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Edited Transcript of OTEL earnings conference call or presentation 6-Nov-19 4:30pm GMT

Q3 2019 Otelco Inc Earnings Call

ONEONTA Nov 18, 2019 (Thomson StreetEvents) -- Edited Transcript of Otelco Inc earnings conference call or presentation Wednesday, November 6, 2019 at 4:30:00pm 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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* 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 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. 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, Cody, 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 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.

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

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Thank you, Dru. 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'll take everyone's questions.

While our results for the third quarter continued to reflect the trends impacting our industry as traditional access revenues and residential RLEC customers decline, 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 ACAM, which included a positive retroactive revenue true-up dating back to January of this year, providing a one-time 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 2 quarters. Excluding the impact of the ACAM 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 switch access revenue affected by the FCC's 2011 intercarrier 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. Costs 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 one-time 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 IT-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.

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

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Thanks, Rob. During the third quarter, we continued to execute the strategy we have 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 in investment aimed at providing customers increased Internet speeds to better meet the requirements of our customers, and over time, 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 our 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 current 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 postauction CAF II filing requirements in February to receive just over $0.9 million 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 relationship with WiValley are now receiving wireless service with additional sites being completed during the fourth quarter. And in October, 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, Otelco 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 resident and business locations within the town with fiber-to-the-premise services. Approximately 100 of the locations in Alton are also part of our ACAM buildout obligations.

Grant funding received from Alton and ConnectME will support approximately 60% 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, Otelco completed its fiber builds, passing approximately 630 locations as part of its announced fiber expansion plans. Another 850 locations were passed with fiber in the month of October and released for marketing and sales efforts. 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 3,300 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 customers. Looking ahead, we'll 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. Customer serves decreased 0.6% or 205 customers from the end of the second quarter. This is an improved trend compared with 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 the continued deployment of fiber-based services over the next 2 years to transition to VDSL in all of our networks and the deployment of DOCSIS 3.1 in our cable networks. 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 Otelco family of companies.

Curtis will now summarize the third quarter financial results.

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

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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 the 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 ACAM 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 cost increased by $0.1 million -- decreased 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 is reflected as an expense over 39 months while cash compensation must be expensed in 12 months. There's no change in total amount of senior management compensation involved.

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 of 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% at $1.8 million in the third quarter of 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 the third quarter compared -- of this year compared to 69% -- $0.69 per share in the same period of 2018.

Consolidated EBITDA was $5.8 million for the third quarter 2019 compared to $6.5 million for the same period last year driven by the decrease in revenue. Our balance sheet reflects cash of $5.3 million at the end of 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 CoBank in third quarter 2019, reducing the loan balance to $71.3 million. As of September 30, 2019, the 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 2 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 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 the 10-Q.

Cody, if you'll provide directions, we can shift 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) We'll hear first from [Wally Walker].

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Unidentified Analyst, [2]

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Okay. While I'm aware Otelco is reluctant to give forward-looking guidance, it's quite clear that revenue in the first 3 quarters of this year has been stable. Now if we assume little-to-no immediate effect on third quarter revenue from the Alabama upgrade, the Massachusetts wireless network and the Alton, Maine fiber build, wouldn't it be logical 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?

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

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Wally, at this point, we're not sure we have enough data points to maybe concur with your expectations or your premise that you're making. We do think all of 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 ACAM. Some of our ACAM companies have some step-down amounts year-over-year, I think somewhere in the neighborhood of approximately $250,000 to $300,000 per year.

So when you net all those things together, I'm not 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.

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Unidentified Analyst, [4]

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Right. I'm just looking at the math here. Just in the month of October alone, you said you added 850 locations passed with fiber. Now if we assume like a 35% take rate, that's about 300 new customers just last month alone. And take rates like places like Western Massachusetts and Alton, wouldn't you agree that the take rate would be higher than 35%?

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Robert J. Souza, Otelco Inc. - CEO & Director [5]

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Wally, one thing that note is when we say we passed 850 new locations, we may already have 35% of those customers on copper. So they're not necessarily customers that we're getting. They're conversions.

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Unidentified Analyst, [6]

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Okay. Do you have an estimate of how many new locations you'll pass in November?

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Robert J. Souza, Otelco Inc. - CEO & Director [7]

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I don't yet. Although for the year, we'll pass 5,600.

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Curtis L. Garner, Otelco Inc. - Secretary & CFO [8]

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And I think, Richard, I think I believe that we'll pass about another 850 or so I think, in the month of November as well.

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Richard Allen Clark, Otelco Inc. - COO & President [9]

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So in most case -- almost all cases, when we're saying we're passing new locations, they're already existing -- they're all existing locations we're passing today with copper.

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Unidentified Analyst, [10]

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Okay. And that...

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Richard Allen Clark, Otelco Inc. - COO & President [11]

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A portion of that customer base already.

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Unidentified Analyst, [12]

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Okay. Obviously, not the wireless one in Massachusetts though. That's brand-new, right?

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Richard Allen Clark, Otelco Inc. - COO & President [13]

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Definitely. That's correct.

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Unidentified Analyst, [14]

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One other final question. Now the SEC recently proposed a $20.4 billion rural digital opportunity fund with a reverse auction format similar to CAF II that Otelco participated in last year. Now while the SEC order hasn't been -- arrived yet, it hasn't been -- so sometime early next year, it looks like. Do you have any immediate thoughts on the initial FCC press release on this?

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Richard Allen Clark, Otelco Inc. - COO & President [15]

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Our thought is that if they take the standard practice to be focused on underserved or unserved, there'll be very little on our territory that qualifies.

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Unidentified Analyst, [16]

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Okay. Got it. And what about -- I mean could you do out of territory? Or is that something that you wouldn't look at?

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

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We'll look at every opportunity. But in most cases, in an out-of-territory environment, the incumbent would have a significant advantage because their cost to build will be significantly lower than ours.

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Operator [18]

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We'll take our next question from [Michael Wu].

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Unidentified Analyst, [19]

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I have a question about the leverage ratio. So candidly, this quarter it's 2.77%, right?

Can you hear me? So I was wondering what is a comfortable level you guys -- going forward, would you guys like to see, like 3 or 4 or 2? What are you guys comfortable with?

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Robert J. Souza, Otelco Inc. - CEO & Director [20]

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Curtis, why don't you respond to this question, please?

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Curtis L. Garner, Otelco Inc. - Secretary & CFO [21]

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The industry has been driving traditional RLECs down to numbers that would be in the 2.5 to 3 range, which puts us in the right location. But as we expand the fiber content of our network and therefore the future viability of the 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, move revenue to where we slow down or stop the decline in revenue.

So where 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 rural telephone company, but one that's increasing fiber content significantly is probably -- needs to be higher than that.

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Unidentified Analyst, [22]

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Okay. So my second question is about what is the capital plan for next year? It's pretty heavily -- like these past 2 years. So would you expect to continue to have it reinvested? Or will you reduce it a little bit? Or kind of rough idea?

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Curtis L. Garner, Otelco Inc. - Secretary & CFO [23]

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I think you can expect that we will try to maximize our capital expenditures to the point of not -- I think it'll be in a similar level as the last couple of years because I think that's what makes sense to continue our fiber expansion and to continue enhancing our network to try to increase data speeds available to our customer base.

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Unidentified Analyst, [24]

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Okay. So I have a question about the covenant of the debt. Is it supposed to be -- I think by January 2021, it's supposed to be under 3, right? So if I remember correctly...

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Curtis L. Garner, Otelco Inc. - Secretary & CFO [25]

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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 lenders prior to any time that any covenants might be at risk as we change our guidance and direction on the capital investment.

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Unidentified Analyst, [26]

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Okay. So basically, you guys are pretty comfortable with the current debt level, right? Because I assume -- 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?

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Curtis L. Garner, Otelco Inc. - Secretary & CFO [27]

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I think we've pretty much demonstrated that it's more valuable to our subscriber -- our shareholders as well as our customers to increase our level of investment as opposed to increase our level of paydown.

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Operator [28]

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(Operator Instructions) We'll hear now from [Alan Caruso] with [Vertigo Capital].

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Unidentified Analyst, [29]

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I'm calling over the Internet so there's 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 bonds for additional capital expenditures? Or would you be interested in selling preferred shares so that you can spend more on capital expenditures?

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Richard Allen Clark, Otelco Inc. - COO & President [30]

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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 a 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.

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Unidentified Analyst, [31]

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And just another question. I think consolidation in this space makes a lot of sense. Are you still looking at potential mergers with some of the other players in this space?

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Robert J. Souza, Otelco Inc. - CEO & Director [32]

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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 that we're going to see any change in that at this point in time.

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Operator [33]

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That does conclude today's question-and-answer session. I would like to turn the conference back over to Mr. Souza for any additional or closing remarks.

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Robert J. Souza, Otelco Inc. - CEO & Director [34]

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Thank you, Cody. 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 developments of our business. Thank you.

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Operator [35]

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Thank you. And that does conclude today's conference. Thank you all for your participation. You may now disconnect.