HickoryTech Corporation (HTCO) Q4 2010 Earnings Conference Call March 1, 2011 10:00 AM ET
Jennifer Spaude – Director, IR and Public Relations
John Finke – President and CEO
David Christensen – SVP and CFO
Imari Love – Morningstar
Scott Hudson – MSI Fund
Good morning. My name is Lindsey and I will be your conference operator today. At this time, I’d like to welcome everyone to HickoryTech’s fourth quarter 2010 earnings conference call. (Operator Instructions). Thank you. I will now turn the call over to Jennifer Spaude, Director of Investor Relations and Marketing. Please go ahead.
Good morning and thank you for joining HickoryTech’s fourth quarter 2010 earnings conference call. I’m Jennifer Spaude and with me today are John Finke, HickoryTech’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 Web site at hickorytech.com. In addition, you’ll find a presentation of today’s call, which will help you in your analysis.
Now I’d like to draw your attention to the 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 this 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 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, which represent estimates as of March 1, 2011.
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, which could affect future results. More information on our potential risks and uncertainties is available in the company’s recent filings with the Securities and Exchange Commission, including HickoryTech’s annual report Form 10-K, quarterly Form 10-Q and Form 8-K reports.
This presentation also contains certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures to the 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 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. 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 fourth quarter and fiscal 2010 results and the progress we’ve made implementing our strategic initiatives. I’ll begin my remarks today with highlights from the fourth quarter. I’ll also update you on our recent fiber network expansion into the Dakota's and the expansion of our network into Des Moines, Iowa, as well as our broadband stimulus project.
Dave will then take you through the financial details of the fourth quarter and fiscal 2010 results.
HickoryTech’s fourth quarter revenue totaled $41.8 million, up 9% from a year ago. Revenue in fiscal 2010 was up 17% and totaled $162.2 million.
Fourth quarter net income was up 48% from a year ago. For fiscal 2010, net income totaled $12.1 million and was up 7%.
Operating income for the fourth quarter was up 10% from one year ago. Operating income for fiscal 2010 totaled $21 million and was up 13%.
HickoryTech's strong focus on growing broadband services and business services has driven continued growth and further transformation for being a peer play traditional telephone company. Today we are an integrative, communication provider delivering a competitive broadband and business services over our local and regional fiber optic networks.
We believe this strategic shift has better positioned HickoryTech for growth and to solidify us as a leader in providing business services within our existing markets while creating new opportunities as we expand our fiber footprint.
Our fourth quarter results demonstrate continued growth, including strong fiber and data revenue increases, broadband services growth and increased equipment sales. In fiscal 2010, we made progress in cost effectively expanding our fiber network to Sioux Falls, South Dakota and Fargo, North Dakota through a joint construction project.
This expansion added approximately 350 route miles of fiber to our network and the construction project added $5 million of revenue in fiscal 2010. The new routes will allow us to reduce our cost to [indiscernible] markets and enable us to aggressively target wholesale business customers within these communities.
We also constructed a local fiber ring in Des Moines, Iowa to allow us to directly service our customers and significantly increase the capacity of our long haul network between Minnesota and Des Moines. This local fiber ring supported with our expanded sales force positions us to compete well in this market with our business services.
In the fourth quarter, we began the planning for the implementation of our broadband stimulus project. This middle mile project involves the construction of two high capacity fiber builds in Northern Minnesota, as well as blast mile fiber builds in Southern Minnesota. Once constructed, this project will further expand our fiber network by approximately 400 route miles.
We will invest approximately $7.2 million of the total project cost of $24 million. The remaining $16.8 million will be funded through a federal grant as part of the Federal Economic Stimulus program.
Planning work and required environmental studies of the project are in progress and we plan to break ground on the first stage of the project in 2011 on the fiber route from Northern St. Paul to Duluth. Construction will be completed in phases between now and August of 2013. Once complete, the stimulus fiber network expansion will serve customers in the healthcare industry, education and government offices.
Now moving to our financials. Starting with our business sector, which we previously referred to as the Enventis Sector.
Fourth quarter revenue totaled $24.5 million, up 17% from a year ago.
Business sector operating income and net income increased 95% and 91% respectively in the fourth quarter of 2010 with both product lines delivering strong, double-digit revenue growth and improved profitability.
Fiber and data services revenue improved 18%, totaling $11.1 million in the fourth quarter 2010. I am pleased to report that this is the fourth consecutive year of fiber and data's double-digit revenue growth, demonstrating our success in growing this line of business each year since we acquired Enventis.
Our growth in fiber and data revenue is driven by increased sales of high capacity Ethernet, MPLS and fiber based services to wholesale and retail businesses. We believe that our reach in fiber network expansion and broadband stimulus project will enable future growth in this area.
The equipment and services, where we increased strong increases in equipment sales in the fourth quarter and in fiscal 2010. Revenue totaled $13.3 million in the fourth quarter, up 17% year-over-year.
Equipment sales rebounded nicely during 2010 and we are optimistic about the outlook. Additionally, net income and operating income increased significantly during the quarter, as a result of increased sales and lower operating costs.
We are pleased with the double-digit increases delivered by the equipment product line in 2010 and will continue to dedicated resources to grow the services side of this business.
During the fourth quarter, Enventis made significant progress with deploying a collaboration and unified communications solution to Park Nicollet Health Services across their 23 sites and 7,500 uses. This healthcare customer is able to reduce its costs while reaping all the benefits and productivity of a secure NJN IP network.
Our Cisco Masters unified communication specialization continues to be an important differentiator for us as a gold partner, affirming our ability to sell, deploy and support highly sophisticated unified communication solutions.
Now moving to our Telecom Sector performance. Fourth quarter Telecom revenue totaled $17.9 million, flat year-over-year. Our Telecom Sector continues to produce strong, stable cash flow and continued growth in broadband services.
Broadband services revenue, which includes DSL, Data, Digital TV and Internet Services, totaled $5 million, up 14% from one year ago. Digital TV subscribers increased 9% year-over-year and we now offer this service in 18 communities. We continue to enhance our broadband services to ensure we're offering the most competitive products and value to our customers.
Our Digital TV boasts more than 50 high definition channels and an exclusive interactive media service with on-demand weather and news now. We continue to add in-demand programming and our entertainment services are marketed as money saving bundles, providing customers an incentive to maintain their high-speed Internet and voice services. Forty-six percent of our customers choose our select bundles, which include local voice and a multitude of calling [indiscernible].
Despite an increase in the competitive landscape, our Telecom Sector continues to produce consistent and stable cash flow, giving us the opportunity to pursue an aggressive growth plan focused on our business services.
Now I’d like to turn the call over to David Christensen, who will provide more details on our financial performance in the fourth quarter. David?
Thank you, John. Good morning. This was a strong finish to our year. For the third consecutive quarter, we produced over $10 million in EBITDA. For the second consecutive quarter, we produced over $40 million of revenue.
John mentioned our 9% revenue increase this quarter and then our prior two quarters, we've noted some of the increased revenue as coming from our massive 2010 fiber network expansion project to Sioux Falls and to Fargo. That project is complete and it contributed just $600,000 of revenue in this most recent quarter.
The majority of the fourth quarter 2010 revenue increase is organic growth from our base businesses. We have a blend of product line revenue increases in our fourth quarter, ranging from 18% revenue growth in our fiber and data product line to 17% revenue growth in our equipment product line, to our Telecom product line where revenue was the same as last year. Rolling these together provides our net 9% overall revenue growth in the fourth quarter.
We also had a 9% increase in total cost and expenses in the fourth quarter compared to one year ago, which was directly related to our growth initiatives and was the same percentage increase as our revenue growth.
Our operating income and EBITDA growth percentages of 10% and 7.5% respectively for the quarter were due to our volume increases. Our overall margins were approximately the same year-over-year.
Our pre-tax income of $3.4 million increased 45% from the same quarter in 2009 due to our operational success and once again due to the decrease in our interest expense, which went down 38% this past quarter compared to the fourth quarter of 2009.
Net income in the fourth quarter 2010 totaled $2.1 million, a 48% increase from a year ago. This quarter was not affected by any income tax reversals, which we incurred in three out of the past five quarters.
In the fourth quarter for both years, we have a pretty straightforward or customary relationship between book income tax expense and pre-tax income.
Now I’ll comment on the Business Sector operating results. As John mentioned, Business Sector is our updated term for what we formally called the Enventis Sector. My comments are from pre-elimination numbers in the Business Sector recap of our earnings release.
Fiber and data services revenues increased $1.7 million, or 18% from the fourth quarter of 2009. Fiber and data revenue totaled $11.3 million for the fourth quarter.
Starting in the second quarter of 2010, we began the project to expand our fiber network to Sioux Falls and Fargo, a project we completed in the fourth quarter. This expansion project brought in $1.1 million of revenue and $400,000 of EBITDA in the second quarter, followed by $3.3 million of revenue and $1.9 million of EBITDA in the third quarter and finally, $600,000 of revenue and $100,000 of EBITDA in the fourth quarter. The total impact of this project in 2010 was approximately $5 million of revenue and $2.4 million of EBITDA.
Most of the revenue increase for fiber and data service in the fourth quarter comes from organic growth in our base business and not the one-time construction project.
Equipment product line revenue increased 17% overall, and was especially good in the equipment sales area, where we experienced 27% higher revenue than a year ago. We’ve had four consecutive quarters now of equipment product line revenue, showing us a strong rebound from prior year levels.
Both major product lines in the Business Sector, fiber and data and equipment, showed good profitability and very robust increases in profitability year-over-year.
Business sector capital expenditures totaled $3.7 million in the fourth quarter of 2010, a similar amount to the fourth quarter a year ago and it's indicative of the fact that our fiber expansion project into Sioux Falls is completed.
Now I’ll comment on the Telecom operating results. Again, my comments are from the pre-elimination numbers in the Telecom Sector recap of our earnings release.
Telecom revenue in the fourth quarter was about the same compared to a year ago. We had strong Telecom broadband revenue growth of 14%, and we also had 24% growth in the bill processing revenue from our information solutions subsidiary, which provides billing and customer management software to other communication providers. These positives serve to overcome the traditional declines in local service, network access, long distance and direct advertising revenue and give us a net neutral position as far as year-over-year Telecom revenue.
Telecom cost and expenses increased 3%, an ordinary cost of living or completionary trend.
We have an operating income decline in our Telecom sector of approximately $440,000 or 14% for the fourth quarter. This decline is symbolic of the wire line portion of our industry. We strive to have our growth initiatives counteract this trend and plan to offset Telecom profit declines with growth in our business sector.
In addition, future Telecom capital expenditures will moderate to coincide with the trend in Telecom net profitability.
Telecom capital expenditures were $2.3 million in the fourth quarter of 2010, approximately $500,000 lower than a year ago.
Our December 31, 2010 debt balance was $119 million, a reduction of $3 million from the previous quarter and is $1.5 million lower than the balance at the beginning of the year 2010. This decline is consistent with our success in lowering debt over the past four years.
We continue to operate with a ratio of less than three times debt to EBITDA, which is a key metric in our industry. Our debt to EBITDA ration is 2.76 as of December 31, 2010, which puts us well below our target levels in our senior debt agreement, and consequently saves us some interest expense.
In the fourth quarter of 2010, we experienced a 38% decrease in net interest expense from a year ago. For the third consecutive quarter, we’re at a level of $1.1 million or less 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 staying there and finally, due to the lower debt level.
We enjoy a very favorable credit facility relative to market and it has another 12 months remaining, with some of its functionality expiring at the end of 2011 and the majority of its term expiring in 2012. We are set for a routine refinancing of our senior debt in mid-2011. We foresee no issues in reestablishing reasonable senior debt financing for our foreseeable business plans.
Typical credit facilities for us have lasted about six years. We initiated the current one in 2005. We feel we are truly positioned for growth with our strong financial position, our cash generating power and a sound business plan.
We are providing our fiscal 2011 guidance in our typical five key financial measurements. Our guidance is that for revenue, we are targeting a range of $158 million to $164 million. For net income, we are targeting a range of $7.4 million to $8.7 million and our diluted earnings per share is targeted at $0.56 to $0.66 per share.
For CapEx, we are targeting $20.5 million to $24 million. Numbers are net of any government grants received for the broadband stimulus project.
For EBITDA, we are targeting $41 to $43.2 million. And for year-end debt, we are targeting a range of $118 million to $123 million.
We'd like to remind you that there is seasonality in our business and not all calendar quarters are symmetrical or alike for our company. Taking any single quarter times four will not capture the seasonality within our business. The year 2010 would be indicative of that trait.
In summary, our fourth quarter of 2010 has given us three quarters in a row of strong financial results. We trace our success further back than that, well back into 2009 when we embarked on an aggressive plan to grow. The year 2010 completes a successful foundation year for our long-term growth plan. We are on a firm, financial position to move forward ambitiously.
More details of our financial results are available in our annual report on Form 10-K fourth quarter 10-K, which is due to be filed later this afternoon.
Thank you. With that, I’d like to turn it back over to John Finke now. John?
Thank you, Dave. As you heard the financial details of our recent quarter, you can understand why we are pleased with our earnings and our overall financial position. We made excellent progress with our strategic initiatives during 2010. We continue to grow our fiber, data and broadband services while we invest in strategic growth opportunities. We remain very confident in our business plan and our executing on our strategic growth initiatives.
We are committed towards our five-year goal to double the value of our company by the end of 2014. And in doing so, we are executing a disciplined growth strategy, one that will increase shareholder value, gain marketshare and further strengthen our position as a leading communications provider.
Our growth plan is focused on expanding our business and broadband services and leveraging and extending our regional fiber network. Our financial and strategic progress in 2010 demonstrates this commitment and our ability to leverage our assets and our core competencies to expand into new markets and increase shareholder value.
Additionally, our broadband growth initiatives are meant to retain our Telecom customer base. The Telecom Sector produces solid, consistent cash flows and is an important part of our overall strategic plan.
Growth requires investment, and while we expect the cash flows of our existing lines of business to support funding these new growth initiatives, we may need to increase debt in the short-term.
The broadband stimulus grant will enable us to build a high capacity fiber network, connecting anchor institutions throughout Minnesota. This greater Minnesota broadband, collaborative project would not have been financially possible without the award and we plan to begin construction in 2011.
In closing, we are pleased with our fourth quarter results and remain excited and confident about HickoryTech's future. HickoryTech is in a good financial position to grow and increase shareholder value. We have a strong balance sheet, solid net income, a growing level of recurring revenues, growth trends in key strategic product lines, a healthy dividend, which we recently increased, strong cash flow, 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 you would initiate them now?
(Operator Instructions) Your first question comes from the line of Imari Love, Morningstar.
Imari Love - Morningstar
Thanks for taking the call guys. Good quarter. So, a couple of quick questions. Q4 EBITDA, the margin was at a multi year low at around 24.7%. I see that there was a slight uptick in the cost of services, percentage of revenue on the Telecom side. That was also at a multi year high. Is anything changing in terms of the landscape on that end? And the second question, just on over overall guidance. Looks like you're targeting a slight erosion in revenues and margins going forward for 2011? What's changing in the landscape or just the business mix that's driving these sort of conservative objectives?
Imari, I'm going to take a swing at a few of those. Your comment on the fourth quarter. I don't know how well you've been able to isolate quarter-by-quarter margins or if you're comparing to annual margins but the fourth quarter is typically, a seasonal lower point for us in margin delivery. We get to a lot year-end [indiscernible] and construction projects and compensation plans and what not. And so sometimes the fourth quarter is not representative of a full year quarter as far as margin goes. To answer the question, no it's not indicative of a trend going forward.
Your second question was about guidance and how, whether there was any signals, I guess you called it an erosion of margin in the year 2011. That's what I'm showing also. A slight downturn from 2010 as far as the EBITDA margin and it's more of a mix answer. We're going to have strong equipment and service results in 2011. And that carries a lower margin than the relative or the same amount of, let's say Telecom or fiber or data business. So it's more of a mix reason for that.
Imari Love - Morningstar
Okay and so in 2010, if we had 16.6% top line growth and if it's going to be flat in 2011, is this a function of loss in revenue on the Telecom side instead of it being flat or just flat growth on the business side?
Let me take you back to that dialog I had in my script where we enumerated the, what ended up being $5 million of construction revenue for the fiber expansion into Sioux Falls and Fargo. That is not recurrable revenue. That was one-time revenue for the construction project. So you have to kind of factor that into your projections going forward. That $5 million that came through in the fiber and data product line was merely for the construction of that route and that won't recur again.
Imari Love - Morningstar
Right. Okay and so if you pulled that $5 million out then that put you at 157 for '10 and then going to 161 next year on the midpoint, would be around 3% growth of the top line. Is that what we sort of foresee as the long-term growth objectives or something happening in 2011 that's going to mute the growth a little bit?
We also are going to see the continued decline in Telcom revenue year-over-year. You mentioned that earlier. This year the year-over-year revenue was flat. We are projecting a continued, gradual decline in that Telecom product line as well. It was a solid year there. We didn’t' have a decline in revenue for, basically offset by some of the growth in broadband services but we are projecting a gradual decline in the Telecom portion of the business.
Imari Love - Morningstar
Gotcha. Okay. Thank you.
Your next question comes from the line of Scott Hudson, MSI Fund.
Scott Hudson - MSI Fund
Good morning. Thanks for taking my question. As far as taxes, I know you mentioned it briefly. If you could just drill down a little bit. You had a 25% rate last year. Did you say that you expected that to stay around the same or?
I did say the fourth quarter relationship of tax to pre-tax is more of a normal relationship. I'll take you through our history a little bit. In 2009, we had a $4.4 million income tax reversal on the book side and then in 2010, we've experienced another $2.7 million of income tax reversal. That total $7.1 million in two years is what's creating some of the different looking relationships, looking backwards compared to what it'll look like going forwards. We have a disclosure in our 10-K coming out as to how much more of that is left and it's a rather small amount. I think it's in the $350,000 neighborhood for the next 12 months. So we're just near the end of that tax reversal process.
Scott Hudson - MSI Fund
Okay and I read the comments about looking to double the company value over the next five years. I guess, where is the inflection point? In other words, if you're flat to maybe up 3% in 2011? Is this pick up growth in '12 or '13 or kind of how do you see that playing out to double?
Yes, we see this playing out as really, part of the plan was to expand the fiber footprint in 2010, creating some growth opportunities that we will have a hard time overcoming the one-time construction gain in 2010. But the plan is that, as we continue to grow both the wholesale and retail fiber business as well as increase the sales and get up the ramp in the small-medium business or commercial markets success, that we will start seeing growth in 2012 and 2013, as we get up those sales ramps and those projects start contributing to the EBITDA growth of the company in those years.
And the value, the doubling the value is also really linked to us being able to manage the cost and manage the debt and really increase shareholder value by growing the EBITDA and managing the debt side of this. So it's a combination of growing top line and managing the cost that will allow us to double the value.
There's really two inflection points. We started with our 2009 commitment to growth. So we began the clock in 2009. There's already been a considerable inflection point already in 2010 with this first year of success that we've had. That's one inflection point and the next inflection point comes a little bit down, farther down the road after we finish the broadband project. So there's probably two inflection points to your point and we've already experienced one of them.
Scott Hudson - MSI Fund
Okay and what exactly do you mean by value in terms of doubling the value? I mean, are you referring to, how do you define that?
We define it as looking at, the value of this place that our individual lines of business. Looking at the EBITDA growth or EBITDA decline in each of our lines of businesses and looking at how those different lines of business are valued in the marketplace. And kind of creating a value there and like I said earlier, looking at the debt side of that and subtracting that out of that overall value calculation to get a shareholder value calculation of, and that's the number we're talking about, being able to double that value over the next five years, or by the end of.
Scott Hudson - MSI Fund
Doubling the net value?
Yes, doubling that net number. It's not a top line number. It's not a pure EBITDA number. It's about EBITDA growth and debt management.
Scott Hudson - MSI Fund
Kind of netting that against each other. For example, the fiber line of business and growing those had the higher value then perhaps the equipment sales lines or the Telecom business and growing those certain parts of the business and managing that and managing the cash flow will create that double to value. Does that answer your question?
Scott Hudson - MSI Fund
Yes. That helps. Thank you for answering all my questions. Good luck, guys.
Okay. Thank you.
Operator: (Operator Instructions) There are no questions at this time. I would like to turn the call over to John Finke for any closing remarks.
Thank you, Lindsay. Thank you for your questions. We appreciate it and if you joined the call late, or would like to hear a replay of the call, please visit our Web site at hickorytech.com. A telephone replay of the call will be available beginning at noon today.
Thank you again for joining us and we look forward to talking to you on our next call. In the meantime, if you have any questions, please do not hesitate to give Jennifer, David or myself a call.
Thanks again and have a great morning.
This concludes today's conference call. You may now disconnect.
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