Iowa Telecommunications Services, Inc. Q1 2008 Earnings Call Transcript

Iowa Telecommunications Services, Inc. (IWA)

Q1 2008 Earnings Call Transcript

May 1, 2008 9:00 am ET

Executives

Alan Wells – Chairman and CEO

Craig Knock – CFO, Vice President and Treasurer

Kevin Inda – IR, Corporate Communications, Inc.

Analysts

Chris King – Stifel Nicolaus

Simon Flannery – Morgan Stanley

Jonathan Chaplin – JPMorgan

Frank Louthan – Raymond James

Patrick Rien – Lehman Brothers

Michael Nelson – Stanford Group

Dave Coleman – RBC Capital Markets

Presentation

Operator

Good day and welcome to the Iowa Telecom conference call. Today's call is being recorded. And at this time for opening remarks and introductions, I would like to turn the conference over to Mr. Kevin Inda. Please go ahead, sir.

Kevin Inda

Thank you, Yolanda, and welcome to this Iowa Telecom conference call to review the company's results for the first quarter which ended March 31st which were released this morning. During today's call, we will refer to certain non-GAAP financial measures and we have reconciled these measures to GAAP figures in our earnings release, which is available on our Web site at iowatelecom.com. Conducting the call today will be Alan Wells, Chairman and Chief Executive Officer; Craig Knock, Vice President and Chief Financial Officer and Treasurer.

Before we start, let me offer the cautionary note that this call contains forward-looking statements that are not based on historical facts, including without limitations statements containing the words believes, plans, will, estimate, continue, anticipates, intends, expects, and similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, events or developments to be materially different from future results, events or developments described in the forward-looking statements. Such factors include those risks described in Iowa Telecom's Form 10-K on file with the SEC.

These factors should be considered carefully and listeners are cautioned not to place undue reliance on such forward-looking statements. All information is current as of the date of this conference call and Iowa Telecom undertakes no duty to update this information.

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

Alan Wells

Thank you, Kevin, and good morning. We're glad you joined us this morning as we review our first quarter results. I want to take a few minutes to focus on our operational and financial highlights and then update you on several market-related topics which we discussed on last quarter's call. Craig Knock, our CFO, will then review the financial results in more detail and we'll then take your questions.

Overall, our business delivered excellent results in the first quarter. In terms of our financial highlights, total revenue remained steady at $60.8 million. Operating income for the quarter was $19.5 million, our adjusted EBITDA was $33.3 million, and our net income was $7 million or $0.22 per diluted share. As a reminder, our first quarter of 2007 results included $4.8 million of one-time revenue from the resolution of some non-recurring network access billing matters, which negatively impacted this quarter's year-over-year comparisons.

Our income tax expense for the quarter was $5 million compared with $7.3 million a year ago. Craig will elaborate on income taxes during his remarks, but it is important to note this income tax charge is primarily non-cash in nature and thus does not impact either our cash flow or ability to pay dividends. Despite this income tax charge in the income statement, our actual cash payments for income taxes during the quarter were only about $4,000, reflecting the usage of both our net operating losses and our continued goodwill amortization for tax purposes.

Our capital expenditures were $5.9 million in the first quarter and were in line with our expectations. For 2008, we continue to expect our capital spending for the year will be similar to 2007 levels and will be between $26 million and $28 million. Interest expense for the quarter excluding amortization of debt issuance costs was $7.6 million and was on track with our guidance of between $29 million and $31 million. Our 2008 guidance for both capital expenditures and interest expense is exclusive of any expenditure for the pending Bishop acquisition which I'll discuss in a few minutes.

Overall, our financial results for the quarter were excellent reflecting the continued success of our DSL service and our ability to control expenses and maintain our margins. Our total access line loss was 3,700 lines during the quarter as ILEC clients declined by 4,000 lines and CLEC clients increased by 300 lines. This compares to a loss of 3,800 ILEC clients and an increase of 800 CLEC clients in the fourth quarter of 2007.

Our line loss for the first quarter included approximately 400 lines caused by the disconnection of what we call Cyber Pops [ph] or wholesale services that are used to provide dial-up Internet service to competing ISPs and the loss of approximately 100 lines related to the Maytag plant closing here in Newton.

Apart from these unusual events, we believe the majority of our ILEC line losses continue to be attributed to the increased cable competition in several of our markets along with wireless substitution consistent with the prior several quarters.

We are very pleased with the success of our DSL offering. Our DSL product continues to grow as do our bundled products. We added 3,000 DSL customers during the quarter, an increase of 800 over the number of customers added during the fourth quarter. It is important to note that despite the total access line loss of over 14,000 lines a year ago, total revenue excluding the previously noted $4.8 million of one-time non-recurring network access revenue in 2007 was generally in line with the first quarter of last year. Our ability to sustain our revenue despite access line losses is primarily the result of our DSL growth and the expansion of our CPE and data business, and reflects the increased dependence on other revenue sources by us and others in our industry.

I'd now like to turn my discussion to competitive landscape and provide a very brief update on the competitive situation in some of our markets. We've seen no major change in Mediacom's offering since our last conference call. I continue to believe they are focused primarily on residential customers within the city limits of our ILEC markets where they have launched service.

We continue to respond to the efforts [ph] of Mediacom and other competitors for our DSL broadband service, the important cornerstone of our bundled offerings. Our video offering included in our bundled packages and enabled through a strategic partnership with EchoStar's DISH Network, we believe is proving to be an attractive, low-cost alternative to our customers.

Looking ahead, we intend to continue our focus on free cash flow by increasing our sales of additional enhanced services such as DSL and our bundled offerings. We also intend to continue to expand our CPE and data services to business customers. In addition, through our competitive local exchange carrier subsidiaries, we intend to continue to selectively pursue customers and markets in proximity to our existing markets.

And finally, we will continue to pursue selective acquisitions that are in line with our free cash flow focus and that clearly meet our criteria for acquisitions to be accretive to free cash flow on a per share basis such as our recently announced acquisition of Bishop Communications.

As it relates to Bishop Communications, we continue to be very excited about this transaction. We've received all but one of the required regulatory and franchise approvals necessary and expect remaining approvals in the next month. As a result, we believe the transaction is on a quicker path than we originally announced and are hopeful to close the acquisition in the third quarter of this year.

And finally, as many of you know, during the quarter, the FCC's 700 MHz auction was concluded and we were the winning bidder on three RSAs in Iowa. As a result of the spectrum acquired in this auction combined with the AWS spectrum we acquired last year, we now have spectrum available to us which covers approximately 84% of our ILEC access lines. While we have no immediate plans to deploy this spectrum, we believe this offers us a unique opportunity to offer wireless data and other services in the future if we determine such an offering would be financially attractive to us. Nonetheless, we remain very focused on the importance of our dividend payments and do not intend to pursue any expansion plan which will put our dividend in jeopardy.

In summary, we're very pleased with our first quarter performance. I'll now turn the call over to Craig Knock, who'll review the first quarter financial and operating results in more detail. Craig?

Craig Knock

Thank you, Alan, and good morning everyone. Since you have access to our full news release, let me review certain of the financial highlights and then we will take your questions.

Overall, operating revenues for the quarter were $60.8 million compared with $66.5 million in the first quarter of 2007, reflecting a decrease of $5.7 million or 8.5%. As a reminder, the year ago period included the previously discussed $4.8 million in revenue from non-recurring network access billing matters. On an adjusted basis, total revenues decreased approximately $850,000 or 1.4%.

Local service revenues decreased $1.2 million or 6.1% for the quarter. The decrease is primarily due to loss of access lines. However, this was partially offset by higher revenue from enhanced local features included in our bundled offerings. Network access revenues decreased $6.6 million or 22.6% for the quarter. The decrease is primarily due to the $4.8 million in revenue discussed previously in access line erosion.

Long distance revenues increased by $480,000 or 8.9% for the quarter. The increase in revenue was due to implementation of customer connection charges partially offset by fewer long distance customers and a decrease in average minutes of use per customer. Data and Internet services increased by $1.1 million or 16.3% for the quarter. The increase was primarily due to growth in DSL Internet access revenue which increased $1.3 million and growth in our data solutions product. This was partially offset by declines in our dial-up business.

Other services and sales increased by $510,000 or 8.5% for the quarter. The revenue increase is primarily due to higher revenue from our CPE and data business. Operating income was $19.5 million for the quarter compared to $25.6 million a year ago. The change is principally due to $4.8 million in revenue previously discussed.

Our total operating cost expenses increased $448,000 or 1.1% for the quarter. Cost of services and sales increased $237,000 or 1.3% due to cost of CPE sales. SG&A cost decreased $366,000 compared to a year ago primarily as a result of lower employee-related cost and as well as marketing cost.

Depreciation and amortization increased $577,000 or 4.8% due to higher plant balances. Interest expense decreased $314,000 or 3.9% for the quarter. This was due to a lower average balance on our revolving credit facility and lower rates on our variable rate debt.

In terms of income tax expense, we've reflected $5 million in book income tax expense during the quarter compared to $7.3 million last year. The recorded book tax expense did not impact the cash taxes paid during the quarter. Again, let me remind everyone as it relates to cash income taxes, the book accounting for income tax expense does not change our outlook for paying cash income taxes as we continue to expect overwhelming majority to be deferred.

Again, we have a very strong tax shield position driven by our continued goodwill amortization at the rate of approximately $40 million per year through June 2015 coupled with our existing NOL of approximately $152 million. Both of these items will shield us from material cash income taxes for a good number of years. However, as we previously disclosed, we may be required to pay AMT cash taxes in the near term. And as noted in the release, we paid cash income taxes of $4,000 during the first quarter. The bottom line for us this quarter was net income of $7 million or diluted earnings per share of $0.22 compared with $10.5 million or diluted earnings per share of $0.33 a year ago.

Our adjusted EBITDA as defined in our credit agreement and reconciled in our press release was $33.3 million for the quarter compared with $38.4 million a year ago. Our adjusted EBITDA for the 12 months ended March 31, 2008 was $129.1 million.

I'd like to take a minute now to discuss our debt and related interest expense. As of March 31, 2008, we had outstanding $477.8 million to senior debt under the term facilities and $3 million drawn under our $100 million revolving credit facility, which are offset by $7.8 million of RTFC capital certificates and $5.5 million of cash.

Our net debt or adjusted total debt as defined in the credit agreement was $467.5 million at quarter end. That level of adjusted total debt correlates to a leverage ratio as defined in the credit agreement of approximately 3.6 times. Our cash interest expense as defined in the credit agreement was on track with our expectations for the quarter at $7.6 million.

For 2008 guidance, we continue to expect that our cash interest expense will be between $29 million and $31 million excluding any increases related to the pending Bishop acquisition.

Turning to our capital expenditures for the quarter, our capital expenditures were $5.9 million. As Alan had indicated, we continue to expect that our 2008 capital expenditures will be between $26 million and $28 million, exclusive of any expenditure related to Bishop.

Now, I'd like to summarize our cash sources and uses for the last 12 months as they demonstrate the strength of our ability to pay dividends; starting with adjusted EBITDA of $129.1 million and deducting cash interest expense of $31 million, capital expenditures of $26.2 million, and cash income taxes of $634,000, results in $71.2 million in cash available for dividends. At our dividend rate of $1.62 per share, we paid dividends of $51.5 million. Thus, for the trailing 12 months, our payout ratio of our free cash flow was approximately 72.3%.

It is also equally important to note that as of March 31, 2008, we had cumulative, distributable cash or actual dividend capacity as defined in our credit agreement of $85.2 million, or said another way, over 1.5 years dividend requirement. Overall, we are very pleased with our results for the quarter.

Operator, we will now answer any questions. Kindly provide instructions for the Q&A session.

Question-and-Answer Session

Operator

(Operator instructions) We'll hear first from Chris King with Stifel Nicolaus.

Chris King – Stifel Nicolaus

Hi, good morning guys. I just had a quick question for you on your spectrum acquisition and I know you guys have said in the past that you don't have any immediate plans to do anything with that. I just was wondering if a good way to think about it would be trying to keep the spectrum out of the hands of your competitors such as Mediacom that may or may not have had interest in that or how should we think about the $5 million or so expenditure if you guys are just going to be sitting on this spectrum for the foreseeable future?

Alan Wells

Thanks, Chris. Good question. I think as we look at the spectrum acquisitions, I think we believe this offers us additional flexibility as the market for these services develop. Obviously, as you know, there's been a lot discussed and written about wireless data and the potential for that. Also keep in mind that we have quite a few CLEC lines across the state that those lines and others can also offer a market for us to offer wireless data services. And as we've looked at how that market might unfold, it seemed to us like one of the important things you'd want to have in order to maintain the flexibility that you'd like to have is spectrum. And given that it only becomes available every now and then, over the past couple of years to the last auctions, we were able to acquire spectrum that covers, again, 85% probably our ILEC lines and not quite that high that closed [ph] of our CLEC lines that exist today. And so I think at this point, we're kind of in a mode to wait and see how the market evolves, but I think in terms of additional flexibility for us down the road, it appears to be an attractive offering.

Chris King – Stifel Nicolaus

Thanks. And in terms of the dial-up Internet and the subscriber loss of about 1,700, do you have any good sense as to how many of those losses just simply went directly to your DSL products?

Craig Knock

Chris, good morning. We monitor that and we would suspect that a majority of those do migrate to one of our DSL products.

Chris King – Stifel Nicolaus

Thank you.

Operator

We'll take our next question from Simon Flannery with Morgan Stanley.

Simon Flannery – Morgan Stanley

Okay. Thank you very much. Good morning. I was wondering if you could just give us an update here on any sort of regulatory developments that you're seeing in Iowa or elsewhere and any sort of potential for some price actions over the course of the rest of the year. And also, if you could just touch on what's going on in the economy, obviously a very strong farm economy presumably that's shielding you from some of the housing and other issues we're seeing in the rest of the country but any perspective there would be great. Thanks.

Alan Wells

Thanks, Simon. Good morning. On the regulatory front, I think within the state of Iowa in particular, probably the most immediate thing that we're focused on is the proceeding the Utility Board has underway in Iowa concerning deregulation. As you recall, under the statute, our prices currently for business services other than single line business customers are deregulated. And under the statute, all of our rates were to be deregulated, retail rates, as of July 1 of this year unless the Utility Board decided to extend that for two additional years and proceeding is underway that is looking at well that should be extended or not. Again, it covers not just us but also the other larger carriers in the state and covers Qwest and Frontier as well.

So that the Utility Board I think has taken pleadings on that and I think probably at some point in time perhaps have a proceeding and issue a decision between now and July regarding whether they intend to extend that for two years. That has a pricing impact as well. And under the statute, if they decide to extend deregulation for two additional years, our ability to change prices changes, and if you recall, we're a price cap carrier in state as well under that statute to extend the price regulation for two additional years. We can change prices by up to $2 per year every 12 months for the two additional years, so we got some ability to change price if we wanted to under the statute.

As far as the economy, you're right. I think probably some of the farm economy has not been quite as hard hit and obviously with higher price -- corn price in the Midwest, that has helped some of our areas. I think though we've seen some of the same slowdowns across the state and other parts of the nation have in terms of housing, but overall, I think we have not seen a huge impact on our business caused by the economy. There's been some like there is everywhere, but it has always been significant.

Simon Flannery – Morgan Stanley

Thanks a lot.

Operator

We'll take our next question from Jonathan Chaplin with JPMorgan.

Jonathan Chaplin – JPMorgan

Thanks. Two quick questions, if I may. Apologies if you've covered this earlier in the call, but the increase we saw in total revenues, what was the driver there? When I look at it on an (inaudible) basis, it looks like it's up almost 12%. And then secondly, the rate of access line losses increased a little bit more than we expected this quarter. It is not the economy that's really driving that; is it increased competitive intensity from Mediacom or it's from smaller cable companies entering some of your markets with voice? Thanks.

Craig Knock

Good morning, Jonathan. Good note on that toll question. In my prepared remarks, I mentioned that we implemented a customer connection charge and that's something that went into effect at the beginning of the year. So, we saw the full impact of that on our LD customers or not all of the LD customers but substantially all. It's on a per account basis, so that charge is roughly $2.49 based on that LD customer accounts that we have.

Jonathan Chaplin – JPMorgan

Got it. And did that impact the decline in total subscribers at all?

Craig Knock

Yes, obviously, it had some elasticity effect but we catered that into our analysis and we're certainly moving ahead by implementing the fixed charge here.

Jonathan Chaplin – JPMorgan

Great.

Craig Knock

And in relative to your access lines of like Alan mentioned just we had a couple of unusual items that accounted for roughly 500 lines. If you take those out of the equation here, we're at better than certainly where we were in Q3 of last year relative to the Mediacom losses and frankly Q2 of last year as well.

Jonathan Chaplin – JPMorgan

Great. Thank you very much.

Operator

(Operator Instructions) We'll hear next from Frank Louthan with Raymond James.

Frank Louthan – Raymond James

Great, thank you. Now you mentioned in the comments that DSL growth and CPE and date and et cetera were changing sort of where your revenue sources are from. Can you give us – be a little bit more specific on that? It's just, again, we continue to see access lines sort of across the group trending downward and financials remaining pretty well in place, and can you give us an idea of maybe what percentage of your revenue is non-residential voice and what percentage of your costs are more variables? Give us a better color on the way your financials are staying relatively steady in the face of the access line decline. Thanks.

Craig Knock

Okay. Good morning, Frank. I don't have all your relevant stats at my fingertips but just to point out like on the toll services, there was one area that we did have some pricing power that I mentioned just a moment ago. You can see the growth in data and Internet period-over-period of knowing two or thereabouts, knowing one continued growth relative to our data services. And as Alan mentioned, our CPE and other data services, data products that we continue to grow that area. So we'll try to put some more clarity in the future in terms of units of metrics around that, but it's our continued focus on the data side.

And probably one other note that kind of ties back into your access lines is we said over the period of time on our CLEC that while we only gain 300 lines in this quarter, we continue to have a greater focus towards business customers and we have shed some of the residential customers. So, in rough numbers, a year ago, we had 40% or less than 40% business customers, and now we have nearly 50% of our mix as business customers. So, we'll continue to pick up ARPU and margin by a stronger focus on the business side.

Frank Louthan – Raymond James

Okay. Any thoughts on ramping that CLEC business up at a faster pace or looking ahead for M&A opportunities? Are there any sort of smaller CLECs in the state that may be kind of landlocked or capital constrained that may be interested in acquiring as you expand those capabilities?

Alan Wells

Good morning, Frank. Obviously, we're always looking for acquisitions that make sense to our company. And so, I think to the extent that we found a smaller sort of CLEC like you've described that would fit with us, I think we obviously would be very interested in that. As far as ramping the CLEC, we have ramped it up a bit but as Craig has said in the past few calls, we intentionally focused more on the business side of the house for CLEC operations in the past year or so, and I think we'll continue to see growth in that as we expand that.

Frank Louthan – Raymond James

And as you're expanding, are you hiring more sales people to go after that part of that market? What exactly are you doing to try and – as you ramp that up?

Alan Wells

I think we have added additional sales folks. We've increased our advertising a bit and we've tried to increase our visibility in some of the other markets, but I wouldn't say it's – I wouldn't characterize this as huge growth. I think it's steady, measured growth on our side to grow that business line.

Frank Louthan – Raymond James

Okay. Great, thank you.

Operator

We'll take our next question from Patrick Rien with Lehman Brothers.

Patrick Rien – Lehman Brothers

Good morning and thanks for taking my question. Two quick ones, first on DSL ads, it looks like the first quarter of last year was your strongest for the year. How do you expect the first quarter of this year to play out over the rest of the year? Was there some promotional activity in there this quarter or is that seasonality? I mean should we expect that to trend down from here?

Craig Knock

Good morning, Patrick. I think Q1 of last year, we were still on a big push that frankly carried over from the prior year. This year I don't think we had anything – in fact, we didn't have anything unusual in terms of our offers out there. We'll continue to push it and stress it in our marketing channels and we feel pretty good about where it's at. And in all likelihood, we'll have some seasonality throughout the summer if it ever becomes summer here in Iowa. But, we feel pretty good about our focus on DSL. Our ARPU remained strong. In fact, it's up just a little bit where it was a year ago.

Patrick Rien – Lehman Brothers

Okay, great, and then one last question on the Bishop acquisition. Is there any change or can you provide an update on how that business is running, and then in terms of your expectations or how EBITDA has been? And then have you guys started to begin the immigration process on that?

Alan Wells

Good morning, Patrick. We've obviously started to look at the planning for the transition process and while we can't take all the steps necessary to integrate that at this point, we've obviously begun to plan for that. And I think as far as that business is running, we continue to take it, it's a very good fit with us, it's doing very well. So we're happy with its EBITDA performance.

Patrick Rien – Lehman Brothers

Okay, thanks guys.

Operator

(Operator Instructions) At this time, we'll hear next from Michael Nelson with Stanford Group.

Michael Nelson – Stanford Group

Yes, hi. Thanks a lot for taking the question. Can you comment on what you're seeing from Mediacom in terms of marketing promotions and maybe what percent of your footprint now cover? And then related I guess, given the trends that you're seeing in the overall economy and from cable and wireless competition, how should we think about access lines trend throughout 2008? Thanks a lot.

Craig Knock

Yes, good morning. This is Craig. From what Mediacom offers is the best that we can tell in the market, they haven't changed materially or frankly at all over the last several months. Their price points or initial offers and their escalators after the promo period that runs off have remained substantially the same. As to the overall crossover between Mediacom overlay and Iowa Telecom, we've said in the past it's very difficult for us to estimate, but we've said roughly 35% is a number that we believe is a reasonable number out there. And we're not aware of any other competitor out there that could come in. As we've said in the past, there isn't really any other concentration of cable operators other than somebody that owns four or five systems. So there's no major brand name in here other than Mediacom.

And relative to your access line loss, I think we'll be not on different than most of our like peers and we felt that we're fairly insulated. And the Mediacom, just to refresh your memory that they came into the market in the second quarter of the last year and we saw probably what we believe would be the high watermark in the Q3 of last year and we'll continue to fight for market share from here on out.

Michael Nelson – Stanford Group

Great. Thanks a lot.

Operator

We'll take a follow-up question from Dave Coleman with RBC Capital Markets.

Dave Coleman – RBC Capital Markets

Great. Thank you very much.

Craig Knock

Good morning, Dave.

Dave Coleman – RBC Capital Markets

How's everything?

Craig Knock

Good.

Dave Coleman – RBC Capital Markets

Just remind me the number of lines Iowa has lost to the Maytag plant closing?

Alan Wells

There was roughly 100.

Dave Coleman – RBC Capital Markets

All right. And then just looking at your historical financials and comparing it for 1Q '08, it seems like the first quarter seems to be the high watermark for gross margins over the past several years. And if I'm looking at this correctly, it seems to be coming from lower cost of service and sales. I'm just wondering if there's something structurally in your business that would be causing 1Q gross margins to be higher than the rest of the year or whether the gross margins you achieved this quarter should carry through for the balance of the year.

Craig Knock

Generally, I'd like to say there's not a lot of seasonality in our business but there are specific items that do occur namely in the cost of goods sold area. Operationally, our folks aren't putting in as much overtime. There's virtually no building going on in Iowa particularly this past winter, so stuff like cable locates and operating expenses are generally down during that timeframe, so during the summer and end of the early fall, we'll see some uptick in those particular items. But generally, our margin percentages are not going to vary, a few basis points.

Dave Coleman – RBC Capital Markets

And then, just to go back to the competition from Mediacom, can you compare the access line loss this quarter versus, say, three or six months ago?

Craig Knock

I'll probably allude to certainly that Q3 was the high watermark in terms of gross access line loss. And again, that was the first full quarter that they were in, if you take out the Maytag and the Cyber Pops, which are arguably revenue neutral to us. We're in a level that is below where we were at in Q4 and certainly below Q3. I don't want to say we're out of the woods yet, but I think prospectively we'll continue to fight for market share and we'll go after our DSL customers and continue to offer our bundled products as best as we can on Mediacom.

Dave Coleman – RBC Capital Markets

Great. Thank you.

Operator

And gentlemen, there appear to be no further questions at this time.

Alan Wells

Okay, thank you. And thank you again for joining us this morning. We appreciate your time. We welcome your questions and hope you can join us again next quarter for our regular scheduled call. Thank you.

Operator

That does conclude today's conference. Thank you all once again for your participation and have a great day.

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