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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

 

þ    

   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2009

 

OR

¨     

  

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

Commission file number 1-32422

WINDSTREAM CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   20-0792300

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

4001 Rodney Parham Road,

Little Rock, Arkansas

  72212
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code (501) 748-7000

    

 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  þ  YES  ¨  NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  þ  YES  ¨  NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  þ            Accelerated filer  ¨            Non-accelerated filer  ¨            Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  ¨  YES  þ  NO

Number of common shares outstanding as of October 31, 2009: 427,390,506

The Exhibit Index is located on page 52

 

 

 


Table of Contents

WINDSTREAM CORPORATION

FORM 10-Q

TABLE OF CONTENTS

 

     Page No.
   PART I – FINANCIAL INFORMATION                   

Item 1.

   Financial Statements   
  

Consolidated Statements of Income (Unaudited)

   2
  

Consolidated Balance Sheets – September 30, 2009 (Unaudited) and December 31, 2008

   3
  

Consolidated Statements of Cash Flows (Unaudited)

   4
  

Consolidated Statements of Shareholders’ Equity (Unaudited)

   5
  

Notes to Unaudited Interim Consolidated Financial Statements

   6

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    29

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    47

Item 4.

   Controls and Procedures    48
   PART II – OTHER INFORMATION                   

Item 1.

   Legal Proceedings    49

Item 1A.

   Risk Factors    49

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    50

Item 3.

   Defaults Upon Senior Securities    *

Item 4.

   Submission of Matters to a Vote of Security Holders    *

Item 5.

   Other Information    *

Item 6.

   Exhibits    50

 

* No reportable information under this item.

 

1


Table of Contents

WINDSTREAM CORPORATION

FORM 10-Q

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

      Three Months
Ended September 30,
    Nine Months
Ended September 30,
 
(Millions, except per share amounts)    2009     2008     2009     2008  

Revenues and sales:

        

Service revenues

   $    704.9      $    741.9      $  2,140.2      $  2,254.7   

Product sales

   29.4      52.2      102.0      139.3   
                        

Total revenues and sales

   734.3      794.1      2,242.2      2,394.0   

Costs and expenses:

        

Cost of services (excluding depreciation of $103.3, $99.3, $306.5 and $294.3 respectively, included below)

   253.0      255.9      753.9      760.2   

Cost of products sold

   26.0      49.5      89.9      128.0   

Selling, general, administrative and other

   87.6      93.3      267.0      273.0   

Depreciation and amortization

   133.8      123.8      399.1      368.7   

Restructuring charges

   7.5      1.0      7.5      2.1   

Merger and integration costs

   1.0           2.4      6.2   
                        

Total costs and expenses

   508.9      523.5      1,519.8      1,538.2   

Operating income

   225.4      270.6      722.4      855.8   

Other income, net

   (2.2   0.5      (0.8   9.1   

Interest expense

   (97.5   (103.3   (295.0   (311.9
                        

Income from continuing operations before income taxes

   125.7      167.8      426.6      553.0   

Income taxes

   45.7      63.5      167.6      208.9   
                        

Income from continuing operations

   80.0      104.3      259.0      344.1   

Discontinued operations, net of tax expense of $1.2 and $0.8, respectively

        1.6           (12.5
                        

Net income

   $    80.0      $    105.9      $  259.0      $  331.6   

Basic and diluted earnings per share:

        

Income from continuing operations

   $.18      $.24      $.59      $.77   

Loss from discontinued operations

                  (.03
                        

Net income

   $.18      $.24      $.59      $.74   

See the accompanying notes to the unaudited interim consolidated financial statements.

 

2


Table of Contents

CONSOLIDATED BALANCE SHEETS

(Millions)

Assets

  

(Unaudited)

September 30,

2009

   

December 31,

2008

 
Current Assets:     

Cash and cash equivalents

   $ 290.0      $ 296.6   

Accounts receivable (less allowance for doubtful accounts of $16.5 and $16.3, respectively)

     294.7        316.6   

Inventories

     23.5        30.8   

Deferred income taxes

     16.5        30.8   

Prepaid expenses and other

     53.9        33.9   
                

Total current assets

     678.6        708.7   
                

Goodwill

     2,198.2        2,198.2   

Other intangibles

     1,072.8        1,132.2   

Net property, plant and equipment

     3,751.8        3,897.1   

Other assets

     66.7        73.1   

Total Assets

   $ 7,768.1      $ 8,009.3   

Liabilities and Shareholders’ Equity

                

Current Liabilities:

    

Current maturities of long-term debt

   $ 24.1      $ 24.3   

Current portion of interest rate swaps

     47.3        40.5   

Accounts payable

     131.9        134.0   

Advance payments and customer deposits

     92.0        94.0   

Accrued dividends

     108.8        109.9   

Accrued taxes

     43.1        48.0   

Accrued interest

     64.1        138.4   

Other current liabilities

     60.8        76.2   
                

Total current liabilities

     572.1        665.3   

Long-term debt

     5,199.0        5,358.2   

Deferred income taxes

     1,177.7        1,070.6   

Other liabilities

     629.5        662.9   

Total liabilities

     7,578.3        7,757.0   
Commitments and Contingencies (See Note 7)     

Shareholders’ Equity:

    

Common stock, $0.0001 par value, 1,000.0 shares authorized, 435.2 and 439.4 shares issued and outstanding, respectively

              

Additional paid-in capital

     63.6        101.5   

Accumulated other comprehensive loss

     (292.8     (336.6

Retained earnings

     419.0        487.4   
                

Total shareholders’ equity

     189.8        252.3   
Total Liabilities and Shareholders’ Equity    $ 7,768.1      $ 8,009.3   

See the accompanying notes to the unaudited interim consolidated financial statements.

 

3


Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

      Nine Months
Ended September 30,
 
(Millions)    2009     2008  

Cash Provided from Operations:

    

Net income

   $ 259.0      $ 331.6   

Adjustments to reconcile net income to net cash provided from operations:

    

Loss on net assets held for sale

            16.4   

Depreciation and amortization

     399.1        370.9   

Provision for doubtful accounts

     32.4        25.1   

Stock-based compensation expense

     14.3        13.5   

Pension and postretirement benefits expense

     72.8        12.3   

Deferred taxes

     92.4        74.3   

Other, net

     4.2        8.8   

Changes in operating assets and liabilities, net:

    

Accounts receivable

     (10.5     (27.9

Prepaid expenses and other

     (20.9     (15.6

Accounts payable

     (2.1     (8.7

Accrued interest

     (74.3     (69.8

Accrued taxes

     (4.9     17.5   

Other current liabilities

     (13.9     (12.5

Other, net

     (6.2     (6.1
                

Net cash provided from operations

     741.4        729.8   

Cash Flows from Investing Activities:

    

Additions to property, plant and equipment

     (206.8     (219.5

Disposition of acquired assets held for sale

            17.3   

Other, net

     0.3        11.6   
                

Net cash used in investing activities

     (206.5     (190.6

Cash Flows from Financing Activities:

    

Dividends paid on common shares

     (328.6     (335.3

Stock repurchase

     (43.5     (200.3

Repayment of debt

     (160.7     (340.7

Debt issued, net of issuance costs

            380.0   

Other, net

     (8.7     (3.3
                

Net cash used in financing activities

     (541.5     (499.6

(Decrease) increase in cash and cash equivalents

     (6.6     39.6   

Cash and Cash Equivalents:

    

Beginning of period

     296.6        72.0   
                

End of period

   $ 290.0      $ 111.6   

Supplemental Cash Flow Disclosures:

    

Interest paid

   $ 367.5      $ 378.6   

Income taxes paid, net of refunds

   $ 95.0      $ 118.3   

See the accompanying notes to the unaudited interim consolidated financial statements.

 

4


Table of Contents

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(Millions, except per share amounts)   

Additional

Paid-In

Capital

   

Accumulated

Other

Comprehensive

Income (Loss)

    Retained
Earnings
    Total  

Balance at December 31, 2008

   $ 101.5      $ (336.6   $ 487.4      $ 252.3   

Net income

         259.0        259.0   

Other comprehensive income, net of tax: (See Note 10)

        

Change in employee benefit plans

            31.7               31.7   

Unrealized holding gain on interest rate swaps

            12.1               12.1   

Comprehensive income

            43.8        259.0        302.8   

Stock repurchase

     (43.5                   (43.5

Stock-based compensation expense

     14.3                      14.3   

Other

     (8.7                   (8.7

Dividends of $0.75 per share declared to stockholders

                   (327.4     (327.4

Balance at September 30, 2009

   $ 63.6      $ (292.8   $ 419.0      $ 189.8   

See the accompanying notes to the unaudited interim consolidated financial statements.

 

5


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

_____

 

1. Preparation of Interim Financial Statements:

Formation of Windstream - In this report, Windstream Corporation and its subsidiaries are referred to as “Windstream”, “we”, or “the Company”. On July 17, 2006, Alltel Corporation, which has subsequently merged with Verizon Communications Inc. (“Alltel”), completed the spin off of its wireline telecommunications division and immediately merged with and into Valor Communications Group, Inc. (“Valor”), with Valor continuing as the surviving corporation. The resulting company was renamed Windstream Corporation.

Windstream is a customer-focused telecommunications company that provides phone, high-speed Internet, and digital television services. The Company also offers a wide range of IP-based voice and data services and advanced phone systems and equipment to businesses and government agencies. The Company has approximately 2.9 million customers primarily located in rural areas in 16 states. In the first quarter of 2009, the Company reorganized its operations to integrate the sales and administrative functions of the product distribution segment into its wireline operations. As a result of this change, the chief operating decision maker no longer reviews the financial statements of the product distribution operations on a stand alone basis, and the Company operates as a single reporting segment. As required by the authoritative guidance for segment presentation, segment results of operations have been retrospectively adjusted to reflect a single segment presentation for all periods presented. As such, separate segment reporting is no longer required, and thus not included. Additionally, certain amounts previously reported have been reclassified to conform to the current year presentation of the consolidated financial statements. These changes and reclassifications did not impact net or comprehensive income.

The accompanying unaudited consolidated financial statements have been prepared based upon Securities and Exchange Commission (“SEC”) rules that permit reduced disclosure for interim periods. Certain information and footnote disclosures have been condensed or omitted in accordance with those rules and regulations. The accompanying consolidated balance sheet at December 31, 2008 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States (“U.S. GAAP”). In our opinion, these financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial condition for the interim periods shown including normal recurring accruals and other items. The results for the interim periods are not necessarily indicative of results for the full year. For a more complete discussion of significant accounting policies and certain other information, this report should be read in conjunction with the consolidated financial statements and accompanying notes included in Windstream’s Annual Report on Form 10-K for the year ended December 31, 2008, which was filed with the SEC on February 19, 2009.

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. The estimates and assumptions used in the accompanying consolidated financial statements and accompanying notes are based upon management’s evaluation of the relevant facts and circumstances as of the date of the consolidated financial statements. Actual results may differ from the estimates and assumptions used in preparing the accompanying consolidated financial statements and accompanying notes, and such differences could be material.

 

2. Accounting Changes:

Change in Accounting Estimate - Effective January 1, 2009, the Company prospectively changed its estimate of useful life for its franchise rights from indefinite-lived to 30 years primarily due to the effects of increasing competition. Commensurate with this change, the Company reviewed its franchise rights for impairment, and noted that no impairment existed as of January 1, 2009. As a result of this change, amortization expense increased by $8.0 million and $23.9 million, calculated on a straight line basis, and net income decreased $5.1 million and $14.5 million or $.01 and $.03 per share for the three and nine month periods ended September 30, 2009, respectively.

Recently Adopted Accounting Standards

Accounting Standards Codification

In the third quarter of 2009, Windstream adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification”) as the single authoritative source for U.S. GAAP. The Codification superseded all existing accounting standard documents and other accounting literature became nonauthoritative. As a result, Windstream has removed all references to superseded accounting standards in its consolidated financial statements and accompanying notes.

 

6


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

2. Accounting Changes, Continued:

 

Subsequent Events

In the second quarter of 2009 Windstream adopted authoritative guidance for subsequent events, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. This guidance sets forth the period after the balance sheet date during which management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. See Note 15 for the disclosures required by this guidance.

Interim Disclosures about the Fair Value of Financial Instruments

Effective April 1, 2009, Windstream adopted authoritative guidance related to interim disclosures about the fair value of financial instruments. This guidance extended the annual disclosures about fair value of financial instruments to interim reporting periods. See Note 6 for the interim disclosures required by this guidance.

Fair Value Measurements

Effective January 1, 2008, Windstream adopted authoritative guidance for fair value measurements of financial assets and liabilities and non-financial assets and liabilities recognized or disclosed at fair value on a recurring basis. This authoritative guidance clarified the definition of fair value, established a framework for measuring fair value and expanded the disclosures related to fair value measurements that are included in a company’s financial statements. It emphasized that fair value is a market-based measurement and not an entity-specific measurement, and that it should be based on an exchange transaction in which a company sells an asset or transfers a liability. The guidance also established a fair value hierarchy in which observable market data would be considered the highest level, while fair value measurements based on an entity’s own assumptions would be considered the lowest level. The Company adopted the provisions of this guidance for non-financial assets and liabilities recognized or disclosed at fair value on a non-recurring basis, except items recognized or disclosed at fair value on an annual or more frequently recurring basis, on January 1, 2009. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

Effective April 1, 2009, Windstream adopted authoritative guidance for determining fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying transactions that are not orderly. This guidance provided additional direction for estimating fair value, in accordance with other authoritative guidance related to fair value measurements, when the volume and level of activity for a financial asset or liability has significantly decreased. This guidance also offers directives on identifying circumstances that indicate a transaction is not orderly. There was no impact to Windstream’s consolidated financial statements upon adoption.

Business Combinations

Effective January 1, 2009, Windstream adopted the revised authoritative guidance for business combinations which establishes principles and requirements for how the acquirer in a business combination recognizes all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. The revised guidance changed the accounting treatment for certain specific items, including acquisition costs, acquired contingent liabilities, restructuring costs, deferred tax asset valuation allowances and income tax uncertainties after the acquisition date. In addition, a substantial number of new disclosures are also required.

In April 2009, the FASB amended the authoritative guidance for subsequent business combinations to require contingent assets acquired or liabilities assumed be initially recognized at fair value at the acquisition date if fair value can be determined during the measurement period. If the acquisition-date fair value cannot be determined, the asset acquired or liability assumed arising from a contingency is recognized only if certain criteria are met. This guidance also requires that a systematic and rational basis for subsequently measuring and accounting for the assets or liabilities be developed depending on their nature. The Company will apply the provisions of this guidance to the acquisitions of D&E Communications, Inc. (“D&E”) and Lexcom, Inc. (“Lexcom”).

Noncontrolling Interests in Consolidated Financial Statements

Effective January 1, 2009, Windstream adopted authoritative guidance for noncontrolling interests in consolidated financial statements. Since Windstream does not have any non-controlling interests, the adoption of this guidance did not impact the Company’s consolidated financial statements.

 

7


Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

2. Accounting Changes, Continued:

 

Disclosures about Derivative Instruments and Hedging Activities

Effective January 1, 2009, Windstream adopted authoritative guidance for disclosures about derivative instruments and hedging activities, which requires companies with derivative instruments to disclose information to enable financial statement users to understand how and why a company uses derivative instruments, how authoritative guidance is applied to derivative instruments and related hedged items, and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. See Notes 5, 6 and 10 for the disclosures required by this guidance.

Determination of the Useful Life of Intangible Assets

Effective January 1, 2009, Windstream adopted authoritative guidance amending the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset and requiring disclosures to enable users of financial statements to assess the extent to which the expected future cash flows associated with the asset are affected by the entity’s intent and/or ability to renew or extend the arrangement. Windstream considered its historical experience in renewing the Company’s franchise rights and determined that it is consistent with previous renewal assumptions used in the determination of useful lives. Thus, the adoption of this guidance did not impact Windstream’s consolidated financial statements.

Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities

Effective January 1, 2009, the Company adopted authoritative guidance for determining whether instruments granted in share-based payment transactions are participating securities. Under this guidance, Windstream’s non-vested share-based payment awards that contain a nonforfeitable right to receive dividends, whether paid or unpaid, are considered participating securities and have been included in the computation of basic earnings per share pursuant to the two-class method, and are no longer considered potentially dilutive. Basic and diluted earnings per share have been retrospectively adjusted as a result of the adoption of this guidance. See Note 11 for the calculation of earnings per share.

Recently Issued Authoritative Guidance

Revenue Arrangements with Multiple Element Deliverables

On September 23, 2009, the FASB reached a consensus on accounting for revenue arrangements with multiple deliverables. The consensus addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, and how the arrangement consideration should be allocated among the separate units of accounting. This guidance is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements.

Fair Value Measurements

On September 30, 2009, the FASB updated the authoritative guidance for fair value measurements to allow a reporting entity to measure the fair value of certain alternative investments on the basis of net asset value per share of the investment if the net asset value of the investment is calculated in a manner consistent with the measurement principles of investment companies. This update is effective for the first interim or annual reporting period ending after December 15, 2009. Early adoption is permitted. The Company does not anticipate that the adoption of this update will have a material impact on its consolidated financial statements.

On August 28, 2009, the FASB updated the authoritative guidance for fair value measurements to clarify that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following methods: 1) a valuation technique that uses a) the quoted price of the identical liability when traded as an asset or b) quoted prices for similar liabilities or similar liabilities when traded as assets or 2) a valuation technique that is consistent with fair value measurement principles (e.g. an income approach or market approach). The amendment also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment relating to the existence of transfer restrictions on that liability. This update is effective for the first interim or annual reporting period beginning after August 28, 2009. The Company does not anticipate that the adoption of this update will have a material impact on its consolidated financial statements.

Determining the Primary Beneficiary of a Variable Interest Entity

On June 12, 2009 the FASB revised the authoritative guidance for determining the primary beneficiary of a variable interest entity to be more qualitative in nature and requires companies to more frequently reassess whether they must consolidate a variable

 

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Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

2. Accounting Changes, Continued:

 

interest entity. This guidance will be effective for fiscal years beginning on or after November 15, 2009. The Company does not expect this guidance to have any impact on its consolidated financial statements.

Accounting for Transfers of Financial Assets

In June 2009, the FASB issued authoritative guidance related to accounting for transfers of financial assets, which includes:

 

   

eliminating the qualifying special-purpose entity concept,

 

   

a new unit of account definition that must be met for transfers of portions of financial assets to be eligible for sale accounting,

 

   

clarifications and changes to the derecognition criteria for a transfer to be accounted for as a sale,

 

   

a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor, and

 

   

extensive new disclosures.

The guidance is effective for fiscal years beginning on or after November 15, 2009. The Company is currently evaluating the impact, if any, that this guidance will have on its consolidated financial statements.

Employers’ Disclosures about Postretirement Benefit Plan Assets

In December 2008, the FASB issued authoritative guidance for employers’ disclosures about postretirement benefit plan assets, which requires employers to disclose:

 

   

the fair value of each major category of plan assets as of each annual reporting date for which a statement of financial position is presented,

 

   

the inputs and valuation techniques used to develop fair value measurements of plan assets at the annual reporting date, including the level within the fair value hierarchy in which the fair value measurements fall as defined by authoritative guidance for fair value measurements,

 

   

investment policies and strategies, including target allocation percentages, and

 

   

significant concentrations of risk in plan assets.

This guidance is effective for fiscal years ending after December 15, 2009. Upon implementation, Windstream will provide expanded disclosures in its December 31, 2009 Form 10-K.

 

3. Dispositions:

Disposition of Out of Territory Product Distribution Operations - On August 21, 2009, Windstream completed the sale of its out of territory product distribution operations to Walker and Associates of North Carolina, Inc. (“Walker”) for approximately $5.3 million in total consideration. The out of territory product distribution operations primarily consisted of product inventory with a carrying value of $4.9 million and customer relationships outside of Windstream’s telecommunications operating territories. These operations were not central to the Company’s strategic goals in its core communications business. Product revenues from these operations totaled $8.2 million and $38.5 million during the three and nine month periods ended September 30, 2009, respectively, with related cost of products sold of $7.6 million and $34.3 million for the same periods in 2009. In conjunction with this transaction, Windstream recognized a gain of $0.4 million in other income, net in its consolidated statements of income for the three and nine month periods ended September 30, 2009.

Disposition of Wireless Business - On November 21, 2008, Windstream completed the sale of its wireless business to AT&T Mobility II, LLC for approximately $56.7 million. The transaction included approximately 52,000 wireless customers, spectrum licenses and cell sites covering a four-county area of North Carolina with a population of approximately 450,000, and six retail locations. Revenues from these operations totaled $11.7 million and $35.2 million during the three and nine month periods ended September 30, 2008, respectively. The operating results of the wireless business have been separately presented as discontinued operations in the accompanying unaudited interim consolidated statements of income.

Disposition of Acquired Assets Held for Sale - Certain assets acquired from CT Communications, Inc. (“CTC”), including the corporate headquarters building and a license for wireless spectrum, were sold during the first nine months of 2008. Windstream

received net proceeds of $17.3 million, which approximated the fair value at the date of acquisition.

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

3. Dispositions, Continued:

During the third quarter of 2008, Windstream recognized a non-cash impairment charge of $6.5 million included in selling, general, administrative and other in the accompanying unaudited interim consolidated statements of income to reduce the carrying value of certain wireless spectrum licenses designated as held for sale, and not used in operations, to their fair market value. The fair market value of these holdings has been reduced to a nominal amount due to an impairment resulting from general market conditions and limited interest on this bandwidth of spectrum.

 

4. Goodwill and Other Intangible Assets:

As of January 1, 2009, the Company completed its annual impairment review of goodwill and franchise rights and determined that no write-down in the carrying value of these assets was required. Commensurate with its change from multiple segments to a single reporting segment as discussed further in Note 1, the Company no longer uses a combination of the discounted cash flows and the calculated market values of comparable companies to determine the fair value of a reporting unit. Rather, the Company assesses impairment of its goodwill by evaluating the carrying value of its shareholders’ equity against the current fair market value of its outstanding equity, where the fair market value of the Company’s equity is equal to its current market capitalization plus a control premium estimated to be 20 percent through the review of recent market observable transactions involving wireline telecommunication companies. During the nine months ended September 30, 2009, there were no changes in the carrying amounts of goodwill.

The carrying value of the Company’s franchise rights was $955.0 million as of December 31, 2008. As discussed in Note 2, effective January 1, 2009, the Company prospectively changed its assessment of useful life for its franchise rights from indefinite-lived to 30 years. Effective with this change, these rights are now amortized on a straight line basis in accordance with the way in which these operations are expected to contribute to the undiscounted cash flows of the Company.

Intangible assets subject to amortization were as follows:

 

(Millions)    September 30, 2009
  

Gross

Cost

  

Accumulated

Amortization

   

Net Carrying

Value

Franchise rights

   $ 955.0    $ (23.9   $ 931.1

Valor customer list

     210.0      (117.9     92.1

CTC customer list

     45.0      (17.6     27.4

Other customer list

     67.6      (45.9     21.7

Cable franchise rights

     22.5      (22.0     0.5
                     
     $ 1,300.1    $ (227.3   $ 1,072.8
                       
     December 31, 2008
(Millions)   

Gross

Cost

  

Accumulated

Amortization

   

Net Carrying

Value

Valor customer list

   $ 210.0    $ (94.4   $ 115.6

CTC customer list

     45.0      (11.7     33.3

Other customer list

     67.6      (40.9     26.7

Cable franchise rights

     22.5      (20.9     1.6
                     
     $ 345.1    $ (167.9   $ 177.2

Amortization expense for intangible assets subject to amortization was $19.1 million and $59.4 million for the three and nine month periods ended September 30, 2009, respectively, as compared to $12.7 million and $39.6 million for the same periods of 2008. Amortization expense for intangible assets subject to amortization is estimated to be $78.2 million in 2009, $71.1 million in 2010, $65.4 million in 2011, $59.7 million in 2012 and $47.4 million in 2013.

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

5. Debt and Derivative Instruments:

Long-term debt was as follows:

 

(Millions)           September 30,
2009
        December 31,
2008
 

Issued by Windstream Corporation:

   

Senior secured credit facility, Tranche A - variable rates, due July 17, 2011 (a)

  $      283.3      $      283.3   

Senior secured credit facility, Tranche B - variable rates, due July 17, 2013 (a)

  1,368.5      1,379.0   

Senior secured credit facility, Revolving line of credit - variable rates, due July 17, 2011 (a) (b)

       150.0   

Debentures and notes, without collateral:

   

2016 Notes – 8.625%, due August 1, 2016 (c)

  1,746.0      1,746.0   

2013 Notes – 8.125%, due August 1, 2013 (c)

  800.0      800.0   

2019 Notes – 7.000%, due March 15, 2019 (c)

  500.0      500.0   

Issued by subsidiaries of the Company:

   

Valor Telecommunications Enterprises LLC and Valor Telecommunications Finance Corp. - 7.75%, due February 15, 2015 (c) (d)

  400.0      400.0   

Windstream Holdings of the Midwest, Inc. - 6.75%, due April 1, 2028 (c) (d)

  100.0      100.0   

Debentures and notes, without collateral:

   

Windstream Georgia Communications LLC - 6.50%, due November 15, 2013

  50.0      50.0   

Teleview, LLC - 7.00%, due January 2, 2010 and May 2, 2010

  0.1      0.3   

Discount on long-term debt, net of premiums

  (24.8   (26.1
           
  5,223.1      5,382.5   

Less current maturities

  (24.1   (24.3
           

Total long-term debt (e)

  $      5,199.0      $      5,358.2   

 

  (a) In October 2009, Windstream received consent from its lenders to an amendment and restatement of its senior secured credit facility (the “Amendment”). See Note 15 for further discussion of the financial impact of the Amendment.

 

  (b) The Company has a revolving line of credit in its senior secured credit facility under which it may borrow up to $500.0 million less outstanding letters of credit. During the second quarter of 2009, the Company repaid the full amount outstanding under the revolving line of credit. The revolving line of credit’s variable interest rates ranged from 1.59 percent to 2.45 percent, with a weighted average rate of 1.77 percent during the nine months ended September 30, 2009. After giving consideration to the Company’s letters of credit, the Company had $491.8 million of available borrowing capacity under the revolving line of credit as of September 30, 2009.

 

  (c) Certain of the Company’s debentures and notes are callable by the Company at various premiums on early redemption.

 

  (d) The Company’s collateralized Valor debt is equally and ratably secured with debt under the senior secured credit facilities. Debt held by Windstream Holdings of the Midwest, Inc., a subsidiary of the Company, is secured solely by the assets of the subsidiary.

 

  (e) On October 8, 2009, Windstream completed the private placement of approximately $400.0 million aggregate principal amount of senior unsecured notes due November 1, 2017, (the “Private Placement”). See Note 15 for further discussion of the financial impact of the Private Placement.

The terms of the senior secured credit facilities and indentures include customary covenants that, among other things, require Windstream to maintain certain financial ratios, restrict its ability to incur additional indebtedness, and limit its cash payments. These financial ratios include a maximum leverage ratio of 4.5 to 1.0 and a minimum interest coverage ratio of 2.75 to 1.0. In addition, the covenants include restrictions on dividend and certain other types of payments, as well as restrictions on capital expenditures. For 2009, the Company has capacity to spend $582.5 million, which includes $132.5 million of unused capacity from 2008, under the capital expenditures restriction in its covenants.

In addition, certain of the Company’s debt agreements contain various covenants and restrictions specific to the subsidiary that is the legal counterparty to the agreement. Under the Company’s long-term debt agreements, acceleration of principal payments would occur upon payment default, violation of debt covenants not cured within 30 days, a change in control including a person or group obtaining 50 percent or more of Windstream’s outstanding voting stock, or breach of certain

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

5. Debt and Derivative Instruments, Continued:

 

other conditions set forth in the borrowing agreements. The Company was in compliance with these covenants as of September 30, 2009.

Maturities for debt outstanding as of September 30, 2009 for each of the twelve month periods ended September 30, 2010, 2011, 2012, 2013, and 2014 were $24.1 million, $307.3 million, $20.5 million, $2,140.0 million and $10.0 million, respectively. See Note 15 for the scheduled principal payments after giving effect to the Private Placement and Amendment.

Interest expense was as follows for the three and nine month periods ended September 30:

 

(Millions)    Three Months Ended     Nine Months Ended  
   2009     2008     2009     2008  

Interest expense related to long-term debt

   $      83.6      $      94.8      $      258.2      $      291.1   

Impacts of interest rate swaps

   14.3      9.0      38.0      22.0   

Other interest expense

             0.1      0.1   

Less capitalized interest expense

   (0.4   (0.5   (1.3   (1.3
                        

Total interest expense

   $      97.5      $      103.3      $      295.0      $      311.9   

Windstream has entered into four identical pay fixed, receive variable interest rate swap agreements totaling $1,600.0 million in notional value in order to mitigate the interest rate risk inherent in its variable rate senior secured credit facilities. The four interest rate swap agreements amortize quarterly to a notional value of $906.3 million at maturity on July 17, 2013. The variable rate received resets on the seventeenth day of each quarter to the three-month LIBOR (London-Interbank Offered Rate). The Company’s interest rate swap agreements are designated as cash flow hedges of the interest rate risk created by the variable interest rate paid on Tranche B of the senior secured credit facilities through July 17, 2013. The variable interest rate paid on Tranche B is based on the three-month LIBOR, and it also resets on the seventeenth day of each quarter.

After the completion of a refinancing transaction in February 2007, a portion of one of the four interest rate swap agreements with a notional value of $125.0 million ($98.4 million as of September 30, 2009) was de-designated as the corresponding hedged item was repaid. Therefore, the undesignated portion of the swap agreement was no longer an effective hedge of the variable interest rate paid on Tranche B.

Set forth below is information related to the Company’s interest rate swap agreements:

 

(Millions, except for percentages)    September 30,
2009
    December 31,
2008
 

Unamortized notional value:

    

Designated portion

   $   1,101.6      $   1,176.2   

Undesignated portion

   $ 98.4      $ 105.0   

Fair value of interest rate swap agreements (see Note 6):

    

Designated portion

   $ (121.1   $ (140.8

Undesignated portion

   $ (10.8   $ (12.6

Fixed rate paid

     5.60     5.60

Variable rate received

     0.51     4.55

The effectiveness of the Company’s cash flow hedges is assessed each quarter using the “Change in Variable Cash Flow Method”. This method utilizes the matched terms principle of measuring effectiveness, and requires the floating-rate leg of the swap and the hedged variable cash flows of the asset or liability to be based on the same interest rate index. It also requires the variable interest rates of both instruments to reset on the same dates. Furthermore, there should be no other differences in the terms of the hedge and the hedged item, and the likelihood of default by the interest rate swap counterparties must be assessed as being unlikely in order to conclude that there is no ineffectiveness in the hedging relationship. The Company performs and documents this assessment each quarter, and it concluded at September 30, 2009 that there was no ineffectiveness to be recognized in earnings for any of its four interest rate swap agreements that are designated as hedges. In addition, the Company has concluded that the Amendment of its debt agreements, described in Note 15, will have no impact on its assessment of hedge effectiveness.

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

5. Debt and Derivative Instruments, Continued:

 

The Company recognizes all derivative instruments at fair value in the accompanying consolidated balance sheets as either assets or liabilities depending on the rights or obligations under the related contracts. Changes in fair value of these derivative instruments were as follows for the three and nine month periods ended September 30:

 

(Millions)

   Three Months Ended     Nine Months Ended
   2009     2008     2009    2008

Change in fair value of effective portion, net of tax (a)

   $ (4.7   $ (1.7   $ 11.8    $ 3.8

Change in fair value of undesignated portion (b)

   $ (0.6   $ (0.3   $ 1.8    $ 0.5

 

  (a) Included as a component of other comprehensive income (loss) and will be reclassified into earnings as the hedged transaction affects earnings.

 

  (b) Represents non-cash income recorded in other income, net in the accompanying consolidated statements of income.

Net amounts due related to designated interest rate swap agreements are recorded as adjustments to interest expense in the accompanying unaudited interim consolidated statements of income when earned or payable.

 

6. Fair Value Measurements:

Windstream utilizes market data or assumptions that market participants would use in valuing its assets and liabilities, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. Valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs are used, and the fair value balances are classified based on the observability of those inputs. The highest priority is given to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority is given to unobservable inputs (level 3 measurement). Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.

The Company’s non-financial assets and liabilities, including goodwill, intangible assets and asset retirement obligations, are measured at fair value on a non-recurring basis. No event occurred during the nine months ended September 30, 2009 requiring these non-financial assets and liabilities to be recognized at fair value.

The Company’s financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, long-term debt and interest rate swaps. The carrying amount of accounts receivable and accounts payable was estimated by management to approximate fair value due to the relatively short period of time to maturity for those instruments. Cash equivalents, long-term debt and interest rate swaps are measured at fair value on a recurring basis.

The fair values of the Company’s cash equivalents and interest rate swaps were determined using the following inputs:

 

(Millions)

                 September 30, 2009
       Quoted Price
in Active
Markets for
Identical Assets
   Significant
Other
Observable
Inputs
    Significant
Unobservable
Inputs
   Fair Value     Carrying Amount     Level 1    Level 2     Level 3

Cash equivalents (a)

   $     290.0      $ 290.0      $ 290.0    $      $

Interest rate swaps (b) (see Note 5)

   $ (131.9   $ (131.9   $    $ (131.9   $

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

6. Fair Value Measurements, Continued:

 

(Millions)

                 December 31, 2008
       Quoted Price
in Active
Markets for
Identical Assets
   Significant
Other
Observable
Inputs
    Significant
Unobservable
Inputs
   Fair Value     Carrying Amount     Level 1    Level 2     Level 3

Cash equivalents (a)

   $     296.6      $ 296.6      $ 296.6    $      $

Interest rate swaps (b) (see Note 5)

   $ (153.4   $ (153.4   $    $ (153.4   $

 

  (a) Included in cash and cash equivalents on the unaudited consolidated balance sheet as of September 30, 2009 and consolidated balance sheet as of December 31, 2008.

 

  (b) Included in current portion of interest rate swaps and other liabilities on the unaudited consolidated balance sheet as of September 30, 2009 and consolidated balance sheet as of December 31, 2008.

The Company’s cash equivalents are primarily highly liquid, actively traded money market funds with next day access. The fair value of interest rate swaps was determined based on the present value of expected future cash flows using LIBOR rates, which are observable at commonly quoted intervals for the full term of the swaps, adjusted for the Company’s non-performance risk. As of September 30, 2009 and December 31, 2008, the fair value of the Company’s interest rate swaps were reduced by $4.5 million and $17.4 million, respectively, to reflect the Company’s non-performance risk. The Company’s non-performance risk is assessed based on the current trading discount of its Tranche B senior secured credit facility as the swap agreements are secured by the same collateral. In addition, the Company routinely monitors and updates its evaluation of counterparty risk, and based on such evaluation has determined that the swap agreements continue to meet the requirements of an effective cash flow hedge. The counterparty to each of the four swap agreements is a bank with a current credit rating at or above A+.

The fair value and carrying value of the Company’s long-term debt, including current maturities, was as follows:

 

(Millions)   

September 30,

2009

  

December 31,

2008

Fair value

   $       5,252.7    $       4,637.0

Carrying value

   $ 5,223.1    $ 5,382.5

The fair value of the corporate bonds was calculated based on quoted market prices of the specific issuances in an active market when available. When an active market is not available for certain bonds and bank notes, the fair market value was determined based on bid prices and broker quotes. In calculating the fair market value of the revolving line of credit and Windstream Holdings of the Midwest, Inc. bonds, an appropriate market price for the same or similar instruments in an active market were used considering credit quality, nonperformance risk and maturity of the instrument.

 

7. Commitments and Contingencies:

The Company is party to various legal proceedings. Although the ultimate resolution of these various proceedings cannot be determined at this time, management of the Company does not believe that such proceedings, individually or in the aggregate, will have a material adverse effect on the future consolidated results of income, cash flows or financial condition of the Company.

In addition, management of the Company is currently not aware of any environmental matters that, individually or in the aggregate, would have a material adverse effect on the consolidated financial condition or results of operations of the Company.

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

8. Employee Benefit Plans and Postretirement Benefits Other Than Pensions:

Windstream maintains a non-contributory qualified defined benefit pension plan, which covers substantially all employees. Prior to establishing the pension plan pursuant to the spin off in 2006, the Company’s employees participated in a substantially equivalent plan maintained by Alltel. Future benefit accruals for all eligible nonbargaining employees covered by the pension plan ceased as of December 31, 2005 (December 31, 2010 for employees who had attained age 40 with two years of service as of December 31, 2005). The Company also maintains supplemental executive retirement plans that provide unfunded, non-qualified supplemental retirement benefits to a select group of current and former management employees. Additionally, the Company provides postretirement healthcare and life insurance benefits for eligible employees. Employees share in, and the Company funds, the costs of these plans as benefits are paid.

The components of pension expense (including provision for executive retirement agreements) were as follows for the three and nine month periods ended September 30:

 

(Millions)

   Three Months Ended     Nine Months Ended  
   2009     2008     2009     2008  

Benefits earned during the year

   $ 3.3      $ 3.3      $ 10.0      $ 9.9   

Interest cost on benefit obligation

     14.3        14.0        42.9        42.1   

Amortization of net actuarial loss

     17.8        1.6        53.4        4.8   

Amortization of prior service credit

                   (0.1     (0.1

Expected return on plan assets

     (12.4     (19.1     (37.4     (57.2
                                

Net periodic benefit expense (income)

   $ 23.0      $ (0.2   $ 68.8      $ (0.5

The components of postretirement expense were as follows for the three and nine month periods ended September 30:

 

(Millions)

   Three Months Ended    Nine Months Ended
   2009     2008    2009     2008

Benefits earned during the year

   $ 0.1      $ 0.1    $ 0.1      $ 0.2

Interest cost on benefit obligation

     2.1        3.1      6.3        10.1

Amortization of transition obligation

            0.1             0.5

Amortization of net actuarial loss

            0.3             1.0

Amortization of prior service (credit) cost

     (0.8     0.1      (2.4     1.0
                             

Net periodic benefit expense

   $ 1.4      $ 3.7    $ 4.0      $ 12.8

Windstream contributed $10.7 million to the postretirement plan during the nine months ended September 30, 2009, and expects to contribute an additional $3.2 million for postretirement benefits throughout the remainder of 2009, excluding amounts that will be funded by participant contributions to the plans. The Company contributed $2.5 million to the pension plan during the nine months ended September 30, 2009, and does not expect to make any additional contributions for pension benefits for the remainder of 2009.

 

9. Merger, Integration and Restructuring Charges:

The following is a summary of merger, integration and restructuring charges recorded in the three and nine month periods ended September 30:

 

(Millions)

   Three Months Ended    Nine Months Ended
   2009    2008    2009    2008

Transaction costs associated with the acquisition of D&E

   $ 0.9    $    $ 2.3    $

Transaction costs associated with the acquisition of Lexcom

     0.1           0.1     

Transaction costs associated with the acquisition of CTC

                    0.1

Computer system separation and conversion costs

                    6.1
                           

Total merger and integration costs

     1.0           2.4      6.2

Severance and employee benefit costs

     7.5      1.0      7.5      2.1
                           

Total merger, integration and restructuring charges

   $ 8.5    $ 1.0    $ 9.9    $ 8.3

 

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Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

9. Merger, Integration and Restructuring Charges, Continued:

Costs triggered by strategic transactions, including transaction costs, rebranding costs and system conversion costs are unpredictable by nature. Restructuring charges, consisting primarily of severance and employee benefit costs, are triggered by the Company’s continued evaluation of its operating structure and identification of opportunities for increased operational efficiency and effectiveness and should not necessarily be viewed as non-recurring. They are reviewed regularly by the Company’s decision makers and are included as a component of compensation targets.

Transaction costs are expensed as incurred and primarily include charges for accounting, legal, broker fees and other miscellaneous costs, including computer system and conversion costs associated with the acquisition of CTC and the pending acquisitions of D&E and Lexcom (see Note 14).

During the third quarter of 2009, Windstream recognized $7.5 million of the $9.0 million total expected severance and employee benefit costs primarily related to the announced workforce reduction initiated to better align the Company’s focus on high-speed Internet and enterprise opportunities. The Company expects to complete the workforce reduction in the fourth quarter of 2009. During the second quarter of 2009, the Company incurred $0.1 million in severance and employee benefit related costs associated with the closure of an out of territory sales and product distribution facility. During the first quarter of 2009, the Company recorded a $0.1 million reduction in liabilities to reflect differences between estimated and actual costs paid associated with a work force reduction initiated during the fourth quarter of 2008. During the three and nine months ended September 30, 2009, the Company expensed consulting fees of $1.0 million and $2.4 million, respectively, associated with the pending acquisitions of D&E and Lexcom.

During the nine months ended September 30, 2008, the Company incurred $2.1 million in severance and employee-related costs primarily related to the announced realignment of certain information technology, network operations and business sales functions. Additionally, in 2008 the Company incurred charges for accounting, legal and broker fees and other miscellaneous costs associated with the acquisition of CTC. Other merger and integration costs during 2008 consisted of computer system and conversion costs, of which $4.6 million incurred during the second quarter was related to a non-cash charge to abandon certain software acquired in the CTC acquisition.

The following is a summary of the activity related to the liabilities associated with the Company’s merger, integration and restructuring charges for the nine months ended September 30, 2009:

 

(Millions)  

Balance, beginning of period

   $ 8.3   

Merger, integration and restructuring charges, net of non-cash charges

     9.9   

Cash outlays during the period

     (9.8
        

Balance, end of period

   $ 8.4   

As of September 30, 2009 the Company had unpaid merger, integration and restructuring liabilities totaling $8.4 million, which consisted of $7.5 million of severance and employee benefit costs, $0.6 million of Valor lease termination costs and $0.3 million of costs associated with the pending acquisitions of D&E and Lexcom. This liability is included in other current liabilities in the accompanying unaudited interim consolidated balance sheet. Substantially all payments for severance and employee benefit costs will be made during the fourth quarter of 2009 as positions are eliminated. Valor lease payments will be made over the remaining term of the lease expiring in the third quarter of 2010. Each of these payments will be funded through operating cash flows.

 

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Table of Contents

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

10. Comprehensive Income (Loss):

Comprehensive income (loss) was as follows for the three and nine month periods ended September 30:

 

(Millions)

   Three Months Ended     Nine Months Ended  
   2009     2008     2009     2008  

Net income

   $ 80.0      $ 105.9      $     259.0      $     331.6   

Comprehensive income:

        

Defined benefit pension plans:

        

Change in net actuarial loss for employee benefit plans

                   (11.2     (27.5

Amounts included in net periodic benefit cost:

        

Amortization of prior service credits

                   (0.1     (0.1

Amortization of net actuarial loss

     17.8        1.6        53.4        4.8   

Income tax (expense) benefit

     (6.8     (0.6     (16.1     8.9   
                                

Change in pension plan

     11.0        1.0        26.0        (13.9
                                

Postretirement plan:

        

Change in net actuarial gain (loss) for employee benefit plans

            67.3        12.9        59.0   

Amounts included in net periodic benefit cost:

        

Amortization of transition obligation

            0.1               0.5   

Amortization of prior service costs (credits)

     (0.8     0.1        (2.4     1.0   

Amortization of net actuarial loss

            0.3               1.0   

Income tax (expense) benefit

     0.3        (26.9     (4.8     (20.5
                                

Change in postretirement plan

     (0.5     40.9        5.7        41.0   
                                

Change in employee benefit plans

     10.5        41.9        31.7        27.1   
                                

Interest rate swaps:

        

Unrealized holding gain (loss) on interest rate swaps

     (7.4     (2.7     20.2        6.2   

Income tax benefit (expense)

     2.8        1.0        (8.1     (2.4
                                

Unrealized holding gain (loss) on interest rate swaps

     (4.6     (1.7     12.1        3.8   
                                

Comprehensive income

   $ 85.9      $ 146.1      $ 302.8      $ 362.5   

Accumulated other comprehensive loss was as follows:

 

(Millions)

       September 30,     December 31,  
   2009     2008  

Pension and postretirement plans

   $ (216.6   $ (248.3

Unrealized holding losses on interest rate swaps:

    

Designated portion

     (74.8     (86.6

Undesignated portion

     (1.4     (1.7
                

Accumulated other comprehensive loss

   $ (292.8   $ (336.6

 

11. Earnings per Share:

Basic earnings per share was computed by dividing net income applicable to common shares by the weighted average number of common shares outstanding during each period. Windstream’s non-vested restricted shares that contain a non-forfeitable right to receive dividends on a one-to-one per share ratio to common shares are considered participating securities, and the impact is included in the computation of basic earnings per share pursuant to the two-class method. The two-class method of computing earnings per share is an earnings allocation formula that determines earnings attributable to common shares and participating

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

11. Earnings per Share, Continued:

securities according to dividends declared (whether paid or unpaid) and participation rights in undistributed earnings. Earnings per common share was computed by dividing the sum of distributed earnings and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and non-vested restricted shares based on the pro-rata weighted average shares outstanding during the period. The Company also computed dilutive earnings per share using the two-class method as this method is more dilutive than the treasury stock method. Under this method, Windstream’s diluted earnings per share is equal to the Company’s calculated basic earnings per share. Effective January 1, 2009, the Company adopted this revised authoritative guidance for calculating earnings per share, and commensurate therewith, has retrospectively adjusted prior period earnings per share data, the impact of which was immaterial.

A reconciliation of net income and number of shares used in computing basic and diluted earnings per share was as follows for the three and nine month periods ended September 30:

 

(Millions, except per share amounts)

   Three Months Ended     Nine Months Ended  
   2009     2008     2009     2008  

Basic and diluted earnings per share:

        

Numerator:

        

Income from continuing operations

   $ 80.0      $   104.3      $   259.0      $   344.1   

Income from continuing operations allocable to non-vested restricted shares

     (0.7     (0.8     (2.9     (2.9
                                

Adjusted income from continuing operations available to common shares

   $ 79.3      $ 103.5      $ 256.1      $ 341.2   

Loss from discontinued operations

            1.6               (12.5

Loss from discontinued operations allocable to non-vested restricted shares

            (0.1            0.1   
                                

Adjusted income from discontinued operations available to common shares

            1.5               (12.4
                                

Net income available to common shares

   $ 79.3      $ 105.0      $ 256.1      $ 328.8   
                                

Denominator:

        

Weighted average common shares outstanding for the period

     433.0        435.9        433.8        442.3   
                                

Basic and diluted earnings per share:

        

From continuing operations

     $.18        $.24        $.59        $.77   

From discontinued operations

                          (.03
                                

Net income

     $.18        $.24        $.59        $.74   

The calculation of earnings per share for common shares shown above excludes the income attributable to the non-vested restricted shares from the numerator and excludes the dilutive impact of non-vested restricted shares from the denominator.

 

12. Stock-Based Compensation Plans:

Under the Company’s stock-based compensation plans, Windstream may issue restricted stock and other equity securities to directors, officers and other key employees. The maximum number of shares available for issuance under the Windstream 2006 Equity Incentive Plan is 10.0 million shares. As of September 30, 2009, the balance available for grant was approximately 3.5 million shares.

During February, May and August 2009, the Windstream Board of Directors approved grants of restricted stock to officers, executives, non-employee directors and certain management employees. These grants include the standard annual grants to this employee and director group as a key component of their annual incentive compensation plan. The vesting periods and grant date fair value for shares issued during the nine months ended September 30, 2009 was as follows:

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

12. Stock-Based Compensation Plans, Continued:

 

      (Thousands)     Weighted Average
Fair Value Per Share
   Number of
Shares
   

Non-vested at December 31, 2008

   3,352.8      $12.30

Granted

   1,857.8      $8.71

Vested

   (2,198.1   $12.50

Forfeited

   (119.4   $10.78
          

Non-vested at September 30, 2009

   2,893.1      $9.90

For performance based shares granted, the operating target for the first vesting period was approved by the Board of Directors in February 2009. While achievement of these performance targets remains uncertain, management has determined that it is probable that such targets will be met for fiscal year 2009.

Non-vested restricted stock activity for the nine months ended September 30, 2009 was as follows:

 

(Thousands)   

Common

Shares

Vest ratably over a three-year service period

     1,125.1

Vest contingently over a three-year performance period

     677.5

Vest one year from date of grant, service based (a)

     55.2
      

Total granted

     1,857.8
      

Grant date fair value (Millions)

   $ 16.2

 

  (a) Represents shares granted to non-employee directors.

The weighted average grant date fair value for restricted stock granted was $1.4 million and $16.2 million for the three and nine month periods ended September 30, 2009, respectively, compared to $14.3 million for the nine month period ended September 30, 2008. There was no change in the weighted average grant date fair value for the three months ended September 30, 2008. At September 30, 2009, unrecognized compensation expense for non-vested Windstream restricted shares was $13.4 million. The unrecognized compensation expense for these non-vested restricted shares has a remaining weighted average vesting period of 1.5 years. Stock-based compensation expense was $3.7 million and $14.3 million for the three and nine month periods ended September 30, 2009, respectively, as compared to $4.3 million and $13.5 million for the same periods of 2008.

 

13. Supplemental Guarantor Information:

In connection with the issuance of the 2013 Notes, the 2016 Notes, and the 2019 Notes (“the guaranteed notes”), certain of the Company’s wholly-owned subsidiaries (the “Guarantors”), including all former subsidiaries of Valor, provided guarantees of those debentures. These guarantees are full and unconditional as well as joint and several. Certain Guarantors may be subject to restrictions on their ability to distribute earnings to the Company. The remaining subsidiaries (the “Non-Guarantors”) of Windstream are not guarantors of the guaranteed notes. Following the acquisition of CTC, the guaranteed notes were amended to include certain subsidiaries of CTC as guarantors.

The following information presents condensed consolidated statements of income for the three and nine month periods ended September 30, 2009 and 2008, condensed consolidated balance sheets as of September 30, 2009 and December 31, 2008, and condensed consolidated statements of cash flows for the nine months ended September 30, 2009 and 2008 of the parent company, the Guarantors, and the Non-Guarantors. Investments in consolidated subsidiaries are held primarily by the parent company in the net assets of its subsidiaries and have been presented using the equity method of accounting.

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

13. Supplemental Guarantor Information, Continued:

 

     Condensed Consolidated Statement of Income (Unaudited)
Three Months Ended September 30, 2009
 
(Millions)    Parent     Guarantors    

Non-

Guarantors

    Eliminations     Consolidated  

Revenues and sales:

          

Service revenues

   $      $ 185.1      $ 522.1      $ (2.3   $ 704.9   

Product sales

            16.8        12.6               29.4   
                                        

Total revenues and sales

            201.9        534.7        (2.3     734.3   

Costs and expenses:

          

Cost of services

            62.4        192.4        (1.8     253.0   

Cost of products sold

            15.4        10.6               26.0   

Selling, general, administrative and other

            20.3        67.8        (0.5     87.6   

Depreciation and amortization

            47.8        86.0               133.8   

Merger, integration and restructuring

            3.0        5.5               8.5   
                                        

Total costs and expenses

            148.9        362.3        (2.3     508.9   

Operating income

            53.0        172.4               225.4   

Earnings (losses) from consolidated subsidiaries

     134.0        17.8               (151.8       

Other income (expense), net

     (1.7     27.5        (28.0            (2.2

Intercompany interest income (expense)

     8.8        (3.8     (5.0              

Interest expense

     (95.3     (1.6     (0.6            (97.5
                                        

Income before income taxes

     45.8        92.9        138.8        (151.8     125.7   

Income tax expense (benefit)

     (34.2     27.4        52.5               45.7   
                                        

Net income

   $ 80.0      $ 65.5      $ 86.3      $ (151.8   $ 80.0   

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

13. Supplemental Guarantor Information, Continued:

 

     Condensed Consolidated Statement of Income (Unaudited)
Three Months Ended September 30, 2008
 
(Millions)    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Revenues and sales:

          

Service revenues

   $      $ 189.9      $ 553.3      $ (1.3   $ 741.9   

Product sales

            35.7        16.5               52.2   
                                        

Total revenues and sales

            225.6        569.8        (1.3     794.1   

Costs and expenses:

          

Cost of services

            59.6        197.3        (1.0     255.9   

Cost of products sold

            33.7        15.8               49.5   

Selling, general, administrative and other

            29.4        64.2        (0.3     93.3   

Depreciation and amortization

            42.2        81.6               123.8   

Merger, integration and restructuring

            0.2        0.8               1.0   
                                        

Total costs and expenses

            165.1        359.7        (1.3     523.5   

Operating income

            60.5        210.1               270.6   

Earnings (losses) from consolidated subsidiaries

     173.9        32.7               (206.6       

Other income (expense), net

     (0.5     0.6        0.4               0.5   

Intercompany interest income (expense)

     (7.9     (3.1     11.0                 

Interest expense

     (101.0     (1.6     (0.7            (103.3
                                        

Income from continuing operations before income taxes

     64.5        89.1        220.8        (206.6     167.8   

Income tax expense (benefit)

     (41.4     21.4        83.5               63.5   
                                        

Income from continuing operations

     105.9        67.7        137.3        (206.6     104.3   

Discontinued operations, net

                   1.6               1.6   
                                        

Net income

   $     105.9      $ 67.7      $ 138.9      $ (206.6   $ 105.9   

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

13. Supplemental Guarantor Information, Continued:

 

     Condensed Consolidated Statement of Income (Unaudited)
Nine Months Ended September 30, 2009
 
(Millions)    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Revenues and sales:

          

Service revenues

   $      $ 559.8      $ 1,586.5      $ (6.1   $ 2,140.2   

Product sales

            66.2        35.8               102.0   
                                        

Total revenues and sales

            626.0        1,622.3        (6.1     2,242.2   

Costs and expenses:

          

Cost of services

            179.1        579.4        (4.6     753.9   

Cost of products sold

            59.5        30.4               89.9   

Selling, general, administrative and other

            65.4        203.1        (1.5     267.0   

Depreciation and amortization

            143.2        255.9               399.1   

Merger, integration and restructuring

            3.1        6.8               9.9   
                                        

Total costs and expenses

            450.3        1,075.6        (6.1     1,519.8   

Operating income

            175.7        546.7               722.4   

Earnings (losses) from consolidated subsidiaries

     427.5        58.7               (486.2       

Other income (expense), net

     0.9        82.5        (84.2            (0.8

Intercompany interest income (expense)

     26.8        (11.4     (15.4              

Interest expense

     (288.6     (4.7     (1.7            (295.0
                                        

Income before income taxes

     166.6        300.8        445.4        (486.2     426.6   

Income tax expense (benefit)

     (92.4     91.3        168.7               167.6   
                                        

Net income

   $     259.0      $ 209.5      $ 276.7      $ (486.2   $ 259.0   

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

13. Supplemental Guarantor Information, Continued:

 

     Condensed Consolidated Statement of Income (Unaudited)
Nine Months Ended September 30, 2008
 
(Millions)    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Revenues and sales:

          

Service revenues

   $      $ 570.7      $ 1,687.4      $ (3.4   $ 2,254.7   

Product sales

            94.7        44.6               139.3   
                                        

Total revenues and sales

            665.4        1,732.0        (3.4     2,394.0   

Costs and expenses:

          

Cost of services

            177.4        585.3        (2.5     760.2   

Cost of products sold

            87.6        40.4               128.0   

Selling, general, administrative and other

            74.0        199.9        (0.9     273.0   

Depreciation and amortization

            127.3        241.4               368.7   

Merger, integration and restructuring

            0.9        7.4               8.3   
                                        

Total costs and expenses

            467.2        1,074.4        (3.4     1,538.2   

Operating income

            198.2        657.6               855.8   

Earnings (losses) from consolidated subsidiaries

     539.7        77.0               (616.7       

Other income (expense), net

     1.2        8.9        (1.0            9.1   

Intercompany interest income (expense)

     (30.7     (11.0     41.7                 

Interest expense

     (305.0     (4.8     (2.1            (311.9
                                        

Income from continuing operations before income taxes

     205.2        268.3        696.2        (616.7     553.0   

Income tax expense (benefit)

     (126.4     72.3        263.0               208.9   
                                        

Income from continuing operations

     331.6        196.0        433.2        (616.7     344.1   

Discontinued operations, net

                   (12.5            (12.5
                                        

Net income

   $ 331.6      $ 196.0      $ 420.7      $ (616.7   $ 331.6   

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

13. Supplemental Guarantor Information, Continued:

 

    Condensed Consolidated Balance Sheet (Unaudited)
As of September 30, 2009
 
(Millions)   Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  

Assets

         

Current Assets:

         

Cash and cash equivalents

  $ 278.6      $ 0.4      $ 11.0             $ 290.0   

Accounts receivable (less allowance for doubtful accounts of $16.5)

    0.5        98.7        195.5               294.7   

Inventories

           14.2        9.3               23.5   

Deferred income taxes

    8.1               8.4               16.5   

Prepaid expenses and other

    20.9        6.5        26.5               53.9   
                                       

Total current assets

    308.1        119.8        250.7               678.6   

Investments in consolidated subsidiaries

    8,096.6        904.5               (9,001.1       

Goodwill and other intangibles

    0.1        1,778.4        1,492.5               3,271.0   

Net property, plant and equipment

    7.6        1,053.0        2,691.2               3,751.8   

Other assets

    28.3        11.4        27.0               66.7   

Total Assets

  $     8,440.7      $     3,867.1      $     4,461.4        $    (9,001.1)      $     7,768.1   

Liabilities and Shareholders’ Equity

                                       

Current Liabilities:

         

Current maturities of long-term debt

  $ 14.0      $ 0.1      $ 10.0             $ 24.1   

Current portion of interest rate swaps

    47.3                             47.3   

Accounts payable

    10.5        25.4        96.0               131.9   

Affiliates payable, net

    2,909.6        40.3        (2,949.9              

Advance payments and customer deposits

           4.6        87.4               92.0   

Accrued dividends

    108.8                             108.8   

Accrued taxes

    (47.1     48.5        41.7               43.1   

Accrued interest

    59.2        3.4        1.5               64.1   

Other current liabilities

    11.1        5.1        44.6               60.8   
                                       

Total current liabilities

    3,113.4        127.4        (2,668.7            572.1   

Long-term debt

    5,059.5        99.6        39.9               5,199.0   

Deferred income taxes

    (49.9     550.9        676.7               1,177.7   

Other liabilities

    127.9        12.8        488.8               629.5   

Total liabilities

    8,250.9        790.7        (1,463.3            7,578.3   

Commitments and Contingencies (See Note 7)

         

Shareholders’ Equity:

         

Common stock

                  45.8        (45.8       

Additional paid-in capital

    63.6        1,764.4        2,619.1        (4,383.5     63.6   

Accumulated other comprehensive loss

    (292.8     (4.3     (216.6     220.9        (292.8

Retained earnings

    419.0        1,316.3        3,476.4        (4,792.7     419.0   
                                       

Total shareholders’ equity

    189.8        3,076.4        5,924.7        (9,001.1     189.8   

Total Liabilities and Shareholders’ Equity

  $ 8,440.7      $ 3,867.1      $ 4,461.4      $ (9,001.1   $ 7,768.1   

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

13. Supplemental Guarantor Information, Continued:

 

     Condensed Consolidated Balance Sheet (Unaudited)
As of December 31, 2008
 
(Millions)    Parent     Guarantors    Non-
Guarantors
    Eliminations     Consolidated  

Assets

           

Current Assets:

           

Cash and cash equivalents

   $ 282.8      $ 1.0    $ 12.8      $      $ 296.6   

Accounts receivable (less allowance for doubtful accounts of $16.3)

     0.3        105.5      210.8               316.6   

Inventories

            21.3      9.5               30.8   

Deferred income taxes

     22.4             8.4               30.8   

Prepaid expenses and other

     2.3        4.2      27.4               33.9   
                                       

Total current assets

     307.8        132.0      268.9               708.7   

Investments in consolidated subsidiaries

     7,637.4        460.5      (1.4     (8,096.5       

Goodwill and other intangibles

     0.1        1,826.2      1,504.1               3,330.4   

Net property, plant and equipment

     7.6        1,103.6      2,785.9               3,897.1   

Other assets

     31.4        11.4      30.3               73.1   

Total Assets

   $     7,984.3      $       3,533.7    $     4,587.8        $    (8,096.5)      $      8,009.3   

Liabilities and Shareholders’ Equity

                                       

Current Liabilities:

           

Current maturities of long-term debt

   $ 14.0      $ 0.3    $ 10.0      $      $ 24.3   

Current portion of interest rate swaps

     40.5                           40.5   

Accounts payable

     10.2        83.0      40.8               134.0   

Affiliates payable, net

     2,155.1        287.3      (2,442.4              

Advance payments and customer deposits

            8.7      85.3               94.0   

Accrued dividends

     109.9                           109.9   

Accrued taxes

     (30.7     23.3      55.4               48.0   

Accrued interest

     135.8        1.7      0.9               138.4   

Other current liabilities

     15.7        13.2      47.3               76.2   
                                       

Total current liabilities

     2,450.5        417.5      (2,202.7            665.3   

Long-term debt

     5,218.8        99.6      39.8               5,358.2   

Deferred income taxes

     (92.7     519.5      643.8               1,070.6   

Other liabilities

     155.4        15.5      492.0               662.9   

Total liabilities

     7,732.0        1,052.1      (1,027.1            7,757.0   

Commitments and Contingencies (See Note 7)

           

Shareholders’ Equity:

           

Common stock

                 45.8        (45.8       

Additional paid-in capital

     101.5        1,764.5      2,619.0        (4,383.5     101.5   

Accumulated other comprehensive loss

     (336.6          (248.2     248.2        (336.6

Retained earnings

     487.4        717.1      3,198.3        (3,915.4     487.4   
                                       

Total shareholders’ equity

     252.3        2,481.6      5,614.9        (8,096.5     252.3   

Total Liabilities and Shareholders’ Equity

   $ 7,984.3      $ 3,533.7    $ 4,587.8      $ (8,096.5   $ 8,009.3   

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

13. Supplemental Guarantor Information, Continued:

 

     Condensed Consolidated Statement of Cash Flows (Unaudited)
Nine Months Ended September 30, 2009
 
(Millions)    Parent     Guarantors    

Non-

Guarantors

    Eliminations     Consolidated  

Cash Provided from Operations:

          

Net income

   $ 259.0      $ 209.5      $ 276.7      $ (486.2   $ 259.0   

Adjustments to reconcile net income to net cash provided from operations:

          

Depreciation and amortization

            143.2        255.9               399.1   

Provision for doubtful accounts

            7.7        24.7               32.4   

Stock-based compensation expense

            1.6        12.7               14.3   

Pension and postretirement benefits expense

            20.9        51.9               72.8   

Equity in earnings (losses) from subsidiaries

     (427.5     (58.7            486.2          

Deferred taxes

     49.1        31.4        11.9               92.4   

Other, net

     3.1        0.3        0.8               4.2   

Changes in operating assets and liabilities, net:

     653.4        (306.7     (479.5            (132.8
                                        

Net cash provided from operations

     537.1        49.2        155.1               741.4   

Cash Flows from Investing Activities:

          

Additions to property, plant and equipment

            (49.7     (157.1            (206.8

Other, net

            0.1        0.2               0.3   
                                        

Net cash used in investing activities

            (49.6     (156.9            (206.5

Cash Flows from Financing Activities:

          

Dividends paid on common shares

     (328.6                          (328.6

Stock repurchase

     (43.5                          (43.5

Repayment of debt

     (160.5     (0.2                   (160.7

Other, net

     (8.7                          (8.7
                                        

Net cash used in financing activities

     (541.3     (0.2                   (541.5

Decrease in cash and cash equivalents

     (4.2     (0.6     (1.8            (6.6

Cash and Cash Equivalents:

          

Beginning of period

     282.8        1.0        12.8               296.6   
                                        

End of period

   $ 278.6      $ 0.4      $ 11.0      $      $ 290.0   

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

13. Supplemental Guarantor Information, Continued:

 

     Condensed Consolidated Statement of Cash Flows (Unaudited)
Nine Months Ended September 30, 2008
 
(Millions)    Parent     Guarantors    

Non-

Guarantors

    Eliminations     Consolidated  

Cash Provided from Operations:

          

Net income

   $ 331.6      $ 196.0      $ 420.7      $ (616.7   $ 331.6   

Adjustments to reconcile net income to net cash provided from operations:

          

Loss on net assets held for sale

                   16.4               16.4   

Depreciation and amortization

            127.3        243.6               370.9   

Provision for doubtful accounts

            3.9        21.2               25.1   

Stock-based compensation expense

            1.9        11.6               13.5   

Pension and postretirement benefits expense

            1.1        11.2               12.3   

Equity in earnings (losses) from subsidiaries

     (539.7     (77.0            616.7          

Deferred taxes

     (0.7     22.4        52.6               74.3   

Other, net

     3.9        (0.9     5.8               8.8   

Changes in operating assets and liabilities, net:

     749.0        (246.4     (625.7            (123.1
                                        

Net cash provided from operations

     544.1        28.3        157.4               729.8   

Cash Flows from Investing Activities:

          

Additions to property, plant and equipment

            (51.6     (167.9            (219.5

Disposition of acquired assets held for sale

            17.3                      17.3   

Other, net

            4.9        6.7               11.6   
                                        

Net cash used in investing activities

            (29.4     (161.2            (190.6

Cash Flows from Financing Activities:

          

Dividends paid on common shares

     (335.3                          (335.3

Stock repurchase

     (200.3                          (200.3

Repayment of debt

     (340.5     (0.2                   (340.7

Debt issued, net of issuance costs

     380.0                             380.0   

Other, net

     (2.1     0.7        (1.9            (3.3
                                        

Net cash provided from (used in) financing activities

     (498.2     0.5        (1.9            (499.6

Increase (decrease) in cash and cash equivalents

     45.9        (0.6     (5.7            39.6   

Cash and Cash Equivalents:

          

Beginning of period

     47.2        1.2        23.6               72.0   
                                        

End of period

   $ 93.1      $ 0.6      $ 17.9      $      $ 111.6   

14. Pending Transactions:

On May 10, 2009 the Company entered into a definitive agreement to acquire all of the outstanding shares of common stock of D&E in a transaction valued at approximately $350.0 million as of September 30, 2009. Under the terms of the agreement, D&E shareholders will receive 0.650 shares of Windstream common stock and $5.00 in cash per each share of D&E common stock. As of September 30, 2009, D&E had outstanding approximately 14.4 million shares of common stock and approximately $180.8 million of long-term debt, including current maturities. Including the early extinguishment of debt, cash consideration to be paid at closing was estimated to be approximately $256.0 million as of September 30, 2009. The acquisition of D&E will significantly increase Windstream’s presence in Pennsylvania. As of September 30, 2009, D&E had approximately 114,000 incumbent local exchange carrier (“ILEC”) access lines, 47,000 competitive local exchange carrier access lines and 46,000 high-speed Internet customers in central Pennsylvania. In addition, we expect this acquisition to generate significant opportunities for operating efficiencies with contiguous Windstream markets. The acquisition is expected to close on November 10, 2009.

 

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

_____

 

14. Pending Transactions, Continued:

 

On September 8, 2009 the Company entered into a definitive agreement to acquire Lexcom based in Lexington, North Carolina, for approximately $141.0 million in cash, net of working capital to be acquired. The acquisition will increase Windstream’s presence in North Carolina. As of September 30, 2009, Lexcom had approximately 23,000 ILEC access lines, 9,000 high-speed Internet customers and 12,000 cable television customers in North Carolina. In addition, we expect this acquisition to generate opportunities for operating efficiencies with contiguous Windstream markets. The acquisition has received Lexcom shareholder approval and is expected to close in the fourth quarter of 2009, subject to certain conditions including the necessary approvals from federal regulators.

15. Subsequent Events:

On October 8, 2009, Windstream completed the Private Placement of $400 million in aggregate principle amount of 7.875 percent senior unsecured notes due November 1, 2017. Proceeds from the Private Placement totaled $394.1 million, excluding debt issuance costs, with a yield of 8.125 percent. Windstream expects to use the net proceeds of the Private Placement to finance the cash portion of the purchase price of the D&E and Lexcom acquisitions, to refinance certain indebtedness of D&E in connection with the D&E merger, to pay related transaction fees and expenses and for general corporate purposes.

Additionally, during October of 2009, Windstream received consent from its lenders to an amendment and restatement of its $2.2 billion senior secured credit facility, including the $500.0 million revolving line of credit. Windstream amended and restated its senior secured credit facility to, among other things, extend the maturities of the facility and amend certain covenants to afford Windstream additional flexibility, resulting in increased interest rates on the extended maturities. The extended maturities and related interest rate increases associated with the Amendment were as follows:

 

      Non-extended    Extended    Total
      Due   

Amount

(Millions)

  

Interest

Rate Increase

(Basis Points)

   Due   

Amount

(Millions)

  

Amount

(Millions)

Senior secured credit facility:

                 

Tranche A - variable rates

   July 17, 2011    $ 114.4    100    July 17, 2013    $ 168.9    $ 283.3  

Tranche B - variable rates

   July 17, 2013    $ 290.5    125    December 17, 2015    $ 1,078.0    $ 1,368.5  

Revolving line of credit - variable rates (a)

   July 17, 2011    $ 152.4    100    July 17, 2013    $ 347.6    $ 500.0  

 

  (a) As of September 30, 2009, the Company repaid the full amount outstanding under the revolving line of credit.

After giving effect to the Private Placement and Amendment, Windstream will have approximately $5.6 billion in long-term debt outstanding, including current maturities. Following the completion of the Private Placement and Amendment, the Company’s scheduled principal payments approximate $23.8 million, $142.8 million, $42.3 million, $1,248.0 million and $20.8 million for each of the twelve month periods ended September 30, 2010, 2011, 2012, 2013 and 2014, respectively. The scheduled principal payments remaining after 2014 approximate $4,170.1 million.

On November 2, 2009, Windstream entered into a definitive agreement to acquire all of the issued and outstanding shares of common stock of NuVox, Inc. (“NuVox”), a privately held competitive local exchange carrier based in Greenville, South Carolina, in a transaction valued at approximately $643.0 million. Under the terms of the agreement, Windstream expects to issue approximately 18.7 million fixed shares of common stock valued at approximately $183.0 million and pay approximately $280.0 million in cash as part of the transaction. Windstream will assume estimated net debt of $180.0 million and intends to finance the acquisition with existing cash on hand and borrowings available under the Company’s revolving line of credit. The acquisition will add approximately 90,000 business customers in complementary markets in 16 states across the southeast and midwest, significantly advancing Windstream’s strategy to increase high-speed Internet and business revenues. The acquisition is expected to close in the first half of 2010, subject to certain conditions including the necessary approvals from federal and state regulators and NuVox shareholders.

The Company evaluated its subsequent events through November 9, 2009, the date the financial statements were issued.

 

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WINDSTREAM CORPORATION

FORM 10-Q

PART I – FINANCIAL INFORMATION

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

Basis of Presentation

The following is a discussion and analysis of the historical results of operations and financial condition of Windstream Corporation (“Windstream”, “we”, or the “Company”). Windstream was formed on July 17, 2006 through the spin off from Alltel Corporation, which has subsequently merged with Verizon Communications Inc. (“Alltel”), of its wireline telecommunications division and the immediate merger with and into Valor Communications Group, Inc. (“Valor”). This discussion should be read in conjunction with the unaudited consolidated financial statements, including the notes thereto, for the interim periods ended September 30, 2009 and 2008 and Windstream’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission (“SEC”) on February 19, 2009.

In the first quarter of 2009, the Company reorganized its operations to integrate the sales and administrative functions of the product distribution segment into its wireline operations. As a result of this change, the chief operating decision maker no longer reviews the financial statements of the product distribution operations on a stand alone basis, and the Company operates as a single reporting segment. As required by the authoritative guidance for segment presentation, segment results of operations have been retrospectively adjusted to reflect a single segment presentation for all periods presented. As such, separate segment reporting is no longer required, and thus not included. Additionally, certain amounts previously reported have been reclassified to conform to the current year presentation of the consolidated financial statements. These changes and reclassifications did not impact net income.

Management believes that the assumptions underlying the Company’s financial statements are reasonable. These financial statements, however, may not be necessarily indicative of future results of operations, financial position or cash flows. Certain statements set forth below under this caption constitute forward-looking statements. See “Forward-Looking Statements” at the end of this discussion for additional factors relating to such statements, and see “Risk Factors” in Item 1A of Part II herein and in Windstream’s Annual Report on Form 10-K, for a discussion of certain risk factors applicable to our business, financial condition, business trends and results of operations.

EXECUTIVE SUMMARY

Windstream is a customer-focused telecommunications company that provides phone, high-speed Internet and digital television services. The Company also offers a wide range of IP-based voice and data services and advanced phone systems and equipment to businesses and government agencies. The Company has approximately 2.9 million customers primarily located in rural areas in 16 states. Our strategy is to enhance the value of these customer relationships by providing one-stop shopping for all of our customer’s communications needs and delivering superior customer service. Among the highlights in the third quarter of 2009:

 

 

The Company added approximately 25,900 high-speed Internet services customers, increasing its high-speed Internet customer base to 1,050,500. Additionally, the Company lost approximately 26,800 access lines. Access lines declined 5.2 percent during the twelve months ended September 30, 2009.

 

 

Revenues and sales decreased $59.8 million, as compared to the third quarter of 2008, primarily due to the decline in access lines, declines in product sales associated with the disposition of the out of territory product distribution operations during the third quarter of 2009, and general declines in product sales to business customers. Partially offsetting these decreases were increases attributable to growth in high-speed Internet customers as discussed above. Operating income decreased $45.2 million primarily due to the increase in pension expense, the impact of continued access line losses and the amortization of franchise rights.

 

 

The Company generated cash flows from operations of approximately $740.0 million for the nine months ended September 30, 2009. Cash flows from operations were used to fund capital expenditures of $206.8 million, to pay $328.6 million in dividends to shareholders and to repay $150.0 million in debt outstanding under the revolving line of credit. Additionally, the Company repurchased 1.1 million of its common shares at a cost of $10.7 million during the third quarter of 2009. As of September 30, 2009, the Company had $156.2 million in remaining capacity under the $400.0 million stock repurchase program announced in February 2008, which expires at the end of 2009.

 

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During the remainder of 2009, the Company will continue to face significant challenges resulting from competition in the telecommunications industry. In addressing competition, the Company will continue to focus its efforts on improving customer service, increasing high-speed Internet penetration and expanding its service offerings and distribution channels.

Business Trends

The following is a discussion of trends affecting Windstream’s operations:

 

 

Access line losses: Wireline voice and switched access revenues are expected to continue to be adversely impacted by future declines in access lines due to competition in the telecommunications industry from cable television providers, wireless communications providers, and providers using other emerging technologies. As of September 30, 2009, all of the Company’s access lines had wireless competition and approximately 63 percent of the Company’s access lines had fixed line voice competition, which represented an increase in fixed line competition of approximately 3 percent from September 30, 2008. Residential lines decreased 5.4 percent during the twelve months ended September 30, 2009, primarily due to the effects of competition and weakness in the general economic environment, which we believe has accelerated line losses by limiting consumer purchasing power causing some households to migrate exclusively to wireless voice service. During the same period, business lines decreased 4.9 percent due to competitive pressures, the migration of services to larger circuits with enhanced functionality representing lost access lines but not a lost customer relationship, and weakness in the general economic environment. We believe weakness in the economic environment has caused some businesses to close or reduce staff, which has had a corresponding impact on the demand for business access lines. Continued weakness in the general economic environment may contribute to further acceleration of line losses.

 

 

Product bundles: To combat competitive pressures, the Company continues to emphasize its bundled products and services. Our residential customers can bundle local voice, high-speed Internet, long distance and video services. These bundles provide customers with one convenient location to obtain all their communications and entertainment needs, a convenient billing solution and bundle discounts. Operating trends for access lines and high-speed Internet customers were favorably impacted during the third quarter of 2009 by the Company’s latest bundle promotion, which offers a price for life guarantee and package discount on its local telephone, unlimited national calling and high-speed Internet bundle.

In addition, during the second quarter of 2009, we began offering bundle discounts to businesses that choose to bundle their voice, high-speed Internet and long distance services with Windstream. We believe that product bundles positively impact our customer retention, and the associated discounts provide our customers the best value for their communications and entertainment dollar.

 

 

High-speed Internet: Growth in high-speed Internet sales, together with the continued migration to higher speeds, are expected to continue to offset some of the revenue declines from the unfavorable access line trends discussed above. During the nine months ended September 30, 2009, the Company added approximately 71,700 high-speed Internet customers. As of September 30, 2009, the Company had 1,050,500 high-speed Internet customers, which represents an approximate 9 percent increase from September 30, 2008. As of September 30, 2009, Windstream provided high-speed Internet service to 36 percent of total access lines in service, and 53 percent of primary residential access lines in service. As of September 30, 2009, approximately 75 percent of total access lines had high-speed Internet competition primarily from cable service providers, which is relatively unchanged from September 30, 2008. We expect the pace of high-speed Internet customer growth to slow as the number of households without high-speed Internet service continues to shrink. Competitive expansions, primarily from cable facilities, into our service areas are expected to slow in 2009, but we could experience some increased competition from high-speed Internet offerings of wireless competitors.

 

 

Business data and special access: Wireline revenues and sales are expected to be favorably impacted by growth in next generation data services provided to business customers. As the data needs of our business customers continue to grow, our virtual local area network, virtual private network and data service revenues are expected to grow. Likewise, due to continued trends toward increasing data traffic, we expect growth in special access revenues from the provisioning of circuits to wireless and other carriers. However, weakness in the general economic environment may have the effect of suppressing near term growth in these revenues.

 

 

Operational efficiencies: We continue to evaluate our operating structure to identify opportunities for increased operational efficiency and effectiveness. Among other things, this involves evaluating opportunities for task automation, network efficiency and the balancing of our workforce based on the current needs of our customers. As part of this effort, the Company announced a work force reduction in the third quarter of 2009. In conjunction

 

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therewith, we expect to incur restructuring charges of approximately $9.0 million, of which $7.5 million was recognized in the third quarter. The Company expects to realize annual savings approximating $20.0 million following the completion of the workforce reduction in the fourth quarter of 2009. In addition, operating expenses have been favorably impacted during 2009 by the work force reduction announced in the fourth quarter of 2008.

 

 

Pension expenses and funding: During the nine months ended September 30, 2009, the fair market value of Windstream’s pension plan assets have increased 9.8 percent from approximately $654.0 million to $718.3 million. This increase is primarily attributable to a 20.5 percent, or $133.9 million, increase in the market value of assets held and contributions of $2.5 million, partially offset by routine benefit payments of $37.3 million, lump sum distributions of $32.1 million and administrative expenses. The Company does not expect to be required to make any further contributions in 2009 or 2010. In 2008, the fair market value of the Company’s pension investments declined 34.7 percent from approximately $1,001.0 million to $654.0 million, due to declines in the market value of assets held as well as benefit payments. As a result, pension expense has increased by approximately $70.0 million for the nine months ended September 30, 2009 as compared to the same period in 2008.

The amount and timing of future contributions will depend on various factors including the finalization of funding regulations, future investment performance, changes in future discount rates and changes in demographics of the population participating in the Company’s qualified pension plan.

We expect the combined impact of the items noted above to result in lower revenues and operating income during 2009. However, these trends may be materially impacted, favorably or unfavorably, by changes in the overall economic environment.

STRATEGIC TRANSACTIONS

Pending Transactions

On November 2, 2009, Windstream entered into a definitive agreement to acquire all of the issued and outstanding shares of common stock of NuVox, Inc. (“NuVox”), a privately held competitive local exchange carrier based in Greenville, South Carolina, in a transaction valued at approximately $643.0 million. Under the terms of the agreement, Windstream expects to issue approximately 18.7 million fixed shares of common stock valued at approximately $183.0 million and pay approximately $280.0 million in cash as part of the transaction. Windstream will assume estimated net debt of $180.0 million and intends to finance the acquisition with existing cash on hand and borrowings available under the Company’s revolving line of credit. The acquisition will add approximately 90,000 business customers in complementary markets in 16 states across the southeast and midwest, significantly advancing Windstream’s strategy to increase high-speed Internet and business revenues. The acquisition is expected to close in the first half of 2010, subject to certain conditions including the necessary approvals from federal and state regulators and NuVox shareholders.

On May 10, 2009 the Company entered into a definitive agreement to acquire all of the outstanding shares of common stock of D&E Communications, Inc. (“D&E”) in a transaction valued at approximately $350.0 million as of September 30, 2009. Under the terms of the agreement, D&E shareholders will receive 0.650 shares of Windstream common stock and $5.00 in cash per each share of D&E common stock. As of September 30, 2009, D&E had outstanding approximately 14.4 million shares of common stock and approximately $180.8 million of long-term debt, including current maturities. Including the early extinguishment of debt, cash consideration to be paid at closing was estimated to be approximately $256.0 million as of September 30, 2009. The acquisition of D&E will significantly increase Windstream’s presence in Pennsylvania. As of September 30, 2009, D&E had approximately 114,000 incumbent local exchange carrier access lines, 47,000 competitive local exchange carrier access lines and about 46,000 high-speed Internet customers in central Pennsylvania. In addition, we expect this acquisition to generate significant opportunities for operating efficiencies with contiguous Windstream markets. The acquisition is expected to close on November 10, 2009.

On September 8, 2009 the Company entered into a definitive agreement to acquire Lexcom, Inc., (“Lexcom”) based in Lexington, North Carolina, for approximately $141.0 million in cash, net of working capital to be acquired. The acquisition will increase Windstream’s presence in North Carolina. As of September 30, 2009, Lexcom had approximately 23,000 ILEC access lines, 9,000 high-speed Internet customers and 12,000 cable television customers in North Carolina. In addition, we expect this acquisition to generate opportunities for operating efficiencies with contiguous Windstream markets. The acquisition has received Lexcom shareholder approval and is expected to close in the fourth quarter of 2009, subject to certain conditions including the necessary approvals from federal regulators.

Dispositions

On August 21, 2009, Windstream completed the sale of its out of territory product distribution operations to Walker and Associates of North Carolina, Inc. (“Walker”) for approximately $5.3 million in total consideration. The out of territory product distribution operations primarily consisted of product inventory with a carrying value of $4.9 million and customer relationships outside of Windstream’s telecommunications operating territories. These operations were not central to the Company’s strategic goals in its core communications business. Product revenues from these operations totaled $8.2 million and $38.5 million during the three and nine month periods ended September 30, 2009, respectively, with related cost of products sold of $7.6 million and $34.3 million for the same periods in 2009. In conjunction with this transaction, Windstream recognized a gain of $0.4 million in other income, net in its consolidated statements of income for the three and nine month periods ended September 30, 2009.

On November 21, 2008, Windstream completed the sale of its wireless business to AT&T Mobility II, LLC for approximately $56.7 million. The completion of this transaction resulted in the divestiture of approximately 52,000 wireless customers, spectrum licenses and cell sites covering a four-county area of North Carolina with a population of approximately 450,000, and six retail locations. The operating results of the wireless business have been separately presented as discontinued operations in the accompanying unaudited interim consolidated statements of income (see Note 3).

 

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RESULTS OF OPERATIONS

The following table reflects the Company’s operating results as of September 30:

 

      Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Millions)    2009     2008     2009     2008  

Revenues and sales:

        

Voice service

   $ 274.5      $ 295.6      $ 843.6      $ 902.5   

Long distance

     63.5        66.7        192.1        201.1   

Data and special access

     203.4        192.5        609.1        568.7   

Switched access and USF

     130.4        147.7        392.2        457.9   

Miscellaneous

     33.1        39.4        103.2        124.5   

Product sales

     29.4        52.2        102.0        139.3   
                                

Total revenues and sales

     734.3        794.1        2,242.2        2,394.0   

Costs and expenses:

        

Cost of services (exclusive of depreciation included below)

     253.0        255.9        753.9        760.2   

Cost of products sold

     26.0        49.5        89.9        128.0   

Selling, general, administrative and other

     87.6        93.3        267.0        273.0   

Depreciation and amortization

     133.8        123.8        399.1        368.7   

Restructuring charges

     7.5        1.0        7.5        2.1   

Merger and integration costs

     1.0        —          2.4        6.2   
                                

Total costs and expenses

     508.9        523.5        1,519.8        1,538.2   

Operating income

     225.4        270.6        722.4        855.8   

Other income, net

     (2.2     0.5        (0.8     9.1   

Interest expense

     (97.5     (103.3     (295.0     (311.9
                                

Income from continuing operations before income taxes

     125.7        167.8        426.6        553.0   

Income taxes

     45.7        63.5        167.6        208.9   
                                

Income from continuing operations

     80.0        104.3        259.0        344.1   

Discontinued operations, net of tax

     —          1.6        —          (12.5
                                

Net income

   $ 80.0      $ 105.9      $ 259.0      $ 331.6   

Basic and diluted earnings per share:

        

Income from continuing operations

     $.18        $.24        $.59        $.77   

Income from discontinued operations

     —          —          —          (.03
                                

Net income

     $.18        $.24