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Executives

Alan L. Wells – Chairman and Chief Executive Officer

Craig Knock – Vice President, Chief Financial Officer and Treasurer

Kevin Inda – Investor Relations

Analysts

David Coleman – RBC Capital Markets

Barry McCarver – Stephens Inc.

Christopher King – Stifel Nicolaus

Jason Fraser – Raymond James

Daniel Gaviria – Morgan Stanley

Iowa Telecommunications Services Inc. (IWA) Q2 2009 Earnings Call July 29, 2009 8:30 AM ET

Operator

Welcome to the Iowa Telecom Incorporated conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would now like to turn the call over to Kevin Inda.

Kevin Inda

Welcome to this Iowa Telecom conference call to review the company's results for the second quarter, which ended June 30 which were released this morning. During today's call we will refer to certain non-GAAP financial measures and we reconciled these measures to GAAP figures in our earnings release, which is available on our Web site at www.iowatelecom.com. Conducting the call today will be Alan Wells, Chairman and Chief Executive Officer, and Craig Knock, Vice President and 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 fact including without limitations statements containing the words beliefs, may, plans, will, estimate, continue, anticipates, intends, expects and similar expressions. Such forward-looking statements involve known and unknown risks, 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'll turn the call over to Alan Wells.

Alan L. Wells

I'd 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 review the financial results in more detail and we will then take your questions.

We're pleased in the results for the quarter and the actions we've taken during the quarter to grow our business. Since our last call, we've made significant progress in expanding our Minnesota operations. We closed on the acquisition of Sherburne Tele Systems, which added approximately 14,700 ILEC lines and 9,800 CLEC lines to our business.

We also announced the acquisition of the assets of WHComm, a CLEC which serves an area between our Sherburne and Lakedale ILEC properties. And finally, we announced the acquisition of additional ownership interest in several other ventures in which we were already a majority owner, including SHAL which operates a 2,500 mile fiber optic network in Minnesota.

Our revenues for the quarter remained strong at $58.8 million. Operating income for the quarter was $12.4 million, our adjusted EBITDA was $28.2 million, and our net income was $2.9 million or $0.08 per diluted share.

It's important to note that our quarterly results were negatively impacted by a $1.8 million one-time charge related to a network access matter. Absent this one-time charge, our adjusted EBITDA would have been $30 million for the quarter. Our access line loss also slowed from recent levels to the lowest levels since early 2007. This decline in the rate of access line losses, we believe, illustrates the success we're having with our bundled offerings.

Our income tax expense for the quarter was $2.1 million compared to $4 million a year ago. Craig will elaborate on income tax in his remarks. It is important to note that this income tax charge is virtually all non-cash in nature and thus did 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 in the quarter were only $70,000 reflecting the usage of both our net operating losses and our continued goodwill amortization for tax purposes. As a reminder as of year-end we had approximately $149 million in unused tax net operating loss carry forwards and continued goodwill amortization which runs through 2015.

Capital expenditures were $6.7 million for the quarter and our cash interest cost was $7.5 million for the quarter. As a result of the Sherburne acquisition which closed on July 1, we are slightly modifying our guidance on capital expenditures, which had previously excluded Sherburne. We expect capital expenditures for the year to be between $26 million and $28 million. This is a $1 million increase over our prior guidance and is due to the capital expenditures at our newly acquired Sherburne operation.

We expect cash interest expense will be towards the upper end of our earlier estimate of between $29 million and $31 million as a result of the additional interest on the newly issued debt related to the Sherburne acquisition. For the first six months of this year, capital expenditures were $10.3 million and our cash interest expense was $14.9 million. Overall, our company continued to deliver solid financial and operating results during the second quarter despite the ongoing macroeconomic challenges occurring nationwide.

Total access lines decreased by 3,000 during the quarter as ILEC access lines decreased by 2,900 lines and CLEC lines decreased by 100 lines. Our CLEC continues to focus on growing its business services and approximately 60% of our CLEC customers are business customers. Overall, our access lines show significant improvement over the first quarter loss rate resulting in our best quarter from a line loss perspective since early 2007.

We had 79,100 DSL subscribers at the end of the quarter, an increase of 900 subscribers in our traditionally soft second quarter. We also ended the quarter with 13,700 dial-up customers and 143,200 long distance customers. In addition, we had approximately 22,500 video customers as of the end of the quarter, up 1,100 subscribers from the first quarter.

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've seen no major changes in our competitor offerings since our last conference call. We continue to respond to the offerings of our competitors with our bundled DSL and video offerings, which we believe are proving to be attractive low cost alternatives for our customers.

I would like to now provide an update on our recently acquired Minnesota properties and on our other pending acquisitions. Most of the Bishop companies, which include Lakedale Communications, have now been fully integrated into our systems. We are very pleased with the results of our acquired Bishop properties thus far. As a result of our integration activities, we reduced the Lakedale workforce by about 20 employees midway through the quarter.

We completed our acquisition of Sherburne on July 1 and are working towards integrating our systems during the third and fourth quarters of this year. Sherburne currently services 14,700 ILEC access lines, 9,800 CLEC lines, 14,500 DSL high-speed Internet customers, and 3,600 video customers primarily in communities in rural areas near the Minneapolis-St. Paul metropolitan area. Sherburne's operations are headquartered only approximately 30 miles from our Lakedale operation. We expect to realize additional synergies in our Minnesota properties as our operations are combined and fully integrated later this year.

On a smaller scale, we announced a definitive agreement on June 23 to acquire substantially all of the assets of WHComm for $1.1 million subject to regulatory approval. WHComm was a CLEC which provides voice and high-speed DSL Internet in several communities near the western suburbs of Minneapolis and is a division of Wright-Hennepin Cooperative Electric Association. More importantly, WHComm operates in between our Lakedale and Sherburne operations enabling us to operate these assets fairly efficiently. As of June 1, 2009, WHComm had approximately 2,000 access lines and 700 DSL subscribers.

Finally on July 2 we announced a definitive agreement to acquire New Ulm Telecom, Inc.'s ownership interest in EN-TEL Communications, LLC, SHAL, LLC and SHAL Networks, Inc. for $1.7 million cash. EN-TEL Communications is a CLEC based in Willmar, Minnesota providing local voice, DSL and digital video services to customers in central Minnesota. Following the acquisition of New Ulm's interest, we will own nearly all of EN-TEL.

SHAL operates a 2,500 mile fiber optic network throughout Minnesota and provides low cost high quality transfer facilities. Upon closing, Iowa Telecom will own all of its outstanding equity in the SHAL entities. We believe that SHAL Network fits nicely with our ILEC and CLEC operations in Minnesota and provides us an opportunity to further expand our data services business and wholesale operations in Minnesota.

We continue to believe that each of these acquisitions individually will be accretive to cash flow. When combined and integrated, however, we believe these transactions provide us a unique opportunity to grow both our revenue and our profitability in Minnesota. We believe the results from these acquisitions will illustrate the power of our strategy of growing our business through accretive transactions.

In summary, we believe our business continues to deliver solid results in an unstable economy. Our business is well-capitalized and substantially all of our long-term debt is fixed until November 2011. Despite the unrest in the financial markets, we've maintained our financial flexibility enabling us to take advantage of acquisition opportunities despite difficult times in the credit markets.

We funded the acquisition of Sherburne with the proceeds of $75 million of new term debt issued under our existing credit facilities, coupled with borrowings in our revolving credit facility and cash on hand. The new term debt bears interest at LIBOR plus 2% and will mature November 2011. At current rates the all end borrowing rate on the $ 75 million of new term debt is approximately 2.31%. We're excited about our new operations in Minnesota and are confident that these transactions will be beneficial to our business for years to come.

Looking ahead we intend to continue to focus on five areas. First, increase free cash flow by expanding sales of our DSL and bundled offerings. Second, we also intend to continue to expand our CP and data services to business customers. Third, through our competitive local exchange carries subsidiaries we intend to continue to selected pursuit of new business customers and markets which are near our existing markets, including our Minnesota markets.

Fourth, we will continue to pursue and integrate acquisitions that are in line with our cash flow focus and that clearly meet our criteria for acquisitions to be accreted with cash flow, such as our recently closed acquisition of Sherburne and our two pending transactions. And above all, we remain committed to returning a stable income stream to our stockholders in the form of our dividends.

I'll now turn over the call to Craig Knock who will review our second quarter results in more detail.

Craig Knock

Since you have access to our full news release, let me review certain financial highlights and then we will take your questions. Overall, operating revenues for the quarter were $58.8 million compared with $58.2 million in the second quarter of 2008 reflecting an increase of $642,000 or 1.1%. Local service revenues increase $413,000 or 2.4% for the quarter, the increase was primarily due to access line increases from our acquisition on Bishop Communications.

Network access revenues decreased $630,000 or 3.1% for the quarter. The decrease was primarily due to lower minutes of use per access line and it declined in our Iowa CLEC in Montezuma access rates partially offset by Bishop.

Long distance revenues decreased by $198,000 or 3.5 % for the quarter. The decrease in revenue was due principally to a decrease in minutes of use per access line and partially offset by Bishop. Data and Internet service revenues increased by $1.4 million or 16.6% for the quarter. The increase was primarily due to the growth in our DSL Internet access service combined with growth in our Data Solutions products, as well as Bishop.

Other services and sales decreased by $339,000 or 5.4% for the quarter. The revenue decrease was primarily due to lower CPE sales and partially offset by Bishop and increased revenue from video services. Our total operating cost and expenses increased $4.9 million or 11.7% for the quarter. Cost of services and sales decreased $92,000.

SG&A cost increased $3.3 million compared to a year ago period due to a $1.8 million charge related to a network axis matter, as well as additionally operating expenses from our acquisition of Bishop Communications and acquisition related cost of $296,000 that are now charged to expense in courts with FAS 141R.

Depreciation in amortization increased $1.7 million or 13.1% primarily due to the Bishop acquisition along with higher plan balances. Interest expense increased $149,000 to $7.6 million for the quarter. This is due to a combination of lower variable interest rates offset by a higher average balance on a revolving line of credit in 2009 as a result of the Bishop acquisition.

In terms of income tax expense, we reflected $2.1 million in book income tax expense during the quarter compared to $4 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 cashing 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 shield position driven by our continued goodwill amortization at the rate of approximately $41 million per year through June 2015, coupled with our existing NOL approximately $149 million. Both of these items will shield us from material cash income taxes for a good number of years. However, we may be required to pay AMT, along with Minnesota cash taxes in the near-term. And as noted in the release, we paid cash income taxes of $70,000 during the first half of the year.

The bottom line for us this quarter was net income of $2.9 million or diluted earnings per share of $0.08. Our adjusted EBITDA as defined in our credit agreement and reconciled in our press release was $28.2 million for the quarter. And absent the one-time charge our adjusted EBITDA would have been $30 million.

I'd like to take a minute now to discuss our debt and related inters expense. As of June 30, 2009, we had outstanding 489.6 million of debt under the term facilities, $31 million drawn under our $100 million revolving credit facility, which are offset by $7.8 million of RTFC capital certificates and $5.6 million of cash.

Our net debt, or just the total debt as defined in the credit agreement, was $507.2 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 4.08 times.

Our cash interest expense, as defined in the credit agreement, was on track with our expectations for the quarter at $7.5 million. Our 2009 guidance we continue to expect that our cash interest expense will be between $29 million and $31 million. However, with the acquisition of Sherburne it will be near the upper end of that range.

Turning to our capital expenditures for the quarter, our capital expenditures were $6.7 million. As Alan indicated earlier, we are increasing our 2009 guidance for capital expenditures by $1 million to $26 million to $28 million to reflect the acquisition of Sherburne.

Now, I'd 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 $124.4 million and deducting cash interest expense of $30.8 million, capital expenditures of $25.5 million, and cash income taxes of $322,000 results in $67.8 million in cash available for dividends, at our annual dividend rate of $1.62 per share we paid $52.1 million.

Thus, for the trailing 12 months our payout ratio of our free cash flow was approximately 76.9%. It is also equally important to note that as of June 30, 2009 we had cumulative distributable cash or actual dividend capacity, as defined in our credit agreement, of approximately $96.1 million, or said in another way, nearly two years dividend requirement.

Operator, we will now answer any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from David Coleman – RBC Capital Markets.

David Coleman – RBC Capital Markets

I was just wondering if I could get more clarity as far as the one-time charge of $1.8 million what that was associated with.

Craig Knock

It was simply just a dispute regarding network access and it's reflected actually down in our SG&A as where it was charged to. But if you look back over time, not only in us, but in other companies you'll see several items like this related to various traffic disputes over the past several years.

David Coleman – RBC Capital Markets

So that occurred just in the second quarter there's no recurring charge for the –

Craig Knock

No, there's nothing ongoing.

David Coleman – RBC Capital Markets

Then as far as the rate of access line loss it shows on the ILEC side improved about 120 basis points quarter-over-quarter, said the promotional activity from competitors haven't changed. Was there anything on your part that would have contributed to the improvement in access line loss? Is there anything that you guys can point to, to explain why that metric improved?

Alan L. Wells

I don't think we've done anything particularly different on price. I think we've probably maybe changed our market activities in some of the ways that we promote our products, but I really don't think our pricing has changed during the quarter.

David Coleman – RBC Capital Markets

Just to expand on that, is it less port outs to wireless or to cable telephony or is there any sort of trend that you're seeing as far as who's not taking share from you.

Alan L. Wells

I don't think we have any real trend one way or the other. I just think we've found that some of our more recent marketing activities have been effective but I don't think there's any one particular segment or competitor that we're losing less to.

David Coleman – RBC Capital Markets

Finally, as far as WHComm and New Ulm acquisitions, any additional CapEx planned once those acquisitions are completed?

Craig Knock

We factored that into our upcoming estimates, Dave.

Operator

Our next question comes from Barry McCarver – Stephens Inc.

Barry McCarver – Stephens Inc.

I think you got my question on competition already covered, but I was wondering if you could give us a little bit more color on what Sherburne looked like now that you've closed. What did their 2Q look like?

Craig Knock

We haven't broken that out, but I think we did put in our release when we closed shortly after July 1 that they're trailing 12 months was $11.1 million adjusted EBITDA, and I think we've disclosed their access lines both in this press release and in the prior one as well.

Barry McCarver – Stephens Inc.

So no big change from that when we see them come in the 3Q numbers?

Craig Knock

I don't want to comment specifically on one of the operating entities, but they have been progressing on. We feel confident in the operations up there and look to integrate them like we did Bishop and perhaps a little faster.

Operator

Our next question comes from Chris King – Stifel Nicolaus.

Christopher King – Stifel Nicolaus

I just wanted to get your latest thoughts on the M&A environment throughout the ILEC industry. I guess, since the last time we've talked you've, obviously, had the Frontier deal with Verizon and what, if any role going forward do you guys see yourself playing in the M&A world and has that environment changed here, given the Century Tel/Embarq deal and now the Frontier deal? Do you see renewed interest from perhaps other carriers from an M&A standpoint in the ILEC space?

Alan L. Wells

I think we talked for quite a while about there will continue to be consolidation throughout our industry. And I think with the close of our Century Tel/Embarq deal and also the Frontier Verizon transaction further reflects that.

I think carriers are coming to understand it's important they grow scale in this business and I think we'll see continued consolidations throughout the sector. And I think the role we play, obviously, is in our area we think there's a lot of opportunities to make accretive transactions to help grow our business. But I think we'll continue to see more and more consolidation as time goes by.

Christopher King – Stifel Nicolaus

How do you guys in relation to the M&A environment, I guess, how do you guys view your corporate strategy with respect to your NOL carry-forward balance going forward? Do you see a certain time and point, be it two to four years down the road, where those do begin to expire? Do you see some pressure to change your capital structure to mitigate the expiration of those NOLs going forward, and how does M&A play a role in your decision-making process on that front?

Alan L. Wells

There are a lot of questions in there, Chris. I think, obviously, we're mindful of our tax position. We talked about our NOL is roughly $150 million that we have and that, plus our goodwill amortization. The goodwill amortization is a piece that folks oftentimes miss, but we also have a fairly significant tax shield by continuing to amortize our goodwill. But if we look in the future, its several years out before we think that we need to worry about becoming a cash taxpayer.

And I think if you look at some transactions like Sherburne for example, which was an asset transaction, we have additional tax benefits we acquired as part of that, so that further lengthens the runway. But I think we're always mindful of what our capital structure looks like and try to plan for that accordingly.

Operator

Our next question comes from Jason Fraser – Raymond James.

Jason Fraser – Raymond James

I want to talk a little bit about the CLEC environment, what you're seeing there, strong access line to I'm guessing it's primarily attributable to residential side, but also wondering if you're seeing continued delay decision-making times, high business churn. Can you just talk about what you're seeing on the business side and the residential side in CLEC business that would be great?

Craig Knock

We did have a slip of 100 on the net CLEC, but I think Alan pointed out earlier that we now how reached roughly 60% business mix. If you look back two years ago, that mix was roughly 40%, so over time we have frankly just churned out residential customers and have replaced them with a renewed business focus.

As far as the business market, I think we have a pretty good value proposition right now and we're just taking it to market and focusing on gaining market share on the business side. Again, we really focus our CLEC on the cash flow and not so much the metrics, and so gain in business shares is what we're really much more focused on.

Jason Fraser – Raymond James

Along those lines, have you seen any deviation from trends on the cash flow generations in the CLEC business over the last couple of quarters? Obviously, the economy is probably pressuring somewhat, but has there been a marked deterioration or has it been relatively steady given your overall markets?

Craig Knock

I think that our aggregate margins on the CLEC have been the same from the retail side of it. I did mention and I think we talked about it a couple of calls ago, that we've had a decline in some of our access rates within the CLEC, but apart from that the value proposition is still there. In fact, we've had some nominal price increases and haven't had much pushback.

Operator

Our next question comes from Daniel Gaviria – Morgan Stanley.

Edward Katz for Daniel Gaviria – Morgan Stanley

This is actually Edward Katz for Daniel Gaviria. I just wanted to get your view on the broadband stimulus now that the rules have been put out of the NCI and RUS, and also what you think as far as viability in the footprint concerning the funds.

Craig Knock

I think I missed the last part of your question. Do you mind repeating the last part again?

Edward Katz for Daniel Gaviria – Morgan Stanley

Sure, just viability in the footprint where you think you could really use the funds, whether that would be Minnesota or Iowa.

Craig Knock

I think our folks are still closely studying the rules and trying to figure out what projects we think that we have that might fit the rules, and which also might benefit us. I think we're looking at both Minnesota and Iowa. Obviously, most of our ILEC operations are in Iowa, so I think we probably would intend on a larger Iowa focus.

I think we were somewhat disappointed with the rules that came out and the commitment to make part of the funding through our U.S. loans for rural properties like what we have, but we're still continuing to evaluate it and hope we reach a decision pretty quickly about our plan to ask for funding.

Operator

It appears that we have no further questions at this time. Mr. Knock, we'll turn it back over to you.

Craig Knock

Thank you again for joining us this morning. We appreciate your time. Hope that you can join us again for next quarter's call. Thank you.

Operator

That does conclude today's conference. Thank you everyone for your participation.

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Source: Iowa Telecommunications Services Inc. Q2 2009 Earnings Call Transcript
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