UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2008

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

For the transition period from  _____  to  _____ 

Commission File Number 000-51446

CONSOLIDATED COMMUNICATIONS HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Delaware		02-0636095
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

121 South 17^th Street
Mattoon, Illinois 61938-3987
(Address of principal executive offices)

Registrant’s telephone number, including area code: (217) 235-3311

Securities registered pursuant to Section 12(b) of the Act:

(Title of each class) Common Stock, $0.01 par value per share		(Name of each exchange on which registered) NASDAQ Global Select Market

Securities registered pursuant to Section12 (g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K. o

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o		Accelerated Filer þ		Non-Accelerated Filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The number of shares of the registrant’s common stock, $.01 par value, outstanding as of March 12, 2009 was 29,488,408. The aggregate market value of the registrant’s common stock held by non-affiliates as of June 30, 2008 was approximately $344,780,109, computed by reference to the closing sales price of such common stock on The NASDAQ Global Select Market as of June 30, 2008. Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and the registrant is not bound by this determination for any other purpose.

Part of Form 10-K		Document Incorporated by Reference
Part III, Items 10, 11, 12, 13, and 14		Portion of the Registrant’s proxy statement to be filed in connection with the Annual Meeting of the Stockholders of the Registrant to be held on May 5, 2009.

 

 

TABLE OF CONTENTS

Acronyms Used in this Annual Report on Form 10-K			1
Terminology Used in this Annual Report on Form 10-K			2
Forward Looking Statements			3
Market and Industry Data			3
PART 1
Item 1. Business			3
Item 1A. Risk Factors			22
Item 1B. Unresolved Staff Comments			33
Item 2. Properties			33
Item 3. Legal Proceedings			34
Item 4. Submission of Matters to a Vote of Security Holders			34
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			34
Item 6. Selected Financial Data			35
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			40
Item 7A. Quantitative and Qualitative Disclosures about Market Risk			62
Item 8. Financial Statements and Supplementary Data			63
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			98
Item 9A. Controls and Procedures			98
Item 9B. Other Information			98
PART III
Item 10. Directors, Executive Officers and Corporate Governance			98
Item 11. Executive Compensation			98
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			98
Item 13. Certain Relationships and Related Transactions, and Director Independence			98
Item 14. Principal Accountant Fees and Services			98
PART IV
Item 15. Exhibits and Financial Statement Schedules			99
Schedule II—Valuation Reserves			100
SIGNATURES			130
INDEX TO EXHIBITS			131
Exhibit 21
Exhibit 23.1
Exhibit 23.2
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

Acronyms Used in this Annual Report on Form 10-K

CLEC		Competitive local exchange carrier
DSL		Digital subscriber line
EBITDA		Earnings before interest, taxes, depreciation and amortization
ETFL		East Texas Fiber Line, Inc.
FASB		Financial Accounting Standards Board
FCC		Federal Communications Commission
GAAP		Generally accepted accounting principles
ICC		Illinois Commerce Commission
ICTC		Illinois Consolidated Telephone Company
ILEC		Incumbent local exchange carrier
IP		Internet protocol
IPO		Initial public offering
IPTV		Internet protocol digital television
ISP		Internet service provider
LIBOR		London interbank offer rate
NECA		National Exchange Carrier Association
NOL		Net operating loss
PAPUC		Pennsylvania Public Utility Commission
PAUSF		Pennsylvania Universal Service Fund
PUCT		Public Utility Commission of Texas
PURA		Texas Public Utilities Regulatory Act
SFAS		Statement of Financial Accounting Standards
TXUCV		TXU Communications Ventures Company
UNE		Unbundled network element
UNE-P		Unbundled network element platform
VOIP		Voice over Internet Protocol

Terminology Used in this Annual Report on Form 10-K

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

Competitive local exchange carriers (CLECs) are telecommunications providers formed after enactment of the Telecommunications Act of 1996 to provide local exchange service that competes with ILECs and other established carriers.

Digital telephone, or VOIP service involves the routing of voice calls, at least in part, over the Internet through packets of data instead of transmitting the calls over the telephone system.

An exchange is a geographic area established for administration and pricing of telecommunications services.

Hosted VOIP is our broadband phone product that utilizes our soft switch to provide an Internet Protocol based voice service to business and residential customers. The product provides the flexibility of utilizing new telephone technology and features provided by our hosted soft switch but does not require an investment in a new telephone system to use the advanced features.

Incumbent local exchange telephone companies (ILECs) are the local telephone companies that provided local telephone exchange service on the effective date of the Telecommunications Act of 1996, or their predecessors. This designation is important because, in light of their competitive advantage, ILECs have statutory obligations that other telephone companies do not have. For example, ILECs are required to give other carriers access to certain equipment (known as unbundled network elements) or to house equipment for other carriers (known as colocation), on reasonable and nondiscriminatory terms. For more information, see Part I—Item 1—“Business—Regulatory Environment.”

Metro Ethernet is the use of carrier Ethernet technology in metropolitan area networks. Metro Ethernet services are provided over a standard, widely used Ethernet interface and can connect business local area networks to wide area networks or to the Internet. Metro Ethernet offers cost-effectiveness, reliability, scalability and bandwidth management superior to most proprietary networks.

MPLS or Multiprotocol Label Switching refers to a highly scalable data carrying mechanism in which data packets are assigned labels. Packet-forwarding decisions are made solely on the contents of this label, without the need to examine the packet itself. This allows for end-to-end circuits across any type of transport medium, using any protocol.

Rural telephone companies provide communications services to geographic areas that are not heavily populated. This designation is important because rural telephone companies are eligible to receive government subsidies to compensate for the disproportionate cost of providing service in low density areas. In addition, ILECs that are rural telephone companies, as defined in the Telecommunications Act of 1996, are exempt from some obligations to provide access to competitors.

Unified messaging is the integration of multiple messaging technologies into a single system. With this application, voice mail, fax, cellular and other messages are sent to the email inbox. From the email system, the messages can be heard, read or forwarded to others.

FORWARD-LOOKING STATEMENTS

Any statements contained in this report that are not statements of historical fact, including statements about our beliefs and expectations, are forward-looking statements. We use words like “anticipate,” “believe,” “expect,” “intend,” “plan,” “estimate,” “target,” “project,” “should,” “may,” and “will” to identify forward-looking statements throughout this report.

Forward-looking statements reflect, among other things, our current expectations, plans, strategies, and anticipated financial results. There are a number of risks, uncertainties, and conditions that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements. Many of these circumstances are beyond our ability to control or predict. Moreover, forward-looking statements necessarily involve assumptions on our part.

All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements that appear throughout this report. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under the federal securities laws or the rules and regulations of the Securities and Exchange Commission, we are not under any obligation to update any forward-looking information—whether as a result of new information, future events, or otherwise. You should not place undue reliance on forward-looking statements.

Please see Part I—Item 1A—“Risk Factors” of this report, as well as the other documents that we file with the SEC from time to time, for important factors that could cause our actual results to differ from current expectations and from the forward-looking statements discussed in this report.

MARKET AND INDUSTRY DATA

Market and industry data and other information used throughout this report are based on independent industry publications, government publications, publicly available information, reports by market research firms, or other published independent sources. Although we believe these sources are reliable, we have not verified the information. Some data also is based on estimates that members of management derive from their industry knowledge and review of internal surveys.

We cannot know, or reasonably determine, our market share in each of our markets or for our services because there is significant overlap in the telecommunications industry; it is difficult to isolate information regarding individual services. For example, wireless providers both compete with and complement our local telephone services.

PART I

Item 1. Business

“Consolidated Communications” or the “Company” refers to Consolidated Communications Holdings, Inc.—either alone or with its wholly-owned subsidiaries, as the context requires. The words “we,” “our,” or “us,” also refer to the Company and its subsidiaries.

On December 31, 2007, the Company acquired all of the capital stock of North Pittsburgh Systems, Inc. The results of operations for North Pittsburgh are included in the Company’s Telephone Operations segment for December 31, 2007, and thereafter.

Website Access to Securities and Exchange Commission Reports

The Company’s website can be found at www.consolidated.com. From our website, you can obtain, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as practicable after they are filed with, or furnished to, the Securities and Exchange Commission.

Overview

Consolidated Communications owns established incumbent local exchange telephone companies (“ILECs”) that provide communications services to residential and business customers in Illinois, Texas, and Pennsylvania. Our ILECs are “rural telephone companies,” which essentially means they provide service in areas that are not heavily populated.

We offer a wide range of telecommunications services, including local and long distance service, custom calling features, private line services, high-speed Internet access, digital TV, carrier access services, network capacity services over our regional fiber optic network, and directory publishing. In addition, we operate a number of complementary businesses, including telemarketing and order fulfillment, telephone services to county jails and state prisons, equipment sales, operator services, and mobile services.

With our acquisition of North Pittsburgh in 2007, we are the 12^th largest local telephone company in the United States. We have 264,323 local access lines, 74,687 Competitive Local Exchange Carrier (“CLEC”) access line equivalents, 91,817 high-speed Internet subscribers (which we refer to as digital subscriber lines, or DSL), 16,666 Internet Protocol digital television (which we refer to as IPTV) subscribers and 6,510 digital telephone service (commonly known as Voice over Internet Protocol, or “VOIP”) subscribers.

For the years ended December 31, 2008, and 2007, we had $418.4 million and $329.2 million of revenues, respectively. In addition, we generated net income of $5.3 million, exclusive of an after tax extraordinary gain of $7.2 million for the year ended December 31, 2008, and we generated net income of $11.4 million for the year ended December 31, 2007. As of December 31, 2008, we had $880.3 million of total long-term debt, net of current portion. In addition, as of December 31, 2008, we had retained earnings of $0.0 million and stockholders’ equity of $70.1 million.

History of the Company

Founded in 1894 as the Mattoon Telephone Company by the great-grandfather of our Chairman, Richard A. Lumpkin, we began as one of the nation’s first independent telephone companies. After several acquisitions, the Mattoon Telephone Company was incorporated as Illinois Consolidated Telephone Company, or ICTC, on April 10, 1924. In 1997, McLeodUSA acquired ICTC and all related businesses from the Lumpkin family, but Mr. Lumpkin and two private equity firms, Spectrum Equity and Providence Equity, repurchased ICTC and several related businesses five years later.

On April 14, 2004, we acquired TXU Communications Ventures Company, or TXUCV, from TXU Corporation. TXUCV owned rural telephone operations in Lufkin, Conroe, and Katy, Texas, which had been operating in those markets for over 90 years. This acquisition approximately tripled the size of the Company.

On July 27, 2005, we completed the initial public offering of our common stock. At the same time, Spectrum Equity sold its entire investment and Providence Equity sold 50 percent of its investment. In July 2006, the Company repurchased the remaining shares owned by Providence Equity.

On December 31, 2007, we completed the acquisition of North Pittsburgh. Through its subsidiaries, North Pittsburgh advanced communication services to residential and business customers in several counties in western Pennsylvania and a CLEC that operates in the Pittsburgh metropolitan area.

Our Strengths

Stable local telephone business

Demand for local telephone services from our residential and business customers has been stable despite changing economic conditions. We operate in a supportive regulatory environment, and competition in our markets is limited. As a result of these favorable conditions, our local telephone business generates relatively consistent cash flow from year to year. Our longstanding relationship with our local telephone customers enables us to pursue increased revenue per access line by selling additional services through a bundling strategy, that includes our triple play offering of voice, DSL, and IPTV services.

Attractive markets

The geographic areas we serve are characterized by a balanced mix of growing suburban areas and stable, rural territories. In the past we had limited competition for basic voice services from wireless carriers and non-facilities-based providers using VOIP, but cable providers have started offering voice services. Both Suddenlink and Comcast, cable competitors in Texas, launched a competing voice product in the second quarter of 2008. The cable operator Mediacom also has launched a voice product in our Illinois markets in 2007. In 2008, NewWave Communications launched a competing voice product in the portions of our Illinois market that is not serviced by Mediacom. In our North Pittsburgh territory, each of the two incumbent cable providers, Armstrong and Comcast, launched a competitive VOIP offering in 2006.

Our Lufkin, Texas, and central Illinois markets have experienced only nominal population growth over the past decade. As of December 31, 2008, 106,419, or approximately 40.2%, of our local access lines were located in these markets. Until the cable operators launched voice services, we had experienced limited competition in these markets because the low customer density and predominantly residential character of the area have discouraged competing networks from making the significant capital investment required to offer service.

Our Conroe and Katy, Texas markets are suburbs on the outskirts of the Houston metropolitan area. As of December 31, 2008, 99,044, or approximately 37.5%, of our local access lines were located in these markets. Conroe and Katy have experienced above-average population and business employment growth over the past decade compared to Texas and the United States as a whole. According to the most recent census, the median household income in the primary county in our Conroe market was $50,000 per year, and in our Katy market was $60,000 per year. In contrast, median annual household income was $39,927 in Texas and $42,148 in the United States.

At the time of the acquisition, North Pittsburgh had three operating subsidiaries: an ILEC, a CLEC, and an Internet service provider (ISP). North Pittsburgh operates in a territory of approximately 285 square miles, including portions of Allegheny, Armstrong, Butler, and Westmoreland counties. Over the past decade, North Pittsburgh’s ILEC territory has experienced population growth because suburban communities have been expanding into its serving area. (The southernmost point of this territory is only 12 miles from Pittsburgh.) For the same reason, the ILEC has benefited from growth in business activity and favorable market demographics. Approximately 58,860, or 22.3%, of our access lines are located in the North Pittsburgh territory.

North Pittsburgh’s CLEC business furnishes telecommunication and broadband services south of the ILEC’s territory to customers in Pittsburgh and its surrounding suburbs as well as to the north in the City of Butler and its surrounding areas. Verizon is the ILEC in the Pittsburgh area, while Embarq (formerly Sprint) is the ILEC in Butler.

Technologically advanced network

We have invested significantly over the last several years in building a technologically advanced network capable of delivering a broad array of reliable, high quality voice, data, and video services to our Illinois and Texas customers on a cost-effective basis. For example, approximately 95% of our total local access lines were DSL-capable as of December 31, 2008. Approximately 96% of these DSL-capable lines are capable of speeds of 3 megabits per second (Mbps) or greater. We believe our superior Internet Protocol, or IP, backbone network gives us a lower cost, better quality, and flexible platform that will enable us to develop and deliver new broadband applications to our customers over our existing network, generating additional revenues per customer. We will need to provide set-top boxes for subscribers, but otherwise we believe our current network can support increased IPTV subscribers with limited additional network preparation.

Our Pennsylvania market offers many of the same advanced IP network capabilities, with DSL available to 100% of the customer base. Metro-Ethernet, VOIP services, and other additional IP services leverage the extensive MPLS (Multi-Protocol Label Switching) core network, making it more efficient and scalable. The wide-ranging network and extensive use of fiber provide an easy reach into existing and new areas. By bringing the fiber network closer to the customer premises, we can enhance service offerings, quality and higher bandwidth services.

Broad service offerings and bundling of services

We offer our residential and business customers a single point of contact for access to a broad array of voice, data, and video services. We provide local and long distance service, multiple speeds of DSL service, and a robust IPTV video offering with over 200 all-digital channels, high definition (“HD”) offerings, and digital video recorder (“DVR”) services. We also offer custom calling services, carrier access services, digital telephone service to residential and business customers, and directory publishing.

Bundling our service offerings enables us to offer and sell a more complete package of services, which simultaneously increases our average revenue per user and adds value for the consumer. We also believe that bundling leads to increased customer loyalty and retention. As of December 31, 2008, we had 42,054 customers who subscribed to service bundles that included local service and a selection of other services including custom calling features, DSL, and IPTV.

Favorable regulatory environment

We benefit from federal and Texas and Pennsylvania state subsidies designed to promote “universal service,” or widely available quality telephone service at affordable prices in rural areas. For the year ended December 31, 2008, we received $32.1 million in payments from the federal universal service fund, $17.9 million from the Texas universal service fund, and $5.2 million from the Pennsylvania universal service fund. In the aggregate, these payments constituted 13.2% of our revenues for the year ended December 31, 2008. For the year ended December 31, 2007, we received $27.0 million from the federal universal service fund and $19.0 million from the Texas universal service fund, constituting 14.0% of revenues for the year.

Experienced management team with proven track record

With an average of over 20 years of experience in both regulated and non-regulated telecommunications businesses, our management team has demonstrated that it can deliver profitable growth while providing high levels of customer satisfaction. Specifically, our management team has a proven track record of:

	•		providing superior quality services to rural customers in a regulated environment;
	•		implementing successful business integrations and acquisitions; and
	•		launching and growing new services, such as DSL and IPTV, along with managing CLEC businesses and complementary services, such as operator, telemarketing, and order fulfillment services and directory publishing.

Business Strategy

Increase revenues per customer

We continue to focus on increasing our revenues per customer, primarily by improving our DSL and IPTV market penetration, increasing the sale of other value-added services, and encouraging customers to subscribe to our service bundles.

Over the last three years we have expanded our service bundle by introducing IPTV in selected Illinois and Texas markets. After making necessary upgrades to our network and purchasing programming content, we launched IPTV in our Pennsylvania markets in April 2008, four months after acquiring the company. All of our markets currently offer HD programming and DVR service that further increases our average revenue per user. As of December 31, 2008, over 90% of our video customers have taken our triple play offering. In total, we had 16,666 video subscribers and the capability of offering the service to over 142,800 households in our territories.

Improve operating efficiency

Over the years, we have made significant operating and management improvements. In particular, we centralized many of our business and back office operations into one functional organization with common work groups, processes, and systems. Following our acquisition of North Pittsburgh, all of its financial, human resource, and supply chain systems were immediately integrated into our existing systems. Because of these efficiencies, management and customer service personnel can focus on running the business and better serving our customers in a cost-effective manner. We also identified several “fast track” projects that allowed us to improve our cost structure while launching new products and improving the customer experience. By mid-2009 we will convert the North Pittsburgh ILEC billing system to a common platform currently used by our Illinois and Texas operations.

Maintain capital expenditure discipline

Across all of our territories we have successfully managed capital expenditures to optimize returns through disciplined planning and targeted capital investment. For example, specific investments in our IP core and access networks allow us to continue to have significant flexibility to expand our new service offerings such as IPTV and digital telephone services in a very cost-efficient manner while maintaining our reputation as a high-quality service provider.

Pursue selective acquisitions

Although we focused on integrating North Pittsburgh in 2008, in the longer term we will continue to pursue a disciplined process of selectively acquiring access lines or operating companies. When we evaluate potential acquisitions, we consider whether:

	•		the market is attractive;
	•		the network is of appropriate quality;
	•		we can integrate the acquired company efficiently;
	•		there are potential operating synergies; and
	•		the transaction is cash flow accretive from day one.

Source of Revenues

The following chart summarizes our primary sources of revenues for the last two years:

		2008								2007
						% of Total								% of Total
		$ (millions)				Revenues				$ (millions)				Revenues
Revenues
Telephone Operations
Local calling services		$	104.6				25.0	%		$	82.8				25.2	%
Network access services			94.6				22.6				70.2				21.3
Subsidies			55.2				13.2				46.0				14.0
Long distance services			24.0				5.7				14.0				4.2
Data and Internet services			62.7				15.0				38.0				11.5
Other services			36.9				8.8				35.8				10.9
Total Telephone Operations			378.0				90.3				286.8				87.1
Other Operations			40.4				9.7				42.4				12.9
Total operating revenues		$	418.4				100	%		$	329.2				100	%

Telephone Operations

Our Telephone Operations segment consists of local calling services, network access services, subsidies, long distance services, data and Internet services (including DSL, IPTV and digital telephone service), and other services. As of December 31, 2008, our Telephone Operations segment had approximately:

	•		264,323 local access lines in service, of which approximately 61.3% served residential customers and 38.7% served business customers;
	•		165,953 long distance lines, which represented 62.8% penetration of our local access lines;
	•		91,817 DSL lines; and
	•		16,666 IPTV subscribers.

Our Telephone Operations segment generated approximately $91.9 million of cash flows from operating activities for the year ended December 31, 2008, and $82.5 million for the year ended December 31, 2007. As of December 31, 2008, our Telephone Operations had total assets of approximately $1,227.3 million.

Local calling services include dial tone and other basic services. We generally charge residential and business customers a fixed monthly rate for access to the network and for originating and receiving telephone calls within their local calling area.

Custom calling features consist of caller name and number identification, call forwarding, and call waiting. Value-added services consist of teleconferencing and voice mail. We usually charge a flat monthly fee for custom calling features and value-added services. Otherwise, we bundle the selected services with local calling services at a discounted rate.

We offer private lines that provide direct connections between two or more local locations—primarily to business customers—at flat monthly rates. In our Pennsylvania and Texas markets, we offer small- and medium-sized businesses a hosted VOIP package, which utilizes our current switch and allows the customer the flexibility of utilizing new telephone technology and features without investing in a new telephone system to get the features. The package bundles local service, calling features, IP business telephones, and unified messaging, which integrates multiple messaging technologies into a single system, such as allowing the customer to receive and listen to voice messages through email. We have introduced a similar product to our residential customers in Texas and Illinois and expect to extend the offering it our Pennsylvania residential customers in 2009.

Network access services allow customers to make or receive calls in our service area. Our long-distance customers typically pay a monthly fee for this service. In addition, other carriers pay network access charges for originating or terminating calls within our service areas. These charges, which are regulated, also apply to private lines that connect a customer in one of our service areas to a location outside of our service areas. Network access charges include subscriber line charges (a fee for being connected to the telephone network), local number portability fees (whereby consumers can keep their telephone number when changing carriers), and universal services surcharges.

We record the details of long distance and private line calls through our carrier access billing system and bill the applicable carriers on a monthly basis. The network access charge rates for intrastate long distance calls and private lines within Illinois, Texas, and Pennsylvania are regulated and approved by the Illinois Commerce Commission (the “ICC”), the Public Utility Commission of Texas (“PUCT”), and the Pennsylvania Public Utility Commission (“PAPUC”), respectively. The access charge rates for interstate long distance calls and private lines are regulated and approved by the Federal Communications Commission (the “FCC”). See “Regulatory Environment—Federal Regulation” and “Regulatory Environment—Access Charges.”

Subsidies consist of federal and state subsidies designed to promote widely available, quality telephone service at affordable prices in rural areas. Subsidies come from pools to which telecommunications providers, including local, long distance, and wireless carriers, contribute on a monthly basis. Subsidies are allocated and distributed to rural carriers monthly based upon their respective costs for providing local service. In Illinois we receive federal but not state subsidies; in Texas and Pennsylvania we receive both federal and state subsidies.

Long distance services enable customers to originate calls that terminate outside their local calling area. We offer a variety of long distance plans, including an unlimited calling plan, and offer a combination of subscription and usage fees.

Data and Internet services include revenues from non-local private lines and for providing access to the Internet and IPTV. We also offer a variety of data connectivity services, including Asynchronous Transfer Mode and gigabit Ethernet products and frame relay networks. In our Pennsylvania markets we also provide virtual hosting services, collocation services, custom web site delevopment, and e-commerce enabling technologies.

Other services include revenues from telephone directory publishing, wholesale transport services on our fiber optic network in Texas, billing and collection services, inside wiring service, and maintenance.

Wireless partnership investments are included as a component of other income in our Telephone Operations segment. This includes our limited partnership interests in Boulevard Communications, a competitive access provider, and five cellular partnerships: GTE Mobilnet of South Texas, GTE Mobilnet of Texas RSA #17, Pittsburgh SMSA, Pennsylvania RSA 6(I), and Pennsylvania RSA 6(II).

We own approximately 2.3% of GTE Mobilnet of South Texas, which serves the greater Houston metropolitan area. Because we have a minor ownership interest and cannot influence operations, we account for this investment using the cost basis; income is recognized only on cash distributions paid to us up to our proportionate earnings in the partnership. We recognized income on cash distributions of $4.1 million from this partnership for the year ended December 31, 2008, and $4.2 million for the year ended December 31, 2007.

We own approximately 17.0% of GTE Mobilnet of Texas RSA #17, which serves areas in and around Conroe, Texas. Because we have some influence over the operating and financial policies of this partnership, we account for the investment under the equity method, recognizing income based on the proportion of the earnings generated by the partnership that would be allocated to us. Cash distributions are recorded as a reduction in our investment amount. For the year ended December 31, 2008, we recognized income of $2.6 million and received cash distributions of $0.9 million from this partnership. For the year ended December 31, 2007, we recognized income of $2.2 million and received cash distributions of $1.9 million.

San Antonio MTA, L.P., a wholly-owned partnership of Cellco Partnership (doing business as Verizon Wireless), is the general partner for both GTE Mobilnet of South Texas and GTE Mobilnet of Texas RSA #17.

In connection with the acquisition of North Pittsburgh, we acquired 3.6% of Pittsburgh SMSA, 16.6725% of Pennsylvania RSA 6(I), and 23.67% of Pennsylvania RSA 6(II) wireless partnerships, all of which are majority owned and operated by Verizon Wireless. These partnerships cover territories that almost entirely overlap the markets served by North Pittsburgh’s ILEC and CLEC operations. Because of our limited influence over Pittsburgh SMSA, we account for the investment using the cost basis. We recognized income on cash distributions from Pittsburgh SMSA of $5.6 million for the year ended December 31, 2008. The Pennsylvania RSA 6(I) and RSA 6(II) partnerships are accounted for under the equity method. We recognized income of $7.5 million and received cash distributions of $7.0 million from these partnerships for the year ended December 31, 2008.

Boulevard Communications, L.L.P. is a Pennsylvania limited liability partnership equally owned by North Pittsburgh and a company in the Armstrong Holdings, Inc. group of companies. Boulevard provides point-to-point data services to businesses in western Pennsylvania, including access to ISPs, connections to interexchange carriers, and high-speed data transmission. We account for the Boulevard investment under the equity method.

Other Operations

Our Other Operations segment, which does not include any North Pittsburgh operations, consists of five complementary businesses:

•

Public Services provides local and long distance service and automated calling service for correctional facilities.

•

Business Systems sells and installs telecommunications equipment, such as key, private branch exchange (PBX), and IP-based telephone systems, to business customers in Texas and Illinois.

•

Market Response provides telemarketing and order fulfillment services.

•

Operator Services offers both live and automated local and long distance operator services and national directory assistance on a wholesale and retail basis.

•

Mobile Services provides one-way messaging service predominantly to our Illinois business customers. A portion of the 2008 revenues included our Illinois cellular agency and Texas Mobile Virtual Network Operator (“MVNO”) operations, which were discontinued in 2008. Beginning in 2009, the remaining product, paging services, will be classified as a product in our Telephone Operations segment rather than as a business within Other Operations.

Our Other Operations segment generated approximately $0.5 million of cash flows from operating activities for the year ended December 31, 2008, and ($0.4) million for the year ended December 31, 2007. As of December 31, 2008, Other Operations had total assets of approximately $14.3 million.

Customers and Markets

Our Illinois local telephone markets consist of 35 geographically contiguous exchanges serving predominantly small towns and rural areas. We cover an area of approximately 2,681 square miles, primarily in five central Illinois counties: Coles, Christian, Montgomery, Effingham, and Shelby. We provide basic telephone services in this territory, with 68,679 local access lines, or approximately 25.6 lines per square mile, as of December 31, 2008. Approximately 57.9% of our local access lines serve residential customers, with the remainder serving business customers. Our Illinois business customers are predominantly small retail, commercial, light manufacturing, and service industry accounts, as well as universities and hospitals.

Our 21 exchanges in Texas serve three principal geographic markets—Lufkin, Conroe, and Katy—in an approximately 2,054 square mile area. We provide basic telephone services in this territory, with 136,784 local access lines, or approximately 66.6 lines per square mile, as of December 31, 2008. Approximately 65.5% of our Texas local access lines serve residential customers, with the remainder serving business customers. Our Texas business customers are predominately manufacturing and retail industries; our largest business customers are hospitals, local governments, and school districts.

The Lufkin market is centered primarily in Angelina county in east Texas, approximately 120 miles northeast of Houston, and extends into three neighboring counties. The area is a center for the lumber industry and includes other significant industries such as education, health care, manufacturing, retail, and social services.

The Conroe market is located primarily in Montgomery County and is centered approximately 40 miles north of Houston. Parts of the Conroe operating territory extend south to within 28 miles of downtown Houston, including parts of the affluent suburb of the Woodlands. Major industries in this market include education, health care, manufacturing, retail, and social services.

The Katy market is located in parts of Fort Bend, Harris, Waller, and Brazoria counties and is centered approximately 30 miles west of downtown Houston along the busy and expanding I-10 corridor. Most of the Katy market is considered part of metropolitan Houston, with major industries including administrative, education, health care, management, professional, retail, scientific and waste management services.

The Pennsylvania ILEC territory covers 285 square miles and serves portions of Allegheny, Armstrong, Butler, and Westmorland counties in western Pennsylvania. The southernmost point of the ILEC territory is just 12 miles from Pittsburgh. We provide basic telephone services in this territory, with approximately 58,860 local access lines, or approximately 206.5 lines per square mile, as of December 31, 2008. Approximately 55.7% of our North Pittsburgh local access lines serve residential customers and the remainder serve business customers. The CLEC operations expand south to serve Pittsburgh and north to serve the city of Butler. The CLEC primarily targets small to mid-sized businesses, educational institutions, and healthcare facilities.

Sales and Marketing

Telephone Operations

The key components of our overall marketing strategy in the Telephone Operations segment include:

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positioning ourselves as a single point of contact for our customers’ communications needs;

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providing customers with a broad array of voice and data services, and bundling services where possible;

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providing excellent customer service, including 24-hour, 7-day a week centralized customer support to coordinate installation of new services, repair and maintenance functions;

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developing and delivering new services; and

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leveraging our history and involvement with local communities and expanding “Consolidated Communications” and “Consolidated” brand recognition.

Our consumer sales strategy is focused on increasing our penetration of broadband services, including DSL, IPTV and digital telephone, in all of our service areas. We are also focused on cross-selling our services, developing additional services to maximize revenues and increase revenues per user, and increasing customer loyalty through superior service, local presence, and motivated service employees.

Our Telephone Operations segment currently has three sales channels: call centers, communication centers, and commissioned sales people. Our customer service call centers serve as the primary sales channels for residential and business customers with one or two phone lines. Commissioned sales representatives provide customized proposals to larger business customers. In 2006, we formed a new group of commissioned sales people, called our “Feet on the Street” team. This team canvasses our territory offering residential customers our full suite of products, leading with our triple-play bundled offering of voice, DSL, and IPTV services. In addition to being a strong sales point of contact, this sales channel also helps us to identify and address customer service issues, if any, on a proactive face-to-face basis. This team of individuals can be scaled up or down to match our business needs, including, for example, if we launch a new product.

Our customers also can visit one of our eight communications centers to address various communications needs, including paying bills or ordering new service. We believe that the availability of communication centers has helped decrease customers’ late payments and bad debt.

Our Telephone Operations’ sales efforts are supported by direct mail, bill inserts, newspaper advertising, public relations activities, sponsorship of community events, and website promotions.

Directory Publishing is supported by a dedicated sales force, which spends months each year focused on each of the directory markets in order to maximize advertising sales. We believe the directory business has been an efficient tool for marketing our other services and for promoting brand development and awareness.

Transport Services has a sales force of commissioned sales people specializing in wholesale transport products.

Other Operations

Each of our Other Operations businesses executes our sales and marketing strategy primarily through an independent sales and marketing team comprising dedicated field sales account managers, management, and service representatives. Salespeople enhance these efforts by attending industry trade shows and assuming leadership roles in industry groups including the U.S. Telecom Association, the Associated Communications Companies of America, and the Independent Telephone and Telecommunications Alliance.

Information Technology and Support Systems

Our information technology and support systems staff is a seasoned organization that supports day-to-day operations and develops system enhancements. The technology supporting our Telephone Operations segment is centered on a core of commercially available and internally maintained systems.

In 2005 and 2006 we successfully migrated most of the key business processes of our Illinois and Texas telephone operations onto single company-wide systems and platforms including common network provisioning, network management, workforce management systems, and financial systems. In 2007, we upgraded and integrated our telephone billing system in Illinois. All of North Pittsburgh’s financial, human resource, and supply chain systems were immediately integrated into our existing systems, while provisioning, network management, and trouble management were integrated to common platforms throughout 2008 and the ILEC billing platform will be integrated in mid-2009. Our core systems and hardware platform are readily expandable.

Network Architecture and Technology

All of our local networks are based on a Carrier Serving Area, or CSA, architecture. CSA architecture allows access equipment to be placed closer to customer premises, which means customers can be connected to the equipment over shorter copper loops than would be possible if all customers were connected directly to the carrier’s main switch. The access equipment is connected back to the main switch on a high capacity fiber circuit, resulting in extensive fiber deployment throughout the network, which enables us to provide broadband services in excess of 20 Mbps to our customers.

A single engineering team is responsible for the overall architecture and interoperability of the various elements in the combined network of our Illinois, Texas, and Pennsylvania telephone operations. Our network operations center, or NOC, in Lufkin, Texas, monitors the performance of our enterprise wide communications network around the clock. This center is connected to our NOC in Mattoon, Illinois, which deals with customer-specific issues. We believe our NOCs allow our Telephone Operations to maintain high network performance standards using common network systems and platforms, which allows us to efficiently handle weekend and after-hours coverage between all of our markets and more efficiently allocate personnel to manage fluctuations in our workload volumes.

Our network is supported by advanced 100% digital switches, with a fiber network connecting 63 of our 65 exchanges. These switches provide all of our local telephone customers with access to custom calling features, value-added services, and dial-up Internet access. We have four additional switches: one that supports feature-rich VOIP, two dedicated to long distance service, and one that supports our Public Services and Operator Services businesses.

After years of making network improvements and developing content relationships, we introduced IPTV service (which is functionally similar to digital cable television) in selected Illinois markets in 2005, Texas markets in 2006, and Pennsylvania markets in 2008. As of December 31, 2008, IPTV was available to approximately 142,800 homes in our markets. Our IPTV subscriber base grew from 12,241 as of December 31, 2007, to 16,666 as of December 31, 2008. We will need to provide set-top boxes to future subscribers, but we do not anticipate having to make any material capital upgrades to our network infrastructure in connection with our expansion of IPTV.

In Texas we also operate a transport network, which consists of approximately 2,500 route-miles of fiber optic cable. Approximately 54% of this network consists of cable sheath that we own, either directly or through East Texas Fiber Line Incorporated (our majority-owned subsidiary) and Fort Bend Fibernet (a partnership partly owned by us). For most of the remaining route-miles of the network, we purchased strands on third-party fiber networks under contracts commonly known as indefeasible rights of use. In limited cases, we also lease capacity on third-party fiber networks to complete routes. These assets also support our IPTV video product in Texas.

In the past ten years, North Pittsburgh has invested over $160 million to develop a high quality 100% digital switching network, comprising nine central offices and 86 CSAs. The CSA architecture has enabled North Pittsburgh to provide DSL service, with speeds up to 3 Mbps, to all of its access lines. In addition, North Pittsburgh has deployed fiber optic cable extensively throughout its network, resulting in a 100% Synchronous Optical Network (SONET) that supports all of the inter-office and host-remote links, as well as the majority of business parks within its ILEC serving area.

Prior to being acquired by Consolidated Communications, North Pittsburgh completed a capital construction project to deploy fiber closer to the homes and businesses it serves. As of December 31, 2008, approximately 90% percent of North Pittsburgh’s potential access lines have fiber within 5,000 feet, which will allow for DSL deployment at speeds ranging between 20 to 25 mbps and support our IPTV product in Pennsylvania. North Pittsburgh also has upgraded its data transmission network to a gigabit Ethernet backbone using a Multiple Protocol Label Switching (MPLS) network that will more efficiently and effectively handle the increased bandwidth demands from its next-generation DSL products and its business-class Ethernet offerings.

The Pennsylvania CLEC operates an extensive network with over 300 route miles of fiber optic facilities in the Pittsburgh metropolitan area. The CLEC has placed equipment in 27 Verizon central offices and one Embarq central office, and primarily serves its customers using UNE loops. In the Pittsburgh market, the CLEC operates a carrier hotel that serves as the hub for its fiber optic network. We offer space in this carrier hotel to ISPs, long distance carriers, other CLECs, and other customers who need a carrier-class location to house voice and data equipment and access to a number of networks, including ours.

Employees

As of December 31, 2008, we had a total of 1,315 employees, of which 1,195 were full-time and 120 were part-time. Approximately 343 of the employees located in Illinois are represented by the International Brotherhood of Electrical Workers under a collective bargaining agreement that expired November 15, 2008. On February 3, 2009 the International Brotherhood of Electrical Workers ratified a new four year collective bargaining agreement, which will expire on November 15, 2012. Approximately 316 of the employees located in Texas and Pennsylvania are represented by the Communications Workers of America under collective bargaining agreements that expire October 15, 2010, and September 30, 2011, respectively. We believe that management currently has a good relationship with the employees of the Company.

Competition

Local telephone market

In general, telecommunications service in rural areas is more costly to provide than service in urban areas; the lower customer density necessitates higher capital expenditures on a per customer basis. As a result, it generally is not economically viable for new entrants to overlap existing networks in rural territories.

Despite the barriers to entry, rural telephone companies face some competition for voice services from cable providers, wireless providers, and competitive telephone companies. Cable providers are upgrading their networks with fiber optics and installing facilities to provide fully interactive transmission of broadband voice, data, and video communications. Competitive telephone companies have been granted permission by state regulators to offer local telephone service in areas already served by a local telephone company. Although they have not yet done so, electric utility companies have existing assets and low cost access to capital that may allow them to enter a market rapidly and accelerate network development.

Industry participants increasingly are embracing VOIP service, which essentially involves the routing of voice calls, at least in part, over the Internet through packets of data instead of transmitting the calls over the telephone system. While current VOIP applications typically complete calls using ILEC infrastructure and networks, as VOIP services become more widespread and technology advances, more calls may be placed without using the telephone system. On March 10, 2004, the FCC issued a Notice of Proposed Rulemaking with respect to IP-enabled services. Among other things, the FCC is considering whether VOIP services are regulated telecommunications services or unregulated information services. The FCC has yet to issue a decision on the matter. We cannot predict the outcome of the FCC’s rulemaking or how it will affect the revenues of our rural telephone companies. The proliferation of VOIP, particularly to the extent such communications do not utilize our networks, may reduce our customer base and cause us to lose access fees and other funding.

Mediacom, which serves portions of our Illinois territories, offers VOIP that competes with our basic voice services. In 2008, NewWave Communications launched a competing voice product in the portions of our Illinois territory that is not served by Mediacom. In addition, both Suddenlink and Comcast, cable competitors in Texas, launched a competing voice product this year. These companies also compete with us for customers interested in video and DSL services. In our North Pittsburgh territory, each of the two incumbent cable providers, Armstrong and Comcast, offer a competitive VOIP offering. Armstrong and Comcast also offer aggressive triple play packages of voice, video, and broadband service. In general, cable companies have modern networks and the capacity to serve a substantial number of customers. We estimate that cable companies now cover 85% of our territory.

Wireless service

Rural telephone companies usually face less wireless competition than non-rural providers of voice services because wireless networks in rural areas generally are less developed. Our service areas in Conroe and Katy, Texas are exceptions to this general rule because they are close to Houston. As a result, we are facing increased competition from wireless service providers in those markets. Our Pennsylvania markets also are exposed to increased competition from wireless service providers because of the concentration of interstate and major highways in the territory. We have experienced the loss of access lines by customers choosing to eliminate their wireline service in favor of a wireless provider. We believe that wireless substitution will continue to be a competitive threat in the years to come.

Internet service

The Internet services market is highly competitive and there are few barriers to entry. Internet services—meaning wired and wireless Internet access and on-line content services—are provided by cable providers, Internet service providers, long distance carriers, and satellite-based companies. Many of these companies provide direct access to the Internet and a variety of supporting services. In addition, many companies offer access to closed, proprietary information networks.

Cable providers have aggressively entered the Internet access markets over the last few years. Both have substantial transmission capabilities, traditionally carry data to large numbers of customers, and have a billing system infrastructure that permits them to add new services. Industry sources expect, and we agree, that competition for Internet services will continue to be very competitive.

Long distance service

The long distance telecommunications market is highly competitive. Competition in the long distance business is based primarily on price, although service bundling, branding, customer service, billing service, and quality all influence customers’ choices.

Other competition

Our other lines of business are subject to substantial competition from local, regional, and national competitors. In particular, our directory publishing and transport businesses operate in competitive markets. We expect that competition in all of our businesses will continue to intensify as new technologies and new services are offered. Customers in these businesses can and do change vendors frequently. Long-term contracts are unusual, and those that do exist have cancellation clauses that allow quick termination. Where long-term contracts are in place, customers are renewing them for shorter terms.

Regulatory Environment

The following summary does not describe all existing and proposed legislation and regulations affecting the telecommunications industry. Regulation can change rapidly, and ongoing proceedings and hearings could alter the manner in which the telecommunications industry operates. We cannot predict the outcome of any of these developments, nor their potential impact on us. See “Risk Factors—Regulatory Risks.”

Overview

The telecommunications industry is subject to extensive federal, state, and local regulation. Under the Telecommunications Act of 1996 (“Telecommunications Act”), federal and state regulators share responsibility for implementing and enforcing statutes and regulations designed to encourage competition and to preserve and advance widely available, quality telephone service at affordable prices.

At the federal level, the Federal Communications Commission, or FCC, generally exercises jurisdiction over facilities and services of local exchange carriers such as our rural telephone companies to the extent they are used to provide, originate, or terminate interstate or international communications. The FCC has the authority to condition, modify, cancel, terminate, or revoke our operating authority for failure to comply with applicable federal laws or FCC rules, regulations, and policies. Fines or other penalties also may be imposed for any of these violations.

State regulatory commissions, such as the ICC in Illinois, PAPUC in Pennsylvania, and the PUCT in Texas, generally exercise jurisdiction over carriers’ facilities and services to the extent they are used to provide, originate, or terminate intrastate communications. In particular, state regulatory agencies have substantial oversight over interconnection and network access by competitors of our rural telephone companies. In addition, municipalities and other local government agencies regulate the public rights-of-way necessary to install and operate networks. State regulators can sanction our rural telephone companies or revoke our certifications if we violate relevant laws or regulations.

Federal regulation

Our rural telephone companies and competitive local exchange companies must comply with the Communications Act of 1934, which requires, among other things, that telecommunications carriers offer services at just and reasonable rates and on non-discriminatory terms and conditions. The 1996 amendments to the Communications Act (contained in the Telecommunications Act discussed below) dramatically changed, and likely will continue to change, the landscape of the industry.

Removal of entry barriers

The central aim of the Telecommunications Act is to open local telecommunications markets to competition while enhancing universal service. Before the Telecommunications Act was enacted, many states limited the services that could be offered by a company competing with an incumbent telephone company. The Telecommunications Act preempts these state and local laws.

The Telecommunications Act imposes a number of interconnection and other requirements on all local communications providers. All telecommunications carriers have a duty to interconnect directly or indirectly with the facilities and equipment of other telecommunications carriers. Local exchange carriers, including our rural telephone companies, are required to:

	•		allow other carriers to resell their services;
	•		provide number portability where feasible;
	•		ensure dialing parity, meaning that consumers can choose their default local or long distance telephone company without having to dial additional digits;
	•		ensure that competitors’ customers receive nondiscriminatory access to telephone numbers, operator service, directory assistance, and directory listing;
	•		afford competitors access to telephone poles, ducts, conduits, and rights-of-way; and
	•		establish reciprocal compensation arrangements with other carriers for the transport and termination of telecommunications traffic.

Furthermore, the Telecommunications Act imposes on incumbent telephone companies (other than rural telephone companies that maintain their so-called “rural exemption” as our subsidiaries do) additional obligations to:

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negotiate interconnection agreements with other carriers in good faith;

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interconnect their facilities and equipment with any requesting telecommunications carrier, at any technically feasible point, at nondiscriminatory rates and on nondiscriminatory terms and conditions;

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offer their retail services to other carriers for resale at discounted wholesale rates;

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provide reasonable notice of changes in the information necessary for transmission and routing of services over the incumbent telephone company’s facilities or in the information necessary for interoperability; and

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provide, at rates, terms, and conditions that are just, reasonable, and nondiscriminatory, for the physical collocation of other carriers’ equipment necessary for interconnection or access to UNEs at the premises of the incumbent telephone company.

Access charges

A significant portion of our rural telephone companies’ revenues come from network access charges paid by long distance and other carriers for originating or terminating calls within our service areas. The amount of network access charge revenues our rural telephone companies receive is based on rates set or approved by federal and state regulatory commissions, and these rates are subject to change at any time.

Intrastate network access charges are regulated by state commissions. Network access charges in our Illinois market currently mirror interstate charges for everything but local switching. Interstate and intrastate network access charges in our North Pittsburgh market also are very similar. In contrast, as required by Texas regulators, our Texas rural telephone companies impose significantly higher network access charges for intrastate transmissions than for interstate transmissions.

The FCC regulates the prices we may charge for the use of our local telephone facilities to originate or terminate interstate and international transmissions. The FCC has structured these prices as a combination of flat monthly charges paid by customers, and usage-sensitive charges or flat monthly rate charges paid by long distance or other carriers.

The FCC regulates levels of interstate network access charges by imposing price caps on Regional Bell Operating Companies, referred to as RBOCs, and other large incumbent telephone companies. These price caps can be adjusted based on various formulas, such as inflation and productivity, and otherwise through regulatory proceedings. Incumbent telephone companies, such as our local telephone companies, may elect to base network access charges on price caps, but are not required to do so.

Historically, all of our rural telephone companies have elected not to apply federal price caps. Instead, they employ rate-of-return regulation for their network interstate access charges, whereby they earn a fixed return on their investment—currently 11.25%—over and above operating costs. In December 2007, we filed a petition with the FCC seeking to permit our Illinois and Texas companies to convert to price cap regulation. Our petition was approved on May 6, 2008 and is effective on July 1, 2008. This conversion gives us greater pricing flexibility for interstate services, especially the increasingly competitive special access segment. It also provides us the potential to increase our net earnings by becoming more productive and introducing new services. On the other hand, we were required to reduce our interstate access charges in Illinois significantly, and because our Illinois intrastate access charges generally mirror interstate rates, this conversion also may result in lower intrastate revenues in Illinois. In addition, we will receive somewhat reduced subsidies from the interstate Universal Service Fund program.

Our Pennsylvania rural telephone company is an average schedule rate of return company, which means its interstate access revenues are based upon a statistical formula developed by the National Exchange Carrier Association (“NECA”) and approved by the FCC, rather than upon its actual costs. In its 2006 and 2007 annual revisions of the average schedule formulas, NECA proposed and the FCC approved structural changes that were fully phased in during 2008, reducing our Pennsylvania rural telephone company’s annual interstate revenues by approximately $3.7 million compared to periods prior to the phase in of the structural changes. NECA and the FCC may make further changes to the formulas in future years, which could have an additional impact on our revenues. Our Pennsylvania rural telephone company has the option to become a cost company, meaning its rates would be subject to its own individual cost and demand data studies, but this option would be irrevocable if exercised. We cannot predict whether or when it would be advantageous to make this conversion.

Traditionally, regulators have allowed network access rates for rural areas to be set higher than the actual cost of terminating or originating long distance calls as an implicit means of subsidizing the high cost of providing local service in rural areas. Following a series of federal court decisions ruling that subsidies must be explicit rather than implicit, the FCC adopted reforms in 2001 that reduced per-minute network access charges and shifted a portion of cost recovery, which historically was imposed on long distance carriers, to flat-rate, monthly subscriber line charges imposed on end-user customers. While the FCC also increased explicit subsidies to rural telephone companies through the universal service fund, the aggregate amount of interstate network access charges paid by long distance carriers to access providers, such as our rural telephone companies, has decreased and may continue to decrease.

Unlike the federal system, Illinois does not provide an explicit subsidy in the form of a universal service fund. Therefore, while subsidies from the federal universal service fund offset the decrease in revenues resulting from the reduction in interstate network access rates in Illinois, there was no corresponding offset for the decrease in revenues from the reduction in intrastate network access rates. In Pennsylvania and Texas, the intrastate network access rate regime applicable to our rural telephone companies does not mirror the FCC regime, so the impact of the reforms was revenue neutral. The Texas legislature is expected to consider potential changes to rates during the legislative session beginning in January 2009.

In recent years, carriers have become more aggressive in disputing the FCC’s interstate access charge rates and the application of access charges to their telecommunications traffic. We believe these disputes have increased in part because advances in technology have made it more difficult to determine the identity and jurisdiction of traffic, giving carriers an increased opportunity to challenge access costs for their traffic. For example, in September 2003, Vonage Holdings Corporation filed a petition with the FCC to preempt an order of the Minnesota Public Utilities Commission asserting jurisdiction over Vonage. The FCC determined that it was impossible to divide Vonage’s VOIP service into interstate and intrastate components without negating federal rules and policies. Accordingly, the FCC found it was an interstate service not subject to traditional state telephone regulation. While the FCC order did not specifically address whether intrastate access charges were applicable to Vonage’s VOIP service, the fact that the service was found to be solely interstate raises that concern. We cannot predict what other actions other long distance carriers may take before the FCC or with their local exchange carriers, including our rural telephone companies, to challenge the applicability of access charges. We have not received any such claims to date, but we cannot guarantee that none will arise. Due to the increasing deployment of VOIP services and other technological changes, we believe these types of disputes and claims are likely to increase.

On July 25, 2006, the FCC issued for comment CC Docket 01-92, Missoula Intercarrier Compensation Plan, or the Missoula Plan—a proposal for a comprehensive reform of network access charges and other forms of compensation for the exchange of traffic among telecommunications carriers. Consolidated Communications has publicly supported the Missoula Plan; our state regulators have filed comments in opposition. The FCC has taken no action on the proposal to date. We continue to actively participate in shaping intercarrier compensation and universal service reforms through our own efforts as well as through industry associations and coalitions.

On October 23, 2006, Verizon Pennsylvania, Inc. and several of its affiliates filed a formal complaint with the PAPUC claiming that our Pennsylvania CLEC’s intrastate switched access rates violate Pennsylvania law. For a detailed description of the dispute, see “Regulatory Risks” included in Item 1A. “Risk Factors.”

Unbundled network element rules

The unbundling requirements have been some of the most controversial provisions of the Telecommunications Act. In its initial implementation of the law, the FCC generally required incumbent telephone companies to lease a wide range of UNE’s to CLEC’s. Those rules were designed to enable competitors to deliver services to their customers in combination with their existing networks or as recombined service offerings on an unbundled network element platform, commonly known as an UNE-P. These unbundling requirements, and the duty to offer UNEs to competitors, imposed substantial costs on the incumbent telephone companies and made it easier for customers to shift their business to other carriers. After a court challenge and a decision vacating portions of the UNE and UNE-P rules, the FCC issued revised rules in February 2005 that reinstated some unbundling requirements for incumbent telephone companies that are not protected by the rural exemption, but eliminated certain other unbundling requirements.

Each of the subsidiaries through which we operate our local telephone businesses is an incumbent telephone company and provides service in rural areas. As discussed above, the Telecommunications Act exempts rural telephone companies from certain of the more burdensome interconnection requirements. However, the Telecommunications Act provides that the rural exemption will cease to apply as to competing cable companies if and when the rural carrier introduces video services in a service area. In that event, a competing cable operator providing video programming and seeking to provide telecommunications services in the area may interconnect. Since each of our subsidiaries now provides video services in their major service areas, the rural exemption no longer applies to cable company competitors in those service areas. Additionally, in Texas, the PUCT has removed the rural exemption for our Texas subsidiaries with respect to telecommunications services furnished by Sprint Communications, L.P. on behalf of cable companies. We believe the benefits of providing video services outweigh the loss of the rural exemptions as to cable operators.

Under its current rules, the FCC has eliminated unbundling requirements for ILECs providing broadband services over fiber facilities, but continues to require unbundled access to mass-market narrowband loops. ILECs are no longer required to unbundle packet switching services. In addition, the FCC found that CLECs generally are not at a disadvantage at certain wire center locations in regard to high bandwidth (DS-1 and DS-3) loops, dark fiber loops, and dedicated interoffice transport facilities. However, where a disadvantage persists, ILECs continue to be required to unbundle loops and transport facilities.

The FCC rules regarding the unbundling of network elements did not have an impact on our Illinois and Pennsylvania ILEC operations because these ILEC’s have rural exemptions. Our Pennsylvania CLEC operations do not currently utilize line sharing, and utilize their own switching for business customers that are served by high-capacity loops, so the elimination of unbundling requirements for these network elements had no effect on our operations or revenues from our existing customer base. In July 2008, our Pennsylvania CLEC renewed, for a three year term, a commercial agreement with Verizon that has set the terms of the pricing and provisioning of lines served utilizing UNE-P. Our Pennsylvania CLEC currently provisions 3.63% of our CLEC access utilizing UNE-P. Although the costs for UNE-P will increase over time pursuant to the terms of the agreement, our relatively low use of UNE-P and our ability to migrate some of the lines to alternative provisioning sources will limit the overall impact on our current cost structure. The CLEC has experienced moderate increases in the overall cost to provision high capacity loops, interoffice transport facilities, and dark fiber as a result of the FCC’s changes to unbundling requirements for those facilities.

In 2006, Verizon filed a petition requesting the FCC to refrain from applying a number of regulations to the Verizon operations in six major metropolitan markets, including the Pittsburgh market area. Among other things, Verizon urged the FCC to forbear from applying loop and transport unbundling regulations, claiming there was sufficient competition in the Pittsburgh market to mitigate the need for these rules. The FCC denied Verizon’s petition in December 2007, but Verizon (and other ILECs) remain free to petition the FCC for similar relief, in Pittsburgh and other markets, in the future. If any such petitions are granted in markets in which our CLEC operates, our cost to obtain access to loop and transport facilities could increase substantially.

Promotion of universal service

In general, telecommunications service in rural areas is more costly to provide than service in urban areas. The lower customer density means that switching and other facilities serve fewer customers and loops are typically longer, requiring greater expenditures per customer to build and maintain. By supporting the high cost of operations in rural markets, federal universal service fund subsidies promote widely available, quality telephone service at affordable prices in rural areas. In 2008 we received $55.2 million in aggregate payments from the federal universal service fund, the Pennsylvania universal service fund and the Texas universal service fund. In 2007 we received $46.0 million from the federal universal service fund and the Texas universal service fund.

Federal universal service fund subsidies are paid only to carriers that are designated eligible telecommunications carriers, or ETCs, by a state commission. Each of our rural telephone companies has been designated an ETC. However, under the Telecommunications Act, competitors can obtain the same level of federal universal service fund subsidies as we do, per line served, if the applicable state regulator determines that granting such federal universal service fund subsidies to competitors would be in the public interest and the competitors offer and advertise certain services as required by the Telecommunications Act and the FCC. The ICC has granted several petitions for ETC designations, but to date no other ETCs are operating in our Illinois service area. We are not aware that any carriers have filed petitions to be designated an ETC in our Pennsylvania or Texas service areas. Under current rules, the subsidies our rural telephone companies receive are not affected by any payments to competitors. The FCC proposed on January 29, 2008, to amend its rules to reduce the support available when more than one carrier provides service in a particular market, but we are unable to predict whether or when it may adopt this proposal.

The formula the FCC uses to calculate universal service fund subsidies is in flux. In November 2007, the Federal-State Joint Board on Universal Service offered some proposals to the FCC to address the long-term reform issues facing the high-cost universal service support system and to make fundamental revisions in the structure of existing universal service mechanisms. On January 29, 2008, the FCC issued a public notice requesting comments on the Joint Board’s proposals.

We cannot predict the outcome of any FCC rulemaking or similar proceedings. The outcome of any proceeding or other legislative or regulatory changes could affect the amount of universal service support our rural telephone companies receive.

State regulation of CCI Illinois

Illinois Telephone Operations’ long distance, operator services, and payphone services subsidiary holds the necessary certifications in Illinois (and the other states in which it operates). This subsidiary is required to file tariffs with the ICC, but generally can change the prices, terms, and conditions stated in its tariffs on one day’s notice, with prior notice of price increases to affected customers. Our Illinois Telephone Operations’ other services are not subject to any significant state regulations in Illinois, and our Other Illinois Operations are not subject to any significant state regulation outside of any specific contractually imposed obligations.

Our Illinois rural telephone company is certified by the ICC to provide local telephone services. This entity operates as a distinct company from a regulatory standpoint and is regulated under a rate of return system for intrastate revenues. Although, as explained above, the FCC has preempted certain state regulations pursuant to the Telecommunications Act, Illinois retains the authority to impose requirements on our Illinois rural telephone company to preserve universal service, protect public safety and welfare, ensure quality of service, and protect consumers. For instance, our Illinois rural telephone company must file tariffs setting forth the terms, conditions, and prices for its intrastate services; these tariffs may be challenged by third parties. Our Illinois rural telephone company has not had a general rate proceeding before the ICC since 1983.

The ICC has broad authority to impose service quality and service offering requirements on our Illinois rural telephone company, including credit and collection policies and practices, and can require our Illinois rural telephone company to take actions to ensure that it meets its statutory obligation to provide reliable local exchange service. For example, as part of its approval of the reorganization we implemented in connection with our 2005 IPO, the ICC imposed various conditions, including (1) prohibitions on payment of dividends or other cash transfers from ICTC to us if ICTC fails to meet or exceed agreed benchmarks for a majority of seven service quality metrics, and (2) the requirement that ICTC have access to $5.0 million or its currently approved capital expenditure budget (whichever is higher) for each calendar year through a combination of available cash and credit facilities. During 2008 we satisfied each of the applicable Illinois regulatory requirements necessary to permit ICTC to pay dividends to us.

The Illinois General Assembly has made major revisions and added significant new provisions to the portions of the Illinois Public Utilities Act governing the regulation and obligations of telecommunications carriers on at least three occasions since 1985. Most recently, in 2007, the Illinois legislature addressed competition for cable and video services and authorized statewide licensing by the ICC to replace the existing system of individual town franchises. This legislation also imposed substantial state-mandated consumer service and consumer protection requirements on providers of cable and video services. The requirements generally became applicable to us on January 1, 2008, and we are operating in compliance with the new law. Although we have franchise agreements for cable and video services in all the towns we serve, this statewide franchising authority will simplify the process in the future. The Illinois General Assembly concluded its session in May 2008 and made no additional changes to the current state telecommunications law, which currently has a sunset date of July 1, 2009. We expect that the Illinois legislature will consider additional amendments in 2009.

State regulation of CCI Texas

Our Texas rural telephone companies are each certified by the PUCT to provide local telephone services in their respective territories. In addition, our Texas long distance and transport subsidiaries are registered with the PUCT as interexchange carriers. The transport subsidiary also has obtained a service provider certificate of operating authority (“SPCOA”) to better assist the transport subsidiary with its operations in municipal areas. Recently, to assist with expanding services offerings, Consolidated Communications Enterprise Services, Inc. also obtained an SPCOA from the PUCT. While our Texas rural telephone company services are extensively regulated, our other services, such as long distance and transport services, are not subject to any significant state regulation.

Our Texas rural telephone companies operate as distinct companies from a regulatory standpoint. Each is separately regulated by the PUCT in order to preserve universal service, protect public safety and welfare, ensure quality of service, and protect consumers. Each Texas rural telephone company must file and maintain tariffs setting forth the terms, conditions, and prices for its intrastate services.

Currently, both of our Texas rural telephone companies have immunity from adjustments to their rates, including their intrastate network access rates, because they elected “incentive regulation” under the Texas Public Utilities Regulatory Act, or PURA. In order to qualify for incentive regulation, our rural telephone companies agreed to fulfill certain infrastructure requirements. In exchange, they are not subject to challenge by the PUCT regarding their rates, overall revenues, return on invested capital, or net income.

PURA prescribes two different forms of incentive regulation in Chapter 58 and Chapter 59. Under either election, the rates, including network access rates, an incumbent telephone company may charge for basic local services generally cannot be increased from the amount(s) on the date of election without PUCT approval. Even with PUCT approval, increases can only occur in very specific situations. Pricing flexibility under Chapter 59 is extremely limited. In contrast, Chapter 58 allows greater pricing flexibility on non-basic network services, customer-specific contracts, and new services.

Initially, both of our Texas rural telephone companies elected incentive regulation under Chapter 59 and fulfilled the applicable infrastructure requirements, but they changed their election status to Chapter 58 in 2003, which gives them some pricing flexibility for basic services, subject to PUCT approval. The PUCT could impose additional infrastructure requirements or other restrictions in the future. Any requirements or restrictions could limit the amount of cash that is available to be transferred from our rural telephone companies to the parent entities, and could adversely affect our ability to meet our debt service requirements and repayment obligations.

In September 2005, the Texas legislature adopted significant telecommunications legislation. Among other things, this legislation created a statewide video franchise for telecommunications carriers; established a framework to deregulate the retail telecommunications services offered by incumbent local telecommunications carriers, and imposed concurrent requirements to reduce intrastate access charges; and directed the PUCT to initiate a study of the Texas Universal Service Fund. The PUCT study submitted to the legislature in 2007 recommended that the Small Company Area High-Cost Program, which covers our Texas telephone companies, should be reviewed by the PUCT from a policy perspective regarding basic local telephone service rates and lines eligible for support. The PUCT has only addressed the large company fund and has no immediate plans to conduct a small company review. The Texas legislature may address issues of importance to rural telecommunications carriers in Texas, including the Texas Universal Service Fund, in the 2009 legislative session.

Texas universal service

The Texas universal service fund is administered by NECA. PURA, the governing law, directs the PUCT to adopt and enforce rules requiring local exchange carriers to contribute to a state universal service fund that helps telecommunications providers offer basic local telecommunications service at reasonable rates in high cost rural areas. The Texas universal service fund is also used to reimburse telecommunications providers for revenues lost by providing Tel-Assistance and to reimburse carriers for providing lifeline service. Our Texas rural telephone companies receive disbursements from this fund.

State regulation of North Pittsburgh

The PAPUC regulates the rates, the system of financial accounts for reporting purposes, and certain aspects of service quality, billing procedures and universal service funding, among other things, related to our rural telephone company and CLEC’s provision of intrastate services. In addition, the PAPUC sets the rates and terms for interconnection between carriers within the guidelines ordered by the FCC.

Price regulation in Pennsylvania

North Pittsburgh’s intrastate rates are regulated under a statutory framework referred to as Act 183. Under this statute, North Pittsburgh’s rates for non-competitive intrastate services are allowed to increase based on an index that measures economy-wide price increases. In return, North Pittsburgh committed to continue to upgrade its network to ensure that all its customers would have access to broadband services, and to deploy a ubiquitous broadband (defined as 1.544 Mbps) network throughout its entire service area by December 31, 2008, which it did.

Pennsylvania universal service and access charges

On September 30, 1999, as part of a proceeding that resolved a number of pending issues, the PAPUC ordered ILECs, including North Pittsburgh, to rebalance and reduce intrastate toll and switched access rates. In that same order, the PAPUC also created a Pennsylvania Universal Service Fund (PAUSF) to help offset the resulting loss of ILEC revenues. In 2003, the PAPUC ordered ILECs to further rebalance and reduce intrastate access charges and left the PAUSF in place pending further review. In 2008, North Pittsburgh’s annual receipts from and contributions to the PAUSF total $5.2 million and $0.3 million, respectively. The CLEC receives no funding from the PAUSF but currently contributes $0.2 million annually. Since Act 183 was adopted in 2004, the PAPUC may not require a LEC to reduce intrastate access rates except on a revenue neutral basis.

In 2004, PAPUC instituted a third review of access charges. This proceeding may affect access charge rates for North Pittsburgh and the CLEC, as well as the amount of funding that North Pittsburgh receives from the PAUSF and the amounts that both companies contribute to that fund. Since 2004, the PAPUC has twice agreed to stay those proceedings while awaiting an FCC ruling in its Unified Compensation docket. The request for a third stay is now pending before the PAPUC and is opposed by several parties. Parties have filed testimony and the hearing will begin in February 2009. It is not known when the PAPUC will rule. During the period of the stay, the current PAUSF continues under the existing regulations.

Local government authorizations

In Illinois, we historically have been required to obtain franchises from each incorporated municipality in which our rural telephone company operates. An Illinois state statute prescribes the fees that a municipality may impose for the privilege of originating and terminating messages and placing facilities within the municipality. Illinois Telephone Operations also may be required to obtain permits for street opening and construction, or for operating franchises to install and expand fiber optic facilities. These permits or other licenses or agreements typically require the payment of fees.

Similarly, Texas incumbent telephone companies historically had been required to obtain franchises from each incorporated municipality in which they operate. Texas law now provides that incumbent telephone companies do not need to obtain franchises or other licenses to use municipal rights-of-way for delivering services. Instead, payments to municipalities for rights-of-way are administered through the PUCT and through a reporting process by each telecommunications provider. Incumbent telephone companies still need to obtain permits from municipal authorities for street opening and construction, but most burdens of obtaining municipal authorizations for access to rights-of-way have been streamlined or removed.

Our Texas rural telephone companies still operate pursuant to the terms of municipal franchise agreements in some territories served by Consolidated Communications of Fort Bend Company. As the franchises expire, they are not being renewed.

Like Illinois, Pennsylvania operates under a structure in which each municipality may impose various fees.

Broadband and Internet regulatory obligations

To date, the FCC has treated ISPs as enhanced service providers rather than common carriers. As a result, ISPs are exempt from most federal and state regulation, including the requirement to pay access charges or contribute to the federal universal service fund. Currently, there is only a small body of law and regulation that governs access to, or commerce on, the Internet. As the Internet becomes more significant, government at all levels may adopt new rules and regulations or apply existing laws and regulations to the Internet. The FCC is reviewing the appropriate regulatory framework governing high speed access to the Internet through telephone and cable providers’ communications networks. We cannot predict the outcome of these proceedings, and they may affect our regulatory obligations and the form of competition for these services.

In 2005, the FCC adopted a comprehensive regulatory framework for facilities-based providers of wireline broadband Internet access service after determining that such service is an information service. This decision places the federal regulatory treatment of DSL service in parity with the federal regulatory treatment of cable modem service. Facilities-based wireline carriers are permitted to offer broadband Internet access transmission arrangements for wireline broadband Internet access services on a common carrier basis or a non-common carrier basis. Revenues from wireline broadband Internet access service are not subject to assessment for the federal universal service fund.

VOIP can be used to carry voice communications over a broadband Internet connection. The FCC has ruled that some VOIP arrangements are not subject to regulation as telephone services. In particular, in 2004, the FCC ruled that certain VOIP services are jurisdictionally interstate, which means that states cannot regulate those applications or the service providers. A number of state regulators filed judicial challenges to that decision. The FCC has pending a proceeding that will address whether various regulatory requirements apply to VOIP providers, including the payment of access charges and the support of programs such as universal service and Enhanced-911. Expanded use of VOIP technology could reduce the access revenues received by local exchange carriers like our ILEC’s and our CLEC. We cannot predict whether or when VOIP providers may be required to pay or be entitled to receive access charges or USF support, the extent to which users will substitute VOIP calls for traditional wireline communications, or the impact of the growth of VOIP on our revenues.

Video service over broadband is lightly regulated by the FCC and states. Such regulation is limited to company registration, broadcast signal call sign management, fee collection, service and billing requirements and administrative matters such as Equal Employment Opportunity reporting. IPTV rates are not regulated.

Item 1A. Risk Factors

Risks Relating to Current Economic Conditions

The current volatility in economic conditions and the financial markets may adversely affect our industry, business, and financial performance.

The second half of 2008 brought unprecedented disruptions in the financial markets, including volatility in asset values and constraints on the availability of credit. At the same time, the U.S. economy slowed significantly. The impact, if any, that these developments might have on our business is uncertain, but current economic and financial market conditions have accentuated each of the risks discussed below and magnified their potential effect on us. Moreover, disruptions in the financial markets could adversely affect our ability to obtain additional credit or refinance existing loans.

Adverse changes in the value of assets or obligations associated with our employee benefit plans could adversely affect our results.

The current economic environment has had an adverse impact on the fair value of pension assets and will cause an increase in our future funding requirements. If unfavorable economic conditions persist, our funding requirements could further increase and impair our liquidity.

Poor economic conditions in our service areas could cause us to lose subscriber connections and revenues.

Substantially all of our customers and operations are located in Illinois, Pennsylvania, and Texas. Our customer base is small and geographically concentrated, particularly for residential customers. Because of our geographic focus, the successful operation and growth of our business depends primarily on economic conditions in the service areas of our rural telephone companies. The economies of these areas, in turn, are dependent upon many factors, including:

•

demographic trends;

•

in Illinois, the strength of the agricultural markets and the light manufacturing and services industries, continued demand from universities and hospitals, and the level of government spending;

•

in Pennsylvania, the strength of small- to medium-sized businesses, health care, and education spending; and

•

in Texas, the strength of the manufacturing, health care, waste management, and retail industries and continued demand from schools and hospitals.

Poor economic conditions and other factors beyond our control in these service areas could cause a decline in our local access lines and revenues.

Risks Relating to Dividends

This section discusses reasons why we may be unable to pay dividends at our historic levels, or at all.

Our board of directors could, in its discretion, depart from or change our dividend policy at any time.

We are not required to pay dividends; our stockholders do not have contractual or other rights to receive them. Our board of directors may decide at any time, in its discretion, to decrease the amount of dividends, change or revoke the dividend policy, or discontinue paying dividends entirely. If we do not pay dividends, for whatever reason, shares of our common stock could become less liquid and the market price of our common stock could decline.

Our ability to pay dividends, and our board of directors’ determination to maintain our dividend policy, will depend on numerous factors, including:

•

the state of our business, the environment in which we operate, and the various risks we face, including competition, technological change, changes in our industry, and regulatory and other risks summarized in this Annual Report on Form 10-K;

•

changes in the factors, assumptions, and other considerations made by our board of directors in reviewing and adopting the dividend policy, as described under “Dividend Policy and Restrictions” in Item 5 of this Annual Report;

•

our results of operations, financial condition, liquidity needs, and capital resources;

•

our expected cash needs, including for interest and any future principal payments on indebtedness, capital expenditures, taxes, and pension and other postretirement contributions; and

•

potential sources of liquidity, including borrowing under our revolving credit facility or possible asset sales.

We might not have sufficient cash to maintain current dividend levels.

While our estimated cash available to pay dividends for the year ended December 31, 2008, was sufficient to pay dividends in accordance with our dividend policy, if our future estimated cash available were to fall below our expectations, or if our assumptions as to estimated cash needs prove incorrect, we may need to:

•

reduce or eliminate dividends;

•

fund dividends by incurring additional debt (to the extent we are permitted to do so under the agreements governing our then-existing debt), which would increase our leverage, debt repayment obligations, and interest expense, decrease our interest coverage, and reduce our capacity to incur debt for other purposes, including to fund future dividend payments;

•

amend the terms of our credit agreement, if our lenders agree, to permit us to pay dividends or make other payments the agreement would otherwise restrict;

•

fund dividends by issuing equity securities, which could be dilutive to our stockholders and negatively affect the price of our common stock;

•

fund dividends from other sources, such as by asset sales or working capital, which would leave us with less cash available for other purposes; and

•

reduce other expected uses of cash, such as capital expenditures.

Over time, our capital and other cash needs will invariably be subject to uncertainties, which could affect whether we pay dividends and at what level. In addition, if we seek to raise additional cash by incurring debt or issuing equity securities, we cannot assure that such financing will be available on reasonable terms or at all. Each of the possibilities listed above could negatively affect our results of operations, financial condition, liquidity, and ability to maintain and expand our business.

Because we are a holding company with no operations, we can only pay dividends if our subsidiaries transfer funds to us.

As a holding company we have no direct operations and our principal assets are the equity interests we hold in our subsidiaries. However, our subsidiaries are legally distinct and have no obligation to transfer funds to us. As a result, we are dependent on our subsidiaries’ results of operations, existing and future debt agreements, governing state law and regulatory requirements, and ability to transfer funds to us to meet our obligations and to pay dividends.

Restrictions in our debt agreements or applicable state legal and regulatory requirements may prevent us from paying dividends.

Our ability to pay dividends will be restricted by current and future agreements governing our debt, including our credit agreement, as well as the corporate law and regulatory requirements in several states.

Based on the results of operations from October 1, 2005, through December 31, 2008, we would have been able to pay a dividend of $78.7 million under the restricted payment covenants in our credit agreement. After giving effect to the dividend of $11.4 million, which was declared in November 2008 and paid in February 2009, we could pay a dividend of $67.3 million under the credit facility.

Under Delaware law, our board of directors may not authorize a dividend unless it is paid out of our surplus (calculated in accordance with the Delaware General Corporation law), or, if we do not have a surplus, it is paid out of our net profits for the fiscal year in which the dividend is declared and the preceding fiscal year. Statutes governing Illinois and Pennsylvania corporations impose similar limitations on the ability of our subsidiaries that are incorporated in those states to declare and pay dividends.

State regulators could require our rural telephone companies to make capital expenditures and could limit the amount of cash those entities may lawfully transfer to us. For example, the ICC imposed various conditions on its approval of the reorganization consummated in connection with our IPO. Those conditions prohibit our subsidiary, ICTC, from paying dividends or making other cash transfers to us if ICTC failed to meet or exceed agreed-upon benchmarks for a majority of seven service quality metrics for the prior reporting year. In addition, ICTC must have access to the higher of $5.0 million or its currently approved capital expenditure budget for each calendar year through a combination of available cash and amounts available under credit facilities. In addition, the Illinois Public Utilities Act prohibits ICTC from paying dividends, except out of earnings and earned surplus, if ICTC’s capital is or would become impaired by the payment, or if payment of the dividend would impair ICTC’s ability to render reasonable and adequate service at reasonable rates, unless the ICC otherwise finds that the public interest requires payment of the dividend, subject to any conditions that regulator may impose. The PAPUC has placed debt and transaction cost recovery restrictions for a three-year period that could have an impact to the payment of dividends.

We expect that our cash income tax liability will increase in 2009, which will reduce our after-tax cash available to pay dividends.

Under the Internal Revenue Code, a corporation with losses in excess of taxable income in a taxable period (known as a “net operating loss,” or NOL) generally may carry the loss back or forward and use it to offset taxable income in a different period. The amount of an NOL that may be used to offset taxable income in a particular year may be limited, such as when a corporation has experienced an “ownership change” under Section 382 of the Internal Revenue Code.

As of December 31, 2008, we have utilized all our federal net operating losses, net of valuation allowances, that we can carry forward to future periods. Pursuant to Section 382, there were some limitations on the amount of losses we could use because of our IPO and prior ownership changes. Since our NOLs have been used or have expired, we will be required to pay additional cash income taxes. The increase in our cash income tax liability will reduce our after-tax cash available to pay dividends and may require us to reduce dividend payments in the future.

Risks Relating to Our Common Stock

If we continue to pay dividends at the level currently anticipated under our dividend policy, our ability to pursue growth opportunities may be limited.

We believe that our dividend policy could limit, but not preclude, our ability to grow. If we continue paying dividends at the level currently anticipated, we may not retain a sufficient amount of cash to fund a material expansion of our business, including any acquisitions or growth opportunities requiring significant and unexpected capital expenditures. For that reason, our ability to pursue any material expansion of our business may depend on our ability to obtain third-party financing. We cannot guarantee that such financing will be available to us on reasonable terms or at all, particularly in the current economic environment.

Our organizational documents could limit or delay another party’s ability to acquire us and, therefore, could deprive our investors of a possible takeover premium for their shares.

A number of provisions in our amended and restated certificate of incorporation and bylaws will make it difficult for another company to acquire us. Among other things, these provisions:

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divide our board of directors into three classes, which results in roughly one-third of our directors being elected each year;

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require the affirmative vote of holders of 75% or more of the voting power of our outstanding common stock to approve any merger, consolidation, or sale of all or substantially all of our assets;

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provide that directors may only be removed for cause and then only upon the affirmative vote of holders of two-thirds or more of the voting power of our outstanding common stock;

•

require the affirmative vote of holders of two-thirds or more of the voting power of our outstanding common stock to amend, alter, change, or repeal specified provisions of our amended and restated certificate of incorporation and bylaws;

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require stockholders to provide us with advance notice if they wish to nominate any candidates for election to our board of directors or if they intend to propose any matters for consideration at an annual stockholders meeting; and

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authorize the issuance of so-called “blank check” preferred stock without stockholder approval upon such terms as the board of directors may determine.

We also are subject to laws that may have a similar effect. For example, federal, Illinois, and Pennsylvania telecommunications laws and regulations generally prohibit a direct or indirect transfer of control over our business without prior regulatory approval. Similarly, Section 203 of the Delaware General Corporation Law restricts our ability to engage in a business combination with an “interested stockholder.” These laws and regulations make it difficult for another company to acquire us and therefore could limit the price that investors might be willing to pay in the future for shares of our common stock. In addition, the rights of our common stockholders will be subject to, and may be adversely affected by, the rights of holders of any class or series of preferred stock that we may issue in the future.

The concentration of the voting power of our common stock could limit a shareholder’s ability to influence corporate matters.

On December 31, 2008, Central Illinois Telephone, which is controlled by our Chairman, Richard A. Lumpkin, owned approximately 19.1% of our common stock. In addition, our executive management owned approximately 2.3%. As a result, these investors will be able to significantly influence all matters requiring stockholder approval, including:

	•		the election of directors;
	•		significant corporate transactions, such as a merger or other sale of our company or its assets;
	•		acquisitions that increase our indebtedness or sell revenue-generating assets;
	•		corporate and management policies;
	•		amendments to our organizational documents; and
	•		other matters submitted to our stockholders for approval.

This concentrated share ownership limits the ability of other shareholders to influence corporate matters. We may take actions that many stockholders do not view as beneficial, which may adversely affect the market price of our common stock.

Risks Relating to Our Indebtedness and Our Capital Structure

We have a substantial amount of debt outstanding and may incur additional indebtedness in the future, which could restrict our ability to pay dividends and fund working capital and planned capital expenditures.

As of December 31, 2008, we had $880.3 million of total long-term debt outstanding, excluding the current portion, and $70.1 million of stockholders’ equity. This amount of leverage could have important consequences, including:

•

we may be required to use a substantial portion of our cash flow from operations to make interest payments on our debt, which will reduce funds available for operations, future business opportunities, and dividends;

	•		we may have limited flexibility to react to changes in our business and our industry;
	•		it may be more difficult for us to satisfy our other obligations;

•

we may have a limited ability to borrow additional funds or to sell assets to raise funds if needed for working capital, capital expenditures, acquisitions, or other purposes;

•

we may become more vulnerable to general adverse economic and industry conditions, including changes in interest rates; and

•

we may be at a disadvantage compared to our competitors that have less debt.

We currently expect our cash interest expense to be approximately $58.0 million to $61.0 million in 2009. Interest expense is significantly higher than it has been in years preceding the acquisition of North Pittsburgh because we incurred additional indebtedness to consummate the merger. We cannot guarantee that we will generate sufficient revenues to service and repay our debt and have adequate funds left over to achieve or sustain profitability in our operations, meet our working capital and capital expenditure needs, compete successfully in our markets, or pay dividends to our stockholders.

If we cannot generate sufficient cash from our operations to meet our debt service and repayment obligations, we may need to reduce or delay capital expenditures, the development of our business generally, and any acquisitions. If we became unable to meet our debt service and repayment obligations, we would be in default under the terms of our credit agreement, which would allow our lenders to declare all outstanding borrowings to be due and payable. If the amounts outstanding under our credit facilities were to be accelerated, we cannot assure you that our assets would be sufficient to repay in full the money owed.

As of December 31, 2008, our credit agreement would have permitted us to incur approximately $74.7 million of additional debt. However, additional debt would exacerbate the risks described above.

Our credit agreement contains covenants that limit management’s discretion in operating our business and could prevent us from capitalizing on opportunities and taking other corporate actions.

Among other things, our credit agreement limits or restricts our ability (and the ability of certain of our subsidiaries) to:

•

incur additional debt and issue preferred stock;

•

make restricted payments, including paying dividends on, redeeming, repurchasing, or retiring our capital stock;

•

make investments and prepay or redeem debt;

•

enter into agreements restricting our subsidiaries’ ability to pay dividends, make loans, or transfer assets to us;

	•		create liens;
	•		sell or otherwise dispose of assets, including capital stock of subsidiaries;
	•		engage in transactions with affiliates;
	•		engage in sale and leaseback transactions;
	•		make capital expenditures;
	•		engage in a business other than telecommunications; and
	•		consolidate or merge.

In addition, our credit agreement requires us to comply with specified financial ratios, including ratios regarding total leverage and interest coverage. Our ability to comply with these ratios may be affected by events beyond our control. These restrictions limit our ability to plan for or react to market conditions, meet capital needs, or otherwise constrain our activities or business plans. They also may adversely affect our ability to finance our operations, enter into acquisitions, or engage in other business activities that would be in our interest.

A breach of any of the covenants contained in our credit agreement, or in any future credit agreement, or our inability to comply with the financial ratios could result in an event of default, which would allow the lenders to declare all borrowings outstanding to be due and payable. If the amounts outstanding under our credit facilities were to be accelerated, we cannot assure that our assets would be sufficient to repay in full the money owed. In such a situation, the lenders could foreclose on the assets and capital stock pledged to them.

We may not be able to refinance our existing debt if necessary, or we may only be able to do so at a higher interest expense.

Our credit facilities mature in full in 2014, and we may not be able to refinance those loans. Alternatively, any renewal or refinancing may occur on less favorable terms. If we are unable to refinance or renew our credit facilities, our failure to repay all amounts due on the maturity date would cause a default under the credit agreement. If we refinance our credit facilities on terms that are less favorable to us than the terms of our existing debt, our interest expense may increase significantly, which could impair our ability to use our funds for other purposes, such as to pay dividends.

Risks Relating to Our Business

The telecommunications industry is constantly changing and competition is increasing.

The telecommunications industry has been, and we believe will continue to be, characterized by several trends, including:

•

increased competition within established markets from providers that may offer competing or alternative services;

•

the blurring of traditional dividing lines between, and the bundling of, different services, such as local dial tone, long distance, wireless, cable, and data and Internet services; and

•

an increase in mergers and strategic alliances that allow one telecommunications provider to offer increased services or access to wider geographic markets.

We expect competition to intensify as a result of new competitors and the development of new technologies, products, and services. Consequently, we may need to spend significantly more in capital expenditures than we currently anticipate to keep existing customers and to attract new ones.

Many of our voice and data competitors, such as cable providers, Internet access providers, wireless service providers, and long distance carriers, have brand recognition and financial, technical, marketing, and other resources that are significantly greater than ours. In addition, due to consolidation and strategic alliances within the industry, we cannot predict the number of competitors we will face at any given time. Increased competition could lead to price reductions, loss of customers, reduced operating margins, or loss of market share.

The use of new technologies by other companies may increase our costs and cause us to lose customers and revenues.

The telecommunications industry is subject to rapid and significant changes in technology, frequent new service introductions, and evolving industry standards. Technological developments may make our services less competitive. We may need to respond by making unbudgeted upgrades or significant capital expenditures, or by developing additional services, which could be expensive and time consuming. If we fail to respond successfully to technological changes or obsolescence, or fail to make use of important new technologies, we could lose customers and revenues and be limited in our ability to attract new customers. The successful development of new services, which is an element of our business strategy, is uncertain and dependent on many factors, and we may not generate anticipated revenues from such services, which would reduce our profitability. We cannot predict the effect of these changes on our competitive position, costs, or profitability.

In addition, we expect that an increasing amount of our revenues will come from providing DSL, digital telephone and IPTV services. The market for high-speed Internet access is still developing, and we expect current competitors and new market entrants to introduce competing services and to develop new technologies. Likewise, the ability to deliver high-quality video service over traditional telephone lines is a recent advance that is still developing. The markets for these services could fail to develop, grow more slowly than anticipated, or become saturated with competitors with superior pricing or services. In addition, federal or state regulators may expand their control over DSL, digital telephone service and IPTV offerings. We cannot predict the outcome of these regulatory developments or how they may affect our obligations or the form of competition for these services. As a result, we could have higher costs and capital expenditures, lower revenues, and greater competition than expected for DSL, digital telephone and IPTV services.

We will incur additional integration and restructuring costs in connection with the completed North Pittsburgh merger.

We have incurred and will continue to incur significant integration and restructuring costs in connection with the North Pittsburgh merger. Although we expect to realize efficiencies from the integration of the businesses that will offset incremental transaction, integration, and restructuring costs over time, we cannot give any assurance that we will achieve this net benefit in the near term.

Future acquisitions could be expensive and may not be successful.

Our acquisition strategy entails numerous risks. The pursuit of acquisition candidates could be expensive and may not be successful. Our ability to complete future acquisitions will depend on whether we can identify suitable acquisition candidates, negotiate acceptable terms, and, if necessary, finance those acquisitions. We may be competing in these endeavors with other parties, some of which may have greater financial and other resources than we do. Whether any particular acquisition is closed successfully, the pursuit of an acquisition would likely require considerable time and effort from management, which would detract from their ability to run our current business. We may face unexpected challenges in receiving any required approvals from the applicable regulator(s), which could delay or prevent an acquisition.

If we are successful in closing an acquisition, we would face several risks in integrating the acquired business. For example, we may face unexpected difficulties entering markets in which we have little or no direct prior experience or generating expected revenue and cash flow from the acquired company or assets.

Any of these potential problems could have a material adverse effect on our business and our ability to achieve sufficient cash flow, provide adequate working capital, service and repay our indebtedness, and pay dividends.

A system failure could cause delays or interruptions of service, which could cause us to lose customers.

In the past, we have experienced short, localized disruptions in our service due to factors such as cable damage, inclement weather, and service failures by our third-party service providers. To be successful, we need to continue to provide our customers reliable service over our network. The principal risks to our network and infrastructure include physical damage to our central offices or local access lines, power surges or outages, software defects, and other disruptions beyond our control.

Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and incur unexpected expenses.

The State of Illinois is a significant customer, and our contracts with the state are favorable to the government.

In 2008 and 2007, 47.4% and 46.5%, respectively, of our Other Operations revenues were derived from our relationships with various agencies of the State of Illinois—principally the Department of Corrections through Public Services. Our relationship with the Department of Corrections accounted for 91.6% of our Public Services revenues during 2008, and 93.5% during 2007. Our relationship (initially through our predecessor) with the Department of Corrections has continued uninterrupted since 1990, despite changes in government administrations. Nevertheless, obtaining contracts from government agencies is challenging, and government contracts often include provisions that are favorable to the government in ways that are not standard in private commercial transactions. Specifically, each of our contracts with the State of Illinois:

•

permits the applicable state agency to terminate the contract without cause and without penalty under some circumstances;

•

has renewal provisions that require decisions of state agencies that are subject to political influence;

•

gives the State of Illinois the right to renew the contract at its option but does not give us the same right; and

•

could be cancelled if state funding becomes unavailable.

The failure of the State of Illinois to perform under the existing agreements for any reason, or to renew the agreements when they expire, could have a material adverse effect on our revenues.

If we cannot obtain and maintain necessary rights-of-way for our network, our operations may be interrupted and we would likely face increased costs.

We need to obtain and maintain the necessary rights-of-way for our network from governmental and quasi-governmental entities and third parties, such as railroads, utilities, state highway authorities, local governments, and transit authorities. We may not be successful in obtaining and maintaining these rights-of-way or obtaining them on acceptable terms. Some agreements relating to rights-of-way may be short-term or revocable at will, and we cannot be certain that we will continue to have access to existing rights-of-way after the governing agreements are terminated or expire. If any of our right-of-way agreements were terminated or could not be renewed, we may be forced to remove our network facilities from the affected areas or relocate or abandon our networks. This would interrupt our operations and force us to find alternative rights-of-way and make unexpected capital expenditures. In addition, our failure to maintain the necessary rights-of-way, franchises, easements, licenses, and permits may result in an event of default under our credit agreement.

We are dependent on third-party vendors for our information, billing, and network systems, as well as IPTV service.

Sophisticated information and billing systems are vital to our ability to monitor and control costs, bill customers, process orders, provide customer service, and achieve operating efficiencies. We currently rely on internal systems and third-party vendors to provide all of our information and processing systems, as well as applications that support our IP services, including IPTV. Some of our billing, customer service, and management information systems have been developed for us by third parties and may not perform as anticipated. In addition, our plans for developing and implementing our information systems, billing systems, network systems, and IPTV service rely primarily on the delivery of products and services by third-party vendors. Our right to use these systems is dependent upon license agreements, some of which can be cancelled by the vendor. If a vendor cancels or refuses to renew one of these agreements, our operations may be impaired. If we need to switch vendors, the transition could be costly and affect operating efficiencies.

We depend on certain key management personnel, and need to continue to attract and retain highly qualified management and other personnel in the future.

Our success depends upon the talents and efforts of key management personnel, many of whom have been with our company and in our industry for decades. The loss of any of these individuals, due to retirement or otherwise, and the inability to attract and retain highly qualified technical and management personnel in the future, could have a material adverse effect on our business, financial condition, and results of operations.

Regulatory Risks

The telecommunications industry is subject to extensive regulation that could change in a manner adverse to us.

Our main sources of revenues are our local telephone businesses in Illinois, Pennsylvania, and Texas. The laws and regulations governing these businesses may be, and in some cases have been, challenged in the courts, and could be changed by Congress, state legislatures, or regulators. In addition, federal or state authorities could impose new regulations that increase our operating costs or capital requirements or that are otherwise adverse to us. We cannot predict future developments or changes to the regulatory environment or the impact such developments or changes may have on us.

Legislative or regulatory changes could reduce or eliminate the revenues our rural telephone companies receive from network access charges.

A significant portion of our ILECs’ revenues come from network access charges paid by long distance and other carriers for originating or terminating calls in our service areas. The amount of network access charge revenues that our ILECs receive is based on interstate rates set by the FCC and intrastate rates set by state regulators. The FCC has reformed, and continues to reform, the federal network access charge system.

The FCC is currently considering sweeping potential changes in network access charges. Depending on the FCC’s decisions, our network access charge revenues could decline materially. We do not know whether increases in other revenues, such as subsidies and monthly line charges, will effectively offset any reductions in access charges. The state regulators also may make changes in our intrastate network access charges that could reduce our revenues. To the extent regulators permit competitive telephone companies to increase their operations in the areas served by our rural telephone companies, a portion of long distance and other carriers’ network access charges will be paid to those competitors rather than to our companies. Finally, the compensation our companies receive from network access charges could be reduced due to competition from wireless carriers.

Our Pennsylvania rural telephone company is an average schedule rate of return company, which means its interstate access revenues are based upon a statistical formula developed by NECA and approved by the FCC, rather than upon its actual costs. The formulas are reviewed by NECA and the FCC annually and there could be changes to the formulas in the future, which could have an impact on our revenues.

On October 23, 2006, Verizon Pennsylvania, Inc. and several of its affiliates filed a formal complaint with the PAPUC claiming that our Pennsylvania CLEC’s intrastate switched access rates violate Pennsylvania law. The provision that Verizon cites in its complaint requires CLEC rates to be no higher than the corresponding incumbent’s rates unless the CLEC can demonstrate that higher access rates are “cost justified.” Verizon’s original claim requested a refund of $1.3 million through December 2006.

We believe that our CLEC’s switched access rates are permissible, and we are vigorously opposing this complaint. In an Initial Decision dated December 5, 2007, the presiding administrative law judge (“ALJ”) recommended that the PAPUC sustain Verizon’s complaint. As relief, the Administrative Law Judge directed that our Pennsylvania CLEC reduce its access rates down to those of the underlying incumbent exchange carrier and provide a refund to Verizon in an amount equal to the access charges collected in excess of the new rate since November 30, 2004. We filed exceptions to the full PAPUC, which requested that Verizon and the Company attempt to resolve the issue through mediation. The parties had until November 29, 2008 to complete the mediation, but through mutual agreement, it has been extended to March 2009.

In the event we are not successful in this proceeding, our Pennsylvania CLEC’s operations could suffer material harm—both because of the refund sought by Verizon and because of the prospective decreases in access revenues resulting from the change in the CLEC’s intrastate access rates, which would apply to all carriers on a non-discriminatory basis. Preliminarily estimates suggest that the decrease in our annual revenues would be approximately $1.2 million on a static basis (keeping access minutes of use constant) if Verizon prevails completely. In addition, other interexchange carriers could file similar claims for refunds. As of December 31, 2008, we have reserved $3.2 million in other liabilities on the balance sheet relating to this complaint.

Legislative or regulatory changes could reduce or eliminate the government subsidies we receive.

The federal and state systems of subsidies, which constitute a significant portion of our revenues, may be modified. During the last two years, the FCC has modified the federal universal service fund system to change the sources of support and the method for determining the level of support that will be distributed. The FCC is considering proposals for additional changes to the federal universal service fund. These issues may become the subject of legislative amendments to the Telecommunications Act.

If our rural telephone companies do not continue to receive federal and state subsidies, or if these subsidies are reduced, these subsidiaries likely will have lower revenues and may not be able to operate as profitably as they have in the past.

Proposed access and universal service reforms could have an adverse impact on our revenues.

The FCC was required to address the ISP remand order by November 5, 2008, to the U.S. Court of Appeals. In conjunction with the requirement, then-FCC Chairman Martin proposed to incorporate comprehensive intercarrier compensation and universal service reform. The FCC circulated an order internally and was scheduled to vote on it at the November 4, 2008, open meeting, but the vote was cancelled. Any comprehensive reform could have an adverse impact on our network access revenue.

The high costs of regulatory compliance could make it more difficult for us to enter new markets, make acquisitions, or change our prices.

Regulatory compliance is a significant expense for us and diverts the time and effort of management and our officers away from running the business. In addition, because regulations differ from state to state, it would be expensive to introduce services in states where we do not currently operate and understand the regulatory requirements. Compliance costs and information barriers could make it difficult and time-consuming to enter new markets or to evaluate and compete for new opportunities to acquire local access lines or businesses as they arise.

Our intrastate services generally are subject to certification, tariff filing, and other ongoing state regulatory requirements. Challenges to our tariffs by regulators or third parties, or delays in obtaining certifications and regulatory approvals, could cause us to incur substantial legal and administrative expenses. Moreover, successful challenges could adversely affect the rates that we are able to charge to customers, which would negatively affect our revenues. Some states also require advance regulatory approval of mergers, acquisitions, transfers of control, stock issuance, and certain types of debt financing, which can increase our costs and delay strategic transactions.

Legislative and regulatory changes in the telecommunications industry could raise our costs and reduce potential revenues.

Currently, there is only a small body of law and regulation applicable to access to, or commerce on, the Internet. As the Internet becomes more significant, governments at all levels may adopt new rules and regulations or find new ways to apply existing laws and regulations. The FCC currently is reviewing the appropriate regulatory framework governing broadband consumer protections for high speed Internet access through telephone and cable providers’ communications networks. The outcome of these proceedings may affect our regulatory obligations and costs and competition for our services, which could have a material adverse effect on our revenues.

We are subject to extensive laws and regulations relating to the protection of the environment, natural resources, and worker health and safety.

Our operations and properties are subject to federal, state, and local laws and regulations relating to protection of the environment, natural resources, and worker health and safety, including laws and regulations governing and creating liability in connection with the management, storage, and disposal of hazardous materials, asbestos, and petroleum products. We also are subject to laws and regulations governing air emissions from our fleets of vehicles. As a result, we face several risks, including:

•

Hazardous materials may have been released at properties we currently own or formerly owned (perhaps through our predecessors). Under certain environmental laws, we could be held liable, without regard to fault, for the costs of investigating and remediating any actual or threatened contamination at these properties, and for contamination associated with disposal by us or our predecessors of hazardous materials at third-party disposal sites.

•

We could incur substantial costs in the future if we acquire businesses or properties subject to environmental requirements or affected by environmental contamination. In particular, environmental laws regulating wetlands, endangered species, and other land use and natural resource issues may increase costs associated with future business or expansion opportunities or delay, alter, or interfere with such plans.

•

The presence of contamination can adversely affect the value of our properties and make it difficult to sell any affected property or to use it as collateral.

•

We could be held responsible for third-party property damage claims, personal injury claims, or natural resource damage claims relating to contamination found at any of our current or past properties.

The cost of complying with environmental requirements could be significant. Similarly, the adoption of new environmental laws or regulations or changes in existing laws or regulations or their interpretations could result in significant compliance costs or unanticipated environmental liabilities.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Our headquarters and most of the administrative offices for our Telephone Operations are located in Mattoon, Illinois.

We lease properties pursuant to agreements that expire at various times between 2009 and 2015. The following chart summarizes the principal facilities owned or leased by us as of December 31, 2008.

								Approximate
Location		Primary Use		Owned/Leased		Operating Segment		Square Feet
Gibsonia, PA		Office and Switching		Owned		Telephone & Other			111,931
Conroe, TX		Regional Office		Owned		Telephone & Other			51,900
Mattoon, IL		Order Fullfillment		Leased		Other Operations			50,000
Mattoon, IL		Corporate Headquarters		Leased		Telephone & Other			49,100
Mattoon, IL		Operator Services and Operations		Owned		Telephone & Other			36,300
Charleston, IL		Communications Center and Office		Leased		Telephone & Other			34,000
Mattoon, IL		Operations and Distribution Center		Leased		Telephone & Other			30,900
Mattoon, IL		Sales and Administration Office		Leased		Telephone & Other			30,700
Lufkin, TX		Office and Switching		Owned		Telephone & Other			28,707
Conroe, TX		Warehouse and Plant		Owned		Telephone & Other			28,500
Terre Haute, IN		Communications Center and Office		Leased		Telephone & Other			25,450
Lufkin, TX		Communications Center and Office		Owned		Telephone & Other			23,190
Katy, TX		Warehouse and Office		Owned		Telephone & Other			19,716
Butler, PA		Office and Switching		Owned		Telephone & Other			18,564
Taylorville, IL		Office and Communications Center		Owned		Telephone & Other			15,900
Taylorville, IL		Operations and Distribution Center		Leased		Telephone & Other			14,700
Lufkin, TX		Warehouse		Owned		Telephone & Other			14,200
Cranberry Twp, PA		Office and Switching		Owned		Telephone & Other			13,110
Charleston, IL		Office and Communications Center		Owned		Telephone & Other			12,661
Litchfield, IL		Office and Switching		Owned		Telephone & Other			12,190
Lufkin, TX		Office and Data Center		Owned		Telephone & Other			11,900
Conroe, TX		Office		Owned		Telephone & Other			10,650
Mattoon, IL		Office		Owned		Telephone & Other			10,100

In addition to the facilities listed above, we own or have the right to use approximately 713 additional properties consisting of equipment at point of presence sites, central offices, remote switching sites and buildings, tower sites, small offices, storage sites and parking lots. Some of the facilities listed above also serve as central office locations.

Item 3. Legal Proceedings

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

On October 23, 2006, Verizon Pennsylvania, Inc. and several of its affiliates filed a formal complaint with the PAPUC claiming that our Pennsylvania CLEC’s intrastate switched access rates violate Pennsylvania law. The provision that Verizon cites in its complaint requires CLEC rates to be no higher than the corresponding incumbent’s rates unless the CLEC can demonstrate that higher access rates are “cost justified.” As of December 31, 2008, we have reserved $3.2 million in other liabilities on the balance sheet relating to this complaint. For further discussion, please see the discussion of Regulatory Risks included in Part I—Item 1A—“Risk Factors.”

In addition, we currently are, and from time to time may be, subject to claims arising in the ordinary course of business. We are not currently subject to any claims that we believe could reasonably be expected to have a material adverse effect on our results of operations or financial condition.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of 2008.

PART II

Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Our common stock is quoted on the NASDAQ Global Select Market under the symbol “CNSL.” As of March 2, 2009, we had 1,575 stockholders of record. Because many of our outstanding shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. Dividends declared and the low and high reported sales prices per share of our common stock are set forth in the following table for the periods indicated:

										Dividends
Quarter Ended		Low				High				Declared
March 31, 2007		$	18.71			$	23.00			$	0.39
June 30, 2007		$	19.30			$	23.71			$	0.39
September 30, 2007		$	15.72			$	23.11			$	0.39
December 31, 2007		$	15.50			$	21.45			$	0.39
March 31, 2008		$	14.00			$	19.19			$	0.39
June 30, 2008		$	13.70			$	15.71			$	0.39
September 30, 2008		$	13.48			$	15.74			$	0.39
December 31, 2008		$	7.82			$	14.65			$	0.39

Dividend Policy and Restrictions

Our board of directors has adopted a dividend policy that reflects its judgment that our stockholders are better served if we distribute a substantial portion of the cash generated by our business in excess of our expected cash needs rather than retaining the cash or using it for investments, acquisitions, or other purposes. We expect to continue to pay quarterly dividends at an annual rate of $1.5495 per share during 2009, but only if and to the extent declared by our board of directors and subject to various restrictions on our ability to do so. Dividends on our common stock are not cumulative.

Please see Part I — Item 1A — “Risk Factors” of this report, which sets forth several factors that could prevent stockholders from receiving dividends in the future. The “Risk Factors” section also discusses how our dividend policy could inhibit future growth and acquisitions.

We expect to fund our expected cash needs, including dividends, with cash flow from operations. We also expect to have sufficient availability under our revolving credit facility for these purposes, but we do not intend to borrow to pay dividends.

Issuer Purchases of Common Stock During the Quarter Ended December 31, 2008

During the year ended December 31, 2008, we acquired and cancelled 23,646 common shares surrendered to pay taxes in connection with employee vesting of restricted common shares issued under our stock-based compensation plan. Further detail of the acquired shares follows:

Total number of

Maximum number

shares purchased

of shares that may

Total number of

Average price paid

as part of publically

yet be purchased

Purchase period

shares purchased

per share

announced plans

under the plans

February 20, 2008

535

$

14.46

Not applicable

Not applicable

October 13, 2008

2,646

$

11.55

Not applicable

Not applicable

November 10, 2008

1,622

$

11.05

Not applicable

Not applicable

December 5, 2008

18,843

$

10.61

Not applicable

Not applicable

Item 6. Selected Financial Data

The selected financial information set forth below have been derived from the audited consolidated financial statements of the Company as of and for the years ended December 31, 2008, 2007, 2006, 2005, and 2004. The following selected historical financial information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8 “Financial Statements and Supplementary Data.”

		Consolidated Communications Holdings, Inc.
		Year Ended December 31,
		2008				2007				2006				2005				2004
		(dollars in millions except per share amounts)
Consolidated Statement of Operations Data:
Telephone operations revenues		$	378.0			$	286.8			$	280.4			$	282.3			$	230.4
Other operations revenues			40.4				42.4				40.4				39.1				39.2
Total operating revenues			418.4				329.2				320.8				321.4				269.6
Cost of services and products (exclusive of depreciation and amortization shown separately below)			143.5				107.3				98.1				101.1				80.6
Selling, general and administrative			108.8				89.6				94.7				98.8				87.9
Intangible assets impairment			6.1				—				11.3				—				11.6
Depreciation and amortization			91.7				65.7				67.4				67.4				54.5
Income from operations			68.3				66.6				49.3				54.1				35.0
Interest expense, net (1)			(66.3	)			(46.5	)			(42.9	)			(53.4	)			(39.6	)
Other, net (2)			9.9				(4.0	)			7.3				5.7				3.7
Income (loss) before income taxes and extraordinary item			11.9				16.1				13.7				6.4				(0.9	)
Income tax expense			(6.6	)			(4.7	)			(0.4	)			(10.9	)			(0.2	)
Income before extraordinary item			5.3				11.4				13.3				(4.5	)			(1.1	)
Extraordinary item, net of tax			7.2				—				—				—				—
Net income (loss)			12.5				11.4				13.3				(4.5	)			(1.1	)
Dividends on redeemable preferred shares			—				—				—				(10.2	)			(15.0	)
Net income (loss) applicable to common shares		$	12.5			$	11.4			$	13.3			$	(14.7	)		$	(16.1	)
Net income (loss) per common share:
Basic:
Income (loss) before extraordinary item		$	0.18			$	0.44			$	0.48			$	(0.83	)		$	(1.79	)
Extraordinary item			0.25				—				—				—				—
Net income (loss)		$	0.43			$	0.44			$	0.48			$	(0.83	)		$	(1.79	)
Diluted:
Income (loss) before extraordinary item		$	0.18			$	0.44			$	0.48			$	(0.83	)		$	(1.79	)
Extraordinary item			0.24				—				—				—				—
Net income (loss)		$	0.42			$	0.44			$	0.48			$	(0.83	)		$	(1.79	)
Consolidated Cash Flow Data:
Cash flows from operating activities		$	92.4			$	82.1			$	84.6			$	79.3			$	79.8
Cash flows used in investing activities			(48.0	)			(305.3	)			(26.7	)			(31.1	)			(554.1	)
Cash flows from (used in) financing activities			(63.3	)			230.9				(62.7	)			(68.9	)			516.3
Capital expenditures			48.0				33.5				33.4				31.1				30.0
Dividends declared per common share		$	1.55			$	1.55			$	1.55			$	0.80			$	—
Consolidated Balance Sheet Data:
Cash and cash equivalents		$	15.5			$	34.3			$	26.7			$	31.4			$	52.1
Total current assets			78.6				99.6				74.2				79.0				98.9
Net plant, property and equipment (3)			400.3				411.6				314.4				335.1				360.8
Total assets			1,241.6				1,304.6				889.6				946.0				1,006.1
Total long-term debt (including current portion) (4) (5)			881.3				892.6				594.0				555.0				629.4
Redeemable preferred shares			—				—				—				—				205.5
Stockholders’ equity/members’ deficit/parent company investment			70.1				155.4				115.0				199.2				(18.8	)
Other Financial Data (unaudited):
Consolidated EBITDA (6)		$	189.8			$	143.8			$	139.8			$	136.8			$	115.8

		Consolidated Communications Holdings, Inc.
		Year Ended December 31,
		2008				2007				2006				2005				2004
		(unaudited)
Other Data (as of end of period) (7):
Local access lines in service:
Residential			162,067				183,070				155,354				162,231				168,778
Business			102,256				103,116				78,335				79,793				86,430
Total local access lines			264,323				286,186				233,689				242,024				255,208
CLEC access line equivalents			74,687				70,063				—				—				—
Digital telephone subscribers			6,510				2,494				—				—				—
IPTV subscribers			16,666				12,241				6,954				2,146				101
ILEC DSL subscribers			91,817				81,337				52,732				39,192				27,445
Total connections			454,003				452,321				293,375				283,362				282,754

Consolidated EBITDA is defined in our current credit facility as:

Consolidated Net Income (also defined in our credit facility),

(a) plus the following, to the extent deducted in arriving at Consolidated Net Income:

(i) interest expense, amortization, or write-off of debt discount and non-cash expense incurred in connection with equity compensation plans;

(ii) provision for income taxes;

(iii) depreciation and amortization;

(iv) non-cash charges for asset impairment; all charges, expenses, and other extraordinary, non-recurring, and unusual integration costs or losses related to the acquisition of North Pittsburgh, including all severance payments in connection with the acquisition, so long as such costs or losses are incurred prior to December 31, 2009, and do not exceed $12.0 million in the aggregate;

(v) all non-recurring transaction fees, charges, and other amounts related to the acquisition of North Pittsburgh (excluding all amounts otherwise included in accordance with U.S. generally accepted accounting principles (“GAAP”) in determining Consolidated EBITDA), so long as such fees, charges, and other amounts do not exceed $18 million in the aggregate;

(b) minus (in the case of gains) or plus (in the case of losses) gain or loss on sale of assets;

(c) minus (in the case of gains) or plus (in the case of losses) non-cash income or charges relating to foreign currency gains or losses;

(d) plus (in the case of losses) or minus (in the case of income) non-cash minority interest income or loss;

(e) plus (in the case of items deducted in arriving at Consolidated Net Income) or minus (in the case of items added in arriving at Consolidated Net Income) non-cash charges resulting from changes in accounting principles;

(f) plus extraordinary losses and minus extraordinary gains as defined by GAAP;

(g) plus (in the case of any period ending on December 31, 2007, and any period ending during the seven immediately succeeding fiscal quarters of the Company, to the extent not otherwise included in Consolidated EBITDA) cost savings to be realized by the Company and its subsidiaries in connection with the acquisition of North Pittsburgh that are attributable to the integration of the Company’s operations and businesses in Illinois and Texas with the acquired Pennsylvania operations, which cost savings are deemed to be the amounts set forth on a schedule to the credit agreement for each such fiscal quarter; and

(h) minus interest income.

If our Consolidated EBITDA were to decline below certain levels, there may be violations of covenants in our credit facilities that are based on this measure, including our total net leverage and interest coverage ratios covenants. The consequences could include a default or mandatory prepayment or a prohibition on dividends.

We believe that net cash provided by operating activities is the most directly comparable financial measure to Consolidated EBITDA under GAAP. Consolidated EBITDA should not be considered in isolation or as a substitute for consolidated statement of operations and cash flows data prepared in accordance with GAAP. Consolidated EBITDA is not a complete measure of profitability because it does not include costs and expenses identified above. Nor is Consolidated EBITDA a complete net cash flow measure because it does not include reductions for cash payments for an entity’s obligation to service its debt, fund its working capital, make capital expenditures, make acquisitions, or pay its income taxes and dividends.

The following table sets forth a reconciliation of Cash Provided by Operating Activities to Consolidated EBITDA:

		CCI Holdings
		Year Ended December 31,
		2008				2007				2006				2005				2004
		(dollars in millions)
		(unaudited)
EBITDA:
Net cash provided by operating activities		$	92.4			$	82.1			$	84.6			$	79.3			$	79.8
Adjustments:
Compensation from restricted share plan			(1.9	)			(4.0	)			(2.5	)			(8.6	)			—
Other adjustments, net (a)			3.8				(9.5	)			(2.0	)			(18.0	)			(22.0	)
Changes in operating assets and liabilities			9.9				8.5				0.6				10.2				(4.4	)
Interest expense, net			66.3				46.5				42.9				53.4				39.6
Income taxes			6.6				4.7				0.4				10.9				0.2
EBITDA (b)			177.1				128.3				124.0				127.2				93.2
Adjustments to EBITDA (c):
Intergration, restructuring and Sarbanes-Oxley (d)			4.8				1.2				3.7				7.4				7.0
Professional service fees (e)			—				—				—				2.9				4.1
Other, net (f)			(19.9	)			(6.6	)			(7.1	)			(3.0	)			(3.7	)
Investment distributions (g)			17.8				6.6				5.5				1.6				3.6
Pension curtailment gain (h)			—				—				—				(7.9	)			—
Loss on extinghishment of debt (i)			9.2				10.3				—				—				—
Intangible assets impairment (a)			6.1				—				11.2				—				11.6
Extraordinary item (j)			(7.2	)			—				—				—				—
Non-cash compensation (k)			1.9				4.0				2.5				8.6				—
Consolidated EBITDA		$	189.8			$	143.8			$	139.8			$	136.8			$	115.8

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) of Consolidated Communications Holdings, Inc. and its subsidiaries should be read in conjunction with our historical financial statements and related notes contained elsewhere in this Report.

Overview

We are an established rural local exchange company that provides communications services to residential and business customers in Illinois, Texas, and Pennsylvania. Our main sources of revenues are our local telephone businesses, which offer an array of services, including local dial tone; digital telephone service, custom calling features; private line services; long distance; dial-up Internet access; high-speed Internet access, which we refer to as Digital Subscriber Line or DSL; inside wiring service and maintenance; carrier access; billing and collection services; telephone directory publishing; wholesale transport services on a fiber optic network in Texas; and Internet Protocol digital video service, which we refer to as IPTV. We also operate a number of complementary businesses that offer telephone services to county jails and state prisons, operator services, equipment sales, telemarketing, and order fulfillment services.

Share repurchase

On July 28, 2006, we completed the repurchase of 3,782,379, or 12.7%, of the outstanding shares from Providence Equity for $56.7 million, or $15.00 per share. The repurchase was funded with $17.7 million of cash on hand and $39.0 million of new borrowings under our previous credit facility. The effect of the transaction was an annual increase of $3.0 million of cash flow due to:

•

a reduction in our annual dividend obligation of $5.9 million;

•

an increase in our after tax net cash interest of $2.9 million due to the increased borrowings incurred and increase in the interest rate on our credit facility of 25 basis points and a decrease in interest income resulting from reduced cash on hand.

Acquisition of North Pittsburgh and new credit facility

On December 31, 2007, the Company completed its acquisition of North Pittsburgh Systems, Inc (“North Pittsburgh”). At the effective time of the merger, 80% of the shares of North Pittsburgh common stock converted into the right to receive $25.00 in cash, without interest, per share, for an approximate total of $300.1 million. Each of the remaining shares of North Pittsburgh common stock converted into the right to receive 1.1061947 shares of common stock of the Company, or an approximate total of 3.32 million shares. The total purchase price, including fees, was $347.0 million, net of cash acquired.

In connection with the acquisition, the Company, through its wholly-owned subsidiaries, entered into a credit agreement with various financial institutions. The credit agreement provides for aggregate borrowings of $950.0 million, consisting of a $760.0 million term loan facility, a $50.0 million revolving credit facility (which remains fully available as of December 31, 2008), and a $140.0 million delayed draw term loan facility. The Company borrowed $120.0 million under the delayed draw term loan facility on April 1, 2008, to redeem the outstanding senior notes. The commitment for the remaining $20 million under the delayed draw facility expired. Other borrowings under the credit facility were used to retire the Company’s previous $464.0 million credit facility and to fund the acquisition of North Pittsburgh.

Redemption of senior notes

On April 1, 2008, the Company redeemed all of the outstanding 9.75% senior notes using $120.0 million borrowed under the delayed draw term loan and cash on hand. The total amount of the redemption was $136.3 million, including a redemption premium of 4.875%, or $6.3 million. We recognized a $9.2 million loss on the redemption of the notes. As a result of the transaction, we expect to realize $4.0 million reduction in annualized cash interest expense.

Discontinuance of the application of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation”

Historically, our Illinois and Texas ILEC operations followed the accounting for regulated enterprises prescribed by Statement of Financial Accounting Standards No. 71 “Accounting for the Effects of Certain Types of Regulation” (“SFAS No. 71”). This accounting recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Recent changes to our operations, however, have impacted the dynamics of the Company’s business environment and caused us to evaluate the applicability of SFAS No. 71. In the last half of 2008, we experienced a significant increase in competition in our Illinois and Texas markets as, primarily, our traditional cable competitors started offering voice services. Also, effective July 1, 2008, we made an election to transition from rate of return to price cap regulation at the interstate level for our Illinois and Texas operations. The conversion to price caps gives us greater pricing flexibility, especially in the increasingly competitive special access segment and in launching new products. Additionally, in response to customer demand we have also launched our own VOIP product offering as an alternative to our traditional wireline services. While there has been no material changes in our bundling strategy and or in our end-user pricing, our pricing structure is transitioning from being based on the recovery of costs to a pricing structure based on market conditions.

Based on the factors impacting our operations, we determined in the fourth quarter 2008, that the application of SFAS No. 71 for reporting our financial results is no longer appropriate. SFAS No. 101, “Regulated Enterprises — Accounting for the Discontinuance of Application of FASB Statement No. 71,” specifies the accounting required when an enterprise ceases to meet the criteria for application of SFAS No. 71. SFAS No. 101 requires the elimination of the effects of any actions of regulators that have been recognized as assets and liabilities in accordance with SFAS No. 71 but would not have been recognized as assets and liabilities by nonregulated enterprises. Depreciation rates of certain assets established by regulatory authorities for the Company’s telephone operations subject to SFAS No. 71 have historically included a systematic charge for removal costs in excess of the related estimated salvage value on those assets, resulting in a net over depreciation of those assets over their useful lives. Costs of removal were then appropriately applied against this reserve. Upon discontinuance of SFAS No. 71, we reversed the impact of recognizing removal costs in excess of the related estimated salvage value, which resulted in recording a non-cash extraordinary gain of $7.2 million, net of taxes of $4.2 million.

Factors affecting results of operations

Revenues

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

Local access lines and bundled services. An “access line” is the telephone line connecting a home or business to the public switched telephone network. The number of local access lines in service directly affects the monthly recurring revenue we generate from end users, the amount of traffic on our network, the access charges we receive from other carriers, the federal and state subsidies we receive, and most other revenue streams. We had 264,323 local access lines in service as of December 31, 2008, compared to 286,186 at the end of 2007. We had 233,689 local access lines in service at the end of 2006, prior to our acquisition of North Pittsburgh.

Many rural telephone companies have experienced a loss of local access lines due to challenging economic conditions and increased competition from wireless providers, competitive local exchange carriers and, in some cases, cable television operators. We have not been immune to these conditions. Both Suddenlink and Comcast, cable competitors in Texas, as well as NewWave Communications in Illinois, launched a competing voice product this year, which caused a spike in our line loss. We estimate that cable companies are now offering voice service to all of their addressable customers, covering 85% of our entire service territory.

We also lost local access lines because residential customers disconnected second telephone lines when they substituted DSL or cable modem service for dial-up Internet access, and wireless service for wired. Second lines decreased from 10,685 as of December 31, 2007, to 8,822 as of December 31, 2008. The disconnection of second lines represented 8.9% of our residential line loss in 2008, and 9.6% in 2007. In addition, since we began to more aggressively promote our digital telephone service, we estimate that approximately one-half of our digital telephone subscriber additions are switching from one of our traditional access lines. We expect to continue to experience modest erosion in access lines both due to market forces and through our own cannibalization.

We have mitigated the decline in local access lines with increased average revenue per access line by focusing on the following:

•

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

•

bundling value-adding services, such as DSL or IPTV, with a combination of local service and custom calling features;

	•		maintaining excellent customer service standards; and
	•		keeping a strong local presence in the communities we serve.

We have implemented a number of initiatives to gain new local access lines and retain existing lines by making bundled service packages more attractive (for example, by adding unlimited long distance) and by announcing special promotions, like discounted second lines. We also market our “triple play” bundle, which includes local telephone service, DSL, and IPTV. As of December 31, 2008, IPTV was available to over 142,800 homes in our markets. Our IPTV subscriber base has grown from 12,241 as of December 31, 2007, to 16,666 as of December 31, 2008. We launched IPTV in our Pennsylvania markets in April 2008.

In addition to our access line and video initiatives, we intend to continue to integrate best practices across our Illinois, Texas, and Pennsylvania regions. We also continue to look for ways to enhance current products and introduce new services to ensure that we remain competitive and continue to meet our customers’ needs. These initiatives include offering:

•

hosted digital telephone service in certain Texas and Pennsylvania markets to meet the needs of small- to medium-sized business customers that want robust function without having to purchase a traditional key or PBX phone system;

•

Digital telephone service for residential customers, which is being offered to our Texas and Illinois customers and will expand to our Pennsylvania customers in 2009 both as a growth opportunity and as an alternative to the traditional phone line for customers who are considering a switch to a cable competitor;

•

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

	•		a DSL product with speeds up to 10 Mbps for those customers desiring greater Internet speed; and
	•		High definition video service and digital video recorders in all of our IPTV markets.

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

The number of DSL subscribers we serve grew substantially in 2008. We had 91,817 DSL lines in service as of December 31, 2008, compared to 81,337 as of December 31, 2007, including 14,713 as a result of the acquisition of North Pittsburgh, and 52,732 as of December 31, 2006. Currently over 95% of our rural telephone companies’ local access lines are DSL-capable.

We also utilize service bundles, which include combinations of local service, custom calling features, and Internet access, to generate revenue and retain customers in our Illinois, Texas and Pennsylvania markets. Our service bundles totaled 42,054 at December 31, 2008, compared to 45,971 at the end of 2007 and 43,175 at the end of 2006.

The following sets forth several key metrics as of the end of the periods presented. Only the information as of December 31, 2008 and 2007 include North Pittsburgh.

		December 31,				December 31,				December 31,
		2008				2007 (1)				2006
Local access lines in service:
Residential			162,067				183,070				155,354
Business			102,256				103,116				78,335
Total local access lines			264,323				286,186				233,689
Digital telephone subscribers			6,510				2,494				—
IPTV subscribers			16,666				12,241				6,954
ILEC DSL subscribers			91,817				81,337				52,732
Broadband Connections			114,993				96,072				59,686
CLEC Access Line Equivalents (2)			74,687				70,063				—
Total connections			454,003				452,321				293,375
Long distance lines (3)			165,953				166,599				148,181
Dial-up subscribers			3,957				5,578				11,942

Expenses

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

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

•

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

•

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

•

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

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

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

Our Telephone Operations segment incurs selling, marketing, and customer care expenses from its customer service centers and commissioned sales representatives. Our customer service centers are the primary sales channels for customers with one or two phone lines, whereas commissioned sales representatives provide customized systems for larger business customers. In addition, we use customer retail centers for various communications needs, including new telephone, Internet, and IPTV purchases.

Each of our Other Operations businesses primarily uses an independent sales and marketing team comprising field sales account managers, management teams, and service representatives to execute our sales and marketing strategy.

Our operating support and back office systems enter, schedule, provision, and track customer orders; test services and interface with trouble management; and operate inventory, billing, collections, and customer care service systems for the local access lines in our operations. We have migrated most key business processes of our Illinois and Texas operations onto single company-wide systems and platforms. We hope to improve profitability by reducing individual company costs through centralizing, standardizing, and sharing best practices. We converted the North Pittsburgh accounting and payroll functions to our existing systems, and have started to integrate many other functions. Our integration and restructuring expenses were $4.8 million for the year ended December 31, 2008, $1.2 million for 2007, and $2.9 million for 2006.

Depreciation and amortization expenses. Prior to the discontinuance of the accounting prescribed by SFAS No. 71 on December 31, 2008 as noted above, we recognized depreciation expenses for our regulated telephone plant using rates and lives approved by the state regulators for regulatory reporting purposes. Upon the discontinuance of SFAS No. 71, we revised the useful lives on a prospective basis to be similar to a non-regulated entity.

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

		Years
Buildings			15-35
Network and outside plant facilities			5-30
Furniture, fixtures and equipment			5-17
Capital Leases			11

Amortization expenses are recognized primarily for our intangible assets considered to have finite useful lives on a straight-line basis. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwill and intangible assets that have indefinite useful lives are not amortized but rather are tested annually for impairment. Because trade names have been determined to have indefinite lives, they are not amortized. Customer relationships are amortized over their useful life. The net carrying value of customer lists at December 31, 2008, is being amortized at a weighted average life of approximately 6.4 years.

The following summarizes our revenues and operating expenses on a consolidated basis for the years ended December 31, 2008, 2007, and 2006:

		Year Ended December 31,
		2008								2007								2006
						% of Total								% of Total								% of Total
		$ (millions)				Revenues				$ (millions)				Revenues				$ (millions)				Revenues
Revenues
Telephone Operations
Local calling services		$	104.6				25.0	%		$	82.8				25.2	%		$	85.1				26.6	%
Network access services			94.6				22.6				70.2				21.3				68.1				21.2
Subsidies			55.2				13.2				46.0				14.0				47.6				14.8
Long distance services			24.0				5.7				14.0				4.2				15.2				4.7
Data and Internet services			62.7				15.0				38.0				11.5				30.9				9.6
Other services			36.9				8.8				35.8				10.9				33.5				10.5
Total Telephone Operations			378.0				90.3				286.8				87.1				280.4				87.4
Other Operations			40.4				9.7				42.4				12.9				40.4				12.6
Total operating revenues			418.4				100.0				329.2				100.0				320.8				100.0
Expenses
Operating expenses
Telephone Operations			213.0				50.9				153.4				46.6				152.4				47.5
Other Operations			45.4				10.9				43.5				13.2				51.7				16.1
Depreciation and amortization			91.7				21.9				65.7				20.0				67.4				21.0
Total operating expenses			350.1				83.7				262.6				79.8				271.5				84.6
Income from operations			68.3				16.3				66.6				20.2				49.3				15.4
Interest expense, net			(66.3	)			(15.8	)			(46.5	)			(14.1	)			(42.9	)			(13.4	)
Other income (expense), net			9.9				2.4				(4.0	)			(1.2	)			7.3				2.2
Income tax expense			(6.6	)			(1.6	)			(4.7	)			(1.4	)			(0.4	)			(0.1	)
Income before extraordinary item			5.3				1.3				11.4				3.5				13.3				4.1
Extraordinary item, net of tax			7.2				1.7				—				—				—				—
Net Income		$	12.5				3.0	%		$	11.4				3.5	%		$	13.3				4.1	%

Segments

In accordance with the reporting requirement of SFAS No. 131 “Disclosure about Segments of an Enterprise and Related Information”, the Company has two reportable business segments: Telephone Operations and Other Operations. The results of operations for North Pittsburgh are included in the Telephone Operations segment for the periods following the acquisition on December 31, 2007. The results of operations discussed below reflect our consolidated results.

Results of Operations

For the year ended December 31, 2008, compared to December 31, 2007

Revenues

Our revenues increased by 27.1%, or $89.2 million, to $418.4 million in 2008, from $329.2 million in 2007. We explain this change in the discussion and analysis below.

Telephone Operations Revenues

Local calling services revenues increased by 26.3% or $21.8 million, to $104.6 million in 2008 compared to $82.8 million in 2007. The increase is primarily due to $27.5 million of new local calling revenue as a result of the acquisition of North Pittsburgh. Without the effect of North Pittsburgh, local calling revenue decreased by $5.7 million, primarily due to a decline in local access lines, as discussed under “—Factors Affecting Results of Operations.”

Network access services revenues increased by 34.8%, or $24.4 million, to $94.6 million in 2008 compared to $70.2 million in 2007. The increase is primarily due to $29.5 million of new network access revenue as a result of the acquisition of North Pittsburgh. Without the effect of North Pittsburgh, network access revenue decreased by $5.1 million. In 2007 we recognized $0.7 million of non-recurring revenue from the favorable settlement of an outstanding billing claim. In 2008, the Texas Infrastructure Fund and Local Number Portability surcharges for Texas were eliminated reducing revenues approximately $1.4 million. In addition, subscriber line charge revenue decreased $1.1 million due to access line loss. As a result of declining minutes of use, our switched access revenues decreased by $3.4 million, which was partially offset by a $1.0 million increase in special access revenue.

Subsidies revenues increased by 20.0%, or $9.2 million, to $55.2 million in 2008 compared to $46.0 million in 2007. The increase is primarily due to $7.3 million of new federal and state subsidy revenue as a result of the acquisition of North Pittsburgh. Without the effect of North Pittsburgh, subsidy revenue increased by $1.9 million. In 2008, we received $1.4 million in refunds of prior period payments; however in 2007 we made payments of $2.6 million for prior periods. Exclusive of the prior period settlements, we received $28.6 million in federal universal service fund (“USF”) support and $17.9 million in Texas USF support in 2008, compared to $29.6 million in federal USF support and $19.0 million in Texas USF support in 2007.

Long distance services revenues increased by 71.4%, or $10.0 million, to $24.0 million in 2008 compared to $14.0 million in 2007. The increase is primarily due to $11.6 million of new long distance revenue as a result of the acquisition of North Pittsburgh. Without the effect of North Pittsburgh, long distance revenue decreased by $1.6 million as a result of a decline in billable minutes.

Data and Internet revenues increased by 65.0%, or $24.7 million, to $62.7 million in 2008 compared to $38.0 million in 2007. The increase is primarily due to $16.7 million of new data and Internet revenue as a result of the acquisition of North Pittsburgh. Without the effect of North Pittsburgh, data and Internet revenues increased by $8.0 million due to an increase in DSL and IPTV subscribers. These increases were partially offset by erosion of our dial-up Internet base.

Other services revenues increased by 3.1%, or $1.1 million, to $36.9 million in 2008 compared to $35.8 million in 2007. The acquisition of North Pittsburgh resulted in $2.2 million of new other services revenue. Without the effect of North Pittsburgh, other service revenues decreased by $1.1 million due to the recognition of $0.1 million of revenue from the settlement of a billing dispute in 2007 and a decrease of $1.0 million in inside wiring revenue in 2008.

Other Operations Revenues

Other Operations revenues decreased by 4.7%, or $2.0 million, to $40.4 million in 2008 compared to $42.4 million in 2007. In 2007 our telemarketing business expanded its call volume capacity. As a result of the expansion, revenue for 2008 increased by $0.9 million compared to 2007. Partially offsetting the increase was a decline of $1.1 million in our operator services business as a result of decreased call attempts, a decline of $0.7 million in business system sales, and lower revenues from our prison systems calling and mobile and paging services.

Operating Expenses

Our operating expenses increased by 33.3%, or $87.5 million, to $350.1 million in 2008 compared to $262.6 million in 2007. We explain this change in the discussion and analysis below.

Telephone Operations Operating Expenses

Operating expenses for Telephone Operations increased by 38.9%, or $59.6 million, to $213.0 million in 2008 compared to $153.4 million in 2007. The increase is primarily due to an additional $57.0 million of telephone operations operating expenses as a result of the acquisition of North Pittsburgh, as well as $1.5 million of costs incurred during the recovery from Hurricane Ike, which caused severe power outages in both Texas and Pennsylvania in 2008.

Other Operations Operating Expenses

Operating expenses for Other Operations increased by 4.4%, or $1.9 million, to $45.4 million in 2008 compared to $43.5 million in 2007. Upon completion of our annual testing, we recognized an impairment charge of $6.1 million due to a decline in the future cash flows that are projected to be generated by the telemarketing and fulfillment business. Cost of services declined by $1.8 million directly related to the decrease in revenues for the various Other Operations businesses. In addition, our operator services business experienced a $1.5 million decrease on operating expense as a result of salary and benefit reductions.

Depreciation and Amortization

Depreciation and amortization expenses increased by 39.6%, or $26.0 million, to $91.7 million in 2008 compared to $65.7 million in 2007. In connection with the acquisition of North Pittsburgh, we acquired property, plant and equipment valued at $116.3 million, which caused an increase in depreciation expense. In addition, we allocated $49.0 million of the purchase price to customer lists, which are being amortized over five years.

Non-Operating Income (Expense)

Interest Expense, Net

Interest expense, net of interest income, increased by 42.6%, or $19.8 million, to $66.3 million in 2008 compared to $46.5 million in 2007. The increase is primarily due to an increase of $296.0 million in our long-term debt as a result of the acquisition of North Pittsburgh. The increase in interest expense resulting from the acquisition was partially offset by the redemption of our senior notes. On April 1, 2008, we redeemed $130.0 million of senior notes paying 9.75% interest by using cash on hand and borrowing $120.0 million at a rate of approximately 7.0%. In addition, during the third quarter of 2008, we entered into $790.0 million of basis swaps, as described in Note 14 to the financial statements. The recognition of ineffectiveness on our interest rate swaps created a non-cash charge of $0.4 million to interest expense.

Other Income (Expense)

Other income, net increased $13.9 million, to $9.9 million in 2008 compared to ($4.0) million in 2007. $13.1 million of income was recognized from three additional cellular partnerships acquired as part of the acquisition of North Pittsburgh, as well as additional earnings from our previously held wireless partnership investments in Texas. In connection with the 2008 redemption of our senior notes, we recognized a loss on extinguishment of debt of $9.2 million, which included a redemption premium of $6.3 million and the write off of unamortized deferred financing costs of $2.9 million. During 2007, we recognized a loss on extinguishment of debt of $10.3 million related to the debt refinancing from the acquisition of North Pittsburgh.

Extraordinary Item

In the fourth quarter of 2008, we determined it was no longer appropriate to continue the application of SFAS No. 71 for certain wholly-owned subsidiaries — Illinois Consolidated Telephone Company, Consolidated Communications of Texas Company, and Consolidated Communications of Fort Bend Company.

The decision to discontinue the application of SFAS No. 71 was based on recent changes to our operations which have impacted the dynamics of the Company’s business environment. In the last half of 2008, we experienced a significant increase in competition in our Illinois and Texas markets as, primarily, our traditional cable competitors started offering voice services. Also, effective July 1, 2008, we made an election to transition from rate of return to price cap regulation at the interstate level for our Illinois and Texas operations. The conversion to price caps gives us greater pricing flexibility, especially in the increasingly competitive special access segment and in launching new products. Additionally, in response to customer demand we have also launched our own VOIP product offering as an alternative to our traditional wireline services. While there has been no material changes in our bundling strategy and or in end-user pricing, our pricing structure is transitioning from being based on the recovery of costs to a pricing structure based on market conditions. As required by the provisions of SFAS No. 101 “Regulated Enterprises — Accounting for the Discontinuation of Application of FASB No. 71”, the Company recorded a non-cash extraordinary gain of $7.2 million, net of tax of $4.2 million from the write off of asset removal costs in excess of the salvage value of regulatory fixed assets which had previously been charged to depreciation over the assets’ useful life.

Income Taxes

Provision for income taxes increased by $1.9 million to $6.6 million in 2008 compared to $4.7 million in 2007. The effective tax rate was 55.8% for 2008 and 29.0% for 2007. The effective rate for 2008 including the extraordinary gain and corresponding tax was 46.3%.

Taxes were higher during 2008 due to state income taxes owed in certain states where we were required to file on a separate legal entity basis and the rate impact of the extraordinary gain presented net of tax. In addition, Consolidated Communications Holdings, Inc. (CCHI) completed a tax free legal entity reorganization project resulting in changes to our state reporting structure. This change resulted in a net decrease in the Company’s state deferred income tax rate. This change in the state deferred income tax rate resulted in approximately $1.2 million tax benefit in 2008 due to applying a lower effective deferred income tax rate to previously recorded deferred tax liabilities. Also, during 2008 the state of Texas completed an audit of two Texas subsidiaries resulting in additional tax expense of $.8 million.

The effective tax rate during 2007 was lower than the statutory rate due to a 2007 amendment to Texas tax legislation first enacted in 2006. For us, the most significant aspect of this amendment was the revision to the temporary credit on taxable margin to convert state loss carryforwards to a state tax credit carryforward. This new legislation effectively reduced our net deferred tax liabilities and corresponding tax provision by approximately $1.7 million. Under Illinois tax law, North Pittsburgh and its directly owned subsidiaries joined Consolidated Communications Holdings, Inc. and its directly owned subsidiaries in the Illinois unitary tax group for 2008. The addition of our Pennsylvania entities to our Illinois unitary group reduced the Company’s state deferred income tax rate. When applied to previously recorded deferred tax liabilities, that reduced rate lowered income tax expense by approximately $0.9 million in 2007.

Exclusive of these adjustments, our effective tax rate would have been approximately 48.1% for the year ended December 31, 2008, compared to 45.1% for the year ended December 31, 2007.

For the year ended December 31, 2007, compared to December 31, 2006

Revenues

Our revenues increased by 2.6%, or $8.4 million, to $329.2 million in 2007, from $320.8 million in 2006. We explain this change in the discussion and analysis below.

Telephone Operations Revenues

Local calling services revenues decreased by 2.7% or $2.3 million, to $82.8 million in 2007 compared to $85.1 million in 2006. The decrease is primarily due to the decline in local access lines, as discussed under “—Factors Affecting Results of Operations.”

Network access services revenues increased by 3.1%, or $2.1 million, to $70.2 million in 2007 compared to $68.1 million in 2006. The increase was primarily driven by rate increases in Illinois and increased demand for point-to-point circuits and other network access services.

Subsidies revenues decreased by 3.4%, or $1.6 million, to $46.0 million in 2007 compared to $47.6 million in 2006, primarily because out of period settlements increased and we received less in USF support. In 2007 we refunded $2.6 million in out of period settlements compared to $1.3 million in 2006. We received $27.0 million in federal USF support and $19.0 million in Texas USF support in 2007 compared to $28.1 million in federal USF support and $19.5 million in Texas USF support in 2006.

Long distance services revenues decreased by 7.9%, or $1.2 million, to $14.0 million in 2007 compared to $15.2 million in 2006. This was driven by general industry trends and the adoption of our unlimited long distance calling plans. These plans are helpful in maintaining and attracting customers, but they also tend to reduce billable minutes since heavy users of long distance services take advantage of fixed pricing plans.

Data and Internet revenues increased by 23.0%, or $7.1 million, to $38.0 million in 2007 compared to $30.9 million in 2006. The revenue increase was due to increased DSL and IPTV penetration. The number of DSL lines in service In Illinois and Texas increased from 52,732 as of December 31, 2006, to 66,624 as of December 31, 2007. IPTV customers increased from 6,954 at December 31, 2006, to 12,241 at December 31, 2007. These increases were partially offset by erosion of our dial-up Internet base.

Other services revenues increased by 6.9%, or $2.3 million, to $35.8 million in 2007 compared to $33.5 million in 2006. The revenue increase was due to growth in our Directory and Carrier Services businesses and a full year effect of late payment fees implemented in the fourth quarter of 2006.

Other Operations Revenues

Other Operations revenues increased by 5.0%, or $2.0 million, to $42.4 million in 2007 compared to $40.4 million in 2006. Revenues from our telemarketing and order fulfillment business increased by $0.5 million due to increased sales to existing customers. Our prison systems unit generated increased revenue of $0.6 million for the period from increased minutes of use. The remaining $0.9 million increase was due to an increase in customer premise equipment sales.

Operating Expenses

Our operating expenses decreased by 3.3%, or $8.9 million, to $262.6 million in 2007 compared to $271.5 million in 2006. We explain this change in our discussion and analysis below.

Telephone Operations Operating Expenses

Operating expenses for Telephone Operations increased by 0.7%, or $1.0 million, to $153.4 million in 2007 compared to $152.4 million in 2006. In 2007 we incurred a $1.2 million reduction in severance costs compared to 2006. These decreases were partially offset by a $1.5 million increase in stock compensation expense and a $0.5 million increase in energy costs.

Other Operations Operating Expenses

Operating expenses for Other Operations decreased by 15.9%, or $8.2 million, to $43.5 million in 2007 compared to $51.7 million in 2006. In 2006, the Operator Services and Market Response businesses recognized intangible asset impairment of $10.2 million and $1.1 million, respectively. Excluding the impairment charges, operating expenses for Other Operations increased by $3.1 million. This increase primarily came from increased costs required to support the growth in our customer premise equipment sales and telemarketing revenues.

Depreciation and Amortization

Depreciation and amortization expenses decreased by 2.5%, or $1.7 million, to $65.7 million in 2007 compared to $67.4 million in 2006. In 2006, the Company recognized $11.0 million in impairment related to its Operator Services and Market Response customer lists. The reduced carrying value of the customer lists resulted in decreased amortization expense in 2007.

Non-Operating Income (Expense)

Interest Expense, Net

Interest expense, net of interest income, increased by 8.4%, or $3.6 million, to $46.5 million in 2007 compared to $42.9 million in 2006. The increase is primarily due to the higher average level of outstanding debt in 2007 because we borrowed an additional $39.0 million in July 2006 to complete the share repurchase.

Other Income (Expense)

Other income, net decreased $11.3 million, to ($4.0) million in 2007 compared to $7.3 million in 2006. During 2007, we recognized a loss on extinguishment of debt of $10.3 million related to the debt refinancing from the acquisition of North Pittsburgh. In addition, we recognized $7.0 million of investment income in 2007, compared to $7.7 million in 2006. Investment income was lower because of lower equity earnings from our cellular partnership investments.

Income Taxes

Provision for income taxes increased by $4.3 million to $4.7 million in 2007 compared to $0.4 million in 2006. The effective tax rate was 29.0% for 2007 and 3.0% for 2006.

The effective tax rate during 2007 primarily resulted from a 2007 amendment to Texas tax legislation first enacted during 2006. The most significant impact of this amendment for us was the revision to the temporary credit on taxable margin converting state loss carryforwards to a state tax credit carryforward. This new legislation resulted in a reduction of our net deferred tax liabilities and corresponding credit to our tax provision of approximately $1.7 million. In addition, under Illinois tax law, North Pittsburgh and its directly owned subsidiaries joined Consolidated Communications Holdings, Inc. and its directly owned subsidiaries in the Illinois unitary tax group for 2008. The addition of our Pennsylvania entities to our Illinois unitary group changed the Company’s state deferred income tax rate. This change in the state deferred income tax rate resulted in a reduction in income tax expense of approximately $0.9 million in 2007 because the lower effective deferred income tax rate was applied to previously recorded deferred tax liabilities.

The low effective tax rate during 2006 resulted primarily from a change in Texas tax legislation enacted in 2006. The most significant impact of the new legislation for us was the modification of our Texas franchise tax calculation to a new “margin tax” calculation used to derive taxable income. This new legislation reduced our net deferred tax liabilities and corresponding credit to our state tax provision of approximately $6.0 million.

Critical Accounting Policies and Use of Estimates

This section discusses the accounting estimates and assumptions that we consider to be the most critical to an understanding of our financial statements because they inherently involve significant judgments and uncertainties. In making the necessary estimates, we considered various assumptions and factors based on our best estimates and all information available to us; however, such assumptions and factors may prove to have been inaccurate, which could have a material impact on our financial condition, results of operations, or cash flows. These assumptions will be analyzed in future periods and adjusted if necessary. We believe that of our significant accounting policies, the following involve the most judgment and complexity.

Derivatives

We regularly use derivative contracts designated as cash flow hedges to convert a portion of our anticipated future floating interest rate cash flows associated with our credit facility to a fixed rate. The change in the market value of such derivative contracts has historically been, and is expected to continue to be, highly effective at offsetting changes in interest rate movements of the hedged item. Gains and losses arising from the change in fair value of the hedging transactions are deferred in other comprehensive income, net of applicable income taxes, and recognized as a component of interest expense in the period in which the hedged item affects earnings. If it is determined that the derivative instruments used are no longer effective at offsetting changes in the price of the hedged item, then the changes in the market value of these instruments would be recorded in the statement of earnings as a component of interest expense.

Fair Value Measurements

Our derivative instruments related to interest rate swap agreements are required to be measured at fair value. The fair values of the interest rate swaps are determined using an internal valuation model which relies on the expected LIBOR based yield curve and estimates of counterparty and the Company’s non performance risk as the most significant inputs.

We evaluate the quality and reliability of the assumptions and data used to measure fair value in the three hierarchy levels, Level 1, 2 and 3, as prescribed by SFAS No. 157 (see note 15 for additional information). Certain material inputs to the interest rate swap valuations are not directly observable and cannot be corroborated by observable market data. We have categorized these interest rate derivatives as Level 3.

We evaluate our risk of non-performance based on risk premiums being assigned to companies of similar size and with similar credit ratings. Counterparty non-performance risk is assigned based on observable market data. The application of non-performance risk to our determination of the value of our derivatives resulted in a reduction of the reported liability of our derivative instruments of $7.1 million for the period ending December 31, 2008. The adjustment for non-performance risk is recorded in other comprehensive income, net of taxes.

The Company’s net liabilities measured at fair value on a recurring basis subject to disclosure requirements of SFAS No. 157 at December 31, 2008 were as follows:

Fair Value Measurements at Reporting Date Using

Quoted Prices

Significant

in Active

Other

Significant

Markets for

Observable

Unobservable

Identical Assets

Inputs

Inputs

Description

December 31, 2008

(Level 1)

(Level 2)

(Level 3)

Interest Rate Derivatives

$

47,908

$

47,908

The following table presents the Company’s net liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as defined in SFAS No. 157 at December 31, 2008:

		Fair Value
		Measurements
		Using Significant
		Unobservable
		Inputs (Level 3)
		Interest Rate
		Derivatives
Balance at December 31, 2007		$	12,769
Settlements			(10,412	)
Total gains or losses (realized/unrealized)
Unrealized loss included in earnings			395
Unrealized loss included in other comprehensive income			45,156
Balance at December 31, 2008		$	47,908
The amount of total loss for the period included in earnings for the period as a component of interest expense		$	395