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Executives

Kevin Enda – IR

Michael Weaver – Chairman, President and CEO

Curtis Garner – CFO and Board Secretary

Analysts

Dave Coleman – RBC

Frank Louthan – Raymond James

Otelco, Inc. (OTT) Q2 2009 Earnings Call Transcript August 6, 2009 11:00 AM ET

Operator

Good day, everyone. And welcome to the Otelco Inc. conference call. Today’s call is being recorded. At this time, for opening remarks and introductions, I’d like turn the conference over to Mr. Kevin Enda. Please go ahead, sir.

Kevin Enda

Thank you, Melissa. And welcome to this Otelco conference call to review the company’s results for the second quarter ended June 30th, 2009, which were released yesterday afternoon. Conducting the call today will be Michael Weaver, President and Chief Executive Officer; and, Curtis Garner, Chief Financial Officer.

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

In addition to statements, which explicitly describes 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 turn the call over to Mike Weaver.

Michael Weaver

Good morning and thanks for joining us on the call. Despite the continuing challenges in the economy, Otelco delivered a solid second quarter as evidenced by the increases in revenue and EBITDA over the first quarter of this year. The $850,000 increase in EBITDA was a result of increased revenue from our CLEC operations, and increase in access revenue on our RLEC operations resulting from one time true-up of annual cost study reports, continued effective cost management, and the realization of synergies from our Country Road acquisition.

Perhaps more importantly, the EBITDA growth occurred in both our CLEC and RLEC operations. For the quarter, our CLEC EBITDA increased by 43%, and our RLEC EBITDA increased by 1.6% when compared to the first quarter of 2009.

Curtis will provide the financial details in a few minutes. So what I’d like to do is focus on some of the other issues that we currently face. First, our integration of the Country Road operations is progressing according to schedule. And we expect to finish the process in the third quarter. For the six months just ended, we’ve realized approximately $1.8 million in synergies, and we’ll continue to see additional savings with the completion of the billing conversion, network consolidation, and other remaining integration projects.

As I've said, the synergies will continue for the remainder of the year, but we’d note that the more significant savings have already been realized. Given our progress on the integration thus far, we don’t anticipate any significant issues completing the remaining items.

On the IPTV front, we continued our expansion of the service as evidenced by our rollout into more of the Alabama service area. By year-end, we plan to pass approximately 1,900 homes and expect to have approximately 400 customers, which represent a 21% take rate. Our plans for 2010 include further expansion of this service.

Our CLEC operations continue to be impacted by Fairpoint system conversion difficulties. As of June 30th, we have approximately 782 orders waiting for service, which represents $32,000 in monthly recurring revenue. We continue to work closely with Fairpoint’s operational staff to facilitate as much progress as possible for our customers.

The opportunities that are provided by the stimulus package are both intriguing and bewildering. We continue to assess these opportunities and have adopted a wait-and-see attitude about the program. Some of the rules of the program, such as the 10-year ownership period requirement and the open network for all competitors, create concern for us. And we will continue to monitor the program for additional clarification on these items.

In the second quarter, our cash grew by $2.4 million as a result of strict management of expense and working capital items. And our pay out ratio was 84% for the second quarter. Due to our continued growth of cash, we anticipate a voluntary prepayment to reduce our senior debt by $5 million.

Finally, we paid our 18th consecutive IDS distribution in June, and remain committed to continuing our policy of returning cash to our shareholders. This time, I’ll ask Curtis to discuss financial results.

Curtis Garner

Thank you, Mike. And thanks to everyone on the call for joining us today. Just as a reminder, our second quarter of 2009 results include the three properties acquired from Country Road Communications LLC on October 31, 2008. And therefore, the majority of the change in performance over the same period in 2008 can be attributed to the acquisition.

With that backdrop, here’s a brief overview of our financial performance for the quarter. We expect to file our 10-Q on Friday which will have additional details.

Total revenues grew 46% in the second quarter of 2009, to $25.8 million from $17.7 million in the same quarter a year ago. The growth in revenue was primarily associated with the acquisition, and as Mike mentioned, growth in our CLEC revenues. That was partially offset by fewer RLEC access lines, reduced billing and collection fees, and on the existing (inaudible) of the company lower switched access revenues.

Local services revenues grew 79.7% in the second quarter of 2009 to $12.1 million from $6.7 million in the same period last year. The acquisition provided an increase of $5.7 million for the quarter.

Network access revenues increased 35.4% in the second quarter to $8.3 million from $6.1 million last year. Again, the acquisition provided an increase of $2.5 million for the quarter.

Cable revenues in the second quarter increased 8.1% to just over $0.6 million from just under $0.6 million a year ago. The addition of high definition services in IPTV subscribers and satellite installations accounted for that increase.

Internet revenue for the second quarter increased 15.5% to $3.5 million from $3 million last year, primarily associated with the acquisition.

Transport services revenues grew 8% to $1.4 million in the second quarter from $1.3 million in the same period in 2008. The source of that is the continued growth of our Wide Area Network at the Maine, and the addition of CLEC costumers.

Operations expenses grew 58.6% to $20.1 million in the first quarter of 2009 from $12.7 million a year ago. Cost of services increased 50.2% to $10.1 million from $6.7 million in the same period last year. That includes a $3.7 million from the acquisition and a reduction of $0.3 million from the existing units.

SG&A increased 32.3% to $3.3 million from $2.5 million a year ago, basically reflecting the acquisition. Depreciation and amortization for the second quarter increased 94.8% to $6.6 million from $3.4 million. The depreciation and amortization include $3.6 million from the acquisition, which includes the amortization of intangible assets acquired and a reduction of $0.4 million from the existing units.

On a June year-to-date basis, revenues and operating expenses increased by similar amounts in each category when compared to the same period in 2008. Interest expense increased 35.1% to $6.4 million from $4.8 million a year ago. The results reflect $1.6 million in interest on the increased senior debt associated with the acquisition and $0.1 million in capital cost amortization associated with interest rate capital we bought in 2004.

The company has two interest rates swaps in place that will limit our exposure to escalation in interest rates through February of 2012. Provision from income taxes for the quarter was less than $100,000 in both periods. We continue to anticipate that the company’s 2008 IDS dividends will be treated as a return of capital for a share in the tax purposes, as they were last year.

As a result of these factors, we had a net loss for the second quarter of $0.7 million compared to net income of $0.4 million in the second quarter of ’08. Basic and diluted net loss per share was $0.6 in both situations, compared to net income of $0.03 and $0.02 in the second quarter of 2008. The higher level of non-cash amortization of intangibles was the biggest swing factor there.

From a cash flow standpoint, cash flow from operating activities was $13.2 million in the first six months of the year, compared to $8.7 million a year ago. Cash used in investing activities for the first six months of the year has amounted to $3.4 million, compared to $4.2 million a year ago. Capital investment in planned equipment was $3.6 million, compared to $3.9 million in the same period last year. This represents an increase over our first quarter of 2009 investment in our business, but continues to reflect our conservative approach to capital expenditures so far this year.

Cash flows used in financing activities for the quarter amounted to $4.5 million, which is the same as last year. That reflects the two quarterly dividend payments in both years.

Looking at the balance sheet, we entered the quarter with $18.9 million in cash and cash equivalents, which was an increase of $5.3 million since the end of 2008. Long term debt remains unchanged at $278.8 million. As Mike mentioned, we expect to make a $5 million voluntary prepayment against our senior debt on next Monday, reducing it from $173.5 million to $168.5 million or almost 3%.

There’s no covenant or other criteria that requires this prepayment as our senior debt runs through October 2013. We found out this morning that our three-month libor rate will reset on Monday to 0.046438%. So libor continues to be low and we’ll benefit from that.

Melissa, if you could provide the directions, we can take questions at this time.

Question-and-Answer Session

Operator

(Operator instructions) And we’ll go first to Dave Coleman with RBC.

Dave Coleman – RBC

Thank you. I dialed in late, so my apologies if you’ve already addresses this. But could you update us on the CLEC business in Maine and the success at getting the backlog of lines ported over? Do you guys – I know there was a backlog in the first quarter, and just where that stands? And then as far as the prepayment of debt, is that just the voluntary prepayment, is that just to reduce interest expense or is there any other reason behind that? And then finally, if you could talk about further M&A prospects. Thanks.

Michael Weaver

Thank you, Dave. Our CLEC business – we’ll take the questions in the order that you asked them. Our CLEC business in Maine continues to do very well and we’re pleased with our progress to date. Specifically to your question, we got about $32,000 in monthly recurring revenue that’s still delayed as a result of Fairpoint’s system conversion difficulties.

The good news in that is that that’s progress, essentially from where we ended the first quarter. The bad news associated with that is, a lot of that is due to – we’re actually doing a lot of manual handling of orders and it takes – that’s expensive. Fairpoint is certainly putting forth a gallant effort to work with us on that.

It remains a problem. There has been some improvement, as I’ve said, since the first quarter. It’s an issue. The real problem with that is it just delays the revenue recognition for us obviously on a going forward basis.

On the debt prepayment, you’ve got it right. It’s simply to reduce the debt expense. There is no – as Curtis mentioned, there is no requirement or covenant or anything else. We feel pretty good about our cash, the continued growth of our cash. And it just make sense to us to start to ratchet down some of the debt. So there is no requirement for that. It’s purely a volunteer prepayment.

We continue to be very optimistic about the opportunities for acquisitions in the future. Like all other companies, we would love to see an easing of the – and more availability of the debt. And we’d like to see more favorable terms in the debt market. We believe that there are a lot of companies out there that will be considering their options. And we also believe that we’re well positioned to take advantage of that.

Dave Coleman – RBC

Thanks. And going back to the CLEC business in Maine, is there a risk of potential customer loss if you’re not able to port these customers over in a timely manner?

Michael Weaver

No, not really because the problem is not unique to Otelco. And again, I would add for the third time that the situation has gotten better. It still is an issue. But there is no other provider that a customer can go to if Fairpoint’s involved, and get faster service. So we have not – to date, we have not experienced orders being cancelled. It’s embarrassing to us to not be able to provide the kind of service that we’re known for. But to date, we’ve not had a significant order of cancellation as a result of that.

Dave Coleman – RBC

Thank you.

Operator

(Operator instructions) We’ll go next to Frank Louthan with Raymond James.

Frank Louthan – Raymond James

Great. Can you give us an update on IPTV deployment and what you saw there in the quarter? I guess it was a seasonally weak quarter for video ads. It’s down a little bit. How do you expect that to ramp in the second half?

Michael Weaver

Thank you. Frank, we expect much better results in the second half. We really only – we have two markets. Two of our four Alabama companies are currently the only ones we’re providing cable TV – the IPTV service to. In the larger market, we only started in mid-June. So we really almost missed the second quarter for getting that service up. That’s our priority in Alabama for the remainder of this year.

As I said, we think we’ll pass around 1,900 homes by end of the year. Our experience and based on our projections, we expect to be in the 20% to 25% take rate range. So it’s going to really be a question of how fast we roll that out.

We’ve been on an area specific basis, more detailed meaning on a node-by-node basis from the remote or the central office that serves certain neighborhoods. So it’ll be a continuing work in progress. We’re pleased with the product. We’ve had no significant issues with the delivery of the product. Customers seem to like it. So again, that will be our push for the remainder of ’09 and frankly for 2010 in our Alabama markets.

Frank Louthan – Raymond James

Okay. Great. Thank you.

Operator

Okay. We have no further questions at this time. I’d like to turn the call back to our speakers for any additional or closing remarks.

Michael Weaver

Well, as always, thanks again for joining us this morning. I appreciate the questions and we look forward to talking to you again in three months on our next regularly scheduled call. Thanks for your time.

Operator

Once again, that does conclude today’s call. We do appreciate your participation.

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