UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
Amendment No. 1
| (Mark One) | |
| | |
| ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | |
| | For the quarterly period ended March 31, 2007 or |
| | |
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | |
| | For the transition period from to |
Commission File Number: 1-32362
OTELCO INC.
(Exact name of registrant as specified in its charter)
| Delaware | | 52-2126395 |
| (State or other jurisdiction of incorporation or | | (I.R.S. Employer Identification No.) |
| organization) | | |
| | | |
| 505 Third Avenue East, Oneonta, Alabama | | 35121 |
| (Address of Principal Executive Offices) | | (Zip Code) |
| | | |
(205) 625-3574
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer ý Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No ý
APPLICABLE ONLY TO CORPORATE USERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | | Outstanding at May 9, 2007 |
| Class A Common Stock ($0.01 par value per share) | | 9,676,733 |
| Class B Common Stock ($0.01 par value per share) | | 544,671 |
OTELCO INC.
FORM 10-Q/A
Amendment No. 1
For the three month period ended March 31, 2007
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
| Item 1. | Financial Statements |
| | Consolidated Balance Sheets as of December 31, 2006 and March 31, 2007 |
| | Consolidated Statements of Income for the three months ended March 31, 2006 and 2007 |
| | Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2007 |
| | Notes to Consolidated Financial Statements |
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
| Item 4. | Controls and Procedures |
PART II OTHER INFORMATION
Unless the context otherwise requires, the words “we”, “us”, “our”, “the Company” and “Otelco” refer to Otelco Inc., a Delaware corporation.
This Quarterly Report on Form 10-Q/A is being filed to amend and restate our consolidated financial statements contained in “Item 1. Financial Statements” of our Quarterly Report on Form 10-Q for the three months ended March 31, 2007 to provide additional information pursuant to Rule 3-10 of Regulation S-X. Except as discussed above, we have not modified or updated disclosure presented in the original Quarterly Report on Form 10-Q. Accordingly, this Form 10-Q/A does not reflect events occurred after the filing of the original Quarterly Report on Form 10-Q or modify or update those disclosures affected by subsequent events. Accordingly, this Form 10-Q/A should be read in conjunction with our periodic filings made with the SEC subsequent to the date of the filing of the original Quarterly Report on Form 10-Q, including any amendments to those filings, as well as any Current Reports filed on Form 8-K subsequent to the date of the filing of the original Quarterly Report on Form 10-Q.
In addition, in accordance with applicable SEC rules, this Form 10-Q/A includes updated certifications from our Chief Executive Officer and Chief Financial Officer.
FORWARD-LOOKING STATEMENTS
The report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations relating to our financial condition, results of operations, plans, objectives, future performance and business. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. These forward-looking statements are based on assumptions that we have made in light of our experience in the industry in which we operate, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial condition or results of operations and cause actual results to differ materially from those in the forward-looking statements.
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
OTELCO INC. CONSOLIDATED BALANCE SHEETS | |
| | | December 31, 2006 | | March 31, 2007 | |
Assets | | | | (unaudited) | |
| Current assets | | | | | |
| Cash and cash equivalents | | $ | 14,401,849 | | $ | 10,641,424 | |
| Accounts receivable: | | | | | | | |
Due from subscribers, net of allowance for doubtful accounts of $207,359 and $184,552 respectively | | | 3,105,636 | | | 2,740,587 | |
| Unbilled receivables | | | 2,324,213 | | | 2,410,991 | |
| Other | | | 1,680,144 | | | 1,878,545 | |
| Materials and supplies | | | 1,962,938 | | | 2,020,599 | |
| Prepaid expenses | | | 1,062,947 | | | 804,447 | |
| Deferred income taxes | | | 766,225 | | | 832,946 | |
| Total current assets | | | 25,303,952 | | | 21,329,539 | |
| | | | | | | | |
| Property and equipment, net | | | 60,493,789 | | | 58,715,659 | |
| Goodwill | | | 134,182,309 | | | 134,403,170 | |
| Intangible assets, net | | | 11,340,806 | | | 10,884,297 | |
| Investments | | | 1,240,250 | | | 1,226,001 | |
| Deferred financing costs | | | 6,652,393 | | | 6,254,272 | |
| Interest rate cap | | | 4,542,160 | | | 3,922,585 | |
| Deferred charges | | | 96,628 | | | 89,896 | |
| Total assets | | $ | 243,852,287 | | $ | 236,825,419 | |
| | | | | | | | |
Liabilities and Stockholders’ Equity (Deficit) | | | | | | | |
| Current liabilities | | | | | | | |
| Accounts payable | | $ | 1,658,911 | | $ | 1,035,816 | |
| Dividends payable | | | 1,705,524 | | | - | |
| Accrued expenses | | | 5,875,863 | | | 3,511,889 | |
| Advance billings and payments | | | 2,119,701 | | | 2,143,593 | |
| Customer deposits | | | 197,496 | | | 213,261 | |
| Total Current Liabilities | | | 11,557,495 | | | 6,904,559 | |
| | | | | | | | |
| Deferred income taxes | | | 24,712,213 | | | 24,778,934 | |
| Other liabilities | | | 187,037 | | | 180,082 | |
| Total deferred tax and other liabilities | | | 24,899,250 | | | 24,959,016 | |
| | | | | | | | |
| Long-term notes payable | | | 201,075,498 | | | 201,075,498 | |
| Derivative liability | | | 2,107,877 | | | 1,890,008 | |
| Class B common convertible to senior subordinated notes | | | 4,085,033 | | | 4,085,033 | |
| | | | | | | | |
| Stockholders’ Equity (Deficit) | | | | | | | |
| Class A Common Stock, $.01 par value-authorized 20,000,000 shares; issued and outstanding 9,676,733 shares | | | 96,767 | | | 96,767 | |
| Class B Common Stock, $.01 par value-authorized 800,000 shares; issued and outstanding 544,671 shares | | | 5,447 | | | 5,447 | |
| Additional paid in capital | | | 284,041 | | | - | |
| Retained deficit | | | (1,137,166 | ) | | (2,676,857 | ) |
| Accumulated other comprehensive income | | | 878,045 | | | 485,948 | |
| Total stockholders’ equity (deficit) | | | 127,134 | | | (2,088,695 | ) |
| Total liabilities and stockholders’ equity (deficit) | | $ | 243,852,287 | | $ | 236,825,419 | |
The accompanying notes are an integral part of these consolidated financial statements.
OTELCO CONSOLIDATED STATEMENTS OF OPERATIONS | |
(unaudited) | |
| | Three months ended March 31, | |
| | | 2006 | | 2007 | |
| Revenues | | | | | |
| Local services | | $ | 4,303,399 | | $ | 6,348,496 | |
| Network access | | | 5,145,055 | | | 6,437,589 | |
| Cable television | | | 542,506 | | | 547,527 | |
| Internet | | | 1,522,437 | | | 2,820,298 | |
| Transport services | | | - | | | 1,018,483 | |
| Total revenues | | | 11,513,397 | | | 17,172,393 | |
| Operating expenses | | | | | | | |
| Cost of services and products | | | 3,174,687 | | | 6,271,057 | |
| Selling, general and administrative expenses | | | 1,671,341 | | | 2,501,800 | |
| Depreciation and amortization | | | 1,968,341 | | | 3,629,091 | |
| Total operating expenses | | | 6,814,369 | | | 12,401,948 | |
| | | | | | | | |
| Income from operations | | | 4,699,028 | | | 4,770,445 | |
| | | | | | | | |
| Other income (expense) | | | | | | | |
| Interest expense | | | (4,549,475 | ) | | (5,376,264 | ) |
| Change in fair value of derivative | | | 179,741 | | | 217,868 | |
| Other income | | | 187,239 | | | 281,449 | |
| Total other expense | | | (4,182,495 | ) | | (4,876,947 | ) |
| | | | | | | | |
| Income (loss) before income tax and accretion expense | | | 516,533 | | | (106,502 | ) |
| | | | | | | | |
| Income tax expense | | | (161,210 | ) | | (11,705 | ) |
| | | | | | | | |
| Income (loss) before accretion expense | | | 355,323 | | | (118,207 | ) |
| | | | | | | | |
| Accretion of Class B common convertible to senior subordinated notes | | | (110,732 | ) | | 0 | |
| | | | | | | | |
| Net income (loss) available to common stockholders | | $ | 244,591 | | $ | (118,207 | ) |
| | | | | | | | |
| Weighted average shares outstanding: | | | | | | | |
| Basic | | | 9,676,733 | | | 9,676,733 | |
| Diluted | | | 10,221,404 | | | 10,221,404 | |
| | | | | | | | |
| Net income (loss) per share | | | | | | | |
| Basic | | $ | 0.03 | | $ | (0.01 | ) |
| Diluted | | $ | 0.02 | | $ | (0.03 | ) |
| | | | | | | | |
| Dividends declared per share | | $ | 0.18 | | $ | 0.18 | |
The accompanying notes are an integral part of these consolidated financial statements.
OTELCO CONSOLIDATED STATEMENTS OF CASH FLOWS | |
(unaudited) | |
| | | Three months ended March 31, | |
| | | 2006 | | 2007 | |
| Cash flows from operating activities: | | | | | |
| Net income (loss) | | $ | 244,591 | | $ | (118,207 | ) |
| Adjustments to reconcile net income to cash flows from operating activities: | | | | | | | |
| Depreciation | | | 1,916,918 | | | 2,980,190 | |
| Amortization | | | 51,424 | | | 648,901 | |
| Interest rate caplet | | | 162,962 | | | 227,478 | |
| Amortization of loan cost | | | 343,437 | | | 398,121 | |
| Accretion expense | | | 110,732 | | | - | |
| Change in fair value of derivative liability | | | (179,741 | ) | | (217,868 | ) |
| Provision for uncollectible revenue | | | 38,947 | | | 17,242 | |
| Changes in assets and liabilities, net of assets and liabilities acquired: | | | | | | | |
| Accounts receivables | | | (31,976 | ) | | (113,935 | ) |
| Material and supplies | | | 3,305 | | | (57,661 | ) |
| Prepaid expenses and other assets | | | (9,089 | ) | | 258,500 | |
| Accounts payable and accrued liabilities | | | 66,293 | | | (4,736,893 | ) |
| Advance billings and payments | | | 49,130 | | | 23,892 | |
| Other liabilities | | | 784 | | | 8,810 | |
| | | | | | | | |
| Net cash from operating activities | | | 2,767,717 | | | (681,430 | ) |
| | | | | | | | |
| Cash flows from investing activities: | | | | | | | |
| Acquisition and construction of property and equipment | | | (1,158,880 | ) | | (1,374,914 | ) |
| Proceeds from retirement of investment | | | 128,558 | | | 7,871 | |
| Deferred charges | | | (14,890 | ) | | (6,428 | ) |
| | | | | | | | |
| Net cash from investing activities | | | (1,045,212 | ) | | (1,373,471 | ) |
| | | | | | | | |
| Cash flows from financing activities: | | | | | | | |
| Cash dividends paid | | | (1,705,524 | ) | | (1,705,524 | ) |
| | | | | | | | |
| Net cash from financing activities | | | (1,705,524 | ) | | (1,705,524 | ) |
| | | | | | | | |
| Net increase (decrease) in cash and cash equivalents | | | 16,981 | | | (3,760,425 | ) |
| Cash and cash equivalents, beginning of period | | | 5,569,233 | | | 14,401,849 | |
| | | | | | | | |
| Cash and cash equivalents, end of period | | $ | 5,586,214 | | $ | 10,641,424 | |
| Supplemental disclosures of cash flow information: | | | | | | | |
| Interest paid | | $ | 4,046,312 | | $ | 7,401,647 | |
| | | | | | | | |
| Income taxes paid (received) | | $ | - | | $ | (173,718 | ) |
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
| 1. | Organization and Basis of Financial Reporting |
Basis of Presentation and Principles of Consolidation
The consolidated financial statements include the accounts of Otelco Inc. (the “Company”), its wholly owned subsidiaries Otelco Telecommunications LLC, Otelco Telephone LLC, Hopper Holding Company, Inc. (“HHC”), Brindlee Holdings LLC (“BH”), Page & Kiser Communications, Inc. (“PKC”), Mid-Missouri Holding Corporation (“MMH”), and Mid-Maine Communications, Inc. (“Mid-Maine”). HHC’s wholly owned subsidiary is Hopper Telecommunications Company, Inc. BH’s owned subsidiary is Brindlee Mountain Telephone Company, Inc. PKC’s wholly owned subsidiary is Blountsville Telephone Company, Inc. MMH’s wholly owned subsidiary is Mid-Missouri Telephone Company (“MMT”). MMT is the sole stockholder of Imagination, Inc. Mid-Maine’s wholly owned subsidiaries are Mid-Maine Telecom, Inc. (“MMTI”) and Mid-Maine TelPlus (“MMTP”). The accompanying consolidated financial statements include the accounts of the Company and all of the aforesaid subsidiaries after elimination of all material intercompany balances and transactions.
The consolidated financial statements and footnotes included in this Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2006. The interim consolidated financial information herein is unaudited. The information reflects all adjustments (which include only normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods included in the report.
| 2. | Commitment and Contingencies |
From time to time, we may be involved in various claims, legal actions and regulatory proceedings incidental to and in the ordinary course of business, including administrative hearings of the Alabama, Maine and Missouri Public Service Commissions related primarily to rate making. Currently, none of the legal proceedings are expected to have a material adverse effect on our business.
| 3. | Derivative and Hedge Activities |
The interest rate cap was purchased on December 21, 2004, coincident with the closing of our initial public offering and the recapitalization of our senior notes payable. The interest rate cap was purchased to mitigate the risk of rising interest rates to limit or cap the rate at 7%. It is considered an effective hedge as all critical terms of the interest rate cap are identical to the underlying debt it hedges. Changes in the fair value of the interest rate cap are not included in earnings but are reported as a component of accumulated other comprehensive income. For the three months ended March 31, 2006 and 2007 the change in the fair value of the interest rate cap was $876,453 and $392,097, respectively. The cost of the interest rate cap is expensed as interest over the effective life of the hedge in accordance with the quarterly value of the caplets as determined at the date of inception. For the three months ended March 31, 2006 and 2007 the cost of the interest rate cap was $162,962 and $227,478, respectively.
| 4. | Income (loss) per Common Share and Potential Common Share |
Basic income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of shares outstanding for the period. Diluted income (loss) per common share reflects the potential dilution that could occur if the Class B common stock were exercised into IDSs. Class B common stock is convertible on a one-for-one basis into IDSs, each of which includes a Class A common share. For periods prior to our conversion, membership units were treated on an as if converted basis into Class A and Class B common shares.
A reconciliation of the common shares and net income (loss) for the Company’s basic and diluted income (loss) per common share calculation is as follows:
| | | Three months ended March 31, | |
| | | 2006 | | 2007 | |
| Weighted average common shares-basic | | | 9,676,733 | | | 9,676,733 | |
| | | | | | | | |
| Effect of dilutive securities | | | 544,671 | | | 544,671 | |
| | | | | | | | |
| Weighted-average common shares and potential common shares-diluted | | | 10,221,404 | | | 10,221,404 | |
| | | | | | | | |
| Net income (loss) available to common stockholders | | | 244,591 | | | (118,207 | ) |
| | | $ | 0.03 | | $ | (0.01 | ) |
| Net Income (loss) per basic share | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| Net income (loss) available to common stockholders | | $ | 244,591 | | $ | (118,207 | ) |
| Plus: Accretion expense of Class B common convertible to senior subordinated notes | | | 110,732 | | | 0 | |
| Less: Change in fair value of derivative | | | (179,741 | ) | | (217,868 | ) |
| | | | | | | | |
| Net income (loss) available for diluted shares | | $ | 175,582 | | $ | (336,075 | ) |
| | | | | | | | |
| Net income (loss) per diluted share | | $ | 0.02 | | $ | (0.03 | ) |
On July 3, 2006, the Company acquired 100% of the outstanding common stock of MMeT through a merger of MMeT with MM Merger Corp, with MMeT as the surviving wholly-owned subsidiary. MMeT owns 100% of two subsidiaries, MMTI and MMTP. MMeT provides telecommunications solutions, including voice, data and Internet services, to residential and business customers in portions of Maine and extends Otelco into the New England market.
The stated purchase price in the acquisition agreement was $37,750,000. The purchase price was $40,555,738, including transaction costs and the assumed notes payable of $24,347,299 which were paid off at closing. The excess of the purchase price over the market value of assets and liabilities is reflected as goodwill of $14,971,176. The goodwill related to the acquisition is not deductible for tax purposes. The aggregate consideration paid for the acquisition was as follows:
| Cash paid | | $ | 16,208,439 | |
| Notes payable assumed | | | 24,347,299 | |
| | | | | |
| Purchase price | | $ | 40,555,738 | |
The allocation of the net purchase price for the MMeT acquisition is as follows:
| | | July 3, 2006 | |
| Cash | | $ | 208,399 | |
| Other current assets | | | 3,691,420 | |
| Property and equipment | | | 20,180,158 | |
| Intangible assets | | | 10,700,606 | |
| Goodwill | | | 14,971,176 | |
| Other assets | | | 2,367,842 | |
| Current liabilities | | | (3,074,876 | ) |
| Other liabilities | | | (8,488,987 | ) |
| Purchase price | | $ | 40,555,738 | |
The intangible assets at time of acquisition included regulated and unregulated customer based assets fair valued at $8.8 million which have remaining lives of 25 years. The customer base assets are being amortized over a 15 year life. Also, intangible assets included a non-competition agreement fair valued at $1.8 million which had a remaining life of 2 years.
Concurrent with the closing of the acquisition, the Company entered into an amended and restated credit agreement, dated as of July 3, 2006, to amend and restate the credit agreement, dated as of December 21, 2004, by and among Otelco and the other credit parties to the agreement and General Electric Capital Corporation as a lender and agent for the lenders. The credit facilities under the amended and restated credit agreement are comprised of:
| · | Term loans of $120 million due July 3, 2011, consisting of an original term loan of $80 million, and an additional term loan of $40 million, used to finance the acquisition and related transaction costs and to provide working capital for the Company and its subsidiaries and for other corporate purposes; and |
| · | A revolving loan commitment of up to $15 million. |
The term loan facility was fully drawn concurrent with closing. Interest rates applicable to the term loan and any revolving loans are an index rate plus 2.25% or LIBOR plus 3.25%. In addition, there are fees associated with undrawn revolver balances and certain annual fees. The Company has an $80 million interest rate cap through December 16, 2009 which caps LIBOR plus 3.25% margin at 6.25%.
The acquisition was accounted for using the purchase method of accounting and accordingly, the accompanying financial statements include the financial position and results of operations from the date of acquisition.
The following unaudited pro forma information presents the combined results of operations of the Company as though the acquisition of MMeT had occurred at the beginning of the preceding year. The results include certain adjustments, including increased interest expense on notes payable and increased amortization expense related to intangible assets. The pro forma financial information does not necessarily reflect the results of operations had the acquisition been completed at the beginning of the period or those which may be obtained in the future.
| | | Unaudited Three months ended March 31, 2006 | |
| Revenues | | $ | 17,365,460 | |
| Income from operations | | | 4,920,517 | |
| Net income | | | 67,036 | |
| Basic net income per share | | $ | 0.01 | |
| Diluted net income per share | | $ | 0.01 | |
In June 2006, the Financial Accounting Standards Board issued FIN 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, Accounting for Income Taxes. The interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.
The Company adopted the provisions of FIN 48 on January 1, 2007. After application of the provisions of FIN 48, it was not necessary for the Company to recognize any liability for unrecognized tax benefits or adjustment to the balance of retained earnings as of January 1, 2007. The Company’s policy is to classify interest and penalties related to unrecognized tax benefits in income tax expense. As of January 1, 2007, the Company had no accrued interest and penalties related to unrecognized tax benefits.
As of January 1, 2007, after the implementation of FIN 48, the Company’s has no unrecognized tax benefits.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and three state jurisdictions. For federal tax purposes, the Company’s 2003 through 2006 tax years remain open for examination by the tax authorities under the normal three year statute of limitations. Generally, for state tax purposes, the Company’s 2002 through 2006 tax years remain open for examination by the tax authorities under a four year statute of limitations The adoption of FIN No. 48 on January 1, 2007, did not have a material effect on the Company’s consolidated results of operations or financial condition.
The Company has no independent assets or operations separate from its operating subsidiaries. The guarantees of its senior subordinated notes by five of its seven operating subsidiaries are full and unconditional, joint and several. The operating subsidiaries have no independent long-term notes payable. There are no significant restrictions on the ability of the Company to obtain funds from its operating subsidiaries by dividend or loan. In 2004, the impact of the non-guarantor subsidiaries of the parent was minor. The condensed consolidated financial information is provided for the guarantor entities.
The following tables present condensed consolidating balance sheets as of March 31, 2007; December 31, 2006; and March 31, 2006; condensed consolidating statements of earnings for the three months ended March 31, 2007 and March 31, 2006 and condensed consolidating statements of cash flows for the three months ended March 31, 2007 and March 31, 2006.
Notes To Consolidated Financial Statements
Condensed Consolidating Balance Sheet
March 31, 2007
| | | Parent | | Guarantor | | Non-Guarantor | | Eliminations | | Consolidated | |
| | | | Subsidiaries | | Subsidiaries | | | | | |
| | | | | | | | | | | | |
| ASSETS | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Current assets | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | - | | $ | 10,630,629 | | $ | 10,795 | | $ | - | | $ | 10,641,424 | |
| Accounts receivable, net | | | 26,070 | | | 5,762,096 | | | 1,241,957 | | | - | | | 7,030,123 | |
| Materials and supplies | | | - | | | 845,050 | | | 1,175,549 | | | - | | | 2,020,599 | |
| Prepaid and other current assets | | | 67,667 | | | 686,695 | | | 50,085 | | | - | | | 804,447 | |
| Deferred income taxes | | | 832,946 | | | - | | | - | | | - | | | 832,946 | |
| Intercompany receivables (payables) | | | (17,051,635 | ) | | 34,107,375 | | | (17,055,740 | ) | | - | | | - | |
| Total current assets | | | (16,124,952 | ) | | 52,031,845 | | | (14,577,354 | ) | | - | | | 21,329,539 | |
| | | | | | | | | | | | | | | | | |
| Property and equipment, net | | | - | | | 41,822,122 | | | 16,893,537 | | | - | | | 58,715,659 | |
| Goodwill | | | - | | | 136,339,810 | | | (1,936,640 | ) | | - | | | 134,403,170 | |
| Intangibles assets, net | | | 5,123,211 | | | 2,184,641 | | | 3,576,445 | | | - | | | 10,884,297 | |
| Investments | | | 1,000 | | | 899,814 | | | 325,187 | | | - | | | 1,226,001 | |
| Other long-term assets | | | 4,515,543 | | | 5,751,210 | | | - | | | - | | | 10,266,753 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | (6,485,198 | ) | $ | 239,029,442 | | $ | 4,281,175 | | $ | - | | $ | 236,825,419 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | | | | |
| Accounts payables and accrued expenses | | $ | 739,450 | | $ | 2,403,385 | | $ | 1,404,870 | | $ | - | | $ | 4,547,705 | |
| Other current liabilities | | | - | | | 2,267,282 | | | 89,572 | | | - | | | 2,356,854 | |
| Total current liabilities | | | 739,450 | | | 4,670,667 | | | 1,494,442 | | | - | | | 6,904,559 | |
| | | | | | | | | | | | | | | | | |
| Deferred income taxes | | | 4,728,411 | | | 17,544,383 | | | 2,506,140 | | | - | | | 24,778,934 | |
| Other liabilities | | | - | | | 180,082 | | | - | | | - | | | 180,082 | |
| Long-term notes payables | | | 105,458,990 | | | 95,616,508 | | | - | | | - | | | 201,075,498 | |
| Derivative liability | | | 1,890,008 | | | - | | | - | | | - | | | 1,890,008 | |
| Class B common convertible to senior subordinated notes | | | 4,085,033 | | | - | | | - | | | - | | | 4,085,033 | |
| Stockholders' equity (deficit) | | | (123,387,090 | ) | | 121,017,802 | | | 280,593 | | | - | | | (2,088,695 | ) |
| | | | | | | | | | | | | | | | | |
| Total liabilities and stockholders' equity (deficit) | | $ | (6,485,198 | ) | $ | 239,029,442 | | $ | 4,281,175 | | $ | - | | $ | 236,825,419 | |
Otelco Inc.
Notes to Consoldiated Financial Statements
Condensed Consolidated Statement of Operations
For the Three Months Ended March 31, 2007
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| Revenue | | $ | 727,815 | | $ | 15,287,319 | | $ | 3,245,673 | | $ | (2,088,414 | ) | $ | 17,172,393 | |
| Operating expenses | | | (823,899 | ) | | (11,236,178 | ) | | (2,430,285 | ) | | 2,088,414 | | | (12,401,948 | ) |
| Income from operations | | | (96,084 | ) | | 4,051,141 | | | 815,388 | | | - | | | 4,770,445 | |
| Other income (expense) | | | (3,711,167 | ) | | (1,165,780 | ) | | - | | | - | | | (4,876,947 | ) |
| Income before income tax and accretion expense | | | (3,807,251 | ) | | 2,885,361 | | | 815,388 | | | - | | | (106,502 | ) |
| Income tax expense | | | (11,705 | ) | | - | | | - | | | - | | | (11,705 | ) |
| Accretion of class B common convertible | | | | | | | | | | | | | | | | |
| to senior subordinated notes | | | - | | | - | | | - | | | - | | | - | |
| | | | | | | | | | | | | | | | | |
| Net income (loss) to common stockholders | | $ | (3,818,956 | ) | $ | 2,885,361 | | $ | 815,388 | | $ | - | | $ | (118,207 | ) |
Notes to Consolidated Financial Statements
Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2007
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | (3,818,956 | ) | $ | 2,885,361 | | $ | 815,388 | | $ | - | | $ | (118,207 | ) |
| Adjustment to reconcile net income (loss) | | | | | | | | | | | | | | | | |
| to cash flows from operating activities | | | 341,197 | | | 2,584,933 | | | 1,127,934 | | | - | | | 4,054,064 | |
| Changes in assets and liabilities, net of | | | | | | | | | | | | | | | | |
| assets and liabilities acquired | | | 5,183,283 | | | (8,035,947 | ) | | (1,764,623 | ) | | - | | | (4,617,287 | ) |
| Cash flows from investing activities | | | | | | (1,180,561 | ) | | (192,910 | ) | | - | | | (1,373,471 | ) |
| Cash flows from financing activities | | | (1,705,524 | ) | | - | | | - | | | - | | | (1,705,524 | ) |
| Net increase (decrease) in cash and cash equivalents | | | - | | | (3,746,214 | ) | | (14,211 | ) | | - | | | (3,760,425 | ) |
| | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, beginning of period | | | - | | | 14,376,843 | | | 25,006 | | | - | | | 14,401,849 | |
| | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, end of period | | $ | - | | $ | 10,630,629 | | $ | 10,795 | | $ | - | | $ | 10,641,424 | |
Notes To Consolidated Financial Statements
Condensed Consolidating Balance Sheet
| | | Parent | | Guarantor | | Non-Guarantor | | Eliminations | | Consolidated | |
| | | | Subsidiaries | | Subsidiaries | | | | | |
| | | | | | | | | | | | |
| ASSETS | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Current assets | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | - | | $ | 14,376,843 | | $ | 25,006 | | $ | - | | $ | 14,401,849 | |
| Accounts receivable, net | | | 21,028 | | | 6,050,195 | | | 1,038,770 | | | - | | | 7,109,993 | |
| Materials and supplies | | | - | | | 847,045 | | | 1,115,893 | | | - | | | 1,962,938 | |
| Prepaid and other current assets | | | 3,487 | | | 1,006,316 | | | 53,144 | | | - | | | 1,062,947 | |
| Deferred income taxes | | | 766,225 | | | - | | | - | | | - | | | 766,225 | |
| Intercompany receivables (payables) | | | (7,613,619 | ) | | 26,350,164 | | | (18,736,545 | ) | | - | | | - | |
| Total current assets | | | (6,822,879 | ) | | 48,630,563 | | | (16,503,732 | ) | | - | | | 25,303,952 | |
| | | | | | | | | | | | | | | | | |
| Property and equipment, net | | | - | | | 42,745,710 | | | 17,748,079 | | | - | | | 60,493,789 | |
| Goodwill | | | - | | | 136,118,949 | | | (1,936,640 | ) | | - | | | 134,182,309 | |
| Intangibles assets, net | | | 5,454,799 | | | 2,235,052 | | | 3,650,955 | | | - | | | 11,340,806 | |
| Investments | | | 1,000 | | | 914,093 | | | 325,157 | | | - | | | 1,240,250 | |
| Other long-term assets | | | 5,135,118 | | | 6,156,063 | | | - | | | - | | | 11,291,181 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | 3,768,038 | | $ | 236,800,430 | | $ | 3,283,819 | | $ | - | | $ | 243,852,287 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | | | | |
| Accounts payables and accrued expenses | | $ | 4,924,962 | | $ | 3,081,839 | | $ | 1,233,497 | | $ | - | | $ | 9,240,298 | |
| Other current liabilities | | | - | | | 2,238,188 | | | 79,009 | | | - | | | 2,317,197 | |
| Total current liabilities | | | 4,924,962 | | | 5,320,027 | | | 1,312,506 | | | - | | | 11,557,495 | |
| | | | | | | | | | | | | | | | | |
| Deferred income taxes | | | 4,661,690 | | | 17,544,383 | | | 2,506,140 | | | - | | | 24,712,213 | |
| Other liabilities | | | - | | | 187,037 | | | - | | | - | | | 187,037 | |
| Long-term notes payables | | | 105,458,990 | | | 95,616,508 | | | - | | | - | | | 201,075,498 | |
| Derivative liability | | | 2,107,877 | | | - | | | - | | | - | | | 2,107,877 | |
| Class B common convertible to senior subordinated notes | | | 4,085,033 | | | - | | | - | | | - | | | 4,085,033 | |
| Stockholders' equity (deficit) | | | (117,470,514 | ) | | 118,132,445 | | | (534,797 | ) | | - | | | 127,134 | |
| | | | | | | | | | | | | | | | | |
| Total liabilities and stockholders' equity (deficit) | | $ | 3,768,038 | | $ | 236,800,400 | | $ | 3,283,849 | | $ | - | | $ | 243,852,287 | |
Notes To Consolidated Financial Statements
Condensed Consolidating Balance Sheet
| | | Parent | | Guarantor | | Non-Guarantor | | Eliminations | | Consolidated | |
| | | | Subsidiaries | | Subsidiaries | | | | | |
| | | | | | | | | | | | |
| ASSETS | | | | | | | | | | | | �� | | | | |
| | | | | | | | | | | | | | | | | |
| Current assets | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | - | | $ | 5,455,136 | | $ | 131,078 | | | - | | $ | 5,586,214 | |
| Accounts receivable, net | | | 30,340 | | | 4,026,161 | | | 459,714 | | | - | | | 4,516,215 | |
| Materials and supplies | | | - | | | 905,129 | | | 24,427 | | | - | | | 929,556 | |
| Prepaid and other current assets | | | 828,087 | | | 394,041 | | | 40,808 | | | - | | | 1,262,936 | |
| Deferred income taxes | | | 872,675 | | | - | | | - | | | - | | | 872,675 | |
| Intercompany receivables (payables) | | | (5,848,169 | ) | | 21,301,951 | | | (15,453,782 | ) | | - | | | - | |
| Total current assets | | | (4,117,067 | ) | | 32,082,418 | | | (14,797,755 | ) | | - | | | 13,167,596 | |
| | | | | | | | | | | | | | | | | |
| Property and equipment, net | | | - | | | 32,552,463 | | | 11,251,488 | | | - | | | 43,803,951 | |
| Goodwill | | | - | | | 116,355,199 | | | 3,076,794 | | | - | | | 119,431,993 | |
| Intangibles assets, net | | | 6,628,173 | | | (6,628,173 | ) | | 1,536,655 | | | - | | | 1,536,655 | |
| Investments | | | 1,000 | | | 955,783 | | | 16,530 | | | - | | | 973,313 | |
| Other long-term assets | | | 6,047,109 | | | 6,628,173 | | | - | | | - | | | 12,675,282 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | 8,559,215 | | $ | 181,945,863 | | $ | 1,083,712 | | | - | | $ | 191,588,790 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | | | | |
| Accounts payables and accrued expenses | | $ | 251,887 | | $ | 2,393,885 | | $ | 219,476 | | | - | | $ | 2,865,248 | |
| Other current liabilities | | | - | | | 1,463,437 | | | 12,912 | | | - | | | 1,476,349 | |
| Total current liabilities | | | 251,887 | | | 3,857,322 | | | 232,388 | | | - | | | 4,341,597 | |
| | | | | | | | | | | | | | | | | |
| Deferred income taxes | | | 4,019,721 | | | 9,173,477 | | | 2,152,692 | | | - | | | 15,345,890 | |
| Other liabilities | | | - | | | 184,538 | | | - | | | - | | | 184,538 | |
| Long-term notes payables | | | 105,458,990 | | | 55,616,508 | | | - | | | - | | | 161,075,498 | |
| Derivative liability | | | 1,650,353 | | | - | | | - | | | - | | | 1,650,353 | |
| Class B common convertible to senior subordinated notes | | | 3,766,186 | | | - | | | - | | | - | | | 3,766,186 | |
| Stockholders' equity (deficit) | | | (106,587,922 | ) | | 113,114,018 | | | (1,301,368 | ) | | - | | | 5,224,728 | |
| | | | | | | | | | | | | | | | | |
| Total liabilities and stockholders' equity (deficit) | | $ | 8,559,215 | | $ | 181,945,863 | | $ | 1,083,712 | | | - | | $ | 191,588,790 | |
Notes to Consoldiated Financial Statements
Condensed Consolidated Statement of Operations
For the Three Months Ended March 31, 2006
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Revenue | | $ | 628,629 | | $ | 10,723,155 | | $ | 1,645,972 | | $ | (1,484,359 | ) | $ | 11,513,397 | |
| Operating expenses | | | (774,199 | ) | | (6,538,197 | ) | | (986,332 | ) | | 1,484,359 | | | (6,814,369 | ) |
| Income from operations | | | (145,570 | ) | | 4,184,958 | | | 659,640 | | | - | | | 4,699,028 | |
| Other income (expense) | | | (3,063,744 | ) | | (1,118,751 | ) | | - | | | - | | | (4,182,495 | ) |
| Income before income tax and accretion expense | | | (3,209,314 | ) | | 3,066,207 | | | 659,640 | | | - | | | 516,533 | |
| Income tax expense | | | (161,210 | ) | | - | | | - | | | - | | | (161,210 | ) |
| Accretion of class B common convertible | | | | | | | | | | | | | | | | |
| to senior subordinated notes | | | (110,732 | ) | | - | | | - | | | - | | | (110,732 | ) |
| | | | | | | | | | | | | | | | | |
| Net income (loss) to common stockholders | | $ | (3,481,256 | ) | $ | 3,066,207 | | $ | 659,640 | | $ | - | | $ | 244,591 | |
Notes to Consolidated Financial Statements
Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2006
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | (3,481,256 | ) | $ | 3,066,207 | | $ | 659,640 | | $ | - | | $ | 244,591 | |
| Adjustment to reconcile net income (loss) | | | | | | | | | | | | | | | | |
| to cash flows from operating activities | | | 437,389 | | | 1,626,910 | | | 380,380 | | | - | | | 2,444,679 | |
| Changes in assets and liabilities, net of | | | | | | | | | | | | | | | | |
| assets and liabilities acquired | | | 4,764,281 | | | (3,821,571 | ) | | (864,263 | ) | | - | | | 78,447 | |
| Cash flows from investing activities | | | (14,890 | ) | | (928,349 | ) | | (101,973 | ) | | - | | | (1,045,212 | ) |
| Cash flows from financing activities | | | (1,705,524 | ) | | - | | | - | | | - | | | (1,705,524 | ) |
| Net increase (decrease) in cash and cash equivalents | | | - | | | (56,803 | ) | | 73,784 | | | - | | | 16,981 | |
| | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, beginning of period | | | - | | | 5,511,939 | | | 57,294 | | | - | | | 5,569,233 | |
| | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, end of period | | $ | - | | $ | 5,455,136 | | $ | 131,078 | | $ | - | | $ | 5,586,214 | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
General
Since 1999, we have acquired and operate six rural local exchange carriers operating in portions of eleven counties in approximately 2,390 square miles of north central Alabama, central Maine and central Missouri. We are the sole wireline telephone services provider in the rural communities we serve. We also provide competitive telecommunications services through several subsidiaries. Our services include local and long distance telephone, network access, transport, digital high-speed and dial-up Internet access, cable television and other telephone related services. We view, manage and evaluate the results of operations from the various telephony products and services as one company and therefore have identified one reporting segment as it relates to providing segment information. As of March 31, 2007, we operated approximately 65,326 total access line equivalents.
Our core businesses are local and long distance telephone services and the provision of network access to other wireline and wireless carriers for calls originated or terminated on our network. Our core businesses generated approximately 74.5% of our total revenues in the first quarter of 2007. We also provide cable television service in some markets, and dial-up and digital high-speed Internet access in all of our markets.
The following discussion and analysis should be read in conjunction with our financial statements and the related notes included in Item 1 of Part 1 and other financial information appearing elsewhere in this report. The following discussion and analysis addresses our financial condition and results of operations on a consolidated basis.
Revenue Sources
We derive our revenues from five sources:
| · | Local services. We receive revenues from providing local exchange telephone services. These revenues include monthly subscription charges for basic service, calling to adjacent communities on a per minute basis, long distance services, local private line services and enhanced calling features, such as voicemail, caller identification, call waiting and call forwarding. We also provide billing and collections services for other carriers under contract and receive revenues from directory advertising in our local communities. A growing portion of our subscribers take bundled service plans which include multiple services including domestic long distance services. |
| · | Network access services. We receive revenues from charges established to compensate us for the origination, transport and termination of calls of long distance and other interexchange carriers. These include subscriber line charges imposed on end users and switched and special access charges paid by carriers. Switched access charges for long distance services within Alabama, Maine and Missouri are based on rates approved by the Alabama Public Service Commission (“APSC”), Maine Public Utilities Commission and Missouri Public Service Commission respectively. Switched and special access charges for interstate and international services are based on rates approved by the Federal Communications Commission. |
| · | Cable television services. We offer basic, digital and pay per view cable television services to a portion of our telephone service territory in Alabama and Missouri. We expect to add high definition and DVR services in Alabama later in 2007. |
| · | Internet services. We receive revenues from monthly recurring charges for dial-up and digital high-speed Internet access, including dial-up customers throughout the State of Maine and in areas surrounding our Missouri service area. |
| · | Transport. We receive monthly recurring revenues for the rental of fiber to transport data and other telecommunications services in Maine. |
Access Line and Customer Trends
The number of traditional access lines served is one of the fundamental factors in determining revenue stability for a telecommunications provider. Reflecting a general trend in the rural local exchange carrier industry, the number of access lines we serve has been decreasing gradually when normalized for territory acquisitions. We expect this trend to continue for the industry and our territory. Our competitive carrier access lines continue to grow as we further penetrate our chosen markets. The introduction of unlimited calling bundles may positively impact customer churn over time. The growth of our digital high-speed Internet access services will continue to reduce demand for second access lines for residential and small business customers. Our response to this trend will have an important impact on our future revenues. Our primary strategy consists of leveraging our strong incumbent market position and bundling services to meet customer communications needs, increasing revenue per access line.
| | | Year Ended December 31, | | March 31, | |
| | | 2005 | | 2006 | | 2007 | |
| Access line equivalents (1): | | | | | | | | | | |
| Residential access lines | | | 24,541 | | | 29,832 | | | 29,789 | |
| Business access lines | | | 8,036 | | | 22,171 | | | 22,577 | |
| Access lines | | | 32,577 | | | 52,003 | | | 52,366 | |
| Digital high-speed lines | | | 6,314 | | | 11,951 | | | 12,960 | |
| Total access lines equivalents | | | 38,891 | | | 63,594 | | | 65,326 | |
| | | | | | | | | | | |
| Long distance customers | | | 14,438 | | | 21,370 | | | 22,066 | |
| Cable television customers | | | 4,220 | | | 4,188 | | | 4,211 | |
| Dial-up Internet customers | | | 12,149 | | | 19,587 | | | 18,313 | |
(1) We define total access line equivalents as access lines, cable modems and digital subscriber lines.
On July 3, 2006, we completed the acquisition of Mid-Maine. Subscriber results for December 31, 2006 and March 31, 2007 include this acquisition.
In 2006, we introduced bundled service packages including unlimited domestic calling to our Alabama residential and all Missouri customers. As of March 31, 2007, over 7,000 customers signed up for one of these packages. Our digital high-speed Internet customers continue to grow from 11,951 customers at December 31, 2006, to 12,963 at March 31, 2007. We expect continued revenue growth in this area of our business.
Our long distance customers increased 3.3% to 22,066 on March 31, 2007 from 21,370 on December 31, 2006. Our cable television customers increased slightly to 4,211 as of March 31, 2007. We anticipate introducing high definition and digital video services in Alabama during the third quarter 2007. Dial-up Internet customers decreased 6.5% to 18,313 on March 31, 2007. This also includes the subscribers we service outside of our telephone service area in Missouri and throughout Maine and will continue to reflect the expected impact of the shift to digital high-speed Internet services.
Our Rate and Pricing Structure
Our Alabama companies are now regulated under the Alabama Communications Reform Act of 2005 (“ACRA”). State regulation under the provisions of ACRA began October 31, 2006 for new services and on February 1, 2007 for existing services. Regulation under ACRA eliminates the APSC’s jurisdiction over retail telephone rates and service terms, with the exception of limited authority to enforce a statutory cap on certain non-bundled basic residential and business service and optional calling features. APSC retains jurisdiction over interconnection agreements, access charges and other wholesale arrangements. The APSC retains exclusive jurisdiction over residential service complaints but its authority is limited to enforcing the terms of service agreements and federal truth in billing requirements.
Categories of Operating Expenses
Our operating expenses are categorized as cost of services and products; selling, general and administrative expenses; and depreciation and amortization.
Cost of services and products. This includes expenses for salaries, wages and benefits relating to plant operation, maintenance and customer service; other plant operations, maintenance and administrative costs; network access costs; and costs of sales for long distance, cable television, Internet and directory services.
Selling, general and administrative expenses. This includes expenses for salaries, wages and benefits and contract service payments (e.g., legal fees) relating to engineering, financial, human resources and corporate operations; public company expenses; information management expenses, including billing; allowance for uncollectibles; expenses for travel, lodging and meals; internal and external communications costs; insurance premiums; stock exchange and banking fees; and postage.
Depreciation and amortization. This includes depreciation of our telecommunications, cable and Internet networks and equipment, and amortization of intangible assets.
Our Ability to Control Operating Expenses
We strive to control expenses in order to maintain our strong operating margins. As our revenue shifts to non-regulated services, operating margins decrease reflecting the lower margins associated with these more competitive services. We expect to control expenses while we continue to grow our business.
Results of Operations
The following table sets forth our results of operations as a percentage of total revenues for the periods indicated.
| | | Three months ended March 31, | |
| | | 2006 | | 2007 | |
| Revenues | | | | | |
| Local service | | | 37.4 | % | | 37.0 | % |
| Network access | | | 44.7 | | | 37.5 | |
| Cable television | | | 4.7 | | | 3.2 | |
| Internet | | | 13.2 | | | 16.4 | |
| Transport | | | 0.0 | | | 5.9 | |
| Total revenues | | | 100.00 | | | 100.00 | |
| Operating expenses | | | | | | | |
| Cost of services and products | | | 27.6 | % | | 36.5 | % |
| Selling, general and administrative expenses | | | 14.5 | | | 14.6 | |
| Depreciation and amortization | | | 17.1 | | | 21.1 | |
| Total operating expenses | | | 59.2 | | | 72.2 | |
| | | | | | | | |
| Income from operations | | | 40.8 | | | 27.8 | |
| | | | | | | | |
| Other income (expense) | | | | | | | |
| Interest expense | | | (39.5 | ) | | (31.3 | ) |
| Change in fair value of derivative | | | 1.6 | | | 1.3 | |
| Other income | | | 1.6 | | | 1.6 | |
| Total other expense | | | (36.3 | ) | | (28.4 | ) |
| | | | | | | | |
| Income before income taxes | | | 4.5 | | | (0.6 | ) |
| | | | | | | | |
| Income tax expense | | | (1.4 | ) | | (0.1 | ) |
| | | | | | | | |
| Income before accretion expense | | | 3.1 | | | (0.7 | ) |
| | | | | | | | |
| Accretion of Class B common convertible to senior subordinated notes | | | (1.0 | ) | | 0.0 | |
| | | | | | | | |
| Net income available to common stockholders | | | 2.1 | % | | (0.7 | )% |
Three months ended March 31, 2007 compared to three months ended March 31, 2006
Total Revenues. Total revenues increased 49.2% in the three months ended March 31, 2007 to $17.2 million from $11.5 million in the three months ended March 31, 2006. The primary reason for the increase is the acquisition of Mid-Maine on July 3, 2006. The tables below provide the components of our revenues for the three months ended March 31, 2007 compared to the same period of 2006.
For the three months ended March 31, 2007 and 2006
| | | Three Months Ended March 31, | | Change | |
| | | 2006 | | 2007 | | Amount | | Percent | |
| | | (dollars in thousands) | |
| Local services | | $ | 4,303 | | $ | 6,348 | | $ | 2,045 | | | 47.5 | % |
| Network access | | | 5,145 | | | 6,438 | | | 1,293 | | | 25.1 | |
| Cable television | | | 543 | | | 548 | | | 5 | | | 0.9 | |
| Internet | | | 1,522 | | | 2,820 | | | 1,298 | | | 85.2 | |
| Transport services | | | - | | | 1,018 | | | 1,018 | | | - | |
| Total | | $ | 11,513 | | $ | 17,172 | | $ | 5,659 | | | 49.2 | |
Local services. Local services revenue increased 47.5% to $6.3 million in the three months ended March 31, 2007 from $4.3 million in the three months ended March 31, 2006. The addition of Mid-Maine accounted for an increase of $2.1 million. Our Alabama and Missouri local services revenue decreased $0.1 million, reflecting a decrease in access lines and directory revenue, partially offset by the increased feature and long distance revenue associated with bundled service offerings. Unlimited calling bundles in Alabama and Missouri represent 32% and 22% respectively of the relevant customer base.
Network access. Network access revenue increased 25.1% to $6.4 million in the three months ended March 31, 2007 from $5.1 million in the three months ended March 31, 2006. The addition of Mid-Maine accounted for an increase of $1.4 million. This increase was partially offset by a decline in universal service fund payments.
Cable television. Cable television revenue in the three months ended March 31, 2007 increased 0.9% to $0.5 million which was slightly higher than in the three months ended March 31, 2006. The increase was due to the impact of higher local advertising revenue.
Internet. Internet revenue increased 85.2% to $2.8 million in the three months ended March 31, 2007 from $1.5 million in the three months ended March 31, 2006. The addition of Mid-Maine accounted for an increase of $1.1 million. The balance of the increase reflects growth of more than 2,000 new digital high-speed Internet customers in the balance of the Company which more than offset the decline in dial-up Internet customers associated with the conversion to digital high-speed Internet.
Transport Services. The addition of $1.0 million in transport services revenue is attributable to the acquisition of Mid-Maine on July 3, 2006.
Operating expenses. Operating expenses in the three months ended March 31, 2007 increased 82.0% to $12.4 million from $6.8 million in the three months ended March 31, 2006. The primary reason for the increase is the acquisition of Mid-Maine on July 3, 2006.
For the three months ended March 31, 2007 and 2006
| | | Three Months Ended March 31, | | Change | |
| | | 2006 | | 2007 | | Amount | | Percent | |
| | | (dollars in thousands) | |
| Cost of services | | $ | 3,175 | | $ | 6,271 | | $ | 3,096 | | | 97.5 | % |
| Selling, general and administrative expenses | | | 1,671 | | | 2,502 | | | 831 | | | 49.7 | |
| Depreciation and amortization | | | 1,968 | | | 3,629 | | | 1,661 | | | 84.4 | |
| Total | | $ | 6,814 | | $ | 12,402 | | $ | 5,588 | | | 82.0 | |
Cost of services and products. Cost of service and products increased 97.5% to $6.3 million in the three months ended March 31, 2007 from $3.2 million in the three months ended March 31, 2006. The addition of Mid-Maine accounted for the increase, including providing competitive local exchange services in Maine. The increased cost associated with higher digital high-speed Internet customers and bundled services usage in Alabama and Missouri was offset by savings from handling our Internet help desk internally and by network and organizational efficiencies.
Selling, general and administrative expenses. Selling, general and administrative expenses increased 49.7% to $2.5 million in the three months ended March 31, 2007 from $1.7 million in the three months ended March 31, 2006. The addition of Mid-Maine accounted for the increase of $0.8 million.
Depreciation and amortization. Depreciation and amortization increased 84.4% to $3.6 million in the three months ended March 31, 2007 from $2.0 million in the three months ended March 31, 2006. An increase of $1.5 million is associated with the acquisition of Mid-Maine, including the amortization of intangibles of $8.8 million for customer based assets with an effective life of 15 years and $1.8 million for a non-competition agreement with a remaining life of two years; and a telephone plant adjustment associated with the purchase price allocation. The balance of $0.1 million is associated with higher depreciation in Alabama and Missouri.
Interest expense. Interest expense increased 18.2% to $5.4 million in the three months ended March 31, 2007 from $4.5 million in the three months ended March 31, 2006. The senior credit facility was amended to add $40 million for the purchase of Mid-Maine. Interest on this additional debt was the primary reason for the increase, which was partially offset by a reduction from 4.0% to 3.25% in the margin charged on LIBOR rates for the full $120 million facility. Increased amortization of costs associated with the five year, $80 million, 7% interest rate cap and amortization of costs associated with the amended credit facility accounted for the balance of the increase.
Change in fair value of derivative associated with Class B common convertible to Class A common. The derivative value associated with the conversion option for our Class B common stock must be fair valued each quarter until conversion occurs, not later than December 21, 2009. The reduction in maximum time to conversion, the change in price of IDSs and the underlying Class A common stock and the expected time for conversion impact the fair value of the derivative. The combination of these factors changed the value of the derivative by less than $0.1 million in the three months ended March 31, 2007 compared to the three months ended March 31, 2006.
Other income. Other income was $0.3 million in the three months ended March 31, 2007, up from $0.2 million in the three months ended March 31, 2006, primarily related to higher interest income on higher cash balances.
Income taxes. Provision for income taxes was less than $0.1 million in the three months ended March 31, 2007 compared to $0.2 million in the three months ended March 31, 2006.
Accretion of Class B common convertible to senior subordinated notes. Our Class B common stock was issued to the existing equity holders coincident with our initial public offering on December 21, 2004. These shares represent their retained interest in the Company. They do not receive any dividends and will convert into IDSs not later than December 21, 2009. For the first two years after their issuance, the present value discount on the portion of the shares related to the conversion to senior subordinated notes was accreted as a non-cash expense to the Company. The process was completed in 2006.
Net income (loss). As a result of the foregoing, there was a net loss of $0.1 million available to common stockholders in the three months ended March 31, 2007 compared to net income of $0.2 million in the three months ended March 31, 2006.
Liquidity and Capital Resources
Our liquidity needs arise primarily from: (i) interest payments related to our credit facility and our senior subordinated notes; (ii) capital expenditures, (iii) working capital requirements; (iv) dividend payments on our Class A common stock; and (v) potential acquisitions.
Cash flows from operating activities for the first three months of 2007 amounted to ($0.7) million compared to $2.8 million for the first three months of 2006. The primary difference relates to the impact of acquiring Mid-Maine, the payment of the $4.3 million for the fourth quarter of 2006 distribution to IDS holders occurring on January 2, 2007 rather than December 30, 2006 (which is a Saturday), the $1.6 million in depreciation and amortization of loan cost and fair valued intangible assets of Mid-Maine, and receipt of $0.2 million in income tax refunds.
Cash flows from investing activities in the first three months of 2007 were $1.4 million compared to $1.0 million in the first three months of 2006. The acquisition and construction of property and equipment utilized $0.2 million more in the first three months of 2007 than in the same period of 2006, reflecting higher expenditures associated with the Mid-Maine acquisition. The balance reflected the sale of an asset in 2006.
Cash flows from financing activities for the first three months of 2007 and 2006 used $1.7 million, reflecting payment of dividends to shareowners in both periods.
We anticipate that operating cash flow, together with borrowings under our credit facility, will be adequate to meet our currently anticipated operating and capital expenditure requirements for at least the next 12 months.
Subsequent Events
On May 3, 2007, we filed a registration statement on Form S-3 to offer up to 3,450,000 Income Deposit Securities (IDSs) in the United States and Canada representing an aggregate of 3,450,000 shares of our Class A common stock and $25,875,000 aggregate principal amount of our 13% senior subordinated notes due 2019. Our IDSs are listed on the American Stock Exchange under the symbol “OTT” and on the Toronto Stock Exchange under the symbol “OTT.UN”.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our short-term excess cash balance is invested in short-term commercial paper. We do not invest in any speculative derivative or commodity type instruments. Accordingly, we are subject to minimal market risk on our investments.
We have the ability to borrow up to $15.0 million under a revolving loan facility. The interest rate is variable and, accordingly, we are exposed to interest rate risk, primarily from the change in LIBOR or a base rate. Currently, we have no loans drawn under this facility.
Item 4. Controls and Procedures
With the participation of the Chief Executive Officer and the Chief Financial Officer, management has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2007.
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the three months ended March 31, 2007 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
Item. 6. Exhibits
Exhibits
See Exhibit Index.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Date: June 14, 2007 | OTELCO INC. |
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| | By: /s/ Curtis L. Garner, Jr. |
| | Curtis L. Garner, Jr. |
| | Chief Financial Officer |
EXHIBIT INDEX
Exhibit No. | | Description |
| 31.1 | | Certificate pursuant to Rule 13A-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Executive Officer |
| 31.2 | | Certificate pursuant to Rule 13A-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Financial Officer |
| 32.1 | | Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive Officer |
| 32.2 | | Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Financial Officer |
