**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 

**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thefiscal year ended December 31, 2004**

 

**CommissionFile Number:  0-13721**

 

**HICKORY TECH CORPORATION**

 

| **Minnesota**                                                              |   | **41-1524393**                         |
|----------------------------------------------------------------------------|--------|----------------------------------------|
| (State or  other jurisdiction of  incorporation or organization)           |   | (I.R.S.  Employer  Identification No.) |
|                                                                       |   |                                   |
| **221 East  Hickory Street  P.O. Box 3248  Mankato, Minnesota 56002**      |
| (Address of  principal executive offices and zip code)                     |
|                                                                       |   |                                   |
| Registrant’s telephone number, including  area code: **800-326-5789** |
|                                                                       |   |                                   |
| Securities  registered pursuant to Section 12(b) of the Act: **None**      |
|                                                                       |   |                                   |
| Securities registered pursuant to Section  12(g) of the Act:               |   |
|                                                                       |
| **Common  Stock, No Par Value   Preferred Stock Purchase Rights**          |
| Title of  Class                                                            |

 

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months,and (2) has been subject to such filing requirements for the past 90 days.    Yes     ý     No     o     

 

Indicate by a check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.    ý

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes     ý     No     o     

 

As of June 30, 2004, theaggregate market value of the common stock held by non-affiliates of theregistrant was $124,990,967 based on the last sale price of $10.15 on TheNasdaq National Market.

 

The total number of shares ofthe registrant’s common stock outstanding as of February 28, 2005:  13,057,106.

 

Documents Incorporated byReference:                   Portions of theregistrant’s definitive Proxy Statement for the Annual Meeting of Shareholdersto be held on May 9, 2005 (“Proxy Statement”) are incorporated by reference inPart III of this Form 10-K.

 

 

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** **

**INDEX**

 
| PART I    |     |                                                                                                               |
|-----------|----------|--------------------------------------------------------------------------------------------------------------------|
|      | Item 1:  | Business                                                                                                           |   |
|      | Item 2:  | Properties                                                                                                         |   |
|      | Item 3:  | Legal Proceedings                                                                                                  |   |
|      | Item  4: | Submission of Matters to a Vote of Security  Holders                                                               |   |
|      |     |                                                                                                               |   |
| PART  II  |     |                                                                                                               |
|      | Item 5:  | Market for Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchases of Equity Securities |   |
|      | Item 6:  | Selected Financial Data                                                                                            |   |
|      | Item 7:  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                        |   |
|      | Item 7A: | Quantitative and Qualitative Disclosures  About Market Risk                                                        |   |
|      | Item 8:  | Financial Statements and Supplementary Data                                                                        |   |
|      | Item 9:  | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure                              |   |
|      | Item 9A: | Controls and Procedures                                                                                            |   |
|      | Item 9B: | Other Information                                                                                                  |   |
|      |     |                                                                                                               |   |
| PART  III |     |                                                                                                               |
|      | Item 10: | Directors and Executive Officers of the  Registrant                                                                |   |
|      | Item 11: | Executive Compensation                                                                                             |   |
|      | Item 12: | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                    |   |
|      | Item 13: | Certain Relationships and Related  Transactions                                                                    |   |
|      | Item 14: | Principal Accountant Fees and Services                                                                             |   |
|      |     |                                                                                                               |   |
| PART IV   |     |                                                                                                               |
|      | Item 15: | Exhibits and Financial Statement Schedule                                                                          |   |

 

1

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**PART I**

 

**Item 1.****                    Business.**

 

##### **GENERAL**

##### ** **

Hickory Tech Corporation (HickoryTech) is a diversified communicationscompany headquartered in Mankato, Minnesota. HickoryTech has over a 100-yearhistory in the local telephone exchange business. From those roots, it hasexpanded into three business segments: Telecom Sector, Information SolutionsSector, and Enterprise Solutions Sector. HickoryTech’s core business is itsTelecom Sector, which consists of two businesses. One of these businesses isthe operation of three incumbent local exchange carriers (ILECs). This businessconsists of connecting customers to the telephone network, providing switchedservice and dedicated private lines, connecting customers to Internet and longdistance service providers and providing other services commonly associated withILECs. The second business of the Telecom Sector is competitive local exchangecarrier (CLEC) services, which HickoryTech initiated in 1998, and itsassociated competitive businesses of long distance service and Internet access.This CLEC business leverages HickoryTech’s expertise and expands itstelecommunications service into areas served by other incumbent LECs (localexchange carriers). In December of 2003, HickoryTech sold what had been a thirdbusiness of the Telecom Sector, which provided wireless telecommunicationsservices to customers in southern Minnesota and its surrounding area, alongwith an area surrounding Minneapolis/St. Paul. The wireless operations arereported as part of the Telecom Sector. All financial statements and scheduleshave been restated to reflect wireless operations as discontinued operations.In addition to the Telecom Sector, HickoryTech provides data processingservices to the telecommunications industry (Information Solutions Sector) andprovides telephone, data and Internet Protocol (IP) equipment sales and service(Enterprise Solutions Sector). The Hickory Tech Corporation parent company wasincorporated in Minnesota in 1985, replacing Mankato Citizens Telephone Company(formed in 1898) as the parent company.

 

The eight subsidiaries of HickoryTech and the business segments inwhich they operate are:

 

**TELECOMSECTOR**

•        MankatoCitizens Telephone Company (MCTC)

**•****       **Mid-Communications,Inc. (Mid-Comm)

•        HeartlandTelecommunications Company of Iowa, Inc. (Heartland)

•        CableNetwork, Inc. (CNI)

•        CrystalCommunications, Inc. (Crystal)

•        MinnesotaSouthern Wireless Company (MSWC) – Discontinued Operations

 

**INFORMATIONSOLUTIONS SECTOR**

•        NationalIndependent Billing, Inc. (NIBI)

** **

**ENTERPRISE SOLUTIONS SECTOR**

•        CollinsCommunications Systems Co. (Collins)

 

HickoryTech and itssubsidiaries are engaged in businesses that provide services to their customersfor a fee. Many of these services are recurring, and, as a result, backlogorders and seasonality are not significant factors. Working capitalrequirements primarily involve financing the construction of networks involvingswitches and cable, and maintaining a high amount of fixed assets. Otherworking capital requirements include the payroll costs of highly skilled labor,the inventory to service its capital projects and maintenance of the networkand telephone equipment customers, and the carrying value of trade accountsreceivable, which may take several months to collect in the normal course ofbusiness.

 

2

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The materials and supplies that are necessary forthe operation of the businesses of HickoryTech and its subsidiaries areavailable from a variety of sources. All of HickoryTech’s central officeswitches, as well as a majority of HickoryTech’s equipment sold in itsEnterprise Solutions Sector, are supplied by Nortel. Nortel is a leadingsupplier of communications equipment, and HickoryTech’s dependence on thisbrand is not viewed as a significant risk. An additional layer of network infrastructureequipment for broadband services is provided by Nextlevel. Nextlevel, asubsidiary of Motorola, is a newer supplier of communications equipment and theCompany is monitoring the risk of maintaining Nextlevel as a supplier. TheCompany also is a distributor of Cisco data equipment in its EnterpriseSolutions Sector.

 

HickoryTech makes available, free of charge, copies of its annualreports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form8-K and amendments to these reports filed or furnished pursuant to Section13(a) or 15(d) of the Securities Exchange Act of 1934 as amended (the “ExchangeAct”). These reports are available on HickoryTech’s Internet websitehttp://www.hickorytech.com as soon as reasonably practicable after suchmaterial is electronically filed with or furnished to the Securities andExchange Commission.

 

As of December 31, 2004, HickoryTech had 394 full-time equivalentemployees.

 

**DISPOSITIONS**

** **

On December 15, 2003, HickoryTechsold its wireless business, Minnesota Southern Wireless Company (MSWC), toWestern Wireless Corporation (WWC). The selling price was comprised of$16,246,000 in cash and 1,038,927 shares of HickoryTech common stock that werereturned to HickoryTech by WWC and subsequently retired. The market value ofthese shares was $12,207,000 at December 15, 2003. Included in the cashproceeds above is $3,401,000 of cash received for construction in progressassets. HickoryTech recorded a pre-tax loss on the sale of $25,642,000($22,758,000 net of income taxes). HickoryTech used the proceeds from the saleto repay a portion of its outstanding debt. The wireless operations arereported as part of the Telecom Sector. The consolidated statements ofoperations for all periods presented have been restated to reflect wirelessoperations as discontinued operations (see Note 3 of the Notes to theConsolidated Financial Statements).

 

**INDUSTRY SEGMENTS FINANCIAL DATA**

** **

Financial information about HickoryTech’s industry segments is includedon pages 14 to 20 and pages 42 to 44 of this Form 10-K.

 

**INDUSTRY SEGMENTS**

** **

HickoryTech reports the business operations of Telephone,Communications Services, and Wireless Services as a single segment referred toas the Telecom Sector. However, the consolidated statements of operations forall periods presented have been restated to reflect wireless operations asdiscontinued operations (see Note 3 of the Notes to the Consolidated FinancialStatements). The other two business segments are the Information Solutions andEnterprise Solutions Sectors and they continue to be reported as previouslystated.

 

TELECOM SECTOR

 

HickoryTech’s Telecom Sector provides local exchange wireline telephoneservice, long distance, dial-up and broadband Internet access, and owns andoperates fiber optic cable facilities. This sector includes three ILECs: MCTC,Mid-Comm and Heartland. MCTC and Mid-Comm provide telephone service in southcentral Minnesota, specifically Mankato (a regional hub) and eleven ruralcommunities surrounding Mankato. The third ILEC, Heartland, provides telephoneservice for eleven rural communities in northwest Iowa. In total there aretwenty-three ILEC exchanges, within the Telecom Sector.

 

3

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The Telecom Sector also includes Crystal, a CLEC. Crystal provideslocal telephone service, long distance, dial-up and broadband Internet accessand digital television on a competitive basis. Crystal also connectscommunication networks of interexchange and wireless carriers with the equipmentand facilities of end users. Crystal has customers in ten rural communities,encompassing eight exchanges, in Minnesota and three communities, encompassingtwo exchanges, in Iowa that are not in HickoryTech’s ILEC service areas.HickoryTech discontinued its service to four other Iowa communities in 2003. Inaddition to the digital television service provided to customers in St. Peter,Minnesota, HickoryTech began providing digital television service to customersin Waseca, Minnesota in July 2004.

 

HickoryTech also owns and operates fiber optic cable facilities inMinnesota in its subsidiary CNI.  Thesefacilities are used to transport interexchange communications as a service totelephone industry customers. HickoryTech’s Minnesota ILECs and CLEC are theprimary users of the fiber optic cable facilities.

 

The Telecom Sector included the operations of MSWC, which was soldDecember 15, 2003. None of the remaining companies in the Telecom Sectorexperienced major changes in operations during 2004.

 

MCTC derives its principal revenues and income from local servicescharged to subscribers in its service area, access services charged tointerexchange carriers, and the operation of a toll tandem-switching center inMankato, Minnesota. Revenues and income for Mid-Comm are also derived fromlocal service charges in its area of operation and by providing access to longdistance services for its subscribers through the toll center in Mankato. Localand interexchange telephone access for the two companies is provided on anintegrated basis. The local and interexchange telephone access for bothtelephone companies utilize the same facilities and equipment and is managedand maintained by a common workforce. Heartland derives its principal revenuesand income from local services charged to subscribers in its service area inIowa, as well as from providing interexchange access for its subscribers.Interexchange telephone access is provided by all three of HickoryTech’s ILECsubsidiaries by connecting the communications networks of interexchange andwireless carriers with the equipment and facilities of end users through itsswitched networks or private lines.

 

MCTC and Mid-Comm are Minnesota public utilities operating pursuant toindeterminate permits issued by the Minnesota Public Utilities Commission.Heartland is also a public utility, which operates pursuant to a certificate ofpublic convenience and necessity issued by the Iowa Utilities Board. Thesestate agencies regulate the services provided by MCTC, Mid-Comm and Heartland.CNI’s operations are not subject to regulation by the state regulatoryauthority. Neither the Minnesota Public Utilities Commission nor the IowaUtilities Board regulates the rate of return or profits of each of HickoryTech’sILEC operations due to the size of these companies relative to stateregulation. In Minnesota, MCTC and Mid-Comm’s price and service levels aremonitored by regulators. MCTC’s and Mid-Comm’s local service rates are belowthose of most Minnesota incumbent LECs. HickoryTech and its subsidiaries willchange rates determined by various factors, including economic and competitivecircumstances.

 

As local exchange telephone companies, MCTC, Mid-Comm and Heartlandprovide end office switching and dedicated circuits to long distance interexchangecarriers. These relationships allow HickoryTech’s telephone subscribers toplace long distance telephone calls and gain access to the telephone network.HickoryTech provides interexchange access for all of the individual customerswho select an alternative long distance carrier. This interexchange accessbusiness is separate and distinct from HickoryTech’s own long distance retailbusiness, which is operated in its Crystal subsidiary. The long distanceinterexchange carriers are significant customers of HickoryTech, but no carrierrepresents more than ten percent of HickoryTech’s consolidated revenues.

 

Alternatives to HickoryTech service include customers leasing privatelines in lieu of switched voice services and data services in or adjacent tothe territories served by HickoryTech, which permits the bypassing of localtelephone switching facilities. Additionally, services provided by othercompanies utilizing various Internet, wireline or wireless technologies permitbypass of the local exchange network. These alternatives to local exchangeservice represent a potential threat to HickoryTech’s long-term ability toprovide local exchange service at economical rates.

 

Competition in HickoryTech’s ILEC service area exists in one ofHeartland’s exchanges. In the city of Hawarden, Iowa, the municipal utilitiesoverbuilt the city’s telephone service infrastructure in 1999 and is providingan alternative to HickoryTech’s telephone service. HickoryTech estimates theHawarden CLEC has approximately 1,400 access lines, or approximately 70 percentof that exchange’s telephone business.

 

4

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Competitionalso exists for some of the HickoryTech services provided to interexchangecarriers, such as customer billing services, dedicated private lines, networkswitching and network routing. This competition comes primarily from theinterexchange carriers themselves, in that carriers may decide that theservices provided by HickoryTech may be redirected or handled on their ownnetwork or on other networks. The provision of these services is primarilymonth-to-month service out of a general tariff, which is a schedule of terms,rates and conditions that is approved by the appropriate state or federalagency.  The use of these services isprimarily controlled by the interexchange carriers. As interexchange carriersmake these service decisions, they have the potential to reduce the Company’srevenue in the Telecom Sector. Other services, such as the provision ofbroadband, long distance service, directory advertising and end user equipment,are open to competition.

 

OnDecember 22, 2004, the Federal Court of Appeals, 8th Circuit upheld an October2003 ruling by the United States District Court, District of Minnesota, inissuing an injunction providing relief from regulation of any service providerproviding Voice over Internet Protocol (VoIP) based services in Minnesota. Thismay result in a change in the business relationship between HickoryTechbusinesses and the interexchange carriers, as interconnections with certainVoIP providers may not be governed by tariffed Minnesota access charges.HickoryTech cannot, at this time, estimate the revenue impact, if any, relatedto this decision.

 

The passage of the 1996 Telecommunications Act created the opportunityfor HickoryTech to offer communications service in territories served by othertelephone companies, and Crystal began operations in January 1998 as a newCLEC. Crystal offers local service, long distance, dial-up and broadband Internetaccess services, and digital television on a competitive basis to customers insouthern Minnesota and Iowa, which were not previously served by HickoryTech’sTelecom Sector service area. These service offerings provide customersalternatives to the incumbent communication providers in various communitiesand are offered under the brand name HickoryTech service. These services arecurrently being offered to customers in ten rural communities, encompassingeight exchanges, in Minnesota, as well as three communities, encompassing twoexchanges, in Iowa. Crystal also provides the long distance service, dial-upand broadband Internet access services to HickoryTech’s ILEC subscribers.

 

CLEC activities require Crystal to file for authority to operate withthe appropriate public utilities commission in each state it serves. Crystalcompetes directly against existing incumbent LECs in the areas in which itoperates. Crystal is not dependent upon any single customer or small group ofcustomers. No single customer in Crystal accounts for ten percent or more ofHickoryTech’s consolidated revenues.

 

It is commonin the incumbent LEC industry for carriers to dispute certain access charges.There is currently a multi-state incumbent LEC industry dispute with a large RBOC(Regional Bell Operating Company) regarding certain access charges. Theincumbent LEC industry in Minnesota has jointly filed a formal complaint withthe Minnesota Public Utilities Commission regarding this dispute. As requestedin the complaint, this matter was referred to the Office of AdministrativeHearings for a contested case proceeding, which is currently in process.

 

On December 15, 2003, HickoryTechsold its wireless business, Minnesota Southern Wireless Company (MSWC), toWestern Wireless Corporation (WWC). The selling price was comprised of$16,246,000 in cash and 1,038,927 shares of HickoryTech common stock that werereturned to HickoryTech by WWC and subsequently retired. The market value ofthese shares was $12,207,000 at December 15, 2003. Included in the cashproceeds above is $3,401,000 of cash received for construction in progressassets. The wireless operations are reported as part of the Telecom Sector.HickoryTech recorded a pre-tax loss on the sale of $25,642,000 ($22,758,000 netof income taxes). HickoryTech used the proceeds from the sale to repay aportion of its outstanding debt. The wireless operations are reported as partof the Telecom Sector. The consolidated statements of operations for allperiods presented have been restated to reflect wireless operations asdiscontinued operations (see Note 3 of the Notes to Consolidated FinancialStatements).

 

5

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In connection with thedetermination by management in the third quarter of 2003 that it would pursuethe sale of its wireless operations and that the selling price would likely beless than the current carrying value of the wireless net assets, the Companycompleted an impairment test in the third quarter of 2003 for the Federal CommunicationsCommission (FCC) licenses pursuant to the requirements of SFAS No. 142, “Goodwilland Other Intangible Assets.” Management estimated the fair value of the FCClicenses using a discounted cash flow technique consistent with the method usedby the Company in performing its most recent impairment analysis at December31, 2002. As a result of this assessment, management determined that the FCClicenses were impaired and recorded an impairment charge of $21,000,000($18,638,000 net of income taxes), in the third quarter of 2003. Thisimpairment charge is recorded as a component of the loss on discontinuedoperations in HickoryTech’s consolidated statement of operations for the yearended December 31, 2003. HickoryTech believes that the decline in the fairvalue of its FCC licenses was due principally to the rapid pace oftechnological change being undertaken by the major wireless service providersto adopt new protocols (i.e. GSM or CDMA) and potentially move away fromHickoryTech’s primary protocol called TDMA, which greatly hindered HickoryTech’sposition in finding a future roaming partner. Other factors include decliningroaming revenues, increasing price competition, and the protracted downturn inthe wireless market. The FCC licenses were tested for impairment on anaggregate basis, which was consistent with HickoryTech’s management of thewireless business.

 

Pursuant to SFAS No. 144, “Accountingfor Impairment or Disposal of Long-Lived Assets,” (SFAS No. 144), the Companyrecorded an impairment charge during the third quarter of 2003 related to theother long-lived assets of the wireless business of $4,345,000 ($3,856,000 netof income taxes). This charge is also recorded as a component of the loss ondiscontinued operations in HickoryTech’s consolidated statement of operationsfor the year ended December 31, 2003.

 

INFORMATION SOLUTIONS SECTOR

 

Through NIBI, HickoryTech’s Information Solutions Sector provides dataprocessing and related services, principally for HickoryTech, other localexchange telephone companies, CLECs, interexchange network carriers andwireless companies. The Information Solutions Sector’s principal activity isthe provision of monthly batch processing of computerized data for HickoryTechas well as non-affiliated companies. Services for telephone company customersinclude the processing of long distance telephone calls from data sources andtelephone switches, the preparation of the subscriber telephone bills, customerrecord keeping and carrier access bills.

 

There are a number of companies engaged in supplying data processingservices comparable to those furnished by the Information Solutions Sector.Competition is based primarily on price and service. HickoryTech’s InformationSolutions Sector has developed an integrated billing and management systemcalled SuiteSolution. SuiteSolution can provide wireline and wireless carriersthe individual benefits of a billing platform or a total system solution.

 

ENTERPRISE SOLUTIONS SECTOR

 

Through Collins, HickoryTech’s Enterprise Solutions Sector providestelephone, data and Voice over Internet Protocol (VoIP) business systemsequipment sales and services to companies primarily based in metropolitanMinneapolis/St. Paul, Minnesota. This sector also supports the businesstelephone system service for HickoryTech ILEC and CLEC operations in southernMinnesota and in Iowa. The customers in the Enterprise Solutions Sector’smarket are the individual business end users of telecommunications service withongoing service requirement offerings. Products consist of communicationplatforms such as Nortel, Cisco and Bay Networks (Nortel) equipment. EnterpriseSolutions specializes in complex design, installation and maintenance of voice,data or Internet Protocol products.

 

Revenues are primarily earned by the sales, installation and service ofbusiness telephone and IP data systems. Enterprise Solutions continues itscommitment to service and support its core product, Nortel, while identifyingnew opportunities such as call centers, computer telephone integration voicemail and interactive voice response systems.

 

HickoryTech’s Enterprise Solutions Sector is not dependent upon anysingle customer or small group of customers. No single customer in theEnterprise Solutions Sector accounts for ten percent or more of HickoryTech’sconsolidated revenues.

 

6

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Enterprise Solutions does business in a competitive market where alarge number of companies compete for the sale, installation and servicing oftelecommunications equipment and VoIP communications products. Competition isbased primarily on price and service. No single company is dominant in thismarket.

 

**OTHERREGULATION**

 

HickoryTech does not anticipate any material effects on its earnings,capital expenditures or competitive position because of laws pertaining to theprotection of the environment.

 

**OTHERCOMPETITION**

 

HickoryTech’s business strategy has been to position itself as aquality communications services provider. Long-term business relationships withits customers have strengthened HickoryTech’s business position. HickoryTechbelieves that its customers value the fact that it is the “local company” whosegoal is to meet the customers’ communications needs. HickoryTech has severalcompetitive advantages: its prices; its service; its investment in technology;it has a direct billing relationship with almost all of the customers in itsservice territories; and it is positioned to offer a wide range of wiredcommunications service from one source.

 

The long-range effect of competition on the provision of communicationsservices and equipment will depend on technological advances, regulatoryactions at both the state and federal levels, court decisions, and possibleadditional future state and federal legislation. The trend resulting from pastlegislation has been to expand competition in the telecommunications industry.It is imperative to HickoryTech that competition in this industry be fosteredwith equal amounts of responsibility, regulation and opportunity for allproviders.

 

**Item 2.****                    Properties.**

 

HickoryTech’s business is primarily focused on the provision ofservices and its properties are used for administrative support and to storeand safeguard equipment. At December 31, 2004, HickoryTech’s gross property,plant and equipment of $246,341,000 consisted primarily of telephone switches,cable and network equipment. HickoryTech owns or leases the telephone property,plant and equipment which it utilizes to operate its telephone systems. Thethree ILEC subsidiaries of HickoryTech in Minnesota and Iowa own centraltelephone offices with related real estate in all of the communities theyserve. HickoryTech’s Telecom Sector owns the telephone network, includingtelephone outside plant, fiber optic cable and central office equipment, overwhich they provide services to their customers. It is the opinion ofHickoryTech’s management that the properties of HickoryTech are suitable andadequate to provide modern and effective telecommunications services within itsservice areas, including both local and long distance service. Facilities areplaced in full use after installation and appropriate testing in associationwith multi-year capital expenditure plans.

 

HickoryTech’s principalproperty locations are the following:

 

(1)                                  MCTC’s general officesand principal central office exchange building are located in downtown Mankato,Minnesota. This facility, built in 1963, is owned by MCTC and is a three-levelbrick and stone building containing approximately 60,000 square feet of floorspace.

 

(2)                                  MCTC’s main warehouseis located in Mankato, Minnesota. The warehouse, built in 1996, is owned byMCTC and is a two-story concrete building containing approximately 48,000square feet. The warehouse is used to store vehicles and supplies and is alsoused as office space for engineers and technicians.

 

(3)                                  Heartland’s maincentral office equipment is located in a one-story brick structure owned byHeartland in Rock Rapids, Iowa containing approximately 1,500 square feet.Heartland also leases approximately 2,000 square feet of general office spacein Rock Valley, Iowa.

 

(4)                                  Crystal leases officespace of approximately 6,800 square feet in Mankato, Minnesota andapproximately 2,000 square feet in West Des Moines, Iowa.

 

(5)                                  NIBI owns a four-levelbuilding in Mankato, Minnesota containing approximately 17,000 square feet.

 

7

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(6)                                  Collins leasesapproximately 26,000 square feet of office building and warehouse space inRoseville, Minnesota.

 

**Item 3.****                    LegalProceedings.**

 

There are no material pending legal or governmentalproceedings directly involving HickoryTech or its subsidiaries, other thanordinary routine litigation or ordinary routine utility matters, incidental tothe business of HickoryTech and its subsidiaries.

 

**Item 4.****                    Submissionof Matters to a Vote of Security Holders.**

 

No matters were submitted to a vote of security holders during thefourth quarter of the fiscal year covered by this 2004 Annual Report on Form10-K.

 

**PART II**

 

**Item 5.****                    Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities**.

 

The common stock of HickoryTech is traded on The Nasdaq National Marketunder the symbol “HTCO”.

 

The following table sets forth for the period indicated the high andlow closing sales price of the common stock.

 
| ** ** | ** **   | ** ** | **High** | ** ** | **Low** | ** ** | **End of Qtr.** | ** ** |
|------------|--------------|------------|----------|------------|---------|------------|-----------------|------------|
| **2004**   | 4th  Quarter |       | $        | 12.03      |    | $          | 10.22           |       | $ | 10.69 |   |
|       | 3rd Quarter  |       | $        | 12.17      |    | $          | 10.00           |       | $ | 11.60 |   |
|       | 2nd Quarter  |       | $        | 13.36      |    | $          | 9.70            |       | $ | 10.15 |   |
|       | 1st Quarter  |       | $        | 12.44      |    | $          | 11.43           |       | $ | 12.24 |   |
|       |         |       |     |       |    |       |            |       |
| **2003**   | 4th  Quarter |       | $        | 12.20      |    | $          | 10.76           |       | $ | 11.47 |   |
|       | 3rd Quarter  |       | $        | 12.35      |    | $          | 10.82           |       | $ | 11.60 |   |
|       | 2nd Quarter  |       | $        | 11.48      |    | $          | 8.43            |       | $ | 11.21 |   |
|       | 1st Quarter  |       | $        | 10.61      |    | $          | 7.90            |       | $ | 8.97 |   |

 

As of February 28, 2005, there were approximately3,236 holders of record of common stock, registered and in street nameaccounts.

 

HickoryTech has declared quarterly dividends on itscommon stock of $0.11 per share during the two years ended December 31, 2004. Aquarterly cash dividend of $0.12 per share will be paid on March 5, 2005 tostockholders of record at the close of business on February 15, 2005.

 

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** **

**Item 6.****                    SelectedFinancial Data.**

 

*(Dollars in Thousands, Except Per ShareAmounts)*

** **
| **FOR THE YEAR:**                           | ** ** | **2004**       | ** **  | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** | **2000**   | ** ** |
|---------------------------------------------|------------|----------------|-------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Operating Revenues (A)(B)                   | ** ** | ** **     | ** **  |       |       |       |       |       |       |       |       |
| Telecom Sector                              | ** ** | **$**          | **76,097**  | ** ** | $          | 75,346     |       | $          | 71,108     |       | $          | 66,364 |   | $ | 60,606 |   |
| Information Solutions Sector                | ** ** | **2,710**      | ** **  | 3,199      |       | 4,249      |       | 4,085      |       | 4,287      | ** ** |
| Enterprise Solutions Sector                 | ** ** | **11,708**     | ** **  | 14,347     |       | 15,781     |       | 20,374     |       | 18,511     | ** ** |
| Total Revenues                              | ** ** | **$**          | **90,515**  | ** ** | $          | 92,892     |       | $          | 91,138     |       | $          | 90,823 |   | $ | 83,404 |   |
| Income from Continuing Operations           | ** ** | **$**          | **7,664**   | ** ** | $          | 8,455      |       | $          | 6,235      |       | $          | 6,890 |   | $ | 5,351 |   |
|                                        | ** ** | ** **     | ** **  | ** ** |       |       |       |       |       |       |       |   |   |   |   |   |
| **PER SHARE:**                              | ** ** | ** **     | ** **  |       |       |       |       |       |       |       |       |
| Basic EPS - Continuing Operations           | ** ** | **$**          | **0.59**    | ** ** | $          | 0.61       |       | $          | 0.44       |       | $          | 0.50 |   | $ | 0.39 |   |
| Basic EPS - Discontinued Operations         | ** ** | **(0.01**      | **)**       | (1.53      | )          | (1.63      | )          | 0.13       |       | 0.17       |       |
| ** **                                  |       | **$**          | **0.58**    | ** ** | $          | (0.92      | )          | $          | (1.19      | )          | $          | 0.63 |   | $ | 0.56 |   |
| ** **                                  |       | ** **     | ** **  |       |       |       |       |       |       |       |       |
| Fully Diluted EPS - Continuing Operations   | ** ** | **$**          | **0.59**    | ** ** | $          | 0.61       |       | $          | 0.44       |       | $          | 0.49 |   | $ | 0.38 |   |
| Fully Diluted EPS - Discontinued Operations | ** ** | **(0.01**      | **)**       | (1.53      | )          | (1.62      | )     | 0.13       |       | 0.17       |       |
| ** **                                  |       | **$**          | **0.58**    | ** ** | $          | (0.92      | )          | $          | (1.18      | )          | $          | 0.62 |   | $ | 0.55 |   |
| Dividends Per Share                         | ** ** | **$**          | **0.44**    | ** ** | $          | 0.44       |       | $          | 0.44       |       | $          | 0.44 |   | $ | 0.44 |   |
|                                        | ** ** | ** **     | ** **  |       |       |       |       |       |       |       |       |
| **AT YEAR END:**                            | ** ** | ** **     | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Assets (C)                            | ** ** | **$**          | **168,537** | ** ** | $          | 175,712    |       | $          | 186,143    |       | $          | 189,179 |   | $ | 169,033 |   |
| Shareholders’ Equity                   | ** ** | **$**          | **31,545**  | ** ** | $          | 28,717     |       | $          | 58,595     |       | $          | 80,765 |   | $ | 77,357 |   |
| Total Debt, Long-Term and Current           | ** ** | **$**          | **102,984** | ** ** | $          | 119,612    |       | $          | 159,040    |       | $          | 170,901 |   | $ | 148,650 |   |
| Debt Ratio (D)                              | ** ** | **76.6**       | **%**       | 80.6       | %          | 73.1       | %          | 67.9       | %          | 65.8       | %          |
|                                        | ** ** | ** **     | ** **  |       |       |       |       |       |       |       |       |
| **CUSTOMER DATA (year end):**               | ** ** | ** **     | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ILEC Access Lines (E)                       | ** ** | **60,472**     | ** **  | 63,099     |       | 65,355     |       | 66,393     |       | 67,120     |       |
| CLEC Access Lines (F)                       | ** ** | **14,086**     | ** **  | 14,147     |       | 13,984     |       | 11,573     |       | 8,283      |       |
| Long Distance Subscribers (G)               | ** ** | **43,702**     | ** **  | 40,366     |       | 35,566     |       | 24,241     |       | 18,366     |       |
| Internet Customers (H)                      | ** ** | **17,191**     | ** **  | 16,132     |       | 14,420     |       | 12,816     |       | 12,129     |       |
| DSL Customers (I)                           | ** ** | **10,430**     | ** **  | 7,407      |       | 3,971      |       | 1,851      |       | 525        |       |
| Digital TV Customers                        | ** ** | **1,941**      | ** **  | 1,179      |       | 803        |       | 460        |       | —     |       |
|                                        | ** ** | ** **     | ** **  |       |       |       |       |       |       |       |       |
| **OTHER DATA:**                             | ** ** | ** **     | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Employees (year end) (J)                    | ** ** | **394**        | ** **  | 414        | ** ** | 481        | ** ** | 502        | ** ** | 552        |       |
| Capital Expenditures                        |       | **$**          | **16,612**  | ** ** | $          | 11,237     |       | $          | 12,381     |       | $          | 30,174 |   | $ | 34,681 |   |
| Shares Outstanding (year end)               |       | **13,507,106** | ** **  | 12,967,811 |       | 13,983,929 |       | 13,935,308 |       | 13,878,568 |       |
| Share Price (K) (year end)                  |       | **$**          | **10.69**   | ** ** | $          | 11.47      |       | $          | 9.53       |       | $          | 16.95 |   | $ | 20.50 |   |
| Shares Holders (L)                          |       | **3,236**      | ** **  | 3,249      |       | 3,193      |       | 3,339      |       | 3,300      |       |

 

----

(A)      Disposition of HickoryTech’ssubsidiary, Amana Colonies Telephone Company (ACTC) in 2001, has affectedHickoryTech’s revenue trends. ACTC accounted for $832,000 and $1,467,000 of theTelecom Sector’s revenue in 2001 and 2000, respectively.

 

(B)        During December 2003,HickoryTech sold its wireless operations. Revenues for all periods have been restatedto exclude revenues of the wireless operations, as they are included indiscontinued operations for all periods presented.

 

(C)        During December 2003,HickoryTech sold its wireless operations. Total assets for all periods havebeen restated to exclude wireless assets.

 

(D)       Debt Ratio = Total Debt /(Total Debt + Ending Shareholders’ Equity).

 

(E)         ILEC Lines refer to thelocal exchange telephone access lines in the Telecom Sector. ILEC Lines includeISDN (High Speed Data) and pay station lines of 1,829 in 2004, 2,115 in 2003,2,406 in 2002, 2,196 in 2001 and 2,198 in 2000.

 

(F)         CLEC Lines refer to thecompetitive local exchange telephone access lines in the Telecom Sector. Typesof CLEC lines:

 

**CLEC Access Lines**

 
| ** **                      |       | **2004**   | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** |   |
|---------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|--------|
| CLEC Access Lines               |       |       |       |     |       |     |       |     |       |     |   |
| Overbuild                       | ** ** | **10,417** |       | 9,871    |       | 7,796    |       | 5,521    |       | 1,819    |   |
| Unbundled Network Element (UNE) | ** ** | **1,726**  |       | 1,647    |       | 1,343    |       | 1,263    |       | 1,757    |   |
| Total Service Resale (TSR)      | ** ** | **1,943**  |       | 2,629    |       | 4,845    |       | 4,789    |       | 4,707    |   |
| Total CLEC Lines                | ** ** | **14,086** |       | 14,147   |       | 13,984   |       | 11,573   |       | 8,283    |   |

 

9

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(G)        Long Distance serviceaccounts are provided in the Telecom Sector to ILEC and CLEC customers.

 

(H)       Internet Customers includedial-up and high-speed Internet accounts within the Telecom Sector, servingILEC, CLEC or stand alone dial-up accounts in HickoryTech’s service area. 4,834customers acquired from Internet Connections are included in 2000.

 

(I)            Digital SubscriberLine service accounts are provided in the Telecom Sector to ILEC and CLECcustomers.

 

(J)           All employee countsreflect actual employee counts at year end. No numbers were restated for thewireless sale.

 

(K)       Price is the last dayclosing price.

 

(L)         Number of Shareholders isapproximate total of Company registrations and street name accounts.

 

 

**Item 7.****                    Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

**BUSINESSES**

 

HickoryTechoperates in three business segments: the Telecom, Information Solutions andEnterprise Solutions Sectors. Its largest and oldest business (since 1898) hasbeen the operation of incumbent local exchange carriers (ILECs) or traditionalwireline telephone service. The ILEC business is in HickoryTech’s TelecomSector. In 1998, HickoryTech began its competitive local exchange carrier(CLEC) line of business, competing for the telephone dial tone, dial-up andbroadband Internet access, data, digital TV and long distance calling businessin incumbent LEC territories owned by others. The CLEC business is in HickoryTech’sTelecom Sector. Since 1964, HickoryTech’s Information Solutions Sector hasprovided computer data processing and software, predominantly for HickoryTech’sTelecom Sector operations and also to other telecommunications companies.HickoryTech acquired its Enterprise Solutions Sector in 1990 and it operates asa telecommunications, data and Internet Protocol equipment distributor from abase in Minneapolis/St. Paul, Minnesota. HickoryTech also began its wirelessoperations in 1998 by acquiring its first wholly owned wireless servicelicense, an additional wireless service license in 1999 and two PCS licenses in2001. HickoryTech sold the wireless operations on December 15, 2003. Thewireless operations are reported as part of the Telecom Sector. All financialstatements and schedules have been restated to reflect wireless operations asdiscontinued operations for all periods presented.

 

**THECOMPANY**

 

Theeight subsidiaries of HickoryTech, all of which publicly operate and conductbusiness as HickoryTech, and the business segments in which they operate are:

 

**TELECOMSECTOR**

MankatoCitizens Telephone Company

Mid-Communications,Inc.

HeartlandTelecommunications Company of Iowa, Inc.

CableNetwork, Inc.

CrystalCommunications, Inc.

MinnesotaSouthern Wireless Company – Discontinued Operations

**INFORMATIONSOLUTIONS SECTOR**

NationalIndependent Billing, Inc.

**ENTERPRISESOLUTIONS SECTOR**

CollinsCommunications Systems Co.

 

10

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**EXECUTIVE SUMMARY OF 2004**

 

The Company focused on internal growth and positioning in 2004.Increased revenues were seen as a result of the Company’s residential broadbandand business high speed data network provisioning. Successful deployment ofDigital TV in the Company’s initial test site in 2001 through 2004 led toDigital TV being initiated in a second CLEC community in mid 2004. The Companyhas undertaken a multi-year network upgrade capital expenditure plan toincrease its broadband capabilities. At the same time, the Company paid downanother $16,000,000 on its credit facility. The goals for 2005 includeprotecting current market share in light of increasing competition, maximizingresidential and business revenue growth and implementing new financial andoperating systems upgrades, which will enable the Company to continue toimprove operating efficiencies.

 

The Telecom business continues to be strong due to solid growth inCommunications Services, and was mainly offset by a decline in access revenues.Telecom Carriers’ continued optimization of their networks and regulatoryreform uncertainty in the future may impact access revenue going forward.

 

Information Solutions and Enterprise Solutions again experienced lowerrevenues in 2004 compared to 2003 due to hesitancy of customer demand. As aresult, management continued to contain or cut cost by improving operatingefficiencies.

 

**CONSOLIDATED RESULTS OF OPERATIONS**

 

**2004 Compared to 2003**

•            Consolidatedrevenues were $90,515,000, a $2,377,000 or 2.6% decrease in 2004 compared to2003. This decrease was largely due to decreases in revenues in the EnterpriseSolutions Sector resulting from decreased demand for Enterprise Solution’sproducts and services. Increases in Telecom Sector revenues partially offsetthe decrease in Enterprise Solutions Sector revenues and a decrease inInformation Solutions Sector revenues.

 

•            Cost ofSales at Enterprise Solutions was $2,005,000 lower in 2004 compared to 2003,which was a result of the decrease in the sales volume for the year.

 

•            Selling,General and Administrative Expenses, excluding Depreciation and Amortizationwere $14,723,000, a $1,564,000 or 11.9% increase in 2004 compared to 2003. Thisincrease was largely due to costs associated with implementation of theSarbanes Oxley Act of 2002 and higher post-retirement medical costs.

 

•            InterestExpense was $1,490,000 lower in 2004 compared to 2003, primarily due to adecrease in total debt outstanding. The outstanding balance of the revolvingcredit facility was $102,500,000 at December 31, 2004 and $118,500,000 atDecember 31, 2003

 

**2003 Compared to 2002**

•            Consolidatedrevenues were $92,892,000, a $1,754,000 or 1.9% increase in 2003 compared to2002. This increase was largely due to increases in revenues in the TelecomSector resulting from increases in network access revenues, the CLEC customerbase and increased broadband data service lines installed.  This increase was partially offset bydecreases in revenues in the Information Solutions and Enterprise SolutionsSectors.

 

•            Bad Debtexpense was $1,109,000 lower in 2003 compared to 2002, due in large part tobankruptcies of interexchange carriers in the telecommunications industry in2002.

 

•            InterestExpense was $1,302,000 lower in 2003 compared to 2002, primarily due to adecrease in total debt outstanding. The outstanding balance of the revolvingcredit facility was $118,500,000 at December 31, 2003 and $158,000,000 atDecember 31, 2002.

 

11

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**OVERALL SUMMARY OF CONTINUING OPERATIONS**

** **
| **Years Ended December 31,**       | ** **   | **2004**                   | ** **   | **2003**   | ** ** | **2002** | ** ** |
|------------------------------------|--------------|----------------------------|--------------|------------|------------|----------|------------|
| *** ***                       | *** *** | **(Dollars in Thousands)** | *** *** |
| Operating  Income/(Loss)           |         |                       |         |       |       |     |       |
| Telecom Sector                     | ** **   | **$**                      | **22,509**   | ** ** | $          | 25,095   |       | $ | 22,679 |   |
| Information Solutions Sector       | ** **   | **(2,799**                 | **)**        | (3,576     | )          | (3,289   | )          |
| Enterprise Solutions Sector        | ** **   | **(1,901**                 | **)**        | (1,358     | )          | (12      | )          |
| Corporate                          | ** **   | **(388**                   | **)**        | 18         |       | (1,809   | )          |
| ** **                         |         | **17,421**                 | ** **   | 20,179     |       | 17,569   |       |
| Other Income                       | ** **   | **61**                     | ** **   | 62         |       | 320      |       |
| Interest  Expense                  | ** **   | **(4,613**                 | **)**        | (6,103     | )          | (7,405   | )          |
| Income Taxes                       | ** **   | **(5,205**                 | **)**        | (5,683     | )          | (4,249   | )          |
| Income from  Continuing Operations | ** **   | **$**                      | **7,664**    | ** ** | $          | 8,455    |       | $ | 6,235 |   |

 

**RESULTS OF OPERATIONS**

 

CONSOLIDATEDOPERATING RESULTS

 

The following is a summarized discussion of consolidated results ofoperations. More detailed discussion of operating results by segment followsthis discussion. Except for the discussion of the wireless business saletransaction and the discussion of discontinued operations, all of thisdiscussion of HickoryTech’s operating results excludes the results ofoperations of the discontinued wireless business, which have been reported asdiscontinued operations in the Telecom Sector for all periods presented.

 

OPERATINGREVENUES – Consolidated operating revenues were $2,377,000 or 2.6%lower in 2004 compared to 2003 and $1,754,000 or 1.9% higher in 2003 comparedto 2002. The decrease in operating revenues in 2004 compared to 2003 isprimarily due to a lower volume of sales in the Enterprise Solutions Sector.The increase in 2003 operating revenues compared to 2002 was largely due toincreases in network access revenues, the increased CLEC customer base and theincrease in broadband data service lines installed, all in the Telecom Sector.This 2003 increase in operating revenues compared to 2002 was partially offsetby a decrease in revenues in the Information Solutions Sector, which canlargely be attributed to the loss of customers and a few customers who haveexperienced a significant decrease in volumes processed. The EnterpriseSolutions Sector also experienced a decrease in revenues in 2003 compared to2002 due to a decline in equipment sales and service.

 

COST OF SALES, ENTERPRISE SOLUTIONS -Cost of sales, which is related to the Enterprise Solutions Sector, was$2,005,000 or 19.6% lower in 2004 compared to 2003 and $422,000 or 4.0% lowerin 2003 compared to 2002. The change in cost of sales for both years isprimarily the result of the change in sales volume in the Enterprise SolutionsSector. The gross profit margin in the Enterprise Solutions Sector was 29.9%,28.8% and 32.6% for 2004, 2003, and 2002, respectively. These margins areprimarily affected by product mix sold and an increased cost of labor due to ahigher degree of technical skill needed with advanced systems.

 

COST OF SERVICES (excluding Asset Impairment, Depreciation andAmortization) – Cost of services excluding assetimpairment, depreciation and amortization were $154,000 or 0.5% higher in 2004compared to 2003 and $473,000 or 1.4% higher in 2003 compared to 2002. Theincrease in cost of services in 2004 compared to 2003 was largely due to a$700,000 inventory valuation adjustment in the Enterprise Solutions Sector, andincreases in expenses related to long distance services and increased bad debtexpense in the Telecom Sector, which were offset by cost control measuresinitiated by management and reduced wages and benefits resulting from aredeployment of personnel to Selling, General and Administrative cost centersin the Information Solution Sector. The increase in 2003 compared to 2002 wasmainly due to higher service costs in the Telecom Sector associated withincreased customer counts in 2003 compared to 2002, which were offset by adecrease in bad debt expense of $1,126,000. In addition, in September of 2003,HickoryTech abandoned a CLEC initiative in a specific market. As a result ofthis operating decision, HickoryTech abandoned approximately $632,000 ofproperty, plant and equipment, which was written down to a carrying value ofzero in the third quarter of 2003.

 

12

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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (excluding Depreciationand Amortization) – Selling, general andadministrative expenses excluding depreciation and amortization were $1,564,000or 11.9% higher in 2004 compared to 2003, and $1,249,000 or 8.7% lower in 2003compared to 2002. The increase in selling, general and administrative expensesin 2004 compared to 2003 was largely due to costs associated with theimplementation of the Sarbanes-Oxley Act of 2002, higher post-retirementmedical costs, and increased wages and benefits resulting from a redeploymentof personnel from Cost of Services cost centers in the Information SolutionsSector. The decrease in selling, general and administrative expenses in 2003compared to 2002 was largely the result of a reduction in managementincentives, which are tied to financial metrics that were not achieved as aresult of the loss from discontinued operations recorded in 2003.

 

ASSET IMPAIRMENT – During 2002, HickoryTechwrote down the carrying value of an intangible asset relating to an agreementto develop a WDSL operation that also entitled HickoryTech to receive a shareof future revenues generated from the WDSL operations. The asset impairmentwrite-down was taken because of the bankruptcy of the third-party networkprovider and HickoryTech’s belief that the revenue sharing agreement would not resultin future cash flows. The $316,000 charge resulting from the write-down wasrecorded as a charge to operations of HickoryTech’s Telecom Sector and isreported as “Asset Impairment” in the consolidated statement of operations forthe year ended December 31, 2002.

 

DEPRECIATIONAND AMORTIZATION - Depreciation expense was $719,000 or4.8% higher in 2004 compared to 2003 and $1,303,000 or 9.6% higher in 2003compared to 2002. The increase in depreciation expense in 2004 compared to 2003was largely due to an increase in the Telecom Sector’s network assets, as wellas an increase related to the depreciation of billing software in theInformation Solutions Sector. The increase in depreciation expense in 2003compared to 2002 was primarily attributed to the increase in HickoryTech’s CLECand fiber optic networks. Amortization expense was $51,000 or 5.1% lower in2004 compared to 2003 and $645,000 or 39.3% lower in 2003 compared to2002.  The decrease in amortizationexpense in 2004 compared to 2003 was largely due to an intangible asset in theInformation Solutions Sector becoming fully amortized in the second quarter of2003. The decrease in amortization expense in 2003 compared to 2002 was largelydue to an intangible asset in the Information Solutions Sector becoming fullyamortized in the second quarter of 2003.

 

OPERATINGINCOME - Operating income was $2,758,000 or 13.7% lower in 2004compared to 2003 and $2,610,000 or 14.9% higher in 2003 compared to 2002. Thedecrease in operating income in 2004 compared to 2003 was largely due todecreased revenues in the Information Solutions and Enterprise SolutionsSectors, increased cost of services, increased selling, general andadministrative expenses in the Telecom and Information Solutions Sectors andincreased depreciation, which were partially offset by increased revenues inthe Telecom Sector and lower cost of products sold in the Enterprise Solutions.The increase in operating income from continuing operations in 2003 compared to2002 was largely due to increased network access revenues, increased CLECrevenues, decreased bad debts in the Telecom Sector and less incentivecompensation in 2003, which were partially offset by the increase in cost ofservices in the Telecom Sector and the decrease in the Information Solutionsand Enterprise Solutions Sectors’ revenues, all of which are described above.

 

INTEREST EXPENSE - Interest expense was$1,490,000 or 24.4% lower in 2004 compared to 2003 and $1,302,000 or 17.6%lower in 2003 compared to 2002. The decreases in interest expense fromcontinuing operations in 2004 and 2003 were primarily due to a decrease intotal debt outstanding. The outstanding balance of the revolving creditfacility was $102,500,000 at December 31, 2004, $118,500,000 at December 31,2003 and $158,000,000 at December 31, 2002, respectively.

 

INCOMEFROM CONTINUING OPERATIONS – Income from continuing operations was$791,000 or 9.4% lower in 2004 compared to 2003 and $2,220,000 or 35.6% higherin 2003 compared to 2002. The decrease in 2004 was largely due to decreasedrevenues in the Information Solutions and Enterprise Solutions Sectors,increased selling, general and administrative expenses in the Telecom Sectorand increased depreciation, which were partially offset by increased revenuesin the Telecom Sector, lower cost of products sold in the Enterprise SolutionsSector and lower interest expense. The increase in 2003 was largely due toincreased network access revenues, increased CLEC revenues, and decreased baddebt in the Telecom Sector, which were partially offset by the increase in costof services in the Telecom Sector, the decrease in the Information Solutionsand Enterprise Solutions Sectors’ revenues and the decrease in interestexpense, as described above.

 

13

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SECTOR RESULTS OF OPERATIONS

 

TELECOM SECTOR – Thefollowing table provides a breakdown of the Telecom Sector operating results.

 

**TELECOM SECTOR**

 
| **(Dollars in Thousands)**                                                             | ** ** | **2004**    | ** ** | **2003**   | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|----------|------------|
|                                                                                   |       |        | ** ** |       |       |     |       |
| Revenues Before Intersegment Eliminations                                              |       |        | ** ** |       |       |     |       |
| ILEC                                                                                   |       |        | ** ** |       |       |     |       |
| Local Service                                                                          | ** ** | **$**       | **15,231** | ** ** | $          | 15,179   |       | $ | 15,195 |   |
| Network Access                                                                         | ** ** | **33,064**  | ** ** | 33,881     |       | 32,377   |       |
| Data                                                                                   | ** ** | **2,152**   | ** ** | 1,821      |       | 1,499    |       |
| Intersegment                                                                           | ** ** | **275**     | ** ** | 275        |       | 274      |       |
| Other                                                                                  | ** ** | **6,747**   | ** ** | 7,099      |       | 7,459    |       |
| Total ILEC                                                                             | ** ** | **57,469**  | ** ** | 58,255     |       | 56,804   |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| CLEC                                                                                   |       |        | ** ** |       |       |     |       |
| Local Service                                                                          | ** ** | **3,657**   | ** ** | 3,482      |       | 2,900    |       |
| Network Access                                                                         | ** ** | **2,334**   | ** ** | 2,374      |       | 1,900    |       |
| Data                                                                                   | ** ** | **1,916**   | ** ** | 1,151      |       | 707      |       |
| Other                                                                                  | ** ** | **1,752**   | ** ** | 1,779      |       | 1,040    |       |
| Total CLEC                                                                             | ** ** | **9,659**   | ** ** | 8,786      |       | 6,547    |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Long Distance                                                                          | ** ** | **4,660**   | ** ** | 4,406      |       | 4,236    |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Internet                                                                               | ** ** | **4,030**   | ** ** | 3,810      |       | 3,563    |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Digital TV                                                                             | ** ** | **554**     | ** ** | 364        |       | 232      |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Total Telecom Revenues                                                                 | ** ** | **$**       | **76,372** | ** ** | $          | 75,621   |       | $ | 71,382 |   |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Total Telecom Revenues Before Intersegment  Eliminations                               |       |        | ** ** |       |       |     |       |
| Unaffiliated Customers                                                                 | ** ** | **$**       | **76,097** | ** ** | $          | 75,346   |       | $ | 71,108 |   |
| Intersegment                                                                           | ** ** | **275**     | ** ** | 275        |       | 274      |       |
| ** **                                                                             |       | **76,372**  | ** ** | 75,621     |       | 71,382   |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Cost of Services, excluding Asset  Impairment, Depreciation and Amortization           | ** ** | **29,723**  | ** ** | 28,071     |       | 27,540   |       |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **10,388**  | ** ** | 9,295      |       | 8,521    |       |
| Asset Impairment                                                                       | ** ** | **—**  | ** ** | —     |       | 316      |       |
| Depreciation and Amortization                                                          | ** ** | **13,752**  | ** ** | 13,160     |       | 12,326   |       |
| Operating Income                                                                       | ** ** | **$**       | **22,509** | ** ** | $          | 25,095   |       | $ | 22,679 |   |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Income from Continuing Operations, net of  Tax                                         | ** ** | **$**       | **13,352** | ** ** | $          | 14,941   |       | $ | 13,617 |   |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Loss from Discontinued Operations, net of  Tax                                         | ** ** | **(74**     | **)**      | (22,897    | )          | (24,164  | )          |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Net Income                                                                             | ** ** | **$**       | **13,278** | ** ** | $          | (7,956   | )          | $ | (10,547 | ) |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Capital Expenditures                                                                   | ** ** | **$**       | **16,100** | ** ** | $          | 10,719   |       | $ | 9,600 |   |
|                                                                                   |       |        | ** ** |       |       |     |       |
| ILEC Access Lines                                                                      | ** ** | **60,472**  | ** ** | 63,099     |       | 65,355   |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| CLEC Access Lines                                                                      |       |        | ** ** |       |       |     |       |
| Overbuild                                                                              | ** ** | **10,417**  | ** ** | 9,871      |       | 7,796    |       |
| Unbundled Network Element (UNE)                                                        | ** ** | **1,726**   | ** ** | 1,647      |       | 1,343    |       |
| Total Service Resale (TSR)                                                             | ** ** | **1,943**   | ** ** | 2,629      |       | 4,845    |       |
| Total                                                                                  | ** ** | **14,086**  | ** ** | 14,147     |       | 13,984   |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Long Distance Customers                                                                | ** ** | **43,702**  | ** ** | 40,366     |       | 35,566   |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Internet Customers                                                                     | ** ** | **17,191**  | ** ** | 16,132     |       | 14,420   |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Total Telecom Customers                                                                | ** ** | **135,451** | ** ** | 133,744    |       | 129,325  |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Digital Subscriber Line (DSL) Customers                                                | ** ** | **10,430**  | ** ** | 7,407      |       | 3,971    |       |
|                                                                                   |       |        | ** ** |       |       |     |       |
| Digital TV Customers                                                                   | ** ** | **1,941**   | ** ** | 1,179      |       | 803      |       |

 

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Revenues:

Telecom Sector operating revenues before intersegment eliminations were$751,000 or 1.0% higher in 2004 compared to 2003, and $4,239,000 or 5.9% higherin 2003 compared to 2002. The increases in 2004 were mainly driven by growth inCLEC data services as well as favorable increases in many product lines offsetby a decrease in ILEC and CLEC network access revenues.  The increases in 2003 and 2002 were primarilydue to increased ILEC network access and growth in the CLEC and Internetservice revenues.

 

ILEC network access revenue was $817,000 or 2.4% lower in 2004 comparedto 2003 and $1,504,000 or 4.6% higher in 2003 compared to 2002. The decrease in2004 was driven by the impact of carriers rerouting traffic, carrier billinginterpretations and lower minutes of use. Network access revenue had been flatin recent quarters. However, a combination of access reform, changing minutesof use (MOU), carriers rerouting traffic, and lower demand for dedicated linesmay negatively impact future access revenues. The increase in network accessrevenue in 2003 and 2002 was driven by higher demand for dedicated lines andhigh-speed circuits. This was partially offset by a decrease in access minutesin 2003 and 2002. HickoryTech’s ILEC operations establish traffic sensitiveaccess rates bi-annually in accordance with required regulation. The Companyexpects further declines in network access revenues when these rates areadjusted in mid-2005.

 

TheMinnesota Public Utilities Commission (PUC) has been considering intrastateaccess reform and universal service for several years (see regulatory section).

 

ILEC data revenue was $331,000 or 18.2% higher in 2004 compared to 2003and $322,000 or 21.5% higher in 2003 compared to 2002. The increase in bothyears is the result of increased digital subscriber line (DSL) customers inboth years.

 

CLEC localservice revenue was $175,000 or 5.0% higher in 2004 compared to 2003 and$582,000 or 20.1% higher in 2003 compared to 2002.  The increase in 2004 was driven primarily byan increase in revenues from business customers and local trunkingarrangements. In addition, in the second quarter of 2003, HickoryTech decidedto exit several exchanges in its Iowa territories, which utilized a resale ofservices approach. This exit decision meant that in 2003, HickoryTech stoppedproviding service for 734 customers. As a result, there was a modest impact onthe growth rates, which was the primary reason for the reduced level ofincrease in local service revenue in 2004 and 2003. The increase in 2003compared to 2002 was primarily the result of increased customers. The incumbentLEC businesses with whom HickoryTech competes are able to provide long distanceservice and face fewer restrictions on offering bundled services. A higherdegree of competition from the incumbent ILECs serving in the Company’s CLECmarkets, and from wireless substitution, could impact HickoryTech’s localservice revenue in future periods.

 

CLECnetwork access revenue was $40,000 or 1.7% lower in 2004 compared to 2003 and$474,000 or 24.9% higher in 2003 compared to 2002. The decrease in 2004 isdriven by a mandated rate decrease in June, 2004 for interstate traffic whichdecreased revenue $100,000 over the six month period of July through December,2004.  Network access revenue had beenflat in recent quarters; however, a combination of access reform, changingMOUs, carriers rerouting traffic and lower demand for dedicated lines couldnegatively impact future access revenues. The increase in 2003 compared to 2002is the result of increased penetration in CLEC communities.

 

CLECdata revenue was $765,000 or 66.5% higher in 2004 compared to 2003 and $444,000or 62.8% higher in 2003 compared to 2002. The increase in both years is theresult of increased residential and business DSL penetration in CLECcommunities, as well as the rollout of Ethernet services to large businesscustomers in 2004.

 

OtherCLEC revenue was $27,000 or 1.5% lower in 2004 compared to 2003, and $739,000or 71.1% higher in 2003 compared to 2002. The primary reason for the changes inother revenue was the revenue recognized as a result of services provided underterms of a multi-year contract awarded to HickoryTech effective July 1, 2002 toprovide Internet access and video conferencing to schools and libraries insouth central Minnesota served by the Project SOCRATES distance-learningnetwork. This service generated $25,000 less in 2004 compared to 2003 and$696,000 more revenue in 2003 compared to 2002.

 

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Long distance revenue was $254,000 or 5.8% higher in 2004 compared to2003, and $170,000 or 4.0% higher in 2003 compared to 2002. HickoryTechexperienced a 3,336 or 8.3% increase in its long distance customer base in2004, and a 4,800 or 13.5% increase in 2003. Although the customer base isincreasing, long distance revenue per customer is decreasing. The decrease inrevenue per customer is primarily the result of optional long distance callingplans available to customers, the increased use of Internet services, and otheralternatives to long distance services and the loss of a wholesale revenuecontract in June 2004 with a large wireless carrier. In 2003, a competitor ofHickoryTech received approval from the state of Minnesota to offer longdistance services in all HickoryTech territories. This competitor alreadyoffers local telephone service in HickoryTech’s CLEC territories, and with thisapproval has the potential to create stronger competition with HickoryTech inthese markets, which could result in a reduction in long distance revenue infuture periods.

 

Internet revenue was $220,000 or 5.8% higher in 2004 compared to 2003and $247,000 or 6.9% higher in 2003 compared to 2002. The increase in revenuewas caused primarily by an increase in Internet customers of 1,059 or 6.6% in2004 compared to 2003 and an increase of 1,712 or 11.9% in 2003 compared to2002.

 

Digital TV revenue was $190,000 or 52.2% higher in 2004 compared to2003 and $132,000 or 56.9% higher in 2003 compared to 2002. The increase inboth years is the result of increased penetration and offering Digital TV in anadditional community in 2004.  Customercounts increased 762 or 64.6% in 2004 compared to 2003.

 

Cost of Services, excluding Asset Impairment, Depreciation andAmortization:

Cost of services, excluding asset impairment, depreciation andamortization was $1,652,000 or 5.9% higher in 2004 compared to 2003 and$531,000 or 1.9% higher in 2003 compared to 2002. The increase in 2004 isprimarily due to increases in expenses related to long distance services thatincreased in conjunction with the corresponding increase in long distancecustomers and revenue, increased billing expenses for bill and data processing,increased bad debt expense due to a carrier bankruptcy, and carrier disputes.Because of the carrier bankruptcy, HickoryTech recognized approximately $421,000of bad debt expense in 2004. HickoryTech is currently pursuing legal remediesto recover a portion of this expense. As of December 31, 2004, HickoryTechcannot estimate the potential recovery. Any potential recovery will berecognized in 2005. The increase in 2003 compared to 2002 is due to HickoryTechabandoning a CLEC initiative in a specific market in September of 2003. As aresult of this operating decision, HickoryTech abandoned approximately $632,000of property, plant and equipment, which was written down to a carrying value ofzero in the third quarter of 2003. In addition, higher service costs associatedwith increased customer counts in 2003 compared to 2002 were partially offsetby a decrease in bad debt expense of $1,126,000.

 

Selling, General and Administrative Expenses (excluding Depreciationand Amortization):

Selling, general and administrative expenses, excluding depreciationand amortization were $1,093,000 or 11.8% higher in 2004 compared to 2003 and$774,000 or 9.1% higher in 2003 compared to 2002. The increase in selling,general and administrative expenses in 2004 compared to 2003 was largely due tocorporate allocations, higher real estate taxes and higher post-retirementmedical costs. The increase in selling, general and administrative expenses in2003 compared to 2002 was largely due to increased regulatory fees and anincrease in fees paid to outside consultants for cost studies done for theHeartland subsidiary.

 

Asset Impairment Charges:

During 2002,HickoryTech wrote down the carrying value of an intangible asset relating to anagreement to develop a wireless DSL (WDSL) operation that also entitledHickoryTech to receive a share of future revenues generated from the WDSLoperations.  The asset impairmentwrite-down was taken because of the bankruptcy of the third-party networkprovider and HickoryTech’s belief that the revenue sharing agreement would notresult in future cash flows. The $316,000 charge resulting from the write-downwas recorded as a charge to operations of HickoryTech’s Telecom Sector and isreported as “Asset Impairment” in the consolidated statement of operations forthe year ended December 31, 2002.

 

 

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Depreciation and Amortization:

Depreciation and amortization was $592,000 or 4.5% higher in 2004compared to 2003 and $834,000 or 6.8% higher in 2003 compared to 2002. Theincrease is largely attributed to increased capital expenditures for networkinfrastructure.  Depreciation expense was$565,000 or 4.3% higher in 2004 compared to 2003, and $903,000 or 7.4% higherin 2003 compared to 2002, due to the expansion of HickoryTech’s CLEC and fiberoptic networks.  Depreciation expense was$323,000 or 3.5% higher in 2004 compared to 2003 and $447,000 or 5.0% higher in2003 compared to 2002 due to the networks associated with its ILECproduct.  Depreciation expense was$242,000 or 6.5% higher in 2004 compared to 2003 and $456,000 or 13.9% higherin 2003 compared to 2002 due to the networks associated with its CLEC product.Depreciation expense is expected to decrease approximately $600,000 in 2005 dueto several assets being fully depreciated. Amortization expense was $27,000 or35.2% higher in 2004 compared to 2003, and $69,000 or 47.3% lower in 2003compared to 2002.

 

Operating Income and Income from Continuing Operations, net of Tax:

Operating income was $2,586,000 or 10.3% lower in 2004 compared to2003, and $2,416,000 or 10.7% higher in 2003 compared to 2002. Income fromcontinuing operations, net of tax was $1,589,000 or 10.6% lower in 2004compared to 2003, and $1,324,000 or 9.7% higher in 2003 compared to 2002. Thedecrease in both operating and income from continuing operations, net of tax,in 2004 compared to 2003 is largely due to decreased network access revenuesand increased expenses for billing services, corporate allocations, bad debt,long distance service expenses and real estate taxes.  The increase in both operating and incomefrom continuing operations, net of tax in 2003 compared to 2002 was largely dueto increased network access revenues, increased CLEC revenues, and decreasedbad debts.

 

Discontinued Operations:

On December 15, 2003, HickoryTechsold its wireless business, Minnesota Southern Wireless Company (MSWC), toWestern Wireless Corporation (WWC). The wireless operations are reported aspart of the Telecom sector.  Theconsolidated statements of operations for all periods presented have beenrestated to reflect wireless operations as discontinued operations.

 

INFORMATION SOLUTIONS – The following tableprovides a breakdown of the Information Solutions Sector operating results.

 

**INFORMATION SOLUTIONS SECTOR**

 
| **(Dollars in Thousands)**                                                             | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|----------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Revenues Before Eliminations                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Unaffiliated Customers                                                                 | ** ** | **$**      | **2,710**  | ** ** | $          | 3,199      |       | $ | 4,249 |   |
| Intersegment                                                                           | ** ** | **4,346**  | ** ** | 3,203      |       | 3,154      |       |
| ** **                                                                             |       | **7,056**  | ** ** | 6,402      |       | 7,403      |       |
| Cost of Services, excluding Depr. and  Amort.                                          | ** ** | **6,318**  | ** ** | 7,002      |       | 7,182      |       |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **981**    | ** ** | 600        |       | 1,107      |       |
| Depreciation and Amortization                                                          | ** ** | **2,556**  | ** ** | 2,376      |       | 2,403      |       |
|                                                                                   |       |       | ** ** |       |       |       |       |
| Operating Loss                                                                         | ** ** | **$**      | **(2,799** | **)**      | $          | (3,576     | )          | $ | (3,289 | ) |
| Net Loss                                                                               | ** ** | **$**      | **(1,692** | **)**      | $          | (2,329     | )          | $ | (2,131 | ) |
|                                                                                   |       |       | ** ** |       |       |       |       |
| Capital Expenditures                                                                   | ** ** | **$**      | **486**    | ** ** | $          | 161        |       | $ | 2,472 |   |
|                                                                                        |            |            |            |            |            |            |            |  |  |  |  |

 

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Revenues:

Revenues from unaffiliated customers decreased $489,000 or 15.3% in2004 compared to 2003, and decreased $1,050,000 or 24.7% in 2003 compared to2002. The decrease in operating revenues in 2004 compared to 2003 was largelydue to the loss of several customers which reduced operating revenues by$885,000 and a $192,000 decrease in volume for a couple of existing customers.Temporary billing services performed for a customer obtained at the end of 2003increased operating revenues by $428,000 in 2004 compared to 2003, whileincreased revenues from a new SuiteSolution customer and increased processingfees from an existing customer of $166,000 in 2004 compared to 2003, partiallyoffset other revenue declines. The decrease in operating revenues in 2003compared to 2002 was due to batch-processing customers experiencing asignificant decrease in volumes amounting to $659,000, and the loss ofbatch-processing customers amounting to $583,000. However, the Company didestablish relationships with new customers employing their SuiteSolutionproduct increasing revenues by $189,000, which partially offset the loss ofbatch processing customers. At the end of 2003, a customer hired the Company todo temporary billing services on its behalf, which also increased revenues by$54,000 in 2003 compared to 2002. This temporary work ended in 2004.  

 

Cost of Services, excluding Depreciation and Amortization:

Cost of services, excluding depreciation and amortization decreased$684,000 or 9.8% in 2004 compared to 2003, and decreased $180,000 or 2.5% in2003 compared to 2002. The decrease in cost of services in 2004 compared to2003 was largely due to cost control measures initiated by management andreduced wages and benefits resulting from a redeployment of personnel toSelling, General and Administrative cost centers. The decrease in cost ofservices in 2003 compared to 2002 primarily reflects cost control measuresinitiated by management.

 

Selling, General and Administrative Expenses (excluding Depreciationand Amortization):

Selling, general and administrative expenses, excluding depreciationand amortization increased $381,000 or 63.5% in 2004 compared to 2003 anddecreased $507,000 or 45.8% in 2003 compared to 2002. The increase in selling,general and administrative expenses in 2004 compared to 2003 was largely due toincreased wages and benefits resulting from a redeployment of personnel fromCost of Services cost centers. The decrease in selling, general andadministrative expenses in 2003 compared to 2002 was primarily the result ofmanagement actions aimed at reducing expenses, a reduction in managementincentives, which are tied to consolidated financial metrics that were notachieved and a decrease in bad debt expense.

 

Depreciation and Amortization:

Depreciation and amortization increased $180,000 or 7.6% in 2004compared to 2003, and decreased $27,000 or 1.1% in 2003 compared to 2002. Theincrease in depreciation and amortization in 2004 compared to 2003 wasprimarily attributable to increased depreciation associated with new billingsoftware, which started amortizing in the second quarter of 2003. Amortizationceased in the second quarter of 2003 for the billing software product WRITE2K.However, amortization started in the second quarter of 2003 for the billingsoftware developed in 2002 and 2003. The net result was a slight decrease indepreciation and amortization in 2003 compared to 2002.  Depreciation expense is expected to decreaseapproximately $130,000 in 2005 due to several assets being fully depreciated.

 

Operating and Net Loss:

Operating loss decreased $777,000 or 21.7% in 2004 compared to 2003,and increased $287,000 or 8.7% in 2003 compared to 2002. Net loss decreased$637,000 or 27.4% in 2004 compared to 2003, and increased $198,000 or 9.3% in 2003compared to 2002. The decrease in operating loss and net loss in 2004 comparedto 2003 was largely due to increases in intersegment revenues, offset by adecrease in revenues from unaffiliated customers, an increase in cost ofservices excluding depreciation and amortization, an increase in selling,general and administrative expenses excluding depreciation and amortization andan increase in depreciation and amortization. The increase in operating lossand net loss in 2003 compared to 2002 was primarily attributable to thedecrease in operating revenues.

 

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ENTERPRISESOLUTIONS – The following table provides a breakdown of theEnterprise Solutions Sector operating results.

 

**ENTERPRISE SOLUTIONS SECTOR**

 
| **(Dollars in Thousands)**                                                             | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|----------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Revenues Before Intersegment Eliminations                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Installation                                                                           | ** ** | **$**      | **4,492**  | ** ** | $          | 6,209      |       | $ | 7,970 |   |
| Service                                                                                | ** ** | **7,216**  | ** ** | 8,138      |       | 7,811      |       |
|                                                                                   | ** ** | **11,708** | ** ** | 14,347     |       | 15,781     |       |
| ** **                                                                             |       | ** ** | ** ** |       |       |       |       |
| Cost of Products Sold                                                                  | ** ** | **8,211**  | ** ** | 10,216     |       | 10,638     |       |
| Cost of Services, excluding Depr. and  Amort.                                          | ** ** | **2,075**  | ** ** | 1,749      |       | 1,576      |       |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **3,152**  | ** ** | 3,494      |       | 3,316      |       |
| Depreciation and Amortization                                                          | ** ** | **171**    | ** ** | 246        |       | 263        |       |
| ** **                                                                             |       | **13,609** | ** ** | 15,705     |       | 15,793     |       |
|                                                                                   |       |       | ** ** |       |       |       |       |
| Operating Loss                                                                         | ** ** | **$**      | **(1,901** | **)**      | $          | (1,358     | )          | $ | (12 | ) |
| Net Loss                                                                               | ** ** | **$**      | **(1,131** | **)**      | $          | (818       | )          | $ | (41 | ) |
|                                                                                   |       |       | ** ** |       |       |       |       |
| Capital Expenditures                                                                   | ** ** | **$**      | **24**     | ** ** | $          | 201        |       | $ | 95 |   |

 

Revenues:

Revenues were $2,639,000 or 18.4% lower in 2004 compared to 2003, and$1,434,000 or 9.1% lower in 2003 compared to 2002. Installation revenue was$1,717,000 or 27.7% lower in 2004 compared to 2003 and $1,761,000 or 22.1%lower in 2003 compared to 2002. The decrease in installation revenue in 2004compared to 2003 was largely due to a decrease in sales and installations ofprivate branch exchange (PBX) systems of $1,299,000 or 60.5%. The decrease ininstallation revenue in 2003 compared to 2002 was primarily a result of adecrease in sales and installations of PBX systems of $2,173,000 or 50.3%.****Service revenue was $922,000 or 11.3%lower in 2004 compared to 2003 and $327,000 or 4.2% higher in 2003 compared to2002.****This sector has encounteredacross the board reductions in demand in all of its major products andservices. The reduction started in early 2002, and is believed to be associatedwith the economy’s effect on customers of this sector, and due to changingtechnology (i.e. voice vs. data protocol) in the communications products, whichthis sector provides. Due to the uncertainty of the economy and the effect ofsuch economic uncertainty on customer buying decisions, HickoryTech cannotestimate when customer demand for these products and services may return tohigher levels.

 

Cost of Products Sold:

Cost of products sold decreased $2,005,000 or 19.6% in 2004 compared to2003, and decreased $422,000 or 4.0% in 2003 compared to 2002. Gross profitmargin for this sector was 29.9%, 28.8% and 32.6% in 2004, 2003 and 2002,respectively. The decrease in costs of products sold was the result of thedecreased installation work in 2004 and 2003. The decrease in gross profitmargin in 2003 compared to 2002 is the result of lower margins associated withtwo large system installations performed in 2003. These margins are primarilyaffected by product mix sold and an increased cost of labor due to a higherdegree of technical skill needed with advanced systems.

 

Cost of Services, excluding Depreciation and Amortization:

Cost of services excluding depreciation and amortization increased$326,000 or 18.6% in 2004 compared to 2003, and increased $173,000 or 11.0% in2003 compared to 2002. The increase in cost of services excluding depreciationand amortization in 2004 compared to 2003 was largely the result of a $700,000inventory valuation adjustment, which was offset by decreased maintenanceexpense associated with customer contracts. The increase in cost of servicesexcluding depreciation and amortization in 2003 compared to 2002 was largelythe result of increased maintenance expense associated with customer contracts.

 

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Selling, General and Administrative Expenses, excluding Depreciationand Amortization:

Selling,general and administrative expenses, excluding depreciation and amortizationdecreased $342,000 or 9.8% in 2004 compared to 2003, and increased $178,000 or5.4% in 2003 compared to 2002. The decrease in selling, general andadministrative expenses in 2004 compared to 2003 was primarily due to costreduction measures, which included reduced wages and benefits from attrition ofpersonnel. The increase in selling, general and administrative expenses in 2003compared to 2002 was primarily due to increases in bad debt, benefits andinsurance.

 

Depreciation and Amortization:

Depreciationand amortization decreased $75,000 or 30.5% in 2004 compared to 2003, anddecreased $17,000 or 6.5% in 2003 compared to 2002. The decrease in 2004 and2003 was the result of certain assets becoming fully depreciated.

 

Operating and Net Loss:

Operatingloss was $1,901,000 in 2004 compared to operating loss of $1,358,000 in 2003,and operating loss of $12,000 in 2002. Net loss in 2004 was $1,131,000 comparedto net loss of $818,000 in 2003 and net loss of $41,000 in 2002. The lossesgenerated in 2004, 2003 and 2002 and the year to year changes during the periodfrom 2002 through 2004 resulted primarily from the changes in operatingrevenues and the $700,000 inventory valuation adjustment described above.

 

**INTEREST EXPENSE**

Interestexpense was $1,490,000 or 24.4% lower in 2004 compared to 2003 and $1,302,000or 17.6% lower in 2003 compared to 2002. The decrease in interest expense from continuing operations in 2004 wasprimarily due to a decrease in total debt outstanding.  The outstanding balance of the revolving creditfacility was $102,500,000 at December 31, 2004 and $118,500,000 at December 31,2003. The decrease in interest expense from continuing operations in 2003 wasalso primarily due to a decrease in total debt outstanding.  The outstanding balance of the revolvingcredit facility was $118,500,000 on December 31, 2003 and $158,000,000 on December 31,2002.

 

**INCOME TAXES**

Theeffective tax rate for continuing operations was 40.4%, 40.2% and 40.5% in2004, 2003 and 2002, respectively. These effective tax rates differ from theU.S. statutory rate primarily due to state income taxes.

 

**CRITICAL ACCOUNTING POLICIES**

Management’sdiscussion and analysis of financial condition and results of operations statedin this Form 10-K are based upon HickoryTech’s consolidated financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the United States of America and, where applicable,conform to the accounting principles as prescribed by federal and statetelephone utility regulatory authorities. HickoryTech presently givesaccounting recognition to the actions of regulators where appropriate, asprescribed by Statement of Financial Accounting Standards (SFAS) No. 71, “Accountingfor the Effects of Certain Types of Regulation.”  The preparation of these financial statementsrequires management to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues, and expenses and related disclosureof contingent assets and liabilities. Management believes that the application of the accounting policies,which are important to HickoryTech’s financial position and results ofoperations, requires significant judgments and estimates on the part ofmanagement.  Senior management hasdiscussed the development and selection of accounting estimates and the relatedMD&A disclosure with the Audit Committee. For a summary of all HickoryTech’s accounting policies, see Note 1 ofthe Notes to Consolidated Financial Statements.

 

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**Revenue Recognition** – Revenuesare recognized when services are rendered or products are delivered tocustomers. Revenues in the Telecom Sector are earned from monthly billings tocustomers for telephone service. ILEC revenues are also derived from chargesfor network access to HickoryTech’s local exchange telephone network, fromsubscriber line charges and from contractual arrangements for services such asbilling and collection and directory advertising. Certain of these revenues arerealized under pooling arrangements with other telephone companies and are dividedamong the companies based on respective costs and investments to provide theservices. The companies that take part in these pooling arrangements may adjusttheir costs and investments for a period of two years, which causes the dollarsdistributed by the pool to be adjusted retroactively. Management believes thatrecorded amounts represent reasonable estimates of the final distribution fromthese pools. However, to the extent that companies participating in these poolsmake adjustments, there will be adjustments to recorded revenues in futureperiods.

 

Revenuein the Enterprise Solutions Sector earned on major installation and changecontracts is recognized using the percentage of completion method, which relieson measuring actual contract completion versus estimates of total expectedcontract revenue and costs. The percentage of completion method is used sincereasonably dependable estimates of the revenue and costs applicable to variousstages of a contract can be made. Recognized revenues and profit are subject torevisions as the contract progresses to completion. Revisions in profitestimates are charged to income in the period in which the facts that give riseto the revision become known.

 

**Allowance for Doubtful Accounts –** HickoryTech’sallowance for doubtful accounts is an estimate based on specifically identifiedaccounts as well as less specific reserves established based upon historicalcollection experience. HickoryTech evaluates specific accounts where it hasinformation that the customer may have an inability to meet its financialobligations, the customer is delinquent or the customer may dispute thecharges. In these cases, management uses its judgment, based on the bestavailable facts and circumstances, and records a specific reserve for thatcustomer against amounts due to reduce the receivable to the amount that isexpected to be collected. These specific reserves are reevaluated and adjustedas additional information is received that impacts the amount reserved.HickoryTech also establishes a less specific reserve for all customers based ona range of percentages applied to aging categories. These percentages are basedon historical collection and write-off experience. If circumstances change,HickoryTech’s estimates of the recoverability of amounts due the Company couldbe reduced or increased by a material amount. Such a change in estimatedrecoverability would be accounted for in the period in which the facts thatgive rise to the change become known. The allowance for doubtful accounts was$1,256,000 and $1,283,000 as of December 31, 2004 and 2003, respectively.

 

**Inventories –** Similar to its allowance for doubtfulaccounts, HickoryTech makes estimates related to the valuation of inventory.HickoryTech adjusts its inventory carrying value for estimated obsolescence orunmarketable inventory to the estimated market value based upon assumptionsabout future demand and market conditions. As market and other conditionschange, additional inventory write-downs may be required at the time that thefacts that give rise to the lower value become known.

 

**Intangible Assets –**HickoryTechamortizes its intangible assets over their estimated useful lives. The customerlists and other intangibles are amortized from 5-8 years.

 

Goodwillassets are subject to an impairment test annually as well as upon certainevents that indicate that an impairment may be present. The goodwill impairmenttest includes two steps, the first of which requires management to determinethe fair value of certain of the Company’s reporting units (as defined by SFASNo. 142).  The Company determines thefair value of their reporting units by application of a discounted cash flowanalysis. Management makes estimates that are included in their discounted cashflow analyses based upon the best available information at the time that thedeterminations of fair value are made. If circumstances change, HickoryTech’s estimates of fair value will alsochange and could result in a determination of additional impairment charges toreduce the carrying value of goodwill.

 

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**Income Taxes –** As part of the process of preparing ourconsolidated financial statements the Company is required to estimate incometaxes in each of the jurisdictions in which it operates. This process involvesestimating current tax exposure together with assessing temporary differencesresulting from differing treatment of items, such as deferred revenue, for taxand accounting purposes. These differences result in deferred tax assets andliabilities, which are included within the Company’s consolidated balancesheet. The Company assesses the likelihood that deferred tax assets will berecovered from future taxable income and to the extent recovery is not likely,it establishes a valuation allowance. To the extent the Company establishes avaluation allowance or increases this allowance in a period, it must include anexpense within the tax provision in the statement of operations.  The Company has established a $1,205,000 and$640,000 valuation allowance at December 31, 2004 and 2003, respectivelydue to uncertainty about realization of benefits associated with net operatinglosses generated in the state of Iowa. Additionally, the Company has reservesfor income tax contingencies. These reserves relate to various tax yearssubject to audit by tax authorities. The Company believes its current incometax reserves are adequate. However, the ultimate outcome may differ from ourestimates and assumptions could impact the provision for income taxes reflectedin the consolidated statements of operations.

 

**Post-Retirement Benefits –**The net post-retirement benefit expense was$1,127,000, $717,000 and $637,000 in 2004, 2003 and 2002, respectively.Post-retirement benefit expense is recorded in cost of services and selling,general and administrative expenses. The post-retirement benefit expense andliability are calculated utilizing various actuarial assumptions andmethodologies. These assumptions include, but are not limited to, the discountrate and the expected health care cost trend rate. The discount rate assumptionis based on the rates of return on high-quality, fixed-income instrumentscurrently available whose cash flows match the timing and amount of expectedbenefit payments. The health care cost trend rate is based upon an evaluationof the historical trends and experience, taking into account current andexpected market conditions. The health care cost trend rate represents theexpected annual rate of change in the cost of health care benefits currentlyprovided due to factors other than changes in the demographics of planparticipants. If the assumptions utilized in determining the post-retirementbenefit expense and liability differ from actual events, the results of operationsfor future periods could be impacted.

 

In measuring the accumulated post-retirement benefitobligation as of December 31, 2004, the Company assumed a discount rate of5.75%. The reduction in the discount rate by 25 basis points would increase theaccumulated post-retirement benefit obligation by approximately $170,000 as of December 31,2004 and would increase the net periodic cost by approximately $37,000. Inmeasuring the accumulated post-retirement benefit obligation as of December 31,2004, the initial health care inflation rate for 2005 was assumed to be 8%which decreases 0.5% each year until it reaches 4.5% in 2012 and remains at4.5% for the years thereafter. These assumptions were provided based on a studyof the ten year history of the Company’s self-funded medical benefits plan, andprovide results unique to the Company’s philosophy of controlling risingmedical costs. This has resulted in the Company consistently having lowerincreases in health care costs than the national averages. Aone-percentage point increase in the health care inflation rate for each yearwould increase the accumulated post-retirement benefit obligation by$1,360,000. A one-percentage point decrease in the health care inflation ratefor each year would decrease the accumulated post-retirement benefit obligationby $1,097,000.

 

When actual events differ from the assumptions orwhen the assumptions used change, an unrecognized actuarial gain or lossresults. As of December 31, 2004, the unrecognized net actuarial loss was$3,685,000. During each of the last three years, the Company has adjusted thediscount rate assumption due to changes in interest rates. In recent years, theCompany has adjusted the health care cost trend rate assumption to reflect thecurrent trend of medical costs. The remainder of the net actuarial loss amountprimarily related to differences between the assumed medical costs and actualexperience and changes in the employee population.

 

**INFLATION**

Itis the opinion of management that the effects of inflation on operatingrevenues and expenses over the past three years have been immaterial.Management anticipates that this trend will continue in the near future.

 

**DIVIDENDS**

HickoryTechpaid dividends of $5,717,000, or $0.44 per share, in 2004. The dividend pershare rate for 2004 was the same as in 2003 and 2002. HickoryTech has announceda first quarter dividend of $0.12 per share in 2005, and if it is continued atthat rate would produce an annual dividend of $0.48, an increase of 9%, whichis not expected to negatively impact the liquidity of HickoryTech.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

**CAPITAL STRUCTURE** – The totalcapital structure (long-term and short-term obligations plus shareholders’equity) for HickoryTech was $134,529,000 at December 31, 2004, reflecting23.4% equity and 76.6% debt.  Thiscompares to a capital structure of $148,329,000 at December 31, 2003,reflecting 19.4% equity and 80.6% debt. The improvement in this position is theresult of the recurring nature of HickoryTech’s operating cash flow, consistentcapital expenditures and dividends, and the proven pace at which the Company isreducing its debt. Management believes adequate internal and external resourcesare available to finance ongoing operating requirements, including capitalexpenditures, business development, debt service and the payment of dividendsfor at least the next twelve months.

 

**CASHFLOWS**– Cash flowsfrom operations continue to be a steady source of funds for HickoryTech,primarily resulting from the Telecom Sector. Cash provided from operations was$34,872,000 in 2004, $36,749,000 in 2003 and $34,667,000 in 2002. Cash flowsfrom operations in 2004 were primarily attributable to net income plus non-cashexpenses, including depreciation and amortization of $16,535,000, and$4,602,000 of deferred taxes. Cash flows in 2003 were primarily attributable tonet loss offset by non-cash expenses, including depreciation and amortizationof $17,638,000, the $25,345,000 asset impairment charges that occurred indiscontinued operations, and $4,817,000 of deferred taxes. Cash flows fromoperations in 2002 were primarily attributable to net loss offset by non-cashexpenses, including depreciation and amortization of $17,789,000 and the$41,951,000 asset impairment charges, which were partially offset by a deferredincome tax benefit of $9,804,000.

 

Cashused in investing activities was $13,968,000 in 2004, while cash provided byinvesting activities was $6,979,000 in 2003 and cash used in investingactivities was $16,331,000 in 2002. Capital expenditures were $16,612,000 in2004, $13,570,000 in 2003 and $16,674,000 in 2002. Capital expenditures wereincurred to construct additional network facilities to provide CLEC servicesand expansion of fiber optic networks. HickoryTech expects capital expenditures in 2005 to be approximately$24,000,000.  There were $2,600,000redemptions of investments in 2004 and $4,144,000 in 2003. Pursuant toconditions of its debt agreement, which allows the Company to reduce its equityinvestment in one of its lenders by an amount equal to 10% of the annualprincipal payments of the term loan component of its debt, the Company reducedits equity investment by $2,600,000 in 2004 and $4,100,000 in 2003. Further,the Company will be entitled to further reduce its equity investment by$2,100,000 in 2005. The remaining $44,000 redemption of investments in 2003represents the Information Solutions Sector’s share in the National IndependentBilling Partnership, which was dissolved in 2003. The sale of HickoryTech’swireless business provided $16,246,000 of cash in 2003.

 

Cashused in financing activities was $20,925,000 in 2004, $45,324,000 in 2003 and$18,470,000 in 2002. In 2004, cash was primarily used to repay $16,000,000 ofborrowings and to pay dividends of $5,717,000. In 2003, cash was primarily usedto repay $39,500,000 of borrowings and to pay dividends of $6,150,000. In 2003,cash was also used to repurchase 66,600 shares of common stock underHickoryTech’s repurchase plan for $661,000, and to retire 18,370 shares ofcommon stock from a compensation plan trust account for $185,000. In 2002, cashwas used primarily to repay $12,000,000 of borrowings, to repurchase commonstock under HickoryTech’s repurchase plan for $1,072,000 and to pay dividendsof $6,170,000.

 

**WORKING CAPITAL –**Workingcapital was $787,000 as of December 31, 2004 compared to working capitalof $9,300,000 as of December 31, 2003. The ratio of current assets to current liabilities was 1.0 to 1.0 as of December 31,2004 and 1.7 to 1.0 as of December 31, 2003. The Company’s credit facilityhas contractual decreases in size, which take place in quarterly increments.Due to the facility decreases in the fourth quarter of 2005, $4,000,000 of theCompany’s long-term debt was reclassified into current portion of long-termdebt in 2004. This classification of debt caused the large reduction in theratio of current assets to current liabilities in 2004 compared to 2003.

 

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**LONG-TERM OBLIGATIONS**–HickoryTech’s long-term obligations as of December 31, 2004, were$97,661,000, excluding current maturities of $5,323,000. As of December 31,2004, HickoryTech had a $118,813,000 credit facility with a syndicate ofbanks.  The credit facility is comprisedof a $107,813,000 revolving credit component and an $11,000,000 term loancomponent. The available line of credit on the $107,813,000 revolving creditcomponent began decreasing in increments in March 2004, and has a finalmaturity date in September 2008. However, since not all of the availablerevolving credit has been utilized as of December 31, 2004, the payment schedule isas follows: 2005 – $4,000,000, 2006 – $26,562,000, 2007 – $32,813,000 and 2008– $28,125,000. The term loan component requires equal quarterly principalpayments of $250,000 during the period of March 2001 to December 2008,and $7,000,000 in the first quarter in 2009. The weighted average interest rateassociated with this credit facility varies with LIBOR and certain otherrates.  The weighted average interestrate was 4.0% at December 31, 2004 and 4.1% at December 31, 2003.HickoryTech has implemented fixed interest terms on various portions of theoverall debt outstanding for varying terms. The longest fixed interest term, on $60,000,000 of the debt, is fixeduntil June 2008. Another fixed interest term, on $20,000,000 of the debt,is fixed until June, 2005. As of December 31, 2004, HickoryTech had drawn$102,500,000 on this credit facility and had $16,313,000 of availablecredit.  Management believes theremaining available credit is sufficient to cover future cash requirements.

 

HickoryTech’sInformation Solutions Sector leases certain computer equipment under capitallease arrangements.  This sector recordedadditions to property, plant and equipment of $81,000, $660,000, and $618,000in 2004, 2003 and 2002, respectively, related to these capital leasearrangements.

 

HickoryTechcontinually monitors the interest rates on its bank loans and has implementedfixed interest terms on various portions of the overall debt outstanding forvarying terms. A lower level of interest expense is likely to occur in 2005because of the large reduction in principle amounts outstanding.

 

Thefollowing table sets forth HickoryTech’s contractual obligations, along withthe cash payments due each period. Interest on long-term debt is estimatedusing the interest rate as of December 31, 2004.

 
| ** **                          | ** ** | **Payments Due by Year****(Dollars in Thousands)** | ** ** |
|-------------------------------------|------------|----------------------------------------------------|------------|
| ** **                          | ** ** | **Total**                                          | ** ** | **2005** | ** ** | **2006 to  2008** | ** ** | **2009 to  2010** | ** ** | **2011 and  after** | ** ** |
| Contractual  Obligations            |       |                                               |       |   |   |   |   |   |   |   |   |
| Long-term  Debt                     |       | $                                                  | 102,500    |   | $ | 5,000 |   | $ | 90,500 |   | $ | 7,000 |   | $ | — |   |
| Interest on  Long-term Debt         |       | 11,266                                             |       | 4,210 |   | 6,953 |   | 103 |   | — |   |
| Capital  Lease Obligations          |       | 484                                                |       | 323 |   | 161 |   | — |   | — |   |
| Interest on  Capital Leases         |       | 23                                                 |       | 16 |   | 7 |   | — |   | — |   |
| Purchase  Obligations               |       | 3,177                                              |       | 3,177 |   | — |   | — |   | — |   |
| Operating  Leases                   |       | 3,204                                              |       | 1,090 |   | 1,399 |   | 367 |   | 348 |   |
| Total  Contractual Cash Obligations |       | $                                                  | 120,654    |   | $ | 13,816 |   | $ | 99,020 |   | $ | 7,470 |   | $ | 348 |   |

 

Thefollowing table sets forth the total line of credit expirations as follows:

 
| ** **                 | ** ** | **Amount of Commitment Expiration  per Year****(Dollars in Thousands)** | ** ** |
|----------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                 | ** ** | **Total**                                                               | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** |
| Revolving Credit Component |       | $                                                                       | 107,813    |   | $ | 20,313 |   | $ | 26,562 |   | $ | 32,813 |   | $ | 28,125 |   | $ | — |   |
|                            |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**CONSTRUCTION PLANS**– Beginning in 2004, HickoryTech embarked ona five-year network enhancement program in its core telephone property inMankato in support of its broadband service strategy. The Company will addapproximately $20,000,000 in total to the network over the next four years, inaddition to the historical levels of capital spending prior to 2004. Managementbelieves that the enhancement will support the broadband product deploymentstrategies of the future, as well as serving as defense against competition inits core market. These upgrades to an already state of the art network willgive HickoryTech the capability to offer more diversified services to its corecustomer base.

 

**REGULATORY ASSET AND LIABILITY**– Effective January 1, 2002, the FederalCommunications Commission (FCC), in its “MAG (Multi Association Group) Order”on Access Charge Reform, directed all rate-of-return carriers to file revisionsto their tariffs to eliminate the transport interconnection charge (TIC) as aseparate rate element. In effect, the costs previously recovered through theTIC were reallocated over all other access categories, including carrier commonline, transport, local switching, information surcharge and special access. TheFCC made it clear that “this tariff filing should be a revenue neutral tarifffiling.”

 

Thetotal revenues reallocated from the TIC to the remaining access elements werelimited to the total revenues recovered from the TIC for the twelve-monthperiod ended June 30, 2001. These revenues were calculated using thecarrier’s traffic volumes and the TIC rate for the twelve-month period ended June 30,2001. These calculations were prepared by an independent third-party and approvedby NECA. TIC was eliminated by reallocating the costs to the other accessbilling categories.

 

TheFCC conducted an investigation of all tariff filings, including NECA’s(National Exchange Carrier Association) CCL (Carrier Common Line) tariff andHeartland’s Traffic Sensitive (TS) tariff, to determine if the filing partieshad properly reallocated the TIC costs among the other access chargecategories.

 

TheFCC terminated its investigation of several tariff filings, concluding that “thecarriers have substantially complied with the Rate-of-Return Access ChargeReform Order and their tariffs no longer warrant investigation.” Despite thisruling by the FCC during the fourth quarter of 2003, NECA informed HickoryTech’sHeartland subsidiary that it would not allow it to recover a portion of the TICcosts allocated to the CCL, because an incorrect TIC rate was used in thecalculation.

 

Asa result of this billing error, the Company recovered $611,000 of excessrevenues from the NECA CCL pool. NECA required Heartland to repay the $611,000in 2004.

 

TheFCC approved a mid-course correction to Heartland’s TS tariff as a supportablemethod of recouping NECA’s CCL reduction. The revision corrects the TIC rateoriginally used, and factors recovery of the $611,000, into the TS rateelements. HickoryTech is recouping this revenue over the remaining eighteenmonths of the TS tariff, which began January 1, 2004. As of December 31,2004 HickoryTech has recognized a recovery of $407,000 of the revenue.

 

Inaccordance with SFAS No. 71, HickoryTech recorded a regulatory asset for therevenue it would recoup with a balance of $204,000 at December 31, 2004and $611,000 at December 31, 2003. Similarly, HickoryTech recorded aliability for the amounts that were to be repaid to the NECA CCL pool with abalance of $0 at December 31, 2004 and $611,000 at December 31, 2003.

 

**OTHER –**HickoryTech operates with original equity capital, retained earningsand indebtedness in the form of bank term and revolving lines of credit.HickoryTech believes its current level of debt to total capital is acceptablefor ongoing operations.

 

**CONTINGENCIES**

InJanuary 2002, National Independent Billing Partnership (NIBP), anunconsolidated partnership of NIBI (see Note 1 of the Notes to ConsolidatedFinancial Statements for discussion of NIBP), received written claims from oneof its customers relating to contractual obligations. The claims are not aformal legal action. NIBP disagrees with the claims made by this customer.There has been no formal dialogue between the parties on this matter since March 2002.The Partnership has been dissolved as of December 31, 2003 with allremaining assets being distributed to the remaining partners. In the opinion ofmanagement, the ultimate resolution of these claims will not have a materialadverse impact on HickoryTech’s financial position, results of operations orcash flows.

 

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**RECENT ACCOUNTING DEVELOPMENTS**

InMay 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2, Accountingand Disclosure Requirements Related to the Medicare Prescription DrugImprovement and Modernization Act of 2003, which supersedes FSP No. FAS 106 ofthe same name. FSP No. FAS 106-2 provides guidance on accounting for theeffects of the Medicare Prescription Drug, Improvement and Modernization Act of2003 (the Act), including the federal subsidy, and requires public companies toreflect the impact, if determinable and significant. The new Act introduces aprescription drug benefit under Medicare Part D, as well as a federal subsidyto sponsors of retiree health care benefit plans that provide a benefit that isat least actuarially equivalent to the Medicare plan. The retiree medical plandoes provide prescription drug coverage. Final regulations on the determinationof actuarial equivalence and the federal subsidy have yet to be issued;however, based on its current understanding of the Act, HickoryTech believesthat the prescription drug benefits provided under its post-retirement benefitplan would be deemed actuarially equivalent to the benefits provided underMedicare Part D. Consequently, the Company adopted FSP 106-2 and remeasured itsaccumulated post-retirement benefit obligation (APBO) as of June 30, 2004,to account for the federal subsidy.  Asof December 31, 2004, the reduction in the APBO due to the subsidy was$762,000. On January 21, 2005, the Department of Health and HumanServices, Centers for Medicare & Medicaid Services, issued final federalregulations related to the federal subsidy. HickoryTech is currently evaluatingthe effects, if any, that these final rules may have on its future benefitcosts and accumulated post-retirement benefit obligation.

 

In December 2004, the Financial AccountingStandards Board (‘‘FASB’’) issued SFAS No. 123(R), ‘‘Share-Based Payment’’,which is a revision of SFAS No. 123 and supersedes APB OpinionNo. 25. SFAS No. 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be valued at fairvalue on the date of grant, and to be expensed over the applicable vestingperiod. SFAS No. 123(R) is effective for all stock-based awards granted onor after July 1, 2005. In addition, companies must also recognizecompensation expense related to any awards that are not fully vested as of theeffective date. Compensation expense for the unvested awards will be measuredbased on the fair value of the awards previously calculated in developing thepro forma disclosures in accordance with the provisions of SFAS No. 123.HickoryTech is currently assessing the impact of adopting SFAS 123(R) to itsconsolidated results of operations and plans to comply with final regulationswhen issued. Reference ismade to the disclosures under APB No. 25 in Note 1 of the Notes to Consolidated Financial Statements.

 

**REGULATED INDUSTRY**

 

ILECMinnesota – HickoryTech’s two Minnesota ILEC subsidiaries continue to operateunder an alternative form of regulation as defined in Minnesota Chapter 237,whereby companies with less than 50,000 customers are regulated on price andservice level rather than profit.

 

TheMinnesota Public Utilities Commission (PUC) has been considering intrastateaccess reform and universal service for several years. In June 2004, theMinnesota PUC issued an order to refer the carrier common line (CCL) componentof the access reform issue to a contested case hearing. In September 2004,the Minnesota PUC also referred the local switching and transport (LST)component of the access reform issue for a separate contested case hearing.Such hearings in Minnesota usually involve full development of a public recordand recommendation of an administrative law judge prior to final PUCdiscussion. The process on both of these dockets was suspended in December 2004subsequent to concerns expressed by state agencies regarding increases in localrates that might be instigated by mandated access reductions. The outcome ofany access reform process will not likely be known until the second quarter of2005 or later. HickoryTech cannot estimate the impact, if any, of futurepotential state access revenue changes.

 

OnDecember 22, 2004, the Federal Court of Appeals, 8th Circuit upheld an October 2003ruling by the United States District Court, District of Minnesota, in issuingan injunction providing relief from regulation of any service providerproviding Voice over Internet Protocol (VoIP) based services in Minnesota. Thismay result in a change in the business relationship between HickoryTechbusinesses and the interexchange carriers, as interconnections with certainVoIP providers may not be governed by tariffed Minnesota access charges.HickoryTech cannot, at this time, estimate the revenue impact, if any, relatedto this decision.

 

ILECIowa – In Iowa, companies with fewer than 15,000 access lines remainunregulated. HickoryTech’s Iowa ILEC subsidiary falls below this regulationthreshold.

 

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WirelineInterstate – The HickoryTech ILEC companies do not participate in the NECAtraffic sensitive pool and set access rates according to either a nationwideaverage cost of providing access, or in the case of Heartland, according to itsown interstate costs. This biannual rate process was completed in June 2003,and established traffic sensitive interstate rates for the period from July 1,2003 through June 30, 2005. HickoryTech ILEC companies participate in theNECA common line pool. In July of 2003, common line rates charged tointerexchange carriers were reduced (to zero), and common line charges to endusers were increased in accordance with an October 2001 FCC order (a/k/aMAG Plan). End User Common Line (EUCL) funds collected are pooled, and some ofHickoryTech revenues are based on settlements distributed from the pool. Poolsettlements are adjusted periodically. The rates will be adjusted in July, 2005for the period of July 1, 2005 through June 30, 2005.

 

CLEC– HickoryTech’s CLEC Company provides local exchange services in Minnesota andIowa with less regulatory oversight than the HickoryTech ILEC companies.Additionally, Crystal offers digital television service in the St. Peter,Minnesota market under a franchise negotiated with the local municipality.Beginning in the third quarter 2004, Crystal began offering digital televisionin the Waseca, Minnesota market under a similar franchise agreement. Crystalalso offers long distance services. In-state services in Minnesota areregulated by the PUC with respect to uniform pricing statewide. In-state longdistance service in Iowa is unregulated. Long distance services are alsoderegulated at the federal level (for interstate services), but are subject toannual certification of geographical rate averaging and rate integration.Dial-up and broadband Internet access, are unregulated at both the state andfederal levels.

 

Other– HickoryTech’s CLEC interstate access rates are established in accordance withan April 2001 FCC order. Under the final phase of this order, interstateswitched access rates for HickoryTech’s CLEC were reduced to levels comparableto those of the incumbent LECs in June 2004.

 

TheFCC has an open docket on intercarrier compensation as well as several docketson VoIP. In February 2005, the FCC issued a Notice of Public Rule Making(NPRM) requesting comments on various proposals for intercarrier compensationreform. HickoryTech cannot predict the outcome of such proceedings nor can itestimate the impact, if any, on HickoryTech.

 

Local Number Portability (LNP) – On November 10, 2003, the FCC released a decision providingguidance on porting between wireline and wireless networks (intermodalporting). The FCC stated that intermodal number porting is required upon bonafide request where the coverage area of the wireless carrier (i.e. the area inwhich the wireless carrier provides service) overlaps the geographic locationin which the wireline number was provisioned. The FCC left issues governing thepayment of call routing costs to another pending proceeding. The Company’swireline operations were subject to a May 24, 2004 implementation date forintermodal porting, however, Heartland Telecommunications Company of Iowajoined in an industry action by the Iowa Telecommunications Association tosuspend the requirements for small rural carriers. After receiving an orderfrom the Iowa Utilities Board allowing Heartland until April 6, 2005, toimplement LNP, Heartland has proceeded and this functionality was added as of January 25,2005.

 

Theeffects of intermodal porting on the Company’s Minnesota wireline operationshave been minimal as of December 31, 2004. Given the short history forwhich intermodal porting has been available, however, the Company cannot fullyquantify the long-term effects of implementing intermodal porting on itswireline operations. It is possible that these requirements could adverselyaffect the Company’s wireline operating costs and customer growth rates.  HickoryTech is also unable to quantify therevenue impact of wireline customers that may switch to wireless or otherwireline alternatives.

 

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TriennialReview Order – In August 2003, the FCC published a review order proposingchanges in rules developed under the provisions of the Telecommunications Actof 1996 Section 251(c)(3) which requires incumbent LECs to make elementsof their networks available on an unbundled basis to new entrants atmodel-based rates. This order was immediately challenged by the United StatesTelecom Association (USTA) and several carriers. In April 2004, theWashington DC district court issued a ruling remanding the issue back to theFCC so that, for specific unbundled network elements (UNEs), incumbent LECsface reduced mandates to make their network available and CLECs face reducedopportunities or increased costs in obtaining network from the incumbent withwhom they compete. Accordingly, in August 2004, the FCC released an NPRMwith transitional rules for elimination of UNEs and adopted final rules on December 15,2004. HickoryTech’s CLEC, Crystal Communications, predominately uses its ownnetwork and has not made extensive use of the type of network elementsaddressed in the ruling. While HickoryTech cannot fully quantify the impact ofthis issue, the FCC orders are not expected to have a material impact onCrystal’s business.

 

**CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISION OF THEPRIVATE SECURITIES LITIGATION REFORM ACT OF 1995**

Forward-Looking Statements

Thisreport on Form 10-K and other documents filed by HickoryTech under the federalsecurities laws, including Form 10-Q and Form 8-K, and future verbal or writtenstatements by HickoryTech and its management, may include forward-lookingstatements. These statements may include, without limitation, statements withrespect to anticipated future operating and financial performance, growthopportunities and growth rates, acquisition and divestiture opportunities,business strategies, business and competitive outlook and other similarforecasts and statements of expectation. A word such as expects, anticipates,intends, plans, believes, seeks, estimates and should, and variations of thesewords and similar expressions, are intended to identify these forward-lookingstatements. Such forward-looking statements are subject to uncertainties thatcould cause HickoryTech’s actual results to differ materially from suchstatements.

 

Uncertaintiescausing differing results from those expressed in the forward-lookingstatements include, but are not limited to, those uncertainties set forthbelow:

 

•             The effects of on-going deregulation in thetelecommunications industry as a result of the Federal Telecommunications Actof 1996 (the “Telecommunications Act”) (which allows competition amongtelephone companies for the rights to offer telephone service to customers in afranchised service area) and other similar federal and state legislation andregulations, including, without limitation, (i) greater-than-anticipatedcompetition in HickoryTech’s predominately rural local exchange telephonemarkets, (ii) greater-than-anticipated reductions in revenues received fromfederal and state access charges for switching long distance traffic, (iii) thefinal outcome of regulatory and judicial proceedings with respect tointerconnection agreements and access charge reforms, and (iv) future stateregulatory actions taken in response to the Telecommunications Act.

 

•             The lack of assurance that HickoryTech cancompete effectively against competitors, especially competitors with a largernational or regional market niche.

 

**•**             Theeffects of greater-than-anticipated competition, including, without limitation,competition requiring new pricing or marketing strategies or new productofferings, the attendant risk that HickoryTech will not be able to respond on atimely or profitable basis and the competitive effect of relationships withother carriers causing new pricing on services such as interexchange accesscharges.

 

•             HickoryTech’s ability to successfullyintroduce new products and services, including, without limitation, (i) theability of Crystal (which started its competitive local exchange carrier (CLEC)business in January 1998) to provide competitive local service in newmarkets, (ii) the ability of NIBI (which is a billing and data servicescompany) to implement, market, and sell its SuiteSolution billing system, (iii)the ability of HickoryTech to offer bundled service packages on termsattractive to its customers, (iv) the ability of HickoryTech to successfullyexpand its long distance and Internet offerings to new markets and (v) theability of HickoryTech to introduce and sell the equipment and systems ofNortel, Bay Networks and Cisco versus the competitive alternatives of othersuppliers.

 

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•             Possible changes in the demand forHickoryTech’s products and services, including, without limitation,lower-than-anticipated demand for, (i) premium telephone services, additionalaccess lines per household or minutes of use volume associated with telephoneservice, (ii) data processing services or billing systems, and (iii)communication and data equipment.

 

•             Regulatory limits on HickoryTech’s ability tochange its prices for telephone services in response to competitive pressures.

 

•             The risks inherent in rapid technologicalchange, including, without limitation, the risk that technologies will not beprocured by HickoryTech on a timely or cost-effective basis or performaccording to expectations.

 

•             The risks associated with decisions of othertelecommunications carriers involving their choice of networking, routes,points of interconnection, technology or signaling protocol, and othertelecommunications issues.

 

•             HickoryTech’s ability to effectively manageits growth, including, without limitation, HickoryTech’s ability to (i)integrate the operations of Crystal into HickoryTech’s operations, (ii) manageNIBI’s development of and migration to SuiteSolution as its primary softwareplatform for billing and customer care management, (iii) achieve projectedeconomies of scale and cost savings, (iv) meet pro forma cash flow projectionsdeveloped by management in valuing newly-acquired businesses, (v) conform withexisting debt covenants and negotiate new debt facilities which conform withevolving business plans, (vi) implement necessary internal controls and retainand attract key personnel and (vii) identify future acquisition opportunitiesfor growth.

 

•             Any difficulties in HickoryTech’s ability toexpand through additional acquisitions, whether caused by financingconstraints, a decrease in the pool of attractive target companies, orcompetition for acquisitions from other interested buyers.

 

•             The effects of more general factors,including, without limitation:

 

•                                Changes in general industry and market conditions and growth rates.

•                                Changes in interest rates or other general national, regional, or localeconomic conditions.

•                                Changes in legislation, regulation or public policy.

•                                Unanticipated increases in capital, operating or administrative costs,or the impact of new business opportunities requiring significant up-frontinvestments.

•                                Adjustments to the allowance for doubtful accounts due to changes inmanagement’s assessment as to the Company’s ability to collect on accountsreceivable and adjustments to inventory reserves due to changes in management’sassessment as to the value of the Company’s inventory.

•                                The continued availability of financing in amounts, terms andconditions necessary to support HickoryTech’s operations.

•                                Changes in HickoryTech’s relationships with vendors.

•                                Changes in HickoryTech’s debt ratios and the resultant effect on debtratings.

•                                Unfavorable outcomes of regulatory or legal proceedings.

•                                Changes in accounting policies or practices adopted voluntarily or asrequired by generally accepted accounting principles.

•                                Stock market volatility which may affect the stock price and theability to fund the future expansion and operations through a public stockoffering.

•                                Other risks and uncertainties which may affect the operating results.

 

Dueto the uncertainties listed above and the fact that any forward-lookingstatements by HickoryTech and its management are based on estimates,projections, beliefs and assumptions of management, they are not guarantees offuture performance. Except as required by law, HickoryTech disclaims anyobligation to update or revise any forward-looking statements based on theoccurrence of future events, the receipt of new information, or otherwise.

 

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**Item7A.**** Quantitative and Qualitative Disclosures About Market Risk.**

 

HickoryTechdoes not have operations subject to risks of foreign currency fluctuations.HickoryTech does, however, use derivative financial instruments to manageexposure to interest rate fluctuations. HickoryTech’s objectives for holdingderivatives are to minimize interest rate risks using the most effectivemethods to eliminate or reduce the impact of these exposures. Variable ratedebt instruments are subject to interest rate risk. HickoryTech has enteredinto interest rate swap agreements with remaining maturities ranging from sixmonths to forty-two months to manage its exposure to interest rate movements ona portion of its variable rate debt obligations. The effective portion of thecumulative gain or loss on these derivative instruments is reported as acomponent of accumulated other comprehensive income/loss in shareholders’equity and is recognized in earnings when the term of the swap agreement isconcluded. HickoryTech’s earnings are affected by changes in interest rates asa portion of its long-term debt has variable interest rates based on LIBOR. Ifinterest rates for the portion of HickoryTech’s long-term debt based onvariable rates had averaged 10% more for the year ended December 31, 2004,HickoryTech’s interest expense would have increased $170,000 in 2004.

 

**Item 8.**** Financial Statements and Supplementary Data.**

 

**MANAGEMENT’S REPORT ON INTERNALCONTROL OVER FINANCIAL REPORTING**

 

Managementis responsible for establishing and maintaining adequate internal control overfinancial reporting as defined in the Securities Exchange Act of 1934 Rule 13a– 15(f), and for performing an assessment of the effectiveness of internalcontrol over financial reporting as of December 31, 2004. Internal controlover financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted accounting principles. The Company’s system of internal control overfinancial reporting includes those policies and procedures that (i) pertain tothe maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company; (ii)provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with generallyaccepted accounting principles, and that receipts and expenditures of theCompany are being made only in accordance with authorizations of management anddirectors of the Company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the Company’s assets that could have a material effect on the financialstatements.

 

Managementperformed an assessment of the effectiveness of the Company’s internal controlover financial reporting as of December 31, 2004 based upon criteria inInternal Control – Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (‘‘COSO’’). Based on our assessment,management determined that the Company’s internal control over financialreporting was effective as of December 31, 2004 based on the criteria inInternal Control-Integrated Framework issued by the COSO.

 

Ourmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting as of December 31, 2004 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which appears herein.

 

Dated March 3, 2005

 

 
| John E. Duffy                         | David A. Christensen                        |
|---------------------------------------|---------------------------------------------|
| President and Chief Executive Officer | Vice President and Chief  Financial Officer |

 

30

----

 

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Shareholders and Board of Directors of

Hickory Tech Corporation:

 

We have completed an integrated audit of Hickory TechCorporation’s 2004 consolidated financial statements and of its internalcontrol over financial reporting as of December 31, 2004 and audits of its2003 and 2002 consolidated financial statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Ouropinions, based on our audits, are presented below.

 

Consolidated financial statements and financial statementschedule

 

In our opinion, the consolidated financial statements listedin the index appearing under Item 15(a)(1) present fairly, in all materialrespects, the financial position of Hickory Tech Corporation and itssubsidiaries at December 31, 2004 and 2003, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2004 in conformity with accounting principles generallyaccepted in the United States of America. In addition, in our opinion, thefinancial statement schedule listed in the index appearing under Item15(a)(1) presents fairly, in all material respects, the information set forththerein when read in conjunction with the related consolidated financialstatements. These financial statements and financial statement schedule arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements and financial statement schedule basedon our audits. We conducted our audits of these statements in accordance withthe standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit of financial statements includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included inManagement’s Report on Internal Control Over Financial Reporting appearingunder Item 8, that the Company maintained effective internal control overfinancial reporting as of December 31, 2004 based on criteria establishedin *Internal Control – Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), is fairly stated, in all material respects, based on those criteria.Furthermore, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31,2004, based on criteria established in *Internal Control –Integrated Framework* issued by the COSO. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessmentand on the effectiveness of the Company’s internal control over financialreporting based on our audit. We conducted our audit of internal control overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. An audit of internal control over financial reportingincludes obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother procedures as we consider necessary in the circumstances. We believe thatour audit provides a reasonable basis for our opinions.

 

31

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A company’s internal control over financial reporting is aprocess designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the Company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the Company are being made only in accordance withauthorizations of management and directors of the Company; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the Company’s assets that could have amaterial effect on the financial statements.

 

Because of its inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements. Also, projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

 

PricewaterhouseCoopers LLP

 

 
| Minneapolis, Minnesota |
|------------------------|
| March 3, 2005     |

 

32

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**HICKORY TECH CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

** **

**Years Ended December 31**

 

*(Dollars in Thousands, Except Per Share Amounts)*

 
| ** **                                                 | ** ** | **2004**       | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|------------------------------------------------------------|------------|----------------|------------|------------|------------|------------|------------|
| OPERATING REVENUES:                                        |       |           |       |       |       |       |       |
| Telecom Sector                                             | ** ** | **$**          | **76,097** |       | $          | 75,346     |       | $ | 71,108 |   |
| Information Solutions Sector                               | ** ** | **2,710**      |       | 3,199      |       | 4,249      |       |
| Enterprise Solutions Sector                                | ** ** | **11,708**     |       | 14,347     |       | 15,781     |       |
| TOTAL OPERATING REVENUES                                   | ** ** | **90,515**     |       | 92,892     |       | 91,138     |       |
|                                                       |       |           |       |       |       |       |       |
| COSTS AND EXPENSES:                                        |       |           |       |       |       |       |       |
| Cost of Sales, Enterprise Solutions                        | ** ** | **8,211**      |       | 10,216     |       | 10,638     |       |
| Cost of Services, excluding Asset  Impairment,             |       |           |       |       |       |       |       |
| Depreciation and Amortization                              | ** ** | **33,625**     |       | 33,471     |       | 32,998     |       |
| Selling, General and Administrative  Expenses, excluding   |       |           |       |       |       |       |       |
| Depreciation and Amortization                              | ** ** | **14,723**     |       | 13,159     |       | 14,408     |       |
| Asset Impairment                                           | ** ** | **—**     |       | —     |       | 316        |       |
| Depreciation                                               | ** ** | **15,589**     |       | 14,870     |       | 13,567     |       |
| Amortization of Intangibles                                | ** ** | **946**        |       | 997        |       | 1,642      |       |
| TOTAL COSTS AND EXPENSES                                   | ** ** | **73,094**     |       | 72,713     |       | 73,569     |       |
|                                                       |       |           |       |       |       |       |       |
| OPERATING INCOME                                           | ** ** | **17,421**     |       | 20,179     |       | 17,569     |       |
|                                                       |       |           |       |       |       |       |       |
| OTHER INCOME/(EXPENSE):                                    |       |           |       |       |       |       |       |
| Equity in Net Income/(Loss) of Investees                   | ** ** | **—**     |       | 9          |       | (25        | )          |
| Interest and Other Income                                  | ** ** | **61**         |       | 53         |       | 345        |       |
| Interest Expense                                           | ** ** | **(4,613**     | )          | (6,103     | )          | (7,405     | )          |
| TOTAL OTHER INCOME (EXPENSE)                               | ** ** | **(4,552**     | )          | (6,041     | )          | (7,085     | )          |
| INCOME BEFORE INCOME TAXES                                 | ** ** | **12,869**     |       | 14,138     |       | 10,484     |       |
| INCOME TAX PROVISION                                       | ** ** | **5,205**      |       | 5,683      |       | 4,249      |       |
| INCOME FROM CONTINUING OPERATIONS                          | ** ** | **7,664**      |       | 8,455      |       | 6,235      |       |
| DISCONTINUED OPERATIONS (Note 3)                           |       |           |       |       |       |       |       |
| Loss from Operations of Discontinued  Component            |       |           |       |       |       |       |       |
| Including Loss on Disposal of $25,642 in  2003             | ** ** | **(125**       | )          | (23,087    | )          | (38,692    | )          |
| Income Tax Benefit                                         | ** ** | **(51**        | )          | (1,857     | )          | (15,830    | )          |
| LOSS ON DISCONTINUED OPERATIONS                            | ** ** | **(74**        | )          | (21,230    | )          | (22,862    | )          |
|                                                       |       |           |       |       |       |       |       |
| NET INCOME/(LOSS)                                          | ** ** | **$**          | **7,590**  |       | $          | (12,775    | )          | $ | (16,627 | ) |
|                                                       | ** ** | ** **     | ** ** |       |       |       |       |   |   |   |
| Basic Earnings Per Share - Continuing  Operations:         | ** ** | **$**          | **0.59**   |       | $          | 0.61       |       | $ | 0.44 |   |
| Basic Loss Per Share - Discontinued  Operations:           | ** ** | **(0.01**      | )          | (1.53      | )          | (1.63      | )          |
| ** **                                                 |       | **$**          | 0.58       |       | $          | (0.92      | )          | $ | (1.19 | ) |
| Dividends Per Share                                        | ** ** | **$**          | **0.44**   |       | $          | 0.44       |       | $ | 0.44 |   |
| Weighted Average Common Shares Outstanding                 | ** ** | **12,993,280** |       | 13,934,178 |       | 14,023,645 |       |
|                                                       | ** ** | ** **     |       |       |       |       |       |
| Diluted Earnings Per Share - Continuing  Operations:       | ** ** | **$**          | **0.59**   |       | $          | 0.61       |       | $ | 0.44 |   |
| Diluted Loss Per Share - Discontinued  Operations:         | ** ** | **(0.01**      | )          | (1.53      | )          | (1.62      | )          |
| ** **                                                 |       | **$**          | 0.58       |       | $          | (0.92      | )          | $ | (1.18 | ) |
| Weighted Average Common and Equivalent  Shares Outstanding | ** ** | **13,025,637** |       | 13,961,282 |       | 14,075,684 |       |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

33

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**HICKORYTECH CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

** **

**As of December 31**

 

*(Dollars in Thousands)*

 
| ** **                                                                | ** ** | **2004**    | ** **  | **2003** | ** ** |
|---------------------------------------------------------------------------|------------|-------------|-------------|----------|------------|
| ASSETS                                                                    |       |        |        |     |       |
| CURRENT ASSETS:                                                           |       |        |        |     |       |
| Cash and Cash Equivalents                                                 | ** ** | **$**       | **257**     |     | $          | 278 |   |
| Receivables, Net of Allowance for Doubtful  Accounts of $1,256 and $1,283 |       | **9,892**   |        | 9,984    |       |
| Income Taxes Receivable                                                   | ** ** | **204**     |        | 2,838    |       |
| Costs in Excess of Billings on Contracts                                  | ** ** | **927**     |        | 934      |       |
| Inventories                                                               | ** ** | **3,182**   |        | 4,453    |       |
| Deferred Income Taxes                                                     | ** ** | **1,430**   |        | 1,057    |       |
| Prepaid Expenses                                                          | ** ** | **1,185**   |        | 1,108    |       |
| Other                                                                     | ** ** | **1,214**   |        | 1,389    |       |
| TOTAL CURRENT ASSETS                                                      | ** ** | **18,291**  |        | 22,041   |       |
| INVESTMENTS                                                               | ** ** | **4,371**   |        | 6,710    |       |
| PROPERTY, PLANT AND EQUIPMENT                                             | ** ** | **246,341** |        | 230,490  |       |
| LESS ACCUMULATED DEPRECIATION                                             | ** ** | **131,649** |        | 116,487  |       |
| PROPERTY, PLANT AND EQUIPMENT, NET                                        | ** ** | **114,692** |        | 114,003  |       |
| OTHER ASSETS:                                                             |       |        |        |     |       |
| Goodwill                                                                  | ** ** | **25,086**  |        | 25,086   |       |
| Intangible Assets, Net                                                    | ** ** | **387**     |        | 481      |       |
| Financial Derivative Instrument                                           | ** ** | **2,501**   |        | 2,515    |       |
| Deferred Costs and Other                                                  | ** ** | **3,209**   |        | 4,876    |       |
| TOTAL OTHER ASSETS                                                        | ** ** | **31,183**  |        | 32,958   |       |
| TOTAL ASSETS                                                              | ** ** | **$**       | **168,537** |     | $          | 175,712 |   |
| LIABILITIES  & SHAREHOLDERS’ EQUITY                              |       |        |        |     |       |
| CURRENT LIABILITIES:                                                      |       |        |        |     |       |
| Cash Overdraft                                                            | ** ** | **$**       | **1,680**   |     | $          | 1,001 |   |
| Accounts Payable                                                          | ** ** | **4,065**   |        | 3,771    |       |
| Accrued Expenses                                                          | ** ** | **3,202**   |        | 3,243    |       |
| Accrued Interest                                                          | ** ** | **76**      |        | 41       |       |
| Billings in Excess of Costs on Contracts                                  | ** ** | **260**     |        | 73       |       |
| Advanced Billings and Deposits                                            | ** ** | **2,898**   |        | 3,040    |       |
| Current Maturities of Long-Term Obligations                               | ** ** | **5,323**   |        | 1,572    |       |
| TOTAL CURRENT LIABILITIES                                                 | ** ** | **17,504**  |        | 12,741   |       |
| LONG-TERM OBLIGATIONS, Net of Current  Maturities                         | ** ** | **97,661**  |        | 118,040  |       |
| DEFERRED INCOME TAXES                                                     | ** ** | **15,270**  |        | 10,331   |       |
| DEFERRED REVENUE AND EMPLOYEE BENEFITS                                    | ** ** | **6,557**   |        | 5,883    |       |
| TOTAL LIABILITIES                                                         | ** ** | **136,992** |        | 146,995  |       |
| COMMITMENTS AND CONTINGENCIES (Notes 7, 8  and 13)                        | ** ** | **—**  |        | —   |       |
| SHAREHOLDERS’ EQUITY:                                                |       |        |        |     |       |
| Common Stock, no par value, $.10 stated  value                            |       |        |        |     |       |
| Shares authorized: 100,000,000                                            |       |        |        |     |       |
| Shares outstanding: 2004, 13,057,106; 2003,  12,967,811                   | ** ** | **1,306**   |        | 1,297    |       |
| Additional Paid-In Capital                                                | ** ** | **8,615**   |        | 7,690    |       |
| Retained Earnings                                                         | ** ** | **20,119**  |        | 18,246   |       |
| Accumulated Other Comprehensive Income                                    | ** ** | **1,505**   |        | 1,484    |       |
| TOTAL SHAREHOLDERS’ EQUITY                                           | ** ** | **31,545**  |        | 28,717   |       |
| TOTAL LIABILITIES & SHAREHOLDERS’  EQUITY                        | ** ** | **$**       | **168,537** |     | $          | 175,712 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

34

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**HICKORY TECH CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **

**Years Ended December 31**

 

*(Dollars in Thousands)*

 
| *** ***                                                | ** ** | **2004**    | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------|------------|-------------|------------|----------|------------|----------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                       |       |        |       |     |       |     |       |
| Net Income/(Loss)                                           | ** ** | **$**       | **7,590**  |     | $          | (12,775  | )          | $ | (16,627 | ) |
| Adjustments to Reconcile Net Income/(Loss)  to Net          |       |        |       |     |       |     |       |
| Cash Provided by Operating Activities:                      |       |        |       |     |       |     |       |
| Depreciation and Amortization                               | ** ** | **16,535**  |       | 17,638   |       | 17,789   |       |
| Intangible Asset Impairment                                 | ** ** | **—**  |       | 21,000   |       | 41,951   |       |
| Long-Lived Asset Impairment                                 | ** ** | **—**  |       | 4,345    |       | —   |       |
| (Gain)/Loss on Sale of Assets                               | ** ** | **95**      |       | (3       | )          | 183      |       |
| Loss on Disposal of Assets                                  | ** ** | **—**  |       | 632      |       | —   |       |
| Provision for Losses on Accounts Receivable                 | ** ** | **1,003**   |       | 1,093    |       | 2,114    |       |
| Deferred Income Taxes                                       | ** ** | **4,602**   |       | 4,817    |       | (9,804   | )          |
| Stock-Based Compensation                                    | ** ** | **99**      |       | (160     | )          | 329      |       |
| Employee Retirement Benefits and Deferred  Compensation     | ** ** | **905**     |       | 412      |       | 471      |       |
| Accrued Patronage Refunds                                   | ** ** | **(357**    | )          | (555     | )          | (583     | )          |
| Equity in Net (Income)/Loss of Investees                    | ** ** | **—**  |       | (9       | )          | 25       |       |
| Tax Benefit from Stock Option Transactions                  | ** ** | **11**      |       | 17       |       | 118      |       |
| Changes in Operating Assets and Liabilities  Net of         |       |        |       |     |       |     |       |
| Effects of Acquisitions and Dispositions:                   |       |        |       |     |       |     |       |
| Receivables                                                 | ** ** | **1,723**   |       | (1,234   | )          | (254     | )          |
| Inventories                                                 | ** ** | **1,270**   |       | 310      |       | (70      | )          |
| Billings and Costs on Contracts                             | ** ** | **195**     |       | 1,166    |       | (676     | )          |
| Accounts Payable and Accrued Expenses                       | ** ** | **557**     |       | (1,241   | )          | (281     | )          |
| Advance Billings and Deposits                               | ** ** | **(142**    | )          | 95       |       | 161      |       |
| Deferred Revenue and Employee Benefits                      | ** ** | **(232**    | )          | (105     | )          | (310     | )          |
| Other                                                       | ** ** | **1,018**   |       | 1,306    |       | 131      |       |
| Net Cash Provided By Operating Activities                   | ** ** | **34,872**  |       | 36,749   |       | 34,667   |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                       |       |        |       |     |       |     |       |
| Additions to Property, Plant and Equipment                  | ** ** | **(16,612** | )          | (13,570  | )          | (16,674  | )          |
| Redemption of Investments                                   | ** ** | **2,600**   |       | 4,144    |       | 100      |       |
| Purchase of Intangible Asset                                | ** ** | **(9**      | )          | —   |       | —   |       |
| Proceeds from Sale of Wireless Business                     | ** ** | **—**  |       | 16,246   |       | —   |       |
| Proceeds from Sale of Assets                                | ** ** | **53**      |       | 159      |       | 243      |       |
| Net Cash Provided By (Used In) Investing  Activities        | ** ** | **(13,968** | )          | 6,979    |       | (16,331  | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES:                       |       |        |       |     |       |     |       |
| Change in Cash Overdraft                                    | ** ** | **679**     |       | 1,001    |       | —   |       |
| Payments of Capital Lease Obligations                       | ** ** | **(710**    | )          | (588     | )          | (480     | )          |
| Borrowings on Credit Facility                               | ** ** | **2,000**   |       | 11,250   |       | 2,950    |       |
| Repayments on Credit Facility                               | ** ** | **(18,000** | )          | (50,750  | )          | (14,950  | )          |
| Proceeds from Issuance of Common Stock                      | ** ** | **865**     |       | 759      |       | 1,252    |       |
| Dividends Paid                                              | ** ** | **(5,717**  | )          | (6,150   | )          | (6,170   | )          |
| Stock Repurchase/Retirement                                 | ** ** | **(42**     | )          | (846     | )          | (1,072   | )          |
| Net Cash Used In Financing Activities                       | ** ** | **(20,925** | )          | (45,324  | )          | (18,470  | )          |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                   | ** ** | **(21**     | )          | (1,596   | )          | (134     | )          |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD           | ** ** | **278**     |       | 1,874    |       | 2,008    |       |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                  | ** ** | **$**       | **257**    |     | $          | 278      |       | $ | 1,874 |   |
|                                                        |       |        |       |     |       |     |       |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:          |       |        |       |     |       |     |       |
| Cash Paid for Interest                                      | ** ** | **$**       | **4,669**  |     | $          | 6,906    |       | $ | 7,682 |   |
| Net Cash Paid (Refunded) for Income Taxes                   | ** ** | **$**       | **(2,094** | )        | $          | (1,392   | )          | $ | (230 | ) |
| NON-CASH INVESTING ACTIVITIES:                              |       |        |       |     |       |     |       |
| Property, Plant and Equipment Acquired with  Capital Leases | ** ** | **$**       | **81**     |     | $          | 660      |       | $ | 618 |   |
| Stock Consideration Received in Wireless  Business Sale     | ** ** | **$**       | **—** |     | $          | 12,207   |       | $ | — |   |

 

The accompanying notes are an integral part ofthe consolidated financial statements.

 

35

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**HICKORY TECH CORPORATION**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME/LOSS**

** **

**Years Ended December 31**

** **

*(Dollars in Thousands)*

 
| ** **                          | ** ** | **Common Stock** | ** ** | **Additional  Paid - In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Other  Comprehensive  Income** | ** ** | **Total  Shareholders’  Equity** | ** ** | **Total  Comprehensive  Income(Loss)** | ** ** |
|-------------------------------------|------------|------------------|------------|------------------------------------|------------|------------------------|------------|----------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                          | ** ** | **Shares**       | ** ** | **Amount**                         | ** ** |
| BALANCE, DECEMBER 31, 2001     |       | 13,935,308       |       | $                                  | 1,394      |                   | $          | 6,254                            |       | $                                     | 73,117     |                                   | $          | — |   | $ | 80,765 |   |   |   |
|                                |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       |   |   |
| Stock Award Plan                    |       | 43,931           |       | 4                                  |       | 295                    |       |                             |       |                                  |       | 299                                    |       |   |   |
| Employee Stock Purchase Plan        |       | 24,777           |       | 2                                  |       | 297                    |       |                             |       |                                  |       | 299                                    |       |   |   |
| Directors’ Stock Retainer Plan |       | 2,282            |       |                               |       | 30                     |       |                             |       |                                  |       | 30                                     |       |   |   |
| Stock Options Exercised             |       | 63,796           |       | 6                                  |       | 696                    |       |                             |       |                                  |       | 702                                    |       |   |   |
| Dividend Reinvestment Plan          |       | 19,535           |       | 2                                  |       | 249                    |       |                             |       |                                  |       | 251                                    |       |   |   |
| Stock Repurchase                    |       | (105,700         | )          | (10                                | )          | (54                    | )          | (1,008                           | )          |                                  |       | (1,072                                 | )          |   |   |
| Stock Option Tax Benefit            |       |             |       |                               |       | 118                    |       |                             |       |                                  |       | 118                                    |       |   |   |
| Net Loss                            |       |             |       |                               |       |                   |       | (16,627                          | )          |                                  |       | (16,627                                | )          | $ | (16,627 | ) |
| Dividends Paid                      |       |             |       |                               |       |                   |       | (6,170                           | )          |                                  |       | (6,170                                 | )          |   |   |
| Total Comprehensive Loss            |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       | $ | (16,627 | ) |
|                                |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       |   |   |
| BALANCE, DECEMBER 31, 2002     |       | 13,983,929       |       | 1,398                              |       | 7,885                  |       | 49,312                           |       | —                                |       | 58,595                                 |       |   |   |
|                                |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       |   |   |
| Stock Award Plan                    |       | 23,193           |       | 2                                  |       | (237                   | )          |                             |       |                                  |       | (235                                   | )          |   |   |
| Employee Stock Purchase Plan        |       | 27,763           |       | 3                                  |       | 256                    |       |                             |       |                                  |       | 259                                    |       |   |   |
| Directors’ Stock Retainer Plan |       | 6,811            |       | 1                                  |       | 74                     |       |                             |       |                                  |       | 75                                     |       |   |   |
| Stock Options Exercised             |       | 24,387           |       | 2                                  |       | 227                    |       |                             |       |                                  |       | 229                                    |       |   |   |
| Dividend Reinvestment Plan          |       | 25,625           |       | 3                                  |       | 268                    |       |                             |       |                                  |       | 271                                    |       |   |   |
| Stock Repurchase                    |       | (84,970          | )          | (8                                 | )          | (218                   | )          | (619                             | )          |                                  |       | (846                                   | )          |   |   |
| Stock Received in Wireless Sale     |       | (1,038,927       | )          | (104                               | )          | (582                   | )          | (11,522                          | )          |                                  |       | (12,207                                | )          |   |   |
| Stock Option Tax Benefit            |       |             |       |                               |       | 17                     |       |                             |       |                                  |       | 17                                     |       |   |   |
| Net Loss                            |       |             |       |                               |       |                   |       | (12,775                          | )          |                                  |       | (12,775                                | )          | $ | (12,775 | ) |
| Dividends Paid                      |       |             |       |                               |       |                   |       | (6,150                           | )          |                                  |       | (6,150                                 | )          |   |   |
| Other Comprehensive Income,         |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       |   |   |
| Net of Income Taxes                 |       |             |       |                               |       |                   |       |                             |       | 1,484                                 |       | 1,484                                  |       | 1,484 |   |
| Total Comprehensive Loss            |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       | $ | (11,291 | ) |
|                                |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       |   |   |
| BALANCE, DECEMBER 31, 2003     |       | 12,967,811       |       | 1,297                              |       | 7,690                  |       | 18,246                           |       | 1,484                                 |       | 28,717                                 |       |   |   |
|                                |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       |   |   |
| Stock Award Plan                    |       | 2,253            |       | —                             |       | 35                     |       |                             |       |                                  |       | 35                                     |       |   |   |
| Employee Stock Purchase Plan        |       | 22,017           |       | 2                                  |       | 190                    |       |                             |       |                                  |       | 192                                    |       |   |   |
| Directors’ Stock Retainer Plan |       | 5,764            |       | 1                                  |       | 63                     |       |                             |       |                                  |       | 64                                     |       |   |   |
| Stock Options Exercised             |       | 37,985           |       | 4                                  |       | 391                    |       |                             |       |                                  |       | 395                                    |       |   |   |
| Dividend Reinvestment Plan          |       | 24,575           |       | 2                                  |       | 276                    |       |                             |       |                                  |       | 278                                    |       |   |   |
| Stock Repurchase                    |       | (3,299           | )          | —                             |       | (42                    | )          |                             |       |                                  |       | (42                                    | )          |   |   |
| Stock Option Tax Benefit            |       |             |       |                               |       | 12                     |       |                             |       |                                  |       | 12                                     |       |   |   |
| Net Income                          |       |             |       |                               |       |                   |       | 7,590                            |       |                                  |       | 7,590                                  |       | $ | 7,590 |   |
| Dividends Paid                      |       |             |       |                               |       |                   |       | (5,717                           | )          |                                  |       | (5,717                                 | )          |   |   |
| Other Comprehensive Income,         |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       |   |   |
| Net of Income Taxes                 |       |             |       |                               |       |                   |       |                             |       | 21                                    |       | 21                                     |       | 21 |   |
| Total Comprehensive Income          |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       | $ | 7,611 |   |
|                                |       |             |       |                               |       |                   |       |                             |       |                                  |       |                                   |       |   |   |
| BALANCE, DECEMBER 31, 2004     |       | 13,057,106       |       | $                                  | 1,306      |                   | $          | 8,615                            |       | $                                     | 20,119     |                                   | $          | 1,505 |   | $ | 31,545 |   |   |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

36

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**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 – ACCOUNTING POLICIES**

Theaccounting policies of Hickory Tech Corporation (HickoryTech) are in conformitywith accounting principles generally accepted in the United States of Americaand, where applicable, conform to the accounting principles as prescribed byfederal and state telephone utility regulatory authorities. HickoryTech presentlygives accounting recognition to the actions of regulators where appropriate, asprescribed by Financial Accounting Standards Board Statement (SFAS) No. 71, “Accountingfor the Effects of Certain Types of Regulation.”

 

**Basis of Consolidation** – The consolidated financial statements of HickoryTech include HickoryTech Corporation and its subsidiaries in the following three businesssegments:  (i) Telecom Sector, (ii)Information Solutions Sector and (iii) Enterprise Solutions Sector. Aninvestment in an unconsolidated partnership for the Information SolutionsSector is accounted for using the equity method.  The operations of this partnership weredissolved during 2003. No material wind-down costs were incurred. Allinter-company transactions have been eliminated from the consolidated financialstatements.

 

Costof services include all costs related to delivery of HickoryTech’scommunications services and products. These costs include all costs ofperforming services and providing related products. It does not include costsassociated with selling, general and administrative, depreciation andamortization of property, plant and equipment, intangible asset impairmentcharges and costs of sales for the Enterprise Solutions Sector.

 

OnDecember 15, 2003, HickoryTech sold its wireless business, MinnesotaSouthern Wireless Company (MSWC), to Western Wireless Corporation (WWC).  The wireless operations are reported as partof the Telecom Sector. The results of operations of the wireless business arereported as discontinued operations for all periods presented (see Note 3).

 

**Revenue Recognition** – Revenues are recognized when services are earned, rendered orproducts are delivered to customers. Customers are billed as of monthly cycle dates. Telecom Sector revenuesare derived from charges for network access to HickoryTech’s local exchangetelephone network, from subscriber line charges and from contractualarrangements for services such as billing and collection and directoryadvertising.  Certain of these revenuesare realized under pooling arrangements with other telephone companies and aredivided among the companies based on respective costs and investments toprovide the services. Management believes that recorded amounts representreasonable estimates of the final distribution from these pools. Revenue in theEnterprise Solutions Sector earned on major installation and change contractsis recognized using the percentage of completion method. Up-front fees,including installation and activation fees, are deferred and recognized on astraight-line basis over the corresponding customer relationship period.

 

**Estimates**–The preparation of the consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues and expenses and disclosure ofcontingent assets and liabilities. The estimates and assumptions used in theaccompanying consolidated financial statements are based upon management’sevaluation of the relevant facts and circumstances as of the date of thefinancial statements. Actual results may differ from these estimates andassumptions.

 

**Reclassifications******– Certain reclassifications were made withinthe 2003 and 2002 revenue lines of the Telecom Sector to conform to the 2004presentation.  These reclassificationshad no impact on previously reported net income (loss), or shareholders’ equityor cash flows.

 

**Property, Plant and Equipment** – Property, plant and equipment are recorded at original cost ofacquisition or construction.  Whenregulated incumbent local exchange carrier (ILEC) telephone assets are sold orretired, the assets and related accumulated depreciation are removed from theaccounts and any gains or losses on disposition are amortized with theremaining net investment in telephone plant. When other plant and equipment is sold or retired, the cost and relatedaccumulated depreciation or amortization are removed from the respectiveaccounts and any resulting gain or loss is included in operating income.  Maintenance and repairs are charged toexpense as incurred.

 

In September of2003 HickoryTech abandoned a CLEC initiative. As a result, HickoryTech wroteoff property, plant and equipment with a carrying value of $632,000. This$632,000 charge is included in the cost of services of the Telecom Sector inthe consolidated statement of operations.

 

Thecomponents of property, plant and equipment are summarized as follows:

 

(Dollars in Thousands)

 
| ** **                             | ** ** | **2004**    | ** **  | **2003** | ** ** |
|----------------------------------------|------------|-------------|-------------|----------|------------|
| ILEC  Telephone Plant (Telecom Sector) | ** ** | **$**       | **174,056** |     | $          | 161,981 |   |
| CLEC  Telephone Plant (Telecom Sector) | ** ** | **58,311**  |        | 55,102   |       |
| Other  Property and Equipment          | ** ** | **13,974**  |        | 13,407   |       |
| Total                                  | ** ** | **246,341** |        | 230,490  |       |
| Less  Accumulated Depreciation         | ** ** | **131,649** |        | 116,487  |       |
| Property,  Plant and Equipment, Net    | ** ** | **$**       | **114,692** |     | $          | 114,003 |   |

 

37

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Depreciationfor financial statement purposes is determined using the straight-line methodbased on the lives of the various classes of depreciable assets. The compositedepreciation rates on ILEC telephone plant for the three years ended December 31,2004, were 6.0%, 6.1%, and 6.1%.  Allother property, plant and equipment is depreciated over estimated useful lives ofthree to twenty years, and buildings are depreciated over their estimateduseful lives of thirty-nine years. Other property and equipment includes$81,000 and $660,000 of equipment acquired under capital leases in 2004 and2003.  Amortization expense related tothese capital leases was $667,000 and $558,000 in 2004 and 2003.   Accumulated amortization related to theseleases was $1,814,000 and $1,147,000 in 2004 and 2003.

 

**Cash Equivalents**– Cash equivalents include short-term investments with original maturities ofthree months or less. The carrying value of cash and cash equivalentsapproximates its fair value due to the short maturity of the instruments.

 

**Investments** –Investments include $3.6 million of non-interest bearing Rural TelephoneFinance Cooperative (RTFC) Subordinated Capital Certificates (SCCs) accountedfor under the cost method of accounting. This method requires HickoryTech to periodically evaluate whether anon-temporary decrease in value of the investment has occurred, and if so, to writethis investment down to its net realizable value.

 

Investmentsalso included an unconsolidated partnership accounted for using the equitymethod of accounting. NIBI, a wholly owned subsidiary of HickoryTech, was a 40%general partner in National Independent Billing Partnership (NIBP), whichperformed billing and collection clearinghouse functions for interexchangecarriers. NIBP was dissolved as of December 31, 2003. For the years ended December 31,2003 and 2002, NIBP had revenues of $19,000 and $184,000 respectively, and netincome/(loss) of $28,000 and ($68,000), respectively.

 

**Inventories** –Inventories, which consist of equipment for resale, materials and supplies, arestated at the lower of average cost or market. Cost is determined on a first-in first-out (FIFO) basis. Reserves offsetthe cost of inventory to arrive at the net realizable value of the inventory.

 

**Income Taxes**– HickoryTech accounts for income taxes in accordance with SFAS No. 109, “Accountingfor Income Taxes,” which requires an asset and liability approach to financialaccounting and reporting for income taxes. Accordingly, deferred tax assets andliabilities arise from the difference between the tax basis of an asset orliability and its reported amount in the financial statements. Deferred taxamounts are determined by using the tax rates expected to be in effect when thetaxes will actually be paid or refunds received, as provided under currentlyenacted tax law. Valuation allowances are established when necessary to reducedeferred tax assets to the amount expected to be realized. Income tax expenseor benefit is the tax payable or refundable, respectively, for the period plusor minus the change in deferred tax assets and liabilities during the period.

 

**Intangible Assets and Goodwill** – HickoryTech adopted the provisions of Statement of FinancialAccounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,”effective January 1, 2002. SFAS No. 142 required that goodwill andintangible assets with indefinite useful lives no longer be amortized, butinstead tested for impairment at least annually. Accordingly, at January 1,2002, HickoryTech ceased amortizing its goodwill.  See Note 2 for a more detailed discussion ofthe intangible assets and goodwill.

 

**Capitalized Software Costs –**Software costs associated with software that is developed or purchasedfor internal use only are accounted for in accordance with the AmericanInstitute of Certified Public Accountants Statement of Position 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use.”HickoryTech capitalizes costs (including right to use fees) associated withexternally acquired software for internal use. Costs associated with internallydeveloped software are segregated into three project stages: preliminaryproject stage, application development stage and post-implementation stage.Costs associated with both the preliminary project stage andpost-implementation stage, are expensed as incurred. Costs associated with theapplication development stage are capitalized. Software maintenance andtraining costs are expensed as incurred. Amortization of software costscommences when the software is ready for its intended use, and is amortizedover a period of three years. During 2004,****2003****and 2002,****HickoryTech capitalized $433,000,****$144,000****and $2,439,000,****respectively, of costs associated with software purchased ordeveloped for internal use only.****Thesesoftware costs are included in property, plant and equipment, and amounted to$2,047,000****and $2,552,000****at December 31, 2004****and 2003,****respectively.****Theseamounts are net of accumulated amortization of $2,137,000 and****$1,199,000 at December 31, 2004****and 2003,****respectively.****Amortizationexpense relating to these costs amounted to $938,000 and $788,000 in 2004 and2003, respectively.

 

Softwarecosts associated with software that is developed or purchased for external saleor license are accounted for in accordance with SFAS No. 86, “Accounting forthe Costs of Computer Software to Be Sold, Leased or Otherwise Marketed.”HickoryTech capitalizes costs related to such software when technologicalfeasibility has been established and continues capitalization until the productbecomes available for general release to customers. These software costs areincluded in other non-current assets,****and****amounted to****$432,000****and$1,275,000 at December 31,****2004and 2003, respectively. Theseamounts are net of accumulated amortization of $3,494,000 and $2,651,000 at December 31, 2004 and 2003, respectively. In accordancewith SFAS No. 86, which states that annual amortization shall be the greater ofthe amount computed using (a) the ratio that current gross revenues for aproduct bear to the total of current and anticipated future gross revenues forthat product or (b) the straight-line method over the remaining estimatedeconomic life of the product including the period being reported on, capitalizedsoftware costs are amortized on a straight-line, product-by-product basis overthe estimated economic lives of the product, which are currently three and fouryears.  Amortization expense relating tothese costs amounted to****$843,000in 2004 and****$895,000 in 2003.

 

**Comprehensive Income**– HickoryTech follows the provisions of SFAS No. 130, “ReportingComprehensive Income.” This statement established rules for the reporting ofcomprehensive income and its components. In addition to net income (loss),HickoryTech’s comprehensive income includes changes in unrealized gains andlosses on derivative instruments qualifying and designated as cash flow hedges.

 

**Advertising Expense** – Advertising is expensed as incurred. Advertising expense charged tooperations was $1,104,000, $935,000 and $926,000 in 2004, 2003 and 2002,respectively.

 

38

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**Earnings (Loss) Per Share** – Basic earnings (loss) per share is computed by dividing net incomeby the weighted average number of shares of common stock outstanding during theyear. Shares used in the earnings per share assuming dilution calculation arebased on the weighted average number of shares of common stock outstandingduring the year increased by potentially dilutive common shares. Potentiallydilutive common shares include stock options and stock subscribed under theemployee stock purchase plan (ESPP).

 
| ** **                          | ** ** | **2004**       | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-------------------------------------|------------|----------------|------------|------------|------------|------------|------------|
| Weighted Average Shares Outstanding |       | **12,993,280** |       | 13,934,178 |       | 14,023,645 |       |
| Stock Options                       |       | **24,852**     |       | 18,809     |       | 39,916     |       |
| Stock Subscribed (ESPP)             |       | **7,505**      |       | 8,295      |       | 12,123     |       |
| Total Dilutive Shares Outstanding   |       | **13,025,637** |       | 13,961,282 |       | 14,075,684 |       |

 

Optionsto purchase 402,050 shares as of December 31, 2004, 481,698 shares as of December 31,2003 and 249,800 shares as of December 31, 2002 were not included in thecomputation of earnings per share assuming dilution because their effect onearnings per share would have been antidilutive.

 

Dividendsper share is based on the quarterly dividend per share as declared by theHickoryTech Board of Directors.

 

**Stock Compensation –**At December 31, 2004, HickoryTech hadfour stock-based employee compensation plans, which are described more fully inNote 6.  HickoryTech has elected to applyAccounting Principles Board Opinion No. 25 and related interpretations inaccounting for its employee and directors’ stock compensation plans. See Note12 for guidance relating to SFAS No 123(R), Share-Based Payment, whichsupersedes Accounting Principles Board Opinion No. 25.  If HickoryTech had elected to recognizecompensation cost based on the fair value of the options as prescribed by SFASNo. 123, the following operating results would have occurred using theBlack-Scholes option-pricing model to determine the fair value of the options(see Note 6):

 

 

 
| ** **                                                                                                                                    | ** **   | **Years Ended December 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------------|----------------------------------|------------|
| **(Dollars in Thousands)**                                                                                                                    | *** *** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Reported Net Income/(Loss)                                                                                                                    | ** **   | **$**                            | **7,590**  |   | $ | (12,775 | ) | $ | (16,627 | ) |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                   |         | **59**                           |       | (96 | ) | 196 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of related  tax effects |         | **(278**                         | )          | (165 | ) | (533 | ) |
| Pro Forma Net Income/(Loss)                                                                                                                   | ** **   | **$**                            | **7,371**  |   | $ | (13,036 | ) | $ | (16,964 | ) |
|                                                                                                                                          |         |                             |       |   |   |   |   |
| Earnings per share:                                                                                                                           |         |                             |       |   |   |   |   |
| Basic - as reported                                                                                                                           | ** **   | **$**                            | **0.58**   |   | $ | (0.92 | ) | $ | (1.19 | ) |
| Basic - pro forma                                                                                                                             | ** **   | **$**                            | **0.57**   |   | $ | (0.94 | ) | $ | (1.21 | ) |
|                                                                                                                                          |         |                             |       |   |   |   |   |
| Diluted - as reported                                                                                                                         | ** **   | **$**                            | **0.58**   |   | $ | (0.92 | ) | $ | (1.18 | ) |
| Diluted - pro forma                                                                                                                           | ** **   | **$**                            | **0.57**   |   | $ | (0.94 | ) | $ | (1.20 | ) |

 

**NOTE 2****–****GOODWILL AND OTHER INTANGIBLE ASSETS**

 

Goodwillassets are subject to an impairment test annually as well as upon certainevents that indicate that an impairment may be present. The goodwill impairmenttest includes two steps, the first of which requires management to determinethe fair value of certain of the Company’s reporting units (as defined by SFASNo. 142).  The Company determines thefair value of their reporting units by application of a discounted cash flowanalysis. Management makes estimates that are included in their discounted cashflow analyses based upon the best available information at the time that thedeterminations of fair value are made. If circumstances change, HickoryTech’s estimates of fair value will alsochange and could result in a determination of additional impairment charges toreduce the carrying value of goodwill.

 

39

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Additionally, uponadoption of SFAS No. 142, HickoryTech was required to reassess the usefullives of its other intangible assets. HickoryTech’s other intangible assetsprimarily consisted of wireless FCC licenses (FCC licenses), which have nowbeen sold as part of the sale of the wireless business. The renewal of FCClicenses is a routine matter involving a nominal fee and HickoryTech has determinedthat no legal, regulatory, contractual, competitive, economic or other factorscurrently exist that limit the useful life of its FCC licenses. As such,effective with the adoption of SFAS No. 142, HickoryTech no longeramortized FCC licenses as they were deemed to be intangible assets that haveindefinite lives. SFAS No. 142 requires that indefinite lived intangibleassets be tested for impairment by comparing the fair value of the assets totheir carrying amount. The FCC licenses were tested for impairment on anaggregate basis, which was consistent with HickoryTech’s management of thewireless business. HickoryTech tested indefinite-lived intangible assets forimpairment between annual tests if events or changes in circumstances indicatedthat the asset might be impaired. In the third quarter of 2003, due to thepending sale of Minnesota Southern Wireless Company, which was closed on December 15,2003, HickoryTech completed an impairment test in the third quarter of 2003 forthe FCC licenses. This impairment test resulted in a total pre-tax impairmentcharge of $21,000,000 in the Telecom Sector. This impairment is reported aspart of discontinued operations in HickoryTech’s consolidated statement ofoperations for the year ended December 31, 2003 (see Note 3).

 

As of December 31,2002, HickoryTech completed its annual impairment test for FCC licenses usingmethodologies consistent with those applied for its transitional impairmenttests performed as of January 1, 2002. Such testing resulted in thedetermination of a total pre-tax impairment charge of $41,635,000 in the fourthquarter of 2002 in the Telecom Sector. HickoryTech believes that the decline inthe fair value of its FCC licenses was due principally to the rapid pace oftechnological change being undertaken by the major wireless service providersto adopt new protocols (i.e. GSM or CDMA) and potentially move away fromHickoryTech’s primary protocol called TDMA, which greatly hindered HickoryTech’sposition in finding a future roaming partner. Other factors included decliningroaming revenues, increasing price competition, and the protracted downturn inthe wireless market.

 

HickoryTechis required to test acquired goodwill for impairment on an annual basis basedupon a fair value approach. Additionally, goodwill shall be tested forimpairment between annual tests if an event occurs or circumstances change thatwould more likely than not reduce the fair value of an entity below itscarrying value. As of December 31, 2004 and 2003, HickoryTech completedits annual impairment tests for acquired goodwill using methodologies consistentwith those applied for its transitional impairment tests performed as of January 1,2002. Such testing resulted in no impairment charge to goodwill, as thedetermined fair value was again sufficient to pass the first step impairmenttest.

 

Thecarrying value of HickoryTech’s goodwill is $25,086,000 as of December 31,2004 and 2003.

 

Thecomponents of HickoryTech’s intangible assets are as follows:

 
| *** ***                     | ** ** | **As of December 31, 2004** | ** ** | **As of December 31, 2003** | ** ** |
|----------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| **(Dollars in Thousands)**       | ** ** | **Gross Carrying  Amount**       | ** ** | **Accumulated  Amortization**    | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Definite-Lived Intangible Assets |       |                             |       |                             |       |   |   |   |   |
| Customers                        | ** ** | **$**                            | **821**    | ** **                       | **$**      | **442** |   | $ | 821 |   | $ | 340 |   |
| Other Intangibles                | ** ** | **109**                          | ** ** | **101**                          |       | 100 |   | 100 |   |
| Total                            | ** ** | **$**                            | **930**    | ** **                       | **$**      | **543** |   | $ | 921 |   | $ | 440 |   |

 

During 2002, HickoryTech wrote downthe carrying value of an intangible asset relating to an agreement to develop awireless DSL operation that also entitled HickoryTech to receive a share offuture revenues generated from the wireless DSL operations.  The asset impairment write-down was takenbecause of the bankruptcy of the third-party network provider and HickoryTechdid not believe that the agreement would result in future cash flows from therevenue sharing agreement. The $316,000 charge resulting from the asset impairmentwrite-down was recorded as a charge to operations of HickoryTech’s TelecomSector and is reported as “Asset Impairment” in the consolidated statement ofoperations for the year ended December 31, 2002.

 

Amortization expense related to thedefinite-lived intangible assets for 2004, 2003 and 2002 was $103,000,$103,000, and $466,000, respectively. Amortization expense for the five years subsequent to 2004 is asfollows: 2005 - $104,000; 2006 - $104,000; 2007 - $104,000; 2008 - $74,000 and2009 - $1,000.

 

**NOTE 3 – ACQUISITIONS, DISPOSITIONS and DISCONTINUED OPERATIONS**

 

Sale of Wireless Operations (DiscontinuedOperations):

On December 15, 2003, HickoryTech sold itswireless business, Minnesota Southern Wireless Company (MSWC), to WesternWireless Corporation (WWC). The selling price was comprised of $16,246,000 incash and 1,038,927 shares of HickoryTech common stock that were returned toHickoryTech by WWC and subsequently retired. The market value of these shareswas $12,207,000 at December 15, 2003. Included in the cash proceeds aboveis $3,401,000 of cash received for construction in progress assets. HickoryTechreported a pre-tax loss on the sale of $25,642,000 ($22,758,000 net of incometaxes). HickoryTech used the proceeds from the sale to repay a portion of itsoutstanding debt. The wireless operations are reported as part of the TelecomSector. The consolidated statements of operations for all periods presentedhave been restated to reflect wireless operations as discontinued operations.

 

40

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In connection with the determination by managementin the third quarter of 2003 that it would pursue the sale of its wirelessoperations and that the selling price would likely be less than the currentcarrying value of the wireless net assets, the Company completed an impairmenttest in the third quarter of 2003 for the FCC licenses pursuant to therequirements of SFAS No. 142, “Goodwill and Other Intangible Assets.”Management estimated the fair value of the FCC licenses using a discounted cashflow technique consistent with the method used by the Company in performing itsmost recent impairment analysis at December 31, 2002. As a result of thisassessment, management determined that the FCC licenses were impaired andrecorded an impairment charge of approximately $21,000,000 ($18,638,000after-tax) in the third quarter of 2003 (see Note 2). This impairment charge isrecorded as a component of the loss on discontinued operations in HickoryTech’sconsolidated statement of operations for the year ended December 31, 2003.HickoryTech believes that the decline in the fair value of its FCC licenses wasdue principally to the rapid pace of technological change being undertaken bythe major wireless service providers to adopt new protocols (i.e. GSM or CDMA)and potentially move away from HickoryTech’s current primary protocol calledTDMA, which greatly hindered HickoryTech’s position in finding a future roamingpartner. Other factors included declining roaming revenues, increasing pricecompetition, and the protracted downturn in the wireless market. The FCClicenses were tested for impairment on an aggregate basis, which was consistentwith HickoryTech’s management of the wireless business.

 

As a result of the Company’s commitment to sell thewireless business, the Company made a determination during the third quarter of2003 that the remaining assets of the wireless operations should be considered “Heldfor sale” pursuant to SFAS No. 144, “Accounting for Impairment or Disposal ofLong-Lived Assets,” (SFAS No. 144). Pursuant to SFAS No. 144, the Companyrecorded an impairment charge during the third quarter of 2003 related to theother long-lived assets of the wireless business of $4,345,000 ($3,856,000after-tax). This charge is also recorded as a component of the loss ondiscontinued operations in HickoryTech’s consolidated statement of operationsfor the year ended December 31, 2003.

 

Wireless business revenue andincome before income taxes included in discontinued operations are as follows:

 

| *** ***                      | ** ** | **For Years Ended December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| **(Dollars in Thousands)**        | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues                          |       | $                                     | —     |   | $ | 14,341 |   | $ | 15,449 |   |
| Income (Loss) Before Income Taxes |       | $                                     | (125       | ) | $ | (23,087 | ) | $ | (38,692 | ) |

 

**NOTE 4 – FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

Thefair value of HickoryTech’s long-term obligations, after deducting currentmaturities, is estimated to be $97,708,000 at December 31, 2004 and$125,088,000 at December 31, 2003, compared to carrying values of$97,662,000 and $118,040,000 respectively. The fair value estimates are basedon the overall weighted average interest rates and maturity compared to ratesand terms currently available in the long-term financing markets.

 

41

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** **

**NO****TE 5 – BUSINESS SEGMENTS**

HickoryTech’s operations are conducted in three business segments as:(i) Telecom Sector, (ii) Information Solutions Sector and (iii) EnterpriseSolutions Sector. The Telecom Sector provides telephone services to Mankato andadjacent areas of south central Minnesota and to eleven communities innorthwest Iowa as an ILEC.  The TelecomSector also operates fiber optic cable transport facilities in Minnesota. TheTelecom Sector also offers an alternative choice for local telecommunicationsservice, known as CLEC (Competitive Local Exchange Carrier) service in thetelecommunications industry, to customers in Minnesota and Iowa not currentlyin HickoryTech’s ILEC service area. In addition, the Telecom Sector resellslong distance service to Minnesota and Iowa subscribers in its ILEC and CLECmarkets. Prior to the sale of the wireless operations as discussed in Note 3,the Telecom Sector provided wireless telephone service to seven counties insouth central Minnesota and a service area around the Minneapolis/St. Paul,Minnesota metropolitan area and PCS service to the Minnesota BTAs ofMankato-Fairmont and Rochester-Austin-Albert Lea. The wireless operations arereported as discontinued operations for all periods presented. The InformationSolutions Sector provides data processing and related services to HickoryTech’sother sectors and to other external telephone companies, municipalities andutilities. The Enterprise Solutions Sector designs, sells, installs andservices business telephone systems and data communications equipment primarilyin metropolitan Minneapolis/St. Paul, Minnesota.

 

Business segment information for the years ended December 31, 2004,2003 and 2002 is as follows.

 

**BUSINESS SEGMENT DATA**

Years Ended December 31

 
| **(Dollars in  Thousands)**                                            | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate    and  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|------------------------------------|------------|------------------|------------|
| **2004**                                                               |       |        |       |                       |       |                      |       |                               |       |             |       |
| Revenue from Unaffiliated Customers                                    |       | $           | 76,097     |                       | $          | 2,710                     |       | $                                  | 11,708     |             | $          | — |   | $ | 90,515 |   |
| Intersegment Revenues                                                  |       | 275         |       | 4,346                      |       | —                    |       | (4,621                             | )          | —           |       |
| Total                                                                  |       | 76,372      |       | 7,056                      |       | 11,708                    |       | (4,621                             | )          | 90,515           |       |
|                                                                   |       |        |       |                       |       |                      |       |                               |       |             |       |
| Depreciation and Amortization                                          |       | 13,752      |       | 2,556                      |       | 171                       |       | 56                                 |       | 16,535           |       |
| Operating Income/(Loss)                                                |       | 22,509      |       | (2,799                     | )          | (1,901                    | )          | (388                               | )          | 17,421           |       |
| Interest Expense                                                       |       | 101         |       | 55                         |       | —                    |       | 4,457                              |       | 4,613            |       |
| Income Taxes                                                           |       | 9,076       |       | (1,152                     | )          | (770                      | )          | (1,949                             | )          | 5,205            |       |
| Income/(Loss) from Continuing Operations                               |       | 13,352      |       | (1,692                     | )          | (1,131                    | )          | (2,865                             | )          | 7,664            |       |
| Income/(Loss) from Discont. Operations Including Intersegment Revenues |       | (74         | )          | —                     |       | —                    |       | —                             |       | (74              | )          |
| Net Income (Loss)                                                      |       | 13,278      |       | (1,692                     | )          | (1,131                    | )          | (2,865                             | )          | 7,590            |       |
| Identifiable Assets                                                    |       | 146,415     |       | 5,760                      |       | 7,879                     |       | 8,483                              |       | 168,537          |       |
| Capital Expenditures                                                   |       | 16,100      |       | 486                        |       | 24                        |       | 2                                  |       | 16,612           |       |
|                                                                        |            |             |            |                            |            |                           |            |                                    |            |                  |            |  |  |  |  |  |

 

42

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| **(Dollars in  Thousands)**                                             | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate    and  Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|------------------------------------|------------|------------------|------------|
| **2003**                                                                |       |        |       |                       |       |                      |       |                               |       |             |       |
| Revenue from Unaffiliated Customers                                     |       | $           | 75,346     |                       | $          | 3,199                     |       | $                                  | 14,347     |             | $          | — |   | $ | 92,892 |   |
| Intersegment Revenues                                                   |       | 275         |       | 3,203                      |       | —                    |       | (3,478                             | )          | —           |       |
| Total                                                                   |       | 75,621      |       | 6,402                      |       | 14,347                    |       | (3,478                             | )          | 92,892           |       |
|                                                                    |       |        |       |                       |       |                      |       |                               |       | —           |       |
| Depreciation and Amortization                                           |       | 13,160      |       | 2,376                      |       | 246                       |       | 85                                 |       | 15,867           |       |
| Operating Income/(Loss)                                                 |       | 25,095      |       | (3,576                     | )          | (1,358                    | )          | 18                                 |       | 20,179           |       |
| Equity in Net Income/(Loss) of Investees                                |       | —      |       | 9                          |       | —                    |       | —                             |       | 9                |       |
| Interest Expense                                                        |       | 13          |       | 86                         |       | —                    |       | 6,004                              |       | 6,103            |       |
| Income Taxes                                                            |       | 10,662      |       | (1,198                     | )          | (569                      | )          | (3,212                             | )          | 5,683            |       |
| Income/(Loss) from Continuing Operations                                |       | 14,941      |       | (2,329                     | )          | (818                      | )          | (3,339                             | )          | 8,455            |       |
| Income/(Loss) from Discont. Operations  Including Intersegment Revenues |       | (22,897     | )          | 605                        |       | —                    |       | 1,062                              |       | (21,230          | )          |
| Net Income/(Loss)                                                       |       | (7,956      | )          | (1,724                     | )          | (818                      | )          | (2,277                             | )          | (12,775          | )          |
| Identifiable Assets                                                     |       | 145,753     |       | 7,773                      |       | 7,939                     |       | 14,247                             |       | 175,712          |       |
| Capital Expenditures                                                    |       | 10,719      |       | 161                        |       | 201                       |       | 156                                |       | 11,237           |       |
|                                                                    |       |        |       |                       |       |                      |       |                               |       |             |       |
| **2002**                                                                |       |        |       |                       |       |                      |       |                               |       |             |       |
| Revenue from Unaffiliated Customers                                     |       | $           | 71,108     |                       | $          | 4,249                     |       | $                                  | 15,781     |             | $          | — |   | $ | 91,138 |   |
| Intersegment Revenues                                                   |       | 274         |       | 3,154                      |       | —                    |       | (3,428                             | )          | —           |       |
| Total                                                                   |       | 71,382      |       | 7,403                      |       | 15,781                    |       | (3,428                             | )          | 91,138           |       |
|                                                                    |       |        |       |                       |       |                      |       |                               |       | —           |       |
| Asset Impairment                                                        |       | 316         |       | —                     |       | —                    |       | —                             |       | 316              |       |
| Depreciation and Amortization                                           |       | 12,326      |       | 2,403                      |       | 263                       |       | 217                                |       | 15,209           |       |
| Operating Income/(Loss)                                                 |       | 22,679      |       | (3,289                     | )          | (12                       | )          | (1,809                             | )          | 17,569           |       |
| Equity in Net Income of Investees                                       |       | —      |       | (25                        | )          | —                    |       | —                             |       | (25              | )          |
| Interest Expense                                                        |       | 20          |       | 62                         |       | —                    |       | 7,323                              |       | 7,405            |       |
| Income Taxes                                                            |       | 9,591       |       | (1,150                     | )          | (29                       | )          | (4,163                             | )          | 4,249            |       |
| Income/(Loss) from Continuing Operations                                |       | 13,617      |       | (2,131                     | )          | (41                       | )          | (5,210                             | )          | 6,235            |       |
| Income/(Loss) from Discont. Operations  Including Intersegment Revenues |       | (24,164     | )          | 477                        |       | —                    |       | 825                                |       | (22,862          | )          |
| Net Income/(Loss)                                                       |       | (10,547     | )          | (1,654                     | )          | (41                       | )          | (4,385                             | )          | (16,627          | )          |
| Identifiable Assets                                                     |       | 151,066     |       | 6,604                      |       | 9,914                     |       | 18,559                             |       | 186,143          |       |
| Investment in Equity Method Investees                                   |       | —      |       | 36                         |       | —                    |       | —                             |       | 36               |       |
| Capital Expenditures                                                    |       | 9,600       |       | 2,472                      |       | 95                        |       | 214                                |       | 12,381           |       |

 

43

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The Telecom Segment Identifiable Assets, Property, Plant and Equipmentand Capital Expenditures presented above, exclude the following amounts relatedto the wireless business, which is reported as a discontinued operation:

 

| ** **                 | ** ** | **For  Years Ended December 31,** | ** ** |
|----------------------------|------------|-----------------------------------|------------|
| **(Dollars in Thousands)** | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Identifiable Assets        |       | $                                 | —     |   | $ | — |   | $ | 54,068 |   |
| Capital Expenditures       |       | $                                 | —     |   | $ | 2,333 |   | $ | 4,293 |   |

 

**NOTE 6 – STOCK COMPENSATION**

 

Employee Stock Purchase Plan:

Under the terms of an employee stock purchase plan, participatingemployees may acquire shares of common stock through payroll deductions of notmore than 10% of their compensation. The price at which the shares can bepurchased is 85% of the lower fair market value for such shares on twospecified dates in each plan year. As of December 31, 2004 and 2003, there were900,000 common shares reserved for this plan and 591,244 shares and 613,261shares, respectively, still available for issuance. At December 31, 2004,employees had subscribed to purchase approximately 23,000 shares in the currentplan year ending August 31, 2005. At December 31, 2003, employees hadsubscribed to purchase approximately 26,000 shares in the plan year endedAugust 31, 2004.

 

Director Grants and Purchase Plan:

Under the terms of a corporate retainer stock plan for directors,participating directors may acquire shares of common stock in exchange fortheir quarterly retainers. The price at which the shares can be purchased is100% of the fair market value for such shares on the date of purchase. Inaddition to any voluntary acquisitions of shares in exchange for quarterlyretainers, directors receive $5,000 of their annual retainer solely in sharesof HickoryTech stock from this plan. As of December 31, 2004, there were300,000 common shares reserved for this plan and 254,542 shares still availablefor future issuance.

 

Non-Employee Director Stock Option Plan:

HickoryTech also offers a directors’ stock option plan to attract andretain outside directors. The plan provides for each outside director toreceive fully vested options to purchase 5,000 shares of common stock ofHickoryTech at an exercise price equal to the fair market value of the commonstock on a date as specified in the plan if HickoryTech meets pre-establishedfinancial objectives. The options may be exercised no later than ten yearsafter the date of grant. As of December 31, 2004, there were 300,000 commonshares reserved for this plan and 81,000 shares available for future grants.

 

Stock Award Plan:

HickoryTech’s stock award plan provides for the granting ofnon-qualified stock options and stock awards to employees.  The plan provides for stock awards based onthe attainment of certain financial targets and for individual achievements. Inaddition, for one component of the plan, HickoryTech utilizes a trust accountfor the funding of long-term performance awards which were issued until 2003.In 2004, 2003 and 2002, HickoryTech paid cash of $23,121, $204,000 and $184,000for its common stock shares and issued shares of 2,053, 22,393 and 12,722in  2004, 2003 and 2002, respectively, toa trust for the benefit of certain key employees.  The stock options issued under the stockoption component of the stock award plan may be exercised no later than tenyears after the date of grant, with one-third of the options vesting each year.As of December 31, 2004, there were 1,750,000 common shares reserved for thisplan and 999,846 shares available for future grants.

 

In2002, HickoryTech’s Board of Directors modified the terms of the stock optionsof a retiring officer.  The modificationextended the period after retirement during which the officer can exercise hisvested options.  This modificationresulted in HickoryTech recognizing $173,000 of compensation expense during thefirst quarter of 2003. During the third quarter of 2003, the Board of Directorsextended the period during which this option holder could exercise his vestedoptions to December 31, 2004. This extension did not result in any additionalcompensation charges.

 

HickoryTech has elected to apply AccountingPrinciples Board Opinion No. 25 and related interpretations in accounting forits employee and directors’ stock compensation plans. If HickoryTech hadelected to recognize compensation cost based on the fair value of the optionsas prescribed by SFAS No. 123, the following operating results would haveoccurred using the Black-Scholes option-pricing model to determine the fairvalue of the options with the following listed assumptions:

 

*(Dollars in Thousands, Except Per Share Amounts)*

 

| ** **                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Pro Forma Net Income/(Loss) |       | **$**    | **7,371**  |     | $          | (13,036) |       | $ | (16,964 | ) |
| Pro Forma Basic EPS         |       | **$**    | **0.57**   |     | $          | (0.94    | )          | $ | (1.21 | ) |
| Pro Forma Diluted EPS       |       | **$**    | **0.57**   |     | $          | (0.94    | )          | $ | (1.20 | ) |
| Volatility                  |       | **37.1** | %          | 36.7     | %          | 36.0     | %          |
| Dividend Yield              |       | **3.8**  | %          | 5.2      | %          | 3.3      | %          |
| Risk-Free Interest Rates    |       | **3.9**  | %          | 3.8      | %          | 4.7      | %          |
| Expected Life in Years      |       | **7**    |       | 7        |       | 7        |       |

 

44

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A summary of the stock optionactivity of the plans is as follows:

 
| ** **                                                      | ** ** | **Shares**  | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|-----------------------------------------------------------------|------------|-------------|------------|---------------------------------------|------------|
| ** **                                                      | ** ** | **2004**    | ** ** | **2003**                              | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Outstanding at Beginning of Year                                | ** ** | **595,798** |       | 554,335                               |       | 482,181 | ** ** | **$** | **13.01** |   | $ | 13.60 |   | $ | 13.37 |   |
| Granted                                                         | ** ** | **88,950**  |       | 103,250                               |       | 137,450 | ** ** | **9.87** |   | 8.90 |   | 13.29 |   |
| Exercised                                                       | ** ** | **(37,985** | )          | (24,387                               | )          | (63,796 | ) | **16.21** |   | 9.41 |   | 11.01 |   |
| Forfeited                                                       | ** ** | **(97,698** | )          | (37,400                               | )          | (1,500 | ) | **13.42** |   | 12.86 |   | 19.08 |   |
| Outstanding at End of Year                                      | ** ** | **549,065** |       | 595,798                               |       | 554,335 | ** ** | **$** | **12.86** |   | $ | 13.01 |   | $ | 13.60 |   |
| Exercisable at End of Year                                      | ** ** | **412,386** |       | 455,356                               |       | 384,377 | ** ** | **$** | **13.47** |   | $ | 13.50 |   | $ | 13.61 |   |
| Weighted Average Fair Value of Options  Granted During the Year | ** ** | **$**       | **3.31**   |                                  | $          | 2.16 |   | $ | 4.25 |   |   |   |   |   |   |   |
|                                                                 |            |             |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table providescertain information with respect to stock options outstanding at December 31,2004:

 
| **Range of  Exercise Prices** | ** **     | **Stock  Options  Outstanding** | ** ** | **Average  Exercise  Price** | ** ** | **Average  Remaining  Contractual Life** | ** ** |
|-------------------------------|----------------|---------------------------------|------------|------------------------------|------------|------------------------------------------|------------|
| $                             | 8.00 - $12.00  |                            | 222,015    |                         | $          | 10.14                                    |       | 7.8 years |   |
| $                             | 12.00 - $16.00 |                            | 261,550    |                         | 13.85      |                                     | 6.1 years  |   |
| $                             | 16.00 - $21.00 |                            | 65,500     |                         | 18.16      |                                     | 6.2 years  |   |
|                          |           | 549,065                         |       | $                            | 12.86      |                                     | 6.8 years  |   |

 

The following table provides certain information with respect to stockoptions exercisable at December 31, 2004:

 
| **Range of  Exercise Prices** | ** **     | **Stock  Options  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-------------------------------|----------------|---------------------------------|------------|----------------------------------------|------------|
| $                             | 8.00 - $12.00  |                            | 105,336    |                                   | $          | 9.55 |   |
| $                             | 12.00 - $16.00 |                            | 241,550    |                                   | 13.91      |   |
| $                             | 16.00 - $21.00 |                            | 65,500     |                                   | 18.16      |   |
|                          |           | 412,386                         |       | $                                      | 13.47      |   |

 

All stock options granted in 2004, 2003 and 2002 had an exercise priceequal to the fair market value of HickoryTech’s common stock on the date ofgrant.

 

Other stock award activity isas follows:

 
| ** **                                                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Stock Awards Granted                                                  |       | **200**  |       | 800      |       | 10,984   |       |
| Weighted Average Fair Value of Stock   Awards Granted During the Year |       | **$**    | **11.87**  |     | $          | 11.03    |       | $ | 14.97 |   |
|                                                                       |            |          |            |          |            |          |            |  |  |  |

 

45

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The Company recognizes stock compensation charges related to stockaward plans when management concludes it is probable that the award will beearned by the participant. Such compensation charges are recorded based uponthe fair value of HickoryTech’s stock and are recognized during the serviceperiod specified by the stock award plan. Changes in estimated compensation arerecorded in the period in which the change occurs.

 

Stock compensation expense (benefit) for 2004, 2003 and 2002 was$99,000, ($160,000) and $329,000 respectively, for all stock compensationplans.

 

**NOTE 7 – DEBT AND OTHER OBLIGATIONS**

Long-term debt:

 

 
| **(Dollars  in Thousands)**                                               | ** ** | **2004**    | ** **  | **2003** | ** ** |
|---------------------------------------------------------------------------|------------|-------------|-------------|----------|------------|
|                                                                      |       |        |        |     |       |
| Credit Facility, Average 4.0%,   maturing in varying amounts through 2009 |       | **$**       | **102,500** |     | $          | 118,500 |   |
| Capitalized Lease Obligations, Interest  at 6.7%, maturing October 2006   |       | **484**     |        | 1,112    |       |
|                                                                      |       | ** **  |        |     |       |
| Total                                                                     |       | **102,984** |        | 119,612  |       |
| Less Current Maturities                                                   |       | **5,323**   |        | 1,572    |       |
| Long-Term Obligations                                                     |       | **$**       | **97,661**  |     | $          | 118,040 |   |

 

Long-term obligations consist of the following:

 

Credit Facility Obligations:

HickoryTech has a $118,813,000 credit facility with a syndicate ofbanks. The credit facility is comprised of a $107,813,000 revolving creditcomponent and an $11,000,000 term loan component.  The available line of credit on the$107,813,000 revolving credit component began decreasing in incrementsbeginning in March 2004, and has a final maturity date in September 2008.  Since HickoryTech still has $16,313,000 ofavailable revolving credit, payments are not scheduled to begin until December2005. The revolving credit expires as follows: 2005 - $20,313,000 and 2006 to 2008 - $87,500,000. The term loanrequires equal quarterly principal payments of $250,000 during the period March2001 to December 2008, and $7,000,000 in the first quarter of 2009. Theweighted average interest rate associated with this credit facility varies withLIBOR and certain other rates.  Theweighted average interest rate was 4.0% and 4.1% at December 31, 2004 and 2003,respectively. The term loan component has a provision whereby HickoryTechperiodically receives patronage capital refunds depending on the amount ofinterest paid. This patronage refund is recorded as an offset to interestexpense and amounted to $357,000 in 2004, $555,000 in 2003 and $583,000 in2002. As of December 31, 2004, HickoryTech had drawn $102,500,000 on thiscredit facility, comprised of $11,000,000 in term loan and $91,500,000 inrevolving credit, and had $16,313,000 of available borrowing capacity of therevolving credit component. The credit facility is collateralized by certainproperty, plant and equipment and contains covenants relating to cash flow andcapitalization.

 

Annual requirements for principal payments for the years subsequent to2004 are as follows: 2005 - $5,000,000; 2006 - $27,562,000; 2007 - $33,813,000;2008 - $29,125,000 and 2009 - $7,000,000.

 

Capital Lease Obligations:

HickoryTech’s Information Solutions Sector leases certain computerequipment under capital lease arrangements. HickoryTech has recorded thepresent value of the future minimum lease payments as a capitalized asset andrelated lease obligation. Assets under this capital lease are included inproperty, plant and equipment and amounted to $587,000 and $1,173,000($2,401,000 and $2,320,000 asset, net of accumulated depreciation of $1,814,000and $1,147,000) as of December 31, 2004 and 2003. Capital leases are part ofproperty, plant and equipment on the balance sheet. Annual requirements forfuture lease payments under this capital lease are as follows:

 

| **Year**                                | ** ** | **Annual  Lease Payments** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|
|                                    |       |                       |       |
| 2005                                    |       | $                          | 339,000    |   |
| 2006                                    |       | 168,000                    |       |
| Total Minimum Lease Payments            |       | 507,000                    |       |
| Amount Representing Interest            |       | (23,000                    | )          |
| Present Value of Minimum Lease Payments |       | 484,000                    |       |
| Less Current Portion                    |       | (323,000                   | )          |
| Long-Term Lease Obligation              |       | $                          | 161,000    |   |

 

46

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Operating Lease Commitments:

HickoryTech owns most of its major facilities, but does lease certainoffice space, land and equipment under principally noncancelable operatingleases.**** Rental expense was $1,082,000 in 2004,$998,000 in 2003 and $1,179,000 in 2002. At December 31, 2004, future minimumoperating lease rental obligations for the next five years and thereafter areas follows: 2005 - $1,090,000; 2006 - $765,000; 2007 - $327,000; 2008-$307,000; 2009 - $277,000 and thereafter - $438,000.

 

###### **NOTE 8 – EMPLOYEE RETIREMENT BENEFITS**

Employees who meet certain service requirements arecovered under a defined contribution retirement savings plan, which includesIRS Section 401(k) provisions. HickoryTech contributes up to 6.0% of theemployee’s eligible compensation, based on the employee’s voluntarycontribution.  HickoryTech contributionsand costs for the retirement savings plan were $1,007,000 in 2004, $1,053,000in 2003 and $1,050,000 in 2002.

 

Inaddition to providing retirement savings benefits, HickoryTech providespost-retirement health care and life insurance benefits for certain employees.HickoryTech is not currently funding these post-retirement benefits, but hasaccrued these liabilities.

 

 
| **(Dollars in Thousands)**                 | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| Change in Benefit Obligation               |       |       | ** ** |       |       |
| Benefit Obligation at Beginning of Year    | ** ** | **$**      | **9,257**  | ** ** | $          | 5,230 |   |
| Service Cost                               | ** ** | **362**    | ** ** | 211        |       |
| Interest Cost                              | ** ** | **508**    | ** ** | 360        |       |
| Amendments                                 | ** ** | **—** | ** ** | —     |       |
| Medicare Part D Subsidy                    | ** ** | **(826**   | **)**      | —     |       |
| Actuarial (Gain)/Loss                      | ** ** | **(1,036** | **)**      | 3,589      |       |
| Benefits Paid                              | ** ** | **(184**   | **)**      | (133       | )          |
| Benefit Obligation at End of Year          | ** ** | **$**      | **8,081**  | ** ** | $          | 9,257 |   |
|                                       |       |       | ** ** |       |       |
| Change in Plan Assets                      |       |       | ** ** |       |       |
| Fair Value of Assets at Beginning of Year  | ** ** | **$**      | **—** | ** ** | $          | — |   |
| Actual Return on Assets                    | ** ** | **—** | ** ** | —     |       |
| Employer Contribution                      | ** ** | **184**    | ** ** | 133        |       |
| Distributions                              | ** ** | **(184**   | **)**      | (133       | )          |
| Fair Value of Assets at End of Year        | ** ** | **$**      | **—** | ** ** | $          | — |   |
|                                       |       |       | ** ** |       |       |
| Reconciliation of Funded Status            |       |       | ** ** |       |       |
| Funded Status                              | ** ** | **$**      | **(8,081** | **)**      | $          | (9,257 | ) |
| Unrecognized Net Actuarial (Gain)/Loss     | ** ** | **3,685**  | ** ** | 5,755      |       |
| Unrecognized Transition Obligation/(Asset) | ** ** | **480**    | ** ** | 540        |       |
| Unrecognized Prior Service Cost            | ** ** | **(84**    | **)**      | (95        | )          |
| Net Amount Recognized                      | ** ** | **$**      | **(4,000** | **)**      | $          | (3,057 | ) |

 
| ** **                                                    | ** ** | **2004**   | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Components of Net Periodic Benefit Cost                       |       |       |       |     |       |     |       |
| Service Cost                                                  |       | **$**      | **362**    |     | $          | 211      |       | $ | 174 |   |
| Interest Cost                                                 |       | **508**    |       | 360      |       | 330      |       |
| Expected Return on Plan Assets                                |       | **—** |       | —   |       | —   |       |
| Amortization of Transition  Obligation/(Asset)                |       | **60**     |       | 60       |       | 60       |       |
| Amortization of Prior Service Cost                            |       | **(11**    | **)**      | (11      | )          | (12      | )          |
| Recognized Net Actuarial (Gain)/Loss                          |       | **208**    |       | 97       |       | 85       |       |
| Net Periodic Benefit Cost                                     |       | **$**      | **1,127**  |     | $          | 717      |       | $ | 637 |   |
|                                                          |       |       |       |     |       |     |       |
| Weighted-Average Discount Rate Assumption  as of December 31: |       |       |       |     |       |     |       |
| Used to Determine the Post-Retirement  Expense                |       | **6.50**   | **%**      | 7.00     | %          | 7.00     | %          |
| Used to Determine the Benefit Obligation                      |       | **5.75**   | **%**      | 6.25     | %          | 7.00     | %          |

 

47

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Health Care Trend Rates for Year-EndingDecember 31, 2003

 
| ** ** | ** ** | **Year**  | ** ** | **Trend** | ** ** |
|------------|------------|-----------|------------|-----------|------------|
|       |       | 2005-2006 |       | 8.00      | %          |
|       |       | 2006-2007 |       | 7.50      | %          |
|       |       | 2007-2008 |       | 7.00      | %          |
|       |       | 2008-2009 |       | 6.50      | %          |
|       |       | 2009-2010 |       | 6.00      | %          |
|       |       | 2010-2011 |       | 5.50      | %          |
|       |       | 2011-2012 |       | 5.00      | %          |
|       |       | 2012+     |       | 4.50      | %          |

 
| **Effective of 1% Increase and 1% Decrease in Trend Rate**     | ** ** | **1% Increase** | ** ** | **1% Decrease** | ** ** |
|----------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|
|                                                           |       |            |       |            |       |
| Accum. Post-Retirement Benefit Oblig. as of  December 31, 2004 |       |            |       |            |       |
| Dollar                                                         |       | $               | 1,360      |            | $          | (1,097 | ) |
| Percentage Change in Retiree Medical                           |       | 16.83           | %          | -13.58          | %          |
|                                                           |       |            |       |            |       |
| Service Cost and Interest Cost for Fiscal  2004                |       |            |       |            |       |
| Dollar                                                         |       | $               | 191        |            | $          | (148 | ) |
| Percentage Change in Retiree Medical                           |       | 21.90           | %          | -17.03          | %          |

 

The health care cost trend rate used indetermining the accumulated post-retirement benefit obligations was 8% in 2005,and decreases 0.5% each year until it reaches 4.5% in 2012 and remains at 4.5%for the years thereafter. These assumptions were provided based on a study ofthe ten year history of the Company’s self-funded medical benefits plan, andprovide results unique to the Company’s philosophy of controlling risingmedical costs. This has resulted in the Company consistently having lowerincreases in health care costs than the national averages. An increase of one-percentage point in theassumed health care cost trend would increase the accumulated post-retirementbenefit obligation at December 31, 2004 by $1,360,000. A decrease ofone-percentage point in the assumed health care cost trend would decrease theaccumulated post-retirement benefit obligation at December 31, 2004 by$1,097,000.

 

In December 2003, the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003 (the Act) was enacted whichintroduced a prescription drug benefit under Medicare, as well as a federalsubsidy to sponsors of retiree health care benefit plans that provide a benefitthat is at least actuarially equivalent to the Medicare plan. In May 2004, theFinancial Accounting Standards Board issued FASB Staff Position No. 106-2,Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003, which requires currentrecognition of the federal subsidy that employers may receive for providingprescription drug coverage to retirees. Based on its current understanding of the Act, HickoryTech believes thata substantial portion of the prescription drug benefits provided under itspost-retirement benefit plan would be deemed actuarially equivalent to thebenefits provided under Medicare Part D. Consequently, the Company remeasured its accumulated post-retirementbenefit obligation (APBO) as of June 30, 2004, to account for the federalsubsidy.  The related reduction in APBOwas deemed to be significant as of the remeasurement date and the Company hasrecognized a decrease in the net periodic cost for the last two quarters offiscal 2004 of $54,000.  As of December31, 2004, the reduction in the APBO due to the Subsidy was $762,000.

 

**NOTE 9**–**INCOME TAXES**

 

The income tax provision(benefit) for operations for the years ended December 31, 2004, 2003 and 2002include the following components:

 
| **(Dollars in Thousands)** | ** ** | **2004**  | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------|------------|-----------|------------|----------|------------|----------|------------|
|                       |       |      |       |     |       |     |       |
| Current Income Taxes:      |       |      |       |     |       |     |       |
| Federal                    | ** ** | **$**     | **430**    |     | $          | (793     | )          | $ | (1,895 | ) |
| State                      | ** ** | **122**   |       | (198     | )          | 118      |       |
| Deferred Income Taxes:     |       |      |       |     |       |     |       |
| Federal                    | ** ** | **3,602** |       | 3,963    |       | (6,987   | )          |
| State                      | ** ** | **1,000** |       | 854      |       | (2,817   | )          |
| Total Income Tax Provision | ** ** | **$**     | **5,154**  |     | $          | 3,826    |       | $ | (11,581 | ) |

 

48

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Income tax expense is included in the financial statements as follows:

 
| **(Dollars in Thousands)** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |     |       |
| Continuing Operations      | ** ** | **$**    | **5,205**  |     | $          | 5,683    |       | $ | 4,249 |   |
| Discontinued Operations    | ** ** | **(51**  | **)**      | (1,857   | )          | (15,830  | )          |
| Total Income Tax Provision | ** ** | **$**    | **5,154**  |     | $          | 3,826    |       | $ | (11,581 | ) |

 

Deferred tax liabilities andassets are comprised of the following at December 31:

 
| **(Dollars in Thousands)**                          | ** ** | **2004**   | ** ** | **2003** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------|------------|
| Tax Liabilities:                                    |       |       |       |     |       |
| Depreciation and Property, Plant and  Equipment     | ** ** | **$**      | **12,792** |     | $          | 11,925 |   |
| Intangible Assets                                   |       | **4,602**  | ** ** | 4,238    |       |
| Derivatives                                         | ** ** | **996**    |       | 1,031    |       |
| Other                                               |       | —     | ** ** | 84       |       |
| Gross Deferred Tax Liability                        | ** ** | **18,390** |       | 17,278   |       |
|                                                |       |       |       |     |       |
| Tax Assets:                                         |       |       |       |     |       |
| Deferred Compensation and Post-Retirement  Benefits | ** ** | **2,156**  |       | 1,937    |       |
| Receivables and Inventories                         | ** ** | **1,070**  |       | 616      |       |
| Accrued Liabilities                                 | ** ** | **269**    |       | 441      |       |
| Other                                               | ** ** | **11**     |       | —   |       |
| Federal Net Operating Loss                          | ** ** | **611**    |       | 4,105    |       |
| State Net Operating Loss                            | ** ** | **1,229**  |       | 1,395    |       |
| Alternative Minimum Tax Credits                     | ** ** | **409**    |       | 150      |       |
| Gross Deferred Tax Asset                            | ** ** | **5,755**  |       | 8,644    |       |
| Valuation Allowance                                 |       | **(1,205** | **)**      | (640     | )          |
| Net Deferred Tax Liability                          |       | **13,840** |       | 9,274    |       |
| Current Deferred Tax Asset                          | ** ** | **1,430**  |       | 1,057    |       |
| Net Non-Current Deferred Tax Liability              |       | **$**      | **15,270** |     | $          | 10,331 |   |

 

A valuation allowance has been established to reduce the carrying valueof the benefits associated with net operating losses incurred by subsidiariesof HickoryTech in the state of Iowa. This valuation allowance was establisheddue to uncertainty as to realization of these benefits based on the continuingnet operating losses generated by these subsidiaries. Future events and changesin circumstances could cause this valuation allowance to change.

 

HickoryTech has federal net operating loss carryforwards for taxpurposes, available to offset future income, of approximately $1,800,000 atDecember 31, 2004. The Company also has state net operating loss carryforwardsof approximately $21,000,000 and alternative minimum tax credit carryforwardsof $409,000. The utilization of these carryforwards as an available offset tofuture taxable income is subject to limitations under U.S. federal andapplicable state income tax laws. The federal net operating loss carryforwardsexpire in 2023. The state net operating loss carryforwards expire in varyingamounts between 2018 and 2023. The alternative minimum tax credit carryforwardsdo not expire.

 

49

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The reconciliation of the U.S. income tax rate to the effective incometax rate for continuing operations is as follows:

 
| ** **                                     | ** ** | **2004**   | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Statutory Tax Rate                             |       | **34.0**   | **%**      | 34.0     | %          | 35.0     | %          |
| Effect of:                                     |       | ** ** |       |     |       |     |       |
| State Income Taxes Net of Federal Tax  Benefit |       | **5.8**    |       | 5.1      |       | 6.0      |       |
| Valuation Allowance                            |       | **—** |       | —   |       | —   |       |
| Other, Net                                     |       | **0.6**    |       | 1.1      |       | (0.5     | )          |
| Effective Tax Rate                             |       | **40.4**   | **%**      | 40.2     | %          | 40.5     | %          |

 

The 2003 income tax rate reconciliation excludes the impact of theincome tax benefit included in discontinued operations which was included inloss from discontinued operations.

 

**NOTE 10**–**FINANCIAL DERIVATIVE INSTRUMENTS**

 

HickoryTech accounts for derivative instruments in accordance with SFASNo. 133, as amended by SFAS No. 149, “Accounting for Derivative Instruments andHedging Activities,” which requires derivative instruments to be recorded onthe balance sheet at fair value. Changes in fair value of derivativeinstruments must be recognized in earnings unless specific hedge accountingcriteria are met, in which case the gains and losses are included in othercomprehensive income rather than in earnings.

 

HickoryTech has variable rate debt instruments, which subject theCompany to interest rate risk. Beginning in the second quarter of 2003,HickoryTech entered into interest rate swap agreements, with remainingmaturities of six months to forty-two months, to manage its exposure to interestrate movements on a portion of its variable rate debt obligations. The marketvalue of the cumulative gain or loss on these derivative instruments isreported as a component of accumulated other comprehensive income/loss inshareholders’ equity and will be recognized in earnings when the term of theswap agreement is concluded.

 

The fair value of the HickoryTech’s derivatives at December 31, 2004and 2003 is a net asset of $2,501,000 and $2,515,000, respectively, which isincluded in other assets in the consolidated balance sheet.

 

**NOTE 11**–**REGULATORY ASSET AND LIABILITY**

 

Effective January 1, 2002, the Federal Communications Commission (FCC),in its “MAG (Multi Association Group) Order” on Access Charge Reform, directedall rate-of-return carriers to file revisions to their tariffs to eliminate thetransport interconnection charge (TIC) as a separate rate element. In effect,the costs previously recovered through the TIC were reallocated over all otheraccess categories, including carrier common line, transport, local switching,information surcharge and special access. The FCCmade it clear that “this tariff filing should be a revenue neutral tarifffiling.”

 

The total revenues reallocated from the TIC to the remaining accesselements were limited to the total revenues recovered from the TIC for thetwelve-month period ended June 30, 2001. These revenues were calculated usingthe carrier’s traffic volumes and the TIC rate for the twelve-month periodended June 30, 2001. These calculations were prepared by an independentthird-party and approved by NECA. TIC was eliminated by reallocating the coststo the other access billing categories.

 

The FCC conducted an investigation of all tariff filings, includingNECA’s (National Exchange Carrier Association) CCL (Carrier Common Line) tariffand Heartland’s Traffic Sensitive (TS) tariff, to determine if the filingparties had properly reallocated the TIC costs among the other access chargecategories.

 

The FCC terminated its investigation of several tariff filings,concluding that “the carriers have substantially complied with theRate-of-Return Access Charge Reform Order and their tariffs no longer warrantinvestigation.” Despite this ruling by the FCC during the fourth quarter of2003, NECA informed HickoryTech’s Heartland subsidiary that it would not allowit to recover a portion of the TIC costs allocated to the CCL, because anincorrect TIC rate was used in the calculation.

 

As a result of this billing error, the Company recovered $611,000 ofexcess revenues from the NECA CCL pool. NECA required Heartland to repay the$611,000 in 2004.

 

The FCC approved a mid-course correction to Heartland’s TS tariff as asupportable method of recouping NECA’s CCL reduction. The revision corrects theTIC rate originally used, and factors recovery of the $611,000, into the TSrate elements. HickoryTech is recouping this revenue over the remainingeighteen months of the TS tariff, which began January 1, 2004. As of December31, 2004 HickoryTech has recognized a recovery of $407,000 of the revenue.

 

In accordance with SFAS No. 71, HickoryTech recorded a regulatory assetfor the revenue it would recoup with a balance of $204,000 at December 31, 2004and $611,000 at December 31, 2003. Similarly, HickoryTech recorded a liabilityfor the amounts that were to be repaid to the NECA CCL pool with a balance of$0 at December 31, 2004 and $611,000 at December 31, 2003.

 

50

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**NOTE12 – RECENT ACCOUNTING DEVELOPMENTS**

 

In May 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2,Accounting and Disclosure Requirements Related to the Medicare PrescriptionDrug Improvement and Modernization Act of 2003, which supersedes FSP No. FAS106 of the same name. FSP No. FAS 106-2 provides guidance on accounting for theeffects of the Medicare Prescription Drug, Improvement and Modernization Act of2003 (the Act), including the federal subsidy, and requires public companies toreflect the impact, if determinable and significant. The new Act introduces a prescriptiondrug benefit under Medicare Part D, as well as a federal subsidy to sponsors ofretiree health care benefit plans that provide a benefit that is at leastactuarially equivalent to the Medicare plan. The retiree medical plan doesprovide prescription drug coverage. Final regulations on the determination ofactuarial equivalence and the federal subsidy have yet to be issued; however,based on its current understanding of the Act, HickoryTech believes that theprescription drug benefits provided under its post-retirement benefit planwould be deemed actuarially equivalent to the benefits provided under MedicarePart D.  Consequently, the Companyadopted FSP 106-2 and remeasured its accumulated post-retirement benefitobligation (APBO) as of June 30, 2004, to account for the federal subsidy.  As of December 31, 2004, the reduction in theAPBO due to the Subsidy was $762,000. On January 21, 2005, the Department ofHealth and Human Services, Centers for Medicare & Medicaid Services, issuedfinal federal regulations related to the federal subsidy. HickoryTech iscurrently evaluating the effects, if any, that these final rules may have onits future benefit costs and accumulated post-retirement benefit obligation.

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 123(R), “Share-Based Payment”, which is a revision of SFASNo. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R)requires all share-based payments to employees, including grants of employeestock options, to be valued at fair value on the date of grant, and to beexpensed over the applicable vesting period. SFAS No. 123(R) is effectivefor all stock-based awards granted on or after July 1, 2005. In addition,companies must also recognize compensation expense related to any awards thatare not fully vested as of the effective date. Compensation expense for theunvested awards will be measured based on the fair value of the awardspreviously calculated in developing the pro forma disclosures in accordancewith the provisions of SFAS No. 123. HickoryTech is currently assessingthe impact of adopting SFAS 123(R) to its consolidated results of operationsand plans to comply with final regulations when issued.

 

**NOTE 13 – CONTINGENCIES**

 

HickoryTech is involved in certaincontractual disputes in the ordinary course of business. HickoryTech does notbelieve the ultimate resolution of any of these existing matters will have amaterial adverse effect on its financial position, results of operations, orcash flows.

 

**NOTE 14 – QUARTERLY FINANCIAL INFORMATION(Unaudited)**

 

 
| ** **                                                | ** ** | **2004** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|
| **(Dollars in thousands, except per share amounts)**      | ** ** | **4th**  | ** ** | **3rd** | ** ** | **2nd** | ** ** | **1st** | ** ** |
| Operating Revenues                                        |       | $        | 22,787     |   | $ | 22,177 |   | $ | 22,864 |   | $ | 22,687 |   |
| Operating Income                                          |       | $        | 3,361      |   | $ | 4,305 |   | $ | 4,953 |   | $ | 4,802 |   |
| Income from Continuing Operations                         |       | $        | 1,318      |   | $ | 1,902 |   | $ | 2,283 |   | $ | 2,161 |   |
| Loss from Disc. Ops., Net of Taxes                        |       | $        | —     |   | $ | (15 | ) | $ | — |   | $ | (59 | ) |
| Net Income                                                |       | $        | 1,318      |   | $ | 1,887 |   | $ | 2,283 |   | $ | 2,102 |   |
| Fully Diluted Earnings Per Share -  Continuing Operations |       | $        | 0.10       |   | $ | 0.15 |   | $ | 0.18 |   | $ | 0.17 |   |
| Fully Diluted Loss Per Share - Discontinued  Operations   |       | $        | —     |   | $ | — |   | $ | — |   | $ | (0.01 | ) |
|                                                      |       | $        | 0.10       |   | $ | 0.15 |   | $ | 0.18 |   | $ | 0.16 |   |
| Dividends Per Share                                       |       | $        | 0.11       |   | $ | 0.11 |   | $ | 0.11 |   | $ | 0.11 |   |

 
| ** **                                                         | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|
| ** **                                                         | ** ** | **4th**  | ** ** | **3rd** | ** ** | **2nd** | ** ** | **1st** | ** ** |
| Operating Revenues                                                 |       | $        | 23,366     |   | $ | 23,077 |   | $ | 22,872 |   | $ | 23,577 |   |
| Operating Income                                                   |       | $        | 5,342      |   | $ | 4,980 |   | $ | 4,719 |   | $ | 5,138 |   |
| Income from Continuing Operations                                  |       | $        | 2,399      |   | $ | 2,017 |   | $ | 1,922 |   | $ | 2,117 |   |
| Income(Loss) from Disc. Ops., Net of Taxes                         |       | $        | 42         |   | $ | (22,090 | ) | $ | 588 |   | $ | 230 |   |
| Net Income                                                         |       | $        | 2,441      |   | $ | (20,073 | ) | $ | 2,510 |   | $ | 2,347 |   |
| Fully Diluted Earnings Per Share - Continuing  Operations          |       | $        | 0.18       |   | $ | 0.14 |   | $ | 0.14 |   | $ | 0.15 |   |
| Fully Diluted Earnings/(Loss) Per Share -  Discontinued Operations |       | $        | —     |   | $ | (1.58 | ) | $ | 0.04 |   | $ | 0.02 |   |
|                                                               |       | $        | 0.18       |   | $ | (1.44 | ) | $ | 0.18 |   | $ | 0.17 |   |
| Dividends Per Share                                                |       | $        | 0.11       |   | $ | 0.11 |   | $ | 0.11 |   | $ | 0.11 |   |

 

51

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The financial information presented above has been restated to reflectwireless operations as discontinued operations. The summation of quarterlyearnings per share computations may not equate to the year-end computation asthe quarterly computations are performed on a discrete basis.

 

**Item 9.   Changes in and Disagreements WithAccountants on Accounting and Financial Disclosure.**

 

None.

 

**Item9A.                 Controlsand Procedures.**

 

**EVALUATION OF DISCLOSURE CONTROLS ANDPROCEDURES AND CHANGES IN INTERNAL CONTROLS**

 

An evaluation was performed under the supervision and with theparticipation of the Company’s management, including the respective personsacting as chief executive officer and chief financial officer, regarding theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Rule 13a-15(e) promulgated under the Securitiesand Exchange Act of 1934, as amended (the “Exchange Act”) as of December 31,2004. Based on that evaluation, the Company’s management, including therespective persons acting as chief executive officer and chief financialofficer, concluded that the Company’s disclosure controls and procedures wereeffective in timely alerting them to material information relating to theCompany (or its consolidated subsidiaries) required to be included in thereports it files or submits under the Exchange Act. There have been nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect internal controls.

 

**MANAGEMENT’S REPORT ON INTERNAL CONTROL OVERFINANCIAL REPORTING**

 

Management’s report on the Company’s internal control over financialreporting is included herein on page 30.

 

Management’s assessment of the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2004 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which is included herein on page 31.

 

**Item 9B.                 Other Information.**

 

None.

 

**PART III**

 

**Item 10.                 Directorsand Executive Officers of the Registrant.**

 

Information as to Directors and Executive Officers of HickoryTechincluded in the Proxy Statement under the headings “Election of Directors,” “Compensationof Directors,” “Security Ownership of Management” and “Section 16(a) BeneficialOwnership Reporting Compliance” are incorporated by reference. Disclosurerelating to the audit committee financial expert found under the heading of “AuditCommittee Report” in the Proxy Statement is also incorporated by reference.

 

HickoryTech has adopted a Code of Ethics that applies to its ChiefExecutive Officer, Chief Financial Officer, all officers of HickoryTech, theDirector of Regulatory Affairs, the Controller, the Manager of InternalControl, the Board of Directors and other appropriate personnel as identified.

 

52

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**Item 11.                 Executive Compensation.**

 

Information as to executive compensation included under the headings of“Summary Compensation Table,” “Option Grants in Last Fiscal Year,” “AggregatedOption/SAR Exercises and Fiscal Year-End Option Values,” “Long Term IncentivePlan Awards in Last Fiscal Year,” “Employment Contracts, Change of ControlAgreements, Severance Agreements and Other Agreements” and “CompensationCommittee Report on Executive Compensation,” in the Proxy Statement isincorporated by reference.

 

**Item 12.****                                                SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters.**

 

The information as to beneficial ownership of more than five percent ofHickoryTech’s common stock included under the heading “Beneficial Owners ofCommon Stock” of the Proxy Statement is incorporated by reference. Theinformation as to security ownership of management included under the headingof “Security Ownership of Management” in the Proxy Statement is incorporated byreference.

 

The following table provides information on equity compensation plansunder which equity securities of the Company are authorized for issuance, as ofDecember 31, 2004.

 
| **Plan Category**                                            | ** ** | **Number of securities to   be issued upon exercise   of outstanding options,   warrants and rights**

**(a)** | ** ** | **Weighted-average   exercise price of  outstanding options,  warrants and rights**

**(b)** | ** ** | **Number of securities  remaining available for  future issuance under   equity compensation   plans (excluding   securities reflected in   column (a))**

**(c)** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                         |       |                                                                                                           |       |                                                                                         |       |                                                                                                                                                               |       |
| Equity compensation plans approved by  security holders (1): |       | 549,065                                                                                                        |       | $                                                                                            | 12.86      |                                                                                                                                                               | 1,926,632  |   |
|                                                         |       |                                                                                                           |       |                                                                                         |       |                                                                                                                                                               |       |
| Equity compensation plans not approved by  security holders: |       | —                                                                                                         |       | —                                                                                       |       | —                                                                                                                                                             |       |
|                                                         |       |                                                                                                           |       |                                                                                         |       |                                                                                                                                                               |       |
| Total                                                        |       | 549,065                                                                                                        |       | $                                                                                            | 12.86      |                                                                                                                                                               | 1,926,632  |   |
|                                                              |            |                                                                                                                |            |                                                                                              |            |                                                                                                                                                                    |            |  |  |

 

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(1)           - Includes theCompany’s Employee Stock Purchase Plan, Directors’ Stock Retainer Plan,Directors’ Stock Option Plan and    StockAward Plan.

 

**Item 13.                 Certain Relationships andRelated Transactions.**

 

HickoryTech does not know of any matter required to be reported under thisitem.

 

**Item 14.****                PrincipalAccountant Fees and Services.**

 

The information under the heading Independent Registered Public AccountingFirm in the Proxy Statement is incorporated herein by reference.

 

53

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** **

**PART IV**

 

**Item 15.           Exhibits and Financial StatementSchedule.**

 

(a)           List of Documents Filed as a Part ofthis Report

 

 
| 1.             Financial Statements                                              | ** ** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                                                                                                                                         |       |       |
| Management’s Discussion and Analysis of  Financial   Condition and Results of Operations                                                |       |       |
| Management’s Report on Internal Control  over Financial    Reporting and Report of Independent Registered Public   Accounting Firm |       |       |
| Consolidated Statements of Operations*   Years Ended December 31, 2004, 2003, and 2002                                                       |       |       |
| Consolidated Balance Sheets*   December 31, 2004 and 2003                                                                                    |       |       |
| Consolidated Statements of Cash Flows*   Years Ended December 31, 2004, 2003, and 2002                                                       |       |       |
| Consolidated Statements of Shareholders’  Equity and   Comprehensive Income/Loss*   Years Ended December 31, 2004, 2003, and 2002       |       |       |
| Notes to Consolidated Financial Statements*                                                                                                  |       |       |
| Selected Financial Data                                                                                                                      |       |       |

 

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*Addressed by Report of IndependentRegistered Public Accounting Firm

 
| 2.             Financial Statement Schedule |   |   |
|---------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                    |   |   |
| Report of Independent Registered Public  Accounting Firm on  Financial Statement Schedule               |   |   |
| Schedule II – Valuation and Qualifying  Accounts                                                   |   |   |

 

All schedules not included are omitted either because of the absence ofconditions under which they are required or because the required information isgiven in the financial statements or notes thereto.

 

3.             Exhibits

 

The following documents are filed as Exhibits to this Form 10-K or incorporatedby reference herein. Any document incorporated by reference is identified by aparenthetical reference to the SEC filing which included such document.

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                 |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                            |
| 3(a)        |       | Restated Articles of Incorporation  (Incorporated by reference to Exhibit 3 to the registrant’s Form 10-Q dated  May 6, 1999)                                                                              |
| 3(b)        |       | Amended and Restated By-Laws (Incorporated  by reference to Exhibit 3(b) to the registrant’s Form 8-K filed February 22,  2005)                                                                            |
| 3(c)        |       | Certificate of  Designations of Series A Junior Participating Preferred Stock of Hickory Tech  Corporation (Incorporated by reference to Exhibit 3(c) to the registrant’s  Form 10-K dated March 29, 2000) |
| 4(a)        |       | Shareholder Rights  Agreement (Incorporated by reference to Exhibit 1 to the registrant’s Form  8-A dated March 9, 1999)                                                                                   |

 

54

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| **Exhibit**   | ** ** | **Description**                                                                                                                                                                                                                                                                                                                |
|---------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4(b)          |       | Second Amended and Restated Credit  Agreement dated as of September 21, 2000, by and among Hickory Tech  Corporation, as Borrower, the Lenders referred to herein and First Union  National Bank, as Administrative Agent (Incorporated by reference to Exhibit  4 to the registrant’s Form 10-Q dated November 10, 2000) |
| 10(a) †  |       | Supplemental Retirement Agreement dated  January 1, 1993, between registrant and Robert D. Alton, Jr. (Incorporated by  reference to Exhibit 10(a) to the registrant’s Form S-8 dated May 11, 1993)                                                                                                                       |
| 10(b) †  |       | Supplemental Retirement Agreement dated  January 31, 1984, between registrant’s subsidiary, Mankato Citizens Telephone  Company, and David A. Christensen (Incorporated by reference to Exhibit 10(b)  to the registrant’s Form S-8 dated May 11, 1993)                                                              |
| 10(c) †  |       | Hickory Tech Corporation Executive  Incentive Plan Amended and Restated December 4, 2002 (Incorporated by  reference to Exhibit 10(a) to the registrant’s Form 10-Q dated May 13, 2003)                                                                                                                                   |
| 10(e) †  |       | Change in Control Agreement dated June 25,  1998, between registrant and Jon L. Anderson, David A. Christensen, John W.  Finke and Mary T. Jacobs (Incorporated by reference to Exhibit 10(e) to the  registrant’s Form 10-K dated March 29, 2000)                                                                        |
| 10(g) †  |       | Hickory Tech Corporation Directors’ Stock  Option Plan Amended and Restated February 5, 2003 (Incorporated by reference  to Exhibit 10(g) to the registrant’s Form 10-K filed March 9, 2004)                                                                                                                         |
| 10(h) †  |       | Employment Agreement dated January 1, 1993,  between registrant and Robert D. Alton, Jr. (Incorporated by reference to  Exhibit 10(h) to the registrant’s Form S-8 dated May 11, 1993)                                                                                                                                    |
| 10(i) †  |       | Hickory Tech Corporation Retainer Stock  Plan for Directors Restated and Amended effective September 1, 1996  (Incorporated by reference to Exhibit 10(m) to the registrant’s Form 10-Q  dated August 12, 1996)                                                                                                           |
| 10(j) †  |       | Hickory Tech Corporation Retirement Savings  Plan and Trust, as amended (Incorporated by reference to Exhibit 10(j) to the  registrant’s Form S-8 dated May 11, 1993)                                                                                                                                                     |
| 10(k) †  |       | Hickory Tech  Corporation Amended and Restated Employee Stock Purchase Plan (Incorporated  by reference to Exhibit 10(j) to the registrant’s Form 10-Q dated August 12,  1996)                                                                                                                                            |
| 10(l) †  |       | Hickory Tech Corporation 1993 Stock Award  Plan (Amended and Restated effective January 29, 1997) (Incorporated by  reference to Exhibit 10(l) to the registrant’s Form 10-K dated March 26,  1997)                                                                                                                       |
| 10(m)         |       | Agreement for Sale of Amana Colonies  Telephone Company Assets, dated July 21, 2000 (Incorporated by reference to  Exhibit 99 to the registrant’s Form 10-Q dated August 11, 2000)                                                                                                                                        |
| 10(n)         |       | Agreement for Purchase and Sale of Assets  dated as of September 29, 2000 between Internet Connections, Inc., as Seller  and Hickory Tech Corporation, as Buyer (Incorporated by reference to Exhibit  10(n) to the registrant’s Form 10-K dated March 29, 2001)                                                          |
| 10(o) †  |       | Change of Control Agreement dated July 1,  2002, between registrant and John E. Duffy (Incorporated by reference to  Exhibit 10(o) to the registrant’s Form 10-Q dated November 14, 2002)                                                                                                                                 |
| 10(p)         |       | Stock Purchase Agreement dated as of  September 18, 2003 between HickoryTech and Western Wireless Corporation  (Incorporated by reference to Exhibit 2.1 to the registrant’s Form 8-K dated  December 30, 2003)                                                                                                           |
| 10(q) †  |       | Summary of the Hickory Tech Corporation  Long-Term Executive Incentive Program (Incorporated by reference to Exhibit  10(q) to the registrant’s Form 8-K filed February 22, 2005)                                                                                                                                         |
| 10(r)* † |       | Form of Stock Option Agreement Used in  Connection with Grants Under the 1993 Stock Award Plan                                                                                                                                                                                                                                 |

 

55

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| **Exhibit** | ** ** | **Description**                                                                                                         |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------|
| 14          |       | Code of Ethics (Incorporated by reference  to Exhibit 14 to the registrant’s Form 10-K dated March 9, 2004)        |
| 21*         |       | Subsidiaries of Hickory Tech Corporation                                                                                |
| 23*         |       | Consent of Independent Registered Public  Accounting Firm                                                               |
| 31(a)*      |       | Certification Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002                                                |
| 31(b)*      |       | Certification Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002                                                |
| 32(a)*      |       | Certification Pursuant to 18 U.S.C. Section  1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32(b)*      |       | Certification Pursuant to 18 U.S.C. Section  1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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*              Filed herewith.

†              Managementcompensation plan or arrangement required to be filed as an exhibit.

 

**Report ofIndependent Registered Public Accounting Firm on Financial Statement Schedule**

 

To the Shareholders and Board of Directors of

Hickory Tech Corporation:

 

Our audits of the consolidated financial statements referred to in ourreport dated March 3, 2005 appearing in the 2004 Annual Report to Shareholdersof Hickory Tech Corporation (which report and consolidated financial statementsare incorporated by reference in this Annual Report on Form 10-K) also includedan audit of the financial statement schedule listed in Item 15(a)(2) of thisForm 10-K.  In our opinion, this financial statement schedule presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements.

 

PricewaterhouseCoopers LLP

Minneapolis, Minnesota

March 3, 2005

 

56

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**SCHEDULEII – VALUATION AND QUALIFYING ACCOUNTS**

 

ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS:

 
| ** **                                             | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|
| **(In Thousands)**                                     | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                   |       |                         |       |   |   |   |   |
| Balance, at beginning of year                          | ** ** | **$**                        | **1,283**  |   | $ | 1,358 |   | $ | 1,231 |   |
| Additions charged to income - Continuing  Operations   | ** ** | **1,003**                    |       | 726 |   | 1,835 |   |
| Write-offs, net of recoveries - Continuing  Operations | ** ** | **(1,030**                   | **)**      | (719 | ) | (1,360 | ) |
| Discontinued Operations, Net                           | ** ** | **—**                   |       | (82 | ) | (348 | ) |
|                                                   |       |                         |       |   |   |   |   |
| Balance, at end of year                                | ** ** | **$**                        | **1,256**  |   | $ | 1,283 |   | $ | 1,358 |   |

 

INVENTORY VALUATION RESERVE:

 
| ** **                    | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------|------------|------------------------------|------------|
| **(In Thousands)**            | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|                          |       |                         |       |   |   |   |   |
| Balance, at beginning of year | ** ** | **$**                        | **734**    |   | $ | 827 |   | $ | 858 |   |
| Additions charged to income   | ** ** | **731**                      |       | 34 |   | — |   |
| Reductions (1)                | ** ** | **(33**                      | **)**      | (127 | ) | (31 | ) |
|                          |       |                         |       |   |   |   |   |
| Balance, at end of year       | ** ** | **$**                        | **1,432**  |   | $ | 734 |   | $ | 827 |   |

 

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(1) Disposal of fully reserved inventory.

 

DEFERRED TAX ASSET VALUATIONALLOWANCE

 
| ** **                    | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------|------------|------------------------------|------------|
| **(In Thousands)**            | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|                          |       |                         |       |   |   |   |   |
| Balance, at beginning of year | ** ** | **$**                        | **640**    |   | $ | 470 |   | $ | 315 |   |
| Additions charged to income   | ** ** | **565**                      |       | 170 |   | 155 |   |
| Reductions                    | ** ** | **—**                   |       | — |   | — |   |
|                          |       |                         |       |   |   |   |   |
| Balance, at end of year       | ** ** | **$**                        | **1,205**  |   | $ | 640 |   | $ | 470 |   |

 

57

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**SIGNATURES**

 

Pursuant to the requirements of section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
| Dated: | March 3,  2005 |                                    | HICKORY TECH CORPORATION |
|--------|----------------|-----------------------------------------|--------------------------|
|   |           |
|   |           |
|   | By:            | /s/ David A. Christensen                |                     |
|   |           | David A. Christensen, Secretary,        |
|   |           | Vice President, Chief Financial Officer |
|   |           | and Treasurer                           |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| /s/ Starr J. Kirklin                                            |   | March 3, 2005 |
|-----------------------------------------------------------------|--------|---------------|
| Starr J. Kirklin, Chair                                         |   |
|                                                            |   |
|                                                            |   |
| /s/ R. Wynn Kearney, Jr.                                        |   | March 3, 2005 |
| R. Wynn Kearney, Jr., Vice Chair                                |   |
|                                                            |   |
|                                                            |   |
| /s/ John E. Duffy                                               |   | March 3, 2005 |
| John E. Duffy                                                   |   |
| President, Chief Executive Officer and  Director                |   |
| (principal executive officer)                                   |   |
|                                                            |   |
|                                                            |   |
| /s/ David A. Christensen                                        |   | March 3, 2005 |
| David A. Christensen, Secretary,                                |   |
| Vice President, Chief Financial Officer and  Treasurer          |   |
| (principal financial officer and principal  accounting officer) |   |
|                                                            |   |
|                                                            |   |
| /s/ Lyle T. Bosacker                                            |   | March 3, 2005 |
| Lyle T. Bosacker, Director                                      |   |
|                                                            |   |
|                                                            |   |
| /s/ James H. Holdrege                                           |   | March 3, 2005 |
| James H. Holdrege, Director                                     |   |
|                                                            |   |
|                                                            |   |
| /s/ Robert E. Switz                                             |   | March 3, 2005 |
| Robert E. Switz, Director                                       |   |
|                                                            |   |
|                                                            |   |
| /s/ James W. Bracke                                             |   | March 3, 2005 |
| James W. Bracke, Director                                       |   |
|                                                                 |        |               |  |  |  |  |  |

 

(a majority of directors)

 

58

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