UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
| (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, 2012 |
| | |
| | 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 7, 2012 |
| 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, 2012
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, 2012.
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.
| | | December 31, | | | March 31, | |
| | | 2011 | | | 2012 | |
| Assets | | | | | | |
| Current assets | | | | | | |
| Cash and cash equivalents | | $ | 12,393,792 | | | $ | 16,041,879 | |
| Accounts receivable: | | | | | | | | |
Due from subscribers, net of allowance for doubtful accounts of $260,568 and $237,182, respectively | | | 4,355,632 | | | | 4,150,049 | |
| Unbilled receivables | | | 2,183,465 | | | | 2,181,672 | |
| Other | | | 5,449,074 | | | | 4,669,856 | |
| Materials and supplies | | | 1,780,820 | | | | 2,026,496 | |
| Prepaid expenses | | | 1,328,475 | | | | 1,380,895 | |
| Deferred income taxes | | | 726,310 | | | | 726,310 | |
| Total current assets | | | 28,217,568 | | | | 31,177,157 | |
| | | | | | | | | |
| Property and equipment, net | | | 65,881,975 | | | | 64,233,220 | |
| Goodwill | | | 188,954,840 | | | | 188,954,840 | |
| Intangible assets, net | | | 20,545,691 | | | | 18,982,111 | |
| Investments | | | 1,943,805 | | | | 1,937,427 | |
| Deferred financing costs | | | 4,485,324 | | | | 4,152,799 | |
| Deferred income taxes | | | 7,454,443 | | | | 7,454,443 | |
| Other assets | | | 240,667 | | | | 387,695 | |
| Total assets | | $ | 317,724,313 | | | $ | 317,279,692 | |
| | | | | | | | | |
Liabilities and Stockholders’ Deficit | | | | | | | | |
| Current liabilities | | | | | | | | |
| Accounts payable | | $ | 1,490,717 | | | $ | 1,422,149 | |
| Accrued expenses | | | 6,034,104 | | | | 7,344,306 | |
| Advance billings and payments | | | 1,590,689 | | | | 1,600,064 | |
| Deferred income taxes | | | 353,285 | | | | 353,285 | |
| Customer deposits | | | 143,657 | | | | 146,032 | |
| Total current liabilities | | | 9,612,452 | | | | 10,865,836 | |
| | | | | | | | | |
| Deferred income taxes | | | 48,112,384 | | | | 48,112,384 | |
| Interest rate swaps | | | 241,438 | | | | - | |
| Advance billings and payments | | | 615,584 | | | | 828,488 | |
| Other liabilities | | | 403,823 | | | | 274,228 | |
| Long-term notes payable | | | 271,106,387 | | | | 271,078,547 | |
| Total liabilities | | | 330,092,068 | | | | 331,159,483 | |
| | | | | | | | | |
| 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 | |
| Retained deficit | | | (12,499,969 | ) | | | (14,012,005 | ) |
| Total stockholders’ deficit | | | (12,367,755 | ) | | | (13,879,791 | ) |
| Total liabilities and stockholders’ deficit | | $ | 317,724,313 | | | $ | 317,279,692 | |
The accompanying notes are an integral part of these consolidated financial statements.
| OTELCO INC. |
|
| (unaudited) |
| | | | | | | |
| | | Three Months Ended | |
| | | March 31, | |
| | | 2011 | | | 2012 | |
| Revenues | | $ | 25,392,000 | | | $ | 25,374,241 | |
| | | | | | | | | |
| Operating expenses | | | | | | | | |
| Cost of services | | | 11,020,212 | | | | 11,028,833 | |
| Selling, general and administrative expenses | | | 3,327,057 | | | | 3,206,077 | |
| Depreciation and amortization | | | 5,724,018 | | | | 4,522,593 | |
| Total operating expenses | | | 20,071,287 | | | | 18,757,503 | |
| | | | | | | | | |
| Income from operations | | | 5,320,713 | | | | 6,616,738 | |
| | | | | | | | | |
| Other income (expense) | | | | | | | | |
| Interest expense | | | (6,170,131 | ) | | | (5,833,650 | ) |
| Change in fair value of derivatives | | | 506,155 | | | | 241,438 | |
| Other income | | | 349,349 | | | | 318,169 | |
| Total other expenses | | | (5,314,627 | ) | | | (5,274,043 | ) |
| | | | | | | | | |
| Income before income tax | | | 6,086 | | | | 1,342,695 | |
| Income tax expense | | | (1,432 | ) | | | (524,457 | ) |
| | | | | | | | | |
| Net income available to common stockholders | | $ | 4,654 | | | $ | 818,238 | |
| | | | | | | | | |
| Common shares outstanding | | | 13,221,404 | | | | 13,221,404 | |
| | | | | | | | | |
| Net income per common share | | $ | - | | | $ | 0.06 | |
| | | | | | | | | |
| Dividends declared per common share | | $ | 0.18 | | | $ | 0.18 | |
The accompanying notes are an integral part of these consolidated financial statements.
| OTELCO INC. |
|
| (unaudited) |
| | | | | | | |
| | | Three Months Ended | |
| | | March 31, | |
| | | 2011 | | | 2012 | |
| Cash flows from operating activities: | | | | | | |
| Net income | | $ | 4,654 | | | $ | 818,238 | |
| Adjustments to reconcile net income to cash flows from operating activities: | | | | | | | | |
| Depreciation | | | 3,522,652 | | | | 2,728,557 | |
| Amortization | | | 2,201,365 | | | | 1,794,036 | |
| Amortization of debt premium | | | (24,795 | ) | | | (27,840 | ) |
| Amortization of loan costs | | | 342,024 | | | | 342,024 | |
| Change in fair value of derivatives | | | (506,155 | ) | | | (241,438 | ) |
| Provision for uncollectible revenue | | | 62,747 | | | | 122,402 | |
Changes in operating assets and liabilities; net of operating assets and liabilities acquired: | | | | | | | | |
| Accounts receivables | | | (215,112 | ) | | | 864,192 | |
| Material and supplies | | | (62,586 | ) | | | (245,676 | ) |
| Prepaid expenses and other assets | | | 220,510 | | | | (200,130 | ) |
| Accounts payable and accrued liabilities | | | (102,141 | ) | | | 1,046,924 | |
| Advance billings and payments | | | (25,786 | ) | | | 222,279 | |
| Other liabilities | | | 2,788 | | | | 67,487 | |
| | | | | | | | | |
| Net cash from operating activities | | | 5,420,165 | | | | 7,291,055 | |
| | | | | | | | | |
| Cash flows used in investing activities: | | | | | | | | |
| Acquisition and construction of property and equipment | | | (2,842,757 | ) | | | (1,303,197 | ) |
| | | | | | | | | |
| Net cash used in investing activities | | | (2,842,757 | ) | | | (1,303,197 | ) |
| | | | | | | | | |
| Cash flows used in financing activities: | | | | | | | | |
| Cash dividends paid | | | (2,330,273 | ) | | | (2,330,272 | ) |
| Loan origination costs | | | - | | | | (9,499 | ) |
| | | | | | | | | |
| Net cash used in financing activities | | | (2,330,273 | ) | | | (2,339,771 | ) |
| | | | | | | | | |
| Net increase in cash and cash equivalents | | | 247,135 | | | | 3,648,087 | |
| Cash and cash equivalents, beginning of period | | | 18,226,374 | | | | 12,393,792 | |
| | | | | | | | | |
| Cash and cash equivalents, end of period | | $ | 18,473,509 | | | $ | 16,041,879 | |
| | | | | | | | | |
| Supplemental disclosures of cash flow information: | | | | | | | | |
| Interest paid | | $ | 5,908,353 | | | $ | 5,820,846 | |
| | | | | | | | | |
| Income taxes paid | | $ | 122,895 | | | $ | 25,250 | |
The accompanying notes are an integral part of these consolidated financial statements.
MARCH 31, 2012
(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 LLC (“HTC”); Brindlee Mountain Telephone LLC (“BMTC”); Blountsville Telephone LLC (“BTC”); Otelco Mid-Missouri LLC (“MMT”) and its wholly owned subsidiary I-Land Internet Services LLC; Mid-Maine Telecom LLC (“MMTI”); Mid-Maine TelPlus LLC (“MMTP”); Granby Telephone LLC (“GTT”); War Telephone LLC (“WT”); Pine Tree Telephone LLC (“PTT”); Saco River Telephone LLC (“SRT”); Shoreham Telephone LLC (“ST”); CRC Communications LLC (“PTN”); and Communications Design Acquisition LLC (“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, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 or any other period.
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, 2011. 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.
Recent Accounting Pronouncements
During 2011, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2011-01 through 2011-12. Except for ASU 2011-04, ASU 2011-05, ASU 2011-08 and ASU 2011-09, which are discussed below, these ASUs provide technical corrections to existing guidance related to specialized industries or entities and therefore, have minimal, if any, impact on the Company.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), an update to Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures (“ASC 820”). ASU 2011-04 provides guidance to change the wording used to describe many of the requirements in U.S. generally accepted accounting principles for measuring fair value and for disclosing information about fair value measurements. For public entities, ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and is to be applied prospectively. As ASU 2011-04 impacts presentation only, the adoption of this update did not impact our consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), an update to ASC 220, Comprehensive Income. This ASU requires the components of net income and the components of other comprehensive income to be presented either in a single continuous statement of comprehensive income or in two separate but continuous statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. This guidance does not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income or how earnings per share is calculated or presented. ASU 2011-05 is effective for public entities for interim and annual periods beginning after December 15, 2011. As ASU 2011-05 impacts presentation only, the adoption of this update did not impact our consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment (“ASU 2011-08”), an update to ASC 350, Intangibles – Goodwill and Other (“ASC 350”). This ASU provides an entity with the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test in accordance with ASC 350. ASU 2011-08 is effective for annual and interim goodwill impairment tests for fiscal years beginning after December 15, 2011. As ASU 2011-08 impacts testing procedures only, the adoption of this update did not impact our consolidated financial statements.
In September 2011, the FASB issued ASU 2011-09, Disclosures about an Employer’s Participation in a Multiemployer Plan (“ASU 2011-09”), an update to ASC 715, Compensation – Retirement Benefits, subtopic 80, Multiemployer Plans. ASU 2011-09 requires additional disclosures for multiemployer pension plans and multiemployer other postretirement benefit plans. ASU 2011-09 is intended to create greater transparency in financial reporting by disclosing the commitments an employer has made to a multiemployer pension plan and the potential future cash flow implications of an employer’s participation in the plan. ASU 2011-09 is effective for public entities for annual periods with fiscal years ending after December 15, 2011. As ASU 2011-09 impacts disclosure only, the adoption of this update did not impact our consolidated financial statements.
2. Acquisitions
On October 14, 2011, ST acquired 100% of the issued and outstanding common stock of Shoreham Telephone Company, Inc. (“STC”) and, immediately thereafter, merged STC with and into ST. ST provides telecommunications solutions, including voice, data and internet services, to residential and business customers in western Vermont.
The stock purchase agreement related to the acquisition of STC provided for cash consideration of $5,248,134, including the extinguishment of notes payable of $410,904 and accrued interest of $3,081, which were paid at closing. The excess of the purchase price over the fair value of identifiable assets and liabilities is reflected as goodwill of $764,761. The goodwill related to the acquisition is not deductible for tax purposes.
The allocation of the net purchase price for the STC acquisition was as follows:
| | | October 14, 2011 | |
| Cash | | $ | 237,850 | |
| Other current assets | | | 552,331 | |
| Property and equipment | | | 4,529,760 | |
| Intangible assets | | | 1,729,600 | |
| Goodwill | | | 764,761 | |
| Current liabilities | | | (332,710 | ) |
| Deferred income tax liabilities | | | (2,233,458 | ) |
| Purchase price | | $ | 5,248,134 | |
The acquisition was recorded at fair value in accordance with ASC 805, Business Combinations, resulting in a plant acquisition adjustment in 2011. Property and equipment have depreciable lives consistent with those shown in the Property and Equipment note contained in the notes to the Company’s consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2011. The intangible assets at time of acquisition included regulated customer based assets at fair value of $1,672,200 which had remaining lives of 10 years; trade name fair valued at $16,200 which had a remaining life of 5 years; and a non-competition agreement fair valued at $41,200 which had a remaining life of 2 years. The acquisition was accounted for using the acquisition method of accounting and, accordingly, the accompanying consolidated 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 STC had occurred at the beginning of 2011. The results include certain adjustments, including 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 2011 or those which may be obtained in the future.
| | | Three Months | |
| | | Ended | |
| | | March 31, | |
| | | 2011 | |
| Revenues | | $ | 26,007,255 | |
| Income from operations | | $ | 5,326,652 | |
| Net income | | $ | 15,241 | |
| Basic net income per common share | | $ | - | |
| Diluted net income per common share | | $ | - | |
3. Derivative Activities
The Company utilized two interest rate swaps which matured on February 8, 2012. The first swap had 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 was effective from February 9, 2009 through February 8, 2012. The second swap had 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 was effective from February 9, 2010 through February 8, 2012. From an accounting perspective, the documentation for both swaps did not meet the technical requirements of ASC 815, Derivatives and Hedging, to allow the swaps to be considered highly effective hedging instruments and therefore the swaps did not qualify for hedge accounting. The change in fair value of the swaps was charged or credited to income as a change in fair value of derivatives. Over the life of the swaps, the cumulative change in fair value was zero.
4. Insurance
The Company adopted a high-deductible insurance program for health care benefits beginning in 2012. In addition, the Company changed from a premium-based plan to self insuring claims up to $125,000 per participant. With this change, an accrual for the estimated amount of self-insured healthcare claims incurred but not reported (“IBNR”) is required. The estimated accrual is based on information provided by the Company’s insurance broker, a third party actuary, and insurer, combined with management’s judgments regarding a number of assumptions and factors, including frequency and severity of claims, claims development history, case jurisdiction, related legislation and claims settlement practice. Significant judgment is required to estimate IBNR claims as parties have yet to assert such claims.
5. Income per Common Share
Income per common share is computed by dividing net income by the number of shares outstanding for the period. The Company does not have any outstanding stock arrangements that might be potentially dilutive.
A reconciliation of the Company’s income per common share calculation is as follows:
| | | Three Months | |
| | | Ended March 31, | |
| | | 2011 | | | 2012 | |
| | | | | | | |
| Common shares outstanding | | | 13,221,404 | | | | 13,221,404 | |
| | | | | | | | | |
| Net income available to common stockholders | | $ | 4,654 | | | $ | 818,238 | |
| | | | | | | | | |
| Net income per common share | | $ | - | | | $ | 0.06 | |
6. Fair Value Measurement
The Company adopted 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. |
The Company did not have any financial assets or liabilities as of March 31, 2012. In accordance with ASC 820, the following table represents the Company’s fair value hierarchy for its financial assets and liabilities as of December 31, 2011:
| | | December 31, 2011 | |
| | | Fair Value | | | Level 1 | | | Level 2 | | | Level 3 | |
| Liabilities | | | | | | | | | | | | |
| Interest rate swaps | | $ | 241,438 | | | $ | - | | | $ | 241,438 | | | $ | - | |
| Total liabilities | | $ | 241,438 | | | $ | - | | | $ | 241,438 | | | $ | - | |
The interest rate swaps were valued at the end of 2011 based on available market information.
7. Subsidiary Guarantees
On October 1, 2011, MMT became a guarantor of the Company’s senior subordinated notes and on October 14, 2011, ST became a guarantor of the Company’s senior subordinated notes.
The Company has no independent assets or operations separate from its operating subsidiaries. The guarantees of its senior subordinated notes by 14 of its 15 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, 2011 and March 31, 2012; condensed consolidating statements of operations for the three months ended March 31, 2011 and 2012; and condensed consolidating statements of cash flows for the three months ended March 31, 2011 and 2012.
Otelco Inc.
Condensed Consolidating Balance Sheet
December 31, 2011
| | | | | | Guarantor | | | Non-Guarantor | | | | | | | |
| | | Parent | | | Subsidiaries | | | Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| ASSETS | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Current assets | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | - | | | $ | 12,393,441 | | | $ | 351 | | | $ | - | | | $ | 12,393,792 | |
| Accounts receivable, net | | | - | | | | 11,445,049 | | | | 543,122 | | | | - | | | | 11,988,171 | |
| Materials and supplies | | | - | | | | 827,194 | | | | 953,626 | | | | - | | | | 1,780,820 | |
| Prepaid expenses | | | 194,244 | | | | 1,115,339 | | | | 18,892 | | | | - | | | | 1,328,475 | |
| Deferred income taxes | | | 726,310 | | | | - | | | | - | | | | - | | | | 726,310 | |
| Investment in subsidiaries | | | 147,614,140 | | | | - | | | | - | | | | (147,614,140 | ) | | | - | |
| Intercompany receivable | | | (154,849,721 | ) | | | (688,391 | ) | | | 688,391 | | | | 154,849,721 | | | | - | |
| Total current assets | | | (6,315,027 | ) | | | 25,092,632 | | | | 2,204,382 | | | | 7,235,581 | | | | 28,217,568 | |
| | | | | | | | | | | | | | | | | | | | | |
| Property and equipment, net | | | - | | | | 64,524,981 | | | | 1,356,994 | | | | - | | | | 65,881,975 | |
| Goodwill | | | 239,970,317 | | | | (47,435,761 | ) | | | (3,579,716 | ) | | | - | | | | 188,954,840 | |
| Intangible assets, net | | | - | | | | 18,186,227 | | | | 2,359,464 | | | | - | | | | 20,545,691 | |
| Investments | | | 1,203,605 | | | | 432,186 | | | | 308,014 | | | | - | | | | 1,943,805 | |
| Deferred income taxes | | | 7,454,443 | | | | - | | | | - | | | | - | | | | 7,454,443 | |
| Other long-term assets | | | 4,485,324 | | | | 240,667 | | | | - | | | | - | | | | 4,725,991 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 246,798,662 | | | $ | 61,040,932 | | | $ | 2,649,138 | | | $ | 7,235,581 | | | $ | 317,724,313 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT) | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | | | | | | | | |
| Accounts payable and accrued expenses | | $ | 1,306,872 | | | $ | 4,793,854 | | | $ | 1,424,095 | | | $ | - | | | $ | 7,524,821 | |
| Intercompany payables | | | - | | | | (154,849,721 | ) | | | - | | | | 154,849,721 | | | | - | |
| Other current liabilities | | | 353,285 | | | | 1,668,933 | | | | 65,413 | | | | - | | | | 2,087,631 | |
| Total current liabilities | | | 1,660,157 | | | | (148,386,934 | ) | | | 1,489,508 | | | | 154,849,721 | | | | 9,612,452 | |
| | | | | | | | | | | | | | | | | | | | | |
| Deferred income taxes | | | 26,421,911 | | | | 20,354,646 | | | | 1,335,827 | | | | - | | | | 48,112,384 | |
| Other liabilities | | | 241,438 | | | | 1,019,407 | | | | - | | | | - | | | | 1,260,845 | |
| Long-term notes payable | | | 230,842,911 | | | | 40,263,476 | | | | - | | | | - | | | | 271,106,387 | |
| Stockholders’ equity (deficit) | | | (12,367,755 | ) | | | 147,790,337 | | | | (176,197 | ) | | | (147,614,140 | ) | | | (12,367,755 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Total liabilities and stockholders’ equity (deficit) | | $ | 246,798,662 | | | $ | 61,040,932 | | | $ | 2,649,138 | | | $ | 7,235,581 | | | $ | 317,724,313 | |
Otelco Inc.
Condensed Consolidating Balance Sheet
March 31, 2012
| | | | | | Guarantor | | | Non-Guarantor | | | | | | | |
| | | Parent | | | Subsidiaries | | | Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| ASSETS | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Current assets | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | - | | | $ | 16,041,529 | | | $ | 350 | | | $ | - | | | $ | 16,041,879 | |
| Accounts receivable, net | | | - | | | | 10,482,516 | | | | 519,061 | | | | - | | | | 11,001,577 | |
| Materials and supplies | | | - | | | | 979,650 | | | | 1,046,846 | | | | - | | | | 2,026,496 | |
| Prepaid expenses | | | 251,467 | | | | 1,113,968 | | | | 15,460 | | | | - | | | | 1,380,895 | |
| Income tax receivables | | | - | | | | - | | | | - | | | | - | | | | - | |
| Deferred income taxes | | | 726,310 | | | | - | | | | - | | | | - | | | | 726,310 | |
| Investment in subsidiaries | | | 154,223,641 | | | | - | | | | - | | | | (154,223,641 | ) | | | - | |
| Intercompany receivable | | | (162,885,185 | ) | | | (877,326 | ) | | | 877,326 | | | | 162,885,185 | | | | - | |
| Total current assets | | | (7,683,767 | ) | | | 27,740,337 | | | | 2,459,043 | | | | 8,661,544 | | | | 31,177,157 | |
| | | | | | | | | | | | | | | | | | | | | |
| Property and equipment, net | | | - | | | | 62,859,409 | | | | 1,373,811 | | | | - | | | | 64,233,220 | |
| Goodwill | | | 239,970,317 | | | | (47,435,761 | ) | | | (3,579,716 | ) | | | - | | | | 188,954,840 | |
| Intangible assets, net | | | - | | | | 16,684,738 | | | | 2,297,373 | | | | - | | | | 18,982,111 | |
| Investments | | | 1,203,605 | | | | 425,808 | | | | 308,014 | | | | - | | | | 1,937,427 | |
| Deferred income taxes | | | 7,454,443 | | | | - | | | | - | | | | - | | | | 7,454,443 | |
| Other long-term assets | | | 4,152,799 | | | | 387,695 | | | | - | | | | - | | | | 4,540,494 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 245,097,397 | | | $ | 60,662,226 | | | $ | 2,858,525 | | | $ | 8,661,544 | | | $ | 317,279,692 | |
| | | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT) | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Current liabilities | | | | | | | | | | | | | | | | | | | | |
| Accounts payable and accrued expenses | | $ | 1,386,921 | | | $ | 5,903,208 | | | $ | 1,476,326 | | | $ | - | | | $ | 8,766,455 | |
| Intercompany payables | | | - | | | | (162,885,185 | ) | | | - | | | | 162,885,185 | | | | - | |
| Other current liabilities | | | 353,285 | | | | 1,679,223 | | | | 66,873 | | | | - | | | | 2,099,381 | |
| Total current liabilities | | | 1,740,206 | | | | (155,302,754 | ) | | | 1,543,199 | | | | 162,885,185 | | | | 10,865,836 | |
| | | | | | | | | | | | | | | | | | | | | |
| Deferred income taxes | | | 26,421,911 | | | | 20,354,646 | | | | 1,335,827 | | | | - | | | | 48,112,384 | |
| Other liabilities | | | - | | | | 1,102,716 | | | | - | | | | - | | | | 1,102,716 | |
| Long-term notes payable | | | 230,815,071 | | | | 40,263,476 | | | | - | | | | - | | | | 271,078,547 | |
| Derivative liability | | | - | | | | - | | | | - | | | | - | | | | - | |
| Class B common convertible to senior subordinated notes | | | - | | | | - | | | | - | | | | - | | | | - | |
| Stockholders’ equity (deficit) | | | (13,879,791 | ) | | | 154,244,142 | | | | (20,501 | ) | | | (154,223,641 | ) | | | (13,879,791 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Total liabilities and stockholders’ equity (deficit) | | $ | 245,097,397 | | | $ | 60,662,226 | | | $ | 2,858,525 | | | $ | 8,661,544 | | | $ | 317,279,692 | |
Otelco Inc.
Condensed Consolidating Statement of Operations
For the Three Months Ended March 31, 2011
| | | | | | Guarantor | | | Non-Guarantor | | | | | | | |
| | | Parent | | | Subsidiaries | | | 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 expense | | | (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 Operations
For the Three Months Ended March 31, 2012
| | | | | | Guarantor | | | Non-Guarantor | | | | | | | |
| | | Parent | | | Subsidiaries | | | Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Revenues | | $ | 880,787 | | | $ | 23,460,360 | | | $ | 1,033,094 | | | $ | - | | | $ | 25,374,241 | |
| Operating expenses | | | (880,787 | ) | | | (16,999,324 | ) | | | (877,392 | ) | | | - | | | | (18,757,503 | ) |
| Income from operations | | | - | | | | 6,461,036 | | | | 155,702 | | | | - | | | | 6,616,738 | |
| Other expense | | | (5,266,807 | ) | | | (7,229 | ) | | | (7 | ) | | | - | | | | (5,274,043 | ) |
| Earnings from subsidiaries | | | 6,609,502 | | | | - | | | | - | | | | (6,609,502 | ) | | | - | |
| Income before income tax | | | 1,342,695 | | | | 6,453,807 | | | | 155,695 | | | | (6,609,502 | ) | | | 1,342,695 | |
| Income tax expense | | | (524,457 | ) | | | - | | | | - | | | | - | | | | (524,457 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Net income to common stockholders | | $ | 818,238 | | | $ | 6,453,807 | | | $ | 155,695 | | | $ | (6,609,502 | ) | | $ | 818,238 | |
Otelco Inc.
Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2011
| | | Parent | | | | | | Non-Guarantor
Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | | | | | | | |
| Net income | | $ | 4,654 | | | $ | 5,047,388 | | | $ | 192,011 | | | $ | (5,239,399 | ) | | $ | 4,654 | |
| Adjustment to reconcile net income | | | | | | | | | | | | | | | | | | | | |
| 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 | |
Otelco Inc.
Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2012
| | | | | | Guarantor | | | Non-Guarantor | | | | | | | |
| | | Parent | | | Subsidiaries | | | Subsidiaries | | | Eliminations | | | Consolidated | |
| | | | | | | | | | | | | | | | |
| Cash flows from operating activities: | | | | | | | | | | | | | | | |
| Net income | | $ | 818,238 | | | $ | 13,063,309 | | | $ | 155,695 | | | $ | (13,219,004 | ) | | $ | 818,238 | |
| Adjustment to reconcile net income | | | | | | | | | | | | | | | | | | | | |
| to cash flows from operating activities | | | 72,746 | | | | 4,508,387 | | | | 136,608 | | | | - | | | | 4,717,741 | |
| Changes in assets and liabilities, net of | | | | | | | | | | | | | | | | | | | | |
| assets and liabilities acquired | | | 8,058,290 | | | | (6,093,315 | ) | | | (209,899 | ) | | | - | | | | 1,755,076 | |
| Net cash provided by operating activities | | | 8,949,274 | | | | 11,478,381 | | | | 82,404 | | | | (13,219,004 | ) | | | 7,291,055 | |
| Cash flows used in investing activities | | | - | | | | (1,220,793 | ) | | | (82,404 | ) | | | - | | | | (1,303,197 | ) |
| Cash flows used in financing activities | | | (8,949,274 | ) | | | (6,609,501 | ) | | | - | | | | 13,219,004 | | | | (2,339,771 | ) |
| Net increase in cash and cash equivalents | | | - | | | | 3,648,087 | | | | - | | | | - | | | | 3,648,087 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, beginning of period | | | - | | | | 12,393,442 | | | | 350 | | | | - | | | | 12,393,792 | |
| | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents, end of period | | $ | - | | | $ | 16,041,529 | | | $ | 350 | | | $ | - | | | $ | 16,041,879 | |
8. Revenue Concentrations
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 9.7% and 9.4% of the Company’s total revenues for the three months ended March 31, 2011 and 2012, 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. Revenue received directly from TW represented approximately 11.4% and 11.8% of the Company’s consolidated revenue for the three months ended March 31, 2011 and 2012, respectively. Additionally, other unrelated telecommunications providers pay the Company access revenue for terminating calls through the Company to TW’s customers, representing approximately 3% to 4% of the Company’s consolidated revenue for the three months ended March 31, 2011 and 2012.
9. 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 Public Service Commission, the Maine Public Utilities Commission, the Massachusetts Department of Telecommunications and Cable, the Missouri Public Service Commission, the New Hampshire Public Utilities Commission, the Vermont Public Service Board and the West Virginia Public Service Commission, relating primarily to rate making. Currently, none of the legal proceedings are expected to have a material adverse effect on our business.
10. Subsequent Events
On April 20, 2012, the Company announced that TW has indicated that it will not renew its existing contract for wholesale network connections provided by the Company. Accordingly, this contract will expire on December 31, 2012, which expiration will include a transition period into 2013. This contract represented 11.4% and 11.8% of the Company’s consolidated revenue for the three months ended March 31, 2011 and 2012, respectively. In addition, other unrelated telecommunications providers pay the Company access revenue for terminating calls through the Company to TW’s customers.
On April 20, 2012, the Company’s board of directors suspended dividends on the common stock portion of the Company’s Income Deposit Securities (“IDSs”). This dividend amounted to $0.705 per IDS for 2011 and $0.17625 per IDS for the first quarter of 2012.
| Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Overview
General
We operate eleven rural local exchange carriers (“RLECs”) serving subscribers in north central Alabama, central Maine, western Massachusetts, central Missouri, western Vermont and southern West Virginia. We are the sole wireline telephone services provider for many of the rural communities we serve. We also operate a competitive local exchange carrier (“CLEC”) 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 and satellite 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, 2012, we operated approximately 101,885 access line equivalents and supplied an additional 159,560 wholesale network connections, primarily to Time Warner Cable (“TW”). Our acquisition of all of the issued and outstanding capital stock of Shoreham Telephone Company, Inc. (“STC”), a privately-held integrated telecommunications services provider serving customers in western Vermont, on October 14, 2011 added approximately 5,100 access line equivalents on that date.
Our core businesses are local and long distance telecommunications services, wholesale access to the local and long distance network and network access to other wireline, long distance and wireless carriers for calls originated or terminated on our network. Our core businesses generated approximately 76.7% of our total revenues in the first quarter of 2012. 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 are derived from five sources:
| | ● | Local services. We receive revenues from providing local exchange telecommunications services in our eleven 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, Vermont 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”), the Vermont Public Service Board 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 the majority of our telephone service territory in Alabama, including Internet Protocol television (“IPTV”) and Video on Demand (“VOD”). We are a reseller of satellite services for DirecTV in Missouri. |
| | ● | 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 New England. |
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(2) | | | | | | | | | | | | |
| (unaudited) | | | | | | | | | | | Quarterly | |
| | | | | | | | | % Change | |
| | | December 31, | | | March 31, | | | from December | |
| | | 2010 | | | 2011 | | | 2012 | | | 31, 2011 | |
Otelco access line equivalents(1) | | | 99,639 | | | | 102,378 | | | | 101,885 | | | | (0.5 | )% |
| | | | | | | | | | | | | | | | | |
| RLEC and other services: | | | | | | | | | | | | | | | | |
| Voice access lines | | | 45,461 | | | | 46,202 | | | | 45,200 | | | | (2.2 | )% |
| Data access lines | | | 20,852 | | | | 22,904 | | | | 23,105 | | | | 0.9 | % |
Access line equivalents(1) | | | 66,313 | | | | 69,106 | | | | 68,305 | | | | (1.2 | )% |
| Cable television customers | | | 4,227 | | | | 4,201 | | | | 4,216 | | | | 0.4 | % |
| Satellite television customers | | | 125 | | | | 226 | | | | 229 | | | | 1.3 | % |
| Additional internet customers | | | 6,975 | | | | 5,414 | | | | 5,159 | | | | (4.7 | )% |
| RLEC dial-up | | | 393 | | | | 301 | | | | 273 | | | | (9.3 | )% |
| Other dial-up | | | 4,300 | | | | 2,797 | | | | 2,501 | | | | (10.6 | )% |
| Other data lines | | | 2,282 | | | | 2,316 | | | | 2,385 | | | | 3.0 | % |
| | | | | | | | | | | | | | | | | |
| CLEC: | | | | | | | | | | | | | | | | |
| Voice access lines | | | 29,944 | | | | 30,189 | | | | 30,476 | | | | 1.0 | % |
| Data access lines | | | 3,382 | | | | 3,082 | | | | 3,104 | | | | 0.7 | % |
Access line equivalents(1) | | | 33,326 | | | | 33,271 | | | | 33,580 | | | | 0.9 | % |
| Wholesale network connections | | | 149,043 | | | | 157,144 | | | | 159,560 | | | | 1.5 | % |
| | | For the Three Months | |
| | | Ended March 31, | |
| | | 2011 | | | 2012 | |
| Total revenues (in millions): | | $ | 25.4 | | | $ | 25.4 | |
| RLEC | | $ | 14.2 | | | $ | 14.2 | |
| CLEC | | $ | 11.2 | | | $ | 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). |
| (2) | We acquired Shoreham Telephone Company, Inc. on October 14, 2011. At December 31, 2011, Shoreham had 3,309 voice access lines and 1,672 data access lines, or 4,981 access line equivalents, and 55 dial-up internet customers which are included in the Key Operating Statistics. |
In our RLEC territories, access line equivalents decreased by 801 during first quarter 2012, or 1.2%, compared to December 31, 2011. Voice access lines declined 2.2% while data access lines increased by 0.9% during the period. We offer location specific bundled service packages, many including unlimited domestic calling, tailored to the telecommunications requirements of our customers and priced competitively.
In our Maine and New Hampshire CLEC operations, access line equivalents increased by 309 during first quarter 2012, or 0.9%, compared to December 31, 2011. Voice access lines increased 1.0% and data access lines increased 0.7% during the period. This increase is primarily driven by installations of our new hosted private branch exchange (“PBX”) product. Virtually all of our competitive customers are businesses, with service bundles tailored to their specific business requirements.
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 increased 0.4% from December 31, 2011 to 4,216 as of March 31, 2012. We upgraded 23 customers to our digital offerings and added 31 new IPTV customers during the same period. Our other internet customers decreased 4.7% to 5,159 as of March 31, 2012 compared to December 31, 2011. 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 46% 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 six 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 Telephone LLC and Pine Tree Telephone LLC, 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; selling, general and administrative expenses; and depreciation and amortization.
Cost of services. 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, | |
| | | 2011 | | | 2012 | |
| Revenues | | | | | | |
| Local services | | | 47.2 | % | | | 45.9 | % |
| Network access | | | 31.0 | | | | 30.8 | |
| Cable television | | | 3.0 | | | | 3.2 | |
| Internet | | | 13.6 | | | | 14.7 | |
| Transport services | | | 5.2 | | | | 5.4 | |
| Total revenues | | | 100.0 | % | | | 100.0 | % |
| Operating expenses | | | | | | | | |
| Cost of services | | | 43.4 | % | | | 43.5 | % |
| Selling, general and administrative expenses | | | 13.1 | | | | 12.6 | |
| Depreciation and amortization | | | 22.5 | | | | 17.8 | |
| Total operating expenses | | | 79.0 | | | | 73.9 | |
| | | | | | | | | |
| Income from operations | | | 21.0 | | | | 26.1 | |
| | | | | | | | | |
| Other income (expense) | | | | | | | | |
| Interest expense | | | (24.3 | ) | | | (23.0 | ) |
| Change in fair value of derivatives | | | 2.0 | | | | 0.9 | |
| Other income | | | 1.3 | | | | 1.3 | |
| Total other expense | | | (21.0 | ) | | | (20.8 | ) |
| | | | | | | | | |
| Income before income tax | | | 0.0 | | | | 5.3 | |
| | | | | | | | | |
| Income tax expense | | | (0.0 | ) | | | (2.1 | ) |
| | | | | | | | | |
| Net income available to common stockholders | | | 0.0 | % | | | 3.2 | % |
Total revenues. Total revenues of $25.4 million in the three months ended March 31, 2012 were nominally lower than revenues for the three months ended March 31, 2011. The table below provides the components of our revenues for the three months ended March 31, 2012 compared to the same period of 2011.
| | | Three Months Ended March 31, | | Change | |
| | | 2011 | | | 2012 | | | Amount | | | Percent | |
| | | (dollars in thousands) | |
| Local services | | $ | 12,006 | | | $ | 11,653 | | | $ | (353 | ) | | | (2.9 | )% |
| Network access | | | 7,861 | | | | 7,814 | | | | (47 | ) | | | (0.6 | ) |
| Cable television | | | 752 | | | | 805 | | | | 53 | | | | 7.0 | |
| Internet | | | 3,456 | | | | 3,726 | | | | 270 | | | | 7.8 | |
| Transport services | | | 1,317 | | | | 1,376 | | | | 59 | | | | 4.5 | |
| Total | | $ | 25,392 | | | $ | 25,374 | | | $ | (18 | ) | | | (0.1 | ) |
Local services. Local services revenue decreased 2.9% in the three months ended March 31, 2012 to $11.7 million from $12.0 million in the three months ended March 31, 2011. The acquisition of STC added $0.2 million, which was offset by lower RLEC basic services revenue of $0.3 million and lower long distance revenue of $0.3 million.
Network access. Network access revenue decreased 0.6% in the three months ended March 31, 2012 to $7.8 million from $7.9 million in the three months ended March 31, 2011. The acquisition of STC added $0.4 million, which was offset by lower access revenue related to RLEC subscriber usage and lower National Exchange Carrier Association (“NECA”) settlements of $0.5 million.
Cable television. Cable television revenue in the three months ended March 31, 2012 increased 7.0% to $0.8 million compared to just under $0.8 million in the same period in 2011. Growth in digital family packages and IPTV of $0.1 million was partially offset by a decrease in basic cable services and satellite television installation revenue of less than $0.1 million.
Internet. Internet revenue for the three months ended March 31, 2012 increased 7.8% to $3.7 million from $3.5 million in the three months ended March 31, 2011. The acquisition of STC accounted for the growth, while the loss of dial-up subscribers was offset by growth in fiber backhaul circuits and RLEC data lines.
Transport services. Transport services revenue increased 4.5% to $1.4 million in the three months ended March 31, 2012 from $1.3 million for the three months ended March 31, 2011. The increase was associated with additional wholesale transport services.
Operating expenses. Operating expenses in the three months ended March 31, 2012 decreased 6.5% to $18.8 million from $20.1 million in the three months ended March 31, 2011. The table below provides the components of our operating expenses for the three months ended March 31, 2012 compared to the same period of 2011.
| | | Three Months Ended March 31, | | | Change | |
| | | 2011 | | | 2012 | | | Amount | | | Percent | |
| | | (dollars in thousands) | |
| Cost of services | | $ | 11,020 | | | $ | 11,029 | | | $ | 9 | | | | 0.1 | % |
| Selling, general and administrative expenses | | | 3,327 | | | | 3,206 | | | | (121 | ) | | | (3.6 | ) |
| Depreciation and amortization | | | 5,724 | | | | 4,523 | | | | (1,201 | ) | | | (21.0 | ) |
| Total | | $ | 20,071 | | | $ | 18,758 | | | $ | (1,313 | ) | | | (6.5 | ) |
Cost of services. Cost of services was $11.1 million for the three months ended March 31, 2012 and March 31, 2011. Costs related to STC added $0.4 million and our hosted PBX product costs increased $0.2 million, reflecting our success with that product in the last year. These increases were offset by lower toll costs of $0.4 million and a one-time NECA adjustment in 2011 of $0.2 million.
Selling, general and administrative expenses. Selling, general and administrative expenses decreased 3.6% to $3.2 million in the three months ended March 31, 2012 from $3.3 million in the three months ended March 31, 2011. An increase associated with the STC acquisition of $0.1 million was more than offset by lower management expenses of $0.2 million.
Depreciation and amortization. Depreciation and amortization for the three months ended March 31, 2012 decreased 21.0% to $4.5 million from $5.7 million in the three months ended March 31, 2011. An increase associated with the acquisition of STC of $0.2 million and CLEC investment of $0.2 million was more than offset by a decrease of $0.3 million in the amortization of intangible assets associated with the acquisition of three entities from Country Road Communications LLC, including a covenant not to compete and contract and customer base intangible assets, and a decrease of $1.3 million reflecting lower depreciation expense of plant assets in our regulated properties.
| | | Three Months Ended | | | | | | | |
| | | March 31, | | | Change | |
| | | 2011 | | | 2012 | | | Amount | | | Percent | |
| | | (dollars in thousands) | |
| Interest expense | | $ | (6,170 | ) | | $ | (5,834 | ) | | $ | (336 | ) | | | (5.4 | )% |
| Change in fair value of derivatives | | | 506 | | | | 241 | | | | (265 | ) | | NM | |
| Other income | | | 349 | | | | 318 | | | | (31 | ) | | | (8.9 | ) |
| Income tax expense | | | (1 | ) | | | (524 | ) | | | (523 | ) | | NM | |
Interest expense. Interest expense decreased 5.4% to $5.8 million in the three months ended March 31, 2012 from $6.2 million in the three months ended March 31, 2011. The decrease in interest expense was primarily driven by the lower effective interest rate on the outstanding balance of our senior long-term notes payable upon expiration of our interest rate swaps on February 8, 2012.
Change in fair value of derivatives. As was required by our senior credit facility, we had two interest rate swap agreements intended to hedge our exposure to changes in interest rate costs associated with that facility. The swap agreements did not qualify for hedge accounting under the technical requirements of Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging (“ASC 815”). Changes in value for the two swaps are reflected in change in fair value of derivatives on the statements of operations and have no impact on cash. Over the life of the swaps, the change in value was zero, with no cumulative impact on net income, Adjusted EBITDA (as defined below) or operations. The value of the swaps increased $0.2 million in the three months ended March 31, 2012 compared to $0.5 million in the same period of 2011. The swaps expired on February 8, 2012, effectively lowering our interest rate beginning February 9, 2012 from approximately 2.0% to the current LIBOR rate, in each case plus a bank margin of 4.25%.
Income tax expense. Provision for income taxes was an expense of $0.5 million in the three months ended March 31, 2012. There was a nominal expense for the three months ended March 31, 2011.
Other income. Other income of $0.3 million in the three months ended March 31, 2012 was nominally lower than other income for the three months ended March 31, 2011, reflecting slightly lower CoBank dividends and interest income on invested cash.
Net income. As a result of the foregoing, there was net income of $0.8 million in the three months ended March 31, 2012 and a nominal net income in the three months ended March 31, 2011.
Liquidity and Capital Resources
Our liquidity needs arise primarily from: (i) interest payments related to our senior credit facility and our senior subordinated notes; (ii) capital expenditures; (iii) working capital requirements; and (iv) potential acquisitions. We suspended dividends on our common stock on April 20, 2012 in order to free up cash for other purposes.
Historically, we satisfy our operating cash requirements from the cash generated by our business and utilize borrowings under our senior credit facility to facilitate acquisitions; however, we financed our acquisition of STC using cash on hand. For the three months ended March 31, 2012, 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 Income Deposit Securities (“IDSs”) and fund a dividend (as declared by our board of directors) on the shares of common stock that are inherent in our IDSs, which was paid on March 30, 2012. After meeting all of these needs of our business, cash increased from $12.4 million at December 31, 2011 to $16.0 million at March 31, 2012.
Cash flows from operating activities for the first three months of 2012 amounted to $7.3 million compared to $5.4 million for the first three months of 2011. Net income, when adjusted for its non-cash components, declined by $0.1 million. The changes in operating assets and liabilities of $1.9 million reflect a reduction of one month’s accrued liability for interest on our senior debt associated with electing one month LIBOR contracts in 2012 versus three month LIBOR contracts in 2011 and an additional month’s receivable on the TW contract in 2011.
Cash flows used in investing activities for the first three months of 2012 were $1.3 million compared to $2.8 million in the first three months of 2011. The lower rate of capital expenditures for property and equipment in the first three months of 2012 accounted for the difference.
Cash flows used in financing activities for the first three months of 2012 and 2011 were $2.3 million, reflecting payments of dividends to stockholders in both periods. The dividend was $0.17625 per common share per quarter in both periods.
We do not invest in financial instruments as part of our business strategy. The Company had two interest rate swaps that expired on February 8, 2012. From an accounting perspective, the documentation for the swaps did not meet the technical requirements of ASC 815 to allow the swaps to be considered highly effective as hedging instruments and therefore the swaps did 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 $1.5 million, or approximately 55% of their issued value.
We anticipate that operating cash flow, together with borrowings under our senior 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, | |
| | | 2011 | | | 2012 | |
| | | (dollars in thousands) | |
| Cash generation | | | | | | |
| Revenues | | $ | 25,392 | | | $ | 25,374 | |
| Other income | | | 349 | | | | 318 | |
| Cash received from operations | | | 25,741 | | | | 25,692 | |
| Cost of services and products | | | 11,020 | | | | 11,029 | |
| Selling, general and administrative expenses | | | 3,327 | | | | 3,206 | |
| Cash consumed by operations | | | 14,347 | | | | 14,235 | |
| Cash generated from operations | | $ | 11,394 | | | $ | 11,457 | |
| | | | | | | | | |
| Cash utilization | | | | | | | | |
| Capital investment in operations | | $ | 2,843 | | | $ | 1,303 | |
| Senior debt interest and fees | | | 2,369 | | | | 1,993 | |
| Interest on senior subordinated notes | | | 3,499 | | | | 3,499 | |
| Dividends | | | 2,330 | | | | 2,330 | |
| Cash utilized by the Company | | $ | 11,041 | | | $ | 9,125 | |
| | | | | | | | | |
| Percentage cash utilized of cash generated | | | 96.9 | % | | | 79.6 | % |
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. 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 (“U.S. 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 or any other performance measures derived in accordance with U.S. 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, 2011 and 2012, and its reconciliation to net income, is reflected in the table below:
| | | Three Months Ended March 31, | |
| | | 2011 | | | 2012 | |
| Net income | | $ | 5 | | | $ | 818 | |
| Add: Depreciation | | | 3,523 | | | | 2,729 | |
| Interest expense - net of premium | | | 5,828 | | | | 5,491 | |
| Interest expense - amortize loan cost | | | 342 | | | | 342 | |
| Income tax expense | | | 1 | | | | 524 | |
| Change in fair value of derivatives | | | (506 | ) | | | (241 | ) |
| Loan fees | | | 19 | | | | 19 | |
| Amortization - intangibles | | | 2,201 | | | | 1,794 | |
| Adjusted EBITDA | | $ | 11,413 | | | $ | 11,476 | |
Recent Accounting Pronouncements
During 2011, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2011-01 through 2011-12. Except for ASU 2011-04, ASU 2011-05, ASU 2011-08, and ASU 2011-09, which are discussed below, these ASUs provide technical corrections to existing guidance related to specialized industries or entities and therefore, have minimal, if any, impact on the Company.
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), an update to ASC 820, Fair Value Measurements and Disclosures. ASU 2011-04 provides guidance to change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For public entities, ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and is to be applied prospectively. As ASU 2011-04 impacts presentation only, the adoption of this update did not impact our consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”) an update to ASC 220, Comprehensive Income. This ASU requires the components of net income and the components of other comprehensive income to be presented either in a single continuous statement of comprehensive income or in two separate but continuous statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. This guidance does not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income or how earnings per share is calculated or presented. ASU 2011-05 is effective for public entities for interim and annual periods beginning after December 15, 2011. As ASU 2011-05 impacts presentation only, the adoption of this update did not impact our consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment (“ASU 2011-08”), an update to ASC 350, Intangibles – Goodwill and Other (“ASC 350”). This ASU provides an entity with the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test in accordance with ASC 350. ASU 2011-08 is effective for annual and interim goodwill impairment tests for fiscal years beginning after December 15, 2011. As ASU 2011-08 impacts testing procedures only, the adoption of this update did not impact our consolidated financial statements.
In September 2011, the FASB issued ASU 2011-09, Disclosures about an Employer’s Participation in a Multiemployer Plan (“ASU 2011-09”), an update to ASC 715, Compensation – Retirement Benefits, subtopic 80, Multiemployer Plans. ASU 2011-09 requires additional disclosures for multiemployer pension plans and multiemployer other postretirement benefit plans. ASU 2011-09 is intended to create greater transparency in financial reporting by disclosing the commitments an employer has made to a multiemployer pension plan and the potential future cash flow implications of an employer’s participation in the plan. ASU 2011-09 is effective for public entities for annual periods with fiscal years ending after December 15, 2011. As ASU 2011-09 impacts disclosure only, the adoption of this update did not impact our consolidated financial statements.
Subsequent Events
On April 20, 2012, we announced that TW has indicated that it will not renew its existing contract for wholesale network connections provided by the Company. Accordingly, this contract will expire on December 31, 2012, which expiration will include a transition period into 2013. Revenue received directly from TW represented approximately 11.4% and 11.8% of our consolidated revenue for the three months ended March 31, 2011 and 2012, respectively. Additionally, other unrelated telecommunications providers pay us access revenue for terminating calls through us to TW’s customers, representing approximately 3% to 4% of our consolidated revenue for the three months ended March 31, 2011 and 2012.
On April 20, 2012, our board of directors suspended dividends on the common stock portion of our IDSs. This dividend amounted to $0.705 per IDS for 2011 and $0.17625 per IDS for the first quarter of 2012.
| 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 expired on February 8, 2012. 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 that expires on October 31, 2013. The interest rate is variable and, accordingly, we are exposed to interest rate risk, primarily from a 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 the Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2012.
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, 2012 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 7, 2012 | 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, 2012 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 |
