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Executives

Jennifer Spaude – Director, Investor and Public Relations

John Finke -- President and CEO

David Christensen -- SVP and CFO

Analysts

Beth Lilly – Gabelli

Hickory Tech Corporation (HTCO) Q3 2009 Earnings Call Transcript October 29, 2009 10:00 AM ET

Operator

Good morning. My name is Lindsay, and I will be your conference operator today. At this time, I would like to welcome everyone to the HickoryTech third quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions) Thank you.

I would now turn the call over to Jennifer Spaude, Director of Investor and Public Relations.

Jennifer Spaude

Good morning and thank you for joining HickoryTech’s third quarter 2009 earnings conference call. Our earnings release was issued yesterday afternoon and is available on our Web site at www.hickorytech.com. This conference call will cover the financial results of HickoryTech for the third quarter. Please note that there is also a slide presentation that accompanies today’s call, which is posted on the Investor Relations section of our Web site. For those of you viewing this presentation, you will see our Safe Harbor statement on slide two.

Before we begin, I would 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 HickoryTech 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 HickoryTech’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 which they were made, which is Thursday, October 29, 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 economy, our industry, and our company in particular. Some or all of which could affect future results. Therefore actual outcomes and results may differ materially from what is expressed or forecasted in such forward looking statements, whether as a result of new information, future events or otherwise.

Before making any investment decisions about our company, we encourage you to review the company’s most recent filings with the Securities and Exchange Commission and HickoryTech’s Annual Report on Form 10-K, which includes descriptions of many of these uncertainties and risk factors. These reports are available on our Web site.

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 HickoryTech’s Investor Relations Web site for the next 30 days.

Following management’s discussion today, we will open the call to a Q&A session. Representing management today are John Finke, HickoryTech’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 Finke

Thank you, Jennifer. Good morning, everyone and welcome to HickoryTech’s third quarter 2009 earnings conference call and webcast. Today, I’ll discuss our business strategy and the trends affecting our business. David Christensen, our CFO will provide details on our third quarter financial results.

We’ve made steady progress in the third quarter to grow our business-to-business operations. In August, we completed our acquisition of CP Telecom, a facility-based telecom provider serving Minneapolis and Northern Minnesota. The adjusted purchase price was $6.6 million, which we paid for with cash on hand. It has been a high priority for us to quickly integrate CP Telecom into our operations in order to expand our focus on the small-medium business marketplace. The building conversion is on schedule to occur in November, and we've identified numerous strategies between the two businesses, including the conversion of off-net circuits to our fiber networks, consolidation of systems, and the integration of engineering operations and customer service functions.

We will add eight additional sales reps to focus on small-medium businesses, and we are making investments in mid-band Ethernet capabilities in strategic markets to enhance our SMB service offerings. As I’ve mentioned in previous calls, HickoryTech is no longer a pure telephone company or an ILEC [ph]. Our strategy and growth over the past four years has been to position HickoryTech as a fiber backbone transport company and a competitive broadband communications provider. In spite of a challenging business environment, we have continued to deliver solid operating results and are pleased with our third quarter results.

HickoryTech's third-quarter revenues totaled $34.9 million, down 12% from the comparable period in 2008, yet up 8% on a sequential basis. Net income totaled $6.1 million or $0.47 per diluted share, and was up substantially from the $2.1 million reported one year ago. A release of an income tax reserves added $4.4 million to the third quarter 2009 net income. Dave is going to provide more details on this tax reserves in his remarks.

Operating income for the third quarter totaled $4.7 million, down 12% from one year ago.

I'll now touch on the results and strategies of our individual sectors. Starting with the telecom sector; third quarter telecom revenue totaled $17.8 million, down 6% compared to the third quarter 2008. Correspondingly, costs and expenses within the telecom sector were reduced 7% compared to one year ago. This sector continues to produce strong stable cash flows.

Local service revenues declined 7%. Access lines were down 7% from one year ago, compared to a 9% decline in the second quarter of 2009. Network access revenues totaled $6 million, down 11% from one year ago.

Broadband services, which included DSL, data and digital TV revenue increased 12% to $3.1 million. DSL lines continue to increase with a 5% increase and digital TV lines increased 19%. We are pursuing cable franchise agreements in two small rural Minnesota communities. We provide local voice and DSL services in these communities today and plan to offer our TV services later this year. Our digital TV service includes choice plans, which allow customers to add channels based on their preferences. This distinguishes us from our competitors. We also offer expanded high-definition programming and DVR service in many of our TV communities.

While our IPTV service is competitive, our strategy is to sell a bundle of services, including local phone, high-speed Internet and digital TV. 37% of our customers subscribe to our select bundles, and we continue to take market share from our competitors as we have grown our DSL and digital TV customer base. All the markets in which we operate are highly competitive. Customers have choices and we continue to leverage our local customer support and our red carpet customer service.

Now turning to the Enventis sector, which is purely business-to-business products and services, continues to build momentum in certain areas, but it’s also been impacted by a difficult economy. Equipment sales have been significantly impacted by the economy as businesses have reduced and delayed capital expenditures in the current economic environment. Lower equipment sales, which are down $15.8 million in 2009 is a primary factor for overall revenue decline. Enventis sector revenue in the third quarter totaled $17.6 million, down $3.7 million from one year ago. Enventis net income totaled $900,000, down 6% from one year ago; and operating income was $1.5 million, also down 6% from one year ago.

We continue to aggressively manage costs to offset the Enventis overall revenue declines. Costs and expenses in the third quarter were down 18% from one year ago. Because of these cost controls all Enventis lines of business remained profitable on a year-to-date basis. We have also worked to improve our processes and procedures to make us more efficient and able to handle customer demand when the economy recovers.

We also continued to see strong growth in our Enventis transport services. Transport services revenue increased 37% in the third quarter compared to one year ago. CP Telecom revenues are now included within the ETS revenue line. This new revenue and growth in wholesale transport services, such as high-capacity Ethernet, MPLS, and wavelength services, are the primary drivers for the significant revenue growth.

While we are not directly in the wireless business, as a service provider, we are well positioned to benefit from increased demand for mobile data services by being a backhaul provider to regional and national wireless providers. We've been building out and upgrading our fiber networks over the past three years to meet increasing demand for higher speed landline connection through wireless towers and switch locations.

Our Minneapolis network was upgraded to allow us to offer 10 Gigabit services this year to handle high-capacity services for wireless carriers. We see great opportunity for HickoryTech to continue to provide backhaul services to wireless operators as they upgrade their networks to accommodate new mobile applications.

We are also increasing the number of co-locations throughout our network, which provides us a competitive pricing advantage for [ph] business and wholesale transport opportunities. Our network is evolving and is well positioned to deliver the higher bandwidth our customers will need. This is another step in an overall plan to expand our network geographically and to build out our business-to-business services.

Throughout our company, we have deep technical knowledge, strong telecom and IT expertise, and strategic business partners that enable us to deliver competitive solutions for our customers, from small to medium size businesses to large national enterprise customers and national service providers. These capabilities along with our statewide fiber network allow us to differentiate ourselves in increasingly competitive marketplace.

I will now refer to David Christensen who will provide details on our operational performance in the third quarter.

David Christensen

Thank you, John. Good morning. To recap our third quarter, net income was $6.1 million, including a $4.4 million tax reserve reversal. We would have had a $1.7 million third quarter net income without that reversal, which would have represented a 20% decrease from the comparable period last year.

Consolidated operating income totaled $4.7 million in the third quarter, a 12% decrease from the comparable quarter in 2008, mainly due to lower Enventis, ENS, equipment and services revenue. Third quarter consolidated revenue totaled $34.9 million, down from $39.9 million a year ago. As was the case with operating income, lower equipment sales in our Enventis business was the primary driver for the revenue decline in the quarter. This was partially offset by increases in telecom broadband revenue, growth in the Enventis transport services, and excellent cost controls in all of our lines of business.

HickoryTech is a company that provides consistent operating results. In our view, each of the three quarters of this year has been very consistent. Outside of the income tax reversal, which I will discuss in a minute, we do experience quarter to quarter variability based on the time of the year, plus there are cyclical peaks and valleys in our Cisco equipment business. Nevertheless, it's possible to look through those variations to find the consistency and stability of the service business that is the core of our company.

As John said, we completed the CP Telecom acquisition in the third quarter, on schedule and without difficulty. We are very happy with the transition. The adjusted purchase price of approximately $6.6 million was paid for with cash on hand and no new borrowing has taken place. CP Telecom has been included in this quarter's results as part of our Enventis transport service product line. We will not disclose separate CP Telecom operating results going forward; however, we will tell you that the two-month revenue from CP Telecom was $1.6 million.

We also observed that CP Telecom operations were accretive to our operating income, net income and free cash flow already in the initial quarter of joint operations. CP Telecom will be fully integrated into our organization by the end of 2009.

Our balance sheet at the end of the third quarter remained strong, and that includes solid levels of cash on hand and reduced debt. After the completion of the acquisition of CP Telecom, we still held $7.3 million of cash on hand on September 30, 2009.

The most notable item of this quarter is our release of $4.4 million of income tax reserves or accruals. During the third quarter, we recognized $4,454,000 of previously unrecognized tax benefit, including interest as a result of the expiration of the statute of limitations related to tax years for examination by tax authorities. Functionally, this is not a cash transaction. It does not change any income tax return filing. On our financial statements, under the FIN 48 accounting standards, we have lowered non-current tax liabilities, and through elevated net income we have increased our shareholders’ equity.

In the fourth quarter, we expect our effective tax rate and tax accrual to return to historical relationships for that quarter, although the total annual numbers will still include this $4.4 million reversal.

Now I’ll touch on the telecom sector highlights. For these discussions, I'm using the pre-elimination numbers from our telecom sector recap in our earnings release. Telecom operating income totaled $3.4 million, approximately the same as last year’s third quarter. Telecom revenue was down $1.1 million or 6% for the third quarter in 2008, but we were able to reduce telecom expenses approximately the same amount. So operating income is similar in both years.

We have a good track record with telecom cost controls having saved $2.3 million or 5% in the nine months ended September 30 of 2009 versus last year; and we are committed to continual process improvement in every aspect of telecom sector costs. The growth in our telecom broadband revenue, which is a combination of our telecom data service and our digital TV service, was 12% year over year. This helped to offset the 7% decline in local telecom revenue and the 11% decline in network access revenue this quarter.

Telecom costs, other than depreciation and amortization, which were $10.5 million in the third quarter decreased 8% or $900,000 compared to one year ago. This is a key element of maintaining our telecom sector profitability during this time of industry change. Examples of what's being done, include gains through operational efficiencies, management action specific to the telecom sector, and general corporate-wide cost control initiatives.

Telecom capital expenditures were $2.6 million in the third quarter of 2009 compared with $3.1 million a year ago. For the year, we've invested $6.4 million in telecom compared with $8.1 million through nine months last year, down 21% year over year. We were able to reduce our telecom CapEx and we will continue to be conservative with our investments in this sector.

We will continue to support our broadband growth and maintain our telecom network, but we will focus closely on maintaining our strong free cash flow from the telecom sector. By a way of example, year-to-date telecom EBITDA totaled $22.3 million, less its $6.1 million CapEx, that equals $15.9 million of telecom free cash flow through nine months this year.

Now I will comment on our Enventis operating results, again my comments are from the pre-elimination numbers in the Enventis sector. Enventis operating income totaled $1.5 million in the third quarter of 2009, down 6% from a year ago. John described the economy related impact on our equipment sales business, offset by the continued systematic high-growth of our transport services business and specific products and service drivers in both of those markets. We are most proud of the 37% increase in Enventis transport services revenues in the third quarter. Even without the newly acquired CP Telecom business, which is recorded there, ETS would have shown a 14% organic growth in revenues.

It is typical for the equipment business to have peaks and valleys. Fortunately, the cost of equipment sales component moves in sync with equipment revenue, giving us less quarterly fluctuation in operating income than you see if you only look at the equipment revenue line.

The lower EMS revenue also impacts ENS services revenue, which is where the labor for equipment design and installation is recorded.

The gross margin dollar impact of the decline in the equipment business for the third quarter was approximately $600,000, significantly less than the gross revenue decline of $5.1 million in equipment sales.

Enventis overall costs and expenses totaled $16 million and declined approximately the same amount as the revenue declined. For year-to-date, Enventis total costs and expenses have decreased 20%.

Enventis sector capital expenditures totaled $1.4 million in the third quarter of 2009 compared with $1.3 million in the corresponding quarter of 2008. For the year to date, we've invested $4.9 million in Enventis compared to the $4.3 million for the same period last year. We continue to invest in the transport portion of the Enventis business to support its growth.

Our debt balance, long-term plus current maturities, totaled $124.9 million as of September 30, 2009, and is down $2.1 million for the year and down $6.5 million from one year ago. One of our strengths is our $125 million debt, which is covered with a 3 to 1 ratio of debt to EBITDA, which can borrowed at a rate of only 175 basis points over a three-month LIBOR, the majority of which is protected with fixed rate products until September of 2011, and our access to an additional $30 million under our existing credit line revolver. In addition, we have $7.3 million of cash on our balance sheet at September 30, 2009; and this is after spending $6.6 million for the acquisition of CP Telecom with cash and no new debt.

We feel we are truly positioned for growth with a strong balance sheet and our ability to generate free cash flow. As an example of our operating cash flow, it's illustrated on slide 10, which accompanies this presentation; this is a nine-month picture. Our operating cash flow is depicted as cash flow from operations or EBITDA minus debt service payments minus CapEx and minus cash taxes. Our cash taxes are typically quite a bit lower than GAAP or book taxes due to the tax benefits of our enhanced CapEx levels.

The cascade chart starts on the left with our cash flows from operations for nine months or EBITDA, which was $30.2 million. As you move across to the right, this charts shows we’ve spent $6.2 million on debt service, $11.3 million for capital expenditures, and $1.2 million for cash taxes. This allows $11.5 million remaining as positive operating cash flow.

We paid out $5.1 million in dividend payments over nine months, creating a dividend payout ratio of 44% of our operating cash flow, a healthy and safe pay out percentage. Plus even in a period of lower earnings due to the economy, we are generating strong cash flow, strong enough to support the dividend to pay down the debt to continue to invest in our business and even to build cash to fund future growth initiatives.

Based on the economic factors impacting our business, we will update our fiscal 2009 guidance at this time. Revenue previously projected between $153 million and $159 million is now expected to range $138 million to $141 million for the year. Net income previously forecasted between $7 million to $7.8 million [ph] will now include the $4.4 million income tax release and is expected to range between $11.5 million and $11.9 million for 2009. Diluted earnings per share is estimated at a range of $0.88 to $0.91 per share. CapEx previously projected between $17 million and $19 million remains in this range. Our year-end debt estimate remains unchanged at $124 million to $127 million.

In summary, our third quarter represents a continuation of our consistent strong operating results this year. We also completed our CP Telecom acquisition flawlessly. We built up more cash and we have the unique opportunity to reverse some income tax accruals. We are well positioned for HickoryTech to grow when the economy gets healthier.

I would like to add that our SEC Form 10-Q will be filed later today and should provide more details on our financial results.

With that I would like to turn it back over to John Finke now. John?

John Finke

Thank you, Dave. In closing, we are pleased with our third quarter results and excited to be in a position to pursue strategic growth opportunity. We will talk more about our growth plans in our year-end earnings call.

We have worked aggressively to integrate CP Telecom into our operations. This acquisition enhances our focus on the small-medium business customer, and we will continue to add resources to pursue growth in this area.

Our strategy is to further grow our business services, while we maintain our growth in broadband services and manage the gradual decline of our telecom business. Despite the declines in local service and network access revenues, the telecom segment continued to produce stable cash flows. Our balance sheet is strong and we are in good financial position to grow our company. We have solid net income, a high level of recurring revenues, a growth trend in key strategic product lines, shareholder value through our dividend, low cost debt covered by strong cash flow and the ability to generate cash to fund future opportunities.

We will continue to invest in organic growth opportunities, which has been our business strategy, such as fiber network investments or data center services. We are confident in our strategy to maximize our core telecom business, while growing our Enventis sector and focusing both sectors on cash flow.

We appreciate your continued interest in HickoryTech, and thank you for joining us on the call today. At the same, we'd be happy to take any questions you might have. Lindsay, if there are any questions you may initiate them now.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Beth Lilly with Gabelli.

Beth Lilly – Gabelli

Good morning.

David Christensen

Good morning.

John Finke

Good morning, Beth.

Beth Lilly – Gabelli

Could you spend a little bit more time discussing what's going on in the ENS business? You lost money in the quarter and just the dynamics, I mean clearly equipment was down substantially. Can you just talk about the dynamics with your customers and whether you think that business will return to profitability in the fourth quarter.

John Finke

Yes, Beth. This is John. We have definitely seen the decrease in the Enventis ENS line of business, and believe that it is very much impacted by the current economy. We still have a very strong backlog or sales funnel for this business but we’re just seeing customers that are very hesitant to pull the trigger and turn those into orders. We have done some work on the cost side of the ENS line of business, and as well as continue to work on the processes and procedures in that business. So on a year-to-date basis, we’ve continued to have that line of business profitable and producing positive EBITDA. So, we do expect it to rebound as the economy rebounds.

David Christensen

Beth, remember, one of the great things about ENS business is it requires no capital. What you make is what you to keep. So even in slim times it's very good for HickoryTech.

Beth Lilly – Gabelli

So what are your customers telling you, that they are just holding off on capital purchases and that as the economy improves they are going to resume their purchases?

John Finke

Yes, that's what we are seeing.

Beth Lilly – Gabelli

Okay.

John Finke

I mean, we have had customers that have even started through the process and then delayed within a process. So I think it's just that businesses are continuing to watch that spend and until they are confident things are going to turn around in their industry, there are not going to make the investments in this type of equipment. But at the meantime, I guess one other things just to elaborate a little bit, we have continued to look at the new opportunities that are going to be within the ENS line of business. You’ve noticed a couple of releases that we’ve had about some new certifications that we have got in that line of business. So we are continuing to, if you will, make some investments in those type of resources so that we can take advantage of those growth opportunities as they advance as well.

Beth Lilly – Gabelli

Just I wanted to be clear about CP Telecom. You paid $6.6 million for it, correct?

David Christensen

That's correct.

Beth Lilly – Gabelli

And what did it add in the quarter to revenue.

David Christensen

$1.6 million for two months of the third quarter.

Beth Lilly – Gabelli

Okay. And in the Q, will it give the financial metrics of the business or did you talk about what you paid for it or anything?

David Christensen

Yes, in the Q, there will be a full disclosure of the purchase price allocation, the typical purchase accounting disclosures. As a small tuck-in acquisition, we will not disclose separate CP Telecom operating results going forward. Over time, the CP Telecom operations are going to evolve into our small-medium business focus. But what we did layout is the purchase accounting metrics.

Beth Lilly – Gabelli

So what was the business generating in revenue and EBITDA when you bought it?

John Finke

We have not disclosed the EBITDA. The revenue that we reported was around $10 million.

David Christensen

Their EBITDA was typical to any typical CLEC.

Beth Lilly – Gabelli

Okay, so it generated $10 million in revenue last year?

John Finke

Yes.

Beth Lilly – Gabelli

Okay. Terrific. Okay, great. Those are all my questions. Thanks so much.

John Finke

Thank you for joining us today. Appreciate the questions.

Beth Lilly – Gabelli

Absolutely.

Operator

(Operator instructions) There are no questions at this time. I would now turn the call back to John Finke.

John Finke

Thank you, Lindsay. If you’ve joined us after the call began or would like a replay of the call, please visit HickoryTech’s Web site at HickoryTech.com. A telephone replay of this call will be available beginning at noon today. Once again, thank you for joining us and we look forward to talking with you in the future. If you have any further questions, I'd certainly invite you to give Jennifer, David, or myself a call. Thanks again and have a great morning.

Operator

This concludes today's conference call. You may now disconnect.

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