UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| (Mark One) | |
| | |
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | |
| | For the quarterly period ended March 31, 2011 |
| | |
| | Or |
| | |
| o | 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer x | Non-accelerated filer o | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
APPLICABLE ONLY TO CORPORATE ISSUERS:
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 6, 2011 |
| Class A Common Stock ($0.01 par value per share) | | 13,221,404 |
| Class B Common Stock ($0.01 par value per share) | | 0 |
OTELCO INC.
FORM 10-Q
For the three month period ended March 31, 2011
TABLE OF CONTENTS
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Unless the context otherwise requires, the words “we,” “us,” “our,” “the Company” and “Otelco” refer to Otelco Inc., a Delaware corporation, and its consolidated subsidiaries as of March 31, 2011.
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.
Item 1. Financial Statements
| | | | | | | |
| | | | | | (unaudited) | |
| Assets | | | | | | |
| Current assets | | | | | | |
| Cash and cash equivalents | | $ | 18,226,374 | | | $ | 18,473,509 | |
| Accounts receivable: | | | | | | | | |
| Due from subscribers, net of allowance for doubtful accounts of $230,752 and $238,321, respectively | | | 4,406,257 | | | | 4,206,972 | |
| Unbilled receivables | | | 2,161,277 | | | | 2,156,605 | |
| Other | | | 3,257,882 | | | | 3,639,031 | |
| Materials and supplies | | | 1,817,311 | | | | 1,879,897 | |
| Prepaid expenses | | | 1,305,028 | | | | 1,072,212 | |
| Deferred income taxes | | | 626,267 | | | | 626,267 | |
| Total current assets | | | 31,800,396 | | | | 32,054,493 | |
| | | | | | | | | |
| Property and equipment, net | | | 63,887,213 | | | | 62,824,961 | |
| Goodwill | | | 188,190,078 | | | | 188,190,078 | |
| Intangible assets, net | | | 25,934,042 | | | | 24,123,076 | |
| Investments | | | 1,967,095 | | | | 1,960,718 | |
| Deferred financing costs | | | 5,757,825 | | | | 5,415,801 | |
| Deferred income taxes | | | 4,415,097 | | | | 4,415,097 | |
| Other assets | | | 183,946 | | | | 169,760 | |
| Total assets | | $ | 322,135,692 | | | $ | 319,153,984 | |
| | | | | | | | | |
| Liabilities and Stockholders’ Deficit | | | | | | | | |
| | | | | | | | | |
| Current liabilities | | | | | | | | |
| Accounts payable | | $ | 768,055 | | | $ | 445,386 | |
| Accrued expenses | | | 6,885,748 | | | | 7,106,276 | |
| Advance billings and payments | | | 1,595,133 | | | | 1,579,693 | |
| Deferred income taxes | | | 353,285 | | | | 353,285 | |
| Customer deposits | | | 172,479 | | | | 184,069 | |
| Total current liabilities | | | 9,774,700 | | | | 9,668,709 | |
| Deferred income taxes | | | 42,512,576 | | | | 42,512,575 | |
| Interest rate swaps | | | 2,471,331 | | | | 1,965,176 | |
| Advance billings and payments | | | 656,968 | | | | 646,622 | |
| Other liabilities | | | 368,349 | | | | 359,547 | |
| Long-term notes payable | | | 271,595,855 | | | | 271,571,060 | |
| Total liabilities | | | 327,379,779 | | | | 326,723,689 | |
| | | | | | | | | |
| Stockholders’ Deficit | | | | | | | | |
| Class A Common Stock, $.01 par value-authorized 20,000,000 shares; issued and outstanding 13,221,404 shares | | | 132,214 | | | | 132,214 | |
| Additional paid in capital | | | 921,718 | | | | - | |
| Retained deficit | | | (6,298,019 | ) | | | ( 7,701,919 | ) |
| Total stockholders’ deficit | | | (5,244,087 | ) | | | ( 7,569,705 | ) |
| Total liabilities and stockholders’ deficit | | $ | 322,135,692 | | | $ | 319,153,984 | |
The accompanying notes are an integral part of these consolidated financial statements.
| | | Three Months Ended March 31, | |
| | | | | | | |
| Revenues | | $ | 25,794,209 | | | $ | 25,392,000 | |
| | | | | | | | | |
| Operating expenses | | | | | | | | |
| Cost of services and products | | | 10,610,193 | | | | 11,020,212 | |
| Selling, general and administrative expenses | | | 3,230,996 | | | | 3,327,057 | |
| Depreciation and amortization | | | 6,084,291 | | | | 5,724,018 | |
| Total operating expenses | | | 19,925,480 | | | | 20,071,287 | |
| | | | | | | | | |
| Income from operations | | | 5,868,729 | | | | 5,320,713 | |
| | | | | | | | | |
| Other income (expense) | | | | | | | | |
| Interest expense | | | (5,988,642 | ) | | | (6,170,131 | ) |
| Change in fair value of derivatives | | | (886,170 | ) | | | 506,155 | |
| Other income | | | 358,832 | | | | 349,349 | |
| Total other expenses | | | (6,515,980 | ) | | | (5,314,627 | ) |
| | | | | | | | | |
| Income (loss) before income tax | | | (647,251 | ) | | | 6,086 | |
| Income tax (expense) benefit | | | 261,595 | | | | (1,432 | ) |
| | | | | | | | | |
| Net income (loss) available to common stockholders | | $ | (385,656 | ) | | $ | 4,654 | |
| | | | | | | | | |
| Weighted average shares outstanding: | | | | | | | | |
| Basic | | | 12,676,733 | | | | 13,221,404 | |
| Diluted | | | 13,221,404 | | | | 13,221,404 | |
| Basic net income (loss) per share | | $ | (0.03 | ) | | $ | - | |
| Diluted net income (loss) per share | | $ | (0.03 | ) | | $ | - | |
| | | | | | | | | |
| Dividends declared per share | | $ | 0.18 | | | $ | 0.18 | |
The accompanying notes are an integral part of these consolidated financial statements.
| | | Three Months Ended March 31, | |
| | | | | | | |
| Cash flows from operating activities: | | | | | | |
| Net income (loss) | | $ | (385,656 | ) | | $ | $ 4,654 | |
| Adjustments to reconcile net income (loss) to cash flows from operating activities: | | | | | | | | |
| Depreciation | | | 3,572,918 | | | | 3,522,652 | |
| Amortization | | | 2,511,373 | | | | 2,201,365 | |
| Amortization of debt premium | | | (22,086 | ) | | | (24,795 | ) |
| Amortization of loan costs | | | 337,976 | | | | 342,024 | |
| Change in fair value of derivatives | | | 886,170 | | | | (506,155 | ) |
| Provision for uncollectible revenue | | | 77,045 | | | | 62,747 | |
| Changes in assets and liabilities; net of assets and liabilities acquired: | | | | | | | | |
| Accounts receivables | | | 365,460 | | | | (215,112 | ) |
| Material and supplies | | | (86,159 | ) | | | (62,586 | ) |
| Prepaid expenses and other assets | | | (26,503 | ) | | | 220,510 | |
| Income tax receivable | | | 389,486 | | | | - | |
| Accounts payable and accrued liabilities | | | (187,900 | ) | | | (102,141 | ) |
| Advance billings and payments | | | 18,706 | | | | (25,786 | ) |
| Other liabilities | | | 10,351 | | | | 2,788 | |
| | | | | | | | | |
| Net cash from operating activities | | | 7,461,181 | | | | 5,420,165 | |
| | | | | | | | | |
| Cash flows used in investing activities: | | | | | | | | |
| Acquisition and construction of property and equipment | | | (1,753,170 | ) | | | (2,842,757 | ) |
| | | | | | | | | |
| Net cash used in investing activities | | | (1,753,170 | ) | | | (2,842,757 | ) |
| | | | | | | | | |
| Cash flows used in financing activities: | | | | | | | | |
| Cash dividends paid | | | (2,234,274 | ) | | | (2,330,273 | ) |
| | | | | | | | | |
| Net cash used in financing activities | | | (2,234,274 | ) | | | (2,330,273 | ) |
| | | | | | | | | |
| Net increase in cash and cash equivalents | | | 3,473,737 | | | | 247,135 | |
| Cash and cash equivalents, beginning of period | | | 17,731,044 | | | | 18,226,374 | |
| | | | | | | | | |
| Cash and cash equivalents, end of period | | $ | 21,204,781 | | | $ | 18,473,509 | |
| | | | | | | | | |
| Supplemental disclosures of cash flow information: | | | | | | | | |
| Interest paid | | $ | 5,569,134 | | | $ | 5,908,353 | |
| | | | | | | | | |
| Income taxes paid (received) | | $ | (326,486 | ) | | $ | 122,895 | |
The accompanying notes are an integral part of these consolidated financial statements.
MARCH 31, 2011
(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”) and its subsidiaries, all of which are either directly or indirectly wholly owned. These include: Otelco Telecommunications LLC (“OTC”); Otelco Telephone LLC (“OTP”); Hopper Telecommunications Company, Inc. (“HTC”); Brindlee Mountain Telephone Company, Inc. (“BMTC”); Blountsville Telephone Company, Inc. (“BTC”); Mid-Missouri Holding Corporation (“MMH”) and its wholly owned subsidiary Mid-Missouri Telephone Company (“MMT”) and its wholly owned subsidiary Imagination, Inc.; Mid-Maine Telecom, Inc. (“MMTI”); Mid-Maine TelPlus (“MMTP”); The Granby Telephone & Telegraph Co. of Massachusetts (“GTT”); War Acquisition Corporation (“WT”); The Pine Tree Telephone and Telegraph Company (“PTT”); Saco River Telegraph and Telephone Company (“SRT”); CRC Communications of Maine, Inc. (“PTN”); and Communications Design Acquisition Corporation (“CDAC”).
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 unaudited operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.
The consolidated financial statements and notes 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, 2010. 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.
Certain prior year amounts have been reclassified to conform with the current year’s presentation.
Recent Accounting Pronouncements
During 2011, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2011-01 and ASU 2011-02. These ASUs provide technical corrections to existing guidance related to specialized industries or entities and, therefore, have minimal, if any, impact on the Company.
| 2. | Commitments 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, Massachusetts, Missouri, New Hampshire and West Virginia Public Service Commissions relating primarily to rate making. Currently, none of the legal proceedings are expected to have a material adverse effect on our business.
The Company has two interest rate swaps with approved counterparties. The first swap has a notional amount of $90 million with the Company paying a fixed rate of 1.85% and the counterparty paying a variable rate based upon the three month LIBOR interest rate. It is effective from February 9, 2009 through February 8, 2012. The second swap has a notional amount of $60 million with the Company paying a fixed rate of 2.0475% and the counterparty paying a variable rate based upon the three month LIBOR interest rate. It is effective from February 9, 2010 through February 8, 2012. From an accounting perspective, the documentation for both swaps do not meet the technical requirements of Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging, to allow the swaps to be considered highly effective hedging instruments and therefore the swaps do not qualify for hedge accounting. The change in fair value of the swaps is charged or credited to income as a change in fair value of derivatives. Over the life of the swaps, the cumulative change in value will be zero.
| 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 would occur had all of the issued and outstanding shares of Class B common stock been exchanged for Income Deposit Securities (“IDSs”) at the beginning of the period. On June 8, 2010, all of the Company’s issued and outstanding shares of Class B common stock were exchanged for IDSs on a one-for-one basis. Each of the IDSs issued in the exchange includes a common share. Diluted amounts are not included in the computation of diluted loss per common share when the inclusion of such amounts would be anti-dilutive. The Company does not have any outstanding stock arrangements that might by potentially dilutive.
A reconciliation of the common shares for the Company’s basic and diluted income (loss) per common share calculation is as follows:
| | | For the Three Months Ended March 31, | |
| | | | | | | |
| | | | | | | |
| Weighted average of common shares-basic | | | 12,676,733 | | | | 13,221,404 | |
| | | | | | | | | |
| Effect of dilutive securities | | | 544,671 | | | | - | |
| | | | | | | | | |
| Weighted average common shares and potential common shares diluted | | | 13,221,404 | | | | 13,221,404 | |
| | | | | | | | | |
| Net income (loss) available to common stockholders | | $ | (385,656 | ) | | $ | 4,654 | |
| | | | | | | | | |
| Net income (loss) per basic share | | $ | (0.03 | ) | | $ | - | |
| | | | | | | | | |
| Net income (loss) available to common stockholders | | $ | (385,656 | ) | | $ | 4,654 | |
| Less: Change in fair value of Class B derivative | | | - | | | | - | |
| | | | | | | | | |
| Net income (loss) available for diluted shares | | $ | (385,656 | ) | | $ | 4,654 | |
| | | | | | | | | |
| Net income (loss) per diluted share | | $ | (0.03 | ) | | $ | - | |
The Company adopted ASC 820, Fair Value Measurement and Disclosures (“ASC 820”), which defines fair value, establishes a framework for measuring fair value and requires additional disclosures about fair value measurements. The framework that is set forth in this standard is applicable to the fair value measurements where it is permitted or required under other accounting pronouncements.
ASC 820 defines fair value as the exit price, which is the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date. ASC 820 establishes a three-tier fair value hierarchy that prioritizes inputs to valuation techniques used for fair value measurement.
| | ● | Level 1 consists of observable market data in an active market for identical assets or liabilities. |
| | | Level 2 consists of observable market data, other than that included in Level 1, that is either directly or indirectly observable. |
| | | Level 3 consists of unobservable market data. The input may reflect the assumptions of the Company, not a market participant, if there is little available market data and the Company’s own assumptions are considered by management to be the best available information. |
In accordance with ASC 820, the following tables represent the Company’s fair value hierarchy for its financial assets and liabilities as of December 31, 2010 and March 31, 2011:
| | | | |
| | | | | | | | | | | | | |
| Liabilities | | | | | | | | | | | | |
| Interest rate swaps | | $ | 2,471,331 | | | $ | - | | | $ | 2,471,331 | | | $ | - | |
| Total liabilities | | $ | 2,471,331 | | | $ | - | | | $ | 2,471,331 | | | $ | - | |
| | | | |
| | | | | | | | | | | | | |
| Liabilities | | | | | | | | | | | | |
| Interest rate swaps | | $ | 1,965,176 | | | $ | - | | | $ | 1,965,176 | | | $ | - | |
| Total liabilities | | $ | 1,965,176 | | | $ | - | | | $ | 1,965,176 | | | $ | - | |
(1) Quoted prices in active markets for identical assets.
(2) Significant other observable inputs.
(3) Significant unobservable inputs.
The interest rate swaps are valued at the end of the quarter based on available market information.
The Company has no independent assets or operations separate from its operating subsidiaries. The guarantees of its senior subordinated notes by 12 of its 14 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 December 31, 2010 and March 31, 2011; condensed consolidating statements of operations for the three months ended March 31, 2010 and 2011; and condensed consolidating statements of cash flows for the three months ended March 31, 2010 and 2011.
Otelco Inc.
Condensed Consolidating Balance Sheet
December 31, 2010
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiaries | | | Eliminations | | | Consolidated | |
| ASSETS | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Current assets | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | - | | | $ | 18,064,970 | | | $ | 161,404 | | | $ | - | | | $ | 18,226,374 | |
| Accounts receivable, net | | | - | | | | 9,031,641 | | | | 793,775 | | | | - | | | | 9,825,416 | |
| Materials and supplies | | | - | | | | 893,186 | | | | 924,125 | | | | - | | | | 1,817,311 | |
| Prepaid expenses | | | 184,055 | | | | 1,022,697 | | | | 98,276 | | | | - | | | | 1,305,028 | |
| Deferred income taxes | | | 626,267 | | | | - | | | | - | | | | - | | | | 626,267 | |
| Investment in subsidiaries | | | 131,010,180 | | | | - | | | | - | | | | (131,010,180 | ) | | | - | |
| Intercompany receivable | | | (129,599,481 | ) | | | - | | | | - | | | | 129,599,481 | | | | - | |
| Total current assets | | | 2,221,021 | | | | 29,012,494 | | | | 1,977,580 | | | | (1,410,699 | ) | | | 31,800,396 | |
| | | | | | | | | | | | | | | | | | | | | |
| Property and equipment, net | | | 218,301 | | | | 54,043,819 | | | | 9,625,093 | | | | - | | | | 63,887,213 | |
| Goodwill | | | 239,970,317 | | | | (49,843,599 | ) | | | (1,936,640 | ) | | | - | | | | 188,190,078 | |
| Intangible assets, net | | | - | | | | 23,326,214 | | | | 2,607,828 | | | | - | | | | 25,934,042 | |
| Investments | | | 1,203,605 | | | | 433,059 | | | | 330,431 | | | | - | | | | 1,967,095 | |
| Deferred income taxes | | | 4,415,097 | | | | - | | | | - | | | | - | | | | 4,415,097 | |
| Other long-term assets | | | 5,757,825 | | | | 183,946 | | | | - | | | | - | | | | 5,941,771 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 253,786,166 | | | $ | 57,155,933 | | | $ | 12,604,292 | | | $ | (1,410,699 | ) | | $ | 322,135,692 | |
| | | | | | | | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT) | |
| | | | | | | | | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | | | | | | | | |
| Accounts payable and accrued expenses | | $ | 2,280,661 | | | $ | 3,950,043 | | | $ | 1,423,099 | | | $ | - | | | $ | 7,653,803 | |
| Intercompany payables | | | - | | | | (131,769,870 | ) | | | 2,170,389 | | | | 129,599,481 | | | | - | |
| Other current liabilities | | | 353,285 | | | | 1,678,145 | | | | 89,467 | | | | - | | | | 2,120,897 | |
| Total current liabilities | | | 2,633,946 | | | | (126,141,682 | ) | | | 3,682,955 | | | | 129,599,481 | | | | 9,774,700 | |
| | | | | | | | | | | | | | | | | | | | | |
| Deferred income taxes | | | 22,592,597 | | | | 16,666,501 | | | | 3,253,478 | | | | - | | | | 42,512,576 | |
| Other liabilities | | | 2,471,331 | | | | 1,025,317 | | | | - | | | | - | | | | 3,496,648 | |
| Long-term notes payable | | | 231,332,379 | | | | 40,263,476 | | | | - | | | | - | | | | 271,595,855 | |
| Stockholders’ equity (deficit) | | | (5,244,087 | ) | | | 125,342,321 | | | | 5,667,859 | | | | (131,010,180 | ) | | | (5,244,087 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Total liabilities and stockholders’ equity (deficit) | | $ | 253,786,166 | | | $ | 57,155,933 | | | $ | 12,604,292 | | | $ | (1,410,699 | ) | | $ | 322,135,692 | |
Otelco Inc.
Condensed Consolidating Balance Sheet
March 31, 2011
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiaries | | | Eliminations | | | Consolidated | |
| ASSETS | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Current assets | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | - | | | $ | 18,381,993 | | | $ | 91,516 | | | $ | - | | | $ | 18,473,509 | |
| Accounts receivable, net | | | - | | | | 8,978,742 | | | | 1,023,866 | | | | - | | | | 10,002,608 | |
| Materials and supplies | | | - | �� | | | 985,257 | | | | 894,640 | | | | - | | | | 1,879,897 | |
| Prepaid expenses | | | 243,710 | | | | 762,528 | | | | 65,974 | | | | - | | | | 1,072,212 | |
| Deferred income taxes | | | 626,267 | | | | - | | | | - | | | | - | | | | 626,267 | |
| Investment in subsidiaries | | | 136,249,579 | | | | - | | | | - | | | | (136,249,579 | ) | | | - | |
| Intercompany receivable | | | (137,862,114 | ) | | | - | | | | - | | | | 137,862,114 | | | | - | |
| Total current assets | | | (742,558 | ) | | | 29,108,520 | | | | 2,075,996 | | | | 1,612,535 | | | | 32,054,493 | |
| | | | | | | | | | | | | | | | | | | | | |
| Property and equipment, net | | | 312,752 | | | | 53,661,931 | | | | 8,850,278 | | | | - | | | | 62,824,961 | |
| Goodwill | | | 239,970,317 | | | | (49,843,599 | ) | | | (1,936,640 | ) | | | - | | | | 188,190,078 | |
| Intangible assets, net | | | - | | | | 21,577,339 | | | | 2,545,737 | | | | - | | | | 24,123,076 | |
| Investments | | | 1,203,605 | | | | 426,682 | | | | 330,431 | | | | - | | | | 1,960,718 | |
| Deferred income taxes | | | 4,415,097 | | | | - | | | | - | | | | - | | | | 4,415,097 | |
| Other long-term assets | | | 5,415,801 | | | | 169,760 | | | | - | | | | - | | | | 5,585,561 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 250,575,014 | | | $ | 55,100,633 | | | $ | 11,865,802 | | | $ | 1,612,535 | | | $ | 319,153,984 | |
| | | | | | | | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT) | |
| | | | | | | | | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | | | | | | | | |
| Accounts payable and accrued expenses | | $ | 1,926,077 | | | $ | 4,161,624 | | | $ | 1,463,961 | | | $ | - | | | $ | 7,551,662 | |
| Intercompany payables | | | - | | | | (139,073,380 | ) | | | 1,211,266 | | | | 137,862,114 | | | | - | |
| Other current liabilities | | | 353,286 | | | | 1,686,535 | | | | 77,226 | | | | - | | | | 2,117,047 | |
| Total current liabilities | | | 2,279,363 | | | | (133,225,221 | ) | | | 2,752,453 | | | | 137,862,114 | | | | 9,668,709 | |
| | | | | | | | | | | | | | | | | | | | | |
| Deferred income taxes | | | 22,592,596 | | | | 16,666,501 | | | | 3,253,478 | | | | - | | | | 42,512,575 | |
| Other liabilities | | | 1,965,176 | | | | 1,006,169 | | | | - | | | | - | | | | 2,971,345 | |
| Long-term notes payable | | | 231,307,584 | | | | 40,263,476 | | | | - | | | | - | | | | 271,571,060 | |
| Stockholders’ equity (deficit) | | | (7,569,705 | ) | | | 130,389,708 | | | | 5,859,871 | | | | (136,249,579 | ) | | | (7,569,705 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Total liabilities and stockholders’ equity (deficit) | | $ | 250,575,014 | | | $ | 55,100,633 | | | $ | 11,865,802 | | | $ | 1,612,535 | | | $ | 319,153,984 | |
Otelco Inc.
Condensed Consolidating Statement of Operations
For the Three Months Ended March 31, 2010
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| Revenues | | $ | 819,513 | | | $ | 25,003,395 | | | $ | 2,796,336 | | | $ | (2,825,035 | ) | | $ | 25,794,209 | |
| Operating expenses | | | (819,513 | ) | | | (19,636,002 | ) | | | (2,295,000 | ) | | | 2,825,035 | | | | (19,925,480 | ) |
| Income from operations | | | - | | | | 5,367,393 | | | | 501,336 | | | | - | | | | 5,868,729 | |
| Other expense | | | (6,437,032 | ) | | | (78,932 | ) | | | (16 | ) | | | - | | | | (6,515,980 | ) |
| Earnings from subsidiaries | | | 5,789,781 | | | | - | | | | - | | | | (5,789,781 | ) | | | - | |
| Income (loss) before income tax | | | (647,251 | ) | | | 5,288,461 | | | | 501,320 | | | | (5,789,781 | ) | | | (647,251 | ) |
| Income tax benefit | | | 261,595 | | | | - | | | | - | | | | - | | | | 261,595 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) to common stockholders | | $ | (385,656 | ) | | $ | 5,288,461 | | | $ | 501,320 | | | $ | (5,789,781 | ) | | $ | (385,656 | ) |
Otelco Inc.
Condensed Consolidating Statement of Operations
For the Three Months Ended March 31, 2011
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| Revenues | | $ | 884,263 | | | $ | 24,787,436 | | | $ | 2,574,974 | | | $ | (2,854,673 | ) | | $ | 25,392,000 | |
| Operating expenses | | | (884,263 | ) | | | (19,658,763 | ) | | | (2,382,934 | ) | | | 2,854,673 | | | | (20,071,287 | ) |
| Income from operations | | | - | | | | 5,128,673 | | | | 192,040 | | | | - | | | | 5,320,713 | |
| Other expense | | | (5,233,313 | ) | | | (81,285 | ) | | | (29 | ) | | | - | | | | (5,314,627 | ) |
| Earnings from subsidiaries | | | 5,239,399 | | | | - | | | | - | | | | (5,239,399 | ) | | | - | |
| Income before income tax | | | 6,086 | | | | 5,047,388 | | | | 192,011 | | | | (5,239,399 | ) | | | 6,086 | |
| Income tax benefit | | | (1,432 | ) | | | - | | | | - | | | | - | | | | (1,432 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Net income to common stockholders | | $ | 4,654 | | | $ | 5,047,388 | | | $ | 192,011 | | | $ | (5,239,399 | ) | | $ | 4,654 | |
Otelco Inc.
Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2010
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | (385,656 | ) | | $ | 5,288,461 | | | $ | 501,320 | | | $ | (5,789,781 | ) | | $ | (385,656 | ) |
| Adjustment to reconcile net income (loss) to cash flows from operating activities | | | 1,202,061 | | | | 5,218,268 | | | | 943,067 | | | | - | | | | 7,363,396 | |
| Changes in assets and liabilities, net of assets and liabilities acquired | | | 7,207,650 | | | | (5,422,314 | ) | | | (1,301,895 | ) | | | - | | | | 483,441 | |
| Net cash provided by operating activities | | | 8,024,055 | | | | 5,084,415 | | | | 142,492 | | | | (5,789,781 | ) | | | 7,461,181 | |
| Cash flows used in investing activities | | | - | | | | (1,619,055 | ) | | | (134,115 | ) | | | - | | | | (1,753,170 | ) |
| Cash flows used in financing activities | | | (8,024,055 | ) | | | - | | | | - | | | | 5,789,781 | | | | (2,234,274 | ) |
| Net increase in cash and cash equivalents | | | - | | | | 3,465,360 | | | | 8,377 | | | | - | | | | 3,473,737 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, beginning of period | | | - | | | | 17,617,266 | | | | 113,778 | | | | - | | | | 17,731,044 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, end of period | | $ | - | | | $ | 21,082,626 | | | $ | 122,155 | | | $ | - | | | $ | 21,204,781 | |
Otelco Inc.
Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2011
| | | Parent | | | Guarantor Subsidiaries | | | Non-Guarantor Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | 4,654 | | | $ | 5,047,388 | | | $ | 192,011 | | | $ | (5,239,399 | ) | | $ | 4,654 | |
| Adjustment to reconcile net income (loss) to cash flows from operating activities | | | (188,926 | ) | | | 4,877,600 | | | | 909,164 | | | | - | | | | 5,597,838 | |
| Changes in assets and liabilities, net of assets and liabilities acquired | | | 7,848,395 | | | | (6,920,897 | ) | | | (1,109,825 | ) | | | - | | | | (182,327 | ) |
| Net cash provided by operating activities | | | 7,664,123 | | | | 3,004,091 | | | | (8,650 | ) | | | (5,239,399 | ) | | | 5,420,165 | |
| Cash flows used in investing activities | | | (94,451 | ) | | | (2,687,068 | ) | | | (61,238 | ) | | | - | | | | (2,842,757 | ) |
| Cash flows used in financing activities | | | (7,569,672 | ) | | | - | | | | - | | | | 5,239,399 | | | | (2,330,273 | ) |
| Net increase in cash and cash equivalents | | | - | | | | 317,023 | | | | (69,888 | ) | | | - | | | | 247,135 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, beginning of period | | | - | | | | 18,064,970 | | | | 161,404 | | | | - | | | | 18,226,374 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, end of period | | $ | - | | | $ | 18,381,993 | | | $ | 91,516 | | | $ | - | | | $ | 18,473,509 | |
Revenues for interstate access services are based on reimbursement of costs and an allowed rate of return. Revenues of this nature are received from the National Exchange Carrier Association in the form of monthly settlements. Such revenues amounted to 10.4% and 9.7% of the Company’s total revenues for the three months ended March 31, 2010 and 2011, respectively.
The Company has a contract through 2012 with Time Warner Cable (“TW”) for the provision of wholesale network connections to TW’s customers in Maine and New Hampshire. TW represented approximately 10.3% and 11.4% of the Company’s consolidated revenue for the three months ended March 31, 2010 and 2011, respectively. Other unrelated telecommunications providers also pay the Company access revenue for terminating calls through us to TW’s customers.
On April 1, 2011, the Company’s newly formed wholly owned subsidiary, Shoreham Telephone LLC, executed a definitive agreement to acquire all of the capital stock of Shoreham Telephone Company, Inc. (“Shoreham”) for $4.5 million, subject to certain purchase price adjustments. Shoreham is a telecommunications company serving approximately 4,975 access lines that is headquartered in Shoreham, Vermont. The acquisition is expected to close in 2011, but is subject to regulatory approval and other customary conditions. The Company anticipates financing this acquisition from cash on hand.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
General
We operate ten rural local exchange carriers (“RLECs”) serving subscribers in north central Alabama, central Maine, western Massachusetts, central Missouri and southern West Virginia. We are the sole wireline telephone services provider for many of the rural communities we serve. We also operate competitive local exchange carriers (“CLECs”) serving subscribers throughout the states of Maine and New Hampshire. Our services include local and long distance telephone services, network access, other telephone related services, cable television (in some markets) and internet access. We view, manage and evaluate the results of operations from the various telecommunications services as one company and therefore have identified one reporting segment as it relates to providing segment information. As of March 31, 2011, we operated approximately 99,271 access line equivalents and supplied an additional 152,101 wholesale network connections.
Our core businesses are local and long distance telecommunications services, wholesale access to the local and long distance network, and the provision of network access to other wireline, long distance and wireless carriers for calls originated or terminated on our network. Our core businesses generated approximately 78.2% of our total revenues in the first quarter of 2011. We also provide cable and satellite television service in some markets and digital high-speed data lines and dial-up 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 I and the 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 offer a wide range of telecommunications and entertainment services to our subscribers. More than half of our residential customers receive packages of services that are delivered and billed together. Our CLEC subscribers contract with us for selected services that meet their specific telecommunications requirements. Our revenues come from five sources:
| | ● | Local services. We receive revenues from providing local exchange telecommunications services in our ten rural territories, from the wholesale network services in New England, and on a competitive basis throughout Maine and New Hampshire. These revenues include monthly subscription charges for basic service, calling beyond the local territory on a fixed price and on a per minute basis, 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. A growing portion of our rural subscribers take bundled service plans which include multiple services, including unlimited domestic calling, for a flat monthly fee. |
| | | Network access. 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, Massachusetts, Missouri, New Hampshire and West Virginia are based on rates approved by the Alabama Public Service Commission, the Maine Public Utilities Commission (“MPUC”), the Massachusetts Department of Telecommunications and Cable, the Missouri Public Service Commission, the New Hampshire Public Utilities Commission (“NHPUC”) and the West Virginia Public Service Commission, respectively, where appropriate. Switched and special access charges for interstate and international services are based on rates approved by the Federal Communications Commission. |
| | | Cable television. We offer basic, digital, high-definition, digital video recording and pay per view cable television services to a portion of our telephone service territory in both Alabama and Missouri, including Internet Protocol television (“IPTV”) and Video on Demand in Alabama. We are a reseller of satellite services for DirecTV. |
| | | Internet. We receive revenues from monthly recurring charges for digital high-speed data lines, dial-up internet access and ancillary services such as web hosting and computer virus protection. |
| | | Transport. We receive monthly recurring revenues for the rental of fiber to transport data and other telecommunications services in Maine. |
Voice and Data Access Line Trends
The number of access lines served is a fundamental factor in determining revenue stability for a telecommunications provider. Reflecting a general trend in the RLEC industry, the number of rural voice access lines we serve has been decreasing gradually when normalized for territory acquisitions. We expect that this trend will continue, and may be potentially impacted by the effect of the economy on our customers. These trends will be partially offset by the growth of data access lines, also called digital high-speed internet access service. Our competitive carrier voice and data access lines have grown as we continue to further penetrate our chosen markets. Our ability to continue this growth and our response to the rural trends will have an important impact on our future revenues. Our primary strategy consists of leveraging our strong incumbent market position, selling additional services to our rural customer base and providing better service and support levels than the incumbent carrier to our competitive customer base.
Key Operating Statistics | | | | | | | | | | | | | |
| | | | | | | | | | | | Quarterly % Change | |
| | | | | | March 31, | | | from | |
| | | | | | | | | | | | | |
Otelco access line equivalents(1) | | | 100,356 | | | | 99,639 | | | | 99,271 | | | | (0.4 | )% |
| | | | | | | | | | | | | | | | | |
| RLEC and other services: | | | | | | | | | | | | | | | | |
| Voice access lines | | | 48,215 | | | | 45,461 | | | | 44,770 | | | | (1.5 | )% |
| Data access lines | | | 20,066 | | | | 20,852 | | | | 21,158 | | | | 1.5 | % |
Access line equivalents(1) | | | 68,281 | | | | 66,313 | | | | 65,928 | | | | (0.6 | )% |
| Cable television customers | | | 4,195 | | | | 4,227 | | | | 4,029 | | | | (4.7 | )% |
| Satellite television customers | | | 100 | | | | 125 | | | | 217 | | | | 73.6 | % |
| Additional internet customers | | | 9,116 | | | | 6,975 | | | | 6,435 | | | | (7.7 | )% |
| RLEC dial-up | | | 786 | | | | 393 | | | | 341 | | | | (13.2 | )% |
| Other dial-up | | | 6,439 | | | | 4,300 | | | | 3,786 | | | | (12.0 | )% |
| Other data lines | | | 1,891 | | | | 2,282 | | | | 2,308 | | | | 1.1 | % |
| | | | | | | | | | | | | | | | | |
| CLEC: | | | | | | | | | | | | | | | | |
| Voice access lines | | | 28,647 | | | | 29,944 | | | | 30,084 | | | | 0.5 | % |
| Data access lines | | | 3,428 | | | | 3,382 | | | | 3,259 | | | | (3.6 | )% |
Access line equivalents(1) | | | 32,075 | | | | 33,326 | | | | 33,343 | | | | 0.1 | % |
| Wholesale network connections | | | 132,324 | | | | 149,043 | | | | 152,101 | | | | 2.1 | % |
| | | | | | | | | | | | | | | | | |
| | | For the Three Months | | | | | | | | | |
| | | | | | | | | | | | |
| | | | 2010 | | | | 2011 | | | | | | | | | |
| Total revenues (in millions): | | $ | 25.8 | | | $ | 25.4 | | | | | | | | | |
| RLEC | | $ | 14.7 | | | $ | 14.2 | | | | | | | | | |
| CLEC | | $ | 11.1 | | | $ | 11.2 | | | | | | | | | |
| (1) | We define access line equivalents as voice access lines and data access lines (including cable modems, digital subscriber lines and dedicated data access trunks). |
In our RLEC territories, access line equivalents decreased by 385 during first quarter 2011, or 0.6%, compared to December 31, 2010. Voice access lines declined 1.5% while data access lines increased 1.5% during the period. We offer location specific bundled service packages, many including unlimited domestic calling, tailored to the telecommunications requirements of our customers.
In our Maine and New Hampshire CLEC operations, access line equivalents increased by 17 during first quarter 2011, or 0.1%, compared to December 31, 2010. Voice access lines increased 0.5% while data access lines decreased 3.6% during the period. Virtually all of our competitive customers are businesses, with service bundles tailored to their specific business requirements. We continue to be impacted by economic factors in our markets.
Competitive pricing and bundling of services have led Otelco’s long distance service to be the choice of the majority of the customers in the rural markets we serve. In addition, almost all of our Maine and New Hampshire CLEC customers have selected us as their long distance carrier. Our cable television customers decreased 4.7% from December 31, 2010 to 4,029 as of March 31, 2011. We completed the conversion of our Missouri cable customers to satellite based services for a reduction of 269 customer during first quarter 2011. In Alabama, we upgraded 57 customers to our digital high-definition offer and added 57 new IPTV customers during the same period. Other internet customers decreased 7.7% to 6,435 as of March 31, 2011 compared to December 31, 2010. This also includes the subscribers we service outside of our telephone service area throughout Missouri and Maine, reflecting the shift to digital high-speed internet services. In Missouri, we are expanding our data access lines for digital high-speed internet in selected areas outside of our telephone service territory. Approximately 36% of the other internet customers are served by high-speed data capability from Otelco.
Our Rate and Pricing Structure
Our CLEC pricing is based on market requirements. We combine varying services to meet individual customer requirements, including technical support, and provide multi-year contracts which are both market sensitive for the customer and profitable for us. The MPUC and the NHPUC impose certain requirements on all CLECs operating in their markets for reporting and for interactions with the various incumbent local exchange and interexchange carriers. These requirements provide wide latitude in pricing services.
Our RLECs operate in five states and are regulated in varying degrees by the respective state regulatory authorities. The impact on pricing flexibility varies by state. In Maine, two of our wholly owned subsidiaries, Saco River Telegraph and Telephone Company and The Pine Tree Telephone and Telegraph Company, have obtained authority to implement pricing flexibility while remaining under rate-of-return regulation. Our rates for other services we provide, including cable, long distance, data lines and dial-up and high-speed internet access, are not price regulated. The market for competitive services, such as wireless, also impacts our ability to adjust prices. With the increase of bundled services offerings, including unlimited long distance, pricing for individual services takes on reduced importance to revenue stability. We expect this trend to continue into the immediate future.
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, sales and customer service; other plant operations, maintenance and administrative costs; network access costs; and costs of services 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 relating to engineering, financial, human resources and corporate operations; information management expenses, including billing; allowance for uncollectible revenue; 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. Certain of these amortization expenses continue to be deductible for tax purposes.
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 and CLEC customers, operating margins decrease reflecting the lower margins associated with these 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, | |
| | | | | | | |
| Revenues | | | | | | |
| Local services | | | 47.5 | % | | | 47.2 | % |
| Network access | | | 30.9 | | | | 31.0 | |
| Cable television | | | 2.6 | | | | 3.0 | |
| Internet | | | 13.6 | | | | 13.6 | |
| Transport services | | | 5.4 | | | | 5.2 | |
| Total revenues | | | 100.0 | % | | | 100.0 | % |
| Operating expenses | | | | | | | | |
| Cost of services and products | | | 41.1 | % | | | 43.4 | % |
| Selling, general and administrative expenses | | | 12.5 | | | | 13.1 | |
| Depreciation and amortization | | | 23.6 | | | | 22.5 | |
| Total operating expenses | | | 77.2 | | | | 79.0 | |
| | | | | | | | | |
| Income from operations | | | 22.8 | | | | 21.0 | |
| | | | | | | | | |
| Other income (expense) | | | | | | | | |
| Interest expense | | | (23.2 | ) | | | (24.3 | ) |
| Change in fair value of derivatives | | | 3.4 | | | | 2.0 | |
| Other income | | | 1.3 | | | | 1.3 | |
| Total other expenses | | | (25.3 | ) | | | (21.0 | ) |
| | | | | | | | | |
| Income (loss) before income tax | | | (2.5 | ) | | | 0.0 | |
| | | | | | | | | |
| Income tax (expense) benefit | | | 1.0 | | | | (0.0 | ) |
| | | | | | | | | |
| Net income (loss) available to common stockholders | | | (1.5 | )% | | | 0.0 | % |
Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010
Total revenues. Total revenues decreased 1.6% in the three months ended March 31, 2011 to $25.4 million from $25.8 million in the three months ended March 31, 2010. The table below provides the components of our revenues for the three months ended March 31, 2011 compared to the same period of 2010.
| | | Three Months Ended March 31, | | | | |
| | | | | | | | | | | | | |
| | | (dollars in thousands) | |
| Local services | | $ | 12,239 | | | $ | 12,006 | | | $ | (233 | ) | | | (1.9 | ) % |
| Network access | | | 7,985 | | | | 7,861 | | | | (124 | ) | | | (1.6 | ) |
| Cable television | | | 666 | | | | 753 | | | | 87 | | | | 13.1 | |
| Internet | | | 3,511 | | | | 3,455 | | | | (56 | ) | | | (1.6 | ) |
| Transport services | | | 1,393 | | | | 1,317 | | | | (76 | ) | | | (5.5 | ) |
| Total | | $ | 25,794 | | | $ | 25,392 | | | $ | (402 | ) | | | (1.6 | ) |
Local services. Local services revenue decreased 1.9% to $12.0 million in the three months ended March 31, 2011 from $12.2 million in the three months ended March 31, 2010. The growth in CLEC revenue accounted for an increase of $0.1 million. RLEC revenue, including bundled services such as long distance, decreased $0.2 million reflecting the decline in RLEC voice access lines.
Network access. Network access revenue decreased 1.6% to $7.9 million in the three months ended March 31, 2011 from $8.0 million in the three months ended March 31, 2010. RLEC interstate and intrastate switched access declined $0.3 million which was partially offset by an increase of $0.2 million in CLEC interstate and intrastate access.
Cable television. Cable television revenue increased 13.1% to $0.8 million in the three months ended March 31, 2011 from $0.7 million in the three months ended March 31, 2010. Growth in IPTV subscribers and the shift to high-definition packages in Alabama and one-time revenue associated with the conversion of our Missouri cable customers to satellite services accounted for the increase.
Internet. Internet revenue remained constant at $3.5 million in the three months ended March 31, 2011 and 2010. The growth in new digital data access lines, including related equipment rental, and Missouri fiber leases offset the decline of dial-up internet customers associated with the conversion to digital data access lines, including those customers in Maine and Missouri that are outside of our local service areas.
Transport services. Transport services revenue decreased 5.5% to $1.3 million in the three months ended March 31, 2011 from $1.4 million in the three months ended March 31, 2010. Market price changes for new and existing customers caused the decline.
Operating expenses. Operating expenses in the three months ended March 31, 2011 increased 0.7% to $20.0 million from $19.9 million in the three months ended March 31, 2010.
| | | Three Months Ended
March 31, | | | | |
| | | | | | | | | | | | | |
| | | (dollars in thousands) | |
| Cost of services and products | | $ | 10,610 | | | $ | 11,020 | | | $ | 410 | | | | (3.9 | ) % |
| Selling, general and administrative expenses | | | 3,231 | | | | 3,327 | | | | 96 | | | | 3.0 | |
| Depreciation and amortization | | | 6,084 | | | | 5,724 | | | | (360 | ) | | | (5.9 | ) |
| Total | | $ | 19,925 | | | $ | 20,071 | | | $ | 146 | | | | 0.7 | |
Cost of services and products. Cost of services and products increased 3.9% to $11.0 million in the three months ended March 31, 2011 from $10.6 million in the three months ended March 31, 2010. The increase is primarily associated with growth in access and sales agent expense associated with increased CLEC revenue, increased internet capacity and a one-time universal service fund expense. Toll costs in Missouri were offset by operational and network synergies in Maine and lower directory costs in Alabama.
Selling, general and administrative expenses. Selling, general and administrative expenses increased 3.0% to $3.3 million in the three months ended March 31, 2011 from $3.2 million in the three months ended March 31, 2010. Increases in employee costs and acquisition related expenses of $0.2 million were partially offset by operational synergies and lower insurance costs of $0.1 million.
Depreciation and amortization. Depreciation and amortization decreased 5.9% to $5.7 million in the three months ended March 31, 2011 from $6.1 million in the three months ended March 31, 2010. Amortization of intangible assets associated with the acquisition of three entities from Country Road Communications LLC decreased $0.3 million, including a covenant not to compete and contract and customer base assets. The remaining decrease of $0.1 million reflected lower depreciation of RLEC plant assets.
| | | Three Months Ended March 31, | | | | |
| | | | | | | | | | | | | |
| | | (dollars in thousands) | |
| Interest expense | | $ | (5,989 | ) | | $ | (6,170 | ) | | $ | 181 | | | | 3.0 | % |
| Change in fair value of derivatives | | | (886 | ) | | | 506 | | | | 1,392 | | | NM | |
| Other income | | | 359 | | | | 349 | | | | (10 | ) | | | (2.8 | ) |
| Income tax (expense) benefit | | | 262 | | | | (1 | ) | | | (263 | ) | | NM | |
Interest expense. Interest expense increased 3.0% to $6.2 million in the three months ended March 31, 2011 from $6.0 million in the three months ended March 31, 2010. Interest associated with the exchange of our Class B shares for Income Deposit Securities (“IDSs”) in June 2010 and the effective date of our $60 million interest rate swap on February 8, 2010 accounted for the increase.
Change in fair value of derivatives. We have two interest rate swap agreements to hedge our exposure to changes in interest rate costs associated with our senior credit facility. From an accounting perspective, the swaps do not meet the technical requirements to allow the swaps to be considered highly effective hedging instruments and therefore the swaps do not qualify for hedge accounting. These swap agreements must be considered investments and the change in value is reflected as a change in fair value of derivatives. The liability associated with the swaps declined $0.5 million in the three months ended March 31, 2011 reflecting the changes in the anticipated interest rate market and the shorter time to maturity, compared to an increase in liability in the three months ended March 31, 2010. Over the life of the swaps, the cumulative change in value will be zero. See —Liquidity and Capital Resources below for additional explanation.
Other income. Other income decreased slightly to $0.3 million in the three months ended March 31, 2011 from $0.4 million in the three months ended March 31, 2010, primarily from a small decline in our CoBank dividend.
Income tax (expense) benefit. Provision for income taxes was an expense of less than $0.1 million in the three months ended March 31, 2011 compared to a benefit of $0.3 million in the three months ended March 31, 2010.
Net income. As a result of the foregoing, there was net income of less than $0.1 million in the three months ended March 31, 2011 and net loss of $0.4 million in the three months ended March 31, 2010.
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 (“common stock”); and (v) potential acquisitions.
Historically, we satisfy our operating cash requirements from the cash generated by our business and utilize borrowings under our credit facility to facilitate acquisitions; however, as set forth below, we expect to finance our acquisition of Shoreham Telephone Company, Inc. (“Shoreham”) using cash on hand. For the three months ended March 31, 2011, we generated cash from our business to invest in additional property and equipment, pay interest on our senior debt, pay interest associated with the senior subordinated debt inherent in our IDSs, and fund dividends (as declared by our board of directors) on the shares of common stock that are inherent in our IDSs. After meeting all of these needs of our business, cash grew from $18.2 million at December 31, 2010 to $18.5 million at March 31, 2011. The Company has as its current policy to return a high percentage of its available cash to its IDS holders.
Cash flows from operating activities for the first three months of 2011 amounted to $5.4 million compared to $7.5 million for the first three months of 2010. Net income, when adjusted for its non-cash components, declined by $1.4 million reflecting lower revenues and somewhat higher costs and expenses. The changes in operating assets and liabilities of $0.6 million reflect a $0.4 million income tax receivable only in 2010, a reduction in the change in accounts receivable of $0.6 million reflecting improved payments from carriers in Maine and a change of $0.4 million in all other asset and liability accounts.
Cash flows used in investing activities for the first three months of 2011 were $2.8 million compared to $1.8 million in the first three months of 2010. The higher rate of capital expenditures for property and equipment in the first three months of 2011 accounted for the difference.
Cash flows used in financing activities for the first three months of 2011 were $2.3 million compared to $2.2 million for the first three months of 2010, reflecting payments of dividends to stockholders in both periods. The dividend was $0.17625 per share for the quarter in both periods. The number of shares of common stock outstanding increased in June 2010 in connection with the exchange of our Class B shares for IDSs. We have paid twenty-five consecutive dividends at this rate since the Company went public in December 2004.
We do not invest in financial instruments as part of our business strategy. The Company had a $90 million notional amount interest rate swap with the Company paying 1.85% and the counterparty paying a variable rate based upon the three month LIBOR for three years beginning February 9, 2009 and a $60 million notional amount interest rate swap with the Company paying 2.0475% and the counterparty paying a variable rate based upon the three month LIBOR for two years beginning February 9, 2010. From an accounting perspective, the documentation for both swaps does not meet the technical requirements of Accounting Standards Codification 815, Derivatives and Hedging, to allow the swaps to be considered highly effective as hedging instruments and therefore the swaps do not qualify for hedge accounting.
We also have received patronage shares, primarily from one of our lenders, over a period of years for which there is a limited market to determine value until the shares are redeemed by the issuing institution. Historically, these shares have been redeemed at a value similar to their issued value. Due to the uncertainty of this future value, these shares are carried at approximately 55% of their issued value.
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.
The following table provides a summary of the extent to which cash generated from operations is reinvested in our operations, used to pay interest on our senior debt and senior subordinated notes or distributed as dividends to our stockholders for the periods indicated.
| | | | Three Months Ended March 31, | |
| | | | | | | | |
| | | | (Dollars in thousands) | |
| | | | | | | | |
| | Cash generation | | | | | | |
| | Revenues | | $ | 25,794 | | | $ | 25,392 | |
| | Other income | | | 359 | | | | 349 | |
| | Cash received from operations | | | 26,153 | | | | 25,741 | |
| | Cost of services and products | | | 10,610 | | | | 11,020 | |
| | Selling, general and administrative expenses | | | 3,231 | | | | 3,327 | |
| | Cash consumed by operations | | | 13,841 | | | | 14,347 | |
| | Cash generated from operations | | $ | 12,312 | | | $ | 11,394 | |
| | Cash utilization | | | | | | | | |
| | Capital investment in operations | | | 1,753 | | | | 2,843 | |
| | Senior debt interest and fees | | | 2,324 | | | | 2,369 | |
| | Interest on senior subordinated notes | | | 3,366 | | | | 3,499 | |
| | Dividends | | | 2,234 | | | | 2,330 | |
| | Cash utilized by the Company | | $ | 9,677 | | | $ | 11,041 | |
| | | | | | | | | | |
| | Percentage of cash utilized of cash generated | | | 78.6 | % | | | 96.9 | % |
We use adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) as an operational performance measurement. Adjusted EBITDA, as presented in this Form 10-Q, corresponds to the definition of Adjusted EBITDA in the indenture governing our senior subordinated notes and our senior credit facility and certain of the covenants contained therein. Adjusted EBITDA, as presented in this Form 10-Q, is a supplemental measure of our performance that is not required by, or presented in accordance with, accounting principles generally accepted in the United States (“GAAP”). Our senior credit facility requires that we report performance in this format each quarter and involved lending institutions utilize this measure to determine compliance with credit facility requirements. We report Adjusted EBITDA in our quarterly earnings press release to allow current and potential investors to understand this performance metric and because we believe that it provides current and potential investors with helpful information with respect to our operating performance and cash flows. However, Adjusted EBITDA should not be considered as an alternative to net income (loss) or any other performance measures derived in accordance with GAAP or as an alternative to net cash provided by operating activities as a measure of our liquidity. Our presentation of Adjusted EBITDA may not be comparable to similarly titled measures used by other companies. Adjusted EBITDA for the three months ended March 31, 2010 and 2011, and its reconciliation to net income (loss), is reflected in the table below:
| | | | Three Months Ended March 31, | |
| | | | | | | | |
| | | | (Dollars in thousands) | |
| | | | | | | | |
| | Net income (loss) | | $ | (386 | ) | | $ | 5 | |
| | Add: Depreciation | | | 3,573 | | | | 3,523 | |
| | Interest expense – net of premium | | | 5,651 | | | | 5,828 | |
| | Interest expense – amortize loan cost | | | 338 | | | | 342 | |
| | Income tax expense (benefit) | | | (262 | ) | | | 1 | |
| | Change in fair value of derivatives | | | 886 | | | | (506 | ) |
| | Loan fees | | | 19 | | | | 19 | |
| | Amortization - intangibles | | | 2,512 | | | | 2,201 | |
| | Adjusted EBITDA | | $ | 12,331 | | | $ | 11,413 | |
Recent Accounting Pronouncements
During 2011, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2011-01 and ASU 2011-02. These ASUs provide technical corrections to existing guidance related to specialized industries or entities and therefore, have minimal, if any, impact on the Company.
Subsequent Events
On April 1, 2011, the Company’s newly formed wholly owned subsidiary, Shoreham Telephone LLC, executed a definitive agreement to acquire all of the capital stock of Shoreham for $4.5 million, subject to certain purchase price adjustments. Shoreham is a telecommunications company serving approximately 4,975 access lines that is headquartered in Shoreham, Vermont. The acquisition is expected to close in 2011, but is subject to regulatory approval and other customary conditions. The Company anticipates financing this acquisition from cash on hand.
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 derivative or commodity type instruments. Our two interest rate swap agreements are technically not effective hedges and therefore do not qualify for hedge accounting. The change in the fair value of the swaps is charged or credited to income as a change in fair value of derivatives. Over the life of the swaps, the cumulative change in value will be zero. 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 would be exposed to interest rate risk, primarily from a change in LIBOR or a base rate, should the facility be used. 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 the Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2011.
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, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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: May 6, 2011 | OTELCO INC. | |
| | | | |
| | 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) under 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) under 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 |
| | | |
| 101 | | The following information from the Company’s quarterly report on Form 10-Q for the quarterly period ended March 31, 2011 formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Cash Flows; and (iv) Notes to Consolidated Financial Statements, tagged as blocks of text |
