Hawaiian Telcom Holdco's CEO Discusses Q4 2013 Results - Earnings Call Transcript

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 |  About: Hawaiian Telcom Holdco, Inc. (HCOM)
by: SA Transcripts

Operator

Good day ladies and gentlemen and welcome to the Fourth Quarter 2013 Hawaiian Telcom Earnings Conference Call. My name is Britney and I’ll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over speaker for today, Director of Investor Relations, Brian Tanner. Please proceed sir.

Brian Tanner

Thank you, Britney. Hello, hi everyone and welcome to our fourth quarter and full year 2013 earnings conference call and webcast. Joining me on the call today are; Eric Yeaman, Chief Executive Officer; Bob Reich, Chief Financial Officer, both who will be making prepared remarks about the quarter and the full year and Scott Barber, Chief Operating Officer, who along with Eric and Bob will be participating in the Q&A portion of the call.

Before we get started, let me remind you that our earnings release and financial statements are available on the Investor Relations section of our website at hawaiiantel.com. In addition, you’ll find a slide presentation for today’s call, which we will be referencing throughout our remarks.

Now I’d like to draw your attention to slide three and our Safe Harbor statement and remind everyone that some of the information provided on this conference call constitutes forward looking statements that are based on currently available information and are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those that may be expressed or implied by such forward looking statements. These risk factors are described in the company’s most recent annual report filing with the Securities and Exchange Commission, which is available on the Hawaiian Telcom and SEC websites. Also our discussion may contain certain non-GAAP financial measures. These non-GAAP financial measures are defined and reconciled in the tables attached to the earnings press release which are also available for review in the Investor Relations section of the Hawaiian Telcom website.

With that I would like to turn the call over to Eric Yeaman, Chief Executive Officer of Hawaiian Telcom. Eric?

Eric Yeaman

Thanks Brian. Hello everyone and welcome to our fourth quarter and full year 2013 earnings conference call. I am pleased with our 2013 results and the progress we made executing our strategic plan and the momentum we’ve built in the key growth areas of our business heading into 2014. So let me begin on slide five with 2013 highlights and some recent accomplishments in 2014.

We achieved a key milestone in 2013 by delivering full year total revenue growth for the first time since becoming a standalone company, which is a claim that not many companies in our industry can make today so I am extremely proud of our efforts. This is proof that the strategic investments we are making are successfully transforming the growth profile of this company.

Revenue for the full year 2013 totaled $391 million, a 1.5% increase compared with $385 million for the full year 2012. Revenue for the fourth quarter totaled $100 million, a 4.1% increase compared with $97 million in the fourth quarter of 2012. Revenues from video and high speed Internet and the additional revenue related to the SystemMetrics and Wavecom acquisitions drove the increase for both the full year and fourth quarter periods, which more than offset the anticipated revenue declines from legacy services and a decrease in customer equipment sales which are generally lower margin.

Adjusted EBITDA for the quarter totaled $31 million and for the full year 2013 totaled $120 million. We generated fourth quarter and full year 2013 net income of $2.7 million and $10.5 million respectively. Consumer revenue grew 4.2% and 2.5% year-over-year for the fourth quarter and full year 2013 respectively. Growth was driven by two of our key strategic products, video and high speed Internet. We achieved solid growth in both Hawaiian Telcom TV and high speed Internet subscribers in the fourth quarter adding a record high number of video subscribers of nearly 2,600 and approximately 1,200 consumer HSI subscribers.

We expanded the reach of Hawaiian Telcom TV to 120,000 households on Oahu by enabling 9,000 additional households in the quarter. A total of 55,000 households were added to our footprint in 2013 and we now address approximately 50% of the marketable households on Oahu, which positions us to capture a greater share of the consumer video and broadband market in Hawaii.

Business revenue grew 10.6% and 4.0% year-over-year for the fourth quarter and full year 2013 respectively, driven by growth in business data revenue, including revenue from Wavecom and revenue from SystemMetrics. Lastly, we recently launched new broadband packages for consumers and businesses and now deliver Hawaii’s fastest Internet service featuring download speed tiers of 100, 300, and 500 megabits. With the investments we are making in our next generation fiber network, we are staying ahead of the increasing demand for bandwidth, sharpening our competitive edge and transforming our growth profile.

So overall I am very pleased with the year that we had and excited about the future prospects for Hawaiian Telcom.

Moving to the next slide let me provide you an update on Hawaii’s economic situation. Overall in 2013 Hawaii’s economy performed well across most sectors. The Hawaii Visitor industry set records for Visitor spending and arrivals despite softening growth in the second half of the year. 2013 Visitor spending increased 2% while Visitor arrivals grew 2.6% to 8.2 million. After two years of record-breaking levels in Visitor spending and arrivals, the Hawaii tourism authority anticipates modest growth in 2014.

Besides tourism the Hawaii construction industry experienced healthy growth and is expected to lead economic activity in the next few years. Total construction spending is forecast to grow by 12.4% in 2014 and 8.3% in 2015, driven by infrastructure and large-scale commercial and residential projects such as the 5.1 billion Oahu Rail project and the redevelopment of Kakaako. This is a neighborhood near downtown Honolulu which currently has 17 planned new buildings that are expected to add 5,800 housing units in the coming years.

Hawaii unemployment rate at the end of December was 4.7%, down from 5% in the same period a year ago. The state unemployment rate is significantly lower than the national rate of 6.7%. It is the eighth lowest among all US states. Overall the prospects for Hawaii’s economy are positive. Local economists project Hawaii’s economy to grow 2.6% in 2014 and continue growing above 2% each year through 2017.

Moving to slide 7. Let me take you on the progress we continue to make against our growth strategy, starting with an update on Hawaiian Telecom TV. 2013 was a significant year for Hawaiian Telecom TV. We expanded the availability of service to an additional 55,000 households. We grew the subscriber base by 87% and added 21 new HD channels and 38 new TV abler channels to our content line-up and added features such as Twitter. We also improved the customer experience as demonstrated by 9% increase in our customer satisfaction scores, and this improvement was of already high levels.

Video revenue grew to $4.2 million for the fourth quarter, more than double from the same period a year ago. We added nearly 2,600 video subscribers during the fourth quarter, the highest quarterly net additions we have had till date ending the year with approximately 18,400 subscribers, giving us the penetration of approximately 15% at year-end, up from 14% last quarter. The strong subscriber growth along with 24% year-over-year increase in monthly video ARPU was the driver for the increase in video revenue.

We continue to have success an increase in the percentage of subscribers on our premium subscription package which now stands at two thirds of our video subscriber base, up from 54% in the same period a year ago. Additional drivers have been higher levels of penetration of premium add-on services like movie packages and HD and DVR services.

In terms of footprint we enabled 9,000 households in the quarter expanding our service footprint to 120,000 households enabled or approximately 50% of the marketable households on Oahu. I also wanted to highlight that at year-end 44% our enabled households where fiber fed compared to 16% at year-end 2012. We talked on past calls about how this investment in fiber gives us a lot more innovative flexibility to deliver advanced services to our customers. We are leveraging that flexibility and seeing results.

We recently offered a free trial promotion through our fiber-to-the-prim double click TV customers to upgrade to 50 megabit high-speed Internet service, and just after four months have seen a 7% to 8% tick rate. With the expanded reach of our next generation fiber network we are using other up sell and cross sell tactics to drive service penetration and increase revenue from each customer. Also we just launched our 100, 300, and 500 megabit broadband packages which is another example of how we’re leveraging our strategic investments in our next generation fiber network to successfully grow our business in the consumer channel.

Moving to slide 8. Before I highlight the progress we continue to meet against our growth strategy in the business channel, I wanted to underscore that the investments we are making in our next-generation fiber network benefit all our corporate needs. We have expanded our fiber footprint 35% over the last two years and we continue to invest in its growth. So while households enabled is a consumer footprint metric we strategically route fiber, so all of our channels can leverage that investment, not only to meet current requirements, but so we are in a better position to target new opportunities and offer more compelling data solutions in the business channel where upstream capabilities are critical to the enablement of call services.

Business that revenue was up 34% year-over-year for the full-year 2013 driven by growth in switched ethernet IP-VPN and dedicated Internet access revenue, and the contribution of revenue from Wavecom. Excluding Wavecom related revenue, business data revenue grew 7% year-over-year in 2013.

The next generation services accounted for 58% of business data revenue in 2013 and will continue to be a key driver of growth in the business channel. We continue to successfully leverage our broadband network to deliver bundled solutions to the SOHO and S&B markets, evidence of this performance was the growth in business high speed Internet subscribers up 4% year-over-year in the fourth quarter. Our SOHO bundled solutions are focused on increasing penetration of high speed Internet service to our existing voice customers as well as attracting new customers. Approximately 64% of SOHO bundles sold in 2013 signed up for new high speed Internet service. In the S&B market, our hosted VoIP and broadband Internet bundle called Business All in One is our lead offer and continues to show good momentum. We saw an approximately 62% year over year increase in the number of VoIP lines from this product in 2013.

Across all our business channels, we are helping our customers to connect, communicate and collaborate more effectively. Our initial focus was transitioning customers to an IP based connectivity platform and as we’ve expanded our product portfolio, we are layering on more communication and collaboration services like our hosted voice product which differentiates us from the competition and create stickier relationships with our customers. And the SystemMetrics acquisition enhances our ability to bundle collaborative cloud type services so we can further enhance to integrated solutions we can offer to our customers and address more opportunity.

We continue to execute on our strategic for SystemMetrics. While we intent for it to remain a standalone company, we are identifying and leveraging operational synergies. We have started adding Hawaiian Telcom product and solution sets into the SystemMetrics product portfolio. Hawaiian Telcom sales people and engineers have been trained to lead customer tours of the datacenter to help facilitate sale opportunities. Our marketing group has redesigned SystemMetrics sales collateral and website and last week SystemMetrics was featured at our business customer event Hawaiian Telcom University. So we’re working to raise awareness and drive increased market momentum for datacenter services to Hawaii. Also in December we completed the first phase of our datacenter expansion adding 33% more capacity. We’ve continued to be very excited about this opportunity.

Turning to slide nine. In wholesale, we now have 289 fiber-to-the-tower cell sites completed, which equates to annualized revenue of approximately $4.2 million and another 441 sites under contract to build. And we are currently pursuing approximately 150 additional sites. These fiber-to-the-tower projects provide attractive investment returns and by strategically routing fiber to these sites we also extend our capabilities to additional potential consumer and business customers.

Turning to slide 10. Let me finish with the look ahead in 2014. We entered 2014 with a strong momentum and are remain excited about the opportunities we have ahead. Our focus for 2014 is to continue to invest in our next generation fiber network, extending our footprint, enhancing speeds and adding advanced features and functionality across our product portfolio. At the same time we’re upgrading and optimizing our systems architecture. Our broadband network investment is the foundation for our strategy to grow the business. In the consumer channel our objective is to win a greater share of the video and broadband market. In our other two channels, business and wholesale, we will continue to launch new and enhanced IP products to grow our customer share of wallet. And as I mentioned earlier, the SystemMetrics acquisition positions us to grow our datacenter and cloud business.

We believe service is really the differentiator in our market so we have a number of initiatives to improve the customer experience. Also with our push into video and datacenter and cloud services, we have an opportunity to evolve and expand our brand as Hawaii’s technology and entertainment leader. We’re now very focused on managing the cost associated with supporting our growth initiatives and optimizing our capital spending with the goal of improving our financial performance. Collectively, I am confident that investments we are making in our key strategic initiatives can further transform our growth profile, lead to stronger financial results and drive long term shareholder value.

With that, I’ll turn the call over to Bob to review the details of our fourth quarter and full year 2013 operating and financial results.

Robert Reich

Thanks Eric. And thanks again to everyone for joining us on the call today. I’ll move directly to slide 12 and we can review the fourth quarter and full year 2013 financial results in more detail. As Eric highlighted, we achieved a key milestone in 2013 by growing full year revenue by 1.5% to 391 million, up from 2012 revenue of 385 million. Revenue growth from video, high speed Internet, approximately 7.5 million of incremental revenues related to the Wavecom acquisition as well as our first quarter of revenue contribution from the SystemMetrics acquisition more than offset the declines from legacy voice services and $4.4 million decrease in revenue from lower sales of customer premise equipment to enterprise customers.

Adjusted EBITDA was 120 million compared to 122 million in 2012. I’ll remind everyone that we recorded a $2.5 million one-time net settlement gain in the fourth quarter of 2012 in connection with the acquisition of Wavecom. After adjusting for this fourth quarter 2012 net settlement gain, adjusted EBITDA was up approximately 400,000 year-over-year. This improvement was primarily due a decrease in direct cost of goods associated with lower equipment revenue and lower cost related to various vendor contracts, mostly offset by increased direct house of goods associated with content costs related to the ramp of video subscribers.

Moving to slide 13, revenue for the fourth quarter was 100.5 million compared to 97 million in the fourth quarter of 2012 up 4.1% year-over-year. Revenue growth in the quarter driven by video and high speed Internet revenue and revenue related to the Wavecom and SystemMetrics acquisitions more than offset the decrease in equipment revenue and a 2.4% decline in access lines inclusive of Wavecom lines.

SystemMetrics contributed approximately 2 million of revenue during the quarter and is now separately disclosed in our revenue tables as data center collocation. Adjusted EBITDA was 31 million for the quarter compared to 33 million in the fourth quarter of 2012. After adjusting for the same $2.5 million net settlement gain in the fourth quarter of 2012 that I described earlier, adjusted EBITDA was consistent with the same period a year ago.

Operating expense increases driven by an increase in wages and employee benefit costs and higher direct cost of goods related to video content were mostly offset by the same operating expense reductions driving the full year adjusted EBITDA improvement. I also wanted to take a moment to reconcile our fourth quarter net income. We reported net income for the fourth quarter and full year 2013 of 2.7 million and 10.5 million respectively, compared to 98.6 million and 110 million respectively for the same period a year ago.

Included in the fourth quarter and full year 2012 amounts our one-time non-cash tax benefits of 94.1 million and 98.4 million respectively relating to the reversal of certain valuation allowances previously established with respect to deferred tax assets. Because this makes the year-over-year comparisons difficult we have provided a table in our earnings release illustrating 2012 pro-forma net income excluding these one-time non-cash tax benefits.

On a pro-forma basis the year-over-year decrease in net income was primarily attributable to the $2.5 million one-time net settlement gain recorded in the fourth quarter of 2012 that I’ve referenced several times previously.

So let’s now move to slide 14, and walk through more details on the quarter results beginning with the consumer channel. Fourth quarter consumer revenue totaled 36.4 million, up 4.2% from the same period a year ago. The year-over-year increase was driven primarily by a $2.4 million increase in video revenue. The increased reach of our next-generation fiber network and the opportunity for consumers on Oahu to subscribe to a superior entertainment solution are the primary catalyst for driving revenue growth in video. We added nearly 2,600 video subscribers during the quarter which was a record high quarter for us. 1,732 were new non-bulk single family home subscribers with the remaining 865 being bulk multi-dwelling unit subscribers. As we have discussed in the past the timing of bulk MDU installations will likely cause bulk subscriber editions to be lumpy quarter-to-quarter.

We indicated last quarter that we entered the fourth quarter of 2013 with 1,900 bulk MD units under -- MDU units under contract to be installed. And as you can see many of those units were installed during the fourth quarter which drove the increase in bulk ads. Of our approximately 18,400 total video subscribers 70% are in the non-bulk single-family category which is up from 62% at the end of 2012.

These subscribers have a higher ARPU which is another factor that’s contributing to the growth in blended ARPU that Eric described earlier. Approximately 60% of the video subscribers we added this quarter are new to Hawaiian Telcom and across all our video subscribers we continue to see very high rate of broadband attachment. When we look at our existing video subscribers approximately 91% have both TV and broadband, so as we continue to expand the reach of our enabled footprint Hawaiian Telcom TV will be critical in helping drive share gain in broadband.

TV is the linchpin to the double and triple play bundles and bundles create sticky relationships with our customers. High-speed Internet revenue was also a driver of consumer revenue growth led by a 3.9% year-over-year increase in subscribers to approximately 91,400 subscribers. HSI subscriber growth continues to be driven by additions from our standalone broadband offering and by high pull-through rates from new video subscribers. Also as Eric highlighted earlier, we are seeing increased adoption of higher speeds, so that’s driving higher ARPU. Revenue increases driven by video and HSI were partially offset by revenue declines related to the year-over-year decline in consumer access and long-distance lines of 8.3% and 7.3% respectively. Secular challenges due to wireless substitution and VoIP competition continue to be the main contributors to the legacy access and long-distance line loss.

As we said before this highlights the importance of investing in our next generation fiber network which gives us the foundation to capitalize on the key growth opportunities from strategic products like video and high-speed Internet, so we can offset the industry wide structural declines in legacy services.

Moving to slide 15, fourth quarter business revenue totaled 44.7 million, up 10.6% from the same period a year ago. This increase was primarily due to revenue added as a result of the SystemMetrics and Wavecom acquisitions as well as increased demand for higher bandwidth IP based data services. As I mentioned earlier, SystemMetrics during the quarter, business data revenue which now accounts for 15% of total business revenues was up 36% year-over-year including an incremental 1.2 million of revenue from Wavecom. Business voice and long distance revenue also increased slightly as legacy revenue declines in this category were more than offset by approximately 900,000 of incremental voice revenue from Wavecom.

Our business access line performance in the fourth quarter of 2013 continued to be very positive. If we exclude the voice lines added as a result of the Wavecom acquisition, the year-over-year decline in total business access lines was 0.8%, down from 2.1% during the same period a year ago. Enhancements we have made to our hosted VoIP and broadband Internet bundle has allowed us to target larger customers driving a 17% year-over-year increase in the average lines per customers and a 62% year-over-year increase in the overall number of business VoIP lines as Eric mentioned earlier. This along with improved retention of access lines from the bundles we offered at the SOHO markets are combining to drive the improvement in business access line performance. And data pull-through from these bundles is helping to drive higher business HSI revenue. Business HSI subscribers grew 4% year-over-year to approximately 18,800 total subscribers.

Moving to slide 16, fourth quarter wholesale revenue which consists of wholesale carrier data revenue and switched access revenue totaled 16 million, down 1.8 million from the same period a year ago. Wholesale carrier data revenue which consists of wholesale customers buying network capacity in the form of special access circuits declined 1.5 million year-over-year to 14.4 million. The decrease was mainly due to the elimination of approximately $1.3 million of special access revenue that we previously recognized for services that we have sold to Wavecom. Wholesale switched access revenue which consists of usage based charges to wholesale carrier customers to access our network facilities declined 300,000 year-over-year to 1.6 million. This decline is attributable to the overall declines in access lines and minutes of use reversing our network and the impact on rates and USF funding as a result of regulatory reforms.

Moving to slide 17, let me turn now to operating expenses. If we exclude depreciation and amortization, non-recurring items and non-cash stock compensation, our fourth quarter operating expenses totaled 69.8 million, up 6.5 million when compared to approximately 63.3 million in the same period a year ago. The bridge on slide 17 illustrates that the increase in our operating expenses was primarily due to the $2.5 million one-time net settlement gain recorded in the fourth quarter of 2012 and increase in wages, employee benefit costs and other costs related to both the SystemMetrics and Wavecom operations and higher direct cost of goods related to video content. These increases were partially offset by lower costs related to various vendor contracts and decreases in other cost of goods.

Moving on to slide 18, let me turn to capital expenditures. Reported CapEx was 86.3 million for the full year 2013, up from 77.7 in 2012. The year-over-year increase was primarily due to three categories, high levels of investments in our broadband network infrastructure having enabled 55,000 homes in 2013, increased success based spending for fiber-to-the-tower builds and increased success based spending related to growth in video subscribers with more of our new subscribers being fiber-to-the-premise. Also we won a couple of large high-value success based projects from two major enterprise customers in the second half of the year. In total we allocated over 80% of our capital investment in 2013 to growth and expansion related initiatives.

Our capital program in 2014 is expected to be approximately 90 million as we continue to expand the reach of our next generation fiber network and deploy success based capital support to subscriber growth of Hawaiian Telecom TV. We anticipate the new video subscribers in 2014 to be predominantly fiber-to-the-premise customers, which have a higher success based CapEx profile due to the need of an optical network terminal at the customer premise.

Also as Eric mentioned in his remarks we had 141 sales sites under contract at the end of 2013 to fiber enable. So we expect increased success based spending in 2014 related to the fiber-to-the-tower builds as well. This will be largely dependent on the schedule of our carrier customers.

Moving to slide 19. Let me provide some detail on cash flow, and I make a few comments on overall liquidity. Our net cash flow for full-year 2013 was negative 17 million, compared to a negative 15 million in 2012. The bridge on slide 19 illustrates the most significant reconciling items between the periods. The primary drivers of the sources of cash in 2013 relative to 2012 included approximately 13 million of net proceeds from the sale of a land parcel and a $7 million lower use of cash related to the results of our refinancing initiatives during the two periods.

In addition, we realized approximately 5 million of cash interest savings in 2013 as a result of our June refinancing. The primary drivers of the use of cash in 2013 relative to 2012 included a higher amount of cash used for the acquisition of Systemetrics versus Wavecom during the two periods, and as we've already discussed CapEx was approximately 9 million higher year-over-year. In addition we had temporary uses related to working capital in 2013, that we expect a partially reverse and normalize in 2014.

From a liquidity standpoint we ended 2013 with 50 million in cash and cash equivalents and we had access to an undrawn revolving credit facility of $30 million. So we had 80 million of total liquidity at year-end. We’re conservatively capitalized with a net debt to EBITDA ratio of under two times and then interest coverage ratio of approximately 6 times. So that concludes my comments.

With that I’ll turn the call back over to Eric for some closing remarks

Eric Yeaman

Thanks Bob. So in summary, I’m pleased with the results for the quarter and full-year and I am excited about the prospects and opportunities that lie ahead for us to drive long-term shareholder value. And we look forward to reporting further progress to you on future calls. With that let me turn the call over to our operator Britney, so that we can take your questions. Britney please proceed with the Q&A.

Question-and-Answer Session

Operator

(Operator Instruction). Your first question comes from the line of Barry McCarver with Stephens Inc. Please proceed.

Barry McCarver - Stephens Inc.

I guess first off on the video subscriber ads, record quarter very good production there; kind of your thoughts on the run rate going forward. I know in the past you talked about achieving a certain level of enabled homes before you might consider increasing your marketing and advertising budgets and potentially expanding the number of subscriber ads per quarter, are we already at a pretty good run rate or do you think you can go higher from here?

Eric Yeaman

Barry, I think you saw the run rate in the quarter impacted by the bulk units. So although we had 2,600 total subs as we had indicated on our third quarter call, we are going to have a higher than normal bulk quarter which we did. We had about nearly 865 bulk units in the quarter, so that left about just over 1,700 non-bulk. I think that when you look at the fourth quarter there is some seasonality there, but that run rate is probably slightly lower then we would expect, but not that far off until we start to move to mass marketing. Our strategy is still to probably shift to a mass strategy in early second half of the year. And we would anticipate at that point we will see some gradual improvement from the fourth-quarter run rate, again on speaking specifically to non-bulk single-family home units. The bulk will continue to be somewhat lumpy. I think we have just under 1,200 bulk units that haven’t yet been installed as of the end of the year.

Barry McCarver - Stephens Inc.

1,200 bulk units, okay. And then on the wholesale markets you mentioned 141 additional sites, cell sites under contract to build. Can you give us an idea of the timing on that build?

Eric Yeaman

Yes, Barry to be honest with you it’s really hard to predict the timing. But I can tell you this and I’ll let Scott add if he’d like. We’re starting to see some ramp up already in the first quarter, I believe Bob shared with you that we project our CapEx to be in the 90 million range that is reflective of some ramp up in our cell site backhaul builds, so we’re anticipating a heavier year that we did in 2013. The timing really is dependent on the carriers. We have the ability I think to ramp up and ramped up -- ramp down our builds there but we’re working closely obviously with the carriers to make sure that we meet their needs and requirements.

Scott Barber

The only thing I’d add Barry, this is Scott, is that the two largest carriers are primarily focused on tuck in now at this point in time, they have baked on their 4G build outs and they are doing some tuck ins so there is still some sites associated with them but the other two carriers are now playing some catch up and it appears as if the speed in which they’re moving now is moving along much faster than we’ve seen over the last couple of years. And so we’re working closely with those carriers to ensure that we align our builds when their sites are ready for build out.

Robert Reich

And Barry, just to add on top of that, the two other carriers that Scott is referring to are also have some heavy RFPs out that if we’re successful at securing those additional sites we might see some further ramp there as well.

Barry McCarver - Stephens Inc.

Okay. And then just lastly you broke out several new revenue line items, thank you for that, that’s very helpful. I’m wondering one of them was wireless revenue which looks like it’s been in pretty steady decline. Can you remind me what that is?

Eric Yeaman

Yes. We have MVNO with Sprint, we’ve had it since I guess before I joined the company, it’s something that we’re not sort of heavily focused on, it's somewhat in harvest mode right now, so you can continue to see slightly decreases as we go along. We sort of kept our toe in the water on the wireless side as we continue to always evaluate our strategic options, so we continue to learn from that business to determine whether we want to pursue that or not but at this stage, it’s not something that we’re focused on in a big way.

Operator

And your next question comes from the line of Donna Jaegers with Davidson. Please proceed.

Donna Jaegers - D.A. Davidson & Co.

Hi guys. Good quarter. On churn for IPTV, you’ve called that out in the past. Can you give us an update there?

Eric Yeaman

Yes. It was 1.4% for the quarter, so we saw a decline from our third quarter which was 1.8% still trending at the 1.6% for the year overall.

Donna Jaegers - D.A. Davidson & Co.

Okay, good. And that’s what have you guys -- I know there has been early on in the process there were issues as far as being able to really install the IPTV in some of the houses. Have you guys cleared up the -- have you streamlined the install process and cleaned up the data so that you know who is eligible for it and who is not?

Eric Yeaman

Yes, no question, that's stuff pretty clear, so our average install times are still running in about 4.5 hour to the five hour range. So we’re pretty happy with that overall.

Donna Jaegers - D.A. Davidson & Co.

Okay. And then the competitive environment, we’ve seen Time Warner Cable call out faster that they were enabling faster speeds on the island as well can you talk about the competitive environment in both consumer end and business?

Eric Yeaman

Yes, sure. I’ll start with consumer. I am trying to think sometime I guess in the third quarter maybe early in the fourth quarter, yes, early in the fourth quarter Oceanic launched their 100 meg speed in the consumer market. We had anticipated that that was coming, they probably launched it a little earlier than I expected. As you know we sort of followed on recently with the launch of our 100, 300 and 500 meg speeds with now the claim of having Hawaii’s fastest Internet service and that’s not just to consumers but also to businesses.

So the dynamics in the marketplace I would say the competitive environment has always been pretty fierce, it remains fierce. They continue to have a pretty loud voice in the market but we believe that our tactics have allowed us to be successful, but we need to continue to be nimble and to adjust as necessary.

On the business side, Dona, to be honest with you, we haven’t seen much impact to our business as a result of their services. We continue to capture more and more of the market share, I mean we do hear their ads, but net-net we still believe that our competitive position remains stronger in the business side. And for the consumer side it’s really hard to go out there and capture and now having the video product really has improved on a competitive advantage in the consumer space.

Donna Jaegers - D.A. Davidson & Co.

Okay. And just two quick numbers questions for Bob, on the switched carrier access, there was about almost $1 million sequential jump in that. I am just wondering that looks like maybe it was just a one-time chew up from past?

Robert Reich

Hey, Dona, so in my prepared remarks I mentioned that wholesale switched access was 1.6 million, which was actually slightly down. The other thing that we actually include in that line item is USF funding and so that’s actually what you saw in the fourth quarter. There is a little bit of additional USF funding. They were really late this year, last year USF funding kind of came ratably through the last five months of the year. This year USF funding got dropped into -- they basically like November or December that they dropped the whole thing on us. So, yea, a little bit of comparability issues in terms of just the money that we got from USF.

Donna Jaegers - D.A. Davidson & Co.

And does that -- on USF, does that go into wholesale or is that when you guys breakout your revenues by market segment, is that totally in wholesale or is some of that flow into retail?

Robert Reich

It’s actually a combination, some of it flows into wholesale and actually some of it flows into consumer because our thought process is some of that money is actually earmarked to invest in the consumer broadband network.

Donna Jaegers - D.A. Davidson & Co.

Okay. So, can you give us a sort of a clear read, you guys were up 4.2% in consumer revenues in the fourth quarter on a year-over-year basis was that maybe 0.5 million that flew into consumer?

Robert Reich

Yes.

Donna Jaegers - D.A. Davidson & Co.

Okay.

Robert Reich

That’s exactly right.

Donna Jaegers - D.A. Davidson & Co.

Okay, great.

Robert Reich

That’s exactly right.

Donna Jaegers - D.A. Davidson & Co.

I getting good at guessing. Then on, there was, I was noticing in the cash flow statement, there was a little larger charge for collectibles, is there anything specific driving that?

Robert Reich

Well, and I must have said it like five times in my prepared remarks, I apologize for that, but the $2.5 million settlement gain for Wavecom was actually recorded as a reversal bad debt last year in 2012 and so basically when you look at, you have to normalize, you have to basically add $2.5 million to the 2012 number in order to get a comparable year-over-year comparison.

Unidentified Analyst

Great, all right. Thanks a lot. I'll get back in the queue, if I have others. Thanks.

Eric Yeaman

Thanks Dona.

Operator

And your next question comes from the line of Barry Sine with Drexel Hamilton. Please proceed.

Barry Sine - Drexel Hamilton

Good afternoon folks.

Eric Yeaman

Hi Barry.

Barry Sine - Drexel Hamilton

First question on video, obviously very good quarter, to what extent are you seeing any moderation in voice line losses as you become more successful in video ads?

Eric Yeaman

Barry, overall we have seen generally positive impact as a result of offering the triple-play. It’s really hard as you know to sort of predict the impact but the way I look at it is we saw improvement of 50 basis points year-over-year. Last year our access line loss was 8.8%, 2013 was 8.3%, so we are seeing some improvement how much of that is due to triple-play or not is really hard to tell but I would think that it's have a reasonable positive impact.

Barry Sine - Drexel Hamilton

Okay. And in terms of your intention in planning both for 2014 and then ultimately in terms of the number of homes passed you expect to reach, could you give us an update there please?

Eric Yeaman

Yes, in 2014, we are looking to enable an additional 40,000 homes and probably generally speaking ratably throughout the year. So, that’s sort of our plan right now to end 2014 at a 160,000 homes enabled.

Barry Sine - Drexel Hamilton

And then ultimately what’s the -- I think the ultimate goal has been about 200 total?

Eric Yeaman

The ultimate goal is 240,000 approximately so we are looking at about another two and a half to three year build out on the network here on Oahu.

Barry Sine - Drexel Hamilton

And then on data center, so you started breaking that business out, could you talk a little bit, you mentioned in the script about the expansion, what's your square footage today, what you’re looking to expand to and what has been the historic organic growth on that revenue stream, just so we have a sense of what you might do in the future?

Eric Yeaman

I’ll talk about capacity and maybe Scott can add about sort of the growth there. So we added our square footage right now, you know we have access to 6,500 square feet which we can also negotiate on their image 6,500 square feet in addition to that in the future. Of the 6,500 square feet about 3,700 square feet is built out and it’s about 100 cabinets of sold space and our space built out ready for sale, which is about 75% utilized.

When I said we had a 33% increase in capacity, I was really referring to and I should have probably been clear and hindsight, I was really relating to cabinets and not so much square feet. We added up 430 square feet built out in the quarter but it added about 25 additional cabinet space. And so that’s sort of from a capacity standpoint. Scott, can you speak to the run rate on revenue?

Scott Barber

Yes, so we’re actually meeting our budget requirements so far Barry and so we’re pleased with the progress that we’re making in that space. As Eric mentioned that the expansion of the cabinets is for physical space our focus is on virtual as well it’s actually a higher margin product for us. So we’re trying to keep ahead of the curve with space requirements for our customers that need physical, but we’re also growing our virtual platform and making more use of that available to our customer base, we've trained all of the sales people in Hawaiian Telcom to help cross sell their products we’re actually training them to do tours, giving them tours, we upgraded the collateral material, we’re expanding the sales staff of SystemMetrics.

So early and gearing up the marketing efforts we’re really pleased with the progress we’re making and so far the interest in the market seems to be exactly where we want it to be.

Barry Sine - Drexel Hamilton

And what’s the organic growth rate on that business you acquired historically?

Eric Yeaman

I don’t what it has been…

Robert Reich

Barry it’s Bob. Obviously we haven’t disclosed sort of what our long-term revenue expectations are other than the fact that we disclosed it, it’s an $8 million business today. And that the revenue growth is going to be really dependent upon how successful we are in driving adoption in the marketplace. As Scott said, we’re very optimistic, we’re seeing very good energy I guess in the market with respect to this asset.

I think we’ve still got at least for the first half of this year sort of an education process to the market to drive what the value proposition is. So I am not necessarily expecting real robust growth in the first half of the year, I think the second half of the year when we start to actually see a little bit higher level of adoption in the marketplace is what we’re really kind of seeking.

I mean the historical trajectory of SystemMetrics, this is a bit of a hybrid business, this is a business that is partial data center and partial network. SystemMetrics started out as a network provider and moved into the datacenter business. And so they still have a fairly robust portfolio of network revenue as well. So if you sort of look at historical run rate of SystemMetrics, it was sort of a declining revenue stream on the network side and an increasing revenue stream on the data center side.

Now that they are a Hawaiian Telcom company, we think we have an opportunity and we’re very confident that we have an opportunity to actually have both of those, really all of those revenue streams put into growth mode as we sort of move through second half of 2014.

Eric Yeaman

Yes, Barry I’ll just add, Bob hit it on the head there. It’s been a business that over the last several years has really shifted in terms of its revenue from almost purely network to split really between network and data center services. And so we’ll probably continue to see that shift, so there is no question the data center service side has grown but it was growing because that’s where the focus of the business was and less on the network side. And as Bob indicated, our focus is to really grow both the data center and network business there now that it’s part of our company.

Barry Sine - Drexel Hamilton

And then my last question is kind of a long one, but I am going to try and see how much I can get out of you guys in terms of forward looking guidance for 2014. So you have given us CapEx, so we got that one. If I think about the business on the revenue side, what drivers and puts and takes should we think about on consumer obviously video passing more homes, what should we think about promotional activity on business? I think you said 7% organic growth in 2013. Is that kind of a number sustainable? And then we’ve got the datacenter on top of that and then if we think about margins, I’m assuming that margins are negatively impacted by strong video subscribers with acquisition cost and the inflation cost. Can you talk may be Bob about what we should expect in terms of margins in 2014?

Eric Yeaman

So Barry I’ll tackle revenue and then I'll let Bob sort of tackle the margins and then Scott can add to our comments if he has any additional comments. On the consumer side, although we’re planning to add 40,000 homes versus 55,000 in 2013, we are going to move to a mass market strategy as well. So our anticipation, again this is the best guidance I’m going to give you, is that we would exceed the net subs that we were able to capture in 2013. I would anticipate that the mix will continue to shift to be more non-bulk single family versus bulk so you’ll continue to see shift there. And we would expect the same similar pull through rates on HSI there and hope fully similar if not better retention on the access lines. So that’s kind of the consumer business.

In the business markets the 7% that we talked about was really business data. So that’s in area that I would expect that we will continue to grow as the demand for more data continues to grow. That’s the one sort of bright spot in our businesses, that’s the one area where the pie is growing. So I hope that we can at least achieve the same level if not better growth there in business data. And we do expect some growth in the datacenter services side. We did I believe when we announced the acquisition indicate that we have a power upgrade that we would need to get completed sometime towards the end of the year to increase our capacity there. So you’ll see some growth in the datacenter side but probably with the power upgrade it will mark turbo boost I think the growth in 2015.

On the wholesale side, we’ve been pleased with the towers that we’ve turned up-to-date. We’ve been sort of on the mark in terms of our CapEx investment. They’ve been upgrading those sites a little faster than we anticipated. The one thing we haven’t anticipated very well is the timing of when they turn down the legacy side. But we see the wholesale business sort of stabilizing in 2014. We did see sort of a continued decline in ’13 but we hope to be maybe towards the stabilized flat level year over year in ’14. So net-net, we would see continued growth in top line in 2014 over 2013.

So I’ll turn it over to Bob to talk a little bit about margins.

Robert Reich

Yes. Barry, the only thing that I would add to that is just ’13 versus ’12 is a very difficult comparison because you have Wavecom results in one year and you don’t have Wavecom results in the other. So in my prepared remarks I disclosed that in 2013 we had $7.5 million worth of incremental revenue from Wavecom that wasn’t there in 2012. So I just remind everyone that keep that in mind and not draw that line when you’re in to 2014. I think with respect to the cost question, we have a plethora of initiatives that are in flight right now which is really related to cost savings that are designed to offset the margin pressure that the content costs are adding to the business. And so our expectation is for 2014 that we should be able to offset that pressure and really maintain our margins in ’14 reasonably consistent with where they were in ’13.

Scott Barber

Barry one last thing that I’d like to add on that mass marketing side is, this is Scott, is that we’ve been increasingly doing targeted mass with billboards and malls, kiosk, little bit of radio, things of that nature and there is not going to be a sudden change from one month to the next in terms of marketing tactics which is going to slowly continue to ramp up our tactics in the market.

And as Eric said, you’re going to see more in the second half of the year but there is not a sudden change in marketing tactics at any given point in the year it’s just going to continue to increase but we’re never going to be at the same levels as our competitor, but we’ve got a better product and we believe once we raise that awareness, that we can continue to grow our subs as we mentioned earlier.

Barry Sine - Drexel Hamilton

Okay. And Bob one more follow-up I guess, for you. If you could -- whatever comment you can give us on what you’re thinking is in terms of interest expense, depreciation expense and then GAAP tax expense for 2014?

Robert Reich

Well so interest will be very close to $15 million, a little over $15 million just because we're amortizing deferred financing costs. But there’s a little bit of an offset to that because we do capitalize some of our interest under the -- just under GAAP rules. So interest shouldn’t be too far off of $15 million, $16 million.

D&A, depreciation and amortization, you know we hit the three year anniversary of fresh start in October 28 of 2013. So we did have some three-year assets that actually came off of the roles for depreciation purposes. We sort of talked about this step function in the past. Obviously the CapEx program is higher than it was back in 2011, 2012, so that puts a little bit of negative pressure on depreciation and amortization. So I think my expectations are depreciation and amortization are probably going to look fairly similar to what it was in 2013, maybe a small increase, but probably not that significant. And the tax effective rate should be in the high 30s. We have some permanent differences, not to get too technical, but we did establish a very small valuation allowance on our deferred tax assets this year which you’ll actually see in our deferred tax disclosure. So when you look at the effective tax rate this year, it’s a little bit higher than we expected to be in 2014. We expect 2014 to be somewhere between 39% and 40%.

Operator

And your next question comes from the line of Lance Vitanza with CRT Capital.

Unidentified Analyst

This is actually Brad in for Lance. I have a quick question for you, just on your thoughts on potentially competing with Comcast, did the Comcast-Time Warner Cable merger actually get approved; how do you think that’s going to change the competitive dynamic and landscape?

Eric Yeaman

Brad, to be honest with you, it’s very difficult for us to speculate. But Time Warner cable is and continues to be a tough competitor. I would expect Comcast to be as tough a competitor for us. I think the key is really that we continue to execute on our strategy to continue to be nimble in how we sort of market and adjust to the market as we see our competitors making their moves. In the end, on the consumer side we have a better product, we provide better service, we have attractive bundles, and we have a local brand and I think in Hawaii local brands will go a long way in our market. So, that’s sort of my thought as it relates to that given sort of the early stages of this announcement.

Okay operator, we can take one more question before we end the call.

Operator

Okay, and there is a follow-up question from Donna Jaegers from Davidson, please proceed.

Donna Jaegers - D.A. Davidson & Co.

On the one-time charges in the quarter and the restructuring charges on Wavecom, can you talk a little bit more about those at the one-time, what were those related to and is Wavecom integrated now? So we shouldn’t see any more of those one timers going forward?

Eric Yeaman

So, I think we disclosed in the EBITDA calculation and the EBITDA reconciliation, right; that there in the quarter there was about $375,000 worth of Wavecom integration cost. The majority of those are actually in our rearview mirror, I mean for the year we had about $1.3 million. We still have one sort of major integration initiative that we have to get behind our switches exiting their main central office location at Honolulu. We have done a lot of the work to position all of that traffic to move out of that facility, the big to-do for 2014 is actually to get the gear de-commissioned, get all the traffic moved, get the gear de-commissioned, and then restore that site and be in a position to turn it back over to the landlord.

So that actually continues to be pretty big integration activity that we’re going to be undertaking in 2014. It won’t actually result in real high onetime cost for us. We’re going to have some small amount of non-recurring cost sort of in the first-half of the year. But then once we turn that facility over to our facilities guys to actually restore, all of those costs will actually be charged to a retirement obligation liability that we have recorded. So they won’t run through the P&L. And so, at that point when we ultimately end up being able to exit that facility, that’s obviously another synergy that we have baked into the overall business plan of Wavecom. I think when we announced the acquisition, we suggested that the integration timeframe was in the 18 to 22 months timeframe, so that sort of puts us towards the end of 2014 to basically -- first of the year in 2015 when we're in a position to actually exit that facility and enjoy the reduction in rent.

Donna Jaegers

Great Bob, and then the other 695,000 cost that were added back in the EBITDA as one time, what were those related to?

Robert Reich

Most of that -- some of that is actually, little of that is actually related to SystemMetrics. And really this, we closed the transaction on September 30th, we still had some deal costs that actually came through in the fourth quarter, legal fees and a success fees for advisors and things like that. Those costs don’t ultimately end up being counted as cost of acquisition anymore. They require to be recorded through the income statement, so a lot of the 695 actually related to deal costs for SystemMetrics.

Donna Jaegers

Okay, and those -- I'm assuming both of those amounts were in SG&A, right?

Robert Reich

They were.

Donna Jaegers

Okay, great.

Robert Reich

Yes, that’s correct.

Donna Jaegers

Okay thanks. That’s all I had.

Eric Yeaman

Thanks Donna.

Operator

There are no further questions, I'll now turn the call back over to Brian Tanner for further remarks.

Brian Tanner

Thank you again for joining us today and for your continued interest and support of Hawaiian Telcom. I'm available for any follow up questions and can be reached in the office in Honolulu at 808-546-3442 or shoot me an email. Thanks again, bye-bye.

Operator

Ladies and gentlemen, that concludes the presentation for today's conference. You may now all disconnect and have a wonderful day.

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