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Executives

Kevin Enda - Investor Relations

Michael Weaver - President and Chief Executive Officer

Curtis Garner - Chief Financial Officer

Analysts

Frank Louthan - Raymond James

Otelco Inc. (OTT) Q4 2012 Earnings Conference Call February 26, 2013 11:00 AM ET

Operator

Good day, ladies and gentlemen. Welcome to today’s Otelco Conference Call. Today’s call is being recorded. I would now like to turn the call over to Mr. Kevin Enda. Please go ahead, sir.

Kevin Enda - Investor Relations

Well, thank you, Margaret, and welcome to Otelco conference call to review the company’s results for the fourth quarter and year ended December 31, 2012 which we released yesterday afternoon. Conducting the call today will be Michael Weaver, President and Chief Executive Officer and Curtis Garner, Chief Financial Officer. After our formal remarks, we will take questions per our usual format.

Before we start, let me offer the cautionary note that statements made on this conference call that are not statements of historical or current fact constitute forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other unknown factors that could cause the actual results of the company to be materially different from historic results or from any future results expressed or implied by such forward-looking statements.

In addition to statements which explicitly describe such risks and uncertainties, listeners are urged to consider statements labeled with the terms believes, belief, expects, intends, anticipates, plans or similar terms to be uncertain and forward-looking. The forward-looking statements contained herein are also subject generally to other risks and uncertainties that are described from time-to-time in the company’s filings with the SEC.

With that stated, I’ll now turn the call over to Michael Weaver.

Michael Weaver - President and Chief Executive Officer

Thank you, David. Good morning and welcome to our call. Before I discuss our proposed restructuring transaction, I want to make a few observations about our fourth quarter and year end results. Fourth quarter generated EBITDA of $11.5 million, which represents our best quarterly results for the year. EBITDA for the full 12-month period was $45.2 million and we generated an EBITDA margin of 45.9%, which represents a 1.4% margin improvement from the prior year. In the fourth quarter, our cash balance increased by $5.3 million from the third quarter as we finished the year with $32.5 million in cash on hand. For the year, our access line equivalents declined by 2.4%. The decline was entirely attributable to a reduction in residential access line equivalents partially offset by modest gains in business access lines.

While we are never pleased with declining metrics, the good news is that we had positive growth in our business customers. Our fourth quarter results point out the fact that our operations remained strong and we continued to produce significant positive cash flow. As we disclosed in April of last year, our contract with Time Warner Cable for wholesale network connections expired at the end of 2012 and the transition of Time Warner customers were substantially completed by the end of January.

Staff reductions associated with the completion of the transition have been implemented and the other planned cost reductions from network and facility expenses are under way. Under the terms of the transition agreement, we will continue to provide limited services to Time Warner through June 30 of this year.

On February 1, we announced our intention to restructure our balance sheet utilizing a prepackaged Chapter 11 bankruptcy. Proposed plan if approved is filed will reduce our total debt by approximately 50% from $270 million to $135 million, amend and extend the senior credit facility through April 30, 2016 and simplify our capital structure. As we noted in our prior press release, the plan has the full support of our senior lender growth. In addition, while informal most of the feedback we have received from our IDS orders and other stakeholders has been positive. The documents describing the transactions were mailed on February 13 with stockholders of record as of February 8. The voting process is under way and votes maybe cast at anytime prior to 5 PM Eastern Time on March 15. If you hold your securities through a broker, I would encourage you to vote several days earlier to ensure that your broker receives the ballot in time to meet this deadline.

Our proposed plan will reduce debt through a combination of a cash payment of the senior lenders and conversion of the subordinated notes to equity. A little bit of detail, so your each IDS unit you now own today consist of common stock and a subordinated note, under our plan the common stock will be canceled and the subordinated debt including our deferred interest will be exchanged for new class like common stock subject to dilution by our management equity plan the existing subordinated note holders will receive approximately 92.5% of the equity of the company including 7.3% which will be distributed to the non-IDS holders of subordinating debt.

The remaining 7.5% of the equity the company will be given to the senior lenders in lieu of the cash fee for amending and extending the senior credit facility. The conversion of subordinated debt to equity will result in a reduction of $108 million in debt. We plan to further big lever by using approximately $24 million to $27 million of our cash on hand at closing to pay down our senior debt. Given that we had approximately $32.5 million in cash on the balance sheet at year end we believe we have sufficient liquidity to affect this transaction and satisfy our operating expenses.

I remain confident that the restructuring plan represents the best possible outcome for the company the holders of our IDS units and our creditors and I urge you for both years. The amended and extended debt agreement will consist of $5 million revolving line of credit and a term loan of not more than $142 million. As conditions for amending and extending the senior credit facility the lenders are requiring a reduction of total debt 7.5% of the equity of the restructured company and certain other concessions.

These concessions involve additional governance rights and specified default quotations. Under the terms of the agreement the lenders as holders of their portion of the equity in the company have the right to approve two or three of the seven board members including independence, experience and qualifications. The requirements for independence include among other things no existing relationships with Otelco, its senior management or board members. I want to be clear however that the process for electing board members has not changed all board members will continue to be elected by the shareholders of Otelco.

In the event of certain items default known as triggering event, the independent board members approved by the lenders would have super voting rights and thus voting control of the board. Triggering events are defined as either senior leverage in excess of 4.2 times EBITDA or a payment default. If a triggering event occurs, the company has an obligation to initiate and complete the sales process within 360 days including, obtaining regulatory and shareholder approval within that timeframe.

Revolver in the term loan have a maturity date of April 30, 2016 with pricing of LIBOR plus 3.5 and LIBOR floor of 3% which would result in an effective rate of 6.5% based on projected LIBOR rates.

The current lended or effective rate we take today is 7.9%, so this represents a significant reduction in future interest expense. Term loan has fixed amortization of 1.25% for quarter or 5% per year and variable amortization of 75% of the excess cash flow on a quarterly basis. As we have the support of the senior lender group we believe our plan can be approved by the bankruptcy court without other creditor approval. However, a fully conceptual bankruptcy will enable us to pay our lenders in full, on-time and result in less time and expense incurred in the process. With out a doubt, that will make company stronger. As an IDS holder the amount of equity you receive in exchange for your subordinated debt will not be affected by how you vote or whether you are able to make full payment for our trade creditors, you will receive the same amount of equity. By paying the trade creditors in full however we are ensuring the flow of business will not be interrupted and reinforcing our relationships with our vendors and suppliers.

We are encouraged by the discussions and communications with our existing IDS unit holders and believe our plan has the support of several of our larger investors. These discussions have identified a couple of common areas of concern. Now, I just want to take a minute to address couple of these arms. On telecom regulatory approval as we were developing our plan, we met with the appropriate state regulatory parties and determined that apart from standard notifications filed upon the closing of the transaction, no state approvals are required for this transaction. Process for obtaining federal approval is well documented and we do not anticipate any issues obtained in the appropriate approvals.

As far as our business outlook, we previously provided financial projections for 2013 through 2017 as these projections illustrate the effect of the restructuring transaction creates a stronger company with less debt, a lower interest rate, the ability to meet its financial obligations, and modest cash growth. The new simplified capital structure implemented by this reorganization will also provide financial flexibility, which makes us a more attractive acquisition target and provides potential upside for investors. Certainly as is the case with all companies, the key to the continuing success of the company is our ability to meet the financial projections and we are encouraged by the early results for 2013 as we experienced the 55% increase in new select business orders in January 2013 versus January of last year. Our communications with our customer buys indicate our plan is understood and well received by our loyal customers.

We have had discussions with a number of vendors and suppliers and they also understand the need for the restructuring and it have expressed their support and desire to maintain the current business relationship of the company. In fact, that our plan if approved this file will result in full payment of their pre-provision invoices is a significant factor in obtaining their support. I’ll remain confident this restructuring plan will result in a stronger company and I ask that you support the plan with your (indiscernible).

Curtis, I would now ask that you summarize the financial results and then we can take if there are any questions.

Curtis Garnet - Chief Financial Officer

Thank you, Mike and thanks everybody on the call for joining us today. Let me provide an abbreviated overview of our financial results. And then as Mike said, we’ll go to questions. Press release has all traditional results comparison, that I usually cover our thoughts. So, I refer you back to the press release for more detail.

Let me first summarize our fourth quarter results. Total revenues decreased 6.9% to $23.9 million from $26.5 million describing the results of the traditional loss of RLEC voice access lines related revenue plus the net impact of the FCC’s Intercarrier Compensation order including the reduction of intrastate rate in May details are the primary forces driving our reduction in revenue. The details by the fact revenue categories are contained in the press release with local services and network service revenues declining by the other three revenues actually.

Operating expenses decreased 7.4% to $18.3 million from $19.8 million. Cost of services and products decreased 9.3% to $10.2 million from $11.2 million. Selling, general and administrative expenses increased by 10.7% to $3.9 million from $3.5 million. As a reminder, restructuring expenses accounted for the preponderance of that increase with an increase of $1.1 million, which was partially offset by decreases in other legal expenses, employee cost including the reductions in employees at the end of second quarter of 2012, and the reduction in management compensation non-profitable expenses and operating tax. Sum of all those was $0.7 million.

Depreciation and amortization decreased 15.8% to $4.3 million from $5.1 million. The decrease was primarily due to lower capital expenditures in 2011 and 2012. Amortization of the Time Warner Cable contract intangible asset increased $5.4 million reflecting its shorter life and it was offset by similar $0.4 million decrease in the amortization of other intangible assets associated with the Country Road acquisition.

As Mike mentioned, adjusted EBITDA was $11.5 million compared to $10.9 million in the same quarter last year and $11.4 million third quarter of 2012. That reflects the restructuring of one-time expenses that are added back into calculation and the details are also in the press release. Our cash balance increased by over $5.3 million during the quarter. We ended the year with $32.5 million in cash on hand. Capital expenditures were $3 for the quarter as we stepped up our investment in infrastructure and cost savings toward the year that puts us right in line with our target. This might probably as you have mentioned in the last year of $17. The annual testing of the value of goodwill in fourth quarter now used no additional charges in the valuation of goodwill or intangible assets. That kind of covers the highlights for the quarter. Our annual results are also detailed in the press release in the 8-K, so you can get a sense for that part as that’s filed in 10-K.

Margaret, if you provide direction, we can take questions now.

Question-and-Answer Session

Operator

Thank you so much sir. (Operator Instructions) We’ll take our first question today from Mr. Frank Louthan with Raymond James.

Frank Louthan - Raymond James

Great, thank you. Can you remind us what the outlook is for EBITDA and free cash from the filing that you made when you announced the restructuring?

Michael Weaver

I can Frank. It’s actually in part of the disclosure statements it’s in Exhibit 6 on the disclosure statement. We are the big payers of that. We finished the year, sorry if I mentioned earlier, we finished the year at $32.5 million of cash. Our projections for 2013 through 2017 show an ending cash, meaning after we have satisfied the required amortization of 5% a year and the excess cash flow based on our projections, the cash balance at the end of 2013 is $8.5 million and it grows to $12.6 million in 2017. If that gives you a flavor again, those details are in Exhibit 6 in the disclosure statement.

Frank Louthan - Raymond James

Okay, thank you. And are there any buyers that were approached here interested in the business or is that probably something we can tell after the restructuring is complete?

Michael Weaver

To be honest, we have been focused solely on the task at hand, which is to get the documents in like our preparations and negotiate with the lenders and have not been anytime considering any other options at this point in time. I think it’s a matter of we needed to spend our time and we spend it on this process entirely.

Frank Louthan - Raymond James

Okay. And is there any special incentive packages for the board or management to stay through the end of the restructuring?

Michael Weaver

No, it’s my opinion senior management is a relatively small group. We have all been together for a long time. It’s my opinion that our team is very committed to say. I have no indications otherwise and will be here. The Board will change as for the time as I mentioned in my opening remarks, but up until that time – up until we exit from the bankruptcy filing, then the existing board will remain in place. It’s a great board. They are very knowledgeable and very loyal.

Frank Louthan - Raymond James

Okay, great. Thank you.

Operator

And ladies and gentlemen, we’ll take our next question from (Eugene Riley).

Unidentified Analyst

I have two just quick questions. The bill and keep started in July 2012 and you say it’s going that transition periods through July 15. Is that pretty much a linear transition or are they going to like lumpy when that happens?

Michael Weaver

I am sorry, I missed it Riley. I didn’t hear the first part of your question, I apologize.

Unidentified Analyst

Okay. Bill and keep, that transition started last summer, that’s going to go on through July 2015, is that a linear effect or is that kind of be lumpy along the way?

Michael Weaver

No, actually I believe what, let me take one step back, I believe what you are talking about are the SEC reforms that it had the effect losing our access revenue. That occurs over a multi-year period of time over three years as the rates go down on an interval – on a regular interval basis. And those reductions – anticipated reductions are reflected in the – in our cash projections and our numbers that I spoke off define well I know again it’s in the disclosure statement. So, we have taken our best estimate what we believe those numbers to be so that we can properly plan and project our cash and our operating results going forward. But it is not a one year reduction, it is over – generally over a three to five year period depending on what particular SEC element you’re speaking on.

Unidentified Analyst

Okay.

Curtis Garner

Mike one thing some of them are stair step in nature in that period the change. There was a change effected in July 1 on intrastate rates that were higher than intrastate rates and the next change in that happened next July. So, there are several that are stair step in nature.

Unidentified Analyst

Okay. Then the other thing was the Time Warner. Okay, one of the step-up for instance, you gave your income you break it into five groups local service, network access, cable TV, etcetera which one of those five buckets do I find Time Warner or if it’s spread among different buckets?

Michael Weaver

I believe it’s in local service Curtis can correct me if I’m wrong…

Curtis Garner

There are two pieces that Time Warner payments are in local service and the payments that we received from other carriers to terminate traffic to Time Warner are in access.

Michael Weaver

Okay. So, okay, both of these income effects are so up in the local service and then in network access line.

Unidentified Analyst

Okay, thank you very much. And then just one other question you mentioned at the beginning of the conference call but I sort of was blinking when you said the transition the Time Warner transition started January and it’s got to be over like six months roughly what percentage of that has been completed as of today?

Michael Weaver

It’s essentially at the end of January Mr. Riley was 100% completed outside.

Unidentified Analyst

Okay, okay. So then we’re going to pretty much see all of that in the quarter one numbers?

Michael Weaver

Yeah, we continue to provide very, very limited service for which we receive a relatively and significant compensation that we will continue through June 30th, but the big change we will see is in the first quarter of this year, that’s true.

Operator

(Operator Instructions) Gentlemen, I have no further questions in the queue at this time. I would like to turn it back over to you for any additional or closing remarks.

Michael Weaver - President and Chief Executive Officer

Thank you, Margaret. Thanks to all of you for joining the call. And we will speak to you again if not before it’s for the first quarter call. Thanks again.

Operator

Ladies and gentlemen that does conclude today’s conference. We thank you for your participation.

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