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Executives

Jennifer Spaude – Director, Public and IR

John Finke – President and CEO

David Christensen – SVP and CFO

Hickory Tech Corporation (HTCO) Q4 2009 Earnings Call Transcript March 2, 2010 10:00 AM ET

Operator

Good morning. My name is Vani, and I will be your conference operator today. At this time, I would like to welcome everyone to the HickoryTech fourth 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 fourth quarter 2009 earnings conference call. I am Jennifer Spaude, and with me today are John Finke, HickoryTech’s President and Chief Executive Officer; and David Christensen, Sr Vice President and Chief Financial Officer.

Before we get started, let me remind you that an earnings release was issued yesterday afternoon, and is available on the Investor Relations section of our Web site at hickorytech.com. In addition, you will find a presentation for today’s call, which we hope you will find helpful in your analysis.

Now, I would like to draw your attention to our safe harbor statement. Information in today’s presentation contains certain statements and predictions 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 the call.

Such forward-looking statements are subject to uncertainties. Actual results or outcomes may differ materially from those indicated or suggested by any forward-looking statements, whether as a result of new information, future events or otherwise. You are cautioned not to place undue reliance on these forward-looking statements made during this conference call, which represents estimates as of March 2, 2010.

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. More information on potential risks and the uncertainties are available in the company’s recent filings with the Securities and Exchange Commission, including HickoryTech’s Annual Form 10-K report, quarterly Form 10-Q report, and Form 8-K report.

This presentation also contains certain non-GAAP financial measures. Reconciliation of these non-GAAP measures to the most directly comparable GAAP measures are available in our presentation. All participants are advised that the audio of this conference call is being broadcast live over the Internet and is also available for playback purposes. The audio will be archived on HickoryTech’s Investor Relations Web site for the next 30 days. Following management’s discussion, we will open the call to a Q&A session today.

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

John Finke

Thank you, Jennifer, and good morning everyone. Yesterday we reported our fourth quarter and fiscal 2009 results. Let me begin with a few financial highlights, and some general remarks about our business climate. I would like to confine most of my remarks this morning to describing a new phase in the evolution of HickoryTech. David will take you through the details of our fourth quarter and fiscal 2009 results later in the call.

Our fourth quarter revenues totalled $38.3 million, up 2% from a year ago, and up $3.4 million from the previous quarter. Operating income in the fourth quarter totalled $4 million, and was relatively flat compared to one year ago. Net income totalled $1.4 million, and was down 15% from a year ago, due to differences in the income taxes between the two years.

As with many companies, we do sense the economy is recovering but the process has been slow and uneven. That said, we are pleased with the strong growth in our Enventis fiber and data services, and the solid results in our Telecom Sector. We have also seen increases in the past two quarters of Enventis equipment sales, and in the past three quarters of Enventis services.

Looking specifically at our financial results, the Enventis Sector, which is focused on providing business-to-business products and services generated fourth quarter revenue of $20.9 million, up $1.3 million from a year ago. Enventis net income totalled $762,000, down 17% from a year ago, and operating income was $1.2 million, up 9% from a year ago. The decrease in net income of the Enventis Sector was a result of decreases in the segment’s income tax reserve in the fourth quarter of 2008.

We closely managed costs throughout 2009 to offset the Enventis overall revenue declines. Cost and expenses in the fourth quarter were up slightly, primarily due to two factors, the addition of CP Telecom to this sector, and increased equipment cost, the result of higher equipment sales. Enventis Sector cost and expenses in fiscal 2009 were down 13% compared to a year ago. The Enventis Sector and its product lines were profitable in 2009. We have improved our processes and procedures to make us more efficient and able to handle additional customer demand when the economy recovers.

Now looking at the Telecom Sector, fourth quarter revenue totalled $17.9 million, down 2% compared to a year ago. We reduced our cost and expenses by 3% compared to one year ago. The Telecom Sector continued to produce strong stable cash flows. Broadband services revenue, which includes DSL, data and digital TV revenue grew 10% in 2009 to more than $12 million in annual revenue. Broadband revenue growth offset some of the weaknesses in other portions of the Telecom Sector.

We have achieved high DSL and digital TV penetrations in many of our markets. DSL subscribers increased 3% from a year ago to 19,346 subscribers, and digital TV subscribers increased 15% totaling 9,653. In 2009, we expanded our digital TV service to two small communities and to additional homes at Mankato, our headquarters location. We increased our DSL speeds, added DVR service, and expanded our high-definition channel lineup in our IP TV communities.

As we strive to retain current customers and add new ones, enhancing the customers experience with more features and value is important. We continue to increase our focus on customer retention through loyalty programs and marketing plans. Our service bundles offer customers an easy way to choose a package that best meets their communication needs. 44% of our customers subscribe to our bundles, which aid in customer retention and increased customer loyalty. All the markets in which we operate are highly competitive. Customers have choices and we continue to leverage our strengths, such as our local customer service, which differentiates us from our competition.

Now, looking at consolidated results for fiscal 2009, revenue totalled $139.1 million, down 9% from a year ago, primarily due to lower equipment sales. Net income totalled $11.3 million, up 40% primarily due to an income tax reserve release, which added $4.4 million of net income in the third quarter of 2009. Operating income totalled $18.6 million, down 8% from a year ago. From an overall perspective, 2009 was a year of solid financial performance for HickoryTech. The economy presented challenges for many businesses but HickoryTech has remained stable with a strong balance sheet and continues to make progress with our strategic initiatives.

Over the past several years, we have been positioning HickoryTech to enter a new phase of its history (inaudible) which we plan to grow our company at an accelerated pace. We are now positioned to provide you with some details about that plan. While seemingly not the most ideal economic conditions to start a growth phase, we see considerable opportunity in our industry, hence we are pursuing growth initiatives, and investing in a strategy meant to accelerate the growth in our Enventis business segment. You have already seen some evidence of this.

Our Enventis fiber and data services revenue, formerly called transport services, totalled $9.5 million in the fourth quarter of 2009, an increase of 46% from the same period one year ago. This strong revenue growth is attributed to increased sales of high capacity ethernet, MPLS, and fiber services, and the contribution from CP Telecom, which we acquired in August of 2009. Excluding CP Telecom’s contribution, fiber and data revenue in fiscal 2009 increased 14%, a significant increase in a down economy. This line of business, fiber and data services, has consistently grown year over year, 19%, 18% and 30% respectively over the past three years.

The acquisition of CP Telecom in 2009 represented the first step in our growth plan when focused on expanding our business products and services. More recently, we further expanded our direct sales force throughout Minnesota by adding sales staff to focus on small-to-medium size businesses. We are making investments in mid-band ethernet capabilities in strategic markets over the past year and we strategically expanded our network to reach more customers.

In sum, our goal is to strategically grow our operations and manage our cash flow in order to double the value of our company over the next five years. The steps we have taken over the past several years to develop and enter new lines of business alongside our investment in broadband services help [ph] us to this point. Our growth plan includes the extension of fiber network to new markets and select towers used by wireless carriers, and an investment in new services for business customers. We have already extended our fiber network to a number of towers used by wireless carriers and we plan to aggressively target (inaudible) tower contracts within our Minnesota footprint. We are well positioned to be a provider of choice for regional and national wires providers. We need to add bandwidth capacity to meet the growing needs in mobile communications.

In 2010, we will extend our network to Des Moines, Iowa and other communities as we focus on growing our business and wholesale fiber and data services to the expansion of our network. This is another step in our overall plan to expand our network geographically, and to build out our business-to-business services. We added a number of co-locations to our network last year, and will continue to do so in 2010. Adding co-locations to our network provides us with a competitive pricing advantage for businesses and wholesale transport opportunities.

In addition, we are expanding our business services to new communities and enhancing our products in these markets by adding mid-band ethernet and other communication services. We will continue to leverage our partnership with Cisco to sell equipment and support services, and we recently expanded our certifications, and were recognized by Cisco as an authorized technology partner for providing data centre unified computing services.

While we expect future broadband growth in our Telecom Sector to slow as we reach higher DSL and digital TV penetrations, we will continue to pursue broadband growth initiatives to protect this customer base. Growth and further diversification of our revenue steams will require investment. We expect the cash flow of our existing lines of business to help us fund the development and investments in new growth initiatives. As in the past, we examine our investments and evaluate their potential to create value for our shareholders. We will continue to review and pursue opportunities to grow our business, either through organic growth initiatives or strategic acquisitions.

Throughout our company, we have deep technical knowledge, strong telecom and IT expertise, and strategic business partners that enable us to deliver competitive communication solutions for our customers, from residential customers to large national enterprise customers, as well as regional and national service providers. These capabilities along with our statewide fiber network, position us well in the competitive landscape.

I will now turn the call over to David Christensen, who will provide details on our operational performance in the fourth quarter and for 2009. David?

David Christensen

Thank you John, good morning. As a complement to John’s discussion, I will focus on a few of the highlights.

Consolidated operating income for the fourth quarter 2009 totalled $4,044,000, down $62,000 or 2% from the same quarter in 2008. We are pleased with these results for two primary reasons. First, the results were good in light of the impact of the recession, which for us was still a factor in the fourth quarter; and second, the results were solid considering we have been hiring and investing resources in the growth plan we launched in 2009.

Fourth quarter consolidated revenue totalled $38.3 million, up $660.000 or 2% from a year ago. We reported increases in both Enventis product lines. Also Enventis revenue increased at a higher level than the Telecom Sector revenue decline. This has been a key piece of our story since we acquired Enventis in 2005. We are managing the declines in Telecom such that they are being offset by steady growth in our broadband services and Enventis fiber and data services.

We have three basic types of revenue. First, we have Enventis services revenue, which comes from both our Enventis fiber and data product line, and from the equipment product line. This is a combination of revenue from fiber and data sales via our regional fiber network to other communications carriers, and to retail business customers, as well as service and maintenance work for equipment customers. Overall, the services business has been a perennially high-growth area for our company. Second, our Telecom revenue includes broadband and switch services within HickoryTech’s traditional ILEC and CLEC service areas. In addition, we include data processing revenues from our suite solution billing services, which we provide to other communications carriers.

Our Telecom Sector revenues have been in a more modest decline than the general perception of our industry, because we are increasing revenue in our broadband, and in our billing services area, and this offsets much of the erosion in our traditional service revenues. And third, we have equipment revenue. This comes from the Enventis sector equipment and services product line. It is the revenue derived from being value added reseller for Cisco’s communications data equipment. Equipment revenue has traditionally grown for us when the economy is good, and it has been lower over the past year during the recession. We believe there is still demand for these products, the challenge is customer willingness to spend.

Total costs and expenses have risen and fallen approximately in line with our revenue trends in 2009. For instance, total cost and expenses for the fourth quarter 2009 up $34.3 million are 2% higher than last year, yet the total for the year, $120.5 million of cost and expenses is 9% lower than last year. 9% decline is also the amount of revenue decline for 2009 in total. Much of the fourth quarter increase in costs is due to adding CP Telecom.

Cost control has been a customer emphasis for us. For instance, cost of services $52.2 million for the year 2009, stayed virtually unchanged from the previous year. We are pleased with these results especially in light of rising costs, such as TV programming or content costs and the increased investments we have made in our network reliability. And especially considering this level of result includes five months with the addition of CP Telecom to our company.

We took a critical look at our selling, general and administrative costs and reduced these costs by 3% to $22.3 million in 2009. That 3% cut is in spite of adding 10 sales people in the fourth quarter, and integrating CP Telecom in August of 2009.

HickoryTech is a company that provides consistent operating results. In our view, each of the four quarters of this year has been very consistent. Outside of the income tax reversal in the third quarter of 2009, you will find relative consistency and stability in our quarter-to-quarter operating results. We do experience quarter-to-quarter variability based on the season of the year, and there are cyclical peaks and values in our Cisco equipment business caused by the current business environment. Nevertheless once you understand the seasonal timing and the uniqueness of the demand based equipment business, our operating income is very consistent.

Now, I will comment on our Enventis operating results specifically. For these comments, I am using the pre-elimination numbers from the Enventis Sector recap in our earnings release. Enventis operating income totalled $1.2 million in the fourth quarter of 2009, up $104,000 or 9% from a year ago. Noteworthy is the 46% increase in fiber and data revenue in the fourth quarter, which John mentioned, even after normalizing for the addition of CP Telecom, this continues a multi-year trend, our fiber and data line of business is on an excellent growth path for us.

Total cost and expenses in the Enventis Sector have fluctuated in line with our revenue trends in 2009. Fourth quarter total costs and expenses for Enventis were $19.7 million, up 6% from a year ago, yet the total for the year is down 13% compared to 2008. These quarterly and annual cost trends closely match the revenue changes in those respective periods.

Enventis Sector capital expenditures totalled $3.8 million in the fourth quarter of 2009 compared with $2.1 million in the corresponding quarter of 2008. For fiscal 2009, we invested $8.7 million at Enventis CapEx, compared to the $6.4 million in 2008. We continue to invest in the fiber and data portion of the Enventis business to support growth, expand our network, reach more customers, and to make specific network builds to address the increasing demand for higher bandwidth, either lighting up buildings with fiber or adding capacity to wireless (inaudible).

Now, I will touch on the Telecom Sector highlights, here again I am using the pre-elimination numbers from our Telecom Sector recap in our earnings release. Telecom operating income totalled $3.1 million, approximately the same as last year’s fourth quarter. Telecom revenue was down $434,000 or 2% from a year ago, but we were able to reduce Telecom expenses $474,000 so operating income is similar in both years.

We have a track record with Telecom cost control having saved $2.7 million or 5% for the year 2009 and we are committed to continual process improvement in every aspect of Telecom sector costs. Some Telecom Sector costs such as TV programming and content are rising and hard to directly control, but we are responding with efficiencies in other areas to more than offset these rising costs. Our Telecom broadband revenue was $3.2 million for the fourth quarter, and $12.1 million for the year, up 10% from 2008. This helped to offset the 6% decline in Telecom local service revenue, and the 7% decline in Telecom network access revenue for the year.

Telecom cost and expenses totalled $14.8 million in the fourth quarter, down 3% in the quarter, and decreased 5% for the entire year. In both the fourth quarter and for fiscal 2009, the rate of cost reduction was greater than the rate of revenue decline. This is a key element to maintaining our Telecom Sector profitability during this time of industry change. Examples of what is being done include gains to operational efficiencies and service delivery; secondly, management actions specific to the sector; and lastly, general corporate like cost control initiatives.

Telecom capital expenditures totalled $2.7 million in the fourth quarter compared to $3 million a year ago. For the year, capital expenditures totalled $9.1 million compared with $11.1 million in 2008, down 18%. We were able to reduce Telecom CapeEx and 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 will focus closely on maintaining our strong net cash flow from the Telecom Sector. For example, our year to date Telecom EBITDA totalled $29.3 million. Subtracting its $9.1 million CapEx provides $20.2 million of Telecom net cash flow in 2009. That is an increase of $2.1 million or 12% in net cash flow from our Telecom Sector over 2008.

Our balance sheet at the end of the fourth quarter remained strong and we took advantage of our increased cash position to reduce our debt by $4.4 million since September 30. We ended 2009 with long term and current portion of senior debt totalling $120.5 million. This year-end balance is down $6.5 million from January 1 of 2009. Even after our debt paydown in the fourth quarter, and the completion of the acquisition of CP Telecom in the third quarter with cash, we still held $2.4 million of cash on hand on December 31, 2009.

Low debt levels is one of our strengths and now with this paydown, we have lowered the ratio of debt to EBITDA below 3 to 1, which bring our borrowing rate down to only 150 basis points over a three-month LIBOR, the majority of which is protected with fixed rate products until September of 2011. We enjoy a very attractive credit facility and it has two remaining years of term from December 31, 2009. We feel we are truly positioned for growth with this strong balance sheet and our ability to generate free cash flow.

Operating cash flow or cash flow from operations, which can be depicted by EBITDA was $39.9 million for 2009. When the minimum debt service payments in a year, the CapEx and the cash based taxes are offset against the EBITDA, it outlines the amount of cash available for our dividend. We spent $8.2 million on our minimum or mandatory debt service payments in 2009. We spent $17.9 million for capital expenditures and $1.4 million for cash taxes. Our cash taxes have been quite a bit lower than GAAP or book taxes due to the tax benefits of our enhanced CapEx level. This allows our net $12.4 million remaining as positive operating cash flow.

We paid out $6.8 million in dividend payments for the year creating a dividend payout ratio of 56% of our operating cash flow, a healthy and safe payout percentage. Thus even in a period of lower earnings due to the economy in 2009, we generated strong cash flow, strong enough to support the dividend to pay down debt, to continue to invest in our business, and even to build cash for future growth initiatives.

Our fiscal 2010 guidance was stated in our press release. Revenue is targeted in the range of $150 million and $158 million. Net income is targeted in the range of $8.2 million to $9.1 million, making diluted earnings per share estimated in the range of $0.62 to $0.69 per share. CapEx is targeted in the range of $22 million and $26 million. An important metric for performance for us is EBITDA, a non-GAAP measure and it is targeted in the range of $40.5 million to $43 million. Our year-end debt is targeted in a range of $117 million and $119 million.

In summary, our fourth quarter represents a continuation of our consistent strong operating results. We also flawlessly completed our CP Telecom integration. We paid down our debt strategically and will lower future interest expense because of it. We invested in our business and still have strong cash positions in spite of paying more than $13 million in cash for acquisitions and debt reductions, and we had the opportunity to reverse some income tax accruals earlier this year. 2009 was a very good year for us and we are well positioned for HickoryTech to grow when the economy gets healthier. Our SEC Form 10-K 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.

John Finke

Thank you David. 2009 was a solid year for HickoryTech as we took steps to grow our company and pursue an accelerated growth plan to the expansion of our fiber network and growth in business-to-business services. We continue to face challenges, but we recognize that challenges also bring opportunities for growth. Currently, our goal of doubling the value of our company is an aggressive one, but one that we are committed to achieving.

As we look ahead, we are focused primarily on growing our Enventis business services while working to maintaining the free cash flow within our Telecom Sector. Our strategic direction is well defined and we are on track with many of our key initiatives. HickoryTech’s balance sheet is strong and we are in a good financial position to grow our company. We had solid net income, a high level of recurring revenues, a growth trend in key strategic product lines, shareholder value, and a healthy dividend, low cost debt covered by strong cash flow, and the ability to generate cash to fund future opportunities. We are excited about our growth plans, appreciate your support and wish to thank you for joining us on the call today.

At this time, we like to open the call for questions. Vani, if there are any questions, you may initiate them now.

Question-and-Answer Session

Operator

(Operator instructions) At this time, there are no questions.

John Finke

Okay, thank you Vani. If you’ve joined us after the call began or would like a replay of the call, please visit our Web site at hickorytech.com. A telephone replay of this call will be available beginning afternoon today.

Once again, thank you for joining us today, and we look forward to talking with you in the future. If you happen to have any further questions that come to your mind later this afternoon, I would 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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