Otelco Inc. (NASDAQ:OTEL) Q3 2019 Results Earnings Conference Call November 6, 2019 11:30 AM ET
Drew Anderson - Head of Investor Relations
Rob Souza - Chief Executive Officer
Richard Clark - President and Chief Operating Officer
Curtis Garner - Chief Financial Officer, Board Secretary
Conference Call Participants
Good day and welcome to the Otelco's Third Quarter 2019 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 Cordi, and welcome to the Otelco conference call to review the company's results for the third quarter ended September 30, 2019. Conducting the call today will be Rob Souza, Chief Executive Officer, Richard Clark, President and Chief Operating 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 caused 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. 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.
Thank you Drew and good morning and welcome to our third quarter 2019 investor call. Richard and I will discuss the third quarter's performance and other key issues affecting our business. And then Curtis will review our financial results. After that, we will take everyone’s questions.
While our results for the third quarter continue to reflect the trends impacting our industry, as traditional access revenues and residential RLEC customers declined, they also reflect our strategic focus on increased investment in fiber and other network improvements to bring higher speed broadband service to our customers, on which Richard will provide an update in just a few minutes.
Total revenue was $15.8 million a 3% decrease from the third quarter 2018. These results were in line with $15.7 million and $15.8 million in revenue reported for second and first quarter 2019.
Third quarter included the FCC’s conversion of our Vermont property to A-CAM which included a positive retroactive revenue true up dating back to January of this year, providing a onetime impact of a little more than 0.1 million. We were encouraged that third quarter 2019 saw a slower customer churn rate when compared to the previous two quarters. Excluding the impact of the A-CAM revenue increases in Vermont and Missouri, the decrease in revenue compared to third quarter 2018 was primarily due to the decrease in residential local services and traditional switched access revenue affected by the FCC’s 2011 inter carrier compensation order.
Net income decreased 21.8% to $1.8 million in the third quarter 2019 compared to $2.3 million in the third quarter 2018. Consolidated EBITDA decreased 10.2% to $5.8 million in third quarter 2019, from $6.4 million in third quarter 2018. Cost and expenses were down when you compare 2019 to 2018, once you exclude the impact of shifting from a stock-based senior management incentive plan in 2018 to a cash based plan in 2019, and onetime legal expenses.
We expect that these trends will continue and may be further influenced by competition in our RLEC properties and the availability of alternative telecommunication products such as cellular and IP based services.
While we continue to build out our network to make higher data speeds available to all of our customer base. At this point, I will turn the call over to Richard Clark, our President and Chief Operating Officer to give everyone an update on progress in our announced network enhancements.
Thanks, Rob. During the third quarter, we continue to execute the strategy we've discussed in previous calls, with a focus on increasing investment in our business to enhance our ability to provide customers’ higher broadband speeds and change the customer churn in our business.
As a reminder in May, the board of directors supported our plans to increase capital expenditures for 2019 to $11.5 million. This investment level represents more than a 40% increase in investment in the business over the $8 million invested in 2018 and the third year of double-digit increases investment, aimed at providing customers increased internet speeds to better meet the requirements of our customers, and overtime reduce customer churn.
During the third quarter, our capital investment increased to $3.2 million compared with $2.4 million for the same period last year. In addition to fiber deployment, we continue the work necessary to prepare the deployment of VDSL throughout all of service areas, and the upgrading our cable distribution network to DOCSIS 3.1 next year.
Fiber to the premise and the cable upgrade both create the capacity and capability to deliver gigabit broadband speeds, while VDSL allows us to offer speeds of at least 25 megabits per second to a large majority of the territory we serve and 50 megabits to many customers.
While we build out and make these enhancements to the network, we have worked to increase the speeds we are providing our customer base to the maximum the tunnel network can deliver to better meet speed requirements and reduce churn.
In 2019, our fiber network expansion will pass nearly 5,600 locations in our territories. As we announced earlier this year, we completed our post post-auction CAF II filing requirements in February to receive just over $0.9 million over a 10-year period for four Massachusetts communities, including approximately 500 locations with a fixed wireless network delivering both broadband and voice services.
The new network will greatly enhance voice and data options for residents in these communities. The first customers in our relationship with WiValley are now receiving wireless service with additional sites being completed during the fourth quarter.
And in October, October beginning Otelco began receiving our FCC approved CAF II funding. Based on successful municipal solutions like the one in Leverett and our ongoing involvement with other municipalities or telco in collaboration with the town of Alton, Maine and the state's ConnectME authority is now nearing completion of a fiber network capable of serving the approximately 260 residence and business locations within the town with fiber-to-the premise. Approximately 100 of the locations in Alton are also part of our A-CAM build out obligation.
Grant funding received from Alton and ConnectME will support approximately 50% of the expected $0.7 million of required investment, allowing for the replacement of the existing copper infrastructure to serve all locations with fiber-to-the premise service. A portion of the network will be open to marketing and sales in November, and we expect this project will be completed before the end of 2019.
During the third quarter, telco completed fiber builds passing approximately 630 locations as part of its announced fiber expansion plans. Another 850 locations will pass with fiber in the month of October and release for marketing and sales efforts.
In 2019, we will 275 miles of fiber to our network passing over 5600 locations. This will bring our total fiber network to approximately 3300 route miles of transport and fiber to the prem deployed within our service territory. This fiber network will pass nearly 10,000 locations. The largest network expansion is in the Arab, Alabama market outlined previously passing over 4,000 locations. We currently serve only 29% of the locations passed with our fiber network. And we believe there is room to grow market share where we have fiber passing potential customers.
We are pleased with our progress in 2019 as our employees have worked hard to execute on these, and a number of other initiatives as we ramp up to get more broadband speed available to our customer. Looking ahead, we will continue our focus on enhancing the customer experience, improving data speeds and adding new customers.
Looking at some customer metrics for the third quarter of 2019, customers served decreased 0.6% or 205 customers from the end of the second quarter. This is an improved trend compared to the decrease of 1% and 1.6% in the second and first quarters of the year respectively.
Services provided to these customers, decreased 1.4% or 960 services over the third quarter period. Data and video have lower percentage decreases than voice services reflecting our focus on increasing data speeds throughout our network. We expect a continued deployment of fiber based services over the next two years. The transition to media cell in all of our networks and the deployment of DOCSIS 3.1 in our cable network.
We’ll continue to improve the speed of our service offerings and further reduce the level of customer and service churn. We believe our concerted effort to enhance our customer's experience and improve available data speeds and product offerings will bring new customers back into the telco family of companies.
Curtis will now summarize the third quarter financial results.
Thank you, Richard. We appreciate everybody joining us today. You and Rob already touched on several results areas. I'll provide a brief overview of other third quarter financial highlights as contained in the press release and in the Form 10-Q both of which were released yesterday.
Unless otherwise noted, everything from a comparison standpoint is against the same period last year generally third quarter 2019 versus third quarter 2018. Total revenues for third quarter 2019 were $15.8 million down 3% from last year's third quarter.
Local services revenue declined 8.6%. Network access revenue was up 3.3% reflecting Vermont and A-CAM funding in Missouri. Internet revenue decreased 2.7%. Transport Services revenue decreased 9.9% while video, security and managed services were basically unchanged from the third quarter of last year.
The 10-Q provides additional explanatory detail by category of revenue. Moving to our operating expenses for third quarter, overall operating expenses increased 1.7% to $11.9 million from $11.7 million.
Cost of services decreased slightly to $7.5 million, customer service and sales decreased $0.1 million and network operating costs increased by $0.1 million, a decrease by $0.1 million which were partially offset by an increase in network access and total expenses of $0.1 million.
Selling, general and administrative expenses increased 5.2% to $2.5 million from $2.4 million during third quarter 2018. The $0.1 million of conversion expenses associated with our new billing system had no comparable expense in the same period in 2019.
This decrease was offset in 2019 by an increase of $0.1 million in legal expense and $0.1 million in senior management incentive compensation accrual reflecting a change from stock to cash incentive compensation for 2019.
Stock compensation’s reflected as an expense over 39 months while cash compensation must be expensed in 12 months. There is no change in the total amount of senior management compensation and….
Depreciation and amortization increased 6.7% to $1.9 million from $1.8 million, an increase in RLEC assets and service from our fiber expansion that Richard mentioned generated increase in our RLEC depreciation, the balance of the increase is related to the depreciation of our new billing system that was placed in service last year.
Operating income for the third quarter was $3.8 million compared to $4.5 million for the prior period, with the change in revenue being the single largest factor impacting the decline. Net income decreased 21.8% to $1.8 million in the third quarter 2019 compared to $2.3 million in third quarter of 2018. Again primarily driven by the change in revenue.
Basic net income was $0.53 per share for third quarter compare of this year compared to 69% -- $0.69 per share in the same period in 2018. Consolidated EBITDA was $5.8 million for third quarter 2019 compared to $6.5 million for the same period last year driven by a decrease in revenue.
Our balance sheet reflects cash of $5.3 million in the third quarter, an increase of $0.6 million compared with our cash position at year-end 2018 of $4.7 million. We made our scheduled $1.1 million principal payment on our credit agreement with co-bank in third quarter 2019 reducing loan balance to $71.3 million.
As of September 30, 2019 ratio of debt net of cash to consolidated EBITDA was 2.77, reflecting the mandatory payments and voluntary prepayments on the debt since its inception two years ago this month.
Capital expenditures as Richard noted were $3.2 million for third quarter 2019 and $7.6 million for year-to-date 2019. With the expectation to that our investment we'll continue to increase with the balance of the year. I think that covers the highlights for the quarter with additional detail in the press release in the 10-Q.
Cordi, if you provide directions, we can shift to taking questions from investors at this time.
Absolutely. [Operator Instructions]. We'll hear from first from Wally [ph] Walker. Please go ahead.
Hey, good morning gentlemen.
Good morning Wally.
Okay. Well, I'm aware Otelco is reluctant to give forward-looking guidance. It's quite clear that revenue in the first three quarters of this year has been stable. Now if we assume little-to-no immediate effect and third quarter revenue from the Alabama upgrade, the Massachusetts wireless network and the Alton, Maine fiber build, wouldn't it be illogical to expect that even with continued loss of voice customers and pricing pressures, these projects will swing the revenue trajectory in a positive way next year?
Wally, at this point we're not sure we have enough data point to maybe concur with your expectations or your premise that you're making. We do think all the steps that we're taking will make a difference for Otelco in the future. You also have to remember there are other headwinds that we continue to face including access rate reductions and reductions that are associated even with A-CAM. Some of our A-CAM companies have some step down amount saw a year-over-year, I think somewhere in the neighborhood of approximately $250,000 to 300,000 per year. So, when you net all of those things together, I'm sure at this point we're willing to predict that next year we're going to turn the corner. But we certainly think we're doing all of the appropriate things to make a difference in the long-term future of the company.
Right. I've just looking at your math here. Just in the month of October alone you said you added 850 locations as with fiber. Now, if we assume like a 35% take rate, that's about 300 new customers just last month alone. And in take rates like places like Western Massachusetts and Alton, Maine, wouldn't you agree that the take rate would be higher than 35%?
Wally, one thing that note is when we add – when we say we've passed 850 new locations, we may already have 35% of those customers on copper. So they're not fairly customer that we're getting. They're conversion.
Okay. Do you any estimate of how many new locations you'll pass in November?
I don't yet, but although for the year we will pass 5600. And I think Richard, I think we believe that we'll pass about another 850 or so I think in the month of November. So most cases – almost all cases when we're saying, we're passing new location, they're already existing – they're all existing locations we're passing today with copper.
Okay. And that…
A portion of that customer base already.
Okay. Obviously, not the wireless one in Massachusetts though. That's brand-new, right?
That's now. That's correct.
One other final question, the SEC recently proposed a $20.4 billion world digital opportunity fund with a reverse action format similar to CAF II that Otelco participated in last year. Now, while the SEC order hasn't been arrived yet, it has -- been sometime early next year looks like. Do you have any immediate thoughts on the initial SEC press release on this?
Our thought is that if they if they take the standard practice to refocus on under served or un-served there'll be very little in our territory that qualifies.
Okay. And what about -- I mean could you do out-of-territory or is that something that you wouldn't look at?
We'll look at every opportunity, but in most cases, in out-of-territory environment, the incumbent will have a significant advantage because their cost-to-build will be significantly lower than ours.
Okay. Thank you.
Thank you, Wally.
Thank you. We'll take our next question from Michael Wu [ph].
Hi. Thank you for taking my question. I have a question about the leverage ratio. So candidly this quarter is 2.77, right? Did you hear me? Yes. So I was wondering what is like comparable level you guys going forward like what do you guys like to see like three, or, or two? What are you guys comfortable with?
Curtis, why don't you respond this question, please.
The industry has been driving traditional RLECs down to numbers that would be in the 2.5 to 3 range which put just in the right location. But as we expand the fiber content of our network and therefore the future viability of a network, I think it's more likely that we'll have to increase our leverage somewhat to get the fiber in place to as Mr. Walker was speaking of earlier more revenue to where we slow down or stop the decline in revenue. So we don't make projections, but I think you can -- if you look at the increase in CapEx that we've had last year and this year you've seen a slowdown in the decline in our leverage ratio. So, I think 2.5 to 3 is probably logical for a world telephone company, but one that's increasing fiber content significantly is probably needs to be higher than that.
Okay. Thank you. So, my second question is about like what is the capital plan for next year? It's pretty heavily – like these past two years. So would you expect that you continue to have reinvested or will be reduced a little bit or kind of rough idea?
I think you can expect that we will try to maximize our capital expenditures to the point of on not – I think you'll be in a similar levels as a last couple of years, because I think that's what makes sense to you our fiber expansion and to continue enhancing our network to try to increase data speeds available to our customer base.
Okay. So I have a question about the covenant of the debt like – it supposed to be like by – I think by January 2021. It supposed to be under three, right? So if I remember correctly…
I believe it would be – the covenant would be – the covenant declines from 3.5 this year to 3.25 next year and then 3.0 the following year. But I think as we've done in the past normally we have renegotiations with our lenders prior to any time that any covenants might be at risk as we change our guidance and direction on capital investment.
Okay. So basically you guys pretty like comfortable with the current debt level, right, because assume like, except this kind of $4.4 million or $5 million annual kind of paydown. So you don't have any plan to pay a little bit more than that range?
I think we've pretty much demonstrated that it's more valuable to our subscribers -- to our shareholders as well as our customers to increase our level of investment as opposed to increase our level of paydown.
Okay. Thank you. That's all my questions. Thank you.
Thank you. [Operator Instructions] We'll hear now from [Indiscernible].
Hello. I'm call over the internet, so there is some delay. I just wanted to ask, since the debt ratio of 2.77 is so low would the company be open to selling, for instance, convertible bond for additional capital expenditures or would you be interested in selling preferred shares so that you can spend more on capital expenditures?
I think the company will examine pretty much all options as it develops its plans for continued fiber rollout. The reality is that, we have great partner with our existing lending institution. The company has spent the last year developing its network evolution plan. We've talked about a number of them on these calls in terms of upgrading our network and we are judicious in how we use capital and we will explore whatever options are available to us as we move forward.
And just some of the questions. I think consolidation in this space makes a lot of spend. Are you still looking at potential merger with some of the other players in the space?
I don't think we've ever announced whether we were specifically looking for mergers or acquisitions or to be acquired, we certainly are always interested in discussing options with all parties but have never really been stating that we are out there looking for an acquisition or mergers. From the standpoint of consolidation certainly the amount of consolidation in our space has slowed over time and I'm not sure they we're going to see any change in that at this point in time.
Thank you very much. I have no further questions.
Thank you. And that does concludes today's question and answer session. I would like to turn that conference back to Mr. Souza for any additional or closing remarks.
Thank you, Cordi. We appreciate you joining us this morning as this will be my last conference call with you before I retire at the end of the year. I want to personally thank all of our investors for your support. I'm confident that Richard Clark and the team is well prepared to provide strategic guidance and direction to every aspect of Otelco's business with valuable insight on how best to apply the continued evolution of technology to meet customer and market requirements, while delivering increased value for our shareholders. We always welcome your questions and we plan on keeping you informed regarding the development of our business. Thank you.
Thank you. And that does conclude today's conference. Thank you all for your participation. You may now disconnect.