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Executives

John Finke – President and Chief Executive Officer

David Christensen – Senior Vice President and Chief Financial Officer

Jennifer Spaude – Director, Investor Relations

Analysts

Justin Ruiss – Sidoti

HickoryTech Corporation (HTCO) Q1 2012 Earnings Call May 1, 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 First Quarter 2012 Earnings Conference Call. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions)

Thank you. Jennifer Spaude, Director of Investor Relations and Marketing, please go ahead.

Jennifer Spaude

Good morning and thank you for joining HickoryTech’s first quarter 2012 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’ll refer you to the Investor Relations section of our Web site at hickorytech.com where you will find a presentation for today’s call.

Our Safe Harbor statement is shown on slide 2 of this 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 the 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 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, our Quarterly Form 10-Q reports, and Form 8-K reports.

Our presentation contains certain non-GAAP financial measures. Reconciliations of these non-GAAP 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 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 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.

John Finke

Thank you, Jennifer, and good morning, everyone. We appreciate you joining us today as we review our results for the first quarter. I’ll start with an overview of our results and then David will provide a detailed review of our financials.

The first quarter was a very strong quarter and a great start to 2012. Driven by strong equipment sales and continued growth in our fiber and data segment, HickoryTech generated $46.9 million in revenue, an increase of 22% over the comparable period last year.

EBITDA, as defined by our credit agreement, totaled $11.5 million, up 11% from a year ago. Consolidated operating income totaled $5.3 million, up 13%, and net income totaled $2.3 million, up 8%. Our business product lines continued to produce excellent results.

Fiber and data revenue increased 22% to $13.4 million, reflecting success we’ve experienced in commercial, enterprise, and wholesale data sales, and the addition of one month of results from IdeaOne, which will be reported within the fiber and data segment.

IdeaOne is a facilities-based CLEC serving the Fargo, North Dakota area. You’ll recall that we closed on this acquisition on March 1st, 2012. This business has a robust metro fiber network which directly connects to our regional fiber network providing future opportunities for us to grow our business and broadband services.

In fact, the acquisition is already adding value. We have already secured new business based on our expanded footprint and anticipate further opportunities in this market. The early spring has allowed us to get a good start on our construction in the Fargo area and lit-building initiatives throughout our network.

The integration of IdeaOne is going well and is on schedule. The financial and building system conversions will be completed later this year. We are already seeing synergies and expect the acquisition to be accretive on a free cash flow basis.

IdeaOne provides data networking, Internet, colocation, phone and hosting services to approximately 3,600 business and residential customers in the Fargo area. The acquisition added 225 route miles of fiber to HickoryTech’s regional fiber network. The network facilities extend fiber to 650 lit buildings and include multiple 10 gigabit fiber rings, Ethernet capabilities, soft-switching infrastructure and colocation services.

We remain focused on growing our commercial and enterprise business services and leveraging our full suite of communication solutions. We feel confident we will be able to continue to grow our fiber and data line of business into the future.

Our equipment segment revenue totaled $17.4 million, an increase of 67% year over year. We had a strong backlog of equipment orders that carried into 2012, which helped drive an 87% increase in hardware sales. Support services revenue in this line of business was down 5%.

We continue to see increasing demand for unified communications, contact center, security and wireless solutions and data center solutions. Our recent unified communications solution engineered for Young America Corporation allowed the customer to cut costs, boost performance and maintain a scalable solution that will meet their future needs.

To further highlight our success in this area of our business, Enventis was recently recognized by Cisco as a Data Center Partner of the Year in the central region. We have demonstrated tremendous growth in the unified computing practice and committed to the technology through our investments in lab equipment and training for our advanced certifications. We are well-positioned as a Cisco Gold Masters Unified Communications Partner to offer end-to-end communications and collaboration solutions.

Turning to our Telecom segment, first quarter Telecom revenue totaled $16.7 million, down 6%. We expect to continue to see declines in our legacy Telecom business. Broadband revenue totaled $5 million, essentially flat year over year. Network access revenue was down 16% reflecting the continued declines due to loss of lines and minutes of use on our network, as well as other events including the impact of certain provisions of the FCC order released in November of 2011. David will provide additional details on the access revenue declines during his financial analysis.

A distinct positive in the Telecom sector was a $468,000 increase in bill processing revenue, a 64% year-over-year increase from our billing and customer management software system, Suite Solution, marketed to external communications service providers by our Information Solutions division.

Given that our Telecom markets are all mature, we are very focused on customer retention and continue to offer consumer solutions that build loyalty and attract new customers. We are leading with our differentiators, our top-notch local customer support, and our strong connection to the communities we serve. Competition for consumer services continues to increase and we anticipate continued network access and local service declines.

Despite the Telecom declines, our Telecom business still provides steady, consistent cash flow for our company. We resumed construction on our greater Minnesota broadband collaborative project a month ago and are 99% complete with the first phase fiber build from Minneapolis-St. Paul to Duluth and Superior, Wisconsin.

The second phase of this project is a fiber build from Brainerd, Minnesota to Fargo, North Dakota, which we just began constructing, and we’ll complete the majority of the construction in 2012. Upon completion of the entire project in 2013, we will add approximately 430 fiber route miles and the network will provide additional growth opportunities for our company.

We remain focused on maintaining our Telecom business, growing our business and broadband services while we pursue new growth opportunities and integrate IdeaOne. We are also focused on managing our strong cash flows and leveraging investments to provide a solid return to our shareholders and increase overall shareholder value.

Now I’ll turn the call over to David Christensen, who will provide some additional detail on our financial results. Dave?

David Christensen

Thank you, John. Good morning. HickoryTech experienced a very good first quarter financially and strategically to start 2012. We had high levels of revenue and exceeded our expectations of operating income and net income.

We closed our IdeaOne acquisition earlier than we originally planned. We used $6 million of our accumulated cash reserves toward the IdeaOne $28 million acquisition cost, thus borrowing only $22 million, and as a result, minimized our ongoing interest cost and keeping our leverage ratio below 3 to 1. The addition of IdeaOne with its momentum gives us additional opportunities to enhance the success of our fiber and data business strategy.

First quarter 2012 revenue of $46.9 million was a 22% increase over last year’s first quarter. Our fiber and data segment revenues were $13.4 million and represented a 22% increase over last year, and equipment sales revenue of $17.4 million was up 67% over first quarter of 2011.

While the impressive star of the first quarter was the 87% increase in our equipment hardware sales revenue, we recognize that this can fluctuate from quarter to quarter and we have said the recurring services revenue, which is two-thirds of our revenue in the first quarter, is our sustainable value builder. 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 our industry and distinguishes us as a stable company. Services revenue of $31.6 million in the first quarter represented a 4% increase over last year and is indicative of the steady growth in which we pride ourselves. The growth is in spite of gradual systematic decline in our landline Telecom revenues.

First quarter 2012 operating income of $5.3 million was a 13% increase over last year’s first quarter. First quarter net income of $2.3 million was an 8% increase over last year. In the first quarter, our EBITDA, as defined in our credit agreement, was $11.5 million and represented an 11% increase over last year.

Cost of services and selling, general and administrative costs have low year-over-year increases of 4% and 2% respectively, despite the fact that these support costs and expenses have increased as we pursue our growth initiatives. We attribute this to our continued effort to improve efficiencies and to cost synergy among all our lines of business.

Our interest expense in the first quarter of $1.4 million was 28% higher than the $1.1 million from last year due to higher interest margins associated with our new credit agreement and higher outstanding balances. While the full quarter effect of carrying the higher IdeaOne-related debt occurs during the second quarter, the run rate level of interest expense for the rest of 2012 is likely to be approximately $1.5 million per quarter, a figure which is factored into our guidance. From a leverage standpoint, we are carrying a higher cash balance this year to mitigate our debt level and provide protection from any unstableness in the economy.

Now I have a few highlights from the individual business segments. First, our fiber and data segment operating results. My comments are from pre-elimination numbers found in the fiber and data segment recap of our earnings release.

Fiber and data segment revenue of $13.4 million increased 22% in the first quarter of 2012. We have two primary reasons for this, the first being the success we are having with sales to our commercial enterprise and wholesale customers from selling circuits on our transport routes, and this led to approximately $1.3 million of the $2.3 million revenue growth in this sector. The second reason is the one-month operations of the newly acquired IdeaOne, providing another $1.1 million of revenue.

Fiber and data had $2.3 million of operating income, a 58% increase over last year’s first quarter. As a percent of revenue, the operating margin, or the operating income divided by revenue, of 17.5% is an improvement over last year, primarily due to the success of IdeaOne and also due to our ongoing goal of moving more circuits onto our network and to reduce leased circuit expense.

Equipment segment revenue of $17.4 million increased 67% compared to the first quarter of 2011. A very active period including an 87% increase in hardware installation revenue led to the great quarter in this segment. Equipment segment generated $820,000 of operating income, a 65% increase over last year’s first quarter. As a percent of revenue, the operating margin of 4.7% is approximately the same as last year.

Now for Telecom segment operating results based on the pre-elimination numbers for the Telecom segment. Telecom revenue totaled $16.7 million in the first quarter and was down 6% compared to the revenues one year ago. Our ongoing decline in the legacy Telecom revenues was offset by growth in bill processing services from our information solutions subsidiary.

We had previously alluded to the fact that our past annual declines in network access revenue in Telecom from lower minutes and lines would increase in 2012 due to the effects of the FCC’s November 2011 order reforming inter-carrier compensation, which has various staggered implementation dates over the next few years. This outlook was accentuated by some additional negative influences, some of them one-time in nature.

Network access revenue declined $909,000, or 16%, year over year. Half of the decline was due to the normal forces of declining switched minutes of use and lines. Additionally, a reduction of $200,000 was attributable to an expiring interstate support fee, which was reimbursing us for our investments in infrastructure.

We also experienced a one-time refund payment of an interstate support fee of $152,000. The balance of the decline is attributable to other impacts of the new access compensation system under the reform doctrine. There may be a repeat of all except the $152,000 interstate support fee refund in the future quarters of 2012.

Telecom costs and expenses decreased 2% for the quarter, a higher rate of decrease than last year due to reductions in expense to serve an external communications provider and less corporate cost in this segment. Telecom operating income of $2.2 million produced an operating margin of 13.1% in 2012 compared to 16.3% operating margin last year. This is seasonally low and we expect a margin closer to 14% the rest of this year.

Telecom CapEx of $1.6 million is down 17% from the $1.9 million of CapEx in the Telecom sector last year for the same quarter. We are trying to manage the net cash flow of all of our segments, particularly in Telecom.

Current maturities and the long-term debt classification of debt on our balance sheet totaled $141.9 million as of March 31, 2012. This represented a $21.7 million increase from the $120.2 million last quarter. The increase is made up of the $22 million we borrowed for the $28 million purchase of IdeaOne, offset by $300,000 of normal quarterly amortization payment.

We continued our plan of holding a higher level of cash on hand. Cash totaled $20.7 million as of March 31, 2012, and represented a $7 million increase from the previous quarter. Net debt, a measure of actual balance sheet strength that subtracts the cash balance from total debt, was $121.2 million as of March 31, 2012, and represented only a $14 million increase in net debt from three months ago.

The fact that our net debt position went up only $14 million is notable as we used $28 million of cash in debt in closing the IdeaOne acquisition. The low increase in net debt is a real tribute to the excellent free cash flow of our business. It is also assisted by the fact that winter is not our active construction season.

As of March 31, 2012 when IdeaOne is given a full year’s effect in our historical calculations, our debt to EBITDA ratio is approximately 2.9 to 1 as defined in our senior credit agreement using trailing twelve-month data. This leverage ratio is very favorable, both in relation to our credit agreement limits and in relation to peers in our industry. Our senior debt agreement currently has a maximum leverage ratio limit of 3.5 to 1. We feel we are conservatively leveraged.

Further details of our overall debt financing are contained in the SEC form 10-Q, which will be filed later on today. Our fiscal 2012 guidance is unchanged and is provided in detail in our press release and on the presentation accompanying this call. Please note that the fiscal guidance includes IdeaOne for the ten months starting March 1 of this year.

In conclusion, I would say first quarter 2012 was successful financially, surpassing our financial targets. It was successful strategically because we closed on IdeaOne and because they contributed profitably. And the quarter was successful tactically because we pooled a healthy reserve of cash to keep our net debt position relatively low. More details of our financial results are available on our quarterly Form 10-Q, again, which is going out later this afternoon.

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

John Finke

Thank you, Dave. We are very pleased with our first quarter results and the strong start to the year. The growth lines of our business are more than offsetting the gradual declines in our Telecom business, which has been the driver of our diversification efforts over the past several years.

The IdeaOne acquisition added a robust metro fiber network in Fargo, North Dakota and further diversified our company, as well as provided additional growth opportunities. We are investing in long-term strategic initiatives while maintaining strong cash flows and a solid balance sheet. We remain confident in our business plan and are delivering results on our strategic initiatives.

We committed to growing HickoryTech, both organically and through acquisition, as we execute a disciplined strategy to diversify our company and increase shareholder value. Our strategic plan is focused on growing our business and broadband services. Key to this expansion is leveraging our assets, specifically our expanded regional fiber network, which now encompasses more than 3,200 fiber route miles.

HickoryTech remains in a very good financial position to grow and increase shareholder value. We have a strong balance sheet, a high level of recurring services revenue, growth trends in key strategic product lines, 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’d be happy to take any questions. Lindsay, you may initiate them now.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Justin Ruiss with Sidoti.

John Finke

Good morning, Justin.

Justin Ruiss – Sidoti

Good morning. Congratulations.

John Finke

Thank you.

Justin Ruiss – Sidoti

I just had a quick question on the IdeaOne rollout. Are you adding more to the sales team up there?

John Finke

Actually, we have. We did add one position to the sales team up there. It was in progress, really, at the time of the acquisition, but we went ahead and followed through with that and added to that. Looking to expand not only in the Fargo area, but also as we complete our broadband stimulus fiber builds, looking at how we might be able to utilize that in the northwestern part of the state, as well.

Justin Ruiss – Sidoti

Is there anything on the map at this point? Have you been shopping around or anything you’re looking at, or --?

John Finke

Yes, that is certainly something that, since we announced the broadband stimulus routes here probably a year and a half ago, we have been targeting specific customers, mainly focused on the government agencies, focused on education and healthcare, so they’re looking more at some specific verticals rather than specific customers.

Justin Ruiss – Sidoti

Got you. Well, that answers my question. Thank you very much.

John Finke

Alright, thank you.

Operator

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

John Finke

Thank you, Lindsay. If you joined us after the call began today or would like a replay of the call, please visit our Web site at hickorytech.com. The telephone replay of this call will be available beginning at noon today.

Thank you again for joining us today and we look forward to our next call. If you have any further questions, I’d invite you to give Jennifer, David, or myself a call at any time. Thanks again.

Operator

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

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