Otelco Inc
Q4 2018 Earnings Call Transcript

Published: 5 Mar 2019

[Operator:]

Good day, and welcome to the Otelco's Fourth Quarter 2018 Earnings Conference Call. 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, Shelby. And welcome to this Otelco conference call to review the company's results for the fourth quarter and year-ended December 30, 2018. Conducting the call today will be Rob Souza, President and Chief Executive Officer; Curtis Garner, Chief Financial Officer; and Richard Clark, Chief Operating 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 believe, 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. Good morning. And welcome to our fourth quarter 2018 investor call. Richard Clark, Otelco's new Chief Operating Officer, is joining today to discuss the fourth quarter's performance and other key issues affecting our business. Richard was previously Executive Vice President and Chief Financial Officer of TVC Albany Incorporated, headquartered in Albany, New York and doing business as first like fiber. We have worked with Richard in recent years in his role as both the supplier and competitor, and he brings a wealth of very business experience as well as knowledge of our industry to Otelco. Initially, Richard focused his attention on plans and network operations and is now expanding his influence to include marketing, sales, billing and regulatory functions. After Richard and I provide an operations update, Curtis will review our financial results and after that, we'll take your questions. Our results for the fourth quarter continue to reflect trends in our industry as traditional access revenues and residential RLEC customers continue to decline, while residential data customers and business poised and data customers have been more stable. Total revenue for the fourth quarter was $16.2 million, down 3.5% compared with $16.8 million in the same quarter in 2017. For the year, total revenue was $66.1 million, also representing 3.5% decline over 2017. We expect this trend will continue and maybe further influenced by competition in our RLEC properties coupled with the availability of alternative telecommunication products, such as cellular and IP services. However, the increase in data speeds and our fiber-fed customer base partially offsets the loss of residential voice services. Operating income for the fourth quarter was down 11.4% to $4 million. For 2018, operating income was $17.8 million compared with $19.6 million last year, a 9.2% decline. Net income was $2.1 million in the fourth quarter 2018 compared to $7.4 million in the fourth quarter 2017. The impact of the Tax Cuts and Jobs Act and the new credit agreement with CoBank in fourth quarter of 2017 limits the comparability of net income. The Tax Act positive affected our taxes in 2017, as well as future tax years and was reflected in an income tax benefit, significantly raising net income for the fourth quarter of 2017 and for the year. Cash was $4.7 million at the end of fourth quarter, an increase of $1.1 million compared with our cash position at year-end 2017 of $3.6 million. Curtis will provide additional balance sheet information when he gets to his comments. As discussed over the past year, in 2017. Otelco began receiving the SEC's ACAM payments in the five states where the program is applicable and will continue to receive funding through 2026. The program funding is being used to enhance and build out our broadband network to provide increased broadband speeds and accessibility to customers. Richard will now provide a summary of our fiber build-out for 2018 and our plans for 2019.

[Richard Clark:]

Thanks Rob. I'm delighted to have join Otelco, and it's great to be with you on this call today. Otelco invested $8 million in 2018 to grow its fiber distribution network and improve its support systems, including $2.3 million invested during the fourth quarter of 2018. Fiber to the premise will be the primary vehicle to increase data capacity for Otelco's customers with fiber to the node and fixed wireless options being employed to more sparsely populated areas. In 2018, we added 135 miles of fiber in our service territory, an increase of 12% from 2017. And we now passed approximately 7,250 discrete locations with fiber. During 2019, we plan to increase our investment in the business by 12% to $9 million, which is expected to expand the reach of our broadband network. In addition, we are evaluating the revised ACAM program, which includes approximately $440,000 per year in additional funding and extends the program through 2028, representing two additional years of funding. Our valuation of the new ACAM offer centers on reviewing the impact of additional locations requiring 25-3 broadband services to our capital program. Reducing customers churn and stabilizing end-user revenues continues to be our focus. And we are targeted in our approach in offering fiber based light wave services to every location we pass with each mile of new fiber. Of the 7,250 locations already passed with fiber, we have approximately 1,950 customers subscribing to our light weight products. This represents a penetration rate of 27%, which we believe leaves room for growth in fiber-based services to both existing and new customers.

[Rob Souza:]

Thanks, Richard. Over the last several quarters, we have talked about our involvement in the FCC's Connect America Fund phase two processes. We were awarded support payments over the next 10 years of just over $0.9 million to improve service in three census blocks in Western Massachusetts. Our partner in serving the four communities expects to sign the final documents with the town will serve this Thursday, and begin the required build-out, which will offer services to some 1,000 locations. We are working with the FCC staff on the final details associated with initiating receipt of funds from the CAF II program. Our previous work with the town of Leverett Massachusetts demonstrates how municipal partnerships can work to improve community’s digital access. Other towns in New England are exploring fiber and fixed wireless options for their communities based on successful solutions like the one in Leverett, and we continue to be engaged in those activities. These public-private partnerships are another way Otelco can participate in the continued focus of bringing broadband services to rural areas. Consolidating and streamlining the business operations has been a strategic focus of our business. As we shared on previous calls, after an extensive multiyear period of planning and customizing the system, Otelco completed the conversion of three billing systems into a single new billing and operational support system. All carrier and end-user activity from ordering, to provisioning, to billing and collecting is being handled in the new system. The next step is to update and integrates all of our service area mass into the system to enhance the capabilities of our service delivery teams for improved installation intervals and the provisioning of new services to existing and new customers. We are pleased with our progress in 2018 as our employees have worked hard to execute on a number of initiatives for both our customers and shareholders. Looking to 2019, we will continue to focus on enhancing the customer experience, improving data speeds and adding new customers to our family of companies. We believe an improvement in our revenue performance and the continued focus on cost management will benefit both our employees and customers and deliver value to our shareholders. We’re confident in steps we've taken in 2018 and will continue to take provide a solid foundation to build on. Curtis will now summarize the fourth quarter results.

[Curtis Garner:]

Thanks Rob and Richard. We appreciate everybody joining us today. Rob and Richard mentioned and discussed several of the important parameters that we use from results standpoint. I will add a few more factoids to that and then we can take your questions. Last quarter, we added an investor presentation to our Web site, which combines our history of the company, our recent financial and stock performance over the last several year periods and summarizes several strategic directions we are pursuing. Last night, we updated the information for fourth quarter results, and it's in the investors section of our Web site. Let's do a brief overview of fourth quarter financial results and the key things that are most relevant to share owners. Unless I otherwise note, all the comparisons are for the same period last year, either quarter-over-quarter or year-over-year. As Rob mentioned, total revenues for the fourth quarter were $16.2 million, down 3.5% from last year's fourth quarter. If you look at the components, local services revenue was $5.4 million, a decrease of 2.9% over the prior-year period. The decline in RLEC residential voice customers lower long distance and directory revenue and the impact of the FCC's 2011 order, which reduced or eliminated intrastate and local cellular revenue, were primarily accountable for the decrease. Network access revenue decreased 3% over last year to $5.2 million. CAF and ACAM transition support payments, which decline each year, lower end-user related fees and special access accounted for the decrease. Internet revenue decreased 4.9% to $3.7 million, primarily due to a small decline in customers due to competition, which was only partially offset by an increase in broadband speed requirements from our customers. As our fiber delivery grows and penetration increases, we should see the benefit in Internet revenue. Transport services revenue increased 2.4% over the fourth quarter last year, reflecting a small increase in Wide Area Network services. Video and security revenue decreased 7.2%, reflecting increases in IPTV and basic cable revenue, offset by declines in digital cable and pay-per-view revenue. And finally, cloud hosting and managed services revenue decreased 27.8% over the fourth quarter of last year, primarily reflecting lower professional services required by our customers. As we move onto operating expenses for fourth quarter, total operating expenses were down slightly, about 26% over the prior year. Cost of services decreased 4.5%, reflecting decreased operating and network expenses over a number of cost categories. SG&A was up 12% to $2.8 million from $2.5 million last year. The increase was primarily due to the transition from our SVP of operations retiring and Richard coming on board as Chief Operating Officer. There was also a high level of uncollectable expense related primarily to CLEC customer. These increases were partially offset by reductions in other G&A expenses. Depreciation and amortization was basically unchanged for the same period a year ago at $1.8 million. Interest expense for the fourth quarter was $1.5 million compared to 5.5% a year ago. Last year included the recognition of $3.8 million balance of our loan cost from the former credit agreement, which had to be written off with the new CoBank agreement. Lower bank margin rates and lower principal balance accounted for the decrease, which was partially offset by higher LIBOR rates. Income tax expense, as was mentioned earlier, The Tax Cuts and Jobs Acts implemented at the end of 2017 increased our bonus depreciation from 50% to 100%, and reduced the maximum federal tax levels from 35% to 21%. We benefit from both of those changes. In the fourth quarter, the provision for taxes was $0.3 million. Consolidated EBITDA was $6 million compared to $6.5 million in the fourth quarter a year ago. Looking at the balance sheet, as Rob noted, we ended the fourth quarter with $4.7 million in cash compared to $3.6 million at the end of 2017. During fourth quarter, we reduced the outstanding principle on our credit facility by $2.1 million, including the $1 million voluntary prepayment. Otelco made more than $11.4 million in scheduled and voluntary payments on its debt held by CoBank. The remaining balance on the loan at the end of 2018 was $74.6 million, excluding loan origination cost, which was down 14.3% since the origination of the $87 million loan on November 2, 2017. At current interest rates, the payments made during 2018 will lower annual interest expense by just under $0.8 million. The interest rate on the loan reflects a reduction in the interest rate margin from 4.5% to 4.25%, which occurred when the company brought its leverage ratio below 3 turns at the end of third quarter. The leverage ratio as computed in our credit facility was 2.9 at the end of fourth quarter applying the cash on our balance sheet to create a net debt leverage ratio bringing the ratio down to 2.72. The lower margin will save the company approximately $2.2 million in interest expense on an annual basis. Capital expenditures were $2.2 million for fourth quarter, in line with our investment in the business in the third quarter, making the full year investment $8 million. As Richard noted, we expect to increase this investment in 2019 to $9 million. I think that covers the highlights for the quarter with additional details in the press release and details for the full year and our 10-K, which will be filed on Friday. The investor presentation on our Web site as noted earlier also has updated fourth quarter results. Shelby, if you provide directions, we can shift to taking questions from our investors at this time.

[Operator:]

[Operator Instructions] [Gene Riley], and he's a Private Investor.

[Unidentified Analyst:]

I just have two questions. How many locations are you required to pass for your ACAM obligations between now and 2026?

[Rob Souza:]

Approximately 13,000 locations, Mr. Riley.

[Unidentified Analyst:]

And then one more quick question. In the quarter three conference call, you mentioned that access line equivalent metric was no longer going to be reported. You're going to replace that with something else, and there was no mention of it in the press release?

[Rob Souza:]

Yes, what we're planning on doing is reporting revenue generating units. And I believe we will begin reporting those at the end of first quarter of this year.

[Unidentified Analyst:]

So, there won't be anything in the 10-K then?

[Rob Souza:]

There will be nothing in the 10-K, no.

[Unidentified Analyst:]

And then when you do start reporting those in the first quarter. Are you going to have some history behind that, show us what they would have been last year and the year before?

[Rob Souza:]

We're going to attempt to do that. Of course with the new billing system conversion, it makes it a little bit more difficult to get that year-over-year comparison. But we’re going to do our best to give a comparison for the investors.

[Unidentified Analyst:]

If they are going to be like an order of magnitude difference or it's just like a percentage difference between access line equivalents and new generating units?

[Rob Souza:]

Certainly, revenue generating units would probably relate more to a customer account as opposed to an access line count. And then I believe we anticipate looking at doing additional reporting maybe to the product level. Those are some of the things we're working on right now, Mr. Riley.

[Operator:]

Our next question comes from [Wally Walker], Private Investor.

[Unidentified Analyst:]

What is the estimated take rate that you have for the new wireless network in Massachusetts, how many customers do you expect to add there?

[Rob Souza:]

Generally speaking, Wally, those areas that we're serving are defiantly underserved by the incumbent carrier. As you know, the incumbent carrier did not take the CAF money that was offered to serve those locations, that’s the reason why the CAF II option even existed. So we would anticipate our take rate to be rather high based on the service level, especially of high speed data services in those areas.

[Unidentified Analyst:]

So I mean total number of customers, what is it about 1,000 did you see potential or whatever. What was the number?

[Rob Souza:]

It was potentially 1,000 customers. Historically, we could give you some take rates that we see in other areas. I would think we would be approaching probably somewhere in the neighborhood of 70%, possibly a little bit higher.

[Unidentified Analyst:]

And compared to the third quarter, the fourth quarter revenue was just down $0.1 million, but EBITDA decreased by $0.5 million. I would like to know what was the primary cause of that? And do you think we’re getting any closer to revenue and EBITDA stabilization?

[Rob Souza:]

To the first question, in the fourth quarter, we had a number of one-time items that certainly impacted EBITDA. I think Curtis referenced the retirement of our senior Vice President. There was some overlap between our SVP of Operations and Richard coming on board. We had some costs associated with that. There were additional expense items that hit the expense line relative to the billing and OSS conversion. So there are a number and varied items including one other item that I think that Curtis mentioned a little bit of it was due to the timing of some uncollectibles based on the billing and operational support conversion.

[Unidentified Analyst:]

And one final question, if I may. The company says it's evaluating the FCC's new offer of additional ATM funding. Now, I realized the FCC offer comes with specific build out requirements. But is this ACAM funding critical to Otelco's goal of a fiber rich network? I guess what I'm trying to say is I can’t really imagine a scenario where Otelco wouldn't accept this additional funding.

[Rob Souza:]

Sure, I don't think we would disagree with your statement, Wally. What I have asked Richard to do though is to analyze the total number of locations that have to reach 25-3. I think it's an increase of around 1,600 locations that have to have the 25-3 capacity. And what I'm asking to do is to see what it will take from a capital expenditure standpoint to reach those locations. I think the preliminary work that we've done indicates that we have a good opportunity to serve those locations with some of the plans that we already had in place. And it appears that the funding would be something that we would be willing to except. But until Richard comes back with his final answer on what it will take to reach those locations, we're just holding off on announcing that we're accepting the funding.

[Unidentified Analyst:]

But the deadline is March 27th, isn’t that?

[Rob Souza:]

It is, and I think Richard and his team are on top of that. And I would anticipate that probably the beginning or middle of next week, we'll have a much better idea of what that means to us. And we'll be able to make the decision well before the March 27th deadline.

[Operator:]

[Operator Instructions] We'll take our next question from [Ira Sochet], Private Investor.

[Unidentified Analyst:]

I know you do not give any guidance. However, we are in March of 2019 and you have your new billing system a pretty good idea of what your billings are going to be for the quarter. Can you give us a little bit of insight as to it's going to be flat -- it would just turn out the billings on revenue. Is it going to be flat with the fourth quarter, it is going to be down or is it going to be up?

[Rob Souza:]

Ira, that's a difficult one to answer. Based on the way we bill, we really only have January numbers in at this point in time. February's will be in the process of being processed. I don’t think those are completed until around March 10th. So it's pretty difficult to tell you how revenue is trending at this point.

[Operator:]

We'll now take our last question again [Gene Riley], Private Investor.

[Unidentified Analyst:]

You mentioned that you have 7,250 discrete locations so far. But just before you said that's the total that you need to cap this 13,000. So you can't really be half way done, right?

[Rob Souza:]

No. Remember Mr. Riley, when we build a piece of fiber, we are passing not only ACAM eligible locations. But to get to those locations, we often pass locations that were not included in the ACAM offer. So of the 7,250, only a portion of those are what we would refer to as ACAM census block locations.

[Unidentified Analyst:]

And what number would that be, would you know?

[Rob Souza:]

I think we're approaching somewhere in the neighborhood of 30% -- after two years, 20% of the 13,000, I think we're in the neighborhood of around 2,500 locations that are passed that are included in the ACAM census blocks.

[Unidentified Analyst:]

So out of the 7,250 are roughly 2,500 that are marked as ACAM eligible locations?

[Rob Souza:]

That is correct. And we have measurement requirements that by year four, we have to be 40% of those locations. And one of the other things that Richard Clark is analyzing is that with the new offer, it will extend funding two additional years, which we believe is a good thing. And it may even push out our reporting deadlines for some of those parameters. So those are all the moving pieces that Richard and his team are analyzing at this time.

[Unidentified Analyst:]

And then one more question. You mentioned again in the press release the new billing system is expected to reduce your expenses by about $700,000 a year. And I wanted to compare that to some past periods, what are we comparing it to? And also is there -- is some of that in cost of service and some of it in SG&A, or is that all in one of those buckets?

[Rob Souza:]

It would probably in both of those buckets. But one area, I think Curtis highlighted cost of services. There is number of the things that go into cost of services. And if you saw on a year-over-year basis, I think they declined close to $800,000. A portion of that are some of the savings that we have already realized from implementing the new billing system.

[Unidentified Analyst:]

So going forward, if I were to say just look at taking out these onetime items from SG&A and then adding into the cost of service, how much would I expect that to fall next year? I know it's going to be less than 700…

[Rob Souza:]

Yes, we've realized I would say the majority of the $700,000 to $750,000 expense savings that we anticipated from converting to the billing and operational support system. So there will be some additional savings, but it's not going to be a lion share, it's a much smaller piece of the $700,000.

[Unidentified Analyst:]

So quarter four is going to be closer than FY'18 minus $700,000?

[Rob Souza:]

I'm sorry I didn't catch the front end of what you're all saying, it broke up a little bit.

[Unidentified Analyst:]

So most of the savings are represented in the quarter four numbers…

[Rob Souza:]

Yes.

[Unidentified Analyst:]

Okay, thank you.

[Curtis Garner:]

If you're modeling the company's performance, that's correct as long as you take out the onetime impacts as Rob was talking, the change is for info…

[Operator:]

We have no more questions in the queue at this time. I would now like to turn the call back over to Mr. Souza for closing remarks.

[Rob Souza:]

Thanks again. We really appreciate you joining us on the call this morning. As we've mentioned in our discussion this morning, we continue to focus on managing the business in tandem with some of those significant changes that continue to happen in our industry. We're always looking for additional growth opportunities in the current marketplace. And as always, we are dedicated to delivering greater value for our shareholders. Thanks again for being with us this morning.

[Operator:]

This concludes today's. Thank you for your participation. You may now disconnect.