rural broadbandDeclining margins are an ongoing issue for small rural telcos, as new data from the Telergee Alliance of accounting firms reminds us. The average small telco saw margins drop 1.7% between 2013 and 2014, despite a 2.1% increase in average revenues, according to the 2015 Telergee Benchmarking Study.

Telergee firms specialize in rural telecom and for years have compiled financial data from clients annually in an anonymous manner. This year’s study was based on responses from 197 companies – a substantial portion of the nation’s 800 or so small rural telcos.

Despite financial challenges, however, rural telcos are showing signs that they are more willing to invest in their networks than they have been in recent years, noted Chris Skidmore, senior manager in the communications and media practice at Moss Adams LLP, in an interview with Telecompetitor. Moss Adams is a Telergee member firm and was responsible for creating the 2015 benchmarking report, which is based on data for 2014.

As in previous years, Telergee used data from the median company in gauging results for the average rural telco.

Rural Telecom Margins
Small telco margins are based on a mix of their traditional wireline voice business and newer non-regulated businesses such as video and wireless. And results for those two different businesses were quite different from one another for 2014.

Non-regulated margins were 4.2% — an increase of 2.1% over 2013. But regulated margins were just .8% — a decrease of 7.5% from 2013.

Skidmore attributes the decrease in wireline margins to regulatory causes.

“The rate of return through NECA [National Exchange Carriers Association] pooling was very low,” said Skidmore.

NECA programs for 2014 were designed to enable rural telcos to earn a return of 11.25% through per-minute access charges and through those special access circuits that are regulated by NECA.  But whether goals are met each year depends on a variety of factors, including whether telcos accurately estimate their cost to provide service and whether NECA accurately forecasts minutes of use and circuit orders. In recent years, the system hasn’t worked as well as intended, Skidmore explained  – perhaps because of sweeping changes in the industry. According to Skidmore, part of the loss in profitability of telcos’ traditional wireline business occurred because “the NECA pool is not yielding th rate of return it’s authorized to yield.”

Also contributing to declining wireline profitability are reforms to the Universal Service program calling for a 5% decrease in switching revenues every year, Skidmore said.

Network Investment Up
The goal of Universal Service reforms is to make broadband available to more Americans and at faster speeds than in the past. But for the last few years, rural telcos in the Telergee study have appeared reluctant to make network investments – a phenomenon that others also have noted and that many stakeholders have attributed to telcos’ uncertainty about how the reform process would play out and the extent to which they would be reimbursed for network investment in the future.

For several years, the Telergee Alliance annual report has showed a decline in telcos’ interest expense, suggesting that telcos are reluctant to borrow  – and 2014 was no exception, with interest expense declining 8.3% in comparison with 2013. But interest expense doesn’t tell the whole story, cautioned Skidmore.

A more important number is consolidated plant additions, which increased to nearly $1.7 million for the median company in 2014 from just over $1.3 million in 2013 and 2012. Investment for 2012 and 2013 showed a substantial drop from the $1.65 million that the Telergee Alliance measured for 2011.

“In 2012 reform had just kicked in” and investment dropped, remaining low for 2013, Skidmore said. But the increase for 2014 suggests telcos may be feeling less uncertain about the future.

“Part of me likes to believe [the 2014 investment increase] is because the dust has settled,” said Skidmore.

As for why the interest expense was down for 2014, Skidmore said telcos may be funding build-outs from operations to a greater extent than in the past.

The 2015 Telergee Benchmarking Report also looked at profitability by line of business and for the first time included detailed data about the extent to which small rural telcos are dependent on subsidies. Telecompetitor will explore those findings in a future post.

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