Hickory Tech Corporation (HTCO) Q3 2010 Earnings Conference Call October 26, 2010 10:00 AM ET
Jennifer Spaude – Director, IR and Public Relations
John Finke – President and CEO
David Christensen – SVP and CFO
Good morning. My name is Lindsey and I will be your conference operator today. At this time, I’d like to welcome everyone to the Hickory Tech’s third quarter 2010 earnings conference call. (Operator Instructions) Thank you. I will now turn the conference over to Jennifer Spaude, Director of Investor Relations and Marketing. Please go ahead.
Good morning and thank you for joining Hickory Tech’s third quarter 2010 earnings conference call. I’m Jennifer Spaude and with me today are John Finke, Hickory Tech’s President and Chief Executive Officer and David Christensen, Senior Vice President and Chief Financial Officer.
Before we get started, let me remind you that our earnings release was issued yesterday afternoon and is available on the investor relations section of our website at hickorytech.com. In addition, you’ll find a presentation for today’s call which we hope you will find helpful in your analysis.
Now I’d like to draw your attention to our safe harbor statement on slide two. Information in today’s presentation contains certain statements and predictions that are not historical fact, but are forward-looking in nature. These forward-looking statements are based on current expectations, estimates and projections about the industry, in which Hickory Tech operates, and management’s beliefs and assumptions as of the time of the call. Such forward-looking statements are subject to uncertainties and actual results or outcomes may differ materially from those indicated or suggested by any forward-looking statement whether as a result of new information, future events or otherwise. You’re cautioned not to place undue reliance on these forward-looking statements made during the conference call today. 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. More information on potential risks and uncertainties is available in the company’s recent filings with the Securities and Exchange Commission including Hickory Tech’s annual Form 10-K report, our quarterly Form 10-Q report and our form 8-K reports.
This presentation also contains certain non-GAAP financial measures. Reconciliation of these non-GAAP measures to most directly comparable GAAP measures are available in the presentation.
All participants are advised that the audio of this conference call is being broadcast live over the internet and is also being recorded for playback purposes. The audio will be archived on Hickory Tech’s investor relations website for the next 30 days.
Following management’s discussion today, we will open the call to a Q&A session. At this time, I’d like to turn the call over to John Finke.
Thank you Jennifer. Good morning everyone. I’m very pleased with our third quarter results and the progress we’ve made implementing our strategic initiatives. I’ll begin my remarks today with highlights from the third quarter and I’ll update you on our fiber network expansion projects. Dave will then take you through the financial details of our third quarter 2010 results.
Hickory Tech’s third quarter revenue totaled $43.5 million, up 25 percent from a year ago. Operating income for the third quarter totaled $6.4 million and was up 36 percent from one year ago. Net income totaled $5 million, down 17 percent from the $6.1 million a year ago.
Our third quarter results included an income tax release in both 2010 and 2009. Excluding the income tax release in 2010 and 2009, net income increased $1.5 million or 89 percent.
Hickory Tech is no longer a peer play traditional telephone company. While delivering voice services to our customers remains important, we have transitioned our company to one focused on delivering competitive broadband and business services over our local and regional fiber optic networks.
We believe this strategic shift has better positioned Hickory Tech to be a leader in providing business services within our existing markets and opening up new opportunities as we expand our fiber network. Our overall third quarter earnings were positively impacted by three primary factors; solid growth in fiber and data services, equipment sales and broadband services and income tax reserve release, and a construction project which is part of our fiber network expansion. Dave will provide details on these factors during his remarks.
Our third quarter results demonstrated our continued growth within our Enventis Sector and our diligent focus on growing our business to business services. We’ve demonstrated our ability to cost effectively expand our fiber network to Sioux Falls, South Dakota and Fargo, North Dakota through a joint construction project.
And our $16.8 million stimulus award announced early this quarter will enable us to further expand our fiber network as we build high capacity routes to serve our customers in health care industry, higher education and state and government offices.
Looking specifically at our financial results in the Enventis Sector, third quarter revenue totaled $25.5 million, up 45 percent from a year ago. Enventis operating income totaled $3.4 million, up 123 percent, and Enventis net income of $2 million was up 125 percent.
Enventis fiber and data services revenue totaled $13.4 million, an increase of 53 percent year over year, and the fifth consecutive quarter of double digit revenue growth. This line of business continues to product steady, stable double digit revenue growth.
Fiber and data revenue growth is driven by increased sales of high capacity Ethernet MPLS and fiber services. The addition of CP Telecom, which we acquired in August of 2009, and the impact of our joint fiber construction project. This tracks consistently to our plan, and we’re paving the way for future growth with our fiber network expansion projects that are currently underway as well as our broadband stimulus project which will start in 2011.
Earlier this year, we announced our plan to expand our fiber network to Sioux Falls, South Dakota and Fargo, North Dakota. This expansion will add 350 fiber route miles to our existing network, increasing our footprint beyond Minnesota.
This expansion will allow us to more aggressively target wholesales business customers in these markets. These fiber routes are expected to be complete in 2010.
Additionally, we have nearly completed our fiber network expansion project in Des Moines, Iowa. This project involves the construction of a fiber ring in Des Moines and a significant increase in the capacity of our long haul network between our Minnesota network and Des Moines. We are well positioned to compete in this market with an expanded sales force focused on selling our business services.
In August, the U.S. Department of Commerce awarded us a $16.8 million broadband stimulus grant through the National Telecommunications and Information Administration to further expand broadband services in greater Minnesota. This middle mile project involves the construction of two high capacity fiber builds in northern and southern Minnesota.
The fiber network construction will be approximately 430 fiber route miles connecting health care facilities, higher education institutions, K12 schools, libraries, public safety and state offices. Hickory Tech will invest approximately $7.2 million of the total project cost of $24 million. Construction will begin in 2011 and will be completed within three years.
The Enventis equipment and services revenue increased 38 percent year over year and totaled $12.1 million in the third quarter of 2010. Net income for equipment and services increases significantly as a result of increased sales and lower operating costs.
We are pleased with the double digit increases delivered each quarter this year in equipment and services, and will continue on growing the services side of this line of business.
Our recently earned Cisco’s Master to Unified Communications designation has proven to be a differentiator as a gold partner. Recently, we announced Enventis was selected by (Park Nicolos) Health Services to deploy a Cisco unified communications and collaboration solution across 23 locations. Deployment of this solution is already underway and will be completed in 2011.
This specialization confirms our ability to sell and deploy and support highly sophisticated Cisco unified communication solutions, and most importantly, it enables us to provide customers all the benefits and productivity of a secure end to end IP network.
Now looking at the Telecom Sector’s performance, third quarter Telecom revenue totaled $18.7 million, up five percent versus a year ago. The increase is primarily driven by broadband growth of 16 percent, and a 35 percent increase in bill processing revenues. Our Telecom Sector continues to product strong, stable cash flow.
Broadband services revenue, which includes DSL, Data, and Digital TV Services, totaled $3.6 million, up 16 percent from one year ago. We achieved an important milestone in the third quarter in surpassing 10,000 digital TV subscribers. This milestone highlights the long term commitment and success of growing Telecom broadband services.
Since 2008, Hickory Tech has expanded its service capabilities with a digital video recorder, and more than 50 high definition channels and an exclusive inter-active media service with on-demand weather and news now available in 13 of our communities. We continue to enhance our digital TV content by adding more channels including the recent addition of the NFL Network.
Other highlights from our third quarter for the Telecom Sector include; digital TV subscribers increased 10 percent year over year totaling 10,300 subscribers. We now offer digital TV service in 18 communities.
Telecom network access revenue was $5.8 million, relatively flat sequentially and down three percent year over year. Local service revenue totaled $3.6 million, even with the second quarter 2010, and down four percent from one year ago. Access lines declined eight percent year over year.
We continue to aggressively market the consumer triple play bundle and leverage our local customer service. Despite increasingly competitive landscapes, our Telecom Sector continues to produce consistent and stable cash flows, giving us the opportunity to pursue an aggressive growth plan focused on business services.
Now I’d like to turn the call over to David Christensen who will provide more details on our financial performance for the third quarter.
Thank you John. Good morning. Taking it from the top again, our third quarter revenue was up 25 percent from the comparable quarter last year, and it totaled $43.5 million. This $8.6 million increase includes about $3.3 million of revenue from the Sioux Falls, Fargo fiber construction project.
Without that fiber construction project, we would have achieved a 15.2 percent revenue growth over the same quarter last year.
We do have a blend of product line increases, running from a five percent growth in Telecom to 51 percent increase in the equipment portion of our equipment and services business. Our fiber and data product line has approximately 16 percent revenue increase without the fiber construction project, and is indicative of our historical growth in this product line and for our expectations going forward.
Our CP Telecom acquisition, which closed last August 2009, accounts for a small amount of the third quarter 2010 revenue increase. Along with this revenue increase, expenses were also up. We had 23 percent increase in total costs and expenses compared to one year ago.
The 51 percent increase in cost of sales is directly related to the 51 percent increase in equipment revenue in the Enventis Sector. The 23 percent increase in cost of services was partially due to our expansion of our small to medium business sales team. All told, there is approximately $1.4 million in costs associated with our Sioux Falls, Fargo fiber construction project.
Finally, accompanying the 16 percent revenue growth in fiber and data is a corresponding increase in fiber transport costs for off network transport services.
The 15 percent increase in our selling, general and administrative costs is related to our initiative to expand our direct sales force in the small to medium size business market, and to support our business customers.
There is a corresponding cost increase in commission in sales expense associated with our success in growing our fiber and data product line by 16 percent, and our equipment and services product by 51 percent. Thus, our overall 23 percent increase in total costs and expenses is directly related to our growth initiatives.
Our $6.4 million operating income is 36 percent higher than last year’s third quarter. Our pre-tax income of $5.3 million increased 77 percent from the same quarter last year due to our operational success and to the decrease in our interest expense this past quarter.
Even by removing the $1.9 million pre-tax income, which the fiber construction project provided in the third quarter of 2010, there was still over 14 percent growth in this year’s third quarter pre-tax income from all organic business and ongoing operations.
Net income in the third quarter 2010 totaled $5 million, a 17 percent decrease from a year ago. Third quarter net income in 2009 and in 2010 included a benefit from reversing income tax reserves, a reversal we were able to do because of the passage of time and closure of some earlier tax years.
Third quarter 2010 included $1.9 million of tax reserve reversal, and the third quarter of last year’s net income which was $6.1 million included $4.5 million of tax reversal. A comparison of these two quarters without the reversal would show the third quarter of 2010 net income was $3.1 million, and is up 89 percent from third quarter 2009 net income before the tax reversal.
Functionally, the reversal was not a cash transaction. We did not change or amend and tax return filings. On our financial statements under accounting standards related to income taxes, we lowered the non current tax liabilities, and through lower tax expense and higher net income, we’ve increased our shareholder equity due to these reversals.
Since we had an $800,000 tax reversal earlier this year in the second quarter, we have $2.7 million of tax reversal in total for this year. For the nine months of 2010, net income without this year’s reversals would be $7.3 million, 34 percent higher than the $5.4 million of net income for 2009 without last year’s tax reversals.
Now I’ll comment on the Enventis Sector operating results. My comments are from the pre-elimination numbers in the Enventis Sector recap of our earnings release.
Fiber and data services revenues increased $4.6 million or 53 percent for the quarter in year over year comparisons, and totaled $13.4 million in revenue for this year’s third quarter. Back in the second quarter we began the Sioux Falls, Fargo fiber project.
Back then, we received $1.1 million of revenue for this project in that second quarter and now in this third quarter 2010, we received another $3.3 million of revenue. Without this fiber construction revenue, our third quarter fiber and data revenue would have increased $1.4 million or 16 percent, and this represents the historical organic growth we’ve seen from this product line.
The construction project is approximately 85 percent complete, and will conclude in the fourth quarter. This project was part of our strategic initiative to grow our wholesale and business to business fiber and data services.
Equipment and service revenue increased 38 percent overall, and was especially good in the equipment sales area where we experienced 51 percent higher revenue than a year ago. We’ve had several consecutive quarters now of strong rebound in revenue from this product line.
Both major product lines in the Enventis Sector, that being the fiber and data product line and the equipment sales and service one, showed good profitability and very robust increases in profitability over the same quarter last year.
Enventis Sector capital expenditures totaled $4.8 million in the third quarter of 2010, up from $1.4 million a year ago. Of course our network expansion to Sioux Falls, Fargo and Des Moines is included in this investment, but it also represents an increase in the success based capital additions for business customers.
These projects have high internal rates of return, and usually have three to five year customer contracts associated with them.
Now I’ll comment on the Telecom operating results. My comments are again, from the pre-elimination numbers in the Telecom Sector recap of our earnings release.
Telecom revenue in the third quarter increased five percent compared to a year ago. We had strong Telecom broadband revenue growth of 16 percent, and we also had 35 percent growth in the bill processing revenue that our information solutions subsidiary is able to contribute by providing billing and customer management software to other communications providers.
Additionally, we experienced a $300,000 increase in other Telecom revenue. It was due to a contract termination settlement from a customer which provided a third quarter increase in other Telecom revenue. These positives served to overcome the traditional declines in Telecom local service, network access, long distance and directory advertising revenues.
Telecom cost and expenses increased eight percent. One reason is we are incurring additional expense to support our broadband revenue growth. Specifically, the costs we’re incurring to support a large new contract with a consortium of schools and libraries.
Another reason is that we have increased expense for bad debt and uncollectible accounts, as we’ve seen inter-exchange carrier disputes and an increase in business customer collection issues.
Finally, we experienced a high amount of legal fees in the period and for the year as we work the legal process for some customer billing disputes.
We have an operating income decline in our Telecom sector of approximately $300,000 or ten percent. This decline is symbolic of the wire line portion of our industry, and we strive to have our growth initiatives counteract this trend.
We plan to offset Telecom profit declines with growth of our Enventis Sector. In addition, future Telecom capital expenditures will moderate to coincide with the trend in Telecom net profitability.
Telecom capital expenditures were $1.7 million in the third quarter of 2010, approximately $900,000 lower than a year ago in the same quarter.
Our September 30, 2010 debt balance was $122 million, up $700,000 from the previous quarter and is $1.5 million higher than the balance at the beginning of the year 2010. This increase is driven by the seasonal construction time period.
The current $122 million debt balance is $2.9 million lower than a year ago at this time. We continue to operate with a ratio of less than three times debt to EBITDA, and that specific percentage is 2.88 as of September 30th, which is a very key metric in our industry and puts us well below our target levels in our senior debt agreement, and consequently saves us some interest expense.
In the third quarter of 2010, we experienced a 35 percent decrease in net interest expense from a year ago. For the second quarter in a row, we’re operating at a level of $1.1 million of quarterly interest expense. This was accomplished primarily as a result of locking in our interest rate at a lower level than last year; also due to our debt ratio going below three to one at the end of the last year, and finally, due to the lower debt level overall.
We enjoy a very favorable credit facility relative to market and it has 15 months remaining with some of its functionality expiring at the end of 2011 and the majority of its term expiring in 2012. We feel we are truly positioned for growth with our strong financial position and our cash generating power.
As John mentioned, we are the proud beneficiaries of a new award of $16.8 million of future Federal grants for a $24 million fiber construction program under the National Broadband Stimulus program. We are in the process of studying and clearing a way for this project in 2011 through 2013.
No money has changed hands yet, and construction is slated to begin in spring of 2011. It is a project which will not affect our debt agreement which is winding down in 2011, and it will be worked into the debt covenants of the future debt facility. We do not anticipate the new broadband project will deter or complicate our new debt funding, nor will it materially add to our current leverage levels.
The Federal funding of this project will provide the funding agency with a security interest in just that asset, but no ownership nor operational control of anything within Hickory Tech goes to the Federal agency.
We updated our fiscal 2010 guidance for our net income ranges to take into consideration the income tax reversals for this quarter, so regarding guidance for revenue; we are targeting a range of $150 million to $158 million. This is unchanged from our previous outlook.
We’ve increased our net income target to a range of $11.6 million to $12.5 million and thus our diluted earnings per share is targeted at $0.88 to $0.95 per share.
For CapEx we are targeting $22 to $26 million, unchanged from our previous guidance. For EBITDA we are targeting $41.5 to $44 million, unchanged from our previous guidance, and for year end debt, we are targeting a range of $117 to $120 million, also unchanged from our previous guidance.
In summary, our third quarter of 2010 turned the corner on an aggressive plan that we plotted for ourselves this year. The year 2010 is the foundation year for our long term growth plan. By having a successful year in 2010, it is giving us what we need as a building block, or a foundation, for reaching our goal of doubling the company’s value in five years.
Our third quarter 10-Q is planned to be filed later today, where you’ll find more details about our operations. Thank you. With that, I’d like to turn back over to John Finke now. John.
Thank you Dave. While our Telecom Sector remains an important component of our overall strategy, we have transformed Hickory Tech into a company focused primarily on delivering broadband and business services over our local and regional fiber optic networks.
As we work toward our five year goal to double the value of our company, we are executing a disciplined growth strategy; one that will increase shareholder value and strengthen our position as a leading communications provider.
Our growth plan is focused on growing our business to business services and leveraging and extending our regional fiber network. Our progress in 2010 demonstrates our commitment and ability to leverage our assets and our core competencies to expand to new markets and increase shareholder value.
Additionally, our broadband growth initiatives are meant to retain our Telecom customer base. The Telecom Sector continues to product solid, consistent cash flow and is an important part of our overall plan.
Our growth plans will require investment, and while we expect the cash flow of our existing lines of business to help fund our new growth initiatives, we may need to increase our debt in the short term to fund those initiatives.
The broadband stimulus grant will enable us to build high capacity fiber network, connecting anchor institutions throughout Minnesota. This greater Minnesota expansion project would not have been financially possible without the award and we are very excited to begin construction in 2011.
We are focused on growing our Enventis Sector while maintaining the free cash flow within our Telecom Sector. Our strategic direction is well defined and we are on track with most of our key initiatives.
In closing, we are pleased with our third quarter results and are excited about our future. Hickory Tech is in a good financial position to grow and increase shareholder value. We have solid net income, a high level of recurring revenues, growth trends in key strategic product lines, a healthy dividend, low cost debt covered by strong cash flows, and the ability to generate cash to fund future opportunities.
We appreciate your support and wish to thank you for joining us on the call today. At this time we’d be happy to take any questions. Lindsay, if there are any questions, you may initiate them now.
(Operator Instructions) There are no questions at this time. I will now turn the call over to John Finke for any closing remarks.
Thank you Lindsay. Well, since we don’t have any questions today, we’ll go ahead and wrap up. If you joined us after the call began, or would like a replay of the call, please visit our website at hickorytech.com. A telephone replay of the call will be available beginning at noon today, and thank you again for joining us today. We look forward to talking to you on our next call, and in the meantime, if you do have any questions, I’d invite you to give Jennifer, David or myself a call.
Thanks again for joining us and have a great morning.
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