Otelco Inc
Q4 2016 Earnings Call Transcript

Published: 7 Mar 2017

[Operator:]

Good day, everyone. Welcome to Otelco’s Fourth Quarter 2016 Earnings Conference. Today’s conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Ms. Drew Anderson. Please go ahead, ma’am.

[Drew Anderson:]

Thank you, Kelly and welcome to the Otelco conference call to review the company’s results for the fourth quarter and year ended December 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 facts 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.

[Rob Souza:]

Thanks Drew. Good morning and welcome to our fourth quarter investor call. I want to begin today by providing some highlights regarding our operational performance for the quarter as well as update everyone on changes within the industry. Curtis will then review our financial results. And afterwards, we will definitely take your questions. The most significant event during the fourth quarter of 2016 was Otelco’s acceptance of the FCC’s A-CAM offer in our eligible RLECs. While A-CAM had no impact on our 2016 financial results, it will certainly affect many companies in our industry as well as Otelco’s results for the next decade. As you recall in March 2016, the FCC issued its Universal Service Fund reform order for rate of return carriers to fundamentally change the way that rural rate of return carriers obtain USF support. As noted last quarter, we elected to accept the new model-based support for the 5 states where we are eligible. The program provides a 10-year funding mechanism to continue the broadband transition to provide increased availability and speed for our rural customers. We charge our Internet customers a flat rate for unlimited Internet usage and a premium for higher speed Internet services and we are able to provide digital high-speed Internet data lines to over 95% of our RLEC access lines. Under A-CAM, we have specific requirements to expand the availability of higher broadband speeds to our customers and expect to invest in our network to meet or exceed those requirements. We have already met the requirements defined by the FCC for our operation in Vermont and we are ineligible for A-CAM. As currently established, the acceptance of A-CAM funding will provide a positive impact on the company. These elections were effective on January 1, 2017 and will provide defined support revenue for the next 10 years. The A-CAM election includes specific broadband deployment obligations, including the number of locations to be capable of specific broadband speeds within certain eligible census blocks in our service area. Funding under the new A-CAM model-based support is expected to increase 2017 support by an estimated $1.5 million compared to 2016 support received under the legacy rate of return regulation. Without the new A-CAM model-based support, in 2017, RLECs would have seen a normal year-over-year funding decrease under the non-model support that included the FCC’s newly adopted budget control mechanism. A-CAM support requires additional investment in plant and equipment to reach targeted broadband speeds and covered locations. A-CAM transition to support will decline through 2026 as the additional broadband investment is completed. Now, looking at the fourth quarter of 2016, our results reflect industry conditions as top line residential revenue remains under pressure for all telephone companies. The impact of the FCC’s 2011 access reform order as well as the commission’s budget control mechanism which became effective in September also had an impact on our operating income, net income and consolidated EBITDA in the fourth quarter as all these metrics were down slightly year-over-year. However, these financial results were consistent with our results for the third quarter of 2016. We continue to make progress in growing data line and Hosted PBX as customers move through the lifecycle of Internet protocol technology adoption and recognize the quality of our product when measured against other market offers. Our Hosted PBX lines grew by 5.3% in 2016, slightly below the 7% growth rate we experienced the prior year as competition and market penetration for this service have matured. During the fourth quarter, we were awarded the contract in Leverett, Massachusetts to provide Internet and voice to this community. We began coordinating the planned conversion of over 600 residential lines and expect to be done with the conversion by the end of the first quarter of 2017 or early in second quarter. In other new developments, in December, we signed a long-term fiber IRU with a national top carrier that will enhance our transport revenue beginning in March. We have also seen favorable trends with newer offerings like video and security and managed services. Our focus on continuous cost improvements and efficiencies across our markets remains a critical element of our strategy. Our operating expenses decreased by 3.3% over the same period a year ago. During the fourth quarter, we selected the replacement product for all of our billing and operation systems to create a consistent platform across our entire business. We have started the conversion planning and we expect that the completion of this conversion over the next 12 months will provide for more granular customer data, enhanced customer service and improved efficiency in handling customer requirement. We also continue to address top line revenue enhancements, promotions and where appropriate, pricing action and we are working hard to identify and take advantage of additional growth opportunities in the current marketplace. Reflecting a general trend in the RLEC industry, the number of rural residential voice access lines we serve has been decreasing each year. However, business access lines have remained steady or shown modest growth. We expect that these trends will continue as we respond to competition in our RLEC territory, cellular and IP-based service substitution as well as general economic conditions. Our ability to grow CLEC and RLEC business voice and data lines will have an important impact on our future revenues. Our primary strategy consists of leveraging our strong incumbent RLEC position, including expanding our fiber network and providing better service and support levels, and a broad suite of services, including managed services and hybrid cloud-based hosting. Our business and enterprise access lines for the quarter were relatively flat both sequentially and on a year-over-year basis. At the end of 2016, business and enterprise access line equivalents accounted for over 56% of our access line equivalents, up from about 55% a year ago. Residential access line equivalents declined by 736 during the fourth quarter of 2016 or a 1.8% change compared with the previous quarter ended September 30, 2016. This reflects industry-wide trend. Residential data lines declined at a much slower pace than voice access lines as customers disconnecting their voice lines chose to retain their data services. For 2016, business and enterprise access line equivalents decreased 1%. Residential access line equivalents decreased 6.2% with the decrease attributable to the loss of RLEC customers to competitive alternatives. At December 31, 2016, we operated 94,029 total access line equivalent. Cable and IPTV television decreased by 107 customers in Alabama, while our relationship with 246 satellite television subscribers in Missouri ended when DirecTV withdrew its resale channel in October 2016. Security systems increased 8%. Finally, last quarter we announced the engagement of The Bank Street Group LLC to explore strategic alternatives for the company. Obviously, our top priority in this process is to identify opportunities for Otelco that maximize shareholder value. At this point, we are evaluating a range of options. However, it is important to note that 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 the 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 laws. Curtis will now summarize the fourth quarter results for you.

[Curtis Garner:]

Thank you, Rob and we appreciate everybody joining us today. I will provide a brief overview of our fourth quarter financial highlights as contained in the press release that we sent out yesterday. Unless noted otherwise, every comparison is against the same period last year which is generally fourth quarter versus fourth quarter. Also, we expect to file our 10-K at the end of the week, which will have additional information about results for the year 2016. Total revenues for the fourth quarter were $16.8 million, a 5% decrease when you compare that to $17.7 million for the same quarter a year ago. The drop in residential RLEC access lines and access revenue decreases due to the FCC’s inter-carrier compensation reform order, account for the majority of the decline, which was partially offset by an increase in Internet, video and security and managed services group. Now let’s look at the components of the revenue briefly. Local services revenue was $5.7 million, which was a decrease of 7.5% over the same period last year. The decline in RLEC residential access – 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, a portion of the RLEC decrease is recovered through the Connect America Fund, which is categorized as interstate access revenue. Decline in long distance and special line revenues accounted for a decrease of $0.2 million. Network access revenue decreased 8.5% to $5 million and Connect America Fund increased $0.3 million, offset by declines in end user fees of $0.1 million, special access charges of $0.2 million and switched access charges of $0.5 million. Internet revenue was $3.9 million, about 3.6% increase as higher equipment fees, increased residential fees and pricing accounted for the increase. Transport services revenue decreased 12.2% to $1.2 million, reflecting customer churn and market prices. Video and security revenue increased 8.4% to just over $0.7 million, reflecting increases in security and IPTV deployment. Managed services revenue increased 6.1% to slightly over $0.2 million in the fourth quarter of 2016, reflecting increases in cloud hosting and professional services revenue. Moving on to operating expenses for the fourth quarter, Rob mentioned our continuing focus on expense management, which resulted in a 3.3% decrease in operating expenses of $12.2 million. Cost of services decreased 3.1% as digital equipment, access, toll and Internet expense decreased $0.3 million. Customer service and sales expense, Hosted PBX equipment expense and resale facility expense were each down $0.1 million. These decreases were partially offset by $0.1 million increase in access digital service and buried cable. SG&A was $2.4 million, a 2.7% increase over last year. The increase was attributable to a one-time benefit in 2015 that was associated with the end of an executive retirement liability associated with a 2003 acquisition. Depreciation and amortization decreased 10.2% to $2 million from $2.2 million, the amortization of other intangible assets in New England decreased by $0.1 million and CLEC depreciation decreased by $0.1 million. Operating income was $4.6 million, a 9.2% decrease over last year, primarily due to the decline of revenue. 41.8% year-over-year increase in interest expense reflects the higher interest rates on our new loan facilities and increased amortization of the related loan costs on the new transactions. Factoring in all of these changes, net income was $0.9 million for the fourth quarter compared to $1.8 million a year ago or a $0.9 million decline primarily due to the increase in interest expense I discussed. Consolidated EBITDA was $6.7 million which is the same as the third quarter, but down $0.7 million from the same period a year ago. Looking at the balance sheet, we ended fourth quarter and the year with $10.5 million in cash or an increase of $3.6 million since the end of 2015. As we announced during first quarter of 2016, the company entered into the new 5-year senior and 5.5-year subordinated loan facilities. Principal payments are $1 million per quarter payable at the 1 January, April, July and October of each year. We made a principal payment in fourth quarter as targeted on December 30, the outstanding senior loan balance was $82 million. Additional reductions of $4.1 million are scheduled for first quarter of this year, including the annualized cash flow base. Capital expenditures were $2.8 million for the fourth quarter of 2016 compared to $2.2 million for the same period in 2015. For the year, our annual level investment increased $0.4 million over the 6.5 million rate in the past several years. This covers the highlights, I think Rob of the quarter and the year of those additional details in the press release and in the upcoming – there will be more in the upcoming 10-K. Kelly, if you can provide directions, we can shift to take investor questions at this time.

[Operator:]

Thank you. [Operator Instructions] We will go first to Wally Walker, private investor.

[Wally Walker:]

Hey, good morning gentlemen, Rob, Curtis, how are you doing?

[Curtis Garner:]

Doing good, how are you doing Wally?

[Wally Walker:]

Wonderful. Good to hear from you Curtis. While I am aware Otelco, historically hasn’t given forward-looking financial projections, but taking into account the positive A-CAM effects starting this year as well as some things that are happening on the non-regulated side of the business, would it be unreasonable to assume that Otelco’s revenue and EBITDA decline the past couple of years possibly stabilize or reverse this year or at least the rate of decline be lower?

[Rob Souza:]

Well, the one thing I can certainly comment on Wally and thank you for the question, it’s a good one. The one thing I can comment on is the fact that with the certainty of A-CAM, we clearly recognized we are going to receive basically $1.5 million more than we would have received from our existing legacy access. As a result of that, we won’t see those traditional declines that we have seen on a year-over-year where that revenue would stabilize. So from that perspective, I think we feel good about our revenue position for 2017.

[Wally Walker:]

Okay. This might be a little bit farther into the future, but I see the FCC is finalizing the Connect America Phase 2 reverse auction, which is more a support for un-served rural high cost areas, I believe the budget is just under $2 billion, is that something that may interest Otelco?

[Curtis Garner:]

Well, certainly, I think it would be something that we would look at Wally. From our perspective, what we want to do is map out those locations, verify proximity to where we are at the present time. And then see whether any of that would make sense. But I think its way too early in the process to have any kind of ideas to what we would do. We are certainly willing and interested in looking into those opportunities to see if they might fit into our forward-looking strategy.

[Wally Walker:]

Okay. One final thing here, it sounds like a lot of options are being considered right now at Otelco, I hope refinancing is one of them, you continue to have lower leverage than many of your wireline peers, the credit market right is now much more favorable than what it was when you weren’t working on this current credit agreement and it was signed and the prepayment penalty has gone down already [indiscernible] that?

[Rob Souza:]

Certainly the prepayment penalty has dropped I think basically about 1 point, I think that was effective possibly the end of February, which is I think the 1 year anniversary of our financing. As I indicated earlier in my comments Wally, I don’t plan on commenting on the strategic alternatives, but as we indicated, we are looking at a broad range of options to see what would work best for the company and maximize shareholder value.

[Wally Walker:]

Alright. Thank you. You guys have a good day.

[Rob Souza:]

Thank you, sir.

[Operator:]

[Operator Instructions] We will move next to Adam Hirsh [ph] of WAM Capital.

[Unidentified Analyst:]

Hi, good morning guys.

[Rob Souza:]

Good morning.

[Unidentified Analyst:]

Wally really just touched on my primary question about the refi-ing as high yield trends have come down almost 430 basis points just over last year, do you consider that more of a strategic alternative, so you won’t comment on that or is that just [indiscernible] is that as you don’t want to talk about future stuff?

[Rob Souza:]

Adam, I am sorry. Can you ask the question again, I am not sure I…?

[Unidentified Analyst:]

I am sorry. My main question was basically, Wally was saying is refi-ing of that high interest debt in this payment pre-penalty and moving on because obviously that’s been a big detriment to your net income and your free cash flow?

[Rob Souza:]

Sure. We recognize that the current debt agreement has its certain, I guess I would call limitations. Obviously, when we announced, we were looking at strategic alternatives, that’s one of the things that certainly enters into the calculation as we look at what our options might be. But as I have indicated at this point, I am not prepared to comment on refinancing or any other opportunity that we might have on the table as we proceed through this process.

[Unidentified Analyst:]

Okay, thanks. And then the additional $1.5 million that you will get from A-CAM going through next year, is that the same margin as other revenue or is that just drop straight to bottom line?

[Rob Souza:]

Well, obviously, access revenue tends to have higher margin than other revenues that we realize. At the same time, we do have build-out obligations, which is what the FCC envisioned with the revenue surety. They believe companies like ours would continue to invest in the network, which has a long-term benefit for the company, short-term and long-term benefit for the company from the standpoint of getting far more customers connected to fiber, therefore higher speeds and therefore, a lot more stickiness when it comes to customers, when it comes to high-speed data connectivity. So from that perspective – I am sorry, go ahead.

[Unidentified Analyst:]

No, I will say great. Thank you for that color.

[Rob Souza:]

You’re welcome sir.

[Operator:]

[Operator Instructions] We will go next to Alex [indiscernible] Investors.

[Unidentified Analyst:]

Hello. Thank you so much for taking the question. Again I know you don’t give forward-looking statements, but just on the trend of capital expenditure, I would assume it goes the A-CAM obligation, there will be increased spending, is my thinking correct, so is 2017 CapEx, would it be higher than ‘16 as a trend? Thank you.

[Rob Souza:]

I would imagine that 2017 trend would be similar to 2016. I think Alex, what it is, is more of a reprioritization of where we are spending our dollars, certainly dialing in to those locations that are covered those census blocks that are covered under the FCC’s A-CAM model and making sure that we are prioritizing where we are spending our money at this point in time.

[Unidentified Analyst:]

Alright. Thank you.

[Rob Souza:]

You’re welcome sir.

[Operator:]

And we have no other questions here at this time.

[Rob Souza:]

Alright.

[Operator:]

Do you all have any closing remarks that you would like to make?

[Rob Souza:]

Certainly, we definitely appreciate everyone joining us this morning. We continue to remain focused on managing Otelco in tandem with the significant changes that are occurring in our industry and we continue to look for additional growth opportunities in the current marketplace. As always, we are dedicated to delivering greater value to our shareholders. So once again, we thank you for being here. We are happy to answer your questions and we look forward to doing this again in another quarter. Thanks so much.

[Operator:]

And that will conclude today’s conference. Again, thank you all for joining us.