Otelco Inc
Q3 2014 Earnings Call Transcript

Published: 13 Nov 2014

[Operator:]

Good day everyone and welcome to the Otelco Third Quarter 2014 Earnings Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Kevin Enda. Please go ahead, sir.

[Kevin Enda:]

Thank you, Vicky, and welcome to this Otelco conference call to review the company’s results for the third quarter ended September 30, 2014. Conducting the call today will be Michael Weaver, Chief Executive Officer; and Curtis Garner, Chief Financial Officer. Before we start, let me offer the cautionary note that statements on this conference 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 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 describes such risks and uncertainties, listeners 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 Mike Weaver.

[Michael Weaver:]

Thanks Kevin. Good morning everyone and welcome to our call. Our third quarter results were in line with previous quarters as we generated adjusted EBITDA of $7.2 million from revenues of $18.4 million for an EBITDA margin of 39%. Access loan equivalence increased by 1.2% for the quarter and have increased by one half of 1% for the year. This is primarily attributable to the continued growth of our Hosted PBX products and the demand for fiber transport. During second quarter we reduced our debt by approximately $2.7 million for the nine months ended September 30, our total debt reduction is $14.2 million which includes $9.2 million of voluntary and excess cash flow payments. With the scheduled fourth quarter debt payments our total debt reduction in 2014 will be in excess of $16 million. Capital expenditures were approximately $1.6 million in the third quarter and $4.5 million year-to-date versus $3.1 million for the same nine month period in 2013. We expect annual CapEx to be in the $6 million to $6.5 million range. Our cash balance was $5.8 million at September 2014 and in addition we have an undrawn $5 million revolver on revolving line of credit that’s available to us. Pursuant to the terms of our 2014 stock incentive plan, we granted a total of 124,167 restricted stock units in the third quarter. Of this balance on aggregate of 10,206 restricted units were granted to the company's board of directors and all of those will vest on December 31 of this year. In addition, 113,961 restricted units were granted to our officers and these units will invest – will vest rather than three equal installments in 2015, 2016, and 2017, this vesting is subject to the achievement of certain 2014 financial objectives. The number of shares of Class A common stock issued will depend on the company's performance versus these objectives and these financial objectives are EBITDA, revenue and net debt. In summary we believe we have stabilized our business after last year's balance sheet restructuring, we remain focused on efficiently operating and growing our enterprise in business customer bias and providing our customers more to services they need to operate their business effectively and how significantly reduced our debt each quarter. Curtis if you would please summarize financial results and then we can take questions.

[Curtis Garner:]

Thank you Mike and thanks to everyone on the call for joining us today. Let me apologize in advance if I am little hard to understand. I am seemed to be losing my voice from I don't know whatever. I will do brief overview Mike of third quarter results and then we can open it up to question as you suggested. Beginning with the top line, total revenues decreased 2.9% to $18.4 million from $19 million. the decrease in residential RLEC access line equivalence and revenue decreases due to the FCC's InterCarrier compensation reform order account from majority of the decline and that was partially offset by new cloud hosting and services revenue of $0.2 million for the third quarter relating to the acquisition of reliable networks at the beginning of the year. Breaking the revenue down into its pieces, local services revenue decreased 5.5% to $6.7 million from $7.1 million. Hosted PBX revenue increased by $100,000 with decline in the RLEC residential voice access lines plus the impact of the FCC's order which reduces or eliminates intrastate and local cellular revenues and CLEC market pricing accounted for decrease of $0.4 million. As a reminder part of the RLEC decrease is recovered through the Connect America Fund which is categorized as intrastate access revenue. The decline in distant revenue which is in the same category also accounted for decrease of $0.1 million. Network access revenue decrease 4.8% in the third quarter to $5.8 million from $6.1 million. The Connect America Fund increased by $0.4 million. The increase was more than offset by lower state and special access charges of $0.5 million and lower use base fees and switch access of $0.2 million. Internet revenue increased 1.5% to $3.7 million from $3.6 million profit increase in fiber rental revenue. Transport services revenue decreased 6.5% in the quarter to $1.3 million from $1.4 million as a result of customer turn and pricing actions. Cable internet and satellite television revenue decreased 7% to just under $0.7 million as growth in securities and satellite revenue was more than offset by our cable subscriber attrition. Cloud and hosting and managed services revenue associated with the Reliable Networks acquisition increased revenue $0.2 million with no comparable revenues in earlier period. Shifting to expenses, operating expenses in third quarter decreased 6% to $13.8 million from $14.7 million. Cost to the services decreased 3.3% to $8.8 million from $9.1 million expenses related to professional services and cloud computing increased by $0.1 million onetime network expense credit received in 2013 $0.4 million and no comparable credits in 2014. Network circuit cost, customer service expansion sales expense reductions implemented earlier in 2014 decreased third quarter expense by $0.7 million when compared to the same period in 2013. In addition total cable and internet expense decreased by $0.1 million, sales, general and administrative expenses decreased 7.9% to $2.6 million from 2.8 million. Cloud hosting expenses associated with the acquisition of Reliable Network including an accrual for non-cash compensation stock compensation increased cost by $0.2 million. Increase was more than offset by lower executive expenses of $0.2 million and lower uncollectable and operating taxes of [indiscernible]. Executive expenses increased $0.2 million based on the non-cash stock incentive compensation expense which excluded from adjusted EBITDA. The depreciation and amortization for third quarter 2014 decreased 12.7% to $2.5 million from $2.8 million. The amortization of other intangible assets in New England and CLEC depreciation accounted for that decrease. As Mike mentioned adjusted EBITDA was $7.2 million which is the same as a year ago and compared to $7.4 million in second quarter. These are the – this is the fifth quarter now that we have that we have been past the time order contract in the first -- year-over-year impact from time. During third quarter the company made scheduled excess cash flow and voluntary payments on our debt of $2.7 million lowering that debt $14.4 million Mike already gave you summary of those so I think we are – we have given you that plus look at how we would do for the total year. As Mike mentioned we also invested $1.6 million in property, plant and equipment bringing us to $4.5 for the year and on track for the $6 million and $6.5 million projection for the year. Cash decreased by $9.9 million from the beginning of the year to $5.8 million due primarily to the additional voluntary loan principal payments above our scheduled quarterly payments. That kind of covers the highlights for the quarter with additional details in the press release our SEC form 10-Q should be filed tomorrow and we will provide additional details on our third quarter year-to-date results. Vicky, I will turn the call back over to you and you can shift in and take some investor calls.

[Operator:]

Thank you. [Operator Instructions] And we will take the first question today from Wally Walker, who is a private investor. Please go ahead sir.

[Wally Walker:]

Mike, Curtis hey good morning. Nice quarter.

[Michael Weaver:]

Thank you. Thank you Wally.

[Wally Walker:]

Since Otelco exited reorganization in May of last 2013, there is kind of a large disconnect between how Otelco the business is performing and how the market perceives this performance like for instance in May of last year when Otelco completed its reorganization, it had $133.3 million in debt now just little over year later, it has $114.4 million in debt. That's the reduction of $18.9 million through the required voluntary excess cash flow payments. Now Otelco has also demonstrated the strong EBITDA during this period of time as well, meanwhile the market has ordered this performance by slicing Otelco's market cap by more than half in this period. Now the only thing I can possibly see for this market behavior is fear of Otelco credit agreement expiring in April 2016 with no extension, I like to get your thoughts on this maybe Curtis as well and whether you have explored an extension yet?

[Michael Weaver:]

Thank you Wally, you have obviously done your homework on our history. Thank you for those comments. I mean you are right, the trade agreement expires in April of 2016 and we are cognizant of that. We think our performance has been steady and strong during this period time, I would agree with that observation. And we will not wait to the last minute to negotiate that credit agreement. Having said that, there is ample time to take those steps and we will start that process at the appropriate time with guidance from our bower, so that's my view of where we are on the credit agreement when we are certainly in compliance we are seeing a debt leverage was reduced in the third quarter from the previous quarter due to the payments – the principal payments on the day so we are making progress. We wish the leverage will come down faster but we are pleased with our progress today. So and we will, short answer is we will have those conversations with our existing lenders as we get closer to time for the renewal of the fully amendment and extension. Curtis I don’t know if you have any thoughts you would like to add to that?

[Curtis Garner:]

No, Mike I think you covered everything. The only thing I point out is that the more history we have are paying down from 133 to 114 to 110 to 105 to 100 that puts us in a better position when we do go into negotiate these things.

[Wally Walker:]

Thanks a lot you guys. Could I ask you one more question here real quick.

[Michael Weaver:]

Of course.

[Wally Walker:]

Okay. One of your competitors in northern New England is involved at work staff right now. I am wondering if this had any effect on Otelco operations in northern New England?

[Michael Weaver:]

Another good question Wally and thank you. It has not a huge effect and I want to expand on that just a little bit so our relationship with Fairpoint is one where, our valued customers and our valued supplier as well as very strong competitor. We have been impacted is almost customers particularly with new orders and new sales where the last month outcome from Fairpoint facility the cause of the strike those orders are being delayed typically on an order like that, we again it’s fairly common to meet the last mile facility for Fairpoint simply because they network is so EBIT and it's the largest network in New England. So typically when we place an order, Fairpoint would put that in a queue and work it in a timely fashion. Due to the strike their response time on that has slowed a great deal, so how that impacts us is it puts those orders at risk for going to cable providers and/ or at the very least slows down our revenue stream. Our understanding from published documents that Fairpoint and the union have scheduled another meeting to come and negotiate type on November 18 and we are hopeful that that those talks will be fruitful and lead to a resolution of the strike.

[Wally Walker:]

Thanks a lot gentlemen.

[Operator:]

And next up is Jane Riley, who is also a private investor. Please go ahead sir.

[Jane Riley:]

Hi there. I just like to know 1975 business lines got added this quarter and that's more than prior two years in total. Do you see this as going forward at this rate or is there like some onetime event that happened this quarter that came out with this large number?

[Michael Weaver:]

Thank you Mr. Riley those are actually, those warrants are derived from the addition of fiber transport primarily to schools and educational facilities. We have had a great year with that's been the probably reason for the overall growth not just the quarter but year-to-date in our business and that has to do primarily with educational facilities and local municipalities where they are combing networks to bring all their data back to one common source and it's been a good year for us. We expect that to slow that typically a stronger in the second and third quarter again because of skills and educational skills out lot more works are done, so that will slow in the fourth quarter. You won't see that kind of growth but we expect that trend while the trend might not be quite as dramatic in future quarters, we do expect some continuation of carriers and other customers for fiber transport.

[Jane Riley:]

Okay and I am going to go back to that last question I missed the Walker a little bit. If the Fairpoint strike cannot happen, do you think that this number would have actually been greater, the 1975?

[Michael Weaver:]

No I don't because most of them, again based on my understanding of your question the primary reason for that extraordinary growth has been the fiber transport most of that occurred outside of our New England territories. And the strike only happened late in the third quarter. So the bigger impact of the Fairpoint strike is for – is on our customers counts, they seen in the fourth quarter if that's not resolved by the end of the year then it will – it's logical to think the growth of business lines will be negatively affected by that for fourth quarter this year.

[Jane Riley:]

Okay and then just to change the topic a little bit the internet I mean intrastate access revenue where we can see that's growing as a percentage of your total revenues unlike the last two years has been going up, is this like a transitional phase for that or do you see that going forward another year or so growing at the rate of spend growing?

[Michael Weaver:]

Really what you are seeing is the effect of the total FCC reform within the excess revenue the numbers are shifting and as Curtis pointed they’re in his comments, been overall we have seen the decline of excess revenue year from third quarter third quarter last year there has been a total decline about $300,000. We expect that decline to continue and again what you are seeing are changes within the bigger revenue category and we do not expect overall growth in excess revenue.

[Jane Riley:]

Okay. Well, I was talking about the intrastate excess revenue when I multiply the percentages of intrastate access that you point out in the 10Q by the total revenues that number looks like it's going up?

[Michael Weaver:]

It's a function of the numbers and not – we are, I don't mean that we’re speaking the total dollar value of access revenue has declined period-over-period. So what you are seeing is a function of the fact that the numbers have declined in total and intrastate is a larger percentage of a smaller total.

[Jane Riley:]

Right and then it's also from quarter-to-quarter it's not really consistent it's slummy and what would the reason for that be?

[Michael Weaver:]

That's another good question. The way the intrastate – the way we are paid for the intrastate access revenue is part of a rather lengthy and complicated settlement process through NECA, the exchange, the national exchange carriers association. Otelco revenue lock every other telephone companies is affected by what other companies file on a quarterly basis, quarterly and monthly basis and is part of the settlement process our revenue can be impacted positively or negatively by actions within the pool. So you will see that on a quarter-to-quarter basis and one of the things that might set hard to predict on a revenue stream for any telephone company is that impact quarter-to-quarter will swing, we had some quarters I think it was second quarter, first quarter in the second quarter we had positive swing with that because of pool adjustments. You are seeing in the third quarter it was negative for us. That's all normal and we will continue for the future.

[Jane Riley:]

Thank you.

[Operator:]

At this time there is one name remaining in the rooster [Operator Instructions] and we will take the next question from Chris Brown. He is with Aristides Capital. Please go ahead.

[Chris Brown:]

Good morning gentlemen. I just had a question it sounds like there is definitely going to be some regulatory headwinds in terms of 4Q and next year, in terms of decreased access rates or decreased subsidiaries. I was just wondering if you guys will be willing to kind of go out and put an estimate in terms of what you think the drag is going to look like?

[Michael Weaver:]

No, not at this time. And I want to be clear about it too. There is nothing new on the horizon the FCC reform that actually started in 2012 is what’s driving the changes in the regulatory environment. And as part of that reform the access revenues will decline over a period through 2020 as Curtis mentioned there is some – it's not dollar for dollar because when you have one part of the access revenue declining Connect America Fund picks up by portion of that revenue. So there is nothing. There is nothing new that we haven’t disclosed and it's not affecting every telephone company but as far as providing information at this time about what we expect that dollar decline to be we are not in a position to do that.

[Chris Brown:]

Okay. One other question. I was just curious what you think your probably company expenses are on an annual basis and if there is any serious possibility or maybe deregistering at some point if those expenses are worth enough to potentially safe?

[Michael Weaver:]

I don't, further cost to Curtis. We currently have over 3,000 share owners. So I think there is no possibility of us becoming a private company I don't think it might at this point in time understand where you coming from where the size of the company would there be substantial savings in there but that's the question that at the appropriate time the board would consider again due to the ownership – the large number of owners that Otelco stock, I don't know that’s a realistic possibility for us.

[Chris Brown:]

So one way you can get around that is to do a reverse split and cash out fractional shares that's a very effective way of getting your shareholders count down if you need to. I am not saying you said to do that I was just kind of curious like your public company expenses because it's as small as you are it just seems like something worth exploring. But alright. Can you give us an update on the new business that you acquired?

[Michael Weaver:]

Yes, we are pleased with the results for Reliable, they are in line, their revenue and their EBITDA are in line with our expectations. We are anticipating growth in that business for next year in the first quarter of this year, we spent $250,000 to $300,000 upgrading some of our facilities in main and anticipation of growth for Reliable is one of the things that we need to have in place in order to achieve that growth. We are currently looking for adding some additional personnel in the sales and technical expertise for Reliable. And we think we are positioned for that to continue to achieve the growth that we are projected. If you recall back when we bought the company more of the things that we identified as a reason for the acquisition was the success of the hosted product where with hosted you are really giving our customers networks and Reliable provides us additional expertise to help manage customer networks and outside facilities. So we are pleased with the acquisition. Those guys are doing a great job and we expect growth in 2015 and beyond. The integration is finished and its going well and candidly we are excited to have them on board.

[Chris Brown:]

Great. Great. Thank you.

[Operator:]

And we will go to Tucker Golden with Solas Capital. Please go ahead.

[Tucker Golden:]

Hi! good morning. Thanks for taking my question. First question is just I saw the tax rates, debt tax rates looked like around 29% this quarter wondering why was this low as this was and or your outlook is on that front?

[Michael Weaver:]

Curtis can you – you better equipped to answer the tax question than I am.

[Curtis Garner:]

I think that the long run tax impact will be a fairly normal more like 35% in fact I thought for some reason that our effective tax rate was 38% for the year. So I think that will be more in that normal range once we pass the restructuring expense or restructuring interval, we basically lost all of our NOLs other than the tax basis in our corporate guide and equipment, we got to retain that and then our intangible asset. So I think you will see us in a being a very normal tax payer beginning with the 2014 tax year.

[Tucker Golden:]

Okay. So in the previous quarters were higher, 38 or so, maybe there is an extra you said was that a cash benefit in the quarter or was that an extra $250,000 or $220,000 in cash flow from this?

[Curtis Garner:]

No. no cash benefits that's just the provision process. When we see this 10Q models, we see that the effective tax rate put at 38% for the year on year-to-date basis.

[Tucker Golden:]

Okay. I will look for that. Got it. Any insight into any possible dividends coming from core bank in the first quarter?

[Curtis Garner:]

The core bank never projects out their dividends in the sense of the dividends come in three forms as I know, one is cash dividends, the second one is patriot stock and the third one is recovering the previous patriot stocking and cashing it out. Last year was the first year they cashed out the significant amount of patron share and so our net income was higher, I would assume that you can't make it well because you can't make the assumption we will do that this year because they haven’t made their decision yet. So the normal cash dividend in the past has been in $200,000 to $225,000 range they could make that higher. They could make that lower depending on their decision and we won't know anything about that until probably the first part of March.

[Tucker Golden:]

Okay. Got it. That help me a little bit, helps. So you said few things in your release and in your comments about EBITDA being consistent in the flat year-over-year comparison, it is encouraging can you commit at this point I guess we are down to $7.25 million of EBITDA in the last quarter can you commit to maintaining that level or at least that being your base line assumption going forward?

[Michael Weaver:]

No and no. for several reasons. First, like all telephone – the other issue that we have like all telephone companies, we continue to lose subscribers overall certainly the business line growth that we have mentioned several times in this call is incredible and it certainly helps to offset that but on a residential as the numbers indicate the residential voices will continue to lose lines with the source of revenue, its logical to think that the revenue could decline some in future years and the other we again as previously stated, we know that it's reasonable to expect the access revenue to decline. Our – we have done judgment pretty good job of managing expenses that's the challenge that we will have going forward as to continue to work on our cost and try to keep that in line with somewhat declined revenue voice. So that's why I would be reluctant in wrong to commit to you that the voice going forward in the 2015 and 2016 on a quarterly basis with the EBITDA of $7.2 million.

[Tucker Golden:]

Right and I think that's perhaps everyone in the call as well, aware of the top line challenges and the solution, is to find cost cuts and opportunities as you have this year to some extend to maintain EBITDA but it sounds like you really I mean I know in the past when you talked about the cost structure you feel it's fairly lean as it is, in your current structure -- getting on a public company expanses doesn’t sound like that's being considered and I am not sure it should be or shouldn't be but it does seem like there aren’t any more obvious opportunities and that's probably why you are reluctant understandably so to commit the flat EBITDA because you really can't offset this revenue decline to keep EBITDA where it is and if I go back to that first caller's comment, it's exciting to see debt come down but when EBITDA is coming down where the debt most, the enterprise side there is no value really being created for shareholders and I think that's the point that lost down some of the shareholders base and I don't know if it's lost or not on the board and management team but I look at their net leverage ratio, it's really not coming down and I don't project it coming down a whole lot either. Debt will come down but net debt EBITDA will not and that just means we are sort of taking on the risk of getting closer to that April 2016 maturity not knowing what the credit market will be like leading into that deadline and I don't see the reward from that risk. One thing if we can say I think EBITDA is going to be high 20s annually going forward because of finding our cost to cut and you are going to therefore de-lever and create value for the equity but by just bringing debt down on finance basis, it has to come down at a certain pace or certainly there is being lot of risk without really in my view any potential reward. I know I talked this topic pretty frequently but I would like to every time three or six months passes, things change -- I would love to hear how you are thinking about that these days and if you can mix in there something that a prior caller asked about in terms of the opportunities you are finding, how you are managing that risk. It's not that far away any more comfort you can provide us that you are managing that risk for shareholders?

[Michael Weaver:]

That's a long question Tucker, it's one of our primary concerns we are addressing it several ways, first we as our results indicate, we are committed to paying down the debt. We take the extra cash that we have and voluntary payments and all and $16 million debt reduction in 12 months which is what will be by the end of the year is pretty significant for some of our size, so that's point one as we are committed to bringing that leverage. Point two is, with to point that you are right that is leverage coming down as fast as the board note and the management would like to see no but it is coming down. We are being successful with we are not staying even, it's not – it is decreasing. So and again not certainly – it's not as rapidly as we would like but it is decreasing. It’s to managing the refinance risk it's certainly I don't know anything we could do that we are not doing meaning we are committed to paying down the debt we manage our cost to try to maximize our EBITDA and maximize – so we have an appropriate match between the revenue and expenses and we are not I don't want to leave you with impression that we are not going to start the process of the extension of standard refinance or whatever we choose until we will start that soon and that's again that's the discussion that we will be headed at the board level to Curtis makes an excellent point that while we are waiting we are not sitting on our hands, we are looking at additional products. We constantly monitor our cost and try to see can we tweak it as you pointed out on the core bank dividend, every little bit heaps on revenue and bottom line things and so we will undertake that process early in the year because we do not, we see that the sign why is the investors is that have significant advantage and we will start that process soon. Other than that I don't know what comfort that can provide to you.

[Tucker Golden:]

Okay. Yes, I just want to make sure there is an understanding that de-levering isn’t value creation unless it is at a pace that reduces your net leverage ratio and debt to EBITDA this year and it's not going down. It's kind of hanging in there 36, 38, 37 now and when I forecast it forward unless EBITDA is flat in which case you do create value for shareholders. I don't see if it's declining few percent a year. I don't see a lot of value either. But hopefully you can keep finding this cost I think operationally it seems like encouraging your team are doing an excellent job. It's a lot of headwind and then so certainly don't mean to be -- in the questions expect to operations it's more governance it's strategy that I am concerned about but I do appreciate your efforts and you are having these cost and I wish you the best of luck.

[Michael Weaver:]

Thank you.

[Curtis Garner:]

Thank you Tucker.

[Operator:]

And there is no one else in the queue but I would like to get everyone one final opportunity. [Operator Instructions] It appears there are no other questions. So I will turn the call back to Mike Weaver for any additional or closing remarks.

[Michael Weaver:]

Just thank you for everyone for joining us. The questions were excellent. I appreciate your participation and we will do this again in three months. So thanks a lot.

[Operator:]

And thank you very much. That does conclude our conference for today. I would like to thank everyone for your participation.