Iowa Telecommunications Services Inc. q3 2008 Earnings Call Transcript

Nov.20.08 | About: Iowa Telecommunications (IWA)

Iowa Telecommunications Services Inc. (IWA) Q3 2008 Earnings Call November 5, 2008 9:00 AM ET

Executives

Alan L. Wells - Chairman and Chief Executive Officer

Craig Knock - Vice President, Chief Financial Officer and Treasurer

Kevin Inda - Investor Relations

Analysts

Chris King - Stifel Nicolaus

Patrick Rand - Barclays Capital

Jason Fraser - Raymond James

David Coleman - RBC Capital Markets

Operator

Good day and welcome to the Iowa Telecom third quarter conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. Kevin Inda. Please go ahead, sir.

Kevin Inda

Thank you, Joseph and welcome to this Iowa Telecom conference call to review the Company's result for the third quarter which ended September 30th which were released this morning. During today's call, we will refer to certain non-GAAP financial measures and we have reconciled these measures to GAAP figures in our earnings release, which is available on our web site at iowatelecom.com. Conducting the call today will be Alan Wells, Chairman and Chief Executive Officer and Craig Knock, Vice President, Chief Financial Officer, and Treasurer.

Before we start, let me offer the cautionary note that this call contains forward-looking statements that are not based on historical facts including, without limitations, statements containing the words believes, make, plans, will, estimate, continue anticipates, intends, expects, and similar expressions. Such forward-looking statements involve known and unknown risks and uncertainties, and other factors that may cause actual results, events or developments to be materially different from future results, events or developments described in the forward-looking statements. Such factors include those risks described in Iowa Telecom's Form 10-K on file with the SEC.

These factors should be considered carefully and listeners are cautioned not to place undue reliance on such forward-looking statements. All information is current as of the date of this conference call and Iowa Telecom undertakes no duty to update this information.

With that stated, I will turn the call over to Alan Wells.

Alan Wells

Thank you, Kevin, good morning. We are glad you joined us this morning as we review our results for the third quarter. I would like to take a few minutes to focus on our operational and financial highlights, and update you on several events which occurred during the quarter. Craig Knock, our CFO, will then review the financial results in more detail and we will then take your questions.

Overall, we are very pleased with the results for the third quarter which in partly reflect our acquisition of Bishop Communications on July 18. During the quarter, we began the process of integrating the Bishop operation and we believe that Bishop properties will enhance our financial performance going forward. Even more importantly, we believe that Bishop acquisition will illustrate the benefits of our strategy of growing our business through acquisition.

Before we review the highlights for the quarter, let me quickly comment on the current economic issues and the impacts that happened in our markets. While the current credit and mortgage crisis is having a significant impact across much of the US, we believe that rural nature of our telecommunications business insulates us somewhat from the major effects of these challenges. As many of you know, agriculture is one of the largest industries in Iowa, and thus far we continue to believe this industry remains relatively stable. It is harvest season in Iowa and foreign related operations in our area seem to be doing business as usual regardless of the turmoil of the financial markets. While our Company has some limited exposures to Lehman's demise as a result of an interest rates swap, as Craig will describe in more detail, we were able limit that exposure with diminimus financial impact. All in all, while we are experiencing some impacts due to the current economic conditions, we do not feel our rural markets are nearly as heavily impacted as many other areas throughout our nation.

Our financial results for the quarter include the Bishop operation’s result for slightly over two months. For the quarter, total revenue was $62.9 million, operating income for the quarter was $16.8 million, our adjusted EBITDA was $31.6 million, and our net income was $5.7 million or $0.18 per diluted share. We are pleased with our financial performance and think our results reflect the stability of our operation. Our income tax expense for the quarter is $4.3 million compared with $4.5million a year ago. Craig will elaborate the income tax during his remarks but it is important to note that this income tax charge is primarily non cash in nature and thus, does not impact either our cash flow or our ability to pay dividends.

Despite this income tax charge in the income statement, our actual cash payments for income taxes during the quarter were only $199,000 reflecting the usage of both our net operating losses and our continued goodwill amortization for tax purposes. Our capital expenditures were $7.1million in the third quarter and were in line with our expectations. We continue to expect capital expenditures for the year to be similar to 2007 level that will be between $27 million and $29 million. This includes capital expenditures of Bishop as well as capital expenditures related to historic [flooding our recent] experience during the quarter or during the year. We also continue expect cash interest expense to be $29 million and $31million for the year and expect our expense to be toward the higher end of the range and as result to the additional interest costs in our debt related to the acquisition of Bishop. For the first nine months of this year, capital expenditures were $20.1 million and our cash interest expense was $22.7 million.

Overall our financial performance for the quarter was strong, reflecting a continued expansion of our DSL service, our ability to control expenses and maintain our margins and our successful Bishop acquisition.

Our quarter or quarter customer counts were also impacted by our acquisition. Inclusive of Bishop, total access lines increased by 12,500 during the quarter, as ILEC access lines increased by 7,700 lines and CLEC lines increased by 4,800 lines. Excluding the Bishop operation, total access lines for the quarter decreased by 3,700 lines, as ILEC lines decreased by 3,900 lines and CLEC lines increased by 200.

At the end of the third quarter, Bishop had 16,200 total access lines including 11,600 ILEC lines and 4,600 CLEC lines. Bishop also had 9,700 long distance subscribers, 4,900 DSL subscribers and 1,700 dialup internet subscribers. On a combined basis, we have 74,500 DSL subscribers at the end of the quarter as well as 18,500 dialup customers and 147,600 long distance customers.

Absent to Bishop acquisition, our DSL subscribers increased by 2,000 during the quarter while long distance subscribers and dialup internet subscribers decreased by 1300 and 2000 respectively,

Consistent with the past several quarters, we believe much of our ILEC line losses are attributable to both wireless substitution and cable competition in several of our markets. We see no major changes in Mediacom's offering since our last conference call and continue to believe they are focused primarily on residential customers within the city limits of our ILEC markets where they have launched service.

We continue to respond of the offerings of our competitors with our bundled DSL and video offerings which we believed are proving to be attractive, low cost alternatives for our customers.

In summary, we are very pleased with our solid performance through the first nine months of the year. Our business is well capitalized and potentially all of our terms that are fixed with attractive interest rates through 2011.

Despite the unrest in the financial markets, we maintain our financial flexibility as evidenced by our unused capacity in the line of credit. And above all, we remain committed to returning the stable income stream to our shareholders in the form of $1.62 annualized dividend.

Looking ahead, we intend to continue our focus on four areas; First, to increase free cash flow by expanding our sales with additional enhanced services such as DSL and our bundled offerings; second, we also intend to continue to expand our CPE data services to business customers; third, through our competitive local exchange services in city areas, we intend to continue the select and pursue new customers in markets which are near our existing markets; finally, we will continue to pursue acquisitions that are in line with our free cash flow focus and that clearly meet our criteria for acquisitions to be accretive to cash flow on a per share basis such as our recently closed acquisition of Bishop.

I will now turn the call over to Craig Knock to review our third quarter financial and operating results in more detail. Craig?

Craig Knock

Thank you, Alan and good morning, everyone. Since you have accessed to our full news release, let me review a certain financial highlights and then we will take you questions. As a reminder, our third quarter results for 2008 reflects the acquisition of Bishop Communications from July 18th onward.

Overall, operating revenues for the quarter were $62.9 million compared with $60.8 million from the third quarter of 2007, reflecting an increase of $2.1 million or 3.5%. Local service revenue is $359,000 or 2% for the quarter. That decrease is primarily due to the lower ILEC lines and slightly lower revenue per line.

Network access revenue is decreased $633,000 or 2.7% for the quarter. The decrease is partially due to a decrease in minutes of use and a slight reduction in an average rate per minute. Long distance revenue is increased by $660,000 or 12.7% for the quarter. The increase in revenue was due principally to the acquisition of Bishop and a higher customer connection charges partially offset by fewer long distance minutes of use per customer.

Data and Internet services increased by $1.6 million or 21% for the quarter, the increase was primarily due to growth in DSL Internet access revenue which increased $1.2 million in the Bishop acquisition this was partially offset by the decline of our dialup internet business.

Other services and sales increased by $389,000 or 14.4% for the quarter. The revenue increase was primarily due to a higher CPE sales and the Bishop acquisition. Operating income was $16.8 million for the quarter compared to $18.8 million a year ago.

Our total operating cost and expenses increased $4.1 million or 9.8% for the quarter principally as a result of the Bishop acquisition. Cost of services in sales increased $1.2 million or 6.3% primarily as the result of Bishop and was partially offset by $448,000 reduction in cost for the Iowa properties.

SG&A cost increased $1.4 million or 13.7% primarily as the result of the Bishop acquisition. Depreciation and amortization increased $1.5 million or 12% primarily due Bishop along with higher plan balances.

Other income included the net credit income of approximately $1 million related to our interest rates swap. The majority of the credit related to an interest rates swap with a counterparty that filed for bankruptcy protection which we terminated during the period, the purpose of the swap was to fix interest rates on a portion of our term loan B debt. As the result of the financial difficulties of the counterparty, our interest rates swap is no longer considered as an effective hedge for accounting purposes.

As such, the accounting rules required that we record certain portions of the change in the recorded fair value to income. It should be noted that this credit was non cash and is not included in adjusted EBITDA.

Going forward, we will be required to record additional expense of approximately $256,000 per year for each of the next three years related to the terminated swap, as the amounts previously recorded in other comprehensive income is effectively reclassified as a charge to earnings. Likewise this will be a non cash charge and will be excluded from the adjusted EBITDA calculation in accordance with the definition in our credit agreement.

Prior to quarter end, we have also entered into a new agreement to fix the rate on a $175 million of term loan B debt at the rate of 4.13% as compared to 4.115% under the prior swap agreement. As a result of the new agreement, we continue to have an interest rate protection on approximately 90% of our term debt through June 2011 and an all in rate of approximately 6.1%. Interest expense decreased $46,000 to $8 million for the quarter. This was due to a combination of lower interest rates partially offset by higher average balance over revolving line of credit.

In terms of income tax expense, we reflected $4.39 million in booked income tax expense during the quarter compared to $4.5 million last year. The recorded book tax expense did not impact the cash taxes paid during the quarter.

Again, let me remind everyone as it relates to cash income taxes, the book accounting for income tax expense does not change our outlook for paying cash income taxes as we continue to expect the overwhelming majority to be deferred.

Again, we have a very strong tax shelter position driven by our continued goodwill amortization at the rate of approximately $40 million per year through June 2015, coupled with our existing NOL of approximately $143.9 million.

Both of these items will shield us from material cash income taxes for a good number of years. However, as we previously disclosed, we may be required to pay AMT and now, Minnesota state cash taxes in the near term and as noted in the release, we paid cash income taxes of $199,000 during the third quarter. The bottom line for us this quarter was net income of $5.7 million or diluted earnings per share of $0.18 compared with $6.3 million or diluted earnings per share of $0.20 a year ago.

Our adjusted EBITDA, as defined in our credit agreement and reconciled in the press release was $31.6 million for the quarter compared with $31.9 million a year ago. Our adjusted EBITDA for the 12 months ended September 30 was $126.9 million.

I would like to take a minute now to discuss our debt and related interest expense. As of September 30, 2008, we had outstanding $490.5 million under the term facilities, $37 million drawn under our $100 million revolving credit facility, which are offset by $7.8 million of RTFC capital certificates and $7.5 million of cash.

Our net debt or adjusted total debt as defined in the credit agreement was $512.3 million at quarter end. That level of adjusted total debt correlates to a leverage ratio as defined and calculated in the credit agreement of approximately 3.9 times. Our cash interest expense as defined in the credit agreement was on track with our expectations for the quarter at $7.9 million.

For 2008 guidance, we continue to expect the cash interest expense will be between $29 million and $31 million although we expect it to be near the upper end including additional interest cost related to the Bishop acquisition.

Turning to our capital expenditures for the quarter, our capital expenditures were $7.1 million. As Alan indicated, we continue to expect that our 2008 capital expenditures will be between $27 million and $29 million, which include capital expenditures at Bishop and cost to cover additional flood restoration.

Now, I would like to summarize our cash sources and uses for the last 12 months as I demonstrate the strength of our ability to pay dividends starting with adjusted EBITDA of $126.9 million and deducting cash interest expense of $30.5 million, capital expenditures of $27.2 million, and cash income taxes of $485,000, results in the $68.7 million in cash available for dividends. At our annual dividend rate of $1.62 per share, we paid dividends of $51.7 million.

Thus, for the trailing 12 months, our payout ratio of our free cash flow was approximately 75.2%. It is also equally important to note that as of September 30, 2008, we had cumulative distributable cash or actual dividend capacity as defined in our credit agreement of approximately $86.6 million, or said another way, well over 1.5 year's dividend requirement. Overall, we are very pleased with our results for the quarter.

Joseph, we will now answer any questions. Kindly provide instructions for the Q&A. session. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Chris King - Stifel Nicolaus.

Chris King - Stifel Nicolaus

Two quick questions for, first of all I just wanted to get your take, if you have any, on the presumably somewhat lengthy delay or postponement on the inter-carrier compensation issue before the FCC which got put on hold yesterday and what you see is the future for that going forward. And secondly also I wanted to get your reaction to the CenturyTel embarked transaction and what you think that means going forward for potential M&A opportunities within the ILEC sector. Thanks.

Alan Wells

Good morning, Chris. Thanks for the question. As far as the FCC actions or maybe inaction on intercarrier comp, I think the internet industry stopped for quite sometime. There will be intercarrier comp and US [separate] form that will take place over the next several years. I think the FCC delay seems to indicate to us that the majority that there was a need to have kind of a thoughtful and open process to evaluate the impacts of the proposed orders on, not only the customers or the companies at all, but also the real customers that we all serve. So, we are encouraged by the delay and think that probably bodes well for a rational process to reformat both in intercarrier comp and USF.

As far as the Century embarked transaction, it is a one more example of a further consolidation in the industry. We think that as access lines have declined, we think consolidation makes sense for the sector and we think it is just one more step towards that which will subsequently be more as times goes by.

Operator

Your next question comes from the line of Patrick Rand - Barclays Capital.

Patrick Rand - Barclays Capital

Just a follow up on that last one in terms of consolidation, in all your previous transactions and all that have been done with the cash given where current credit markets are and the difficulty of getting a hold of cheap credits you have in the past, would you be able to deal with equity? Is that something that you guys have not done because it is your choice or the acquisitions you have done, the seller is not interested in the equity and then just on top of that, the average rate of 5.3% you are paying on your drawn revolver, can you get that amount on the remaining $17 million on that revolver? Thanks.

Alan Wells

Good morning Patrick. Thanks. I will take the first and I will let Craig talk about the revolver. As far as transaction we deal with cash I think we have flexibility to do a transaction with either cash or equity. I think we have thought of the transaction that we have done so far that given our borrowing capacity, cash transactions made the most sense for us, but I think obviously, we have the flexibility to use equity if it meets our needs and meet the seller's needs. Craig, you want to talk?

Craig Knock

Just around the revolver, again, we have roughly $37 million drawn at the end of the quarter and you are right, we have a roughly $68 million to $70 millions left on that. It is priced at LIBOR plus 200 so since LIBOR has come off even since the date we fixed that, we would be borrowing below 5% on revolvers so that is available to us and we could lock that and then swap some of that if we even wanted to.

Operator

Your first question comes from the line of Frank Louthan - Raymond James.

Jason Fraser - Raymond James

Hi, good morning. This is Jason Fraser, filling in for Frank. Just really quick just on the CLEC operation, could you just comment about how it had been turning the last a couple of weeks in terms of the sales cycles and just the customers are taking services roughly recently. Thank you.

Alan Wells

Yes, again for the quarter, we only added you know a net 200 lines in our CLEC but again I think that reflects a continued trend of us shifting away from the residential customer counts to more business, and again I do not know that we have seen the impacts within our markets that others have seen across more material areas. Again our basic customers are school districts and local governments and then smaller mom and pops insurance agents and so forth and within a smaller cross markets that we serve.

Jason Fraser - Raymond James

Great. So, I can assume again, it is not exactly an average customer but in general, ARPU for the CLEC segments that had been going up, presumably I would imagine?

Alan Wells

Yes, on a per line basis. Certainly, as we migrate to more business again, there are much stickier customer and that probably see that continued trend.

Operator

Your last question comes from the line Dave Coleman with RBC Capital Markets.

David Coleman - RBC Capital Markets

Just on the ILEC business, is it possible to breakout the ILEC access line losses that were attributable to competitive telephony replacement versus wireless replacement? And the just a quick follow up to that, any change in the competitive environment particularly for Mediacom as far as going after business customers?

Craig Knock

Relative to Mediacom's change, they have not changed anything that we are really seeing in the marketplace as to the core economics that they offer. We have modified ours a little bit, enhance in some areas and so we are feeling pretty good about that. Again as Alan said, we have remained focused on residential customers at this juncture. We understand that they have taken business on isolated occasions but we continue to compete against those on the Mediacom front. I think our bundle package with the Dish network has been received pretty well out there. Relative to breaking out the access lines, we have not done that and I have not really seen in many others in the industry do that. Again, we continue to believe that probably wireless substitution is certainly one of the larger areas of our loss. Mediacom has been out there since second quarter of 2007 and so, it is beginning to stabilize in many of those markets.

David Coleman - RBC Capital Markets

3Q, the rate of access line loss is 1.8% for the quarter? Is that a good assumption to use for subsequent quarters assuming that there have been really no change and Mediacom's marketing efforts on wireless replacements is really just an ongoing trend.

Craig Knock

Well again we do not give forecast out for access lines but historically I think that has ticked down a little bit from where it was in the prior quarter. And again, Mediacom is out there for a longer, longer time. I believe it will have a, hopefully we could bring that trend down.

David Coleman - RBC Capital Markets

And then just one last question on the M&A, any change in multiples since the Bishop acquisitions? I guess to understand why their seller expectations have come down with the overall market multiple contractions.

Alan Wells

Good morning Dave, I will take that one. As far as M&A goes, I think it is probably like the entire financial market, you will probably see that multiples have come and now, how contracted some other with the past several months. I would expect that you probably will see lower multiples on transactions in the future than what you may have seen six or twelve months ago.

David Coleman - RBC Capital Markets

That would be?

Alan Wells

I’m sorry?

David Coleman - RBC Capital Markets

Is there anyway to quantify how much multiples would have come down over the past few months?

Alan Wells

I do not think there is a scientific way to do that, but I would think if you look at the broader sector of the telecom companies and where their multiples have gone down in marketplace probably the contractions with their multiples would probably translate the multiple contraction and smaller transaction.

Operator

We have no further questions in queue. (Operator Instructions) And it would appear there are no further questions at this time.

Alan Wells

Okay, thank you Joseph, and thank you again for joining us this morning. We appreciate your time, we welcome your questions and we hope you will join us again next quarter as we discuss our quarter result. Thank you.

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