Otelco Inc
Q4 2017 Earnings Call Transcript

Published: 6 Mar 2018

[Operator:]

Good day, and welcome to the Otelco’s Fourth Quarter 2017 Earnings 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, Tracy. And welcome to your Otelco conference call to review the Company’s results for the fourth quarter and year ended December 31, 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 cause the actual results of the Company to be materially different from the historic 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, sir.

[Robert Souza:]

Thanks Drew. Good morning and welcome to our fourth quarter investor call. Let me touch on two key events before I discuss the quarter’s operational performance as both of these have current and long-term benefits to Otelco. Then I'll provide some color on fourth quarter. Curtis will review our financial results and we will take your questions. The most significant event for Otelco last year was the announcement of our new credit facility. As we disclosed on our November call, we refinanced our existing credit facility with a new $92 million five-year credit facility from a consortium of banks led by CoBank, ACB. The facility includes a $5 million revolver which is undrawn. 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 when compared with what interest would have been under the former facilities. The facility also includes more flexible terms concerning the payment of dividends and the capacity for additional borrowing. CoBank has been a lender to Otelco or the companies we have acquired for more than 15 years. They understand Otelco and the world telecommunication companies we serve and the ongoing support being provided by the FCC’s Alternative Connect America Model program to build out stronger and more versatile networks to serve the needs of our customers. The second key events for the fourth quarter impacted most public companies. It was the Tax Cut and Jobs Act, enacted in December 2017. The Tax Act positively affected our taxes as well as future tax years. Bonus depreciation was increased from 50% to 100% beginning in 2017. The reduced maximum tax rate also has lowered the Company's deferred tax liabilities and is reflected in an income tax benefit significantly raising net income for the quarter and the year. We recently announced to our employees that everyone would receive a special bonus of $500 which was paid last week. Coupled with lower tax withholding rates that most employees should experience, everyone should start 2018 with more take home pay. Consolidating and streamlining the business operations remains a strategic focus of our business. As announced early last year, we selected a partner to consolidate all of our billing and operational systems on one platform. During the fourth quarter, we developed all of the operational data needed for the partner to build the new system and our team has continued making the decisions necessary to consolidate all of our disparate processes into the new system. Training on the new system is involving every employee. Our first carrier bills under the new system are going out this week, with end-user customer billing to follow in the second quarter of 2018. As we move to a Company-wide operational system, we are rebranding all of our services as Otelco. In New England, OTT Communications will become Otelco. The new logo with a tagline technology, tradition together has been incorporated in our updated website otelco.com. Over the past 10 months, we have transformed our organization from geography-based management to a functional structure with sales, customer service, and technical operations teams functioning together across our entire footprint. We expect the new 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. Clearly 2017, was a busy and productive year for Otelco. With that as a backdrop, let me turn to the fourth quarter results. Revenue and income from operations were basically flat when compared to the same period in 2016 given the continued decline of residential customers in our industry that can be considered good news. As discussed last year, Otelco began receiving the FCC’s ACAM 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. The program provides a fixed 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. Support under the new ACAM model-based approach allows the company to increase its capital expenditures in 2017 with plans for similar investment in 2018. In its first year of ACAM funding, Otelco placed approximately 81 miles of new fiber passing over 1,900 locations and reaching 7.5% of its eligible ACAM location. Including the ACAM fiber, the Company invested $2.6 million in the business in the fourth quarter of 2017 and over $8.5 million during the full-year for an increase of $1.6 million when compared to its 2016 investment. During fourth quarter 2017, Otelco’s net income was $7.4 million compared to $946,000 in the same period of 2016, primarily reflecting the impact of the Tax Act on tax liabilities. Consolidated EBITDA was $6.5 million for the fourth quarter 2017 compared with $6.7 million a year-ago. During the fourth quarter 2017, the Company made a principal payment of $1.1 million on the new credit facility reducing the outstanding balance to $85.9 million. The Company's total ratio of debt net of cash to consolidated EBITDA at December 31, 2017 as defined and calculated in our press release was 2.98. The number of voice, data, and other access lines served as a fundamental factor in our industry. 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, but also trending lower. For the fourth quarter of 2017, our residential access line equivalents declined by 2.2% compared with the previous quarter and declined 4% compared with the end of 2016. This decline was lessened by the addition of over 600 customers in one municipality in Western Massachusetts in April of 2017. Our business and enterprise access line equivalents decreased by 1.2% compared to the end of the third quarter and 5% compared to the end of last year. Approximately 53% of our access line equivalents at the end of 2017 served business and enterprise customers. As of December 31, 2017, we operated 95,277 total access line equivalents. Our ongoing 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. Our marketing approach emphasizes locally managed customer oriented sales marketing and service. We believe that we are able to differentiate ourselves from our competitors by providing a superior level of service in our territory. Each of our RLEC have a long history in the communities it serves, which has helped to enhance our reputation among local residents by fostering familiarity with our products and level of service. All of our employees are local residents and often have a direct connection with their communities which we believe improves customer satisfaction and enhances our reputation within those communities. Curtis will now summarize the fourth quarter financial results.

[Curtis Garner:]

Thank you, Rob. We appreciate everybody joining us today. I apologize if there is some background noise. Unfortunately, I am at an airport right now. Let me provide a brief overview of our fourth quarter financial highlights as contained in the press release. Unless noted otherwise, every comparison is against the same period last year, generally fourth quarter versus fourth quarter. Our SEC Form 10-K should be filed early next week, which will contain annual comparisons as well as additional information on the Company. Total revenues for the fourth quarter were $16.8 million, down 0.2% from last years fourth quarter. The decrease in residential RLEC access line equivalents and traditional access revenue affected by the FCC’s inter-carrier compensation reform order were offset by increases associated with the FCC’s ACAM and Connect America Fund programs. Looking at the components of revenue, local service revenue was $5.4 million, a decrease of 5.2% over the prior year period. The decline in RLEC residential voice 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 the RLEC decrease is recovered through the CAF, which is categorized as interstate access revenue. The decline in long distance revenue, Hosted PBX equipment sales and directory revenue accounted for a decrease of $0.2 million. Wholesale services in a municipality in Massachusetts as Rob mentioned, provided an increase of $0.1 million. Moving on to network access revenue, it increased 6.2% over the last year, a $2 million increase in CAF, ACAM and related transition payments was partially offset by a $1.5 million decrease in switched and special access and a $0.2 million decrease in end user-based fees. Internet revenue was unchanged at $3.9 million. Increased speed and additional data customers in a municipality in Massachusetts were offset by a reduction in residential RLEC customers. Transport services revenue decreased 2.9% over fourth quarter last year reflecting wide area network market pricing, but partially offset by an increase in wholesale transport services. Video and security revenue was unchanged at $0.7 million, reflecting increases in IPTV and security revenue, offset by decreases in basic cable. Managed services revenue decreased 15.2%, reflecting a decrease in professional services revenue. Moving on to expenses for the fourth quarter, total operating expenses were up 0.1%, so basically unchanged compared to the prior year period. Cost of services increased 0.2% to remain at $7.9 million in both periods. Cable and internet, pole rental and network operations expense each increased $0.1 million, while access and toll expenses combined for a decrease of $0.2 million. In addition, customer service and sales expense decreased $0.1 million. SG&A was up 4.1% to $2.5 million from $2.4 million last year. The increase was attributable to $0.1 million increase or change in executive compensation expense associated with the use of the cash bonus plan versus in 2017 versus the stock bonus plan which was used in 2016. Depreciation and amortization decreased 4.7%. The amortization of other intangible assets and the telephone plant adjustment which is associated with the acquisition of Shoreham and Vermont in 2011 accounted for the decrease. Operating income was $4.5 million down 1.4% for the fourth quarter from last year. Interest expenses for fourth quarter was up $5.5 million, up from $2.7 million – was up at $5.5 versus $2.7 million a year ago. The write-off of the remaining loan costs associated with terminating the Company’s former credit facilities increased loan cost amortization by $3.6 million in the fourth quarter of 2017 compared with the same period last year. The increase was partially offset by lower interest expense of $0.8 million under the new CoBank term loan in the final two months of fourth quarter. Loss on debt prepayment penalty, we had $2.2 million in one-time termination fees associated with replacing the Company’s credit facilities with the new CoBank term loan in fourth quarter. There were no comparable expenses in the same period last year, and GAAP requires that these expenses be shown on a separate line item. Rob noted on income tax expense change in the federal tax law at the end of 2017 had a material impact on deferred income tax liabilities, producing a tax benefit of $9.3 million for the fourth quarter. The Company experienced a net loss after taxes of $3.2 million due to accounting for the change in the new credit facility resulting in a $1.3 million book tax benefit. The combined $10.6 million tax benefit compares with a tax expense of $1 million for the previous year's period. The increase in bonus depreciation from 50% to 100% positively affected 2017 and will impact future years also. In addition to the reduction in the federal tax rate which begins in 2018 from 35% to 21%. For 2017 increase in bonus depreciation reduced federal income taxes by over $600,000. For 2018 bonus depreciation and a lower tax rate are estimated below our cash income taxes by approximately $3 million. Factoring in all of these changes, net income increase $6.4 million to $7.4 million for the fourth quarter primarily due to that tax law change in the implementation of the new CoBank credit facility. Consolidated EBITDA was $6.5 million compared with $6.7 million for the fourth quarter a year-ago as Rob mentioned earlier. Looking at the balance sheet, we ended the fourth quarter and year with $3.6 million in cash, compared to $10.5 million at the end of 2016. In the 22 months ended in December 2017, we reduced our outstanding long-term notes from $100.3 million in February of 2016 to $85.8 million at the end December 27 or 14.3%. Capital expenditures were $2.6 million for the fourth quarter 2017, compared to $2.8 million the same period in 2016. For the year, CapEx was $8.5 million compared to $6.9 million in 2016. The increase reflects the build out requirements for ACAM and the work to convert our billing and operations systems to a single platform. We anticipate an annual investment in network in 2018 will be higher than in the last several years, but probably in line with the 2017 expenditures. Our new credit facility doesn't put a specific limitation on CapEx, allowing us to be more flexible in our investment in the business. Rob, I think that covers the highlights for the quarter. Additional details were in the press release and upcoming 10-K. Tracy, if you want to provide directions, we can shift to taking operator questions at this time.

[Operator:]

Thank you. [Operator Instructions] And we will go first to [Wally Walker], Private Investor.

[Unidentified Analyst:]

Hi, Rob and Curtis. Good morning.

[Robert Souza:]

Good morning, Wally. How are you?

[Curtis Garner:]

Hi, Wally.

[Unidentified Analyst:]

Hey, Curtis. I would just like to get your general thoughts from the places that are being paid in the current marketplace for fiber. About a month ago, I observed through wireline quite like Otelco with the small fiber presence and it sold for an EBITDA multiple far above anything that seen before. Also recently another wireline and its conference call described the current prices paid for fiber companies as a bubble and I was just kind of wondering what your current impressions of fiber situation are at the moment?

[Robert Souza:]

Wally, thanks for the question. We certainly watch the activity in the market and see what's happening. I'm not sure that I'm a real good prognosticator or individual to suggest that the values are reasonable or not reasonable. We certainly see some pretty high multiples being paid for companies, where their primary focus happens to be fiber and far less activity as the one that you mentioned whether it's maybe a mix of fiber and more traditional services. So I'm not sure, what the right answer is? We certainly have seen those multiples begin to increase as a result of fiber and we think fiber is the right thing to do and we're following the lead of the industry and continuing to place fiber in our Company with the hopeful expectation that it makes a difference for our customers with the ability to provide broadband services and also to investors like you who watch us pretty closely.

[Unidentified Analyst:]

Based upon Otelco’s fiber numbers for 2017 and your more favorable environment now from lower debt and lower taxes in 2018, I was just wondering if we would be reasonable to assume that Otelco would go over 100 fiber route miles this year.

[Robert Souza:]

Yes, Wally, that’s a good question and comments, obviously Otelco really didn't get the news from the FCC, if he follow that ACAM receiving fairly closely. We were unsure whether the ACAM program was going to be something that was afforded to all of our companies based on some of the variables, the FCC was working. We did not really receive the award or the proposed award of ACAM money. I think it was until around December 20 or 22 of 2016. So 2017 really for us was a ramp up here. A lot of the planning that we had in place began to be implemented, but at the same time we needed to do additional planning for those out years. So I would anticipate in the out years that the amount of fiber we place would likely increase. Now having said that, we are certainly looking at locations where we can pass as many ACAM eligible locations as possible with a dollar spent. That factors in for two reasons. One, it meets the obligation that the FCC has imposed on us and by your four we need to reach 40% of those ACAM eligible locations. The second thing it does is we will be building into those higher density locations where ultimately the return on our investment, which would be much higher. So it's going to be a mix of those two things that drive our investment decisions, but in all likelihood, Wally, one would anticipate the number of overall miles would increase in future years.

[Unidentified Analyst:]

Thanks a lot. And by the way, I've got one more in there for you. As I understand that the FCC up March 30 as a deadline for carriers to decide whether or not they are going to participate in the new $1.9 billion Connect America Phase II reverse action now. I guess it begins in July and looking at the eligibility map that I received here from the FCC. Many of the eligible census blacks are adjacent to Otelco’s service areas and various states that Otelco serves. And I'm just wondering, are you planning on being a participant?

[Robert Souza:]

We are certainly exploring the opportunity, Wally, we certainly have not made a decision whether we will or will not participate, but it's something that we're keeping our eye on closely and will make a determination as that deadline for filing approaches.

[Unidentified Analyst:]

Thanks a lot guys. Have a great day.

[Robert Souza:]

Thank you, sir.

[Operator:]

[Operator Instructions] And we will go next to [Phil Gunn], a Private Investor.

[Unidentified Analyst:]

Hello.

[Robert Souza:]

Good morning.

[Unidentified Analyst:]

Yes. With the changes in both the tax and the lower interest rates, would this be a good time to institute a dividend for the common shareholders, who have been – most of whom I guess if they're still around after all these years it would be a nice time to reward them?

[Robert Souza:]

Sure. It certainly appreciate the question. And as mentioned earlier the new credit facility does provide the flexibility to pay dividends of up to $1.25 million in 2018 and 2019, but it is subject to certain requirements. And if those requirements are met and our board determines that it's in the best interest of the Company and its shareholders to pay dividends, I expect that we will do that.

[Unidentified Analyst:]

Thank you.

[Robert Souza:]

Thank you.

[Operator:]

And we will go next to [Gene Riley], Private Investor.

[Unidentified Analyst:]

Hi there. I'm just curious if you were to look at your company as divided into the census blocks that you serve by wire versus those that are currently served by fiber, what would the difference in the attrition rates stay between those two groups?

[Robert Souza:]

Well I don't know that I could answer that off the top of my head with a hard factual number, but certainly we would anticipate with every mile of fiber that we place and location that we pass on customer that serves the attrition rate would be lower. We believe once the customer attaches to fiber and our services stand to fiber, that the likelihood of them staying with us is much greater.

[Unidentified Analyst:]

Okay. Maybe next conference call you could give us just a little bit more information on that and appreciate it.

[Robert Souza:]

Yes. It's difficult for us to just to respond to that. It's difficult for us to respond down to the census block level based on attrition, but our census blocks is not something that we necessarily have tracked providers to ACAM. That is a work that's in progress, so those details will probably not be available in the near future.

[Unidentified Analyst:]

Thank you.

[Robert Souza:]

You're welcome. End of Q&A

[Operator:]

[Operator Instructions] There are no other questions at this time. I'd like to turn the conference back to Mr. Souza for any additional or closing remarks.

[Robert Souza:]

Thank you, Tracy. We always appreciate the opportunity to talk to our investors and we appreciate you joining our calls. We remain focused on managing Otelco in tandem with the significant changes that continue to occur in our industry. We continue to look for additional growth opportunities in the current marketplace, and as always, we are dedicated to delivering greater value for our shareholders. So thanks for joining us and we look forward to talking to you again. Thanks so much.

[Operator:]

This does conclude today's conference. We thank you for your participation. You may now disconnect.