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Otelco Inc. (OTT)

Q4 2009 Earnings Call

February 18, 2010 12:00 am ET

Executives

Kevin Enda - IR

Michael Weaver - Chairman, President & CEO

Curtis Garner - CFO

Analysts

Tim Horan - Oppenheimer

Frank Louthan - Raymond James

Dave Coleman - RBC Capital Markets

Operator

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

Kevin Enda

Thank you Robbie, and welcome to this Otelco Conference Call, to review the company's results for the fourth quarter and year ended December 31, 2009, which we 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 that statements made on this conference call but 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 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. 2009 was a very good year for us as we experienced over 34% growth in revenue and 31% growth in EBITDA. This growth in revenue and EBITDA coupled with our [promise] to shareholders of $1.68 per share for interest in dividends resulted in a 99% increase in our stock price to 1506 at 12/31/09 versus $7.57 to 12/31/08. On a longer term view, $100 invested in Otelco on December 31, 2004 at a cumulative return of $155.78 at 12/31/09 including the impact of dividends in interest.

The catalyst for our progress in 2009 was the successful integration of the Country Road entities that we acquired in the fourth quarter of 2008. Our results for the Country Road operations exceeded our estimates at the time we closed the acquisitions primarily due to realization of more synergies than expected and our expansion into New Hampshire.

For the fourth quarter, we generated EBITDA of $12.2 million, which was approximately 600,000 behind last quarter's record level. This decline is explained by a combination of some softness in our markets due to the general economic conditions, a reduction in excess revenue due to an adjustment related to our annual cost study filings and increase in the reserve for bad debts and year-end bonus accruals.

These expenses were somewhat offset by a decline in the cost of services and products resulting from the annual true-up of network cost. The net affect of these adjustments was to reduce fourth quarter EBITDA by approximately $400,000.

Now shifting our focus to annual results revealed some noteworthy accomplishments. Thanks to the 7.6% growth in our CLEC metrics, our access line equivalents increased slightly for the year.

Wholesale network connections aided by our expansion into the New Hampshire market increased about 35%. One of our focuses this year has been the IPTV and introduction of those services in our Alabama markets allowed us to have a modest increase in our cable customers. As of the year end, we had approximately 340 IPTV customers.

Cash grew by $9.2 million for the year from which we made a voluntary prepayment of $5 million to reduce senior debt. At year-end, our cash balance was $17.7 million. Our plans for 2010 include the continued expansion of IPTV in Alabama, expansion of our wireless internet services and the introduction of Telephony outside of our regulated territory in Missouri and the addition of five to six new co-location sites in New England.

On the IPTV front, we currently pass approximately 2500 homes and expect to add another 5000 homes past in 2010. If our marketing plans prove successful, we expect to add another 500 to 700 IPTV customers in 2010.

In Missouri, we continue to add more wireless internet customers that are located primarily outside our regulated telephone territory. The acquisition of Softswitch in 2009 will allow us to add Telephony as a new service offering to these customers in the coming year.

In New England, we plan to expand our customer base by adding five to six new co-location sites. These sites represent a combination of growth opportunities and cost reductions. Three of the new sites are in Greenfield opportunities as they are in areas we don't currently offer service. While there would be some one-time cost associated with these new opportunities, we expect these areas to be cash flow positive by the end of the year.

The remaining two to three sites will result in cost savings as the new co-location sites give us the ability to move more of the traffic on to our network and away from third-party providers. Finally, we paid our 20th consecutive audience distribution in December and we've remain committed to continuing our policy of returning cash to our shareholders.

I'll now ask Curtis to discus the financial results.

Curtis Garner

Thank you, Mike, and thanks everybody on the call for joining us today. Just as a reminder our fourth quarter and the year 2009 results include the three properties acquired from Country Road Communications on October 31, 2008.

As Mike has mentioned, the integration is complete and fully met our expectations. Because the New England operations are [happening] working as a single unit it has become more difficult to differentiate between the contribution of the acquisition and the actual growth of the combined unit.

In the 10-K you'll see some additional specificity on the source of improvements for 2009. With that is a backdrop here is a brief overview of our financial performance for the quarter and the year.

Total revenues grew 11.6% in the quarter to $26.1 million from $23.3 million in the same quarter a year ago. The growth in revenue was primarily associated with growth in CLEC sales in Maine and New Hampshire, plus the additional month of the Country Road acquisition in fourth quarter when compared to fourth quarter of 2008.

Total revenue for the year increased to 34.6% to $103.8 million from $77.1 million in 2008. Local services revenue grew 22.1% in the fourth quarter to $12.1 million from $9.9 million in the same quarter a year ago. The acquisition in CLEC provided increases of $1.7 million and $0.7 million respectively for the quarter, these increases were partially offset by lower RLEC access lines. For the year local services revenue grew 61.4% to $48.4 million from $30 million in 2008.

Network access revenue increased 5.1% in the fourth quarter to $8.4 million from $8 million a year ago. The acquisition provided an increase of $0.7 million for the quarter partially offset a decrease of $0.3 million in switches and special access, including the estimated impact 2009 cost study adjustments and some Fair Point accrual adjustments. For the year network access revenue increased 22% to $33.3 million from $27.3 million

Cable television revenue in the quarter decreased to 2.9% to just under $0.7 actually in both periods. Growth in IPTV and high definition subscribers was offset by attrition of basic customers as a result of the economy.

Cable television revenue for the year, however, increased 4.2% to $2.5 million from $2.4 million in 2008. Internet revenue for the fourth quarter 2009 increased 2.9% to $3.5 million from $3.4 million to growth in data lines and the acquisition impact were partially offset by decline in dial-up subscribers outside of our territory. For the year internet revenue increased 12.7% to $14 million from $12.4 million in 2008.

Transport services revenues grew 1.8% to $1.4 million in the fourth quarter, from $1.3 million in the same period in 2008. Transport services revenues for the year increased 10.4% to $5.5 million in 2008. The driver is CLEC sale of dark and special use fiber as we continue to expand our network in Maine.

Moving on to expenses, operating expenses in the fourth quarter increased 13.5% to $20.5 million from $18.1 million in the same period a year ago. For the year operating expenses increased 46.1% to $81.8 million from $56 million in 2008. These increases were primarily attributable to the acquisition of Country Road and the cost of increase in CLEC and high speed lines partially offset by network and operating efficiencies.

Breaking down the three components, cost of services for the quarter increased 8.7% to $9.9 million from $9.1 million in the same period last year. The press release lists the number of factors driving the increase including higher [pole] rental payments and increases in Missouri long distance expense, which were partially offset by controlling variable costs and lower long distance rates in main through the use of our least cost routing platform plus of course the acquisitions synergies. For 2009 cost of services increased 41.1% to $41.2 million from $29.2 million in 2008. Acquisitions are clearly the largest single factor in these countries.

Selling general and administrative expenses for the quarter increased 24.5% to $4 million from $3.2 million a year ago; reflecting the acquisition changes in our bad debt reserves and increases an employee expense. We also booked the majority of management incentive compensation expense in fourth quarter once we determine that it was earned for the year.

For the year selling, general and administrative expenses increase 26.1% to $14.2 million from $11.2 million in 2008, again primarily from the acquisitions.

Depreciation and amortization in fourth quarter increased 15.1% to $6.6 million from $5.7 million, this included an increase $0.7 million from the acquisition and $0.2 million associated with the early retirement of the switch in Missouri that was replaced by Softswitch.

Interest expense to the fourth quarter decreased 22.1% to $5.9 million from $7.6 million a year ago. In the fourth quarter 2008 you may remember we reflected the impact of writing off the remaining loan costs when our senior credit facility was considered extinguished from an accounting perspective at the time of financing the acquisition. The interest rate cost associated with the 2004-05 year interest rate cap were fully amortized at the end of the third quarter generating a reduction in fourth quarter and a quarter-over-quarter environment of $0.3 million.

The company has two interest rate swaps to limit our exposure to changes in interest rates through February 2012. Interest expense for the year increased 16.5% to $25.4 million from $21.8 million in 2008 reflecting the higher debt outstanding with the acquisition as well as the changes that I just mentioned above.

In the press release yesterday we announced that the company had identified, we had identified that the company was not incompliance with some technical requirements in the Accounting Standards Codification 815, known to many of us as the old FAS 133. Concerning treatment for our two interest rate swaps as effective hedges against changes in the LIBOR interest rate on our single debt.

Instead of treating the swaps as effective hedges and reflecting changes in their value each quarter in the other comprehensive income line in the equity section of the balance sheet, we must now flow these changes through the income statement as if they were investments which of course we've never intended them to be. This change impacts our quarterly results for 2009 and we will be reflected in the 2009 Form 10-K we filed.

The change has no impact on EBITDA, cash generations or operations of the business, but it will make net income swinging up and down based on changes in the future expectations interest rate movement as reflected in the swap valuation each quarter.

Obviously earnings per share will move in the same direction as evaluation changes for the hedges. The impacts in fourth quarter and for the year are in the 8-K that was filed. For the year, net income declines by $1.6 million related to this change, there was no impact in 2008 and the details associated are in the 8-K.

Cash flow from operating activities was $27.9 million for the year compared to $18.7 million a year ago, cash used in investing activities for the year amounted to $9.8 million compared to $117.9 million a year ago. The Country Road acquisition was responsible for $108.7 million of that increase last year in 2008.

Capital investment in property, plant and equipment was $9.6 million in 2009 compared to $9.2 million in the same period the previous year. Fourth-quarter capital investment moved us back toward a more normal pattern of investing after pretty conservative start in the year that puts us back into the range of approximately 10% of revenue.

Cash flows used in financing activities for the year amounted to $13.9 million compared to an inflow of $99.9 million in 2008. The change is a result of $108.9 million in proceeds from the long-term notes payable that were associated with the acquisition in 2008.

In terms of the balance sheet, we ended the year with $17.7 million in cash and cash equivalents, an increase of $4.2 million since the end of 2008 or as Mike mentioned at $9.2 million for the year if you considered that we made a voluntary prepayment of $5 million on our senior loan facility that runs through October 2013.

Long-term debt was $273.7 million at year-end. Mike mentioned there are 20 consecutive dividend payments. We continue to anticipate that the company's 2010 dividends will continue to be treated as a return of capital for tax purposes as they were in 2008 and 2009.

Robbie, if you provide directions, we can take some questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions). We will go first to Tim Horan - Oppenheimer.

Tim Horan - Oppenheimer

Just a quick question, Mike. You had a couple of one-time impacts on the quarter or true ups, could you maybe just in aggregate quantify the impact that you take over for revenue and EBITDA or just give us a sense of maybe what you think first quarter can get back to some of the normal run rate that you saw in the first three quarters of the year? Thanks.

Michael Weaver

I've sort of delineated without giving you the numbers on those, as we walk through that, the total, the sum just sort of take a short cut on that if you don't mind and if you have further questions we could come back to it, but the net sum of those adjustments again, we had some decline in revenue that we attributed primarily to just being timing, fourth quarter is never our best quarter and also some general economic conditions certainly played a part in that.

Revenue was impacted negatively by the cost studied adjustments that I mentioned reduce access revenue. In addition, we did have an increase in our reserve for bad debts for the Fair Point filing as Curtis mentioned and the year-end bonus accruals. If you take all that and we also had some savings that we recognized in our network cost. If you look at the cost of sales on our fourth quarter versus third quarter, you can certainly see some decline in that was due to just a true-up of network cost that is fairly typical for the end of the year.

The sum of that conglomeration of additional year-end expenses and true-up, the network cost is somewhere around $450 and in my way of thinking, if you took that amount and you could make a case that if you added that to that 12.2, we would been in the range of 12.6 to 12.650 somewhere in the range for a normalized fourth quarter.

Tim Horan - Oppenheimer

And that 450 give or take, do you think that will bounce back in the first quarter or these you know, mostly just true-ups or will the bad debt expense kind of continue and the network cost is also just a true-up, it's not a run rate right?

Michael Weaver

No, that is true. The network cost is a true-up, we actually think that most of those bounced back specifically on the reserve for bad debts. We feel like we have been, we monitored that situation very closely and spent a fair amount of time thinking and preparing for that and we believe that the reserve that we have should be conservative and we believe that it is adequate based on what we see right now in that filing and the status of the process, we believe that reserve will be adequate.

So, I think that is reasonable to expect run rate of 12.5 to 12.6 and if you look back at our - if you sort of look back at the year, the comfort that I draw from that, if you look back at the year that seems to be a reasonably consistent run rate, it was certainly lower in the first quarter, but that's because we had not implemented all the synergies from the Country Road acquisition. So, I think the reasonable rate would be in the 12.5 to 12.6 range.

Tim Horan - Oppenheimer

And would there be any other reason maybe trying to bump up that here for '10. Any other synergies we can expect or benefits from any other revenue growth in '10?

Michael Weaver

No, I think this is fairly realistic Tim. One of the things that it is a good problem to have, but as I mentioned, we are expanding our sales effort in England really those five or six co-location sites and the reason it is five or six really only depends on the speed with which we are able to deploy those.

We certainly have plans for six, it is just a matter of can we get the work done in 2010 and will some of that follow through in 2011, because three of those five or six sites are in true Greenfield opportunities. We are going to have some one-time cost associated with that for network and we will certainly beef up our sales staff and have some of those costs that will actually have a negative impact on our CLEC potentially although not great as we go though the year. As I said earlier, by the end of the year, we expect all of those three green field opportunities to be positive cash flow producers.

Tim Horan - Oppenheimer

What is the interest level out there these days with - on the acquisition front or are there many private companies within, that are increasing or looking to sell or other things pretty much status quo?

Michael Weaver

No, that's a great question Tim. There is actually more activity than we have seen in a long time. In all of last year, I would tell you that in the last two to three months, the number of calls that we received and people that are either owners that are considering running the process. The level of activity certainly increased. I think that there is a couple of unknowns with that from behind my [days], the first is, the debt markets rather has been an improvement or not, but were before the downturn, money is still expensive. There is not as the number of lender that are available to you, are certainly less than they were before. Certainly all the traditional lenders to telcom are still in the business of lending, the rights are not were they were before so the cost of money will go up.

The other thing is that, I'm not certain what the market, what the sellers' expectation or price I guess. There have not been a lot of transactions in the last several months so there is some unknown to what, the give and ask kind of scenario. I don't know exactly where that is, but we are encouraged by the level of activity that we see and the opportunities that that we think are out there for Otelco in 2010 and beyond on the acquisition front.

Operator

Your next question come from Frank Louthan - Raymond James.

Frank Louthan - Raymond James

Great thank you, couple of questions. One, have the B shares already converted and if so when or if not when do you expect that to continue and can you give us a little more update on what's going on in Maine with Fair Point, is that situation improving? Has it gotten better over the last two months and how the operating environment with their billing issues that they have had? Thanks.

Michael Weaver

Frank, let me answer the later part of the question and allow Curtis on the B share. I think everybody is aware of exactly where Fair Point is on their bankruptcy falling, so I will not address that. On the operating front, I would say that it's exactly the [locket] was in previous quarters. Fair Point continues to work hard on their systems issues. We've seen little to no improvement in the flow of orders, just a sort of recap from previous conversations that we've had on these calls, the effect that it has on Otelco is it's actually a deferral of revenue. To be really specific, we have quite a nice backlog of sales orders, the problem comes from translating those from orders into executed contracts many when the service is installed and working properly at the customers premises.

The effect that has on our existing deferral revenue, it's not a problem that's unique to Otelco, meaningful partner Fair Point as the same struggles that we do in servicing their customers on a timely basis due to the confusion that still exist and the additional time that it takes to get in an order through the process from a piece of paper to actually work in service.

Again, Fair Point is working hard on that, I think we have yet to see significant improvement in that. The other effect that has on Otelco is there is more, we've had to beef up some of our staff in order to make that system in its current form of work, you have to do a lot more manual work to get the orders processed and get them in place and get them working, you have to do follow up that we would normally not have to do with some of the work. So there is an element of expense in that, it's not great. I don't want to overstate that, but it is an additional expense, the biggest problem is the time that it takes. With that said, let me ask Curtis if he would to speak to the status of the B share conversion and the time table for that.

Curtis Garner

All the B share holders have in writing requested that the company convert their B shares into IDS units. So, the process has started for the conversion. We will file an S4 with the SEC right after we do the 10-K filing and then from there it will depend on the SEC in terms of what the time frames would be. As an example, this is the third year since we have been reviewed and if the SEC follows their normal process, this would be our year for review, sometimes that review will have to be completed before the filing to be handled, don't know that they will get related, but that could happen. I would say that you know, the best guess right now is that the conversion would happen sometime in the late second quarter.

Frank Louthan - Raymond James

Just one follow-up on the Fair Point situation, so you might say you have a nice backlog there, is that backlog been growing. Have you been increasing sales there or is it staying flat. I mean they are obviously converting something, just sort of delayed. I mean is it getting how is that trending? And then can you maybe tell us how much you had some dark fiber sales. What were the dark fiber sales in the fourth quarter and for the full year of 2009?

Michael Weaver

Our sales effort in backlog is growing. I mean, we in preparation for some of the new (inaudible) sites that we anticipate having. I have done some work and in one case in particular, there is on a small scale, we have entered into a new territory for us in the northern part of Maine and are meeting with some success on that, but we had a good strong fourth quarter on our sales effort and backlog and I'm pleased that one of the things that we've advantages is, that we have right now is there is still quite a bit of due to Fair Point's difficulties. There is some confusing in the market, so it's an opportunity for Otelco to be really aggressive on the sales front and go after those customers and certainly that's been our strategy not just for 2009, but before.

So because of that and because of our increased efforts and because of the one area that we've gone into this Greenfield, sales are strong for us on the CLEC side, we're pleased with that and again it operates more as a situation, Fair Point is really a deferral of revenue, it's my opinion we've not lost any material or significant revenue as a result of people changing because there are no other alternatives, so sales were strong.

Let me, let Curtis says those numbers readily available for the - we call that the transport revenue in the dark fiber, if he has those in front, let me ask him if he can to provide a little bit color on the transport or dark fiber revenue. Curtis?

Curtis Garner

Thanks. Transport services is up about 10% year-over-year and as you know those sales tend to be kind of step function kinds of things. The one that we announced some time ago was the University of Maine and so that functionality went in as a fairly significant reasonable increase. In 2009 we expanded our fiber network to 296 miles worth of fiber, as you know we bought Mid-Maine they had 212 miles of fiber. So, I think last year's increase was about 40 additional miles.

So, I don't have the authority to give you any customer names, but some of the work would have been for existing customers where we now have the capability to add fiber capability for them to other locations. And so, beyond that I don't know that I can tell you specifically who. So, it's about $0.5 million in net revenue increase and I think probably maybe half of that was in the dark fiber side as opposed to leasing services over the fiber.

Michael Weaver

Frank, just a little bit more color on that, the dark fiber revenue increased by 10.4% in 2009 versus 2008. We finished the year with about $5.5 million in dark fiber revenues as opposed to $5 million the year before, Curtis is right on, it was about $0.5 million increase in that. Most of those contracts are or most of the revenue generated from that are multiyear contracts. So, it is a reasonable expectation to think that - we should continue to see some increase on that revenue line.

Operator

(Operator Instructions) Your next question comes from Dave Coleman - RBC Capital Markets.

Dave Coleman - RBC Capital Markets

I think in the prior quarters, regarding the Fair Point situation, you sort of quantified the revenue backlog and if my memory serves me correctly I think it was in like $30,000 range of revenue backlog. So, I guess following up on the earlier questions regarding that, is that number is accurate? Can you say whether the revenue backlog is above or below or at approximately the same amount as to when you gave that revenue backlog before.

And then as far as 2010 CapEx, you have outlined a number of projects. I was just wondering if 2010 CapEx, we should anticipate that being higher than 2009 levels or about the same amount and then final question just on the cable business was a nice quarter-to-quarter increase in revenues. Is that attributable to IPTV subscriber growth or was there also increase in pricing amount, the other cable customers to contribute to the revenue lift?

Michael Weaver

In the order that you asked, the revenue backlog has actually increased since the $30,000 number that you remember that we talked about earlier. That's probably has much to do with our increased sales effort and strong fourth quarter as Fair Point. Fair Point certainly has not, I don't want overstate that they are operational problems have not gotten any worse, they just have not gotten any better. That is just direct as I know how to say that and again the sales backlog really comes from a strong fourth quarter.

CapEx, you are right, will go up some. I think Curtis can keep me honest on this, but I believe that in our budget for 2010, we have about 11.2 million, which is another 1.6 million above the number that we spent in 1.5-1.6 million more than we spent in 2009. Your assumption is correct, that with the new projects, that we have that's going to take some CapEx. We certainly think the returns are there for that. There was no price increase on the Cable TV, what you are seeing is the growth in customers and you are also right about that Dave, it is primarily coming from the IPTV.

We are bit behind the schedule that I had hoped we would be at for customer heads at the end of '09, it took a bit longer to role out the product and to get the marketing in place and to create some customer awareness that products now available to them.

So, at the end of the year, we had passed approximately 2500 homes and had 240 customers. So, at this early stage, it's about a 10% take rate on that. If we meet our expectations for next year and add another 5,000 homes and you assume that take rate at 10% or 11% you can see, we are thinking that it will be in the 500 to 700 customers added for next year.

So, that's our expectations for cable. We are pleased with the products; we've changed some of our marketing and increased some of our marketing efforts that in our plans for 2010 to try to really take advantage of the Greenfield opportunity that Cable gives us. Just as a reminder that Cable is being introduced in our northern most (inaudible) territory and so these are customers, the people we are selling to are people that we already have a business relationship with and are currently billing. So, it is just a matter of getting the work done.

Operator

(Operator Instructions) It appears at that this time we have no further questions in queue. I would like to turn the program back over to Mr. Weaver for any additional or closing comments.

Michael Weaver

Thank you, Robbie. As always we want to thank you for joining us on the call this morning and certainly welcome your questions and hope you will join us again in three months for our next regularly scheduled call. Thank you.

Operator

And that does conclude today's conference. Thank you for your participation.

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