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Executives

Kevin Enda - IR

Michael Weaver - Chairman, President & CEO

Curtis Garner - CFO

Analysts

Peter Brey - Buena Vista Investment Management

Patrick Hayes - Golub Capital

Michael Kerrigan - Boenning & Scattergood

Otelco, Inc. (OTT) Q3 2012 Earnings Call November 7, 2012 10:30 AM ET

Operator

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

Kevin Enda

Thank you, Alicia, and welcome to this Otelco conference call to review the company's results for the third quarter ended September 30, 2012, which were released yesterday afternoon. Conducting the call today will be Michael Weaver, President and Chief Executive Officer and Curtis Garner, Chief Financial Officer.

Before we start, let me offer the cautionary note that statements made on this conference call that are not statements of historical or current fact constitute forward-looking statements. 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 historic results or from any future results expressed or implied by such forward-looking statements.

In addition to statements which explicitly describe 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 will now turn the call over to Michael Weaver.

Michael Weaver

Thanks Kevin. Good morning and welcome to the call. For the third quarter, we produced adjusted EBITDA of $11.4 million which represented a 5% increase over our second quarter results. The improvement between the quarters is primarily a result of the reduction in our work force and other cost savings measures that we implemented at the end of the second quarter. These improvements helped offset the impact from the FCC’s order which particularly impacted our CLEC in Maine with a reduction in intrastate rates and no offset from the CAF or Connect America Fund.

As we discussed in April, our contract with Time Warner for wholesale network connections will expire at the end of this year. We continue to negotiate the terms of the transition agreement with Time Warner and expect the negotiations to be concluded in the next few weeks.

As reported previously, we expect the time of the transition agreement to be through June 30, 2013. During the transition period in 2013, the revenue will decline as customers are moved from the Otelco service platform to Time Warner’s network.

We continue to aggressively work on strategic alternatives related to our existing levels of debt and strengthening our balance sheet. We are engaged in active negotiations with the lenders for a senior credit facility with respect to a potential balance sheet restructuring. In addition to Evercore Partners, an investment banking firm we hired in May, we've retained restructuring counsel in October. Together with these advisors we are evaluating our alternatives.

As provided in the terms of the indenture, the company may at its selection defer the payment of interests on the subordinated notes on four occasions for up to two quarters only to cost. The interest payment due on September 30, 2012, was deferred as announced in August which resulted in cash savings of approximately $3.5 million. Yesterday, the Board of Directors approved the deferral of interest payments that were otherwise due on December 30, 2012. This will conserve an additional $3.5 million.

We also continue to focus on operational improvements, the introduction of new products, enhancing existing services and concentrating on cost reductions and cash conservation. In Alabama, our new offering of security services to residential and business customers has been well received. In addition, the fiber installation is complete to all, but two of the county school systems in Blount County, Alabama, that’s total of 10 school contracts and those are finished.

We outsourced our first hosted PBX system in Western Massachusetts and continue to grow this product in New Hampshire and Maine. Our Missouri operations have plans for two more locations to introduce our wireless internet offerings. Thanks to creative negotiations and transport, we will further reduce our long distance cost for the services that we provide to our customers.

Curtis, if you would summarize the financial results and then we will both take questions.

Curtis Garner

Thank you, Mike. Thanks everybody on the call for joining us today. Let me provide an abbreviated overview of our financial highlights and then we can, as Mike said, open it up to questions. We expect to file our SEC Form 10-Q later today, which will expand on the details of the third quarter and year-to-date performance. As a reminder, our acquisition of Shoreham last October is included in the 2012 results, but it wouldn't be in the 2011 results. The acquisition is living up to our expectations. In fact, Shoreham has access line equivalent growth for 2012, as we’ve expanded their data capability in Vermont.

Total revenues decreased to 3.5% to $24.4 million from $25.3 million. Shoreham added $0.8 million across three revenue categories and transport services added another $0.1 million. Declines from the traditional loss of RLEC voice access lines related revenues and the net impact of the FCC’s Intercarrier Compensation order, particularly in interest based CLEC revenue in Maine, offset these gains.

Details of our five revenue categories are contained in the press release with local services and network services declining 6.1% and 6.8% respectively versus a year ago, while cable, internet and transport services showed modest growth. While the FCC’s Inter-Carrier compensation order also shift some revenue out of local services and into access revenue as the new Connect America fund is actually considered access revenue.

Operating expenses declined to 6.5% to 17.9 million from 19.2 million, cost services and products decreased 5.7% to 10.4 million from 11 million. SG&A expenses decreased 1.9% to 3.3 million from 3.2 million; actually they increased $100,000 (inaudible). Shoreham added 0.4 million and restructuring and legal expenses added 0.6 million across those two categories. These increases were more than offset by reduced RLEC expenses, long distance costs and overhead expenses including the reduction in employees implemented at the end of second quarter.

Depreciation and amortization decreased 6.7% to 4.6 million from 4.9 million in the third quarter of 2011. Shoreham accounted for increase of 0.2 million, primary change was in the amortization of intangible assets associated with the Country Road acquisition which increased 0.2 million, reflecting the short remaining economic life of the Time Warner cable contract.

Depreciation on our other RLEC assets decreased by 0.7 million. There was a goodwill impairment decrease of 0.3 million compared to no impairment in last year, as we adjusted the purchase price of Shoreham for the updated deferred taxes information. Mike already covered several items that impacted adjusted EBITDA in the third quarter, our cash balances adjusted to reflect the payment of the second quarter interest on our IDS debt, which was made on July 2, but was for the period of June 30, since June 30, it was a Saturday. For the quarter, we increased cash by over $7 million, CapEx continued at a moderate pace of $900,000 during the third quarter and $3.4 million on a year-to-date basis.

I think that covers the highlights Mike for the quarter. Alicia if you will provide directions, we can take questions at this time.

Question-And-Answer Session

Operator

(Operator Instructions) We will go first to Peter Brey from Buena Vista Investment Management.

Peter Brey - Buena Vista Investment Management

I just wanted some clarification as it pertains to the suspension of the dividend for two quarters. Does that mean in the next period based on what we have read that you will pay three, or you will just pay the two on the (inaudible) or is that to be determined?

Michael Weaver

Thank you, Peter. This is Mike. If I understood the question, you are actually asking about the interest on the subordinated notes. So as I’ve said earlier, we have the option to defer that. It’s a contractual right. We have the option to defer that interest for up to four occasions for two quarters per occasions. So we've now deferred that interest for two consecutive quarters. Before we deferred interest for an additional period beyond the fourth quarter of this year, we would be required to pay the deferred interest of $7 million which is a sum of the two quarters that we deferred plus the interest, only deferred interest. Do you understand my answer to you.

Peter Brey - Buena Vista Investment Management

Yeah, I think what you are saying is the last two quarters need to be paid next time around.

Michael Weaver

We have to do that before we can defer again. My understanding of the indenture is that should we wish to resume the payment of that interest in March we certainly can’t do that. We simply can't defer, like another deferral in the future until we paid the back deferral, the sum of which is $7 million plus the interest on that deferral.

Peter Brey - Buena Vista Investment Management

Alright. So based on next year having lowered top line or having top line, lowered revenue with the Time Warner going away can you talk a little bit about the philosophy behind this, because you are going to have greater obligations if you were to remain solvent at a time where your top line revenue is going to be dramatically lower.

Michael Weaver

Let me address your question this way. As I mentioned in the earlier part of the call, one of our focuses has been on cash conservation and part of that cash conservation has been to take advantage of the two quarters deferral for the first occasion and that's what we've done. Our thought process is that it’s a more prudent use of our cash and a prudent business decision to not pay the interest on that sub debt and have that cash available as a tool that we can use as we are negotiating with our senior lenders in an effort to expand or amend the existing credit agreement which expires in October 2013.

Peter Brey - Buena Vista Investment Management

Alright, so we are buying time basically, alright I understand it. Thank you for your answers.

Operator

We will go next to Patrick Hayes from Golub Capital.

Patrick Hayes - Golub Capital

Curtis could you expand on, you mentioned kind of the net effects of the impact of the ICC order, can you tell what the gross effect of that, the changes from that order were.

Curtis Garner

Certainly, part of it would be in the 10-K when we file it this afternoon, part of it we are still working on because you have to look at the changes in volume in addition to the changes in units and we haven't completed that analysis yet. But if you look in the Q that we filed in about an hour, you will find a detail buy of the line items that are there. As an example in their local services revenue, local cellular revenue is considered there. The local cellular carriers get to stop paying local cellular rates and pay the intrastate rates instead and so that stuff moves to access, so things move around. So you will see a fair amount of that in the queue.

Operator

We will go next to Michael Kerrigan from Boenning & Scattergood.

Michael Kerrigan - Boenning & Scattergood.

I have a couple of questions, first you spent some time in both the last few press releases talking about your new products and your new introductions. I assume that when Time Warner contract is over, it's going to cost about $3 million in revenue a quarter approximately. What kind of timeframe do you see and what kind of growth do you see from these other initiatives? Do they have the possibility to eventually make up that, I know not immediately but the delay have the potential to make up a portion or all of that over a period of years?

Michael Weaver

Thank you for the question, Michael. They do not have the ability to make up the total loss revenue that we will receive from Time Warner. These are, let’s talk specifically about the items I mentioned. The security services that we rolled out in Alabama. It's an add-on. It's simply another service that we can offer to our existing customers. We have had great reception on that but that’s a relatively, it's a reasonable margin on that product but it's a relatively low dollar volume, value per customer. The school system that we mentioned has, that’s a five-year contract. This is for the 10 school systems in one county that we served in Alabama. That has some potential forward but that revenue is fixed. I mean there is 10 school systems we will serve in them all and other than get an increase in bandwidth over the next five years, that revenue stream will be fairly consistent.

The expansion in Missouri, we have a lot of sites, multiple sites for the wireless offering. We're simply adding two more there that will marginally make some marginal difference but none of these, some of these offerings it’s not close to replacing the Time Warner and if you stop and think about the Time Warner for just a second, we have a 162,000 network connections with Time Warner that will go away somewhere between January 1 and June 30 of next year. So and that’s a pretty substantial revenue stream to offset. So that’s why we are not taking a one prong approach we are also as one we have looked at being real careful with our cash to try to take advantage of the things that are available to us for cash conservation. But we also want you to know that we are working hard every day to try to continue to expand the offerings that we have.

Michael Kerrigan - Boenning & Scattergood.

Okay. And my second question is I know that from what you are talking about with the Evercore and their restructuring attorney and stuff that there are a lot of options on the table, is one of the options a potential $25 million pay down to the senior lenders and then a much better negotiated rate going forward and if that occurred, I know that you are not there yet, but if that occurred do you see what with the new cuts you have made and all that stuff, do you see being able to at least pay the note going forward after that or is that too much information to give out?

Michael Weaver

It’s too much information to give out on this call, understand you need to know and desire to know we simply are, there are a lot of things to consider. We have excellent advisors that we are working with on everyday basis but we have not, the final plan is not yet in place.

Michael Kerrigan - Boenning & Scattergood.

Okay and you have not been able to buyback, there are some confusion about you have not been able to buyback any of these things in the open market and you have not allowed any inside or buying or selling, is that correct?

Michael Weaver

That's correct, and we have not, we do not have the right to buyback the units, to buyback for units would require lender approval under the terms of the senior debt instrument and we have not thought to seek that approval. As I said, we are in current active intense negotiations with the lenders. So it’s not appropriate to bring that up at this time and (inaudible) our judgment.

Operator

At this time we have no further questions.

Michael Weaver

Okay. We would conclude the call just by saying that I appreciate your interest and we appreciate your questions and we will continue to work hard and diligently and aggressively to define and execute the plan. Thank you for your participation.

Operator

That does conclude today's conference. We thank you for your participation. You may now disconnect.

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