UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| (Mark One) | |
| | |
| ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | For the quarterly period ended June 30, 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
(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) |
| | | |
(Registrant’s telephone number, including area code)
(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.
Yes ý No ¨
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 མ Accelerated filer ý Non-accelerated filer མ
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 August 8, 2007 | |
| Class A Common Stock ($0.01 par value per share) | | | 12,676,733 | |
| Class B Common Stock ($0.01 par value per share) | | | 544,671 | |
OTELCO INC.
FORM 10-Q
For the three month period ended June 30, 2007
Unless the context otherwise requires, the words “we”, “us”, “our”, “the Company” and “Otelco” refer to Otelco Inc., a Delaware corporation.
FORWARD-LOOKING STATEMENTS
This 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.
OTELCO INC. | |
| | | December 31, 2006 | | June 30, 2007 | |
Assets | | | | (unaudited) | |
| Current assets | | | | | |
| Cash and cash equivalents | | $ | 14,401,849 | | $ | 16,116,971 | |
| Accounts receivable: | | | | | | | |
| Due from subscribers, net of allowance for doubtful accounts of $207,359 and $206,343 respectively | | | 3,105,636 | | | 2,650,306 | |
| Unbilled receivables | | | 2,324,213 | | | 2,504,002 | |
| Other | | | 1,680,144 | | | 1,925,038 | |
| Materials and supplies | | | 1,962,938 | | | 1,748,999 | |
| Prepaid expenses | | | 1,062,947 | | | 774,530 | |
| Deferred income taxes | | | 766,225 | | | 832,946 | |
| Total current assets | | | 25,303,952 | | | 26,552,792 | |
| | | | | | | | |
| Property and equipment, net | | | 60,493,789 | | | 56,903,708 | |
| Goodwill | | | 134,182,309 | | | 134,570,435 | |
| Intangible assets, net | | | 11,340,806 | | | 10,427,789 | |
| Investments | | | 1,240,250 | | | 1,219,623 | |
| Deferred financing costs | | | 6,652,393 | | | 5,856,148 | |
| Interest rate cap | | | 4,542,160 | | | 4,305,773 | |
| Deferred charges | | | 96,628 | | | 237,654 | |
| Total assets | | $ | 243,852,287 | | $ | 240,073,922 | |
| | | | | | | | |
Liabilities and Stockholders’ Equity (Deficit) | | | | | | | |
| Current liabilities | | | | | | | |
| Accounts payable | | $ | 1,658,911 | | $ | 1,613,722 | |
| Dividends payable | | | 1,705,524 | | | 1,705,524 | |
| Accrued expenses | | | 5,875,863 | | | 5,954,465 | |
| Advance billings and payments | | | 2,119,701 | | | 2,118,865 | |
| Customer deposits | | | 197,496 | | | 204,590 | |
| Total Current Liabilities | | | 11,557,495 | | | 11,597,166 | |
| | | | | | | | |
| Deferred income taxes | | | 24,712,213 | | | 24,778,934 | |
| Other liabilities | | | 187,037 | | | 173,127 | |
| Total deferred tax and other liabilities | | | 24,899,250 | | | 24,952,061 | |
| | | | | | | | |
| Long-term notes payable | | | 201,075,498 | | | 201,075,498 | |
| Derivative liability | | | 2,107,877 | | | 1,639,460 | |
| 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 | ) | | (4,486,961 | ) |
| Accumulated other comprehensive income | | | 878,045 | | | 1,109,451 | |
| Total stockholders’ equity (deficit) | | | 127,134 | | | (3,275,296 | ) |
| Total liabilities and stockholders’ equity (deficit) | | $ | 243,852,287 | | $ | 240,073,922 | |
| |
| |
| The accompanying notes are an integral part of these consolidated financial statements. |
| | | Three months ended June 30, | | Six months ended June 30, | |
| | | 2006 | | 2007 | | 2006 | | 2007 | |
| Revenues | | | | | | | | | |
| Local services | | $ | 4,290,057 | | $ | 6,530,615 | | $ | 8,593,456 | | $ | 12,879,111 | |
| Network access | | | 5,170,581 | | | 6,140,830 | | | 10,315,636 | | | 12,578,418 | |
| Cable television | | | 538,565 | | | 548,414 | | | 1,081,071 | | | 1,095,941 | |
| Internet | | | 1,558,610 | | | 2,859,407 | | | 3,081,047 | | | 5,679,704 | |
| Transport services | | | — | | | 1,038,936 | | | — | | | 2,057,419 | |
| Total revenues | | | 11,557,813 | | | 17,118,202 | | | 23,071,210 | | | 34,290,593 | |
| Operating expenses | | | | | | | | | | | | | |
| Cost of services and products | | | 3,187,114 | | | 6,534,399 | | | 6,361,801 | | | 12,805,456 | |
| Selling, general and administrative expenses | | | 1,481,324 | | | 2,419,527 | | | 3,152,664 | | | 4,921,328 | |
| Depreciation and amortization | | | 2,009,159 | | | 3,775,623 | | | 3,977,500 | | | 7,404,714 | |
| Total operating expenses | | | 6,677,597 | | | 12,729,549 | | | 13,491,965 | | | 25,131,498 | |
| | | | | | | | | | | | | | |
| Income from operations | | | 4,880,216 | | | 4,388,653 | | | 9,579,245 | | | 9,159,095 | |
| | | | | | | | | | | | | | |
| Other income (expense) | | | | | | | | | | | | | |
| Interest expense | | | (4,584,505 | ) | | (5,412,345 | ) | | (9,133,980 | ) | | (10,788,609 | ) |
| Change in fair value of derivative | | | 130,721 | | | 250,549 | | | 310,462 | | | 468,417 | |
| Other income | | | 2,809,272 | | | 165,581 | | | 2,996,511 | | | 447,033 | |
| Total other expense | | | (1,644,512 | ) | | (4,996,215 | ) | | (5,827,007 | ) | | (9,873,159 | ) |
| | | | | | | | | | | | | | |
| Income (loss) before income tax and accretion expense | | | 3,235,704 | | | (607,562 | ) | | 3,752,238 | | | (714,064 | ) |
| | | | | | | | | | | | | | |
| Income tax (expense) benefit | | | (1,071,400 | ) | | 502,981 | | | (1,232,610 | ) | | 491,276 | |
| | | | | | | | | | | | | |
| Income (loss) before accretion expense | | | 2,164,304 | | | (104,581 | ) | | 2,519,628 | | | (222,788 | ) |
| | | | | | | | | | | | | | |
| Accretion of Class B common convertible to senior | | | | | | | | | | | | | |
| subordinated notes | | | (110,731 | ) | | — | | | (221,463 | ) | | — | |
| Net income (loss) available to common stockholders | | $ | 2,053,573 | | $ | (104,581 | ) | $ | 2,298,165 | | $ | (222,788 | ) |
| | | | | | | | | | | | | | |
| Weighted average shares outstanding: | | | | | | | | | | | | | |
| Basic | | | 9,676,733 | | | 9,676,733 | | | 9,676,733 | | | 9,676,733 | |
| Diluted | | | 10,221,404 | | | 10,221,404 | | | 10,221,404 | | | 10,221,404 | |
| | | | | | | | | | | | | | |
| Net income (loss) per share | | | | | | | | | | | | | |
| Basic | | $ | 0.21 | | $ | (0.01 | ) | $ | 0.24 | | $ | (0.02 | ) |
| Diluted | | $ | 0.20 | | $ | (0.03 | ) | $ | 0.22 | | $ | (0.07 | ) |
| | | | | | | | | | | | | | |
| Dividends declared per share | | $ | 0.18 | | $ | 0.18 | | $ | 0.35 | | $ | 0.35 | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
| | | Six months ended June 30, | |
| | | 2006 | | 2007 | |
| Cash flows from operating activities: | | | | | |
| Net income (loss) | | $ | 2,298,165 | | $ | (222,788 | ) |
| Adjustments to reconcile net income to cash flows from operating activities: | | | | | | | |
| Depreciation | | | 3,874,647 | | | 6,107,336 | |
| Amortization | | | 102,853 | | | 1,297,378 | |
| Interest rate caplet | | | 344,946 | | | 467,793 | |
| Amortization of loan cost | | | 686,875 | | | 796,245 | |
| Accretion expense | | | 221,463 | | | — | |
| Change in fair value of derivative liability | | | (310,462 | ) | | (468,417 | ) |
| Provision for uncollectible revenue | | | 60,903 | | | 78,231 | |
| Gain on disposition of other assets | | | (2,686,745 | ) | | — | |
| Changes in assets and liabilities; net of assets and liabilities acquired: | | | | | | | |
| Accounts receivables | | | (358,856 | ) | | (224,145 | ) |
| Material and supplies | | | (42,213 | ) | | 59,352 | |
| Prepaid expenses and other assets | | | 66,930 | | | 288,417 | |
| Accounts payable and accrued liabilities | | | 1,461,447 | | | (1,716,412 | ) |
| Advance billings and payments | | | (19,941 | ) | | (836 | ) |
| Other liabilities | | | (5,158 | ) | | (6,816 | ) |
| Net cash from operating activities | | | 5,694,854 | | | 6,455,338 | |
| | | | | | | | |
| Cash flows from investing activities: | | | | | | | |
| Acquisition and construction of property and equipment | | | (1,968,233 | ) | | (2,875,642 | ) |
| Proceeds from retirement of investment | | | 3,226,651 | | | 7,871 | |
| Deferred charges | | | (85,940 | ) | | (166,921 | ) |
| | | | | | | | |
| Net cash from investing activities | | | 1,172,478 | | | (3,034,692 | ) |
| | | | | | | | |
| Cash flows from financing activities: | | | | | | | |
| Cash dividends paid | | | (3,411,048 | ) | | (1,705,524 | ) |
| | | | | | | | |
| Net cash from financing activities | | | (3,411,048 | ) | | (1,705,524 | ) |
| | | | | | | | |
| Net increase in cash and cash equivalents | | | 3,456,284 | | | 1,715,122 | |
| Cash and cash equivalents, beginning of period | | | 5,569,233 | | | 14,401,849 | |
| | | | | | | | |
| Cash and cash equivalents, end of period | | $ | 9,025,517 | | $ | 16,116,971 | |
| | | | | | | | |
| Supplemental disclosures of cash flow information: | | | | | | | |
| Interest paid | | $ | 8,085,647 | | $ | 9,547,279 | |
| | | | | | | | |
| Income taxes paid (received) | | $ | 40,000 | | $ | (173,718 | ) |
| | | | | | | | |
| Dividends declared but not paid | | $ | — | | $ | 1,705,524 | |
| | | | | | | | |
| | | | | | | |
The accompanying notes are an integral part of these 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 June 30, 2006 and 2007 the change in the fair value of the interest rate cap was $610,139 and $623,504, respectively. For the six months ended June 30, 2006 and 2007 the change in the fair value of the interest rate cap was $1,486,592 and $231,407, 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 June 30, 2006 and 2007 the cost of the interest rate cap was $181,984 and $240,316, respectively. For the six months ended June 30, 2006 and 2007 the cost of the interest rate cap was $344,946 and $467,794, 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:
| | | For the three months | | For the six months | |
| | | ended June 30, | | ended June 30, | |
| | | 2006 | | 2007 | | 2006 | | 2007 | |
| | | | | | | | | | |
| Weighted average common shares-basic | | | 9,676,733 | | | 9,676,733 | | | 9,676,733 | | | 9,676,733 | |
| | | | | | | | | | | | | | |
| Effect of dilutive securities | | | 544,671 | | | 544,671 | | | 544,671 | | | 544,671 | |
| | | | | | | | | | | | | | |
| Weighted-average common shares and potential | | | | | | | | | | | | | |
| common shares-diluted | | | 10,221,404 | | | 10,221,404 | | | 10,221,404 | | | 10,221,404 | |
| | | | | | | | | | | | | | |
| Net income (loss) available to common stockholders | | $ | 2,053,573 | | $ | (104,581 | ) | $ | 2,298,165 | | $ | (222,788 | ) |
| | | | | | | | | | | | | | |
| Net income (loss) per basic share | | $ | 0.21 | | $ | (0.01 | ) | $ | 0.24 | | $ | (0.02 | ) |
| | | | | | | | | | | | | | |
| Net income (loss) available to common stockholders | | $ | 2,053,573 | | $ | (104,581 | ) | $ | 2,298,165 | | $ | (222,788 | ) |
| Plus: Accretion expense of Class B common | | | | | | | | | | | | | |
| convertible to senior subordinated notes | | | 110,732 | | | — | | | 221,463 | | | — | |
| Less: Change in fair value of derivative | | | (130,721 | ) | | (250,549 | ) | | (310,462 | ) | | (468,417 | ) |
| | | | | | | | | | | | | | |
| Net income (loss) available for diluted shares | | $ | 2,033,584 | | $ | (355,130 | ) | $ | 2,209,166 | | $ | (691,205 | ) |
| | | | | | | | | | | | | | |
| Net income (loss) per diluted share | | $ | 0.20 | | $ | (0.03 | ) | $ | 0.22 | | $ | (0.07 | ) |
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 | | | 3,536,833 | |
| Property and equipment | | | 20,167,479 | |
| Intangible assets | | | 10,700,606 | |
| Goodwill | | | 15,138,442 | |
| 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 | | Unaudited | |
| | | Three months ended | | Six months ended | |
| | | June 30, 2006 | | June 30, 2006 | |
| Revenues | | $ | 17,062,776 | | $ | 34,428,236 | |
| Income from operations | | | 3,962,257 | | | 8,882,774 | |
| Net income | | | 1,388,731 | | | 1,455,767 | |
| Basic net income per share | | $ | 0.14 | | $ | 0.15 | |
| Diluted net income per share | | $ | 0.14 | | $ | 0.14 | |
On July 5, 2007, the Company completed its offering of 3,000,000 Income Deposit Securities (IDS) units through an underwritten public offering at $19.80 per unit. The price per unit is comprised of $11.68 allocated to each share of Class A common stock and $8.11 allocated to each senior subordinated note, plus $0.01 representing accrued interest from June 30, 2007. The Company used the net proceeds of approximately $55.4 million to repay senior secured indebtedness under its credit facility, reducing senior debt from $120.0 million to approximately $64.6 million. The $8.11 allocated to each senior subordinated note represents a premium of $0.61 over the $7.50 stated principal amount. The additional IDS units increase senior subordinated debt by $22.5 million, bringing senior subordinated debt to approximately $103.6 million. Therefore, total debt was reduced from approximately $201.1 million to $168.2 million.
On July 13, 2007, the Company entered into a first amendment to its amended and restated credit agreement dated July 3, 2006. Among other things, the amendment reduced the applicable margins on the interest rates under the credit agreement, initially reducing the applicable LIBOR margin from 3.25% to 1.75% on the $64.6 million of senior debt. After September 30, 2007, the margins will adjust quarterly on a prospective basis based on the total leverage ratio of the Company.
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. The condensed consolidated financial information is provided for the guarantor entities.
The following tables present condensed consolidating balance sheets as of June 30, 2007 and December 31, 2006; condensed consolidating statements of operations for the three months ended June 30, 2007 and June 30, 2006; condensed consolidating statements of operations for the six months ended June 30, 2006 and June 30, 2007; and condensed consolidating statements of cash flows for the six months ended June 30, 2007 and June 30, 2006.
Condensed Consolidating Balance Sheet |
June 30, 2007 |
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| ASSETS | | | | | | | | | | | |
| | | | | | | | | | | | |
| Current assets | | | | | | | | | | | |
| Cash and cash equivalents | | $ | — | | $ | 16,082,629 | | $ | 34,342 | | $ | — | | $ | 16,116,971 | |
| Accounts receivable, net | | | 46,548 | | | 5,960,563 | | | 1,072,235 | | | — | | | 7,079,346 | |
| Materials and supplies | | | — | | | 800,582 | | | 948,417 | | | — | | | 1,748,999 | |
| Prepaid and other current assets | | | 46,175 | | | 680,163 | | | 48,192 | | | — | | | 774,530 | |
| Deferred income taxes | | | 832,946 | | | — | | | — | | | — | | | 832,946 | |
| Investment in subsidiaries | | | 82,548,846 | | | — | | | — | | | (82,548,846 | ) | | — | |
| Intercompany receivables | | | 23,860,587 | | | — | | | — | | | (23,860,587 | ) | | — | |
| Total current assets | | | 107,335,102 | | | 23,523,937 | | | 2,103,186 | | | (106,409,433 | ) | | 26,552,792 | |
| | | | | | | | | | | | | | | | | |
| Property and equipment, net | | | — | | | 40,717,500 | | | 16,186,208 | | | — | | | 56,903,708 | |
| Goodwill | | | — | | | 136,507,075 | | | (1,936,640 | ) | | — | | | 134,570,435 | |
| Intangibles assets, net | | | — | | | 6,925,852 | | | 3,501,937 | | | — | | | 10,427,789 | |
| Investments | | | 1,000 | | | 893,436 | | | 325,187 | | | — | | | 1,219,623 | |
| Other long-term assets | | | 9,841,590 | | | 557,985 | | | — | | | — | | | 10,399,575 | |
| Total assets | | $ | 117,177,692 | | $ | 209,125,785 | | $ | 20,179,878 | | $ | (106,409,433 | ) | $ | 240,073,922 | |
| | | | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | | | | |
| Accounts payables and accrued expenses | | $ | 4,541,094 | | $ | 2,998,410 | | $ | 1,734,207 | | $ | — | | $ | 9,273,711 | |
| Intercompany payables | | | — | | | 8,657,058 | | | 15,203,529 | | | (23,860,587 | ) | | — | |
| Other current liabilities | | | — | | | 2,217,342 | | | 106,113 | | | — | | | 2,323,455 | |
| Total current liabilities | | | 4,541,094 | | | 13,872,810 | | | 17,043,849 | | | (23,860,587 | ) | | 11,597,166 | |
| | | | | | | | | | | | | | | | | |
| Deferred income taxes | | | 4,728,411 | | | 17,544,383 | | | 2,506,140 | | | — | | | 24,778,934 | |
| Other liabilities | | | — | | | 173,127 | | | — | | | — | | | 173,127 | |
| Long-term notes payables | | | 105,458,990 | | | 95,616,508 | | | — | | | — | | | 201,075,498 | |
| Derivative liability | | | 1,639,460 | | | — | | | — | | | — | | | 1,639,460 | |
| Class B common convertible to senior subordinated notes | | | 4,085,033 | | | — | | | — | | | — | | | 4,085,033 | |
| Stockholders' equity (deficit) | | | (3,275,296 | ) | | 81,918,957 | | | 629,889 | | | (82,548,846 | ) | | (3,275,296 | ) |
| Total liabilities and stockholders' equity (deficit) | | $ | 117,177,692 | | $ | 209,125,785 | | $ | 20,179,878 | | $ | (106,409,433 | ) | $ | 240,073,922 | |
| | | | | | | | | | | | | | | | | |
Condensed Consolidating Balance Sheet |
December 31, 2006 |
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| 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 | |
| Investment in subsidiaries | | | 75,751,926 | | | — | | | — | | | (75,751,926 | ) | | — | |
| Intercompany receivables | | | 34,232,103 | | | — | | | — | | | (34,232,103 | ) | | — | |
| Total current assets | | | 110,774,769 | | | 22,280,399 | | | 2,232,813 | | | (109,984,029 | ) | | 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 | | | 0 | | | 7,689,851 | | | 3,650,955 | | | — | | | 11,340,806 | |
| Investments | | | 1,000 | | | 914,063 | | | 325,187 | | | — | | | 1,240,250 | |
| Other long-term assets | | | 10,589,917 | | | 701,264 | | | — | | | — | | | 11,291,181 | |
| Total assets | | $ | 121,365,686 | | $ | 210,450,236 | | $ | 22,020,394 | | $ | (109,984,029 | ) | $ | 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 | |
| Intercompany payables | | | — | | | 15,495,558 | | | 18,736,545 | | | (34,232,103 | ) | | — | |
| Other current liabilities | | | — | | | 2,238,188 | | | 79,009 | | | — | | | 2,317,197 | |
| Total current liabilities | | | 4,924,962 | | | 20,815,585 | | | 20,049,051 | | | (34,232,103 | ) | | 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) | | | 127,134 | | | 76,286,723 | | | (534,797 | ) | | (75,751,926 | ) | | 127,134 | |
| Total liabilities and stockholders' equity (deficit) | | $ | 121,365,686 | | $ | 210,450,236 | | $ | 22,020,394 | | $ | (109,984,029 | ) | $ | 243,852,287 | |
Condensed Consolidated Statement of Operations |
For the Three Months Ended June 30, 2007 |
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Revenue | | $ | 760,071 | | $ | 15,581,804 | | $ | 2,918,105 | | $ | (2,141,780 | ) | $ | 17,118,200 | |
| Operating expenses | | | (663,987 | ) | | (11,638,546 | ) | | (2,568,797 | ) | | 2,141,780 | | | (12,729,550 | ) |
| Income from operations | | | 96,084 | | | 3,943,258 | | | 349,308 | | | — | | | 4,388,650 | |
| Other income (expense) | | | (3,799,817 | ) | | (1,196,384 | ) | | (11 | ) | | — | | | (4,996,212 | ) |
| Earnings from subsidiaries | | | 3,096,171 | | | — | | | — | | | (3,096,171 | ) | | — | |
| Income before income tax and accretion expense | | | (607,562 | ) | | 2,746,874 | | | 349,297 | | | (3,096,171 | ) | | (607,562 | ) |
| Income tax expense | | | 502,981 | | | — | | | — | | | — | | | 502,981 | |
| Accretion of class B common convertible | | | | | | | | | | | | | | | | |
| to senior subordinated notes | | | — | | | — | | | — | | | — | | | — | |
| Net income (loss) to common stockholders | | $ | (104,581 | ) | $ | 2,746,874 | | $ | 349,297 | | $ | (3,096,171 | ) | $ | (104,581 | ) |
Condensed Consolidated Statement of Operations |
For the Three Months Ended June 30, 2006 |
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Revenue | | $ | 628,629 | | $ | 10,925,401 | | $ | 1,521,502 | | $ | (1,517,719 | ) | $ | 11,557,813 | |
| Operating expenses | | | (573,707 | ) | | (6,633,619 | ) | | (987,990 | ) | | 1,517,719 | | | (6,677,597 | ) |
| Income from operations | | | 54,922 | | | 4,291,782 | | | 533,512 | | | — | | | 4,880,216 | |
| Other income (expense) | | | (3,184,933 | ) | | 1,540,419 | | | — | | | — | | | (1,644,514 | ) |
| Earnings from subsidiaries | | | 6,365,713 | | | — | | | — | | | (6,365,713 | ) | | — | |
| Income before income tax and accretion expense | | | 3,235,702 | | | 5,832,201 | | | 533,512 | | | (6,365,713 | ) | | 3,235,702 | |
| Income tax expense | | | (1,071,400 | ) | | — | | | — | | | — | | | (1,071,400 | ) |
| Accretion of class B common convertible | | | | | | | | | | | | | | | | |
| to senior subordinated notes | | | (110,732 | ) | | — | | | — | | | — | | | (110,732 | ) |
| Net income (loss) to common stockholders | | $ | 2,053,570 | | $ | 5,832,201 | | $ | 533,512 | | $ | (6,365,713 | ) | $ | 2,053,570 | |
| | | | | | | | | | | | | | | | | |
Condensed Consolidated Statement of Operations |
For the Six Months Ended June 30, 2007 |
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Revenue | | $ | 1,487,886 | | $ | 30,869,122 | | $ | 6,163,778 | | $ | (4,230,193 | ) | $ | 34,290,593 | |
| Operating expenses | | | (1,487,886 | ) | | (22,874,723 | ) | | (4,999,082 | ) | | 4,230,193 | | | (25,131,498 | ) |
| Income from operations | | | — | | | 7,994,399 | | | 1,164,696 | | | — | | | 9,159,095 | |
| Other income (expense) | | | (7,510,984 | ) | | (2,362,164 | ) | | (11 | ) | | — | | | (9,873,159 | ) |
| Earnings from subsidiaries | | | 6,796,920 | | | — | | | — | | | (6,796,920 | ) | | — | |
| Income before income tax and accretion expense | | | (714,064 | ) | | 5,632,235 | | | 1,164,685 | | | (6,796,920 | ) | | (714,064 | ) |
| Income tax expense | | | 491,276 | | | — | | | — | | | — | | | 491,276 | |
| Accretion of class B common convertible | | | | | | | | | | | | | | | | |
| to senior subordinated notes | | | — | | | — | | | — | | | — | | | — | |
| Net income (loss) to common stockholders | | $ | (222,788 | ) | $ | 5,632,235 | | $ | 1,164,685 | | $ | (6,796,920 | ) | $ | (222,788 | ) |
| | | | | | | | | | | | | | | | | |
Condensed Consolidated Statement of Operations |
For the Six Months Ended June 30, 2006 |
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Revenue | | $ | 1,257,258 | | $ | 21,648,556 | | $ | 3,167,474 | | $ | (3,002,078 | ) | $ | 23,071,210 | |
| Operating expenses | | | (1,347,907 | ) | | (13,171,813 | ) | | (1,974,323 | ) | | 3,002,078 | | | (13,491,965 | ) |
| Income from operations | | | (90,649 | ) | | 8,476,743 | | | 1,193,151 | | | — | | | 9,579,245 | |
| Other income (expense) | | | (6,248,677 | ) | | 421,668 | | | — | | | — | | | (5,827,009 | ) |
| Earnings from subsidiaries | | | 10,091,562 | | | — | | | — | | | (10,091,562 | ) | | — | |
| Income before income tax and accretion expense | | | 3,752,236 | | | 8,898,411 | | | 1,193,151 | | | (10,091,562 | ) | | 3,752,236 | |
| Income tax expense | | | (1,232,610 | ) | | — | | | — | | | — | | | (1,232,610 | ) |
| Accretion of class B common convertible | | | | | | | | | | | | | | | | |
| to senior subordinated notes | | | (221,463 | ) | | — | | | — | | | — | | | (221,463 | ) |
| Net income (loss) to common stockholders | | $ | 2,298,163 | | $ | 8,898,411 | | $ | 1,193,151 | | $ | (10,091,562 | ) | $ | 2,298,163 | |
| | | | | | | | | | | | | | | | | |
Condensed Consolidating Statement of Cash Flows |
For the Six Months Ended June 30, 2007 |
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | | | |
| Net income (loss) | | $ | (222,788 | ) | $ | 5,632,235 | | $ | 1,164,685 | | $ | (6,796,920 | ) | $ | (222,788 | ) |
| Adjustment to reconcile net income (loss) | | | | | | | | | | | | | | | | |
| to cash flows from operating activities | | | 662,554 | | | 5,309,769 | | | 2,306,241 | | | — | | | 8,278,564 | |
| Changes in assets and liabilities, net of | | | | | | | | | | | | | | | | |
| assets and liabilities acquired | | | 8,213,916 | | | (6,902,671 | ) | | (2,911,683 | ) | | — | | | (1,600,438 | ) |
| Cash flows from investing activities | | | (151,238 | ) | | (2,333,547 | ) | | (549,907 | ) | | — | | | (3,034,692 | ) |
| Cash flows from financing activities | | | (8,502,444 | ) | | — | | | — | | | 6,796,920 | | | (1,705,524 | ) |
| Net increase (decrease) in cash and cash equivalents | | | — | | | 1,705,786 | | | 9,336 | | | — | | | 1,715,122 | |
| | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, beginning of period | | | — | | | 14,376,843 | | | 25,006 | | | — | | | 14,401,849 | |
| Cash and cash equivalents, end of period | | $ | — | | $ | 16,082,629 | | $ | 34,342 | | $ | — | | $ | 16,116,971 | |
| | | | | | | | | | | | | | | | | |
Condensed Consolidating Statement of Cash Flows |
For the Six Months Ended June 30, 2006 |
| | | | | Guarantor | | Non-Guarantor | | | | | |
| | | Parent | | Subsidiaries | | Subsidiaries | | Eliminations | | Consolidated | |
| | | | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | | | |
| Net income (loss) | | $ | 2,298,163 | | $ | 8,898,411 | | $ | 1,193,151 | | $ | (10,091,562 | ) | $ | 2,298,163 | |
| Adjustment to reconcile net income (loss) | | | | | | | | | | | | | | | | |
| to cash flows from operating activities | | | 942,821 | | | 587,238 | | | 764,421 | | | — | | | 2,294,480 | |
| Changes in assets and liabilities, net of | | | | | | | | | | | | | | | | |
| assets and liabilities acquired | | | 10,347,566 | | | (7,502,212 | ) | | (1,743,143 | ) | | — | | | 1,102,211 | |
| Cash flows from investing activities | | | (85,940 | ) | | 1,475,176 | | | (216,758 | ) | | — | | | 1,172,478 | |
| Cash flows from financing activities | | | (13,502,610 | ) | | — | | | — | | | 10,091,562 | | | (3,411,048 | ) |
| Net increase (decrease) in cash and cash equivalents | | | — | | | 3,458,613 | | | (2,329 | ) | | — | | | 3,456,284 | |
| | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, beginning of period | | | — | | | 5,511,939 | | | 57,294 | | | — | | | 5,569,233 | |
| Cash and cash equivalents, end of period | | $ | — | | $ | 8,970,552 | | $ | 54,965 | | $ | — | | $ | 9,025,517 | |
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 June 30, 2007, we operated approximately 66,373 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 74.4% of our total revenues in both the second quarter and first half 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 digital video recording 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, | | June 30, | |
| | | 2005 | | 2006 | | 2007 | | 2007 | |
| Access line equivalents (1): | | | | | | | | | |
| Residential access lines | | | 24,541 | | | 29,832 | | | 29,789 | | | 29,483 | |
| Business access lines | | | 8,036 | | | 22,171 | | | 22,577 | | | 23,537 | |
| Access lines | | | 32,577 | | | 52,003 | | | 52,366 | | | 53,020 | |
| Digital high-speed lines | | | 6,314 | | | 11,951 | | | 12,960 | | | 13,353 | |
| Total access line equivalents | | | 38,891 | | | 63,954 | | | 65,326 | | | 66,373 | |
| | | | | | | | | | | | | | |
| Long distance customers | | | 14,438 | | | 21,370 | | | 22,066 | | | 22,358 | |
| Cable television customers | | | 4,220 | | | 4,188 | | | 4,211 | | | 4,187 | |
| Dial-up Internet customers | | | 12,149 | | | 19,587 | | | 18,313 | | | 17,220 | |
| | | | | | | | | | | | | |
| (1) | We define total access line equivalents as access lines, cable modems and digital subscriber lines. |
Access lines increased 1.2% during second quarter 2007 and 2.0% year-to-date 2007, with 53,020 access lines in service as of June 30, 2007. Our digital high-speed Internet customers continue to grow from 12,960 subscribers at March 31, 2007, to 13,353 at June 30, 2007. Access line equivalents increased 1.6% during second quarter 2007 and 3.8% year-to-date 2007, with 66,373 access line equivalents in service as of June 30, 2007. On July 3, 2006, we completed the acquisition of Mid-Maine. Subscriber results for December 31, 2006, March 31, 2007 and June 30, 2007 include this acquisition. The primary factors in the growth in access lines and access line equivalents is the increase in digital high-speed lines across all of our operating areas and the increase in business access lines in Maine.
In 2006, we introduced bundled service packages including unlimited domestic calling to our Alabama residential and all Missouri customers. As of June 30, 2007, over 8,100 customers signed up for one of these packages representing over 33% of the offered base. Our long distance customers increased 1.3% to 22,358 during second quarter 2007 for year-to-date growth of 4.6%. Our cable television customers remained flat year-to-date 2007 at 4,187. We anticipate introducing high definition and digital video services in Alabama by the end of third quarter 2007. Dial-up Internet customers decreased 6.0% to 18,313 during second quarter 2007 and 12.1% year-to-date 2007. This also includes the subscribers we serve 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 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, such as non-compete agreements and customer lists.
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 June 30, | | Six Months Ended June 30, | |
| | | 2006 | | 2007 | | 2006 | | 2007 | |
| Revenues | | | | | | | | | |
| Local services | | | 37.1 | % | | 38.1 | % | | 37.2 | % | | 37.5 | % |
| Network access | | | 44.7 | | | 35.9 | | | 44.7 | | | 36.7 | |
| Cable television | | | 4.7 | | | 3.2 | | | 4.7 | | | 3.2 | |
| Internet | | | 13.5 | | | 16.7 | | | 13.4 | | | 16.6 | |
| Transport services | | | — | | | 6.1 | | | — | | | 6.0 | |
| Total revenues | | | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| Operating expenses | | | | | | | | | | | | | |
| Cost of services and products | | | 27.6 | % | | 38.2 | % | | 27.6 | | | 37.3 | |
| Selling, general and administrative expenses | | | 12.8 | | | 14.1 | | | 13.7 | | | 14.4 | |
| Depreciation and amortization | | | 17.4 | | | 22.1 | | | 17.2 | | | 21.6 | |
| Total operating expenses | | | 57.8 | | | 74.4 | | | 58.5 | | | 73.3 | |
| | | | | | | | | | | | | | |
| Income from operations | | | 42.2 | | | 25.6 | | | 41.5 | | | 26.7 | |
| | | | | | | | | | | | | | |
| Other income (expense) | | | | | | | | | | | | | |
| Interest expense | | | (39.7 | ) | | (31.6 | ) | | (39.6 | ) | | (31.5 | ) |
| Change in fair value of derivative | | | 1.2 | | | 1.5 | | | 1.3 | | | 1.4 | |
| Other income | | | 24.3 | | | 0.9 | | | 13.0 | | | 1.3 | |
| Total other expense | | | (14.2 | ) | | (29.2 | ) | | (25.3 | ) | | (28.8 | ) |
| | | | | | | | | | | | | | |
| Income before income taxes | | | 28.0 | | | (3.6 | ) | | 16.2 | | | (2.1 | ) |
| | | | | | | | | | | | | | |
| Income tax expense | | | (9.3 | ) | | 3.0 | | | (5.3 | ) | | 1.4 | |
| | | | | | | | | | | | | | |
| Income before accretion expense | | | 18.7 | | | (0.6 | ) | | 10.9 | | | (0.7 | ) |
| | | | | | | | | | | | | | |
| Accretion of Class B common convertible to senior | | | | | | | | | | | | | |
| subordinated notes | | | (0.9 | ) | | 0.0 | | | (0.9 | ) | | — | |
| Net income available to common stockholders | | | 17.8 | % | | (0.6 | )% | | 10.0 | % | | (0.7 | )% |
Three months and six months ended June 30, 2007 compared to three months and six months ended June 30, 2006
Total Revenues. Total revenues increased 48.1% in the three months ended June 30, 2007 to $17.1 million from $11.6 million in the three months ended June 30, 2006. Total revenues increased 48.6% in the six months ended June 30, 2007 to $34.3 million from $23.1 million in the six months ended June 30, 2006. The primary reason for the increase is the acquisition of Mid-Maine as of July 3, 2006. The tables below provide the components of our revenues for the three months and six months ended June 30, 2007 compared to the same period of 2006.
For the three months ended June 30, 2007 and 2006
| | | Three Months Ended June 30, | | Change | |
| | | 2006 | | 2007 | | Amount | | Percent | |
| | (dollars in thousands) | |
| Local service | | $ | 4,290 | | $ | 6,531 | | $ | 2,241 | | | 52.2 | % |
| Network access | | | 5,171 | | | 6,141 | | | 970 | | | 18.8 | |
| Cable television | | | 538 | | | 548 | | | 10 | | | 1.9 | |
| Internet | | | 1,559 | | | 2,859 | | | 1,300 | | | 83.4 | |
| Transport Services | | | — | | | 1,039 | | | 1,039 | | | — | |
| Total | | $ | 11,558 | | $ | 17,118 | | $ | 5,560 | | | 48.1 | |
Local services. Local services revenue increased 52.2% to $6.5 million in the three months ended June 30, 2007 from $4.3 million in the three months ended June 30, 2006. The addition of Mid-Maine accounted for an increase of $2.3 million. Our Alabama and Missouri local services revenue decreased $0.1 million, reflecting a decrease in access lines partially offset by the increased feature and long distance revenue associated with bundled service offerings. Unlimited calling bundles in Alabama and Missouri represent 34% and 32% respectively of the relevant customer base.
Network access. Network access revenue increased 18.8% to $6.1 million in the three months ended June 30, 2007 from $5.2 million in the three months ended June 30, 2006. The addition of Mid-Maine accounted for the increase of just under $1.0 million. In Alabama and Missouri, increases in special access revenue offset declines in switched access revenue.
Cable television. Cable television revenue in the three months ended June 30, 2007 increased 1.9% to $0.5 million which was slightly higher than in the three months ended June 30, 2006. The increase was due to the impact of higher local advertising revenue and service fees.
Internet. Internet revenue increased 83.4% to $2.9 million in the three months ended June 30, 2007 from $1.6 million in the three months ended June 30, 2006. The addition of Mid-Maine accounted for an increase of $1.2 million. The balance of the increase reflects growth of more than 1,900 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.
For the six months ended June 30, 2007 and 2006
| | | Six Months Ended June 30, | | Change | |
| | | 2006 | | 2007 | | Amount | | Percent | |
| | (dollars in thousands) | |
| Local service | | $ | 8,593 | | $ | 12,879 | | $ | 4,286 | | | 49.9 | % |
| Network access | | | 10,316 | | | 12,579 | | | 2,263 | | | 21.9 | |
| Cable television | | | 1,081 | | | 1,096 | | | 15 | | | 1.4 | |
| Internet | | | 3,081 | | | 5,680 | | | 2,599 | | | 84.4 | |
| Transport services | | | — | | | 2,057 | | | 2,057 | | | — | |
| Total | | $ | 23,071 | | $ | 34,291 | | $ | 11,220 | | | 48.6 | |
Local services. Local services revenue in the six months ended June 30, 2007 increased 49.9% to $12.9 million from $8.6 million for the six months ended June 30, 2006. The addition of Mid-Maine accounted for an increase of $4.6 million. Our Alabama and Missouri local services revenue decreased $0.3 million, reflecting a decrease in access lines, partially offset by the increased feature and long distance revenue associated with bundled service offerings.
Network access. Network access revenue in the six months ended June 30, 2007 increased 21.9% to $12.6 million from $10.3 million in the six months ended June 30, 2006. The addition of Mid-Maine accounted for an increase of $2.4 million. This increase was partially offset by a decline in universal service fund payments in Missouri.
Cable television. Cable television revenue in the six months ended June 30, 2007 increased 1.4% to $1.1 million which was slightly higher than in the six months ended June 30, 2006. The increase was due to the impact of higher sales and local advertising revenue.
Internet. Internet revenue in the six months ended June 30, 2007 increased 84.4% to $5.7 million from $3.1 million in the six months ended June 30, 2006. The addition of Mid-Maine accounted for an increase of $2.3 million. The addition of more than 1,900 new digital high-speed Internet customers generated $0.6 million, partially offset by $0.3 million associated with the decline in dial-up Internet customers associated with the conversion to digital high-speed Internet.
Transport services. The addition of $2.1 million in transport services revenue is attributable to the acquisition of Mid-Maine.
Operating expenses. Operating expenses in the three months ended June 30, 2007 increased 90.6% to $12.7 million from $6.7 million in the three months ended June 30, 2006. Operating expenses in the six months ended June 30, 2007 increased 86.3% to $25.1 million from $13.5 million in the six months ended June 30, 2006. The primary reason for the increase is the acquisition of Mid-Maine as of July 3, 2006.
For the three months ended June 30, 2007 and 2006
| | | Three Months Ended June 30, | | | |
| | | 2006 | | 2007 | | Amount | | Percent | |
| | | (dollars in thousands) | |
| Cost of services | | $ | 3,187 | | $ | 6,534 | | $ | 3,347 | | | 105.0 | % |
| Selling, general and administrative expenses | | | 1,482 | | | 2,420 | | | 938 | | | 63.3 | |
| Depreciation and amortization | | | 2,009 | | | 3,776 | | | 1,767 | | | 88.0 | |
| Total | | $ | 6,678 | | $ | 12,730 | | $ | 6,052 | | | 90.6 | |
| | | | | | | | | | | | | | |
Cost of services and products. Cost of service and products increased 105.0% to $6.5 million in the three months ended June 30, 2007 from $3.2 million in the three months ended June 30, 2006. The addition of Mid-Maine accounted for an increase of $3.2 million, including providing competitive local exchange services in Maine. The increased cost associated with higher cable television programming costs, increased long distance usage associated with bundled services and bandwidth to support increased digital high-speed Internet
customers 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 63.3% to $2.4 million in the three months ended June 30, 2007 from $1.5 million in the three months ended June 30, 2006. The addition of Mid-Maine accounted for an increase of $0.8 million. Corporate costs and property taxes were responsible for the balance of the increase.
Depreciation and amortization. Depreciation and amortization increased 88.0% to $3.8 million in the three months ended June 30, 2007 from $2.0 million in the three months ended June 30, 2006. An increase of $1.7 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 one year; 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.
For the six months ended June 30, 2007 and 2006
| | | Six Months Ended June 30, | | Change | |
| | | 2006 | | 2007 | | Amount | | Percent | |
| | (dollars in thousands) | |
| Cost of services | | $ | 6,362 | | $ | 12,805 | | $ | 6,443 | | | 101.3 | % |
| Selling, general and administrative expenses | | | 3,153 | | | 4,921 | | | 1,768 | | | 56.1 | |
| Depreciation and amortization | | | 3,977 | | | 7,405 | | | 3,428 | | | 86.2 | |
| Total | | $ | 13,492 | | $ | 25,131 | | $ | 11,639 | | | 86.3 | |
| | | | | | | | | | | | | | |
Cost of services and products. Cost of services and products increased 101.3% to $12.8 million in the six months ended June 30, 2007 from $6.4 million in the six months ended June 30, 2006. The addition of Mid-Maine accounted for $6.3 million of the increase, including providing competitive local exchange services in Maine. The balance of $0.1 million reflects the increased cost associated with additional digital high-speed Internet customers and bundled long distance services usage in Alabama and Missouri partially 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 56.1% to $4.9 million in the six months ended June 30, 2007 from $3.2 million in the six months ended June 30, 2006. The acquisition of Mid-Maine accounted for just under $1.7 million of the increase. Corporate legal and external affairs costs and property taxes were responsible for the balance of the increase.
Depreciation and amortization. Depreciation and amortization increased 86.2% to $7.4 million in the six months ended June 30, 2007 from $4.0 million in the six months ended June 30, 2006. An increase of $3.2 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 one year; and a telephone plant adjustment associated with the purchase price allocation. The balance of $0.2 million is associated with higher depreciation in Alabama and Missouri.
Interest expense. Interest expense increased 18.1% to $5.4 million in the three months ended June 30, 2007 from $4.6 million in the three months ended June 30, 2006. Interest expense increased 18.1% to $10.8 million in the six months ended June 30, 2007 from $9.1 million in the six months ended June 30, 2007. The senior credit facility was amended on July 3, 2006 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, 3% LIBOR 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 is adjusted to fair value each
quarter until conversion occurs, not later than December 21, 2009. The reduction in maximum time to conversion, the change in price of our 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 $0.1 million in the three months ended June 30, 2007 compared to the three months ended June 30, 2006. The combination of these factors changed the value of the derivative by $0.2 million in the six months ended June 30, 2007 compared to the six months ended June 30, 2006.
Other income. Other income was $0.2 million in the three months ended June 30, 2007, down from $2.8 million in the three months ended June 30, 2006. Other income was $0.4 million in the six months ended June 30, 2007, down from $3.0 million in the six months ended June 30, 2006. In 2006, we reflected a one time gain of $2.7 million associated with the redemption of Rural Telephone Bank (RTB) stock owned by three of our companies. The balance of the change is related to higher interest income on higher cash balances.
Income taxes. Provision for income taxes was a benefit of $0.5 million in the three months and six months ended June 30, 2007 compared to an expense of $1.0 million and $1.2 million respectively in the three months and six months ended June 30, 2006 reflecting the net loss for both periods in 2007. The RTB gain in 2006 was the primary driver of the difference in net income before taxes which resulted in the tax expense for 2006. The primary factor in the change in the effective tax rate is the impact on the permanent differences attributable to the change in estimated fair value of the Class B derivative.
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, resulting in no charges in 2007.
Net income (loss). As a result of the foregoing, there was a net loss of $0.1 million and $0.2 million available to common stockholders respectively in the three months and six months ended June 30, 2007 compared to net income of $2.1 million and $2.3 million respectively in the three months and six months ended June 30, 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 six months of 2007 amounted to $6.5 million compared to $5.7 million for the first six months of 2006. The primary differences relate to the impact of acquiring Mid-Maine in 2006; the one-time $2.7 million RTB stock gain in 2006; the payment of the $4.3 million for the second quarter 2007 distribution to IDS holders occurring on July 2, 2007 rather than June 30, 2007 (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 six months of 2007 used $3.0 million compared to generating $1.2 million in the first six months of 2006. The acquisition and construction of property and equipment utilized $0.9 million more in the first six months of 2007 than in the same period of 2006, reflecting higher expenditures associated with the Mid-Maine acquisition. The balance reflected the one-time gain on the liquidation of RTB stock in 2006.
Cash flows from financing activities for the first six months of 2007 and 2006 used $1.7 million and $3.4 million, reflecting payments of dividends to shareowners in both periods. The June 30, 2007 (Saturday) dividend was paid on July 2, 2007 (Monday), accounting for the difference.
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 July 5, 2007, the Company completed its offering of 3,000,000 Income Deposit Securities (IDS) units through an underwritten public offering at $19.80 per unit. The price per unit is comprised of $11.68 allocated to each share of Class A common stock and $8.11 allocated to each senior subordinated note, plus $0.01 representing accrued interest from June 30, 2007. The Company used the net proceeds of approximately $55.4 million to repay senior secured indebtedness under its credit facility, reducing senior debt from $120.0 million to approximately $64.6 million. The $8.11 allocated to each senior subordinated note represents a premium of $0.61 over the $7.50 stated principal amount. The additional IDS units increase senior subordinated debt by $22.5 million, bringing senior subordinated debt to approximately $103.6 million. Therefore, total debt was reduced from approximately $201.1 million to $168.2 million.
On July 13, 2007, the Company entered into a first amendment to its amended and restated credit agreement dated July 3, 2006. Among other things, the amendment reduced the applicable margins on the interest rates under the credit agreement, initially reducing the applicable LIBOR margin from 3.25% to 1.75% on the $64.6 of senior debt. After September 30, 2007, the margins will adjust quarterly on a prospective basis based on the total leverage ratio of the Company.
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.
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 June 30, 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 June 30, 2007 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Otelco Inc. held its Annual Meeting of Stockholders on May 17, 2007. At that meeting, stockholders elected Howard J. Haug, Stephen P. McCall and William F. Reddersen as Directors of the Company for a term to expire at the 2010 Annual Meeting of Stockholders. The results of the voting are as follows:
| | | Votes For | | Votes Withheld | |
| | | | | | |
| Howard J. Haug | | | 9,279,566 | | | 118,312 | |
| Stephen P. McCall | | | 9,289,293 | | | 108,585 | |
| William F. Reddersen | | | 9,277,983 | | | 119,895 | |
The following directors also have terms in office that continue after the Annual Meeting of Stockholders: William Bak, Andrew J. Meyers, John P. Kunz, and Michael D. Weaver.
In addition, stockholders ratified the appointment of BDO Seidman, LLP as our Independent Registered Public Accounting Firm for the fiscal year ending December 31, 2007. The result of the voting is as follows:
| | | Votes For | | Votes Against | | Abstain | | Broker Non-Vote | |
| | | | | | | | | | |
| Ratification of appointment of independent | | | | | | | | | | | | | |
| registered public accounting firm | | | 9,308,840 | | | 34,421 | | | 54,617 | | | 0 | |
Exhibits
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.
| | | |
| | OTELCO INC. |
|
|
|
| Date: August 9, 2007 | By: | /s/ Curtis L. Garner, Jr. |
| |
|
| | Name: Curtis L. Garner, Jr. Title: Chief Financial Officer |
Exhibit No. | | Description |
| | Certificate pursuant to Rule 13A-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Executive Officer |
| | Certificate pursuant to Rule 13A-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Financial Officer |
| | 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 |
| | 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 |
