**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**Forthe fiscal year ended December 31, 2002**

 

**Commission File Number:  0-13721**

 

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

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months, and (2) has been subject to such filing requirements for the past 90days.

Yes  ý   No  o.

 

Indicate by a check markif disclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K.  ý

 

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

 

As of June 30, 2002, theaggregate market value of the common stock held by non-affiliates of theregistrant was $198,842,730 based on the last sale price of $15.00 on TheNasdaq National Market.

 

The total number ofshares of the registrant’s common stock outstanding as of February 28,2003:  14,003,335.

 

Documents Incorporated by Reference: Portions of the registrant’s definitive Proxy Statement for the AnnualMeeting of Shareholders to be held on April 14, 2003 (“Proxy Statement”) are incorporatedby reference in Part III of this Form 10-K.

 

 

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**INDEX**

 
| PART I    |                                                                                        |
|-----------|---------------------------------------------------------------------------------------------|
| Item  1:  | Business                                                                                    |
| Item  2:  | Properties                                                                                  |
| Item  3:  | Legal Proceedings                                                                           |
| Item  4:  | Submission of Matters to a Vote of Security  Holders                                        |
|      |                                                                                        |
| PART II   |                                                                                        |
| Item  5:  | Market for Registrant’s Common Equity and  Related Stockholder Matters                 |
| 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 Disclosures      |
|      |                                                                                        |
| PART III  |                                                                                        |
| Item  10: | Directors and Executive  Officers of HickoryTech                                            |
| Item  11: | Executive Compensation                                                                      |
| Item  12: | Security Ownership of Certain  Beneficial Owners and Management                             |
| Item  13: | Certain Relationships and  Related Transactions                                             |
| Item  14: | Controls and Procedures                                                                     |
|      |                                                                                        |
| PART IV   |                                                                                        |
| Item  15: | Exhibits, Financial Statement  Schedules and Reports on Form 8-K                            |

 

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**PART I**

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

##### ** **

**GENERAL**

 

Hickory Tech Corporation (HickoryTech) is a diversified communicationscompany headquartered in Mankato, Minnesota. HickoryTech has over a 100-yearhistory in the local telephone exchange business. From those roots, it hasexpanded into three business segments: Telecom Sector, Information SolutionsSector and Enterprise Solutions Sector. HickoryTech’s core business is itsTelecom Sector.  The Telecom Sectorconsists of three businesses.  One ofthe Telecom Sector’s three businesses is the operation of three incumbent localexchange carriers (ILECs). This business consists of connecting customers tothe telephone network, providing switched service and dedicated private lines,connecting customers to long distance service providers and providing manyother services commonly associated with ILECs. The second business of theTelecom Sector is competitive local exchange carrier (CLEC) services, whichHickoryTech initiated in 1998, and its associated competitive businesses oflong distance service and dial-up Internet access. This business leveragesHickoryTech’s telecommunications expertise and expands service into areasserved by other ILECs. The third business of the Telecom Sector provideswireless telecommunications services to customers in HickoryTech’s ILEC serviceterritory in Minnesota and its surrounding area, including an area surroundingMinneapolis/St. Paul. In addition to the Telecom Sector, HickoryTech providesdata processing services to the telecommunications industry (InformationSolutions Sector) and provides telephone and data equipment sales and serviceas well as the sale, installation and ongoing service of voice over InternetProtocol equipment (Enterprise Solutions Sector).

 

Theeight subsidiaries of HickoryTech and the business segments in which theyoperate are:

 

**TELECOM SECTOR**

•   Mankato Citizens Telephone Company (MCTC)

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

•   Heartland Telecommunications Company of Iowa,Inc. (Heartland)

•   Cable Network, Inc. (CNI)

•   Crystal Communications, Inc. (Crystal)

•   Minnesota Southern Wireless Company (MSWC)

 

**INFORMATIONSOLUTIONS SECTOR**

•   National Independent Billing, Inc. (NIBI)

 

**ENTERPRISESOLUTIONS SECTOR**

•   Collins Communications Systems Co. (Collins)

 

HickoryTech and its subsidiaries are engaged in businesses that provideservices to their customers for a fee. Many of these services are repetitiveand recurring, and, as a result, backlog orders and seasonality are notsignificant factors. Working capital requirements primarily involve the fundingof the construction and maintenance of telephone landline and wireless fixedassets, the payroll costs of highly skilled labor and the inventory to serviceits telephone equipment customers.

 

The materials and supplies that are necessary for the operation of thebusinesses of HickoryTech and its subsidiaries are available from a variety ofsources, and no future supply problems are anticipated. All of HickoryTech’sILEC and CLEC central office switches and wireless switches, as well as amajority of HickoryTech’s equipment sold in its Enterprise Solutions Sector,are supplied by Nortel. Nortel is a leading supplier of communicationsequipment, and HickoryTech’s dependence on this brand is not viewed as asignificant risk.

 

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HickoryTech makes available, free of charge,copies of its annual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and amendments to these reports filed or furnishedpursuant to Section 13(a) or 15(d) of the Exchange Act. These reports areavailable on HickoryTech’s Internet website http://www.hickorytech.com as soon as reasonably practicable after suchmaterial is electronically filed with the Securities and Exchange Commission.

 

As of December 31, 2002, HickoryTech had 481 full-time equivalentemployees.

 

**ACQUISITIONS**

 

On June 26, 2001, HickoryTech acquired two digital personalcommunications services (PCS) licenses from McLeodUSA Incorporated for$11,100,000 in cash.  The PCS licensesacquired by HickoryTech include the Minnesota Basic Trading Areas (BTAs) ofMankato-Fairmont and Rochester-Austin-Albert Lea, an area covering a populationof approximately 493,000 people.  Theacquisition was a purchase of the licenses only.  There were no customers, existing revenue stream or physicalproperty and equipment included with this acquisition as the BTAs wereundeveloped.  The operations of thesePCS licenses are included in the Telecom Sector.  All FCC minimum buildout requirements have been met, thussecuring the FCC licenses.

 

On October 9, 2000, HickoryTech acquired the dial-up Internet customeraccounts of Internet Connections, a Mankato-based Internet service provider.Internet Connections had approximately 5,000 Internet customers in southernMinnesota. The operations of this Internet services business were immediatelyintegrated into HickoryTech’s existing dial-up Internet business, which is partof the Telecom Sector.

 

**DISPOSITIONS**

 

OnAugust 6, 2001, HickoryTech sold its local telephone exchange in Amana, Iowa toSouth Slope Cooperative Telephone Company, Inc. for $6,500,000 in cash. TheAmana operation, known as Amana Colonies Telephone Company (ACTC), servedapproximately 1,500 access lines in the seven communities of the Amana Coloniesin east central Iowa.  HickoryTechrecorded a pre-tax gain on the sale of $1,015,000 ($566,000 net of tax).  HickoryTech used the proceeds from the saleto repay a portion of its outstanding debt. The operations of ACTC wereincluded in the Telecom Sector.  For theyears ended December 31, 2001 and 2000, ACTC generated revenues of $832,000 and$1,467,000, and generated an operating income (loss) of ($13,000) and $70,000,respectively.

 

**INDUSTRY SEGMENTSFINANCIAL DATA**

 

Financialinformation about HickoryTech’s industry segments is included on pages 16 to 23and 43 of this Form 10-K.

 

**INDUSTRY SEGMENTS**

 

Beginningin 2002, HickoryTech has reported the business segments of Telephone,Communications Services and Wireless Services as a single segment referred toas the Telecom Sector versus individual business segments.  This new basis of segment reporting reflectsthe integration of HickoryTech’s management, sales, service and supportfunctions in these three areas, as well as reflecting the level at whichmanagement now reviews and makes resource allocation and other managementdecisions regarding the operations of the company.  All segment information reported in 2001 and 2000 has beenreclassified to conform to this new presentation.  The other two business segments are the Information Solutions andEnterprise Solutions Sectors and they continue to be reported as  previously.

 

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TELECOMSECTOR

 

HickoryTech’sTelecom Sector (formerly identified as the individual Telephone Sector,Communications Services Sector and Wireless Services Sector) provides localexchange wireline and wireless telephone service, long distance, dial-upInternet access and owns and operates fiber optic cable facilities.  This sector includes three incumbent localexchange carriers (ILECs), MCTC, Mid-Comm and Heartland.  MCTC and Mid-Comm provide telephone servicein south central Minnesota, specifically Mankato (a regional hub) and elevenrural communities surrounding Mankato. The third ILEC, Heartland, provides telephone service for eleven ruralcommunities in northwest Iowa.

 

TheTelecom Sector also includes Crystal, a competitive local exchange carrier(CLEC). Crystal provides local telephone service, long distance and dial-upInternet access on a competitive basis. Crystal has customers in eight rural communities in Minnesota and sixrural communities in Iowa that are not in HickoryTech’s ILEC service areas.

 

HickoryTechalso owns and operates fiber optic cable facilities (CNI) in Minnesota, whichare used to transport interexchange communications as a service to telephoneindustry customers.  HickoryTech’sMinnesota ILECs and its CLEC are the primary users of the fiber optic cablefacilities.

 

TheTelecom Sector also owns and operates a wireless telephone business in southcentral Minnesota.  The wirelesstelephone business consists of the “A-side” FCC wireless license to operate inMinnesota’s Rural Service Area (RSA) 10, the Minneapolis/St. Paul Metro A-2wireless license and two digital personal communications services (PCS)licenses covering the Minnesota Basic Trading Areas (BTAs) of Mankato-Fairmontand Rochester-Austin-Albert Lea.

 

TheTelecom Sector included the operations of ACTC, which was sold on August 6,2001. None of the remaining companies in the Telecom Sector experienced majorchanges in scope or direction of their operations during the past year.

 

MCTCderives its principal revenues and income from local services charged tosubscribers in its service area, access services charged to interexchangecarriers and the operation of a toll tandem switching center in Mankato,Minnesota. Revenues and income for Mid-Comm are also derived from local servicecharges in its area of operation and by providing access to long distanceservices for its subscribers through the toll center in Mankato. Local andinterexchange telephone access for the two companies is provided on anintegrated basis. The local and interexchange telephone access for bothtelephone companies utilize the same facilities and equipment and is managedand maintained by a common work force. Heartland derives its principal revenuesand income from local services charged to subscribers in its service area inIowa, as well as from providing interexchange access for its subscribers. Interexchangetelephone access is provided by all three of HickoryTech’s telephonesubsidiaries by connecting the communications networks of interexchange andwireless carriers with the equipment and facilities of end users through itsswitched networks or private lines.

 

MCTCand Mid-Comm are Minnesota public utilities operating pursuant to indeterminatepermits issued by the Minnesota Public Utilities Commission. Heartland is alsoa public utility, which operates pursuant to a certificate of publicconvenience and necessity issued by the Iowa Utilities Board. These stateagencies regulate the services provided by MCTC, Mid-Comm and Heartland.  CNI’s operations are not subject toregulation by the state regulatory authority. Neither the Minnesota Public Utilities Commission nor the Iowa UtilitiesBoard regulates the rate of return or profits of each of HickoryTech’s ILECoperations. However, the Minnesota Public Utilities Commission regulates theprices and service levels provided by MCTC and Mid-Comm because each company’soperations fall below the 50,000 customer line minimum level for rateregulation in Minnesota. In Iowa, Heartland’s operations are not rate regulatedby the Iowa Utilities Board.  MCTC,Mid-Comm and Heartland are each required to file local service rates as tariffswith the applicable state public utilities commission. MCTC’s and Mid-Comm’slocal service rates are below those of most Minnesota ILECs. Regardless ofwhether a particular rate is subject to regulatory review, the ability ofHickoryTech and its subsidiaries to change rates will be determined by variousfactors, including economic and competitive circumstances.

 

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Aslocal exchange telephone companies, MCTC, Mid-Comm and Heartland provide endoffice switching and dedicated circuits to long distance interexchangecarriers. These relationships allow HickoryTech’s telephone subscribers toplace long distance telephone calls and gain access to the telephone network.  HickoryTech provides long distance accessfor all of the individual customers who select an alternative long distancecarrier.  The long distanceinterexchange carriers are significant customers of HickoryTech, but no carrierrepresents more than ten percent of HickoryTech’s consolidated revenues.

 

Alternativesto HickoryTech service include customers leasing private line switched voiceand data services in or adjacent to the territories served by HickoryTech,which permits the bypassing of local telephone switching facilities. In addition,microwave transmission services, wireless communications, fiber optic andcoaxial cable deployment and other services provided by other companies permitbypass of the local exchange network. These alternatives to local exchangeservice represent a potential threat to HickoryTech’s long-term ability toprovide local exchange service at economical rates.

 

Competitionin HickoryTech’s ILEC service area exists in one of Heartland’s exchanges. Inthe city of Hawarden, Iowa, the municipal city government overbuilt the city’stelephone service infrastructure and is providing an alternative toHickoryTech’s telephone service. The Hawarden CLEC has acquired approximately1,000 access lines or approximately 59% of that community’s telephone businessfrom HickoryTech. The impact of this competition is reflected in HickoryTech’s2002, 2001 and 2000 financial results and HickoryTech management does notbelieve there will be significant further impact from competition in Hawarden.HickoryTech constantly responds to competitive changes with active programs tomarket products and to engineer its infrastructure for higher customersatisfaction.

 

Competitionalso exists for some of the services provided to interexchange carriers, suchas customer billing services, dedicated private lines, and network switching.This competition comes primarily from the interexchange carriers themselves.The provision of these services is of a contractual nature and is primarilycontrolled by the interexchange carriers. Other services, such as directory advertising and wirelesscommunications, are open to competition. Competition is based primarily on service and experience.

 

Thepassage of the 1996 Telecommunications Act created the opportunity forHickoryTech to offer communications service in territories served by othertelephone companies, and Crystal began operations in January 1998 as a newcompetitive local exchange carrier (CLEC). Crystal offers local service, longdistance and dial-up Internet access services on a competitive basis tocustomers in towns in southern Minnesota and Iowa, which are not served byHickoryTech’s Telecom Sector’s service area. These service offerings providecustomers alternatives to the incumbent telephone carrier in variouscommunities and are offered under the brand name HickoryTech wireline service.These services are currently being offered to customers in eight ruralcommunities in Minnesota, as well as six rural communities in Iowa. Crystal’sprimary strategy is to provide service by overbuilding with newtelecommunications switching networks and telephone lines.  Crystal also provides the long distanceservice and dial-up Internet access services to HickoryTech’s subscribers inboth ILEC and CLEC markets.

 

Crystalis not subject to regulation by the public utilities commissions in the statesit serves regarding rates and services. CLEC activities require Crystal to file for authority to operate withthe appropriate public utilities commission in each state it serves. Crystalcompetes directly against existing ILECs in the areas in which Crystaloperates.

 

Crystalis not dependent upon any single customer or small group of customers. No onecustomer in Crystal accounts for ten percent or more of HickoryTech’sconsolidated revenues.

 

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HickoryTech,through its subsidiary MSWC, owns and operates wireless telephone businesses insouth central Minnesota and in the Minneapolis/St. Paul area. In south centralMinnesota, MSWC provides wireless service for Minnesota’s Rural Service Area(RSA) 10, under the brand name of HickoryTech Wireless. This business is inHickoryTech’s Telecom Sector.  Thissector owns 100% of the  “A-side” FCCwireless license to operate in seven counties in south central Minnesota. Thearea overlaps and is larger than HickoryTech’s Minnesota ILEC and CLEC serviceareas and serves a population of approximately 230,000. This sector also ownsthe Minneapolis/St. Paul Metro A-2 (Metro A-2) wireless license, which wasacquired on June 1, 1999. The Metro A-2 property surrounds the metropolitanMinneapolis/St. Paul area and is located in five Minnesota counties and in oneWisconsin county. Metro A-2 provides service to an area with a population ofapproximately 170,000. In addition, this sector also owns the PCS licenses forthe Minnesota BTAs of Mankato-Fairmont and Rochester-Austin-Albert Lea. The twoBTAs are located in 16 Minnesota counties and one Iowa county and provideservice to an area with a population of approximately 493,000, some of whichcoincide with the previously mentioned wireless RSA 10 population of 230,000.

 

MSWC,which owns all four of the Company’s FCC wireless licenses, derives itsprincipal revenues and income from providing wireless telephone service to theretail customers in seven counties in south central Minnesota and from wirelessroaming traffic. MSWC also derives roaming revenue from the six countiessurrounding the metropolitan Minneapolis/St. Paul Metro A-2 area and roamingrevenues from the PCS service territory that is comprised of 17 counties.  MSWC directly competes against localwireless and PCS companies in southern Minnesota and in the Minneapolis/St.Paul area.

 

INFORMATIONSOLUTIONS SECTOR

 

ThroughNIBI, HickoryTech’s Information Solutions Sector provides data processing andrelated services, principally for HickoryTech, other local exchange telephonecompanies, CLECs, interexchange network carriers, wireless companies,municipalities and utilities. The Information Solutions Sector’s principalactivity is the provision of monthly batch processing of computerized data forHickoryTech as well as non-affiliated companies. Services for telephone companycustomers include the processing of long distance telephone calls from datasources and telephone switches, the preparation of the subscriber telephonebills, customer record keeping, carrier access bills and general accounting andpayroll services. NIBI, under the brand name HickoryTech Information Solutions,also provides certain billing clearinghouse functions for interexchangecarriers.

 

Thereare a number of companies engaged in supplying data processing servicescomparable to those furnished by NIBI. Competition is based primarily on priceand service. HickoryTech’s Information Solutions Sector has developed a newintegrated billing and management system called SuiteSolution. For internaluse, SuiteSolution enables HickoryTech to become a full-service billingprovider for all aspects of the telecommunications industry on a fullyintegrated basis. For external use, SuiteSolution can provide wireline orwireless carriers the individual benefits of a billing platform, or tointegrated service providers, such as HickoryTech, a total systemsolution.  SuiteSolution was implementedin the Company’s CLEC businesses in 2002, and will be implemented in thewireless business in 2003.  Anothersignificant service is the NIBI Carrier Access Billing System (CABS) providedto ILECs and CLECs.  CABS systems areimportant elements to all wireline carriers, and NIBI has recently developed astate of the art version for its internal use by HickoryTech operations.

 

ENTERPRISESOLUTIONS SECTOR

 

HickoryTech’sEnterprise Solutions Sector provides telephone and data equipment sales andservices as well as the sale, installation and service of voice over InternetProtocol business systems to companies primarily based in metropolitanMinneapolis/St. Paul, Minnesota. This sector also supports the businesstelephone system service for HickoryTech ILEC and CLEC operations in southernMinnesota and in Iowa. The customers in the Enterprise Solutions Sector’smarket are the individual business end users of telecommunications service withongoing service requirement offerings. Products consist of telecommunicationplatforms such as Nortel on the voice side of the Enterprise Solutions’business, and Cisco and Bay Networks (Nortel) equipment on the data side of itsbusiness. Enterprise Solutions specializes in the quality custom installationand maintenance of wide area networking, local networking and transportsolutions in telecommunications for end user customers.

 

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Revenuesare primarily earned by the sales, installation and service of businesstelephone systems. Enterprise Solutions continues its commitment to service andsupport its core product, Nortel, while identifying new opportunities such ascall centers, computer telephone integration voice mail and interactive voiceresponse systems.

 

HickoryTech’sEnterprise Solutions Sector is not dependent upon any single customer or smallgroup of customers. No one customer in the Enterprise Solutions Sector accountsfor ten percent or more of HickoryTech’s consolidated revenues.

 

There are companiescompeting in the equipment sales and service and voice over Internet Protocolcommunications products market in which Enterprise Solutions operates.Competition is based primarily on price and service. No one company is dominantin this field. Enterprise Solutions offers customer premises telephone and dataequipment through well-trained and experienced market representatives withlong-term customer relationships. The Enterprise Solutions Sector enjoys a verystrong brand awareness and a reputation for quality service. EnterpriseSolutions has built a strong base of solid customers with ongoing needs andEnterprise Solutions’ goal is to derive 60-70% of its recurring revenue fromsales to its existing customer base.

 

**OTHER REGULATION**

 

HickoryTechdoes not anticipate any material effects on its earnings, capital expendituresor competitive position because of laws pertaining to the protection of theenvironment.

 

**OTHER COMPETITION**

 

Since the mid-1980’s, HickoryTech’s businessstrategy has been to position itself as a “one-stop” telecommunicationsservices provider. Long-term business relationships with its customers havestrengthened HickoryTech’s business position. HickoryTech believes that itscustomers value the fact that it is the “local company” whose goal is to meetthe customers’ total communications needs. HickoryTech has several competitiveadvantages: its prices and costs are low; its service reputation is high; itsinvestment in technology is strong and it has a direct billing relationshipwith almost all of the customers in its service territories; and it is uniquelypositioned to offer all forms of telecommunications service from one source.

 

Thelong-range effect of competition on the provision of telecommunicationsservices and equipment will depend on technological advances, regulatoryactions at both the state and federal levels, court decisions, and possibleadditional future state and federal legislation. The trend resulting from pastlegislation has been to expand competition in the telecommunications industry.It is imperative to HickoryTech that competition in this industry remains openon an equal basis to all providers. HickoryTech has chosen to participate inthe competitive trend and enhance its growth by establishing its Crystaloperations.

 

**FORWARD-LOOKING STATEMENTS**

 

This Form 10-K Annual Report, Management’sDiscussion and Analysis and other sections of this Annual Report containforward-looking statements that are based on current expectations, estimatesand projections about the industry in which HickoryTech operates and management’sbeliefs and assumptions.  Suchforward-looking statements are subject to uncertainties that could causeHickoryTech’s future actual results to differ materially from such statements.  Forward-looking statements include theinformation concerning our future financial performance, continuation ofhistorical trends, business strategy, projected plans and objectives, futureliquidity and capital resource needs, the effect of regulatory changes on thebusiness, the effect of decisions by other telecommunications carriers, theeconomy in general, and the future of the communications industry andcommunications services.  Thesestatements are not guarantees of future performance and involve certain risks,uncertainties and probabilities, which are difficult to predict. Therefore,actual outcomes and results may differ materially from what is expressed orforecasted in such forward-looking statements, whether as a result of newinformation, future events or otherwise. Factors that might cause such a difference include:

 

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•                  increased competition in core business sectorswhich may decrease market share and or affect the pricing of the products andservices offered;

 

•                  the continuation of historical trends;

 

•                  sufficient cash generation from currentoperations to fund future liquidity needs;

 

•                  the investment in technological innovations whichmay affect future capital resource needs;

 

•                  the effect of legal and both federal and stateregulatory changes which may have an effect on business;

 

•                  the effect of decisions by othertelecommunications carriers which may affect future operations and futurecapital resource needs;

 

•                  the economy in general or the future of thecommunications industry and communications services;

 

•                  changing market conditions which may affectgrowth rates within the industry;

 

•                  stock market volatility which may affect thestock price and the ability to fund the future expansion and operations througha public stock offering;

 

•                  the ability to secure financing for futureexpansion and operations;

 

•                  the ability to improve the operations with newtechnologies and efficiencies;

 

•                  the ability to retain key employees;

 

•                  other risks and uncertainties which may affectthe operating results.

 

Additional information concerning these and otherfactors that could cause actual results or events to differ materially fromcurrent expectations are contained in Exhibit 99, which is incorporated hereinby reference.  You are cautioned not toplace undue reliance on these forward looking statements, which speak only asof the date on which they were made. Except as otherwise required by law,HickoryTech undertakes no obligation to update any of its forward-lookingstatements for any reason.

 

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

 

HickoryTech’sbusiness is primarily focused on the provision of services and its propertiesare used for administrative support and to store and safeguard equipment.  At December 31, 2002, HickoryTech’s grossproperty, plant and equipment of $247,375,000 consisted primarily of telephoneswitches, cable and network equipment. HickoryTech owns or leases the telephoneproperty, plant and equipment which it utilizes to operate its telephonesystems. The three ILEC subsidiaries of HickoryTech in Minnesota and Iowa owncentral telephone offices with related real estate in all of the communitiesthey serve. HickoryTech’s Telecom Sector owns the telephone network, includingtelephone outside plant, fiber-optic cable and central office equipment, overwhich they provide services to their customers. This sector also owns theswitches and wireless/PCS radio equipment which provides its unique wirelessnetwork. It is the opinion of HickoryTech’s management that the properties ofHickoryTech are suitable and adequate to provide modern and effectivetelecommunications services within its service areas, including both local andlong distance service. The capacity for furnishing these services bothcurrently and in the future is under ongoing review by HickoryTech’sengineering staff. Facilities are placed in full use after installation andappropriate testing under the guidance associated with multi-year capitalexpenditure plans.

 

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HickoryTech’sprincipal property locations are the following:

 

(1)       MCTC’sgeneral offices and principal central office exchange building are located indowntown Mankato, Minnesota.  Thisfacility is owned by MCTC and is a three-level brick and stone buildingcontaining approximately 60,000 square feet of floor space.  Portions of this building are leased toHickoryTech for its general offices and to NIBI for its data processingequipment.

 

(2)       MCTC’smain 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 is used to store vehicles andsupplies and is also used as office space for engineering and outside telephonepersonnel.

 

(3)       Heartland’smain central office equipment is located in a one-story brick structure ownedby Heartland in Rock Rapids, Iowa containing approximately 1,500 square feet.Heartland also leases general office space in Rock Valley, Iowa.

 

(4)       Crystalleases office space in Mankato, Minnesota and West Des Moines, Iowa.

 

(5)       MSWCleases office space in Mankato, Minnesota for wireless switch equipment andadministration. MSWC also leases and owns various wireless and PCS tower sitesthroughout southern Minnesota and the Minneapolis/St. Paul metropolitan area,and various retail stores and mall kiosks in its service territory.

 

(6)       NIBIowns a three-story building in Mankato, Minnesota containing approximately17,000 square feet.

 

(7)       Collins(Enterprise Solutions Sector) leases building and warehouse space in Roseville,Minnesota.

 

**Item 3.****    Legal Proceedings.**

 

There are no material pending legal or governmental proceedingsdirectly involving HickoryTech or its subsidiaries, other than ordinary routinelitigation or ordinary routine utility matters, incidental to the business ofHickoryTech and its subsidiaries.

 

**Item 4.****    Submission of Matters to a Vote ofSecurity Holders.**

 

Nomatters were submitted to a vote of security holders during the fourth quarterof the fiscal year covered by this 2002 Annual Report on Form 10-K.

 

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**THISPAGE INTENTIONALLY LEFT BLANK**

 

 

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**PART II**

 

**Item 5.****      Market for Registrant’s Common Equityand Related Stockholder Matters**.

 

Thecommon stock of HickoryTech is traded on The Nasdaq National Market under thesymbol “HTCO”.

 

Thefollowing table sets forth for the period indicated, the high and low closingsales price of the common stock.

 
|     |   |        |   | **High** |    | **Low** |   | **End of Qtr.** |   |
|----------|--------|-------------|--------|----------|---------|---------|--------|-----------------|--------|
| **2002** |   | 4th Quarter |   | $        | 13.3400 |    | $      | 8.3900          |   | $ | 9.5300 |   |
|     |   | 3rd Quarter |   | $        | 16.0500 |    | $      | 11.2100         |   | $ | 13.2500 |   |
|     |   | 2nd Quarter |   | $        | 17.7990 |    | $      | 12.7500         |   | $ | 15.0000 |   |
|     |   | 1st Quarter |   | $        | 17.8500 |    | $      | 13.1400         |   | $ | 16.2700 |   |
|     |   |        |   |     |    |    |   |            |   |
| **2001** |   | 4th Quarter |   | $        | 19.0000 |    | $      | 14.8000         |   | $ | 16.9500 |   |
|     |   | 3rd Quarter |   | $        | 18.4000 |    | $      | 14.5100         |   | $ | 16.3000 |   |
|     |   | 2nd Quarter |   | $        | 16.0000 |    | $      | 13.5000         |   | $ | 16.0000 |   |
|     |   | 1st Quarter |   | $        | 20.8125 |    | $      | 12.1875         |   | $ | 14.8750 |   |

 

As of February 28, 2003, there were approximately 3,193 holders ofrecord of common stock, registered and in street name accounts.

 

HickoryTech has declared quarterly dividends on its common stock of$0.11 per share during the two years ended December 31, 2002. A quarterly cashdividend of $0.11 per share will be paid on March 5, 2003 to stockholders ofrecord at the close of business on February 15, 2003.

 

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

 

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

 
| **FOR THE  YEAR:**                |   | **2002**       |        | **2001**   |   | **2000**   |   | **1999**   |    | **1998**   |   |
|-----------------------------------|--------|----------------|-------------|------------|--------|------------|--------|------------|---------|------------|--------|
| Operating Revenues(A)             |   |           |        |       |   |       |   |       |    |       |   |
| Telecom Sector                    |   | **$**          | **86,557**  |       | $      | 84,019     |   | $          | 79,505  |       | $      | 70,245 |   | $ | 58,021 |   |
| Information Solutions Sector      |   | **4,249**      |        | 4,085      |   | 4,287      |   | 4,368      |    | 7,962      |   |
| Enterprise Solutions Sector       |   | **15,781**     |        | 20,374     |   | 18,511     |   | 22,576     |    | 28,721     |   |
| Total Operating Revenues          |   | **$**          | **106,587** |       | $      | 108,478    |   | $          | 102,303 |       | $      | 97,189 |   | $ | 94,704 |   |
|                              |   |           |        |       |   |       |   |       |    |       |   |
| Net Income (Loss)                 |   | **$**          | **(16,627** | **)**      | $      | 8,738      |   | $          | 7,705   |       | $      | 14,666 |   | $ | 13,526 |   |
|                              |   |           |        |       |   |       |   |       |    |       |   |
| **PER SHARE:**                    |   |           |        |       |   |       |   |       |    |       |   |
| Fully Diluted Earnings Per Share  |   | **$**          | **(1.19**   | **)**      | $      | 0.62       |   | $          | 0.55    |       | $      | 1.06 |   | $ | 0.99 |   |
| Dividends Per Share               |   | **$**          | **0.44**    |       | $      | 0.44       |   | $          | 0.44    |       | $      | 0.44 |   | $ | 0.44 |   |
|                              |   |           |        |       |   |       |   |       |    |       |   |
| **AT YEAR END:**                  |   |           |        |       |   |       |   |       |    |       |   |
| Total Assets                      |   | **$**          | **240,211** |       | $      | 283,292    |   | $          | 255,487 |       | $      | 214,804 |   | $ | 161,429 |   |
| Shareholders’ Equity         |   | **$**          | **58,595**  |       | $      | 80,765     |   | $          | 77,357  |       | $      | 74,476 |   | $ | 63,629 |   |
| Total Debt, Long-Term and Current |   | **$**          | **159,040** |       | $      | 170,901    |   | $          | 148,650 |       | $      | 111,361 |   | $ | 76,042 |   |
| Debt Ratio(B)                     |   | **73.1**       | **%**       | 67.9       | %      | 65.8       | %      | 59.9       | %       | 54.4       | %      |
|                              |   |           |        |       |   |       |   |       |    |       |   |
| **CUSTOMER DATA (year end):**     |   |           |        |       |   |       |   |       |    |       |   |
| ILEC Access Lines(C)              |   | **65,355**     |        | 66,393     |   | 67,120     |   | 64,969     |    | 61,346     |   |
| CLEC Access Lines(D)              |   | **13,984**     |        | 11,573     |   | 8,283      |   | 3,704      |    | 344        |   |
| Wireless Customers(E)             |   | **26,484**     |        | 26,230     |   | 25,698     |   | 20,309     |    | 15,955     |   |
| Internet Customers(F)             |   | **14,420**     |        | 12,816     |   | 12,129     |   | 5,835      |    | 3,195      |   |
| Long Distance Subscribers(G)      |   | **35,566**     |        | 24,241     |   | 18,366     |   | 12,146     |    | 6,012      |   |
|                              |   |           |        |       |   |       |   |       |    |       |   |
| **OTHER DATA:**                   |   |           |        |       |   |       |   |       |    |       |   |
| Employees (year end)              |   | **481**        |        | 502        |   | 552        |   | 502        |    | 479        |   |
| Capital Expenditures              |   | **$**          | **16,674**  |       | $      | 32,868     |   | $          | 39,662  |       | $      | 28,531 |   | $ | 12,190 |   |
| Shares Outstanding (year end)     |   | **13,983,929** |        | 13,935,308 |   | 13,878,568 |   | 13,787,416 |    | 13,662,216 |   |
| Share Price(H) (year end)         |   | **$**          | **9.53**    |       | $      | 16.95      |   | $          | 20.50   |       | $      | 15.00 |   | $ | 12.63 |   |
| Shareholders(I)                   |   | **3,193**      |        | 3,339      |   | 3,300      |   | N/A        |    | N/A        |   |

 

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(A)              Acquisitions ofMinnesota Southern Wireless Company in 1998 and Metro A-2 (Minneapolis/St. Paularea) wireless telephone business in 1999 and dispositions of HickoryTech’ssubsidiaries, Digital Techniques, Inc. (DTI) in 1998 and Amana ColoniesTelephone Company (ACTC) in 2001, have affected HickoryTech’s revenue trends.

 

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

 

(C)                ILEC Lines referto the local exchange telephone access lines in the Telecom Sector. ILEC Linesinclude ISDN (High Speed Data)  and paystation lines of 2,406 in 2002, 2,196 in 2001, and 2,198 in 2000.

 

(D)               CLEC Lines refer tothe competitive local exchange telephone access lines in the Telecom Sector.

 

(E)                 WirelessCustomers refer to the wireless service subscribers in the Telecom Sector.

 

(F)                 InternetCustomers are dial-up Internet accounts within the Telecom Sector, servingILEC, CLEC or stand alone dial-up accounts in HickoryTech’s service area. 2000includes 4,834 customers acquired from Internet Connections. This does notinclude DSL customers, which are not included in any of the listed customercounts.

 

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

 

(H)               Price is the lastday closing price for 2002 through 1999 and the last five-day closing priceaverage for 1998.

 

(I)                    Number ofShareholders is approximate total of Company registrations and street nameaccounts. Data prior to 2000 is not available.

 

12

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

 

**BUSINESSES**

HickoryTech operates in three business segments: the Telecom,Information Solutions and Enterprise Solutions Sectors. Its largest and oldestbusiness (since 1898) has been the operation of incumbent local exchangecarriers (ILECs) or traditional wireline telephone service. The ILEC businessis in HickoryTech’s Telecom Sector.  In1998, HickoryTech began its competitive local exchange carrier (CLEC),competing for the telephone dial tone, data and long distance calling businessin other ILECs’ territories. CLEC is in HickoryTech’s Telecom Sector.  HickoryTech also began its wirelessoperations in 1998 by acquiring its first wholly-owned wireless servicelicense, additional wireless service license in 1999 and the acquisition of twoPCS licenses in 2001. These wireless operations, combined with ILEC and CLEC,form HickoryTech’s Telecom Sector. Since 1964, HickoryTech’s InformationSolutions Sector has provided computer data processing and software,predominantly for HickoryTech’s Telecom Sector operations and also to othertelecommunications companies. HickoryTech acquired its Enterprise SolutionsSector in 1990 and it has operated as a leading telecommunications and data equipmentdistributor from a base in Minneapolis/St. Paul, Minnesota.

 

**THECOMPANY**

The eight subsidiaries of HickoryTech, all of which publicly operateand conduct business as HickoryTech, and the business segments in which theyoperate are:

 

**TELECOM SECTOR**

Mankato CitizensTelephone Company

Mid-Communications, Inc.

HeartlandTelecommunications Company of Iowa, Inc.

Cable Network, Inc.

Crystal Communications,Inc.

Minnesota SouthernWireless Company

**INFORMATION SOLUTIONS SECTOR**

National IndependentBilling, Inc.

**ENTERPRISE SOLUTIONS SECTOR**

Collins CommunicationsSystems Co.

 

**CONSOLIDATEDRESULTS OF OPERATIONS**

 

**2002 Compared to 2001**

 

•                          2002consolidated operating revenues were $106,587,000, a $1,891,000 or 1.7%decrease relative to 2001. Excluding revenues of $832,000 in 2001 related toACTC, which was sold in 2001, consolidated operating revenues decreased 1%relative to 2001.  Two main reasons forthe lack of revenue growth in 2002 were the decline in roaming revenue in theTelecom Sector and a decline in equipment sales and service in the EnterpriseSolutions Sector.

 

•                          In2002 HickoryTech incurred a total of $41,951,000 of asset impairmentcharges.  The details of these chargesinclude $41,635,000 of wireless license impairment and $316,000 of wireless DSL(WDSL) impairment.  At December 31,2002, HickoryTech completed its annual goodwill and wireless FCC licensesimpairment assessment, concluding that an impairment charge of $41,635,000 wasrequired to reduce the carrying value of its FCC wireless licenses to $34,000,000.  HickoryTech believes this impairment oflicense carrying values, which was charged to operations in the fourth quarterof 2002, reflects the impact of declining roaming revenues, the rapid pace oftechnological change being undertaken by the major wireless service providersto adopt new protocols (i.e. GSM or CDMA) and potentially move away fromHickoryTech’s current primary protocol called TDMA, increased pricecompetition, and the protracted downturn in the telecommunications market.  At December 31, 2002****HickoryTechwrote down the carrying value of an intangible asset relating to an agreementto develop a WDSL operation that also entitled HickoryTech to receive a shareof future revenues generated from the WDSL operations.  The asset impairment write-down was recordedbecause of the bankruptcy of the third-party network provider and

 

13

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HickoryTech does not believe that the agreement will resultin future cash flows from the revenue sharing agreement.  The $316,000 charge resulting from thewrite-down was recorded as a charge to operations in HickoryTech’s Telecomsegment and is reported as “Asset Impairment” in the consolidated statement ofincome for the year ended December 31, 2002.  See “Sector Results of Operations - Telecom Sector - ImpairmentCharges” for discussion of these impairment charges.

 

•                          BadDebt expense was $1,332,000 higher in 2002 compared to 2001, due in large partto bankruptcies of interexchange carriers in the telecommunications industry.

 

**2001Compared to 2000**

 

•                          2001consolidated operating revenues were $108,478,000, a $6,175,000 or 6.0%increase relative to 2000. Excluding revenues of $832,000 in 2001 and$1,467,000 in 2000 related to ACTC, which was sold in 2001, consolidatedoperating revenues in 2001 increased 6.7% over 2000.

 

•                          2001consolidated net income of $8,738,000 represents a $1,033,000 or 13.4% increaserelative to 2000. The 2001 net income includes a $566,000 after-tax gain fromthe sale of ACTC. The 2001 net income also includes a $53,000 after-tax gainfrom the sale of various property and investments. The 2000 net income includesa $161,000 after-tax gain related to final payment received from the 1998 saleof Digital Techniques, Inc. The 2000 net income also includes a $233,000after-tax extraordinary loss related to the early extinguishment of debt and a$20,000 after-tax loss from the cumulative effect of a change in accountingprinciple. Without the effect of these gains and other one-time items in eitheryear, consolidated net income would have increased 4.1% in 2001 relative to2000.

 

**OVERALLSUMMARY OF OPERATIONS**

 
| **Years  Ended December 31,**                                               |   | **2002**                    |        | **2001** |   | **2000** |   |
|-----------------------------------------------------------------------------|--------|-----------------------------|-------------|----------|--------|----------|--------|
|                                                                        |   | **(Dollars  in thousands)** |        |
| Operating  Income/(Loss)                                                    |   |                        |        |     |   |     |   |
| Telecom  Sector(A)                                                          |   | **$**                       | **(16,790** | **)**    | $      | 22,826   |   | $ | 22,903 |   |
| Information  Solutions Sector                                               |   | **(2,481**                  | **)**       | 408      |   | 706      |   |
| Enterprise  Solutions Sector                                                |   | **(12**                     | **)**       | 1,340    |   | (308     | )      |
| Corporate(A)                                                                |   | **(1,657**                  | **)**       | (533     | )      | (773     | )      |
|                                                                        |   | **(20,940**                 | **) ** | 24,041   |   | 22,528   |   |
| Other  Income                                                               |   | **320**                     | ** **  | 408      |   | 434      |   |
| Gain  on Sale of Assets                                                     |   | **(183**                    | **)**       | 1,115    |   | 271      |   |
| Interest  Expense                                                           |   | **(7,405**                  | **)**       | (10,855  | )      | (9,988   | )      |
| Income  Taxes                                                               |   | **11,581**                  | ** **  | (5,971   | )      | (5,287   | )      |
| Extraordinary  Item and Cumulative Effect(B)                                |   | —                      | ** **  | —   |   | (253     | )      |
| Net  Income/(Loss)                                                          |   | **$**                       | **(16,627** | **)**    | $      | 8,738    |   | $ | 7,705 |   |
|                                                                        |   |                        | ** **  |     |   |     |   |
| Operating  Income/(Loss)                                                    |   | **$**                       | **(20,940** | **)**    | $      | 24,041   |   | $ | 22,528 |   |
| Depreciation  and Amortization                                              |   | **17,789**                  | ** **  | 16,626   |   | 14,083   |   |
|                                                                        |   |                        | ** **  |     |   |     |   |
| Earnings  Before Interest, Taxes, Depreciation and Amortization (EBITDA)(1) |   | **$**                       | **(3,151**  | **)**    | $      | 40,667   |   | $ | 36,611 |   |

 

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(A)             Includes the asset impairment charges of$41,951,000 in the Telecom Sector.

(B)               Includes extraordinary loss of $233,000 fromearly extinguishment of debt and $20,000 charge resulting from cumulativeeffect of an accounting change to adopt SAB No. 101.

 

14

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**RESULTS OF OPERATIONS**

 

CONSOLIDATEDOPERATING RESULTS

 

Thefollowing is a summarized discussion of consolidated results ofoperations.  More detailed discussion ofoperating results by segment follows this discussion.

 

OPERATING REVENUES- Consolidated operating revenues were $1,891,000 or 1.7% lower in 2002compared to 2001 and $6,175,000 or 6.0% higher in 2001 compared to 2000.  The revenue decrease in 2002 was primarilyattributable to a lower volume of business in the Enterprise Solutions Sectorand a decline in wireless roaming revenue in the Telecom Sector. Thesedecreases were partially offset by the increase in HickoryTech’s total customerbase in its Telecom Sector, the impact of local rate increases by HickoryTech’sILECs in the Telecom Sector, and the result of services provided under terms ofa multi-year contract awarded to HickoryTech effective July 1, 2002 to provideInternet access and video conferencing to schools and libraries in southcentral Minnesota served by the Project SOCRATES distance-learningnetwork.  The increase in 2001 comparedto 2000 was due to the impact of ILEC rate increases, an increase in the CLECcustomer base, an increase in wireless service revenue and an increase inEnterprise Solution revenues.  Theseincreases were partially offset by a decrease in roaming revenue.

 

COST OF SALES -Cost of sales is related to the Enterprise Solutions Sector and was $2,924,000or 21.6% lower in 2002 compared to 2001 and $1,052,000 or 8.4% higher in 2001compared to 2000.  The change in cost ofsales for both years is primarily the result of the change in sales volume inthe Enterprise Solutions Sector.  Thegross profit margin in the Enterprise Solutions Sector was 32.6% and 33.4% and31.4% for 2002, 2001, and 2000, respectively.

 

OPERATINGEXPENSES (excluding Asset Impairment, Depreciation and Amortization) - Operating expenses excluding asset impairment,depreciation and amortization increased $2,900,000 or 5.3% in 2002 compared to2001 and $1,067,000 or 2.0% in 2001 compared to 2000. Operating expenses in2002 were higher partially due to increased bad debt expense of $1,332,000 in2002 compared to 2001, due in large part to bankruptcies of interexchangecarriers in the telecommunications industry. Telecom Sector operating expenseswere also higher due to increased customer counts.  The increase in 2001 compared to 2000 was due primarily to thecosts associated with the growth in CLEC customers.

 

ASSETIMPAIRMENT – In 2002,HickoryTech incurred a total of $41,951,000 of impaired asset charges,primarily to wireless assets.  Thedetails of these charges are described below.

 

Inthe fourth quarter of 2002, HickoryTech recognized an impairment charge basedon annual assessment of its wireless assets. The carrying book value of the FCC licenses as of December 31, 2002 was$75,635,000.  The calculated fair valueof the FCC licenses was determined to be $34,000,000, resulting in animpairment charge of $41,635,000 in operating income in 2002.

 

During2002, HickoryTech wrote down the carrying value of an intangible asset relatingto an agreement to develop a WDSL operation that also entitled HickoryTech toreceive a share of future revenues generated from the WDSL operations.  The asset impairment write-down was takenbecause of the bankruptcy of the third-party network provider and HickoryTechdoes not believe that the agreement will result in future cash flows from therevenue sharing agreement.  The $316,000charge resulting from the write-down was recorded as a charge to operations ofHickoryTech’s Telecom Sector and is reported as “Asset Impairment” in theconsolidated statement of income for the year ended December 31, 2002.

 

Allimpairment charges were recognized in the Telecom Sector.  See “Sector Results ofOperations    Telecom Sector – Impairment Charges” fordiscussion of these impairment charges.

 

15

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DEPRECIATION AND AMORTIZATION - Depreciation expense was $2,997,000 or 23.2%higher in 2002 compared to 2001 and $1,827,000 or 16.5% higher in 2001 comparedto 2000.  The buildout of HickoryTech’sCLEC and fiber optic networks primarily accounts for the increase indepreciation expense. Amortization expense was $1,834,000 or 49.4% lower in2002 compared to 2001 and $716,000 or 23.9% higher in 2001 compared to2000.  If SFAS No. 142, which requiredthe Company to cease amortization of goodwill and wireless licenses in 2002,had taken effect in 2001, amortization expense would have increased $686,000 or57.6% in 2002 compared to 2001 and increased $716,000 or 150.7% in 2001compared to 2000. The increase in amortization expense which would have beenrecorded in 2002 without the cessation of goodwill and license amortization wasdue to amortization of capitalized software development costs related to theInformation Solutions Sector’s SuiteSolution billing software, which began inthe third quarter of 2001.

 

OPERATING INCOME(LOSS) - Operatingincome was $44,981,000 or 187.1% lower in 2002 compared to 2001 and $1,513,000or 6.7% higher in 2001 compared to 2000. The decrease in operating income in 2002 primarily reflects the impactof $41,951,000 of impairment charges related to a reduction in the carryingvalue of wireless FCC license assets and a reduction in a WDSL investment.  All asset impairment write-downs werecharged to the Telecom Sector. The remaining decrease of $3,030,000 in 2002 wasdue to the increase in operating expenses primarily due to bankruptcy lossesfrom interexchange carrier customers, along with the increase in depreciationexpense related to building out the infrastructure of the CLEC business in theTelecom Sector, the decrease in roaming revenues in the Telecom Sector, and thedecrease in operating revenues for the Enterprise Solutions Sector resulting fromfewer equipment installations. These impacts were partially offset by loweramortization expense due to the adoption of SFAS No. 142.  The increase in 2001 compared to 2000 wasdue primarily to rate increases in ILEC, increased demand for vertical servicessuch as caller identification, call waiting and three-way calling, an increasein wireless service revenue and an increase in Enterprise Solutions’ salesvolume.

 

INTEREST EXPENSE - Interest expense decreased $3,450,000 or 31.8%in 2002 compared to 2001 and increased $867,000 or 8.7% in 2001 compared to2000.  The decrease in interest expensein 2002 was primarily due to a decrease in the weighted average interest rateon HickoryTech’s revolving credit facility from 6.66% to 4.45% for the years2001 and 2002, respectively, and a decrease in total debt outstanding. Theoutstanding balance of the revolving credit facility was $158,000,000 onDecember 31, 2002 and $170,000,000 on December 31, 2001.  Total debt outstanding was $159,000,000 onDecember 31, 2002 and $171,000,000 on December 31, 2001. The increase ininterest expense in 2001 compared to 2000 was due to an increase in total debtoutstanding, offset by a decrease in the weighted average interest rate from8.17% in 2000 to 6.66% in 2001.

 

NET INCOME(LOSS) - Consolidated net income was $25,365,000 or 290.3%lower in 2002 compared to 2001 and $1,033,000 or 13.4% higher in 2001 comparedto 2000.  $24,751,000 of the decrease in2002 is the result of the impairment charge of $41,951,000 net of a related taxbenefit of $17,200,000 resulting from the asset impairment write-down in theTelecom Sector. The primary reasons for the remaining decrease in 2002 were thedecrease in operating revenues in the Enterprise Solutions Sector, the decreasein roaming revenues in the Telecom Sector, the increase in depreciation expensedue to the build out of the CLEC infrastructure and the additional bad debtexpense recorded in 2002.   The increasein 2001 compared to 2000 was due to the impact of ILEC rate increases, an increasein the CLEC customer base, an increase in wireless service revenue and anincrease in Enterprise Solutions’ revenues. These increases were partially offset by a decrease in roaming revenueand an increase in costs associated with the growth in the CLEC customers.

 

16

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SECTORRESULTS OF OPERATIONS

 

**TELECOMSECTOR**

 
| **(Dollars in Thousands)**                                                     |   | **2002**    |        | **2001** |       | **2000** |       |
|--------------------------------------------------------------------------------|--------|-------------|-------------|----------|------------|----------|------------|
|                                                                           |   |        |        |     |       |     |       |
| Revenues  Before Intersegment Eliminations                                     |   |        |        |     |       |     |       |
| ILEC                                                                           |   |        |        |     |       |     |       |
| Local  Service                                                                 |   | **$**       | **15,137**  |     | $          | 14,498   |       | $ | 13,135 |   |
| Network  Access                                                                |   | **32,377**  |        | 31,442   |       | 30,897   |       |
| Intersegment                                                                   |   | **274**     |        | 274      |       | 274      |       |
| Other                                                                          |   | **9,016**   |        | 9,227    |       | 8,630    |       |
| Total  ILEC                                                                    |   | **56,804**  |        | 55,441   |       | 52,936   |       |
|                                                                           |   |        |        |     |       |     |       |
| CLEC                                                                           |   |        |        |     |       |     |       |
| Local  Service                                                                 |   | **3,063**   |        | 2,287    |       | 1,450    |       |
| Other                                                                          |   | **3,934**   |        | 2,048    |       | 1,125    |       |
| Total  CLEC                                                                    |   | **6,997**   |        | 4,335    |       | 2,575    |       |
|                                                                           |   |        |        |     |       |     |       |
| Long  Distance                                                                 |   | **4,018**   |        | 3,796    |       | 3,411    |       |
|                                                                           |   |        |        |     |       |     |       |
| Internet                                                                       |   | **3,563**   |        | 3,066    |       | 1,958    |       |
|                                                                           |   |        |        |     |       |     |       |
| Wireless                                                                       |   |        |        |     |       |     |       |
| Service                                                                        |   | **9,880**   |        | 10,531   |       | 8,818    |       |
| Home  Roaming                                                                  |   | **942**     |        | 740      |       | 586      |       |
| Roaming                                                                        |   | **4,627**   |        | 6,384    |       | 9,495    |       |
| Total  Wireless                                                                |   | **15,449**  |        | 17,655   |       | 18,899   |       |
| Total  Telecom Revenues                                                        |   | **$**       | **86,831**  |     | $          | 84,293   |       | $ | 79,779 |   |
|                                                                           |   |        |        |     |       |     |       |
| Total  Telecom Revenues Before Intersegment Eliminations                       |   |        |        |     |       |     |       |
| Unaffiliated  Customers                                                        |   | **$**       | **86,557**  |     | $          | 84,019   |       | $ | 79,505 |   |
| Intersegment                                                                   |   | **274**     |        | 274      |       | 274      |       |
|                                                                           |   | **86,831**  |        | 84,293   |       | 79,779   |       |
|                                                                           |   |        |        |     |       |     |       |
| Operating  Expenses, excluding Asset Impairment, Depreciation and Amortization |   | **46,764**  |        | 46,568   |       | 43,652   |       |
| Asset  Impairment                                                              |   | **41,951**  |        | —   |       | —   |       |
| Depreciation  and Amortization                                                 |   | **14,906**  |        | 14,899   |       | 13,224   |       |
| Operating  Income/(Loss)                                                       |   | **$**       | **(16,790** | **)**    | $          | 22,826   |       | $ | 22,903 |   |
|                                                                           |   |        | ** **  |     |       |     |       |
| Net  Income/(Loss)                                                             |   | **$**       | **(9,888**  | **)**    | $          | 13,069   |       | $ | 13,286 |   |
|                                                                           |   |        | ** **  |     | ** ** |     | ** ** |
| Operating  Income/(Loss)                                                       |   | **$**       | **(16,790** | **)**    | $          | 22,826   |       | $ | 22,903 |   |
| Depreciation  and Amortization                                                 |   | **14,906**  | ** **  | 14,899   |       | 13,224   |       |
| Earnings  Before Interest, Taxes, Depreciation and Amortization (EBITDA)(1)    |   | **$**       | **(1,884**  | **)**    | $          | 37,725   |       | $ | 36,127 |   |
|                                                                           |   |        |        |     |       |     |       |
| Capital  Expenditures                                                          |   | **$**       | **13,893**  |     | $          | 31,132   |       | $ | 39,206 |   |
|                                                                           |   |        |        |     |       |     |       |
| ILEC  Access Lines                                                             |   | **65,355**  |        | 66,393   |       | 67,120   |       |
|                                                                           |   |        |        |     |       |     |       |
| CLEC  Access Lines                                                             |   |        |        |     |       |     |       |
| Overbuild                                                                      |   | **7,796**   |        | 5,521    |       | 1,819    |       |
| UNE                                                                            |   | **1,343**   |        | 1,263    |       | 1,757    |       |
| TSR                                                                            |   | **4,845**   |        | 4,789    |       | 4,707    |       |
| Total                                                                          |   | **13,984**  |        | 11,573   |       | 8,283    |       |
|                                                                           |   |        |        |     |       |     |       |
| Long  Distance Customers                                                       |   | **35,566**  |        | 24,241   |       | 18,366   |       |
|                                                                           |   |        |        |     |       |     |       |
| Internet  Customers                                                            |   | **14,420**  |        | 12,816   |       | 12,129   |       |
|                                                                           |   |        |        |     |       |     |       |
| Wireless  Customers                                                            |   | **26,484**  |        | 26,230   |       | 25,698   |       |
|                                                                           |   |        |        |     |       |     |       |
| Total  Telecom Customers                                                       |   | **155,809** |        | 141,253  |       | 131,596  |       |

 

17

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Revenues:

TelecomSector operating revenues before intersegment eliminations increased $2,538,000or 3.0% in 2002 compared to 2001, and $4,514,000 or 5.7% in 2001 compared to2000.  Amana Colonies Telephone Company(ACTC), which was sold on August 6, 2001, contributed $832,000 and $1,467,000of revenues to this sector during 2001 and 2000, respectively. Local servicerates were increased in HickoryTech’s Iowa ILEC in May 2001 and in theMinnesota ILECs in December 2001, which contributed $942,000 of incrementalrevenue for 2002. Without the local service rate increases and excluding therevenues from ACTC, Telecom revenues would have increased $2,428,000 or 2.9% in2002 compared to 2001.  The increase in2001 compared to 2000 was primarily due to growth in CLEC, increased ILEC localservice and access, and increased wireless service revenue, partially offset bya decrease in roaming revenue.

 

ILEClocal service revenue increased by $639,000 or 4.4% in 2002 compared to 2001,and $1,363,000 or 10.4% in 2001 compared to 2000. ACTC contributed $159,000 tolocal service revenue in 2001. Without the local service rate increase andexcluding the revenues from ACTC, local service revenue would have decreased$144,000 or 1% in 2002. The decrease in local service revenue in the 2002 wasdue to a 1,038 or 1.6% decline in ILEC access lines and credits given toCentrex customers based on trunk equivalency for the subscriber line charge,which was increased in January 2002. The trunk equivalency credits were offsetby increased demand for local private lines and higher revenue from verticalservices such as caller identification, call waiting and three-way calling in2002.  The increase in 2001 compared to2000 was primarily due to the increased demand for local private line andhigher penetration of vertical services such as caller identification, callwaiting and three-way calling.

 

ILECnetwork access revenue increased $935,000 or 3% in 2002 and $545,000 or 1.8% in2001. ACTC contributed $592,000 to network access revenue in 2001.  Excluding the revenue from ACTC, networkaccess revenue would have increased $1,527,000 or 4.9% in 2002 compared to2001. The increase in network access revenue was driven by higher demand fordedicated lines and high-speed circuits in 2002 and 2001.  This was partially offset by a decrease inaccess minutes in 2002 compared to 2001. In 2001, the negative effects of network switched access pricing, acommon industry trend, began to erode access revenue.

 

 

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CLEClocal service revenue increased $776,000 or 33.9% in 2002 compared to 2001, and$837,000 or 57.7% in 2001 compared to 2000. CLEC access lines grew 2,411 or20.8% in 2002 and 3,290 or 39.7% in 2001, which was the primary reason for theincrease in local service revenue in 2002 and 2001.

 

OtherCLEC revenue increased $1,886,000 or 92.1% in 2002 compared to 2001, and$923,000 or 82% in 2001 compared to 2000. Other revenue included network accessand high-speed data revenues, which generally grew along with the increase inaccess lines in 2002 and 2001.  Alsoincluded in other revenue was the revenue recorded from CLEC’s offering ofdigital TV service, which was initiated in May 2001 and has 803 customers as ofDecember 31, 2002, compared to 460 customers as of December 31, 2001.  This growth in digital TV resulted inincreased revenues of $160,000 in 2002 compared to 2001 and $72,000 in 2001compared to 2000. Another reason for the increase in other revenue in 2002 wasthe additional $761,000 of revenue recognized as a result of services providedunder terms of a multi-year contract awarded to HickoryTech effectiveJuly 1, 2002 to provide Internet access and video conferencing to schools andlibraries in south central Minnesota served by the Project SOCRATES distance-learningnetwork.

 

Longdistance revenue increased $222,000 or 5.8% in 2002 compared to 2001, and$385,000 or 11.3% in 2001 compared to 2000. This sector experienced an 11,325or 46.7% increase in its long distance customer base in 2002, and a 5,875 or32% increase in 2001.  Although thecustomer base is increasing, revenue per customer is decreasing.  The decrease in revenue per customer isprimarily the result of optional long distance services available to customers,the increased use of Internet services and other alternatives to long distanceservices.

 

Internetrevenue increased $497,000 or 16.2% in 2002 compared to 2001 and $1,108,000 or56.6% in 2001 compared to 2000. The increase in revenue was caused primarily byan increase in Internet customers of 1,604 or 12.5% in 2002 and an increase of687 or 5.7% in 2001.  In addition to theincrease in customers, Internet revenue increased due to a migration ofInternet customers from low-price introductory rate plans to mid-rangefull-service Internet packages.

 

Wirelessservice revenue decreased $651,000 or 6.2% in 2002 compared to 2001 andincreased $1,713,000 or 19.4% in 2001 compared to 2000. Wireless customercounts increased 254 or 1% in 2002 compared to 2001 and increased 532 or 2.1%in 2001 compared to 2000.  The decreasein service revenue in 2002 was due to a decline in the average revenue persubscriber. HickoryTech began marketing new wireless service plans during 2002which offered customers less expensive options, as well as options for unlimitedairtime.

 

Wireless roaming revenuedecreased $1,757,000 or 27.5% in 2002 compared to 2001 and $3,111,000 or 32.8%in 2001 compared to 2000. Roaming minutes from other wireless carriers’customers traveling into HickoryTech’s wireless service territory have declinedfrom historical levels, particularly due to technological changes among otherwireless providers, which re-route the roaming minutes from HickoryTech’swireless service towers to other providers. In addition, other PCS wirelesscarriers have continued to build-out PCS licenses to carry their own customers’traffic rather than pay roaming to HickoryTech.  Management expects roaming revenues to continue to decline in thefuture, primarily due to continuing technological changes in the industry.

 

OperatingExpenses, excluding Asset Impairment, Depreciation and Amortization:

Operatingexpenses excluding asset impairment, depreciation and amortizationincreased  $196,000 or .4% in 2002compared to 2001 and $2,916,000 or 6.7% in 2001 compared to 2000. ACTCcontributed $656,000 of operating expenses to this sector in 2001. Excludingthe operating expenses from ACTC, Telecom operating expenses would haveincreased $852,000 or 1.9% in 2002 compared to 2001. One reason for theincrease in operating expenses was $1,272,000 of additional bad debt expenserecorded in 2002, due in large part to bankruptcies of interexchange carriersin the telecommunications industry. The increases in operating expenses notedin 2002 were partially offset by improved efficiencies achieved in the designand operation of HickoryTech’s network as it pertains to its CLEC and Internetoperations. In addition, management actions aimed at reducing operating costs,which began in 2001, and the combination of certain operating functions aidedin reducing operating expenses for this sector in 2002. HickoryTech has alsoimplemented specific cost reduction initiatives such as using its PCS networkto reduce roaming expense for its wireless product, closely auditing theinterconnection fees paid to other carriers for its CLEC product and reducingthe plant installation and engineering costs of its Network Design andOperations Division.  The increase in2001 compared to 2000 was due primarily to the costs associated with the growthin CLEC customers.

 

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AssetImpairment Charges:

Effective January 1,2002, HickoryTech adopted SFAS No. 142, “Goodwill and Other IntangibleAssets.” SFAS No. 142 established new standards related to how acquiredgoodwill and other intangible assets are to be recorded upon their acquisitionas well as how they are to be accounted for after they have been initiallyrecognized in the financial statements.

 

Effective with theadoption of this standard, HickoryTech is no longer amortizing acquiredgoodwill. Instead, SFAS No. 142 requires acquired goodwill to be evaluatedfor impairment using a two-step test based upon a fair value approach. Thefirst step is used to identify a screen for potential impairment, while thesecond step calculates the amount of impairment, if any. Upon adoption of thisstandard, HickoryTech completed a transitional impairment test for its acquiredgoodwill, determining fair value using primarily a discounted cash flow model.The determined fair value was sufficient to pass the first step impairmenttest, and therefore no impairment was recorded.

 

Additionally, uponadoption of SFAS No. 142, HickoryTech was required to reassess the usefullives of its other intangible assets. HickoryTech’s other intangible assetsprimarily consist of customer lists and wireless FCC licenses (FCC licenses).HickoryTech’s FCC licenses have terms of ten years, but are renewable.  The renewal of FCC licenses is a routine matterinvolving a nominal fee and HickoryTech has determined that no legal,regulatory, contractual, competitive, economic or other factors currently existthat limit the useful life of its FCC licenses. As such, effective with theadoption of SFAS No. 142, HickoryTech is no longer amortizing FCC licensesas they are deemed to be intangible assets that have indefinite lives.  Prospectively, HickoryTech will continue toperiodically reevaluate its determination of an indefinite useful life withregards to FCC licenses. SFAS No. 142 requires that indefinite livedintangible assets be tested for impairment by comparing the fair value of theassets to their carrying amount. Upon adoption of this standard, HickoryTechcompleted a transitional impairment test for FCC licenses, calculating fairvalue using primarily a discounted cash flow model and corroboratingmarketplace transactions, and determined that there was no impairment to berecorded. The FCC licenses were tested for impairment on an aggregate basis,which is consistent with HickoryTech’s management of the wireless businesswithin the telecom segment. HickoryTech also re-assessed the useful life of itsother intangible assets and concluded that the existing lives of up to eightyears should be continued.

 

On a prospective basis,HickoryTech is required to test both acquired goodwill and FCC licenses forimpairment on an annual basis based upon a fair value approach. Additionally,goodwill shall be tested for impairment between annual tests if an event occursor circumstances change that would more likely than not reduce the fair valueof an entity below its carrying value. Other indefinite-lived intangible assetswill be tested between annual tests if events or changes in circumstancesindicate that the asset might be impaired. During the fourth quarter,HickoryTech completed its annual impairment tests for both acquired goodwilland FCC licenses.  Such testing resultedin no impairment charge to goodwill as the determined fair value was againsufficient to pass the first step impairment test. The first annualreassessment of HickoryTech’s FCC licenses, however, resulted in a totalpre-tax impairment charge of $41,635,000 in the fourth quarter of 2002. Theseimpairments are reported as an “Asset Impairment” in HickoryTech’s consolidatedstatement of income for the year ended December 31, 2002. HickoryTech believesthat the decline in the fair value of its FCC licenses is due principally todeclining roaming revenues, the rapid pace of technological change beingundertaken by the major wireless service providers to adopt new protocols (i.e.GSM or CDMA) and potentially move away from HickoryTech’s current primaryprotocol called TDMA, increasing price competition, and the protracted downturnin the telecommunications market.  Thecharges are reported as an “Asset Impairment” in HickoryTech’s consolidatedstatement of income for the year ended December 31, 2002.

 

During 2002, HickoryTech wrote downthe carrying value of an intangible asset relating to an agreement to develop aWDSL operation that also entitled HickoryTech to receive a share of futurerevenues generated from the WDSL operations. The asset impairment write-down was taken because of the bankruptcy ofthe third-party network provider and HickoryTech’s belief that the revenuesharing agreement will not result in future cash flows. The $316,000 chargeresulting from the write-down was recorded as a charge to operations ofHickoryTech’s Telecom Sector and is reported as “Asset Impairment” in theconsolidated statement of income for the year ended December 31, 2002.

 

Total asset impairment charges forthe Telecom Sector include the $41,635,000 for wireless licenses, and $316,000for WDSL, or $41,951,000 in total.

 

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Depreciationand Amortization:

Depreciation andamortization increased $7,000 or 0.1% in 2002 compared to 2001 and $1,675,000or 12.7% in 2001 compared to 2000.  Thebuildout of HickoryTech’s CLEC and fiber optic networks primarily account forthe increase in depreciation expense. Depreciation expense increased $817,000 or 10.1% in 2002 compared to2001, and $544,000 or 7.2% in 2001 compared to 2000, for the networksassociated with its ILEC product. Depreciation expense increased $1,456,000 or 79.3% in 2002 compared to2001, and $1,160,000 or 171.8% in 2001 compared to 2000, for the networksassociated with its CLEC product. Amortization expense decreased $2,430,000 or86.5% in 2002 compared to 2001, and increased $145,000 or 5.4% in 2001 comparedto 2000. If SFAS No. 142, which required the Company to cease amortization ofgoodwill and wireless FCC licenses, had taken effect in 2001, amortizationexpense would have decreased $21,000 or 5.2% in 2002 compared to 2001, andincreased $145,000 or 56.4% in 2001 compared to 2000.

 

Operatingand Net Income/(Loss):

Operatingincome decreased $39,616,000 or 173.6% in 2002 compared to 2001, and decreased$77,000 or .3% in 2001 compared to 2000. Net income decreased $22,957,000 or 175.7% in 2002 compared to 2001, anddecreased $217,000 or 1.6% in 2001 compared to 2000. The decreases in operatingand net income in 2002 resulted primarily from the $41,951,000 asset impairmentwrite-down of assets.  The assetimpairment write-downs included $41,635,000 for FCC licenses and $316,000 forthe WDSL investment.  These assetimpairment write-downs were partially offset by a decrease in amortizationexpense and increases in revenues described above, while operating income andnet income remained comparable to each other in 2001 compared to 2000.  If the discontinuance of goodwill and FCClicense amortization pursuant to SFAS No. 142 had taken effect in 2001,operating income would have decreased $42,024,000 or 166.5% in 2002 compared to2001, and decreased $78,000 or 0.3% in 2001 compared to 2000.  If the discontinuance of goodwill and FCClicense amortization pursuant to SFAS No. 142 had taken effect in 2001, netincome would have decreased $24,378,000 or 168.2% in 2002 compared to 2001, anddecreased $217,000 or 1.5%, in 2001 compared to 2000.

 

Earningsbefore Interest, Taxes, Depreciation and Amortization (EBITDA)(1):

Earningsbefore Interest, Taxes, Depreciation and Amortization(1) decreased  $39,609,000 or 105% in 2002 compared to2001, and increased $1,598,000 or 4.4% in 2001 compared to 2000.  EBITDA(1) in 2002 included the $41,951,000asset impairment charges described above. EBITDA(1) margins for this sector were (2.2%), 44.8% and 45.3% in 2002,2001 and 2000, respectively. The EBITDA(1) margin in 2002 was affected by the$41,951,000 asset impairment charges described above.  The EBITDA(1) and EBITDA(1) margin in 2002 compared to 2001without regard to the $41,951,000 asset impairment charges would have increasedprimarily due to the increase in revenues. The increase in EBITDA(1) and EBITDA(1) margin in 2001 compared to 2000was primarily due to the increases in revenues, partially offset by theincreases in operating expenses.

 

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INFORMATIONSOLUTIONS – The followingtable provides a breakdown of the Information Solutions Sector operatingresults.

 

**INFORMATION SOLUTIONS SECTOR**

 
| **(Dollars  in Thousands)**                                                 |   | **2002**  |       | **2001** |   | **2000** |   |
|-----------------------------------------------------------------------------|--------|-----------|------------|----------|--------|----------|--------|
| Revenues Before Eliminations                                                |   |      |       |     |   |     |   |
| Unaffiliated Customers                                                      |   | **$**     | **4,249**  |     | $      | 4,085    |   | $ | 4,287 |   |
| Intersegment                                                                |   | **3,962** |       | 5,022    |   | 4,668    |   |
|                                                                        |   | **8,211** |       | 9,107    |   | 8,955    |   |
| Operating Expenses, excluding Depr. and Amort.                              |   | **8,289** |       | 7,570    |   | 7,869    |   |
| Depreciation and Amortization                                               |   | **2,403** |       | 1,129    |   | 380      |   |
|                                                                        |   |      |       |     |   |     |   |
| Operating Income/(Loss)                                                     |   | **$**     | **(2,481** | **)**    | $      | 408      |   | $ | 706 |   |
|                                                                        |   |      |       |     |   |     |   |
| Net Income/(Loss)                                                           |   | **$**     | **(1,655** | **)**    | $      | 128      |   | $ | 427 |   |
|                                                                        |   |      |       |     |   |     |   |
| Operating Income/(Loss)                                                     |   | **$**     | **(2,481** | **)**    | $      | 408      |   | $ | 706 |   |
| Depreciation and Amortization                                               |   | **2,403** |       | 1,129    |   | 380      |   |
| Earnings Before Interest, Taxes, Depreciation and Amortization  (EBITDA)(1) |   | **$**     | **(78**    | **)**    | $      | 1,537    |   | $ | 1,086 |   |
|                                                                        |   |      |       |     |   |     |   |
| Capital Expenditures                                                        |   | **$**     | **2,472**  |     | $      | 1,347    |   | $ | 123 |   |

 

Revenues:

Operatingrevenues from unaffiliated customers increased $164,000 or 4% in 2002 comparedto 2001, and decreased $202,000 or 4.7% in 2001 compared to 2000.  The increase in operating revenues in 2002was due to the impact of new customer relationships for monthly batchprocessing services, as well as the implementation of the predecessor toSuiteSolution, called WRITE2K, by a newcustomer.  The decrease in 2001compared to 2000 was primarily the result of lower processing volumes.

 

Operating Expenses,excluding Depreciation and Amortization:

Operating expensesexcluding depreciation and amortization increased $719,000 or 9.5% in 2002compared to 2001, and decreased $299,000 or 3.8% in 2001 compared to 2000. Thissector capitalized internal development costs associated with SuiteSolutionduring 2001. The capitalization of these costs ended during the third quarterof 2001 as the development of SuiteSolution had reached the point where theproduct was available for release to customers. Because development costs areno longer being capitalized for SuiteSolution, operating expenses for thissector were higher in 2002 compared to 2001 and higher in 2001 compared to 2000as development personnel were deployed on routine operating and implementationduties.

 

Depreciation andAmortization:

Depreciation andamortization increased $1,274,000 or 112.8% in 2002 compared to 2001, and$749,000 or 197.1% in 2001 compared to 2000. Depreciation expense in 2002 was$517,000 higher compared to 2001. Depreciation expense in 2001 was $286,000higher compared to 2000. The increase was due to depreciation expense recordedon capitalized leases for new computer equipment and depreciation expenserecorded on other capital expenditures related to equipment acquired in supportof the development and implementation of SuiteSolution. Amortization expense in2002 was $757,000 higher than 2001. Amortization expense in 2001 was $463,000higher than 2000. The increase was due to the amortization of capitalizedSuiteSolution development costs, which began in the third quarter of 2001.

 

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Operating and NetIncome/(Loss):

Operating incomedecreased $2,889,000 or 708.1% in 2002 compared to 2001, and $298,000 or 42.2%in 2001 compared to 2000.  Net incomedecreased $1,783,000 or 1393% in 2002 compared to 2001, and $299,000 or 70% in2001 compared to 2000. The decrease inoperating income and net income was primarily attributable to the decrease inoperating revenues and the increase in operating expenses, includingdepreciation and amortization.

 

Earningsbefore Interest, Taxes, Depreciation and Amortization (EBITDA)(1):

Earningsbefore Interest, Taxes, Depreciation and Amortization(1) decreased $1,615,000or 105.1% in 2002 compared to 2001, and increased $451,000 or 41.5% in 2001compared to 2000. The EBITDA(1) margin for this sector was (0.9%) in 2002,compared to 16.9% in 2001. The decrease in EBITDA(1) and the EBITDA(1) marginwas primarily due to decreased operating revenues and increased operatingexpenses.

 

ENTERPRISESOLUTIONS – The following table provides abreakdown of the Enterprise Solutions Sector operating results.

 

**ENTERPRISE SOLUTIONS SECTOR**

 
| **(Dollars in Thousands)**                                                  |   | **2002**   |       | **2001** |   | **2000** |   |
|-----------------------------------------------------------------------------|--------|------------|------------|----------|--------|----------|--------|
| Revenues Before Intersegment Eliminations                                   |   |       |       |     |   |     |   |
| Installation                                                                |   | **$**      | **7,970**  |     | $      | 11,227   |   | $ | 8,688 |   |
| Service                                                                     |   | **7,811**  |       | 9,147    |   | 9,823    |   |
|                                                                        |   | **15,781** |       | 20,374   |   | 18,511   |   |
| Cost of Sales                                                               |   | **10,638** |       | 13,562   |   | 12,701   |   |
| Operating Expenses, excluding Depr. and Amort.                              |   | **4,892**  |       | 5,113    |   | 5,781    |   |
| Depreciation and Amortization                                               |   | **263**    |       | 359      |   | 337      |   |
|                                                                        |   | **15,793** |       | 19,034   |   | 18,819   |   |
|                                                                        |   |       |       |     |   |     |   |
| Operating Income/(Loss)                                                     |   | **$**      | **(12**    | **)**    | $      | 1,340    |   | $ | (308 | ) |
|                                                                        |   |       |       |     |   |     |   |
| Net Income/(Loss)                                                           |   | **$**      | **(41**    | **)**    | $      | 748      |   | $ | (250 | ) |
|                                                                        |   |       | ** ** |     |   |     |   |
| Operating Income/(Loss)                                                     |   | **$**      | **(12**    | **)**    | $      | 1,340    |   | $ | (308 | ) |
| Depreciation and Amortization                                               |   | **263**    |       | 359      |   | 337      |   |
| Earnings Before Interest, Taxes, Depreciation and Amortization  (EBITDA)(1) |   | **$**      | **251**    |     | $      | 1,699    |   | $ | 29 |   |
|                                                                        |   |       |       |     |   |     |   |
| Capital Expenditures                                                        |   | **$**      | **95**     |     | $      | 213      |   | $ | 157 |   |

 

Revenues:

Operatingrevenues decreased $4,593,000 or 22.5% in 2002 compared to 2001, and increased$1,863,000 or 10.1% in 2001 compared to 2000. Sales volumes in 2002 are down inthis sector compared to 2001. Installation revenue was $3,257,000 or 29% lowerin 2002 compared to 2001 and $2,539,000 or 29.2% higher in 2001 compared to2000. The decrease in installation revenue in 2002 compared to 2001 wasprimarily a result of a decrease in sales and installations of PBX and smallbusiness systems of $1,313,000 or 21.4% and a decrease in sales of data networkequipment of $1,585,000 or 35%. Service revenue was $1,336,000 or 14.6% lowerin 2002 compared to 2001 and $676,000 or 6.9% lower in 2001 compared to 2000.This sector has encountered across the board reductions in demand in all of itsmajor products and services. The reduction occurred in early 2002, and isbelieved to be associated with the economy’s effect on customers of thissector, and due to changing technology (i.e. voice vs. data protocol) in thecommunications products, which this sector provides.  Management is uncertain when customer demand for these productsand services may return to historical levels. HickoryTech is installing asignificant voice over Internet Protocol network in the corporate offices of alarge specialty retailer, which added significant installation revenues during2002.  This contract represents what isexpected to be the largest single-campus telecommunication deployment in theUnited States this year and has added significant revenues to the EnterpriseSolutions Sector in 2002. As of December 31, 2002, this installation wasvirtually complete.

 

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Costof Sales:

Costof sales decreased $2,924,000 or 21.6% in 2002 compared to 2001, and increased$861,000 or 6.8% in 2001 compared to 2000. Gross profit margin for this sector in 2002, 2001 and 2000 was 32.6%,33.4% and 31.4%, respectively.  Thedecrease in cost of sales was in line with the decrease in operating revenuesin this sector as is evident in the relatively consistent margins.

 

OperatingExpenses, excluding Depreciation and Amortization:

Operatingexpenses excluding depreciation and amortization decreased $221,000 or 4.3% in2002 compared to 2001, and $668,000 or 11.6% in 2001 compared to 2000.  This sector reduced its operating expensesthrough cost reduction measures including workforce reductions.

 

Depreciationand Amortization:

Depreciationand amortization decreased $96,000 or 26.7% in 2002 compared to 2001, andincreased only $22,000 or 6.5% in 2001 compared to 2000.  This decrease in 2002 was primarily due tothe implementation of SFAS No. 142 effective January 1, 2002, which requiredHickoryTech to discontinue amortization of goodwill.

 

Operatingand Net Income/(Loss):

Operatingloss was $12,000 in 2002 compared to operating income of $1,340,000 in 2001,and an operating loss of $308,000 in 2000. Net loss in 2002 was $41,000compared to net income of $748,000 in 2001 and a net loss of $250,000 in 2000.  The losses generated in 2002 as compared toincome in 2001 resulted primarily from the changes in operating revenuesdescribed above.  If SFAS No.142 hadtaken effect in 2001, operating income would have decreased $1,464,000 or100.8% in 2002 compared to 2001, and increased $1,648,000 or 840.8% in 2001compared to 2000.  If SFAS No. 142 hadtaken effect in 2001, net income would have decreased $855,000 or 105% in 2002compared to 2001, and increased $998,000 or 542.4% in 2001 compared to 2000.

 

Earningsbefore Interest, Taxes, Depreciation and Amortization (EBITDA):

Earningsbefore Interest, Taxes, Depreciation and Amortization(1) decreased $1,448,000or 85.2% in 2002 compared to 2001, and increased $1,670,000 or 5758.6% in 2001compared to 2000. The EBITDA(1) margin for this sector was 1.6% in 2002compared to 8.3% in 2001.  The changesin EBITDA(1) and the EBITDA(1) margin were primarily due to the decrease inoperating revenues.

 

**TOTAL COSTS AND EXPENSES**

Total consolidated costsand expenses after eliminations increased $43,090,000 or 51.0% in 2002 comparedto 2001 and $4,662,000 or 5.8% in 2001 compared to 2000.  Asset impairment write-downs totaling$41,951,000 in the Telecom Sector are included in Total Costs and Expenses for2002. FCC licenses had asset impairments of $41,635,000, and a WDSL investmenthad a $316,000 asset impairment write-down. Depreciation and amortization increased $1,163,000 or 7.0% in 2002compared to 2001 and $2,543,000 or 18.1% in 2001 compared to 2000 due primarilyto the higher pace of capital investment in Crystal, and the amortization ofcapitalized SuiteSolution software development costs.  These increases were partially offset by the decrease in wirelesslicense and goodwill amortization as a result of the adoption of SFAS No. 142in 2002.  Cost of goods sold decreased$2,924,000 or 21.6% in 2002 compared to 2001 and increased $1,052,000 or 8.4%in 2001 compared to 2000, due to sales volume changes at EnterpriseSolutions.  Operating expenses(excluding asset impairment, depreciation and amortization) increased$2,900,000 or 5.3% in 2002 compared to 2001 and $1,067,000 or 2.0% in 2001compared to 2000.  The causes of the netincreases are explained in the sector discussions above, although the primarycause of the overall increase was the growth of Crystal.  Crystal’s growth in costs includes thehiring of staff and marketing expenses prior to revenue streams and payinginterconnection fees to incumbent carriers for transferring customers to theCLEC telephone network.

 

**INTEREST EXPENSE**

Interest expensedecreased by $3,450,000 in 2002 compared to 2001 and increased $867,000 in 2001compared to 2000. The decrease in interest expense in 2002 was due to thedecrease in total outstanding debt from $171 million at December 31, 2001 to$159 million at December 31, 2002, as well as a decrease in the annual weightedaverage interest rate from 6.66% in 2001 to 4.45% in 2002.  The increase in interest expense in 2001 wasdue to the increase in total debt outstanding from $149 million at December 31,2000 to $171 million at December 31, 2001, partially offset by a decrease inthe annual weighted average interest rate from 8.17% in 2000 to 6.66% in2001.  The debt level increased in 2001to fund internal growth and to fund the PCS acquisition.

 

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**GAIN/LOSS ON SALE OF ASSETS**

The 2002 loss on sale ofassets relates primarily to various CLEC assets.  The 2001 gain on sale of assets includes $1,015,000 from the saleof ACTC and $100,000 from the sale of various other assets. HickoryTechreceived proceeds of $6.5 million on the sale of ACTC. The 2000 gain on sale ofassets of $271,000 is related to a final contingent payment received from the1998 sale of DTI.

 

**INCOME TAXES**

The effective tax ratein 2002 was (41.1%), versus 40.6% in 2001 and 39.9% in 2000. These effectivetax rates differ from the U.S. statutory rate primarily due to state incometaxes.

 

**EXTRAORDINARY LOSS ON DEBT EXTINGUISHMENT**

In June 2000,HickoryTech increased its revolving credit facility and used the proceeds torepay $40,000,000 of senior unsecured notes. As a result of the extinguishmentof the senior unsecured notes, HickoryTech recorded an extraordinary loss of$233,000, net of income tax benefit of $158,000.  This action was taken to align the capital financing ofHickoryTech more suitably with its current business plan.

 

**CUMULATIVE EFFECT OF ACCOUNTING CHANGE**

In December 1999, theSEC issued Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition inFinancial Statements,” which provides additional guidance in applying generallyaccepted accounting principles for revenue recognition. Implementation of SABNo. 101 required HickoryTech to defer revenues resulting from up-front fees andto also defer the associated direct costs. These deferred revenues and costsare now recognized ratably over the customer relationship period. As permittedby SAB No. 101, HickoryTech accounted for the change in accounting policyprospectively as a cumulative effect of accounting change retroactively toJanuary 1, 2000. The cumulative effect of accounting change in 2000 was a lossof $20,000, net of a tax benefit of $14,000.

 

**CRITICAL ACCOUNTING POLICIES**

Management’s discussionand analysis of financial condition and results of operations are based uponHickoryTech’s consolidated financial statements, which have been prepared inaccordance 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 Statement of Financial Accounting Standards(SFAS) No. 71, “Accounting for the Effects of Certain Types ofRegulation.”  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 following accounting policies, which are important to HickoryTech’sfinancial position and results of operations, requires significant judgmentsand estimates 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 allHickoryTech’s accounting policies, see Note 1 of the Consolidated FinancialStatements.

 

**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 (wireline or wireless) service. ILEC revenues are alsoderived 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 revenues are realized under pooling arrangementswith other telephone companies and are divided among the companies based onrespective costs and investments to provide the services. The companies thattake part in these pooling arrangements may adjust their costs and investmentsfor a period of two years, which causes the dollars distributed by the pool tobe adjusted retroactively. Management believes that recorded amounts representreasonable estimates of the final distribution from these pools.  However, to the extent that companiesparticipating in these pools make adjustments, there will be adjustments torecorded revenues in future periods.

 

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

 

**Allowancefor Doubtful Accounts –** HickoryTech’s allowance for doubtfulaccounts is an estimate based on specifically identified accounts as well asgeneral reserves. HickoryTech evaluates specific accounts where it hasinformation that the customer may have an inability to meet its financialobligations. In these cases, management uses its judgment, based on the bestavailable facts and circumstances, and records a specific reserve for thatcustomer against amounts due to reduce the receivable to the amount that isexpected to be collected. These specific reserves are reevaluated and adjustedas additional information is received that impacts the amount reserved.HickoryTech also establishes a general reserve for all customers based on arange 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.

 

**Inventories–**Similar to its allowance for doubtful accounts, HickoryTech makes estimatesrelated to the valuation of inventory. HickoryTech adjusts its inventorycarrying value for estimated obsolescence or unmarketable inventory to theestimated market value based upon assumptions about future demand and marketconditions. As market conditions change, if inventory valuations are lower,additional inventory write-downs may be required at the time that the factsthat give rise to the lower value become known.

 

**IntangibleAssets –**HickoryTech amortizes its intangible assets over theirestimated useful lives. The intangible assets and their estimated useful liveswere as follows: customer lists – 5-8 years, and other intangibles – 5-8 years.Prior to adoption of SFAS No. 142, HickoryTech amortized goodwill over 40 yearsand FCC licenses over 37-40 years.

 

Effective January 1,2002, HickoryTech adopted SFAS No. 142 which required the company to ceaseamortization of goodwill and FCC licenses. Instead, these assets were subject to an impairment test upon adoptionon January 1, 2002.  Goodwill and FCClicenses are also subject to an annual impairment test.  The goodwill impairment test includes twosteps, the first of which requires management to determine the fair value ofcertain of the Company’s reporting units (as defined by SFAS No. 142).  The Company determines the fair value oftheir reporting units by application of a discounted cash flow analysis.  The FCC license impairment test consists ofone step, comparing the aggregate book carrying value of the FCC licenses totheir aggregate estimated fair value. The Company makes a determination of FCC license fair values usingmethodologies that include analyzing market comparable transactions andapplying discounted cash flow analyses specific to the FCC licenses.  Management makes estimates that are includedin their discounted cash flow analyses based upon the best availableinformation at the time that the determinations of fair value are made.  If circumstances change, HickoryTech’sestimates of fair value will also change and could result in a determinationthat additional impairment charges to reduce the carrying value of goodwilland/or FCC licenses are necessary.

 

**DeferredTaxes –** As part of the process of preparing our consolidatedfinancial statements the Company is required to estimate income taxes in eachof the jurisdictions in which it operates. This process involves estimatingactual current tax exposure together with assessing temporary differencesresulting from differing treatment of items, such as deferred revenue, for taxand accounting purposes. These differences result in deferred tax assets andliabilities, which are included within the Company’s consolidated balancesheet. The Company assesses the likelihood that deferred tax assets will be recoveredfrom future taxable income and to the extent recovery is not likely, itestablishes a valuation allowance. To the extent the Company establishes avaluation allowance or increases this allowance in a period, it must include anexpense within the tax provision in the statement of operations.  The Company has established a $470,000valuation allowance due to uncertainty about realization of benefits associatedwith net operating losses generated in the state of Iowa.  Other than the uncertainty about realizationof this net operating loss carryforward, HickoryTech expects to be able toutilize all of its deferred tax assets.

 

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**INFLATION**

It is the opinion ofmanagement that the effects of inflation on operating revenues and expensesover the past three years have been immaterial. Management anticipates thatthis trend will continue in the near future.

 

**DIVIDENDS**

HickoryTech paiddividends of $6,170,000, or $0.44 per share, in 2002. The dividend per sharerate was the same as in 2001 and 2000. HickoryTech expects paying at theexisting level of dividends in 2003, which is not expected to negatively impactthe liquidity of HickoryTech.

 

**CAPITAL STRUCTURE** – The total long-term capital structure (long-term obligations plusshareholders’ equity) for HickoryTech was $216,194,000 at December 31, 2002,reflecting 27.1% equity and 72.9% debt. This compares to a capital structure of $250,424,000 at December 31,2001, reflecting 32.3% equity and 67.7% debt. Management believes adequate internal and external resources areavailable to finance ongoing operating requirements, including capitalexpenditures, business development, debt service and the payment of dividendsfor at least the next twelve months.

 

**CASHFLOWS**– Cash flowsfrom operations continue to be a steady source of funds for HickoryTech,primarily coming from the Telecom Sector. Cash provided from operations was$34,667,000 in 2002, $25,135,000 in 2001, and $22,908,000 in 2000. Cash flowsfrom operations in 2002 were primarily attributable to net loss offset bynon-cash expenses, including depreciation, amortization and the $41,951,000asset impairment charges, which were primarily offset by a decrease in deferredincome taxes.  Cash flows fromoperations in 2001 were primarily attributable to net income plus non-cashexpenses, including depreciation, amortization and an increase in deferred taxliabilities, partially offset by increases in income taxes receivable,increases in costs in excess of billings on contracts in the EnterpriseSolutions Sector and decreases in accounts payable relating to timing ofpayments and decreases in billings in excess of costs on contract in theEnterprise Solutions Sector. Cash flows from operations in 2000 were primarily attributableto net income offset by non-cash expenses, including depreciation andamortization, partially offset by increases in inventory in the TelephoneSector and decreases in accounts payable relating to timing of payments.

 

Cash used in investingactivities was $16,331,000 in 2002, $39,979,000 in 2001, and $51,238,000 in2000. Capital expenditures relating to ongoing businesses were $16,674,000 in2002, $32,868,000 in 2001, and $39,662,000 in 2000. Capital expenditures wereincurred to construct additional network facilities to provide CLEC servicesand buildout fiber optic and wireless networks.  HickoryTech expects capital expenditures in 2003 to be at similarlevels to those made in 2002.  Cash usedin investing activities also included $2,717,000 in 2001, and $1,450,000 in 2000 for capitalized softwaredevelopment costs associated with SuiteSolution in the Information SolutionsSector. Cash used in investing activities included $11,386,000 in 2001 for theacquisition of PCS licenses (including direct acquisition costs).  Proceeds from sale of assets also provided$6,992,000 in 2001 related primarily to the sale of ACTC. In 2000, cash used ininvesting activities included a $10,000,000 investment in Rural TelephoneFinance Cooperative (RTFC) which was required as part of HickoryTech’s newrevolving credit facility entered into in September 2000 with a syndicate whichincluded RTFC and other banks.

 

Cash used in financingactivities was $18,470,000 in 2002, while cash provided by financing activitieswere $15,662,000 in 2001, and $26,812,000 in 2000.  In 2002, cash was used primarily to repay $12,000,000 ofborrowings, to repurchase common stock for $1,072,000 and to pay dividends of$6,170,000.  In 2001 and 2000,HickoryTech borrowed approximately $21,000,000 and $37,000,000 under its creditfacilities, respectively, and paid cash dividends of  $6,117,000, and $6,085,000, respectively.  In November 2002, HickoryTech resumedrepurchasing its stock in over-the-counter trading under a previously announcedrepurchase plan.  HickoryTech funds therepurchase of its stock from cash flows from operations.  During 2002, HickoryTech repurchased 105,700common shares for $1,072,000.

 

**WORKINGCAPITAL –**Working capital was $13,073,000 as ofDecember 31, 2002, compared to working capital of $13,737,000 as of December31, 2001.  The ratio of current assetsto current liabilities was 1.9 to 1.0 as of December 31, 2002 and 2.0 to 1.0 asof December 31, 2001.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

**LONG-TERMOBLIGATIONS**– HickoryTech’s long-term obligations asof December 31, 2002, were $157,599,000, excluding current maturities of$1,441,000.  As of December 31, 2002,HickoryTech had a $183,000,000 credit facility with a syndicate of banks.  The credit facility is comprised of a$125,000,000 revolving credit component and a $58,000,000 term loancomponent.  The available line of crediton the $125,000,000 revolving credit component decreases in incrementsbeginning in March 2004 with a final maturity date in September 2008.  The term loan component requires equalquarterly principal payments of $250,000 during the period of March 2001 toDecember 2008, $23,000,000 of principal payments per quarter for the first twoquarters in 2009 and $6,000,000 in the third quarter of 2009.  The weighted average interest rateassociated with this credit facility varies with LIBOR and certain otherrates.  The weighted average interestrate was 4.32% at December 31, 2002 and 5.30% at December 31, 2001.  HickoryTech has implemented fixed interestterms on various portions of the overall debt outstanding for varyingterms.  The longest fixed interest term,on $40,000,000 of the debt, is fixed until June 2003.  As of December 31, 2002, HickoryTech had drawn $158,000,000 onthis credit facility and had $25,000,000 of available credit.  In April 2002, HickoryTech reduced itsrevolving credit facility by $40,000,000 to its current level as of December31, 2002.  Management believes theremaining available credit is sufficient to cover future cash requirements.

 

HickoryTech’sInformation Solutions Sector leases certain computer equipment under capitallease arrangements.  This sectorrecorded additions to property, plant and equipment of $618,000 and $1,041,000in 2002 and 2001, respectively, related to these capital lease arrangements.

 

In 2001, HickoryTech’sacquisition of PCS licenses was funded with debt, using its revolving creditfacility.

 

HickoryTech continuallymonitors the interest rates on its bank loans.    Aconsistent level of interest expense is likely to occur in 2003 because of themore limited use of the revolving credit facility for capital expenditures andpotentially consistent weighted average interest rate for the year 2003.  Based on HickoryTech’s bankingrelationships, HickoryTech continues to have access to multiple forms offinancing based upon its 2002 current ratio (1.9 to 1.0), its EBITDA, its debtto EBITDA ratio and its proven access to debt markets.

 

The following table setsforth HickoryTech’s contractual obligations, along with the cash payments dueeach period (long-term debt and capital lease payments do not includeassociated interest):

 
|                                |   | **Payments  Due by Period** |    |
|-------------------------------------|--------|-----------------------------|---------|
| **(Dollars in Thousands)**          |   | **Total**                   |    | **Less than  1 year** |   | **1 – 3  years** |   | **4 – 5  years** |   | **After 5  years** |   |
| Contractual  Obligations            |   |                        |    |   |   |   |   |   |   |   |   |
| Long-term Debt                      |   | $                           | 158,000 |   | $ | 1,000 |   | $ | 42,063 |   | $ | 114,937 |   | $ | 0 |   |
| Capital Lease  Obligations          |   | 1,040                       |    | 441 |   | 599 |   | 0 |   | 0 |   |
| Operating Leases                    |   | 3,783                       |    | 1,030 |   | 1,649 |   | 378 |   | 726 |   |
| Total  Contractual Cash Obligations |   | $                           | 162,823 |   | $ | 2,471 |   | $ | 44,311 |   | $ | 115,315 |   | $ | 726 |   |

 

The following table setsforth the total commitment expirations as follows:

 
|                        |   | **Amount of  Commitment Expiration per Period** |    |
|-----------------------------|--------|-------------------------------------------------|---------|
| **(Dollars in Thousands)**  |   | **Total**                                       |    | **Less than  1 year** |   | **1 – 3  years** |   | **4 – 5  years** |   | **After 5  years** |   |
| Revolving Credit  Component |   | $                                               | 125,000 |   | $ | — |   | $ | 64,063 |   | $ | 60,937 |   | $ | — |   |
|                             |        |                                                 |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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On June 26, 2001,HickoryTech acquired two PCS licenses in southern Minnesota. Refer to Note 3 ofNotes to Consolidated Financial Statements for further discussion of thisacquisition.

 

On August 6, 2001,HickoryTech completed the sale of its local telephone exchange in Amana, Iowa.Refer to Note 3 of Notes to Consolidated Financial Statements for furtherdiscussion of this disposition.

 

**CONTINGENCIES**

In January 2002,National Independent Billing Partnership (NIBP), an unconsolidated partnershipof NIBI (see Note 1 of the Notes to Consolidated Financial Statements fordiscussion of NIBP), received written claims from one of its customers relatingto contractual obligations. The claims are not a formal legal action. NIBPdisagrees with the claims made by this customer. There has been no formaldialogue between the parties on this matter since March 2002.  NIBP continues to provide services for thecustomer without further dispute.  Inthe opinion of management, the ultimate resolution of these claims will not havea material adverse impact on HickoryTech’s financial position, results of operationsor cash flows.

 

In 2002, HickoryTech’sBoard of Directors modified the terms of the stock options of a retiringofficer.  The modification extended theperiod after retirement during which the officer can exercise options.  This modification may result in HickoryTechrecognizing up to $173,000 of compensation expense during the first quarter of2003.

 

**RECENT ACCOUNTING DEVELOPMENTS**

In July 2001, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 141, “Business Combinations,” and No. 142,“Goodwill and Other Intangible Assets.” SFAS No. 141 requires that the purchasemethod of accounting be used for all business combinations initiated after June30, 2001. SFAS No. 141 also specifies the criteria that intangible assetsacquired in a purchase method business combination must meet to be recognizedand reported apart from goodwill. HickoryTech made no acquisitions after June30, 2001 and, therefore, SFAS No. 141 had no impact on its 2002 or 2001 results.

 

InJune 2001, the FASB issued SFAS No. 143, “Accounting for Asset RetirementObligations.” SFAS No. 143 requires entities to record the fair value of theliability for legal obligations associated with an asset retirement in theperiod in which the obligation is incurred. When the liability is initiallyrecorded, the entity capitalizes the cost of the asset retirement obligation byincreasing the carrying amount of the related long-lived asset. Over time, theliability is accreted to its present value each period, and the capitalizedcost is depreciated over the useful life of the related asset. As stated inNote 1, HickoryTech’s incumbent local exchange carrier companies (ILEC) followthe provisions of SFAS 71, and therefore conform to the accounting principlesas prescribed by the respective state public utilities commissions and otherfederal agencies, and where applicable, accounting principles generallyaccepted in the United States of America. On December 20, 2002, the FederalCommunications Commission (FCC) notified carriers that they would not adoptSFAS No. 143 for regulatory accounting purposes. Current regulatory accountingrequires incumbent local telephone companies to accrue for asset retirementobligations through prescribed depreciation rates, therefore any assetretirement obligations are effectively recorded in accumulated depreciation.Pursuant to the FCC’s order and the provisions of SFAS No. 71, HickoryTechanticipates that the adoption of SFAS No. 143 will not have a material impacton the financial position or results of operations of its ILEC companies.  HickoryTech has not yet completed itsanalysis of the impact of adoption of SFAS No. 143 for its non-ILEC companies.  However, based upon a preliminary analysis,management does not expect adoption to have a material impact on HickoryTech’sfinancial position or results of operations.

 

In October 2001, theFASB issued SFAS No. 144, “Accounting for Impairment or Disposal of Long-LivedAssets,” SFAS No. 144 requires that long-lived assets that are to be disposedof by sale be measured at the lower of book value or fair value less cost tosell and also sets forth requirements for recognizing and measuring impairmentlosses on certain long-lived assets to be held and used.  The Company adopted SFAS No. 144 effectiveJanuary 1, 2002.  The adoption had noimpact on HickoryTech’s financial position or its results of operations.

 

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InApril 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4,44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.”SFAS No. 145 rescinds FASB Statement No. 4, “Reporting Gains and Losses fromExtinguishment of Debt,” and an amendment of that Statement, FASB Statement No.64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” SFASNo. 145 also rescinds FASB Statement No. 44, “Accounting for Intangible Assetsof Motor Carriers,” and amends FASB Statement No. 13, “Accounting for Leases.”In June 2000, HickoryTech recorded an extraordinary loss of $233,000, net ofincome tax benefit of $158,000, as a result of an extinguishment of debt. UnderSFAS No. 145, this extraordinary loss on debt extinguishment will bereclassified to operating expenses when HickoryTech adopts SFAS No. 145 in thefirst quarter of 2003.

 

InJune 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated withExit or Disposal Activities,” which replaces Emerging Issues Task Force (EITF)Issue No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity (including Certain Costs Incurredin a Restructuring).” SFAS No. 146 requires companies to recognize costsassociated with exit or disposal activities when they are incurred rather thanat the date of a commitment to an exit or disposal plan. SFAS No. 146 iseffective for, and HickoryTech will apply this standard to exit or disposalactivities that are initiated after December 31, 2002.

 

InDecember 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition Disclosure – an amendment of FAS 123” (SFAS No.148).  This Statement amends SFAS No.123, “Accounting for Stock-Based Compensation”, to provide alternative methodsof transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, this Statement amends the disclosure requirements ofStatement 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results.  The provisions of FAS 148 are effective forfinancial statements for fiscal years ending after December 15, 2002, anddisclosure requirements shall be effective for interim periods beginning afterDecember 15, 2002.  The Company intendsto continue to account for stock-based compensation to its employees anddirectors using the intrinsic value method prescribed by APB Opinion No. 25,and related interpretations.  TheCompany has made certain disclosures required by SFAS No. 148 in theconsolidated financial statements for the year ended December 31, 2002 and willbegin making the additional disclosures required by SFAS No. 148 in the firstquarter of 2003.  Accordingly, adoptionof SFAS No. 148 will not impact HickoryTech’s financial position or results ofoperations.

 

InNovember 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accountingand Disclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others.”  Thisinterpretation elaborates on the disclosures required in financial statementsconcerning obligations under certain guarantees.  It also clarifies the requirements related to the recognition ofliabilities by a guarantor at the inception of certain guarantees.  The disclosure requirements of thisinterpretation were effective for HickoryTech on December 31, 2002 but did notrequire any additional disclosures.  Therecognition provisions of the interpretation are effective for HickoryTech in2003 are applicable only to guarantees issued or modified after December 31,2002.  HickoryTech does not expectadoption of these recognitions to have a material impact on its financialposition or results of operations.

 

**REGULATED INDUSTRY**

**STATE**– HickoryTechincreased local rates in its Iowa ILEC subsidiary effective May 2001 and in itsMinnesota ILEC subsidiaries effective December 2001, adding approximately$942,000 of revenues in 2002 and approximately $128,000 of revenues in 2001.

 

Under Minnesota law,telephone companies with less than 50,000 customers are regulated on price andservice level rather than on profit. HickoryTech’s two Minnesota ILECsubsidiaries fall under this alternative form of regulation. HickoryTech’ssubsidiaries’ local service rates are lower than the rates of most Minnesotatelephone companies. While this relieves HickoryTech of substantial regulatoryoversight, the Minnesota Department of Commerce has the authority toinvestigate rates and profits of telephone companies in Minnesota.

 

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In Iowa, HickoryTech’soperations fall below the 15,000 access line minimum level for rate regulationby the Iowa Utilities Board. No regulatory matters in Iowa affect HickoryTech’scurrent operation.

 

State regulators areconsidering many issues, including universal service and access charge reform.There are no specific active dockets at this time, and HickoryTech cannotestimate the amount, if any, of future potential state universal servicematters and access revenue changes.

 

HickoryTech’s CLECcompanies operate in Minnesota and Iowa with less regulatory oversight thanHickoryTech’s ILEC companies.  A CLECpetitions regulators for authority to operate in certain geographic areas,submits tariffs to describe services and the rates at which it will provideservice, and submits interconnection agreements it has reached with othercarriers for regulatory review.  However,there is no regulatory oversight of the prices charged or the rate of returnearned by the CLEC.  HickoryTech’swireless business is also not subject to state regulatory oversight.

 

**INTERSTATE**–****The TelecomSector’s three local exchange telephone companies establish their interstateaccess rates in conjunction with a nationwide pool of companies known as theNational Exchange Carriers Association (NECA). These access charges reflect theFCC rules and changes in regulation as they apply to the other companies thatare in the NECA pools, and ultimately establish the prices that the ILECcompanies can charge for interstate access. HickoryTech’s Minnesota ILEC’sestablish tariffs based on an ‘average schedule’ basis using the overall costsreported by pool members.  HickoryTech’sIowa ILEC performs annual cost studies in accordance with NECA procedures andon which its tariff prices are established.

 

There has been a declinein the level of interstate access charges in the last several years, andHickoryTech foresees a continuation of this trend. The FCC ordered to amend theinterstate access charge rate design in late 2001. The FCC modifications ofILEC transport rate structure, reallocation of costs in the transportinterconnection charge and amendments to universal service funds are effective January1, 2002. The net effect of these changes did not materially change theinterstate revenues for HickoryTech beginning in 2002.  In July of 2002, interstate access rates forHickoryTech’s ILEC’s were further reduced in accordance with the FCC’s accessreform order from October 2001.  Thisreduction was offset by increased support from the ‘Interstate Common LineSupport’ (ICLS) fund.  HickoryTech’sCLEC interstate access charges are set in accordance with the FCC’s 2001 order.

 

FCC regulators may consideradditional access reform. There is a commission proceeding exploring theframework of intercarrier compensation to replace the current access regimeplans when they expire.  HickoryTechcannot estimate the amount, if any, of future potential interstate revenuechanges.

 

InSeptember 1999, by order of the FCC, HickoryTech moved its Iowa telephoneexchange from “average schedule” status for interstate traffic to a pure “costbasis” form of revenue recognition and tariffs. This means that for the Iowatelephone exchange, interstate access revenues are determined based on thespecific company’s cost of service rather than nationwide averages of othercompanies. The switch from “average schedule” to “cost basis” for Iowa’sinterstate revenue has reduced company revenues by less than $200,000 on anannualized basis.

 

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**Item 7A****.       Quantitativeand Qualitative Disclosures About Market Risk.**

 

HickoryTechdoes not have operations subject to risks of foreign currency fluctuations, nordoes HickoryTech use derivative financial instruments in its operations orinvestment portfolio. HickoryTech’s earnings are affected by changes ininterest rates as a portion of its long-term debt has variable interest ratesbased on LIBOR. If interest rates for the portion of HickoryTech’s long-termdebt based on variable rates had averaged 10% more for the entire year endedDecember 31, 2002, HickoryTech’s interest expense would have increased $774,000in 2002. In case of a change of this magnitude, management would likely act tomitigate its exposure to the change by converting a portion of itsvariable-rate debt to fixed-rate debt.

 

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(1)                                  -EBITDA aspresented in this report represents operating income/(loss) excludingdepreciation and amortization expense. EBITDA, which is not a measure of financial performance or liquidityunder generally accepted accounting principles, is provided because HickoryTechbelieves that EBITDA is a useful supplement to operating income/(loss) andother statements of operations data in understanding HickoryTech’s ability toservice and/or incur indebtedness and is useful in measuring the performanceand relative value of HickoryTech’s business. Because of the variety of methods used by companies and analysts tocalculate EBITDA, and the fact that EBITDA calculations may not accuratelymeasure a company’s profitability or its ability to meet debt servicerequirements, caution should be used in relying on any EBITDA presentation.

 

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**Item 8.****          Financial Statements andSupplementary Data.**

 

**REPORTOF MANAGEMENT**

 

Managementof Hickory Tech Corporation (HickoryTech) is responsible for the consolidatedfinancial statements and the other financial information contained in thisAnnual Report. The financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of Americaapplied on a consistent basis and necessarily include some amounts that arebased on management’s estimates and judgment. They are considered by managementto present fairly HickoryTech’s financial position, results of operations andcash flows.

 

Toprovide reasonable assurance that assets are safeguarded against loss and thataccounting records are reliable for preparing financial statements, HickoryTechmanagement maintains a system of internal controls. The Board of Directorspursues its oversight role with respect to HickoryTech’s financial statementsthrough the Audit Committee.  The AuditCommittee, which is composed of directors who are not officers or employees,meets regularly with the independent accountants and management to review thescope of internal controls, the manner in which they perform theirresponsibilities, audit activities and financial reporting. The independentpublic accountants have unrestricted access to the Audit Committee.  The Audit Committee reviews and approvesfinancial disclosures prior to their public release.

 

HickoryTech’sfinancial statements have been audited by PricewaterhouseCoopers LLP,independent accountants. Management has made available to the independentaccountants all HickoryTech financial records and related data. Their audits,which included consideration of the internal controls, culminated in their reportwhich appears on this page.

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

 

**REPORT OF INDEPENDENT ACCOUNTANTS**

 

Tothe Shareholders and Board of Directors of

HickoryTech Corporation

 

Inour opinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of operations, shareholders’ equity and cash flowspresent fairly, in all material respects, the financial position of HickoryTech Corporation and its subsidiaries (HickoryTech) at December 31, 2002 and2001, and the results of their operations and their cash flows for each of thethree years in the period ended December 31, 2002, in conformity withaccounting principles generally accepted in the United States of America. Thesefinancial statements are the responsibility of HickoryTech’s management; ourresponsibility is to express an opinion on these financial statements based onour audits. We conducted our audits of these statements in accordance withauditing standards generally accepted in the United States of America, whichrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

Asdescribed in Note 2 to the consolidated financial statements, effective January1, 2002, the Company adopted Statement of Financial Accounting Standards No.142, “Goodwill and Other Intangible Assets.”

 

PricewaterhouseCoopersLLP

 

Minneapolis,Minnesota

February27, 2003

 

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**HICKORYTECH CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**YearsEnded December 31**

 

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

 
|                                                                                               |   | **2002**       |        | **2001**   |   | **2000**   |   |
|----------------------------------------------------------------------------------------------------|--------|----------------|-------------|------------|--------|------------|--------|
| OPERATING REVENUES:                                                                                |   |           | ** **  |       |   |       |   |
| Telecom Sector                                                                                     |   | **$**          | **86,557**  | ** ** | $      | 84,019     |   | $ | 79,505 |   |
| Information Solutions Sector                                                                       |   | **4,249**      | ** **  | 4,085      |   | 4,287      |   |
| Enterprise Solutions Sector                                                                        |   | **15,781**     | ** **  | 20,374     |   | 18,511     |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| TOTAL OPERATING REVENUES                                                                           |   | **106,587**    | ** **  | 108,478    |   | 102,303    |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| COSTS AND EXPENSES:                                                                                |   |           | ** **  |       |   |       |   |
| Cost of Sales                                                                                      |   | **10,638**     | ** **  | 13,562     |   | 12,510     |   |
| Operating Expenses, Excluding Asset Impairment, Depreciation and  Amortization                     |   | **57,149**     | ** **  | 54,249     |   | 53,182     |   |
| Asset Impairment                                                                                   |   | **41,951**     | ** **  | —     |   | —     |   |
| Depreciation                                                                                       |   | **15,912**     | ** **  | 12,915     |   | 11,088     |   |
| Amortization of Intangibles                                                                        |   | **1,877**      | ** **  | 3,711      |   | 2,995      |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| TOTAL COSTS AND EXPENSES                                                                           |   | **127,527**    | ** **  | 84,437     |   | 79,775     |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| OPERATING INCOME/(LOSS)                                                                            |   | **(20,940**    | **)**       | 24,041     |   | 22,528     |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| OTHER INCOME/(EXPENSE):                                                                            |   |           | ** **  |       |   |       |   |
| Gain/(Loss) on Sale of Assets                                                                      |   | **(183**       | **)**       | 1,115      |   | 271        |   |
| Equity in Net Income/(Loss) of Investees                                                           |   | **(25**        | **)**       | (27        | )      | 23         |   |
| Interest and Other Income                                                                          |   | **345**        | ** **  | 435        |   | 411        |   |
| Interest Expense                                                                                   |   | **(7,405**     | **)**       | (10,855    | )      | (9,988     | )      |
|                                                                                               |   |           | ** **  |       |   |       |   |
| TOTAL OTHER INCOME (EXPENSE)                                                                       |   | **(7,268**     | **)**       | (9,332     | )      | (9,283     | )      |
|                                                                                               |   |           | ** **  |       |   |       |   |
| INCOME/(LOSS) BEFORE INCOME TAXES, EXTRAORDINARY ITEM, AND CUMULATIVE  EFFECT OF ACCOUNTING CHANGE |   | **(28,208**    | **)**       | 14,709     |   | 13,245     |   |
| INCOME TAX (BENEFIT)/PROVISION                                                                     |   | **(11,581**    | **)**       | 5,971      |   | 5,287      |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| INCOME/(LOSS) BEFORE EXTRAORDINARY ITEM AND CUMULATIVE EFFECT OF  ACCOUNTING CHANGE                |   | **(16,627**    | **)**       | 8,738      |   | 7,958      |   |
| EXTRAORDINARY LOSS ON DEBT EXTINGUISHMENT, NET OF TAX BENEFIT OF $158                              |   | **—**     | ** **  | —     |   | (233       | )      |
| CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX BENEFIT OF $14                                  |   | **—**     | ** **  | —     |   | (20        | )      |
|                                                                                               |   |           | ** **  |       |   |       |   |
| NET INCOME/(LOSS)                                                                                  |   | **$**          | **(16,627** | **)**      | $      | 8,738      |   | $ | 7,705 |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| Basic Earnings/(Loss) Per Share:                                                                   |   | **$**          | **(1.19**   | **)**      | $      | 0.63       |   | $ | 0.56 |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| Dividends Per Share                                                                                |   | **$**          | **0.44**    | ** ** | $      | 0.44       |   | $ | 0.44 |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| Weighted Average Common Shares Outstanding                                                         |   | **14,023,645** | ** **  | 13,904,690 |   | 13,832,502 |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| Diluted Earnings/(Loss) Per Share:                                                                 |   | **$**          | **(1.19**   | **)**      | $      | 0.62       |   | $ | 0.55 |   |
|                                                                                               |   |           | ** **  |       |   |       |   |
| Weighted Average Common and Equivalent Shares Outstanding                                          |   | **14,023,645** | ** **  | 14,001,478 |   | 13,923,015 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

34

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**HICKORYTECH CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**As ofDecember 31**

 

*(Dollarsin Thousands)*

 
|                                                                                                                                   |   | **2002**    |        | **2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|----------|--------|
| ASSETS                                                                                                                                 |   |        |        |     |   |
| CURRENT ASSETS:                                                                                                                        |   |        |        |     |   |
| Cash and Cash  Equivalents                                                                                                             |   | **$**       | **1,874**   |     | $      | 2,008 |   |
| Receivables, Net  of Allowance for Doubtful Accounts of $1,358 and  $1,231                                                        |   | **11,056**  |        | 14,616   |   |
| Income Taxes  Receivable                                                                                                               |   | **3,222**   |        | 1,675    |   |
| Costs in Excess  of Billings on Contracts                                                                                              |   | **2,107**   |        | 1,520    |   |
| Inventories                                                                                                                            |   | **5,059**   |        | 4,989    |   |
| Deferred Income  Taxes                                                                                                                 |   | **951**     |        | 646      |   |
| Other                                                                                                                                  |   | **2,840**   |        | 2,329    |   |
| TOTAL CURRENT  ASSETS                                                                                                                  |   | **27,109**  |        | 27,783   |   |
|                                                                                                                                   |   |        |        |     |   |
| INVESTMENTS                                                                                                                            |   | **10,517**  |        | 10,701   |   |
|                                                                                                                                   |   |        |        |     |   |
| PROPERTY, PLANT  AND EQUIPMENT                                                                                                         |   | **247,375** |        | 231,675  |   |
| Less ACCUMULATED  DEPRECIATION                                                                                                         |   | **111,101** |        | 96,031   |   |
| PROPERTY, PLANT  AND EQUIPMENT, NET                                                                                                    |   | **136,274** |        | 135,644  |   |
|                                                                                                                                   |   |        |        |     |   |
| OTHER ASSETS:                                                                                                                          |   |        |        |     |   |
| Goodwill                                                                                                                               |   | **25,086**  |        | 25,086   |   |
| Intangible  Assets, Net                                                                                                                |   | **34,669**  |        | 76,991   |   |
| Deferred Costs  and Other                                                                                                              |   | **6,556**   |        | 7,087    |   |
| TOTAL OTHER  ASSETS                                                                                                                    |   | **66,311**  |        | 109,164  |   |
| TOTAL ASSETS                                                                                                                           |   | **$**       | **240,211** |     | $      | 283,292 |   |
|                                                                                                                                   |   |        |        |     |   |
| LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                            |   |        |        |     |   |
| CURRENT  LIABILITIES:                                                                                                                  |   |        |        |     |   |
| Accounts Payable                                                                                                                       |   | **$**       | **4,543**   |     | $      | 3,338 |   |
| Accrued Expenses                                                                                                                       |   | **3,719**   |        | 5,335    |   |
| Accrued Interest                                                                                                                       |   | **512**     |        | 382      |   |
| Billings in  Excess of Costs on Contracts                                                                                              |   | **80**      |        | 169      |   |
| Advanced  Billings and Deposits                                                                                                        |   | **3,741**   |        | 3,580    |   |
| Current  Maturities of Long-Term Obligations                                                                                           |   | **1,441**   |        | 1,242    |   |
| TOTAL CURRENT  LIABILITIES                                                                                                             |   | **14,036**  |        | 14,046   |   |
|                                                                                                                                   |   |        |        |     |   |
| LONG-TERM  OBLIGATIONS, Net of Current Maturities                                                                                      |   | **157,599** |        | 169,659  |   |
|                                                                                                                                   |   |        |        |     |   |
| DEFERRED INCOME  TAXES                                                                                                                 |   | **4,377**   |        | 13,876   |   |
|                                                                                                                                   |   |        |        |     |   |
| DEFERRED REVENUE  AND EMPLOYEE BENEFITS                                                                                                |   | **5,604**   |        | 4,946    |   |
|                                                                                                                                   |   |        |        |     |   |
| TOTAL  LIABILITIES                                                                                                                     |   | **181,616** |        | 202,527  |   |
|                                                                                                                                   |   |        |        |     |   |
| COMMITMENTS AND  CONTINGENCIES (Notes 7, 8 and 12)                                                                                     |   | **—**  |        | —   |   |
|                                                                                                                                   |   |        |        |     |   |
| SHAREHOLDERS’  EQUITY:                                                                                                            |   |        |        |     |   |
| Common Stock, no  par value, $.10 stated value  Shares authorized: 100,000,000  Shares outstanding: 2002, 13,983,929; 2001, 13,935,308 |   | **1,398**   |        | 1,394    |   |
| Additional  Paid-In Capital                                                                                                            |   | **7,885**   |        | 6,254    |   |
| Retained  Earnings                                                                                                                     |   | **49,312**  |        | 73,117   |   |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                                       |   | **58,595**  |        | 80,765   |   |
|                                                                                                                                   |   |        |        |     |   |
| TOTAL  LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                     |   | **$**       | **240,211** |     | $      | 283,292 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

35

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**HICKORY TECH CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**Years Ended December 31**

 

*(Dollars in Thousands)*

 
|                                                                                          |   | **2002**    |        | **2001**   |   | **2000** |   |
|-----------------------------------------------------------------------------------------------|--------|-------------|-------------|------------|--------|----------|--------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                         |   |        |        |       |   |     |   |
| Net Income/(Loss)                                                                             |   | **$**       | **(16,627** | **)**      | $      | 8,738    |   | $ | 7,705 |   |
| Adjustments to Reconcile Net Income to Net Cash Provided by Operating  Activities:            |   |        | ** **  |       |   |     |   |
| Depreciation and Amortization                                                                 |   | **17,789**  | ** **  | 16,794     |   | 14,268   |   |
| Asset Impairment                                                                              |   | **41,951**  | ** **  | —     |   | —   |   |
| (Gain)/Loss on Sale of Assets                                                                 |   | **183**     | ** **  | (1,115     | )      | (271     | )      |
| Extraordinary Loss on Debt Extinguishment                                                     |   | **—**  | ** **  | —     |   | 391      |   |
| Cumulative Effect of Accounting Change                                                        |   | **—**  | ** **  | —     |   | 34       |   |
| Provision for Losses on Accounts Receivable                                                   |   | **2,114**   | ** **  | 782        |   | 1,005    |   |
| Deferred Income Taxes                                                                         |   | **(9,804**  | **)**       | 5,217      |   | 2,577    |   |
| Stock-Based Compensation                                                                      |   | **329**     | ** **  | 217        |   | 660      |   |
| Employee Retirement Benefits and Deferred Compensation                                        |   | **471**     | ** **  | 170        |   | 202      |   |
| Accrued Patronage Refunds                                                                     |   | **(583**    | **)**       | (1,114     | )      | —   |   |
| Equity in Net (Income)/Loss of Investees                                                      |   | **25**      | ** **  | 27         |   | (23      | )      |
| Tax Benefit from Stock Option Transactions                                                    |   | **118**     | ** **  | —     |   | —   |   |
| **Cash Provided From Operations Before Changes In  Assets and Liabilities**                   |   | **35,966**  | ** **  | 29,716     |   | 26,548   |   |
| Changes in Operating Assets and Liabilities Net of Effects of  Acquisitions and Dispositions: |   |        | ** **  |       |   |     |   |
| Receivables                                                                                   |   | **(254**    | **)**       | (823       | )      | 878      |   |
| Inventories                                                                                   |   | **(70**     | **)**       | (442       | )      | (2,102   | )      |
| Billings and Costs on Contracts                                                               |   | **(676**    | **)**       | (1,321     | )      | 379      |   |
| Accounts Payable and Accrued Expenses                                                         |   | **(281**    | **)**       | (1,525     | )      | (2,319   | )      |
| Advance Billings and Deposits                                                                 |   | **161**     | ** **  | 125        |   | 181      |   |
| Deferred Revenue and Employee Benefits                                                        |   | **(310**    | **)**       | 23         |   | (584     | )      |
| Other                                                                                         |   | **131**     | ** **  | (618       | )      | (73      | )      |
| Net Cash Provided By Operating Activities                                                     |   | **34,667**  | ** **  | 25,135     |   | 22,908   |   |
|                                                                                          |   |        | ** **  |       |   |     |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                         |   |        | ** **  |       |   |     |   |
| Additions to Property, Plant and Equipment                                                    |   | **(16,674** | **)**       | (32,868    | )      | (39,662  | )      |
| Additions to Capitalized Software Development Costs                                           |   | **—**  | ** **  | (2,717     | )      | (1,450   | )      |
| Increase in Investments                                                                       |   | **—**  | ** **  | —     |   | (10,363  | )      |
| Redemption of Investments                                                                     |   | **100**     | ** **  | —     |   | 700      |   |
| Acquisitions, Net of Cash Acquired                                                            |   | **—**  | ** **  | (11,386    | )      | (885     | )      |
| Proceeds from Sale of Assets                                                                  |   | **243**     | ** **  | 6,992      |   | 422      |   |
| Net Cash Used In Investing Activities                                                         |   | **(16,331** | **)**       | (39,979    | )      | (51,238  | )      |
|                                                                                          |   |        | ** **  |       |   |     |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                         |   |        | ** **  |       |   |     |   |
| Change in Cash Overdraft                                                                      |   | **—**  | ** **  | —     |   | (3,552   | )      |
| Payment of Debt Issuance Costs                                                                |   | **—**  | ** **  | —     |   | (1,300   | )      |
| Repayments of Debt                                                                            |   | **—**  | ** **  | (649       | )      | (40,452  | )      |
| Payments of Capital Lease Obligations                                                         |   | **(480**    | **)**       | (141       | )      | —   |   |
| Borrowings on Credit Facility                                                                 |   | **2,950**   | ** **  | 30,500     |   | 78,600   |   |
| Repayments on Credit Facility                                                                 |   | **(14,950** | **)**       | (8,500     | )      | (1,100   | )      |
| Proceeds from Issuance of Common Stock                                                        |   | **1,252**   | ** **  | 569        |   | 701      |   |
| Dividends Paid                                                                                |   | **(6,170**  | **)**       | (6,117     | )      | (6,085   | )      |
| Stock Repurchase                                                                              |   | **(1,072**  | **)**       | —     |   | —   |   |
| Net Cash (Used In) Provided By Financing Activities                                           |   | **(18,470** | **)**       | 15,662     |   | 26,812   |   |
|                                                                                          |   |        | ** **  |       |   |     |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                          |   | **(134**    | **)**       | 818        |   | (1,518   | )      |
|                                                                                          |   |        | ** **  |       |   |     |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                              |   | **2,008**   | ** **  | 1,190      |   | 2,708    |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                    |   | **$**       | **1,874**   | ** ** | $      | 2,008    |   | $ | 1,190 |   |
|                                                                                          |   |        | ** **  |       |   |     |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                             |   |        | ** **  |       |   |     |   |
| Cash Paid for Interest                                                                        |   | **$**       | **7,682**   | ** ** | $      | 11,337   |   | $ | 10,643 |   |
| Cash Paid for Income Taxes, Net of $990 of Tax Refunds in 2002                                |   | **$**       | **(230**    | **)**      | $      | 1,750    |   | $ | 2,205 |   |
| NON-CASH INVESTING ACTIVITIES:                                                                |   |        | ** **  |       |   |     |   |
| Property, Plant and Equipment Acquired with Capital Leases                                    |   | **$**       | **618**     | ** ** | $      | 1,041    |   | $ | — |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

36

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**HICKORYTECH CORPORATION**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY**

**YearsEnded December 31**

 
|                                 |   | **Common Stock** |   | **Additional  Paid - In  Capital** |   | **Retained  Earnings** |   | **Total  Shareholders’  Equity** |   |
|--------------------------------------|--------|------------------|--------|------------------------------------|--------|------------------------|--------|---------------------------------------|--------|
| **Shares**                           |   | **Amount**       |
|                                 |   |             |   |                               |   |                   |   |                                  |   |   |   |
| BALANCE AT  DECEMBER 31, 1999        |   | 13,787,416       |   | $                                  | 1,379  |                   | $      | 4,221                                 |   | $ | 68,876 |   | $ | 74,476 |   |
|                                 |   |             |   |                               |   |                   |   |                                  |   |   |   |
| Stock Award Plan                     |   | 29,788           |   | 3                                  |   | 496                    |   |                                  |   | 499 |   |
| Employee Stock  Purchase Plan        |   | 28,464           |   | 3                                  |   | 287                    |   |                                  |   | 290 |   |
| Directors’ Stock  Retainer Plan |   | 2,967            |   |                               |   | 50                     |   |                                  |   | 50 |   |
| Stock Options  Exercised             |   | 15,384           |   | 2                                  |   | 181                    |   |                                  |   | 183 |   |
| Dividend  Reinvestment Plan          |   | 14,549           |   | 1                                  |   | 238                    |   |                                  |   | 239 |   |
| Net Income                           |   |             |   |                               |   |                   |   | 7,705                                 |   | 7,705 |   |
| Dividends Paid                       |   |             |   |                               |   |                   |   | (6,085                                | )      | (6,085 | ) |
|                                 |   |             |   |                               |   |                   |   |                                  |   |   |   |
| BALANCE AT  DECEMBER 31, 2000        |   | 13,878,568       |   | 1,388                              |   | 5,473                  |   | 70,496                                |   | 77,357 |   |
|                                 |   |             |   |                               |   |                   |   |                                  |   |   |   |
| Stock Award Plan                     |   | 18,374           |   | 2                                  |   | 211                    |   |                                  |   | 213 |   |
| Employee Stock  Purchase Plan        |   | 20,781           |   | 2                                  |   | 291                    |   |                                  |   | 293 |   |
| Directors’ Stock  Retainer Plan |   | 2,089            |   |                               |   | 33                     |   |                                  |   | 33 |   |
| Dividend  Reinvestment Plan          |   | 15,496           |   | 2                                  |   | 246                    |   |                                  |   | 248 |   |
| Net Income                           |   |             |   |                               |   |                   |   | 8,738                                 |   | 8,738 |   |
| Dividends Paid                       |   |             |   |                               |   |                   |   | (6,117                                | )      | (6,117 | ) |
|                                 |   |             |   |                               |   |                   |   |                                  |   |   |   |
| BALANCE AT  DECEMBER 31, 2001        |   | 13,935,308       |   | 1,394                              |   | 6,254                  |   | 73,117                                |   | 80,765 |   |
|                                 |   |             |   |                               |   |                   |   |                                  |   |   |   |
| Stock Award Plan                     |   | 43,931           |   | 4                                  |   | 295                    |   |                                  |   | 299 |   |
| Employee Stock  Purchase Plan        |   | 24,777           |   | 2                                  |   | 297                    |   |                                  |   | 299 |   |
| Directors’ Stock  Retainer Plan |   | 2,282            |   |                               |   | 30                     |   |                                  |   | 30 |   |
| Stock Options  Exercised             |   | 63,796           |   | 6                                  |   | 696                    |   |                                  |   | 702 |   |
| Dividend  Reinvestment Plan          |   | 19,535           |   | 2                                  |   | 249                    |   |                                  |   | 251 |   |
| Stock Repurchase                     |   | (105,700         | )      | (10                                | )      | (54                    | )      | (1,008                                | )      | (1,072 | ) |
| Stock Option Tax  Benefit            |   |             |   |                               |   | 118                    |   |                                  |   | 118 |   |
| Net  Income/(Loss)                   |   |             |   |                               |   |                   |   | (16,627                               | )      | (16,627 | ) |
| Dividends Paid                       |   |             |   |                               |   |                   |   | (6,170                                | )      | (6,170 | ) |
|                                 |   |             |   |                               |   |                   |   |                                  |   |   |   |
| BALANCE AT  DECEMBER 31, 2002        |   | 13,983,929       |   | $                                  | 1,398  |                   | $      | 7,885                                 |   | $ | 49,312 |   | $ | 58,595 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

37

----

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 –ACCOUNTING POLICIES**

The accounting policies of Hickory Tech Corporation (HickoryTech) arein conformity with accounting principles generally accepted in the UnitedStates of America and, where applicable, conform to the accounting principlesas prescribed 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 ofConsolidation** - The consolidated financial statements ofHickoryTech include Hickory Tech Corporation and its subsidiaries in thefollowing three business segments:  (i)Telecom Sector, (ii) Information Solutions Sector and (iii) EnterpriseSolutions Sector. An investment in an unconsolidated partnership for theInformation Solutions Sector is accounted for using the equity method.  All intercompany transactions have beeneliminated from the consolidated financial statements.

 

Beginning in 2002, HickoryTech reports its previously reported businesssegments of Telephone, Communications Services and Wireless Services as asingle segment referred to as the Telecom Sector. This new basis of segmentreporting reflects the integration of HickoryTech’s management, sales, serviceand support functions in these three areas, as well as reflecting the level atwhich management now reviews and makes resource allocation and other managementdecisions regarding the operations of the company. All segment informationreported in 2001 and 2000 has been reclassified to conform to this newpresentation.

 

In addition to the change in business segments, certainreclassifications were made to the financial statements as of and for the yearsended December 31, 2001 and 2000 to conform to the 2002 presentation. Thesereclassifications had no impact on previously reported operating revenue, netincome or shareholders’ equity.

 

Operating expenses include all costs related to delivery ofHickoryTech’s communications services and products. These costs include allselling, general and administrative costs and all costs of performing servicesand providing related products, except for costs associated with thedepreciation and amortization of property, plant and equipment, intangibleasset impairment charges related to FCC licenses and costs of sales for theEnterprise Solutions Sector.

 

**RevenueRecognition** – Revenues are recognized when services areearned, rendered or products are delivered to customers.  Customers are billed as of monthly cycledates. Telecom Sector revenues are derived from charges for network access toHickoryTech’s local exchange telephone network, from subscriber line chargesand from contractual arrangements for services such as billing and collectionand directory advertising.  Certain ofthese revenues are realized under pooling arrangements with other telephonecompanies and are divided among the companies based on respective costs andinvestments to provide the services. Management believes that recorded amountsrepresent reasonable estimates of the final distribution from these pools.Revenue in the Enterprise Solutions Sector earned on major installation andchange contracts is recognized on the percentage of completion method. Up-frontfees, including installation and activation fees, are deferred and recognizedon a straight-line basis over the corresponding customer relationship period.

 

**Estimates–** The preparation of the consolidated financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses anddisclosure of contingent assets and liabilities. The estimates and assumptionsused in the accompanying consolidated financial statements are based uponmanagement’s evaluation of the relevant facts and circumstances as of the dateof the financial statements. Actual results may differ from these estimates andassumptions.

 

**Reclassifications****–**In addition to the change in business segments, certain reclassifications weremade to the financial statements to conform to the 2002 presentation.  These reclassifications had no impact onpreviously reported net income or shareholders’ equity.  These reclassifications increased cost ofsales and reduced other operating expenses by $13,562,000 and $12,510,000 for2001 and 2000 respectively.

 

**Property,Plant and Equipment** - Property, plant and equipment arerecorded at original cost of acquisition or construction.  When regulated incumbent local exchangecarrier (ILEC) telephone assets are sold or retired, the assets and relatedaccumulated depreciation are removed from the accounts and any gains or losseson disposition are amortized with the remaining net investment in telephoneplant.  When other plant and equipmentis sold or retired, the cost and related accumulated depreciation oramortization are removed from the respective accounts and any resulting gain orloss is included in other income(expense).

 

The components of property, plant and equipment are summarized asfollows:

 
| **(Dollars in Thousands)**            |   | **2002**    |        | **2001** |   |
|---------------------------------------|--------|-------------|-------------|----------|--------|
|                                  |   |        |        |     |   |
| ILEC Telephone Plant (Telecom Sector) |   | **$**       | **152,305** |     | $      | 147,315 |   |
| CLEC Telephone Plant (Telecom Sector) |   | **54,786**  |        | 51,175   |   |
| Wireless Plant (Telecom Sector)       |   | **27,871**  |        | 23,606   |   |
| Other Property and Equipment          |   | **12,413**  |        | 9,579    |   |
| Total                                 |   | **247,375** |        | 231,675  |   |
| Less Accumulated Depreciation         |   | **111,101** |        | 96,031   |   |
| Property, Plant and Equipment, Net    |   | **$**       | **136,274** |     | $      | 135,644 |   |

 

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Depreciation for financial statement purposes is determined using thestraight-line method based on the lives of the various classes of depreciableassets. The composite depreciation rates on ILEC telephone plant for the threeyears ended December 31, 2002, were 6.1%, 5.9%, and 6.0%.  All other property, plant and equipment isdepreciated over estimated useful lives of three to fifteen years, andbuildings are depreciated over their estimated useful lives of thirty-nineyears. Other property and equipment includes $618,000 and $1,041,000 ofequipment acquired under capital leases in 2002 and 2001.  Amortization expense related to thesecapital leases was $459,000 and $130,000 in 2002 and 2001.

 

**CashEquivalents** - Cash equivalents include short-term investmentswith original maturities of three months or less. The carrying value of cashand cash equivalents approximates its fair value due to the short maturity ofthe instruments.

 

**Investments**– Investments include $10.1 million of non-interest bearing Rural TelephoneFinance Cooperative (RTFC) Subordinated Capital Certificates (SCCs) accountedfor under the cost method of accounting. This method requires HickoryTech to periodically evaluate whether anon-temporary decrease in value of the investment has occurred, and if so, towrite this investment down to its net realizable value.

 

Investments also include an unconsolidated partnership accounted forusing the equity method of accounting. NIBI, a wholly-owned subsidiary ofHickorytech is a 40% general partner in National Independent BillingPartnership (NIBP), which performs billing and collection clearinghousefunctions for interexchange carriers. NIBP had total assets of $496,000 and$1,623,000 as of December 31, 2002 and 2001, respectively. NIBP had totalliabilities of $413,000 and $1,472,000 as of December 31, 2002 and 2001,respectively. For the years ended December 31, 2002, 2001 and 2000, NIBP hadrevenues of $184,000, $620,000 and $1,006,000 respectively, and netincome/(loss) of ($68,000), $(67,000) and $57,000, respectively.

 

**Inventories**– Inventories, which consist of equipment for resale, materials and supplies,are stated at the lower of average cost or market.  Cost is based on FIFO valuations.

 

**IncomeTaxes** – HickoryTech accounts for income taxes in accordancewith SFAS No. 109, “Accounting for Income Taxes,” which requires an asset andliability approach to financial accounting and reporting for income taxes.Accordingly, deferred tax assets and liabilities arise from the differencebetween the tax basis of an asset or liability and its reported amount in thefinancial statements. Deferred tax amounts are determined by using the taxrates expected to be in effect when the taxes will actually be paid or refundsreceived, as provided under currently enacted tax law. Valuation allowances areestablished when necessary to reduce deferred tax assets to the amount expectedto be realized. Income tax expense or benefit is the tax payable or refundable,respectively, for the period plus or minus the change in deferred tax assetsand liabilities during the period.

 

**IntangibleAssets and Goodwill** – HickoryTech adopted the provisions ofStatement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and OtherIntangible Assets,” effective January 1, 2002. SFAS No. 142 required thatgoodwill and intangible assets with indefinite useful lives no longer beamortized, but instead tested for impairment at least annually. Accordingly, atJanuary 1, 2002, HickoryTech ceased amortizing its goodwill and FCClicenses.  See Note 2 for a moredetailed discussion of the intangible assets and goodwill.

 

**CapitalizedSoftware Costs –**Software costs associated with software thatis developed or purchased for internal use only are accounted for in accordancewith the American Institute of Certified Public Accountants Statement ofPosition 98-1, “Accounting for the Costs of Computer Software Developed orObtained for Internal Use.” HickoryTech capitalizes costs (including right touse fees) associated with externally acquired software for internal use. Costsassociated with internally developed software are segregated into three projectstages: preliminary project stage, application development stage andpost-implementation stage. Costs associated with both the preliminary projectstage and post-implementation stage, are expensed as incurred. Costs associatedwith the application development stage are capitalized. Software maintenanceand training costs are expensed as incurred. Amortization of software costscommences when the software is ready for its intended use, and is amortizedover a period of three years. During 2002,****2001****and 2000,HickoryTech capitalized $2,439,000,$1,285,000****and$492,000,****respectively, of costsassociated with software purchased or developed for internal use only.****These software costs are included inproperty, plant and equipment, and amounted to $3,196,000****and $1,503,000****at December 31, 2002****and2001,****respectively.****These amounts are net of accumulatedamortization of $412,000 and****$184,000at December 31, 2002****and 2001,****respectively.****Amortization expense relating to these costs amounted to$746,000 and $196,000 in 2002 and 2001, respectively.

 

Software costs associated with software that is developed or purchasedfor external sale or license are accounted for in accordance with SFAS No. 86,“Accounting for the Costs of Computer Software to Be Sold, Leased or OtherwiseMarketed.” HickoryTech capitalizes costs related to such software whentechnological feasibility has been established and continues capitalizationuntil the product becomes available for general release to customers. In 2002,HickoryTech did not incur any capitalizable software development costsassociated with software for sale or external license.  HickoryTech capitalized software costs of****$2,717,000 and****$1,450,000****in****2001****and2000, respectively,****related tosoftware that will be sold or licensed externally.****These software costs are included in other non-currentassets,****and****amounted to****$2,170,000****and$3,197,000 at December 31,****2002****and 2001, respectively.****These amounts are net of accumulatedamortization of****$1,756,000 and****$729,000at December 31, 2002****and2001,****respectively.****Capitalized software costs are amortizedon a product-by-product basis over the estimated economic life of the product,which are currently three and four years. Amortization expense relating to these costs amounted to****$1,027,000 in 2002 and****$596,000 in 2001.

 

**ComprehensiveIncome –** SFAS No. 130 requires that a full set of generalpurpose financial statements include the reporting of “comprehensiveincome.”  In addition to netincome(loss), comprehensive income is generally comprised of foreign currencyitems, minimum pension liability adjustments and unrealized gains and losses oncertain investments in debt and equity securities. During the years endedDecember 31, 2002, 2001 and 2000, comprehensive income(loss) was comprisedsolely of net income(loss).

 

39

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**AdvertisingExpense** – Advertising is expensed as incurred. Advertisingexpense charged to operations was $1,403,000, $952,000 and $1,050,000 in 2002,2001 and 2000, 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 employee stockpurchase plan (ESPP).

** **
|                                |   | **2002**       |   | **2001**   |   | **2000**   |   |
|-------------------------------------|--------|----------------|--------|------------|--------|------------|--------|
| Weighted Average Shares Outstanding |   | **14,023,645** |   | 13,904,690 |   | 13,832,502 |   |
| Stock Options                       |   | **—**     |   | 95,645     |   | 89,305     |   |
| Stock Subscribed (ESPP)             |   | **—**     |   | 1,143      |   | 1,208      |   |
|                                |   |           |   |       |   |       |   |
| Total Dilutive Shares Outstanding   |   | **14,023,645** |   | 14,001,478 |   | 13,923,015 |   |

 

Options to purchase 554,335 shares and 13,029 shares subscribed underthe employee stock purchase plan in 2002, options to purchase 76,750 shares in2001 and options to purchase 15,750 shares in 2000 were not included in thecomputation of earnings per share assuming dilution because their effect onearnings per share would have been antidilutive.  The increase in number of shares excluded in 2002 is the resultof all shares being antidilutive in net loss years, such as 2002.

 

Dividends per share is based on the quarterly dividend per share asdeclared by the HickoryTech Board of Directors.

 

**Stock Compensation –**AtDecember 31, 2002, HickoryTech has four stock-based employee compensationplans, which are described more fully in Note 6.  HickoryTech has elected to apply Accounting Principles BoardOpinion No. 25 and related interpretations in accounting for its employee anddirectors’ stock compensation plans.  IfHickoryTech had elected to recognize compensation cost based on the fair valueof the options as prescribed by SFAS No. 123, the following operating resultswould have occurred using the Black-Scholes option-pricing model to determinethe fair value of the options (see Note 6):

** **
|                                                                                                                                         |   | **Years  Ended December 31** |        |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|-------------|
| **Dollars  in Thousands**                                                                                                                    |   | **2002**                     |        | **2001** |   | **2000** |   |
|                                                                                                                                         |   |                         |        |   |   |   |   |
| Reported Net Income/(Loss)                                                                                                                   |   | **$**                        | **(16,627** | **)** | $ | 8,738 |   | $ | 7,705 |   |
| Add: Stock-based employee compensation expense included in reported  net income, net of related tax effects                                  |   | **329**                      | ** **  | 217 |   | 660 |   |
| Deduct: Total stock-based employee compensation expense determined  under fair value based method for all awards, net of related tax effects |   | **(666**                     | **)**       | (539 | ) | (1,085 | ) |
|                                                                                                                                         |   |                         | ** **  |   |   |   |   |
| Pro Forma Net Income/(Loss)                                                                                                                  |   | **$**                        | **(16,964** | **)** | $ | 8,416 |   | $ | 7,280 |   |
|                                                                                                                                         |   |                         | ** **  |   |   |   |   |
| Earnings per share:                                                                                                                          |   |                         | ** **  |   |   |   |   |
| Basic - as reported                                                                                                                          |   | **$**                        | **(1.19**   | **)** | $ | 0.63 |   | $ | 0.56 |   |
| Basic - pro forma                                                                                                                            |   | **$**                        | **(1.21**   | **)** | $ | 0.61 |   | $ | 0.53 |   |
|                                                                                                                                         |   |                         | ** **  |   |   |   |   |
| Diluted - as reported                                                                                                                        |   | **$**                        | **(1.19**   | **)** | $ | 0.62 |   | $ | 0.55 |   |
| Diluted - pro forma                                                                                                                          |   | **$**                        | **(1.21**   | **)** | $ | 0.60 |   | $ | 0.52 |   |

 

**NOTE 2 –****GOODWILL AND OTHER INTANGIBLE ASSETS -ADOPTION OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS (SFAS) NO. 142**

Effective January 1, 2002, HickoryTech adopted SFAS No. 142,“Goodwill and Other Intangible Assets.” SFAS No. 142 established newstandards related to how acquired goodwill and other intangible assets are tobe recorded upon their acquisition as well as how they are to be accounted forafter they have been initially recognized in the financial statements.

 

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Effective with the adoption of this standard, HickoryTech is no longeramortizing acquired goodwill. Instead, SFAS No. 142 requires acquiredgoodwill to be evaluated for impairment using a two-step test based upon a fairvalue approach. The first step is used to identify potential impairment, whilethe second step calculates the amount of impairment, if any. Upon adoption ofthis standard, HickoryTech completed a transitional impairment test for itsacquired goodwill, determining fair value using primarily a discounted cash flowmodel. The determined fair value was sufficient to pass the first stepimpairment test, and therefore no impairment was recorded.

 

Additionally, upon adoption of SFAS No. 142, HickoryTech wasrequired to reassess the useful lives of its other intangible assets.HickoryTech’s other intangible assets primarily consist of customer lists andwireless FCC licenses (FCC licenses). HickoryTech’s FCC licenses have terms often years, but are renewable.  Therenewal of FCC licenses is a routine matter involving a nominal fee andHickoryTech has determined that no legal, regulatory, contractual, competitive,economic or other factors currently exist that limit the useful life of its FCClicenses. As such, effective with the adoption of SFAS No. 142, HickoryTechis no longer amortizing FCC licenses as they are deemed to be intangible assetsthat have indefinite lives. Prospectively, HickoryTech will continue to periodically reevaluate itsdetermination of an indefinite useful life with regards to FCC licenses. SFAS No. 142requires that indefinite lived intangible assets be tested for impairment bycomparing the fair value of the assets to their carrying amount. Upon adoptionof this standard, HickoryTech completed a transitional impairment test for FCClicenses, calculating fair value using primarily a discounted cash flow modeland corroborating marketplace transactions, and determined that there was noimpairment to be recorded. The FCC licenses were tested for impairment on anaggregate basis, which is consistent with HickoryTech’s management of thewireless business within the Telecom Sector. HickoryTech also re-assessed theuseful life of its other intangible assets and concluded that the existinglives of up to eight years should be continued.

 

On a prospective basis, HickoryTech is required to test both acquiredgoodwill and FCC licenses for impairment on an annual basis based upon a fairvalue approach. Additionally, goodwill shall be tested for impairment betweenannual tests if an event occurs or circumstances change that would more likelythan not reduce the fair value of an entity below its carrying value. Otherindefinite-lived intangible assets will be tested between annual tests ifevents or changes in circumstances indicate that the asset might be impaired.During the fourth quarter, HickoryTech completed its annual impairment testsfor both acquired goodwill and FCC licenses using methodologies consistent withthose applied for its transitional impairment tests performed as ofJanuary 1, 2002. Such testing resulted in no impairment charge to goodwillas the determined fair value was again sufficient to pass the first stepimpairment test. The first annual reassessment of HickoryTech’s FCC licenses,however, resulted in a total pre-tax impairment charge of $41,635,000 in thefourth quarter of 2002 in the Telecom Sector. This impairment is reported as an“Asset Impairment” in HickoryTech’s consolidated statement of income for theyear ended December 31, 2002. HickoryTech believes that the decline in the fairvalue of its FCC licenses is due principally to declining roaming revenues, therapid pace of technological change being undertaken by the major wirelessservice providers to adopt new protocols (i.e. GSM or CDMA) and potentiallymove away from the HickoryTech’s primary protocol called TDMA, increasing pricecompetition, and the protracted downturn in the telecommunications market.

 

The following tables provide a reconciliation of the reported netincome (loss) to an adjusted net income (loss) and basic and dilutedearnings per share to add back amortization of goodwill and FCC licenseamortization, assuming that SFAS No. 142 had been adopted as ofJanuary 1, 2000:

 

 
| **(Dollars in Thousands, except Per  Share Amounts and shown Net of Income Tax)** |   | **2002**   |        | **2001** |   | **2000** |   |
|-----------------------------------------------------------------------------------|--------|------------|-------------|----------|--------|----------|--------|
|                                                                              |   |       |        |     |   |     |   |
| Reported Net Income/(Loss)                                                        |   | **$**      | **(16,627** | **)**    | $      | 8,738    |   | $ | 7,705 |   |
| Goodwill Amortization                                                             |   | **—** | ** **  | 452      |   | 452      |   |
| FCC License Amortization                                                          |   | **—** | ** **  | 1,035    |   | 1,035    |   |
| Adjusted Net Income/(Loss)                                                        |   | **$**      | **(16,627** | **)**    | $      | 10,225   |   | $ | 9,192 |   |
|                                                                              |   |       | ** **  |     |   |     |   |
| Basic Earnings Per Share:                                                         |   |       | ** **  |     |   |     |   |
| Reported Net Income/(Loss)                                                        |   | **$**      | **(1.19**   | **)**    | $      | 0.63     |   | $ | 0.56 |   |
| Goodwill Amortization                                                             |   | **—** | ** **  | 0.03     |   | 0.03     |   |
| FCC License Amortization                                                          |   | **—** | ** **  | 0.07     |   | 0.07     |   |
| Adjusted Net Income/(Loss)                                                        |   | **$**      | **(1.19**   | **)**    | $      | 0.73     |   | $ | 0.66 |   |
|                                                                              |   |       | ** **  |     |   |     |   |
| Diluted Earnings Per Share:                                                       |   |       | ** **  |     |   |     |   |
| Reported Net Income(Loss)                                                         |   | **$**      | **(1.19**   | **)**    | $      | 0.62     |   | $ | 0.55 |   |
| Goodwill Amortization                                                             |   | **—** | ** **  | 0.03     |   | 0.03     |   |
| FCC License Amortization                                                          |   | **—** | ** **  | 0.07     |   | 0.07     |   |
| Adjusted Net Income(Loss)                                                         |   | **$**      | **(1.19**   | **)**    | $      | 0.72     |   | $ | 0.65 |   |

 

The carrying value of HickoryTech’s goodwill, which is all included inthe Telecom segment (see Note 5), is $25,086,000 as of December 31, 2002 and2001.

 

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The components of HickoryTech’s intangible assets are as follows:

** **
| **(Dollars  in Thousands)**        |   | **As of  December 31, 2002** |       | **As of December 31, 2001**   |   |
|------------------------------------|--------|------------------------------|------------|-------------------------------|--------|
|                               |   | **Gross  Carrying  Amount**  |       | **Accumulated  Amortization** |   | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   |
| Definite-Lived Intangible Assets   |   |                         |       |                          |   |   |   |   |   |
| Customers                          |   | **$**                        | **821**    | ** **                    | **$**  | **237** |   | $ | 1,701 |   | $ | 780 |   |
| Other Intangibles                  |   | **185**                      | ** ** | **100**                       |   | 538 |   | 103 |   |
| Total                              |   | **$**                        | **1,006**  | ** **                    | **$**  | **337** |   | $ | 2,239 |   | $ | 883 |   |
|                               |   |                         |       |                          |   |   |   |   |   |
| Indefinite-Lived Intangible Assets |   |                         |       |                          |   |   |   |   |   |
| FCC Licenses                       |   | **$**                        | **34,000** |                          |   |   | $ | 75,635 |   |   |   |

 

During 2002, HickoryTechwrote down the carrying value of an intangible asset relating to an agreementto develop a wireless DSL operation that also entitled HickoryTech to receive ashare of future revenues generated from the wireless DSL operations.  The asset impairment write-down was takenbecause of the bankruptcy of the third-party network provider and HickoryTechdoes not believe that the agreement will result in future cash flows from therevenue sharing agreement.  The $316,000charge resulting from the asset impairment write-down was recorded as a chargeto operations of HickoryTech’s Telecom Sector and is reported as “AssetImpairment” in the consolidated statement of income for the year ended December31, 2002.

 

Total asset impairmentcharges of $41,951,000 in 2002 include $41,635,000 for wireless licenses and $316,000for wireless DSL.

 

Amortization expense relatedto the definite-lived intangible assets for 2002 and the estimated amortizationexpense for the five years subsequent to 2002 is as follows: 2002 - $466,000;2003 - $102,000; 2004 - $102,000; 2005 - $102,000; 2006 - $102,000 and 2007 -$102,000.

 

**NOTE 3 –ACQUISITIONS AND DISPOSITIONS**

On June 26, 2001, HickoryTech acquired two digital personalcommunications services (PCS) licenses from McLeodUSA Incorporated for$11,100,000 in cash. The PCS licenses acquired by HickoryTech include theMinnesota Basic Trading Areas (BTAs) of Mankato-Fairmont andRochester-Austin-Albert Lea, an area covering a population of approximately493,000 people. The acquisition was a purchase of the licenses only. There wereno customers, existing revenue stream or physical property and equipmentincluded with this acquisition as the BTAs were undeveloped. HickoryTech paidfor the acquisition with advances under its revolving credit facility.HickoryTech allocated the entire purchase price to the fair value of the PCSlicense, which was being amortized over 37 years prior to 2002.  Effective January 1, 2002 HickoryTechadopted SFAS No. 142 and ceased amortization of this indefinite lived intangibleasset (see Note 2).

 

On August 6, 2001, HickoryTech sold its local telephone exchange inAmana, Iowa to South Slope Cooperative Telephone Company, Inc. for $6,500,000in cash. The Amana operation, known as Amana Colonies Telephone Company (ACTC),served approximately 1,500 access lines in the seven communities of the AmanaColonies in east central Iowa. HickoryTech recorded a pre-tax gain on the saleof $1,015,000 ($566,000 net of tax). HickoryTech used the proceeds from thesale to repay a portion of its outstanding debt. The operations of ACTC wereincluded in the Telecom Sector. For the years ended December 31, 2001, and2000, ACTC generated revenues of $832,000 and $1,467,000 and generated anoperating income (loss) of ($13,000) and $70,000, respectively. The pro-formaimpact of this disposition on net income and earnings per share for the periodspresented herein is not considered material.

 

On October 9, 2000, HickoryTech completed the acquisition of thedial-up Internet customer accounts, along with certain assets and liabilities,of Internet Connections, a Mankato Internet service provider, in exchange for$870,000 in cash. Internet Connections had approximately 5,000 Internetcustomers in southern Minnesota and the Twin Cities area. The acquisition wasaccounted for under the purchase method of accounting. HickoryTech paid for theacquisition with available funds. HickoryTech allocated $840,000 of thepurchase price to customers (intangible asset), $100,000 to other intangibleassets and $70,000 to tangible net liabilities. The operations of the InternetConnections dial-up Internet business are included in the Telecom Sector.  The customer asset is being amortized over aperiod of eight years.

 

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

The fair value of HickoryTech’s long-term obligations, after deductingcurrent maturities, is estimated to be $157,151,000 at December 31, 2002 and$170,923,000 at December 31, 2001, compared to carrying values of $157,599,000and $169,659,000 respectively. The fair value estimates are based on the overallweighted average interest rates and maturity compared to rates and termscurrently available in the long-term financing markets.

 

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**NO****TE 5 –BUSINESS SEGMENTS**

HickoryTech’s operations are conducted in three business segments as:(i) Telecom Sector, (ii) Information Solutions Sector and (iii) EnterpriseSolutions Sector.  The Telecom Sectorprovides telephone services to Mankato and adjacent areas of south centralMinnesota and to eleven communities in northwest Iowa as an ILEC.  The Telecom Sector also operates fiber opticcable transport facilities in Minnesota. The Telecom Sector also included theoperations of Amana Colonies Telephone Company, a local telephone exchangeserving the Amana Colonies in east central Iowa, which was sold in August 2001.The Telecom Sector also offers an alternative choice for localtelecommunications service, known as CLEC (Competitive Local Exchange Carrier)service in the telecommunications industry, to customers in Minnesota and Iowanot currently in HickoryTech’s ILEC service area. In addition, the TelecomSector resells long distance service to Minnesota and Iowa subscribers in itsILEC and CLEC markets. The Telecom Sector provides wireless telephone serviceto seven counties in south central Minnesota and a service area around theMinneapolis/St. Paul, Minnesota metropolitan area. The Telecom Sector alsoprovides PCS service to the Minnesota BTAs of Mankato-Fairmont andRochester-Austin-Albert Lea. The Information Solutions Sector provides dataprocessing and related services to HickoryTech’s other sectors and to otherexternal telephone companies, municipalities and utilities. The EnterpriseSolutions Sector designs, sells, installs and services business telephone systemsand data communications equipment primarily in metropolitan Minneapolis/St.Paul, Minnesota.

 

Business segment information for the years 2002, 2001 and 2000 is asfollows.   Certain amounts in 2001 and2000 have been reclassified to conform with the 2002 presentation.

 

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**BUSINESS SEGMENT DATA**

Years Ended December 31

 
| **(Dollars in  Thousands)**               |   | **Telecom** |   | **Information  Solutions** |   | **Enterprise  Solutions** |   | **Corporate  and  Eliminations** |   | **Consolidated** |   |
|-------------------------------------------|--------|-------------|--------|----------------------------|--------|---------------------------|--------|----------------------------------|--------|------------------|--------|
| **2002**                                  |   |        |   |                       |   |                      |   |                             |   |             |   |
| Revenue from Unaffiliated Customers       |   | $           | 86,557 |                       | $      | 4,249                     |   | $                                | 15,781 |             | $      | — |   | $ | 106,587 |   |
| Intersegment Revenues                     |   | 10,156      |   | 3,962                      |   | —                    |   | (14,118                          | )      | —           |   |
| Total                                     |   | 96,713      |   | 8,211                      |   | 15,781                    |   | (14,118                          | )      | 106,587          |   |
|                                      |   |        |   |                       |   |                      |   |                             |   |             |   |
| Asset Impairment                          |   | 41,951      |   | —                     |   | —                    |   | —                           |   | 41,951           |   |
| Depreciation and Amortization             |   | 14,906      |   | 2,403                      |   | 263                       |   | 217                              |   | 17,789           |   |
| Operating Income/(Loss)                   |   | (16,790     | )      | (2,481                     | )      | (12                       | )      | (1,657                           | )      | (20,940          | )      |
| Equity in Net Income/(Loss) of Investees  |   | —      |   | (25                        | )      | —                    |   | —                           |   | (25              | )      |
| Interest Expense                          |   | 20          |   | 62                         |   | —                    |   | 7,323                            |   | 7,405            |   |
| Income Taxes                              |   | (6,898      | )      | (1,150                     | )      | (29                       | )      | (3,504                           | )      | (11,581          | )      |
| Net Income/(Loss)                         |   | (9,888      | )      | (1,655                     | )      | (41                       | )      | (5,043                           | )      | (16,627          | )      |
| Identifiable Assets                       |   | 204,871     |   | 6,604                      |   | 9,914                     |   | 18,822                           |   | 240,211          |   |
| Investment in Equity Method Investees     |   | —      |   | 36                         |   | —                    |   | —                           |   | 36               |   |
| Capital Expenditures                      |   | 13,893      |   | 2,472                      |   | 95                        |   | 214                              |   | 16,674           |   |
|                                      |   |        |   |                       |   |                      |   |                             |   |             |   |
| **2001**                                  |   |        |   |                       |   |                      |   |                             |   |             |   |
| Revenue from Unaffiliated Customers       |   | $           | 84,019 |                       | $      | 4,085                     |   | $                                | 20,374 |             | $      | — |   | $ | 108,478 |   |
| Intersegment Revenues                     |   | 9,957       |   | 5,022                      |   | —                    |   | (14,979                          | )      | —           |   |
| Total                                     |   | 93,976      |   | 9,107                      |   | 20,374                    |   | (14,979                          | )      | 108,478          |   |
|                                      |   |        |   |                       |   |                      |   |                             |   |             |   |
| Depreciation and Amortization             |   | 14,899      |   | 1,129                      |   | 359                       |   | 239                              |   | 16,626           |   |
| Operating Income/(Loss)                   |   | 22,826      |   | 408                        |   | 1,340                     |   | (533                             | )      | 24,041           |   |
| Equity in Net Income/(Loss) of Investees  |   | —      |   | (27                        | )      | —                    |   | —                           |   | (27              | )      |
| Interest Expense                          |   | 31          |   | 32                         |   | —                    |   | 10,792                           |   | 10,855           |   |
| Income Taxes                              |   | 9,179       |   | 89                         |   | 520                       |   | (3,817                           | )      | 5,971            |   |
| Net Income/(Loss)                         |   | 13,069      |   | 128                        |   | 748                       |   | (5,207                           | )      | 8,738            |   |
| Identifiable Assets                       |   | 248,188     |   | 6,500                      |   | 11,413                    |   | 17,191                           |   | 283,292          |   |
| Investment in Equity Method Investees     |   | —      |   | 60                         |   | —                    |   | —                           |   | 60               |   |
| Capital Expenditures                      |   | 31,132      |   | 1,347                      |   | 213                       |   | 176                              |   | 32,868           |   |
|                                      |   |        |   |                       |   |                      |   |                             |   |             |   |
| **2000**                                  |   |        |   |                       |   |                      |   |                             |   |             |   |
| Revenue from Unaffiliated Customers       |   | $           | 79,505 |                       | $      | 4,287                     |   | $                                | 18,511 |             | $      | — |   | $ | 102,303 |   |
| Intersegment Revenues                     |   | 9,439       |   | 4,668                      |   | —                    |   | (14,107                          | )      | —           |   |
| Total                                     |   | 88,944      |   | 8,955                      |   | 18,511                    |   | (14,107                          | )      | 102,303          |   |
|                                      |   |        |   |                       |   |                      |   |                             |   |             |   |
| Depreciation and Amortization             |   | 13,224      |   | 380                        |   | 337                       |   | 142                              |   | 14,083           |   |
| Operating Income/(Loss)                   |   | 22,903      |   | 706                        |   | (308                      | )      | (773                             | )      | 22,528           |   |
| Equity in Net Income of Investees         |   | —      |   | 23                         |   | —                    |   | —                           |   | 23               |   |
| Interest Expense                          |   | 34          |   | —                     |   | 1                         |   | 9,953                            |   | 9,988            |   |
| Income Taxes                              |   | 9,293       |   | 295                        |   | (174                      | )      | (4,127                           | )      | 5,287            |   |
| Extraordinary Loss on Debt Extinguishment |   | —      |   | —                     |   | —                    |   | (233                             | )      | (233             | )      |
| Cumulative Effect of Accounting Change    |   | (20         | )      | —                     |   | —                    |   | —                           |   | (20              | )      |
| Net Income/(Loss)                         |   | 13,286      |   | 427                        |   | (250                      | )      | (5,758                           | )      | 7,705            |   |
| Identifiable Assets                       |   | 226,603     |   | 4,720                      |   | 10,559                    |   | 13,605                           |   | 255,487          |   |
| Investment in Equity Method Investees     |   | —      |   | 87                         |   | —                    |   | —                           |   | 87               |   |
| Capital Expenditures                      |   | 39,206      |   | 123                        |   | 157                       |   | 176                              |   | 39,662           |   |

 

44

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**NOTE 6 –STOCK COMPENSATION**

Under the terms of an employee stock purchase plan, participatingemployees may acquire shares of common stock through payroll deductions of notmore than 10% of their compensation. The price at which the shares can bepurchased is 85% of the lower fair market value for such shares on twospecified dates in each plan year. As of December 31, 2002, there were 900,000common shares reserved for this plan and 641,024 shares still available forissuance. At December 31, 2002, employees had subscribed to purchaseapproximately 24,700 shares in the current plan year ending August 31,2003.

 

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.  As of December 31, 2002, there were 300,000common shares reserved for this plan and 267,117 shares still available forfuture issuance.

 

HickoryTech also offers a directors’ stock option plan to attract andretain outside directors. The plan provides for each outside director toreceive fully vested options to purchase 5,000 shares of common stock ofHickoryTech at an exercise price equal to the fair market value on a date asspecified in the plan if HickoryTech meets pre-established financialobjectives. The options may be exercised no later than ten years after the dateof grant. As of December 31, 2002, there were 300,000 common shares reservedfor this plan and 131,000 shares available for future grants.

 

HickoryTech’s stock award plan provides for the granting of incentivestock options, non-qualified stock options and stock awards. 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 a long-term performanceaward. In 2002, 2001 and 2000, HickoryTech paid cash of $184,000, $157,000 and$170,000 for its common stock shares and issued shares of 12,722, 8,904 and12,038 in 2002, 2001 and 2000, respectively, to a trust for the benefit of certainkey employees.  The stock options issuedunder the stock option component of the stock award plan may be exercised nolater than ten years after the date of grant, with one-third of the optionsvesting each year. As of December 31, 2002, there were 1,750,000 common sharesreserved for this plan and 1,032,394 shares available for future grants.

 

HickoryTech has elected to apply Accounting Principles Board OpinionNo. 25 and related interpretations in accounting for its employee anddirectors’ stock compensation plans. If HickoryTech had elected to recognizecompensation cost based on the fair value of the options as prescribed by SFASNo. 123, the following operating results would have occurred using theBlack-Scholes option-pricing model to determine the fair value of the optionswith the following listed assumptions:

 

*(Dollars in Thousands, Except PerShare Amounts)*

 
|                        |   | **2002** |        | **2001** |   | **2000** |   |
|-----------------------------|--------|----------|-------------|----------|--------|----------|--------|
| Pro Forma Net Income/(Loss) |   | **$**    | **(16,964** | **)**    | $      | 8,416    |   | $ | 7,280 |   |
| Pro Forma Basic EPS         |   | **$**    | **(1.21**   | **)**    | $      | 0.61     |   | $ | 0.53 |   |
| Pro Forma Diluted EPS       |   | **$**    | **(1.21**   | **)**    | $      | 0.60     |   | $ | 0.52 |   |
| Volatility                  |   | **36.0** | **%**       | 32.8     | %      | 30.6     | %      |
| Dividend Yield              |   | **3.3**  | **%**       | 2.5      | %      | 3.1      | %      |
| Risk-Free Interest Rates    |   | **4.7**  | **%**       | 5.0      | %      | 6.4      | %      |
| Expected Life in Years      |   | **7**    | ** **  | 7        |   | 7        |   |

 

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

 
|                                                           |   | **Shares**  |     | **Weighted  Average  Exercise Price** |   |
|----------------------------------------------------------------|--------|-------------|----------|---------------------------------------|--------|
|                                                           |   | **2002**    |     | **2001**                              |   | **2000** |   | **2002** |   | **2001** |   | **2000** |   |
| Outstanding at Beginning of Year                               |   | **482,181** |     | 343,781                               |   | 226,781 | ** ** | **$** | **13.37** |   | $ | 12.46 |   | $ | 11.07 |   |
| Granted                                                        |   | **137,450** |     | 138,400                               |   | 137,750 | ** ** | **13.29** |   | 15.62 |   | 14.66 |   |
| Exercised                                                      |   | **(63,796** | **)**    | **—**                            |   | (15,384 | ) | **11.01** | ** ** | **—** |   | 11.81 |   |
| Forfeited                                                      |   | **(1,500**  | **)**    | **—**                            |   | (5,366 | ) | **19.08** | ** ** | **—** |   | 11.87 |   |
| Outstanding at End of Year                                     |   | **554,335** |     | 482,181                               |   | 343,781 | ** ** | **$** | **13.60** |   | $ | 13.37 |   | $ | 12.46 |   |
| Exercisable at End of Year                                     |   | **384,377** |     | 312,040                               |   | 214,736 | ** ** | **$** | **13.61** |   | $ | 12.86 |   | $ | 11.81 |   |
| Weighted Average Fair Value of Options Granted During the Year |   | **$**       | **4.25** |                                  | $      | 5.00 |   | $ | 4.66 |   |   |   |   |   |   |   |
|                                                                |        |             |          |                                       |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

45

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The following table provides certain information with respect to stockoptions outstanding at December 31, 2002:

 
| **Range of  Exercise Prices** |   | **Stock  Options  Outstanding** |   | **Average  Exercise  Price** |   | **Average  Remaining  Contractual Life** |       |
|-------------------------------|--------|---------------------------------|--------|------------------------------|--------|------------------------------------------|------------|
| $ 9.00 - $12.00               |   | 126,252                         |   | $                            | 10.26  |                                     | 4.7  years |   |
| $ 12.00 - $16.00              |   | 352,933                         |   | 13.83                        |   | 8.0  years                               |       |
| $ 16.00 - $21.00              |   | 75,150                          |   | 18.17                        |   | 8.3  years                               |       |
|                          |   | 554,335                         |   | $                            | 13.60  |                                     | 7.3  years |   |

 

The following table provides certain information with respect to stockoptions exercisable at December 31, 2002:

 
| **Range of  Exercise Prices** |   | **Stock  Options  Exercisable** |   | **Weighted  Average  Exercise  Price** |   |
|-------------------------------|--------|---------------------------------|--------|----------------------------------------|--------|
| $ 9.00 - $12.00               |   | 106,802                         |   | $                                      | 10.27  |   |
| $ 12.00 - $16.00              |   | 220,936                         |   | 14.02                                  |   |
| $ 16.00 - $21.00              |   | 56,639                          |   | 18.29                                  |   |
|                          |   | 384,377                         |   | $                                      | 13.61  |   |

 

All stock options granted in 2002, 2001 and 2000 had an exercise priceequal to the fair market value of HickoryTech’s common stock on the date ofgrant.

 

Other stock award activity is as follows:

 
|                                                                |   | **2002**   |      | **2001** |   | **2000** |   |
|---------------------------------------------------------------------|--------|------------|-----------|----------|--------|----------|--------|
| Stock Awards Granted                                                |   | **10,984** |      | 9,470    |   | 17,750   |   |
| Weighted Average Fair Value of Stock Awards Granted During the Year |   | **$**      | **14.97** |     | $      | 17.43    |   | $ | 14.76 |   |
|                                                                     |        |            |           |          |        |          |        |  |  |  |

 

Stock compensation expense for 2002, 2001 and 2000 was $329,000,  $217,000 and $660,000 respectively, for allstock compensation plans.

 

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**NOTE 7 – DEBT AND OTHER OBLIGATIONS**

Long-term obligations consist of the following:

 
| **(Dollars in Thousands)**                                               |   | **2002**    |        | **2001** |   |
|--------------------------------------------------------------------------|--------|-------------|-------------|----------|--------|
|                                                                     |   |        |        |     |   |
| Credit Facility, Average 4.3%, maturing in varying amounts through  2009 |   | **$**       | **158,000** |     | $      | 170,000 |   |
| Capitalized Lease Obligations, 6.8%, maturing June 2005                  |   | **1,040**   |        | 901      |   |
|                                                                     |   |        |        |     |   |
| Total                                                                    |   | **159,040** |        | 170,901  |   |
| Less Current Maturities                                                  |   | **1,441**   |        | 1,242    |   |
| Long Term Obligations                                                    |   | **$**       | **157,599** |     | $      | 169,659 |   |

 

HickoryTech has a $183,000,000 credit facility with a syndicate ofbanks. The credit facility is comprised of a $125,000,000 revolving creditcomponent and a $58,000,000 term loan component.  The available line of credit on the $125,000,000 revolving creditcomponent decreases in increments beginning in March 2004 with a final maturitydate in September 2008.  The term loanrequires equal quarterly principal payments of $250,000 during the period March2001 to December 2008, and $23,000,000 of principal payments for the first twoquarters in 2009 and $6,000,000 in the third quarter of 2009. The weightedaverage interest rate associated with this credit facility varies with LIBORand certain other rates.  The weightedaverage interest rate was 4.3% and 5.3% at December 31, 2002 and 2001,respectively. The term loan component has a provision whereby HickoryTechperiodically receives patronage capital refunds depending on the amount ofinterest paid. This patronage refund is recorded as an offset to interestexpense and amounted to $583,000 in 2002, $807,000 in 2001, and $399,000 in2000. As of December 31, 2002, HickoryTech had drawn $158,000,000 on thiscredit facility, comprised of $58,000,000 in term loan and $100,000,000 inrevolving credit, and had $25,000,000 of available borrowing capacity of therevolving credit component. The credit facility is collateralized by certainproperty, plant and equipment and contains covenants relating to cash flow andcapitalization.

 

In June 2000, HickoryTech amended and increased its $90,000,000unsecured revolving credit facility with a syndicate of banks to $125,000,000.Proceeds from the increased credit facility were used to repay $40,000,000 ofsenior unsecured notes dated April 1997. As a result of the extinguishment ofthe senior unsecured notes, HickoryTech recorded an extraordinary loss of$233,000, net of an income tax benefit of $158,000.

 

In December 2001, HickoryTech repaid the outstanding balance remainingon its debt with Rural Utilities Service and the Rural Telephone Bank. Theseloans were originally used for the financing of telephone property, plant andequipment of Mid-Communications, Inc. and were scheduled to mature in the years2003 and 2007, respectively.

 

Annual requirements for principal payments for the years subsequent to2002 are as follows: 2003 - $1,000,000; 2004 - $1,000,000; 2005 - $13,500,000;2006 - $27,563,000; 2007 - $33,813,000 and thereafter - $81,124,000.

 

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 $1,071,000 ($1,660,000 asset, netof accumulated depreciation of $589,000) as of December 31, 2002. Annualrequirements for future lease payments under this capital lease are as follows:

 
| **Year**                                |   | **Annual Lease Payments** |      |
|-----------------------------------------|--------|---------------------------|-----------|
|                                    |   |                      |      |
| 2003                                    |   | $                         | 552,814   |   |
| 2004                                    |   | 419,430                   |      |
| 2005                                    |   | 150,518                   |      |
| Total minimum lease payments            |   | 1,122,762                 |      |
| Amount representing interest            |   | 82,843                    |      |
| Present value of minimum lease payments |   | $                         | 1,039,919 |   |

 

HickoryTech owns most of its major facilities, but does lease certainoffice space, land and equipment under principally noncancelable operatingleases.**** Rental expense was $1,812,000 in 2002, $2,033,000 in 2001 and$2,295,000 in 2000. At December 31, 2002, future minimum operating leaseobligations for the next five years are as follows: 2003 - $1,030,000; 2004 -$817,000; 2005 - $469,000; 2006- $363,000; 2007 - $198,000 and thereafter -$906,000.

 

47

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###### **NOTE 8 - EMPLOYEE RETIREMENT BENEFITS**

Employees who meet certain service requirements are covered under adefined contribution retirement savings plan, which includes IRS Section 401(k)provisions. HickoryTech contributes up to 6.0% of the employee’s eligiblecompensation, based on the employee’s voluntary contribution.  HickoryTech contributions and costs for theretirement savings plan were $1,142,000 in 2002, $1,128,000 in 2001 and $1,018,000in 2000.

 

In addition to providing retirement savings benefits, HickoryTechprovides postretirement health care and life insurance benefits for certainemployees. HickoryTech is not currently funding these postretirement benefits,but has accrued these liabilities.

 
| **(Dollars in Thousands)**                    |   | **2002**   |       | **2001**   |   |
|-----------------------------------------------|--------|------------|------------|------------|--------|
| Change in Benefit Obligation                  |   |       |       |       |   |
| Benefit Obligation at Beginning of Year       |   | **$**      | **1,970**  |       | $      | 1,712 |   |
| Net Periodic Benefit Cost                     |   | **637**    |       | 364        |   |
| Benefits Paid                                 |   | **(133**   | **)**      | (106       | )      |
| Benefit Obligation at End of Year             |   | **$**      | **2,474**  | ** ** | $      | 1,970 |   |
|                                          |   |       | ** ** |       |   |
| Accumulated Postretirement Benefit Obligation |   | **$**      | **5,230**  | ** ** | $      | 4,479 |   |
| Unrecognized Transition Obligation            |   | **(600**   | **)**      | (660       | )      |
| Unrecognized Prior Service Cost               |   | **107**    | ** ** | 119        |   |
| Unrecognized Cumulative Net Loss              |   | **(2,263** | **)**      | (1,968     | )      |
| Accrued Benefit Cost                          |   | **$**      | **2,474**  |       | $      | 1,970 |   |

 
|                                    |   | **2002** |    | **2001** |   | **2000** |   |
|-----------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| Components of Net Periodic Benefit Cost |   |     |    |     |   |     |   |
| Service Cost                            |   | **$**    | **174** |     | $      | 112      |   | $ | 117 |   |
| Interest Cost                           |   | **330**  |    | 198      |   | 186      |   |
| Amortization of Unrecognized:           |   |     |    |     |   |     |   |
| Transition Obligation                   |   | **60**   |    | 60       |   | 60       |   |
| Prior Service Cost                      |   | **(12**  | **)**   | (12      | )      | (12      | )      |
| Cumulative Net Loss                     |   | **85**   |    | 6        |   | 18       |   |
| Net Periodic Benefit Cost               |   | **$**    | **637** |     | $      | 364      |   | $ | 369 |   |

 

The health care cost trend rate used in determining the accumulatedpostretirement benefit obligations was 9%, decreasing to 8% in the year 2004,decreasing to 6% in the year 2008 and then decreasing to 5% for the yearsthereafter.  An increase of onepercentage point in the assumed health care cost trend would increase theaccumulated postretirement benefit obligation at December 31, 2002 by $920,000and the net periodic post-retirement benefit cost for the year then ended by$105,000. A decrease of one percentage point in the assumed health care costtrend would decrease the accumulated postretirement benefit obligation atDecember 31, 2002 by $733,000 and the net periodic postretirement benefit costfor the year then ended by $82,000.

 

A weighted average discount rate of 7.00%, 7.50% and 7.50% was used todevelop net periodic postretirement benefit cost and the actuarial presentvalue of accumulated benefit obligations in 2002, 2001 and 2000, respectively.

 

48

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**NOTE 9 - INCOME TAXES**

The income tax provision (benefit) for the yearsended December 31, 2002, 2001 and 2000 include the following components:

 
| **(Dollars  in Thousands)**           |   | **2002**   |        | **2001** |   | **2000** |   |
|---------------------------------------|--------|------------|-------------|----------|--------|----------|--------|
| Current Income Taxes:                 |   |       |        |     |   |     |   |
| Federal                               |   | **$**      | **(1,895**  | **)**    | $      | 571      |   | $ | 1,936 |   |
| State                                 |   | **118**    | ** **  | 183      |   | 601      |   |
| Deferred Income Taxes:                |   |       | ** **  |     |   |     |   |
| Federal                               |   | **(6,987** | **)**       | 3,954    |   | 1,967    |   |
| State                                 |   | **(2,817** | **)**       | 1,263    |   | 611      |   |
| Total Income Tax  (Benefit)/Provision |   | **$**      | **(11,581** | **)**    | $      | 5,971    |   | $ | 5,115 |   |

 

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

 
| **(Dollars  in Thousands)**                       |   | **2002**   |       | **2001** |   |
|---------------------------------------------------|--------|------------|------------|----------|--------|
| Tax Liabilities:                                  |   |       |       |     |   |
| Depreciation and Fixed Assets                     |   | **$**      | **12,313** |     | $      | 8,206 |   |
| Intangible Assets                                 |   | **—** |       | 7,685    |   |
| Other                                             |   | **57**     |       | 80       |   |
| Gross Deferred Tax Liability                      |   | **12,370** |       | 15,971   |   |
|                                              |   |       |       |     |   |
| Tax Assets:                                       |   |       |       |     |   |
| Deferred Compensation and Postretirement Benefits |   | **2,213**  |       | 1,970    |   |
| Receivables and Inventories                       |   | **656**    |       | 631      |   |
| Accrued Liabilities                               |   | **294**    |       | 136      |   |
| Intangible Assets                                 |   | **5,777**  |       | —   |   |
| Other                                             |   | **4**      |       | 4        |   |
| Net Operating Loss                                |   | **470**    |       | 315      |   |
| Gross Deferred Tax Asset                          |   | **9,414**  |       | 3,056    |   |
| Valuation Allowance                               |   | **(470**   | **)**      | (315     | )      |
| Net Deferred Tax Liability                        |   | **3,426**  |       | 13,230   |   |
| Current Deferred Tax Asset                        |   | **951**    |       | 646      |   |
| Net Non-Current Deferred Tax Liability            |   | **$**      | **4,377**  |     | $      | 13,876 |   |

 

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

 
|                                          |   | **2002**  |       | **2001** |   | **2000** |   |
|-----------------------------------------------|--------|-----------|------------|----------|--------|----------|--------|
| Statutory Tax Rate                            |   | **(35.0** | **)%**     | 35.0     | %      | 35.0     | %      |
| Effect of:                                    |   |      | ** ** |     |   |     |   |
| State Income Taxes Net of Federal Tax Benefit |   | **(6.4**  | **)**      | 6.7      |   | 6.4      |   |
| Valuation Allowance                           |   | **0.6**   | ** ** | 2.1      |   | —   |   |
| Other, Net                                    |   | **(0.3**  | **)**      | (3.2     | )      | (1.5     | )      |
| Effective Tax Rate                            |   | **(41.1** | **)%**     | 40.6     | %      | 39.9     | %      |

 

The valuation allowance has been recorded due to the uncertainty ofrealization of the benefits associated with net operating losses incurred by asubsidiary of HickoryTech in the state of Iowa.  This effectively reduces the net deferred tax asset related tothese net operating loss carryforwards to $0. Future events and changes in circumstances could cause this valuationallowance to change.

 

49

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**NOTE 10 – CHANGE IN REVENUERECOGNITION ACCOUNTING PRINCIPLE**

In December 1999, the SEC issued Staff AccountingBulletin (SAB) No. 101, “Revenue Recognition in Financial Statements,” which,as amended by SAB No. 101A and SAB No. 101B, provides additional guidance inapplying generally accepted accounting principles for revenue recognition.Implementation of SAB No. 101 required HickoryTech to defer revenues resultingfrom up-front fees, including installation and activation fees, and to alsodefer the associated direct costs. These deferred revenues and costs are nowrecognized ratably over the corresponding customer relationship period. Thesecustomer relationship periods range from one to seven years. Prior toimplementation of SAB No. 101 in the fourth quarter of 2000, HickoryTechrecognized revenues resulting from up-front fees and the corresponding directcosts in the period that installation and activation services were provided. Aspermitted by SAB No. 101, HickoryTech accounted for the change in accountingprinciple prospectively as a cumulative effect of accounting change retroactiveto January 1, 2000. The cumulative effect of accounting change was a loss of$20,000, net of a tax benefit of $14,000.

 

**NOTE 11– RECENT ACCOUNTING DEVELOPMENTS**

In July 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 141, “BusinessCombinations.” SFAS No. 141 requires that the purchase method of accounting beused for all business combinations initiated after June 30, 2001. SFAS No. 141also specifies the criteria that intangible assets acquired in a purchasemethod business combination must meet to be recognized and reported apart fromgoodwill. HickoryTech made no acquisitions after June 30, 2001 and, therefore,SFAS No. 141 had no impact on 2002 or 2001 results.

 

In June 2001, the FASB issued SFAS No. 143,“Accounting for Asset Retirement Obligations.” SFAS No. 143 requires entitiesto record the fair value of the liability for legal obligations associated withan asset retirement in the period in which the obligation is incurred. When theliability is initially recorded, the entity capitalizes the cost of the assetretirement obligation by increasing the carrying amount of the relatedlong-lived asset. Over time, the liability is accreted to its present valueeach period, and the capitalized cost is depreciated over the useful life ofthe related asset. As stated in Note 1, HickoryTech’s incumbent local exchangecarrier companies (ILEC) follow the provisions of SFAS 71, and thereforeconform to the accounting principles as prescribed by the respective statepublic utilities commissions and other federal agencies and, where applicable,accounting principles generally accepted in the United States of America. OnDecember 20, 2002, the Federal Communications Commission (FCC) notifiedcarriers that they would not adopt SFAS No. 143 for regulatory accountingpurposes. Current regulatory accounting requires incumbent local telephonecompanies to accrue for asset retirement obligations through prescribeddepreciation rates, therefore any asset retirement obligations are effectivelyrecorded in accumulated depreciation. Pursuant to the FCC’s order and the provisions of SFAS No. 71,HickoryTech anticipates that the adoption of SFAS No. 143 will not have amaterial impact on the financial position or results of operations of its ILECcompanies. HickoryTech has not yet completed its analysis of the impact ofadoption of SFAS No. 143 for its non-ILEC companies.  However, based upon a preliminary analysis, management does notexpect adoption to have a material impact on HickoryTech’s financial positionor results of operations.

 

HickoryTech adopted the provisions of SFAS No. 144, “Accounting forImpairment or Disposal of Long-Lived Assets,” as of January 1, 2002. SFAS No.144 requires that long-lived assets that are to be disposed of by sale bemeasured at the lower of book value or fair value less cost to sell and alsosets forth requirements for recognizing and measuring impairment losses oncertain long-lived assets to be held or used. The Company adopted SFAS No. 144 effective January 1, 2002.  The adoption had no impact on HickoryTech’sfinancial position or its results of operations.

 

In April 2002, the FASB issued SFAS No. 145,“Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB StatementNo. 13, and Technical Corrections.” SFAS No. 145 rescinds FASB Statement No. 4,“Reporting Gains and Losses from Extinguishment of Debt,” and an amendment ofthat Statement, FASB Statement No. 64, “Extinguishments of Debt Made to SatisfySinking-Fund Requirements.” SFAS No. 145 also rescinds FASB Statement No. 44,“Accounting for Intangible Assets of Motor Carriers,” and amends FASB StatementNo. 13, “Accounting for Leases.” In June 2000, HickoryTech recorded anextraordinary loss of $233,000, net of income tax benefit of $158,000, as aresult of an extinguishment of debt. Under SFAS No. 145, this extraordinaryloss on debt extinguishment will be reclassified to operating expenses whenHickoryTech adopts SFAS No. 145 in the first quarter of 2003.

 

In June 2002, the FASB issued SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities,” whichreplaces Emerging Issues Task Force (EITF) Issue No. 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring).” SFAS No.146 requires companies to recognize costs associated with exit or disposalactivities when they are incurred rather than at the date of a commitment to anexit or disposal plan. SFAS No. 146 is effective for, and HickoryTech will applythis standard to exit or disposal activities that are initiated after December31, 2002.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation – Transition Disclosure – an amendment of FAS 123”(SFAS No. 148).  This Statement amendsSFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, this Statement amends the disclosure requirements ofStatement 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results.  The provisions of FAS 148 are effective forfinancial statements for fiscal years ending after December 15, 2002, anddisclosure requirements shall be effective for interim periods beginning afterDecember 15, 2002.  The Company intendsto continue to account for stock-based compensation to its employees anddirectors using the intrinsic value method prescribed by APB Opinion No. 25,and related interpretations.  TheCompany has made certain disclosures required by SFAS No. 148 in theconsolidated financial statements for the year ended December 31, 2002 and willbegin making the additional disclosures required by SFAS No. 148 in the firstquarter of 2003.  Accordingly, adoptionof SFAS No. 148 will not impact HickoryTech’s financial position or results ofoperations.

 

50

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In November 2002, the FASB issued InterpretationNo. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.”  This interpretation elaborates on thedisclosures required in financial statements concerning obligations undercertain guarantees.  It also clarifiesthe requirements related to the recognition of liabilities by a guarantor atthe inception of certain guarantees. The disclosure requirements of this interpretation were effective forHickoryTech on December 31, 2002 but did not require any additionaldisclosures.  The recognition provisionsof the interpretation are effective for HickoryTech in 2003 are applicable onlyto guarantees issued or modified after December 31, 2002.  HickoryTech does not expect adoption ofthese recognitions to have a material impact on its financial position orresults of operations.

 

**NOTE 12 – CONTINGENCIES**

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

 

In the second quarter of 2002, HickoryTech’s Board of Directors modified the terms ofthe stock options of a retiring officer. The modification extended the periodafter retirement during which the officer can exercise options. Thismodification may result in HickoryTech recognizing up to $173,000 ofcompensation expense during the first quarter of 2003.

 

**NOTE 13 - QUARTERLY FINANCIAL INFORMATION (Unaudited)**

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

** **
|                                    |   | **2002** |    |
|-----------------------------------------|--------|----------|---------|
|                                    |   | **4th**  |    | **3rd** |   | **2nd** |   | **1st** |   |
| Operating Revenues                      |   | $        | 27,272  |   | $ | 28,712 |   | $ | 25,491 |   | $ | 25,112 |   |
| Operating Income/(Loss)                 |   | $        | (36,523 | ) | $ | 5,258 |   | $ | 4,857 |   | $ | 5,468 |   |
| Net Income/(Loss)                       |   | $        | (22,613 | ) | $ | 2,094 |   | $ | 1,802 |   | $ | 2,090 |   |
| Fully Diluted Earnings/(Loss) Per Share |   | $        | (1.61   | ) | $ | 0.15 |   | $ | 0.13 |   | $ | 0.15 |   |
| Dividends Per Share                     |   | $        | 0.11    |   | $ | 0.11 |   | $ | 0.11 |   | $ | 0.11 |   |

 
|                             |   | **2001** |   |
|----------------------------------|--------|----------|--------|
|                             |   | **4th**  |   | **3rd** |   | **2nd** |   | **1st** |   |
| Operating Revenues               |   | $        | 26,734 |   | $ | 27,559 |   | $ | 26,954 |   | $ | 27,231 |   |
| Operating Income                 |   | $        | 5,583  |   | $ | 6,239 |   | $ | 6,049 |   | $ | 6,170 |   |
| Net Income                       |   | $        | 2,031  |   | $ | 2,740 |   | $ | 2,004 |   | $ | 1,963 |   |
| Fully Diluted Earnings Per Share |   | $        | 0.14   |   | $ | 0.20 |   | $ | 0.14 |   | $ | 0.14 |   |
| Dividends Per Share              |   | $        | 0.11   |   | $ | 0.11 |   | $ | 0.11 |   | $ | 0.11 |   |

 

As described in Note 2, during the fourth quarterof 2002 HickoryTech recorded an impairment charge of $41,635,000 resulting fromthe write-down of the carrying value of its wireless FCC licenses and animpairment charge of $316,000 resulting from the write-down of the carryingvalue of its WDSL investment.

 

**Item 9.****    Changes in and Disagreements withAccountants on Accounting and Financial Disclosures.**

 

None.

 

51

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**PARTIII**

 

**Item 10.****     Directors andExecutive Officers of HickoryTech.**

 

Information as to Directors and Executive Officers of HickoryTechincluded on pages 3, 4 and 6 of the Proxy Statement and “Section 16(a)Beneficial Ownership Reporting Compliance” on page 17 of the Proxy Statementare incorporated by reference.

 

**Item 11.****     ExecutiveCompensation.**

 

Information as to executive compensation included on pages 8 to 13 of theProxy Statement is incorporated by reference.

 

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

 

The information as to beneficial ownership of more than five percent ofHickoryTech’s common stock included on page 7 of the Proxy Statement isincorporated by reference. The informationas to security ownership of management included on page 5 of the ProxyStatement is incorporated by reference.

 

The following table provides information onequity compensation plans under which equity securities of the Company areauthorized for issuance, as of December 31, 2002.

** **
| **Plan  Category**                                           |   | **Number of  securities to  be issued upon exercise  of outstanding options,  warrants and rights(a)** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights(b)** |   | **Number of  securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))(c****)** |      |
|--------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
| Equity  compensation plans approved by security holders(1):  |   | 554,335                                                                                                |   | $                                                                                     | 13.60  |                                                                                                                                                          | 2,071,535 |   |
|                                                         |   |                                                                                                   |   |                                                                                  |   |                                                                                                                                                          |      |
| Equity  compensation plans not approved by security holders: |   | —                                                                                                 |   | —                                                                                |   | —                                                                                                                                                        |      |
| Total                                                        |   | 554,335                                                                                                |   | $                                                                                     | 13.60  |                                                                                                                                                          | 2,071,535 |   |

 

----

(1)  -  Includes the Company’s Employee Stock Purchase Plan, Directors’Stock Retainer Plan, Directors’ Stock Option Plan and Stock Award Plan.

 

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

 

HickoryTech does not know of any matter required to bereported under this item.

 

52

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**Item 14.****     Controlsand Procedures.**

 

Within the 90-day period prior to the filing of thisAnnual Report on Form 10-K, an evaluation was carried out under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness ofour disclosure controls and procedures. Disclosure controls and procedures are procedures that are designed withthe objective of ensuring that information required to be disclosed in our reportsfiled under the Securities Exchange Act of 1934, such as this Form 10-K, isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.  Based on that evaluation, our CEO and CFOhave concluded that our disclosure controls and procedures are effective tosatisfy the objectives for which they are intended.  Subsequent to the date of our management’s evaluation, there wereno significant changes in our internal controls or in other factors that couldsignificantly affect these controls, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

53

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**PARTIV**

 

**Item 15.****     Exhibits, Financial Statement Schedules,and Reports on Form 8-K.**

 

(a)          1.               Consolidated Financial Statements

 

The following are contained inthe Annual Report:

 
| Management’s Discussion  and Analysis                                                                                                |
|-------------------------------------------------------------------------------------------------------------------------------------------|
| Report of Management and Report of  Independent Accountants                                                                               |
| Consolidated  Statements of Operations*       Years Ended December 31, 2002,  2001, and 2000                |
| Consolidated Balance  Sheets*       December 31, 2002 and 2001                                              |
| Consolidated  Statements of Cash Flows*       Years Ended December 31, 2002,  2001, and 2000                |
| Consolidated  Statements of Shareholders’ Equity*       Years Ended December 31, 2002,  2001, and 2000 |
| Notes to  Consolidated Financial Statements*                                                                                              |
| Selected Financial and Operating Data                                                                                                     |

 

----

*Addressed by Report ofIndependent Accountants

 

2.                    Consolidated Financial Statement Schedules

 
| Report  of Independent Accountants onFinancial  Statement Schedule |
|--------------------------------------------------------------------|
| Schedule  II – Valuation and Qualifying Accounts              |

 

All schedules not included are omitted either becauseof the absence of conditions under which they are required or because therequired information is given in the financial statements or notes thereto.

 

3.                    Exhibits

 
| **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)         |   | Restated By-Laws (Incorporated by reference to  Exhibit 3(b) to the registrant’s Form 10-K dated March 29, 2000)                                                                                                                                                                                                          |
| 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)                                                                                                                                                                                                   |
| 4(b)         |   | Second Amended and Restated Credit Agreement dated  as of September 21, 2000, by and among Hickory Tech Corporation, as Borrower,  the Lenders referred to herein and First Union National Bank, as  Administrative Agent (Incorporated by reference to Exhibit 4 to the  registrant’s Form 10-Q dated November 10, 2000) |
| 10(a) † |   | Supplemental Retirement Agreement dated January 1,  1993, between registrant and Robert D. Alton, Jr. (Incorporated by reference  to Exhibit 10(a) to the registrant’s Form S-8 dated May 11, 1993)                                                                                                                       |

 

54

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| **Exhibit**  |   | **Description**                                                                                                                                                                                                                                                            |
|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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  (Incorporated by reference to Exhibit 10(c) to the registrant’s Form S-8  dated May 11, 1993)                                                                                                                      |
| 10(d) † |   | Change in Control Agreement dated June 25, 1998,  between registrant and Robert D. Alton (Incorporated by reference to Exhibit  10(d) to the registrant’s Form 10-K dated March 29, 2000)                                                                             |
| 10(e) † |   | Change in Control Agreement dated June 25, 1998,  between registrant and Jon L. Anderson, David A. Christensen, John W. Finke,  Mary T. Jacobs and F. Ernest Lombard (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 March 29, 2000 (Incorporated by reference to  Exhibit 10 to the registrant’s Form 10-Q dated May 5, 2000)                                                                            |
| 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)                                                                             |
| 21 *         |   | Subsidiaries of Hickory Tech Corporation                                                                                                                                                                                                                                   |
| 23 *         |   | Consent of Independent Accountants                                                                                                                                                                                                                                         |
| 99 *         |   | Cautionary Statement for Purposes of the “Safe Harbor”  Provision of the Private Securities Litigation Reform Act of 1995                                                                                                                                        |

 

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*                 Filedherewith.

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

 

 

b)             1.               Reports on Form 8-K

 

HickoryTech filed a Form 8-K on December 9, 2002 announcing theelection of Myrita P. Craig, an outside director, to serve as Chair of theBoard, effective January 1, 2003.

 

55

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## **Reportof Independent Accountants onFinancial Statement Schedule**

 

To the Shareholders and Board of Directors ofHickory Tech Corporation

 

Our audits of the consolidated financial statement referred to in ourreport dated February 27, 2003 also included an audit of the financialstatement schedules listed in Item 14(a)(2) of this Form 10-K. In our opinion,this financial statement schedules present fairly, in all material respects,the information set forth therein when read in conjunction with the relatedconsolidated financial statements.

 

 

PricewaterhouseCoopers LLP

Minneapolis, Minnesota

February 27, 2003

#  

# 56

# 

#  

#  

# **SCHEDULEII – VALUATION AND QUALIFYING ACCOUNTS**

 

ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS:

 
|                          |   | **Years Ended December 31,** |      |
|-------------------------------|--------|------------------------------|-----------|
| **(In  Thousands)**           |   | **2002**                     |      | **2001** |   | **2000** |   |
| Balance, at beginning of year |   | **$**                        | **1,231** |   | $ | 961 |   | $ | 413 |   |
| Additions charged to income   |   | **2,114**                    |      | 782 |   | 1,005 |   |
| Write-offs, net of recoveries |   | **(1,987**                   | **)**     | (512 | ) | (457 | ) |
| Balance, at end of year       |   | **$**                        | **1,358** |   | $ | 1,231 |   | $ | 961 |   |

 

INVENTORY VALUATION RESERVE:

 
|                          |   | **Years  Ended December 31,** |    |
|-------------------------------|--------|-------------------------------|---------|
| **(In  Thousands)**           |   | **2002**                      |    | **2001** |   | **2000** |   |
| Balance, at beginning of year |   | **$**                         | **858** |   | $ | 836 |   | $ | 1,016 |   |
| Additions charged to income   |   | **—**                    |    | 95 |   | — |   |
| Reductions                    |   | **(31**                       | **)**   | (73 | ) | (180 | ) |
| Balance, at end of year       |   | **$**                         | **827** |   | $ | 858 |   | $ | 836 |   |

 

57

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**SIGNATURES**

 

Pursuant to the requirements of section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
| Dated: | February 28, 2003 |                                                    | HICKORY TECH CORPORATION |
|--------|-------------------|---------------------------------------------------------|--------------------------|
|   |              |                                                    |
|   | By:               | /s/ David A. Christensen                                |                     |
|   |              | David A. Christensen,  Secretary,                       |
|   |              | Vice President, Chief  Financial Officer  and Treasurer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
|   | /s/ Myrita P. Craig                                             |   | February 28, 2003 |
|--------|-----------------------------------------------------------------|--------|-------------------|
|   | Myrita P. Craig, Chair                                          |   |
|   |                                                            |   |
|   |                                                            |   |
|   | /s/ John E. Duffy                                               |   | February 28, 2003 |
|   | John E. Duffy                                                   |   |
|   | President, Chief Executive  Officer and Director                |   |
|   | (principal executive officer)                                   |   |
|   |                                                            |   |
|   |                                                            |   |
|   | /s/ David A. Christensen                                        |   | February 28, 2003 |
|   | David A. Christensen,  Secretary,                               |   |
|   | Vice President, Chief  Financial Officer and Treasurer          |   |
|   | (principal financial officer  and principal accounting officer) |   |
|   |                                                            |   |
|   |                                                            |   |
|   | /s/ Robert E. Switz                                             |   | February 28, 2003 |
|   | Robert E. Switz, Director                                       |   |
|   |                                                            |   |
|   |                                                            |   |
|   | /s/ Robert K. Else                                              |   | February 28, 2003 |
|   | Robert K. Else, Director                                        |   |
|   |                                                            |   |
|   |                                                            |   |
|   | /s/ Lyle G. Jacobson                                            |   | February 28, 2003 |
|   | Lyle G. Jacobson, Director                                      |   |
|   |                                                            |   |
|   |                                                            |   |
|   | /s/ R. Wynn Kearney, Jr.                                        |   | February 28, 2003 |
|   | R. Wynn Kearney, Jr., Director                                  |   |

 

(amajority of directors)

 

58

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**CERTIFICATIONS**

 

I,John E. Duffy, certify that:

 

1.                                       I have reviewed this annual report on Form 10-Kof HickoryTech;

 

2.                                       Based on my knowledge, this annual report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this annual report;

 

3.                                       Based on my knowledge, the financial statements,and other financial information included in this annual report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisannual report;

 

4.                                       The registrant’s other certifying officers and Iare responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)              designed such disclosure controls and proceduresto ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

b)             evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

c)              presented in this annual report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers and Ihave disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)              all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)             any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.                                       The registrant’s other certifying officers and Ihave indicated in this annual report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  February 28, 2003 |
|-------------------------------|
|                          |
|                          |
| /s/ John E. Duffy             |   |
| John E. Duffy                 |
| Chief Executive Officer       |

 

59

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**CERTIFICATIONS**

 

I, David A. Christensen, certify that:

 

1.                                       I have reviewed this annual report on Form 10-Kof HickoryTech;

 

2.                                       Based on my knowledge, this annual report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this annual report;

 

3.                                       Based on my knowledge, the financial statements,and other financial information included in this annual report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisannual report;

 

4.                                       The registrant’s other certifying officers and Iare responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)              designed such disclosure controls and proceduresto ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

b)             evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this annual report (the “Evaluation Date”);and

 

c)              presented in this annual report our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers and Ihave disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)              all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internal controls;and

 

b)             any fraud, whether or not material, that involvesmanagement or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers and Ihave indicated in this annual report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  February 28, 2003 |
|-------------------------------|
|                          |
|                          |
| /s/ David A. Christensen      |   |
| David A. Christensen          |
| Chief Financial Officer       |

 

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CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Annual Report of Hickory Tech Corporation(HickoryTech) on Form 10-K for the year 2002 as filed with the Securities andExchange Commission on the date hereof (the Report), I, John E. Duffy, ChiefExecutive Officer of HickoryTech, certify, pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that:

 

(1)                                  TheReport fully complies with the requirements of section 13(a) or 15(d) of theSecurities Exchange Act of 1934; and

 

(2)                                  Theinformation contained in the Report fairly presents, in all material respects,the financial condition and results of operations of HickoryTech.

 

 
| /s/ John E. Duffy       |   |
|-------------------------|--------|
| John E. Duffy           |
| Chief Executive Officer |
| February 28, 2003       |

 

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CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Annual Report of Hickory Tech Corporation(HickoryTech) on Form 10-K for the year 2002 as filed with the Securities andExchange Commission on the date hereof (the Report), I, David A. Christensen,Chief Financial Officer of HickoryTech, certify, pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002that:

 

(1)          The Report fullycomplies with the requirements of section 13(a) or 15(d) of the SecuritiesExchange Act of 1934; and

 

(2)          The informationcontained in the Report fairly presents, in all material respects, thefinancial condition and results of operations of HickoryTech.

 

 
| /s/ David A. Christensen |   |
|--------------------------|--------|
| David A. Christensen     |
| Chief Financial Officer  |
| February 28, 2003        |

 

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