**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, 2005**

 

**CommissionFile Number:  0-13721**

 

**HICKORY TECH CORPORATION**

 

| **Minnesota**                    | ** ** | **41-1524393**       |
|----------------------------------|------------|----------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer     |
| incorporation or  organization)  |       | Identification  No.) |

** **

**221 EastHickory Street**

**P.O. Box3248**

**Mankato,Minnesota  56002**

 (Address of principal executive offices andzip 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:

 

**CommonStock, No Par Value**

**PreferredStock Purchase Rights**

**Title ofClass**

 

Indicate by check mark if the registrant is a well-known seasonedissuer, as defined in Rule 405 of the Securities Act. Yes o No ý

 

Indicate by check mark if the registrant is not required to filereports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months, and (2) has been subject to such filingrequirements for the past 90 days. Yes ý No o

 

Indicate by a check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of Registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. ý

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See the definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.

(Check one): Large accelerated filer oaccelerated filer ý non-acceleratedfiler o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Act). Yes o No ý

 

As of June 30, 2005, the aggregate market value of the common stockheld by non-affiliates of the registrant was $99,901,710 based on the last saleprice of $8.07 on The Nasdaq National Market.

 

The total number of shares of the registrant’s common stock outstandingas of February 28, 2006:  13,133,928

 

Documents Incorporated by Reference:          Portionsof the registrant’s definitive Proxy Statement for the Annual Meeting ofShareholders to be held on April 24, 2006 (“Proxy Statement”) are incorporatedby reference in Part III of this Form 10-K.

 

 

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**INDEX**

 
| PART I   |     |
|----------|----------|
|     | Item 1:  |   | Business |   |
|     | Item 1A: |   | Risk Factors |   |
|     | Item 1B: |   | Unresolved Staff Comments |   |
|     | 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 |   |

 

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**PART I**

 

**CAUTIONARY STATEMENT**

 

The Private SecuritiesLitigation Reform Act of 1995 contains certain safe harbor provisions regardingforward-looking statements. This 2005 Annual Report on Form 10-K and otherdocuments filed by Hickory Tech Corporation (“HickoryTech,” the “Company,” we,us or our) under the federal securities laws, including Form 10-Q and Form 8-K,and future verbal or written statements by HickoryTech and its management mayinclude forward-looking statements. These statements may include, withoutlimitation, statements with respect to anticipated future operating andfinancial performance, growth opportunities and growth rates, acquisition anddivestiture opportunities, business strategies, business and competitiveoutlook and other similar forecasts and statements of expectation. Words suchas expects, anticipates, intends, plans, believes, seeks, estimates and should,and variations of these words and similar expressions, are intended to identifythese forward-looking statements. Such forward-looking statements are subjectto uncertainties that could cause HickoryTech’s actual results to differmaterially from such statements.

 

Due to the uncertaintieslisted and the fact that any forward-looking statements made by HickoryTech andits management are based on estimates, projections, beliefs and assumptions ofmanagement, they are not guarantees of future performance. Except as requiredby law, HickoryTech disclaims any obligation to update or revise anyforward-looking statements based on the occurrence of future events, thereceipt of new information, or otherwise.

 

**Item 1.          Business.**

 

##### **GENERAL**

##### ** **

HickoryTech is adiversified communications company headquartered in Mankato, Minnesota.HickoryTech has over a 100-year history in the local telephone exchangebusiness. From those roots, it has expanded into four business segments:Telecom Sector, Information Solutions Sector, Enterprise Solutions Sector andEnventis Sector. HickoryTech’s core business is its Telecom Sector, whichconsists of two businesses. One of these businesses is the operation of threeincumbent local exchange carriers (ILECs). This business consists of connectingcustomers to the telephone network, providing switched service and dedicatedprivate lines, connecting customers to Internet and long distance serviceproviders and providing other services commonly associated with ILECs. Thesecond business of the Telecom Sector is competitive local exchange carrier(CLEC) services, which HickoryTech initiated in 1998, and its associatedcompetitive businesses of long distance service and Internet access. This CLECbusiness leverages HickoryTech’s expertise and expands its telecommunicationsservice into areas served by other incumbent LECs (local exchange carriers). InDecember 2003, HickoryTech sold what had been a third business of the TelecomSector, which provided wireless telecommunications services to customers insouthern Minnesota and its surrounding area, along with an area surroundingMinneapolis/St. Paul. The wireless operations are reported as part of theTelecom Sector. All financial statements and schedules have been restated toreflect wireless operations as discontinued operations. In addition to theTelecom Sector, HickoryTech provides data processing services to thetelecommunications industry (Information Solutions Sector) and providestelephone, data and Internet Protocol (IP) equipment sales and service(Enterprise Solutions Sector). On December 30, 2005, HickoryTech purchasedEnventis Telecom (Enventis). Enventis is a Minnesota-based regional provider ofintegrated fiber network, IP Telephony, and data services, with 1,500 routemiles of fiber network serving more than 300 business customers in over 40communities in the Upper Midwest. Enventis had formerly been a wholly ownedsubsidiary of another public corporation. The HickoryTech parent company wasincorporated in Minnesota in 1985, replacing Mankato Citizens Telephone Company(formed in 1898) as the parent company.

 

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The eight currentsubsidiaries and one discontinued subsidiary of HickoryTech and the businesssegments in which they operate are:

 

**TELECOMSECTOR**

•    MankatoCitizens Telephone Company (MCTC)

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

•    HeartlandTelecommunications Company of Iowa, Inc. (Heartland)

•    Cable Network,Inc. (CNI)

•    CrystalCommunications, Inc. (Crystal)

•    MinnesotaSouthern Wireless Company (MSWC) – Discontinued Operations

 

**INFORMATIONSOLUTIONS SECTOR**

•    NationalIndependent Billing, Inc. (NIBI)

 

**ENTERPRISESOLUTIONS SECTOR**

•   CollinsCommunications Systems Co. (Collins)

 

**ENVENTISSECTOR**

•   Enventis Telecom,Inc. (Enventis)

 

HickoryTech and its subsidiariesare engaged in businesses that provide services to its customers for a fee.Many of these services are recurring, and, as a result, backlog orders andseasonality are not significant factors. Working capital requirements for theTelecom Sector involve financing the construction of networks involvingswitches and cable, maintaining a high amount of fixed assets, payroll costs ofhighly skilled labor, inventory to service its capital projects and maintenanceof the network and telephone equipment customers, and the carrying value oftrade accounts receivable, which may take several months to collect in thenormal course of business. Working capital requirements for the InformationSolutions Sector involve capital for software development, operating losses,payroll costs of highly skilled labor and the carrying value of trade accountsreceivable. Working capital requirements for the Enterprise Solutions Sectorinvolve capital for payroll costs, inventory to service its customers, thecarrying value of trade accounts receivable, work-in-process and operatinglosses. Working capital requirements in the Enventis Sector involve capital forpayroll costs, the carrying value of accounts receivable and work-in-process.

 

The materials and supplies that arenecessary for the operation of the businesses of HickoryTech and itssubsidiaries are available from a variety of sources. All of HickoryTech’scentral office switches, as well as a majority of HickoryTech’s equipment soldin its Enterprise Solutions and Enventis Sectors, are supplied by Nortel andCisco. Nortel and Cisco are leading suppliers of communications and dataequipment, and HickoryTech’s dependence on these brands is not viewed as asignificant risk.

 

HickoryTech makesavailable, free of charge, copies of its annual reports on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K and amendments to thesereports filed or furnished pursuant to Section 13(a) or 15(d) of the SecuritiesExchange Act of 1934 as amended (the “Exchange Act”). These reports areavailable on HickoryTech’s Internet website (http://www.hickorytech.com) assoon as reasonably practicable after such material is electronically filed withor furnished to the Securities and Exchange Commission.

 

As of December 31, 2005,HickoryTech had 460 full-time equivalent employees.

 

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**ACQUISITION**

** **

On December 30, 2005,HickoryTech purchased Enventis from ALLETE, Inc. The purchase price wascomprised of $35,500,000 in cash, subject to normal working capital adjustments.Enventis is a transport and enterprise IP telephony sales business whichspecializes in providing telecommunications and network solutions. In additionto its statewide SONET-based network, Enventis provides innovative IP servicesthat combine voice and data onto a single platform. Since 1997, Enventis hasprovided network solutions for a broad spectrum of large corporate, non-profit,government and small business clients. Enventis has offices located in Duluth,Plymouth, and Rochester, Minnesota and Sioux Falls, South Dakota.

 

On December 30, 2005,HickoryTech entered into a $160,000,000 credit agreement with a syndicate ofbanks, which amended its previous credit facility. The proceeds were used tocarryover the outstanding obligations under the previous credit facility, payfees and expenses associated with the new credit facility, and pay costsassociated with the acquisition of Enventis.

 

**DISPOSITION**

** **

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 of operationsfor all periods presented have been restated to reflect wireless operations asdiscontinued operations (see Note 3 of the Notes to the Consolidated FinancialStatements).

 

**INDUSTRY SEGMENTS FINANCIAL DATA**

** **

Financial informationabout HickoryTech’s industry segments is included on pages 22 to 28 and pages 49to 50 of this 2005 Annual Report on Form 10-K.

 

**INDUSTRY SEGMENTS**

** **

HickoryTech reports thebusiness operations of Telephone, Communications Services, and WirelessServices as a single segment referred to as the Telecom Sector. The results ofoperations of the wireless business are reported as discontinued operations(see Note 3 of the Notes to the Consolidated Financial Statements). The otherthree business segments are the Information Solutions, Enterprise Solutions andEnventis Sectors.

 

TELECOM SECTOR

 

HickoryTech’s TelecomSector provides local exchange wireline telephone service, long distance,dial-up and broadband Internet access, and owns and operates fiber optic cablefacilities. This sector includes three ILECs: MCTC, Mid-Comm and Heartland.MCTC and Mid-Comm provide telephone service in south central Minnesota,specifically Mankato (a regional hub) and eleven rural communities surroundingMankato. The third ILEC, Heartland, provides telephone service for eleven ruralcommunities in northwest Iowa. In total, there are twenty-three ILEC exchangeswithin the Telecom Sector.

 

The Telecom Sector alsoincludes Crystal, a CLEC. Crystal provides local telephone service, longdistance, dial-up and broadband Internet access and digital TV on a competitivebasis. Crystal also connects communication networks of interexchange andwireless carriers with the equipment and facilities of end users. Crystal hascustomers in ten rural communities, encompassing eight exchanges, in Minnesotaand three communities, encompassing two exchanges, in Iowa that are not inHickoryTech’s ILEC service areas. HickoryTech discontinued its service to fourother Iowa communities in 2003. Crystal also provides digital TV service in fiveMinnesota communities in addition to its telephone services listed above. Theyinclude St. Peter, initiated in 2001, Waseca, in July 2004, New Richland andEllendale in June 2005, and St. Clair, in September 2005, all communities whereHickoryTech provides telephone service either as an ILEC or CLEC.

 

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HickoryTech also owns andoperates fiber optic cable facilities in Minnesota in its Telecom Sector, inaddition to its new Enventis Sector. These facilities are used to transportinterexchange communications as a service to telephone industry customers.HickoryTech’s Minnesota ILECs and CLEC are the primary users of the fiber opticcable facilities in the Telecom Sector. The Telecom Sector included the operationsof MSWC, which was sold on December 15, 2003. None of the remaining companiesin the Telecom Sector experienced major changes in operations during 2005 or2004.

 

MCTC derives itsprincipal revenues and income from local services charged to subscribers in itsservice area, access services charged to interexchange carriers, and theoperation of a toll tandem-switching center in Mankato, Minnesota. Revenues andincome for Mid-Comm are also derived from local service charges in its area ofoperation and by providing access to long distance services for its subscribersthrough the toll center in Mankato. Local and interexchange telephone accessfor the two companies is provided on an integrated basis. The local andinterexchange telephone access for both telephone companies utilize the samefacilities and equipment and is managed and maintained by a common workforce.Heartland derives its principal revenues and income from local services chargedto subscribers in its service area in Iowa, as well as from providinginterexchange access for its subscribers. Interexchange telephone access isprovided by all three of HickoryTech’s ILEC subsidiaries by connecting thecommunications networks of interexchange and wireless carriers with theequipment and facilities of end users through its switched networks or privatelines. Network access revenue accounted for 36.1%, 39.1% and 39.0% of totalrevenue for HickoryTech in 2005, 2004 and 2003 respectively.

 

MCTC and Mid-Comm areMinnesota public utilities operating pursuant to indeterminate permits issuedby the Minnesota Public Utilities Commission (PUC). Heartland is also a publicutility, which operates pursuant to a certificate of public convenience andnecessity issued by the Iowa Utilities Board. These state agencies regulate theservices provided by MCTC, Mid-Comm and Heartland. CNI’s operations are notsubject to regulation by the state regulatory authority. Neither the PUC northe Iowa Utilities Board regulates the rate of return or profits of each ofHickoryTech’s ILEC operations due to the size of these companies relative tostate regulation. In Minnesota, regulators monitor MCTC and Mid-Comm’s priceand service levels. MCTC’s and Mid-Comm’s local service rates are below thoseof most Minnesota incumbent LECs. HickoryTech and its subsidiaries will changerates determined by various factors, including economic and competitivecircumstances.

 

As local exchangetelephone companies, MCTC, Mid-Comm and Heartland provide end office switchingand dedicated circuits to long distance interexchange carriers. Theserelationships allow HickoryTech’s telephone subscribers to place long distancetelephone calls and gain access to the telephone network. HickoryTech providesinterexchange access for all of the individual customers who select analternative long distance carrier. This interexchange access business isseparate and distinct from HickoryTech’s own long distance retail business,which is operated in its Crystal subsidiary. The long distance interexchangecarriers are significant customers of HickoryTech, but no carrier representsmore than ten percent of HickoryTech’s consolidated revenues.

 

Alternatives toHickoryTech service include customers leasing private lines in lieu of switchedvoice services and data services in or adjacent to the territories served byHickoryTech, which permits the bypassing of local telephone switchingfacilities. Additionally, services provided by other companies utilizingvarious Internet, wireline or wireless technologies permit bypass of the localexchange network. These alternatives to local exchange service represent apotential threat to HickoryTech’s long-term ability to provide local exchangeservice at economical rates.

 

Competition inHickoryTech’s ILEC service area exists in one of Heartland’s exchanges. In thecity of Hawarden, Iowa, the municipal utilities overbuilt the city’s telephoneservice infrastructure in 1999 and are providing an alternative to HickoryTech’stelephone service. HickoryTech estimates the Hawarden CLEC has approximately1,400 access lines, or approximately 70 percent of that exchange’s telephonebusiness.

 

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Competition also exists for some of the HickoryTechservices provided to interexchange carriers, such as customer billing services,dedicated private lines, network switching and network routing. Thiscompetition comes primarily from the interexchange carriers themselves, in thatcarriers may decide that the services provided by HickoryTech may be redirectedor handled on their own network or on other networks. The provision of theseservices is primarily month-to-month service ordered from a general tariff,which is a schedule of terms, rates and conditions that is approved by theappropriate state or federal agency. The interexchange carriers primarilycontrol the procurement of these services. As interexchange carriers make theseservice decisions, they have the potential to reduce the Company’s revenue inthe Telecom Sector. Other services, such as the provision of broadband, longdistance service, directory advertising and end user equipment, are open tocompetition.

 

HickoryTech companies aresometimes engaged in negotiations or renegotiations of arrangements for networkinterconnections with other carriers and contracts with various wireless orwireline service providers. In the second half of 2005, negotiations regardinginterconnection of networks were concluded with a potential competitor formarkets served by HickoryTech in Minnesota. HickoryTech is presently involvedin interconnection negotiations with service providers that may compete withHickoryTech companies in several small towns in Iowa. Although such competitionmay result in reduced revenue, HickoryTech cannot, at this time, estimate thepotential impact related to these negotiations.

 

Crystal began operationsin January 1998 as a new CLEC. Crystal offers local service, long distance,dial-up and broadband Internet access services, and digital TV on a competitivebasis to customers in southern Minnesota and Iowa, which were not previouslyserved by HickoryTech’s Telecom Sector service area. These service offeringsprovide customers alternatives to the incumbent communication providers invarious communities and are offered under the brand name HickoryTech service.These services are currently being offered to customers in ten ruralcommunities, encompassing eight exchanges, in Minnesota, as well as threecommunities, encompassing two exchanges, in Iowa. Crystal also provides thelong distance service, dial-up and broadband Internet access services toHickoryTech’s ILEC subscribers and is providing digital TV in one communityserved by Mid-Comm.

 

CLEC activities requireCrystal to file for authority to operate with the appropriate public utilitiescommission in each state it serves. Crystal competes directly against existingincumbent LECs in the areas in which it operates. Crystal competes directlywith incumbent cable TV providers and satellite for its digital TV services.Crystal is presently providing these services under franchise agreements withthe local communities. Crystal is not dependent upon any single customer orsmall group of customers. No single customer in Crystal accounts for tenpercent or more of HickoryTech’s consolidated revenues.

 

There is currently a multi-state LEC industry disputewith a large RBOC (Regional Bell Operating Company) regarding certain accesscharges. Following a formal complaint process with the PUC, the Minnesota ILECindustry and Qwest have negotiated an interim arrangement, which placed thecomplaint process in a “continuance” while they conduct a trial of proposedresolution. The Iowa industry is also engaged in negotiations to resolve thedispute. HickoryTech has already recognized the potential impact of thedispute, so future resolution should not have a material impact.

 

On December 15, 2003, HickoryTechsold its wireless business, Minnesota Southern Wireless Company (MSWC), to WWC.The wireless operations are reported as part of the Telecom Sector. The resultsof operations of the wireless business are reported as discontinued operationsfor all periods presented.

 

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INFORMATION SOLUTIONSSECTOR

 

Through NIBI, HickoryTech’sInformation Solutions Sector provides data processing and related services,principally for HickoryTech, other local exchange telephone companies, CLECs,interexchange network carriers and wireless companies. The InformationSolutions Sector’s principal activity is the provision of monthly batchprocessing of computerized data for HickoryTech as well as non-affiliatedcompanies. Services for telephone company customers include the processing oflong distance telephone calls from data sources and telephone switches, thepreparation of the subscriber telephone bills, customer record keeping andcarrier access bills. There are a number of companies engaged in supplying dataprocessing services comparable to those furnished by the Information SolutionsSector. Competition is based primarily on price and service. HickoryTech’sInformation Solutions Sector has developed an integrated billing and managementsystem called SuiteSolution. SuiteSolution can provide wireline and wirelesscarriers the individual benefits of a billing platform or a total systemsolution. SuiteSolution is comparable in the majority of functional elements tosimilar products/companies providing end-user billing services for small to medium-sizeindependent wireline and wireless service providers in North America. Certainfeatures and functionality of SuiteSolution are, based on Request For Proposal(RFP) responses, more highly rated than competing products, while otherfeatures and functionality may not be as highly rated as competing products.HickoryTech Information Solutions counts 18 to 20 companies as its primarycompetitors in marketing to small to medium-size independent wireline andwireless service providers in North America. The product does not utilizeuniquely patentable inventions or technological innovations in the constructionof the product. Commercially available programming languages are utilized inthe development of code that may, based on needs of a prospective user, deliversolutions that are preferred over those of competing products.

 

ENTERPRISE SOLUTIONSSECTOR

 

Through Collins,HickoryTech’s Enterprise Solutions Sector provides telephone, data and VoIPbusiness systems equipment sales and services to companies primarily based inmetropolitan Minneapolis/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. Enterprise Solutions specializes incomplex design, installation and maintenance of voice, data or InternetProtocol products. Enterprise Solutions continues its commitment to service andsupport its core products, Nortel and Cisco, while identifying newopportunities such as call centers, computer telephone integration voice mailand interactive voice response systems.

 

Revenues are primarilyearned by the sales, installation and service of business telephone and IP datasystems. 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.

 

Enterprise Solutions doesbusiness in a competitive market where a large number of companies compete forthe sale, installation and servicing of telecommunications equipment and voice overinternet protocol technology (VoIP) communications products. Competition isbased primarily on price and service. No single company is dominant in thismarket.

 

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ENVENTIS SECTOR

 

On December 30, 2005,HickoryTech acquired Enventis. Through Enventis, HickoryTech providesintegrated data services, offering fiber optic-based communication and advanceddata services to business communities in the Upper Midwest. Enventis providesconverged IP services that allow all communications (voice, video and data) touse the same fiber optic-based delivery technology. Enventis owns or haslong-term leases to approximately 1,500 route miles of fiber optic cable.Enventis also has extensive local fiber optic rings that directly connect theEnventis network with its larger clients (health care, government, education,etc.). Other local fiber rings connect the Enventis network to the localtelephone company’s central offices. This allows Enventis to utilize thetelephone company’s connections to access its smaller clients. Enventis servescustomers from facilities that are primarily leased from third parties.Enventis has offices located in Plymouth, Duluth and Rochester, Minnesota andSioux Falls, South Dakota. Enventis has a strong business relationship withCisco Systems, Inc. and is recognized by Cisco Systems as a Gold Partner.Enventis is a regional leader in deploying leading edge technologies such as IPcall centers. Enventis’ product portfolio includes Encompass UnifiedCommunications, which serves small-to-medium-sized businesses. Encompass is asingle vendor-hosted or managed IP communications service including local andlong distance voice; business IP telephony via hosted IP PBX; unified messaging(a single inbox for voicemail, e-mail, and fax), and dedicated Internet access.Encompass leverages VoIP or IP telephony over a private connection, minimizingupfront capital investment and IT management overhead. VoIP enables advancedfunctionality, voice interoperability with PCs, and scalability. Enventis,whose assets represented 23.3% of total consolidated assets as of December 31,2005, was excluded from HickoryTech’s December 31, 2005 assessment of theeffectiveness of the Company’s internal control over financial reportingbecause it was acquired one day before the end of the year.

 

**OTHER REGULATION**

** **

HickoryTech does notanticipate any material effects on its earnings, capital expenditures orcompetitive position because of laws pertaining to the protection of theenvironment.

 

**OTHERCOMPETITION**

 

HickoryTech’s businessstrategy has been to position itself as a quality communications servicesprovider. Long-term business relationships with its customers have strengthenedHickoryTech’s business position. HickoryTech believes that its customers valuethe fact that it is the “local company” whose goal is to meet the customers’communications needs. HickoryTech has several competitive advantages: price;service; investment in technology; direct billing relationship with almost allof the customers in its service territories; and positioned to offer a widerange of wired communications service from one source.

 

The long-range effect ofcompetition on the provision of communications services and equipment willdepend on technological advances, regulatory actions at both, the state andfederal levels, court decisions, and possible additional future state andfederal legislation. The trend resulting from past legislation has been toexpand competition in the telecommunications industry. It is imperative toHickoryTech that competition in this industry be fostered with equal amounts ofresponsibility, regulation and opportunity for all providers.

 

**Item 1A.       Risk Factors.**

 

##### **Our businessfaces many risks, all of which may not be described below. Additional risks ofwhich we are currently unaware or believe to be immaterial may also result inevents that could impair our business operations. If any of the events orcircumstances described in the following risks actually occur, our business,financial condition or results of operations may suffer, and the trading priceof our stock could decline.**

 

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**We maynot be able to successfully introduce new products and services.**

 

Our success depends uponour ability to successfully introduce new products and services, such as theability of our competitive local exchange carrier (CLEC) business, which weinitiated in 1998, to provide competitive local service in new markets, theability of our Information Solutions subsidiary (which is a billing and dataservices company) to implement, market, and sell its SuiteSolution billingsystem, our ability to offer bundled service packages on terms attractive toour customers, our ability to successfully expand our long distance andInternet offerings to new markets, our ability to introduce and distribute theequipment and systems of manufacturers of switching equipment and the suppliersof communications technology compared to the competitive alternatives of othersuppliers and the ability of Enventis to provide competitive IP services,including telecommunications and network solutions.

 

We may not accuratelypredict technological trends or the success of new products in these markets.New product development often requires long-term forecasting of market trends,development and implementation of new technologies and processes andsubstantial capital investment. In addition, we do not know whether ourproducts and services will meet with market acceptance or be profitable. Manyof our competitors have greater resources than we do. If we fail to anticipateor respond in a cost-effective and timely manner to technological developments,changes in industry standards or customer requirements, if we have anysignificant delays in product development or introduction, or if any of ourrelationships with our vendors are negatively impacted, our business, operatingresults and financial condition could be materially adversely affected.

 

**Shifts inour product mix may result in declines in gross margins.**

 

Possible changes in thedemand for our products and services including lower-than-anticipated-demandfor telephone services, reductions in access lines per household or minutes ofuse volume associated with telephone service, declines in demand for dataprocessing services or billing systems for the Information Solutions Sector, incommunication and data equipment for the Telecom, Enterprise Solutions and theEnventis Sectors, migration in technology from circuit switched to IP basedtechnology for services for all sectors, and for network solutions for our Telecomand Enventis Sectors, may result in lower gross margins and operatingprofitability. In addition, our gross margins could decrease based on theamount of new products we sell that have lower startup gross margins than ourexisting products and services. All of these factors could reduce our grossmargin. Changes in product mix may also cause some of our inventory to becomeobsolete. We currently manage potential obsolescence through reserves, butfuture technology changes may exceed current reserves.

 

**Somesectors of our business have experienced lower customer demand in recent years.**

 

Over the past severalyears, we have experienced lower customer demand for our billing services outof our Information Solutions Sector due to the reluctance of customers to spendcapital dollars on billing software and services offered by our InformationSolutions Sector. We do not know whether customer demand for these serviceswill increase. Also, due to the general slowdown in the economy over the pastseveral years, and due to innovation in the Internet Protocol network migrationof communications systems, our Enterprise Solutions Sector has experiencedreduction of demand for its products and services. During downturns in theeconomy and during periods of technology migration, customers are hesitant tospend capital dollars on telephone and communications equipment offered byEnterprise Solutions as they seek to retain the use of their existing systems.We cannot estimate when customer demand for Enterprise Solutions’ products andservices will increase.

 

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**We mayexperience difficulty integrating Enventis into our existing business.**

 

We acquired Enventis onDecember 30, 2005 and are in the beginning stages of selecting effective integrationstrategies. Enventis is a self-contained operations entity, with its own sales,service, customer support, accounting, planning and management. It is capableof being a successful addition to HickoryTech as a subsidiary with minimal changeand with a transition of corporate support functions only. The seller ofEnventis has executed a nine-month transition support agreement with us, and webelieve this provides adequate time to bring accounting systems from the Oracledatabase environment where they are now operated, to the PeopleSoft environmentwe will utilize in 2006. In addition to systems, there is the risk ofintegrating the market served. Enventis and HickoryTech operate in similarindustries, but our niche markets are different. Only in rare cases didEnventis and HickoryTech bid on the same business account. In summary, systemsand market integration are risks in bringing Enventis into HickoryTech in 2006.If we experience difficulty integrating Enventis, then maximum cash flow potentialfor the acquisition may not be realized.

 

**Technological advances in the telecommunications industry createincreased operating costs.**

 

The telecommunicationsindustry has seen ever increasing technological advances over the past severalyears. These technological advances increase costs to maintain and improvenetworks and provided top-end communication products and services that are demandedby our customer base in order to stay competitive with other companies that offersimilar services. Innovation in the Internet Protocol network migration ofswitched communication services as well as in our communication system productsmay create challenges to our ability to provide high-quality service and may createreduced demand as customers wait to study their choices. Wirelesscommunications, mobile/non-fixed point service and various Internet andsatellite communication innovations also create technological competition for us.

 

**The telecommunications industry is highly competitive.**

 

The TelecommunicationsAct of 1996 permitted competition among communication companies for the rightsto interconnect with established networks and to establish new networks inorder to offer telephone service to customers in a franchised area. We serve asan incumbent local exchange carrier in a number of franchised areas, as well ascompeting in a number of markets against other established incumbents. Thedifferentiating competitive factors include products and service, technologyadvancement, reputation and price. We believe that competition and pricingpressures will increase in the future as competitors seek to increase marketshare by offering new products and services or reduced pricing. This enhancesthe risk that we may not be able to respond on a timely or profitable basis. Inaddition, other telecommunication carriers look to stay competitive by alteringtheir choice of networking routes, points of interconnection, technology orsignaling protocol, and other telecommunication issues, all which could have amaterial adverse affect on our profitability.

 

**Futureregulation may result in lower revenues.**

 

The outcome of futureregulatory and judicial proceedings pertaining to interconnection agreementsand access charge reform may result in greater-than-anticipated reductions inrevenues received from federal and state access charges for switching longdistance traffic. Regulatory rules and policies also may adversely affect ourability to change our prices for telephone services in response to competitivepressures.

 

**We maynot be able to manage our growth effectively.**

 

Our ability to manage ourgrowth effectively, including our ability to integrate the operations of newbusinesses internally developed or external businesses acquired into ouroperations, may adversely affect our business results of operations andfinancial condition. In addition, our ability to manage our business sectors’development of and migration to SuiteSolution as its primary software platformfor billing and customer care management and our ability to achieve projectedeconomies of scale and cost savings, meet pro forma cash flow projections invaluing newly acquired businesses, successfully absorb the impact of changes inaccounting policies as required by generally accepted accounting principles, conformwith existing debt covenants and negotiate new debt facilities, and identifyfuture acquisition opportunities for growth may also adversely affect ourbusiness results of operations and financial condition.

 

10

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**A failurein our operational systems or infrastructure could impair our liquidity,disrupt our business, damage our reputation and cause loss.**

 

Shortcomings or failuresin our internal processes, people or systems could impair our liquidity, disruptour business, result in liability to customers or regulatory intervention,damage our reputation or result in financial loss. For example, our telephoneoperations rely on a central switch to complete local and long distance phonecalls to various customers. An interruption in the switch operations could leadto interrupted service for customers. In addition, our financial, accounting,data processing or other operating systems and facilities may fail to operateproperly or become disabled as a result of events that are wholly or partiallybeyond our control, thereby adversely affecting our ability to processtransactions. Our inability to accommodate an increasing volume of transactionsalso could constrain our ability to increase revenues and expand our businesses.Despite the existence of contingency plans and facilities, our ability toconduct business may be adversely impacted by a disruption in theinfrastructure that supports our businesses and the communities in which thesebusinesses are located.

 

**Our businessesmay be adversely affected if we are unable to hire and retain qualifiedemployees.**

 

Our performance islargely dependant on the talents and efforts of highly skilled individuals inthe operations of our telecommunication businesses, including telephoneoperations, billing software development and telecommunications equipment salesand service. Technological advances force our employees to upgrade theirknowledge base continually in order to keep pace with these advances. Our abilityto compete effectively depends upon our ability to attract new qualifiedemployees and retain and motivate our existing employees. In addition, becausewe just acquired Enventis in December 2005 and may acquire additionalbusinesses in the future, our success will depend, in part, upon our ability toretain and integrate personnel from acquired businesses who are necessary tothe continued success or the successful integration of these acquiredbusinesses.

 

**Unanticipatedincreases in capital spending, operating or administrative costs, or the impactof new business opportunities requiring significant up-front investments.**

 

We operate incash-flow-dependent businesses. Our existing networks require large capitalizedup-front investments for growth and maintenance. Our operating expenses in theform of payroll for a highly trained workforce and the maintenance cost oftelecommunications networks are also large uses of cash. Our debt serviceobligation and our dividends to shareholders also require significant cash eachyear. New business development may require additional up-front investment inassets and funding of early stage operating losses. We have business planswhich provide adequate sources of cash from operations to fund these endeavors,and we select the balance of old and new business to appropriately fund thecompany. The risk is from any sudden unanticipated increases in cash outflowafter we have already initiated our business plans. If this were to happen, wewould have to alter our future business plans, which possibly could affect ourgrowth.

 

**Customer payment defaults could have an adverse effect on ourfinancial condition and results of operations.**

 

As a result of adverse conditions in thecommunications market, some of our customers have experienced and may continueto experience serious financial difficulties. In some cases these difficultieshave resulted or may result in bankruptcy filings or cessation of operations.If customers experiencing financial problems default on paying amounts owed tous, we may not be able to collect these amounts or recognize expected revenue.It is possible those customers from whom we expect to derive substantialrevenue will default or that the level of defaults will increase. Any materialpayment defaults by our customers would have an adverse affect on our resultsof operations and financial condition. We currently manage this exposurethrough an allowance for doubtful accounts. An unexpected bankruptcy or defaultfrom a customer may not be fully reserved in our allowance. In addition, someof our competitors engage in financing transactions with some of theircustomers for the purchase of equipment. To remain competitive, it may becomenecessary for us to offer similar financing arrangements. If such financingsoccur, it would be our intent to sell all or a portion of these commitments andoutstanding receivables to third parties. In the past, we have sold somereceivables with recourse and have had to compensate the purchaser for therelated losses.

 

11

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**We may encounter litigation that has a material impact on ourbusiness.**

 

We are a party to various lawsuits, proceedings andclaims arising in the ordinary course of business or otherwise. Many of thesedisputes may be resolved amicably without resort to formal litigation. Theamount of monetary liability resulting from the ultimate resolution of thesematters cannot be determined at this time. None of the matters we are aware ofhave required us to record loss reserves, and at this time we believe theultimate resolution of these lawsuits, proceedings and claims will not have amaterial adverse impact on our business, results of operations or financialcondition. Because of the uncertainty inherent in litigation, it is possiblethat unfavorable resolutions of these or other lawsuits, proceedings and claimsagainst us have a material adverse affect on our business, results ofoperations or financial condition.

 

**Afailure to maintain effective internal controls could adversely affect ourbusiness.**

 

Although we have completed the documentation andtesting of the effectiveness of our internal control over financial reportingfor fiscal 2005, as required by Section 404 of the Sarbanes-Oxley Act of 2002,we expect we will have to incur continuing costs, including increasedaccounting fees and increased staffing levels, in order to maintain compliancewith that section of the Sarbanes-Oxley Act. In addition, our ability tointegrate the operations of Enventis or other companies that we acquire in thefuture could impact our compliance with Section 404. In the future, if we failto complete the Sarbanes-Oxley 404 evaluation in a timely manner, or if ourindependent registered public accounting firm cannot attest in a timely manner toour evaluation or to the efficacy of our internal controls, we could be subjectto regulatory scrutiny and a loss of public confidence in our internalcontrols. In addition, any failure to implement required new or improvedcontrols, or difficulties encountered in their implementation, could harm ouroperating results or cause us to fail to meet our reporting obligations.

 

**Anti-takeover provisions in our charter documents, our shareholderrights plan and Minnesota law could prevent or delay a change in control of ourcompany.**

 

Provisions of our articles of incorporation andbylaws, our shareholder rights plan (also known as a “poison pill”) andMinnesota law may discourage, delay or prevent a merger or acquisition that ashareholder may consider favorable and may limit the market price for ourcommon stock. These provisions include the following:

 

•                  advance noticerequirements for shareholder proposals;

•                  authorization for ourBoard of Directors to issue preferred stock without shareholder approval; and

•                  limitations onbusiness combinations with interested shareholders.

 

Some of these provisions may discourage a futureacquisition of HickoryTech even though our shareholders would receive anattractive value for their shares or a significant number of our shareholdersbelieve such a proposed transaction would be in their best interest.

 

**Our stock price is volatile.**

 

Based on the trading history of our common stock andthe nature of the market for publicly traded securities of companies in ourindustry, we believe that some factors have caused and are likely to continueto cause the market price of our common stock to fluctuate substantially. Thesefluctuations could occur day-to-day or over a longer period of time. Thefactors that may cause such fluctuations include, without limitation:

 

•                  announcements of newproducts and services by us or our competitors;

•                  quarterly fluctuationsin our financial results or the financial results of our competitors orcustomers;

•                  increased competitionwith our competitors or among our customers;

•                  consolidation amongour competitors or customers;

•                  disputes concerningintellectual property rights;

•                  the financial healthof HickoryTech, our competitors or our customers;

•                  developments intelecommunications regulations;

•                  general economicconditions in the U.S. or internationally; and

•                  rumors or speculationregarding HickoryTech’s future business results and actions.

 

In addition, stocks of companies in our industry inthe past have experienced significant price and volume fluctuations that areoften unrelated to the operating performance of such companies. This marketvolatility may adversely affect the market price of our common stock.

 

12

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**We are subject to risks associated with changes in interestrates.**

 

We face market risks from changes in interest rates.Market fluctuations could affect our results of operations and financialcondition adversely. At times, we reduce this risk through the use ofderivative financial instruments. However, we do not enter into derivativeinstruments for the purpose of speculation. We have entered into these interestrate protection agreements, which have remaining maturities of thirty months,in order to manage our exposure to interest rate movements. If interest ratesfail to rise as anticipated when the instruments were acquired, the affect onthe company will be that it will experience higher-than-market-rate interestexpense, and have paid for protection which wasn’t needed. We also risk enteringa higher interest rate environment when the interest rate protection agreementsexpire in 2008. This could affect our future interest expense level.

 

**Consolidation among our customers could result in our losinga customer or experiencing a slowdown as integration takes place.**

 

Consolidation may impact our business as ourcustomers focus on integrating their operations. We believe that in certaininstances customers engaged in integrating large-scale acquisitions may scaleback their purchases of network equipment while the integration is ongoing.Further, once consolidation occurs, our customers may choose to reduce thenumber of vendors they use to source their equipment or consolidate theircircuits or network routing, although we have not yet seen this impact. After aconsolidation occurs, there can be no assurance that we will continue to supplyequipment or network services to the surviving communications service provider.The impact of significant mergers on our business is likely to be unclear untilsometime after such transactions have closed.

 

**If we seek to secure additional financing, we may not be ableto obtain it. Also, if we are able to secure additional financing, ourshareholders may experience dilution of their ownership interest or we may besubject to limitations on our operations.**

 

We currently anticipate that our available cashresources, which include our credit facility, existing cash, cash equivalentsand available-for sale securities, will be sufficient to meet our anticipatedneeds for working capital and capital expenditures to execute our near-termbusiness plan, based on current business operations and economic conditions. Ifour estimates are incorrect and we are unable to generate sufficient cash flowsfrom operations and we expend our credit facility, we may need to raiseadditional funds. In addition, if one or more of our strategic acquisitionopportunities exceeds our existing resources, we may be required to seekadditional capital. If we raise additional funds through the issuance of equityor equity-related securities, our shareholders may experience dilution of theirownership interests and the newly issued securities may have rights superior tothose of common stock. Our existing debt covenants require a portion of the proceedsof an equity offering be applied to the outstanding debt balance. If we raiseadditional funds by issuing additional debt, we may be subject to restrictivecovenants that could limit our operating flexibility and interest paymentscould dilute earnings per share.

 

**Employeemisconduct is difficult to detect and prevent and may have an adverse effect onthe Company’s business.**

 

Although we have notexperienced any significant employee misconduct to date, there have been anumber of highly publicized cases with other companies involving fraud or othermisconduct by employees in recent years, and we may run the risk that employeemisconduct could occur. It is not always possible to deter or prevent employeemisconduct, and the precautions that we take to prevent and detect thisactivity may not be effective in all cases.

 

**Item 1B.       Unresolved Staff Comments.**

 

There are no materialunresolved written comments that were received from the Securities and ExchangeCommission (SEC) staff 180 days or more before the end of our fiscal yearrelating to our periodic or current reports under the Securities Exchange Actof 1934.

 

13

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**Item 2.          Properties.**

 

HickoryTech’s business isprimarily focused on the provision of service and its properties are used foradministrative support and to store and safeguard equipment. At December 31,2005, HickoryTech’s gross property, plant and equipment of $290,499,000 (netbalance of $149,342,000) consisted primarily of telephone switches, cable andnetwork equipment. HickoryTech owns or leases the telephone property, plant andequipment that it utilizes to operate its telephone systems. The three ILECsubsidiaries of HickoryTech in Minnesota and Iowa own central telephone officeswith related real estate in all of the communities they serve. HickoryTech’sTelecom Sector owns the telephone network, including telephone outside plant,fiber optic cable and central office equipment, over which they provideservices to its customers. HickoryTech’s Enventis Sector owns, or hasindefeasible rights to use, or has long-term leasing commitments to itsextensive fiber optic network and switching system. It is the opinion ofHickoryTech’s management that the properties of HickoryTech are suitable and adequateto provide modern and effective telecommunications services within its serviceareas, including local dial-tone, long distance service, dedicated and switchedlong-haul transport.

 

HickoryTech’s principalproperty locations are the following:

 

(1)                            MCTC’s general offices and principal central officeexchange building are located in downtown Mankato, Minnesota. This facility,built in 1963, is owned by MCTC and is a three-level brick and stone buildingcontaining approximately 60,000 square feet of floor space.

 

(2)                            MCTC’s main warehouse is located in Mankato,Minnesota. The warehouse, built in 1996, is owned by MCTC and is a two-storyconcrete building containing approximately 48,000 square feet. The warehouse isused to store vehicles and supplies and is also used as office space forengineers and technicians.

 

(3)                            Heartland’s main central office equipment is locatedin a one-story brick structure owned by Heartland in Rock Rapids, Iowacontaining approximately 1,500 square feet. Heartland also leases approximately2,000 square feet of general office space in Rock Valley, Iowa.

 

(4)                            Crystal leases office space of approximately 6,800square feet in Mankato, Minnesota and approximately 2,000 square feet in WestDes Moines, Iowa.

 

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

 

(6)                            Collins leases approximately 26,000 square feet ofoffice building and warehouse space in Roseville, Minnesota.

 

(7)                            Enventis leases approximately 13,000 square feet ofoffice space in Plymouth, Minnesota for general offices, technology services,and system support.

 

(8)                            Enventis leases approximately 7,500 square feet inDuluth, Minnesota for general offices and the network operations center.

 

(9)                            Enventis leases approximately 1,700 square feet inRochester, Minnesota for general offices and a network equipment facility.

 

(10)                      Enventis leases approximately 800 square feet inSioux Falls, South Dakota for general offices.

 

**Item 3.          Legal Proceedings.**

 

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.          Submission of Matters to a Vote ofSecurity Holders.**

 

No matters were submittedto a vote of security holders during the fourth quarter of the fiscal yearcovered by this 2005 Annual Report on Form 10-K.

 

14

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**PART II**

 
| **Item 5.** | ** ** | **Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities**. |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------|

 

The common stock ofHickoryTech is traded on The NASDAQ National Market under the symbol “HTCO”.

 

The following table setsforth for the period indicated the high and low closing sales price of thecommon stock.

 

| ** ** | ** ** | ** **  | ** ** | **High** | ** ** | **Low** | ** ** | **End of Qtr.** | ** ** |
|------------|------------|-------------|------------|----------|------------|---------|------------|-----------------|------------|
| **2005**   |       | 4th Quarter |       | $        | 8.70       |    | $          | 7.75            |       | $ | 7.89 |   |
|       |       | 3rd Quarter |       | $        | 9.47       |    | $          | 8.11            |       | $ | 8.80 |   |
|       |       | 2nd Quarter |       | $        | 10.47      |    | $          | 8.00            |       | $ | 8.07 |   |
|       |       | 1st Quarter |       | $        | 11.25      |    | $          | 10.16           |       | $ | 10.16 |   |
|       |       |        |       |     |       |    |       |            |       |
| **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 |   |

 

As of February 1, 2006, there were approximately 3,212holders of record of common stock, registered and in street name accounts.

 

HickoryTech has declared quarterly dividends on itscommon stock of $0.12 per share during the year ended December 31, 2005,totaling $0.48 per share. A quarterly cash dividend of $0.12 per share will bepaid on March 5, 2006 to stockholders of record at the close of business onFebruary 15, 2006. In 2005 the dividend per share was increased to $0.48 from$0.44 in 2004. The 2004 dividends were also issued quarterly.

 

15

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**Item 6**. **Selected Financial Data.**

 

*(Dollarsin Thousands, Except Per Share Amounts)*

 
| **FOR THE YEAR:**                  | ** ** | **2005**       | ** **  | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** |
|----------------------------------------------|------------|----------------|-------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Operating  Revenues (A)(B)                   |       |           | ** **  |       |       |       |       |       |       |       |       |
| Telecom Sector                               | ** ** | **$**          | **75,400**  | ** ** | $          | 76,097     |       | $          | 75,346     |       | $          | 71,108 |   | $ | 66,364 |   |
| Information  Solutions Sector                | ** ** | **2,522**      | ** **  | 2,710      |       | 3,199      |       | 4,249      |       | 4,085      |       |
| Enterprise  Solutions Sector                 | ** ** | **14,590**     | ** **  | 11,708     |       | 14,347     |       | 15,781     |       | 20,374     |       |
| Enventis Sector                              | ** ** | **—**     | ** **  | —     |       | —     |       | —     |       | —     |       |
| Total Revenues                               | ** ** | **$**          | **92,512**  | ** ** | $          | 90,515     |       | $          | 92,892     |       | $          | 91,138 |   | $ | 90,823 |   |
|                                         |       |           | ** **  |       |       |       |       |       |       |       |       |
| Income from  Continuing Operations           | ** ** | **$**          | **8,343**   | ** ** | $          | 7,664      |       | $          | 8,455      |       | $          | 6,235 |   | $ | 6,890 |   |
|                                         |       |           | ** **  |       |       |       |       |       |       |       |       |
| **PER  SHARE:**                              |       |           | ** **  |       |       |       |       |       |       |       |       |
| Basic EPS -  Continuing Operations           | ** ** | **$**          | **0.64**    | ** ** | $          | 0.59       |       | $          | 0.61       |       | $          | 0.44 |   | $ | 0.50 |   |
| Basic EPS -  Discontinued Operations         | ** ** | **0.01**       | ** **  | (0.01      | )          | (1.53      | )          | (1.63      | )          | 0.13       |       |
| ** **                                   |       | **$**          | **0.65**    | ** ** | $          | 0.58       |       | $          | (0.92      | )          | $          | (1.19 | ) | $ | 0.63 |   |
|                                         |       |           | ** **  |       |       |       |       |       |       |       |       |
| Fully Diluted  EPS - Continuing Operations   | ** ** | **$**          | **0.64**    | ** ** | $          | 0.59       |       | $          | 0.61       |       | $          | 0.44 |   | $ | 0.49 |   |
| Fully Diluted  EPS - Discontinued Operations | ** ** | **0.01**       | ** **  | (0.01      | )          | (1.53      | )          | (1.62      | )          | 0.13       |       |
| ** **                                   |       | **$**          | **0.65**    | ** ** | $          | 0.58       |       | $          | (0.92      | )          | $          | (1.18 | ) | $ | 0.62 |   |
| Cash Dividends  Per Share                    | ** ** | **$**          | **0.48**    | ** ** | $          | 0.44       |       | $          | 0.44       |       | $          | 0.44 |   | $ | 0.44 |   |
|                                         |       |           | ** **  |       |       |       |       |       |       |       |       |
| **AT YEAR  END:**                            |       |           | ** **  |       |       |       |       |       |       |       |       |
| Total Assets (C) (M)                         | ** ** | **$**          | **223,267** | ** ** | $          | 168,537    |       | $          | 175,712    |       | $          | 186,143 |   | $ | 189,179 |   |
| Shareholders’  Equity                   | ** ** | **$**          | **35,009**  | ** ** | $          | 31,545     |       | $          | 28,717     |       | $          | 58,595 |   | $ | 80,765 |   |
|                                         |       |           | ** **  |       |       |       |       |       |       |       |       |
| Current  Maturites of Long-Term Obligations  | ** ** | **$**          | **1,778**   | ** ** | $          | 5,323      |       | $          | 1,572      |       | $          | 1,441 |   | $ | 1,242 |   |
| Long Term Debt                               | ** ** | **140,980**    | ** **  | 97,661     |       | 118,040    |       | 157,599    |       | 169,659    |       |
| Total Debt,  Long-Term and Current (M)       | ** ** | **$**          | **142,758** | ** ** | $          | 102,984    |       | $          | 119,612    |       | $          | 159,040 |   | $ | 170,901 |   |
| Debt Ratio (D) (M)                           | ** ** | **80.3**       | **%**       | 76.6       | %          | 80.6       | %          | 73.1       | %          | 67.9       | %          |
|                                         |       |           | ** **  |       |       |       |       |       |       |       |       |
| **CUSTOMER  DATA (year end):**               |       |           | ** **  |       |       |       |       |       |       |       |       |
| ILEC Access  Lines (E)                       | ** ** | **55,625**     | ** **  | 60,472     |       | 63,099     |       | 65,355     |       | 66,393     |       |
| CLEC Access  Lines (F)                       | ** ** | **14,465**     | ** **  | 14,086     |       | 14,147     |       | 13,984     |       | 11,573     |       |
| Long Distance  Subscribers (G)               | ** ** | **40,321**     | ** **  | 43,702     |       | 40,366     |       | 35,566     |       | 24,241     |       |
| Internet  Customers (H)                      | ** ** | **18,396**     | ** **  | 17,191     |       | 16,132     |       | 14,420     |       | 12,816     |       |
| DSL Customers (I)                            | ** ** | **13,022**     | ** **  | 10,430     |       | 7,407      |       | 3,971      |       | 1,851      |       |
| Digital TV  Customers                        | ** ** | **2,766**      | ** **  | 1,941      |       | 1,179      |       | 803        |       | 460        |       |
|                                         |       |           | ** **  |       |       |       |       |       |       |       |       |
| **OTHER  DATA:**                             |       |           | ** **  |       |       |       |       |       |       |       |       |
| Employees (year  end) (J) (M)                | ** ** | **460**        | ** **  | 394        |       | 414        |       | 481        |       | 502        |       |
| Capital  Expenditures (N)                    | ** ** | **$**          | **19,481**  | ** ** | $          | 16,612     |       | $          | 11,237     |       | $          | 12,381 |   | $ | 30,174 |   |
| Shares  Outstanding (year end)               | ** ** | **13,124,928** | ** **  | 13,057,106 |       | 12,967,811 |       | 13,983,929 |       | 13,935,308 |       |
| Share Price (K) (year end)                   | ** ** | **$**          | **7.89**    | ** ** | $          | 10.69      |       | $          | 11.47      |       | $          | 9.53 |   | $ | 16.95 |   |
| Shareholders (L)                             | ** ** | **3,212**      | ** **  | 3,236      |       | 3,249      |       | 3,193      |       | 3,339      |       |

 

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| (A)    |   | Disposition of  HickoryTech’s subsidiary, Amana Colonies Telephone Company (ACTC) in 2001,  has affected HickoryTech’s revenue trends. ACTC accounted for $832,000 of the  Telecom Sector’s revenue in 2001.               |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                      |
| (B)    |   | During December 2003,  HickoryTech sold its wireless operations. Revenues for all periods have been  restated to exclude revenues of the wireless operations, as they are included  in discontinued operations for all periods presented. |
|   |   |                                                                                                                                                                                                                                      |
| (C)    |   | During December 2003,  HickoryTech sold its wireless operations. Total assets for all periods have  been restated to exclude wireless assets.                                                                                             |
|   |   |                                                                                                                                                                                                                                      |
| (D)    |   | Debt Ratio = Total Debt  / (Total Debt + Shareholders’ Equity as of December 31).                                                                                                                                                    |

 

16

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(E)   ILECLines refer to the local exchange telephone access lines in the Telecom Sector.ILEC Lines include ISDN (High-Speed Data) and pay station lines of 1,632 in2005, 1,829 in 2004, 2,115 in 2003, 2,406 in 2002 and 2,196 in 2001.

 

(F)   CLECLines refer to the competitive local exchange telephone access lines in theTelecom Sector. Types of CLEC lines:

 
| ** **                       | ** ** | **CLEC Access Lines** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|---------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                       | ** ** | **2005**                        | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001** | ** ** |
| CLEC Access  Lines               |       |                            |       |       |       |       |       |       |       |   |   |
| Overbuild                        | ** ** | **11,325**                      |       | 10,417     |       | 9,871      |       | 7,796      |       | 5,521 |   |
| Unbundled  Network Element (UNE) | ** ** | **1,595**                       |       | 1,726      |       | 1,647      |       | 1,343      |       | 1,263 |   |
| Total Service  Resale (TSR)      | ** ** | **1,545**                       | ** ** | 1,943      |       | 2,629      |       | 4,845      |       | 4,789 |   |
| Total CLEC Lines                 |       | **14,465**                      |       | 14,086     |       | 14,147     |       | 13,984     |       | 11,573 |   |

 

(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.

 

(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. The Enventis acquisition in 2005 added approximately 75employees.

 

(K)       Price is the last dayclosing price.

 

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

 

(M)    Includes Enventis for the yearended December 31, 2005.

 

(N)       Capital expenditures for2003 exclude $2,333 for wireless.

 

**Item 7.    Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

**BUSINESSES**

 

HickoryTechoperates in four business segments: the Telecom, Information Solutions,Enterprise Solutions and Enventis Sectors. Its largest and oldest business(since 1898) has been the operation of ILECs or traditional wireline telephoneservice. The ILEC business is in HickoryTech’s Telecom Sector. In 1998,HickoryTech began its CLEC line of business, competing for the telephone dialtone, dial-up and broadband Internet access, data, digital TV and long distancecalling business in incumbent LEC territories owned by others. The CLECbusiness is in HickoryTech’s Telecom Sector. Since 1964, HickoryTech’sInformation Solutions Sector has provided computer data processing andsoftware, predominantly for HickoryTech’s Telecom Sector operations and also toother telecommunications companies. HickoryTech acquired its EnterpriseSolutions Sector in 1990, and it operates as a telecommunications, data andInternet Protocol equipment distributor from a base in Minneapolis/St. Paul,Minnesota. In December 2005, HickoryTech purchased Enventis. Enventis is a Minnesota-basedregional provider of integrated fiber network, IP telephony, and data services,with 1,500 route miles of fiber network serving more than 300 businesscustomers in over 40 communities in the Upper Midwest. From 1998 to 2003,HickoryTech also had wireless operations. HickoryTech 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 its 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.

 

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**THE COMPANY**

 

Theeight current subsidiaries and one discontinued subsidiary of HickoryTech, allof which publicly operate and conduct business as HickoryTech, and the businesssegments in which they operate, are:

 

**TELECOM SECTOR**

Mankato Citizens Telephone Company

Mid-Communications, Inc.

Heartland Telecommunications Company of Iowa,Inc.

Cable Network, Inc.

Crystal Communications, Inc.

Minnesota Southern Wireless Company –Discontinued Operations

 

**INFORMATION SOLUTIONS SECTOR**

National Independent Billing, Inc.

 

**ENTERPRISE SOLUTIONS SECTOR**

Collins Communications Systems Co.

 

**ENVENTIS SECTOR**

Enventis Telecom, Inc.

 

**EXECUTIVE SUMMARY OF 2005**

 

HickoryTech realized bothexternal and internal growth in 2005. With the purchase of Enventis on December30, 2005, HickoryTech expanded its business strategy by broadening itsgeographic business market via the expanded network that it purchased, addedregional carrier transport services to its portfolio and enhanced HickoryTech’sposition and product offerings in the business enterprise solutions market.HickoryTech expanded its residential broadband and business high-speed datanetwork provisioning and successfully launched digital TV in three newcommunities. HickoryTech continued to increase its broadband capabilitiesthrough a multi-year network upgrade capital expenditure plan that began in2004. To improve its internal administrative capabilities, HickoryTechcompleted preparations for the installation of new enterprise resource planning(ERP) software, which will assist HickoryTech in managing its human resources,financial, inventory and distribution data through one operating system.HickoryTech started using this system on January 1, 2006.

 

The Telecom businessexperienced solid growth in its CLEC initiatives, which was offset by a declinein access revenues. Telecom carriers’ continued optimization of their networksand future regulatory reform may impact access revenue going forward.

 

Information Solutionsexperienced lower revenues in 2005 compared to 2004 due to the loss of severalcustomers, including $473,000 from a temporary customer relationship that endedin 2004. The loss of customers was offset by the recognition of $413,000 inlicense fees from the sale of SuiteSolution to a customer and increasedbillings to several other customers. As a result of the lower revenues in 2005compared to 2004, management continued to contain or cut cost.

 

Enterprise Solutionsexperienced higher revenues as customer demand for its products and servicesrebounded in 2005. Management also focused on cutting costs in 2005.

 

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**CONSOLIDATEDRESULTS OF OPERATIONS**

 

**2005 Compared to 2004**

 

•            Consolidatedrevenues were $92,512,000, a $1,997,000 or 2.2% increase in 2005 compared to2004. This increase was primarily due to increases in revenues in theEnterprise Solutions Sector resulting from increased demand for EnterpriseSolutions’ products and services. Decreases in Telecom Sector revenues andInformation Solutions Sector revenues partially offset the increase inEnterprise Solutions Sector revenues.

 

•            Cost ofSales at Enterprise Solutions was $2,118,000 or 25.8% higher in 2005 comparedto 2004, which was a result of the increase in the sales volume for the year.

 

•            Cost ofServices (excluding Depreciation and Amortization) was $33,255,000, a $370,000or 1.1% decrease in 2005 compared to 2004. The decrease was primarily due tomanagement cost reduction actions in the Information Solutions Sector, lower Internetexpense in the Telecom Sector and reduced inventory valuation adjustments inthe Enterprise Solutions Sector, but was offset by increased wages, transportcosts and consulting fees, all in the Telecom Sector.

 

•            Selling,General and Administrative Expenses (excluding Depreciation and Amortization)were $15,266,000, a $543,000 or 3.7% increase in 2005 compared to 2004. Thisincrease was primarily due to fees associated with the termination of leases inthe Information Solutions Sector, increased support fees for the UniversalService Fund and sales expenses in the Telecom Sector, but was offset by lowerwages and bad debt expense in the Enterprise Solutions Sector.

 

•            DepreciationExpense was $15,061,000, a $528,000 or 3.4% decrease in 2005 compared to 2004.This decrease was primarily due to central office equipment becoming fullydepreciated in the third quarter of 2005.

 

•            AmortizationExpenses was $493,000, a $453,000 or 47.9% decrease in 2005 compared to 2004.This decrease was primarily due to billing software, which became fullyamortized in the second quarter of 2005.

 

**2004 Compared to 2003**

 

•            Consolidatedrevenues were $90,515,000, a $2,377,000 or 2.6% decrease in 2004 compared to2003. This decrease was primarily due to decreases in revenues in theEnterprise Solutions Sector resulting from decreased demand for EnterpriseSolutions’ products and services. Increases in Telecom Sector revenuespartially offset the decrease in Enterprise Solutions Sector revenues and adecrease in Information Solutions Sector revenues.

 

•            Cost ofSales at Enterprise Solutions was $2,005,000 or 19.6% lower in 2004 compared to2003, which was a result of the decrease in the sales volume for the year.

 

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

 

•            Interest Expensewas $1,490,000 or 24.4% 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.

 

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**OVERALL SUMMARY OF CONTINUINGOPERATIONS**

 
| **Years Ended December 31,** | ** ** | **2005**                             | ** ** | **2004**   | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|------------|------------|----------|------------|
| ** **                                  | ** ** | **(Dollars in Thousands)** | ** ** |
| Operating  Income/(Loss)                    |       |                                 | ** ** |       |       |     |       |
| Telecom Sector                              | ** ** | **$**                                | **21,136** | ** ** | $          | 22,509   |       | $ | 25,095 |   |
| Information  Solutions Sector               | ** ** | **(2,306**                           | **)**      | (2,799     | )          | (3,576   | )          |
| Enterprise  Solutions Sector                | ** ** | **(546**                             | **)**      | (1,901     | )          | (1,358   | )          |
| Enventis Sector                             | ** ** | **—**                           | ** ** | —     |       | —   |       |
| Corporate                                   | ** ** | **(176**                             | **)**      | (388       | )          | 18       |       |
| ** **                                  |       | **18,108**                           | ** ** | 17,421     |       | 20,179   |       |
| Other Income                                | ** ** | **97**                               | ** ** | 61         |       | 62       |       |
| Interest Expense                            | ** ** | **(4,363**                           | **)**      | (4,613     | )          | (6,103   | )          |
| Income Taxes                                | ** ** | **(5,499**                           | **)**      | (5,205     | )          | (5,683   | )          |
| Income from  Continuing Operations          | ** ** | **$**                                | **8,343**  | ** ** | $          | 7,664    |       | $ | 8,455 |   |

 

**RESULTS OF OPERATIONS**

 

CONSOLIDATEDOPERATING RESULTS

 

The following is asummary of consolidated results of operations. More detailed discussion ofoperating results by segment follows this discussion. Except for the discussionof the wireless business sale transaction and the discussion of discontinuedoperations, all of this discussion of HickoryTech’s operating results excludesthe results of operations of the discontinued wireless business, which havebeen reported as discontinued operations in the Telecom Sector for all periodspresented. Due to the purchase of Enventis on December 30, 2005, operations forone business day were immaterial. Therefore, there is no discussion ofoperations for Enventis included in this Annual Report on Form 10-K.

 

OPERATINGREVENUES – Consolidated operating revenues were $1,997,000 or 2.2%higher in 2005 compared to 2004 and $2,377,000 or 2.6% lower in 2004 comparedto 2003. The increase in operating revenues in 2005 compared to 2004 wasprimarily due to a higher volume of sales in the Enterprise Solutions Sector,which offset decreases in the Information Solutions and Telecom Sectors. Thedecrease in operating revenues in 2004 compared to 2003 was primarily due to alower volume of sales in the Enterprise Solutions Sector.

 

COST OF SALES, ENTERPRISE SOLUTIONS - Cost of salesincreased $2,118,000 or 25.8% in 2005 compared to 2004, and decreased $2,005,000or 19.6% in 2004 compared to 2003. The increase in costs of products sold in2005 compared to 2004 was primarily due to the increase in sales and a greaterpercentage of sales are derived from data equipment sales, which have a lowermargin. The decrease in cost of sales in 2004 compared to 2003 was primarilydue to the decreased installation work.

 

COST OF SERVICES(excluding Depreciation and Amortization) – Cost of services(excluding depreciation and amortization) was $370,000 or 1.1% lower in 2005compared to 2004 and $154,000 or 0.5% higher in 2004 compared to 2003. Thedecrease in 2005 compared to 2004 was primarily due to management costreduction actions in the Information Solutions Sector, lower Internet expensein the Telecom Sector and lower inventory valuation costs in the EnterpriseSolutions Sector, but was offset by increased wages, transports costs andconsulting fees, all in the Telecom Sector. The increase in 2004 compared to2003 was primarily due to a $700,000 inventory valuation charge in theEnterprise Solutions Sector, and increases in expenses related to long distanceservices and increased bad debt expense in the Telecom Sector, which wereoffset by cost control measures initiated by management and reduced wages andbenefits resulting from a redeployment of personnel to Selling, General andAdministrative cost centers in the Information Solution Sector. In 2004,HickoryTech recognized approximately $421,000 of bad debt expense due to acarrier bankruptcy. The Company was able to recover $410,000 of that bad debtin 2005.

 

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SELLING, GENERALAND ADMINISTRATIVE EXPENSES (excluding Depreciation and Amortization)– Selling, general and administrative expenses (excluding depreciation and amortization)were $543,000 or 3.7% higher in 2005 compared to 2004, and $1,564,000 or 11.9%higher in 2004 compared to 2003. The increase in 2005 compared to 2004 wasprimarily due to fees associated with the termination of leases in theInformation Solutions Sector, increased support fees for the Universal ServiceFund and sales expenses in the Telecom Sector, but was offset by lower wagesand bad debt expense in the Enterprise Solutions Sector. The increase in 2004compared to 2003 was primarily due to costs associated with the compliance withthe Sarbanes-Oxley Act of 2002, higher post-retirement medical costs, andincreased wages and benefits resulting from a redeployment of personnel fromCost of Services cost centers in the Information Solutions Sector.

 

DEPRECIATIONAND AMORTIZATION - Depreciation expense was $528,000 or3.4% lower in 2005 compared to 2004 and $719,000 or 4.8% higher in 2004compared to 2003. The decrease in depreciation expense in 2005 compared to 2004was primarily due to central office equipment becoming fully depreciated in thethird quarter of 2005 in the Telecom Sector. The increase in depreciationexpense in 2004 compared to 2003 was primarily due to an increase in theTelecom Sector’s network assets, as well as an increase related to thedepreciation of billing software in the Information Solutions Sector.Amortization expense was $453,000 or 47.9% lower in 2005 compared to 2004 and$51,000 or 5.1% lower in 2004 compared to 2003. The decrease in amortizationexpense in 2005 compared to 2004 was primarily due to billing software in theInformation Solutions Sector, which became fully amortized in the secondquarter of 2005. The decrease in amortization expense in 2004 compared to 2003was primarily due to an intangible asset in the Information Solutions Sectorbecoming fully amortized in the second quarter of 2003.

 

OPERATINGINCOME - Operating income was $687,000 or 3.9% higher in 2005compared to 2004 and $2,758,000 or 13.7% lower in 2004 compared to 2003. Theincrease in operating income in 2005 compared to 2004 was primarily due toincreased revenues in the Enterprise Solutions Sector, decreased costs ofservices (excluding depreciation and amortization), decreased amortization inthe Information Solutions Sector and decreased depreciation expense in theTelecom Sector, but was offset by increased cost of sales in the EnterpriseSolutions Sector and increased selling, general and administrative expenses(excluding depreciation and amortization) in the Telecom Sector, all of which aredescribed above. The decrease in operating income in 2004 compared to 2003 wasprimarily due to decreased revenues in the Information Solutions and EnterpriseSolutions Sectors, increased cost of services (excluding depreciation andamortization), increased selling, general and administrative expenses(excluding depreciation and amortization) in the Telecom and InformationSolutions Sectors and increased depreciation, which were partially offset byincreased revenues in the Telecom Sector and lower cost of sales in theEnterprise Solutions Sector, all of which are described above.

 

INCOMEFROM CONTINUING OPERATIONS – Income from continuing operations was$679,000 or 8.9% higher in 2005 compared to 2004 and $791,000 or 9.4% lower in2004 compared to 2003. The increase in operating income in 2005 compared to2004 was primarily due to increased revenues in the Enterprise SolutionsSector, decreased costs of services (excluding depreciation and amortization),decreased amortization in the Information Solutions Sector, decreaseddepreciation in the Telecom Sector and decreased interest expense, but wasoffset by increased cost of sales in the Enterprise Solutions Sector andincreased selling, general and administrative expenses (excluding depreciationand amortization) in the Telecom Sector. The decrease in 2004 compared to 2003was primarily due to decreased revenues in the Information Solutions andEnterprise Solutions Sectors, increased selling, general and administrativeexpenses in the Telecom Sector and increased depreciation, which were partiallyoffset by increased revenues in the Telecom Sector, lower cost of sales in theEnterprise Solutions Sector and lower interest expense.

 

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SECTOR RESULTS OFOPERATIONS

 

TELECOM SECTOR– The following table provides a breakdown of the Telecom Sector operatingresults.

 

**TELECOMSECTOR**

 
| *** ***                                                                           | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------|------------|----------|------------|----------|------------|
| *** ***                                                                           | ** ** | ***(Dollars in Thousands)*** | ** ** |
| Revenues Before Intersegment Eliminations                                              |       |                         |       |     |       |     |       |
| ILEC                                                                                   |       |                         |       |     |       |     |       |
| Local Service                                                                          | ** ** | **$**                        | **14,962** |     | $          | 15,231   |       | $ | 15,179 |   |
| Network Access                                                                         | ** ** | **31,399**                   |       | 33,064   |       | 33,881   |       |
| Data                                                                                   | ** ** | **2,384**                    |       | 2,152    |       | 1,821    |       |
| Intersegment                                                                           | ** ** | **205**                      |       | 275      |       | 275      |       |
| Other                                                                                  | ** ** | **6,580**                    |       | 6,747    |       | 7,099    |       |
| Total ILEC                                                                             | ** ** | **55,530**                   |       | 57,469   |       | 58,255   |       |
| CLEC                                                                                   |       |                         |       |     |       |     |       |
| Local Service                                                                          | ** ** | **3,558**                    |       | 3,657    |       | 3,482    |       |
| Network Access                                                                         | ** ** | **1,985**                    |       | 2,334    |       | 2,374    |       |
| Data                                                                                   | ** ** | **2,584**                    |       | 1,916    |       | 1,151    |       |
| Other                                                                                  | ** ** | **1,787**                    |       | 1,752    |       | 1,779    |       |
| Total CLEC                                                                             | ** ** | **9,914**                    |       | 9,659    |       | 8,786    |       |
| Long Distance                                                                          | ** ** | **4,821**                    |       | 4,660    |       | 4,406    |       |
| Internet                                                                               | ** ** | **4,361**                    |       | 4,030    |       | 3,810    |       |
| Digital TV                                                                             | ** ** | **979**                      |       | 554      |       | 364      |       |
| Total Telecom Revenues                                                                 | ** ** | **$**                        | **75,605** |     | $          | 76,372   |       | $ | 75,621 |   |
| Total Telecom Revenues Before Intersegment  Eliminations                               |       |                         |       |     |       |     |       |
| Unaffiliated  Customers                                                                | ** ** | **$**                        | **75,400** |     | $          | 76,097   |       | $ | 75,346 |   |
| Intersegment                                                                           | ** ** | **205**                      |       | 275      |       | 275      |       |
| ** **                                                                             |       | **75,605**                   |       | 76,372   |       | 75,621   |       |
| Cost of Services,  excluding Depreciation and Amortization                        |       | **30,062**                   |       | 29,723   |       | 28,071   |       |
| Selling, General  and Administrative Expenses, excluding Depreciation and Amortization |       | **11,052**                   |       | 10,388   |       | 9,295    |       |
| Depreciation and Amortization                                                          | ** ** | **13,355**                   |       | 13,752   |       | 13,160   |       |
| Operating Income                                                                       | ** ** | **$**                        | **21,136** |     | $          | 22,509   |       | $ | 25,095 |   |
| Income from Continuing Operations, net of Tax                                          | ** ** | **$**                        | **12,746** |     | $          | 13,352   |       | $ | 14,941 |   |
|                                                                                   |       |                         |       |     |       |     |       |
| Loss from Discontinued Operations, net of Tax                                          | ** ** | **186**                      |       | (74      | )          | (22,897  | )          |
| Net Income                                                                             | ** ** | **$**                        | **12,932** |     | $          | 13,278   |       | $ | (7,956 | ) |
| Capital Expenditures                                                                   | ** ** | **$**                        | **16,901** |     | $          | 16,100   |       | $ | 10,719 |   |
| ILEC Access Lines                                                                      | ** ** | **55,625**                   |       | 60,472   |       | 63,099   |       |
| CLEC Access Lines                                                                      |       |                         |       |     |       |     |       |
| Overbuild                                                                              | ** ** | **11,325**                   |       | 10,417   |       | 9,871    |       |
| Unbundled  Network Element (UNE)                                                       | ** ** | **1,595**                    |       | 1,726    |       | 1,647    |       |
| Total Service  Resale (TSR)                                                            | ** ** | **1,545**                    |       | 1,943    |       | 2,629    |       |
| Total                                                                                  | ** ** | **14,465**                   |       | 14,086   |       | 14,147   |       |
| Long Distance Customers                                                                | ** ** | **40,321**                   |       | 43,702   |       | 40,366   |       |
| Internet Customers                                                                     | ** ** | **18,396**                   |       | 17,191   |       | 16,132   |       |
| Total Telecom Customers                                                                | ** ** | **128,807**                  |       | 135,451  |       | 133,744  |       |
| Digital Subscriber Line (DSL) Customers                                                | ** ** | **13,022**                   |       | 10,430   |       | 7,407    |       |
| Digital TV Customers                                                                   | ** ** | **2,766**                    |       | 1,941    |       | 1,179    |       |

 

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Revenues:

Telecom Sector operatingrevenues before intersegment eliminations were $767,000 or 1.0% lower in 2005compared to 2004, and $751,000 or 1.0% higher in 2004 compared to 2003. Thedecrease in 2005 compared to 2004 was primarily due to a decrease in networkaccess, but was offset by growth in data, digital TV and Internet. The increasein 2004 compared to 2003 was primarily due to growth in CLEC data as well asfavorable increases in many product lines, but was offset by a decrease in ILECand CLEC network access revenues.

 

ILEC local servicerevenue was $269,000 or 1.8% lower in 2005 compared to 2004 and $52,000 or .3%higher in 2004 compared to 2003. The decrease in 2005 compared to 2004 wasprimarily the result of 4,847 fewer access lines at December 31, 2005 than atDecember 31, 2004. Enterprise Solutions signed a large contract with a collegecampus in Minnesota to provide an Internet Protocol (IP) Telephony System. Thissystem has replaced 3,224 access lines since its installation, which wascomplete, as of December 31, 2005.

 

ILEC network accessrevenue was $1,665,000 or 5.0% lower in 2005 compared to 2004, and $817,000 or2.4% lower in 2004 compared to 2003. The decrease in 2005 compared to 2004 wasprimarily due to a mandated interstate rate decrease on July 1, 2005 and lowerminutes of use. The decrease in 2004 compared to 2003 was primarily due to theimpact of carriers rerouting traffic, carrier billing interpretations and lowerminutes of use. A combination of changing minutes of use, carriers reroutingtraffic, and lower demand for dedicated lines may negatively impact futureaccess revenues. In addition, future access reform may provide further negativeinfluences. PUC has been considering intrastate access reform and universalservice for several years (see Regulated Industry on pages 35-36).

 

ILEC data was $232,000 or10.8% higher in 2005 compared to 2004, and $331,000 or 18.2% higher in 2004compared to 2003. The increase in both years was primarily due to increaseddigital subscriber line (DSL) customers.

 

CLEC local service revenue was $99,000 or 2.7% lowerin 2005 compared to 2004, and $175,000 or 5.0% higher in 2004 compared to 2003.Access lines increased 379 lines or 2.7% from December 31, 2004 to December 31,2005. Despite the increase in lines, an implementation of package pricing tomeet competitive pricing pressures by incumbent LEC’s in those markets resultedin the decreased revenue in 2005 compared to 2004. The new package pricingresulted in lower revenues of approximately $162,000. The increase in 2004compared to 2003 was primarily due to an increase in revenues from businesscustomers and local trunking arrangements. In addition, in the second quarterof 2003, HickoryTech decided to exit several exchanges in its Iowa territories,which utilized a resale of services approach. This exit decision meant that in2003, HickoryTech stopped providing service for 734 customers. As a result,there was a modest impact on the growth rates, which was the primary reason forthe reduced level of increase in local service revenue in 2004 and 2003. Ahigher degree of competition from the incumbent ILECs serving in the Company’sCLEC markets, and from wireless substitution, could impact HickoryTech’s localservice revenue in future periods.

 

CLECnetwork access revenue was $349,000 or 15.0% lower in 2005 compared to 2004,and $40,000 or 1.7% lower in 2004 compared to 2003. The decrease in 2005compared to 2004 was primarily due to a mandated rate decrease implemented inJune 2004 and lower minutes of use. The rate decrease and lower minutes ofuse  reduced interstate revenues by$100,000 in 2005 compared to 2004. The decrease in 2004 compared to 2003 wasprimarily due to a mandated rate decrease in June 2004 for interstate traffic, whichdecreased revenue $100,000 over the six-month period from July through December2004. A combination of access reform changing minutes of use, carriers reroutingtraffic and lower demand for dedicated lines could negatively impact futureaccess revenues.

 

CLEC data revenue was$668,000 or 34.9% higher in 2005 compared to 2004, and $765,000 or 66.5% higherin 2004 compared to 2003. The increase in 2005 and 2004 was due primarily toincreased residential and business DSL penetration in CLEC communities, as wellas the rollout of Ethernet services to large business customers in 2004.Ethernet service revenues will continue to provide growth opportunities forHickoryTech. Expanded networking opportunities among medium and large enterprisecustomers are key drivers for this growth.

 

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In January 2006, HickoryTech wasinformed that its bid to renew its multi-year contract with Project SOCRATES(South Central Regional Area Telecommunications System) was not accepted.HickoryTech had been providing Internet access and video conferencing forProject SOCRATES, which are a distance-learning network connecting schools andlibraries in a 12-county region in south central Minnesota. HickoryTech willcontinue to serve the SOCRATES network through June 30, 2006. The Companyexpects CLEC’s other revenues will decrease by approximately $700,000associated with loss of revenues from this contract in 2006, which will beevenly distributed over the last two quarters of the year.

 

Long distance revenue was $161,000 or 3.5%higher in 2005 compared to 2004, and $254,000 or 5.8% higher in 2004 comparedto 2003. The long distance customer base decreased 3,381 or 7.7% in 2005compared to 2004. In June, 2005 a large Minnesota college campus ended itscontract for long distance services, which resulted in a loss of approximately2,800 long distance customers. Despite the loss of customers, long distancerevenue increased primarily due to higher long distance usage customer growthoffsetting the loss of the lower long distance usage customers mentioned above.HickoryTech experienced a 3,336 or 8.3% increase in its long distance customerbase in 2004. Although the customer base increased in 2004, long distancerevenue per customer decreased. The 2004 decrease in revenue per customer wasprimarily the result of optional long distance calling plans available tocustomers, the increased use of Internet services, and other alternatives tolong distance services and the loss of a wholesale revenue contract in June 2004with a large wireless carrier.

 

Internet revenue was $331,000 or 8.2% higherin 2005 compared to 2004, and $220,000 or 5.8% higher in 2004 compared to 2003.The increase in revenue was primarily due to an increase in Internet customersof 1,205 or 7.0% in 2005 compared to 2004 and 1,059 or 6.6% in 2004 compared to2003.

 

Digital TV revenue was $425,000 or 76.7%higher in 2005 compared to 2004, and $190,000 or 52.2% higher in 2004 comparedto 2003. The increase in 2005 compared to 2004 was primarily due to theoffering of digital TV in three additional communities in 2005. The increase in2004 compared to 2003 was primarily due to increased penetration and theoffering of digital TV in an additional community in 2004. Customer countsincreased 825 or 42.5% in 2005 compared to 2004, and 762 or 64.6% in 2004 comparedto 2003.

 

Cost of Services (excluding Depreciation andAmortization):

Cost of services (excluding depreciation andamortization) was $339,000 or 1.1% higher in 2005 compared to 2004, and$1,652,000 or 5.9% higher in 2004 compared to 2003. The increase in 2005compared to 2004 was primarily due to increased wages, transport costs andconsulting fees, but was partially offset by lower Internet expense due tolower costs associated with bandwidth and customers who have switched fromdial-up Internet to broadband Internet as well as lower bad debt expense. Thedecrease in bad debt expense in 2005 compared to 2004 relates to $410,000 ofbad debt recoveries associated with a carrier bankruptcy. The increase in 2004compared to 2003 was primarily due to increases in expenses related to longdistance services that increased in conjunction with the corresponding increasein long distance customers and revenue, increased billing expenses for bill anddata processing, increased bad debt expense due to a carrier bankruptcy, andcarrier disputes. Because of the carrier bankruptcy, HickoryTech recognizedapproximately $421,000 of bad debt expense in 2004.

 

In conjunction with the cancellation of theSOCRATES network contract, there are approximately $250,000 of related costsand expenses associated with the SOCRATES contract which will be phasedout.  The impact in 2006 will be evenlydistributed over the last two quarters of the year.

 

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

Selling, general and administrative expenses(excluding depreciation and amortization) were $664,000 or 6.4% higher in 2005compared to 2004, and $1,093,000 or 11.8% higher in 2004 compared to 2003. Theincrease in 2005 compared to 2004 was primarily due to increased support feesfor the Universal Service Fund, corporate expenses and sales expensesassociated with the Customer Premise Equipment (CPE) phone system sales. Theincrease in 2004 compared to 2003 was primarily due to corporate expenses, higherreal estate taxes and higher post-retirement medical costs.

 

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Depreciation and Amortization:

Depreciation and amortization was $397,000 or2.9% lower in 2005 compared to 2004, and $592,000 or 4.5% higher in 2004compared to 2003. Depreciation was $397,000 or 2.9% lower in 2005 compared to2004, and $565,000 or 4.3% higher in 2004 compared to 2003. The decrease indepreciation in 2005 compared to 2004 was primarily due to central officeswitching equipment becoming fully depreciated in the third quarter of 2005.The increase in depreciation in 2004 compared to 2003 was primarily due toincreased capital expenditures for network infrastructure. Amortization expenseremained the same in 2005 compared to 2004, and was $27,000 or 35.2% higher in2004 compared to 2003.

 

Operating Income and Income from ContinuingOperations, net of Tax:

Operating income was $1,373,000 or 6.1% lowerin 2005 compared to 2004, and $2,586,000 or 10.3% lower in 2004 compared to 2003.Income from continuing operations, net of tax, was $606,000 or 4.5% lower in2005 compared to 2004, and $1,589,000 or 10.6% lower in 2004 compared to 2003.The decrease in both operating income and income from continuing operations,net of tax, in 2005 compared to 2004 was primarily due to decreased revenues,increased selling, general and administrative expenses (excluding depreciationand amortization), increased cost of service (excluding depreciation andamortization), but was offset by decreased depreciation. The decrease in bothoperating income and income from continuing operations, net of tax, in 2004compared to 2003 was primarily due to decreased network access revenues andincreased expenses for billing services, corporate allocations, bad debt, longdistance service expenses and real estate taxes.

 

In conjunction with the cancellation of theSOCRATES network contract, operating income will be affected by approximately$450,000 and net income will be affected by approximately $268,000 associatedwith the loss of business from this contract in 2006.  The impact in 2006 will be evenly distributedover the last two quarters of the year.

 

Discontinued Operations:

On December 15, 2003,HickoryTech sold its wireless business, Minnesota Southern Wireless Company(MSWC), to WWC. The wireless operations are reported as part of the Telecomsector.  The consolidated statements ofoperations for all periods presented have been restated to reflect wirelessoperations as discontinued operations.

 

INFORMATION SOLUTIONS– The following table provides a breakdown of the Information Solutions Sectoroperating results.

 

**INFORMATION SOLUTIONS SECTOR**

 
| **(Dollars in Thousands)**                                                             | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Revenues  Before Eliminations                                                          |       |       |       |     |       |     |       |
| Unaffiliated Customers                                                                 | ** ** | **$**      | **2,522**  |     | $          | 2,710    |       | $ | 3,199 |   |
| Intersegment                                                                           | ** ** | **4,312**  |       | 4,346    |       | 3,203    |       |
| ** **                                                                             |       | **6,834**  |       | 7,056    |       | 6,402    |       |
| Cost of  Services, excluding Depr. and Amort.                                          | ** ** | **5,734**  |       | 6,318    |       | 7,002    |       |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **1,386**  |       | 981      |       | 600      |       |
| Depreciation  and Amortization                                                         | ** ** | **2,020**  |       | 2,556    |       | 2,376    |       |
|                                                                                   |       |       |       |     |       |     |       |
| Operating  Loss                                                                        | ** ** | **$**      | **(2,306** | )        | $          | (2,799   | )          | $ | (3,576 | ) |
| Net Loss                                                                               | ** ** | **$**      | **(1,422** | )        | $          | (1,692   | )          | $ | (2,329 | ) |
|                                                                                   | ** ** | ** ** |       |     |       |     |       |
| Capital  Expenditures                                                                  | ** ** | **$**      | **2,411**  |     | $          | 486      |       | $ | 161 |   |

 

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Revenues:

Revenues from unaffiliated customersdecreased $188,000 or 6.9% in 2005 compared to 2004, and decreased $489,000 or15.3% in 2004 compared to 2003. The decrease in operating revenues in 2005compared to 2004 was primarily due to the loss of several customers, including$473,000 from a temporary customer relationship that ended in 2004. The loss ofcustomers was offset by the recognition of $413,000 in license fees from thesale of SuiteSolution to a customer and increased billings to several othercustomers. The decrease in operating revenues in 2004 compared to 2003 wasprimarily due to the loss of several customers, which reduced operatingrevenues by $885,000, and a $192,000 decrease in volume for a couple ofexisting customers. Temporary billing services performed for a customerobtained at the end of 2003 increased operating revenues by $428,000 in 2004compared to 2003, while increased revenues from a new SuiteSolution customerand increased processing fees from an existing customer of $166,000 in 2004compared to 2003, partially offset other revenue declines.   

 

Cost of Services (excluding Depreciation andAmortization):

Cost of services (excluding depreciation andamortization) decreased $584,000 or 9.2% in 2005 compared to 2004, anddecreased $684,000 or 9.8% in 2004 compared to 2003. The decrease in 2005compared to 2004 was primarily due to management cost reduction actions. Thedecrease in 2004 compared to 2003 was primarily due to cost control measuresinitiated by management and reduced wages and benefits resulting from aredeployment of personnel to selling, general and administrative cost centers.

 

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

Selling, general and administrative expenses(excluding depreciation and amortization) increased $405,000 or 41.3% in 2005compared to 2004, and increased $381,000 or 63.5% in 2004 compared to 2003. Theincrease in 2005 compared to 2004 was primarily due to fees associated with thetermination of leases. The increase in 2004 compared to 2003 was primarily dueto increased wages and benefits resulting from a redeployment of personnel fromcost of services cost centers.

 

Depreciation and Amortization:

Depreciation and amortization decreased$536,000 or 21.0% in 2005 compared to 2004, and increased $180,000 or 7.6% in2004 compared to 2003. The decrease in depreciation and amortization in 2005compared to 2004 was primarily due to billing software, which became fullyamortized in the second quarter of 2005. The increase in depreciation andamortization in 2004 compared to 2003 was primarily due to increaseddepreciation associated with new billing software, which started amortizing inthe second quarter of 2003.

 

Operating and Net Loss:

Operating loss decreased $493,000 or 17.6% in2005 compared to 2004, and decreased $777,000 or 21.7% in 2004 compared to2003. Net loss decreased $270,000 or 16.0% in 2005 compared to 2004, anddecreased $637,000 or 27.4% in 2004 compared to 2003. The decrease in operatingloss and net loss in 2005 compared to 2004 was primarily due to a decrease incost of services (excluding depreciation and amortization) and a decrease indepreciation and amortization, but was offset by an increase in selling,general and administrative expenses (excluding depreciation and amortization)and a decrease in revenues from unaffiliated customers. The decrease inoperating loss and net loss in 2004 compared to 2003 was primarily due toincreases in intersegment revenues, but was offset by a decrease in revenuesfrom unaffiliated customers, an increase in cost of services (excludingdepreciation and amortization), an increase in selling, general andadministrative expenses (excluding depreciation and amortization) and an increasein depreciation and amortization.

 

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ENTERPRISE SOLUTIONS – Thefollowing table provides a breakdown of the Enterprise Solutions Sectoroperating results.

 

**ENTERPRISESOLUTIONS SECTOR**

 
| **(Dollars in Thousands)**                                                             | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Revenues  Before Intersegment Eliminations                                             |       |       |       |     |       |     |       |
| Installation                                                                           | ** ** | **$**      | **6,544**  |     | $          | 4,492    |       | $ | 6,209 |   |
| Service                                                                                | ** ** | **8,046**  |       | 7,216    |       | 8,138    |       |
| ** **                                                                             |       | **14,590** |       | 11,708   |       | 14,347   |       |
| Cost of  Sales                                                                         | ** ** | **10,329** |       | 8,211    |       | 10,216   |       |
| Cost of  Services, excluding Depr. and Amort.                                          | ** ** | **1,847**  |       | 2,075    |       | 1,749    |       |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **2,842**  |       | 3,152    |       | 3,494    |       |
| Depreciation  and Amortization                                                         | ** ** | **118**    |       | 171      |       | 246      |       |
| ** **                                                                             |       | **15,136** |       | 13,609   |       | 15,705   |       |
|                                                                                   |       |       |       |     |       |     |       |
| Operating Loss                                                                         | ** ** | **$**      | **(546**   | )        | $          | (1,901   | )          | $ | (1,358 | ) |
| Net Loss                                                                               | ** ** | **$**      | **(329**   | )        | $          | (1,131   | )          | $ | (818 | ) |
|                                                                                   |       |       |       |     |       |     |       |
| Capital  Expenditures                                                                  | ** ** | **$**      | **47**     |     | $          | 24       |       | $ | 201 |   |

 

Revenues:

Revenues were $2,882,000 or 24.6% higher in2005 compared to 2004, and $2,639,000 or 18.4% lower in 2004 compared to 2003.New system installation revenue was $2,052,000 or 45.7% higher in 2005 comparedto 2004 and $1,717,000 or 27.7% lower in 2004 compared to 2003. The increase innew system installation revenue in 2005 compared to 2004 was primarily due toincreased data equipment sales of $1,501,000 or 60.2%, which was primarily theresult of a large contract with a college campus in Minnesota. The decrease innew system installation revenue in 2004 compared to 2003 was primarily due to adecrease in sales and installations of private branch exchange (PBX) systems of$1,299,000 or 60.5%. Service revenue was $830,000 or 11.5% higher in 2005compared to 2004 and $922,000 or 11.3% lower in 2004 compared to 2003.****Theincrease in service revenue in 2005 compared to 2004 was primarily due to an$861,000 or 40.3% increase in Move, Add and Change (MAC) Contract revenues.This sector had encountered across the board reductions in demand in all of itsmajor products and services. The reduction started in early 2002, and was believedto be associated with the economy’s effect on customers of this sector, and dueto changing technology (i.e., voice vs. data protocol) in the communicationsproducts, which this sector provides. Although customer sale activity increasedin 2005, future technology changes may affect customer buying decisions.HickoryTech cannot estimate what affect future technology changes may have oncustomer demand for its products and services.

 

Cost of Sales:

Cost of sales increased $2,118,000 or 25.8%in 2005 compared to 2004, and decreased $2,005,000 or 19.6% in 2004 compared to2003. The increase in costs of products sold in 2005 compared to 2004 wasprimarily due to the increase in sales and a greater percentage of sales arederived from data equipment sales, which have a lower margin. The decrease incost of sales in 2004 compared to 2003 was primarily due to the decreasedinstallation work.

 

Cost of Services (excluding Depreciation andAmortization):

Cost of services (excluding depreciation andamortization) decreased $228,000 or 11.0% in 2005 compared to 2004, andincreased $326,000 or 18.6% in 2004 compared to 2003. The decrease in 2005compared to 2004 was primarily due to reduced inventory valuation adjustments,which was offset by increased wages. The increase in 2004 compared to 2003 wasprimarily due to a $700,000 inventory valuation adjustment resulting from thewrite-down of inventory to its net realizable value that was offset bydecreased maintenance expense associated with customer contracts.  

 

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

Selling, general and administrative expenses(excluding depreciation and amortization) decreased $310,000 or 9.8% in 2005compared to 2004, and decreased $342,000 or 9.8% in 2004 compared to 2003. Thedecrease in 2005 compared to 2004 was primarily due to decreased wages and baddebt expense. The decrease in 2004 compared to 2003 was primarily due to costreduction measures, which included reduced wages and benefits from attrition ofpersonnel.

 

Depreciation and Amortization:

Depreciation and amortization decreased$53,000 or 31.0% in 2005 compared to 2004, and decreased $75,000 or 30.5% in2004 compared to 2003. The decrease in 2005 and 2004 was the result of certainassets becoming fully depreciated.

 

Operating Loss and Net Loss:

Operating loss was $546,000 in 2005 comparedto an operating loss of $1,901,000 in 2004 and an operating loss of $1,358,000in 2003. Net loss in 2005 was $329,000 compared to a net loss of $1,131,000 in2004 and a net loss of $818,000 in 2003. Operating loss and net loss werereduced in 2005 compared to 2004 primarily due to increased revenues, decreasedcost of services (excluding depreciation and amortization) and decreasedselling, general and administrative costs (excluding depreciation andamortization), but was offset by the increase in cost of sales. The lossesgenerated in 2004 and 2003 were primarily due to changes in operating revenues andthe $700,000 inventory valuation adjustment described above.

 

ENVENTIS SECTOR –Due to the purchase of Enventis on December 30, 2005, operations for onebusiness day were immaterial. Therefore, there is no discussion of operationsfor Enventis included in this Annual Report on Form 10-K.

 

On December 30, 2005 HickoryTechpurchased Enventis from ALLETE, Inc. Enventis specializes in providingtelecommunications and network solutions for companies of all sizes. Inaddition to its statewide, SONET-based network, Enventis provides innovative IPservices that combine voice and data onto a single platform. Since 1997,Enventis has provided network solutions for a broad spectrum of largecorporate, non-profit, government and small business clients. Enventis has officesin Duluth, Plymouth, and Rochester, Minnesota and Sioux Falls, South Dakota.

 

**INTEREST EXPENSE**

Interest expense was $250,000 or 5.4% lower in2005 compared to 2004 and $1,490,000 or 24.4% lower in 2004 compared to 2003.The outstanding balance of the revolving credit facility was $142,035,000 at December 31,2005 and $102,500,000 at December 31, 2004.  The increase in debt was due to theacquisition of Enventis, which took place at the end of 2005.

 

**INCOME TAXES**

The effective tax rate for continuing operationswas 39.7%, 40.4% and 40.2% in 2005, 2004 and 2003, respectively. Theseeffective tax rates differ from the U.S. statutory rate primarily due to stateincome taxes.

 

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**CRITICAL ACCOUNTING POLICIES**

Management’s discussion and analysis offinancial condition and results of operations stated in this 2005 Annual Reporton 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 thesefinancial statements requires management to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues, and expenses andrelated disclosure of contingent assets and liabilities.  Management believes that the application ofthe accounting policies, which are important to HickoryTech’s financialposition and results of operations, requires significant judgments andestimates on the part of management. Senior management has discussed the development and selection ofaccounting estimates and the related MD&A disclosure with the AuditCommittee. For a summary of all HickoryTech’s accounting policies, see Note 1of the Notes to Consolidated Financial Statements. There were no significantchanges to these accounting policies during the year ended December 31,2005.

 

**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 aredivided among the companies based on respective costs and investments toprovide the services. The companies that take part in these poolingarrangements may adjust their costs and investments for a period of two years,which causes the dollars distributed by the pool to be adjusted retroactively.Management believes that recorded amounts represent reasonable estimates of thefinal distribution from these pools. However, to the extent that companiesparticipating in these pools make adjustments, there will be adjustments torecorded revenues in future periods.

 

Revenue in the Enterprise Solutions Sectorearned on major installation and change contracts is recognized using thepercentage of completion method, which relies on measuring actual contractcompletion versus estimates of total expected contract revenue and costs. Thepercentage of completion method is used since reasonably dependable estimatesof the revenue and costs applicable to various stages of a contract can bemade. Recognized revenues and profit are subject to revisions as the contractprogresses to completion. Revisions in profit estimates are charged to incomein the period in which the facts that give rise to the revision become known.

 

HickoryTech did not recognize revenue for theEnventis Sector due to its acquisition by HickoryTech at the end of the year2005.

 

**Allowance for Doubtful Accounts–**HickoryTech’s allowance for doubtful accounts is an estimate based onspecifically identified accounts as well as less specific reserves establishedbased upon historical collection experience. HickoryTech evaluates specificaccounts where it has information that the customer may have an inability tomeet its financial obligations, the customer is delinquent or the customer maydispute the charges. In these cases, management uses its judgment, based on thebest available facts and circumstances, and records a specific reserve for thatcustomer against amounts due to reduce the receivable to the amount that is expectedto be collected. These specific reserves are reevaluated and adjusted asadditional 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$334,000 and $1,256,000 as of December 31, 2005 and 2004, respectively.

 

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**Inventories –** Similar toits allowance for doubtful accounts, HickoryTech makes estimates related to thevaluation of inventory. HickoryTech adjusts its inventory carrying value forestimated obsolescence or unmarketable inventory to the estimated market valuebased upon assumptions about future demand and market conditions. As market andother conditions change, additional inventory write-downs may be required atthe time that the facts 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 1-8 years.

 

Goodwill assets are subject to an impairmenttest annually as well as upon certain events that indicate that an impairmentmay be present. The goodwill impairment test includes two steps, the first ofwhich requires management to determine the fair value of certain of the Company’sreporting units (as defined by SFAS No. 142).  The Company determines the fair value of itsreporting units by application of a discounted cash flow analysis. Managementmakes estimates that are included in its discounted cash flow analysis basedupon the best available information at the time that the determinations of fairvalue are made. If circumstances change, HickoryTech’s estimates of fair valuewill also change and could result in a determination of additional impairmentcharges to reduce the carrying value of goodwill.

 

**Income Taxes –**As part of the process of preparing its consolidated financial statements theCompany is required to estimate income taxes in each of the jurisdictions inwhich it operates. This process involves estimating current tax exposure,together with assessing temporary differences resulting from differingtreatment of items, such as deferred revenue, for tax and accounting purposes.These differences result in deferred tax assets and liabilities, which areincluded within the Company’s consolidated balance sheet. The Company assessesthe likelihood that deferred tax assets will be recovered from future taxableincome and to the extent recovery is not likely, it establishes a valuationallowance. To the extent the Company establishes a valuation allowance or increasesthis allowance in a period, it must include an expense within the tax provisionin the statement of operations. The Company established a $1,531,000 and$1,205,000 valuation allowance at December 31, 2005 and 2004,respectively, due to uncertainty about realization of benefits associated withnet operating losses generated in the state of Iowa. Additionally, the Companyhas reserves for income tax contingencies. These reserves relate to various taxyears subject to audit by tax authorities. The Company believes its currentincome tax reserves are adequate. However, the ultimate outcome may differ fromestimates, and assumptions could impact the provision for income taxesreflected in the consolidated statements of operations.

 

**Post-Retirement Benefits –**The net post-retirement benefit expense was$1,051,000, $1,127,000 and $717,000 in 2005, 2004 and 2003, 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.

 

Post-retirementbenefits were calculated in accordance with the methods specified in Statementof Financial Accounting Standards (SFAS) No. 106, “Employers’ Accountingfor Postretirement Benefits Other Than Pensions.” Where SFAS No. 106provides alternative methods for determining net periodic benefit costs,HickoryTech adopted the following policies: Any prior service cost, orcumulative net gains and losses in excess of 10% of the SFAS No. 106corridor, are amortized on a straight-line basis over the average futureservice lives of the covered group. There are no substantive commitments for benefits other than as statedin the written plan. According to the guidance of paragraph 186 of SFAS No. 106,“the objective of selecting assumed discount rates is to measure the singleamount that, if invested at the measurement date in the portfolio ofhigh-quality debt instruments, would provide the necessary future cash flows topay the accumulated benefits when due.” The assumed discount rate representsthe discounted value of necessary future cash flows required to pay theaccumulated benefits when due.  The ratewas determined based on available market data regarding the spot yields onhigh-quality fixed income securities with the affects of puts and calls removedthat provide cash flows at the same time and in the same amount as theprojected cash flows of the plan.

 

In measuringthe accumulated post-retirement benefit obligation as of December 31,2005, the Company assumed a discount rate of 5.5%. The reduction in thediscount rate by 25 basis points would increase the accumulated post-retirementbenefit obligation by approximately $332,000 as of December 31, 2005 andwould increase the net periodic cost by approximately $36,000 as of December 31,2005.

 

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The healthcare cost trend rate is based upon an evaluation of the historical trends andexperience, taking into account current and expected market conditions. Thehealth care cost trend rate represents the expected annual rate of change inthe cost of health care benefits currently provided due to factors other thanchanges in the demographics of plan participants. If the assumptions utilizedin determining the post-retirement benefit expense and liability differ fromactual events, the results of operations for future periods could be impacted.

 

In measuringthe accumulated post-retirement benefit obligation as of December 31,2005, the initial health care inflation rate for 2006 was assumed to be 8%,which decreases 0.5% each year until it reaches 4.5% in 2013 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. A one-percentage point increase in the healthcare inflation rate for each year would increase the accumulated post-retirementbenefit obligation by $1,329,000. A one-percentage point decrease in the healthcare inflation rate for each year would decrease the accumulatedpost-retirement benefit obligation by $1,066,000.

 

When actualevents differ from the assumptions or when the assumptions used change, anunrecognized actuarial gain or loss results. As of December 31, 2005, theunrecognized net actuarial loss was $2,317,000. During each of the last threeyears, the Company has adjusted the discount rate assumption due to changes ininterest rates. In recent years, the Company has adjusted the health care costtrend rate assumption to reflect the current trend of medical costs. Theremainder of the net actuarial loss amount primarily related to differencesbetween the assumed medical costs and actual experience and changes in theemployee population. The unrecognized net actuarial loss outside the allowablecorridor is expected to be recognized over the next 12.8 years. This amountwill change in future years as economic and market conditions generate gainsand losses.

 

**INFLATION**

It is the opinion of management that the effectsof inflation on operating revenues and expenses over the past three years havebeen immaterial. Management anticipates that this trend will continue in thenear future.

 

**DIVIDENDS**

HickoryTech paid dividends of $6,277,000, or$0.48 per share, in 2005. The 2005 dividend per share rate was $0.01 perquarter more than 2004 and 2003. HickoryTech has announced a first quarterdividend of $0.12 per share in 2006, and if it is continued at that rate wouldproduce an annual dividend of $0.48 per share.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

**CAPITAL STRUCTURE** – The totalcapital structure (long-term and short-term obligations plus shareholders’equity) for HickoryTech was $177,767,000 at December 31, 2005, reflecting19.7% equity and 80.3% debt. This compares to a capital structure of$134,529,000 at December 31, 2004, reflecting 23.4% equity and 76.6% debt.The increase in debt is due to the recent acquisition of Enventis. HickoryTechhas a history of paying down its debt with its operating cash flow. Managementbelieves adequate operating cash flows and other internal and externalresources are available to finance ongoing operating requirements, includingcapital expenditures, business development, debt service and the payment ofdividends, for at least the next twelve months.

 

**CASH FLOWS**– Cash flows from operations continue to be a steady sourceof funds for HickoryTech, primarily resulting from the Telecom Sector. Cashprovided from operations was $33,360,000 in 2005, $34,872,000 in 2004 and$36,749,000 in 2003. Cash flows from operations in 2005 were attributable tonet income plus non-cash expenses, including depreciation and amortization of$15,554,000 and $4,969,000 of income taxes. Since HickoryTech acquired Enventison December 30, 2005, net income does not include any results forEnventis. Cash flows from operations in 2004 were attributable to net incomeplus non-cash expenses, including depreciation and amortization of $16,535,000and $4,602,000 of deferred taxes. Cash flows from operations in 2003 wereattributable to net loss offset by non-cash expenses, including depreciationand amortization of $17,638,000, the $25,345,000 asset impairment charges thatoccurred due to discontinued operations, and $4,817,000 of deferred taxes.

 

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Cash used in investing activities was$56,579,000 in 2005, and $13,968,000 in 2004, while cash provided by investingactivities was $6,979,000 in 2003. Capital expenditures were $19,481,000 in2005, $16,612,000 in 2004 and $13,570,000 in 2003. Capital expenditures wereincurred to construct additional network facilities to provide CLEC servicesand expand fiber optic networks. HickoryTech expects capital expenditures in2006 to be approximately $20,000,000. There were $2,100,000 redemptions of investments in 2005 and $2,600,000in 2004. The December 30, 2005 acquisition of Enventis for $35,500,000plus working capital adjustments significantly impacted the acquisitions, netof cash acquired. The sale of HickoryTech’s wireless business provided$16,246,000 of cash in 2003.

 

Cash provided by financing activities was$23,563,000 in 2005, and cash used in investing activities was $20,925,000 in2004 and $45,324,000 in 2003. On December 30, 2005, HickoryTech enteredinto a $160,000,000 credit agreement with a syndicate of banks, which amendedits previous credit facility. The proceeds were used to repay the outstandingobligations under the previous credit facility, pay fees and expensesassociated with the new credit facility, and pay costs associated with theacquisition of Enventis. In addition, HickoryTech paid $6,277,000 of dividendsin 2005. In 2004, cash was primarily used to repay $16,000,000 of borrowingsand to pay dividends of $5,717,000. In 2003, cash was primarily used to repay$39,500,000 of borrowings and to pay dividends of $6,150,000. In 2003, cash wasalso used to repurchase 66,600 shares of common stock under HickoryTech’srepurchase plan for $661,000, and to retire 18,370 shares of common stock froma compensation plan trust account for $185,000.

 

**WORKING CAPITAL –**Workingcapital was $8,078,000 as of December 31, 2005 compared to working capitalof $787,000 as of December 31, 2004. The ratio of current assets tocurrent liabilities was 1.3 to 1.0 as of December 31, 2005 and 1.0 to 1.0as of December 31, 2004. The increase in working capital as of December 31,2005 compared to December 31, 2004 was the result of the Enventis assetsacquired, financed with long-term debt.

 

**LONG-TERM OBLIGATIONS**–HickoryTech’s long-term obligations as of December 31, 2005, were$140,980,000, excluding current maturities of $1,300,000 on debt and $478,000on current maturities of capital leases. On December 30, 2005, HickoryTechentered into a $160,000,000 credit agreement with a syndicate of banks whichamended its previous credit facility. The credit facility is comprised of a$30,000,000 revolving credit component that expires on December 30, 2011and a $130,000,000 term loan component. The term loan component is comprised oftwo components which are defined as term loan B and term loan C. The proceedswere used to repay the outstanding obligations under the previous creditfacility, pay fees and expenses associated with the new credit facility, andpay costs associated with the acquisition of Enventis. Under the terms of thecredit facility, HickoryTech is required to make quarterly payments on theoutstanding principal of the term loans beginning March 31, 2006. Theoutstanding principal balance of term loan B is $110,000,000 as of December 31,2005, and is held in varying amounts by three of the lenders in the syndicate,US Bank, GE Commercial Distribution Finance Corporation and CoBank. Under theterms of term loan B, HickoryTech is required to make quarterly principalpayments of $275,000 from March 31, 2006 through December 31, 2011with the remainder of the aggregate principal due in two payments on March 31,2012 and June 30, 2012. The outstanding principal balance of termloan C is $20,000,000 as of December 31, 2005, and is held entirely byRural Telephone Finance Cooperative. Under the terms of term loan C,HickoryTech is required to make quarterly principal payments of $50,000 on the aggregateprincipal amount from March 31, 2006 through December 31, 2012 withthe remainder of the aggregate principal due in two payments on March 31,2013 and June 30, 2013. Under the terms of the revolving creditfacility, any outstanding principal is payable in full on December 30,2011. Under the credit facility, interest will be payable at an applicablemargin in excess of a prevailing pricing level. The prevailing pricinglevel will be based on a Base Rate, LIBOR Rate Loans or Rural Telephone FinanceCorporation (RTFC) rate table. The prevailing rate for Base Rate Loans is thehigher of Prime Rate or the Federal Funds Rate plus 0.5%. The prevailingrate for LIBOR Rate Loans is publicly available. The RTFC rate tables areestablished based on RTFC policies, are not publicly available, and change fromtime to time. The applicable margin for the revolving credit facility, termloan B, and term loan C will be determined quarterly based on the leverageratio of HickoryTech. The credit facility also provides for an annual feeon any undrawn commitment of the revolving credit facility, payablequarterly. The credit facility is collateralized by certain property,plant and equipment and contains covenants relating to cash flow and capitalexpenditures. The credit facility requires HickoryTech to enter into ormaintain in effect interest rate protection agreements on at least 50% of thefacility’s outstanding balance, to manage the Company’s exposure to interestrate fluctuations. As a result of the new credit agreement, HickoryTechincurred $1,525,000 of new debt placement costs.

 

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HickoryTech is required to comply with specifiedfinancial ratios and tests applicable to the Company and its currentsubsidiaries, including maximum leverage ratio, minimum interest coverage ratioand maximum capital expenditures. HickoryTech’s obligations under the creditfacility are secured by a first-priority lien on all property and assets,tangible and intangible, of HickoryTech and its current subsidiaries,including, but not limited to, accounts receivable, inventory, equipment andintellectual property; general intangibles, cash and proceeds of the foregoing;and a first-priority pledge of the capital stock of HickoryTech’s currentsubsidiaries.

 

HickoryTech’s Information Solutions Sectorleases certain computer equipment under capital lease arrangements. This sectorrecorded additions to property, plant and equipment of $782,000, $81,000, and$660,000 in 2005, 2004 and 2003, respectively, related to these capital leasearrangements.

 

HickoryTech continually monitors the interestrates on its bank loans and has implemented interest rate protection agreementson various portions of the overall debt outstanding for varying terms. A higherlevel of interest expense is likely to occur in 2006 because of the higherlevel of debt outstanding to accommodate the purchase of Enventis.

 

The following table sets forth HickoryTech’scontractual obligations, along with the cash payments due each period. Intereston long-term debt is estimated using the interest rate as of December 31,2005.

 
| ** **                         | ** ** | **Payments Due by Year**   | ** ** |
|------------------------------------|------------|----------------------------|------------|
| ** **                         | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                         | ** ** | ** **                 | ** ** | ** ** | ** ** | **2007 to** | ** ** | **2010 to** | ** ** | **2012 and** | ** ** |
| ** **                         | ** ** | **Total**                  | ** ** | **2006** | ** ** | **2009** | ** ** | **2011** | ** ** | **after** | ** ** |
| Contractual  Obligations           |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Long-term Debt                     |       | $                          | 142,035    |   | $ | 1,300 |   | $ | 3,900 |   | $ | 14,635 |   | $ | 122,200 |   |
| Interest on Long-term Debt         |       | 52,263                     |       | 8,078 |   | 23,732 |   | 16,047 |   | 4,406 |   |
| Capital Lease Obligations          |       | 723                        |       | 478 |   | 245 |   | — |   | — |   |
| Interest on Capital Leases         |       | 52                         |       | 39 |   | 13 |   | — |   | — |   |
| Purchase Obligations               |       | 4,276                      |       | 4,276 |   | — |   | — |   | — |   |
| Operating Leases                   |       | 15,189                     |       | 2,556 |   | 5,742 |   | 2,762 |   | 4,129 |   |
| Total Contractual Cash Obligations |       | $                          | 214,538    |   | $ | 16,727 |   | $ | 33,632 |   | $ | 33,444 |   | $ | 130,735 |   |

 

Purchase obligations consist primarily of commitmentsincurred for construction projects.

 

In addition, HickoryTech has change of controlagreements with key employees.  The details of the agreements are outlinedin the proxy statement.  These potential commitments are not included inthe above schedule.

 

**OFF-BALANCE SHEETARRANGEMENT/CONTINGENT COMMITMENTS** -  HickoryTech is not engaged in anytransactions, arrangements or other relationships with unconsolidated entitiesor other third parties that are reasonably likely to have a material effect on itsliquidity, or on its access to, or requirements for capital resources. Inaddition, HickoryTech has not established any special purpose entities.

 

**CONSTRUCTION PLANS**–HickoryTech is halfway through a five-year network enhancement program in itscore telephone property in Mankato, Minnesota in support of its broadbandstrategy. The level of capital spending in 2004 and 2005 is indicative ofthe level HickoryTech expects to maintain over the next two to threeyears. Management believes that the enhancement will support the broadbandproduct deployment strategies of the future, as well as serving as defenseagainst competition in its core market. These upgrades will giveHickoryTech the capability to offer more diversified services to its core customerbase.

 

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**REGULATORY ASSET ANDLIABILITY**– Effective January 1, 2002, theFederal Communications Commission (FCC), in its “MAG (Multi Association Group)Order” on Access Charge Reform, directed all rate-of-return carriers to filerevisions to their tariffs to eliminate the transport interconnection charge(TIC) as a separate rate element. In effect, the costs previously recoveredthrough the TIC were reallocated over all other access categories, includingcarrier common line, transport, local switching, information surcharge andspecial access. The FCC made it clear that “this tariff filing should be arevenue neutral tariff filing.” The total revenues reallocated from the TIC tothe remaining access elements were limited to the total revenues recovered fromthe TIC for the twelve-month period ended June 30, 2001. These revenueswere calculated using the carrier’s traffic volumes and the TIC rate for thetwelve-month period ended June 30, 2001. These calculations were preparedby an independent third party and approved by the National Exchange CarrierAssociation (NECA). Reallocating the costs to the other access billingcategories eliminated TIC. The FCC conducted an investigation of all tarifffilings, including NECA’s CCL (Carrier Common Line) tariff and Heartland’sTraffic Sensitive (TS) tariff, to determine if the filing parties had properlyreallocated the TIC costs among the other access charge categories. The FCCterminated 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. As a result of this billing error, the Company recovered $611,000of excess 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 TStariff as a supportable method of recouping NECA’s CCL reduction. The revisioncorrects the TIC rate originally used, and factors recovery of the $611,000,into the TS rate elements. HickoryTech recouped this revenue over the remainingeighteen months of the TS tariff, from January 1, 2004 to June 30,2005. In accordance with SFAS No. 71, HickoryTech recorded a regulatoryasset for the revenue it would recoup with a balance of $0 at December 31,2005 and $204,000 at December 31, 2004.

 

**OTHER –**HickoryTechoperates with original equity capital, retained earnings and indebtedness inthe form of bank term and revolving lines of credit. HickoryTech believes itscurrent level of debt to total capital is acceptable for ongoing operations.

 

**CONTINGENCIES**

HickoryTech is involved in certain contractualdisputes in the ordinary course of business. HickoryTech does not believe theultimate resolution of any of these existing matters will have a materialadverse effect on its financial position, results of operations or cash flows.

 

**RECENT ACCOUNTING DEVELOPMENTS**

In December 2004,the Financial Accounting Standards Board (‘‘FASB’’) issued SFAS No. 123(R),‘‘Share-Based Payment’’, which is a revision of SFAS No. 123 andsupersedes APB Opinion No. 25. SFAS No. 123(R) requires allshare-based payments to employees, including grants of employee stock options,to be valued at fair value on the date of grant, and to be expensed over theapplicable vesting period. Companies must recognize compensation expenserelated to any awards that are not fully vested as of the effective date.Compensation expense for the unvested awards will be measured based on the fairvalue of the awards previously calculated in developing the pro formadisclosures in accordance with the provisions of SFAS No. 123(R).Originally, SFAS No. 123(R) was effective for all stock-based awardsgranted beginning with the first annual or interim period after June 15,2005. On April 14, 2005, the Securities and Exchange Commission (SEC)approved a new rule that changed the effective date of SFAS No. 123(R)for public companies to the first annual or interim period in the first fiscalyear beginning after June 15, 2005. HickoryTech has chosen to use themodified prospective basis of the Black-Scholes option-pricing model tocalculate future stock-compensation expense, using a fair value method asprescribed under SFAS 123(R). The valuation of equity instruments underlyingstock-based compensation and the period during which the related stockcompensation expense is recognized will be based in part on variousassumptions, including the estimated life of equity instruments, stock volatility,interest rates and vesting terms. HickoryTech has assessed the impact ofadopting SFAS 123(R) to its consolidated results of operations. HickoryTech hasdetermined that the reference made to the disclosures under SFAS No. 123in Note 1 of the Notes to ConsolidatedFinancial Statements is a reasonable expectation of future expense.

 

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**REGULATED INDUSTRY**

 

ILEC Minnesota – HickoryTech’s two MinnesotaILEC subsidiaries continue to operate under an alternative form of regulationas defined in Minnesota Chapter 237, whereby companies with less than 50,000customers are regulated on price and service level rather than profit. In 2005,the Minnesota legislature enacted a statute deregulating multi-line businessesin certain metropolitan markets.

 

PUC has been considering intrastate accessreform and universal service for several years. In June 2004, PUC issuedan order to refer the carrier common line (CCL) component of the access reformissue to a contested case hearing. In September 2004, PUC also referredthe local switching and transport (LST) component of the access reform issuefor a separate contested case hearing. The process on both of these dockets wassuspended in December 2004 subsequent to concerns expressed by stateagencies regarding increases in local rates and the potential that federalactivity may also address this issue. HickoryTech cannot estimate the impact,if any, of future potential state access revenue changes.

 

In December 2004, the Federal Court ofAppeals, 8th Circuit, upheld an October 2003 ruling by the United StatesDistrict Court, District of Minnesota, in issuing an injunction providingrelief from regulation of any service provider of VoIP based services inMinnesota. The issue of regulation of VoIP is also under consideration at theFCC. Future decisions regarding the regulation of VoIP may result in a changein the business relationship between HickoryTech companies and theinterexchange carriers, as interconnections with certain VoIP providers may notbe governed by tariffed access charges. HickoryTech cannot, at this time,estimate the revenue impact, if any, related to these events.

 

On June 27, 2005, the United States SupremeCourt reversed a prior ruling that required cable operators to open up theirhigh-speed Internet lines to competition. In October 2005, the FCC alsoreleased new regulations intended to spur the development of broadbandservices. HickoryTech cannot, at this time, estimate the revenue impact, ifany, related to these events.

 

ILEC Iowa – In 2005, rate deregulation wasgranted to all Iowa companies for all services other than single line services.Previously, only companies with fewer than 15,000 access lines wereunregulated. HickoryTech’s Iowa ILEC subsidiary has maintained less than 15,000access lines. As a result, it has been and will remain unregulated.

 

Wireline Interstate – The HickoryTech ILECcompanies do not participate in the NECA traffic sensitive pool and set accessrates according to either a nationwide average cost of providing access, or inthe case of Heartland, according to its own interstate costs. This biannualrate process was completed in June 2005, and established traffic sensitiveinterstate rates for the period from July 1, 2005 through June 30,2007. HickoryTech ILEC companies participate in the NECA common line pool. EndUser Common Line (EUCL) funds collected, are pooled and some of HickoryTech’srevenues are based on settlements distributed from the pool. Pool settlementsare adjusted periodically.

 

CLEC – HickoryTech’s CLEC business provideslocal exchange services in Minnesota and Iowa with less regulatory oversightthan the HickoryTech ILEC companies. HickoryTech’s Crystal subsidiary alsooffers long distance services. In-state services in Minnesota are regulated byPUC with respect to uniform pricing statewide. In-state long distance servicein Iowa is unregulated. Long distance services are also deregulated at thefederal level (for interstate services), but are subject to annualcertification of geographical rate averaging and rate integration. Dial-up andbroadband Internet access are unregulated at both the state and federal levels.

 

In addition to the deregulation granted by newIowa law, the Iowa Utilities Board has opened another docket investigatingeffective competition for several additional communities and may authorizeadditional deregulation for those communities. This docket includes onecommunity served by Crystal.

 

Crystal offers digital TV service in St. Peter,Waseca, Ellendale, New Richland and St. Clair, Minnesota markets underfranchises negotiated with these local municipalities.

 

Other – HickoryTech’s CLEC interstate accessrates are established in accordance with an April 2001 FCC order. Underthe final phase of this order, interstate switched access rates for HickoryTech’sCLEC were reduced to levels comparable to those of the incumbent LECs in June 2004.

 

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The FCC has an open docket on intercarrier compensationas well as several dockets on VoIP. In February 2005, the FCC issued aFurther Notice of Public Rule Making (FNPRM) and has received voluminouscomments reflecting diverse opinions for intercarrier compensation reform.HickoryTech cannot predict the outcome of such proceedings nor can it estimatethe impact, if any, on HickoryTech.

 

Local Number Portability (LNP) – On November 10,2003, the FCC released a decision providing guidance on porting betweenwireline and wireless networks (intermodal porting). Most of the Company’swireline operations were subject to a May 24, 2004 implementation date forintermodal porting, however, Heartland Telecommunications Company of Iowareceived a suspension order from the Iowa Utilities Board allowing additionaltime and implemented LNP on January 25, 2005. The effects of intermodalporting on the Company’s Minnesota wireline operations have been minimal as of December 31,2005. Given the short history for which intermodal porting has been available,however, the Company cannot fully quantify the long-term effects ofimplementing intermodal porting on its wireline operations. It is possible thatthese requirements could adversely affect the Company’s wireline operatingcosts and customer growth rates. HickoryTech is also unable to quantify the revenue impact of wirelinecustomers that may switch to wireless or other wireline alternatives.

 

**Item 7A.   Quantitative and Qualitative DisclosuresAbout Market Risk.**

 

HickoryTech does not have operations subjectto risks of foreign currency fluctuations. HickoryTech does, however, usederivative financial instruments to manage exposure to interest ratefluctuations. HickoryTech’s objectives for holding derivatives are to minimizeinterest rate risks using the most effective methods to eliminate or reduce theimpact of these exposures. Variable rate debt instruments are subject tointerest rate risk. HickoryTech has entered into interest rate protectionagreements with remaining maturities of thirty months to manage its exposure tointerest rate movements on a portion of its variable rate debt obligations. Theeffective portion of the cumulative gain or loss on these derivativeinstruments is reported as a component of accumulated other comprehensiveincome/loss in shareholders’ equity and is recognized in earnings when the termof the swap agreement is concluded. HickoryTech’s earnings are affected bychanges in interest rates as a portion of its long-term debt has variableinterest rates based on LIBOR. If interest rates for the portion of HickoryTech’slong-term debt based on variable rates had averaged 10% more for the year endedDecember 31, 2005, HickoryTech’s interest expense would have increased$135,000 in 2005.

 

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Shareholders and Board of Directors of Hickory TechCorporation:

 

We have completed integrated audits of Hickory TechCorporation’s 2005 and 2004 consolidated financial statements and of itsinternal control over financial reporting as of December 31, 2005, and anaudit of its 2003 financial statements in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Our opinions, basedon our audits, are presented below.

 

Consolidated financial statements and financial statementschedules

 

In our opinion, the consolidated financial statements listedin the index appearing under Item 15(a)(1) respectively present fairly, inall material respects, the financial position of Hickory Tech Corporation andits subsidiaries at December 31, 2005 and 2004, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2005 in conformity with accounting principles generally acceptedin the United States of America. In addition, in our opinion, the financialstatement schedules listed in the index appearing under Item 15(a)(2) presentfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements. Thesefinancial statements and financial statement schedules are the responsibilityof the Company’s management. Our responsibility is to express an opinion onthese financial statements and financial statement schedules based on ouraudits. We conducted our audits of these statements in accordance with thestandards 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 finanical 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 9A, that the Company maintained effective internal control overfinancial reporting as of December 31, 2005 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 31,2005, 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.

 

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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, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the Company are being madeonly in accordance with authorizations of management and directors of theCompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisitions, use or disposition of theCompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

As described in Management’s Report onInternal Control over Financial Reporting, management has excluded Enventisfrom its assessment of internal control over financial reporting as of December 31,2005 because it was acquired by the Company in a purchase business combinationat the end of 2005. We have also excluded Enventis from our audit of internalcontrol over financial reporting. Enventis is a wholly owned subsidiary whosetotal assets and total revenues represent 23.3% and 34.9%, respectively, of therelated consolidated financial statement amounts as of and for the year ended December 31,2005. (Note: Revenue % based upon total Enventis revenues for the year ended December 31,2005, which were unaudited and not included in the consolidated incomestatement due to the acquisition closing date.)

 

PricewaterhouseCoopers LLP

 

Minneapolis, Minnesota

March 7, 2006

 

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**Item 8.    Financial Statements and SupplementaryData.**

** **

**HICKORYTECH CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**YearsEnded December 31**

* *

*(Dollars in Thousands, Except Per ShareAmounts)*

 
| ** **                                                    | ** ** | **2005**       | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------------------------------------|------------|----------------|------------|------------|------------|------------|------------|
| OPERATING  REVENUES:                                          |       |           |       |       |       |       |       |
| Telecom Sector                                                | ** ** | **$**          | **75,400** |       | $          | 76,097     |       | $ | 75,346 |   |
| Information Solutions Sector                                  | ** ** | **2,522**      |       | 2,710      |       | 3,199      |       |
| Enterprise Solutions Sector                                   | ** ** | **14,590**     |       | 11,708     |       | 14,347     |       |
| Enventis Sector (Note 3)                                      | ** ** | **—**     |       | —     |       | —     |       |
| TOTAL OPERATING REVENUES                                      | ** ** | **92,512**     |       | 90,515     |       | 92,892     |       |
|                                                          |       |           |       |       |       |       |       |
| COSTS AND  EXPENSES:                                          |       |           |       |       |       |       |       |
| Cost of Sales, Enterprise Solutions                           | ** ** | **10,329**     |       | 8,211      |       | 10,216     |       |
| Cost of Services                                              |       |           |       |       |       |       |       |
| Depreciation and Amortization                                 | ** ** | **33,255**     |       | 33,625     |       | 33,471     |       |
| Selling, General and Administrative  Expenses, excluding      |       |           |       |       |       |       |       |
| Depreciation and Amortization                                 | ** ** | **15,266**     |       | 14,723     |       | 13,159     |       |
| Depreciation                                                  | ** ** | **15,061**     |       | 15,589     |       | 14,870     |       |
| Amortization of Intangibles                                   | ** ** | **493**        |       | 946        |       | 997        |       |
| TOTAL COSTS AND EXPENSES                                      | ** ** | **74,404**     |       | 73,094     |       | 72,713     |       |
|                                                          |       |           |       |       |       |       |       |
| OPERATING  INCOME                                             | ** ** | **18,108**     |       | 17,421     |       | 20,179     |       |
|                                                          |       |           |       |       |       |       |       |
| OTHER  INCOME/(EXPENSE):                                      |       |           |       |       |       |       |       |
| Equity in Net Income/(Loss) of Investees                      | ** ** | **—**     |       | —     |       | 9          |       |
| Interest and Other Income                                     | ** ** | **97**         |       | 61         |       | 53         |       |
| Interest Expense                                              | ** ** | **(4,363**     | )          | (4,613     | )          | (6,103     | )          |
| TOTAL OTHER INCOME (EXPENSE)                                  | ** ** | **(4,266**     | )          | (4,552     | )          | (6,041     | )          |
| INCOME  BEFORE INCOME TAXES                                   | ** ** | **13,842**     |       | 12,869     |       | 14,138     |       |
| INCOME TAX  PROVISION                                         | ** ** | **5,499**      |       | 5,205      |       | 5,683      |       |
| INCOME FROM  CONTINUING OPERATIONS                            | ** ** | **8,343**      |       | 7,664      |       | 8,455      |       |
| DISCONTINUED  OPERATIONS (Note 3)                             |       |           |       |       |       |       |       |
| Income/(Loss) from Operations of  Discontinued Component      |       |           |       |       |       |       |       |
| Including Loss on Disposal of $25,642 in  2003                | ** ** | **308**        |       | (125       | )          | (23,087    | )          |
| Income Tax Expense/(Benefit)                                  | ** ** | **122**        |       | (51        | )          | (1,857     | )          |
| INCOME/(LOSS)  ON DISCONTINUED OPERATIONS                     | ** ** | **186**        |       | (74        | )          | (21,230    | )          |
| NET  INCOME/(LOSS)                                            | ** ** | **$**          | **8,529**  |       | $          | 7,590      |       | $ | (12,775 | ) |
|                                                          |       |           |       |       |       |       |       |
| Basic  Earnings Per Share - Continuing Operations:            | ** ** | **$**          | **0.64**   |       | $          | 0.59       |       | $ | 0.61 |   |
| Basic  Earning/(Loss) Per Share - Discontinued Operations:    | ** ** | **0.01**       |       | (0.01      | )          | (1.53      | )          |
| ** **                                                    |       | **$**          | **0.65**   |       | $          | 0.58       |       | $ | (0.92 | ) |
| Dividends  Per Share                                          | ** ** | **$**          | **0.48**   |       | $          | 0.44       |       | $ | 0.44 |   |
| Weighted  Average Common Shares Outstanding                   | ** ** | **13,083,252** |       | 12,993,280 |       | 13,934,178 |       |
|                                                          |       |           |       |       |       |       |       |
| Diluted  Earnings Per Share - Continuing Operations:          | ** ** | **$**          | **0.64**   |       | $          | 0.59       |       | $ | 0.61 |   |
| Diluted  Earnings/(Loss) Per Share - Discontinued Operations: | ** ** | **0.01**       |       | (0.01      | )          | (1.53      | )          |
| ** **                                                    |       | **$**          | **0.65**   |       | $          | 0.58       |       | $ | (0.92 | ) |
| Weighted Average  Common and Equivalent Shares Outstanding    | ** ** | **13,097,417** |       | 13,025,637 |       | 13,961,282 |       |

 

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

 

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**HICKORY TECH CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**As of December 31**

*(Dollars in Thousands)*

 
| ** **                                                                                                                                      | ** ** | **2005**    | ** **  | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|----------|------------|
| ASSETS                                                                                                                                          |       |        |        |     |       |
| CURRENT  ASSETS:                                                                                                                                |       |        |        |     |       |
| Cash and Cash Equivalents                                                                                                                       | ** ** | **$**       | **601**     |     | $          | 257 |   |
| Receivables, Net of Allowance for Doubtful  Accounts of $334 and $1,256                                                                         | ** ** | **19,867**  |        | 9,892    |       |
| Income Taxes Receivable                                                                                                                         | ** ** | **—**  |        | 204      |       |
| Costs in Excess of Billings on Contracts                                                                                                        | ** ** | **462**     |        | 927      |       |
| Inventories                                                                                                                                     | ** ** | **4,577**   |        | 3,182    |       |
| Deferred Income Taxes                                                                                                                           | ** ** | **300**     |        | 1,430    |       |
| Prepaid Expenses                                                                                                                                | ** ** | **5,066**   |        | 1,185    |       |
| Other                                                                                                                                           | ** ** | **1,155**   |        | 1,214    |       |
| TOTAL CURRENT ASSETS                                                                                                                            | ** ** | **32,028**  |        | 18,291   |       |
| INVESTMENTS                                                                                                                                     | ** ** | **3,407**   |        | 4,371    |       |
| PROPERTY,  PLANT AND EQUIPMENT                                                                                                                  | ** ** | **290,499** |        | 246,341  |       |
| LESS  ACCUMULATED DEPRECIATION                                                                                                                  | ** ** | **141,157** |        | 131,649  |       |
| PROPERTY, PLANT AND EQUIPMENT, NET                                                                                                              | ** ** | **149,342** |        | 114,692  |       |
| OTHER  ASSETS:                                                                                                                                  |       |        |        |     |       |
| Goodwill                                                                                                                                        | ** ** | **27,109**  |        | 25,086   |       |
| Intangible Assets, Net                                                                                                                          | ** ** | **4,312**   |        | 387      |       |
| Financial Derivative Instrument                                                                                                                 | ** ** | **3,429**   |        | 2,501    |       |
| Deferred Costs and Other                                                                                                                        | ** ** | **3,640**   |        | 3,209    |       |
| TOTAL OTHER ASSETS                                                                                                                              | ** ** | **38,490**  |        | 31,183   |       |
| TOTAL ASSETS                                                                                                                                    | ** ** | **$**       | **223,267** |     | $          | 168,537 |   |
| LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                                | ** ** | ** **  | ** **  |     |       |   |   |
| CURRENT  LIABILITIES:                                                                                                                           |       |        |        |     |       |
| Cash Overdraft                                                                                                                                  | ** ** | **$**       | **514**     |     | $          | 1,680 |   |
| Accounts Payable                                                                                                                                | ** ** | **5,224**   |        | 4,065    |       |
| Accrued Expenses                                                                                                                                | ** ** | **6,809**   |        | 3,202    |       |
| Accrued Interest                                                                                                                                | ** ** | **—**  |        | 76       |       |
| Accrued Taxes                                                                                                                                   | ** ** | **4,765**   |        | —   |       |
| Billings in Excess of Costs on Contracts                                                                                                        | ** ** | **283**     |        | 260      |       |
| Advanced Billings and Deposits                                                                                                                  | ** ** | **4,577**   |        | 2,898    |       |
| Current Maturities of Long-Term Obligations                                                                                                     | ** ** | **1,778**   |        | 5,323    |       |
| TOTAL CURRENT LIABILITIES                                                                                                                       | ** ** | **23,950**  |        | 17,504   |       |
| LONG-TERM  OBLIGATIONS, Net of Current Maturities                                                                                               | ** ** | **140,980** |        | 97,661   |       |
| DEFERRED  INCOME TAXES                                                                                                                          | ** ** | **15,346**  |        | 15,270   |       |
| DEFERRED  REVENUE AND EMPLOYEE BENEFITS                                                                                                         | ** ** | **7,982**   |        | 6,557    |       |
| TOTAL LIABILITIES                                                                                                                               | ** ** | **188,258** |        | 136,992  |       |
| COMMITMENTS  AND CONTINGENCIES (Notes 7, 8 and 13)                                                                                              |       |        |        |     |       |
| SHAREHOLDERS’  EQUITY:                                                                                                                     |       |        |        |     |       |
| Common Stock, no par value,  $.10 stated value hares authorized:  100,000,000 Shares issued and outstanding: 2005, 13,124,928; 2004, 13,057,106 | ** ** | **1,312**   |        | 1,306    |       |
| Additional Paid-In Capital                                                                                                                      | ** ** | **9,262**   |        | 8,615    |       |
| Retained Earnings                                                                                                                               | ** ** | **22,371**  |        | 20,119   |       |
| Accumulated Other Comprehensive Income                                                                                                          | ** ** | **2,064**   |        | 1,505    |       |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                                 | ** ** | **35,009**  |        | 31,545   |       |
| TOTAL  LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                         | ** ** | **$**       | **223,267** |     | $          | 168,537 |   |

 

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

 

40

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** **

**HICKORY TECHCORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**Years Ended December 31**

 

*(Dollarsin Thousands)*

 
| ** **                                                  | ** ** | **2005**    | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------|------------|-------------|------------|----------|------------|----------|------------|
| CASH FLOWS  FROM OPERATING ACTIVITIES:                      |       |        |       |     |       |     |       |
| Net Income/(Loss)                                           | ** ** | **$**       | **8,529**  |     | $          | 7,590    |       | $ | (12,775 | ) |
| Adjustments to Reconcile Net Income/(Loss)  to Net          |       |        |       |     |       |     |       |
| Cash Provided by Operating Activities:                      |       |        |       |     |       |     |       |
| Depreciation and Amortization                               | ** ** | **15,554**  |       | 16,535   |       | 17,638   |       |
| Intangible Asset Impairment                                 | ** ** | **—**  |       | —   |       | 21,000   |       |
| Long-Lived Asset Impairment                                 | ** ** | **—**  |       | —   |       | 4,345    |       |
| (Gain)/Loss on Sale of Assets                               | ** ** | **12**      |       | 95       |       | (3       | )          |
| Loss on Disposal of Assets                                  |       | —      |       | —   |       | 632      |       |
| Provision for Losses on Accounts Receivable                 | ** ** | **953**     |       | 1,003    |       | 1,093    |       |
| Deferred Income Taxes                                       | ** ** | **835**     |       | 4,602    |       | 4,817    |       |
| Stock-Based Compensation                                    | ** ** | **107**     |       | 99       |       | (160     | )          |
| Employee Retirement Benefits and Deferred  Compensation     | ** ** | **778**     |       | 905      |       | 412      |       |
| Accrued Patronage Refunds                                   | ** ** | **(367**    | **)**      | (357     | )          | (555     | )          |
| Equity in Net (Income)/Loss of Investees                    | ** ** | **—**  |       | —   |       | (9       | )          |
| Tax Benefit from Stock Option Transactions                  | ** ** | **—**  |       | 11       |       | 17       |       |
| Changes in Operating Assets and Liabilities  Net of         |       |        |       |     |       |     |       |
| Effects of Acquisitions and Dispositions:                   |       |        |       |     |       |     |       |
| Receivables                                                 | ** ** | **(334**    | )          | 1,723    |       | (1,234   | )          |
| Inventories                                                 | ** ** | **411**     |       | 1,270    |       | 310      |       |
| Billings and Costs on Contracts                             | ** ** | **487**     |       | 195      |       | 1,166    |       |
| Accounts Payable and Accrued Expenses                       | ** ** | **2,426**   |       | 557      |       | (1,241   | )          |
| Advance Billings and Deposits                               | ** ** | **(216**    | )          | (142     | )          | 95       |       |
| Deferred Revenue and Employee Benefits                      | ** ** | **(122**    | )          | (232     | )          | (105     | )          |
| Income Taxes                                                | ** ** | **4,969**   |       | —   |       | —   |       |
| Other                                                       | ** ** | **(662**    | )          | 1,018    |       | 1,306    |       |
| Net Cash Provided By Operating Activities                   | ** ** | **33,360**  |       | 34,872   |       | 36,749   |       |
|                                                        |       |        |       |     |       |     |       |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                      |       |        |       |     |       |     |       |
| Additions to Property, Plant and Equipment                  | ** ** | **(19,481** | )          | (16,612  | )          | (13,570  | )          |
| Increase in Investments                                     | ** ** | **(900**    | )          | —   |       | —   |       |
| Redemption of Investments                                   | ** ** | **2,100**   |       | 2,600    |       | 4,144    |       |
| Purchase of Intangible Asset                                | ** ** | **—**  |       | (9       | )          | —   |       |
| Proceeds from Sale of Wireless Business                     | ** ** | **—**  |       | —   |       | 16,246   |       |
| Acquisitions, Net of Cash Acquired                          | ** ** | **(38,378** | )          | —   |       | —   |       |
| Proceeds from Sale of Assets                                | ** ** | **80**      |       | 53       |       | 159      |       |
| Net Cash Provided By/(Used In) Investing  Activities        | ** ** | **(56,579** | )          | (13,968  | )          | 6,979    |       |
|                                                        |       |        |       |     |       |     |       |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                      |       |        |       |     |       |     |       |
| Change in Cash Overdraft                                    | ** ** | **(1,165**  | )          | 679      |       | 1,001    |       |
| Repayments of Credit Agreement                              | ** ** | **(8,532**  | )          | —   |       | —   |       |
| Payments of Capital Lease Obligations                       | ** ** | **(543**    | )          | (710     | )          | (588     | )          |
| Borrowings on Credit Facility                               | ** ** | **138,785** |       | 2,000    |       | 11,250   |       |
| Repayments on Credit Facility                               | ** ** | **(99,250** | )          | (18,000  | )          | (50,750  | )          |
| Proceeds from Issuance of Common Stock                      | ** ** | **545**     |       | 865      |       | 759      |       |
| Dividends Paid                                              | ** ** | **(6,277**  | )          | (5,717   | )          | (6,150   | )          |
| Stock Repurchase/Retirement                                 | ** ** | **—**  |       | (42      | )          | (846     | )          |
| Net Cash Provided by/(Used In) Financing  Activities        | ** ** | **23,563**  |       | (20,925  | )          | (45,324  | )          |
|                                                        |       |        |       |     |       |     |       |
| NET  INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS       | ** ** | **344**     |       | (21      | )          | (1,596   | )          |
| CASH AND  CASH EQUIVALENTS AT BEGINNING OF PERIOD           | ** ** | **257**     |       | 278      |       | 1,874    |       |
| CASH AND  CASH EQUIVALENTS AT END OF PERIOD                 | ** ** | **$**       | **601**    |     | $          | 257      |       | $ | 278 |   |
|                                                        |       |        |       |     |       |     |       |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:          |       |        |       |     |       |     |       |
| Cash Paid for Interest                                      | ** ** | **$**       | **4,521**  |     | $          | 4,669    |       | $ | 6,906 |   |
| Net Cash Paid (Refunded) for Income Taxes                   | ** ** | **$**       | **(182**   | )        | $          | (2,094   | )          | $ | (1,392 | ) |
| NON-CASH  INVESTING ACTIVITIES:                             |       |        |       |     |       |     |       |
| Property, Plant and Equipment Acquired with  Capital Leases | ** ** | **$**       | **782**    |     | $          | 81       |       | $ | 660 |   |
| Stock Consideration Received in Wireless  Business Sale     | ** ** | **$**       | **—** |     | $          | —   |       | $ | 12,207 |   |
|                                                             |            |             |            |          |            |          |            |  |  |  |  |  |  |

 

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

 

41

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**HICKORY TECH CORPORATION**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY ANDCOMPREHENSIVE INCOME/LOSS**

**Years Ended December 31**

*(Dollarsin Thousands)*

 
| ** **                          | ** ** | **Common  Stock** | ** ** | **Additional  Paid - In** | ** ** | **Retained** | ** ** | **Other  Comprehensive** | ** ** | **Total  Shareholders’** | ** ** | **Total   Comprehensive** | ** ** |
|-------------------------------------|------------|-------------------|------------|---------------------------|------------|--------------|------------|--------------------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                          | ** ** | **Shares**        | ** ** | **Amount**                | ** ** | **Capital**  | ** ** | **Earnings**             | ** ** | **Income**                    | ** ** | **Equity**                | ** ** | **Income (Loss)** | ** ** |
|                                |       |              |       |                      |       |         |       |                     |       |                          |       |                      |       |   |   |
| 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                    |       |   |   |
|                                |       |              |       |                      |       |         |       |                     |       |                          |       |                      |       |   |   |
| Stock Award Plan                    |       | 6,309             |       |                      |       | 43           |       |                     |       |                          |       | 43                        |       |   |   |
| Employee Stock Purchase Plan        |       | 25,054            |       | 2                         |       | 282          |       |                     |       |                          |       | 284                       |       |   |   |
| Directors’ Stock Retainer Plan |       | 7,521             |       | 1                         |       | 64           |       |                     |       |                          |       | 65                        |       |   |   |
| Dividend Reinvestment Plan          |       | 28,938            |       | 3                         |       | 258          |       |                     |       |                          |       | 261                       |       |   |   |
| Net Income                          |       |              |       |                      |       |         |       | 8,529                    |       |                          |       | 8,529                     |       | $ | 8,529 |   |
| Dividends Paid                      |       |              |       |                      |       |         |       | (6,277                   | )          |                          |       | (6,277                    | )          |   |   |
| Other Comprehensive Income,         |       |              |       |                      |       |         |       |                     |       |                          |       |                      |       |   |   |
| Net of Income Taxes                 |       |              |       |                      |       |         |       |                     |       | 559                           |       | 559                       |       | 559 |   |
| Total Comprehensive Income          |       |              |       |                      |       |         |       |                     |       |                          |       |                      |       | $ | 9,088 |   |
|                                |       |              |       |                      |       |         |       |                     |       |                          |       |                      |       |   |   |
| BALANCE, DECEMBER 31, 2005     |       | 13,124,928        |       | $                         | 1,312      |         | $          | 9,262                    |       | $                             | 22,371     |                      | $          | 2,064 |   | $ | 35,009 |   |   |   |
|                                     |            |                   |            |                           |            |              |            |                          |            |                               |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |

 

 

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

 

42

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 – ACCOUNTING POLICIES**

 

The accounting policies of HickoryTech are inconformity with accounting principles generally accepted in the United Statesof America and, where applicable, conform to the accounting principles asprescribed by federal and state telephone utility regulatory authorities.HickoryTech presently gives accounting recognition to the actions of regulatorswhere appropriate, as prescribed by Financial Accounting Standards BoardStatement (SFAS) No. 71, “Accounting for the Effects of Certain Types ofRegulation.”

 

**Basis of Consolidation**– The consolidated financial statements of HickoryTech include HickoryTech andits subsidiaries in the following four business segments:  (i) Telecom Sector, (ii) InformationSolutions Sector, (iii) Enterprise Solutions Sector and (iv) EnventisSector. All inter-company transactions have been eliminated from theconsolidated financial statements.  Dueto the purchase of Enventis at the end of 2005, no results of operations forEnventis are included in the financial statements.  The Enventis balance sheet is consolidatedwith the HickoryTech and its subsidiaries for the year ended December 31,2005.

 

Cost of services includes all costs relatedto delivery of HickoryTech’s communications services and products. These costsinclude all costs of performing services and providing related products. Itdoes not include costs associated with selling, general and administrative,depreciation and amortization of property, plant and equipment, intangibleasset impairment charges and cost of sales for the Enterprise Solutions and EnventisSectors.

 

On December 15, 2003, HickoryTech soldits wireless business, Minnesota Southern Wireless Company (MSWC), to WWC. Thewireless operations are reported as part of the Telecom Sector. The results ofoperations of the wireless business are reported as discontinued operations forall 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.Revenue for the equipment sales portion of the Enventis Sector is generallyrecognized when equipment is shipped or when services are completed under short-termcontracts. Revenue from fiber optic transport service and support services isrecognized monthly as the services are provided.

 

**Estimates**– Thepreparation 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.

 

**Property, Plant and Equipment**– Property, plant and equipment are recorded at original cost of acquisition orconstruction.  When regulated incumbentlocal exchange carrier (ILEC) telephone assets are sold or retired, the assetsand related accumulated depreciation are removed from the accounts and anygains or losses on disposition are amortized with the remaining net investmentin telephone plant.  When other plant andequipment is sold or retired, the cost and related accumulated depreciation oramortization are removed from the respective accounts and any resulting gain orloss is included in operating income. Maintenance and repairs are charged to expense as incurred.

 

On December 30, 2005 HickoryTechacquired Enventis. The Enventis property, plant and equipment, consistingprimarily of fiber optic communications network was valued under SFAS 141 and142 as it pertains to accounting for assets under Purchase Accounting andessentially recorded the assets at fair value at the time of acquisition.

 

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.

 

The components of property, plant andequipment are summarized as follows:

 

*(Dollarsin Thousands)*

 
| ** **                                 | ** ** | **2005**    | ** **  | **2004** | ** ** |
|--------------------------------------------|------------|-------------|-------------|----------|------------|
|                                       |       |        |        |     |       |
| ILEC  Telephone Plant (Telecom Sector)     | ** ** | **$**       | **184,509** |     | $          | 174,056 |   |
| CLEC  Telephone Plant (Telecom Sector)     | ** ** | **63,077**  |        | 58,311   |       |
| Enventis  Property and Equipment           | ** ** | **24,044**  |        | —   |       |
| Enventis  Indefeasable Rights To Use (IRU) | ** ** | **5,496**   |        | —   |       |
| Other  Property and Equipment              | ** ** | **13,373**  |        | 13,974   |       |
| Total                                      | ** ** | **290,499** |        | 246,341  |       |
| Less  Accumulated Depreciation             | ** ** | **141,157** |        | 131,649  |       |
| Property,  Plant and Equipment, Net        | ** ** | **$**       | **149,342** |     | $          | 114,692 |   |

 

43

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Included in the Enventis property, plant andequipment is fiber optic cable and indefeasible rights of use of fiberinstalled by others accompanied by ownership rights. Both of these categoriesof assets have depreciable lives of 16 to 20 years on the assets acquired on December 30,2005 and 25 years for new additions.

 

Depreciation for financial statement purposesis determined using the straight-line method based on the lives of the variousclasses of depreciable assets. The composite depreciation rates on ILECtelephone plant were 5.4%, 6.0%, and 6.1% for 2005, 2004 and 2003,respectively. All other property, plant and equipment are depreciated overestimated useful lives of three to twenty years. Other property and equipmentincludes $782,000, and $81,000 of equipment acquired under capital leases in2005 and 2004. Amortization expense related to these capital leases was$653,000 and $667,000 in 2005 and 2004. Accumulated amortization related tothese leases was $841,000 and $1,814,000 in 2005 and 2004.

 

**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.

 

**Accounts Receivable**–As of December 31, 2005, HickoryTech’s consolidated accounts receivabletotal $19,867,000, net of the allowance of doubtful accounts and includes $10,593,000of receivables relating to Enventis. As of December 31, 2005, HickoryTechbelieves accounts receivable are recorded at its fair value. As there may byexposure or risk with accounts receivable, HickoryTech routinely monitors itsaccounts receivable and adjusts the allowance for doubtful accounts whencertain events occur that may potentially impact the collection of accountsreceivable. The Company’s receivables can be concentrated with a small numberof carriers or geographically.

 

**Investments** – Investmentsinclude $2,466,000 of non-interest bearing Rural Telephone Finance Cooperative(RTFC) Subordinated Capital Certificates (SCCs) accounted for under the costmethod of accounting.  This methodrequires HickoryTech to periodically evaluate whether a non-temporary decreasein value of the investment has occurred, and if so, to write this investmentdown to its net realizable value.

 

Investments also included an unconsolidatedpartnership accounted for using the equity method of accounting. NIBI, a whollyowned subsidiary of HickoryTech, was a 40% general partner in NationalIndependent Billing Partnership (NIBP), which performed billing and collectionclearinghouse functions for interexchange carriers. NIBP was dissolved as of December 31,2003. For the year ended December 31, 2003, NIBP had revenues of $19,000and net income of $28,000.

 

**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 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 reduce deferredtax assets to the amount expected to be realized. Income tax expense or benefitis the tax payable or refundable, respectively, for the period plus or minusthe change in deferred tax assets and liabilities during the period.

 

**Intangible Assets and Goodwill**– HickoryTech adopted the provisions of Statement of Financial AccountingStandards (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.

 

The changes in goodwillduring 2005 are summarized as follows:

 
| (Dollars in thousands)                                |       |      |       |
|-------------------------------------------------------|------------|-----------|------------|
|                                                  |       |      |       |
| ** **                                            | ** ** | **2005**  | ** ** |
| Goodwill as  of December 31, 2004                | ** ** | **$**     | **25,086** | ** ** |
| Goodwill  associated with the acquisition of Enventis | ** ** | **2,023** | ** ** |
| Goodwill as  of December 31, 2005                | ** ** | **$**     | **27,109** | ** ** |

 

**Capitalized Software Costs –**Softwarecosts associated with software that is developed or purchased for internal useonly are accounted for in accordance with the American Institute of CertifiedPublic Accountants Statement of Position 98-1, “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use.” HickoryTechcapitalizes costs (including right to use fees) associated with externallyacquired software for internal use. Costs associated with internally developedsoftware are segregated into three project stages: preliminary project stage,application development stage and post-implementation stage. Costs associatedwith both the preliminary project stage and post-implementation stage, areexpensed as incurred. Costs associated with the application development stageare capitalized. Software maintenance and training costs are expensed asincurred. Amortization of software costs commences when the software is readyfor its intended use, and is amortized over a period of three years. During2005,****2004****and 2003,****HickoryTech capitalized $2,147,000,****$433,000****and $144,000,****respectively, of costs associated withsoftware purchased or developed for internal use only. The 2005 and 2004 costsrelate primarily to costs associated with integrating the new enterpriseresource planning software that HickoryTech will convert to on January 1,2006.****These software costs areincluded in property, plant and equipment, and amounted to $3,335,000****and $2,047,000****at December 31, 2005****and2004,****respectively.****These amounts are net of accumulatedamortization of $2,997,000 and****$2,137,000at December 31, 2005****and2004,****respectively.****Amortization expense relating to thesecosts amounted to $859,000 and $938,000 in 2005 and 2004, respectively.

 

44

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Software costs associated with software thatis developed or purchased for external sale or license are accounted for inaccordance with SFAS No. 86, “Accounting for the Costs of ComputerSoftware to Be Sold, Leased or Otherwise Marketed.” HickoryTech capitalizescosts related to such software when technological feasibility has beenestablished and continues capitalization until the product becomes availablefor general release to customers. These software costs, net of accumulatedamortization, are included in other non-current assets,****and****amountedto****$0****and $432,000 at December 31,****2005 and 2004, respectively. These amounts are net of accumulatedamortization of $3,926,000 and $3,494,000 at December 31, 2005 and 2004, respectively. In accordance with SFAS No. 86, whichstates that annual amortization shall be the greater of the amount computedusing (a) the ratio that current gross revenues for a product bear to thetotal of current and anticipated future gross revenues for that product or (b) thestraight-line method over the remaining estimated economic life of the productincluding the period being reported on, capitalized software costs areamortized on a straight-line, product-by-product basis over the estimatedeconomic lives of the product, which are currently three and four years.  Amortization expense relating to these costsamounted to****$389,000 in 2005 and****$843,000 in 2004.

 

**Comprehensive Income**–HickoryTech follows the provisions of SFAS No. 130, “Reporting ComprehensiveIncome.” 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 $1,251,000, $1,104,000 and $935,000 in 2005, 2004 and 2003,respectively.

 

**Earnings (Loss) Per Share**– Basic earnings (loss) per share is computed by dividing net income by theweighted average number of shares of common stock outstanding during the year.Shares used in the earnings per share assuming dilution calculation are basedon the weighted average number of shares of common stock outstanding during theyear increased by potentially dilutive common shares. Potentially dilutivecommon shares include stock options and stock subscribed under the employeestock purchase plan (ESPP).

 
| ** **                           | ** ** | **2005**       | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------|------------|----------------|------------|------------|------------|------------|------------|
|                                 |       |           |       |       |       |       |       |
| Weighted  Average Shares Outstanding | ** ** | **13,083,252** |       | 12,993,280 |       | 13,934,178 |       |
| Stock  Options                       | ** ** | **5,955**      |       | 24,852     |       | 18,809     |       |
| Stock  Subscribed (ESPP)             | ** ** | **8,210**      |       | 7,505      |       | 8,295      |       |
| Total  Dilutive Shares Outstanding   | ** ** | **13,097,417** |       | 13,025,637 |       | 13,961,282 |       |

 

Options to purchase 503,850 shares as of December 31,2005, 402,050 shares as of December 31, 2004 and 481,698 shares as of December 31,2003 were not included in the computation of earnings per share assumingdilution because their effect on earnings per share would have beenantidilutive.

 

Dividends per share are based on thequarterly dividend per share as declared by the HickoryTech Board of Directors.

 

45

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**Stock Compensation –**AtDecember 31, 2005, HickoryTech had five stock-based employee compensationplans, which are described more fully in Note 6.  HickoryTech has elected to apply AccountingPrinciples Board Opinion No. 25 and related interpretations in accountingfor its employee and directors’ stock compensation plans. See Note 12 forguidance relating to SFAS No 123(R), Share-Based Payment, which supersedesAccounting Principles Board Opinion No. 25.  If HickoryTech had elected to recognizecompensation cost based on the fair value of the options as prescribed by SFAS No. 123,the following operating results would have resulted using the Black-Scholesoption-pricing model to determine the fair value of the options (see Note 6):

** **
| ** **                                                                                                               | ** ** | **Years Ended December 31** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(Dollars in Thousands)**                                                                                               | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                     |       |                             |       |   |   |   |   |
| Reported Net  Income/(Loss)                                                                                              | ** ** | **$**                            | **8,529**  |   | $ | 7,590 |   | $ | (12,775 | ) |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects              | ** ** | **64**                           |       | 59 |   | (96 | ) |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of |       |                             |       |   |   |   |   |
| related tax effects                                                                                                      | ** ** | **(224**                         | )          | (278 | ) | (165 | ) |
|                                                                                                                     | ** ** | ** **                       |       |   |   |   |   |
| Pro Forma  Net Income/(Loss)                                                                                             | ** ** | **$**                            | **8,369**  |   | $ | 7,371 |   | $ | (13,036 | ) |
|                                                                                                                     |       |                             |       |   |   |   |   |
| Earnings per  share:                                                                                                     |       |                             |       |   |   |   |   |
| Basic - as reported                                                                                                      | ** ** | **$**                            | **0.65**   |   | $ | 0.58 |   | $ | (0.92 | ) |
| Basic - pro forma                                                                                                        | ** ** | **$**                            | **0.64**   |   | $ | 0.57 |   | $ | (0.94 | ) |
|                                                                                                                     |       |                             |       |   |   |   |   |
| Diluted - as reported                                                                                                    | ** ** | **$**                            | **0.65**   |   | $ | 0.58 |   | $ | (0.92 | ) |
| Diluted - pro forma                                                                                                      | ** ** | **$**                            | **0.64**   |   | $ | 0.57 |   | $ | (0.94 | ) |

 

**NOTE 2****– GOODWILL AND OTHERINTANGIBLE ASSETS**

 

Goodwill assets are subject to an impairmenttest annually as well as upon certain events that indicate that an impairmentmay be present. The goodwill impairment test includes two steps, the first ofwhich requires management to determine the fair value of certain of the Company’sreporting units (as defined by SFAS No. 142).  The Company determines the fair value of itsreporting units by application of a discounted cash flow analysis. Managementmakes estimates that are included in its discounted cash flow analyses basedupon the best available information at the time that the determinations of fairvalue are made.  If circumstances change,HickoryTech’s estimates of fair value will also change and could result in adetermination of additional impairment charges to reduce the carrying value ofgoodwill.

 

HickoryTech is required to test acquiredgoodwill for impairment on an annual basis based upon a fair value approach.Additionally, goodwill shall be tested for impairment between annual tests ifan event occurs or circumstances change that would more likely than not reducethe fair value of an entity below its carrying value. As of December 31,2005 and 2004, HickoryTech completed its annual impairment tests for acquiredgoodwill. Such testing resulted in no impairment charge to goodwill, as thedetermined fair value was again sufficient to pass the first step impairmenttest.

 

On December 30, 2005 HickoryTechacquired Enventis. The Enventis acquisition added preliminarily $2,023,000 ofgoodwill and $4,000,000 of intangible assets. Both are recorded in theaccompanying balance sheet.

 

The carrying value of HickoryTech’s goodwillis $27,109,000 as of December 31, 2005 which increased during 2005 as aresult of the $2,023,000 related to the Enventis acquisition.

 

The components of HickoryTech’s intangibleassets are as follows:

** **
| *** ***                      | ** ** | *** ***     | ** ** | **As of December  31, 2005** | ** ** | **As of December 31, 2004** | ** ** |
|-----------------------------------|------------|------------------|------------|-----------------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | ** **       | ** ** | **Gross Carrying**                | ** ** | **Accumulated**                  | ** ** | **Gross Carrying** | ** ** | **Accumulated** | ** ** |
| **(Dollars in Thousands)**        | ** ** | **Useful Lives** | ** ** | **Amount**                        | ** ** | **Amortization**                 | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Definite-Lived  Intangible Assets |       |             |       |                              |       |                             |       |   |   |   |   |
| Customers                         |       | 1 - 8 years      | ** ** | **$**                             | **4,229**  | ** **                       | **$**      | **544** |   | $ | 821 |   | $ | 442 |   |
| Other Intangibles                 |       | 1 - 5 years      | ** ** | **730**                           | ** ** | **103**                          |       | 109 |   | 101 |   |
| Total                             | ** ** |             | ** ** | **$**                             | **4,959**  | ** **                       | **$**      | **647** |   | $ | 930 |   | $ | 543 |   |

 

During 2005,HickoryTech acquired Enventis. Part of the acquisition price included$3,400,000 for customers and $600,000 for the intangibles. In addition,HickoryTech completed another acquisition in 2005 that included $8,000 forcustomers and $21,000 for other intangibles.

 

46

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Amortization expense related to the definite-lived intangible assetsfor 2005, 2004 and 2003 was $104,000, $103,000, and $103,000,respectively.  Amortization expense forthe five years subsequent to 2005 is as follows: 2006 - $1,172,000; 2007 -$1,157,000; 2008 - $1,127,000; 2009 - $853,000 and 2010 - $3,000.

 

**NOTE 3 – ACQUISITION, DISPOSITION andDISCONTINUED OPERATIONS**

 

Acquisition of Enventis

On December 30, 2005 HickoryTechpurchased Enventis from ALLETE, Inc. Enventis was formerly a wholly ownedsubsidiary of ALLETE, Inc.  Enventisis a network transport and an enterprise Internet Protocol telephony salesbusiness.  The acquisition of Enventiswas made to expand the geographic region which HickoryTech could serve with itsbusiness broadband service capabilities. Both Enventis and HickoryTech have similar bundled service businessplans.

 

The purchase price was cash of $35,500,000 inexchange for the common stock of Enventis, with further purchase priceadjustments and transaction costs making the estimated total purchaseconsideration $38,602,000.  Enventis hadno debt at the time of acquisition.  Thepurchase agreement outlines certain purchase price adjustments which willresult in cash payments between Allete and HickoryTech in the first quarter of2006.  These purchase price adjustmentsare for working capital, capital expenditures and employee benefits.  Any purchase price adjustments which alterthe amounts estimated in the table below will be reflected in changes togoodwill.  There are no contingentpayments or earn-out payments.

 

The financing for the estimated $38.6 milliontotal purchase consideration for Enventis, plus an additional $8.5 million forEnventis working capital, was entirely from HickoryTech’s credit agreement, asestablished on December 30, 2005. The credit facility is comprised of a $30 million revolving creditcomponent which expires on December 30, 2011 and a $130 million term loancomponent, which has partial maturities during its term, with final maturity onJune 30, 2013.  See Note 7.

 

The transaction was accounted for using thepurchase method of accounting. Accordingly, the purchase price was allocated to the estimated fairvalue of assets acquired and liabilities assumed. The preliminary purchaseprice allocation resulted in goodwill of $2,023,000. Allete and HickoryTechhave agreed to treat the transaction under Section 338 of the InternalRevenue Code. Accordingly, the tax basis of the acquired assets and assumedliabilities will be the same for financial reporting.

 

Due to the purchase of Enventis on December 30,2005, operations for essentially one business day were immaterial and notincluded in the results for 2005. Therefore, there is no discussion of operations for Enventis included inthis Annual Report on Form 10-K. HickoryTech intends to manage and reportEnventis as a separate operating segment called Enventis.

 

The consolidated balance sheet as of December 31,2005 reflects the preliminary allocation of the purchase price to the estimatedassets acquired and liabilities assumed based on their estimated fair values atthe date of acquisition.

 

A third party valuation specialist assistedthe Company with the valuation of the identified intangible assets, andproperty and equipment, and has provided its preliminary report. The valuationresulted in the allocation of $4.0 million to identifiable intangibles, whichwill be amortized over periods ranging from three to four years. The valuationspecialist applied the income valuation approach to assist the Company indetermining the estimated fair value of the intangible assets (purchasedcustomer relationships and supplier relationship) These estimates were basedupon:

 

•                  Theestimated revenue growth over the next ten years based upon HickoryTech estimates.

•                  Estimatedoperating margins of earnings before interest, taxes, depreciation, andamortization of 37% in Enventis transport product line and between 2 to 5% onthe Enventis equipment sales product line.

•                  Workingcapital investment changes commensurate with historical patterns in theEnventis transport product and equipment sales product lines.

•                  Thediscount rate used in the valuation was based on the weighted average cost ofcapital (“WACC”).  The WACC calculationproduces the average required rate of return of an investment in an operatingenterprise based upon various required rate of return from investors in variousareas of that enterprise.  The discountrate used in the income valuation approach was 12%.

 

47

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The table below sets forth the purchase priceallocation, which is considered preliminary largely due to the fact thissignificant acquisition closed one day before year-end. Specific reasonscausing the purchase price to be preliminary are: 1) finalization of the thirdparty valuation, 2) finalization of the purchase price adjustments, 3) theliquidation of acquired accounts receivable, and 4) resolution of onelitigation matter. On the litigation matter, HickoryTech has received anindemnification from Allete which management believes to be more than adequateto cover any loss. The first two items are expected to be resolved by April 2006.The third item is expected to be resolved by July 2006 and the last itemby December 2006.

 
| **(Dollars in Thousands):**                   | ** ** | ** ** |
|-----------------------------------------------|------------|------------|
| Initial  purchase price paid                  | $          | 35,500     | ** ** |
| Estimated  purchase price adjustments accrued | 1,895      |       |
| Transaction  costs paid and accrued           | 1,207      |       |
| Total estimated purchase consideration        | $          | 38,602     |   |
| Identifiable  intangible assets:              |       |       |
| Customer relationship and contracts           | $          | 3,400      |   |
| Cisco gold supplier relationship              | 600        |       |
| Net working  capital                          | 3,808      |       |
| Property and  equipment                       | 24,044     |       |
| Indefeasible  rights to use                   | 5,496      |       |
| Other assets  and liabilities                 | (769       | )          |
| Goodwill                                      | 2,023      |       |
| Allocation of purchase consideration          | $          | 38,602     |   |

 

The intangible assets identified above,customer relationships and contracts have useful lives of four years, and theCisco Gold supplier relationship has a useful life of three years. Useful livesfor identifiable intangible assets are estimated at the time of acquisitionbased on the periods of time from which the Company expects to derive benefitsfrom the identifiable intangible assets. The identifiable intangible assets are amortized using the straight-linemethod, which reflects the pattern in which the assets are consumed.

 

The followingunaudited pro forma condensed consolidated results of operations have beenprepared as if the acquisition of Enventis had occurred as of the beginning offiscal 2004 for the year ended December 31, 2004 and the beginning offiscal 2005 for the year ending December 31, 2005.  Pro forma adjustments relate to amortizationof identified intangible assets, depreciation on assets at fair market value,interest expense and income taxes.

 
| ** **                                                   | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|
| **(Dollars in Thousands, except  per share amounts)**        | ** ** | **2005**                    | ** ** | **2004** | ** ** |
| Revenues                                                     |       | $                           | 143,348    |   | $ | 133,714 |   |
| Income from  Continuing Operations                           |       | $                           | 8,318      |   | $ | 6,791 |   |
| Income from  Continuing Operations per common share, basic   |       | $                           | 0.64       |   | $ | 0.52 |   |
| Income from  Continuing Operations per common share, diluted |       | $                           | 0.64       |   | $ | 0.52 |   |

 

The unaudited pro formacondensed consolidated results of operations are not necessarily indicative ofresults that will be obtained in the future.

 

Sale of Wireless Operations(Discontinued Operations):

On December 15, 2003,HickoryTech sold its wireless business, Minnesota Southern Wireless Company(MSWC), to WWC. The wireless operations are reported as part of the TelecomSector. The results of operations of the wireless business are reported asdiscontinued operations for all periods presented.

 

Wireless business revenue and income before incometaxes included in discontinued operations are as follows:

 
| *** ***                      | ** ** | **For Years Ended December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| **(Dollars in Thousands)**        | ** ** | **2005**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues                          |       | $                                     | —     |   | $ | — |   | $ | 14,341 |   |
| Income (Loss) Before Income Taxes |       | $                                     | 308        |   | $ | (125 | ) | $ | (23,087 | ) |

 

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

 

The fair value of HickoryTech’s long-termobligations, after deducting current maturities, is estimated to be$135,855,000 at December 31, 2005 and $97,708,000 at December 31,2004, compared to carrying values of $140,980,000 and $97,662,000 respectively.The fair value estimates are based on the overall weighted average interestrates and maturity compared to rates and terms currently available in thelong-term financing markets.

 

HickoryTech’s financial instruments alsoinclude cash equivalents, trade accounts receivable, and accounts payable forwhich current carrying amounts approximate fair market value.

 

48

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**NO****TE 5 – BUSINESS SEGMENTS**

 

HickoryTech’s operations are conducted in four business segments as:(i) Telecom Sector, (ii) Information Solutions Sector, (iii) EnterpriseSolutions Sector and (iv) Enventis Sector. The Telecom Sector providestelephone services to Mankato and adjacent areas of south central Minnesota andto eleven communities in northwest Iowa as an ILEC.  The Telecom Sector also operates fiber opticcable transport facilities in Minnesota. The Telecom Sector also offers analternative choice for local telecommunications service, known as CLEC(Competitive Local Exchange Carrier) service in the telecommunicationsindustry, to customers in Minnesota and Iowa not currently in HickoryTech’sILEC service area. In addition, the Telecom Sector resells long distanceservice to Minnesota and Iowa subscribers in its ILEC and CLEC markets. Priorto the sale of the wireless operations as discussed in Note 3, the TelecomSector provided wireless telephone service to seven counties in south centralMinnesota and a service area around the Minneapolis/St. Paul, Minnesotametropolitan area and PCS service to the Minnesota BTAs of Mankato-Fairmont andRochester-Austin-Albert Lea. The wireless operations are reported asdiscontinued operations for all periods presented. The Information SolutionsSector provides data processing and related services to HickoryTech’s othersectors and to other external telephone companies, municipalities andutilities. The Enterprise Solutions Sector designs, sells, installs and servicesbusiness telephone systems and data communications equipment primarily inmetropolitan Minneapolis/St. Paul, Minnesota. The Enventis Sector specializes in providingtelecommunications and network solutions for companies of all sizes. Inaddition to its statewide, SONET-based network, Enventis provides innovative IPservices that combine voice and data onto a single platform.  Due to its acquisition by HickoryTech at theend of the year 2005, no results of operations for Enventis are included in theaccompanying financial statements.

 

Business segment information for the years ended December 31, 2005,2004, and 2003 is as follows:

 

**BUSINESS SEGMENT DATA**

Years Ended December 31

 

*(Dollars in Thousands**)***

 
| ** **                                | ** ** | ** **  | ** ** | ** **      | ** ** | ** **     | ** ** | ** **   | ** ** | **Corporate**    | ** ** | ** **       | ** ** |
|-------------------------------------------|------------|-------------|------------|-----------------|------------|----------------|------------|--------------|------------|------------------|------------|------------------|------------|
| ** **                                | ** ** | ** **  | ** ** | **Information** | ** ** | **Enterprise** | ** ** | **Enventis** | ** ** | **and**          | ** ** | ** **       | ** ** |
| ** **                                | ** ** | **Telecom** | ** ** | **Solutions**   | ** ** | **Solutions**  | ** ** | **Telecom**  | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **2005**                                  |       |        |       |            |       |           |       |         |       |             |       |             |       |
| Revenue from  Unaffiliated Customers      |       | $           | 75,400     |            | $          | 2,522          |       | $            | 14,590     |             | $          | —           |       | $ | — |   | $ | 92,512 |   |
| Intersegment  Revenues                    |       | 205         |       | 4,312           |       | —         |       | —       |       | (4,517           | )          | —           |       |
| Total                                     |       | 75,605      |       | 6,834           |       | 14,590         |       | —       |       | (4,517           | )          | 92,512           |       |
|                                      |       |        |       |            |       |           |       |         |       |             |       |             |       |
| Depreciation and  Amortization            |       | 13,355      |       | 2,020           |       | 118            |       | —       |       | 61               |       | 15,554           |       |
| Operating  Income/(Loss)                  |       | 21,136      |       | (2,306          | )          | (546           | )          | —       |       | (176             | )          | 18,108           |       |
| Interest Expense                          |       | 5           |       | 56              |       | —         |       | —       |       | 4,302            |       | 4,363            |       |
| Income Taxes                              |       | 8,401       |       | (937            | )          | (217           | )          | —       |       | (1,748           | )          | 5,499            |       |
| Income/(Loss)  from Continuing Operations |       | 12,746      |       | (1,422          | )          | (329           | )          | —       |       | (2,652           | )          | 8,343            |       |
| Income/(Loss)  from Discont. Operations   |       | 186         |       | —          |       | —         |       | —       |       | —           |       | 186              |       |
| Net Income/(Loss)                         |       | 12,932      |       | (1,422          | )          | (329           | )          | —       |       | (2,652           | )          | 8,529            |       |
| Identifiable  Assets                      |       | 148,808     |       | 3,419           |       | 6,433          |       | 52,061       |       | 12,546           |       | 223,267          |       |
| Capital  Expenditures                     |       | 16,901      |       | 2,411           |       | 47             |       | —       |       | 122              |       | 19,481           |       |
|                                           |            |             |            |                 |            |                |            |              |            |                  |            |                  |            |  |  |  |  |  |  |

 

49

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*(Dollars inThousands)*

 
| ** **                                | ** ** | ** **  | ** ** | ** **      | ** ** | ** **     | ** ** | ** **   | ** ** | ** **       | ** ** | ** **       | ** ** |
|-------------------------------------------|------------|-------------|------------|-----------------|------------|----------------|------------|--------------|------------|------------------|------------|------------------|------------|
| ** **                                | ** ** | ** **  | ** ** | ** **      | ** ** | ** **     | ** ** | ** **   | ** ** | **Corporate**    | ** ** | ** **       | ** ** |
| ** **                                | ** ** | ** **  | ** ** | **Information** | ** ** | **Enterprise** | ** ** | **Enventis** | ** ** | **and**          | ** ** | ** **       | ** ** |
| ** **                                | ** ** | **Telecom** | ** ** | **Solutions**   | ** ** | **Solutions**  | ** ** | **Telecom**  | ** ** | **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   |       | (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           |       |
| ** **                                |       |        |       |            |       |           |       |         |       |             |       |             |       |
| **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 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   |       | (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           |       |

 

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:

 

*(Dollars inThousands)*

 

| ** **            | ** ** | **For Years Ended December 31,** | ** ** |
|-----------------------|------------|------------------------------------------------------|------------|
| ** **            | ** ** | **2005**                                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Identifiable  Assets  |       | $                                                    | —     |   | $ | — |   | $ | — |   |
| Capital  Expenditures |       | $                                                    | —     |   | $ | — |   | $ | 2,333 |   |

 

50

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**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. Effective with the plan year commencingSeptember 2005, the price at which shares can be purchased is 85% of the fairmarket value for shares on one specified date, the end of the plan year. Priorto plan year commencing in September 2005 the price at which shares werepurchased was 85% of the lower fair market value for such shares on twospecified dates in each plan year. As of December 31, 2005 and 2004, there were900,000 common shares reserved for this plan and 566,190 shares and 591,244shares, respectively, still available for issuance. At December 31, 2005,employees had subscribed to purchase approximately 23,970 shares in the currentplan year ending August 31, 2006. At December 31, 2004, employees hadsubscribed to purchase approximately 23,000 shares in the plan year endedAugust 31, 2005.

 

Retainer Stock Plans for Directors:

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, 2005, there were300,000 common shares reserved for this plan and 247,021 shares still availablefor future issuance.

 

Non-Employee Director Stock Option Plan:

HickoryTech previously offered a directors’ stock option plan toattract and retain outside directors. The plan provided for each outsidedirector to receive fully vested options to purchase 5,000 shares ofHickoryTech common stock at an exercise price equal to the fair market value ofthe common stock on a date as specified in the plan if HickoryTech metpre-established financial objectives. The options could be exercised no laterthan ten years after the date of grant. On May 9, 2005 the Director’s IncentivePlan replaced this plan. The 81,000 remaining shares under the Directors’ StockOption Plan are no longer available for use.

 

Non-Employee Directors’ Incentive Plan:

Beginning in May 2005, HickoryTech began offering a Directors’Incentive Plan to attract and retain outside Directors. The plan provides foreach Director to receive 1,000 shares of HickoryTech common stock ifHickoryTech meets pre-established financial objectives. As of December 31,2005, there were 200,000 common shares reserved for this plan and 200,000shares 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 providesfor stock awards based on the attainment of certain financial targets and forindividual achievements. In addition, for one component of the plan,HickoryTech utilizes a trust account for the funding of long-term performanceawards, which were issued until 2003. In 2005, 2004 and 2003, HickoryTech paidcash of $25,000, $23,000 and $204,000 for its common stock shares and issuedshares of 2,757, 2,053 and 22,393 in 2005, 2004 and 2003, respectively, to a trust for the benefit of certainkey employees. The stock options issued under the stock option component of thestock award plan may be exercised no later than ten years after the date ofgrant, with one-third of the options vesting each year. As of December 31,2005, there were 1,750,000 common shares reserved for this plan and 936,279shares available for future grants.

 

HickoryTech haselected to apply Accounting Principles Board Opinion No. 25 and relatedinterpretations in accounting for its employee and directors’ stockcompensation plans. If HickoryTech had elected to recognize compensation costbased on the fair value of the options as prescribed by SFAS No. 123, thefollowing operating results would have occurred using the Black-Scholes option-pricingmodel to determine the fair value of the options with the following listedassumptions:

 

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

 

| ** **                   | ** ** | **2005** | ** ** | **2004**   | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|------------|------------|----------|------------|
| Pro Forma Net  Income/(Loss) | ** ** | **$**    | **8,369**  |       | $          | 7,371    |       | $ | (13,036 | ) |
| Pro Forma Basic  EPS         | ** ** | **$**    | **0.64**   | ** ** | $          | 0.57     |       | $ | (0.94 | ) |
| Pro Forma  Diluted EPS       | ** ** | **$**    | **0.64**   | ** ** | $          | 0.57     |       | $ | (0.94 | ) |
| Volatility                   | ** ** | **33.9** | **%**      | 37.1       | %          | 36.7     | %          |
| Dividend Yield               | ** ** | **4.5**  | **%**      | 3.8        | %          | 5.2      | %          |
| Risk-Free  Interest Rates    | ** ** | **4.1**  | **%**      | 3.9        | %          | 3.8      | %          |
| Expected Life in  Years      | ** ** | **7**    | ** ** | 7          |       | 7        |       |

 

51

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A summary of the stock option activity of the plans is as follows:

 
| ** **                                                      | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted Average** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------|------------|-------------|------------|------------|------------|------------|------------|------------|------------|---------------------------|------------|------------|------------|
| ** **                                                      | ** ** | ** **  | ** ** | **Shares** | ** ** | ** ** | ** ** | ** ** | ** ** | **Exercise Price**   | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **2005**    | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2005**   | ** ** | **2004**                  | ** ** | **2003**   | ** ** |
| Outstanding at Beginning  of Year                               | ** ** | **549,065** | ** ** | 595,798    |       | 554,335    | ** ** | **$**      | **12.86**  |                      | $          | 13.01      |       | $ | 13.60 |   |
| Granted                                                         | ** ** | **60,000**  | ** ** | 88,950     |       | 103,250    | ** ** | **6.31**   |       | 9.87                      |       | 8.90       |       |
| Exercised                                                       | ** ** | **—**  | ** ** | (37,985    | )          | (24,387    | )          | **—** |       | 16.21                     |       | 9.41       |       |
| Forfeited                                                       | ** ** | **(30,215** | **)**      | (97,698    | )          | (37,400    | )          | **4.15**   |       | 13.42                     |       | 12.86      |       |
| Outstanding at End  of Year                                     | ** ** | **578,850** | ** ** | 549,065    |       | 595,798    | ** ** | **$**      | **12.63**  |                      | $          | 12.86      |       | $ | 13.01 |   |
| Exercisable at End  of Year                                     | ** ** | **449,895** | ** ** | 412,386    |       | 455,356    | ** ** | **$**      | **13.14**  |                      | $          | 13.47      |       | $ | 13.50 |   |
| Weighted Average  Fair Value of Options Granted During the Year | ** ** | **$**       | **2.68**   | ** ** | $          | 3.31       |       | $          | 2.16       |                      |       |       |       |   |   |   |
|                                                                 |            |             |            |            |            |            |            |            |            |                           |            |            |            |  |  |  |  |  |  |

 

Thefollowing table provides certain information with respect to stock optionsoutstanding at December 31, 2005:

 

| ** **               | ** ** | **Stock**       | ** ** | **Average**  | ** ** | **Average**               | ** ** |
|--------------------------|------------|-----------------|------------|--------------|------------|---------------------------|------------|
| **Range of**        | ** ** | **Options**     | ** ** | **Exercise** | ** ** | **Remaining**             | ** ** |
| **Exercise Prices** | ** ** | **Outstanding** | ** ** | **Price**    | ** ** | **Contractual Life** | ** ** |
| $8.00 – $12.00      |       | 272,800         |       | $            | 10.31      |                      | 7.4 years  |   |
| $12.00 – $16.00     |       | 245,550         |       | 13.83        |       | 5.1 years                 |       |
| $16.00 – $21.00     |       | 60,500          |       | 18.17        |       | 5.3 years                 |       |
|                     |       | 578,850         |       | $            | 12.63      |                      | 6.2 years  |   |

 

Thefollowing table provides certain information with respect to stock optionsexercisable at December 31, 2005:

 
| ** **               | ** ** | ** **      | ** ** | **Weighted** | ** ** |
|--------------------------|------------|-----------------|------------|--------------|------------|
| ** **               | ** ** | **Stock**       | ** ** | **Average**  | ** ** |
| **Range of**        | ** ** | **Options**     | ** ** | **Exercise** | ** ** |
| **Exercise Prices** | ** ** | **Exercisable** | ** ** | **Price**    | ** ** |
| $8.00 – $12.00      |       | 143,845         |       | $            | 9.83       |   |
| $12.00 – $16.00     |       | 245,550         |       | 13.83        |       |
| $16.00 – $21.00     |       | 60,500          |       | 18.17        |       |
|                     |       | 449,895         |       | $            | 13.14      |   |

 

Allstock options granted in 2005, 2004 and 2003 had an exercise price equal to thefair market value of HickoryTech’s common stock on the date of grant.

 

Otherstock award activity is as follows:

 
| ** **                                                           | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|
| Stock Awards  Granted                                                | ** ** | **3,552** |       | 200      |       | 800      |       |
| Weighted Average  Fair Value of Stock Awards Granted During the Year | ** ** | **$**     | **8.22**   |     | $          | 11.87    |       | $ | 11.03 |   |
|                                                                      |            |           |            |          |            |          |            |  |  |  |

 

52

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The Company recognizes stock compensation charges related to stockaward plans when management concludes it is probable that the participant willearn the award. Such compensation charges are recorded based upon the fairvalue of HickoryTech’s stock and is recognized during the service periodspecified by the stock award plan. Changes in estimated compensation arerecorded in the period in which the change occurs.

 

Stock compensation expense (benefit) for 2005, 2004 and 2003 was$107,000, $99,000 and $(160,000) respectively, for all stock compensationplans.

 

**NOTE 7 – DEBT AND OTHER OBLIGATIONS**

 

Long-term debt:

 

*(Dollarsin Thousands)*

 

| ** **                                                               | ** ** | **2005**    | ** **  | **2004** | ** ** |
|--------------------------------------------------------------------------|------------|-------------|-------------|----------|------------|
| Credit Facility,  Average 5.7%, maturing in varying amounts through 2013 | ** ** | **$**       | **142,035** |     | $          | 102,500 |   |
| Capitalized  Lease Obligations, Interest at 8.2%, maturing April 2009    | ** ** | **723**     |        | 484      |       |
|                                                                     |       |        |        |     |       |
| Total                                                                    | ** ** | **142,758** |        | 102,984  |       |
| Less Current  Maturities                                                 | ** ** | **1,778**   |        | 5,323    |       |
| Long-Term  Obligations                                                   | ** ** | **$**       | **140,980** |     | $          | 97,661 |   |

 

Long-termobligations consist of the following:

 

Credit Facility Obligations:

On December 30, 2005HickoryTech entered into a $160,000,000 credit agreement with a syndicate of bankswhich amended its previous credit facility. Thecredit facility is comprised of a $30,000,000 revolving credit component and a$130,000,000 term loan component.Theterm loan component is comprised of two components which are defined as termloan B and term loan C. The proceeds wereused to repay the outstanding obligations under the previous credit facility,pay fees and expenses associated with the new credit facility, and pay costs associated with the acquisition of Enventis. Under theterms of the credit facility, HickoryTech is required to make quarterlypayments on the outstanding principal of the term loans from March 31,2006. Under the terms of term loan B, HickoryTech is required to makequarterly principal payments of $275,000 from March 31, 2006 throughDecember 31, 2011 with the remainder of the aggregate principal due in twopayments on March 31, 2012 and June 30, 2012. Under the terms ofterm loan C, HickoryTech is required to make quarterly principal payments of$50,000 from March 31, 2006 through December 31, 2012 with theremainder of the aggregate principal due in two payments on March 31, 2013and June 30, 2013. Under the terms of the revolving credit facility,any outstanding principal is payable in full on December 30, 2011. Under thecredit facility, interest will be payable at an applicable margin in excess ofa prevailing pricing level. The prevailing pricing level will be based ona Base Rate, LIBOR Rate, or RTFC rate table. The prevailing rate for Base RateLoans is the higher of Prime Rate or the Federal Funds Rate plus 0.5%. Theprevailing rate for LIBOR Rate Loans is publicly available. The RTFC ratetables are established based on RTFC policies, are not publicly available, andchange from time to time.Theapplicable margin for the revolving credit facility, term loan B, and term loanC will be determined quarterly based on the leverage ratio ofHickoryTech. The credit facility also provides for an annual fee on anyundrawn commitment of the revolving credit facility, payable quarterly. The credit facility is collateralized by certainproperty, plant and equipment and contains covenants relating to cash flow andcapital expenditures.  The credit facilityrequires HickoryTech to enter into or maintain in effect interest rate protectionagreements on at least 50% of the facility’s outstanding balance, to manage thecompany’s exposure to interest rate fluctuations. Asa result of the new credit agreement, HickoryTech incurred $1,525,000 of newdebt placement costs.

 

HickoryTech is required to comply with specifiedfinancial ratios and tests applicable to the Company and its currentsubsidiaries, including maximum leverage ratio, minimum interest coverage ratioand maximum capital expenditures. HickoryTech’s obligations under the creditfacility are secured by a first-priority lien on all property and assets,tangible and intangible, of HickoryTech and its current subsidiaries,including, but not limited to, accounts receivable, inventory, equipment andintellectual property; general intangibles, cash and proceeds of the foregoingand first-priority pledge of the capital stock of HickoryTech’s currentsubsidiaries.

 

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 $367,000 in 2005, $357,000 in 2004 and $555,000 in2003.

 

Annual requirements for principal payments for the years subsequent to2005 are as follows: 2006 - $1,300,000; 2007 - $1,300,000; 2008 - $1,300,000;2009 - $1,300,000; 2010 - $1,300,000 and thereafter - $135,535,000.

 

53

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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 $714,000 and $587,000 ($1,555,000and $2,401,000 asset, net of accumulated depreciation of $841,000 and$1,814,000) as of December 31, 2005 and 2004. 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** | ** ** |
|------------------------------------------|------------|-------------------------------------|------------|
|                                     |       |                                |       |
| 2006                                     |       | $                                   | 517,000    |   |
| 2007                                     |       | 201,000                             |       |
| 2008                                     |       | 50,000                              |       |
| 2009                                     |       | 7,000                               |       |
| Total Minimum  Lease Payments            |       | 775,000                             |       |
| Amount Representing  Interest            |       | (52,000                             | )          |
| Present Value of  Minimum Lease Payments |       | 723,000                             |       |
| Less Current  Portion                    |       | (478,000                            | )          |
| Long-Term Lease  Obligation              |       | $                                   | 245,000    |   |

 

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 $1,240,000in 2005, $1,082,000 in 2004 and $998,000 in 2003. At December 31, 2005, futureminimum operating lease rental obligations for the next five years andthereafter are as follows: 2006 - $2,556,000; 2007 - $2,083,000; 2008- $1,945,000;2009 - $1,714,000;  2010 - $1,488,000 andthereafter - $5,403,000.

 

54

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

 

Employees who meetcertain service requirements are covered under a defined contributionretirement savings plan, which includes IRS Section 401(k) provisions.HickoryTech contributes up to 6.0% of the employee’s eligible compensation,based on the employee’s voluntary contribution. HickoryTech contributions and costs for the retirement savings plan were$1,013,000 in 2005, $1,007,000 in 2004 and $1,053,000 in 2003.

 

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)**                 | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| Change in  Benefit Obligation              |       |       |       |       |       |
| Benefit  Obligation at Beginning of Year   | ** ** | **$**      | **8,081**  |       | $          | 9,257 |   |
| Service Cost                               | ** ** | **367**    |       | 362        |       |
| Interest Cost                              | ** ** | **460**    | ** ** | 508        |       |
| Amendments                                 | ** ** | **—** | ** ** | —     |       |
| Medicare Part D  Subsidy                   | ** ** | **—** | ** ** | (826       | )          |
| Acquisition                                | ** ** | **365**    | ** ** | —     |       |
| Actuarial Gain                             | ** ** | **(1,202** | **)**      | (1,036     | )          |
| Benefits Paid                              | ** ** | **(193**   | **)**      | (184       | )          |
| Benefit Obligation  at End of Year         | ** ** | **$**      | **7,878**  | ** ** | $          | 8,081 |   |
|                                       |       |       | ** ** |       |       |
| Change in Plan  Assets                     |       |       | ** ** |       |       |
| Fair Value of  Assets at Beginning of Year | ** ** | **$**      | **—** | ** ** | $          | — |   |
| Actual Return on  Assets                   | ** ** | **—** | ** ** | —     |       |
| Employer  Contribution                     | ** ** | **193**    | ** ** | 184        |       |
| Distributions                              | ** ** | **(193**   | **)**      | (184       | )          |
| Fair Value of  Assets at End of Year       | ** ** | **$**      | **—** | ** ** | $          | — |   |
| Reconciliation  of Funded Status           |       |       | ** ** |       |       |
| Funded Status                              | ** ** | **$**      | **(7,878** | **)**      | $          | (8,081 | ) |
| Unrecognized Net  Actuarial Loss           | ** ** | **2,317**  | ** ** | 3,685      |       |
| Unrecognized  Transition Obligation        | ** ** | **420**    | ** ** | 480        |       |
| Unrecognized  Prior Service Cost           | ** ** | **(73**    | **)**      | (84        | )          |
| Net Amount  Recognized                     | ** ** | **$**      | **(5,214** | **)**      | $          | (4,000 | ) |

 
| ** **                                       | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|----------|------------|
| Components of  Net Periodic Benefit Cost         |       |       |       |       |       |     |       |
| Service Cost                                     | ** ** | **$**      | **367**    | ** ** | $          | 362      |       | $ | 211 |   |
| Interest Cost                                    | ** ** | **460**    | ** ** | 508        |       | 360      |       |
| Expected Return  on Plan Assets                  | ** ** | **—** | ** ** | —     |       | —   |       |
| Amortization of  Transition Obligation           | ** ** | **60**     | ** ** | 60         |       | 60       |       |
| Amortization of  Prior Service Cost              | ** ** | **(11**    | **)**      | (11        | )          | (11      | )          |
| Recognized Net  Actuarial Loss                   | ** ** | **175**    | ** ** | 208        |       | 97       |       |
| Net Periodic  Benefit Cost                       | ** ** | **$**      | **1,051**  | ** ** | $          | 1,127    |       | $ | 717 |   |
| Weighted-Average  Assumptions as of December 31: |       |       | ** ** |       |       |     |       |
| Used to  Determine the Post-Retirement Expense   | ** ** | **5.75**   | **%**      | 6.50       | %          | 7.00     | %          |
| Used to  Determine the Benefit Obligation        | ** ** | **5.50**   | **%**      | 5.75       | %          | 6.25     | %          |

 

55

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Health Care Trend Rates for Year-Ending December 31, 2005

 
| ** ** | ** ** | **Year**  | ** ** | **Trend** | ** ** |
|------------|------------|-----------|------------|-----------|------------|
|       |       | 2006-2007 |       | 8.00      | %          |
|       |       | 2007-2008 |       | 7.50      | %          |
|       |       | 2008-2009 |       | 7.00      | %          |
|       |       | 2009-2010 |       | 6.50      | %          |
|       |       | 2010-2011 |       | 6.00      | %          |
|       |       | 2011-2012 |       | 5.50      | %          |
|       |       | 2012-2013 |       | 5.00      | %          |
|       |       | 2013+     |       | 4.50      | %          |

 
| **Effect of 1% Increase and 1% Decrease in Trend Rate** | ** ** | **1% Increase** | ** ** | **1% Decrease** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
|                                                                                                 |       |                 |       |                 |       |
| Accum.  Post-Retirement Benefit Oblig. as of December 31, 2005                                       |       |                 |       |                 |       |
| Dollar                                                                                               |       | $                    | 1,329      |                 | $          | (1,066 | ) |
| Percentage  Change in Retiree Medical                                                                |       | 17.9                 | %          | (14.4                | )%         |
|                                                                                                 |       |                 |       |                 |       |
| Service Cost and  Interest Cost for Fiscal 2005                                                      |       |                 |       |                 |       |
| Dollar                                                                                               |       | $                    | 173        |                 | $          | (135 | ) |
| Percentage Change  in Retiree Medical                                                                |       | 21.8                 | %          | (17.0                | )%         |

 

Post-retirement benefits were calculated inaccordance with the methods specified in FAS 106. Where FAS 106 providesalternative methods for determining net periodic benefit costs, HickoryTechadopted the following policies: Any prior service cost, or cumulative net gainsand losses in excess of 10% of the FAS 106 corridor, are amortized on astraight-line basis over the average future service lives of the covered group.There are no substantive commitments for benefits other than as stated in thewritten plan. According to the guidance of paragraph 186 of FAS 106, “theobjective of selecting assumed discount rates is to measure the single amountthat, if invested at the measurement date in the portfolio of high-quality debtinstruments, would provide the necessary future cash flows to pay theaccumulated benefits when due.” The assumed discount rate represents thediscounted value of necessary future cash flows required to pay the accumulatedbenefits when due. The rate was determined based on available market dataregarding the spot yields on high-quality fixed income securities with theaffects of puts and calls removed that provide cash flows at the same time andin the same amount as the projected cash flows of the plan.

 

The health care cost trend rate used indetermining the accumulated post-retirement benefit obligations was 8% in 2006,and decreases 0.5% each year until it reaches 4.5% in 2013 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 ofone-percentage point in the assumed health care cost trend would increase theaccumulated post-retirement benefit obligation at December 31, 2005 by$1,329,000. A decrease of one-percentage point in the assumed health care costtrend would decrease the accumulated post-retirement benefit obligation atDecember 31, 2005 by $1,066,000.

 

In December 2003, the Medicare PrescriptionDrug, Improvement and Modernization Act of 2003 was enacted which introduced aprescription drug benefit under Medicare, as well as a federal subsidy tosponsors of retiree health care benefit plans that provide a benefit that is atleast actuarially equivalent to the Medicare plan. In May 2004, the Financial AccountingStandards Board issued FASB Staff Position No. 106-2, Accounting and DisclosureRequirements Related to the Medicare Prescription Drug, Improvement andModernization Act of 2003, which requires current recognition of the federalsubsidy that employers may receive for providing prescription drug coverage toretirees. Substantial portions of the prescription drug benefits provided underits post-retirement benefit plan are deemed actuarially equivalent to thebenefits provided under Medicare Part D. Consequently, HickoryTech remeasured its accumulated post-retirementbenefit obligation (APBO) as of June 30, 2004, to account for the federalsubsidy. The related reduction in APBO was deemed to be significant as of theremeasurement date and HickoryTech has recognized a decrease in the netperiodic cost for the last two quarters of fiscal 2004 of $54,000. As ofDecember 31, 2005 and 2004, the reduction in the APBO due to the subsidy was$939,000 and $762,000.

 

56

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**NOTE 9**–**INCOME TAXES**

 

The income tax provision (benefit) for operations for the years endedDecember 31, 2005, 2004 and 2003 include the following components:

 

| **(Dollars in Thousands)** | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------|------------|-----------|------------|----------|------------|----------|------------|
|                                 |       |      |       |     |       |     |       |
| Current Income  Taxes:               |       |      |       |     |       |     |       |
| Federal                              |       | **$**     | **3,726**  |     | $          | 430      |       | $ | (793 | ) |
| State                                |       | **1,060** |       | 122      |       | (198     | )          |
| Deferred Income  Taxes:              |       |      |       |     |       |     |       |
| Federal                              |       | **496**   |       | 3,602    |       | 3,963    |       |
| State                                |       | **339**   |       | 1,000    |       | 854      |       |
| Total Income Tax  Provision          |       | **$**     | **5,621**  |     | $          | 5,154    |       | $ | 3,826 |   |

 

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

 

| **(Dollars in Thousands)** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |     |       |
| Continuing  Operations               | ** ** | **$**    | **5,499**  |     | $          | 5,205    |       | $ | 5,683 |   |
| Discontinued  Operations             | ** ** | **122**  |       | (51      | )          | (1,857   | )          |
| Total Income Tax  Provision          | ** ** | **$**    | **5,621**  |     | $          | 5,154    |       | $ | 3,826 |   |

 

Deferred tax liabilities and assets are comprised of the following atDecember 31:

 

| **(Dollars in Thousands)**                | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|
| Tax Liabilities:                                    |       |       |       |       |       |
| Depreciation and  Fixed Assets                      | ** ** | **$**      | **12,045** | ** ** | $          | 12,792 |   |
| Intangible  Assets                                  | ** ** | **5,129**  | ** ** | 4,602      |       |
| Derivatives                                         | ** ** | **1,366**  | ** ** | 996        |       |
| Other                                               | ** ** | **268**    | ** ** | —     |       |
| Gross Deferred  Tax Liability                       | ** ** | **18,808** | ** ** | 18,390     |       |
|                                                |       |       | ** ** |       |       |
| Tax Assets:                                         |       |       | ** ** |       |       |
| Deferred  Compensation and Post-Retirement Benefits | ** ** | **2,607**  | ** ** | 2,156      |       |
| Receivables and  Inventories                        | ** ** | **231**    | ** ** | 1,070      |       |
| Accrued  Liabilities                                | ** ** | **244**    | ** ** | 269        |       |
| Other                                               | ** ** | **—** | ** ** | 11         |       |
| Federal Net  Operating Loss                         | ** ** | **—** | ** ** | 611        |       |
| State Net  Operating Loss                           | ** ** | **1,531**  | ** ** | 1,229      |       |
| Alternative  Minimum Tax Credits                    | ** ** | **680**    | ** ** | 409        |       |
| Gross Deferred  Tax Asset                           | ** ** | **5,293**  | ** ** | 5,755      |       |
| Valuation  Allowance                                | ** ** | **(1,531** | **)**      | (1,205     | )          |
| Net Deferred Tax  Liability                         | ** ** | **15,046** | ** ** | 13,840     |       |
| Current Deferred  Tax Asset                         | ** ** | **300**    | ** ** | 1,430      |       |
| Net Non-Current  Deferred Tax Liability             | ** ** | **$**      | **15,346** | ** ** | $          | 15,270 |   |

 

57

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HickoryTech hasstate net operating loss carryforwards for tax purposes, available to offsetfuture income, of approximately $26,000,000 at December 31, 2005.  The state net operating loss carryforwardsexpire in varying amounts between 2018 and 2025.  The utilization of these carryforwards as anavailable offset to future taxable income is subject to limitations underapplicable state income tax laws.  Avaluation allowance has been established to reduce the carrying value of thebenefits associated with the net operating losses incurred by subsidiaries ofHickoryTech in the state of Iowa. This valuation allowance was established dueto uncertainty as to realization of these benefits based on the continued netoperating losses generated by these subsidiaries.  Future events and changes in circumstancescould cause this valuation allowance to change.

 

The Company alsohas alternative minimum tax credit carryforwards of $680,000.  The alternative minimum tax creditcarryforwards do not expire.

 

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

 

| ** **                                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statutory Tax  Rate                            | ** ** | **34.0** | **%**      | 34.0     | %          | 34.0     | %          |
| Effect of:                                     |       |     | ** ** |     |       |     |       |
| State Income  Taxes Net of Federal Tax Benefit | ** ** | **5.8**  | ** ** | 5.8      |       | 5.1      |       |
| Medicare Part D  Subsidy                       | ** ** | **(0.4** | **)**      | —   |       | —   |       |
| Other, Net                                     | ** ** | **0.3**  | ** ** | 0.6      |       | 1.1      |       |
| Effective Tax  Rate                            | ** ** | **39.7** | **%**      | 40.4     | %          | 40.2     | %          |

 

The 2003 incometax rate reconciliation excludes the impact of the income tax benefit includedin 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 the Companyto interest rate risk. Beginning in the second quarter of 2003, HickoryTechentered into interest rate protection agreements, with remaining maturities ofthirty months, to manage its exposure to interest rate movements on a portionof its variable rate debt obligations. The market value of the cumulative gainor loss on these derivative instruments is reported as a component ofaccumulated other comprehensive income/loss in shareholders’ equity and will berecognized in earnings when the term of the swap agreement is concluded.

 

The fair value of the HickoryTech’s derivatives at December 31, 2005and 2004 is a net asset of $3,429,000 and $2,501,000, 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 FCC made it clear that “thistariff filing should be a revenue neutral tariff filing.” The total revenuesreallocated from the TIC to the remaining access elements were limited to thetotal revenues recovered from the TIC for the twelve-month period ended June30, 2001. These revenues were calculated using the carrier’s traffic volumesand the TIC rate for the twelve-month period ended June 30, 2001. Thesecalculations were prepared by an independent third-party and approved by theNational Exchange Carrier Association (NECA). Reallocating the costs to theother access billing categories eliminated TIC. The FCC conducted aninvestigation of all tariff filings, including NECA’s CCL (Carrier Common Line)tariff and Heartland’s Traffic Sensitive (TS) tariff, to determine if thefiling parties had properly reallocated the TIC costs among the other accesscharge categories. The FCC terminated its investigation of several tarifffilings, 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 billingerror, the Company recovered $611,000 of excess revenues from the NECA CCLpool. NECA required Heartland to repay the $611,000 in 2004. The FCC approved amid-course correction to Heartland’s TS tariff as a supportable method ofrecouping NECA’s CCL reduction. The revision corrects the TIC rate originallyused, and factors recovery of the $611,000 into the TS rate elements.HickoryTech recouped this revenue over the remaining eighteen months of the TStariff, from January 1, 2004 to June 30, 2005. In accordance with SFAS No. 71,HickoryTech recorded a regulatory asset for the revenue it would recoup with abalance of $0 at December 31, 2005 and $204,000 at December 31, 2004.

 

58

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**NOTE12 – RECENT ACCOUNTING DEVELOPMENTS**

 

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-BasedPayment”, 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. Companies must recognize compensation expense related to any awardsthat are not fully vested as of the effective date. Compensation expense forthe unvested awards will be measured based on the fair value of the awards previouslycalculated in developing the pro forma disclosures in accordance with theprovisions of SFAS No. 123(R). Originally, SFAS No. 123(R) was effectivefor all stock-based awards granted beginning with the first annual or interimperiod after June 15, 2005. On April 14, 2005, the Securities and ExchangeCommission (SEC) approved a new rule that changed the effective date of SFASNo. 123(R) for public companies to the first annual or interim period in thefirst fiscal year beginning after June 15, 2005. HickoryTech has chosen to usethe modified prospective basis of the Black-Scholes option-pricing model tocalculate future stock-compensation expense, using a fair value method asprescribed under SFAS 123(R). The valuation of equity instruments underlyingstock-based compensation and the period during which the related stockcompensation expense is recognized will be based in part on variousassumptions, including the estimated life of equity instruments, stockvolatility, interest rates and vesting terms. HickoryTech has assessed theimpact of adopting SFAS 123(R) to its consolidated results of operations.HickoryTech has determined that the reference made to the disclosures under SFAS No. 123 in Note 1 of the Notes toConsolidated Financial Statements is a reasonable expectation of futureexpense.

 

**NOTE 13 – CONTINGENCIES**

 

HickoryTechis involved in certain contractual disputes in the ordinary course of business.HickoryTech does not believe the ultimate resolution of any of these existingmatters will have a material adverse effect on its financial position, resultsof operations, or cash flows.

 

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

 

*(Dollars in thousands, except per share amounts)*

 
| ** **                                                  | ** ** | **2005** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|
| ** **                                                  | ** ** | **4th**  | ** ** | **3rd** | ** ** | **2nd** | ** ** | **1st** | ** ** |
| Operating Revenues                                          |       | $        | 21,832     |   | $ | 22,304 |   | $ | 25,268 |   | $ | 23,108 |   |
| Operating Income                                            |       | $        | 4,047      |   | $ | 4,666 |   | $ | 4,873 |   | $ | 4,522 |   |
| Income from Continuing Operations                           |       | $        | 1,788      |   | $ | 2,130 |   | $ | 2,309 |   | $ | 2,116 |   |
| Income from Disc. Ops., Net of Taxes                        |       | $        | 63         |   | $ | 22 |   | $ | 101 |   | $ | — |   |
| Net Income                                                  |       | $        | 1,851      |   | $ | 2,152 |   | $ | 2,410 |   | $ | 2,116 |   |
| Fully Diluted Earnings Per Share - Continuing  Operations   |       | $        | 0.14       |   | $ | 0.16 |   | $ | 0.18 |   | $ | 0.16 |   |
| Fully Diluted Earnings Per Share - Discontinued  Operations |       | $        | —     |   | $ | — |   | $ | 0.01 |   | $ | — |   |
|                                                        |       | $        | 0.14       |   | $ | 0.16 |   | $ | 0.19 |   | $ | 0.16 |   |
| Dividends Per Share                                         |       | $        | 0.12       |   | $ | 0.12 |   | $ | 0.12 |   | $ | 0.12 |   |

 
| ** **                                                         | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|
| ** **                                                         | ** ** | **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 Earnings/(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 |   |

 

The summation of quarterly earnings per share computations may not equateto the year-end computation as the quarterly computations are performed on adiscrete basis.

 

59

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**Item 9.****                               Changes in and Disagreements With Accountants onAccounting and Financial Disclosure.**

 

None.

 

**Item 9A.**       **Controls and Procedures.**

 

**EVALUATIONOF DISCLOSURE CONTROLS AND PROCEDURES AND CHANGES IN INTERNAL CONTROLS**

 

An evaluation wasperformed under the supervision and with the participation of the Company’smanagement, including the respective persons acting as chief executive officerand chief financial officer, regarding the effectiveness of the design andoperation of the Company’s disclosure controls and procedures (as defined inRule 13a-15(f) promulgated under the Securities and Exchange Act of 1934, asamended (the “Exchange Act”) as of December 31, 2005. Based on that evaluation,the Company’s management, including the respective persons acting as chiefexecutive officer and chief financial officer, concluded that the Company’sdisclosure controls and procedures were effective.

 

**MANAGEMENT’SREPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

Management isresponsible for establishing and maintaining adequate internal control overfinancial reporting as defined in the Securities Exchange Act of 1934 Rule13a-15(f), and for performing an assessment of the effectiveness of internalcontrol over financial reporting as of December 31, 2005. Internal control overfinancial 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, 2005 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, 2005 based on the criteria inInternal Control-Integrated Framework issued by the COSO.

 

Our management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2005 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which appears herein.

 

On December 30, 2005, theCompany acquired Enventis. We have excluded Enventis from our audit of internalcontrol over financial reporting. Enventis is a wholly owned subsidiary whose total assets and totalrevenues represent 23.3% and 34.9%, respectively, of the related consolidatedfinancial statement amounts as of and for the year ended December 31, 2005.(Note: Revenue % is based on total Enventis revenues for the year endedDecember 31, 2005, which were unaudited and not included in the consolidated incomestatement due to the acquisition date.)

 

Dated March 7,2006

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

 

60

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**CHANGESIN INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

There have been nochanges in the Company’s internal control over financial reporting during theCompany’s most recently completed fiscal quarter that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting, other than the new processes and proceduresassociated with the Enventis acquisition.

 

On January 1, 2006,HickoryTech began using new enterprise resource planning software. This softwarewill assist HickoryTech in managing its human resources, financial, inventoryand distribution data through one operating system. HickoryTech expects thissoftware installation to significantly impact its internal control structure asinternal controls over numerous processes and procedures will be automated, forthe year ended December 31, 2006.

 

**Item 9B.**       **Other Information.**

 

None.

 

**PART III**

 

**Item 10.       Directors and Executive Officers ofthe Registrant.**

 

Information as toDirectors and Executive Officers of HickoryTech included in the Proxy Statementunder the headings “Election of Directors,” “Security Ownership of Management,”“Other Executive Officers” and “Section 16(a) Beneficial Ownership ReportingCompliance” is incorporated by reference. Disclosure relating to the auditcommittee financial expert found under the heading of “Audit Committee Report”in the Proxy Statement is also incorporated by reference.

 

HickoryTech has adopted aCode of Ethics that applies to its Chief Executive Officer, Chief FinancialOfficer, all officers of HickoryTech, the Director of Regulatory Affairs, theController, the Manager of Internal Control, the Board of Directors and otherappropriate personnel as identified.

 

**Item 11.       ExecutiveCompensation.**

 

Information as toexecutive compensation included under the headings of “Summary CompensationTable,” “Option Grants in Last Fiscal Year,” “Aggregated Option/SAR Exercisesand Fiscal Year-End Option Values,” “Long Term Incentive Plan Awards in LastFiscal Year,” “Employment Contracts, Change of Control Agreements, SeveranceAgreements and Other Agreements” and “Compensation of Directors” in the ProxyStatement is incorporated by reference.

 

**Item 12.****                      Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters.**

 

The information as tobeneficial ownership of more than five percent of HickoryTech’s common stockincluded under the heading “Beneficial Owners of Common Stock” of the ProxyStatement 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.

 

61

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Thefollowing table provides information on equity compensation plans under whichequity securities of the Company are authorized for issuance, as of December31, 2005.

 
| ** **                                                   | ** ** | ** **                                 | ** ** | ** **                        | ** ** | **Number of securities**    | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------|------------|---------------------------------------|------------|
| ** **                                                   | ** ** | ** **                                 | ** ** | ** **                        | ** ** | **remaining available for** | ** ** |
| ** **                                                   | ** ** | ** **                                 | ** ** | ** **                        | ** ** | **future issuance under**   | ** ** |
| ** **                                                   | ** ** | **Number of securities to** | ** ** | **Weighted-average**              | ** ** | **equity compensation**          | ** ** |
| ** **                                                   | ** ** | **be issued upon exercise** | ** ** | **exercise price of**   | ** ** | **plans (excluding**             | ** ** |
| ** **                                                   | ** ** | **of outstanding options,**      | ** ** | **outstanding options,**     | ** ** | **securities reflected in** | ** ** |
| **Plan Category**                                       | ** ** | **warrants and rights**          | ** ** | **warrants and rights** | ** ** | **column (a))**                  | ** ** |
| ** **                                                   | ** ** | **(a)**                                    | ** ** | **(b)**                           | ** ** | **(c)**                               | ** ** |
| Equity compensation  plans approved by security holders (1): |       | 578,850                                    |       | $                                 | 12.63      |                                  | 1,949,490  |   |
|                                                         |       |                                       |       |                              |       |                                  |       |
| Equity  compensation plans not approved by security holders: |       | —                                     |       | —                            |       | —                                |       |
|                                                         |       |                                       |       |                              |       |                                  |       |
| Total                                                        |       | 578,850                                    |       | $                                 | 12.63      |                                  | 1,949,490  |   |

 

----

(1)          - Includes the Company’s Employee Stock Purchase Plan, Retainer StockPlans for Directors, Non-Employee Director Stock Option Plan, Non-EmployeeDirectors’ Incentive Plan, and Stock Award Plan.

 

**Item 13.       Certain Relationships and RelatedTransactions.**

 

HickoryTech does not know of any matter required to be reported underthis item.

 

**Item 14.****       Principal Accountant Fees and Services.**

 

The information under the heading Independent Auditors in the ProxyStatement is incorporated herein by reference.

 

62

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**PART IV**

 

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

 

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

 

1.             Financial Statements

 
| ** **                                                                                                                          | ** ** | **Page(s) in 2005 Annual** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                                          | ** ** | **Report on Form 10-K**    | ** ** |
|                                                                                                                                |       |                       |       |
| Management’s Discussion and Analysis of Financial Condition  and Results of Operations                                         |       | 17-36                      |       |
| Report of Independent Registered Public Accounting  Firm                                                                            |       | 37-38                      |       |
| Consolidated  Statements of Operations* Years Ended December 31, 2005, 2004, and 2003                                               |       | 39                         |       |
| Consolidated  Balance Sheets* December 31, 2005 and 2004                                                                            |       | 40                         |       |
| Consolidated  Statements of Cash Flows* Years Ended December 31, 2005, 2004, and 2003                                               |       | 41                         |       |
| Consolidated  Statements of Shareholders’ Equity and Comprehensive Income/Loss* Years Ended  December 31, 2005, 2004, and 2003 |       | 42                         |       |
| Notes to Consolidated Financial Statements*                                                                                         |       | 43-59                      |       |
| Management’s Report on Internal Control over  Financial Reporting                                                              |       | 60                         |       |
| Selected Financial Data                                                                                                             |       | 16-17                      |       |

 

----

*Addressedby Report of Independent Registered Public Accounting Firm

 

2.         Financial StatementSchedule

 
| Report of Independent  Registered Public Accounting Firm on Financial Statement Schedule |   | 66 |   |
|------------------------------------------------------------------------------------------|--------|----|--------|
| Schedule II – Valuation and  Qualifying Accounts                                    |   | 67 |   |

 

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 followingdocuments are filed as Exhibits to this Form 10-K or incorporated by referenceherein. Any document incorporated by reference is identified by a parentheticalreference 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)                                                                                   |

 

63

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| **Exhibit**   | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                             |
|---------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |       |                                                                                                                                                                                                                                                                                                                                                        |
| 4(b)          |       | Third Amended and Restated Credit Agreement dated as  of December 30, 2005, by and among Hickory Tech Corporation, as Borrower, the  Lenders referred to herein and Wachovia (formerly known as First Union  National Bank), as Administrative Agent (Incorporated by reference to Exhibit  4.1 to the registrant’s Form 8-K filed on January 6, 2006) |
| 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 Hickory Tech 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                                                                                                                                                                                                                                                              |

 

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| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10(s)       |       | Hickory Tech Corporation Directors’ Incentive Plan

(Incorporated by reference to Exhibit 10(s) to the  registrant’s Form 8-K filed May 9, 2005)                                                                                                                                                                                                                                                                                      |
| 10(t)       |       | Stock Purchase Agreement by and between Hickory Tech  Corporation and Minnesota Power Enterprises, Inc. dated November 9,  2005. Exhibit 2.1 omits schedules and exhibits. The registrant will  furnish supplementally a copy of any omitted schedule or exhibit to the  Commission upon request.  (Incorporated  by reference from Exhibit 2.1 to the registrant’s Current Report on Form 8-K  filed on November 10, 2005) |
| 10(u)       |       | First Amendment to the Stock Purchase Agreement by  and between Hickory Tech Corporation and Minnesota Power Enterprises, Inc.,  dated December 30, 2005.  (Incorporated  by reference from Exhibit 2.1A to the registrant’s Current Report on Form 8-K  filed on January 05, 2006)                                                                                                                                                   |
| 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.

 

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## **Report of Independent Registered Public AccountingFirm on Financial Statement Schedule**

 

To the Shareholders andBoard of Directors of

Hickory Tech Corporation:

 

Our audits of theconsolidated financial statements referred to in our report dated March 7, 2006appearing in the 2005 Annual Report to Shareholders of Hickory Techop (whichreport and consolidated financial statements are incorporated by reference inthis Annual Report on Form 10-K) also included an audit of the financialstatement schedule listed in Item 15(a)(2) of this Form 10-K.  In ouropinion, this financial statement schedule presents fairly, in all materialrespects, the information set forth therein when read in conjunction with therelated consolidated financial statements.

 

 

PricewaterhouseCoopersLLP

Minneapolis, Minnesota

March 7, 2006

 

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# **SCHEDULE II – VALUATION ANDQUALIFYING ACCOUNTS**

#  

ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS:

 
| ** **                                             | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|
| **(In Thousands)**                                     | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                   |       |                         |       |   |   |   |   |
| Balance, at beginning of year                          | ** ** | **$**                        | **1,256**  |   | $ | 1,283 |   | $ | 1,358 |   |
| Additions  charged to income - Continuing Operations   | ** ** | **953**                      |       | 1,003 |   | 726 |   |
| Write-offs, net  of recoveries - Continuing Operations | ** ** | **(1,875**                   | )          | (1,030 | ) | (719 | ) |
| Discontinued  Operations, Net                          | ** ** | **—**                   |       | — |   | (82 | ) |
| Balance, at end of year                                | ** ** | **$**                        | **334**    |   | $ | 1,256 |   | $ | 1,283 |   |

 

INVENTORY VALUATION RESERVE:

 
| ** **                    | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------|------------|------------------------------|------------|
| **(In Thousands)**            | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                          |       |                         |       |   |   |   |   |
| Balance, at beginning of year | ** ** | **$**                        | **1,432**  |   | $ | 734 |   | $ | 827 |   |
| Additions  charged to income  | ** ** | **239**                      |       | 731 |   | 34 |   |
| Reductions (1)                | ** ** | **(1,405**                   | )          | (33 | ) | (127 | ) |
| Balance, at end of year       | ** ** | **$**                        | **266**    |   | $ | 1,432 |   | $ | 734 |   |

 

(1) Disposal offully reserved inventory.

 

DEFERRED TAX ASSET VALUATION ALLOWANCE

 
| ** **                    | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------|------------|------------------------------|------------|
| **(In Thousands)**            | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                          |       |                         |       |   |   |   |   |
| Balance, at beginning of year | ** ** | **$**                        | **1,205**  |   | $ | 640 |   | $ | 470 |   |
| Additions  charged to income  | ** ** | **326**                      |       | 565 |   | 170 |   |
| Reductions                    | ** ** | **—**                   |       | — |   | — |   |
| Balance, at end of year       | ** ** | **$**                        | **1,531**  |   | $ | 1,205 |   | $ | 640 |   |

 

67

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**SIGNATURES**

 

Pursuantto the requirements of section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| Dated: | March 7, 2006 |   | HICKORY  TECH CORPORATION                       |
|--------|---------------|--------|-------------------------------------------------|
|   |          |   |
|   |          | By:    | /s/  David A. Christensen                       |   |
|   |          |   | David  A. Christensen, Secretary,               |
|   |          |   | Senior  Vice President, Chief Financial Officer |
|   |          |   | and  Treasurer                                  |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the following persons on behalf of the registrant and in the capacities and onthe dates indicated have signed this report.

 
| /s/  Starr J. Kirklin                                           |   | March  7, 2006 |
|-----------------------------------------------------------------|--------|----------------|
| Starr  J. Kirklin, Chair                                        |   |
|                                                            |   |
| /s/  R. Wynn Kearney, Jr.                                       |   | March  7, 2006 |
| R.  Wynn Kearney, Jr., Vice Chair                               |   |
|                                                            |   |
| /s/  John E. Duffy                                              |   | March  7, 2006 |
| John  E. Duffy                                                  |   |
| President,  Chief Executive Officer and Director                |   |
| (principal  executive officer)                                  |   |
|                                                            |   |
| /s/  David A. Christensen                                       |   | March  7, 2006 |
| David  A. Christensen, Secretary,                               |   |
| Senior  Vice President, Chief Financial Officer and Treasurer   |   |
| (principal  financial officer and principal accounting officer) |   |
|                                                            |   |
|                                                            |   |
| /s/  James W. Bracke                                            |   | March  7, 2006 |
| James  W. Bracke, Director                                      |   |
|                                                            |   |
| /s/  Myrita P. Craig                                            |   | March  7, 2006 |
| Myrita  P. Craig, Director                                      |   |
|                                                            |   |
| /s/  James H. Holdrege                                          |   | March  7, 2006 |
| James  H. Holdrege, Director                                    |   |
|                                                            |   |
| /s/  Robert E. Switz                                            |   | March  7, 2006 |
| Robert  E. Switz, Director                                      |   |

 

(amajority of directors)

 

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