Otelco Inc. (NASDAQ:OTEL) Q2 2016 Earnings Conference Call August 3, 2016 11:30 AM ET
Drew Anderson – Investor Relations
Rob Souza – President & Chief Executive Officer
Curtis Garner – Chief Financial Officer
Peter Carmack – Private Investor
Wally Walker – Otelco
Good day and welcome to the Otelco Second 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, ma'am.
Thank you, Don, and welcome to the Otelco conference call to review the company's results for the second quarter ended June 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 on this conference 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 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, readers are urged to consider statements labeled with the terms believes, belief, expects, intends, anticipates, plans, or similar terms to be uncertain and forward-looking. The forward-looking statements contained herein are also subject generally to other risks and uncertainties that are described from time-to-time in the Company's filings with the Securities and Exchange Commission.
With that stated, I'll now turn the call over to Rob Souza. Please go ahead, sir.
Thank you, Drew, and good morning and welcome to our second quarter investor call. I want to begin today by providing some highlights regarding our results for the quarter, and of course Curtis will then review our financial results, and afterward we'll take your questions.
Our results for the second quarter reflect the current industry conditions as the topline residential revenue remains under pressure for all telephone companies. The decline in residential voice subscribers was not offset by growth in business and enterprise services, residential broadband, and newer offerings like security and over-the-top services. We are working hard to identify and take advantage of additional growth opportunities in the currently marketplace, including extending our managed service offerings.
Continuous cost improvements across our markets remains a critical element of our strategy, while we address topline revenue enhancements, promotions and well appropriate pricing actions. The improvements we have made in our network and operation cost structure, offset the decline in revenue this quarter when the results are compared to the same period in 2015.
For the second quarter, operating income increased $0.1 million and consolidated EBITDA was eventually flat when compared to 2015. While residential voice access lines have continued to decrease in our territories, business access lines has remained steady or shown modest growth. We have the ability to leverage our strong incumbent market position and sell additional services to our rural customer base, such as alarm and medical alert monitoring services, and we are trialing and over-the-top content product where we are not the incumbent cable provider.
For our CLEC customer base, we believe Otelco can provide better service and support levels in a broader suite of services, including managed services and hybrid cloud-based hosting. As a result of our focus marketing programs, including new speed and pricing options and delivery approaches, our residential data lines were relatively flat compared to the end of 2015, declining just 80, while residential voice lines declined by more than 1,000. We have received the multi-year contract extensions for circuits serving Alabama schools in and in adjacencies to our territory, including orders to increase capacity on the majority of these circuits which will be upgraded during the third quarter 2016.
In addition, we have added a second 10 gigabit light-wave to our new northern fiber ring project to meet another customer's requirement for high-speed conductivity in Northern Maine. We continue to increase the reach of fiber in our network to support higher data speeds as required by our customers, with another 2,500 homes passed by the end of 2016. Video and security products, which are residentially focused have both grown since the end of 2015. While our Hosted PBX product continues to grow as our flagship CLEC business product, we saw a slower growth rate in the second quarter due to customer downsizing and the exploration of multi-year contracts resulting in higher churn.
On the regulatory front, the outcome of an industry-wide intra-ladder MTA issue with Sprint and Verizon continues to look positive. Based on the court's March ruling, both Verizon and Sprint have remitted to us 100% of the disputed amount they had withheld. We will continue to monitor this, but given the court's action thus far, our overall position looks favorable. In March 2016, the SEC issued its Universal Service Fund Reform Order or the USF order for rate-of-return carriers, which will fundamentally change the way that rural rate-of-return carriers obtain USF support. Specifically, the USF order will impose a cap of 2.15 billion on USF available to rural rate-of-return carriers, offer two separate paths for receiving USF and impose new broadband build-out requirements on carriers in return for receiving USF. Each rate-of-return-carrier will be required to choose between one of the two paths within 90 days of a forthcoming public notice, and we continue to analyze our options as we wait for the SEC's final plan revisions, which were originally promised to be available in the first week of June.
Curtis will now summarize for you the financial results, and then we'll take your questions.
Thank you, Rob. We appreciate everyone is joining us today. I'll provide a brief overview of second quarter financial highlight as contained in our press release, and then we will open it up for questions, unless otherwise noticed every comparison is against the same period last year, generally second quarter versus second quarter that will keep me from continuing to repeat all of that information. Also we expect to file our Form 10-Q this afternoon, which will provide some additional information about results for the first quarter and first half of 2016.
Total revenues for the second quarter were $17.2 million, a 3.7% decrease compared to $17.9 million in the second quarter of 2015. The drop in residential RLEC voice 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 revenue. Second quarter is also when we'll receive the annual cost study adjustments for the previous year, which was a small negative for the current year versus $0.1 million positive for second quarter of 2016.
Let's look at the components of revenue. Local services revenue was $5.9 million, a decrease of 7.4% over the prior year period. The decline in RLEC residential access lines and the impact of the FCC's order which reduces or eliminates intrastate and local cellular revenue, accounted for a decrease in $0.3 million. A portion of the RLEC decrease is recovered through the Connect America Fund, which shows up in access revenue. The decline in long distance and special line revenue accounted for a decrease of $0.2 million. Network access revenue decreased 4.8% to $5.3 million, Connect America Fund and end user charges increased $0.1 million, offset by declines in special access charges of $0.2 million and interstate and intrastate switched access charges of $0.2 million, including the cost study impact.
Internet revenue was $3.9 million, a 4.1% increase as higher equipment fees, increased broadband speeds and pricing accounted for the increase. Transport services revenue decreased 7.4% to $1.2 million. The decrease was in wide area networking revenue, including a one-time customer adjustment and first month of a recast two-year wholesale contract, which adjusted contract pricing to the current market conditions.
Video and security revenue increased 4.4% 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 digital cable subscribers. Managed services revenue decreased 5% in second quarter of 2016, reflecting lower equipment sales and groupware services.
Moving on to operating expenses for the second quarter, as a result of discontinuing focused that Rob mentioned on expense management, our total operating expenses for second quarter of 2016 decreased 6.1% to $12.3 million. Looking at the end of two pieces, cost for services decreased 6.3%, as internet, circuit and digital equipment expense decreased $0.2 million; access, toll and reciprocal compensation expense decreased by $0.1 million; Hosted PBX expense decreased by $0.1 million; and marketing, sales and directory expense decreased by $0.1 million, most of those reflect the New England operations optimization.
SG&A was $2.4 million, a 2.2% decrease with modest declines in external relations, executive, insurance and uncollectible expense partially offset by small increases in legal expense and sales concession costs. Depreciation and amortization decreased 9.4% to $2.1 million from $2.3 million. New England CLEC and RLEC and Alabama cable depreciation decreased $0.1 million as a group and the amortization of other intangible assets decreased by $0.1 million.
As Rob noted, operating income increased 2.8% in the second quarter of 2016 as cost improvement and expense management savings exceeded the decrease in revenue for the period. The 36.7% year-over-year increase in interest expense reflects the higher interest rates on our new loan facilities and increased amortization of loan costs on the new transactions. Factoring in all of these changes, net income decreased $0.3 million to $1.3 million for the second quarter, and consolidated EBITDA decreased slightly to just under $7.1 million.
If you look at the balance sheet, we ended the second quarter with $8.3 million in cash or an increase of $1.4 million since December of 2015. As we announced during first quarter, the company entered into new five-year senior and five and a half year subordinated loan facilities. The current financial statements reflect the first $1 million principal payment made on April 1 on the senior facility, as well as the 2% fixed interest on the subordinated loan. So $5 million revolver under senior loan facility remains undrawn. On June 30, the outstanding senior loan balance was $84 million and the outstanding subordinated loan balance was $15.4 million.
As a reminder, our previous credit facility included a quarterly excess cash flow suite that was used to reduce the principal, the current senior facility as an excess cash flow suite, but it is measured annually, therefore the impact of the suite are reducing debt will occur in first quarter of 2017 based on 2016 performance. Capital expenditures for the quarter were $1.5 million both this year and last year, which is consistent with our annual level investment over the past several years of around $6.5 million.
I think that covers the highlights from a financial standpoint, more detailed in press release and in the 10-Q. Don, if you want to provide the directions, we can shift now to taking investor questions.
Thank you. [Operator Instructions] We'll take our first question from Peter Carmack, a Private Investor.
Good morning, gentlemen. Thanks for taking my question. I am just trying to reconcile one thing in the press release. So, in the body of the press release, it says the senior loan balance of $84 million and then the subordinated loan is $15.4 million, so that totals $99.4 million. But then on the consolidated balance sheet, it shows current maturity is $2.912 million, and then long-term note payable $91.2 million, so that's $94.1 million. So there is a $5 million delta in there. I think that's probably because of the loan cost that I want to get some clarification on that please.
Curtis, why don't you go ahead and address that one please?
Certainly, Rob. Pete, you're exactly right. The gap requirements change this year, so that the balance sheet have to show the net debt outstanding, gross debt less the loan costs on the balance sheet. So you're exactly right. That's the reason that I specifically identified the amounts, because quite frankly you can't tell them very effectively from the financial statements unless you read the footnote associated with them, which you don't have yet.
So the $5 million was all the, those were the loan issuance costs?
Okay. But if you were to pay that off today, you have to pay off $99.4 million?
Okay. That's a little weird. I don't know. I am not a GAAP guy. So I don't understand why they would have done that, but that seems odd. Anyway, thanks for the clarification.
Certainly, anyway, we tend to agree with you on the GAAP account.
We'll go now to Wally Walker for the next question. He is with Otelco.
Good morning, gentlemen.
First off, it was nice to see that five of seven board members made direct purchases of Otelco stock following the release of the first quarter results. I am guessing other shareholders of Otelco were encouraged by this activity, especially since Otelco traded at just 3.6 times trailing 12-month EBITDA. Rob, my first question for you regarding A-CAM, you touched on it, and the alternative the Connect America Fund broadband loop support program. My understanding is the FCC is going to make this effective on January 1, it doesn't seem like they're giving you much time to make a determination on this.
We would agree with you Wally, and thanks for your positive comment. Yeah, the FCC staff had promise to get information of the – basically at the beginning of June. We are still waiting on that information. I think what's going to happen is they will probably extend the timeline from the standpoint of the decision making, but our decisions will probably be retroactive back to January 1. At least that's our current thinking. Hopefully, we will find out more soon. They really need to provide the A-CAM offers to us, and then the accompanying data that will help us to decide, what's the best path for each of our companies. So that's what were our current thinking is at this point, Wally.
So basically, you don't have enough details to make determination whether either one of these two things would be positive or negative or neutral for Otelco.
I think the last time we commented on – we're thinking it's relatively neutral, but you're exactly right. We are really lacking some of the legacy support information, because you have the option to stay with legacy support or to go with A-CAM, and without the legacy support information, it's extremely difficult to compare and contrast the two plans. Until we have that, we can't make that final determination.
All right. You also talked about the multi-year extension with Alabama schools. I believe if my memory serves me correctly, the original contract was for five years, you said multi-year. Could you be more specific or can't you?
I think I can't be more specific. I believe it's a five-year extension. I believe that's what they do each time, Wally. So, I believe this is a five-year extension to that contract.
Okay. And one other thing, the northern loop Three Ring Binder in Maine, how do you feel about the project so far as you added another customer and lit another strand to whatever?
Yeah, exactly. We are extremely positive about that. Obviously, it was a big commitment on our part, but we really felt that that type of capacity was lacking from the northern part of the state. And I think as evidenced by the addition of a new customer that truly needed a 10-gigabit connection, it's going to prove positive for us. We have the ability to continue to grow that circuit and we look forward to additional growth coming from there. That is what our hope is and that's what our plan was in moving in that direction in Northern Maine.
Okay. It's been all business so far, do you have anything going with individual communities, because I think there is like 77 towns along that loop, correct?
Wally, I can't get into specifics per se, but our director of sales and marketing is actively participating in any of the municipal broadband initiatives that many of the communities have begun to explore. We participate closely. We certainly would like to participate if the economics work for us. And it would certainly be good to try to leverage the possibility of municipality wanting to get us involved. So, I think that's what I have to say about that.
Okay. Last question here, when Otelco was going through their refinancing process last year, interest rates on high yield debt were spiking, some described the high yield market at the time in the back half of 2015 and the first part of 2016 has essentially closed. Now single B high yield have reached north of 10%, at certain times they have since dropped around the 6.8% range in single B.
Now I realized Otelco spend a lot of money like more than $5 million in getting this deal done, and it was a necessity and there were prepayment penalties associated with the credit lines. But at what point if high yield rates keep dropping, would Otelco consider refinancing again even though they've just did?
To me, Otelco is paying higher rates right now than other wireline peers that are currently up at higher leverage. So, at what point would it make sense to refinance again if the high yield continues to drop as it's been doing ever since first of the year?
Yeah. I appreciate that question, Wally, and your observations are good ones. I am not convinced that the market for us and the industry in general would be any better than when we ran our extensive refi process that was conducted last year. I don't know that industry fundamentals have changed significantly that would make a big difference for us at this point. And when you couple it with the two other points that you made regarding the cost of refinancing that we've just extended, and the fact that there is a prepayment exit penalty for early pay down, I am not sure I can predict exactly when rates and availability of rates that you're expressing would be available to us to make it worth our while. But I can assure you we were very much like to reduce our debt costs and we continue to explore options. We are always looking at ways to improve shareholder value, and the correct timing – I am not 100% sure of when that is.
All right. Thanks guys.
[Operator Instructions] It appears there are no further questions. At this time, I'd like to turn the conference back to Mr. Rob Souza for any closing remarks.
Thank you, Don. We definitely appreciate all of you joining this morning. As I've noted earlier and even in responses to the question, we 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. We're dedicated to delivering greater value for our shareholders and we always welcome your questions. So, thanks again for joining us.
This does conclude today's conference. Thank you for your participation. You may now disconnect.
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