Otelco Inc
Q2 2017 Earnings Call Transcript

Published: 5 Aug 2017

[Operator:]

Good day, and welcome to Otelco’s Second Quarter 2017 Earnings Conference Call. Today’s conference is being recorded. At this time, for opening remarks and introductions, I like to turn the call over to Ms. Drew Anderson. Please go ahead.

[Drew Anderson:]

Thank you, John, and welcome to the Otelco conference call to review the company’s results for the second quarter ended June 30, 2017. 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 an impact on the company’s strategic review process or cause the actual results to 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. There can be no assurance regarding the outcome of any decisions that the company may make regarding strategic alternatives in connection with the strategic review process. 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, sir.

[Rob Souza:]

Thank you, Drew, and good morning, and welcome to our second quarter investor call. I’ll begin today’s call by providing the highlights of our results for the second quarter and Curtis will review our financial results, and then we will take any questions you may have. Our second quarter 2017 financial and operating results reflect the ongoing industry conditions affecting all telecommunications providers. As previously noted, during the first quarter, Otelco began receiving the FCC’s A-CAM payments in the 5 states where the program is applicable to the company. A-CAM provides a stable 10-year funding mechanism to continue the expansion of fiber-based broadband services in rural communities. Under the program, we will continue to expand the availability of higher broadband speeds and expect to make that investment throughout our network. We are currently, we currently have around 1,600 route miles of fiber serving our customers including fiber-to-the-home and fiber-to-the-node systems. Our A-CAM election includes specific deployment obligations, including the number of locations to be capable of specific broadband speeds within eligible census blocks in our service area. Our next milestone review for the period will be 4 years from now in 2020. Ten of our RLECs receive support payments through A-CAM, and one of our RLECs continues to receive support payments through modified legacy rate of return support mechanisms for USF high-cost loop and ICLS support. The new model-based support plus higher CAF funding provided an increase of over $4, $0.4 million in revenue for the second quarter of 2017 compared with the revenue it replaced in 2016, leading to an increase in operating income of $0.2 million. Net income for the second quarter of 2017 increased by $0.2 million. The decline in residential voice service was more than offset by the decrease in interest costs associated with the company’s credit agreements and the increase in A-CAM and CAF revenue. Consolidated EBITDA declined by less than the $0.1 million for the same period in 2016. On our first quarter call, I mentioned that our RLECs would’ve seen a normal year-over-year funding decrease under USF HCl, which now includes the FCC’s newly adopted budget control mechanism. We expected funding under the new A-CAM model-based support to increase 2017 revenues by an estimated $1.5 million compared to 2016 support, and to date, we are right on target to receive that $1.5 million increase. The first phase of A-CAM fiber-to-the-home projects in Missouri, Maine and Alabama totaling $2.4 million are underway with the completion of this work expected in the fourth quarter of 2017. The increase in revenue due to the A-CAM funding can be used to support the additional capital investments in our network above the levels of the last several years and we have amended our credit agreement to allow for this increased spending. As discussed on previous calls, we were awarded the contract in Leverett, Massachusetts to provide Internet and voice services to this community. On April 1, we successfully connected over 1,000 voice and data access lines in accordance with this multiyear contract. Importantly, we have also entered discussions with several communities in Massachusetts on potential future projects. We continue to make progress with the detailed pre-conversion work to replace our billing and operation systems with a common platform across our entire operation. We are adjusting our current billing cycles on October 1, 2017, to common dates and remain on schedule to complete the system conversion in 2018. Carrier access billing is expected to begin conversion during the first quarter of 2018, with end-user billing to follow in the second quarter. Our sales, marketing, customer service and technical teams are working together on a company-wide basis in preparation for the conversion. We expect the completion of this conversion will provide for more granular customer data, enhanced customer service and efficiencies throughout the company. Reflecting general trends in the RLEC industry, the number of residential voice access lines we serve has been decreasing, whereas business access lines have remained generally steady or grown. However, for the second quarter of 2017, our residential access line equivalents increased by 471, or 1% compared to March 31, 2017, reflecting the addition of the Leverett customers I just mentioned. This was partially offset by industry-wide trends of reduced residential voice lines. For the second quarter, our business and enterprise access line equivalents decreased by 928, or 1.8% compared to the end of the first quarter. Customer churn in our New England CLEC customer base and a decrease in multiuse voice lines in Alabama accounted for the decline. As of June 30, 2017, we operated 98,059 total access line equivalents. The company continues to make significant progress in implementing its strategic goals of driving fiber connectivity deeper into our network to provide advanced service to our customers. We continue to maximize our strong incumbent position and technical expertise in pursuing revenue opportunities and we continue to delever our balance sheet. Yesterday, we made an additional $3 million prepayment of our senior credit facility in addition to the regularly scheduled quarterly $1 million principal payment made the first of July. As noted in our press release, the total leverage ratio net of cash was 2.95 at June 30, 2017. Finally, as previously disclosed in the fall of 2016, we announced the engagement of the Bank Street Group LLC to explore the company’s strategic alternatives. Our top priority in this process is to identify opportunities for Otelco that maximize the shareholder value. At this point, we are in discussions with a number of entities and are evaluating a broad range of options, including a potential acquisition, merger or sale. It is important to note that until any definitive announcements are made, there can be no assurance that our review of strategic alternatives will result in any transaction. Our management team and our board continue to be actively involved in this process. However, we will not make any further comment during this call or address any questions at this time. We will continue to restrict public comments to those required by applicable law. Curtis will now summarize for you the second quarter financial results.

[Curtis Garner:]

Thank you, Rob. We appreciate everybody joining us today. I’ll provide a brief overview of our second quarter financial highlights as contained in the press release. Unless noted otherwise, every comparison is against the same period last year, generally that’s second quarter versus second quarter. Also, we expect to file our Form 10-Q on Friday, which will have additional information about results for the second quarter and year-to-date. Total revenues for the second quarter were $17.4 million, up slightly from $17.2 million a year ago. The increase in network access revenue associated with the FCC’s A-CAM program, plus increased Internet, video and security revenue was partially offset by a decrease in local service revenue associated with declining residential RLEC voice access lines and compared to the, when you compare that to the same quarter last year. This specific dollar and percentage changes in the components of revenue are reflected in the press release and are consistent with changes experienced in the first quarter of 2017. Rather than reiterating each number and percentage, I’ll summarize the primary reason for change in each category. Local service revenue decreased as RLEC residential voice access lines and their related revenues, such as long-distance, decrease. Higher PBX and fiber revenue partially offset that trend. Network access revenue increased reflecting the change in Connect America Fund, the A-CAM revenue and transition payments. Decreases in end-user fees partially offset that growth. Internet growth reflected the demand for increased data speeds and higher equipment run speed. Transport services revenue decreased reflecting customer churn and market pricing. Video and security revenue increased reflecting increases in IPTV coverage and security revenue. Managed services revenue decreased reflecting a decrease in professional services revenue. Moving to our operating expenses for the second quarter, a little more detail than I provided for revenue, I think is appropriate. Our total operating expenses in the second quarter of 2017 increased 0.2% to $12.4 million. In general, this reflects increased wages and cost of doing business, several one-time items and the change in the senior management bonus parameters offset by improvements in network and operations efficiency. Cost of services increased 2.1% to just over $8 million, network and other operational expenses increased just over $0.1 million and pole rental expense increased by $0.1 million on a true-up of billing from an electric utility for previous periods. These increases were partially offset by a decrease of $0.1 million in customer service and sales cost. Circuit, access, Internet and cable cost were unchanged. SG&A was $2.5 million, a 2.5% increase over last year. The increase was attributable to the transition from a stock-based senior management bonus plan, which have been in place for 3 years, and is expensed over 39 months through a cash-based bonus plan for 2017, which is expensed over 12 months. Depreciation and amortization decreased 10.2% to $1.8 million from $2.1 million last year. New England RLEC depreciation and the amortization of other intangible assets decreased $5.1 million, and the amortization of the telephone plan adjustment also decreased by $0.1 million. As we increase our average annual level of investment in our networks expansion, we can expect depreciation levels to increase over time. Operating income was $5.1 million, a 3.1% increase over last year, primarily related to the increase in revenue associated with the A-CAM transition. The 5.5% year-over-year decrease in interest expense for the quarter reflects the lower outstanding balance on our senior credit facility. As you recall, and Rob mentioned, we executed new senior subordinated credit facilities in second quarter last year and we have repaid $8.1 million of principal through June 30 with another $4 million repaid during third quarter, which obviously, isn’t reflected in the financial statement. Factoring in all these changes, net income increased $0.2 million to $1.5 million for the second quarter, again primarily due to the new A-CAM reference. Consolidated EBITDA was $7 million, down less than $0.1 million from second quarter a year ago and consistent with first quarter of 2017, when you adjust for the annual CoBank dividend that’s included in first quarters each year. Looking at the balance sheet, we ended the second quarter with $11.3 million in cash and cash equivalents, or an increase of $0.8 million since the end of 2016, showing the strong operating performance of the company. In terms of our senior loan facility, we have scheduled principal payment of $1 million, and as a Rob mentioned -- which we’ve already made, and as Rob mentioned, we made a $3 million payment yesterday in line with our strategy to reduce Otelco’s leverage. On June 30 of ‘17, the outstanding senior loan balance was $76.9 million. The $5 million revolver remains undrawn. Capital expenditures were at $2.5 million for the second quarter of ‘17 compared to $1.5 million in the same period in ‘16, with the buildout requirements for A-CAM and the ongoing work to convert our billing and operation systems to a single platform. We anticipate our annual investments for 2017 and 2018 will be higher than previous years. As we previously noted, we amended our credit facility to allow for that potential increase in capital expenditures to $8.5 million for this year and $7.5 million next year. Rob, I think that covers the highlights for the quarter, additional details in the press release and the 10-Q will be out on Friday. John, if you want to provide directions, we can shift to taking investor questions at this time.

[Operator:]

Yes, thank you. [Operator Instructions]. We’ll take our first question from Wally Walker. [Ph]

[Unidentified Analyst:]

I’m not trying to understand market psychology here but logic tells me that Otelco has not been rewarded for its efforts since it had its reorganization in 2013. Your net debt is now down over $40 million, your EBITDA in the following 3 years has been relatively steady, and to me the only logical reason is your inferior credit agreement. And now I see the total leverage ratio net of cash now is at 2.95. My question is, how much lower do we have to get that number before we can refinance it much better terms and we have a favorable environment now? And I’m just kind of wondering, at what point, what number do we have to get to before we consider such a thing?

[Rob Souza:]

I’m not sure that I have an exact number in mind, Wally. Certainly agree with your assessment regarding the performance, our ability to continue to reduce debt. The fact that our quarter-over-quarter performance has really been stable and steady. We certainly believe we’re closing in on that number. I think we’ve mentioned in the past, refi is something is, has been considered, certainly it’s something that we review on a regular basis with the board and we will continue to look for opportunities to improve our position there.

[Unidentified Analyst:]

All right. You also mentioned Otelco is up to 1,600 fiber route miles now. Do you have a rough estimate of how many fiber miles you’ll add over year under A-CAM now? Because that should help.

[Rob Souza:]

I don’t know that I can give you an exact number on that, Wally. Certainly, last year prior to the A-CAM arrangement in Alabama alone, we added 56 miles of fiber. I don’t know that, that number will be the same this year or a little bit higher. But you can do the reverse math on the $2.4 million with an estimated build cost of $15,000 to $20,000 per mile, and you might come up with a rough approximation of mileage.

[Operator:]

[Operator Instructions]. And it appears there’re no further questions at this time. I’d like to turn the conference over to back, excuse me, back over to Mr. Souza for any additional or closing remarks.

[Rob Souza:]

Thanks, John. We definitely appreciate you joining us this morning. I think you can see that we remain focused on managing Otelco in tandem with the significant changes that continue to occur in the industry. We always are looking for additional growth opportunities in the current marketplace, and as always, we are dedicated to delivering greater value for our shareholders. We certainly welcome your questions and we plan on keeping you informed regarding the developments in our business. Thanks again for joining us today.

[Operator:]

And that concludes today’s call. Thank you for your participation. You may now disconnect.