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HTCO > SEC Filings for HTCO > Form 10-Q/A on 9-Nov-2012All Recent SEC Filings

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Form 10-Q/A for HICKORY TECH CORP


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

The Private Securities Litigation Reform Act of 1995 contains certain safe harbor provisions regarding forward-looking statements. This Quarterly Report on Form 10-Q/A may include forward-looking statements. These statements may include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities and growth rates, acquisition and divestiture opportunities, business strategies, business and competitive outlook, and other similar forecasts and statements of expectation. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," "targets," "projects," "will," "may," "continues," and "should," and variations of these words and similar expressions, are intended to identify these forward-looking statements. Such forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from such statements. Factors that might cause such a difference include, but are not limited to, those contained in Item 1A of Part II, "Risk Factors" of this quarterly report on Form 10-Q/A and Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2011 which is incorporated herein by reference.

Because of these risks, uncertainties, and assumptions and the fact that any forward-looking statements made by us and our management are based on estimates, projections, beliefs, and assumptions of management, they are not guarantees of future performance and you should not place undue reliance on them. In addition, forward-looking statements speak only as of the date they are made. With the exception of the requirements set forth in the federal securities laws or the rules and regulations of the Securities and Exchange Commission, we do not undertake any obligations to update any forward-looking information, whether as a result of new information, future events or otherwise.

Critical Accounting Policies

The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. A description of the accounting policies that we consider particularly important for the portrayal of our results of operations and financial position, and which may require a higher level of judgment by our management, is contained under the caption, "Critical Accounting Policies," in the Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011 and Amendment No. 1 on Form 10-K/A.

Acquisition/Business Combinations
We utilize the acquisition accounting method for acquisitions/business combinations requiring us to recognize assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at fair value on the acquisition date. Acquisition costs are expensed as incurred.

Financial Derivative Instruments

We enter into fixed interest rate swap agreements (financial derivative instruments) to manage exposure to interest rate fluctuations on a portion of our variable-interest rate debt. Our interest rate swaps increase or decrease the amount of cash paid for interest depending on the increase or decrease of interest required on our variable rate debt.

We account for our financial derivative instruments in accordance with ASC 815, "Derivatives and Hedging." ASC 815 requires that all derivative instruments be recorded on the balance sheet as either an asset or a liability measured at its fair value, and that changes in the derivatives' fair value be recognized in earnings unless specific hedge accounting criteria are met. The fair value estimate of our interest rate swaps represent the net present value of future cash flows based on projections of the three month LIBOR rate over the life of each swap. Our financial derivative instruments are not designated as hedges and therefore are not accounted for using hedge accounting. The difference between interest paid and interest received, which may change as market interest rates change, is accrued and recognized as a component of interest expense.

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Results of Operations

We conduct our operations in three business segments: (i) Fiber and Data, (ii) Equipment and (iii) Telecom.

Our Fiber and Data Segment serves wholesale, enterprise and small-to-medium business customers with high-speed communications products supported by our extensive statewide fiber network and community access rings. With our experience and communication expertise we are able to provide standard and customized network solutions which can be extended beyond our network to provide end-to-end national connectivity. The Fiber and Data segment also includes revenue from our SingleLink services and voice, data and Internet services sold to SMB business customers in several metropolitan markets.

Our Equipment Segment provides equipment solutions and support for a broad spectrum of business customers. Our equipment solutions team plans, designs and implements networks utilizing emerging technological advancements including TelePresence Video, Unified Communications and data center solutions. We provide a complete array of products and services to support the Cisco equipment sold to business customers including professional services, maintenance, total care support and security. Professional services include network assessments, planning, design, implementation and training. Our total care support team provides a single-point-of-contact for the support of applications, systems and infrastructure. We also offer security solutions combining leading network security products with our experience and expertise in integrated communications systems.

Our Telecom Segment provides bundled residential and business services including high-speed Internet, broadband services, digital TV, local voice and long distance services in our legacy telecom service area. Telecom is comprised of two markets. The first includes an incumbent local exchange carrier ("ILEC") operating in 13 south central Minnesota communities and 13 rural northwest Iowa communities. The second market is a competitive local exchange carrier ("CLEC") operation. We own our network in both the ILEC and CLEC communities. The Telecom Segment, through National Independent Billing, Inc., also provides data processing and related billing services to HickoryTech and external communication providers including wireline, wireless and entertainment providers.

Executive Summary

Total consolidated revenue of $46.9 million during the first quarter of 2012 represents an increase of 22% over the first quarter of 2011. Net income of $2.3 million, or $0.17 per diluted share, compares to net income of $2.3 million, or $0.18 per diluted share, earned during the same period in 2011.

Our Fiber and Data Segment posted revenue of $13.4 million in the first quarter of 2012, an increase of $2.4 million or 22% compared to 2011. Organic business revenue grew by $1.3 million with the balance attributable to one month of results from our IdeaOne Telecom acquisition which closed on March 1, 2012. Our Equipment Segment had a high of $17.4 million of revenue in the first quarter of 2012, a $7.0 million increase from the first quarter of 2011 driven by advanced unified communication and data center equipment sales.

Revenue from our Telecom Segment declined by $1,035,000, or 6%, reflecting a decline in legacy voice and switched access services. Network access services revenue fell by $909,000 or 16%, reflecting the continued decline in these services as well as the additional impact of certain provisions of FCC order 11-161, released in November 2011. Intense competition and price compression impacted broadband services revenue, which was 1% lower in the first quarter of 2012 compared to 2011. While we cannot predict the ultimate impact of the new FCC order, we anticipate that the new requirements could increase the level of decline in our legacy services. This decline, combined with an intense competitive environment, provides challenges for our Telecom Segment revenue streams. Offsetting a portion of the revenue decline within the Telecom Segment was a $468,000 or 64% increase in bill processing revenue resulting from the growth in our external customer base utilizing our billing and customer management software system SuiteSolution®.

Total costs and expenses increased by 23% in the first quarter of 2012 compared to 2011, reflecting higher sales volumes in our Equipment Segment combined with continued investment in growing our Fiber and Data Segment. Depreciation increased 8% driven by our acquisition of IdeaOne Telecom and higher levels of capital spending totaling $22.9 million in 2010 and $21.4 million in 2011. We have made significant investments in our network during the last two years expanding our fiber footprint and increasing capacity in strategic locations. These investments, which increase costs in advance of generating revenue, provide the groundwork for continued growth in our Fiber and Data Segment.

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We completed our IdeaOne Telecom acquisition on March 1, 2012, utilizing a $22 million expansion of our senior credit facility. This raised our debt obligation (short and long-term) from $120.2 million at December 31, 2011 to $141.9 million at March 31, 2012. We have maintained a leverage ratio of approximately 2.9 times debt to EBITDA as defined in our credit agreement, well within acceptable limits for our agreement and our industry. Interest expense in the first quarter of 2012 was $682,000 or 94% higher than the same period in 2011 as a result of higher interest rates associated with our new credit facility and increased debt levels. Of the increase in interest expense the change in the fair value of our interest rate swap agreements increased 2012 interest expense by $47,000 while decreasing 2011 interest expense by $339,000.

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Fiber and Data Segment
The following table provides a breakdown of the Fiber and Data Segment operating
results.

                                               Fiber and Data

                                                                 Three Months Ended March 31            %
(Dollars in thousands)                                            2012                 2011          Change
Operating revenue before intersegment eliminations:
  Services                                                   $       13,219       $       10,861          22 %
  Intersegment                                                          193                  161          20 %
Total operating revenue                                      $       13,412       $       11,022          22 %

Cost of services (excluding depreciation and amortization)            6,595                5,821          13 %
Selling, general and administrative expenses                          2,506                2,130          18 %
Depreciation and amortization                                         1,966                1,586          24 %
  Total costs and expenses                                           11,067                9,537          16 %

Operating income                                             $        2,345       $        1,485          58 %
Net income                                                   $        1,395       $          883          58 %

Capital expenditures                                         $        1,965       $        1,806           9 %

Revenue

Fiber and Data. We serve wholesale, enterprise and small-to-medium business customers with high-speed communications products delivered through our extensive regional fiber network and community access rings supported by a 24x7x365 network operations center. This revenue stream is generally based on multi-year contracts with retail businesses, regional and national service providers and wireless carriers, building a solid monthly recurring revenue base.

Fiber and Data services revenue increased $2,390,000 or 22% in the first quarter of 2012 compared to the same period in 2011. Organic growth in the first quarter was $1,315,000 or 12%, led by revenue from data services such as Ethernet, Multi-Protocol Label Switching ("MPLS"), Internet, data center services and VoIP and dynamic services. Our acquisition of IdeaOne Telecom, a metro fiber network provider serving Fargo, ND, was completed on March 1 and contributed $1,075,000 to revenue in the first quarter of 2012.

The IdeaOne acquisition advances our strategy of growing our business and broadband services, as approximately 85% of IdeaOne revenue comes from business services. In 2010, we extended our fiber network to Fargo, ND and will further accentuate the capabilities and services we have in this market when we complete our Broadband stimulus route from Brainerd, MN to Fargo, ND in 2012. The IdeaOne acquisition adds 225 fiber route miles to our regional network, extending to 650 on-net fiber-lit buildings within the Fargo market.

Total Cost and Expenses

IdeaOne Telecom's operating results are reflected in our financial results of this Segment beginning on March 1, 2012. The primary drivers of expense variances are noted below with the balance of the increases resulting from including this new entity, which is reported within the Fiber and Data Segment.

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Cost of Services (excluding Depreciation and Amortization)

Fiber and Data Segment cost of services increased by $774,000 or 13% in the first quarter of 2012 as compared to the same period in 2011. The primary drivers of the increase in cost of services were a $145,000 increase in volume-driven circuit costs supporting increased revenue and a $125,000 increase in wages and benefits supporting the organic growth in Fiber and Data services.

Selling, General and Administrative Expenses

Fiber and Data Segment selling, general and administrative expenses increased $376,000 or 18% in the first quarter of 2012 as compared to the same period in 2011 primarily due to a $139,000 increase in corporate overhead costs and a $110,000 increase in wages and benefits.

Depreciation and Amortization

Fiber and Data Segment depreciation and amortization increased by $380,000 or 24% in the first quarter of 2012 as compared to the same period in 2011. This increase was primarily due to our IdeaOne Telecom acquisition which added $283,000 of depreciation and amortization to the first quarter and the investments made in our fiber and broadband network during the past several years. Amortization expense remained constant except for the addition of IdeaOne Telecom intangible assets.

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Equipment Segment
The following table provides a breakdown of the Equipment Segment operating
results.

                                                 Equipment

                                                                 Three Months Ended March 31            %
(Dollars in thousands)                                            2012                 2011          Change
Operating revenue before intersegment eliminations:
  Equipment                                                  $       15,299       $        8,195          87 %
  Services                                                            2,122                2,229          -5 %
Total operating revenue                                      $       17,421       $       10,424          67 %

Cost of sales (excluding depreciation and amortization)              13,466                6,999          92 %
Cost of services (excluding depreciation and amortization)            1,712                1,678           2 %
Selling, general and administrative expenses                          1,352                1,181          14 %
Depreciation and amortization                                            71                   68           4 %
  Total costs and expenses                                           16,601                9,926          67 %

Operating income                                             $          820       $          498          65 %
Net income                                                   $          486       $          295          65 %

Capital expenditures                                         $           73       $            6        1117 %

Revenue

Equipment. We are a Master Unified Communications and Gold Certified Cisco partner providing Cisco equipment solutions and support for a broad spectrum of business clients. Our equipment solutions team plans, designs and implements networks utilizing emerging technological advancements including TelePresence Video, Unified Communications and data center solutions. Equipment sales are non-recurring in nature, making this revenue dependent upon new sales to existing and new customers, which makes it susceptible to fluctuations on a quarter to quarter basis based on customer contracts and project completion.

Equipment revenue was $15,299,000, an increase of $7,104,000 or 87% in the first quarter of 2012 compared to the same period in 2011, and $6,982,000 higher than our fourth quarter 2011 equipment revenue. In the first quarter we experienced strong sales of advanced unified communication and data center equipment and also had success selling new technology advanced products including converged infrastructure solutions which enable our customers to rapidly deploy cloud computing applications.

Equipment Services. Services include network assessments, planning, design, implementation, and training. Maintenance contracts ("Smartnet" contracts) are offered in collaboration with Cisco systems. Our total care support team provides a single-point-of-contact for the support of applications, systems and infrastructure. We also offer security solutions combining leading network security products with our experience and expertise in integrated communications systems.

Services revenue declined by $107,000 or 5% in the first quarter of 2012 compared to the same period in 2011, primarily due a decline of $169,000 in contract services revenue which includes the design, configuration and installation of voice and data equipment. In late 2010, we implemented a new approach to our network and equipment monitoring services in an attempt to grow recurring revenue streams in the Equipment Segment. In the first quarter of 2012, we realized a year-over-year growth rate of 29% in this area, partially offsetting the decline in contract services.

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Cost of Sales

Equipment Segment cost of sales is composed primarily of equipment material costs. Higher equipment sales volume in the first quarter of 2012 as compared to the same period in 2011 drove the $6,467,000 or 92% increase in cost of sales. Labor associated with installation of the equipment is included in cost of services (excluding depreciation and amortization) described below.

Cost of Services (excluding Depreciation and Amortization)

Equipment Segment cost of services increased by $34,000 or 2% in the first quarter of 2012 as compared to the same period in 2011 due to an increase of $171,000 in wages and benefit costs, partly offset by a $76,000 reduction in contract labor resources.

Selling, General and Administrative Expenses

Equipment Segment selling, general and administrative expenses increased $171,000 or 14% in the first quarter of 2012 as compared to the same period in 2011 primarily due to a $103,000 increase in corporate overhead costs and a $83,000 increase in wages and benefits.

Depreciation and Amortization

Equipment Segment depreciation and amortization increased by $3,000 or 4% in the first quarter of 2012 as compared to the same period in 2011.

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Telecom Segment

The following table provides a breakdown of the Telecom Segment operating
results.

                                                   Telecom

                                                                 Three Months Ended March 31            %
(Dollars in thousands)                                            2012                 2011           Change
Operating revenue before intersegment eliminations:
  Local Service                                              $        3,429       $        3,693           -7 %
  Network Access                                                      4,903                5,812          -16 %
  Broadband                                                           5,002                5,054           -1 %
  Directory                                                             782                  872          -10 %
  Long Distance                                                         648                  729          -11 %
  Bill Processing                                                     1,205                  737           64 %
  Intersegment                                                          410                  412            0 %
  Other                                                                 335                  440          -24 %
Total Telecom operating revenue                              $       16,714       $       17,749           -6 %

Total Telecom revenue before intersegment eliminations
  Unaffiliated customers                                     $       16,304       $       17,337
  Intersegment                                                          410                  412
                                                                     16,714               17,749

Cost of services (excluding depreciation and amortization)            7,561                7,761           -3 %
Selling, general and administrative expenses                          2,833                3,084           -8 %
Depreciation and amortization                                         4,133                4,003            3 %
  Total Telecom costs and expenses                                   14,527               14,848           -2 %

Operating Income                                             $        2,187       $        2,901          -25 %

Net income                                                   $        1,299       $        1,716          -24 %

Capital expenditures                                         $        1,596       $        1,930          -17 %

Key metrics
  Business access lines                                              21,954               23,932           -8 %
  Residential access lines                                           23,679               26,678          -11 %
Total access lines                                                   45,633               50,610          -10 %
Long distance customers                                              31,498               33,513           -6 %
Digital Subscriber Line customers                                    19,451               20,032           -3 %
Digital TV customers                                                 10,247               10,591           -3 %

Revenue

Local Service. We receive monthly recurring revenue from end-user customers primarily for providing local telephone services, enhanced calling features, miscellaneous local services and reciprocal compensation from wireless carriers.

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Local service revenue declined by $264,000 or 7% in the first quarter of 2012 as compared to the same period in 2011 with the largest declines experienced in residential access and feature revenue. Total access lines as of March 31, 2012 were 45,633, down 4,977 subscribers or 10% from March 31, 2011. The Telecom Segment's access lines declined at a higher rate than we have experienced in recent years. Some of our own business customers' are replacing traditional wire-line services with our VoIP services, primarily our Enventis Hosted VoIP Solution, Singlelink which is recorded within the Fiber and Data Segment. Also contributing to the decline in our business lines was the modification of a contract with an external communications provider as required by traffic stimulation provisions in FCC order 11-161.

Voice service revenue will continue to be adversely impacted by the decline in access lines due to intense competition, changes within the regulatory environment and continued technological advances providing alternative communications offerings for our customers. In an effort to manage the decline we emphasize our service bundles, which include local phone service and long distance as well as a variety of features and broadband options including: DSL, high-speed internet and digital TV.

Network Access. We receive a variety of fees and settlements to compensate us for the origination, transport, and termination of calls and traffic on our network. These include the fees assessed to interexchange carriers, subscriber line charges imposed on end-users, and settlements from nationally administered and jointly funded revenue pools.

Network access revenue declined by $909,000 or 16% in the first quarter of 2012 as compared to the same period in 2011. Declining switched minutes-of-use from access lines and carriers and lower end-user fees accounted for $443,000 of the first quarter decline. In the first quarter of 2012 we also experienced a one-time reduction of support totaling $152,000 from the National Exchange Carrier Association ("NECA"). At December 31, 2011 a type of USAC support reimbursing us for significant investments made in our infrastructure expired lowering year-over-year revenue by approximately $200,000. We believe the loss of this support mechanism combined with the business customer loss noted below will increase the percentage decline we will realize in this revenue stream in 2012.

In November 2011, the FCC released order 11-161, which contains comprehensive rules reforming all forms of intercarrier compensation and implements a new support mechanism for the deployment of broadband. Generally, the intercarrier compensation reform sets forth a path toward a "Bill & Keep" method where there is no compensation for termination of traffic received from another carrier. The timeline for this transition has numerous steps depending on the type of traffic exchanged and the regulated status of the affected local exchange carrier. We anticipate that these changes will increase the rate of decline in access revenue that we have experienced in prior years and are reflecting these declines in our 2012 and long-term plans.

We felt the first impact of the order in January of 2012, when we modified a contract with an external communications provider due to traffic stimulation provisions in the order. This drove our business line loss percentage to top 8% in the first quarter of 2012, up from loss rates of 3% to 4% in 2011 and 2010, respectively. We will experience additional line loss in the second quarter of 2012 due to this contract termination and then anticipate 2012 business line loss rates to return to levels realized in the past.

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