599

 

Accrued interest

 

260

 

237

 

Accrued site commissions

 

2,799

 

3,559

 

Other accrued expenses

 

7,578

 

5,941

 

Total accrued expenses

 

$

26,211

 

$

24,571

 

 

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10.                              Debt

 

Long-term debt consists of the following:

 

(In thousands)

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Senior secured credit facility - revolving loan

 

$

 

$

 

Senior secured credit facility - term loan

 

877,800

 

880,000

 

 

 

877,800

 

880,000

 

Less: current portion

 

(8,800

)

(8,800

)

Total long-term debt

 

$

869,000

 

$

871,200

 

 

Credit Agreement

 

The Company, through certain of its wholly owned subsidiaries, has an 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 $877.8 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.

 

Our term loan credit facility is made up of two separate tranches, resulting in different maturity dates and interest rate margins for each term loan tranche.  The first term loan tranche consists of $469.8 million aggregate principal amount, matures on December 31, 2014 and has an applicable margin (at our election) equal to either 2.50% for a LIBOR-based term loan or 1.50% for an alternative base rate loan.  The second term loan tranche consists of $408.0 million aggregate principal amount, matures on December 31, 2017 and has an applicable margin (at our election) equal to either 3.75% for a LIBOR-based term loan or 2.75% for an alternative base rate term loan.  The applicable margins for each of the term loan tranches are fixed for the duration of the loans.  The amended term loan facility also requires $2.2 million in quarterly principal payments which began on March 31, 2012.

 

Our revolving credit facility has a maturity date of June 8, 2016 and an applicable margin (at our election) of between 2.75% and 3.50% for LIBOR-based borrowings and between 1.75% and 2.50% for alternative base rate borrowings, depending on our leverage ratio.  Based on our leverage ratio of 4.59:1 at March 31, 2012, the borrowing margin for the next three month period ending June 31, 2012 will be at a weighted-average margin of 3.25% for a LIBOR-based loan or 2.25% for an alternative base rate loan.  The applicable borrowing margin for the revolving credit facility is adjusted quarterly to reflect the leverage ratio from the prior quarter-end.  There were no borrowings or letters of credit outstanding under the revolving credit facility as of March 31, 2012 or December 31, 2011, or at any time during the quarter ended March 31, 2012.

 

The weighted-average interest rate incurred on our credit facilities during the three month periods ended March 31, 2012 and 2011, including amounts paid on our interest rate swap agreements and the applicable margin, was 4.90% and 5.15% 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, 2012, we were in compliance with the credit agreement covenants.

 

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Table of Contents

 

In connection with the acquisition of SureWest described in Note 2, on February 5, 2012 the Company received committed financing for a total of $350.0 million to fund the cash portion of the anticipated transaction, to refinance SureWest’s debt and to pay for certain transaction costs. The financing package includes a $350.0 million Senior Unsecured Bridge Loan Facility (“Bridge Facility”) with a one year maturity and a seven year rollover to Senior Unsecured Notes at our election.  Though the financing under the Bridge Facility is currently committed, no amount has been drawn or funded as of March 31, 2012.  In connection with the Bridge Facility we recorded $6.1 million in commitment fees which were capitalized as deferred debt issuance costs and are being amortized over the expected life of the Bridge Facility of less than one year.

 

Also in connection with the acquisition of SureWest, we amended our credit facility which became effective on February 17, 2012.  The amendment provides us with the ability to escrow proceeds from a high-yield note offering prior to closing the acquisition and, until closing, excludes the debt from current leverage calculations.  The amendment also permits us additional flexibility for future high yield notes issuances with the same subsidiary guarantees as the current credit facility.  All other terms, coverage and leverage ratios were unchanged.   Fees totaling $3.5 million were recognized as expense in connection with the amendment while $1.2 million in fees were capitalized as deferred debt issuance costs and amortized over the remaining life of the term debt.

 

11.                              Derivatives

 

In order to manage the risk associated with changes in interest rates, we have entered into 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 ASC 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 income (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.

 

The following interest rate swaps, all designated as cash flow hedges, were outstanding at March 31, 2012:

 

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Table of Contents

 

(In thousands)

 

Notional
Amount

 

2012 Balance Sheet Location

 

Fair
Value

 

 

 

 

 

 

 

 

 

Fixed to 3-month floating LIBOR

 

$

100,000

 

Current portion of long-term liabilities

 

$

(2,723

)

Fixed to 3-month floating LIBOR

 

130,000

 

Current portion of long-term liabilities

 

(5,134

)

3-month floating LIBOR minus spread to 1-month floating LIBOR

 

100,000

 

Current portion of long-term liabilities

 

(105

)

3-month floating LIBOR minus spread to 1-month floating LIBOR

 

130,000

 

Current portion of long-term liabilities

 

(162

)

Fixed to 1-month floating LIBOR

 

100,000

 

Other long-term liabilities

 

(1,922

)

Fixed to 1-month floating LIBOR

 

200,000

 

Current portion of long-term liabilities

 

(3,025

)

Forward starting fixed to 1-month floating LIBOR

 

275,000

 

Other long-term liabilities

 

(1,306

)

Total Fair Values

 

 

 

 

 

$

(14,377

)

 

The following interest rate swaps, all designated as cash flow hedges, were outstanding at December 31, 2011:

 

(In thousands)

 

Notional
Amount

 

2011 Balance Sheet Location

 

Fair Value

 

 

 

 

 

 

 

 

 

Fixed to 3-month floating LIBOR

 

$

100,000

 

Current portion of long-term liabilities

 

$

(3,401

)

Fixed to 3-month floating LIBOR

 

130,000

 

Other long-term liabilities

 

(6,053

)

3-month floating LIBOR minus spread to 1-month floating LIBOR

 

100,000

 

Current portion of long-term liabilities

 

(179

)

3-month floating LIBOR minus spread to 1-month floating LIBOR

 

130,000

 

Other long-term liabilities

 

(269

)

Fixed to 1-month floating LIBOR

 

300,000

 

Other long-term liabilities

 

(5,343

)

Forward starting fixed to 1-month floating LIBOR

 

200,000

 

Other long-term liabilities

 

(736

)

Total Fair Values

 

 

 

 

 

$

(15,981

)

 

At both March 31, 2012 and December 31, 2011, the interest rate on approximately 60%, respectively, of our outstanding debt was fixed through the use of interest rate swaps.

 

The counterparties to our various swaps are 5 major U.S. and European banks.  None of the swap agreements provide for either us or the counterparties to post collateral nor do the agreements include any covenants related to the financial condition of Consolidated or the counterparties.  The

 

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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.

 

At March 31, 2012 and December 31, 2011, the pretax deferred losses related to our interest rate swap agreements included in accumulated other comprehensive income totaled $14.3 million and $15.9 million, respectively.  The change in fair value of any ineffective portion of the hedging derivative is recognized immediately in earnings.

 

Information regarding our cash flow hedge transactions at March 31 are as follows:

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Loss/(gain) recognized in accumulated other comprehensive income (loss) (“AOCI”) (net of tax)

 

$

(1,003

)

$

(2,956

)

Loss/(gain) arising from ineffectiveness increasing/(reducing) interest expense

 

$

(16

)

$

(34

)

Deferred losses/(gains) reclassed from AOCI to interest expense

 

$

(13

)

$

483

 

 

(In thousands, except months)

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Aggregate notional value of current derivatives outstanding

 

$

530,000

 

$

530,000

 

Aggregate notional value of forward derivatives outstanding

 

$

275,000

 

$

200,000

 

Period through which derivative positions currently exist

 

March 2016

 

June 2015

 

Fair value of derivatives

 

$

14,377

 

$

15,981

 

Deferred losses included in AOCI (pretax)

 

$

14,343

 

$

15,932

 

Gains included in AOCI to be recognized in the next 12 months

 

$

55

 

$

65

 

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

 

12

 

15

 

 

12.           Interest Expense, Net of Interest Income

 

The following table summarizes interest expense for the three month periods end March 31:

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Interest expense — credit facility

 

$

7,460

 

$

6,087

 

Payments on swap liabilities, net

 

3,461

 

5,257

 

Amortization of deferred financing costs — bridge facility

 

3,063

 

 

Interest expense- capital leases

 

161

 

156

 

Uncertain tax position interest accrual

 

9

 

12

 

Other interest

 

128

 

173

 

Amortization of deferred financing fees

 

400

 

324

 

Capitalized interest

 

(40

)

(33

)

Total interest expense

 

14,642

 

11,976

 

Less: interest income

 

(42

)

(37

)

Interest expense, net of interest income

 

$

14,600

 

$

11,939

 

 

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Table of Contents

 

13.                              Retirement and Pension Plans

 

We offer defined contribution 401(k) plans to substantially all of our employees.  Contributions made under our defined contribution plans include a match, at the Company’s discretion, of employee contributions to the plans.  We recognized expense with respect to these plans of $0.6 million and $0.7 million for the three month periods ended March 31, 2012 and 2011.

 

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)

 

2012

 

2011

 

 

 

 

 

 

 

Service cost

 

$

357

 

$

416

 

Interest cost

 

2,627

 

2,549

 

Expected return on plan assets

 

(2,611

)

(2,494

)

Net amortization loss

 

798

 

870

 

Prior service credit amortization

 

(41

)

(51

)

Net periodic pension cost

 

$

1,130

 

$

1,290

 

 

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 cover certain former employees of our Pennsylvania and Texas operations.  The Restoration Plans restores 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 following table summarizes the components of net periodic pension cost for the Restoration Plans for the three months ended March 31:

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Interest cost

 

$

14

 

$

14

 

Net amortization loss

 

11

 

12

 

Net periodic pension cost

 

$

25

 

$

26

 

 

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

 

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Table of Contents

 

deferred compensation agreements totaled approximately $0.1 million for the three month period ended March 31, 2012 and $0.2 million for the three month period ended March 31, 2011.  The net present value of the remaining obligations was approximately $2.4 million at March 31, 2012 and $2.5 million at December 31, 2011, 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, 2012 or 2011 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 $2.1 million at March 31, 2012 and $2.0 million at December 31, 2011.  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.

 

14.                              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.

 

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

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Service cost

 

$

213

 

$

223

 

Interest cost

 

414

 

392

 

Net prior service cost amortization

 

(47

)

(47

)

Net periodic postretirement benefit cost

 

$

580

 

$

568

 

 

15.                              Other Long-term Liabilities

 

Other long-term liabilities are as follows:

 

(In thousands)

 

March 31,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Long-term derivative liabilities

 

$

3,228

 

$

12,401

 

Uncertain tax positions

 

1,224

 

1,224

 

Accrued interest on uncertain tax positions

 

59

 

50

 

Other long-term liabilities

 

479

 

492

 

Total

 

$

4,990

 

$

14,167

 

 

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Table of Contents

 

16.                              Stock-based Compensation Plans

 

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

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Restricted stock

 

$

325

 

$

349

 

Performance shares

 

176

 

162

 

Total

 

$

501

 

$

511

 

 

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

 

As of March 31, 2012, we had not yet recognized compensation expense on the following non-vested awards.

 

(In thousands)

 

Non-recognized
Compensation

 

Average Remaining
Recognition Period
(years)

 

 

 

 

 

 

 

Restricted stock

 

$

2,177

 

1.5

 

Performance shares

 

1,773

 

1.5

 

Total

 

$

3,950

 

1.5

 

 

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

 

 

 

2012

 

2011

 

 

 

# of
Shares

 

Price(1)

 

# of
Shares

 

Price(1)

 

Non-vested restricted shares outstanding – January 1

 

129,203

 

$

17.79

 

101,435

 

$

17.40

 

Shares granted

 

14,732

 

19.30

 

127,377

 

17.92

 

Shares vested

 

 

 

 

 

Non-vested restricted shares outstanding – March 31

 

143,935

 

$

17.94

 

228,812

 

$

17.69

 

 


(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:

 

 

 

2012

 

2011

 

 

 

# of
Shares

 

Price(1)

 

# of
Shares

 

Price(1)

 

 

 

 

 

 

 

 

 

 

 

Non-vested performance shares outstanding – January 1

 

50,879

 

$

17.04

 

68,880

 

$

15.74

 

Shares granted

 

67,040

 

17.92

 

50,440

 

18.65

 

Shares vested

 

 

 

 

 

Non-vested performance shares outstanding – March 31

 

117,919

 

$

17.54

 

119,320

 

$

16.66

 

 


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

 

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17.                              Income Taxes

 

There have been no changes to the balance of our unrecognized tax benefits reported at December 31, 2011.  As of March 31, 2012 and December 31, 2011, the amount of unrecognized tax benefits was $1.2 million.  The total amount of unrecognized benefits that, if recognized, would affect the effective tax rate is $0.8 million.  We do not expect any changes in our unrecognized tax benefits during the remainder of 2012.

 

Our practice is to recognize interest and penalties related to income tax matters in interest expense and general and administrative expense, respectively.  At March 31, 2012, we had no material liability for interest or penalties and had no material interest or penalty expense.

 

The only periods subject to examination for our federal return are years 2008 through 2010.  The periods subject to examination for our state returns are years 2005 through 2010.  We are not currently under examination by federal taxing authorities.  We are currently under examination by state taxing authorities.  We do not expect any settlement or payment that may result from the audit to have a material effect on our results of operations or cash flows.

 

Our effective tax rate was 34.9% and 38.1%, for the three months ended March 31, 2012 and 2011, respectively.  The effective tax rate differs from the federal and state statutory rates primarily due to non-deductible expenses and a change in the Illinois state income tax rate.

 

18.                              Accumulated Other Comprehensive Loss, Net

 

Accumulated other comprehensive loss, net is comprised of the following components:

 

 

 

March 31,

 

December 31,

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Fair value of cash flow hedges

 

$

(14,343

)

$

(15,932

)

Prior service credits and net losses on postretirement plans

 

(43,382

)

(44,102

)

 

 

(57,725

)

(60,034

)

Deferred taxes

 

21,344

 

22,201

 

Totals

 

$

(36,381

)

$

(37,833

)

 

19.                              Environmental Remediation Liabilities

 

Environmental remediation liabilities were $0.2 million and $0.3 million at March 31, 2012 and December 31, 2011, and are included in other long-term 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.

 

20.                              Capital Leases

 

The Company has four capital leases, all of which expire in 2021, for the lease of office, warehouse and tech center space.  As of March 31, 2012, the present value of the minimum remaining lease commitments was approximately $4.7 million, of which $0.2 million is due and payable within the next 12 months.  The leases will require total rental payments to LATEL, a related party entity, of approximately $7.9 million and total rental payments to Spruce of approximately $1.6 million over the term of the leases.  These leases have total payments of $8.4 million on the remaining terms of the leases.

 

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21.                              Litigation and Contingencies

 

Six putative class action lawsuits have been filed by alleged SureWest shareholders challenging the Company’s proposed merger with SureWest in which the Company, WH Acquisition Corp. and WH Acquisition II Corp, SureWest and members of the SureWest board of directors have been named as defendants. Five shareholder actions were filed in the Superior Court of California, Placer County, and one shareholder action was filed in the United States District Court for the Eastern District of California. The actions are called Needles v. SureWest Communications, et al., filed February 17, 2012, Errecart v. Oldham, et al., filed February 24, 2012, Springer v. SureWest Communications, et al., filed March 9, 2012, Aievoli v. Oldham, et al., filed March 15, 2012, and Waterbury v. SureWest Communications, et al., filed March 26, 2012, and the federal action is called Broering v. Oldham, et al., filed April 18, 2012. The actions generally allege, among other things, that each member of the SureWest board of directors breached fiduciary duties to SureWest and its shareholders by authorizing the sale of SureWest to the Company for consideration that allegedly is unfair to the SureWest shareholders and agreeing to terms that allegedly unduly restrict other bidders from making a competing offer. The complaints also allege that the Company and SureWest aided and abetted the breaches of fiduciary duties allegedly committed by the members of the SureWest board of directors. The Broering complaint also alleges, among other things, that the joint proxy statement/prospectus filed with the SEC on March 28, 2012 does not make sufficient disclosures regarding the merger, that SureWest’s board should have appointed an independent committee to negotiate the transaction and that SureWest should have gone back to another bidder to create a competitive bid process. The lawsuits seek equitable relief, including an order to prevent the defendants from consummating the merger on the agreed-upon terms and/or an award of unspecified money damages. We believe that these claims are without merit. On March 14, 2012, the Placer County Superior Court entered an order consolidating the Needles, Errecart and Springer actions into a single action under the caption In re SureWest Communications Shareholder Litigation. Under the terms of this order, all cases subsequently filed in the Superior Court for the State of California, County of Placer, that relate to the same subject matter and involve similar questions of law or fact are to be consolidated with these cases as well. Any party objecting to such consolidation must file its objection within ten days of receiving a copy of the order. Attorneys for the plaintiffs in Aievoli and Waterbury received copies of the order on or before March 29, 2012 and have not filed any objection. On April 10, 2012, the plaintiff in Waterbury filed a request for voluntary dismissal of her complaint without prejudice.

 

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.  Salsgiver originally claimed to have sustained losses of approximately $125 million and did 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 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.

 

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Two of our subsidiaries, Consolidated Communications of Pennsylvania Company LLC (“CCPA”) and Consolidated Communications Enterprise Services Inc. (“CCES”), received assessment notices from the Commonwealth of Pennsylvania Department of Revenue increasing the amounts owed for Pennsylvania Gross Receipt Taxes for the tax period ending December 31, 2009.  These two assessments adjusted the subsidiaries’ combined total outstanding taxable gross receipts liability (with interest) to approximately $2.3 million.  In addition, based upon recently completed audits of CCES for 2008, 2009 and 2010, we believe the Commonwealth of Pennsylvania may issue additional assessments totaling approximately $1.7 million for Gross Receipt Taxes allegedly owed.  Our CCPA subsidiary has also been notified by the Commonwealth of Pennsylvania that they will conduct a gross receipts audit for the calendar year 2008.  An appeal challenging the 2009 CCPA assessment was filed with the Department of Revenue’s Board of Appeals on September 15, 2011, and we filed a similar appeal for CCES with the Board of Appeals on November 11, 2011 challenging the 2009 CCES assessment.  We also intend to appeal any adverse decisions from the Board of Appeals involving CCPA or CCES to the Commonwealth’s Board of Finance and Revenue.  At the Board of Finance and Revenue, we anticipate that these matters will be continued pending the outcome of present litigation in Commonwealth Court between Verizon Pennsylvania, Inc and the Commonwealth of Pennsylvania (Verizon Pennsylvania, Inc. v. Commonwealth, Docket No. 266 F.R. 2008).  The Gross Receipts Tax issues in the Verizon Pennsylvania case are substantially the same as those presently facing CCPA and CCES.  In addition, there are numerous telecommunications carriers with Gross Receipts Tax matters dealing with the same issues that are in various stages of appeal before the Board of Finance and Revenue and the Commonwealth Court.  Those appeals by other similarly situated telecommunications carriers have been continued until resolution of the Verizon Pennsylvania case.  We believe that these assessments and the positions taken by the Commonwealth of Pennsylvania are without substantial merit.  We do not believe that the outcome of 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, will 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.

 

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For the Three Months
Ended March 31,

 

(In thousands, except per share amounts)

 

2012

 

2011

 

 

 

 

 

 

 

Basic Earnings Per Share Using Two-class Method:

 

 

 

 

 

Net income

 

$

1,884

 

$

7,497

 

Less: net income attributable to noncontrolling interest

 

125

 

132

 

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

 

1,759

 

7,365

 

Less: earnings allocated to participating securities

 

65

 

127

 

Net income attributable to common stockholders

 

$

1,694

 

$

7,238

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding

 

29,689

 

29,593

 

 

 

 

 

 

 

Net income per common share attributable to common stockholders - basic

 

$

0.06

 

$

0.25

 

 

 

 

 

 

 

Diluted Earnings Per Share Using Two-class Method:

 

 

 

 

 

Net income

 

$

1,884

 

$

7,497

 

Less: net income attributable to noncontrolling interest

 

125

 

132

 

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

 

1,759

 

7,365

 

Less: earnings allocated to participating securities

 

65

 

127

 

Net income attributable to common stockholders

 

$

1,694

 

$

7,238

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding (1)

 

29,689

 

29,593

 

 

 

 

 

 

 

Net income per common share attributable to common stockholders - diluted

 

$

0.06

 

$

0.25

 

 


(1)  To the extent that restricted shares are anti-dilutive, they have been excluded from the calculation of diluted earnings per share in accordance with the applicable accounting guidance.

 

An additional 0.3 million shares were not included in the computation of potentially dilutive securities at March 31, 2012 and 2011, because they were anti-dilutive.

 

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

 

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Three Months Ended
March 31,

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Telephone operations

 

$

85,083

 

$

87,394

 

Other operations

 

8,281

 

8,047

 

Total net revenue

 

93,364

 

95,441

 

 

 

 

 

 

 

Operating expense — telephone operations

 

52,888

 

48,945

 

Operating expense — other operations

 

7,326

 

7,438

 

Total operating expense

 

60,214

 

56,383

 

 

 

 

 

 

 

Depreciation and amortization expense — telephone operations

 

21,929

 

21,947

 

Depreciation and amortization expense — other operations

 

208

 

211

 

Total depreciation expense

 

22,137

 

22,158

 

 

 

 

 

 

 

Operating income — telephone operations

 

10,266

 

16,502

 

Operating income - other operations

 

747

 

398

 

Total operating income

 

11,013

 

16,900

 

 

 

 

 

 

 

Interest expense, net of interest income

 

(14,600

)

(11,939

)

Investment income

 

6,466

 

6,917

 

Other, net

 

14

 

227

 

Income before taxes

 

$

2,893

 

$

12,105

 

 

 

 

 

 

 

Capital expenditures:

 

 

 

 

 

Telephone operations

 

$

11,151

 

$

9,987

 

Other operations

 

73

 

56

 

Total

 

$

11,224

 

$

10,043

 

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Goodwill:

 

 

 

 

 

Telephone operations

 

$

519,542

 

$

519,542

 

Other operations

 

1,020

 

1,020

 

Total

 

$

520,562

 

$

520,562

 

 

 

 

 

 

 

Total assets:

 

 

 

 

 

Telephone operations (1)

 

$

1,178,753

 

$

1,187,708

 

Other operations

 

5,990

 

6,361

 

Total

 

$

1,184,743

 

$

1,194,069

 

 


(1)            Included within the telephone operations segment assets are our equity method investments totaling $48.6 million at March 31, 2012 and $48.3 million at December 31, 2011, 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, 2012 and 2011 should be read in conjunction with the unaudited condensed 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:

 

·                   our ability to complete the proposed merger with SureWest Communications (“SureWest”);

·                   our ability to successfully integrate SureWest’s operations and to realize the synergies from the acquisition;

·                   failure of SureWest’s shareholders to approve the Agreement and Plan of Merger, dated as of February 5, 2012 (the “Merger Agreement”), by and among the Company, SureWest, WH Acquisition Corp, and WH Acquisition II Corp.;

·                   failure of our stockholders to approve the issuance of our common stock to SureWest shareholders contemplated by the Merger Agreement;

·                   failure to obtain, delays in obtaining or adverse conditions contained in any required regulatory approvals;

·                   final terms of the financing we use for the cash portion of the merger consideration contemplated by the Merger Agreement and to repay SureWest debt;

·                   risks to the mergers contemplated by the Merger Agreement and the surviving company related to litigation in which we and SureWest are or may become involved;

·                   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 refinance it or to incur additional debt in the future;

 

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·                   our need for a significant amount of cash to service 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;

·                   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, 2011, 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 U.S. Securities and Exchange Commission, 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 carrier 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, high-speed broadband Internet access (“DSL”), standard and high-definition digital television (“IPTV”), digital telephone service (“VOIP”), custom calling features, private line services, carrier access services, network capacity services over our regional fiber optic network, directory publishing and Competitive Local Exchange Carrier (“CLEC”) services.  We also operate two non-core complementary businesses:  telephone services to correctional facilities and equipment sales.

 

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Executive Summary

 

On February 5, 2012, we entered into a definitive agreement with SureWest Communications (“SureWest”) to acquire all of its outstanding shares in a cash and stock transaction for a total consideration valued at approximately $340.9 million, exclusive of debt, based on our February 3, 2012 closing stock price.  SureWest provides a wide range of telecommunications, digital video, Internet, data and other facilities-based communications services in Northern California, primarily in the greater Sacramento region, and in the greater Kansas City, Kansas and Missouri areas.  In 2011, SureWest reported $248.1 million in total operating revenues.  We anticipate closing on the SureWest transaction early in the third quarter of 2012.

 

We generated net income attributable to common stockholders of $1.8 million, or $0.06 per diluted share, in the first three months of 2012, as compared to net income attributable to common stockholders of $7.4 million, or $0.25 per diluted share, in the first three months of 2011.  Net income for first three months of 2012 is lower than the first three months of 2011 primarily due to certain financing and transaction related costs incurred as a result of our acquisition of SureWest.  During the first quarter of 2012 we incurred $4.6 million in fees related to an amendment of our existing credit facility that provided us with escrow consent, we incurred approximately $200 thousand in acquisition-related expenses and an additional $3.1 million in interest expense for the amortization of fees related to securing the $350.0 million bridge loan commitment to finance the SureWest acquisition.

 

Revenue in the first quarter of 2012 decreased $2.0 million to $93.4 million as compared to $95.4 million in the first quarter of 2011.  The decrease in revenue in the first three months of 2012 is a result of declines, caused primarily by a loss of access lines (which includes local calling services, network access services, subsidies and long-distance services).  These declines were partially offset by growth in DSL and IPTV subscriptions and increased revenue from our prison services business.

 

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 either of our two operating segments except for through acquisitions.  On February 5, 2012, we entered into an agreement to acquire SureWest.  SureWest provides a wide range of telecommunications, digital video, Internet, data and other facilities-based communications services in Northern California, primarily in the greater Sacramento region, and in the greater Kansas City, Kansas and Missouri areas.  In 2011, SureWest reported $248.1 million in total operating revenues.  We anticipate closing on the SureWest transaction early in the third quarter of 2012.

 

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 226,167, 227,992 and 234,928 local access lines in service as of March 31, 2012, December 31, 2011 and March 31, 2011, respectively.

 

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Most wireline telephone companies have experienced a loss of local access lines due to increased competition from wireless providers, competitive local exchange carriers and, in some cases, cable television operators, along with challenging economic conditions.  While we have industry leading access line performance, 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, we expect to continue to experience modest erosion in access lines both due to market forces and through our own competing VOIP product.

 

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, 2012, IPTV was available to approximately 212,000 homes in our markets.  Our IPTV subscriber base continues to grow and totaled 35,337, 34,356 and 30,380 subscribers as of March 31, 2012, December 31, 2011 and March 31, 2011, respectively.

 

We also continue to experience growth in the number of DSL subscribers we serve.  We had 112,368, 110,913 and 107,634 DSL lines in service as of March 31, 2012, December 31, 2011 and March 31, 2011, 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 mega-bits per second (“mbps”) to 40 mbps;

 

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·                   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.

 

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;

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

·                   Costs associated with our standard and high definition video products.

 

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.

 

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

 

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are not amortized.  Customer relationships are amortized over their useful life.  The net carrying value of customer lists at March 31, 2012 is being amortized at a weighted-average life of approximately 2.5 years.

 

Results of Operations

 

Segments

 

We have two reportable business segments, Telephone Operations and Other Operations.  The discussion below covers our consolidated results and results by segment.

 

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

 

For the Three Months Ended March 31, 2012 Compared to March 31, 2011

 

The following summarizes our revenues and operating expenses on a consolidated basis for the three months ended March 31, 2012 and 2011:

 

 

 

2012

 

2011

 

(In millions, except for percentages)

 

$

 

%

 

$

 

%

 

Revenue

 

 

 

 

 

 

 

 

 

Telephone operations

 

 

 

 

 

 

 

 

 

Local calling services

 

$

19.9

 

21.3

 

$

21.7

 

23.2

 

Network access services

 

19.8

 

21.2

 

21.4

 

22.4

 

Subsidies

 

11.5

 

12.3

 

11.5

 

12.1

 

Long-distance services

 

3.5

 

3.7

 

4.3

 

4.5

 

Data and Internet services

 

22.0

 

23.6

 

20.0

 

20.5

 

Other services

 

8.4

 

9.0

 

8.5

 

8.9

 

Total telephone operations

 

85.1

 

91.1

 

87.4

 

91.6

 

Other operations

 

8.3

 

8.9

 

8.0

 

8.4

 

 

 

 

 

 

 

 

 

 

 

Total operating revenue

 

93.4

 

100.0

 

95.4

 

100.0

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Telephone operations

 

53.0

 

56.7

 

48.9

 

51.3

 

Other operations

 

7.3

 

7.8

 

7.4

 

7.7

 

Depreciation and amortization

 

22.1

 

23.7

 

22.2

 

23.3

 

Total operating expense

 

82.4

 

88.2

 

78.5

 

82.3

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

11.0

 

11.8

 

16.9

 

17.7

 

 

 

 

 

 

 

 

 

 

 

Interest expense