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Executives

John W. Finke – Chief Executive Officer, President

David A. Christensen – Chief Financial Officer, Principal Accounting Officer

Jennifer Spaude – Director of Investor & Public Relations

Hickory Technology Corp. (HTCO) Q4 2008 Earnings Call March 4, 2009 10:00 AM ET

Operator

Welcome to the fourth quarter 2008 Hickory Tech earnings conference call. (Operator Instructions). I would now like to turn the presentation over to your host for today’s call Director of Investor and Public Relations, Jennifer Spaude.

Jennifer Spaude

Thank you for joining Hickory Tech’s fourth quarter earnings conference call. Our earnings release was issued yesterday afternoon and is available on our website at hickorytech.com. This conference call will cover the financial results of Hickory Tech for the fourth quarter and full year 2008. Please note that there is also a slide presentation that accompanies today’s call, which is posted on the investor relations section of our website. For those of you viewing the presentation, you will see our Safe Harbor statement on slide two.

Before we begin, I’d like to remind you as a Safe Harbor that this conference call and webcast may contain certain statements that are not historical facts but are forward-looking in nature. These forward-looking statements are based on current expectations, estimates and projections about the industry in which Hickory Tech operates and management’s beliefs and assumptions as of the time of this call.

Such forward-looking statements are subject to uncertainties that could cause Hickory Tech’s future actual results to differ materially from such statements. You’re cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of they were made, which is Wednesday, March 04, 2009.

These statements are not guarantees of future performance and involve certain risks, uncertainties and probabilities, which are difficult to predict. There are many such risks and uncertainties which could affect the company, our industry and our company, in particular some or all, which could affect future results. Therefore, actual outcomes and results might differ materially from what is expressed or forecasted in such forward-looking statements, which whether as a result of new information future events or otherwise.

Before making any investment decision about our company, we encourage you to review the company’s most recent filings with the Securities and Exchange Commission and Hickory Tech’s annual report or Form 10-K, which will be filed tomorrow, and includes descriptions of many of these uncertainties and risk factors. These reports are available on our website on the investor relations page.

All participants are advised that the audio of this conference call is being broadcast live over the internet and is also being recorded for playback purposes. The audio will be archived on Hickory Tech’s investor relations website for the next 30 days. Following management’s discussion we will open the call today to a Q&A session. Representing management today are John Finke Hickory Tech’s President and Chief Executive Officer, and David Christensen Senior Vice President and Chief Financial Officer.

At this time, I’d like to turn the call over to John Finke.

John W. Finke

Welcome to Hickory Tech’s fourth quarter and fiscal 2008 earnings conference call and webcast. Today I’m going to provide commentary on our fourth quarter results and full year 2008 earning. I will further comment on our business strategy and our focus for 2009, as well as the economic impact we are seeing in our business sectors. David Christensen, our CFO, will provide more detail on our financial results and our outlook for 2009.

We are pleased with our 2008 results and our ability to nearly duplicate our 2007 performance, a year of extraordinary growth for Hickory Tech, which set the bar very high for 2008. As reported yesterday afternoon, Hickory Tech delivered fourth quarter revenues of $37.7 million. Net income for the fourth quarter 2008 totaled $1.7 million, a 10% increase over the fourth quarter 2007.

Earnings per share were $0.13 compared to $0.12 one year ago, and consolidated operating income for the fourth quarter totaled $4.1 million, a 16% decline compared to the fourth quarter in 2007. In the fourth quarter, we continued to see businesses scrutinize capital spending and delay purchases, which negatively impacted our Enventis equipment sales.

Consumers are still purchasing equipment but they are also finding ways to delay purchases when possible. Despite this, Hickory Tech’s diverse customers base ranging from consumer to small and large enterprise business and service providers, has helped to balance the economic impact. Hickory Tech is stronger today because of the diversification in our customer segment and, therefore, our products and revenue streams.

In addition, our geographic footprint throughout Minnesota and Iowa, including metro and rural markets, provides further diversification. Our balance sheet remains strong, and I’ll provide additional commentary on how the economy is impacting our business later in the call.

Let’s take a look at our overall fiscal 2008 results. As we compare 2008 results year-over-year, I’ll remind you 2007 was an extraordinary year of growth and included $1.9 million of non-recurring revenue from a settlement with an interexchange carrier.

Hickory Tech’s total 2008 revenues were $153.2 million down 2%. Excluding the settlement revenue, revenues would have declined 1%. Operating income totaled $20.2 million down 13%. Excluding the settlement, operating income would have decreased 5%, and net income totaled $8 million down 7%. Excluding the settlement, net income would have increased 7%.

Now let’s take a look at the individual sectors, and I will start today with the Telecom Sector. Fiscal 2008 telecom revenue totaled $74 million down 4% as compared to fiscal 2007. The primary drivers for the telecom revenue decline were local service and network access.

Local service revenue declined 5% driven by a 9% reduction in local lines. This rate of line loss was inflated by a single large customer disconnecting Centrex services. Local lines would have decreased 6.9% for the year if not for the impact of this one customer.

Consumer competition is strong in the majority of our markets with aggressive marketing tactics being deployed across the communities were serve by national and regional service providers, primarily charter and media count.

We continue to leverage our local customer support as a differentiator and implemented a red carpet approach to customer service in 2008. This approach, which focuses on resolving the customer’s issue on the first call, involved extensive training and reorganization of our customer service department.

Network access revenue declined 16% in fiscal 2008. Excluding the one-time carrier settlement revenue of $1.9 million recorded in 2007, the network access revenue decline would have been 11% or $3 million.

Broadband service revenue continued to be a strong upside for Hickory Tech as we grew our broadband revenues 20% in 2008. Broadband services include DSL, data and digital TV services. DSL subscribers increased 7% now totaling more than 18,500 lines. We expect DSL to continue to show growth but in a modest level considering the penetration levels we have achieved.

Hickory Tech’s digital TV subscribers increased 29% in 2008 as compared to one year ago. We differentiate our digital TV offering by allowing customers to choose their channels as part of our choice plans. Additionally, our competitive high definition channel lineup in our IP TV communities, our select money saving bundles and our local customer support allowed us to compete with national providers for new business.

The majority of our digital TV customers subscribe to our DSL service and to our select bundles. These bundle plans are a key asset to helping customers save money and retain their services during these difficult times. Thirty-seven percent of our customers subscribe to our select bundles.

Now I will turn my comments to our Enventis Sector. The Enventis Sector revenue for fiscal 2008 was

$80 million relatively flat as compared to 2007. Enventis services revenue increased 27% in 2008, which was a key initiative. We extended our statewide fiber network to bring additional quest central offices onto our network. This gives us a competitive position for both business and wholesale transport opportunities.

Enventis’s product portfolio includes communications and data solutions, managed data centers, unified communications, SingleLink Unified Communication, networking, security and professional support. We took an important step and opened a new data center and co-location facility last December. We now have two geographically diverse data centers connected to our fiber network, one in Minneapolis St. Paul and the other located in Mankato, our headquarters.

We recently added Cisco’s Advanced Data Center Network Infrastructure Certification to our list of credentials affirming our expertise in the design, implementation and operation of data centers. Our enhanced SingleLink Unified Communication solution is gaining momentum with increased demand for this hosted solution, which offers an integrated voice and data network, mobility functionality, integrated messaging and more.

We see important growth opportunities in this product line, which can be deployed to midsized businesses with multiple locations throughout our fiber footprint and across the United States through agreements with national carriers.

In a downturn economy, hosted solutions such as SingleLink, are viable options for businesses looking to achieve savings by outsourcing and consolidating their communication needs. We currently serve nearly 200 SingleLink business customers with more than 5,000 users across the platform.

The ETS product line had shown significant operating income growth in fiscal 2008 reporting a 60% increase over 2007. Enventis Network Services and Transport Services revenue increased 27% in 2008. ENS equipment revenue was down 15% from an extraordinary growth rate of 2007 due mainly to the economic impacts discussed earlier.

Enventis, our leading business brand, is known for our consultative sales approach, a clear focus on understanding customer’s needs and designing cost effective solutions to meet those needs. Our deep technical knowledge, our strong telecom and IP expertise, and strategic business partnerships help us compete in a marketplace and differentiate us from our competitors.

From an overall Hickory Tech perspective, 2008 was a solid year. The economic climate was challenging but Hickory Tech remained stabled and maintains a strong balance sheet. We made progress delivering on our business plan to grow broadband revenues, offer integrated services and focus on growing our business services and transport revenues, which are generally recurring in nature.

In 2008, we announced an increase in our fourth quarter dividend from $0.12 to $0.13. Our 2008 dividend and payments totaled $0.49 per share. We also had the opportunity to purchase and retire 393,000 shares of our stock in the fourth quarter. We believe the combination of these initiatives demonstrates our continued commitment to deliver shareholder value. Additionally, we were able to pay down our debt $2.2 million while still investing $17.7 million in capital expenditures.

The economic environment is a concern for us and we are carefully monitoring all signs from our customers. Currently, we are experiencing a slowdown in business capital spending, specifically in equipment sales. Some customers are choosing to decrease their spending or delay purchases.

On the consumer front, both competition and the economy are factors impacting our local line losses. We have limited visibility into how individual spending habits may change as the year progresses. We believe line losses could be impacted in 2009 due to the economy. However, we still project growth in our broadband services. We are cautious yet optimistic about the coming year. We are confident in our portfolio of business and residential services.

We are pleased with our position of strength in the marketplace. We have a strong balance sheet, diverse revenue streams and are financially stable. We will continue to make investments in our network while we focus on increasing profitability and free cash flow across all of our lines of business.

I’ll now defer to David Christensen who will provide insight into our operational performance in the fourth quarter and fiscal 2008.

David A. Christensen

There are several financial items which demonstrate how Hickory Tech is proceeding from a position of strength in these challenging economic times. They include our net income, revenue increases in key strategic areas, our strong free cash flow, our debt reduction, our dividend increase and the share repurchase we made in the fourth quarter and the confidence has showed in our plan, and our ability to generate cash as a reserve on the balance sheet.

We reported fourth quarter net income of $1.7 million up 10% from one year ago. Consolidated operating income decreased 16% for the fourth quarter of 2008 versus the same period last year due to lower telecom revenues, lower Enventis equipment revenue and increased cost of services in the Enventis service business.

A one-time reduction of tax expense of fourth quarter 2008 offset the decline in operating income and net income was increased over that of the same quarter last year. Our overall results are reported in two sectors, and I’ll begin with the Telecom Sector. For these discussions I’m using the pre-elimination numbers from our Telecom Sector recap on page six of our press release.

The Telecom Sector’s fourth quarter 2008 revenue of $18.3 million was down from the $18.8 million we reported in the fourth quarter of 2007. Telecom’s network access revenue for the fourth quarter 2008 was down from the same quarter in 2007 by $739,000. For the full year, network access was down $5 million as compared to 2007.

In a year-to-date comparison, it’s important to again note that 2007 includes a $1.9 million of non-recurring settlement revenue. Even without this, the other $3.1 million of network access revenue decline has been large, and its 11% decline is due to more than just the loss of lines and lower minutes of use on our network.

Disputes with interexchange carriers and settlement agencies elevated our network access decline. Earlier this year we had a dispute with an agency which reduced a portion of our access revenue settlements by $739,000 spread evenly throughout 2008. Separately, the fourth quarter 2008 included a one-tine negative adjustment of $244,000 associated with distribution of cost-based revenue from pools with other carriers.

Each quarter of 2008 was impacted by an anomaly regarding disputes with interexchange carriers or settlement agencies. Our first two quarters were low due to carrier disputes. Our third quarter was high because we resolved the carrier dispute and our fourth quarter was low due to an adjustment involving a settlement agency. Our 2008 network access revenue averaged $6.5 million per quarter.

Looking forward, our interstate access rates will be reviewed and reset in July of 2009. Without the anomalies we had in 2008, our quarterly network access revenue is expected to return to an average between $6.3 and $6.4 million per quarter for the first half of 2009, and to $5.8 to $5.9 million per quarter for the second half of 2009 after the July 1 interstate access rate reset.

Aside from the anomalies, we experienced the same downward network access trends, which our industry peers also experienced, caused by the reduction in minutes and network utilization by end user customers and carriers. Access revenue, due to volume and rate reductions, has been in gradual decline for many years and it is a condition we can plan for and offset with other growth areas.

Telecom’s broadband revenue increased 20% over the same quarter last year continuing a longstanding positive trend. This revenue increase offset the declines in local service and long distance revenue. Telecom operating income decreased $435,000 or 12.5% in the fourth quarter of 2008.

On a full year basis, Telecom operating income declined 27%. However, this includes the $1.9 million non-recurring settlement with an interexchange carrier recorded in the second quarter of 2007. Excluding that one-time settlement form 2007, the year-to-date decline would have totaled $2.9 million or 18%.

Telecom non-depreciation non-amortization costs decreased $329,000 in the fourth quarter and have increased less than 1% year-to-date. Deprecation and amortization combined have increased 6% year-to-date and when all expenses are combined, total Telecom costs show increase of 2%.

Telecom has relatively fixed costs in relation to revenues and may not decrease in proportion to revenue declines. However, over the longer run Telecom costs can be leveled and even lowered. Telecom cost control will continue to be an area of focus for us.

The declines in local service revenue and network access revenue and network access revenue in fiscal 2008 were partially offset by the increase in broadband revenue and bill processing revenue. The net revenue declined, combined with a modest increase in Telecom expense are the causes of a systematic decline in Telecom profitability.

Telecom capital expenditures were $3 million in the fourth quarter of 2008 and $11.1 million for the year. As we continue the planned expansion of our digital TV service in the Mankato market and a systematic upgrade of the Mankato market infrastructure.

Now I’ll comment on the Enventis operating results. Again my comments are from pre-elimination numbers in the Enventis Sector recap on pages seven and eight of our press release. Our focus on increasing Enventis service revenue is clear, as enterprise network services revenue increased $1.7 million or 68% in the fourth quarter.

Transport services, which is also recurring services revenue, increased 19% to $6.5 million during the fourth quarter. We highlight the equipment revenue and the services revenue distinctly within Enventis on slide 13. The comparisons depict service revenue as a growing proportion of our business and that is our strategy.

Equipment revenue within the Enventis Sector was $8.9 million in the fourth quarter compared to $11.7 million a year ago. Equipment sales opened the door to other products and services. This revenue will always vary on a quarter-to-quarter basis, as you can see by the up and down wave on slide 13. And it is also a product line impacted by the economy as customers look to reduce spending and delay their equipment purchases.

Fortunately, the cost of equipment sales component moves in sync with the ENS revenue, giving us less quarterly fluctuation in operating income than you see if you only look at the equipment revenue line. The gross margin dollar impact of the decline in the equipment business for the fourth quarter was approximately $730,000, a much smaller amount than the gross revenue decline in equipment.

Enventis overall cost of service, excluding depreciation and amortization, increased 64% in the fourth quarter 2008 compared to the same quarter last year, and is up 48% for the year compared to 2007. This is due to our commitment to grow our service business and invest in our network. We’ve added staff and third party resources in anticipation of more activity on the service side of our business.

During fiscal 2008, the service business at ENS grew 49%, while the service business within Enventis transport increased 18%. In 2008, we grew the combined service business of ENS and ETS $7.7 million. And we expect to handle additional growth in service revenue in the future enabled by our past increase in resources.

Enventis operating income totaled $1.1 million in the fourth quarter and was lower than the fourth quarter of 2007 because of the economy induced decline in equipment sales and our cost of service increase. For 2008, Enventis operating income increased 2% primarily attributable to the success of our transport services product, which expanded customer use of our network.

We retained most of our customers, we renewed their contracts, we added more circuits and customers in the wholesale market, which serves interexchange carriers, and we developed more business to business customer relationships at both the enterprise size and the small to medium size through our unified communications VOIP product.

Our ETS product line was a large financial success in 2008. It continued a three-year run of double-digit percentage increase growth since Hickory Tech acquired Enventis in 2005. Enventis capital expenditures totaled $2.1 million in the fourth quarter of 2008 up from $1.9 million in the same quarter of 2007. Enventis capital spending totaled $6.4 million in 2008 and was slightly higher in comparison to the $5.9 million of CapEx spent in 2007.

Our fourth quarter 2008 income tax realized an approximate $400,000 benefit that is a lower level of GAAP or book taxes. This lower tax expense is a reversal of prior tax expense reported. It is due to amended tax returns and benefits we receive from loss carryovers and credits. The cash benefit has already been received we’re just chewing up the book accounting. Income taxes per book will return to their typical 42% to 43% levels again in the future quarters.

Our debt balance of $127 million at year end is a reduction of $2.2 million from the beginning of 2008 and down $4.4 million from the third quarter. As we projected in our 2008 guidance, we were able to bring our debt level into the target range of $126 to $129 million. In addition, we had $1.6 million of cash on our balance sheet at year end.

To illustrate where our money is used, we’ll provide an example of free cash flow on slide 15. Free cash flow is depicted as cash flow from operations minus CapEx, minus interest and minus cash taxes. Our cash taxes have been quite a bit lower than GAAP or book taxes for several years now due to the tax benefits of our advanced CapEx level.

The cascade chart starts on the left with our cash flow from operations in fiscal 2008, which was $40.8 million. As you move across to the right, this chart shows we utilized $6.9 million for interest and another $17.7 million for capital expenditures, and we spent $1.5 million for cash taxes. This allows $14.7 million remaining as positive free cash flow.

We paid out $6.5 million in dividend payments making our dividend payout ratio 44% of our free cash flow. Besides the dividend, other uses of or free cash flow in 2008 were the $2.4 million we spent purchasing our own shares, the debt reduction of $2.2 million and the remainder went to improving our working capital by reducing our payables and increasing our cash.

The dividend increase on the share repurchases were allowed under the terms of our credit agreement. We believe this is instrumental for our shareholder value, the ability to consistently address all these accreted forms of shareholder return and growth to our strong cash flows.

Now I’d like to comment on our fiscal 2009 outlook. As John discussed, an uncertain economy may affect our customer’s purchasing decisions. We’ve been successful with our business plan but remain cautious about our customer’s inclination to buy.

Our fiscal 2009 guidance is as follows, we project fiscal 2009 revenues to range between $153 and $159 million. We estimate net income will range between $7 million and $7.8 million resulting in diluted earnings per share estimated to range between $0.54 to $0.60 per share. We expect to spend between $17 and $19 million on capital expenditures in 2009.

Looking back at our year end 2008 debt balance of $127 million, we have a favorable debt position, which is approximately 3.1 times our EBITDA. Looking ahead, we expect year end 2009 debt to be between $124 and $127 million and in addition, we expect to generate cash to hold for new opportunities in an incremental amount of between $1 and $3 million. Our Form 10-K will be released tomorrow and give you more details.

In summary, our fourth quarter produced solid results and we’re weathering a storm fairly well. There were several financial measures in the fourth quarter, which demonstrate we’re able to proceed from a position of strength, which John can speak to next. I’d like to turn it back over to John Finke now, John?

John W. Finke

To put this all in perspective, 2008 was a solid year for Hickory Tech given the steps we took to increase shareholder value despite the challenging economic conditions. Hickory Tech’s balance sheet is healthy and we are in a strong financial position with the ability to proceed from position of strength.

Our strengths include, strong net income, revenue increases in key strategic product lines, free cash flow generating potential, debt reduction, dividend increased and share repurchased shows our confidence in our plan and the ability to generate cash for future growth opportunities.

We’ll continue to look for strategic opportunities to invest in organic growth, such as last model network investments and geographic expansion to further penetrate our business-to-business services. In addition, we are not letting up on our initiative to target acquisitions that fit well within our business-to-business strategy. We believe there are select opportunities to expand our business portfolio. We are well positioned for growth either organically or through an acquisition.

We have confidence in our ability to invest for growth and return value to our shareholders. As we proceed, we are cautious about the economy but confident in our strategy to maximize our core telecom business while growing our Enventis business and focusing both sectors on cash flow. We appreciate your continued interest in Hickory Tech and thank you for joining us today.

At this time, we’d be happy to answer any of your questions. Operator, if there are any questions please initiate them now.

Operator

(Operator Instructions). At this time, we are showing no further questions available. John Finke, you may proceed.

John W. Finke

If you joined us after the call began or would like to replay the call, please visit our website at hickorytech.com. A telephone replay of this call will be available beginning at noon today. If you have questions for us, I’d invite you to give Jennifer, David or myself a call. Once again, thank you for joining us today and we look forward to talking with you in the future. Have a great morning.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

Question-and-Answer Session

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Source: Hickory Technology Corp. Q4 2008 Earnings Call Transcript
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