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Executives

Kevin Inda - IR

Alan Wells - Chairman and CEO

Craig Knock - VP, CFO and Treasurer

Analysts

Simon Flannery - Morgan Stanley

Chris King - Stifel Nicolaus

Patrick Rien - Lehman Brothers

Jason Frazier - Raymond James

Todd Rethemeier - Soleil Securities

Iowa Telecommunications Services, Inc. (IWA) Q3 2007 Earnings Call November 7, 2007 9:00 AM ET

Operator

Good day, and welcome to the Iowa Telecom IncorporatedConference Call. Today's call is being recorded. At this time, for openingremarks and introductions, I would like to turn the call over to Mr. KevinInda. Please go ahead, sir.

Kevin Inda

Thank you, Rianne. And welcome to this Iowa Telecomconference call to review the company's results for the third quarter endedSeptember 30, 2007, which were released this morning.

During today's call, we'll refer to certain non-GAAPfinancial measures. We reconcile these measures to GAAP figures in our earningsrelease, which is available on our website at www.iowatelecom.com.

Conducting the call today will be Alan Wells, Chairman andChief Executive Officer, and Craig Knock, Vice President, Chief FinancialOfficer, and Treasurer.

Before we start, let me offer the cautionary note that thiscall contains forward-looking statements that are not based on historical fact,including, without limitation, statements containing the words beliefs, may,plans, will, estimate, continue, anticipates, intends, expects, and similarexpressions. Such forward-looking statements involve known and unknown risks,uncertainties, and other factors that may cause actual results, events, ordevelopments to be materially different from future results, events, ordevelopments described in the forward-looking statements. Such factors includethose risks described in Iowa Telecom's Form 10-K on file with the SEC. Thesefactors should be considered carefully, and listeners are cautioned not toplace undue reliance on such forward-looking statements.

All information is current as of the date of this conferencecall. And Iowa Telecom undertakes no duty to update this information.

With that stated, I'll turn the all over to Alan Wells.

Alan Wells

Thank you, Kevin, and good morning. We're glad you joined usthis morning as we review our results for the third quarter of this year.

I'd like to take a few minute to focus on our operational andfinancial highlights and then update you on several market-related topics whichwe discussed in last quarter's call. Craig Knock, our CFO, will then review thefinancial results in more detail and we'll then take your questions.

We are very pleased with our third quarter results, whichwere in line with our expectations, both operationally and financially. Ourrevenues, our adjusted EBITDA improved over the levels of a year ago, and ourDSL product sale continued to grow as we added 2,700 new customers during thequarter.

As we noted on our last quarter's conference call, Mediacomentered many of our markets with a voice service [going] into the secondquarter of 2007, and therefore we have expected to have somewhat higher thannormal access line losses in the near-term. Our access line loss for thequarter of 4,400 lines was consistent with our expectation. The line loss isprimarily residential and the increase in the rate of loss was attributable toMediacom's initial market entry.

Despite the slightly higher access line loss, total revenuefor the quarter increased 1.9% to $60.8 million as compared to the year agoquarter, primarily as a result of our DSL growth and the expansion of our CPEand data business. Operating income for the quarter was $18.8 million andadjusted EBITDA was also up, increasing to $31.9 million.

Our net income was $6.3 million or $0.20 per diluted share,compared to net income of $8 million a year ago. The change in net income wasprimarily the result of a $2.9 million gain we recorded in the sale of fourexchanges during the third quarter of 2006 that Craig will review in a fewminutes.

As a reminder, in 2006 we began to record book income taxexpense due to our current tax position. Our net income for the quarter wasimpacted by book income taxes of $4.5 million. It's important to note that thisincome tax charge is primarily non-cash in nature, and thus does not impacteither our cash flow or ability to pay dividends. Despite this charge in theincome statement, our actual cash payments for income taxes during the quarterwere only $52,000 and were only $494,000 for the first nine months of thisyear, reflecting the usage of our net operating losses and our continued goodwill amortization for tax purposes.

Our capital expenditure was $6.6 million in the quarter andour cash interest expense was $7.8 million. Both of these levels are on trackwith our 2007 guidance and we continue to expect our CapEx a little between $25million and $27 million for the year and expect cash interest expense tobetween $30 million and $32 million.

As I previously stated our total access line loss was 4,400lines during the quarter, as ILEC lines declined by 4,700 lines and CLEC linesincreased by 300 lines. Our DSL products continue to have solid growth as weadded 2,700 more DSL customers this quarter. Although our distance subscribersdeclined slightly during the quarter we attribute most of this decline on longdistance to some increased competition and a fewer markets and as a by productwere access line losses. Nonetheless, our long distance penetration continuesto remain strong and nearly 60%.

I'd now like to turn my discussion to the competitivelandscape and provide a very brief update on Mediacom's entry into some of ourmarkets with voice service. As most of you know Mediacom launched voice offeringsin 100 of the communities within our service area through a businessarrangement with Sprint midway through the second quarter of 2007. We have seenno major changes in Mediacom's offering since our last conference call. Wecontinue to believe their focus primarily is residential customers within thecity limits of our ILEC markets where they have launched service. While thefirst full quarter in which Mediacom's is competing for voice service in our marketsis also in some of the higher access line losses for us. We believe thepreparations we have made for Mediacom's market entry are proving successful.Our DSL broadband service continues to have strong growth as importantcomponent of our bundle offerings.

Furthermore our video service included our bundled packagesenabled through our partnership with Echostar's dish network is proving to bean attractive low cost alternative for our customers.

While we expect, we may continue to have slightly higherthan normal access line losses due to Mediacom's market entry in the near-term.We continue to believe that customers will find our bundle packages, includingour dish service, to be a very attractive and economical alternative.

Furthermore, we believe the strong financial results for thequarter reflect our emphasis on and success in our CLEC data and CPEoperations, which were not that materially impacted by Mediacom's market entry.

In closing, we are very pleased with our financial andoperating results for the first nine months of the year. Looking ahead, weintend to continue our efforts to grow our DSL product penetration, our bundleofferings, and our CLEC, CPE and data businesses. We will also continue to evaluateor pursue acquisition opportunities that meet our free cash flow focus and planto continue return a significant portion of our cash flow back to ourshareholders in the form of our dividends.

I'll now turn the call over to Craig Knock, who will reviewour third quarter financial and operating results in some more detail. Craig.

Craig Knock

Thank you, Alan, and good morning, everyone. Since you haveaccess to our full news release, let me review certain of the financialhighlights for the quarter, and then we will take your questions.

Overall, operating revenues for the quarter were $60.8million, compared with $59.6 million in the third quarter of 2006, reflectingan increase of $1.1 million, or 1.9%. Local service revenues decreased $763,000,or 4% for the quarter. The decrease is primarily due to access line erosion,however, this was partially offset by higher revenue from enhanced localservices and local rate increases. Network access revenues decreased $47,000 or0.2% for the quarter. The decrease is primarily due to access line erosioncombined with a decrease in [DSL] revenue. However, these were partially offsetby an increase in switched access revenue.

Long distance revenues decreased by $234,000 or 4.3% for thequarter. The decrease in revenue is due to decreases in both the number of longdistance customers, which decreased by approximately 500 or 0.3% and in theaverage minutes of use per customer.

Other services and sales increased $2.2million or 19% forthe quarter. DSL internet access service revenues increased $1.5 million, or33.6%, due primarily to customer growth. This increase was partially offset bydecreases in dialup internet revenue of $503,000. Additionally the revenueincrease was due in part to growth of our CPE and data business, principally asa result of our acquisition of Baker Communications in August 2006.

Cost of services and sales increased $1.4 million, or 7.8%for the quarter. The increase was principally due to the growth of our CPE anddata business, driven by our acquisition of Baker Communications in August oflast year, as well as some additional operating costs for our newly acquiredcorporate headquarters.

SG&A cost increased $2.1 million, or 24.8%, primarilydue to a non-recurring benefit in 2006. The third quarter of 2006 reflected thebenefit of a $2.9 million gain on sale of exchanges. Excluding this non-recurringitems, SG&A costs actually decreased by approximately $800,000.

Depreciation and amortization increased $565,000, or 4.8%for the quarter, as compared to the same period in 2006, primarily due tohigher average [plant] balances.

Operating income was $18.8 million for the quarter, comparedto $21.7 million a year ago. Again, the change is principally attributed to the$2.9 million gain on sale of exchanges in 2006. Interest expense increased$18,000 or 0.2% for the quarter. This is due to higher interest rates on theterm loans fee and partially offset by a lower average balance on a revolving creditfacility.

In terms of income tax expense, we reflected $4.5 million inbook income tax expense during the quarter, compared to $5.6 million last year.We continue to estimate that book income tax expense will be recorded in aneffective tax rate of approximately 41% in future periods.

The recorded book tax expense did not impact the cash taxespaid during the quarter. Again, let me remind everyone as related to cashincome taxes, the book accounting for income tax expense does not change ouroutlook for paying cash income taxes as we continue to expect an overwhelmingmajority to be deferred. Again, we have a very strong tax shield positiondriven by our continued goodwill amortization at a rate of approximately $40million per year through June 2015, coupled with our existing NOL ofapproximately $158 million.

Both of these items will shield us from material cash incometaxes for a good number of years. However as we previously disclosed we may berequired to pay nominal amounts of cash taxes in the near-term. And as noted inthe release we paid cash income taxes of $52,000 during the third quarter and $494,000for the first nine months of the year.

The bottom line for us this quarter was net income of $6.3million or diluted earnings per share of $0.20 compared with $8 million ordiluted earnings per share of $0.26 a year ago. A change from the prior periodwas primarily due to the $2.9 million gain on sale of exchanges in the year agoperiod. Our adjusted EBITDA as defined in the credit agreement and reconciledin the press release was $31.9 million for the quarter, up $674,000 or $31.2million from a year ago.

I would like to take a minute now to discuss our debt andrelated interest expense. As of September 30, 2007, we had outstanding $477.8million of senior debt under term facilities and $8 million drawn under our$100 million revolving credit facility, which are offset by 7.89 of RTFCcapital certificates and $4.5 million of cash. Our net debt or adjusted totaldebt, as defined in the credit agreement, was $473.5 million at quarter end.That level of adjusted total debt correlates to a leverage ratio as defined inthe credit agreement of approximately 3.6 times. Additionally, I should notethat since year end, our net debt has decreased approximately $13.9 million.

Our cash interest expense, as defined in the creditagreement, was on track with our expectations for the quarter at $7.8 million.For 2007 guidance, we continue to expect that our cash interest expense will bebetween $30 million and $32 million.

Turning to our capital expenditures, for the quarter our capitalexpenditures were $6.6 million. As Alan indicated, we continue to expect our2007 capital expenditures will be between $25 million and $27 million. Now I'dlike to summarize our cash sources and uses for the last 12 months, as theydemonstrate the strength of our ability to pay dividends. Starting withadjusted EBITDA of $131.3 million, and deducting cash interest expense of $31.5million, capital expenditures of $27.5 million and cash income taxes of $804,000,results in $71.4 million in cash available for dividends.

At our dividend rate of $1.62 per share, we paid dividendsof $51.4 million. Thus, for the trailing 12 months, our payout ratio of ourfree cash flow was approximately 72%. It is also equally important to note thatas of September, 30, 2007 we had cumulative distributable cash or actualdividend capacity, as defined in our credit agreement, of $76.3 million or saidin another way, nearly 1.5 years dividend requirement.

Overall we are very pleased with our results for the quarterand for the first nine months of the year.

Operator, we will now answer any questions. Kindly provideinstructions for the Q&A.

Question-and-AnswerSession

Operator

Thank you. (Operator Instructions). We'll take our firstquestion from Simon Flannery from Morgan Stanley.

Simon Flannery -Morgan Stanley

Thanks very much. Good morning everybody. I was wondering ifyou could give us any sort of sense on run rate, CapEx and interest expenseinto 2008, any changes due to this sort of turmoil in the credit markets toyour cost of funding on interest, and any major initiatives or savings that yousee on CapEx? And also if you can talk about any productivity initiatives orcost cutting that might help you over the next few quarters? Many thanks.

Craig Knock

Good morning, Simon and thank you for the question. Let mestart with the line of credit [jumping at us], as far as going into 2008,obviously we haven't issued guidance yet for either CapEx or interest expensein 2008. But one of the things that you probably saw was during the quarter welocked in for additional debt with the RTFC sometime, and I think it was Julyperiod, that, as a result of that we've got 90% of our debt locked in fixed ratesthrough sometime of 2011.

So I think the turmoil in the credit markets really don'taffect us too much. As with the CapEx, I think, as we go through our budgetingprocess we continue to look for ways to improve the operation both from CapExon operation and our expense side, and are continuing to do that. But nothingmajor we've announced beyond that.

Alan Wells

All right yeah. And to just to highlight on the cost offunding Simon, over 90% of our term debt is of locked at fixed interest ratesright now, so.

Simon Flannery -Morgan Stanley

Okay great. Well may be another with the way on productivitycan you just talk about trends in headcount where they have been over the lastcouple of quarters, and where you see them going?

Craig Knock

We haven't had any material changes on that, but if you lookto cost containments along those lines if you recall in the second quarter, wenegotiated a longer-term agreement with CWA and part-and-parcel to that werecertain reductions in post-retirement healthcare and that will benefit us tothe tune of roughly $1.1 million annually for the next five years.

So there are a number of items like that that we continue tofocus on in both that healthcare cost.

Simon Flannery -Morgan Stanley

Thank you.

Operator

We'll take our next question from Chris King with Stifel Nicolaus.

Chris King - Stifel Nicolaus

Good morning, guys. Two quick questions for you. First ofall, your DSL penetration has certainly increased nicely over the course of thelast year or so. I think you guys are running it right around 25% penetrationof your total access line count at this point. How do you see that trendplaying itself out over the course of the next year or so, in other words, Iguess what ultimate level of penetration by the end of 2008 do you think isreasonable to assume now?

And secondly, in terms of long distance revenues, it lookslike your long distance revenue per subscriber has been slipping a little bitover the course of the last couple of quarters. I was wondering if that wasmore of a result of a lower pricing or lower minutes of use or some combinationof both? Thanks.

Alan Wells

Good morning, Chris. Thanks for the question. Let me startwith the DSL sale and let Craig talk about long distance. I think, we continueto think our DSL penetration can grow as time goes by.

If you look at -- as you have said, we have had increasedpenetration for quite sometime, I think that's going to continue. Probably likea lot of the rest of the industry, we think the rate of growth is going to slowa bit, just because it’s been on a pretty strong trajectory in the past severalquarters. But we think there is still quite a bit of room on DSL. We don’tprovide guidance on penetration rates, but it wouldn't be out of line if wecontinue this pace for quite some time.

Craig, as far as LD?

Craig Knock

Yeah, Chris you hit on the key points for LD. Minutes usedper subscriber have gone down just normally over the past several quarters aswe believe, more folks are using wireless substitution for their LD usage. Wehaven't really changed pricing on a downward basis, but for bundling packagesand so forth, that we have done. And again, this is not really a real growtharea for us, but it's still a meaningful revenue stream to us.

And just one other point on the DSL, to help expand thatnumber if you recall, we have estimated in the past that we can have DSL reachto about 75% to 80% of our network as we continue to expand that out furtherinto the network. We envision we will be able to pick up additional customersfrom there.

Chris King - Stifel Nicolaus

Thank you.

Operator

And we will take our next question from Patrick Rien ofLehman Brothers.

Patrick Rien - LehmanBrothers

Good morning, and thanks for taking my question. Just a followup on that in terms of the DSL penetration, are you able to break out what yourpenetration rates are in the areas where Mediacom is providing service? Andthen also, can you break out maybe what [speed] offerings you have there andhow that compares to what Mediacom has? And then just one last final question,it looks like in the Mediacom results they had kind of a flatquarter-over-quarter in terms of net ads. So we would assume, maybe there issome high level of churn, that they are seeing, are you guys starting to seeany defectors come back to you, and if there is any general trends there?Thanks.

Alan Wells

Okay. Good morning Patrick. Yeah on the DSL penetration bymarket we haven't broken that out historically or publicly but as we've said Ithink several quarters ago we believe that we were perhaps first to market inmany of the key media compounds and so I think that we perhaps probably have ahigher market share in those areas relative to high speed internet.Specifically to your speed question I think we talked on last quarter that weannounced a new product and I'll probably get this wrong but we call it extremeDSL and that was in approximately 65 -- 68 of our top markets and though wehave speeds up to 15 meg depending on location and proximity to the centraloffice. So with that I think that we have you know a product parity if notperhaps even better than what the cable guys can offer relative to that. And asfar as diffractions of course we monitor that and we monitor all the losses, wemonitor who comes back but there is no stats that we would put out at thisjuncture.

Patrick Rien - LehmanBrothers

Okay, all right. Thanks a lot guys.

Alan Wells

Thank you, Patrick.

Operator

Our next question comes from Jason Frazier with Raymond James.

Jason Frazier -Raymond James

Hey good morning. As you guys could talk really about anyeconomic impact you guys have been seeing here over the last quarter or two ifthere is anything at all going on there where expectations are for that goingforward and also just what you guys have been going to do with the excess freecash flow where your priorities are buy back, debt pay down what your plansare? That will be great. Thanks.

Alan Wells

Jason, thank you for the question. I think as the general economictrends probably they are not a lot of different for us from [half of] the restof the nation. I think we've seen housing slow downs and some decline inspending levels but I think probably whatever you see for the rest of thecountry that wouldn't be different by our markets. As far as excess cash flowwe have said for quite some time we continue to evaluate what the right thingfor us to do with our extra cash is as you know we generate, I think based uponthe last 12 months $70 million of $80 million of extra cash flow by way of ourdividend pay out and historically we've used that to make acquisitions toreduce our debt. We reduced our debt so far this year by above $13 million andwe'll continue to evaluate that on an ongoing basis. It's a regular topic forour discussion about should we buy something with that, that's as cash flowaccretive on a per share basis, should we pay it on debt, should we buybackstock or should we do I think that's an ongoing discussion.

Jason Frazier -Raymond James

Great, thanks.

Operator

(Operator Instructions). Our next question is from ToddRethemeier from Soleil Securities.

Todd Rethemeier -Soleil Securities

Thanks, good morning. Could you may be talk about the CLECbusiness a little bit. There seems to be a drop in the access lines are down to300 houses this quarter and then obviously about debt this quarter and how doesthat compare to your [last]? Thanks.

Craig Knock

Good morning, Todd. This is Craig, just a couple ofcommentaries on our CLEC, as we've kind of talked about over the past severalquarters. We are not so much focused on an absolute growth in CLEC numbers. Weare much more business focused now and what we are seeing is a constant changeto a more business focus and I can tell you just over [the quarter] of pastyear, we've gone from roughly one-third business to nearly 45% of our productmix as business customers. So we have had churn out in some of the residentialbut we are much more focused on the business market and therefore our ARPU's aregoing up and the business customers are much more, stickier and churn out lossand they are frankly more profitable for us. So that's what we've focused onnow relative to the CLEC business. As to bad debt of course we monitor that butI don't think that we have necessarily the subprime meltdown or anything likethat impacting our overall customer base and we don't have any [note book]churn relative to our bad debt.

Is that it?

Operator

Thank you. There are no further questions. For closingremarks, I will turn the call back over to Mr. Alan Wells.

Alan Wells

Well thank you again for joining us this morning. Weappreciate your time. We welcome your questions and hope you can join us againon the next quarter's call. Thank you.

Operator

This concludes today's conference. You may now disconnectand have a good day.

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Source: Iowa Telecommunications Services Q3 2007 Earnings Call Transcript

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