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Executives

Kevin Enda – IR

Michael Weaver – Chairman, President & CEO

Curtis Garner – CFO

Analysts

Jason Fraser – Raymond James

Tim Horan – Oppenheimer

Otelco Inc. (OTT) Q1 2010 Earnings Conference Call May 5, 2010 11:00 AM ET

Operator

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

Kevin Enda

Thank you Jessica and welcome to this Otelco Conference Call to review the Company’s results for the first quarter ended March 31, 2010 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 that are not statements of historical or current fact constitute forward-looking statements. Such forward-looking statements involve known and unknown risks and uncertainties and other unknown factors that could cause the actual results of the Company to be materially different from 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 now turn the call over to Mike Weaver.

Michael Weaver

Thanks Kevin and good morning everyone. I’m following our usual format, I’ll provide a few just a brief overview of our first quarter results and key accomplishments and then ask Curtis to provide the financial overview and at the end of Curtis’s remarks we’ll take any questions you might have.

With our positive first quarter results, we continued the growth trend that started last year with successful integration of our New England properties. Some of the highlights from this quarter are an EBITDA increase of $120,000 over the fourth quarter results. The really good news in this item is the improvement in the early cooperation and the corresponding increase in the EBITDA margin about approximately 1% to 48% from 47% in the fourth quarter.

This quarter we increased cash by $3.5 million over the fourth quarter. The improvement in the EBITDA margin coupled with the receipt of our annual cash dividend from combined and an income tax relief fund allowed us to increase cash by 20% over the year in balance. Our CapEx of $1.8 for the quarter is under our expected run rate of $2.7 million per quarter, but as we continued to add new (inaudible) sites in New England, expand our IPTV operations in Alabama, and add additional wireless internet sites in Missouri, the quarterly capital expenditures will increase.

Just as a reminder for the year, we expect total CapEx to be between $10 million and $11 million. Another bright spot for the first quarter was the slight growth in access line equivalents for the enterprise primarily as a result of growth in our data lines and CLEC operations.

For the second quarter in a row, RLEC access line metric actually improved. It declined only 0.2% compared to RLEC decline of 0.7% in the fourth quarter of 2009. With the completion of the integration process of the New England properties in the fourth quarter, we’re now focusing on expanding our service area, products and customer base throughout the area.

As part of this process, our New England operations will become known as OTT Communications. The name reflects our goal of one team serving the diverse needs of our expanding customer base through innovative services and quality customer care. On the regulatory front, we’re following the proposed national broadband plan with a great deal of interest. While it’s too early to reach any conclusions on the potential effect the plan may have on us, there are several points that are particular interest to us.

The plan mentions the lowering of state access rights to be equal to Federal rights. If this would become a part of the final plan, we believe this would have a minimal effect on us. Missouri is the only state where we currently have operations where there is an imbalance between state and Federal rates.

Of more concern to us is the mechanism for establish the Connect America Fund and the Mobility Fund. These are potentially more problematic for us and we will continue to follow discussions closely and seek to have our views expressed through visits with our Congressmen and through existing Telephone Associations. Our 2010 plan include the continued expansion of our IPTV service in Alabama.

Currently we passed 2500 homes and expect to add another 5000 homes pass this year. If our marketing plans proves successful, we expect to add another 500 IPTV customers in 2010. It’s evidenced by the recent announcement of acquisitions; it appears consolidation within our industry will continue to occur. We remain diligent in our efforts to find and identify accretive acquisition targets and we’re encouraged by the increase in the number of smaller RLECs exploring their alternatives.

Finally, we paid our 21st consecutive IDS distribution in March and remain committed to continuing our policy of returning cash to our shareholders. Curtis, I’ll now ask you to speak to the financial results.

Curtis Garner

Thank you, Mike and thanks everyone on the call for joining us today as I know it’s a busy day for earnings calls. Let me provide an overview of our financial performance for the first quarter of this year. As aside we expect to file our 10-Q tomorrow, so there will be additional information available through that.

Total revenues grew 1.2% in the quarter to $25.8 million from $25.5 million a year ago. The growth in revenue was primarily associated with growth in CLEC sales in New England, data access lines throughout our territories as well as the few selected price increases partially offset by declines in our RLEC voice lines.

Local services revenue grew 3.2% in the first quarter to $12.2 million from $11.9 million a year ago. Growth in CLEC revenue of $0.8 million was partially offset by lower RLEC voice access lines. Network access revenue decreased 1.3% in the first quarter to $8 million from $8.1 million a year ago. Special circuits access decreased $0.4 which was partially offset by an increase of $0.3 million in switch to inter and intrastate access.

Cable television revenue in the first quarter increased to 9.7% to $0.7 million from $0.6 million in the first quarter of 2009. Growth in IPTV subscribers as Mike mentioned and the shift in to high definition services in Alabama exceeded attrition in basic customers as a result of the sluggish economy. Internet revenue for the first quarter of 2010 was basically flat remaining at $3.5 million for both periods. Growth in broadband data lines was offset by the continued attrition of dial-up subscribers. Approximately 25% of our other internet customers those outside of our RLEC service territories receive high speed broadband services from Otelco today, that therefore slowing this rate of attrition.

Transport services was also basically flat holding at $1.4 in both periods. Operating expenses in the first quarter decreased 5.3% to $19.9 million from $21 million a year ago. Cost of services decreased half a percent to $10.5 million in the quarter from – $10.6 million in the quarter from $10.7 million in the same period last year. Operation and network synergies including network consolidation from the acquisition as well as lower directory costs in Alabama, more than offset higher access cost and sales agent expense associated with the CLEC revenue and higher total resale cost in Missouri.

Selling, general and administrative expenses decreased 9.7% to $3.2 million in the first quarter from $3.6 million a year ago. The decrease reflects synergies from completion of the acquisition con Country Road reduced legal and insurance costs and lower additions to our uncollectible reserve. These savings were partially offset by higher salaries, IT increases and higher operational and property taxes.

Depreciation and amortization for the first quarter of 2010 decreased 10.4% to $6.1 million from $6.8 million in the first quarter of 2009. Amortization of intangible assets associated with the Country Road acquisition decreased $0.6 million including covenant not to compete and contract customer base assets. The remaining decrease of $0.1 million reflected lower depreciation plan assets in Alabama.

Interest expense also decreased by 9.2% to $6 million in the first quarter from $6.6 million a year ago. Half of that decline reflects the interest rate caplet expense present in first quarter 2009 that was a fully expense during 2009. The difference reflects a reduction of $5 million in principal from 2009 to 2010 and lower LIBOR rates but partially offset by fixed rate swap impact of our second swap which became effective in February of 2010.

The interest rate swaps help limit the Company’s exposure to upside changes in the interest rates through February of 2012. Adjusted EBITDA as Mike mentioned for the first quarter was $12.3 million compared to $11.5 million in the same period of 2009 and $12.2 million in the fourth quarter of 2009.

The cash payout ratio as we express had dropped below 80% for the first time since we publicly began reporting results. Cash flow from operations was $7.5 million for the first quarter compared to $6.3 million a year ago. Cash used in investing activities for the quarter amounted to $1.7 million compared to $1.2 million a year ago basically that’s all capital, purchase or property and equipment. Cash flows from financing activities for the quarter amounted to $2.2 million flat the year ago and reflecting continued payment of our dividends.

Turning to the balance sheet, we had cash and cash equivalents of $21.2 million compared to $17.7 million at the end of 2009. Total long term notes payable were unchanged at $272.7 million. The Company continues to meet all of its loan covenants. The Company expects also to convert the Class B shares held by the original selling share owners into IDS units in June as requested by the Class B share owners that’s a one-per-one conversion.

The first quarter distribution of $5.3 million in interest in dividends to our shareholders and $0.3 million in interest to our bondholders occurred on March 30. Again that represents the 21st consecutive quarterly distribution since we went public in December of 2004.

Jessica, if you will provide directions, we can take questions at this time.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We will go first to Jason Fraser with Raymond James.

Jason Fraser – Raymond James

Hi great, thanks. Good morning guys. Just real quick, I wondered if you could talk a little bit about what you’re seeing at a Fair Point up in New England properties. Are you seeing any increase or decrease in the backlog and also if you could just briefly update us on the install times going there and any thoughts on New England at this point will be great? Thanks.

Michael Weaver

Thank you, Jason. Fair Point on an operational level is we’ve been for quite a period of time. I’d say that it’s no better or no worse than it has been. The frustration with that is it continues to defer revenue opportunities for us. As you’ve heard me say on prior quarterly calls, it’s my opinion we’ve not lost any revenue or customers as a result of that but it’s certainly slows our ability to expand our operations into New Greenfield locations.

The installs are continued to run significantly behind what a normal schedule would be. We’ve learned how to deal with that, I guess is probably the best answer to say because it’s been the status quo for quite sometime now and I remain skeptical that there will be any of the improvement in that until after Fair Point exits the bankruptcy.

Jason Fraser – Raymond James

Great. Thanks very much and congratulations on the quarter.

Michael Weaver

Thank you.

Operator

We will go next to Tim Horan with Oppenheimer.

Tim Horan – Oppenheimer

Thanks guys. Good quarter. Mike or Curtis, do you think this is kind of a good run rate for the rest of year in terms of revenue and margin on EBITDA around those $26 million of revenue and 47.8% of EBITDA, what can maybe drive that up or down a little bit?

Michael Weaver

Curtis is probably better equipped to answer this and let me defer that question to him.

Curtis Garner

Tim, I think the answer to that is yes, as Mike mentioned on Fair Point, one of the expansions we plan for this year to help offset any declines in the traditional RLEC side of the businesses moving into New Hampshire and they have slowed our request for access to two key central offices up there. And so that will have an impact on some of the growth. But the short answer is yes, I think you can see that kind of revenue and EBITDA on a going forward basis.

Tim Horan – Oppenheimer

Great. And I know it’s longer term, but I mean it seems like it should be relatively stable next year also, maybe EBITDA slightly increasing as the investment kind of pays off and going to some of these new territories?

Michael Weaver

I think –

Curtis Garner

That’s – go ahead Mike.

Michael Weaver

I am sorry, Curtis. That’s a good assumption, Tim. We – as I think we mentioned to you before, we are actually planning on the increases in all of our territories, in all of our primary territories. But the big driver there will be actually like the operations in New England. We plan to have either five or six new co-location sites and the significance of that is, off those five or six, three of those are in new Greenfield opportunities. And what I mean by that in territories where we have not attempted any sales efforts. And we are actually quite excited about that.

In addition to that, we have introduced the new product in New England of a hosted PBX service. It’s proving to be quite popular with our customer base. So we are looking for growth from the expansion of the new co-location sites and the product in New England. In Alabama, as I mentioned, we continued to expand our IPTV service. In addition to that, starting May 1st, we rolled out a complete new marketing campaign to focus one of the highlights of that is to bring attention to the IPTV service, it’s in areas where we have never offered cable TV before work, so we need to make that – make our customers more aware that we are in that market.

In Missouri, we continue to expand the wireless Internet. We think that product has served us well. It works well. So the combination of the expansion of – for CLEC, the IPTV’s expanded service, and the new wireless Internet operations in Missouri are what we think will result in an increase in 2011. And frankly, we hope to start seeing some of that – some of those increases and the benefit of those expenditures in the latter part of this year.

Tim Horan – Oppenheimer

Got you. Since I wasn’t kind of aware of that, but we have in fact we have modeled in much revenue growth for ‘011, ‘012, you think it could be kind of in the 1% range, 2% as you think about (inaudible) long way out and it’s going to depend on economy.

Michael Weaver

It does Tim. It depends on the economy and it really depends almost primarily the speed with which we can deploy the new co-location sites in New England. Those are certainly within the range that we have modeled ourselves for increases. As Curtis mentioned, we are slightly behind schedule on the New Hampshire project and that’s the – that of course delays in your growth until we can get that product up and running. But I think 1% to 2% at a minimum growth in the revenues is certainly what we have modeled for that.

Tim Horan – Oppenheimer

Great, and sorry to monopolize here for a little bit. There, on the acquisition front, I know you mentioned RLECs. But are there any CLEC type businesses or businesses that are peripheral to telecom that you could add on that maybe an opportunity for M&A here in the next year or so.

Michael Weaver

Yes, we are looking hard for that Tim, and I am glad you asked that question, because just expand on those great comments and the ideal candidate for us. We still like the RLEC business, but we like it RLECs with other non-regulated sources of income. The Country Road and Mid Maine acquisitions which were our last two – those type of acquisitions are ideal for us and that they have RLEC operations and you have that stability of the revenue flow, plus you have the opportunity to grow it with the CLEC operations.

Certainly CLEC operations in adjoining states are always of interest to us as our fiber networks, we – a combination of revenue streams and a diversification in a way into more non-reg again like a CLEC or a fiber network. Those are the really good type of opportunities we shifted our focus to be more on that than just the traditional RLECs. As I said, we love the RLEC business, but we also – the ideal candidate for us would have a combination of regulated and non-regulated type businesses, so we can diversify the revenue.

Tim Horan – Oppenheimer

Are you seeing much opportunity in the wireless backhaul business, it seems to be fairly hard topic with a bunch of peers. And I guess related to that, are you opting to broadband speeds of your existing customers and capabilities, it seems to be a hot button for the MCC right now?

Michael Weaver

We are. The answer to both of those questions is yes. On the backhaul business, one of the things that we have done is we have mapped out our where our network runs in proxy, where there is close proximity to existing wireless carriers. And we want to be proactive on that and actually – and we are actually going out and contacting the wireless carries and so.

Particularly in Alabama and New England, we have good extensive networks and we can haul that traffic as efficiently and effectively as anyone else and we perhaps even cheaper than what they are paying now. So we do see. You are right. That is an opportunity for us and one that we are trying to capitalize on. What was the second part of your question?

Tim Horan – Oppenheimer

The second part was really just your RLEC of broadband speeds is kind of a hot button item for the FCC to kind of get those speeds up a little bit. I wonder if you can focus on that.

Michael Weaver

We have and particularly in New England, what we are trying to do and some commitments that we have made is we want to get that speed up to like six mix and throughout the majority of our territory. Parts of our territory in New England have that capability today and we are – part of our CapEx for 2010 is to increase the speeds not just in New England, but in Alabama and Missouri as well.

The demand in Missouri perhaps they have seen at this point in time seems to be slightly behind where it is in our other two primary states. So that – so we are focusing first on New England in Alabama. But yes, the answer to that is yes. And it’s driven not our desire to do that, it’s driven not so much by the regulatory environment. But simply, we believe that the demand is there and the demand that that will continue to be something that our customers want is just faster speed which, of course, means just more bandwidth.

Tim Horan – Oppenheimer

And on – just lastly on the tele front, can it be meaningful CapEx expenditure or revenue driver, Qwest was talking about of fairly meaningful numbers and some of your peers are also.

Michael Weaver

It could be and I don’t want to mislead you. We have – we are in the early stages of that as far as identifying the CapEx and potential revenue opportunities for us. Ideally, you could get a long-term contract where you know that your costs were more than covered with any incremental CapEx that you needed to make in order to provide exactly the service that the wireless guys would want. Our moms indicated that’s – that all works from a number standpoint, but we have yet to execute on that plan.

Operator

And we have no further questions.

Michael Weaver

Right, just in closing, I just want to say as always, thank you for joining us on the call. And the questions were insightful and we look forward that you are joining us again in three months for our next call. Thank you.

Operator

That concludes today’s conference. Thank you for your participation.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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