Otelco Inc
Q3 2017 Earnings Call Transcript

Published: 10 Nov 2017

[Operator:]

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

[Drew Anderson:]

Thank you, Kayla. And welcome to the Otelco conference call to review the company’s results for the third quarter ended September 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 actual results or cause the actual results to the company to be materially different from the historical results or 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 SEC. 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 third quarter investor call. I’ll begin today by providing some highlights on our replacement credit facility and then cover the key events impacting our results for the third quarter. Curtis will review our financial results and then we’ll take your questions. We are pleased to announce that on November 2, 2017, Otelco refinanced our existing credit facilities with a new $92 million five-year credit facility from a consortium of banks led by CoBank, ACB. The key points of the new facility include the following, A five-year term loan of $87 million, replacing Otelco’s previous senior and subordinated term loans, the principles amounts of which had been reduced by $13.3 million since February 2016, a current interest rate of LIBOR plus an applicable margin currently 4.5% with reductions in the applicable margin as leverage declines, providing significant savings relative to Otelco’s previous debt facility, a $5 million undrawn revolving loan, quarterly principal payment -- repayments of open approximately $1.1 million and subject to compliance with certain covenants, the ability to pay dividends to shareholders beginning in 2018, a potential to expand the term loan by an additional $20 million over the next five years and no prepayment penalties, proceeds from the new term loan and cash on hand were used to repay Otelco’s previous term loans, their prepayment penalties and fees associated with the new transaction. The new facility reduces the effective interest rate on the company’s debt by more than 400 basis points and supports Otelco’s continued focus on reducing leverage. Our cash interest expense for 2018 will be reduced by over $3.5 million compared with the former facilities. Partnering with CoBank will allow Otelco to free up cash from interest payments for investments in the business, repay additional debt and provide the capacity to pay dividends to our shareholders. CoBank has been a lender to Otelco or the companies it has acquired from more than 15 years. They understand the needs of rural telecommunication companies and support being -- and the support being provided by the FCC’s Alternative Connect America Model funding, a program that’s designed to build out stronger and more versatile networks to serve the needs of our customers. And other key events for the quarter the company has concluded its previously announced review of strategic alternatives. These alternatives included a broad range of merger, sale and acquisition transactions, among other things. The company and its financial advisor, The Bank Street Group LLC contacted a wide range of prospective financial and strategic partners to determine their level of interest in a sale, merger or other transactions involving the company. However, none of the parties contacted by the company or The Bank Street Group LLC presented a transaction that Otelco’s Board of Directors determined to be viable or in the best interest of the company and our shareholders. Our comparable approach to the market was concluded three years ago with similar results. We continue to believe the wireline telecommunication industry and in particular the rural wireline industry would benefit from further consolidation. We will continue to look for opportunities to participate in that consolidation. In the meantime, Otelco remains focused on reducing our leverage and investment in our network. I want to also note that the company periodically receives indications of interest and has discussions regarding possible strategic alternatives. The company and the Board remains committed to maximizing shareholder value and will pursue reasonable alternatives that present themselves. Looking at the third quarter of 2017, our financial and operating results reflects the ongoing industry conditions affecting all telecommunications providers. As previously noted during the first quarter, Otelco begin receiving the FCC’s ACAM payments in the five states where the program is applicable to the company. ACAM provides a stable 10-year funding mechanism to continue the expansion of broadband in rural communities. Under ACAM we will continue to expand the availability of higher broadband speeds and expect to invest throughout our network. The ACAM election includes specific deployment obligations, including the number of locations to be capable of specific broadband speeds within certain eligible census blocks in our service areas. As I mentioned in previous calls, we expect funding under the new ACAM model-based support to increase in 2017 by an estimated $1.5 million compared to 2016 support received under legacy rate of return regulation. Without the new ACAM model-based support in 2017, our RLECs would have seen a normal year-over-year funding decrease under Universal Service Fund high cost loop and the FCC’s newly adopted budget control mechanism. With the introduction of the ACAM funding in 2017, the increase in revenue can be used to support additional capital investments in our networks above the levels of the last several years to enhance broadband speeds and coverage. For Otelco, the first phase of ACAM fiber-to-the-home projects in Missouri, Maine and Alabama totaling $2.4 million are underway with completion of this work expected in the fourth quarter of 2017. The stable revenue associated with ACAM in the five states where the program is applicable and effective cost and expense management were the primary factors driving the improvement in net income. During third quarter 2017, Otelco’s net income was $1.6 million, compared to $1.1 million in the same period of 2016. The increase in capital invested in its network this quarter and year-to-date reflects the company’s commitment to the buildout required by the program. Consolidated EBITDA of $6.9 million for the third quarter 2017 was $0.2 million higher than the same period in 2016. Last year included some one-time expenses that did not recur in 2017, which would make the year-over-year performance very consistent. Excluding the $0.2 million positive impact of CoBank dividends in the first quarter of 2017, consolidated EBITDA has been approximately $7 million in each quarter this year. During third quarter 2017, the company made an additional principal payment of $3 million to further reduce senior debt as part of our plan to reduce leverage towards current industry norms and to prepare for replacing our credit facility. The improved terms of the new facility reflect the lending institutions recognition of that fact and the continuing strength of Otelco’s operations. The company’s total leverage ratio net of cash at September 30, 2017, as defined and calculated in our press release was 2.87. Consolidating and streamlining business operations remains a strategic focus of the business. We have made significant progress in replacing our billing and operation support systems with a common platform across the entire operation. Our current billing cycles were changed on October 1, 2017, to common dates in preparation for the system conversion in 2018. We will begin training on the new platform in the fourth quarter of this year. Carrier billing conversion to the new system begins during the first quarter of 2018, with end user billing to follow in the second quarter. Over the past six months, we have transformed our organization from regional-based management to a functional structure with sales, customer service and technical operation teams functioning together across our entire footprint. We expect the completion of the billing and operation systems, coupled with the conversion to the functional organization structure will provide more granular customer data, enhanced customer service and deliver efficiencies and savings throughout the company. Reflecting the general trend in the RLEC industry, the number of residential voice access lines we serve has been decreasing, whereas business access line trends have been more stable. For the third quarter of 2017, our residential access line equivalents declined by 766 or 1.6% compared to June 30, 2017. Our business and enterprise access lines decrease by 396 or 1.2% compared to the end of the second quarter. As of September 30, 2017, we operated 96,897 total access line equivalents. Our ongoing operational strategy consists of leveraging our incumbent market position, selling additional services to our rural customer base and expanding the availability of fiber-based broadband service throughout the company. Curtis will now summarize the third quarter financial results.

[Curtis Garner:]

Thank you, Rob. We appreciate everybody joining us today, not only to hear about our quarterly results but also to celebrate the new CoBank credit facility. I’ll provide a brief overview of our third quarter financial highlights as contained in the press release. Unless noted otherwise, every comparison is against the same period last year, generally third quarter versus third quarter. As we expect to file our third quarter 10-Q tomorrow, you’ll be able to get additional information in that document. Total revenues for third quarter were $16.9 million, down $2.5 million from $17.4 million a year ago. The industry-wide decrease in residential voice service including long distance, the annual 5% reduction in certain subsidies from the FCC’s 2011 order and the lower Hosted PBX equipment sales were primary factors for the decline. Please note the Hosted PBX lines actually increase. Looking at the components of revenue, local service revenue was $5.6 million, a decrease of 7% over the prior year period. The decline in residential voice access lines and related revenues such as long distance accounted for a decrease of $0.3 million, a portion of the RLEC decrease is recovered through the Connect America Fund, which is categorized as interstate access revenue. In addition, Hosted PBX equipment sales were down $0.2 million, as more customers combined their hardware and service into long-term agreements. Network access revenue increased 1% to $5.3 million, including a $2.5 million increase in the combined Connect America Fund and the initial ACAM revenue and transition payments. They were partially offset by a $2.1 million decrease in interstate switched access, including the Universal Service Fund. End-user based fees decreased $0.2 million and special access declined by $0.1 million. Internet revenue was just under $4 million, a 0.7% decrease, higher revenue from increased data speeds and pricing were offset by lower equipment rental fees. Transport services revenue decreased 2% to just under $1.2 million, reflecting customer churn and market pricing, partially offset by an increase in wholesale transport services. Video and security revenues increased 3.9% to remain at just over $7 -- $0.7 million, reflecting increases in IPTV, pay-per-view and security revenue, partially offset by a decline in digital services. Moving on to our operating expenses for third quarter, total operating expenses for the third quarter decreased 6.2% to $12 million, reflecting decreases in each of the three categories. Cost of services decreased 4.4% to $7.6 million, access, toll and reciprocal compensation expense decreased $0.3 million, Hosted PBX equipment expense was down $0.2 million, which is in line with the revenue reduction that I mentioned earlier and market -- marketing and project management expense decreased $0.2 million. These two -- these decreases were partially offset by an increase of $0.3 million and plant operation expense, including costs associated with the new municipal services we’re providing in Massachusetts and a $0.1 million increase in internet and cable expense. SG&A was $2.6 million, which was a 10.4% decrease over last year. The decline reflects lower legal, human resources, accounting, cloud hosting, uncollectable and property tax expense, partially offset by higher expenses for loan fees, training for the new billing platform and the substitution of a cash based senior management, incentive compensation plan for 2017 for the stock-based plan which was used in 2016. Depreciation and amortization decreased 7.5% to $1.8 million from $2 million last year. The amortization of telephone plant adjustment decreased $0.1 million. Cable depreciation and amortization of other intangible assets decreased $0.1 million, primarily driven by the end of amortization of intangibles associated with the acquisitions. Operating income was $4.9 million, a 7.7% increase over last year, primarily related to better cost and expense management, 5.9% year-over-year decrease in interest expense reflects the lower outstanding balance on the previous senior credit facility, we paid an additional $3 million of principal during third quarter, prior to the refinancing as Rob noted, we are reducing our effective interest rate by approximately 4 percentage points with the new credit facility, the impact of which will -- we will begin to see in the fourth quarter once we get past the impact of the fees associated with the transaction. In case you wondered why we didn’t wait until late February to close transaction to reduce the prepayment penalties by 1%, our savings in interest between closing date and February ‘17 more than offset the 1% penalty reduction. Factoring in all these changes, net income increased 46.4% to $1.6 million for the third quarter, primarily due to ACAM revenue and cost and expense reductions. Consolidated EBITDA was $6.9 million, up slightly from $6.7 million for third quarter a year ago, as Rob mentioned earlier. Looking at the balance sheet, we ended third quarter with $8.9 million in cash and cash equivalents, compared to $10.5 million at the end of 2016. Excluding the $3 million principal payment we made in August on our senior credit facility, cash grew by $1.4 million. At September 30, 2017, the outstanding senior loan balance was just over $87 -- $88.7 million, the $5 million revolver was and remains undrawn. As noted, we refinanced our credit facility subsequent to the end of the quarter and now have $87 million in outstanding debt. Capital expenditures were $2.2 million for third quarter compared to $1.9 million in the same period of 2016, with the buildout requirements for ACAM 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 in previous years. Our new credit facility does not put specific limitations on CapEx, allowing us more flexibility on investing in the business. Rob, I think, that covers the highlights for the quarter, more details in the press release and in the upcoming 10-Q. Kayla, if you can provide directions, we can shift to taking investor questions at this time.

[Operator:]

Thank you. [Operator Instructions] We’ll go first to Ira Sochet, Sochet & Company.

[Ira Sochet:]

Good morning and congratulations.

[Rob Souza:]

Thank you, Ira. We appreciate that.

[Ira Sochet:]

Based on the press release and so on it appears that you can now with the reduced [Technical Difficulty] (20

[Rob Souza:]

It was difficult to hear you, Ira. But I think that you were asking if we were providing an EBITDA projection. I think what we did is we indicated that our performance has been very, very consistent and running around $7 million per quarter in this past trailing 12 months.

[Curtis Garner:]

And it has been our past -- and our -- this is Curtis. This has been our, I think, our game plan of the past. We generally don’t provide projections in terms of EBITDA, net income or even revenue.

[Ira Sochet:]

Okay. Thanks you.

[Rob Souza:]

Thank you, Ira.

[Operator:]

We’ll go next to Joe Helmer with Caldwell Sutter Capital.

[Joe Helmer:]

Hi, guys. So, I guess, this is a continuation of Ira’s question, which is the interest savings. How would we go about calculating the after-tax savings to -- I guess, what tax rate should we apply to that interest component to arrive with after-tax earnings per share increases?

[Rob Souza:]

Curtis, I am going to let you handle that one, if you would, please.

[Curtis Garner:]

And I am going to toss that off to Congress and say, based on whatever Congress decides, we will -- it will impact us the same way. Just to be clear, we don’t have any NOLs. So, therefore, we pay taxes at the -- just whatever the rate is for earnings of our size, so we’re a full level of taxpayer. So I think you can depend -- lot depends on what Congress decides to do for 2018, if they do nothing, then somewhere in the 35% to 40% range would be the impact of taxes on interest rates.

[Joe Helmer:]

Okay. Thanks.

[Rob Souza:]

Thank you.

[Operator:]

[Operator Instructions] We’ll go next to Edward Painter, SHomer Capital.

[Edward Painter:]

Hi, guys. Congratulations. Great work on the refinancing and keeping the company going strong. Let’s see just wanted to get a sense, I don’t know if you mentioned on the call, I came in a little bit late. What sort of payout ratio versus earnings if you can talk about that a little bit and then, possibly think about a stock split just from the interest of liquidity of shares, but that spread is very wide and shares are relatively a liquid and could get as long as the stock prices above $5 could get substantially more interest with a little bit better liquidity?

[Rob Souza:]

Yeah. Edward, thanks for the question. I don’t believe Curtis and I and the Board have really had any time to kind of consider the idea of a stock split or anything on a forward looking basis. I am certain that those types of things will be ideas that we discuss and bounce around, but not prepared to discuss or even entertain that idea at this point in time. And as far as payout ratio, I really haven’t sat down and calculated that either and so at this point, I don’t have an answer for that question.

[Edward Painter:]

Okay. That’s fine. Thanks.

[Rob Souza:]

Thank you.

[Operator:]

And we have a follow-up from Ira Sochet.

[Ira Sochet:]

Yeah. Good morning, again.

[Rob Souza:]

Good morning, again, Ira.

[Ira Sochet:]

Nice. Just sort of a follow-up to the last caller, I don’t see and as a larger shareholder in the company, I am certainly do not see any point in the stock split at this point. I believe management has proven itself since coming out of bank [Technical Difficulty] (24

[Rob Souza:]

Thank you, Ira. Your point is noted. Thank you.

[Operator:]

And we have no further questions in queue. I’d like to turn it back to Mr. Souza for closing remarks.

[Rob Souza:]

Thank you, Kayla. We appreciate all of you joining us this morning. As you can see, we remain focused on managing Otelco in tandem with all of the changes that are occurring in the telecommunications industry. We will continue to look 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, and again, we thank you for joining our call this morning. Thanks.

[Operator:]

That concludes today’s conference. We thank you for your participation. You may now disconnect.