ITEM 2. MANAGEMENT’S DISCUSSIO
N AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The Securities and Exchange Commission (“SEC”) encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. Certain statements in this Quarterly Report on Form 10-Q, including those which relate to the impact on future revenue sources, pending and future regulatory orders, continued expansion of the telecommunications network and expected changes in the sources of our revenue and cost structure resulting from our entrance into new communications markets, are forward-looking statements and are made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. These forward-looking statements reflect, among other things, our current expectations, plans, strategies and anticipated financial results. There are a number of risks, uncertainties and conditions that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements. Many of these circumstances are beyond our ability to control or predict. Moreover, forward-looking statements necessarily involve assumptions on our part. These forward-looking statements generally are identified by the words “believe”, “expect”, “anticipate”, “estimate”, “project”, “intend”, “plan”, “should”, “may”, “will”, “would”, “will be”, “will continue” or similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of Consolidated Communications Holdings, Inc. and its subsidiaries (“Consolidated”, the “Company”, “we” or “our”) to be different from those expressed or implied in the forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements that appear throughout this report. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward–looking statements is included in our 2016 Annual Report on Form 10-K filed with the SEC. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under federal securities laws or the rules and regulations of the SEC, we disclaim any intention or obligation to update or revise publicly any forward-looking statements. Undue reliance should not be placed on forward-looking statements. Management’s Discussion and Analysis (“MD&A”) should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes to the financial statements (“Notes”) as of and for the quarter ended March 31, 2017 included in Item 1 of Part I of this Quarterly Report on Form 10-Q.
Throughout this MD&A, we refer to certain measures that are not measures of financial performance in accordance with accounting principles generally accepted in the United States (“US GAAP” or “GAAP”). We believe the use of these non-GAAP measures on a consolidated basis provides the reader with additional information that is useful in understanding our operating results and trends. These measures should be viewed in addition to, rather than as a substitute for, those measures prepared in accordance with GAAP. See the “Non-GAAP Measures” section below for a more detailed discussion on the use and calculation of these measures.
Overview
We are an integrated communications services company that operates as both an Incumbent Local Exchange Carrier (“ILEC”) and a Competitive Local Exchange Carrier (“CLEC”) dependent upon the territory served. We provide an array of services in consumer, commercial and carrier channels in 11 states, including local and long-distance service, high-speed broadband Internet access, video services, Voice over Internet Protocol (“VoIP”), custom calling features, private line services, carrier grade access services, network capacity services over our regional fiber optic networks, data center and managed services, directory publishing, equipment sales, and cloud services.
We generate the majority of our consolidated operating revenues primarily from subscriptions to our video, data and transport services (collectively “broadband services”) to business and residential customers. Commercial and carrier services represent the largest source of our operating revenues and are expected to be the primary driver of our growth in the future. We continue to focus on commercial and broadband growth opportunities and are continually expanding our commercial product offerings for both small and large businesses in order to capitalize on technological advances in the industry. We can leverage our fiber optic networks and tailor our services for business customers by developing solutions to fit their specific needs. In addition, we recently launched a suite of cloud services and an enhanced hosted voice product, which increases efficiency and enables greater scalability and reliability for businesses. We anticipate future momentum
in commercial and carrier services as these new products gain traction as well as from the growing demand from customers for additional bandwidth and data-based services.
We market services to our residential customers either individually or as a bundled package. Our “triple play” bundle includes our data, video and voice services. As the market demands for bandwidth continue to increase as a result of consumer trends toward increased Internet usage, our continued focus is on enhancing product and service offerings, such as our progressively increasing consumer data speeds.
We offer data speeds of up to 1 Gbps in select markets.
Where 1 Gbps speeds are not yet offered, the maximum broadband speed is 100 Mbps, depending on the geographic market availability. As of March 31, 2017, approximately 27% of the homes in the areas we serve subscribe to our data service. Our exceptional consumer broadband speed allows us to continue to meet the needs of our customers and the demand for higher speeds resulting from the growing trend of over-the-top (“OTT”) content viewing. The availability of 1 Gbps data speed also complements our wireless home networking (“Wi-Fi”) that supports our TV Everywhere service and allows our subscribers to watch their favorite programs at home or away on a computer, smartphone or tablet.
The consumer’s growing acceptance of OTT video services either to augment their current viewing options or to entirely replace their video subscription may impact our future video subscriber base, which could result in a decline in video revenue as well as a reduction in video programing costs. Total video connections decreased 10% as of March 31, 2017 compared to the same period in 2016. We believe the trend in changing consumer viewing habits will continue to impact our business model and strategy of providing consumers the necessary broadband speed to facilitate OTT content viewing.
Operating revenues also continue to be impacted by the anticipated industry-wide trend of a decline in voice services, access lines and related network access revenue. Many customers are choosing to subscribe to alternative communications services and competition for these subscribers continues to increase. Total voice connections decreased 5% as of March 31, 2017 compared to the same period in 2016. Competition from wireless providers, competitive local exchange carriers and, in some cases, cable television providers has increased in recent years in the markets we serve. We have been able to mitigate some of the access line losses through marketing initiatives and product offerings, such as our VoIP service.
As discussed in the “Regulatory Matters” section below, our operating revenues are also impacted by legislative or regulatory changes at the federal and state levels, which could reduce or eliminate the current subsidies revenue we receive. A number of proceedings and recent orders relate to universal service reform, intercarrier compensation and network access charges. There are various ongoing legal challenges to the orders that have been issued. As a result, it is not yet possible to fully determine the impact of the regulatory changes on our operations.
Significant Recent Developments
Acquisitions
FairPoint Communications, Inc.
On December 3, 2016, we entered into a definitive agreement and plan of merger (the “Merger Agreement”) with FairPoint Communications, Inc. (“FairPoint”) to acquire all the issued and outstanding shares of FairPoint in exchange for shares of our common stock. FairPoint is an advanced communications provider to business, wholesale and residential customers within its service territory, which spans across 17 states. FairPoint owns and operates a robust fiber-based network with more than 21,000 route miles of fiber, including 17,000 route miles of fiber in northern New England. The acquisition reflects our strategy to diversify revenue and cash flows amongst multiple products and to expand our network to new markets. The merger is subject to standard closing conditions including required federal and state regulatory approvals and other customary closing conditions. We expect the merger to close by mid-2017.
In connection with the merger, in December 2016, we secured committed debt financing through a $935.0 million incremental term loan facility, as described in the “Liquidity and Capital Resources” section below, that, in addition to cash on hand and other sources of liquidity, will be used to repay and redeem certain existing indebtedness of FairPoint and pay the fees and expenses in connection with the merger.
Champaign Telephone Company, Inc.
On July 1, 2016, we acquired substantially all of the assets of Champaign Telephone Company, Inc. and its sister company, Big Broadband Services, LLC (collectively “CTC”), a private business communications provider in the Champaign-Urbana, IL area. The aggregate purchase price, including customary working capital adjustments, consisted of cash consideration of $13.4 million, which was paid from our existing cash resources.
Divestitures
On December 6, 2016, we completed the sale of substantially all of the assets of the Company’s Enterprise Services equipment and IT Services business (“EIS”) to ePlus Technology inc. (“ePlus”) for cash proceeds of $9.2 million net of a customary working capital adjustment. As part of the transaction, we entered into a Co-Marketing Agreement with ePlus, a nationwide systems integrator of technology solutions, to cross-sell both broadband network services and IT services. The strategic partnership will provide our business customers access to a broader suite of IT solutions, and will also provide ePlus customers access to Consolidated’s business network services.
On May 3, 2016, we entered into a definitive agreement to sell all of the issued and outstanding stock of Consolidated Communications of Iowa Company (“CCIC”), formerly Heartland Telecommunications Company of Iowa. CCIC operates as an incumbent local exchange carrier providing telecommunications and data services to residential and business customers in 11 rural communities in northwest Iowa and surrounding areas. The sale was completed on September 1, 2016 for total cash proceeds of approximately $21.0 million, net of certain contractual and customary working capital adjustments.
Results of Operations
The following tables reflect our financial results on a consolidated basis and key operating metrics as of and for the quarters ended March 31, 2017 and 2016.
Financial Data
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Quarter Ended March 31,
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(In millions, except for percentages)
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2017
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2016
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$
Change
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%
Change
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Operating Revenues
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Commercial and carrier:
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Data and transport services (includes VoIP)
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$
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49.4
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$
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49.1
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$
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0.3
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1
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%
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Voice services
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23.5
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25.0
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(1.5)
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(6)
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Other
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3.9
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2.6
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1.3
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50
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76.8
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76.7
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0.1
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0
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Consumer:
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Broadband (VoIP, data and video)
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51.7
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54.6
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(2.9)
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(5)
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Voice services
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12.9
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14.5
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(1.6)
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(11)
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64.6
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69.1
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(4.5)
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(7)
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Equipment sales and service
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—
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9.6
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(9.6)
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(100)
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Subsidies
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10.6
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13.1
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(2.5)
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(19)
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Network access
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14.5
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16.8
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(2.3)
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(14)
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Other products and services
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3.4
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3.5
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(0.1)
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(3)
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Total operating revenues
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169.9
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188.8
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(18.9)
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(10)
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Operating Expenses
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Cost of services and products (exclusive of depreciation and amortization)
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71.4
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79.7
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(8.3)
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(10)
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Selling, general and administrative costs
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36.4
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40.7
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(4.3)
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(11)
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Acquisition and other transaction costs
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1.3
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—
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1.3
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100
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Depreciation and amortization
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42.2
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44.1
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(1.9)
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(4)
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Total operating expenses
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151.3
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164.5
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(13.2)
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(8)
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Income from operations
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18.6
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24.3
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(5.7)
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(23)
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Interest expense, net
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(29.7)
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(18.6)
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11.1
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60
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Other income
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5.2
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7.2
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(2.0)
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(28)
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Income tax expense (benefit)
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(2.2)
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5.0
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(7.2)
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(144)
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Net income (loss)
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(3.7)
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7.9
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(11.6)
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(147)
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Net income attributable to noncontrolling interest
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—
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0.1
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(0.1)
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(100)
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Net income (loss) attributable to common shareholders
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$
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(3.7)
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$
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7.8
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$
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(11.5)
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(147)
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Adjusted EBITDA
(1)
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$
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71.1
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$
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78.6
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$
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(7.5)
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(10)
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%
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(1)
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A non-GAAP measure. See the “Non-GAAP Measures” section below for additional information and reconciliation to the most directly comparable GAAP measure.
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Key Operating Statistics
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As of March 31,
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2017
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2016
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Change
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% Change
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Consumer customers
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248,796
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265,428
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(16,632)
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(6)
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%
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Voice connections
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453,332
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478,035
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(24,703)
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(5)
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Data connections
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477,180
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459,597
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17,583
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4
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Video connections
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102,906
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114,485
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(11,579)
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(10)
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Total connections
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1,033,418
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1,052,117
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(18,699)
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(2)
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%
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Operating Revenues
Commercial and Carrier
Data and Transport Services
We provide a variety of business communication services to small, medium and large business customers, including many services over our advanced fiber network. The services we offer include scalable high speed broadband Internet access and VoIP phone services, which range from basic service plans to virtual hosted systems. In addition to Internet and VoIP services, we also offer private line data services to businesses that include dedicated Internet access through our Metro Ethernet network. Wide Area Network (“WAN”) products include point-to-point and multi-point deployments from 2.5 Mbps to 10 Gbps to accommodate the growth patterns of our business customers. Data center and disaster recovery solutions provide a reliable and local colocation option for commercial customers. We also offer wholesale services to regional and national interexchange and wireless carriers, including cellular backhaul and other fiber transport solutions.
Data and transport services revenues increased $0.3 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to an increase in data connections and a continued increase in Internet access and Metro Ethernet revenues. During the quarter ended March 31, 2017, growth in data and transport services was hampered by increased competition and price compression as customers are migrating from legacy products to Ethernet based products, which have a lower average revenue per user. This decline is expected to be partially offset with the increasing need for bandwidth and other Ethernet services.
Voice Services
Voice services include basic local phone and long-distance service packages for business customers. The plans include options for voicemail, conference calling, linking multiple office locations and other custom calling features such as caller ID, call forwarding, speed dialing and call waiting. Services can be charged at a fixed monthly rate, a measured rate or can be bundled with selected services at a discounted rate.
Voice services revenues decreased $1.5 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to a 7% decline in access lines as commercial customers are increasingly choosing alternative technologies, including our own VoIP product, and the broad range of features that Internet based voice services can offer.
Other
Other revenues include business equipment sales
and related hardware and
maintenance support, rental income of customer premise equipment,
video services and other miscellaneous revenues
. Other revenues increased $1.3 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to an increase in business equipment sales contributed by the acquisition of CTC and additional revenue related to the new Co-Marketing Agreement entered into with ePlus in connection with the sale of EIS in 2016.
Consumer
Broadband Services
Broadband services include revenues from residential customers for subscriptions to our VoIP, data and video products. We offer high speed Internet access at speeds of up to 1 Gbps, depending on the nature of the network facilities that are available, the level of service selected and the location. Our VoIP digital phone service is also available in certain markets as an alternative to the traditional telephone line. Depending on geographic market availability, our video services range from limited basic service to advanced digital television, which includes several plans each with hundreds of local, national and music channels including premium and pay-per-view channels as well as video on-demand service. Certain customers may also subscribe to our advanced video services, which consist of high-definition television, digital video recorders (“DVR”) and/or a whole home DVR.
Broadband services revenues decreased $2.9 million during the quarter ended March 31, 2017 compared to the same period in 2016 despite price increases for data and video services implemented during the first quarter of 2017. Total data and video connections decreased 5% and 12%, respectively, as of March 31, 2017 compared to the same period in 2016 as a result of increased competition as consumers are choosing to subscribe to alternative communications services particularly for video services. VoIP revenue also declined during the same period due to an 11% decline in connections as more consumers continue to rely exclusively on wireless service.
Voice Services
We offer several different basic local phone service packages and long-distance calling plans, including unlimited flat-rate calling plans. The plans include options for voicemail and other custom calling features such as caller ID, call forwarding and call waiting. Voice services revenues decreased $1.6 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to a 10% decline in access lines. The number of local access lines in service directly affects the recurring revenues we generate from end users and continues to be impacted by the industry-wide decline in access lines. We expect to continue to experience modest erosion in voice connections due to competition from alternative technologies, including our own competing VoIP product.
Equipment Sales and Service
Until the sale of EIS in December 2016, we were an accredited Master Level Unified Communications and Gold Certified Cisco Partner providing equipment solutions and support for business customers. As an equipment integrator, we offered network design, implementation and support services, including maintenance contracts, in order to provide integrated communication solutions for our customers. When an equipment sale involved multiple deliverables, revenue was allocated to each respective element based on relative selling price. Equipment sales and service revenues decreased $9.6 million during the quarter ended March 31, 2017 compared to the same period in 2016 due to the sale of EIS in December 2016.
Subsidies
Subsidies consist of both federal and state subsidies, which are designed to promote widely available, quality broadband services at affordable prices with higher data speeds in rural areas. Subsidies revenue decreased $2.5 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to the scheduled reduction in the annual Connect America Fund (“CAF”) Phase II funding rate in August 2016, the sale of CCIC in September 2016 and a decrease in state funding support for our Texas ILEC. See the “Regulatory Matters” section below for further discussion of the subsidies we receive.
Network Access Services
Network access services include interstate and intrastate switched access revenues, network special access services and end user access. Switched access revenues include access services to other communications carriers to terminate or originate long-distance calls on our network. Special access circuits provide dedicated lines and trunks to business
customers and interexchange carriers. Network access revenues decreased $2.3 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily as a result of the continuing decline in minutes of use, voice connections and carrier circuits; however, a portion of the decrease can be attributed to carriers shifting to our fiber Metro Ethernet product, contributing to the growth in that area.
Other Products and Services
Other products and services include revenues from telephone directory publishing, video advertising and billing and support services. Other products and services revenues decreased $0.1 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to a decline in telephone directory advertising revenues.
Operating Expenses
Cost of Services and Products
Cost of services and products decreased $8.3 million during the quarter ended March 31, 2017 compared to the same period in 2016. Cost of goods sold related to equipment sales decreased $6.5 million as a result of the sale of EIS in 2016, as discussed above. Employee costs decreased due to savings from a reduction in headcount. Video programming costs also decreased as a result of a 10% decline in video connections, which was largely offset by an increase in programming costs per channel as costs continue to rise as a result of annual rate increases.
Selling, General and Administrative Costs
Selling, general and administrative costs decreased $4.3 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to a decline in employee costs from a reduction in headcount as part of cost saving initiatives as well as a decrease in incentive compensation. Advertising expense also decreased due to a reduction in radio advertising and marketing promotions in 2017.
Acquisition and Other Transaction Costs
Acquisition and other transaction costs increased $1.3 million during the quarter ended March 31, 2017 compared to the same period in 2016 as a result of the pending merger with FairPoint, which is expected to close in mid-2017. Transaction costs consist primarily of legal, finance and other professional fees incurred in connection with the merger.
Depreciation and Amortization
Depreciation and amortization expense decreased $1.9 million during the quarter ended March 31, 2017 compared to the same period in 2016, primarily due to the sale of EIS and CCIC in 2016 and certain intangibles and software becoming fully amortized in 2016, which was offset in part by ongoing capital expenditures related to network enhancements and success-based capital projects for consumer and commercial services.
Regulatory Matters
Our revenues are subject to broad federal and/or state regulation, which include such telecommunications services as local telephone service, network access service and toll service and are derived from various sources, including:
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Business and residential subscribers of basic exchange services;
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Surcharges mandated by state commissions;
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·
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Long distance carriers for network access service;
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·
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Competitive access providers and commercial customers for network access service; and
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Support payments from federal or state programs.
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The telecommunications industry is subject to extensive federal, state and local regulation. Under the Telecommunications Act of 1996, federal and state regulators share responsibility for implementing and enforcing statutes and regulations designed to encourage competition and to preserve and advance widely available, quality telephone service at affordable prices.
At the federal level, the Federal Communications Commission (“FCC”) generally exercises jurisdiction over facilities and services of local exchange carriers, such as our rural telephone companies, to the extent they are used to provide, originate or terminate interstate or international communications. The FCC has the authority to condition, modify, cancel, terminate or revoke our operating authority for failure to comply with applicable federal laws or FCC rules, regulations and policies. Fines or penalties also may be imposed for any of these violations.
State regulatory commissions generally exercise jurisdiction over carriers’ facilities and services to the extent they are used to provide, originate or terminate intrastate communications. In particular, state regulatory agencies have substantial oversight over interconnection and network access by competitors of our rural telephone companies. In addition, municipalities and other local government agencies regulate the public rights-of-way necessary to install and operate networks. State regulators can sanction our rural telephone companies or revoke our certifications if we violate relevant laws or regulations.
FCC Matters
In general, telecommunications service in rural areas is more costly to provide than service in urban areas. The lower customer density means that switching and other facilities serve fewer customers and loops are typically longer, requiring greater expenditures per customer to build and maintain. By supporting the high-cost of operations in rural markets, Universal Service Fund (“USF”) subsidies promote widely available, quality telephone service at affordable prices in rural areas. Revenues from the federal and certain states’ USFs decreased $2.5 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to the scheduled reduction in the annual CAF Phase II rate in August 2016 and a decrease in state funding support for our Texas ILEC.
An order adopted by the FCC in 2011 (the “Order”) has significantly impacted the amount of support revenue we receive from the USF, CAF and intercarrier compensation (“ICC”). The Order reformed core parts of the USF, broadly recast the existing ICC scheme, established the CAF to replace support revenues provided by the current USF and redirected support from voice services to broadband services. In 2012, CAF Phase I was implemented, which froze USF support to price cap carriers until the FCC implemented a broadband cost model to shift support from voice services to broadband services. The Order also modified the methodology used for ICC traffic exchanged between carriers. The initial phase of ICC reform was effective on July 1, 2012, beginning the transition of our terminating switched access rates to bill-and-keep over a seven year period, and as a result, our network access revenue for 2017 will be reduced by as much as approximately $2.0 million.
In December 2014, the FCC released a report and order that addressed, among other things, the transition to CAF Phase II funding for price cap carriers and the acceptance criteria for CAF Phase II funding. For companies that accept the CAF Phase II funding, there is a three year transition period in instances in which their current CAF Phase I funding exceeds the CAF Phase II funding. If CAF Phase II funding exceeds CAF Phase I funding, the transitional support is waived and CAF Phase II funding begins immediately. Companies are required to commit to a statewide build out requirement to 10 Mbps downstream and 1 Mbps upstream in funded locations. We accepted the CAF Phase II funding in August 2015. The annual funding under CAF Phase I of $36.6 million was replaced by annual funding under CAF Phase II of $13.9 million through 2020. With the sale of our Iowa ILEC in 2016, this amount was further reduced to $11.5 million through 2020. The acceptance of funding at the lower level CAF Phase II will transition over a three year period based on the CAF Phase I funding levels at the rates of 75% in the first year, 50% in the second year and 25% in the third year.
State Matters
California
In an ongoing proceeding relating to the New Regulatory Framework, the California Public Utilities Commission (“CPUC”) adopted Decision 06-08-030 in 2006, which grants carriers broader pricing freedom in the provision of telecommunications services, bundling of services, promotions and customer contracts. This decision adopted a new regulatory framework, the Uniform Regulatory Framework (“URF”), which among other things (i) eliminates price regulation and allows full pricing flexibility for all new and retail services, (ii) allows new forms of bundles and promotional packages of telecommunication services, (iii) allocates all gains and losses from the sale of assets to shareholders and (iv) eliminates almost all elements of rate of return regulation, including the calculation of shareable earnings. In December 2010, the CPUC issued a ruling to initiate a new proceeding to assess whether, or to what extent, the level of competition in the telecommunications industry is sufficient to control prices for the four largest ILECs in the state. Subsequently, the CPUC issued a ruling temporarily deferring the proceeding. When the CPUC may open this proceeding is unclear and on hold at this time. The CPUC’s actions in this and future proceedings could lead to new rules and an increase in government regulation. The Company will continue to monitor this matter.
Pennsylvania
In 2011, the Pennsylvania Public Utilities Commission (“PAPUC”) issued an intrastate access reform order reducing intrastate access rates to interstate levels in a three-step process, which began in March 2012. With the release of the FCC order in November 2011, the PAPUC temporarily issued a stay. A final stay was issued in 2012 to implement the FCC ordered intrastate access rate changes. The PAPUC had indicated that it would address state universal funding in 2013, but delayed conducting a proceeding pending any state legislative activity that may occur in the 2017 legislative session. The Company will continue to monitor this matter.
Texas
The Texas Public Utilities Regulatory Act (“PURA”) directs the Public Utilities Commission of Texas (“PUCT”) to adopt and enforce rules requiring local exchange carriers to contribute to a state universal service fund that helps telecommunications providers offer basic local telecommunications service at reasonable rates in high-cost rural areas. The Texas Universal Service Fund is also used to reimburse telecommunications providers for revenues lost by providing lifeline service. Our Texas rural telephone companies receive disbursements from this fund.
Our Texas ILECs have historically received support from two state funds, the small and rural incumbent local exchange company plan High Cost Fund (“HCF”) and the High Cost Assistance Fund (“HCAF”). The HCF is a line-based fund used to keep local rates low. The rate is applied on all residential lines and up to five single business lines. The amount we receive from the HCAF is a frozen monthly amount that was originally developed to offset high intrastate toll rates.
In September 2011, the Texas state legislature passed Senate Bill No. 980/House Bill No. 2603 which, among other things, mandated the PUCT to review the Universal Service Fund and issue recommendations by January 1, 2013 with the intent to effectively reduce the size of the Universal Service Fund. This would be accomplished by implementing an urban floor to offset state funding reductions with a phase-in period of four years. The PUCT recommended that (i) frozen line counts be lifted effective September 1, 2013 and (ii) rural and urban local rate benchmarks be developed. The large company fund review was completed in September 2012 and the PUCT addressed the small fund participants in Docket 41097
Rate Rebalancing
(“Docket 41097”), as discussed below.
In June 2013, the Texas state legislature passed Senate Bill No. 583 (“SB 583”). The provisions of SB 583 were effective September 1, 2013 and froze HCF and HCAF support for the remainder of 2013. As of January 1, 2014, our annual $1.4 million HCAF support was eliminated and the frozen HCF support returned to funding on a per line basis. In July 2013, the Company entered into a settlement agreement with the PUCT on Docket 41097, which was approved by the PUCT in August 2013. In accordance with the provisions of the settlement agreement, the HCF draw is being reduced by approximately $1.2 million annually over a four year period beginning June 1, 2014 through 2018. However, we have the ability to fully offset this reduction with increases to residential rates where market conditions allow.
In addition, the PUCT is required to develop a needs test for post-2017 funding and has held workshops on various proposals. The PUCT issued its recommendation to the Texas state commissioners in May 2014, which was approved in December 2014. The needs test allows for a one-time disaggregation of line rates from a per line flat rate, then a competitive test must be met to receive funding. The Company filed its submission for the needs test on December 28, 2016. The PUCT issued docket 46699 on January 4, 2017 to review the filing and a decision is expected in the second quarter of 2017.
Other Regulatory Matters
We are also subject to a number of regulatory proceedings occurring at the federal and state levels that may have a material impact on our operations. The FCC and state commissions have authority to issue rules and regulations related to our business. A number of proceedings are pending or anticipated that are related to such telecommunications issues as competition, interconnection, access charges, intercarrier compensation, broadband deployment, consumer protection and universal service reform. Some proceedings may authorize new services to compete with our existing services. Proceedings that relate to our cable television operations include rulemakings on set top boxes, carriage of programming, industry consolidation and ways to promote additional competition. There are various on-going legal challenges to the scope or validity of FCC orders that have been issued. As a result, it is not yet possible to fully determine the impact of the related FCC rules and regulations on our operations.
Non-Operating Items
Other Income and Expense, Net
Interest expense, net of interest income, increased $11.1 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to ticking fees incurred in 2017 and the amortization of commitment fees related to the committed financing of the $935.0 million incremental term loan secured for the pending acquisition of FairPoint, as described in the “Liquidity and Capital Resources” section below. However, interest expense was reduced in part by the refinancing of our Credit Agreement in October 2016, which included a 0.25% reduction in the interest rate for our outstanding term loan resulting in annual interest savings of approximately $2.0 million.
Other income decreased $2.0 million during the quarter ended March 31, 2017 compared to the same period in 2016 primarily due to a decline in investment income from our wireless partnership interests.
Income Taxes
Income taxes decreased $7.2 million during the quarter ended March 31, 2017 compared to the same period in 2016.
Our effective tax rate was
37.0
% and 38.6% for the quarters ended March 31, 2017 and 2016, respectively
. The effective tax rate differed from the federal and state statutory rates primarily due to various permanent income tax differences and differences in allocable income for the Company’s state tax filings.
Non-GAAP Measures
In addition to the results reported in accordance with US GAAP, we also use certain non-GAAP measures such as EBITDA and adjusted EBITDA to evaluate operating performance and to facilitate the comparison of our historical results and trends. These financial measures are not measures of financial performance under US GAAP and should not be considered in isolation or as a substitute for net income as a measure of performance and net cash provided by operating activities as a measure of liquidity. They are not, on their own, necessarily indicative of cash available to fund cash needs as determined in accordance with GAAP. The calculation of these non-GAAP measures may not be comparable to similarly titled measures used by other companies. Reconciliations of these non-GAAP measures to the most directly comparable financial measures presented in accordance with GAAP are provided below.
EBITDA is defined as net earnings before interest expense, income taxes and depreciation and amortization. Adjusted EBITDA is comprised of EBITDA, adjusted for certain items as permitted or required under our credit facility as described
in the reconciliations below. These measures are a common measure of operating performance in the telecommunications industry and are useful, with other data, as a means to evaluate our ability to fund our estimated uses of cash.
The following table is a reconciliation of net income (loss) to adjusted EBITDA for the quarters ended March 31, 2017 and 2016:
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
|
|
|
March 31,
|
|
|
(In thousands, unaudited)
|
|
2017
|
|
2016
|
|
|
Net income (loss)
|
|
$
|
(3,705)
|
|
$
|
7,902
|
|
|
Add (subtract):
|
|
|
|
|
|
|
|
|
Interest expense, net of interest income
|
|
|
29,671
|
|
|
18,646
|
|
|
Income tax expense (benefit)
|
|
|
(2,174)
|
|
|
4,973
|
|
|
Depreciation and amortization
|
|
|
42,195
|
|
|
44,140
|
|
|
EBITDA
|
|
|
65,987
|
|
|
75,661
|
|
|
|
|
|
|
|
|
|
|
|
Adjustments to EBITDA:
|
|
|
|
|
|
|
|
|
Other, net
(1)
|
|
|
(1,045)
|
|
|
(4,725)
|
|
|
Investment distributions
(2)
|
|
|
5,644
|
|
|
6,796
|
|
|
Non-cash, stock-based compensation
(3)
|
|
|
538
|
|
|
892
|
|
|
Adjusted EBITDA
|
|
$
|
71,124
|
|
$
|
78,624
|
|
|
|
(1)
|
|
Includes the equity earnings from our investments, dividend income, income attributable to noncontrolling interests in subsidiaries, acquisition and transaction related costs, including severance, and certain other miscellaneous items.
|
|
(2)
|
|
Includes all cash dividends and other cash distributions received from our investments.
|
|
(3)
|
|
Represents compensation expenses in connection with the issuance of stock awards, which, because of the non-cash nature of these expenses, are excluded from adjusted EBITDA.
|
Liquidity and Capital Resources
Outlook and Overview
Our operating requirements have historically been funded from cash flows generated from our business and borrowings under our credit facilities. We expect that our future operating requirements will continue to be funded from cash flows from operating activities, existing cash and cash equivalents and, if needed, borrowings under our revolving credit facility and our ability to obtain future external financing. We anticipate that we will continue to use a substantial portion of our cash flow to fund capital expenditures, meet scheduled payments of long-term debt, make dividend payments and invest in future business opportunities.
The following table summarizes our cash flows:
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
(In thousands)
|
|
2017
|
|
2016
|
Cash flows provided by (used in):
|
|
|
|
|
|
|
Operating activities
|
|
$
|
51,718
|
|
$
|
59,541
|
Investing activities
|
|
|
(28,982)
|
|
|
(28,674)
|
Financing activities
|
|
|
(23,184)
|
|
|
(22,284)
|
Increase (decrease) in cash and cash equivalents
|
|
$
|
(448)
|
|
$
|
8,583
|
Cash Flows Provided by Operating Activities
Net cash provided by operating activities was $51.7 million during the quarter ended March 31, 2017, a decrease of $7.8 million compared to the same period in 2016. Cash flows provided by operating activities decreased primarily as a result of a decline in net income from a reduction in revenue and additional transaction costs related to the pending acquisition of FairPoint. Cash distributions received from our wireless partnerships also decreased $1.2 million during the quarter ended March 31, 2017 compared ot the same period in 2016.
Cash Flows Used In Investing Activities
Net cash used in investing activities was $29.0 million during the quarter ended March 31, 2017 and consisted primarily of cash used for capital expenditures.
Capital Expenditures
Capital expenditures continue to be our primary recurring investing activity and were $29.0 million during the quarter ended March 31, 2017, an increase of $0.3 million compared to the same period in 2016. Capital expenditures for the remainder of 2017 are expected to be $85.0 million to $90.0 million, of which approximately 56% is planned for success-based capital projects for consumer and commercial initiatives. Capital expenditures for the remainder of 2017 and subsequent years will depend on various factors, including competition, changes in technology, regulatory changes and the timing in the deployment of new services. We expect to continue to invest in existing and new services and the expansion of our fiber network in order to retain and acquire more customers through a broader set of products and an expanded network footprint.
Cash Flows Provided by (Used In) Financing Activities
Net cash provided by (used in) financing activities consists primarily of our proceeds from and principal payments on long-term borrowings and the payment of dividends.
Long-term Debt
Credit Agreement
In October 2016, the Company, through certain of its wholly owned subsidiaries, entered into a Third Amended and Restated Credit Agreement with various financial institutions (the “Credit Agreement”). The Credit Agreement consists of a $110.0 million revolving credit facility and initial term loans in the aggregate amount of $900.0 million (“Term 5”). The Credit Agreement also includes an incremental term loan facility which provides the ability to borrow up to $300.0 million of incremental term loans subject to certain terms and conditions and to borrow more than $300.0 million provided that its senior secured leverage ratio would not exceed 3.00:1.00. Borrowings under the senior secured credit facility are secured by substantially all of the assets of the Company and its subsidiaries, with the exception of Consolidated Communications of Illinois Company and our majority-owned subsidiary, East Texas Fiber Line Incorporated.
The Term 5 loan was issued in an original aggregate principal amount of $900.0 million with a maturity date of October 5, 2023, but is subject to earlier maturity on March 31, 2022 if the Company’s unsecured Senior Notes due in October 2022 are repaid in full or redeemed in full on or prior to March 31, 2022. The Term 5 loan contains an original issuance discount of 0.25% or $2.3 million, which is being amortized over the term of the loan. The Term 5 loan requires quarterly principal payments of $2.25 million and has an interest rate of 3.00% plus the London Interbank Offered Rate (“LIBOR“) subject to a 1.00% LIBOR floor.
Our revolving credit facility has a maturity date of October 5, 2021 and an applicable margin (at our election) of between 2.50% and 3.25% for LIBOR-based borrowings or between 1.50% and 2.25%
for alternate base rate borrowings, depending on our total net leverage ratio. Based on our leverage ratio as of March 31, 2017, the borrowing margin for the three month period ending June 30, 2017 will be at a weighted-average margin of
3.25% f
or a LIBOR-based loan or
2.25%
for an alternate base rate loan. The applicable borrowing margin for the revolving credit facility is adjusted quarterly to reflect
the leverage ratio from the prior quarter-end. As of March 31, 2017 and December 31, 2016, there were no outstanding borrowings under the revolving credit facility. A stand-by letter of credit of
$1.6
million, issued primarily in connection with the Company’s insurance coverage, was outstanding under our revolving credit facility as of March 31, 2017. The stand-by letter of credit is renewable annually and reduces the borrowing availability under the revolving credit facility. As of March 31, 2017, $108.4 million was available for borrowing under the revolving credit facility.
The weighted-average interest rate on outstanding borrowings under our credit facility was 4.00%
as of March 31, 2017 and December 31, 2016. Interest is payable at least quarterly
.
Credit Agreement Covenant Compliance
The Credit Agreement contains various provisions and covenants, including, among other items, restrictions on the ability to pay dividends, incur additional indebtedness and issue capital stock. We have agreed to maintain certain financial ratios, including interest coverage and total net leverage ratios, all as defined in the Credit Agreement. As of March 31, 2017, we were in compliance with the Credit Agreement covenants
.
In general, our Credit Agreement restricts our ability to pay dividends to the amount of our available cash as defined in our Credit Agreement. As of March 31, 2017, and including the $19.7 million dividend declared in February 2017 and paid on May 1, 2017, we had $269.8 million in dividend availability under the credit facility covenant.
Under our Credit Agreement, if our total net leverage ratio, as defined in the Credit Agreement, as of the end of any fiscal quarter is greater than 5.10:1.00, we will be required to suspend dividends on our common stock unless otherwise permitted by an exception for dividends that may be paid from the portion of proceeds of any sale of equity not used to fund acquisitions or make other investments. During any dividend suspension period, we will be required to repay debt in an amount equal to 50.0% of any increase in available cash, among other things. In addition, we will not be permitted to pay dividends if an event of default under the Credit Agreement has occurred and is continuing. Among other things, it will be an event of default if our total net leverage ratio or interest coverage ratio as of the end of any fiscal quarter is greater than 5.25:1.00 and less than 2.25:1.00, respectively. As of March 31, 2017, our total net leverage ratio under the Credit Agreement was 4.60:1.00, and our interest coverage ratio was 3.73:1.00.
Committed Financing
In connection with the execution of the Merger Agreement, in December 2016, the Company entered into two amendments to its Credit Agreement to secure committed financing related to the acquisition of FairPoint. On December 14, 2016, we entered into Amendment No. 1 to the Credit Agreement, to increase the senior secured incremental term loan credit facility under the Credit Agreement from $865.0 million to an aggregate amount of $935.0 million. Fees of $2.5 million paid to the lenders in connection with Amendment No. 1 are reflected as an additional discount on the Term 5 loan and are being amortized over the term of the debt as interest expense. On December 21, 2016, the Company entered into Amendment No. 2 to the Credit Agreement in which a syndicate of lenders has agreed to provide an incremental term loan in an aggregate principal amount of up to $935.0 million under the Credit Agreement (the “Incremental Term Loan”), subject to the satisfaction of certain conditions. The proceeds of the Incremental Term Loan may be used, in part, to repay and redeem certain existing indebtedness of FairPoint and to pay certain fees and expenses in connection with the Merger and the related financing. The terms, conditions and covenants of the Incremental Term Loan are materially consistent with those in the existing Credit Agreement, as described above. The Incremental Term Loan included an original issue discount of 0.50% and has an interest rate of 3.00% plus LIBOR based on the three-month adjusted rate subject to a 1.00% LIBOR floor. Ticking fees began accruing on the Incremental Term Loan commitments on January 15, 2017 at the rate equal to the interest rate of the Incremental Term Loan. In connection with entering into the committed financing, commitment fees of $14.0 million were capitalized in December 2016 and are being amortized to interest expense over the term of the commitment period of one year.
6.50% Senior Notes due 2022
In September 2014, we completed an offering of $200.0 million aggregate principal amount of 6.50% Senior Notes due in October 2022 (the “Existing Notes”). The Existing Notes were priced at par, which resulted in total gross proceeds of
$200.0 million. On June 8, 2015, we completed an additional offering of $300.0 million in aggregate principal amount of 6.50% Senior Notes due 2022 (the “New Notes” and together with the Existing Notes, the “Senior Notes”). The New Notes were issued as additional notes under the same indenture pursuant to which the Existing Notes were previously issued on in September 2014. The New Notes were priced at 98.26% of par with a yield to maturity of 6.80% and resulted in total gross proceeds of approximately $294.8 million, excluding accrued interest. The discount is being amortized using the effective interest method over the term of the notes.
The Senior Notes mature on October 1, 2022 and interest is payable semi-annually on April 1 and October 1 of each year. Consolidated Communications, Inc. (“CCI”) is the primary obligor under the Senior Notes, and we and certain of our wholly‑owned subsidiaries have fully and unconditionally guaranteed the Senior Notes. The Senior Notes are senior unsecured obligations of the Company.
Senior Notes Covenant Compliance
Subject to certain exceptions and qualifications, the indenture governing the Senior Notes contains customary covenants that, among other things, limits CCI’s and its restricted subsidiaries’ ability to: incur additional debt or issue certain preferred stock; pay dividends or make other distributions on capital stock or prepay subordinated indebtedness; purchase or redeem any equity interests; make investments; create liens; sell assets; enter into agreements that restrict dividends or other payments by restricted subsidiaries; consolidate, merge or transfer all or substantially all of its assets; engage in transactions with its affiliates; or enter into any sale and leaseback transactions. The indenture also contains customary events of default.
Among other matters, the Senior Notes indenture provides that CCI may not pay dividends or make other restricted payments, as defined in the indenture, if its total net leverage ratio is 4.75:1.00 or greater. This ratio is calculated differently than the comparable ratio under the Credit Agreement; among other differences, it takes into account, on a pro forma basis, synergies expected to be achieved as a result of certain acquisitions not yet reflected in historical results. As of March 31, 2017, this ratio was 4.64:1.00. If this ratio is met, dividends and other restricted payments may be made from cumulative consolidated cash flow since April 1, 2012, less 1.75 times fixed charges, less dividends and other restricted payments made since May 30, 2012. Dividends may be paid and other restricted payments may also be made from a “basket” of $50.0 million, none of which has been used to date, and pursuant to other exceptions identified in the indenture. Since dividends of $351.2 million have been paid since May 30, 2012, including the quarterly dividend declared in February 2017 and paid on May 1, 2017, there was $402.6 million of the $753.8 million of cumulative consolidated cash flow since May 30, 2012 available to pay dividends as of March 31, 2017. As of March 31, 2017, the Company was in compliance with all terms, conditions and covenants under the indenture governing the Senior Notes.
Capital Leases
We lease certain facilities and equipment under various capital leases which expire between 2017 and 2021. As of March 31, 2017, the present value of the minimum remaining lease commitments was approximately $17.6 million, of which $6.8 million was due and payable within the next twelve months.
The leases require total remaining rental payments of
$19.6 million as of March 31, 2017, of which $3.4 million will be paid to LATEL LLC, a related party entity.
Dividends
We paid $19.6 million in dividend payments to stockholders during each of the quarters ended March 31, 2017 and 2016. In February 2017, our board of directors declared a quarterly dividend of $0.38738 per common share, which was paid on May 1, 2017 to stockholders of record at the close of business on April 15, 2017. Our current annual dividend rate is approximately $1.55 per share.
The cash required to fund dividend payments is in addition to our other expected cash needs, which we expect to fund with cash flows from our operations. In addition, we expect we will have sufficient availability under our revolving credit facility to fund dividend payments in addition to any expected fluctuations in working capital and other cash needs, although we do not intend to borrow under this facility to pay dividends.
We believe that our dividend policy will limit, but not preclude, our ability to grow. If we continue paying dividends at the level currently anticipated under our dividend policy, we may not retain a sufficient amount of cash, and may need to seek refinancing to fund a material expansion of our business, including any significant acquisitions or to pursue growth opportunities requiring capital expenditures significantly beyond our current expectations. In addition, because we expect a significant portion of cash available will be distributed to holders of common stock under our dividend policy, our ability to pursue any material expansion of our business will depend more than it otherwise would on our ability to obtain third-party financing.
Sufficiency of Cash Resources
The following table sets forth selected information regarding our financial condition.
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
December 31,
|
|
(In thousands, except for ratio)
|
|
2017
|
|
2016
|
|
Cash and cash equivalents
|
|
$
|
26,629
|
|
$
|
27,077
|
|
Working capital (deficit)
|
|
|
(30,920)
|
|
|
(16,884)
|
|
Current ratio
|
|
|
0.81
|
|
|
0.89
|
|
Our net working capital position declined $14.0 million as of March 31, 2017 compared to December 31, 2016 primarily as a result of an increase in accrued interest related to the timing in the semi-annual interest payments for our Senior Notes and the addition in 2017 of accrued ticking fees on the committed financing secured in December 2016 for the acquisition of FairPoint. The ticking fees will accrue until the completion of the merger, which is expected in mid-2017 and will become due and payable on the closing date.
Our most significant uses of funds in the remainder of 2017 are expected to be for: (i) dividend payments of approximately $58.8 million; (ii) interest payments on our indebtedness of approximately $97.0 million and principal payments on debt of $6.8 million; and (iii) capital expenditures of between $85.0 million and $90.0 million. In the future our ability to use cash may be limited by our other expected uses of cash, including our dividend policy, and our ability to incur additional debt will be limited by our existing and future debt agreements. In addition, we expect to use significant funds in connection with the acquisition of FairPoint, which is expected to close in mid-2017. As discussed above, we have secured committed financing for the acquisition through a $935.0 million Incremental Term Loan, which will be used with cash on hand, and other sources of liquidity to repay and redeem certain existing indebtedness of FairPoint and to pay certain fees and expenses in connection with the merger.
We believe that cash flows from operating activities, together with our existing cash and borrowings available under our revolving credit facility, will be sufficient for at least the next twelve months to fund our current anticipated uses of cash. After that, our ability to fund these expected uses of cash and to comply with the financial covenants under our debt agreements will depend on the results of future operations, performance and cash flow. Our ability to fund these expected uses from the results of future operations will be subject to prevailing economic conditions and to financial, business, regulatory, legislative and other factors, many of which are beyond our control.
We may be unable to access the cash flows of our subsidiaries since certain of our subsidiaries are parties to credit or other borrowing agreements, or are subject to statutory or regulatory restrictions, that restrict the payment of dividends or making intercompany loans and investments, and those subsidiaries are likely to continue to be subject to such restrictions and prohibitions for the foreseeable future. In addition, future agreements that our subsidiaries may enter into governing the terms of indebtedness may restrict our subsidiaries’ ability to pay dividends or advance cash in any other manner to us.
To the extent that our business plans or projections change or prove to be inaccurate, we may require additional financing or require financing sooner than we currently anticipate. Sources of additional financing may include commercial bank borrowings, other strategic debt financing, sales of nonstrategic assets, vendor financing or the private or public sales of equity and debt securities. There can be no assurance that we will be able to generate sufficient cash flows from operations in the future, that anticipated revenue growth will be realized or that future borrowings or equity issuances will be available in amounts sufficient to provide adequate sources of cash to fund our expected uses of cash. Failure to obtain adequate financing, if necessary, could require us to significantly reduce our operations or level of capital expenditures which could have a material adverse effect on our financial condition and the results of operations.
Surety Bonds
In the ordinary course of business, we enter into surety, performance and similar bonds as required by certain jurisdictions in which we provide services. As of March 31, 2017, we had approximately $3.4 million of these bonds outstanding.
Defined Benefit Pension Plans
As required, we contribute to a qualified defined pension plan (the “Retirement Plan”) and non-qualified supplemental retirement plans (collectively with the Retirement Plan, the “Pension Plans”) and other post-retirement benefit plans, which provide retirement benefits to certain eligible employees. Contributions are intended to provide for benefits attributed to service to date. Our funding policy is to contribute annually an actuarially determined amount consistent with applicable federal income tax regulations.
The costs to maintain our Pension Plans and future funding requirements are affected by several factors including the expected return on investment of the assets held by the Pension Plans, changes in the discount rate used to calculate pension expense and the amortization of unrecognized gains and losses. Returns generated on Pension Plans assets have historically funded a significant portion of the benefits paid under the Pension Plans. We estimate the long-term rate of return of Pension Plans assets will be 7.75%. The Pension Plans invest in marketable equity securities which are exposed to changes in the financial markets. If the financial markets experience a downturn and returns fall below our estimate, we could be required to make a material contribution to the Pension Plans, which could adversely affect our cash flows from operations.
In 2017, we expect to make contributions totaling approximately $6.4 million to our Pension Plans and $3.9 million to our other post-retirement benefit plans, which represents an increase of $6.4 million from the total contributions made in 2016. As of March 31, 2017, we have contributed $0.1 million and $1.0 million to our Pension Plans and our other post-retirement benefit plans, respectively. Our contribution amounts meet the minimum funding requirements as set forth in employee benefit and tax laws. See Note 9 to the Condensed Consolidated Financial Statements, included in this report in Part I – Item I “Financial Information” for a more detailed discussion regarding our pension and other post-retirement plans.
Income Taxes
The timing of cash payments for income taxes, which is governed by the Internal Revenue Service and other taxing jurisdictions, will differ from the timing of recording tax expense and deferred income taxes, which are reported in accordance with GAAP. For example, tax laws in effect regarding accelerated or “bonus” depreciation for tax reporting resulted in less cash payments than the GAAP tax expense. Acceleration of tax deductions could eventually result in situations where cash payments will exceed GAAP tax expense.
Regulatory Matters
As discussed in the “Regulatory Matters” section above, in December 2014, the FCC released a report and order that significantly impacts the amount of support revenue we receive from the USF, CAF and ICC by redirecting support from voice services to broadband services. The annual funding under CAF Phase I of $36.6 million was replaced by annual funding under CAF Phase II of $13.9 million through 2020. With the sale of our Iowa ILEC in 2016, this amount was further reduced to $11.5 million through 2020. The acceptance of funding at the lower level CAF Phase II will transition over a three year period, beginning in August 2015, at the rates of 75% of the CAF Phase I funding level in the first year, 50% in the second year and 25% in the third year.
The Order also modifies the methodology used for ICC traffic exchanged between carriers. As a result of implementing the provisions of the Order, our network access revenue decreased approximately $0.5 million during the quarter ended March 31, 2017. We anticipate that network access revenue will continue to decline as a result of the Order through 2018 by as much as $2.0 million and $1.9 million in 2017 and 2018, respectively.
In accordance with the provisions of SB 583, as discussed in the “Regulatory Matters” section above, our annual $1.4 million Texas HCAF support was eliminated effective January 1, 2014. In addition, in accordance with the provisions of
the settlement agreement reached with the PUCT, the HCF draw is being reduced by approximately $1.2 million annually over a four year period beginning June 1, 2014 through 2018. However, we have the ability to fully offset this reduction with increases to residential rates where market conditions allow.
Critical Accounting Estimates
Our condensed consolidated financial statements and accompanying notes are prepared in accordance with US GAAP. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Our judgments are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making estimates about the carrying values of assets and liabilities that are not readily apparent from other sources. For a full discussion of our accounting estimates and assumptions that we have identified as critical in the preparation of our condensed consolidated financial statements, refer to our 2016 Annual Report on Form 10-K filed with the SEC.
Recent Accounting Pronouncements
For information regarding the impact of certain recent accounting pronouncements, see Note 1 “Summary of Significant Accounting Policies” to the Condensed Consolidated Financial Statements, included in this report in Part I - Item I “Financial Information”.