Otelco Inc
Q3 2016 Earnings Call Transcript

Published: 4 Nov 2016

[Operator:]

Good day and welcome to Otelco’s Third Quarter 2016 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.

[Drew Anderson:]

Thank you, Katy and welcome to the Otelco conference call to review the company’s results for the third quarter ended September 30, 2016. 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 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. 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:]

Thanks, Drew and good morning to everyone and welcome to our third quarter call. I will begin by providing some highlights regarding our results for the quarter, Curtis will then review our financial results, and then we will take your questions. Our results for the third quarter reflect current industry conditions as top line residential revenue remains under pressure for all telephone companies. However, we continue to make process in growing our business and enterprise services and maintaining our residential broadband base by enhancing those services with our newer offerings like security and over-the-top services. Our focus on continuous cost improvements across our markets remains a critical element of our strategy, while we address top line revenue enhancements, promotions and where appropriate service pricing actions. We are working hard to identify and take advantage of additional growth opportunities in the current marketplace. Last week, our CLEC was awarded the contract to serve the residents of a Western Massachusetts community for internet and voice services and we expect to complete the service transition for their over 600 residents during the first quarter of 2017. Sales and installation of our Hosted PBX products had their best quarter of the year as customers adopt internet protocol technology and recognized the quality of our product when measured against other market offers. And notably, our marketing focus on speed and pricing options helped internet revenue grow during the third quarter and year-to-date when compared with the same periods last year. The improvements we have made in our network and operations cost structure again offset the decline in revenue this quarter when the results are compared to the same period in 2015. Excluding the impact of the legal cost associated with an exploratory project, operating income for the third quarter declined by less than $0.1 million and consolidated EBITDA was down less than $0.2 million compared with the prior year. While residential voice access lines have continued to decrease in our territories, business access lines have remained steady or showing modest growth. We expect these trends will continue as competition for cable and cooperative electric providers in our RLEC territories, the availability of alternative telecommunications products such as cellular and IP-based services and general economic conditions affect our business. Our primary RLEC strategy consist of leveraging our strong incumbent market position, taking advantage of carrier requirements such as wireless backhaul and the never ending demand for educational bandwidth in our operating territories and we continue to sell additional services in our rural customers – or to our rural customers. During the third quarter, we saw a 4.1% increase in the security monitoring and medical alert services we offer in Alabama and Missouri when compared to the second quarter of this year. Our cable television customers decreased by 9.1% since the end of the second quarter, reflecting AT&T’s reseller channel decision in its DIRECTV division. This was partially offset by increases in over-the-top services and IPTV expansion as we reached additional locations with our fiber-to-the-home services. And the loss of the DIRECTV subscribers has little impact on our results as we have only reflected the monthly commissions we have received for those services. Our other internet customers decreased by 1.8% over the same period. This includes the subscribers we serve outside of our RLEC telephone service areas in Maine and Central Missouri. Our business and enterprise access line equivalents increased by 959 during third quarter of 2016 or a 1.8% increase compared to June 30, 2016. The growth in Hosted PBX lines in our New England CLEC and business services for schools in our Alabama RLEC territory accounted for the growth. Business and enterprise access line equivalents account for over 56% of our access line equivalents. Residential access line equivalents declined 862 during the third quarter or approximately 2% compared to June 30, 2016, reflecting industry-wide trends. Residential data declines were much lower than voice access lines during the third quarter 2016. And for the year, as customers – and for the year, as customers disconnecting their voice lines chose to retain and in some cases enhance their data services. I will spend a few minutes now updating you on the regulatory front. As you know in March of 2016, the FCC issued its Universal Service Fund reform order or the USF order for rate of return carriers like ours. This will fundamentally change the way the rural rate of return carriers obtain USF support. Specifically, the USF order reduces the FCC authorized rate of return over a 6-year phase-in period, which commenced July 1 of 2016, imposes a cap of $2.15 billion on the Universal Service Funds available to rate of return carriers. Introduces a new voluntary path based on the FCC’s Alternative Connect America model or ACAM under which rate of return carriers may elect the revised support for the term of 10 years and it imposes new broadband build-out requirements on carriers in return for receiving universal service support. Specifically, the USF Order requires carriers electing the voluntary model base support to notify the FCC of their election by November 1 of this year. As noted in our press release, we have elected to accept the new model based support for all of our eligible RLECs and the notification of this election was completed on October 31 and has been confirmed by the FCC. The proposals provide a 10-year funding mechanism to continue the broadband transition for our rural customers. As currently established, the acceptance of ACAM funding will provide a slight positive impact on the company beginning in 2017. Of course, the FCC may revise the model based support amounts companies receive after it reviews all of the rate of return company’s USF elections. If the FCC makes a revised model based support offer that is lower than the offer made at the time of our election, we will be given time to accept the new offer or continue with the modified legacy support mechanism. At this point, Curtis will now summarize the third quarter financial results.

[Curtis Garner:]

Thank you, Rob. We truly do appreciate everyone joining us today. I will provide a brief overview of our third quarter financial results as contained in the press release. Unless otherwise noted, the comparison is against the same period last year, generally third quarter versus third quarter. Also we will file our 10-Q on Monday, which will have additional information about results for the first nine months of 2016. Total revenues for the third quarter were $17.4 million, which represents a 2.6% decrease compared with $17.9 million in the third quarter of 2015. The drop in residential RLEC voice access lines, access revenue decreases due to the FCC’s inter-carrier compensation reform order and pricing for selected transport services account for the majority of the decline, which was partially offset by an increase in Internet, Hosted PBX and video and security revenue. Now let’s look at the components of the revenue. Local services revenue was $6 million, a decrease of 4% over the prior year period. Hosted PBX and fiber rental revenue increased $0.2 million, the decline in RLEC residential voice access lines and the impact of the FCC’s order, which reduces or eliminates intrastate and local cellular revenue accounted for a decrease of $0.3 million. As a reminder, a portion of the RLEC decreases recovered through the Connect America Fund, which is categorized in access revenue. The decline in long distance and special line revenue accounted for a decrease of $0.2 million. Now looking at network access revenue, it decreased 5.1% to $5.3 million. The Connect America Fund, as I mentioned earlier increased by $0.1 million, offset the declines in end user fees of $0.1 million, special access charges of $0.1 million and interstate and intrastate switched access charges of $0.2 million. Internet revenue was up 6.2% to $4 million increases based on higher equipment fees, increased broadband speed and pricing were the main sources. Transport revenue decreased 13.1% to $1.2 million. Wide area network and wholesale transport revenue each decreased $0.1 million, reflecting some specific market pricing adjustments associated with multi-year contracts. Video and security revenue increased 4.8% to just over $0.7 million. Increases in security and IPTV deployment and cable pricing were partially offset by decreases in pay per view revenue and a small amount of digital cable suppliers. As Rob mentioned, the relationship with DirecTV was canceled and that has a minimal impact. Managed services revenue decreased 5.4% to slightly over $0.2 million in the third quarter of 2016, reflecting lower groupware services and equipment sales, which are not really our focus, but occasionally come with the sale of other services. Now let’s move on to operating expenses for the third quarter. As a result of our continued focus on expense management, our total operating expenses for third quarter of 2016 decreased 0.9% to $12.8 million. Cost of services decreased 4.1% as digital equipment, access, toll and Internet expense decreased $0.3 million, cable television program and computer expense increased by $0.1 million and other expenses decreased by $0.1 million, reflecting primarily the New England operations optimization projects. SG&A was $2.9 million, which is a 17.5% increase. A portion of this was – or the majority of this was really an increase due to our directors related project expense of $0.3 million which didn’t have any comparable expenses in 2015. The earlier timing of our audit expenses accounted for $0.1 million of the increase. We have small decreases in insurance, property taxes, uncollectible expenses which were offset by smaller increases in external relations, stock compensation and other general and administrative costs. Depreciation and amortization decreased 9.1% to $2 million from $2.2 million last year. The New England CLEC depreciation decreased by $0.1 million and Alabama cable depreciation and the amortization of other intangible assets decreased by $0.1 million. As Rob noted, operating income was down slightly to $4.6 million, a 7.1% decline primarily related to the Board of Directors project costs. Expense management savings exceeded the decrease in revenue for the period. The 40% year-over-year increase in interest expense reflects the higher interest rates of our new loan facilities and the increased amortization of loan costs of those new transactions. The interest rates that the company enjoyed prior to the new agreements going in place in February and after the restructuring of our balance sheet were really below market rates for similarly situated companies, which accounted for the size of the increase. Factoring in all these changes, net income decreased $0.7 million to $1.1 million for the third quarter and consolidated EBITDA decreased to $6.7 million. Looking at the balance sheet briefly, we ended the third quarter with $9.3 million in cash, which is an increase of $2.4 million since the end of last year. We completed the new 5-year senior and 5.5-year subordinated loan facilities during the first quarter of 2016, as I just mentioned. Since then, we have made three principal payments of $1 million per quarter on the senior loan and on April 1, July 1 and October 1. As a reminder, our current senior facility has an annual excess cash flow suite, which will occur in first quarter of 2017 based on 2016 performance. Our $5 million revolver under the senior loan facility remains un-drawn. At September 30, the outstanding senior loan balance was $83 million and the outstanding subordinated loan balance was $15.5 million, reflecting the increase in fixed interest. Capital expenditures were $1.9 million for third quarter compared to $1.6 million in the same period last year. This is consistent with our annual level of operational investment over the past several years of about $6.5 million. I think that covers the highlights for the quarter with the addition detail in the press release and in the forthcoming 10-Q. Katy, before we take questions, let me turn the call back over to Rob for a few additional comments.

[Rob Souza:]

Thanks Curtis. Changes to the structure in telecom industry are lot limited to the FCC actions that I described a little bit earlier. In recent months, there have been a number of consolidation actions and plans announced. They range from the private equity actions such as Oak Hill Partners string of acquisitions to the recent large public company announcements involving CenturyLink and Level 3. As noted in our press release, we have recently engaged The Bank Street Group to help our management team and Board of Directors explore various strategic alternatives available to Otelco. We believe that the wireline telecommunications industry is poised for further consolidation. Obviously, our top priority in this process is to identify opportunities for Otelco that maximize shareholder value. And at this point, we are evaluating a broad range of options. While it remains too early in the process to discuss any progress, it is important to note that there can be no assurance that our review of strategic alternatives will result in any transaction. At this time, we do not intend to make any further public comment regarding the strategic review and exploration process. And therefore I will not be answering any questions on the topic. Katy, if you would provide directions, we can shift to taking investor questions on our operations performance at this time.

[Operator:]

Thank you. [Operator Instructions] We will take our question from Tucker Golden with Solas Capital.

[Tucker Golden:]

Good morning. I am happy to see the proactive move to retain a banker and hopefully explore a better option for shareholders than the current situation. I have a question about the $300,000 spent by the board on exploratory projects. Can you provide more color on this?

[Rob Souza:]

Tucker, I really can’t. It all really roles into what we are talking about the exploratory process that’s under way. And pretty much, I will have to leave it there.

[Tucker Golden:]

I mean was this spent on the advisor you disclosed or other advisors or...?

[Rob Souza:]

It was spent on legal advice as we are working through the process.

[Tucker Golden:]

Okay, alright. Well, best of luck, I think it probably took too long to get to this point, but I am glad we are here in a I hope if we go up from here.

[Rob Souza:]

Thanks. I appreciate the positive comments. Thank you.

[Operator:]

We will take our next question from Wally Walker, private investor.

[Wally Walker:]

Hi there, gentlemen, good morning.

[Rob Souza:]

Good morning Wally.

[Wally Walker:]

Hey, how are you doing Curtis. I see both revenue and access line equivalents rose slightly in the third quarter from the second quarter, that was encouraging, I have a question for you Curtis, I am trying to figure out here on the balance sheet, this $1.8 million in investments is that still the CoBank stock, is that what is in reference to?

[Curtis Garner:]

Yes, that’s the net value of the CoBank stock.

[Wally Walker:]

Okay. Is it still being carried out like 34% of its face value like it was last year or something like that?

[Curtis Garner:]

It’s a little higher than 30%, Wally. When we acquired two earlier companies and they had CoBank stock on their balance sheet, we have used their – the mode they were doing to handle the stock as we just took that as is and we didn’t make any changes. So therefore, there are some of that – value has been already reflected in earnings statements of the companies prior to the time we acquired them. So, we left them at that level.

[Wally Walker:]

Right. So basically you are guessing the best guess on fair value of that stock?

[Curtis Garner:]

We haven’t – the stock has relatively limited exchange capability. The only people that can buy the CoBank stock are those we have other CoBank stock and are continue to be CoBank investors. So, it’s not – given the low interest rates today, I am not sure how much of a discount somebody would want to build into an equation to figure out the pricing. So we really don’t have a number. I think the total dollar value is north of $3 million today in terms of the way we look at it. So, over the next 9 years, we should receive those dividends repatriated and – and for cash.

[Wally Walker:]

Right, right. And I have a question for Rob too. I got on the call a little late here. Otelco is eligible in 5 states for ACAM, correct?

[Rob Souza:]

I believe so, Wally. The only state that we are not eligible is in Vermont, our Shoreham Telephone Company.

[Wally Walker:]

And that will still be picked up as far as legacy, right? You are eligible for legacy support there?

[Rob Souza:]

That is correct. The modified legacy support would continue in that Shoreham area, yes.

[Wally Walker:]

And there is like a 30-day window on this ACAM thing if you – the FCC makes a counter offer, it’s like 30 days, correct. So, this will be in place on January 1, right, your final decision?

[Rob Souza:]

I guess, in theory it’s supposed to be in place as of January 1. The FCC has not necessarily kept to their timelines. We anticipate we will have the information before the end of the year, but based on some of the other dates that slipped, we are not 100% confident we will have the final answer by January 1, but we anticipate our decision would be retroactive to the beginning of the year.

[Wally Walker:]

Alright. Good luck, gentlemen. Thank you.

[Rob Souza:]

Thank you, Wally.

[Operator:]

[Operator Instructions] We will go next to Joe Helmer with Caldwell Securities Inc.

[Joe Helmer:]

Hi, guys. You mentioned in the call that there was a cash sweep anticipated in January of 2017. If you – did you mention the amount or can you tell us what roughly the amount would be?

[Rob Souza:]

We didn’t mention the amount. I am not sure whether Curtis has that on the – off the top of his head but I will certainly defer to Curtis on that.

[Curtis Garner:]

Rob, since we haven’t announced that and put it in the 10-Qs, I don’t think it will be appropriate to release it just on the call. It’s – I think the targeting of the whole credit agreement was to make sure that Otelco got to keep cash above $5 million in terms of operating cash and that the balance of it was used to pay down the loan. So, while I can’t give you an amount, because we haven’t published it, I think that investors can look at that and see approximately what they would see as potential pay down for the investment.

[Joe Helmer:]

Okay, that’s helpful. And also go back a little bit to the – you mentioned a couple of transactions by Oak Hill Partners, I missed that as well. Was there something in particular – I am not exactly familiar with them, could you highlight that again for me?

[Rob Souza:]

Sure. I can’t really provide you any details other than what I have seen in the press which suggested that Oak Hill had acquired a company called First Light, which is somewhat known here in New England and the New York area. And then there was another announcement recently that they plan to acquire a local company in Maine, Oxford Networks, those were the couple that I was thinking of when I made reference to Oak Hill.

[Curtis Garner:]

Did they also decide to buy APNI?

[Rob Souza:]

I am not sure, Curtis whether APNI is part of their acquisition strategy or not I really just know about those two entities at this point.

[Joe Helmer:]

Okay. Thank you, guys. Appreciate it.

[Rob Souza:]

Thank you.

[Operator:]

At this time, there are no additional questions in the queue. I would like to turn the call back over to our speakers for any additional or closing remarks.

[Rob Souza:]

Alright. Sorry about that, I was waiting to see if there are more questions. Obviously we, as Curtis said, we greatly appreciate the time you spent with us. We appreciate your interest in our company. We will continue to update your as information is publicly available and we look forward to talking to you at the end of next quarter. Thanks so much.

[Operator:]

That concludes today’s call. We appreciate your participation.