Otelco's (OTEL) CEO Michael Weaver on Q1 2014 Results - Earnings Call Transcript

| About: Otelco, Inc. (OTEL)

Otelco Inc. (NASDAQ:OTEL)

Q1 2014 Earnings Conference Call

May 07, 2014, 11:30 AM ET


Kevin Enda - Investor Relations

Michael Weaver - Chief Executive Officer

Curtis Garner - Chief Financial Officer and Board Secretary


Chris Brown - Aristides Capital

Steve Hale - Hale Partnership

Tucker Golden - Solas Capital


Good day, and welcome to the Otelco Inc. conference call. Today's even is being recorded. For opening remarks and introductions, I will turn the call over to Mr. Kevin Enda.

Kevin Enda

Thank you, Felicia, and welcome to this Otelco conference call to review the company's results for the first quarter ended March 31, 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 please, believes, belief, expects, intends, anticipate 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'll now turn the call over to Mike Weaver.

Michael Weaver

Thank you, Kevin. Good morning, and welcome to our call. Aided by approximately $700,000 in non-recurring items, we produced adjusted EBITDA of $7.5 million in the first quarter of 2014. These non-recurring items consisted of a larger than expected cash dividend from one of our lenders CoBank and a one-time increase in access revenue from the settlement of our projected 2013 NECA cost study.

In the first quarter, our access line equivalents remained essentially the sign as the fourth quarter of 2013. We experienced a growth of 1.2% in our business access and data lines, as a result of the installation of fiber transport facilities in our RLEC operations.

We continue to see growth in our Hosted PBX services and modest overall growth in our data lines. As expected, our residential access line equivalents declined as is happening throughout our industry.

Capital investment for the quarter was $1.44 million and consisted of both maintenance and growth items. Approximately 21% of the first quarter investment was spent for the expansion of our switching facilities in Maine.

This expansion created additional co-location space and provides additional capacity for anticipated growth from Reliable Networks to manage services company we purchased in January of this year. We expect similar levels of investment throughout the balance of 2014.

As part of our ongoing efforts to control cost and improve operating efficiency, we've identified approximately $1.2 million of cost that we expect to eliminate in 2014. The review was comprehensive and included an independent third-party review of our network facilities and operations in New England. This review along with management's efforts to streamline operations should result in cost savings of approximately $530,000 in our RLEC and cable TV operations and $650,000 in the CLEC operations.

These cost savings have been implemented and consist of an 8% reduction in the number of employees, refinements in our cable television offerings and reductions in our network cost. The realization of these cost reductions will begin in July after payment of severance packages and other costs associated with the reductions.

The first few months after an acquisition are typically a bit disruptive, as you work through the process of integrating two unique entities. We've been very pleased with the results from Reliable Networks during the first quarter, as their revenue and EBITDA met our expectations.

We're continuing our efforts to introduce our expanded customer base to the products that both Reliable Networks and Otelco offer, and we're beginning to gain traction and see positive results from all these efforts.

We also continue to look for new products and services that are user-friendly and create opportunities for growth in our existing product lines. This week we began offering a product known as [ph] eFax, which is an enhancement to our Hosted PBX services that's offered using our IP technology.

Regulated industries that have to deal with security concerns, faxes remain a primary means of transmitting data and our new service works well with our hosted systems. We also plan to expand our relationship with DISH Satellite and expect to begin selling and billing for DISH services in Maine later this year.

On the regulatory front and recent FCC announcements indicate that the quantitative regression analysis, which is commonly referred to as QRA, that was previously announced as part of the comprehensive FCC Reforms has be abandoned.

Based on our understanding of this change and our own analysis, this will result in additional revenue for our RLEC. At this time, we're not able to quantify that amount, because we're waiting on more information from the FCC determine the start date and effective date of this change, so that we can determine the dollar impact.

In other FCC announcements, Chairman Wheeler indicated, he will recommend a postponement in the implementation of the rule benchmark rate hike that would go in to effect June 1, as a result of one of the provisions of U.S.A. of transformation order issued in November 2011.

In his proposal, the 2014 rate increase, which is required to be in place about December 1, 2014, is limited to a maximum of $2 per basic line charge. After the December rate increase, the next plan increase is July 1, 2016. We expect the final order to be published later this year. The effect it has on Otelco is that we have three companies that will need to increase their rates, and these increases will be from $0.74 to $2 per line in these three RLEC companies.

In another positive note, we promoted Rob Souza to Corporate President of Otelco. Rob has many years of experience in our industry and has worked with Otelco as a member of senior management since our acquisition of Country Road in 2008.

At the time of that acquisition, Rob was President of the company, so the responsibilities of his new role were not new to him. Rob's experience is primarily in network and operations of our business and the expansion of his role allow us to utilize his skills across our entire company, instead of limiting those skills to the Northeast.

In summary, we remain focused on efficiently operating and growing our enterprise and business customer base and providing more of the services they need to operate their businesses effectively.

I'll now ask Curtis to summarize the financial results, and then we will take your questions.

Curtis Garner

Thank you, Mike, and thanks everyone on the call for joining us today. Let me provide a brief overview of first quarter financial highlights, and then we will open it up for questions.

Beginning with the topline, first quarter revenue decreased $2.2 million or 10.5% when compared to first quarter of 2013 to $18.8 million from $21.0 million. The non-renewal of the Time Warner contract accounted for approximately $1.3 million or some 61% of the decline.

The majority of the remaining decline was a result of a decrease in residential RLEC access line equivalents and revenue decreases driven by the continued implementation of the FCC's Intercarrier Compensation Reform Order.

Breaking down the revenue pieces, local services revenue decreased to 20.7% to $6.8 million from $8.5 million, including a $1.1 million Time Warner cable decrease. The FCC's Intercarrier Compensation 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, but this is categorized as interstate access revenue. The decline in RLEC voice access lines and CLEC market pricing accounted for the balance.

Network access revenue decreased 4.6% to $6.2 million from $6.5 million in the quarter ended March 31, 2014, including a decrease of $0.3 million associated with the end of the Time Warner contract. Increases in the Connect America Fund and the 2013 one-time NECA cost study receivable, Mike mentioned, of $0.3 million were offset by decreases in Universal Services Fund and Transition Services Fund support, end-user charges and switched access revenue.

Internet revenue decreased 3.1% to $3.6 million from $3.7 million. The decrease in residential data lines and dial-up internet was partially offset by an increase in RLEC fiber rental. Transport services revenue decreased 11.5% to $1.3 million from $1.5 million, primarily from customer churn.

Cable television revenue decreased 5.7% to just under $0.8 million from just over $0.7 million. The decline in cable and IPTV revenue was due to subscriber attrition and was partially offset by an increase in security systems revenue, which shows up in the same category.

Cloud hosting and managed services revenue associated with the acquisition of Reliable Networks increased our revenue by $0.2 million for first quarter with no comparable revenue for the year earlier period.

Moving on to cost and expense. All of the categories in cost and expense decreased to $14.8 million for a decline of $1.3 million or 8%. Cost of services decreased 2.7% to $9.4 million from $9.7 million with the elimination of Time Warner cost accounting for a decrease of $0.2 million. Lower internet customer service and network operations expenses accounted for the balance of the decrease.

Selling, general and administrative expenses decreased 8.8% to $2.6 million from $2.9 million in the three months ended March 31, 2014. Cloud hosting expense associated with our acquisition of Reliable Networks, including an accrual for non-cash stock compensation to the owners, increased costs $0.2 million, which were more than offset by lower uncollectible expenses, lower property and operational taxes and reduced insurance and legal expenses.

Depreciation and amortization for first quarter 2014 decreased 21.9% to $2.8 million from $3.6 million in first quarter of 2013. Amortization associated with the Time Warner Cable contract intangible asset decreased by just under $0.7 million as the contract was fully amortized in June of last year. The amortization of other intangible assets associated with the Country Road acquisition in October of 2008 decreased by $0.1 million.

As Mike mentioned, we received our annual patronage dividend from CoBank during first quarter. Compared to first quarter of 2013, the 2014 cash dividend increased other income by $0.04 million was approximately half of the increase, reflecting patronage capital extinguishment. Adjusted EBITDA was $7.5 million compared to $8.8 million in the year ago and $7.3 million in fourth quarter of 2013.

During first quarter of 2014 the company made scheduled and voluntary payments on our debt of over $5.4 million lowering our debt to $123.2 million. We continue to meet all the requirements for our loan -- all the covenants for our loan. We used cash of $500,000 to acquire Reliable Networks and invested as Mike mentioned $1.4 million in property, plant and equipment during first quarter. Cash decreased from $9.9 million at the end of last year to $6.9 million at the end of the quarter.

This covers the highlights for the quarter with additional detail in the press release. Our SEC Form 10-Q should be filed next Monday and provide additional details on our first quarter results. It will probably be more productive, Mike, if we shift to answering some questions. Felicia, if you will provide directions, we can take question at this time.

Question-and-Answer Session


(Operator Instructions) We'll go to Chris Brown of Aristides Capital.

Chris Brown - Aristides Capital

I just have an easy one. What do you see the dividend being if any fro CoBank in 2015 and beyond?

Curtis Garner

It's hard to tell, normally based on the size of our loan, our CoBank dividend is run about $200,000 in cash per year plus the patronage capital dividend. That was true again this year, although the percentage that they paid out went up to 75% from what it's usually been in the 60s.

So it kind of depends on whether CoBank's dividends, cash, 50-50, 75-25 versus patronage. We also don't know whether if they will continue to redeem older patronage shares next year and at what rates. So right now if I were going to budget as the CFO, I probably wouldn't budget anymore than the $200,000.

Chris Brown - Aristides Capital

And then, not so easy question. I know you guys don't like to give financial guidance. But I was a little bit pleasantly surprised by line equivalents trending at zero percent across the business. Is that something that you think is potentially sustainable as we go through 2014?

Michael Weaver

Probably not, Chris, to be honest with you. That the logic behind or the reason for those staying flat in the first quarters, as we've mentioned on previous calls, we've been very successful, particularly on our RLECs providing fiber transport for it's skilled systems. And we had a big installation that have been planned for sometime in the RLECs and our Alabama territories that really caused that number to go up.

Our attrition was slightly lower excluding that event. We were pleased that the business lines activity was more positive than it had been in previous quarters. The RLEC line loss is in line unfortunately with our expectations and what we've done historically.

Chris Brown - Aristides Capital

And just one question on the rate hike. You mentioned rate presently going from $0.74 to $2 per line. Is that revenue that you'll have to pass through to the government or is that revenue that you would get to keep?

Michael Weaver

We get to keep it. As a matter of fact, it affects three of our RLECs. And to just provide a little bit more specificity on that, we have one RLEC of the rate increases at $0.74, the other two RLECs will be at $2. As I mentioned in my comments that was required as part of the FCC reform, so it will be nice to have the revenue from those increases. It's always a bit scary in those three companies, our competition is from wireless and they're not required or they're not affected by that portion of the FCC order. So I hope that gives you some a bit of idea.

Chris Brown - Aristides Capital

So if you kept all of those lines and didn't lose any of them, what would be roughly the extra revenue that would come in as a result of that rate increase on an annualized basis?

Michael Weaver

Haven't computed that yet.

Chris Brown - Aristides Capital

Do you know roughly how many lines between the three RLECs altogether you're talking about?

Michael Weaver

Let me take the next question and we can do a little bit of math, while we're doing that, so we could really close.

Curtis Garner

The lines don't have to be -- the pricing doesn't have to be changed until the end of the year, and so if it doesn't go in until December, the impact is relative low. I'm not sure what our game plan is. We have just gotten the order of say, what you could and couldn't do. And so I think we'll probably, at least into August before you could see any kind of an impact. So I think the states remark Missouri and West Virginia, I believe.

Michael Weaver

Well, again the impact goes in affect, the change goes affect in December 1, so you'll only have one month in 2014. But just give me a second -- and we literally just got that order, that changed in the last few days, so we could do that.


We'll go next to Steve Hale of Hale Partnership.

Steve Hale - Hale Partnership

On the tax rate that you guys have, the D&A, what's the difference between the book and the tax on that as we just think about tax? I'm just trying to establish like a tax rate, the model going forward?

Curtis Garner

I think you can assume we will be a traditional tax payer going forward. If you noticed, when you see the tax footnote in the 10-Q, I think it will give you more information. But the effective tax rate is expected to be in the 39% range versus 5% for last year.

Last year, you had a CODI income the bankruptcy, which kind of made things unusual, but they also in essence eliminated all of our NOLs both on a state and federal basis. So the short answer is somewhere in the 39% to 40% range, will be a standard modeling approach I think going forward.

Steve Hale - Hale Partnership

But help me as I get down to what to tax, if I'm looking at operating profit. And I'm thinking about D&A specifically, it appears looking at the deferred tax liability that the tax depreciation is ahead of the booked depreciation. I am just trying to figure out is there a significant difference between book and tax for depreciation and amortization?

Curtis Garner

There we are ahead of tax because of the -- we are ahead in the tax arena as it we deals with depreciation and amortization. So we've used bonus depreciation up to 2012. And in 2013 it didn't make any sense for us to do that because of the way the taxes being impacted by the CODI and the bankruptcy. So I think it you are correct in looking at the deferreds as being were ahead of the game on that the tax side.

Steve Hale - Hale Partnership

So just to that, is there any order of magnitude of what that -- if you're running I think $12 million or so depreciation and amortization for GAAP purposes on the books, what's the tax deduction if we're just trying to model free cash flow?

Curtis Garner

I think you'll also have to separate depreciation from amortization in the depreciation and amortization lines. And the reason for that is that we're amortizing some goodwill for earlier purchases and those goodwill amortizations begin to play out in 2014 and 2015.

So I don't I think we've provided any more detail than that in terms of looking at it. But I think you can look at our CapEx and assume about a five-year lifespan and the CapEx over the last five years has been in the $7 million to -- or $6.5 million to $10 million range. And assume that we had accelerated depreciation or the bonus depreciation as allowed by the federal tax.

Steve Hale - Hale Partnership

And that was through 2012 that you had the bonus?

Curtis Garner

Right, we could have taken it in 2013, but chose not to.

Steve Hale - Hale Partnership

And I guess, said differently, if I just solve this backward, if we're looking at you're clean going forward this year, we are just looking at the cash taxes paid that you disclosed, then that's going to be the reflective of the 39% rate that we can kind of net out the D&A for tax purposes. I guess, I'm saying that being accurate reflection of what, if I saw backwards from the net income up, using the cash taxes paid that can help me reverse engineer your D&A for tax purposes.

Curtis Garner

I think you can make a fairly good step at that, but if you're looking at cash tax -- yes, I think that's a reasonable approach. It's just that the issue we have taken out of the amortization piece.


We'll go next to Tucker Golden of Solas Capital.

Tucker Golden - Solas Capital

I have to pod as I was just able to get on the call now, so if any of my questions are redundant, feel free to refer me to the transcript or maybe to call out later. But I wanted to make sure, I had chance to throw a few at this. So just a simple one that you may have addressed on the cost cuts, you referenced $1.2 million this year realized. What would that look like on an annualized basis?

Michael Weaver

It's approximately $1.6 million on an annual basis.

Tucker Golden - Solas Capital

And then in terms of your cash balance, is there a minimum you must maintain either contractually or just for the business to be able to operate?

Michael Weaver

No, there is no contractual minimum that were required to keep or so. And I think the cash declined by about $3 million as opposed from this yearend. And of course, the excess cash would went to, as Curtis mentioned $5.4 million on the debt. And the primary reason for the cash decline was that we made some voluntary payments on the debt and used the cash to reduce the debt.

Tucker Golden - Solas Capital

I was just trying to understand your gross leverage covenant better, so you could in there use virtually all of your remaining cash to pay down debt, if you needed to, to work around the covenants?

Michael Weaver

That's correct.

Tucker Golden - Solas Capital

In terms of incentive plan that I think should be a lot easier to pass in a couple of weeks than was last year. And I am a supporter of that. Can you give us some insight as to what metrics the board and management has discussed in terms of how management team will be incentivized going forward?

Curtis Garner

Tucker, the compensation committee hasn't met since the shareowners haven't bode in, hasn't approved the plan. Their game plan is to, assuming that the shareowners approved the use of some sort of stock plan, they plan to develop the 2014 bonus approach for management at that time determining what type of stocks to use and what type of measures.

Last year, as we put in the proxy, that were three primary measures, EBITDA, which made up about 60% of the measure, 30% split between RLEC and CLEC revenue and 10% based on basically net debt in the past that has been cash. So I think those were the three things they had used in the past. Those are still the same logical potential measures, but until the board decides what they want to do in terms of focusing management's incentive pay. I don't know how 2014 will look.

Tucker Golden - Solas Capital

It makes sense, I think from a shareholders perspective at this point, debt reduction is good, but it's not yet creating shareholder value and that you're sort of maintaining a fairly consistent leverage ratio. And so obviously the goal would be to get EBITDA to a point where it's not declining or not declining enough such that debt reduction only really maintains the leverage profile.

So we can get some of this value to choose to kind of transfer back towards the equity. So anything you can think of doing there or if we can think of maybe to from our bad debt goal would make sense to me, otherwise it seems, it's hard to justify remaining independent, when value is really not accruing shareholders, but they are bearing risk in this sort of leverage capital structure, but I'm sure you're on it.

And then, I just would also like to ask, I know we brushed the subject last quarter, and I wondered three months later if maybe, you had given anymore thought to sort of thinking about using equity for acquisitions, using equity for compensation beyond the extent that you're replacing cash compensation, as you guys remember some comments to that extent. Have you thought anymore about how you value your equity and how you use it as currency?

Michael Weaver

You're going to hear somewhat a repeat of the answer to your question last time. First I guess, before I do that, the big reason for the stock incentive plan is that it absorbs cash and is a significant part of management compensation that would save the cash and allow us to use that cash to further reduce debt or expand our CapEx or make acquisitions.

So that's the whole idea of, of course behind the stock incentive plan. I still believe that as we did with Reliable Networks, that there is a place for using the equity to make acquisitions, but I don't know how to give you exactly what you're asking for on that Tucker.

Tucker Golden - Solas Capital

I know, I mean I have spent all day and all night thinking about this and you have, knowing other things to think about that, I couldn't begin to understand, but I think from my perspective using equity to replace cash comes with the whole evaluation and that how is my equity valued.

And when we're looking at 50%, 60% plus free cash flow yields, I would say it's not valued very well because I don't think the market is pricing in any potential for stabilization at the company. They're just assuming a status quo, which is declining EBITDA, staying hopefully on the right side of the leverage covenant and just kind of going along that path.

And so when you use equity, for me, the reason, I'm supportive of the incentive plan is that I want incentives more aligned. I want management thinking like owners. And I know you own some stock, but I'd love you for you to own more even if you didn't have to buy it per se as long as its part of your compensation, I think you have vested.

And that to me is the reason for, but I don't like the idea of replacing cash where I think, cash has sort of simple value and your equity is undervalued. So I'd rather use cash to the extent you can. And then when you're thinking about acquiring another company and I think you need to create that acquisition at a very, very discounted valuation in order to justify using any equity component.

So I know this last one was pretty small and hopefully we'll turn out to have accomplished that goal. But again, I really think it requires a lot of thought when you use equity as currency, whether it's in compensation or in acquisition, you're really making sure that this additional shares issued are not diluting value from shareholders perceptive. So again, I think that's more of a reflection of how I am looking at this in essence, but I think all of your shareholders would probably agree.

Michael Weaver

I understand and I certainly appreciate your comments on that. They're very consistent with the comments last quarter. And I think as management, our goal is twofold and we're certainly want to increase the equity value and the value of the business.

And we have to be creative on how we do that. The fastest way to create equity is to reduce the debt, which is exactly what we have been focused on doing as evidenced by the payments in the first quarter. We are very cognizant of expenses, and trying to control and trying to improve those margins. Again, look at we just talked about with the 8% employee reduction and other cost savings.

So the balancing act, if you will, is to use the proper amount of equity for acquisitions and compensations, so that we can maintain a strong management team and then continue in the acquisitions as we did with Reliable Networks to have some growth opportunities that we can create.

And I understand exactly your comments and the trick is to get that balance correct. And so just that mine is more in a way of a reply back to you, but I want to assure you that I understand exactly where you're coming from. And we try very hard to keep that balancing act at the appropriate level

Tucker Golden - Solas Capital

So do you see a path -- are you focused on a path where we can get the leverage ratio to come down. So if we're in the mid-to-high-3s now and EBITDA declines while you're reducing debt, but the leverage ratio stays about the same. And we probably look at the equity is not growing in value and potentially shrinking, if we're assuming a similar multiple for the business. But if you can get that leverage ratio down over time, in other words, reduce debt at a faster way than EBITDA declines and your ability to reduce debt declines then we can potentially create all sorts of value for the equity, is that the goal?

Michael Weaver

Yes. And look at what we've done. What I would tell you is that the best part of the logic for the Reliable acquisition in January, yes, it was small. We are pleased with where we are. The integration process is going well. We have a whole new customer base, a combined customer base that we can sell all of our products to. And it would be great to duplicate that, but we're not dependent on that.

The reason that I mentioned, the new products that we are working on is we need to drive both the revenue and we need to try to improve the EBITDA margin through reductions of cost. That's how we grow the EBITDA and try to improve that leverage ratio over time.

It's a tough business. We continue to have what you saw on the residential access line is having, as you already know, the RLECs in our industry. So there is going to be continued access line decline. So we are looking for other products and services that we can offer to try to help more than offset that and try to grow that revenue. It's just a tough industry, right now.


Currently, there is no one else in the queue.

Michael Weaver

Great. Well, thank you to everyone for joining the call. And we will speak to you soon. I apologize, I hold Chris Brown an answer. Chris, that was three using your assumption that if the access line stays essentially the same, the revenue created from those costs -- excuse me, the rate hikes will be approximately somewhere between $148,000 million and $154,000 a year.

And with that positive note, thank you again for joining us on the call. And we will just talk to you in the next quarter.


And that does conclude today's teleconference. Thank you for your participation.

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