HickoryTech Corporation (HTCO) Q2 2012 Earnings Call August 2, 2012 10:00 AM ET
John Finke – President and CEO
David Christensen – SVP and CFO
Jennifer Spaude – Director, IR
[No Q&A session]
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 Second Quarter 2012 Earnings Conference Call. (Operator Instructions)
Thank you. Jennifer Spaude, Director of Investor Relations and Marketing, you may begin.
Good morning and thank you for joining HickoryTech’s second quarter 2012 earnings 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 website 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 our Form 8-K reports.
Our presentation also contains certain non-GAAP financial measures. Reconciliations 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 and is also being recorded for playback purposes. The audio will be archived on our Investor Relations website for the next 30 days. Following management’s discussion today, we will open the call to a Q&A session.
At this time, I’d like to turn the call over to John Finke.
Thank you, Jennifer, and good morning everyone. We appreciate you joining us today as we discuss HickoryTech’s results for the second quarter 2012. I’ll start with an overview of our results and then David will provide a detailed review of our financials.
Year to date we are on plan and on track to achieve our 2012 objectives. Our business fiber and data services continues to deliver solid growth, offsetting revenue declines in our legacy telecom services. On a consolidated basis, overall revenue grew 9% as we reported $43.9 million of revenue in the second quarter.
Fiber and data service revenue grew 37% from one year ago, although the declines in our telecom segment were steeper than we anticipated in the second quarter. Our business segments delivered solid growth and this is the driving force to define our diversification strategy and our continued emphasis on growing business services.
Consolidated operating income totaled $4.5 million, down 10% year over year and net income totaled $1.8 million, down 33% for the same period. Second quarter lower earnings are attributed primarily to a large decline in the telecom segment, specifically in network access and local service revenue, and an increase in depreciation and interest expense associated with the acquisition of IdeaOne.
EBITDA was $11.2 million, an increase of 5% from one year ago. Overall growth in the fiber and data segment contributed to that increase in EBITDA and despite a decline in telecom profitability, telecom segment still produces solid free cash flow.
Now turning to the fiber and data segment, fiber and data revenue increased 37% to $15.4 million in the second quarter, reflecting a full quarter of IdeaOne operations. Excluding IdeaOne operations, we delivered organic growth of 9% in the fiber and data segment, attributed (ph) to the success we continue to experience in the commercial enterprise and wholesale customer segment. Specifically we are gaining market share in our commercial customer segment within our core Minnesota market as well as West Des Moines, Iowa.
Demand for bigger bandwidth and high capacity data network connections is driving revenue in Ethernet, dedicated internet and transport services. We are on track to complete the integration of IdeaOne by year end. As a reminder, we closed on the IdeaOne acquisition on March 1 of this year. The financial systems were converted in July and the billing system conversions will be complete later this year.
We continue to see synergies and expect the acquisition to be accretive on a free cash flow basis. We are leveraging the Fargo metro fiber network which directly connects our regional fiber network. The Fargo market is already delivering value as we secure new business based on our expanded footprint. We recently secured a long term contract to provide fiber connections to 33 towers in Northwest Minnesota and in the Fargo area.
We are focused on growing our commercial and enterprise fiber and data services as we leverage our full suite of communication solutions. We are targeting opportunities to extend fiber directly to our customers and increase our penetration in markets where we already have a network presence.
Our greater Minnesota broadband collaborative project is on schedule. We recently completed construction of the first base, a 184 mile fiber build from Minneapolis, St. Paul to Duluth and Superior, Wisconsin. We are currently testing and finalizing the turn-off of the long-haul segment.
The second phase of this project is a fiber build from Brainerd, Minnesota to Moorhead, Minnesota and Fargo, North Dakota. Construction along this route is underway and the entire project which will add 430 fiber route mile to our network is scheduled to be complete in August of 2013.
The equipment segment revenue totaled $12.9 million, up 10% year over year. We have a strong backlog of equipment orders following Cisco’s fiscal year end in July when sales activity is quite high. In addition to hardware sales, we worked to increase the level of professional services, which is a (indiscernible) in this segment as we target recurring higher margin revenue. While services revenue was down 22% in the second quarter, professional services are tied to the current equipment backlog. So we anticipate solid results in this area during the remainder of the year.
There is a solid demand for data center infrastructure. Services, storage, virtualization were the driver of hardware sales and professional services. Recently Enventis achieved the Cisco designated Cloud Builder designation which demonstrates our ability to sell and implement Cisco end to end cloud solution and have a forma cloud professional services practice.
As a Gold Masters Unified Communications Cisco Partner, we are recognized – we were recognized this year as data center partner of the year in the central region. We are proud to add these recent certifications to our credentials and that will further differentiate our company within the company we serve.
Our equipment business is on track with a solid backlog of orders and a good deal of potential in the pipeline. Looking specifically at our business product lines, we believe overall and over the long term we will continue to deliver excellent results towards meeting our strategic objectives.
Now turning to our telecom segment, second quarter revenue totaled $16.3 million, down 8% from one year ago. Telecom results reflect a greater decline in network access revenue and continued decline in local service revenue, partially offset by increases in bill processing revenue from our suite solution, billing and customer management solution sold to other communication service providers.
Network access revenue was down 18% in the second quarter and 16% in the first quarter, reflecting greater than anticipated decline year to date as a result of expiration of interstate infrastructure to support reimbursement, the cancellation of conferencing company contract due to traffic demolition provision in the FCC order released in November of 2011, the initial impact of industry wide access reform regulation and the continued access line and minute of use erosion. David will provide some additional details on access revenue decline during his financial analysis.
Local service revenue was down 7%, reflecting the continued trend of access line losses and broadband services revenue was down 2% compared to one year ago due to increased competitive pressures in our market. We recently launched new consumer bundles which we believe are highly competitive and offer to both new and existing customers an excellent value to maintain services or to future (indiscernible).
The new plans feature simple discounts which are highly customizable and offer deeper discount for one or two year agreement. In addition, a multi-service two-year term customer can take free services such as DVR, high definition, free long distance or movie. The new bundles were launched in July and refund to date has been very positive.
Given our telecom markets are mature, we remain very focused on developing programs to ensure customer retention and targeted consumer promotions to build loyalty. We are leading with our differentiators, our top-notch local customer support and our strong connections to the communities we serve.
We recently introduced a new marketing them, we process, local, committed, to highlight our position as a local service provider. Telecom expenses were down 5% in the second quarter as we worked to moderate our spending in the segment. Despite anticipated decline in revenue and profitability, the telecom segment provides steady, consistent cash flows for our company.
Now I would like to turn the call over to David Christensen who will provide more details on our second quarter financial results. David?
Thank you, John. Consolidated second quarter revenue was $43.9 million, a 9% increase over last year. As part of this, we had $10.7 million of equipment sales, that is the revenues from non-recurring transactions. Equipment sales often experience high and low quarters.
While our second quarter equipment sales were good, all these are our last four quarters of equipment revenue as a comparison. Last year’s third quarter equipment sales was $14.3 million of revenue. Last year’s fourth quarter was $8.3 million. Our first quarter this year was $15.3 million and our most recent quarter it’s $10.7 million. You can see how swings in equipment sales from the high of $15.3 million to the low of $8.3 million can make our total revenue picture vary quite a bit.
Growth in our fiber and data segment is the main driver of our 9% overall second quarter revenue increase. We experienced a 9% organic growth in fiber and data revenue for the quarter before the effects of the newly acquired IdeaOne. This organic growth number was 10% for the six months year to date. This segment’s interexchange carriers with wholesale transport or back-haul network, it serves enterprise businesses, municipal and government agencies and schools with the same point to point transport and Ethernet services and it serves small, medium businesses with all their voice, data and internet needs. This is where we record revenue for fiber to the tower, our transport and our last mile fiber based network services to business customers as a CLEC.
The 10% six month revenue growth is net of any customer price reductions as they migrate from our traditional TDM network to more IP-based network connections, allowing them to experience price economies. When this organic growth is combined with the full quarter’s revenue impact from IdeaOne, it gives us the combined 37% revenue growth in this segment for the quarter and 29% revenue growth for the six months year to date.
Our telecom segment revenue was down 8% in the second quarter and year to date this decrease was 7%. Network access revenue declined 18% for the quarter and 17% year to date. We have experienced diminishing access lines and minutes of use on our network for many years, as well as a reduction of the rates we are allowed to charge for network access, as many telephone companies have. That has led to the gradual network access revenue decline.
For the past three years, these declines were between 3% and 7% annually. This year we are feeling the impact of access reform in addition to the historic decline. To name a few of the effects, some of our historic interstate support mechanisms expired. For example, the safety net additive is gone which previously rewarded companies for making investments in the network. This type of support expired and caused $300,000 of erosion of our revenues thus far in network access.
Also, new interstate access rules reduced our average schedule settlements. Altogether our support payments including the safety net additive were down $161,000 in the second quarter and $511,000 year to date over last year. We canceled service to a conference call service provider due to the new access rule, further reducing the minutes of use and local access lines.
We’ve seen interchange carriers report more of their users on the interstate side where rates are lower than on the state side where rates are higher, as kind of jurisdictional arbitrage. In the second half of the year, additional access rate declines are set to go and deplete. And that will begin to reduce the difference between interstate and the fed rates providing less expenses for interchange carriers to report minutes in another jurisdiction merely to reduce their costs.
Fortunately, there are some positive aspects of the new access rules also going into place in the second half of the year. For instance, the new carrier access fund, which we expect to stabilize the revenue decline and make it more predictable over the long run.
Telecom local service declines which are down 7% over the prior year is related to the nation-wide trend coming to all wireline telephone companies, the challenge of holding wireline customers on our reliable network. The pace of decline we are experiencing in 2012 is a little higher than we have seen in the past couple of years. This pace is exaggerated by the one-time loss of business lines we experienced when we canceled service to a conference call service provider and also we experienced more local service charge in this past six months, including some broadband turnover. As John said, we are rolling out new service bundles to improve our retention of local and broadband services.
Now I have been speaking about the facts and trends involving our second quarter. I would like to comment now on our focus for each of the business segment. In our fiber and data segment, we continue to invest in this which is our growth business. Its operating expenses and production capabilities have grown as evidenced by a 40% increase in cost for the quarter and 28% increase year to date. Growth rates which are roughly in line with the revenue increases and driven in part by the acquisition of IdeaOne.
We have continued to invest in the Fargo market as we see additional opportunities to expand in this area. We’ve also added sales and sales engineering resources to support and continue our growth pattern in the fiber and data segment. We spent $3.6 million in capital expenditures for the quarter and $5.6 million in CapEx year to date levels that are 49% and 32% higher than last year for the quarter and the year to date respectively.
Our reaction in the equipment segment which has experienced 37% growth in the first half of 2012 is not different than we always approach this business. Our equipment business has an exceptional reputation in our market. We have a very robust backlog and we feel very good about the future in this business line.
We can understand the peaks and plateaus this line of business can pose financially from quarter to quarter and focus more on the fiscal year for them. Our response in the telecom segment is consistent with our historic reaction. We’ve experienced 5% reduction in operating costs in the second quarter and 4% reductions in costs year to date. We spent 5% less on capital expenditures for the telecom segment for the quarter and 10% less year to date. As John said, we are very aware and are focusing on maintaining healthy operating cash flow from this important legacy business.
Our overall 10% decline in operating income as a company this quarter has many contributing causes, including declines in the telecom business and cyclical decline in the equipment business. The fact that our EBITDA of $11.2 million is 5% higher than last year yet operating income is lower points to depreciation as another cause. We have the new depreciations for IdeaOne’s network which was valued at fair value from our $28 million acquisition, and we have the ongoing organic influence on depreciation from our multi-year network expansion and CapEx.
Our interest expense in the second quarter was $1.5 million and is almost $500,000 higher than last year at this time. The increase is the combined effect of an extra $22 million borrowed for the IdeaOne acquisition and higher interest rate margins paid to banks as a result of our refinancing last August.
Even at a $1.5 million quarterly interest cost, we have an effective interest cost of approximately 4.2% on an annualized basis this year compared with 4.1% for 2011. Our debt to EBITDA leverage is less than 3 to 1 and in full compliance with our debt agreement. We are in a debt facility which has a term lasting through 2016 and we are fortunate that it’s such a great source of capital.
Current maturities and long term debt as classified on our balance sheet totaled $141.5 million as of June 30, 2012. This is similar to last quarter and represented a $21.3 million increase from the $120.2 million level at the beginning of 2012. This increase is made up of the funds borrowed for the purchase of IdeaOne.
We continue our plan of holding a higher level of cash on hand. Cash and short term investments totaled $17.4 million as of June 30, 2012, higher than the $13 million on hand at the beginning of the year. Cash is either in commissional (ph) base counts or is in treasury bills and is classified as short term investments on the balance sheet.
Further details of our quarter are contained in the SEC Form 10-Q which will be filed later today. We will continue to focus on the perspective of our six months year to date results rather than merely focussing on a single quarter. But an even better perspective is a full year activity. A complete perspective is gained when you have multiple years of operating performance as a chance to see several business cycles back to back. We are on plan and on track to achieve our business plan objectives. We have not changed the basic revenue, net income and EBITDA guidance for the full year. And we remain committed to the building shareholder value prospects of our business plan and focus on the long run.
Our fiscal 2012 guidance has only minor changes to forecasted year end debt and CapEx levels and is provided in detail in our press release and on the presentation accompanying this call. Please note fiscal guidance includes IdeaOne for the 10 months starting March 1 of this year.
I will end by saying our six months year to date 2012 has been a success financially and is in line with our financial targets. First half 2012 has been successful strategically because we closed on IdeaOne. They are contributing profitably and we are rapidly integrating them into our fiber and data segment.
With that, I would like to turn it back over to John.
Thank you David. In closing, we are on track to meet our 2012 objectives and fiscal guidance. In the second quarter, we grew overall revenue 9% and increased EBITDA 5%. We recorded very strong revenue growth in our fiber and data segment of 37%. We remain focused on growing our business services and leveraging the strong fiber and data growth trends as business customers transition to next generation data services.
Our telecom operations decreased a greater level of decline in legacy services. However we do not anticipate network access decline to accelerate from the previous two quarters. Despite the declines in income and earnings, our growth business has strong momentum and our equipment business has strong backlog.
We are on track to complete the integration of IdeaOne by year end and we will see additional synergies as we combine this business with our overall operation. We are investing in long term strategic initiatives as we execute a disciplined strategy to diversify our company and increase shareholder value. We are confident in our business plans and our ability to deliver results as we enter the second half of the year.
HickoryTech remains in very good financial position to grow and increase shareholder value. We have a strong balance sheet, growth trends in key strategic product lines, a very high level of recurring services revenue, a healthy dividend with approximate 5% yield, 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.
(Operator Instructions) At this time there are no questions. I would now like to turn the call over to John Finke for any closing remarks.
Thank you, Lindsay. If you joined us after the call began or would like a replay of the call, please visit our website at hickorytech.com. The telephone replay of this call will be available beginning at noon today.
Thank you again for joining us on the call today. We look forward to our next call. And if you have any questions, I’d invite you to give Jennifer, David, or myself a call at any time. Thanks again.
This concludes today’s conference call. You may now disconnect.
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