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Executives

Jennifer Spaude – Director of Investor Relations and Marketing

John Finke – President and CEO

David Christensen – CFO, SVP, Treasurer and Corporate Secretary

Hickory Tech Corporation (HTCO) Q1 2011 Earnings Call May 3, 2011 10:00 AM ET

Operator

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 first quarter 2011 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. I will now turn the conference over to Jennifer Spaude, Director of Investor Relations and Marketing. Please go ahead.

Jennifer Spaude

Good morning and thank you for joining Hickory Tech’s first quarter 2011 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 hicktorytech.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 facts, 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 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 statements whether as a result of new information, future events or otherwise. You are cautioned not to place undue reliance on these forward-looking statements made during the conference call, which represents estimates as of today, May 3, 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 potential risks and uncertainties is available in the company’s recent filing 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 report.

This presentation also contains certain non-GAAP financial measures. Reconciliation of these non-GAAP measures to most directly comparable GAAP measures are available on 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, we will open the call to a Q&A session.

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

John Finke

Thank you Jennifer. Good morning everyone. I’m pleased to share with you our first quarter 2011 results and our continued progress implementing our strategic initiatives. Today I will cover highlights from the first quarter and bring you up to date on our strategic directions. David will then walk you through the financial details of our first quarter 2011 results.

First off, I am pleased with our first quarter results. Revenue totaled $38.6 million and was even with the first quarter of 2010. Although revenue was even year over year, we achieved solid growth in several key product lines. Net income increased 50% from a year ago and totaled $2.1 million. Operating income was up 5% from a year ago and totaled $4.7 million.

Our plan and focus to grow our business in broadband services has driven continued growth and further diversification for Hickory Tech. 68% of our first quarter revenue was from our business sector and our broadband revenue streams. We believe our strategic shift in focusing on business and broadband services has positioned Hickory Tech for sustained and reliable growth.

Our first quarter earnings were enhanced as a result of our continued efforts to manage our strong cash flows, our investment in strategic growth initiatives and our ability to lower our borrowing cost and manage our debt level.

We have a solid strategic plan and the financial resources to support our growing lines of business; specifically in leveraging our recent fiber network expansion, which was completed in 2010. This expansion added 350 route miles of fiber through new routes through Sioux Falls, South Dakota, and Fargo, North Dakota. The new routes will allow us to reduce our cost to serve these markets and enable us to aggressively target wholesale carrier customers within these communities.

We also constructed a local fiber network in Des Moines, Iowa to allow us to directly serve our customers in this market and significantly increased our bandwidth between Minnesota and Des Moines. This local fiber network, along with our expanded sales force, positions us as a strong competitor in the Des Moines market where we see growth opportunities in serving business customers.

Now I’ll turn to our business sector results, which we previously referred to as the Enventis sector. First quarter business sector revenue totaled $21.4 million, even on a year over year basis, but a stronger mix of recurring revenue. Operating income and net income increased 4% and 5% respectively and all our product lines were profitable.

Fiber and Data revenue improved 13%, totaling $11 million in the first quarter. This is the start of the sixth consecutive year of double digit fiber and data revenue growth, demonstrating our continued success in growing this line of business.

Our Fiber and Data revenue growth is a result of strong sales of Enventis business Ethernet and wholesale carrier services. We believe our recent fiber network expansion and broadband stimulus projects will enable future growth in this product line.

Now turning to the Equipment product line within the business sector; equipment sales were $8.2 million, down $1.7 million from a year ago. Equipment sales fluctuate quarter to quarter based on the timing of sales and revenue recognition. However, we have a strong sales funnel and a solid backlog.

Equipment support services, a key growth area in this product line, was up 20% from a year ago. During the first quarter, we repositioned Enventis’s total care support offering to provide more value to our customers. Total care support offers customers peace of mind through a single point of contact for full coverage support, trouble isolation, proactive remote monitoring and maintenance coordination. Support services are recurring revenue streams and are now positioned with all equipment sales.

Enventis holds more than 160 individual Cisco designations and these certifications continue to differentiate us and affirm our ability to sell, deploy and support unified communications solutions. The equipment product line achieved double digit net income and operating income increases in the quarter as a result of lower costs and expenses.

Now moving to our Telecom sector performance; first quarter Telecom revenue totaled $17.7 million, even with a year ago. Our Telecom sector continued to produce strong, stable cash flows and continued growth in broadband services.

Broadband services revenue, which included DSL, data, digital TV and internet services, totaled $5.1 million, up 14% from a year ago. DSL subscribers surpassed 20,000 in the quarter. Since launching DSL in 1999, we have consistently upgraded our broadband services and network to increase our speeds and expand the reach across our rural communities. Today, we are offering residential DSL speeds of up to 20 megabits per second and business DSL speeds up to 45 megabits per second.

Last fall, we announced another broadband milestone of exceeding 10,000 digital TV subscribers. We have continued to grow our digital TV subscribers, which increased 8% in the first quarter year over year. We continue to enhance our broadband services, to ensure we are offering competitive features and value to our customers.

Our entertainment services are marketed with valuable bundles with discounts when adding high speed internet and voice services. 46% of our customers subscribe to our select bundles, which include local voice and a multitude of calling features.

In the first quarter, we made progress with the project planning and reporting for the implementation of our broadband stimulus project. This project involves the construction of two high capacity fiber builds in northern Minnesota as well as last mile fiber builds in southern Minnesota. Once constructed, this project will further expand our fiber network by approximately 400 route miles of fiber.

We will invest approximately $7.2 million of the total project cost of $24 million. The remaining $6.8 million will be funded through a federal grant as part of the Federal Economic Stimulus program. We are finalizing the route design, cost estimates and environmental assessments.

The construction bid process is in progress and we plan to break ground on the first phase of this project this summer on the route from St. Paul to Duluth. We will also be constructing numerous last mile fiber builds across southern Minnesota for a prominent health care provider.

Construction will be completed between now and August 2013 on the entire project. Once complete, the fiber route will serve customers in the health care industry, education and government offices.

Now I’d like to turn the call over to David Christensen, who will provide more details on our financial performance in the first quarter. David.

David Christensen

Thank you John. Good morning. The first quarter of 2011 was our fourth consecutive strong quarter. The year over year increases in quarterly pre-tax income for the last four quarters sequentially were 27% in Q2 of last year, 77% in the third quarter of 2010, 45% in the fourth quarter of 2010 and 24% in this most recent first quarter of 2011.

For the fourth consecutive quarter, we produced more than $10 million in EBITDA. Our first quarter 2011 EBITDA of $10.4 million represented a 26.8% EBITDA margin on our revenue of $38.6 million. This was similar to our calendar year 2010 margin of 26.5%.

Our total costs and expenses in the first quarter declined by 1% versus a year ago. Operating income and EBITDA growth percentages of 5% for the quarter were a result of our revenue mix where we resold less of our lower margin equipment and more of our higher margin services and fiber transport capacity.

Pre-tax income of $3.6 million increased 24% from the comparable quarter of 2010 due to our operational success and once again, to the decrease in our interest expense, which was down 33% this past quarter compared with first quarter 2010.

Net income in the first quarter 2011 totaled $2.1 million, a 50% increase from a year ago. This quarter was not affected by any income tax reversals, which we have incurred in three out of the past six quarters.

In this year’s first quarter, we have a more customary relationship between book income tax expense and pre-tax income of approximately 41%. For comparison, the first quarter 2010 included a $279,000 income tax expense due to the 2010 Patient Protection and Affordable Care and the Health Care and Reconciliation Act, and that generated a 51% ratio of book tax to pre-tax income.

Now I’ll comment on the business sector operating results. My comments are from the pre-elimination numbers in the business sector recap in our earnings release. Fiber and data services revenue of $11 million increased 13% or $1.3 million from the first quarter 2010. John shared highlights with you about our continuing double digit fiber and data revenue growth, but for a future point of reference, I’d like to recap the 2010 fiber expansion project, which greatly impacted the 2010 results.

In the second quarter of 2010, we started a nine month project to expand our fiber network to Sioux Falls and Fargo. This fiber expansion project was completed in 2010 and brought in approximately $5 million on non-recurring revenue and $2.3 million of EBITDA spread over the last three quarters of 2010. This was a unique project for us last year.

The 13% revenue increase for fiber and data service in the first quarter of 2011 comes entirely from organic growth in our base business and not the one time construction project revenue I just outlined.

Equipment product line revenues of $10.4 million decreased 11% or $1.3 million overall. The decline in this product line was entirely attributable to lower equipment sales, which were own 17% year over year. Equipment support service, a strategic growth area for us, grew 20% from last year.

Business sector capital expenditures totaled $1.8 million in the first quarter of 2011, slightly less than the $2.1 million spent in the comparable quarter a year ago.

Now I’ll comment on Telecom operating results based on the pre-elimination numbers in the Telecom sector recap in our earnings release. Revenue of $17.7 million was about the same compared to a year ago. We had strong Telecom/broadband revenue growth of 14%, which offset the ongoing decline in the other customer line driven areas of Telecom operations; that being local service, network access, long distance and directory advertising revenue, resulting in a net neutral position as far as year over year Telecom revenue change.

Telecom costs and expenses decreased 1% due to efforts to streamline the cost of service delivery in our Telecom business. We reported an operating income increase in our Telecom sector of 3% for the first quarter. Telecom capital expenditures were $1.9 million in the first quarter of 2011, approximately $565,000 higher than a year ago.

As of March 31, 2011, our senior debt balance was $118.8 million, using the combined look of our long term and current maturities classifications on our balance sheet. This represented a slight reduction from the $119 million level of the previous quarter.

We continue to operate with a ratio of less than three times debt to EBITDA as of March 31, which is a key metric in our industry. Our debt to EBITDA ratio is approximately 2.7 as defined in our senior credit agreement using trailing 12 month data and it is comparable to our year end position as illustrated in our 10-K.

This puts us in favorable terms for our senior debt agreement and consequently saves us interest expense. In the first quarter of 2011, we experienced a 33% decrease in net interest expense as compared with the same period last year.

For the fourth consecutive quarter, we’re at a level of $1.1 million or less of quarterly interest expense. We accomplished this by locking in our interest rate at a lower level than last year, holding our debt ratio below three to one, which where it has been since the end of 2009, and finally, due to a lower intra quarterly level of debt outstanding.

We’d also like to draw attention to the higher level of cash on hand as of March 31, 2011. Specifically, we held $9.9 million of cash at the most recent quarter end. Net debt, a measure of actual balance sheet strength that subtracts the cash balance from total debt, was $108.9 million as of March 31, 2011 and represented a $10 million improvement from the $118.9 million net debt balance as of December 31, 2010.

Net debt is not a bank ratio or a factor in our current debt agreement, but it is a common banking term in comparable situations. We see it as a useful statistic for measuring our balance sheet health.

Beginning in 2011, we shifted to a strategy of holding higher levels of cash on hand and feel that this combined with our access to funds in our revolving credit agreement, which now has $20 million available, provides us with protection against short term interruption to our business.

We enjoy very favorable credit facility terms relative to the market and it has another nine months remaining. Some of the facility’s functionality will expire at the end of 2011 and the majority of its term will expire in 2012.

We are set for a routine refinancing of our senior debt in mid-2011. We foresee no issues in re-establishing reasonable senior debt financing for our foreseeable business plan. Typical credit agreements for us have had a term of five or six years. We initiated the current one in last 2005. We expect to have a new senior credit facility in place by the third quarter of 2011 and we expect our new credit facility to have similar structure as our existing credit facility.

We also expect to experience changes in pricing of our credit facility to coincide with current market conditions for similar financing with other companies in our industry. We currently enjoy financing terms, priced at 150 basis points over the LIBOR rates. At this time, we estimate our interest expense could increase by $2.5 million to $3 million annually in the first full year after this refinancing as a result of bringing our debt up to current market terms.

Our projections of cash flow indicate that we will be able to pay for this change in cash flow through cash provided by our operations. We feel we are truly positioned for growth with our strong financial position, our cash generating power and a sound business plan.

We are reaffirming our fiscal 2011 guidance in our five key financial measures. Our guidance is 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 and these numbers are net of government grants received from the broadband stimulus project. For EBITDA we are targeting $41 million to $43.2 million. For year-end debt, we are targeting a range of $118 million to $123 million. And none of these numbers I just went over represent a change from our statements in our previous call.

We remind you there is seasonality in our business and not all calendar quarters are symmetrical. 2010 is indicative of this trait. As you compare our guidance to 2010 results, we remind you of the unique income tax reversals and the fiber construction project I outlined earlier, both of which were unique items which contributed positively to our 2010 results.

In summary, with our first quarter of 2011, we have now had four quarters in a row of strong financial results. We trace our success (inaudible) when back in 2009 we embarked on an aggressive plan to grow. Last year was an inflection year for our long term growth plan. It’s not always possible to have back to back inflection years, but for 2011, we are in a firm financial position to provide a solid base year for another step forward.

More details of our financial results are available in our quarterly report on Form 10-Q, which is due to be filed later this afternoon. With that, I’d like to turn the call back over to John Finke. John.

John Finke

Thank you Dave. We are off to a good start in 2011. We are investing in long-term growth initiatives with a focus on increasing shareholder value while maintaining strong cash flows and a solid balance sheet.

We remain confident in our business plan and are executing on our strategic initiatives. We are committed to the goal to double the value of our company by 2014, and in doing so, we are executing a disciplined strategy; one that will increase shareholder value, gain market share, and further strengthen our position as a leading communications provider.

Our five-year goal is based on a starting point of 2009 using 2009 EBITDA of approximately $40 million and a debt of $120 million. By growing our EBITDA, driving growth in lines of business that have a higher value and by managing our debt, we have set a goal to double Hickory Tech’s shareholder value. Slide 12 in our presentation outlines these details and the starting point for this goal.

Our growth plan is focused on expanding our business and broadband services and leveraging and extending our regional fiber network. Growth requires investment and while I expect the cash flow of our existing lines of business to support funding of these new growth initiatives, we may need to increase our debt in the short term.

In closing, we are pleased with our first quarter results. As we focus on the long term, there will be inflection points that reflect our progress. In comparing 2011 results to the previous year or to evaluate our guidance, it is important to note unique factors of the income tax reserve release and the fiber construction project which added revenue and enhanced our earnings in 2010.

Hickory Tech 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. Lindsey, you may initiate the questions now.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) There are no questions at this time. I would like to turn the call back to John Finke for any closing remarks.

John Finke

Thank you Lindsey, appreciate it. If you joined us after the call began today 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. Thank you again for joining us and we look forward to talking to you on our next call.

And I would also invite you that if you have additional questions after the call today, to give Jennifer, David or myself a call. Thanks again and have a great morning.

Operator

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

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