Otelco Inc
Q1 2018 Earnings Call Transcript

Published: 11 May 2018

[Operator:]

Good day and welcome to the Otelco’s First Quarter 2018 Conference. Today’s conference is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Ms. Drew Anderson. Please go ahead ma’am.

[Drew Anderson:]

Thank you, Tiffany and welcome to the Otelco conference call to review the company’s results for the first quarter ended March 31, 2018. Conducting the call today will be Rob Souza, President and Chief Executive Officer, and Curtis Garner, Chief Financial Officer. Before we start, let me offer the cautionary note that statements made during this call that are not statements of historical or current fact constitute forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other unknown factors that could have caused the actual results of the company to be materially different from the historical results or from any future results expressed or implied by such forward looking statements. In addition to statements which explicitly describe such risks and uncertainties, readers are urged to consider statements labeled with the terms believes, belief, expects, intends, anticipates, plans, or similar terms to be uncertain and forward-looking. The forward-looking statements contained herein are also subject generally to other risks and uncertainties that are described from time to time in the company’s filings with the Securities and Exchange Commission. With that stated, I will now turn the call over to Rob Souza. Please go ahead.

[Rob Souza:]

Thank you, Drew and good morning and welcome to our rescheduled first quarter 2018 investor call. We made a last-minute change at the request of several of our investors to move up the earnings release and conference call to provide the most current financial performance information before tomorrow’s annual stockholders meeting in New York. I will discuss the first quarter’s operational performance and other key issues affecting our business. Curtis will then review our financial results and we will take your questions. Our results for the first quarter continue to reflect trends in our industry, as traditional access revenues and residential RLEC customers continue to decline, while cost of service delivery is seeing the impact of inflation in a tightening job market. Total revenue was $16.7 million, down 3.8% over last year and our operating income was $4 million, a 19% decline for the same period last year. As we noted on our last call, we paid out a special bonus to our employees in the first quarter and this, along with several other one-time and project expenses accounted for almost half of the decline in operating income. We have implemented price increases and fee changes to help support our operating margins. Additionally, we continue to identify other cost efficiencies and at the same time look for ways to improve the customer experience and expand the reach of our fiber network. Net income, however, increased from $1.6 million in the first quarter 2017 to $2 million for the first quarter 2018, driven by reductions in interest expense and reduced provision for federal corporate income taxes reflecting lower rates included in the Tax Cut and Jobs Act. Cash interest expense decreased by $1 million given the lower rates in our new CoBank credit agreement. Cash increased by $2.7 million during the first quarter to $6.3 million. We will use some of this cash during the second quarter to make a voluntary payment to further reduce our long-term debt. As discussed over the past year, Otelco began receiving the FCC’s A-CAM payments in the five states where the program is applicable to the company. The program funding is being used to enhance and build out our broadband network to provide increased broadband speeds and accessibility to customers over the next 10 years. As an update on the program, in April the FCC announced that another $500 million would be included in the Connect America Fund. The additional funding is expected to be apportioned companies already receiving A-CAM and legacy support. Once finalized by the FCC, the additional funding will increase Otelco’s overall support with some of the funding being paid retroactively for 2017. We also believe the additional A-CAM support offer will include a small amount of additional broadband build-out requirements for targeted broadband speeds and covered locations. Otelco will recognize this additional revenue as it is received and adjust its build-out program for the marginal increase in speed for locations already included in the original program. Consolidating and streamlining the business operations remains a strategic focus of our business. As announced earlier last year, we selected a partner to consolidate all of our billing and operational systems on one platform. After nearly 18 months of planning, development and training, we are prepared to convert all of our operational and billing systems onto a single platform during the second quarter. The process has been designed to have minimal impact on serving our customers. However, there are planned periods where we will have a delay – have to delay new customer orders, while the data from the old systems is rolled over to the new system. Our employees have worked very hard to get to this conversion point and are excited to be updating to the new technology. We look forward to the operational benefits it will provide our customers, as well as the favorable financial impact we should see from a more efficient system. As we noted last quarter, with the move to a company-wide operational system, we are now branding all of our services as Otelco. In New England, OTT Communications has become Otelco. The new logo with the tagline

[Curtis Garner:]

Thank you, Rob. We appreciate everybody joining us today and accommodating the changed announcement schedule. I’ll provide a brief overview of our first quarter financial highlights as contained in the press release. Unless noted otherwise, every comparison is against the same period last year, first quarter to first quarter. We expect to file our Form 10-Q on Friday, which will have additional details supporting our results. Total revenue for the first quarter was $16.7 million, down 3.8% from last year’s first quarter. The decrease was primarily due to the decrease in traditional access revenue, affected by the FCC’s intercarrier compensation reform order and the decline in residential RLEC access line equivalents. If we look at the components, local services revenue was $5.5 million, a decrease of 2% over the prior period. The decline in RLEC residential access lines and the impact of the FCC’s order, which reduced or eliminated intrastate and local cellular revenue accounted for a decrease of $0.2 million. A portion of this RLEC decrease is recovered through CAF, which is categorized as interstate access revenue. Wholesale services provided to a municipality in Massachusetts provided an increase of $0.1 million. Network access revenue decreased 8.4% over last year to $5.2 million, a $0.2 million decrease in switched and special access, a $0.2 million decrease in end user based fees and a $0.1 million decrease in the CAF and transition payments funding accounts for that decline. Internet revenue was unchanged at $3.9 million, increased speeds and additional data customers in a municipality in Massachusetts were offset by the reduction in residential RLEC customers. Transport services revenue increased 3.7% over first quarter last year, reflecting small increases in both wide area network and wholesale transport services. Video and security revenue was $0.7 million, which was a 3.3% decline, which reflected increases in IPTV, offset by decreases in basic cable and pay-per-view revenue. Managed services revenue decreased 28.5% over the first quarter of last year, which included some one-time revenue from which there was no comparable revenue in 2018. Moving on to operating expenses for the first quarter, total operating expenses were up 2.5% over the prior year. The details are broken down by the following

[Operator:]

[Operator Instructions] We’ll go first to Wally Walker.

[Wally Walker:]

Hey, good morning Rob, Curtis.

[Rob Souza:]

Good morning Wally.

[Curtis Garner:]

Hey Wally.

[Wally Walker:]

I got on the call late. Did I hear correctly that Otelco did elect to participate in the Connect America Phase II reverse auction?

[Rob Souza:]

We have applied for eligibility Wally. We had to have that in the end of March. The FCC has not given an indication as to whether our application was accepted. I don’t believe there are any problems with it, but we’re still waiting to hear from the FCC if we are eligible.

[Wally Walker:]

Yes, that’s nice to hear. Also it’s encouraging that the FCC added another $500 million to the Connect America Fund now. Since Otelco receives both A-CAM and legacy support, could you give a rough estimate, how much total revenue Otelco lost last year due to the FCC’s budget shortfall? I’m looking at some stuff here that seems to me it appears that the FCC has revised A-CAM offer just for Otelco’s Missouri operation was about $700,000 lower per year than its original offer, is that in the ballpark?

[Rob Souza:]

I believe that was the amount that was projected for the reduction or the actual reduction last year. We don’t anticipate receiving 100% of that amount Wally. The $500 million fund obviously is being spread amongst all A-CAM recipients, and it’s being used to reduce the legacy support haircut that was given starting in July of last year and actually will culminate at June 30 this year. So we don’t expect to recover 100% of that funding. I believe the FCC was going to be coming out with their decision and providing A-CAM offers to the companies, because we certainly have to review that and then accept the offer and we anticipate having that information soon. But at this point, I am not sure exactly what that will amount to for Otelco.

[Wally Walker:]

Thanks a lot. This has been helpful and we’ll see you tomorrow at the annual meeting.

[Rob Souza:]

We look forward to meeting you in person Wally. Thank you.

[Wally Walker:]

Have a good day!

[Rob Souza:]

You too.

[Operator:]

We’ll go next to Jean Riley.

[Unidentified Analyst:]

Hi there. You mentioned in the press release the training expenses for the new billing system were about $200,000 in quarter one. Is it going to be about the same level in quarter two?

[Curtis Garner:]

I would anticipate there will be additional training expenses in Q2. I’m not sure they will be quite that high, but I would think, thinking in that $200,000 range would be reasonable at this point in time.

[Unidentified Analyst:]

Okay. And then going forward, how much do you expect that would save expenses, you know on an annual basis?

[Curtis Garner:]

We are certainly looking at that and working on those numbers. We have not quantified those numbers from a public perspective at this point. We certainly do anticipate there would be savings throughout the company as a result of the efficiencies that we will see with the system and we will certainly keep investors updated as we convert to the new system.

[Unidentified Analyst:]

Okay, and the last question would be, you also mentioned in the press release that legal expenses were about $100,000 higher this year than last year. Is that a one-time thing?

[Curtis Garner:]

Part of it. Most of it is, although there may be a little bit that rolls over into the third quarter also.

[Unidentified Analyst:]

Okay. Are there any other one-time expenses that weren’t mentioned?

[Curtis Garner:]

I think those are the largest of the key items.

[Unidentified Analyst:]

Okay, thank you.

[Curtis Garner:]

You’re welcome. Thank you.

[Operator:]

[Operator Instructions] We’ll go next to Ira Socket.

[Ira Socket:]

Good morning.

[Rob Souza:]

Good morning Ira.

[Ira Socket:]

How are you? Okay, on your breakout you indicated that $600,000 was due to a bonus and other operating expenses. Can you break that out, how much was bonus and what were the other expenses, the one-time?

[Rob Souza:]

I don’t think we quantified the total amount from the standpoint of overall expense increases. Certainly the bonus for employees was one of the larger numbers that we had, including the other items that Curtis mentioned, including the billing and operational support system, not only the training of that system or training for that new system, but in addition to that, not a 100% of the cost of upgrading to the system can be capitalized, certain portions of it have to be expense. Those two items along with a couple of other minor items Ira really made up the majority of the expense increase in the first quarter.

[Ira Socket:]

Well that leads into the next question. How much of – under the new bonus depreciation and so on and so forth, how much of your anticipated CapEx or how much of your actual capital expenditures are going to be expensed as opposed to capitalized this year or what percentages?

[Rob Souza:]

What we did – the process of capitalizing expenses won’t change from 2017 to 2018, so anything that would have been capitalized in 2017 will again be capitalized in 2018. And we anticipate that we’ll – we had about $8.5 million in CapEx last year. It’ll probably be about the same this year. The only difference and it won’t be a big difference, because any CapEx spent after September, I think it was 17th of last year, qualified for the 100% bonus depreciation, which was not originally anticipated. This year all of the CapEx will qualify for the 100% bonus depreciation.

[Ira Socket:]

And where will that reflect? Will that show up as a higher depreciation number?

[Rob Souza:]

It will show up in the tax line.

[Ira Socket:]

It will show up as a lower tax rate?

[Rob Souza:]

Right. We’ll end up with lower cash taxes, because what would have originally been 50% going downwards to 10% bonus depreciation is now 100%. So what you’ll see is lower cash taxes and lower provision for income taxes. Cash taxes on the cash flow statement and the provision for taxes on the income statement.

[Ira Socket:]

In your release, and I may have read it wrong, but I thought it said $1 million tax refund in the first quarter, but in the actual number there was a tax in the first quarter not a refund.

[Rob Souza:]

In the income statement there was a tax, but at the bottom of the cash flow statement there was no cash taxes paid in the first quarter, other than those state taxes.

[Ira Socket:]

So it is a difference between book accounting and tax accounting?

[Rob Souza:]

Yes sir.

[Ira Socket:]

Then this is a question that you may not have to answer until tomorrow. Can you and your business plan and projections see any time this year that the decline in total customers and customer revenue would start – could break even or go positive?

[Rob Souza:]

I don’t think we’re prepared to provide that level of detail Ira. We certainly believe that as we continue to place more and more fiber, not only related to the A-CAM projects under the FCC plan, but other fiber that we place in the business, that we certainly will begin to see that impact overall numbers for the company. But at this point I don’t believe we’re prepared to provide any guidance as to when that number will flatten completely or turn.

[Ira Socket:]

Okay, then last question, are you going to have a Q&A session at the annual meeting tomorrow?

[Rob Souza:]

Our general practice is yes. We will go through the normal formalities of the shareholder meeting, and then when that concludes we’ll certainly open it up to shareholders to ask questions and we dialog with the shareholders after the meeting.

[Curtis Garner:]

And all of our board members will be attending at that meeting.

[Ira Socket:]

Okay, thank you.

[Rob Souza:]

Thank you, Ira.

[Operator:]

And we have no further questions at this time.

[Rob Souza:]

If there are no further questions, we certainly do appreciate everyone joining us this morning. We always remain focused on managing Otelco in tandem with the significant changes that have occurred and continue to occur in the telecommunications industry, and we continue to look for additional growth opportunities in the current marketplace. As always, we are dedicated to delivering greater value to our shareholders. We welcome your questions and we plan on keeping you informed regarding the developments in our business, and thanks again for joining us this morning.

[Operator:]

This will conclude today’s call. Thank you for your participation. You may now disconnect.