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Edited Transcript of OTEL earnings conference call or presentation 14-Aug-19 3:30pm GMT

Q2 2019 Otelco Inc Earnings Call

ONEONTA Sep 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Otelco Inc earnings conference call or presentation Wednesday, August 14, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Curtis L. Garner

Otelco Inc. - Secretary & CFO

* Richard Allen Clark

Otelco Inc. - COO & President

* Robert J. Souza

Otelco Inc. - CEO & Director

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Conference Call Participants

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* Joseph Francis Helmer

Caldwell Sutter Capital, Inc. - President

* Tim Bergin;On Beyond Investing

* Dru L. Anderson

Corporate Communications, Inc. - SVP and Principal

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Presentation

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Operator [1]

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Good day, and welcome to Otelco's 2Q '19 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 Mrs. Dru Anderson. Please go ahead, ma'am.

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Dru L. Anderson, Corporate Communications, Inc. - SVP and Principal [2]

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Thank you, Chloe, and welcome to the Otelco conference call to review the company's results for the second quarter ended June 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. Otelco has updated its investor presentation posted on the Investor Relations section of the company's website, and management may reference some of these slides during today's call.

Before we start, let me offer the cautionary note that statements made during this 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 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, sir.

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Robert J. Souza, Otelco Inc. - CEO & Director [3]

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Thank you, Dru, and good morning, and welcome to our Second Quarter 2019 Investor Call. I'll discuss the second quarter's performance and other key issues affecting our business. Richard will provide operational updates, and Curtis will then review our financial results. After that, we'll take questions.

Last quarter, we walked through our traditional investor presentation on this call. As Dru noted, the slide deck we used in May has been updated with the latest fiber build-out plans and some of second quarter's financial results. It is posted on our website and was filed on Form 8-K, along with the earnings press release. We will not be using the updated deck in today's call, but may reference a few pages included in it.

While our results for the second quarter continue to reflect trends in our industry as traditional access revenues and residential RLEC customers decline, it also illustrates our plan for increased investment in fiber and other network improvements to bring higher speed broadband service to our customers.

Total revenue was $15.7 million, a 7.3% decrease from the second quarter 2018. These results were in line with our $15.8 million in revenue reported for the first quarter 2019.

Second quarter 2018 results reflected a full 6 months of the increased A-CAM revenue from Missouri and Shoreham's legacy short support haircut refund of the second half of 2017 and first 6 months of 2018 for a $469,000 onetime increase in revenue 1 year ago.

While second quarter 2019 saw a slower customer churn rate when compared to the previous quarter, the loss of residential customers and competitive pricing pressures on Internet services negatively impacted second quarter 2019 results.

Net income decreased 41% to $1.7 million in second quarter 2019 compared to $2.9 million in second quarter 2018. Consolidated EBITDA decreased 19.8% to $5.7 million in second quarter 2019 from $7.1 million in second 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. We expect these trends will continue and may be further influenced by competition in our RLEC properties and the availability of alternative telecommunications products such as cellular and IP-based services while we continue to build out our network to make higher data speeds available.

As discussed, since 2017, Otelco began receiving the FCC's A-CAM payments in the 5 states where the program was applicable to the company in 2017 and will continue to receive funding through 2028. The program funding is being used to enhance and build out our broadband network to provide increased broadband speeds and accessibility to customers.

The FCC made an additional offer for Otelco to receive increased A-CAM model-based support beginning in 2019 for a commitment to increase the coverage with higher speeds. Mid-Missouri is receiving an additional $442,000 in A-CAM support each year, and the 10-year A-CAM support program was extended 2 years for all 10 of our companies that receive A-CAM support.

Shoreham, our subsidy that was not -- our subsidiary that was not included in previous A-CAM support offers, received an offer of support on May 2, 2019 and filed a letter with the FCC on June 17, 2019 to accept the A-CAM support offer, which is effective retrospectively back to January 1, 2019.

The A-CAM support replaces the legacy rate of return support it currently receives. For 2019, the support payments we will receive for Shoreham under A-CAM is essentially identical to the support payments we would have received under traditional support mechanisms, but will require additional investment in plant and equipment to reach the targeted broadband speeds and covered locations.

However, by accepting A-CAM, we avoid the risk of potential reductions of funding in future years under the current legacy support regulation.

In addition, participation in the A-CAM program provided Otelco the opportunity to move our broadband data services, also known as BDS, from rate of return to price cap regulation. This change provides Otelco additional retail pricing flexibility to meet competitive pressures and reduces operating expenses by eliminating the burdensome cost study work associated with rate of return regulation.

At this point, I'll turn the call over to Richard, our President and Chief Operating Officer.

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Richard Allen Clark, Otelco Inc. - COO & President [4]

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Thanks, Rob. I'm sure everyone has noticed the new theme in our investor information, increasing investment in our business to increase our ability to provide customers higher broadband speeds and change the churn in our business.

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 25% increased investment in the business over 2018, and the second year of double-digit increases in investment, aimed to providing customers increased Internet speeds to reduce customer churn.

In June, we announced locally in Alabama, our plans to invest some $5 million for additional fiber build-out in Alabama to standardize our infrastructure on BDSL throughout the company and beginning next year to upgrade our cable network in Alabama to DOCSIS 3.1.

Fiber-to-the-premise and the cable upgrade both create the capability to deliver gigabit broadband speeds, while BDSL allows us to offer speeds of at least 25 megabits to a large majority of the territory we serve and 50 megabits to many customers.

While the industry buzzword has been gigabit Internet, in reality, it isn't required to meet the majority of our customers' needs or their willingness to pay for gigabit-priced service. 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 help reduce churn.

Just last week, we finished the build-out and mapping for another 416 locations for fiber-to-the-premise in the Plymouth and Jones Valley areas, near Arab, Alabama. The routes are shown in the investor presentation on pages 28 and 29. In 2019, fiber network expansion will pass nearly 5,600 locations in our territories.

As we announced earlier this year, we completed our postauction CAF II filing requirements in February, to receive just over -- $900,000 over a 10-year period for 4 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 partnership with WiValley are now receiving wireless service.

Our previous work with the town of Leverett, Massachusetts, demonstrates how municipal partnerships can work to improve communities' digital access.

Based on successful solutions like the one in Leverett and our ongoing involvement with other municipalities, Otelco, in collaboration with the town of Alton, Maine and the states' ConnectME Authority, will be constructing a fiber network capable of serving the approximately 260 resident 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 obligations.

Grant funding received from Alton and ConnectME will support approximately 60% of the expected $700,000 of required investment, allowing for the replacement of the existing copper infrastructure to serve all locations with fiber-to-the-premise service. We expect this project to be completed before the end of 2019.

In 2019, we will add 275 miles of fiber to our network, passing over 5,600 locations. This will bring our total fiber network to approximately 3,500 route miles of transport and FTTP 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 within our fiber network. We believe there's room to grow market share where we have fiber passing potential customers.

We are pleased with our progress for the first half of 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 customers.

Looking ahead, we'll continue our focus on enhancing the customer experience, improving data speeds and adding new customers. We believe an improvement in our revenue performance and a continued focus on cost management will benefit both our employees and customers and to deliver additional value to our shareholders.

Looking at some customer metrics for the second quarter of 2019. Customers served decreased 1% or 337 customers, an improvement when compared to a decrease of 1.6% or 552 customers in the first quarter of 2019.

Services provided to these customers decreased 1.1% or 786 services in the second quarter, an improvement when compared to 1.3% or 950 services in the first quarter. While a portion of the reduction in churn can be attributed to customers activating service for vacation homes, we believe a portion of the change represents the first hints on the impact of our increased investment. Retaining customers and stabilizing end-user revenues continues to be our focus. Our marketing, sales and customer service teams are targeted in their approach to offering light wave services to every location we pass with each mile of new fiber. We plan to be well positioned to enhance our customers' experience, improve available data speeds and product offerings, and bringing new customers back into the Otelco family of companies.

Curtis will now summarize the second quarter financial results.

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Curtis L. Garner, Otelco Inc. - Secretary & CFO [5]

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Thank you, Richard. We appreciate everyone joining us today. As Rob mentioned, a few updates were made to the investor presentation we used last quarter, and the whole deck is available on our website. It provides a good summary of the company history and our focus for the future for those who might be new to the Otelco story.

I'll provide a brief overview of our second quarter financial highlights as contained in the press release and the Form 10-Q, which we released and filed yesterday afternoon. Unless otherwise noted, every comparison is against the same period last year, generally second quarter 2019 versus second quarter 2018.

Total revenues for the second quarter 2019 were $15.7 million, down 7.3% from last year's second quarter. Each of the 6 components of revenue declined. Rob mentioned the impact of the onetime A-CAM and traditional revenue in second quarter 2018 had on our comparison as well as the loss of residential customers, which account for the majority of the difference. The 10-Q provides additional detail by category, none of which require any additional explanation. Rob also noted that the sequential comparison of second quarter 2019 to first quarter 2019 revenue shows a decrease of $100,000.

Moving to our operating expenses for the second quarter. Overall, operating expenses decreased -- increased 2% to $11.9 million from $11.7 million. Cost of services was unchanged at $7.5 million. Service -- customer service and sales increased $0.1 million as our CLEC sales force continued to increase its effectiveness in generating new revenue. Total and access costs were unchanged, while all of our operating costs decreased $0.1 million.

Selling, general and administrative expenses increased $5.3 million to $2.6 million from $2.4 million.

During the second quarter 2018, the $200,000 of conversion expense associated with our new billing system had no comparable expense in the same period in 2019. This decrease was offset by, in 2019, the $200,000 increase in onetime expenses associated with the development of our long-term network design plans and $200,000 in the senior management incentive compensation accrual, reflecting change from stock-to-cash incentive compensation for the 2019 performance year. Stock compensation is reflected as an increase -- as an expense over 39 months, while cash compensation must be expensed in 12 months.

Depreciation and amortization increased 5.6% to $1.9 million from $1.8 million. An increase in RLEC assets and service from our fiber expansion generated an increase in RLEC depreciation. The balance of the increase was reflected in -- from the new billing system.

Operating income for second quarter was $3.7 million compared to $5.2 million for prior period -- year primarily driven by the change in revenue. Net income decreased 41% to $1.7 million in second quarter of 2019 compared to $2.9 million in second quarter of 2018, again, primarily driven by the change in revenue. Basic net income was $0.50 per share for the second quarter 2019 compared to $0.86 per share in the same quarter of 2018. Consolidated EBITDA was $5.7 million for the second quarter of 2019 compared to $7.1 million in the same period in the previous year driven by the onetime impacts in 2018 and the decrease in revenue.

As Rob mentioned, our balance sheet reflects cash of $5.4 million at the end of second quarter, an increase of $0.7 million compared to our cash position at year-end 2018 of $4.7 million. We made our scheduled $1.1 million principal payment on a credit agreement with CoBank in second quarter 2019, reducing the loan balance to $72.4 million.

As of June 30, the ratio of debt net of cash to consolidated EBITDA was 2.74, reflecting the mandatory payments and voluntary prepayments made on the debt since its inception in November of 2017.

The history of our improvement in leverage over the last several years can be seen on Page 16 of the investor presentation. Capital expenditures were $2.9 million for the second quarter of 2019 and $4.4 million for the year-to-date 2019, with an expectation that our investment will continue to increase for the balance of the year.

I think that covers the highlights for the quarter with additional detail on the press release and 10-Q. Chloe, if you'll provide directions, we can shift our -- to taking questions from our investors at this time.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Wally Walker, and he is a private investor.

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Unidentified Participant, [2]

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I've been following Otelco aggressively attack its debt at the expense of lower CapEx for many years now. And with CapEx expected to be $11.5 million this year, it appears that Otelco is finally committed to catching up. Despite a $1.8 million drop in EBITDA in second quarter '19 from second quarter '18, the net leverage ratio hardly changed this quarter due to the debt payment.

My question is, with the future comparisons getting easier, the new municipal projects that you guys have going coming online in the second half of the year and the benefit of faster speeds due to the higher CapEx, do you expect the leverage ratio to continue to decline? And if so, how soon do you anticipate the benefits? And basically, what I'm asking is, when does the fiber build-out start to pay off?

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Robert J. Souza, Otelco Inc. - CEO & Director [3]

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Great question, Wally. We certainly believe the fiber build-outs begin to take effect slowly, but over time, we'll continue to accelerate as more and more fiber has been placed. I think Richard made note of the fact that our current penetration rate in most of the fiber that we have built is around 29%. We'll be adding over 4,000 locations in the Arab territory, Arab, Alabama, this year. And we certainly would expect to see an increase in the number of customers we serve with that fiber facility, and we are hopeful that we can drive that penetration rate up. It is not going to be an immediate change in the overall trajectory, but we believe, over time, with the additional investment, top line revenue will be stabilized and eventually will begin to grow.

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Unidentified Participant, [4]

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All right. A question for Curtis, real quick. Did we receive our CAF II payment for 2019 in the second quarter?

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Curtis L. Garner, Otelco Inc. - Secretary & CFO [5]

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No. There were no special payments or unusual payments yet, and we have not received any of the WiValley Massachusetts CAF II payments yet.

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Unidentified Participant, [6]

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Okay. And if I may, one final question. I noticed, Otelco was granted a waiver from the MPUC to obtain 4 1,000 phone number blocks for a customer in Maine, who requested them due to an expansion. 4,000 numbers to me sounds like adding a small city. Do you expect any meaningful impact from that customer?

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Richard Allen Clark, Otelco Inc. - COO & President [7]

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Now one of the things, when they are requesting that type of impact, some of it is just transporting existing numbers to the block, so that we don't expect a large increase in that demand over time -- in the short run. Over time, as they expand, they will add the phone lines. But a lot of that was just repositioning.

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Operator [8]

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(Operator Instructions) Our next question comes from Tim Bergin from On Beyond Investing.

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Tim Bergin;On Beyond Investing, [9]

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My question is, while I agree with the change in philosophy from debt repayment to CapEx, I do wonder how or what you feel the benefit to additional capital primarily to be used to pay down debt. Something like that could give more time for some of the investment to pay off and may give the company a bit more buffer. I'm curious -- thoughts on that?

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Robert J. Souza, Otelco Inc. - CEO & Director [10]

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Tim, I appreciate the question. I think over the past few years, Otelco had been fairly aggressive in paying down debt, trying to reduce our overall leverage ratio and get it into a position that we felt more comfortable with. We believe at this point in time, we certainly will continue to pay down debt at the required rate of our current debt instrument. And at least for this year and next, we believe that continuing to invest in infrastructure is the best position for the company to take. So while we will continue to pay down debt, we believe investing in infrastructure is what's in the best interest of the company at this time.

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Tim Bergin;On Beyond Investing, [11]

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Right. Well yes, I certainly agree. But a capital injection could help accelerate infrastructure improvement and help the balance sheet. So I guess that was more of my question.

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Richard Allen Clark, Otelco Inc. - COO & President [12]

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So if anything, right, when we talk about making investments, there is a time line in terms of return and having a positive impact on our net -- our overall churn. Obviously, a new -- a significant injection of new capital could increase the amount of investment, but you have to balance that sometimes against its impact on existing shareholders, but also the ability for the company to manage it. So building fiber is not something you just decide to do today and it starts tomorrow, it takes planning. As Curtis referred to a minute ago, we spent a couple of hundred thousand dollars this quarter, onetime cost to develop our long-term fiber build plan. That will go in -- that goes into our planning for the future.

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Operator [13]

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(Operator Instructions) Our next question comes from Joe Helmer from Caldwell Sutter Capital.

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Joseph Francis Helmer, Caldwell Sutter Capital, Inc. - President [14]

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Going back to the topic of cost management. I'll bring up a topic that might be hard to answer, but I'd like your thoughts on it anyways. When you look at the SG&A in relation to the revenue here, the declining revenue, the increased churn, the substantial investments you guys are going to make over time, does it make sense to -- for someone with scale to pursue this strategy versus us? And at what point would you guys consider revisiting strategic alternatives?

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Robert J. Souza, Otelco Inc. - CEO & Director [15]

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At this point, I'm not sure that I'm prepared to answer the question on when or if we would continue to look at strategic alternatives. I think our history is pretty clear. I think we've been rather forthright with our investors suggesting that work has happened in the past. We believe at this point in time, we've done a really good job at controlling expenses and then continue to look at every opportunity to cut our expenses overall. We believe now is the time to continue to invest in the company, especially in its infrastructure. We believe that's the best plan going forward to stabilize top line revenue and turn that revenue line around.

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Joseph Francis Helmer, Caldwell Sutter Capital, Inc. - President [16]

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Okay. But going back to the previous question. You mentioned you spent a couple of hundred thousand bucks on a plan to build out the fiber. Can you tell me like, could a larger provider -- couldn't they achieve the same plan for the same amount of money with more scale? I think even the shareholders will be better off in that type of situation.

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Richard Allen Clark, Otelco Inc. - COO & President [17]

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Sure, I mean that is -- scale always helps. But if you look at the larger providers, most of them have leverage that well exceeds ours. And one of them is in bankruptcy and a couple of others have announced plans to try to find ways to reduce leverage down to our level. So I think you have to factor in what the other players are doing relative to fiber-to-the-home in the marketplace, fiber-to-the-prem. It's just getting started in this country. And we are, I think, well positioned in our territories to be that provider with capital investment and infrastructure investment, as Rob just talked about.

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Joseph Francis Helmer, Caldwell Sutter Capital, Inc. - President [18]

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Okay. I mean you guys say, it takes -- it's going to happen slowly, but over time, and I believe you on that. It's going to happen slowly. But from an investment perspective, we're concerned with an internal rate of return on the investment, not necessarily getting to a destination. So my own view is that strategic alternatives should be brought back to the table.

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Robert J. Souza, Otelco Inc. - CEO & Director [19]

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I think the company is always willing to listen to alternatives and ideas. And I know that the Board always is willing to discuss those ideas with Curtis and Richard and myself, and we certainly appreciate your comments.

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Operator [20]

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It appears there are no further questions, and that ends our question-and-answer session for today. I'd like to turn the conference back over to Mr. Souza for any closing remarks.

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Robert J. Souza, Otelco Inc. - CEO & Director [21]

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Thank you, Chloe. We appreciate all of you joining this morning. As you've heard, we remained focused on growing our capability to serve customers with the services they need for the changing digital world while we continue to deliver increased value to our shareholders. We always welcome your questions, and we certainly plan on keeping you informed regarding the developments in our business. Thank you again for being on the call. Take care.