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Edited Transcript of CNSL earnings conference call or presentation 25-Apr-19 2:00pm GMT

Q1 2019 Consolidated Communications Holdings Inc Earnings Call

MATTOON May 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Consolidated Communications Holdings Inc earnings conference call or presentation Thursday, April 25, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* C. Robert Udell

Consolidated Communications Holdings, Inc. - President, CEO & Director

* Lisa R. Hood

Consolidated Communications Holdings, Inc. - VP, Treasurer & IR

* Steven L. Childers

Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary

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Conference Call Participants

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* Bryan Lee

Private Management Group, Inc. - Investment Professional

* Davis Hebert

Wells Fargo Securities, LLC, Research Division - Director and Senior High Yield Analyst

* Frank Garrett Louthan

Raymond James & Associates, Inc., Research Division - MD of Equity Research

* Jennifer Murtaugh Fritzsche

Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst

* Jonathan David Charbonneau

Cowen and Company, LLC, Research Division - VP

* Marc Berkowitz

Aviva Investors Americas LLC - Senior Credit Analyst

* Michael Rollins

Citigroup Inc, Research Division - MD and U.S. Telecoms Analyst

* Michael L. McCormack

Guggenheim Securities, LLC, Research Division - MD & Telecommunications Senior Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Consolidated Communications Holdings First Quarter 2019 Results Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I would like to introduce your host for today's call, Mrs. Lisa Hood. Ma'am, you may begin.

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Lisa R. Hood, Consolidated Communications Holdings, Inc. - VP, Treasurer & IR [2]

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Thank you, and good morning, everyone. We appreciate you joining us today for Consolidated Communications' first quarter earnings call. On the call with me today are Bob Udell, President and Chief Executive Officer; and Steve Childers, Chief Financial Officer. After our prepared remarks, we will open the call for questions. Please review the safe harbor provisions in our press release and in our SEC filings.

Today's discussions include statements about expected future events and financial results that are forward-looking and subject to risks and uncertainties. A discussion of factors that may affect future results is contained in Consolidated's filings with the SEC, which are available on our website. Today's discussion will include certain non-GAAP financial measures. Our earnings release has been posted on the Investor Relations section of our website at Consolidated.com. It includes reconciliations of these measures to their nearest GAAP equivalent. With that, I will turn the call over to Bob Udell.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [3]

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Good morning, and thank you for joining Consolidated Communications' first quarter earnings call. Before we review operating and financial results of the quarter, I would like to discuss our new capital allocation plan. This is a significant change for our company and an important step in building our future.

After careful consideration, our Board of Directors has elected to eliminate our longstanding practice of paying a dividend to shareholders in order to focus on deleveraging. Our industry continues to transition, and we believe this change in capital allocation will create long-term value for our shareholders by reducing debt, creating additional financial flexibility and improving our future cost of capital. To be clear, this isn't a change driven by a diminished view of our business. It is driven by our view that the long-term interest of shareholders is best served by proactively improving our balance sheet through accelerated delevering.

Now let me provide specific details on our capital allocation plans and leverage targets. While our leverage ratio was 4.38 at the end of first quarter, our near-term leverage target is to be below 4x in advance of our plan refinancing no later than mid-2021, and the longer-term target is 3.5 or less. As we achieve our leverage targets, we will accelerate investment in our network. We have identified a number of attractive opportunities to deploy capital to expand and densify our fiber networks in support of growing strategic fiber and data revenues.

In summary, with the new capital allocation plan, the primary focus will be on strengthening the balance sheet. This, when combined with a disciplined investment and high-return fiber projects supplemented by opportunistic sales of noncore assets, will drive value.

Now let's turn to the discussion of first quarter results. First, within our commercial and carrier channels, we are off to a strong start in 2019, and I'm happy to report we continue to show growth in our data and transport revenues, growing more than 2% year-over-year. Our consultative sales approach with leading data and cloud solutions continues to provide value to our existing and new customers, resulting in a 7% increase in Ethernet revenues. Again, this past quarter, we have expanded our commercial product portfolio, launching next-generation CloudSecure and enhancing our DDoS mitigation solution. These advanced solutions provide customers greater bandwidth, throughput and new tools to address the most sophisticated security threats with innovative technology. Additionally, we launched our virtual intelligent agent, an interactive voice response application providing industry leading call center tools.

Let me share a few commercial sales that highlight our consultative sales approach. Our California sales team has recently provided bids on 12 RFPs. Of those 12, we won 10, with a total contract value of $3.7 million. This is significant, as it demonstrates our ability to win substantially more than our fair share when you consider the competition we bid against. This high success rate is attributed to the fact that all 10 sales were for fiber connectivity using our on-net facilities, giving us an advantage over any competition. In our Illinois market, we secured a contract for data services which included MPLS, ProConnect, DDoS and SD-WAN for a multilocation bank. I highlight this sale as it began with a simple conversation about their business, which turned into a consultative sales opportunity underscoring our strategy of utilizing our full portfolio of services and adding value to our customers' businesses. And I'm pleased to highlight continued momentum within the commercial sales channel in northern New England during this past quarter. Our Gov/Ed vertical, which targets large municipal and educational entities, secured just under $64,000 of monthly recurring revenue from new and renewal contracts, representing over $2.7 million in total contract value.

As we continue to demonstrate steady growth in data and transport revenues, I'm also today announcing the expansion of our network in Des Moines, Iowa. This expansion provides another 1,200 businesses with access to our expansive national fiber network along with our portfolio of enhanced services. We are preselling into the market and enjoying early success. This is a multiyear commercial build as we increase our investment in vibrant, growing communities.

Our carrier channel had a strong start to 2019 as well. We've seen continued demand for wholesale local and regional Ethernet and dedicated internet access services as a result of our larger scale. We continue to leverage our 37,000-mile fiber network for other carriers who need connectivity to end users in our markets. This contributed over 1/3 of the new monthly recurring carrier revenue for first quarter. Total tower connections under contract increased by 157, or 5%, as compared to the first quarter of 2018, reaching a new record high of 3,744 tower connections. We're encouraged as we continue to see steady sales in our carrier funnel as we head into the second quarter.

In regards to consumer, we are executing on our strategy of leading with broadband service and increasing speeds. We're bundling video where it is most profitable and can be used to increase broadband speeds in data ARPU. Extending this playbook in our northern New England market drives our top 2 priorities of, one, improving service delivery times, and two, driving revenue growth with faster broadband speeds. We made significant progress in Maine, New Hampshire, and Vermont, where service levels are now in line with our other markets. We began in February and by mid-March had fully resumed all customer acquisition and retention activities. Inbound contacts in our call centers are increasing and our installation volume is also increasing, and our back office is ready for this load. We are seeing increased adoption of faster broadband speeds and growth as our network upgrades and marketing plans in all regions take effect. In Maine, our investment along with CAF II funds have extended more than 500 fiber miles to enable broadband speeds up to 100 meg to more than 21,000 residences in rural Maine. Additionally, we've launched 1 gig internet speeds in Upstate, New York, in conjunction with grants from the state. We've recently announced community partnerships to upgrade broadband infrastructure with a mix of public and private funds in Brooklyn, Maine and Chesterfield, New Hampshire, adding 3,000 network speed upgrade opportunities.

As predicted during our prior earnings call, we showed positive growth in total data and internet connections for the quarter as we continue to win in the legacy markets and began to take full advantage of our extensive fiber network in northern New England. Now with a clear field to execute on our strategy in all markets, we expect to see continued progress on these priorities.

Now I'll turn the call over to Steve for the financial review. Steve?

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [4]

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Thanks, Bob, and good morning to everyone. Today I will review our first quarter financial results as compared to the same quarter of last year and provide updated guidance for full year 2019.

Operating revenues for the first quarter were $338.6 million. After normalizing for the 2018 sale of the Virginia properties and the onetime local switching support settlement we received in the first quarter of 2018, revenue declined 3.4% year-over-year.

Now I'll discuss each of the customer channels. In the quarter, total commercial carrier revenue grew $1.3 million. We continue to realize strong momentum in data and transport revenue, which increased $2.1 million, or 2.4%. Data and transport revenue growth has been trending above 2% for the past 4 quarters. This is driven by our commercial team's success in linking our traditional data products with advanced services such as SD-WAN and Cloud combined with diverse wireless sales within our carrier channel. Other commercial revenue increased $3.3 million primarily due to equipment sales.

Consumer revenue was down $8.3 million, or 6% for the quarter. Voice revenues accounted for $6.2 million of the decline. As expected, video revenues declined $2.1 million, and this trend is consistent with our strategy to encourage our customers to transition from linear video products to over-the-top streaming content with higher broadband speeds and higher data ARPUs. For the quarter, overall consumer broadband revenue was flat, but after normalizing for the divesture of the Virginia property, total broadband revenue grew [6.2%], or $384,000. This was driven by strong increases in legacy broadband, partially offset by decreases related to Hurricane Michael in Florida. Subsidy revenues were down $7.1 million during the quarter, of which $4 million was attributed to the LSS settlement received in the first quarter of '18, with the remainder due to the impact of the final CAF-II step down in transitional support.

Network access revenues declined $3.1 million, or 7.9% for the quarter. Operating expenses exclusive of depreciation and amortization were $222.7 million, compared to $238.9 million for the first quarter of last year, a $16.2 million or 6.8% improvement. Cost of services and products decreased $7 million, driven by network cost optimization as well as lower salaries and benefits associated with headcount reductions from our cost savings initiatives. Pension costs also decreased as a result of the freezing of certain benefit plans in connection with the new collective bargaining agreements ratified in 2018. These savings were offset by a $2.4 million increase in costs associated with higher equipment sales. SG&A costs improved $11.6 million during the quarter as we continue to realize headcount synergy and operational efficiencies. To date, we have realized $72 million of our targeted synergy achievement of $75 million, which will be achieved by the end of the second quarter.

Net interest expense for the quarter was $34.3 million, compared to $32.7 million for the same period last year. The change was primarily due to LIBOR increases. As of March 31, our weighted cost of debt was approximately 5.6%. Cash distribution from the company's wireless partnerships were $7.3 million in the first quarter, compared to $9.5 million a year ago. The prior year distribution included a true-up of $2.4 million associated with the partnerships accounting for prepaid data roaming. Adjusted EBITDA was $130.3 million, compared to $135.4 million in the first quarter last year. The year-over-year decline is primarily due to onetime benefit from the $4 million LSS settlement and a $2.2 million reduced distribution from wireless partnerships as previously discussed.

In the first quarter, CapEx totaled $53.4 million, with a capital intensity rate of approximately 16%. Total liquidity, including cash on hand and availability under our revolver, was approximately $85 million. For the first quarter, our total net leverage ratio was 4.38x. As we implement our new capital allocation plan, we will improve our capital structure as we accelerate deleveraging toward our goal of total net leverage of less than 4x no later than mid-2021.

Due to the change in dividend practice, we are modifying guidance for cash interest. Cash interest costs are now expected to be in the range of $130 million to $135 million down from previous guidance of $135 million to $140 million. The reduction is primarily associated with our plans to use substantially all the 2019 dividend savings to pay down debt. Capital expenditures are still expected to be in the range of $210 million to $220 million, and we still expect cash income taxes to be less than $3 million.

With that, I'll now turn the call back over to Bob for closing remarks.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [5]

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Thanks, Steve. In closing, while this change in capital allocation was not taken lightly, it is the right step for Consolidated Communications. I am confident in our business, as demonstrated by strong first quarter results. We have made significant progress with our most recent integration and are optimistic about our long-term future.

With that, thanks for taking time to join our call today, and we'll now take questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Davis Hebert from Wells Fargo Securities.

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Davis Hebert, Wells Fargo Securities, LLC, Research Division - Director and Senior High Yield Analyst [2]

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I know the dividend elimination was a difficult decision, and I just wanted to ask about what the decision making was that went into that. What if anything changed between February and where you sit today?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [3]

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Yes, Davis, thanks for the question. Nothing's really changed. What we're informed by is over 5 or 6 quarters of continued pressure across the sector. And if you think about it, it was very careful consideration, looking at the financing markets, the sector. And we believe the prudent course of action is to focus on achieving our near-term leverage targets way in advance of any financing opportunity that may occur. And so by using substantially all of our free cash flow that comes from the dividend reallocation towards debt reduction, we feel like it puts us in that position as well as allowing us to continue investing in the business at a level of 16% of revenue against our CapEx. So as we achieve our leverage targets, we may even put more into those projects that we're very well prepared and our team is very energized to pursue.

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Davis Hebert, Wells Fargo Securities, LLC, Research Division - Director and Senior High Yield Analyst [4]

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Okay. That's helpful. And then on the leverage reduction, you mentioned below 4x by mid-2021. Do you anticipate that leverage reduction to be fairly linear, or will there be a faster pace of leverage reduction next year versus this year? I wonder if you could kind of frame that up for us.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [5]

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Yes. I'll start that and then Steve can finish it. What we're doing is finishing up the integration of the FairPoint assets, and so that has a little tail of continued investment through the first and second quarter. But beyond that, I think you can do the math pretty straightforward for 2019 and our efforts to get the leverage down. Steve, you want to. . .

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [6]

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Yes. So Dave, this is Steve. I would say to expect it to be fairly linear. I mean, number one, it's incumbent upon us to execute against the business plan. And then part of it when we -- in 2019, all the dividend savings, as Bob said, will be going for debt reduction. We expect the majority of that to go against debt reduction in 2020, but we will continue to evaluate high-return projects. And again, I think the target of getting below 4x, as you know, our bonds are due in October of '22. We want to take care of any kind of bond refinancing well before those would go current in mid-2021. So we will be at 4 somewhere between the end of '20 and mid-'21.

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Davis Hebert, Wells Fargo Securities, LLC, Research Division - Director and Senior High Yield Analyst [7]

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And then last question. As you think about applying that free cash flow to reducing debt directly, would you anticipate repaying your credit facility? Would that be the first priority, or would you consider repurchasing bonds at a discount today?

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [8]

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I think the answer is we would attack the highest cost of capital, and so we would be open to open market repurchases on the bond as well as evaluating the term debt.

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Operator [9]

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Our next question comes from Jon Charbonneau from Cowen and Company.

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Jonathan David Charbonneau, Cowen and Company, LLC, Research Division - VP [10]

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You noted that you plan on accelerating your fiber investment strategy as you achieve your leverage target. To what degree are you seeing fiber opportunities today that you're not able to invest in given your balance sheet? And then I guess along the same lines, how much has demand changed for you guys over the past 6 to 12 months?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [11]

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When you reference demand, you're talking about customer commercial carrier…

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Jonathan David Charbonneau, Cowen and Company, LLC, Research Division - VP [12]

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Yes, yes.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [13]

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Carrier demand? Okay. Well, let me start with we remained really excited about the business. The question about what's changed since the past quarter is nothing with regards to this team's motivation and hunger to continue to serve those 3 customer groups. With regards to fiber projects, we have an excellent diversity of 5 regions which we service the 3 customer groups with common assets. And we have a substantial number of projects that we have access to. And so it's really not a matter of are we turning projects down at this stage, we're just pursuing the highest return projects. And there's sufficient projects for us to invest more capital. But at the stage we're at right now, we feel the capital allocation's right and we're able to address the top priority projects on a by market basis. And we do have some expansion opportunities as we get deeper in the existing markets that we can pivot to, and a lot of that work has already been done. But I wouldn't say they're projects that we feel like we can't address. They're just not projects that make sense right now with the stage we're at in our integration and focus on getting deeper in existing markets. It's kind of a sweet spot, we think, where we are right now. But we also feel like as we get deeper penetrations, we can expand our fiber footprint and get the excellent returns we've seen as we've done that, for example, in the Des Moines announcement that I made today.

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Operator [14]

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Our next question comes from Mike McCormack from Guggenheim Partners.

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Michael L. McCormack, Guggenheim Securities, LLC, Research Division - MD & Telecommunications Senior Analyst [15]

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Just looking at the math on this, it looks like, at least in my model, if I eliminate the dividend you can get 4x roughly, a little below that, just on the dividend cut alone on the additional cash. Is there any operational change that you're seeing here that could drive better EBITDA in the next couple of years? And then also, I guess associated with that, the discussion with -- have you had discussion with banks that gives you confidence that 4.0 is the sort of right level, or just below 4.0? And then I guess lastly on cable competition, what are you guys seeing out there for consumer broadband? It seems like the cable companies really ramped up the gigabit offering across a much wider footprint. Any change in the competitive landscape?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [16]

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Yes. I'll take the business question and the cable competition question. But Steve, why don't you comment on the rate of deleveraging?

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [17]

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Yes. So Mike, I think the math that you're calculating on, particularly if you're using what we have for LTM EBITDA in the earnings release, I think the math you see works out. I think we're being conservative on the number assuming that we're flat, and again, maybe down a little bit. But again, to your question, we are still looking for opportunities to improve the overall cash flow from the business from an operating perspective. Your question on the talking to banks about refinancing and whether 4.0 is the right number, I think the bar for leverage continues to sort of be reset over time. So we think the feedback that we've had talking to our advisors, basically, the 4.0 is definitely the target. I think less is better as we get ready for refinancing. And again, I think we looked at where we're at relative to however you define our peer group. And we just feel like getting to 4x is a good first step relative to refinancing, and we will definitely be shooting for lower leverage hopefully by the time we get there.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [18]

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Yes. As far as the outlook on the business, we're not going to guide on EBITDA at this stage. But what I can say is the achievement of the synergies and the continued efficiency gains that we're realizing not only produce cost savings but our ability to hit install targets on a consistent basis across all markets. So for example, in northern New England, we're within 10 days now on our new installs, which is very competitive positioning. And more important, we're hitting our appointment targets, or expectations we set with customers, 89% of the time now. And we want to be at 95%, so we're not satisfied yet, but we're definitely above our competitors in terms of service delivery and managing customer expectations. And that's something we've been known for in the past. So I think I addressed the outlook on, yes, on -- did I miss your consumer question? I think I got them both.

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Michael L. McCormack, Guggenheim Securities, LLC, Research Division - MD & Telecommunications Senior Analyst [19]

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Just again, just sort of give me a sense for what the epithet is for consumers with these new higher cable offering speeds, and whether or not that's having more of a detrimental impact from a competitive standpoint.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [20]

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Yes. All bandwidth isn't created equal, and so we've had no trouble creating demand in our markets. It seems that when you get to 100 meg, and even 50 meg in many markets, our customers are very satisfied. That doesn't mean a gig doesn't give us a marketing advantage, and we enjoy that, but I will tell you that meeting service commitments has been paramount in keeping our reputation positive and being competitive. Secondly is consistency of bandwidth availability. We don't suffer the busy hour challenge that our cable competitors sometimes do even when they offer gig. And making the Wi-Fi work inside a structure is something that we're very good at, and that continues to position us well. And we've shown that we can create demand. And now that we've got the throughput capabilities, a year later we're building that demand again in the pipelines, filling -- and the return to positive net adds is demonstrative of that.

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Operator [21]

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Our next question comes from Frank Louthan from Raymond James.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [22]

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Is the Des Moines network in the current? I got a couple questions. There's one, and then secondly, Steve, you mentioned being able to sell some noncore assets to further delevering. Can you quantify that? And what are those types of assets? How easy are they to sell?

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [23]

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Can I go first?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [24]

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Yes. Go ahead.

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [25]

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Yes. So Frank, we'll take the noncore assets first. So no, we can't throw a number out on what the total opportunity is. But we have demonstrated in the past that we've sold our equipment business back in 2016. We've sold our Iowa to ILEC. We've sold our Virginia operations. Those were all noncore remote businesses that we probably weren't going to invest in over time. We have several properties, the smaller legacy FairPoint markets. We give offers on different pieces of that business all the time, and we would entertain offers of reasonable value on that. It seems like a lot of people try to bargain shop some of those smaller properties, but we're not interested in selling anything at a distressed kind of value or anything like that, so it's got to be worth our time from a deintegration standpoint. But I think you could talk probably 2 or 3 opportunities. We sold Iowa and Virginia for $20 million apiece. There's probably a couple of those that are out there. And then again, we sometimes get offers for other pieces of our business, select routes of our network or whatever that again, for the right value, we would probably entertain them.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [26]

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But I mean, how much higher than your current value do you consider to not be depressed? I mean, what would you take?

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [27]

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I think it's got to be really close to our trading multiple or above. We're getting offers that are -- and some of these were maybe half of what we're trading at or whatever. I mean, it's situational, Frank. I mean, that's really hard to answer on how noncore is it or is it the opportunity to invest. So I mean, I think the point I'm trying to make is some of those, whether they're small or whether they're at our current trading value or above, you're doing a certain amount of brand damage to deintegrate, right, so we're just trying to make it worthwhile for the business going forward.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [28]

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Got it. And on the Des Moines network?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [29]

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Yes. That's within our current budget. We have historically allocated beyond just a normal sales success base a high portion of our capital investment, which has kept us above some of our peers in what we spend. And it gives us some room to allocate to projects like Des Moines, to north of the Houston metro market, like the Conroe-Willis extension we've talked about in the past, the northern Kansas City extension. And so it's my effort to share the extension, and you can see it in our buildings count and our fiber miles that we add per quarter in the metrics that we're continuing to expand our footprint, not only getting more dense in the markets in which we already operate, but giving our sales team new fields to plow.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [30]

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Okay. Got it. And then what is your expectation for the CAF II reauction that might be next year, but maybe '21? Will you try and bid to keep that, what you're getting? And maybe remind us what you're getting on an annual basis from CAF II. And then, yes, just your appetite for continuing to bid and be involved in those properties.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [31]

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Yes. While Steve looks for the CAF II run rate, let me comment on the CAF III. And we're active, as you know, in those discussions. And we're looking with our network extension efforts on where we can have new coverage areas, both with our fixed wireless extensions as well as fiber extensions. It's always a macro look at where does it give us access to new carrier opportunities, where does it allow us to enhance current broadband speeds? And so yes, we're going to look at, however, CAF III gets defined, how we leverage that to our benefit. And we also expect there to be some extension from a CAF II perspective, because I don't see the FCC ready to enter into the rule definition for CAF III yet. In terms of current run rate, Steve?

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [32]

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Yes. I'm sorry, I'm still looking for that. But it looks like we're probably -- first quarter total subsidies are about $18 million, right, and probably $2 million or $3 million of that in state funding. So maybe to back up, though, just to remind people that for when we elected to take CAF II funding when we took Legacy Consolidated, we took all of it. FairPoint elected -- they took all their properties except for Kansas and…

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [33]

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Virginia, I think.

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [34]

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Or maybe, yes, maybe 2 of them, so yes.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [35]

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All right, great. And then just one other question related to the dividend change. I'm not sure if anyone on the board is there to comment, but I'm just curious on the logic of taking the dividend abruptly down to 0. I can understand the logic for eliminating it over time, but putting income and funds and so forth in position to be forced to sell when a slower ramp down could have been put in place, what was the logic there? As that alienates a lot of investors and makes it hard for them to look at the name.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [36]

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Yes. I appreciate the question, but I got to tell you, as a member of the board we considered all alternatives. And it's a very thoughtful board, but while maintaining a partial dividend or even considering a step down may seem appealing, the long-term positioning of the company was and is the priority. And instead of taking half measures, we came to the conclusion that best use of cash and the highest return to both the company and shareholders was to get the balance sheet in the current environment better positioned for refinancing and to continue our investment in strengthening our footprint in the markets that we serve. So it's really that simple.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [37]

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Okay. And just one last question on that. Steve, you mentioned you'll use substantially all the dividend to delever. What does that mean? Is that 50%, 60%, or 99%? Or we going to see projects get chased and not see all the delevering? What can investors count on for using this cash going towards delevering?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [38]

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What…

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [39]

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I'm sorry, go ahead.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [40]

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Yes. Let me start. It goes back to what I just said. The balance sheet is the first priority, and making the dividend change protects our ability to continue to invest in the business and continue to pursue the transition. And if you step back and look, it's an industry that's really in transition right now, and the capital structure with the dividend didn't feel to the board like the best use of capital. And so we're going to focus first on the debt reduction, and as we hit our leverage targets, potentially then, it's kind of an if-then statement, increase our allocation.

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Operator [41]

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Our next question comes from Marc Berkowitz from Aviva Investors.

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Marc Berkowitz, Aviva Investors Americas LLC - Senior Credit Analyst [42]

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Bob, I heard you mention 16% of revenues is the target amount. I'm just curious if you could kind of explain that there. That seems a little elevated relative to what you've historically done prior to the acquisition. And can you kind of bucket the use of dollars between fiber, maintenance, plant expansion, et cetera?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [43]

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Yes. I'll do my best on the last point. It'll be more general terms. But on the first point, it's really not elevated. I mean, we've been in the 15%, 16% range for some time. And it's been as high as almost 18% during the integration activities. And so in this environment, we're continuing to refine our network architecture, increase speeds across our footprint and certainly tap some of the increased build out opportunity. It feels like the right range for right now, but it's really a function of balancing the capital structure. If I thought that and revenue elasticity was serviced appropriately by 14% or 15% next year, then that's where our target will be. We're going to start with making sure our balance sheet is in the right position for refinancing and then really balance that with appropriate investment to keep the broadband revenues turning. In terms of maintenance investment, and it's really in terms of the old copper plant, things like that, we don't spend much more than a couple million bucks. Any place where there's copper maintenance necessary, we're replacing it with fiber. So when you look at our distribution of capital, it's really 60%, at worst case maybe 50%, driven by actual sales and/or upgrades of customers. And then you're into the normal activity that's associated with keeping rev levels consistent. So if you want to call that maintenance, I can understand the vernacular terminology we may need to sort out. But on a $210 million, $220 million capital budget, we're literally putting $100 million-plus against upgrades or in ensuring that our revenues are long-term sustainable as well as growing broadband revenues.

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Marc Berkowitz, Aviva Investors Americas LLC - Senior Credit Analyst [44]

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Got it. Kind of a balancing cash flow question for you guys. It looks like there was about a $9 million swing into the negative in terms of working capital. And specifically, that looks like it was a $14 million negative variance on the accrued compensation line. I'm just curious if you can explain that, and if that's expected to reverse over the balance of the year.

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [45]

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Mark, this is Steve. Let me find my working capital deal here. On the first part, I think there are a couple things that change in working capital. On accrued compensation, we actually -- bonuses were paid for in Q1, and then we also had changes in the new lease accounting that went up for part of what you had to put on the balance sheet. On the operating leases part of that, I think about $6 million or $7 million of that went into current liabilities. And then also, our working capital does skew quarter-to-quarter based on the timing of our semiannual bond interest payments, so we can break that out a little bit more for you if we need to.

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Marc Berkowitz, Aviva Investors Americas LLC - Senior Credit Analyst [46]

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Okay. So just to understand, if you can focus mostly on accrued competition, that seems like the most area of variability in working capital. Was Q1 payments made this year and not last year? Is that what explains the difference?

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [47]

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It was higher…

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Marc Berkowitz, Aviva Investors Americas LLC - Senior Credit Analyst [48]

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Again, it looks like last year was a $4 million storage. This year was a $10 million use.

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [49]

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We paid a higher bonus in 2019 for '18 than we did the prior year.

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Operator [50]

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Our next question comes from Michael Rollins from Citi.

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Michael Rollins, Citigroup Inc, Research Division - MD and U.S. Telecoms Analyst [51]

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First, if you were to take the portfolio of operations that you had and look at it by the markets, are there certain meaningfully sized markets that are growing revenue or have a meaningfully different level of revenue change versus the numbers that we get to see in the Consolidated financial statements?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [52]

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It varies. That's the benefit of our portfolio of markets, is -- and I've said this before. California and northern New England right now is turning, but California, the central north, and even Illinois on a relative basis because of the growth in Champagne, we've just been extremely pleased with that acquisition. They've been the bigger contributors in the last year, but prior years, it's been Texas and the economic growth there. And so it really follows when we make network extensions and where the sales team is most productive. And at some times it is somewhat affected by regional economic factors or trends. But we can drive growth in any of the markets depending on what the regional economic activity is.

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Michael Rollins, Citigroup Inc, Research Division - MD and U.S. Telecoms Analyst [53]

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Your second question is if you wanted to get full fiber capabilities to 70%, 80% or 90% of your footprint, how should investors think about the long-term capital requirement to get to that endpoint?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [54]

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Yes. I think that's what we're in the process of doing, and so you're seeing us in the 15%, 16% range, sometimes eking up a little bit of positioning to continue the extension. And in some cases, in every case, actually, we're doing it by shortening the fiber loop links. We're doing it by replacing high-maintenance copper last mile areas with fiber. And so you're seeing that run rate, and we'll try and get more specific in upcoming quarters as to the progress we're making because we know we have to rethink our approach to guidance in this situation. But bottom line is that's the path we're on, and yet the -- in order to keep on that path, we have to make sure that we're well positioned to tap the capital markets over the next few years as we have to readdress in our financing.

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Operator [55]

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Our next question comes from Bryan Lee of Private Management Group.

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Bryan Lee, Private Management Group, Inc. - Investment Professional [56]

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Just a quick one on the noncore asset deals. Would you consider the Verizon Wireless partnership as noncore?

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [57]

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This is Steve. That's a great question. As we talked about in the past, we are limited partners. Basically, we're cashing the check on the distributions. I guess they're noncore from an operating standpoint, but they obviously generate significant amounts of cash for us. We have, and again, I think we talked about this in the past on these calls, but these were acquired from our predecessor companies during various acquisitions. We have very low historical carryover tax bases in those, so as we've -- again, I think there's a limited market for the buyers, but it's really kind of hard to think about selling those on a meaningful tax adjusted basis and really making a significant dent in leverage. But I think in this environment, anything's open for consideration.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [58]

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Yes. I mean that's part of…

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Bryan Lee, Private Management Group, Inc. - Investment Professional [59]

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And just to be…

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [60]

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Go ahead.

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Bryan Lee, Private Management Group, Inc. - Investment Professional [61]

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Just to be clear, I just wanted to make sure that those are perpetual cash flows that are debt free.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [62]

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Correct.

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Steven L. Childers, Consolidated Communications Holdings, Inc. - CFO, CAO & Assistant Secretary [63]

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Correct.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [64]

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It's part of the…

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Bryan Lee, Private Management Group, Inc. - Investment Professional [65]

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Sorry, what were you going to say?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [66]

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It's part of the differentiation in investment in us, is we get -- that's part of our wireless hedge, in addition to the tower and backhaul expansion efforts in our markets.

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Operator [67]

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And our final question comes from Jennifer Fritzsche from Wells Fargo.

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Jennifer Murtaugh Fritzsche, Wells Fargo Securities, LLC, Research Division - MD and Senior Analyst [68]

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I wanted to focus on, I think Bob, you said that you had won 10 of 12 RFPs. Can you talk about what areas and the amount of competition in there? We've seen some other, I'll call them, fiber overbuilders come in. And some of these are private equity backed that it came through acquisition but have now gotten more capital to build out in fiber areas, specifically in the Midwest. Are you seeing any competitors here? And can you describe the win rate? Or what was the differentiation to get you 10 of the 12? And then a second bigger picture question. While 5G seems to me more hype than reality at this point, it does feel like the long pull in the 10 is fiber, and in rural America or more rural areas, fiber is more difficult to deploy. Are you having any kind of big-picture conversations about the role you all can play with some of these wireless operators as they evolve into a 5G landscape?

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [69]

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Yes. Thanks, Jennifer, for the question. With regards to the commercial opportunities in California in particular, we see different competitors by customer size, and when you look at it on a by market basis, especially in light of the more suburban and rural areas that we serve, we're not seeing more than one and at most 2 competitors at any one customer deal point. And so on a RFP, you might have a muni trying to get an opportunity; you might have Zayo; you might have one of the incumbents if it's a competitive area for us, AT&T and Verizon. But in all cases, when it boils down to what's really viable, there's at most one other facilities-based provider where we're really investing in sales and in our solution. Why we win is the consultative sales approach. As corny as it sounds, our folks are steeped in the application of the cloud services and our bandwidth with QoS prioritizing the voice traffic even at the small business level, which the cable guys don't do as well as we do. We make sense out of how to use that technology for our customers, and even in the small business space, the SMB, our BusinessOne solution has been really doing well. And as we beefed up that sales team, we're seeing increased success rates. So it's really the diversity that we play, both from a market perspective and customer size, and customizing our building block solutions to solve business problems for those target customers. As far as the 5G, that is an opportunity for us. We're pushing our way into discussions all across the 4 major carriers' management teams to position ourselves as the best provider for the markets in which we have facilities or adjacent markets where we can expand facilities. So we do think that concept of 5G is driving more interest. AT&T's first net deployment's driving more site deployment. All this is pushing network dents more deeply into current markets, filling in voids, which is good for us, and extending footprint into more rural areas. And so we're going to continue to be active in that space and position ourselves to be the best choice for solving those distribution coverage area needs across the 23 state markets we serve.

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Operator [70]

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I'm showing no further questions at this time. I will now like to turn the call over to Bob Udell for closing remarks.

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C. Robert Udell, Consolidated Communications Holdings, Inc. - President, CEO & Director [71]

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Thank you, Operator, and thanks for the questions today. I am optimistic about our business and confident in our new capital allocation plan as we focused on the near term deleveraging and increased fiber deployment in our network. Appreciate your continued support of our company, and appreciate you joining us today.

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Operator [72]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may disconnect and have a wonderful day.