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Executives

Jennifer Spaude – Director, IR

John Finke – President and CEO

David Christensen – SVP and CFO

Analysts

Justine Ruiss – Sidoti

HickoryTech Corporation (HTCO) Q4 2011 Earnings Call March 7, 2012 10:00 AM ET

Operator

Good morning. My name is Lindsay, and I will be your conference operator today. At this time, I would like to welcome everyone to the HickoryTech’s Fourth 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. Ms. Jennifer Spaude, Director of Investor Relations and Marketing please go ahead.

Jennifer Spaude

Good morning, and thank you for joining HickoryTech’s fourth quarter 2011 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, I will refer you to the Investor Relations section of our website at hickorytech.com where you will find a presentation for today’s call.

Our Safe Harbor statement is shown on slide 2 of the presentation. As a reminder 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 statements, whether as a result of new information, future events or otherwise.

You are cautioned not to place undue reliance on these forward-looking statements made during this conference call. 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 our potential risks and uncertainties is available in the company’s recent filings with the Securities and Exchange Commission, including HickoryTech’s Annual Form 10-K report, which will be filed by here today, our Quarterly Form 10-Q reports, and Form 8-K reports.

Our presentation today also contains certain non-GAAP financial measures. Reconciliation of these non-GAAP measures to the most directly comparable GAAP measures are available in our presentation.

All participants are advised that the audio of this conference call is being broadcast and is being recorded for playback purposes. The audio will be archived on HickoryTech’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 and good morning everyone. I’m pleased with our fourth quarter and fiscal 2011 financial results and the significant progress we’ve made during the year as we focused on our strategic initiatives and continued the company’s transformation. It was a year of making investments in the future of HickoryTech, as we met and exceeded our objectives for fiscal 2011. We remain committed to following our strategic plan and pursuing opportunities which will grow our company while increasing shareholder value.

I’m also pleased to report that we closed on our acquisition of IdeaOne on March 1st. The IdeaOne acquisition which was announced in early December further expands our business and broadband services and gives us immediate access to the Fargo market for future growth opportunities.

IdeaOne recorded fiscal 2011 revenue of $12.3 million the majority of which was from the business customer base. We expect the acquisition to be immediately accretive on a free cash flow basis and we plan to continue to invest in the Fargo market as the deep metro fiber based footprint is already connected to our regional fiber network. We will provide additional redundancy to the Fargo market with our broadband stimulus route from Greater Minnesota to Fargo in 2012.

The combination of these two networks is expected to provide additional growth opportunities for our company as we market our business services in this market. IdeaOne provides data networking, Internet, colocation, phone and hosting services to approximately 3600 business and residential customers in the Fargo area. The company has 40 employees and the acquisition will add 225 route miles of fiber to HickoryTech’s Regional Fiber Network. The network facilities which extend in fiber to 650 buildings include multiple 10 gigabit fiber rings, Ethernet capabilities, soft-switching infrastructure and colocation services.

Now looking at our fourth quarter and fiscal 2011 earnings. I’ll begin my remarks today with full year 2011 highlights and then Dave will take you through the financial details of our fourth quarter results as well as our guidance for 2012. 2011 revenue totaled $163.5 million up 1% from fiscal 2010. Within our Business sector fiber and data revenue totaled $45.9 million up 2% year-over-year. However, up 14% when you exclude the fiber construction project which added $5 million of onetime revenue in 2010.

We were able to replace a large one-time revenue stream from 2010 with organic recurring revenue in 2011. Our fiber and data revenue growth is driven by strong sales of high capacity data services within the wholesale market as well as continued growth in our retail business services.

We are actively engaged in coating wireless backhaul solutions and had some success in this area in 2011.

We remain focused on growing our retail business services and leveraging our full suite of services including our SingleLink Hosted Unified Communications Solution. We did predicate our services from our competitors as we are an experienced local service provider with a long history of providing communications solutions. We feel confident we can continue to grow our fiber and data line of business into the future.

Now turning to our Equipment segment where revenue was up 3% year-over-year. We have developed strong customer relationships and a good reputation in the industry to generate repeat sales from our current customer base as well as attracting new customers.

Equipment support services were up 12% year-over-year, we play traditional focus to grow this recurring revenue stream in 2011 and our results reflect the early progress in this area.

We are well-positioned as a Cisco Gold Master Unified Communication partner to offer end-to-end communications collaboration solutions. We added TelePresence, our video capabilities in 2011, which is a next evolution of these services.

Telecom fiscal 2011 revenue totaled $69.5 million down slightly or 1%, which is expected for our legacy service business. Broadband revenue for 2011 was up 8% and totaled $20.4 million. Our broadband product line has grown significantly in the past decade and it has helped to compensate for the telecom declines in local service and network access revenue. Broadband services accounted for 12% of our consolidated revenue and 29% of our telecom revenue in 2011.

In 2012 we remained focused on customer retention and it designed our consumer promotions around offering value to both new and existing customers. We’re leading with our differentiators. Our topnotch local customer support and our strong connection to the communities we serve.

Application for consumer services continues to increase. And given our mature telecom markets we anticipate single digit broadband revenue growth in the future. Our Telecom business still provides steady, consistent cash flows for our company. Our consolidated operating income totaled $19.7 million for fiscal 2011 and net income totaled $9.2 million. We had unique tax reserve releases, which makes the year-over-year comparisons challenging. Additionally the fiber construction project in 2010 added a $1.4 million benefits in net income is building the tax reserve releases in both years and the net income benefits associated with the fiber construction project in 2010. Net income for 2011 was 11% higher year-over-year.

Our 2011 results demonstrates solid progress with our long term strategy, which focuses on maintaining our Telecom business, growing our business in broadband services while we pursue new growth opportunities such as the IdeaOne acquisition. We remain focused on managing our strong cash flows and leveraging investments to provide a solid return to our shareholders and to increase overall shareholder value.

A key project in 2011 was initiating our Greater Minnesota broadband collaborative project which we both ground on last August. This $24 million project is being funded by 16.8 million grant from the US Department of Commerce, National Telecommunications and Information Administration. Additionally, we will invest approximately $7.2 million and about half of that was expanded in 2011.

This project involves a construction of two high capacity fiber builds in Northern Minnesota as well as last mile fiber built in Southern Minnesota. So the majority of the first fiber route was constructed in 2011 and we begin the North Western Minnesota route this spring.

Upon completion of this project in 2013, we will add approximately 430 fiber route miles creating one of the most extensive fiber footprints in our region.

Now I would like to turn the call over to David, who will talk about our fourth quarter results. Dave?

David Christensen

Thank you, John. Good morning. We delivered solid financial performance to our shareholders this past fiscal year which increased HickoryTech’s overall value. In time when we have committed significant resources to pursuing our strategic objectives we maintained an advantageous financial position.

As an example we use $6 million of our cumulative cash reserves to complement the idea $128 million acquisition price last week only borrowing 22 million thus minimizing our interest cost and keeping our leverage ratio below 3 to 1.

Fourth quarter 2011 revenue of $39.6 million was down 5% from last year’s fourth quarter due to normal fluctuations of equipment sales. Equipment sales revenue of $8.3 million was down 28% from fourth quarter 2010. In contrast our overall $31.2 million of services revenue was 3% higher than fourth quarter of 2010.

On a full year basis our equipment sales business was a story of timing. Our equipment revenue which come from one-time sales primarily in the fiscal product line had virtually the same successful year in 2011 as 2010 totaling $39.8 million this year and $39.4 million the year before. The difference is that we received high levels of revenue in the second and third quarter this year. We’re at the highest sales for 2010 came later in the year including the fourth quarter of 2010.

76% of our overall revenue for the year or $123.7 million is services revenues which is primarily recurring revenue and of over reporting a 1% increase in this revenue for the full year 2011 when you normalize the comparison by backing out the unique fiber construction revenue from 2010 a rare $5 million opportunity which did not reoccur then you see that our services revenue actually grew 5% over last year.

Services revenue is a broad mix of our Fiber and Data business, our legacy telecom services and even some services revenue from our Equipment business. This recurring revenue stream is vital. Recurring revenue is what distinguishes us as an industry.

In the fourth quarter our EBITDA as defined in our credit agreement was $10.1 million. It does not include $510,000 of expenses that we took in the fourth quarter directly associated with the acquisition of IdeaOne Telecom of fiber CLEC in Fargo North Dakota.

Our fourth quarter 2011 EBITDA represented a 25.5% EBITDA margins on our overall revenues of $39.6 million. This was lower than the full year 2011 margin of 26.5% due to system development improvements and year end compensation adjustments.

Total selling, general and administrative costs in the fourth quarter 2011 increased by 17% from a year ago with $510,000 of those costs directly related to the IdeaOne transaction. Excluding those costs SG&A cost would have been up 9% over last year and that is similar to the year-to-date increase. These support costs and expenses have increased as we pursue our growth initiatives.

Our interest expense in the fourth quarter of $1.3 million was 20% higher than the $1.1 million interest expense from last year due to higher interest margins associated with our new credit agreement and higher outstanding balances. Offsetting this we are carrying a higher cash balance this year.

Consolidated pre-tax income for the fourth quarter 2011 totaled $2.3 million down 31% from the comparable quarter in 2010. The decline of pre-tax income was primarily due to lower equipment sales and the unique costs associated with the IdeaOne transactions combined with higher interest costs.

Consolidated net income for the quarter totaled $1.4 million a 32% decrease from one year ago. For the full year net income totaled $9.2 million a 24% decrease from 2010. As John stated earlier this year’s $9.2 million actually represent in a 11% increase over 2010 had we not had two unique benefits in 2010 namely the tax reserves and the unique fiber project.

Now I’ll review our Business sector operating results. My comments come from pre-elimination numbers found in the Business sector recap of our earnings release and remind you that Business sector revenues were down 9% in the fourth quarter and that we have two segments in our Business sector, fiber and data and equipment.

Fiber and data services revenue totaled $12.1 million in the fourth quarter, an increase of 7% from the same quarter in 2010. Equipment segment revenues of $10.3 million decreased $3 million or 22% compared to the same period last year. Equipment sales themselves were down 28% while equipment services – while support services for equipment were up nicely 15% increase compared to the same quarter last year. We are striving to grow equipment support service revenue.

Business sector capital expenditures for both the Fiber and the Equipment segments totaled 4.4 – $4.5 million in the fourth quarter of 2011 which is $800,000 higher than the fourth quarter a year ago. For fiscal 2011 we spent $12 million in the Business sector compared to $14.5 million in 2010. Our CapEx in 2011 is net of almost $7 million of grant reimbursements received for our Greater Minnesota broadband collaborative project.

Now moving to the telecom operating results and based on the pre-elimination numbers for the Telecom sector revenue in the Telecom group totaled $17.8 million in the fourth quarter and was down $147,000 or less than 1% compared to the results reported one year ago. Our ongoing decline in the legacy telecom services was offset by growth in broadband services and in our bill processing revenue from our information solution subsidiary.

Telecom cost of expenses decreased 1% for the quarter and lock step with the revenue decline due to efforts to streamline the cost of service delivery in our Telecom business.

Telecom capital expenditures totaled $2.8 million in the fourth quarter of 2011 approximately $560,000 more than the same quarter one year ago. And fiscal 2011 telecom CapEx of $9.4 million is approximately 1 million or 11% higher than 2011. The higher CapEx supported system improvements which will benefit our entire company.

Regarding our debt level, using the current maturities and the long-term debt classifications on our balance sheet in total we had $120.2 million of total debt including capitalized leases as of December 31, 2011. This represented a slight decrease from the $120.6 million at the end of the third quarter 2011 and it represented a slight increase from the $119 million level of debt we had one year ago.

We continued our plan of holding a higher level of cash on hand which totaled $13.1 million as of December 31, 2011. Net debt a measure of actual balance sheet strength that subtract the cash balance from the total debt was $107.2 million as of December 31, 2011 and represented a $11.7 million improvement in net debt year-over-year.

We continued to operate with a ratio of less than three times that EBITDA as of December 31, 2011 which is a key metric in our industry. Our most recent debt to EBITDA ratio is approximately 2.81 as defined in our senior credit agreement using trailing 12 months data. This puts us on favorable terms for our new senior debt agreement which currently has a maximum leverage of 3.5 to 1. We feel we are conservatively leveraged and this new five year credit facility will provide excellent financial support for our future growth plans. It was used for the incremental financing of IdeaOne acquisition last week.

In the fourth quarter of 2011 we experienced a $221,000 increase in net interest expense compared with the same period of 2010. Interest expense on the fourth quarter of $1.3 million was down from the $1.5 million level of the third quarter because of onetime costs associated with our new five-year credit facility in the third quarter.

For run rate costs for interest expense currently we had $1.3 million a quarter will increase approximately $200,000 for our full calendar quarter starting with the second quarter of 2012 and run at approximately $1.5 million quarterly in 2012. We closed on the incremental $22 million debt for IdeaOne acquisition on March 1, so there will be a partial quarter impact for this interest cost increase in this next quarter.

Further details of our overall debt financing are contained in the SEC Form 10-K which will be filed later today. And our incremental financing for the IdeaOne acquisition was discussed in our 8-K filing on March 2. We are pleased with our new bank syndicate and the arrangement fueling our business plan perfectly.

As John mentioned we completed our IdeaOne acquisition transaction last week and our press release and 8-K filing on March 2 provided the details. We are encouraged about the growth prospects this new CLEC in the former area brings us.

I only having to borrow $22 million of the $28 million purchase price and by utilizing the strong cash flows of IdeaOne to fund its CapEx need this transaction should be accretive to us in the first year.

We are providing the full-year 2012 fiscal guidance and please note the fiscal guidance includes IdeaOne for ten months starting on March 1 of this year. For revenue we are targeting a range of $177 million to $183 million.

For EBITDA we are targeting a range of $46 million to $48 million. For net income in 2012 we are targeting a range of $7.6 million to $8.6 million and diluted earnings per share at 57 to 54 – $0.57 to $0.64.

For CapEx we are targeting a range of $25 million to $29 million and these numbers are net of the government grants received for the broadband stimulus project. And our year-end debt of 2012 is targeted to be in a range of $141 million to $144 million.

We are also citing a few trend changes which we anticipate for 2012 and which are in these guidance numbers. First, the comprehensive reform of telecom access revenue rules was announced in late 2011 and is scheduled to begin in 2012. While these rules maybe appealed or reconsidered, we tried to estimate their impact. We foresee a decline in our telecom profitability and that contributes to our overall EBITDA guidance range of $46 million to $48 million. Secondly depreciation expense has systematically climbed by $100 to $200,000 per quarter in the best and it will continue to rise as we invest in higher most of capital expenditures than we did before 2010.

In addition IdeaOne brings approximately $750,000 of quarterly depreciation. That’s our total depreciation and amortization for 2012 maybe $4 million higher than the $23 million we recorded in 2011. And thirdly I’ve already commented on the new interest expense run rates due to our financing for IdeaOne, it is the combined effects of interest expense being over $1 million higher in 2012 and depreciation being over $4 million higher which lead to our net income guidance of $7.6 million to $8.6 million.

2011 was another very good year. We put in place the solid foundation of long-term financing and 2012 is already capitalizing on that with the successful acquisition of IdeaOne. More details of our financial results are available in our annual report or Form 10-K which is due to be filed later this afternoon.

And with that I’d like to turn it back over to John Finke. John?

John Finke

Thank you, Dave. 2011 was an eventful year another important year demonstrating HickoryTech’s transformation from a peer telephone company to a leading business in broadband service provider. Key highlights from the 2011 include, we acquired IdeaOne and added a robust metro fiber network in Fargo, North Dakota further expanding our business services and our regional fiber network.

We increased our fourth quarter dividend to $0.14 per share a 4% increase. We signed a favorable new financing agreement offering our company low cost capital to fund our growth initiatives. We announced a plan to repurchase up to $3 million of HickoryTech’s common stock. We both ground on our Greater Minnesota broadband collaborative project and we were added to the Russell 2000 Index and recognized as one of the best 100 small companies by Fortune magazine.

We are investing in long-term strategic initiatives with the 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 growing HickoryTech both organically and through acquisition as we executed discipline strategy to diversify our company and increase shareholder value.

Our strategic plans focused on growing our business and broadband services, expansion is leveraging our assets. Specifically our expanded regional fiber network which now encompasses 3250 fiber route miles.

In closing 2011 was another solid year that position HickoryTech to be successful in 2012. Looking ahead to next year, we will focus on integrating IdeaOne operations, implementing system improvements to enhance our sales and customer support processes and initiate the construction of our Northwestern Minnesota fiber route.

HickoryTech remains in a very good financial position to grow an increased shareholder value. We have a strong balance sheet, a high level of recurring revenues, growth trends in key strategic pipelines, a healthy dividend, strong cash flow and the ability to generate cash to fund future opportunities.

We appreciate your continued support of HickoryTech and thank you for joining us on the call today. At this time we’ll be happy to take any questions. Lindsay, you may initiate those now.

Question-and-Answer Session

Operator

Thank you (Operator Instructions) The first question comes from the line of Justine Ruiss with Sidoti.

Justine Ruiss – Sidoti

Hello.

John Finke

Good morning, Justine.

Justine Ruiss – Sidoti

Good morning how are you.

John Finke

Just fine.

Justine Ruiss – Sidoti

I just had a quick question on just the guidance. You’re guiding higher for revenue yet lower for earnings can you just speak through that?

David Christensen

Justine, this is Dave. I’ll answer that. We are guiding higher on earnings and that our EBITDA guidance is I think 8.5% higher on the EBITDA and as I try to explain in the trend changes it is the non-operating events of depreciation and interest which maybe lead to your conclusion that the net income is lower. Does that help?

Justine Ruiss – Sidoti

Yes, it does. I think that’s pretty...

John Finke

Yes, Justine, the main impact, I think Dave touched on it as well is that we have been investing significantly in the network and with the broadband stimulus routes and with the organic investment in our business that the depreciation is starting to accumulate and that’s what Dave starting to point out there.

Justine Ruiss – Sidoti

Would there be any plans to refinance the debt at this point just to as a fill-in but?

David Christensen

No, that is probably an issue Justine we have a very low cost of debt, we are borrowing at – in the neighborhood of 4%. We don’t consider the interest cost to be the major factor here. I think the depreciation is becoming more of the influence on our net income.

John Finke

Yeah, in fact in relating to debt, I mean, the one thing I think you need to focus on also is that because of the strong cash flows we are actually able to fund the capital expenditures out of free cash flow and that we are not borrowing to fund the CapEx. Now as a matter of fact we paid down debt or accumulated cash over the past several quarters and really the borrowing we did was for the IdeaOne acquisition and as Dave mentioned also we only had to take out the $22 million in term debt and funded $6 million of that with cash on hand. So I think from a debt perspective and from a cash perspective we are in a pretty solid position at this point in time.

David Christensen

Probably one more thing that we could add is the last couple of years, the net income has been and we have always itemized this and illuminated this in our dialogs here, vastly helped by the reversal of income tax reserves and that no longer will be in 2012 going forward. We reversed a total of $7 million over the last couple of years and the income tax reversals and that has helped the net income number in the past.

Justine Ruiss – Sidoti

All right.

John Finke

Does that help?

Justine Ruiss – Sidoti

Yes, absolutely. Thank you very much.

John Finke

Thanks for the question.

Operator

(Operator Instructions) There are no questions at this time. I’d like to turn the call over to John Finke for any closing remarks.

John Finke

Thank you, Lindsey. 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 this call will be available beginning at noon today. I would like to thank you again for joining us on the call today. We look forward to our next call. And we’d also invite you that if you had any additional questions to give Jennifer, David or myself a call at any point in time. Thanks again and have a great day.

Operator

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

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