**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

**(Markone)**

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

 

**For the fiscal periodending December 31, 2007**

 

**or**

 

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

 

**For the transition periodfrom         to         **

 

**Commission File Number0-13721**

 

**HICKORY TECH CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**221 East Hickory Street**

**P.O. Box 3248**

**Mankato, MN  56002-3248**

(Address of principalexecutive offices)

 

Registrant’s telephonenumber, including area code: **(800) 326-5789**

 

Securities registeredpursuant to Section 12(b) of the Act:

 
| **Title of Class**         | ** ** | **Name of Exchange on Which Registered** |
|----------------------------|------------|------------------------------------------|
| Common Stock, no par value |       | NASDAQ Global Select Market              |

 

Securities registered pursuant to Section 12(g) ofthe Act:  **None**

 

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

 

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

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x  No o

 

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

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,a non-accelerated filer or a smaller reporting company. See the definition of“large accelerated filer, accelerated filer, a non-accelerated filer or smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

o Large accelerated filer      xAccelerated filer     o Non-accelerated filer    o Smaller reporting company

 

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

 

The number of shares of the registrant’s common stock, no par value,outstanding as of February 22, 2008 was 13,294,027. The aggregate marketvalue of the registrant’s common stock held by non-affiliates as of June 29,2007 was $113,996,847 based on the closing sale price of $9.10 per share on TheNASDAQ Global Select Market.

 

**DOCUMENTS INCORPORATED BYREFERENCE**

 

Certain portions of the Company’s Proxy Statement for the AnnualMeeting of Shareholders to be held on May 6, 2008 (“Proxy Statement”) areincorporated by reference in Part III of this Form 10-K.

 

 

----

 

**TABLE OF CONTENTS**

 
| Cautionary  Statement with respect to Forward Looking Statements | 3                                                                                                                   |
|------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------|
|                                                             |                                                                                                                |
| ** **                                                       | **PART I**                                                                                                     |   |
| ** **                                                       | ** **                                                                                                          |   |
| Item 1.                                                          | Business                                                                                                            | 3 |
| Item 1A.                                                         | Risk Factors                                                                                                        | 14 |
| Item 1B.                                                         | Unresolved Staff  Comments                                                                                          | 24 |
| Item 2.                                                          | Properties                                                                                                          | 24 |
| Item 3.                                                          | Legal Proceedings                                                                                                   | 24 |
| Item 4.                                                          | Submission of  Matters to a Vote of Security Holders                                                                | 25 |
|                                                             |                                                                                                                |   |
| ** **                                                       | **PART II**                                                                                                    |   |
| ** **                                                       | ** **                                                                                                          |   |
| Item 5.                                                          | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 25 |
| Item 6.                                                          | Selected Financial  Data                                                                                            | 27 |
| Item 7.                                                          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 28 |
| Item 7A.                                                         | Quantitative  and Qualitative Disclosures about Market Risk                                                         | 49 |
| Item 8.                                                          | Financial  Statements and Supplementary Data                                                                        | 53 |
| Item 9.                                                          | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                               | 78 |
| Item 9A.                                                         | Controls and  Procedures                                                                                            | 79 |
| Item 9B.                                                         | Other Information                                                                                                   | 79 |
|                                                             |                                                                                                                |   |
|                                                             | **PART III**                                                                                                   |   |
|                                                             | ** **                                                                                                          |   |
| Item 10.                                                         | Directors,  Executive Officers of the Registrant and Corporate Governance Matters                                   | 80 |
| Item 11.                                                         | Executive  Compensation                                                                                             | 80 |
| Item 12.                                                         | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    | 80 |
| Item 13.                                                         | Certain  Relationships and Related Transactions and Director Independence                                           | 81 |
| Item 14.                                                         | Principal  Accountant Fees and Services                                                                             | 81 |
|                                                             |                                                                                                                |   |
|                                                             | **PART IV**                                                                                                    |   |
|                                                             | ** **                                                                                                          |   |
| Item 15.                                                         | Exhibits and  Financial Statement Schedules                                                                         | 81 |

# ** **

2

----

 

# **Cautionary Statement with respect toForward Looking Statements**

# ** **

The PrivateSecurities Litigation Reform Act of 1995 contains certain safe harborprovisions regarding forward-looking statements. This 2007 Annual Report on Form 10-K(“Report”) and other documents filed by HickoryTech Corporation under thefederal securities laws, including Form 10-Q and Form 8-K, and futureverbal or written statements by HickoryTech and its management, may includeforward-looking statements. These statements may include, without limitation,statements with respect to anticipated future operating and financialperformance, growth opportunities and growth rates, acquisition and divestitureopportunities, business strategies, business and competitive outlook and othersimilar forecasts and statements of expectation. Words such as “expects,” “anticipates,”“intends,” “plans,” “believes,” “seeks,” “estimates,” “targets,” “projects,” “will,”“may,” “continues,” and “should,” and variations of these words and similarexpressions, are intended to identify these forward-looking statements. Suchforward-looking statements are subject to risks and uncertainties that couldcause HickoryTech’s actual results to differ materially from such statements.These risks and uncertainties include those identified under Part I – Item1A – “Risk Factors” on pages 14 to 24.

 

Because of theserisks, uncertainties and assumptions and the fact that any forward-lookingstatements made by HickoryTech and its management are based on estimates,projections, beliefs and assumptions of management, they are not guarantees offuture performance and you should not place undue reliance on them. Inaddition, forward-looking statements speak only as of the date they are made.With the exception of the requirements set forth in the federal securities lawsor the rules and regulations of the Securities and Exchange Commission, wedo not undertake any obligation to update or review any forward-lookinginformation, whether as a result of new information, future events orotherwise.

 

**PART I**

 

# **Item 1. Business**

# ** **

“HickoryTech” or the “Company” refers to Hickory Tech Corporation aloneor with its wholly owned subsidiaries, as the context requires. When thisreport uses the words “we,” “our,” or “us,” it refers to the Company and itssubsidiaries unless the context otherwise requires.

 

##### ***Company Overview and History***

##### *** ***

HickoryTech is adiversified communications company headquartered in Mankato, Minnesota thatleverages over 110 years of experience in the local telephone exchangebusiness. We operate in two principal business segments: the Telecom Sector andthe Enventis Sector.

 

The Telecom Sectoris comprised of two service and product lines. The first service and productline is the operation of three local telephone companies or incumbent localexchange carriers (“ILECs”) and the operation of one telephone company that isa competitive local exchange carrier (“CLEC”). Our original business, which wasformed in 1898, consisted of the operation of a single ILEC. In 1985, we formedHickoryTech Corporation as a holding company for our then current ILECs and toserve as a platform to expand our business. In 1998, we formed the CLEC, whichprovides the competitive services of long distance, high-speed Internet access(“DSL”) and digital TV. The second service and product line consists of dataprocessing services, which are sold to the telecommunications industry and areprovided through National Independent Billing, Inc., which is a subsidiaryof HickoryTech. Prior to 2006, operating results for NIBI had been reported inthe Information Solutions Sector, but have been recast to be included in theTelecom Sector to consolidate our reporting for similar operations for allyears presented. The primary internal user of NIBI services are the ILECs andCLEC we operate in the Telecom Sector. NIBI activities are of strategic valueto HickoryTech, primarily because of the support services it provides to thesecaptive telephone companies. The goals and objectives, and the way that theNIBI product line is run, are closely aligned with those of the Telecom Sector.

 

3

----

 

We started theoperations of our second business segment, the Enventis Sector, when wepurchased Enventis on December 30, 2005. Enventis is currently asubsidiary of HickoryTech and is a Minnesota-based regional provider ofintegrated fiber network, Internet protocol telephony and data services, with1,500 route miles of fiber network serving business customers in the UpperMidwest. Enventis had formerly been a wholly owned subsidiary of another publiccorporation.

 

In December 2006,we sold what had been a third business segment (Enterprise Solutions), whichprovided telephone, data and Internet protocol equipment sales and service. Allfinancial statements and schedules have been restated to reflect EnterpriseSolutions operations as discontinued operations.

 

Our operations are currently conducted through the following sevensubsidiaries:

 

Telecom Sector

 

·      MankatoCitizens Telephone Company (“MCTC”)

·      Mid-Communications, Inc.(“Mid-Com”)

·      HeartlandTelecommunications Company of Iowa, Inc. (“Heartland”)

·      CableNetwork, Inc. (“CNI”)

·      CrystalCommunications, Inc. (“Crystal”)

·      NationalIndependent Billing, Inc. (“NIBI”)

 

Enventis Sector

 

·      EnventisTelecom, Inc. (“Enventis”)

 

**OurStrategy**

 

Our core strategy focuseson the offering of integrated communication solutions to businesses andconsumers. As we sell integrated bundles of services to our customers, weincrease market share, provide additional value and increase customer loyalty.

 

Our consumer strategy,focused on residential customers, is to market competitive multi-servicebundles, which include: DSL, high speed Internet, digital TV, local phoneservice, long distance and home networking services. We utilize value addedservices, such as speed, content and features, to differentiate our services inthe marketplace. In addition, we intend to provide outstanding customer care inorder to win new customers and maintain existing customers. We intend to usethe following tactics to achieve this strategy:

 

·      Leverage the HickoryTech brand and itsstrong reputation in legacy markets to deliver residential solutions,

·      Maximize our return in each market weserve by promoting a competitive, multi-service bundle to offer value,competitive pricing, create loyalty and retain customers,

·      Increase our digital TV market share bystriving to offer customers a competitive entertainment service includingcustomer value added services and flexible channel line-ups, and

·      Grow our home networking service in aneffort to “own the home” and provide complete communication services to ourresidential customers.

 

Our business-to-businessstrategies focus on supporting the business customers, ranging from small tolarge enterprise-sized business. We will offer integrated communicationsolutions which include Internet protocol telephony, transport, data andnetwork integration services that combine voice and data into a singleplatform. We intend to differentiate our service offerings by providing ourbusiness customers with a fully integrated communications solution that blendsour hosted solutions with customer-owned systems.  In addition, we will strive to provideunparalleled customer service as a differentiator and we will leverage ourInternet protocol expertise both in the metro and out-state areas of Minnesota.We intend to use the following tactics to achieve this strategy:

 

·      Build the Enventis brand to become the regionalleader in providing integrated business communication solutions outside of ourlegacy markets. Leverage the HickoryTech brand and its strong reputation toserve customers within our legacy markets,

 

4

----

 

·      Develop additional service offerings toincrease our product portfolio and meet our customers’ growing communicationsneeds,

·      Focus on cross selling all services toexisting customers in an effort to maximize our relationship and providecomplete solutions,

·      Expand business services to targeted newmarkets along our fiber network,

·      Further develop our unifiedcommunications product, and

·      Leverage our Ethernet service offeringand focus on local area network, multi-point sales.

 

Our wholesale customer strategyfocuses on regional and national wireline and wireless carriers, LEC’s,Internet service providers and data service providers. We intend to leverageour fiber network and provide competitive transport solutions within Minnesotaand reaching into Wisconsin, Iowa, North Dakota and South Dakota. We intend todifferentiate our service by utilizing a consultative approach in developinginnovative and flexible solutions to deliver the best overall value. We intendto leverage our core optical/Internet protocol expertise to deliver and supportfully integrated solutions that meet or exceed customer expectations. We intendto use the following tactics to support our wholesale strategy:

 

·      Build the Enventis brand to become theregional leader in providing wholesale solutions,

·      Leverage the dense wavelength divisionmultiplexing overlay, multi-protocol label switching overlay and Ethernetcapabilities to lead the market with advanced high bandwidth capabilities andservices,

·      Focus on key wholesale growth verticalssuch as the wireless sector, data centers, and data local exchange carriers,where we are well positioned to succeed in putting key sites on-net andaggregating out-state connections,

·      Focus on the cross-selling of additionalservices to existing customers in an effort to maximize our relationship andprovide those customers with broader solutions, and

·      Look for opportunities to increase ourcarrier interconnections to on-net buildings, central offices and data centers.

 

Our Information Solution’sstrategies focus on the support and marketing of SuiteSolution®, which is ourbranded customer care and billing solution, to the telecommunications industryserving CLECs, LECs, interexchange carriers, wireless and Internet protocolproviders, and resellers. Additionally, the Information Solutions divisionprovides internal information technology support across all divisions, enablingus to meet our customer’s technology and billing needs.

 

**IndustrySegments**

 

Wereport the business operations of our three ILECs and CLEC and their associatedservices along with our data processing (NIBI) services as a single segmentthat we refer to as the Telecom Sector. The second business segment, Enventis,includes predominately business-to-business operations generally outside of theTelecom Sector service area. The results of operations of the Enterprise SolutionsSector are reported as discontinued operations (see Note 3 to the Notes to theConsolidated Financial Statements).

 

**Telecom Sector**

 

OurTelecom Sector provides local exchange wireline telephone service, longdistance, DSL, digital TV services and owns and operates fiber optic cablefacilities. This sector includes three ILEC’s (MCTC, Mid-Com and Heartland).MCTC and Mid-Com provide telephone service in south central Minnesota,specifically Mankato (a regional hub) and eleven rural communities surroundingMankato. The third ILEC, Heartland, provides telephone service for eleven ruralcommunities in northwest Iowa. In total, there are twenty-three ILEC exchanges withinthe Telecom Sector. The Telecom Sector also includes Crystal, a CLEC thatprovides local telephone service, long distance, DSL and digital TV on acompetitive basis. NIBI,which is also part of the Telecom Sector, provides data processing and relatedservices, principally for our affiliated ILECs and CLEC, as well as for otherlocal exchange telephone companies, CLEC’s, interexchange network carriers,wireless companies and cable TV providers.

 

5

----

 

We also own and operate fiber optic cable facilitiesin Minnesota in both our Telecom and Enventis Sectors. These facilities areused to transport interexchange communications as a service to telephoneindustry customers. Our Minnesota ILEC’s and CLEC are the primary users ofthese fiber optic cable facilities in the Telecom Sector. None of the remainingcompanies in the Telecom Sector experienced major changes in operations during2007 or 2006, other than the cumulative effect of repeated periodic declines innetwork access revenue and the gradual erosion of access lines in service,which has reduced the profitability of this Sector. However, the expansion andgrowth of DSL and broadband services has helped to offset this profitabilitydecline.

 

**The ILEC’s**

 

MCTCderives its principal revenue and income from local services charged tosubscribers in its service area, access services charged to interexchangecarriers such as AT&T and the operation of a toll tandem-switching centerin Mankato, Minnesota. Revenue and income for Mid-Com are also derived fromlocal service charges in its area of operation and by providing access to longdistance services for its subscribers through the toll center in Mankato. Localand interexchange telephone access for the two companies is provided on anintegrated basis. The local and interexchange telephone access for bothtelephone companies utilize the same facilities and equipment and are managedand maintained by a common workforce. Heartland derives its principal revenueand income from local services charged to subscribers in its service area inIowa, as well as from providing interexchange access for its subscribers.Interexchange telephone access is provided by all three of our ILECsubsidiaries by connecting the communications networks of interexchangecarriers and wireless carriers with the equipment and facilities of end usersthrough its switched networks or private lines. Network access revenueaccounted for 19.7%, 22.5% and 42.8% of our total revenue in 2007, 2006 and 2005,respectively. The lower percentages in 2007 and 2006 are primarily due to theEnventis acquisition and subsequent operations growth. Without the EnventisSector, access revenue would have accounted for 40.2% and 39.8% of the totalrevenue for HickoryTech in 2007 and 2006, respectively.

 

Aslocal exchange telephone companies, MCTC, Mid-Com and Heartland provide endoffice switching and dedicated circuits to long-distance interexchangecarriers. These relationships allow our telephone subscribers to place long-distancetelephone calls to the telephone network. We provide interexchange access toour network for interexchange carriers to conduct long-distance business withindividual customers who select a long-distance carrier and for termination ofcalls to all customers. This interexchange access business is separate anddistinct from our own long-distance retail business, which is operated throughCrystal. The long-distance interexchange carriers are significant customers ofours, but no carrier represents more than ten percent of our consolidatedrevenue.

 

OurILECs compete with companies that offer private lines to our potentialcustomers in lieu of our switched voice services and with data services in oradjacent to the territories we serve that permit potential customers to bypasslocal telephone switching facilities. Additionally, services provided by othercompanies utilizing various Internet, wireline or wireless technologies permitbypass of the local exchange network. Cable TV companies also provide Internet,DSL and voice services in our markets. These alternatives to the local exchangeservice represent a potential threat to our long-term ability to provide localexchange service at economical rates.

 

Competition exists for some of the services we provide to interexchangecarriers, such as dedicated private lines, network switching and networkrouting. This competition comes primarily from the interexchange carriers whoredirect the services provided by us to their own network or other networks.The provision of these services is primarily month-to-month service ordered from a general tariff, which is aschedule of terms, rates and conditions which are approved by the appropriatestate or federal agency. The interexchange carriers primarily control theprocurement of these services. Asinterexchange carriers make these service decisions, they have the potential toreduce our revenue in the Telecom Sector. Other services, such as the provisionof broadband, long distance, directory advertising, end user equipment andcustomer billing services are open to competition.

 

6

----

 

Specificcompetition exists in several of our ILEC service areas. A municipality hasoverbuilt Heartland’s network in one community in Iowa and now serves over halfof that market. Additionally, cable TV providers are offering voice, Internetand cable TV services in several Heartland, Mid-Com, MCTC and Crystalcommunities. Our ILECs and CLEC are also periodically engaged in negotiationsor renegotiations of arrangements for network interconnections and potentialunit price declines with other wireline carriers and various wireless serviceproviders. Although competition from these various sources may result inreduced revenue, we cannot, at this time, estimate the potential impact relatedto these events or negotiations

 

**CLEC**

 

Crystalbegan operations in January of 1998 as a CLEC. Crystal offers localtelephone service, long-distance, DSL and digital TV on a competitive basis tocustomers in Southern Minnesota and Iowa and also connects communicationsnetworks of interexchange carriers and wireless carriers with the equipment andfacilities of end users. Crystal has customers in ten rural communities,encompassing eight exchanges in Minnesota and three communities encompassingtwo exchanges in Iowa that are not in the geographies of our ILEC serviceareas. In addition to these telephone services, Crystal provides long distanceservice, DSL and digital TV service in eleven communities, including communitiesserved by some of our ILECs. The communities in which Crystal provides digitalTV services include St. Peter (initiated in 2001); Waseca (since 2004); NewRichland, Ellendale and St. Clair (since 2005); Faribault, Lake Crystal andEagle Lake (since 2006); and Janesville, North Mankato and Mankato (since2007), all of which are communities where we provide telephone service eitheras an ILEC or CLEC.

 

Crystalis not dependent upon any single customer or small group of customers. Nosingle customer in Crystal accounts for ten percent or more of HickoryTech’sconsolidated revenue.

 

**NIBI**

 

NIBI’s principal activityis the provision of monthly batch processing of computerized data. Services forour telephone company customers include the processing of long distancetelephone calls from data sources and telephone switches, the preparation ofsubscriber telephone bills, customer record keeping and carrier access bills.There are a number of companies engaged in supplying data processing servicescomparable to those furnished by NIBI. Competition is based primarily on priceand service. NIBI has developed an integrated billing and management systemcalled SuiteSolution®. SuiteSolution® can provide wireline and wirelesscarriers the individual benefits of a billing platform or a total systemsolution. SuiteSolution® is comparable in the majority of functional elementsto similar products/companies providing end user billing services for small tomedium-size independent wireline and wireless service providers in NorthAmerica. Certain features and functionality of SuiteSolution®, which are basedon “Request for Proposal” responses, are more highly rated than competingproducts, while other features and functionality may not be as highly rated ascompeting products. NIBI counts approximately 20 companies as its primarycompetitors in marketing to small to medium-size independent wireline andwireless service providers in North America. SuiteSolution® does not utilizeunique patentable inventions or technological innovations in the constructionof the product. Commercially available programming languages are utilized inthe development of code that may, based on needs of a prospective user, deliversolutions that are preferred over those of competing products.

 

7

----

 

**Enventis Sector**

 

We acquired Enventis on December 30,2005. Through Enventis, we provide integrated data services, offering fiberoptic-based communication and advanced data services to business communities inthe Upper Midwest. Enventis owns or has long-term leases to approximately 1,500route miles of fiber optic cable. Enventis also has extensive local fiber opticrings that directly connect the Enventis network with its larger clients (e.g.interexchange carriers, retail, health care, government and educationcustomers, etc.). Other local fiber rings connect the Enventis network to thelocal telephone enterprise’s central offices. This allows Enventis to utilizethe telephone company’s connections to access its smaller clients. Enventisserves customers through interconnections that are primarily leased from thirdparties (commonly referred to as “the last mile”). Enventis, through itsequipment revenue product line, has business relationships with Cisco Systems, Inc.and is recognized by Cisco as a Gold Partner. The relationship with CiscoSystems, Inc. is a strategic partnership of Cisco (as the supplier) andEnventis (as the distributor). Enventis is a regional leader in deployingleading edge technologies such as Internet protocol call centers. Enventisprovides converged Internet protocol services that allow all communications(e.g. voice, video and data) to use the same fiber optic-based deliverytechnology. Enventis has Minnesota offices located in Plymouth, Duluth andRochester.

 

Enventis’ productportfolio includes Encompass Unified Communications, which servessmall-to-medium-sized businesses. Encompass is a hosted or managed Internetprotocol communications service includinglocal and long distance voice; business Internet protocol telephony via ahosted Internet protocol private branch exchange; unified messaging (a singleinbox for voicemail,e-mail, and fax), and dedicated Internet access. Encompass leverages voice overInternet protocol or Internet protocol telephony over a private connection,which minimizes upfront capital investment and information technologymanagement overhead. Voice over Internet protocol enables advancedfunctionality, voice interoperability with personal computers and scalability.Enventis has been granted authority to operate from the public utilitycommissions in Minnesota and Wisconsin for private line services that aresubject to minimal regulation. Enventis has also been granted Minnesotaauthority to provide regulated local telephone (voice) services. Those servicesare provided primarily in a fashion that augments its voice over Internetprotocol service. Services provided by Enventis compete directly with thosefrom ILEC’s and other communications providers in the area in which itoperates. Enventis is not dependent upon any single customer or small group ofcustomers.

 

**Regulation**

 

The following summarydoes not describe all present and proposed federal, state and local legislationand regulations affecting the telecommunications industry. Some legislation andother regulations are currently the subject of judicial proceedings,legislative hearings and administrative proposals that could change the mannerin which this industry operates. Neither the outcome of any of thesedevelopments nor their potential impact on us can be predicted at this time.Regulation can change rapidly in the telecommunications industry and thesechanges may have an adverse effect on us in the future. See “Risk Factors –Risks related to Regulations” on pages 17 to 20 for a further discussionof the risks associated with regulatory change.

 

*Overview*

 

The services we offer aresubject to varying levels of regulatory oversight. Federal and state regulatoryagencies share responsibility for enforcing statutes and rules relative tothe provision of communications services. Our interstate or internationaltelecommunications services are subject to regulation by the FederalCommunications Commission. Intrastate services are governed by the relevantstate regulatory commission. The Telecommunications Act of 1996 and the rules enactedunder it also gave oversight of interconnection arrangements and access tonetwork elements to the state commissions. Our digital TV services are governedby Federal Communication Commission rules and also on the local level bymunicipal franchise agreements.

 

There are alsovarying levels of regulatory oversight depending on the nature of the servicesoffered or if the services are offered by an incumbent or competitive carrier.

 

8

----

 

MCTC,Mid-Com and Heartland are incumbent local exchange carriers. MCTC and MidComare public utilities operating pursuant to indeterminate permits issued by theMinnesota Public Utilities Commission. Heartland is also a public utility,which operates pursuant to a certificate of public convenience and necessityissued by the Iowa Utilities Board. Due to the size of the HickoryTech ILECcompanies, neither the Minnesota Public Utilities Commission nor the IowaUtilities Board regulate their rates of return or profits. In Minnesota,regulators monitor MCTC and Mid-Com price and service levels. Heartland, ourIowa ILEC, is not price-regulated with respect to its local service. Ourcompanies can change local rates by evaluating various factors includingeconomic and competitive circumstances.

 

Our CLEC businessesprovide services in Minnesota, Iowa and Wisconsin with less regulatoryoversight than our ILEC companies. A company must file for CLEC or interexchangeauthority to operate with the appropriate public utility commission in eachstate it serves. Crystal provides local exchange services in Minnesota andIowa, and Enventis provides private line services in Minnesota and Wisconsin.

 

Both Crystal and Enventisoffer interexchange carrier services including long-distance that may beregulated at both the federal and state levels. The Federal CommunicationsCommission has authority over interstate and international long-distanceservices but has chosen to lightly regulate these services in recent years.Long-distance service is subject to consumer protection, complaint-basedregulation at the federal level. The regulatory burden is primarily compliancereporting which includes an annual certification of geographical rate averagingand rate integration. In-state long-distance services in Minnesota areregulated by the Minnesota Public Utilities Commission with respect to uniformpricing statewide while in-state long distance services in Iowa areunregulated.

 

Dial-up access andhigh-speed Internet access are unregulated at both the state and federallevels.

 

Crystalcompetes directly against existing ILEC’s in the areas in which it operates andalso competes directly against incumbent cable TV providers and satellite TVproviders for its high speed Internet and digital TV services. Crystal ispresently providing these services to eleven Minnesota markets under franchiseagreements negotiated with these local municipalities or rural townships.

 

*FederalRegulatory Framework*

 

All carriers must complywith the Federal Communications Act of 1934 as amended, which requires, amongother things, that our interstate services be provided at just and reasonablerates and on non-discriminatory terms and conditions. The FederalCommunications Act of 1934 also requires Federal Communications Commissionapproval before we transfer control of our operating companies, assign, acquireor transfer licenses or authorizations issued by the Federal CommunicationsCommission, or before we discontinue any interstate service. The FederalCommunications Act of 1934 was amended by the Telecommunications Act of 1996,which has had a dramatic effect on the competitive environment in thetelecommunications industry. In addition to these laws, we are also subject to rules promulgatedby the Federal Communications Commission and could be affected by anyregulatory decisions or orders that they issue.

 

*AccessCharges*

 

“Access charges” refer tothe compensation received by local exchange carriers for the use of theirnetworks to originate or terminate interexchange or international calls. Weprovide two types of access services, which include special access and switchedaccess. Special access is provided through dedicated circuits which connectother carriers to our network. Special access pricing is structured on a flatmonthly fee basis. Switched access rates, which are billed to other carriers,are based on a per-minute of use fee basis. The Federal CommunicationsCommission regulates the prices that our ILECs and CLEC charge for interstateaccess charges. Historically, switched access rates for rural carriers wereallowed to be higher than those for larger, more urban companies. This was doneto provide a means of implicitly subsidizing the high per-unit cost of localservice in rural areas. However, following a series of court cases in 2001,which ruled that subsidies must be explicit rather than implicit, the FederalCommunications Commission began to examine various proposals to reforminterstate network access rates. One result of those proposals was the loweringof the rates charged to carriers accessing local networks and the applicationof a subscriber line charge as a flat rate on the end users’ bills. Thelowering of the per minute per use access rate combined with overall lowerminutes due to competition, has resulted in a decrease in network accessrevenue, which may continue.

 

9

----

 

Each of our ILECsdetermines its interstate access charges under rate of return regulation, underwhich they earn a fixed return over and above operating costs. The FederalCommunications Commission has established the authorized rate of return at11.25%. The specific process of setting interstate access rates is governed bypart 61.39 of the Federal Communications Commission rules, which applies onlyto service providers with fewer than 50,000 lines. Two of our ILECs (MCTC andMid-Com), utilize an average schedule process and the concept of pooling withother ILECs in the National Exchange Carrier Association to arrive at rates andfair compensation.

 

Our CLEC’s interstateaccess rates were established according to an order issued by the FederalCommunications Commission in 2001. Under that order, the switched access ratescharged by a competitive carrier can be no higher than the rates charged by theincumbent carrier with whom the CLEC competes. Consequently, the rates chargedby our facilities-based CLEC for switched access are significantly lower thanthe rates charged by our ILECs. Because of the emerging nature of the servicesprovided by our other competitive affiliate Enventis, it does not collectaccess charges from carriers.

 

In July 2006, theFederal Communications Commission solicited comments on a proposal to reformthe interstate access system, now commonly referred to as “intercarriercompensation.” This proposal is known as the Missoula Intercarrier CompensationPlan, or Missoula Plan. We participate in evaluating and influencing anyproposed reforms through our industry associations and affiliations. It ispossible that our ILECs could experience a change in revenue if the MissoulaPlan were to be adopted by the Federal Communications Commission. There is nodefinite timeline for the Federal Communications Commission to act in thisproceeding however, so it is not possible for us to predict when any change inrevenue will occur or the extent of the impact.

 

The Minnesota PublicUtilities Commission has been considering intrastate access reform anduniversal service for several years. The Minnesota Public Utilities Commissionopened two dockets in 2004 regarding state access reform. These dockets weresuspended in December 2004 after concerns were expressed by state agenciesregarding increases in local rates and the potential that federal activity mayalso address this issue, and they were officially closed in January 2006.The Minnesota Public Utilities Commission then opened a similar docket on theissue of state access reform and has recently asked for comments to refresh therecord. The Iowa Utilities Board had previously not exercised oversight in theaccess rates of small local exchange carriers. In November of 2007,however, it indicated that it intends to resume that role. We cannot estimatethe impact, if any, of future potential state access revenue changes.

 

In recent years,interexchange carriers and others have become more aggressive in disputinginterstate carrier access charges and/or the applicability of access charges totheir traffic. A prime example of this is the claim that companies who providevoice communication services over Internet protocol technology are exempt fromhaving to pay access charges. In 2005, the Federal Communications Commission ruledthat it was impossible to separate the voice traffic of voice over Internetprotocol providers into interstate and intrastate jurisdictions, and thereforesuch providers would be regulated by the Federal Communications Commission andnot by state regulatory commissions. The Federal Communications Commission iscurrently considering the question of whether or not voice over Internetprotocol services are subject to access charges. In the meantime, we believethat long distance and other communication providers will continue to seek tochallenge the applicability of access charges either before the FederalCommunications Commission or with their local exchange carriers. To date, nolong distance or other carriers have made a claim to us contesting the applicabilityof access charges. We cannot assure you however, that such claims will not bemade in the future, nor if such a claim is made, can we estimate the impact.

 

The U.S. 8thCircuit Court of Appeals has upheld a ruling by the United States District Court,District of Minnesota, in issuing an injunction providing relief fromregulation of any service provider of voice over Internet protocol basedservices in Minnesota. In July 2006, the Federal Communications Commissionruled that voice over Internet protocol services are subject to FederalUniversal Service Fund Contributions, but any further regulation of voice overInternet protocol under consideration at the Federal Communications Commissionis uncertain. Future decisions regarding the regulation of voice over Internetprotocol may result in a change in the business relationship betweenHickoryTech companies and the interexchange carriers as interconnections withcertain voice over Internet protocol providers may not be governed by tariffedaccess charges. We cannot, at this time, estimate the revenue impact, if any,related to these events.

 

10

----

 

Due to the combination ofrate reforms instituted by the Federal Communications Commission, competitivesubstitution by wireless and other carriers and customer usage trends, theaggregate amount of interstate network access charges paid by long distance carriersto access providers such as our ILECs and CLEC, has decreased and we projectthat this will continue. For the year ended December 31, 2007, carrieraccess revenue, both minutes of use and special access, representedapproximately 19.7% of all of our company operating revenue.

 

Wireline Interstate – OurILEC companies participate in the National Exchange Carrier Association commonline pool. End User Common Line funds collected, are pooled and some of ourILEC revenue is based on settlements distributed from the pool. These poolsettlements are adjusted periodically. Our ILEC companies do not participate inthe National Exchange Carrier Association traffic sensitive pool, but instead,set their own access rates according to the formulas contained in Section 61.39of the Federal Communications Commission rules and have done this for manyyears. This biennial rate process was completed in June 2007 andestablished traffic sensitive interstate rates for the period from June 30,2007 through July 1, 2009.

 

Some local exchangecarriers have chosen to exit the National Exchange Carrier Association poolunder Section 61.39 of the Federal Communication Commission rules, whichapply only to service providers with fewer than 50,000 lines. Normally, theNational Exchange Carrier Association files interstate access tariffs on behalfof pool members, manages the access revenue pools themselves and distributesthe funds. When rural local exchange carriers choose to leave the pool, whichthey can do for a two-year period, they can set access fees based on theirhistory of calling volumes that differ from National Exchange CarrierAssociation rates. This results in a higher per minute of use charge. Somecompanies may then provide service to conference calling companies or otherproviders who generate a large number of minutes. Such practices have becomeknown in the industry as “traffic pumping.” These types of businessarrangements have been challenged by AT&T with the Federal CommunicationsCommission and by Qwest in the state of Iowa.

 

*UniversalService*

 

The Federal UniversalService Fund was established to overcome geographic differences in costs ofproviding service and to enable all citizens to communicate over networksregardless of geographical location and or personal income. Prior to theadoption of the Telecommunications Act of 1996, universal service was achievedlargely through implicit support subsidies, including federal access chargespreviously discussed.

 

The FederalCommunications Commission establishes universal service policies at thenational level under terms contained in the Telecommunications Act of 1996. TheTelecommunications Act of 1996 requires explicit Federal Universal Service Fundmechanisms and enlarged the scope of universal service to include four distinctprograms:

 

·      High-Cost program, which subsidizes localcarriers operating in high-cost regions of the country to ensure reasonablybased telephone rates. This is the program which has the most direct impact onour operating companies,

·      Low-Income Subscribers program, whichincludes the Link Up and Lifeline programs that provide subsidies for serviceinitiation and monthly fees, respectively, with eligibility based on subscriberincome,

·      Rural Health Care Providers program,which subsidizes telecommunications services used by rural health careproviders and provides them with toll free access to an Internet serviceprovider, and

·      Schools and Libraries program, alsocalled the E-Rate program, which provides support funding to schools and librariesfor telecommunications services, Internet access and internal connections.

 

The National ExchangeCarrier Association collects and disburses Federal Universal Service Fundpayments. The National Exchange Carrier Association was formed by the FederalCommunications Commission in 1983 following the break-up of AT&T intoseparate local and long distance operations.

 

11

----

 

Federal Universal ServiceFund payments are only available to carriers that have been designated asEligible Telecommunications Carriers by a state commission. Each of our ILECshas been designated as an Eligible Telecommunications Carrier. Competitivecarriers (CLECs) are also eligible to be designated as EligibleTelecommunications Carrier, provided that they meet the requirements of theprogram and meet a public interest standard as determined by the appropriatestate regulatory agency. CLECs receive support payments based on the supportprovided to the incumbent carrier in the area in which they serve. Both theMinnesota Public Utilities Commission and Iowa Utilities Board have grantedEligible Telecommunications Carrier status to numerous carriers, including manywireless companies. Under current rules, the payments received by our ILECs arenot affected by the payments to the competitive Eligible TelecommunicationsCarriers. Because of the growing number of competitive EligibleTelecommunications Carriers and the accompanying funds which are beingdisbursed to them, the Federal Communications Commission is considering severaluniversal service reforms including an interim cap on the Federal UniversalService Fund as it pertains to the competitive carriers.

 

All EligibleTelecommunications Carriers must certify to their appropriate state regulatorycommission that the funds they receive from the Federal Universal Service Fundare being used in the manner intended. The states must then certify to theFederal Communications Commission which carriers have met this standard. Thatcertification is due to the Federal Communications Commission in October ofeach year in order for carriers to receive funding for the upcoming year. In2006, both Minnesota and Iowa adopted more stringent guidelines for thisdetermination as recommended by the Federal Communications Commission. To someextent, this increased level of scrutiny puts our receipts of Federal UniversalService Fund payments at risk each year.

 

There is legislationpending in Congress which would address the Anti-Deficiency Act as it appliesto the Federal Universal Service Fund. The Anti-Deficiency Act prevents federalagencies from committing to provide funding in excess of their funds on hand.Currently, the Federal Universal Service Fund administrator makes commitmentsto fund recipients in advance of collecting the contributions from the carriersthat will pay for these commitments. Congress is considering whether topermanently exempt the Federal Universal Service Fund from the Anti-DeficiencyAct requirements. If it does not grant this extension however, the FederalUniversal Service Fund payments to our companies may be delayed or reduced inthe future.

 

We cannot predict theoutcome of any Federal Communications Commission rulemaking or pendinglegislation. The outcome of any of these proceedings or other legislative orregulatory changes could affect the amount of universal support received by ourILECs. For the year ended December 31, 2007, Federal Universal ServiceFund payments represented 4.2% of our telecom revenue and 2.1% of our totalrevenue.

 

*Regulationof the Internet*

 

In an order released on September 23,2005, the Federal Communications Commission adopted a comprehensive regulatoryframework for facilities-based providers of wireline broadband Internet accessservices (“the WBBO”). The Federal Communications Commission determined thatfacilities-based wireline broadband Internet access is an information service,and not a telecommunications service. This designation positioned thehigh-speed DSL Internet access offered by price cap telcos and CLEC’s on thesame regulatory footing as cable modem service. Following a transitionalperiod, which has passed, facilities-based wireline carriers are no longerobligated to provide broadband Internet access transmission to unaffiliatedInternet service providers. In addition, the WBBO allowed for the provision ofwireline broadband Internet access on a common carrier, or non-common carrierbasis. Our CLEC DSL service in our CLEC markets is provided on a non-commoncarrier basis. We have determined it is in the best interest of our ILECcompanies to continue to offer DSL on a tariffed, common-carrier basis however.As our circumstances continue to shift, we also continue to re-evaluate ouroptions.

 

*TheTelecommunications Act of 1996 and Local Competition*

 

The primary goal of theTelecommunications Act of 1996 and the Federal Communications Commission’s rules promulgatedunder it was to open local telecommunications markets to competition whileenhancing universal service. To some extent, Congress pre-empted the localauthority of states to oversee local telecommunications services.

 

12

----

 

The TelecommunicationsAct of 1996 imposes a number of requirements on all local telecommunicationsproviders which include:

 

·      To interconnect directly or indirectlywith other carriers,

·      To allow others to resell their services,

·      To provide for number portability, whichallows end users to retain their telephone number when changing providers,

·      To ensure dialing parity,

·      To ensure that competitor’s customershave nondiscriminatory access to telephone numbers, operator services,directory assistance and directory listing services,

·      To allow competitors access to telephonepoles, ducts, conduits and rights-or-way, and

·      To establish reciprocal compensationarrangements for the transport and termination of telecommunications traffic.

 

LocalNumber Portability – In 2003, the Federal Communications Commission released adecision providing guidance on porting between wireline and wireless networks(inter-modal porting). All of the Company’s wireline operations have operatedwith local number portability capabilities since early 2005. Although theeffects of inter-modal porting on our wireline operations have been minimal todate, it is possible that these requirements could adversely affect ourwireline operating costs and customer growth rates. We are unable to quantifythe long-term effects or revenue impact of wireline customers that may switchto wireless or other wireline alternatives.

 

Unbundling - Thereis another tier of requirements under the Telecommunications Act of 1996 whichapply to incumbent carriers that are not designated as “rural telephonecompanies”. Each of our ILECs is a rural telephone carrier and this designationcan only be removed by a petition of a competing carrier to the stateregulatory commission. As no one has challenged our designation, our ILECs havenot yet had to meet these requirements. If this designation was removed, ourILECs would be required to:

 

·      Provide non-discriminatory access todiscrete parts of the network, such as local loops and transport facilities.This is referred to as Unbundled Network Elements, and

·      Providing, at rates, terms and conditionsthat are just, reasonable and non-discriminatory, for the physical co-locationof equipment necessary for interconnection or access to unbundled networkelements.

 

The unbundlingrequirements of the Telecommunications Act of 1996 have been some of the mostcontroversial provisions of the act and the rules implementing them havebeen revised by the Federal Communications Commission over the years. While ourILECs have not been required to un-bundle their networks, our CLEC operatingentities have taken advantage of the unbundling and co-location requirementsand currently purchase both in territories served by Qwest Communications.

 

Under the direction ofCongress, the Federal Communications Commission is required to revisit theunbundling requirements every three years. Under the Triennial Review process,certain unbundled network elements are now no longer available. We have notbeen affected by those decisions. There are other processes available forincumbents to limit the network elements they must un-bundle. One process callsfor a petition to the state regulatory commission to determine if particularcentral offices are no longer “impaired”. This impairment threshold, initiallyestablished by the Federal Communications Commission, indicates that if threeor more facilities-based providers are offering special access services in ageographical area, then the area is not impaired absent access to unbundledservices from the incumbent. The requirement to provide those unbundled networkelements is then removed from the incumbent for that area. There is currentlysuch a petition before the Minnesota Public Utilities Commission for review ofseveral exchanges. We do not anticipate any impact from this eventual decisionas the affected unbundled network elements are not ones which we purchase.

 

13

----

 

A related issue is a “forbearance”procedure whereby an ILEC may petition the Federal Communications Commission toforbear from applying unbundling requirements if they show a threshold level ofcompetition. On April 27, 2007, Qwest Communications filed such a petitionfor the Minneapolis-St. Paul metropolitan statistical area (FederalCommunications Commission Wireline Competition Bureau Docket 07-97). Again,purchases of unbundled network elements in this metropolitan statistical areahave not been an extensive component of our CLEC’s business plan, so we do notanticipate that a decision will affect our current plans, though it couldaffect future strategic planning.

 

**Employees**

 

We employapproximately 400 employees, most of whom are based in Minnesota. A total ofapproximately 270 employees are located at our headquarters in Mankato,Minnesota. We have a collective bargaining agreement with the InternationalBrotherhood of Electrical Workers Local 949, which covers approximately 92 ofour employees. There have been no work stoppages or strikes by ourInternational Brotherhood of Electrical Workers Local 949 employees in the past30 years and we consider our labor relations to be good.

 

**IntellectualProperty**

 

We believe we havetrademarks, trade names and licenses that are necessary for the operation ofour business as we currently conduct it. The HickoryTech logo is a registeredtrademark of the United States. We do not consider our trademarks, trade namesor licenses to be material to the operation of our business.

 

**Available Information and Website Access to Securities and ExchangeCommission Reports**

 

Our Internet website is located at *http://www.hickorytech.com*.Information contained in our website is not part of this Form 10-K.

 

Copies of our most recent Annual Report on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K and amendments tothose reports filed pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934, can be obtained, free of charge, as soon as reasonablypractical after such material is electronically filed, or furnished to theSecurities and Exchange Commission. To obtain this information visit ourwebsite noted above and click on “Investor Relations,” or call 507-387-3355, orwrite a request addressed to:

 

Investor Relations

HickoryTech Corporation

PO Box 3248

221 East Hickory Street

Mankato, MN  56002-3248

 

**Code of Ethics and Code of Conduct**

 

Our board of directors has adopted a Code of Ethics that is applicableto all directors, the chief executive and chief financial officers, toemployees involved in financial reporting, and to other designated employees.All employees of the Company have adopted a Code of Conduct and have undergonetraining on this code and ethics. Our Board of Directors has also adoptedwritten charters for its committees that comply with the NASDAQ Global SelectMarket. Copies of the committee charters are available on our website or uponrequest by contacting our Investor Relations department at 507-387-3355 or bywriting the Investor Relations department at the address noted above.

 

# **Item 1A.    Risk Factors**

# ** **

Our businesses face manyrisks, the most important of which we attempt to describe below. If any of theevents or circumstances described in the following risks actually occurred, ourbusiness financial condition or results of operations may suffer and impact thetrading price of our stock.

 

14

----

 

**Risks Related to Our Business**

 

*The telecommunications industry is generally subject to substantialregulatory changes, rapid development and introduction of new technologies andintense competition that could cause us to suffer price reductions, reducedoperating margins or loss of market share*. The telecommunicationsindustry has been, and we believe will continue to be, characterized by severaltrends, including the following:

 

·      Substantial regulatory changedue to the passage and implementation of the Telecommunications Act of 1996,which included changes designed to stimulate competition for both local andlong distance telecommunications services,

·      Rapid development andintroduction of new technologies and services,

·      Increased competition withinestablished markets from current and new market entrants that may providecompeting or alternative services,

·      The blurring of traditionaldividing lines between, and the bundling of, different services, such as localdial tone, long distance, wireless, cable TV, data and Internet services, and

·      An increase in mergers andstrategic alliances that allow one telecommunications provider to offerincreased services or access to wider geographic markets.

 

*The telecommunications industry is highly competitive.*TheTelecommunications Act of 1996 permitted competition among communicationcompanies for the rights to interconnect with established networks and toestablish new networks in order to offer telephone service to customers in afranchised area. We serve as an ILEC in a number of franchised areas, as well asa CLEC in a number of markets. Other telecommunications carriers have theauthority under this legislation to provide new networking routes, points ofinterconnection, technology or signaling protocol, creating competition, whichcould have a material adverse affect on our profitability. Many of our voiceand data competitors, such as cable TV providers, Internet access providers,wireless service providers and long distance carriers, have brand namerecognition and financial, personnel, marketing and other resources that aresignificantly greater than ours. In addition, due to consolidation andstrategic alliances within the telecommunications industry, we cannot predictthe number of competitors that will emerge, especially as a result of existingor new federal and state regulatory or legislative actions. Such increasedcompetition from existing and new entities could lead to price reductions andreduced operating margins or loss of market share. Although we attempt todifferentiate our products and service through technology, reputation andprice, competition has increased in the majority of the markets that we serve.This competition has impacted our profitability in the past and we cannotassure you that it will not continue to impact our profitability in the future.

 

*We maynot accurately predict technological trends or the success of new products inthese markets*.New product development often requires long-term forecasting of market trends,development and implementation of new technologies and processes andsubstantial capital investment. If we fail to anticipate or respond in acost-effective and timely manner to technological developments, changes inindustry standards or customer requirements, our business, operating resultsand financial condition could be materially adversely affected.

 

*We may not be able to successfully introduce new products and services*.**Our success depends, in part, upon our ability tosuccessfully introduce new products and services, our ability to offer bundledservice packages on terms attractive to our customers, our ability to expandour long distance, Internet, and digital TV offerings to new markets, ourability to introduce and distribute the equipment and systems of manufacturersof switching equipment and the suppliers of communications technology comparedto the competitive alternatives of other suppliers, our ability to providetransport solutions and competitive Internet protocol services, includingtelecommunications and network solutions, and the ability of our CLEC businessto provide competitive local service in new markets.

 

*Shifts in our product mix may result in declines in operatingprofitability*. Our traditional ILEC services carry higher marginsthan many of the newer services. Changes in product mix may also cause some ofour inventory to become obsolete. We currently manage potential obsolescencethrough reserves, but future technology changes may exceed current reserves.

 

15

----

 

*Consolidation among our customers could result in our losing customersor experiencing a slowdown as integration takes place*. Consolidation may impact our business asour customers focus on integrating their operations. We believe that in certaininstances, customers engaged in integrating large-scale acquisitions may scaleback their purchases of network equipment and network services while theintegration is ongoing. Further, once consolidation occurs, our customers maychoose to reduce the number of vendors they use to source their equipment orconsolidate their circuits or network routing. After a consolidation occurs,there can be no assurance that we will continue to supply equipment or networkservices to the surviving communications service provider. The impact ofsignificant mergers on our business is likely to be unclear until sometimeafter such transactions have closed.

 

*Wedepend on third parties, over whom we have no control, to deliver our services*. Because of the interconnectednature of the communications industry, we depend heavily on othertelecommunications companies, network providers, program service providers andequipment vendors to deliver our services. In addition, we are dependenton easements, franchises and licenses from various private and public entitiesin order to construct and to operate our networks. The failure to maintainthese necessary third party arrangements on acceptable terms would have anadverse effect on our ability to conduct our business.

 

*Ourpossible pursuit of acquisitions could be expensive, may not be successful and,even if successful may be more costly than anticipated*. Our acquisition strategy entailsnumerous risks. The pursuit of acquisition candidates could be expensive andmay not be successful. Our ability to complete future acquisitions will dependon our ability to identify suitable acquisition candidates, negotiateacceptable terms for their acquisition and, if necessary, finance thoseacquisitions, in each case, before any attractive candidates are purchased byother parties, some of whom may have greater financial resources than us.Whether or not any particular acquisition is closed successfully, each of theseactivities is expensive and time consuming and would likely require ourmanagement to spend considerable time and effort to accomplish them, whichwould detract from their ability to run our current business. We may faceunexpected challenges in receiving any required approvals from the FederalCommunications Commission or other applicable state regulatory commissions, whichcould result in delay or our not being able to consummate the acquisition.Although we may spend considerable expense and effort to pursue acquisitions,we may not be successful in closing them.

 

If we are successful inclosing any acquisitions, we would face several risks associate withintegration. In addition, any due diligence we perform may not prove to havebeen accurate. For example, we may face unexpected difficulties in enteringmarkets in which we have little or no direct experience or in generatingunexpected revenue and cash flow from the acquired companies or assets.

 

If we do pursue anacquisition or other strategic transactions and any of these risks materialize,they could have a material adverse effect on our business and our ability to achievesufficient cash flow, provide adequate working capital, service and repay ourindebtedness and leave sufficient funds to pay dividends.

 

**Risks Related to the Management of Our Operations**

 

*A failure in our operational systems or infrastructure could impair ourliquidity, disrupt our business, damage our reputation and cause los*s. Shortcomings or failures in our internalprocesses, people or systems could impair our liquidity, disrupt our business,result in liability to customers or regulatory intervention, damage ourreputation or result in financial loss. For example, our telephone operationsrely on a central switch to complete local and long distance phone calls tovarious customers. An interruption in the switch operations could lead tointerrupted service for customers. To be successful, we will need to continueproviding our customers with a reliable and secure network. Disruptions orsystem failures may cause interruptions in service or reduced capacity forcustomers. In addition, our financial, accounting, data processing or otheroperating systems and facilities may fail to operate properly or becomedisabled as a result of events that are wholly or partially beyond our control,thereby adversely affecting our ability to process transactions. Our inabilityto accommodate an increasing volume of transactions could constrain our abilityto increase revenue and expand our businesses. Despite the existence ofcontingency plans and facilities, our ability to conduct business may beadversely impacted by a disruption in the infrastructure that supports ourbusinesses and the communities in which these businesses are located.

 

16

----

 

*Weoperate our network and our business under contracts and franchises that aresubject to non-renewal or termination*. Our network operates pursuant tofranchises, permits or rights from public and private entities, which areterminable if we fail to comply with material terms of the authority wereceive. These permits, and many contracts we utilize in our network, havefixed terms and must be renewed periodically. Our success is dependent oncontinuing these relationships without material increase in our expenses orrestrictions on our use.

 

*Our businesses may be adversely affected if we are unable to hire andretain qualified employees*. Our performance is largely dependant on the talentsand efforts of highly skilled individuals in the operations of ourtelecommunication businesses, including telephone operations, billing softwaredevelopment and telecommunications equipment sales and service. Technologicaladvances require our employees to upgrade their knowledge base continually. Ourability to compete and grow our business effectively depends upon our abilityto attract qualified employees and retain and motivate our existing employees.In addition, we may acquire new businesses in the future and our success willdepend, in part, upon our ability to retain and integrate personnel fromacquired businesses, who are critical to the continued success or thesuccessful integration of these acquired businesses.

 

*We may have unanticipated increases in capital spending, operating oradministrative costs, or seek new business opportunities that requiresignificant up-front investments***.**We operate in cash-flow-dependent businesses. Ourexisting networks require large capitalized up-front investments for growth andmaintenance. Our operating expenses in the form of payroll for a highly trainedworkforce and the maintenance cost of telecommunications networks are largeuses of cash. Our debt service obligation and our dividends to shareholdersalso require significant cash each year. New business development may requireadditional up-front investment in assets and funding of early stage operatinglosses. We have business plans which provide adequate sources of cash fromoperations to fund these endeavors, and we select the balance of old and newbusiness to appropriately fund the Company. The risk is from any suddenunanticipated increases in cash outflow after we have already initiated ourbusiness plans. If this were to happen, we would alter our future businessplans, which could possibly affect our growth or ability to maintain ourcurrent network infrastructure.

 

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

 

**Risks related to Regulations**

 

*Thetelecommunications industry in which we operate is subject to extensivefederal, state and local regulation that could change in a manner adverse tous.* Ourlocal telephone businesses in Minnesota and Iowa are a significant source ofour revenue and free cash flow. The laws and regulations governing thesebusinesses may be, and in some cases have been, challenged in the courts andcould be changed by Congress, state legislatures or regulators at any time. Inaddition, new regulations could be imposed by federal or state authoritiesincreasing our operating costs or capital requirements or that are otherwiseadverse to us. We cannot predict the impact of future developments or changesto the regulatory environment or the impact such developments or changes mayhave on us. Adverse rulings, legislation or changes in governmental policy onissues material to us could increase our competition, cause us to losecustomers to competitors and decrease our revenue, increase our costs anddecrease our profitability.

 

17

----

 

*Legislativeor regulatory changes and technological advances could reduce the revenue ourILEC and CLEC operations receive from network access charges.*Access charges, which are intended tocompensate our ILEC and CLEC operations for originating, terminating ortransporting long distance and other carriers’ calls in our service areas,accounted for approximately 19.7% of our total revenue in 2007. The amount ofnetwork access charges we receive is based on interstate rates set by theFederal Communications Commission and intrastate rates set by the MinnesotaPublic Utilities Commission and the Iowa Utilities Board. The large nationalcarriers who pay these charges have advocated in the past that access chargesshould be reduced and some network providers have argued that access charges donot apply to specific types of their traffic. Emerging technologies, such asvoice over Internet protocol, have caused a debate about whether access chargesapply. As our business becomes increasingly competitive, the regulatorydisparities regarding network access revenue, the marketplace forces on itspricing levels and our ability to enforce the historical rules forcollecting this revenue, could have a material adverse effect on our business.We cannot predict whether or when action may be taken on any of these issues,or what effect any action may have on revenue and costs of our ILEC and CLECoperations.

 

Traditionally, regulatorshave allowed network access rates to be set higher in rural areas in relationto the actual cost of originating or terminating calls as an implicit means ofsubsidizing the high cost of providing rural service. In 2001, the FederalCommunications Commission adopted rules reforming the network accesscharge system for rural carriers, including reductions in per-minute accesscharges and increases in both, Federal Universal Service Fund subsidies andflat-rate monthly per line charges on end-user customers. The FederalCommunications Commission is currently considering more changes in networkaccess charges. Depending on the Commission’s decisions, our current networkaccess charge revenue could be reduced materially and we do not know whetherincreases in other revenue, such as federal subsidies and monthly line charges,will be sufficient to offset any such reductions or if competitive pressureswill allow increases. The Minnesota Public Utilities Commission and IowaUtilities Board may make changes in our intrastate network access charges,which may also cause reductions in our revenue. To the extent any of ourcompanies become subject to competition, a portion of long distance and othercarriers’ network access charges will be paid to our competitors rather than toour companies. In addition, the compensation our companies receive from networkaccess charges could be reduced due to competition from wireless carriers to agreater extent than historically.

 

We believe that there hasbeen a general increase in the unauthorized use of telecommunications providers’networks without payment of appropriate access charges, or so-called “phantomtraffic,” due in part to advances in technology that have made it easier to usenetworks while also avoiding payment for the traffic. As a general matter, webelieve this phantom traffic is due to unintended usage and, in some cases,fraud. We cannot assure you that there will not be material claims made againstus contesting the applicability of network access charges billed by our ILECand CLEC operations or continued or increased phantom traffic that uses ournetwork without paying us for it. If there is a successful dispute or avoidanceof the applicability of network access charges, our revenue could decrease.

 

*Legislativeor regulatory changes could reduce or eliminate the government subsidies wereceive.*Thefederal system of subsidies, from which we derive a significant portion of ourrevenue, is subject to modification. Our ILEC and CLEC operations receivesignificant federal subsidy payments.

 

·      For the year ended December 31,2007, we received an aggregate of $3,268,000 from the Federal Universal ServiceFund, which comprised 2.1% of our revenue for the year.

·      For the year ended December 31,2006, we received an aggregate of $2,495,000 from the Federal Universal ServiceFund, which comprised 1.9% of our revenue for the year.

·      For the year ended December 31,2005, we received an aggregate of $2,345,000 from the Federal Universal ServiceFund, which comprised 3.0% of our revenue for the year.

 

18

----

 

During the last twoyears, the Federal Communications Commission has made modifications to theFederal Universal Service Fund system that changed the sources of support andthe method for determining the level of support to Federal Universal ServiceFund recipients. It is unclear whether the changes in methodology will continueto accurately reflect the costs incurred by our ILEC operations and whether wewill continue to receive the same amount of Federal Universal Service Fundsupport that we have received in the past. The Federal CommunicationsCommission is also currently considering a number of issues regarding thesource and amount of contributions to, and eligibility for payment from, theFederal Universal Service Fund, and these issues may also be the subject oflegislative amendments to the Telecommunications Act of 1996.

 

In December 2007,Congress suspended the application of a law called the Anti-Deficiency Act untilDecember 31, 2008. The Anti-Deficiency Act prohibits government agenciesfrom making financial commitments in excess of their funds on hand. Currently,the Federal Universal Service Fund administrator commits to fund recipients inadvance of collecting the contributions from carriers that will pay for thesecommitments. The Federal Communications Commission has not determined whetherthe Anti-Deficiency Act would apply to payments to our ILEC operations.Congress is now considering whether to extend the current temporary legislationthat exempts the Federal Universal Service Fund from the Anti-Deficiency Act.If it does not grant this extension, however, our Federal Universal ServiceFund subsidy payments may be delayed or reduced. We cannot predict the outcomeof any federal or state legislative action or any Federal CommunicationsCommission, Minnesota Public Utilities Commission or Iowa Utilities Boardrulemaking or similar proceedings. If we do not continue to receive federal andstate subsidies, or if these subsidies are reduced, our ILEC operations willlikely have lower revenue and may not be able to operate as profitably as theyhave historically.

 

In addition, under theTelecommunications Act of 1996, our competitors may obtain the same level of FederalUniversal Service Fund subsidies we do if the Minnesota Public UtilitiesCommission or Iowa Utilities Board, as applicable, determines that grantingthese subsidies to competitors would be in the public interest and thecompetitors offer and advertise certain telephone services as required by theTelecommunications Act of 1996 and the Federal Communications Commission. Undercurrent rules, any such payments to our competitors would not affect the levelof subsidies received by our ILEC and CLEC operations, but they wouldfacilitate competitive entry into our ILEC and CLEC service areas and we maynot be able to compete as effectively or otherwise continue to operate asprofitably.

 

*Legislativeand regulatory changes in the telecommunications industry could raise our costsby facilitating greater competition against us and reduce potential revenue.*Legislative and regulatory changes in thetelecommunications industry could adversely affect our business by facilitatinggreater competition against us, reducing our revenue or raising our costs. Forexample, federal or state legislatures or regulatory commissions could imposenew requirements relating to standards or quality of service, credit andcollection policies, or obligations to provide new or enhanced services such ashigh-speed access to the Internet or number portability, whereby consumers maykeep their telephone number when changing carriers. Any such requirements couldincrease operating costs or capital requirements.

 

The TelecommunicationsAct of 1996 provides for significant changes and increased competition in thetelecommunications industry. This federal statute and the related regulationsremain subject to judicial review and additional rulemakings of the FederalCommunications Commission, as well as to implementing actions by statecommissions.

 

Currently, there existsonly a small body of law and regulation applicable to access to, or commerceon, the Internet. As the significance of the Internet expands, federal, stateand local governments may adopt new rules and regulations or applyexisting laws and regulations to the Internet. The Federal CommunicationsCommission is currently reviewing the appropriate regulatory frameworkgoverning broadband consumer protections for high-speed access to the Internetthrough telephone and cable TV providers’ communications networks. The outcomeof these proceedings may affect our regulatory obligations and costs andcompetition for our services which could have a material adverse effect on ourrevenue.

 

19

----

 

Our operations andproperties are subject to federal, state and local laws and regulationsrelating to the protection of the environment, natural resources and workerhealth and safety that could adversely affect our profitability. We operateunder a number of environmental and health and safety laws, including laws andregulations governing and creating liability to, the management, storage anddisposal or hazardous materials, asbestos, petroleum products and otherregulated materials. We are subject to environmental laws and regulationsgoverning air emissions from our fleets of vehicles. As a result, we faceseveral risks, including the following:

 

·      Under certain environmental laws, wecould be held liable, jointly and severally and without regard to fault, forthe costs of investigating and the remediation of any actual or threatenedenvironmental contamination at currently and formerly owned or operatedproperties, and those of our predecessors, and for contamination associatedwith disposal by us or our predecessors of hazardous materials at third partydisposal sites,

·      The presence of contamination canadversely affect the value of or properties and our ability to sell any suchaffected property or to use it as collateral,

·      We could be held responsible for thirdparty property damage claims, personal injury claims or natural resource damageclaims relating to any such contamination,

·      The cost of complying with existingenvironmental requirements could be significant,

·      Adoption of new environmental laws orregulations or changes in existing laws or regulations or their interpretationscould result in significant compliance costs or as yet identified environmentalliabilities,

·      Future acquisition of businesses orproperties subject to environmental requirements or affected by environmentalcontamination could require us to incur substantial costs relating to suchmatters, and

·      In addition, environmental lawsregulating wetland, endangered species and other land use and natural resourceissues may increase costs associated with future business or expansionopportunities, delay, alter or interfere with such plans, or otherwiseadversely affect such plans.

 

*A lack ofparity between us and our competitors concerning assessments and tax laws couldadversely impact our ability to profitably compete*. The telecommunications industry isheavily taxed and assessed. As regulated entities, we serve as the pass-throughentity responsible for charging and collecting the fees and taxes from ourend-user customers and remitting the monies collected to the taxing andregulatory authorities. Unless regulators and taxing authorities change orclarify their rules and regulations to include our competitors, orderegulate and exclude us, the lack of parity could adversely impact ourability to effectively compete on price.

 

*The highcosts of regulatory compliance could make it more difficult for us to enter newmarkets, make acquisitions or change our prices.*Regulatory compliance results insignificant costs for us and diverts the time and effort of our management andofficers away from running the business. In addition, because regulationsdiffer from state to state, we could face significant costs in obtaininginformation necessary to compete effectively if we try to provide services,such as long distance services, in different states. These information barrierscould cause us to incur substantial costs and to encounter significantobstacles and delays in entering these markets. Compliance costs andinformation barriers could also affect our ability to evaluate and compete fornew opportunities to acquire local access lines or businesses as they arise.

 

Our intrastate servicesare also generally subject to certification, tariff filing and other ongoingstate regulatory requirements. Challenges to our tariffs by regulators or thirdparties or delays in obtaining certifications and regulatory approvals couldcause us to incur substantial legal and administrative expenses. If successful,these challenges could adversely affect the rates that we are able to charge tocustomers, which would negatively affect our revenue.

 

20

----

 

**Risks Related to Our Indebtedness and Our Capital Structure**

 

*We have alarge balance of senior bank debt outstanding and may incur additionalindebtedness in the future, which could restrict our ability to pay dividendsand fund our operations*. We have senior bank debt outstandingunder long-term financing agreements. As of December 31, 2007, we had$129,206,000 of total long-term debt outstanding, including current maturities,and $31,932,000 of stockholders’ equity. The degree to which we are leveraged couldhave important consequences including:

 

·                  Requiringus to dedicate a substantial portion of our cash flow from operations to makeprincipal and interest payments on our debt. These payments are currentlyexpected to be approximately $9,225,000 in 2008 and have been incorporated intoour historical cash flow plans. To the extent that future principle andinterest payments change significantly, it could affect our future planning,thereby reducing funds available for current operations, future business operationsand other purposes, and/or dividends on our common stock,

·                  Limitingour flexibility in planning for, or reacting to, changes in our business andthe industry in which we operate,

·                  Makingit more difficult for us to satisfy our debt and other obligations,

·                  Limitingour ability to borrow additional funds, or to sell assets to raise funds, ifneeded, for working capital, capital expenditures, acquisitions or otherpurposes,

·                  Increasingour vulnerability to general adverse economic and industry conditions,including changes in interest rates, and

·                  Placingus at a competitive disadvantage compared to our competitors that have lessdebt.

 

We cannot assure you thatwe will generate sufficient revenue to service and repay our debt and havesufficient funds left over to achieve or sustain profitability in our operations,meet our working capital and capital expenditure needs, compete successfully inour markets or pay dividends to our stockholders.

 

*If we seek additional financing, we may not be ableto obtain it. Also, if we are able to secure additional financing, ourshareholders may experience dilution of their ownership interest or we may besubject to limitations on our operations*. We currentlyanticipate that our available cash resources, which include our creditfacility, existing cash, cash equivalents and available-for sale securities,will be sufficient to meet our anticipated needs for working capital andcapital expenditures to execute our near-term business plan, based on currentbusiness operations and economic conditions. If our estimates are incorrect andwe are unable to generate sufficient cash flows from operations and we expendour credit facility, we may need to raise additional funds. In addition, if oneor more of our strategic acquisition opportunities exceeds our existingresources, we may be required to seek additional capital. If we raiseadditional funds through the issuance of equity or equity-related securities,our shareholders may experience dilution of their ownership interests and thenewly issued securities may have rights superior to those of common stock. Ourexisting debt covenants require a portion of the proceeds of an equity offeringbe applied to the outstanding debt balance. If we raise additional funds byissuing additional debt, we may be subject to restrictive covenants that couldlimit our operating flexibility, and increased interest payments could diluteearnings per share.

 

*We are subject to risks associated with changes in interest rates*. We currently expect our cash interestexpense to be approximately $8,494,000 in 2008. We face market risksfrom changes in interest rates that could affect our results of operations andfinancial condition adversely. Although we attempt to reduce this risk throughthe use of derivative financial instruments, we do not enter into derivative instrumentsfor the purpose of speculation. We have entered into an interest rateprotection agreement on approximately $60,000,000 of our variable-interest ratedebt, which has a remaining maturity of twenty-four months, in order to manageour exposure to interest rate movements. If interest rates fail to rise asanticipated when the instruments were acquired, we will experiencehigher-than-market-rate interest expense and would have paid for protectionthat wasn’t needed. We also risk entering a higher interest rate environmentwhen the interest rate protection agreements expire in 2010. This could affectour future interest expense level. In addition, we have a fixed interest ratelock on $19,000,000 of our variable interest rate debt, which expires in 2008.We are subject to the same positive or negative impacts relative to variablerate alternatives as described above for our use of derivative instruments.

 

21

----

 

**Risks Related to Financial Aspects of Our Company**

 

*Customer payment defaults could have an adverseeffect on our financial condition and results of operations*. As a result of adverse marketconditions, some of our customers may experience serious financialdifficulties. Some of the interexchange carriers and long distance companiesthat utilize our network are our largest customers when it comes to recurringrevenue. In some cases these difficulties have resulted or may result inbankruptcy filings or cessation of operations. If customers experiencingfinancial problems default on amounts owed to us, we may not be able torecognize expected revenue. Although we currently manage this exposure throughan allowance for doubtful accounts, an unexpected bankruptcy or default by acustomer may not be fully reserved in our allowance. In addition, it may becomenecessary for us to offer equipment financing to some of our customers in thefuture to remain competitive. If we offer such financing it would be our intentto sell all or a portion of the financing receivables to third parties. In thepast, we have sold some receivables with recourse and have had to compensatethe purchaser for the related losses.

 

*A failure to maintain effective internal controlscould adversely affect our business*. Although we have completedthe documentation and testing of the effectiveness of our internal control overfinancial reporting for fiscal 2007, as required by Section 404 of theSarbanes-Oxley Act of 2002, we expect we will have to incur continuing costs,which may include increased accounting fees and increased staffing levels, inorder to maintain compliance with that section of the Sarbanes-Oxley Act. Inaddition, our ability to integrate the operations of other companies that wemay acquire in the future could impact our compliance with Section 404. Inthe future, if we fail to complete the Sarbanes-Oxley 404 evaluation in atimely manner, or if our independent registered public accounting firm cannotattest in a timely manner to the effectiveness of our internal controls, wecould be subject to regulatory scrutiny and a loss of public confidence in ourinternal controls. In addition, any failure to implement required new orimproved controls, or difficulties encountered in their implementation, couldharm our operating results or cause us to fail to meet our reportingobligations.

 

**Risks Related to Our Common Stock**

 

*Our boardof directors could, in its discretion, depart from or change our dividendpayment practices at any time.*We are not required to paydividends and our stockholders are not guaranteed, and do not have contractualor other rights, to receive dividends. Our board of directors may decide at anytime, in its discretion, to decrease the amount of dividends, otherwise changeor revoke our past dividend payment practices or discontinue entirely thepayment of dividends. In addition, if we do not pay dividends for whateverreason, your shares of our common stock could become less liquid and the marketprice of our common stock could decline.

 

Our ability to pay dividends,and our board of directors’ determination to maintain our past dividend paymentpractices, will depend on numerous factors, including the following:

 

·                  Thestate of our business, the environment in which we operate and the various riskfactors we face, including, but not limited to competition, technologicalchange, changes in our industry, regulatory and other risks summarized in thisAnnual Report on Form 10-K,

·                  Ourfuture results of operations, financial condition, liquidity needs and capitalresources,

·                  Ourcash needs, including interest and any future principal payments on ourindebtedness, capital expenditures, taxes, pension and other post-retirementcontributions and certain other costs, and

·                  Potentialsources of liquidity, including borrowing under our revolving credit facilityor possible asset sales.

 

22

----

 

While our cash flowavailable to pay dividends for the year ended December 31, 2007 wassufficient to pay dividends in accordance with our past dividend paymentpractices, if our estimated cash flow available to pay dividends were to fallbelow our expectations, our assumptions as to estimated cash needs are too lowor if other applicable assumptions were to prove incorrect, we may need to:

 

·                  Eitherreduce or eliminate dividends,

·                  Funddividends by incurring additional debt (to the extent we were permitted to doso under agreements governing our then existing debt), which would increase ourleverage, debt repayment obligations and interest expense and decrease ourinterest coverage, resulting in, among other things, reduced capacity to incurdebt for other purposes, including to fund future dividend payments,

·                  Amendthe terms of our credit agreement, if our lenders agreed, to permit us to paydividends or make other payments if we are otherwise not permitted to do so,

·                  Funddividends from future issuances of equity securities, which could be dilutiveto our stockholders and negatively affect the price of our common stock,

·                  Funddividends from other sources, such as by asset sales or by working capital,which would leave us with less cash available for other purposes, and

·                  Reduceother expected uses of cash, such as capital expenditures.

 

*If wecontinue to pay dividends at the level currently anticipated under our currentdividend payment practices, our ability to pursue growth opportunities may belimited.* We believe that our current dividend paymentpractices could limit, but not preclude, our ability to grow. If we continuepaying dividends at the level currently anticipated under our current dividendpayment practices, we may not retain a sufficient amount of cash and may needto seek financing to fund a material expansion of our business, including anysignificant acquisitions or to pursue growth opportunities requiring capitalexpenditures significantly beyond our current expectations.

 

*        Anti-takeover provisions in our charterdocuments, our shareholder rights plan and Minnesota law could prevent or delaya change in control of our Company*. Provisions of our articles of incorporation and bylaws, ourshareholder rights plan (also known as a “poison pill”) and Minnesota law maydiscourage, delay or prevent a merger or acquisition that a shareholder mayconsider favorable and may limit the market price for our common stock. Theseprovisions include the following:

 

·                  Advancenotice requirements for shareholders proposals,

·                  Authorizationfor our Board of Directors to issue preferred stock without shareholderapproval;  and

·                  Limitationson business combinations with interested shareholders.

 

Some of these provisions may discourage a futureacquisition even though our shareholders would receive an attractive value fortheir shares or a significant number of our shareholders believe such a proposedtransaction would be in their best interest.

 

*Our stockprice is volatile*. Basedon the trading history of our common stock and the nature of the market forpublicly traded securities of companies in our industry, we believe that somefactors have caused and are likely to continue to cause the market price of ourcommon stock to fluctuate substantially. These fluctuations could occurday-to-day or over a longer period of time and may be accentuated by the lackof liquidity in our stock. The factors that may cause such fluctuationsinclude, without limitation:

 

·                  Generaleconomic conditions in the United States or internationally,

·                  Thefinancial health of HickoryTech, our competitors or our customers,

·                  Developmentsin telecommunications regulations,

·                  Consolidationamong our competitors or customers,

·                  Rumorsor speculation regarding HickoryTech’s future business results and actions,

·                  Increasedcompetition with our competitors or among our customers,

·                  Quarterlyfluctuations in our financial results or the financial results of ourcompetitors or customers,

·                  Announcementsof new products and services by us or our competitors, and

·                  Disputesconcerning intellectual property rights.

 

23

----

 

In addition, stocks ofcompanies in our industry in the past have experienced significant price andvolume fluctuations that are often unrelated to the operating performance ofsuch companies. This market volatility may adversely affect the market price ofour common stock.

 

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

# ** **

There are no written commentsthat were received from the Securities and Exchange Commission staff 180 daysor more before the end of our fiscal year relating to our periodic or currentreports under the Securities Exchange Act of 1934.

 

# **Item 2.  Properties**

# ** **

Ourbusiness is primarily focused on the provision of service and our propertiesare used for administrative support and to store and safeguard equipment. On December 31,2007, HickoryTech’s gross property, plant and equipment of $322,249,000 (netbalance of $152,931,000) consisted primarily of telephone switches, cable,fiber optic networks and network equipment. We own or lease the telephoneproperty, plant and equipment that are utilized to operate our telephonesystems. Our three ILEC subsidiaries in Minnesota and Iowa own centraltelephone offices with related real estate in all of the communities theyserve. Our Telecom Sector owns the telephone network, including telephoneoutside plant, fiber optic cable and central office equipment over which theyprovide services to its customers. Our Enventis Sector owns, or hasindefeasible rights to use, or has long-term leasing commitments to itsextensive fiber optic network and switching system. It is our opinion that ourproperties are suitable and adequate to provide modern and effectivetelecommunications services within our service areas, including localdial-tone, long distance service, DSL, digital TV and dedicated and switchedlong-haul transport.

 

        Our principal property locations are thefollowing;

 

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

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

3.               Heartland’s main central office equipment locatedin a one-story brick structure owned by Heartland in Rock Rapids, Iowacontaining approximately 1,500 square feet of space. Heartland also leasesapproximately 2,000 square feet of general office space in Rock Valley, Iowa.

4.               Crystal leases office space of approximately6,000 square feet in Urbandale, Iowa.

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

6.               Enventis leases approximately 16,000 square feetof office space in Plymouth, Minnesota for general offices, technology servicesand system support.

7.               Enventis leases approximately 7,500 square feetin Duluth, Minnesota for general offices and a network operations center.

8.               Enventis leases approximately 1,700 square feetin Rochester, Minnesota for general offices and a network equipment facility.

9.               Enventis licenses approximately 2,000 square feetin Edina, Minnesota for a data center.

 

# **Item 3. Legal Proceedings**

# ** **

Other than routinelitigation incidental to our business, including the items listed below, thereare no pending material legal proceedings to which we are a party or to whichany of our property is subject.

 

HickoryTechis investigating a potential civil dispute being discussed with a municipalityregarding contract payments from HickoryTech to the municipality in support ofthe Company’s CLEC voice and data services. No formal dispute or claim has beenfiled to-date.

 

24

----

 

HickoryTechhas received notice from a large interexchange carrier that they are disputingapproximately $654,000 of interstate and intrastate switched access chargesthat HickoryTech billed them between October 2005 and October 2007. HickoryTechdoes not agree with this dispute and cannot predict the outcome of suchproceedings nor their impact, if any, on the Company.

 

# **Item 4. Submission of Matters to a Vote of Security Holders**

# ** **

Nomatters were submitted to a vote of security holders during the fourth quarterof the fiscal year covered by this 2007 Annual Report on Form 10-K.

 

**PART II**

 

# **Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities**

# ** **

Ourcommon stock is quoted on the NASDAQ Global Select Market under the symbol “HTCO”.As of February 15, 2008, there were 1,430 registered shareholdersand 1,778 beneficial owners of HickoryTech stock. HickoryTech has declaredquarterly dividends on its common stock of $0.12 per share for the two yearsended December 31, 2007 and 2006. A quarterly cash dividend of $0.12 pershare will be paid on March 5, 2008 to stockholders of record at the closeof business on February 15, 2008.

 

 
| ** ** | ** ** | ** **   | ** ** | **High** | ** ** | **Low** | ** ** | **End of Qtr.** | ** ** |
|------------|------------|--------------|------------|----------|------------|---------|------------|---------------------------|------------|
| **2007**   | ** ** | 4th  Quarter |       | $        | 9.85       |    | $          | 8.80                      |       | $ | 9.32 |   |
|       |       | 3rd  Quarter |       | $        | 9.88       |    | $          | 8.01                      |       | $ | 9.69 |   |
|       |       | 2nd  Quarter |       | $        | 9.29       |    | $          | 6.93                      |       | $ | 9.10 |   |
|       |       | 1st  Quarter |       | $        | 7.42       |    | $          | 6.84                      |       | $ | 6.93 |   |
|       |       |         |       |     |       |    |       |                      |       |
| **2006**   | ** ** | 4th  Quarter |       | $        | 7.50       |    | $          | 6.85                      |       | $ | 7.15 |   |
|       |       | 3rd  Quarter |       | $        | 7.22       |    | $          | 6.93                      |       | $ | 7.00 |   |
|       |       | 2nd  Quarter |       | $        | 8.20       |    | $          | 6.61                      |       | $ | 7.00 |   |
|       |       | 1st  Quarter |       | $        | 8.95       |    | $          | 7.95                      |       | $ | 8.43 |   |

 

**Dividend Tendencies and Restrictions**

 

Our board of directorshave adopted dividend payment practices that reflect its judgment that ourstockholders would be better served if we distributed to them a portion of thecash generated by our business in excess of our expected cash needs rather thanretaining it or using the cash for other purposes, such as to make investmentsin our business, or to make acquisitions. We expect to continue to payquarterly dividends at an annual rate of $0.48 per share during 2008, but onlyif and to the extent declared by our board of directors on a quarterly basisand subject to various restrictions on our ability to do so (see below).Dividends on our common stock are not cumulative.

 

The terms of our creditfacility include certain restrictions regarding the payment of dividends. Thedividend restriction provides that we will not make dividend distributions orrepurchase stock in an aggregate amount in excess of 100% of the previous year’snet income. In 2007, we were in violation of this dividend restriction, but awaiver was obtained.

 

The cash requirements ofour current dividend payment practices are in addition to our other expectedcash needs, both of which we expect to be funded with cash flow fromoperations. In addition, we expect we will have sufficient availability underour revolving credit facility to fund dividend payments in addition to anyexpected fluctuations in working capital and other cash needs, although we donot intend to borrow under this facility to pay dividends.

 

25

----

 

**FiveYear Shareholder Return Performance Presentation**

 

The following tablecompares the cumulative total shareholder return on the common stock ofHickoryTech for the last five fiscal years with the cumulative total return onthe Russell 2000 Index and the NASDAQ Telecommunications Index. “Totalshareholder return” assumes the investment of $100 in HickoryTech’s commonstock, the Russell 2000 index and the NASDAQ Telecommunication Index on December 31,2002 and reinvestment of all dividends.

 

Total Return toShareholders (Includes reinvestment of dividends)

 

**COMPARISONOF 5 YEAR CUMULATIVE TOTAL RETURN***

Among Hickory TechCorporation, The Russell 2000 Index

And The NASDAQTelecommunications Index

 

 

----

* $100 invested on 12/31/02 in stock or index-including reinvestment ofdividends.

Fiscal year ending December 31.

 

26

----

 

# **Item 6. Selected Financial Data**

# ** **

*(Dollars in thousands except share and per shareamounts)*

 
| **FOR THE YEAR:**                 | ** ** | **2007**       | ** **  | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------------------|------------|----------------|-------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Operating  revenues (A)                     |       |           |        |       |       |       |       |       |       |       |       |
| Telecom Sector  (B)                         | ** ** | **$**          | **76,847**  |       | $          | 74,896     |       | $          | 77,922     |       | $          | 78,807 |   | $ | 78,545 |   |
| Enventis Sector  (C)                        |       |           |        |       |       |       |       |       |       |       |       |
| Equipment  revenue                          | ** ** | **51,046**     |        | 36,191     |       | —     |       | —     |       | —     |       |
| Services revenue                            | ** ** | **28,756**     |        | 21,814     |       | —     |       | —     |       | —     |       |
| Total Enventis  Sector                      | ** ** | **79,802**     |        | 58,005     |       | —     |       | —     |       | —     |       |
| Total revenues                              | ** ** | **$**          | **156,649** |       | $          | 132,901    |       | $          | 77,922     |       | $          | 78,807 |   | $ | 78,545 |   |
|                                        |       |           |        |       |       |       |       |       |       |       |       |
| Income from  continuing operations          | ** ** | **$**          | **8,635**   |       | $          | 5,235      |       | $          | 8,566      |       | $          | 8,681 |   | $ | 9,096 |   |
|                                        |       |           |        |       |       |       |       |       |       |       |       |
| **PER  SHARE:**                             |       |           |        |       |       |       |       |       |       |       |       |
| Basic EPS -  continuing operations          | ** ** | **$**          | **0.65**    |       | $          | 0.40       |       | $          | 0.65       |       | $          | 0.66 |   | $ | 0.65 |   |
| Basic EPS - discontinued  operations        | ** ** | **—**     |        | (0.23      | )          | —     |       | (0.08      | )          | (1.57      | )          |
| ** **                                  |       | **$**          | **0.65**    |       | $          | 0.17       |       | $          | 0.65       |       | $          | 0.58 |   | $ | (0.92 | ) |
|                                        |       |           |        |       |       |       |       |       |       |       |       |
| Diluted EPS -  continuing operations        | ** ** | **$**          | **0.65**    |       | $          | 0.40       |       | $          | 0.65       |       | $          | 0.66 |   | $ | 0.65 |   |
| Diluted EPS -  discontinued operations      | ** ** | **—**     |        | (0.23      | )          | —     |       | (0.08      | )          | (1.57      | )          |
| ** **                                  |       | **$**          | **0.65**    |       | $          | 0.17       |       | $          | 0.65       |       | $          | 0.58 |   | $ | (0.92 | ) |
| Dividends per  share                        | ** ** | **$**          | **0.48**    |       | $          | 0.48       |       | $          | 0.48       |       | $          | 0.44 |   | $ | 0.44 |   |
|                                        |       |           |        |       |       |       |       |       |       |       |       |
| **AT YEAR  END: (C)**                       |       |           |        |       |       |       |       |       |       |       |       |
| Total assets (A)                            | ** ** | **$**          | **227,495** |       | $          | 226,900    |       | $          | 216,834    |       | $          | 160,658 |   | $ | 167,773 |   |
| Shareholders’  equity (D)              | ** ** | **$**          | **31,932**  |       | $          | 30,086     |       | $          | 35,009     |       | $          | 31,545 |   | $ | 28,717 |   |
| Current  maturites of long-term obligations | ** ** | **$**          | **731**     |       | $          | 1,560      |       | $          | 1,778      |       | $          | 5,323 |   | $ | 1,572 |   |
| Long term debt                              | ** ** | **128,475**    |        | 141,529    |       | 140,980    |       | 97,661     |       | 118,040    |       |
| Total debt,  long-term and current          | ** ** | **$**          | **129,206** |       | $          | 143,089    |       | $          | 142,758    |       | $          | 102,984 |   | $ | 119,612 |   |
|                                        |       |           |        |       |       |       |       |       |       |       |       |
| Debt ratio (E)                              | ** ** | **80.2**       | %           | 82.6       | %          | 80.3       | %          | 76.6       | %          | 80.6       | %          |
|                                        |       |           |        |       |       |       |       |       |       |       |       |
| **CUSTOMER  DATA (year end):**              |       |           |        |       |       |       |       |       |       |       |       |
| Business access  lines                      | ** ** | **27,403**     |        | 27,014     |       | 27,145     |       | 28,666     |       | 29,539     |       |
| Residential  access lines                   | ** ** | **37,428**     |        | 41,029     |       | 42,945     |       | 45,892     |       | 47,707     |       |
| Total access  lines (F)                     | ** ** | **64,831**     |        | 68,043     |       | 70,090     |       | 74,558     |       | 77,246     |       |
| Long distance  subscribers (G)              | ** ** | **40,956**     |        | 41,196     |       | 40,321     |       | 43,702     |       | 40,366     |       |
| DSL customers  (H)                          | ** ** | **17,427**     |        | 15,724     |       | 13,022     |       | 10,430     |       | 7,407      |       |
| Digital TV  customers (I)                   | ** ** | **6,487**      |        | 4,632      |       | 2,766      |       | 1,941      |       | 1,179      |       |
|                                        |       |           |        |       |       |       |       |       |       |       |       |
| **OTHER  DATA:**                            |       |           |        |       |       |       |       |       |       |       |       |
| Employees (year  end) (C)(J)                | ** ** | **400**        |        | 399        |       | 460        |       | 394        |       | 414        |       |
| Capital  expenditures (K)                   | ** ** | **$**          | **17,500**  |       | $          | 21,058     |       | $          | 19,434     |       | $          | 16,588 |   | $ | 11,036 |   |
| Shares  outstanding (year end)              | ** ** | **13,284,903** |        | 13,207,970 |       | 13,124,928 |       | 13,057,106 |       | 12,967,811 |       |
| Share price (L)  (year end)                 | ** ** | **$**          | **9.32**    |       | $          | 7.15       |       | $          | 7.89       |       | $          | 10.69 |   | $ | 11.47 |   |
| Shareholders                                |       |           |        |       |       |       |       |       |       |       |       |
| Registered                                  | ** ** | **1,430**      |        | 1,470      |       | 1,511      |       | 1,559      |       | 1,646      |       |
| Beneficial  owners (M)                      | ** ** | **1,778**      |        | 1,792      |       | 1,701      |       | 1,677      |       | 1,603      |       |
| Total  shareholders                         | ** ** | **3,208**      |        | 3,262      |       | 3,212      |       | 3,236      |       | 3,249      |       |

 

----

(A).             Revenueand total assets for all periods have been restated to exclude revenue andassets of the wireless and Enterprise Solutions operations, which are includedin discontinued operations for all periods presented. We sold our wirelessoperations in December 2003 and sold our Enterprise Solutions Sector in December 2006.

 

27

----

 

|   | (B). | Operating revenue for  NIBI, which prior to 2006 had been reported in the Information Solutions  Sector, has been recast for all years presented to consolidate our reporting  for similar operations for all years presented. Revenue is now being reported  as part of the Telecom Sector results.                                                 |
|--------|------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | (C). | Enventis was purchased  by HickoryTech as of December 30, 2005.                                                                                                                                                                                                                                                                                 |
|   | (D). | Shareholders’ Equity at  December 31, 2006 includes the impact of adopting SFAS No. 158 as  described in Note 10 to the Notes to the Consolidated Financial Statements.                                                                                                                                                               |
|   | (E). | Debt Ratio = Total Debt  / (Total Debt+ Shareholders’ Equity as of December 31).                                                                                                                                                                                                                                                           |
|   | (F). | Access Lines refer to  the ILEC and CLEC access lines in the Telecom Sector.                                                                                                                                                                                                                                                                         |
|   | (G). | Long Distance service  accounts are provided in the Telecom Sector.                                                                                                                                                                                                                                                                                  |
|   | (H). | DSL services are  provided in the Telecom Sector to ILEC and CLEC customers. DSL line counts  were reduced by 478 in the 2007 due to a data conversion. There was no  restatement of prior periods.                                                                                                                                                  |
|   | (I). | Digital TV customer  counts refer to ILEC and CLEC customers.                                                                                                                                                                                                                                                                                        |
|   | (J). | All employee counts  reflect actual employee counts at year-end. No numbers have been restated for  the discontinued wireless or Enterprise Solutions operations. The Enventis  acquisition in 2005 added 75 employees. The Enterprise Solutions sale in 2006  reduced employee counts by 64 employees.                                              |
|   | (K). | Capital expenditures  have been restated to exclude wireless and Enterprise Solutions operations  for all years presented.                                                                                                                                                                                                                           |
|   | (L). | Share price is the last  day closing price.                                                                                                                                                                                                                                                                                                          |
|   | (M). | The number of  beneficial shareholders is the approximate number of company registrations in  street name accounts. The number previously presented in the Annual Report on  Form 10K for 2006 was the pre-suppression number of shareholders. The  number has been changed to reflect the post-suppression number of beneficial  shareholders. |

 

# **Item 7.  Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

# ** **

**CriticalAccounting Policies and Estimates**

 

Management’sdiscussion and analysis of financial condition and results of operations statedin this 2007 Annual Report on Form 10-K are based upon HickoryTech’sconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States and, whereapplicable, conform to the accounting principles as prescribed by federal andstate telephone utility regulatory authorities. HickoryTech presently givesaccounting recognition to the actions of regulators where appropriate, asprescribed by Statement of Financial Accounting Standards No. 71, “Accountingfor the Effects of Certain Types of Regulation” (“SFAS No. 71”). Thepreparation of these financial statements requires management to make estimatesand judgments that affect the reported amounts of assets, liabilities, revenueand expenses, and related disclosure of contingent assets and liabilities.Management believes that the application of the accounting policies, which are importantto HickoryTech’s financial position and results of operations, requiressignificant judgments and estimates on the part of management. Seniormanagement has discussed the development and selection of accounting estimatesand the related Management Discussion and Analysis disclosure with the AuditCommittee. For a summary of all HickoryTech’s accounting policies, see Note 1to the Notes to the Consolidated Financial Statements. There were nosignificant changes to these accounting policies during the year ended December 31,2007 except for the adoption of new policies to comply with adopting FinancialInterpretation Number 48, “Accounting for Uncertainty in Income Taxes – aninterpretation of Financial Accounting Standards Board (“FASB”) No. 109” (“FINNo. 48”).

 

***Revenue Recognition***

 

We recognizerevenue when (i) persuasive evidence of an arrangement between thecustomer and us exists, (ii) delivery of the product to the customer hasoccurred or service has been provided to the customer, (iii) the price tothe customer is fixed or determinable and (iv) collectibility isreasonably assured.

 

28

----

 

*Telecom Sector Revenue Recognition:***Revenuein the ILEC and CLEC companies is earned from monthly billings to customers fortelephone services, long distance, digital TV, DSL, Internet services, andhardware and other services. ILEC and CLEC revenue is also derived from chargesfor network access to our local exchange telephone network from subscriber linecharges and from contractual arrangements for services such as billing andcollection and directory advertising. Some revenue is realized under poolingarrangements with other telephone companies and is divided among the companiesbased on respective costs and investments to provide the services. Thecompanies that take part in pooling arrangements may adjust their costs andinvestments for a period of two years, which causes the dollars distributed bythe pool to be adjusted retroactively. We believe that recorded amountsrepresent reasonable estimates of the final distribution from these pools.However, to the extent that the companies participating in these pools makeadjustments, there will be corresponding adjustments to our recorded revenue infuture periods. Revenue is recognized in the period in which service isprovided to the customer. With multiple billing cycles and cut-off dates, weaccrue for revenue earned but not yet billed at the end of a quarter. We alsodefer services billed in advance and recognize them as income when earned basedon billing dates.

 

*Enventis Sector Revenue Recognition:*Revenue in the**EnventisSector is generated from the following primary sources: i) the distribution ofvoice and data communications equipment provided primarily from Cisco, ii)providing design, configuration and installation services related to voice anddata equipment, iii) the provision of Cisco maintenance support contracts, iv)the sale of professional support services related to customer voice and datasystems, v) the sale of transport services over the Company-owned and leasedfiber optic network, and vi) the sale of managed voice and data services,including resale of long distance services. Our revenue recognition policy foreach of these types of products and services is as follows:

 

·                  Ininstances where Enventis sells Cisco voice and data communications equipmentwith no installation obligations (equipment only sales), all warrantyobligations reside with Cisco. Therefore, revenue is recognized when the equipmentis delivered to the customer site. In instances where Enventis sells Ciscovoice and data communications equipment with installation obligations, terms ofthe agreements typically provide for installation services withoutcustomer-specific acceptance provisions, but sometimes may providecustomer-specific acceptance provisions. For arrangements with nocustomer-specific acceptance arrangements, we recognize revenue when titlepasses to the customer. For contracts with customer specific acceptance provisions,we defer revenue recognition until the receipt of formal customer acceptance,assuming that all other revenue recognition criteria have been met. When a saleinvolves multiple elements, revenue is allocated to each respective element inaccordance with Emerging Issues Task Force No. 00-21, “Accounting ForRevenue Arrangements with Multiple Deliveries” (“EITF No. 00-21”), whichaddresses certain aspects of the accounting by a vendor for arrangements underwhich it will perform multiple revenue-generating activities. EITF No. 00-21provides guidance on how an arrangement involving multiple deliverables shouldbe divided into separate units of accounting, but does not change otherwiseapplicable revenue recognition criteria. In the event that we enter into amultiple element arrangement and there are undeliverable elements as of thebalance sheet date, we assess whether the elements are separable and havedeterminable fair values in assessing the amount of revenue to record. Allocationof revenue to elements of the arrangement is based on fair value of the elementbeing sold on a stand-alone basis.

 

29

----

 

·                  Whenwe sell equipment to customers, we also typically sell Cisco support contracts(“SmartNet” contracts). These support contracts state that Cisco will provideall support services, product warranty and updates directly to the customer.Because Enventis has no service obligations under these types of contracts, theearnings process has culminated for us upon the sale of the contract andtherefore revenue is recognized immediately. Further, we are serving in anagency relationship to the customer for the sale of the contract and thereforethe revenue is recorded net of the cost that we pay Cisco for the contract.Support services also include Enventis offered “24X7” support of a customer’svoice and data systems. Most of these contracts are billed on a time andmaterials basis and revenue is recognized either as services are provided orover the term of the contract. Support services also include Enventis sponsoredprofessional support services. Such services are typically sold on a time andmaterials basis, but may be sold as a pre-paid block of time. This revenue isrecognized as the services are provided (deferred and recognized as utilized ifpre-paid). In the event that these services are part of a multiple elementarrangement, the fair value of the services are measured and deferred inaccordance with EITF No. 00-21 mentioned above. Allocation of revenue toelements of the arrangement is based on fair value of the element being sold ona stand-alone basis.

·                  Transportservices are sold primarily through a contractual flat monthly fee. The revenuegenerated by these services is typically billed one month in advance and isdeferred until the appropriate month of recognition.

·                  Enventisalso manages customer voice and/or data services. Under these contracts,Enventis bills either a flat monthly fee or a fee that is variable based on thenumber of “seats” that the customer has. This revenue is recognized on amonthly basis as the services are provided.

 

***Allowance for Doubtful Accounts***

 

We maintain allowances for doubtful accounts for estimated lossesresulting from the inability of our customers to make required payments. Inmaking the determination of the appropriate allowance for doubtful accounts, weconsider specific accounts, historical write-offs, changes in customerrelationships and credit worthiness and concentrations of credit risk. Specificaccounts receivable are written off once a determination is made that theaccount is uncollectible. Additional allowances may be required if thefinancial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments. The allowance for doubtfulaccounts was $1,184,000 and $851,000 as of December 31, 2007 and 2006,respectively.

 

***Inventories***

 

Inventories are valued using the lower of cost (perpetual weightedaverage-cost or specific identification) or market method. Similar to itsallowance for doubtful accounts, we make estimates related to the valuation ofinventory. We adjust our inventory carrying value for estimated obsolescence orunmarketable inventory to the estimated market value based upon assumptionsabout future demand and market conditions. As market and other conditionschange, additional inventory reserves may be established at a time when thefacts that give rise to the lower value are warranted.

 

***FinancialDerivative Instruments***

 

We use financial derivative instruments to manage our overall exposureto fluctuations in interest rates. We account for derivative instruments inaccordance with SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities” (“SFAS No. 133”), as amended by SFAS No. 149, “Amendmentof Statement 133 Accounting for Derivative Instruments and Hedging Activities”(“SFAS No. 149”), which requires derivative instruments to be recorded onthe balance sheet at fair value. Changes in fair value of derivativeinstruments must be recognized in earnings unless specific hedge accountingcriteria are met, in which case the gains and losses are included in othercomprehensive income rather than in earnings.

 

We utilize interest-rate swapagreements that qualify as cash-flow hedges to manage our exposure to interestrate fluctuations on a portion of our variable-interest rate debt. The marketvalue of the cumulative gain or (loss) on financial derivative instruments isreported as a component of accumulated other comprehensive income (loss) inshareholders’ equity and is recognized in earnings over the term of the swapagreement. In March 2007, we terminated two outstanding interest-rate swapagreements with original maturities of June 2008 in exchange for$1,936,000 in proceeds. Proceeds of $1,272,000 were recognized as an offset tointerest expense during 2007.

 

30

----

 

***Intangible Assets***

 

We amortize ourdefinite-lived intangible assets over their estimated useful lives. Customerlists and other intangibles are amortized from one to eight years. Intangibleassets with finite lives are amortized over their respective estimated usefullives to their estimated residual values. Identifiable intangible assets thatare subject to amortization are evaluated for impairment.

 

Goodwill assetsare not amortized, but are subject to an impairment test annually as well asupon certain events that indicate that impairment may be present. The goodwillimpairment test requires management to determine the fair value of several ofour reporting units (as defined by SFAS No. 142, “Goodwill and OtherIntangible Assets” (“SFAS No. 142”)). We determine the fair value of ourreporting units by application of a discounted cash flow analysis. Managementmakes estimates that are included in its discounted cash flow analysis basedupon the best available information at the time that the determinations of fairvalue are made. If circumstances change, our estimates of fair value will alsochange and could result in a determination of additional impairment charges toreduce the carrying value of goodwill.

 

***Income Taxes***

 

We account forincome taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”(“SFAS No. 109”), as clarified by FIN No. 48. Under this methoddeferred income taxes are based on the estimated future tax effects ofdifferences between the financial statement and tax basis of assets andliabilities given the provisions of enacted tax laws. Deferred income taxprovisions and benefits are based on changes to the assets or liabilities fromyear to year. In providing for deferred taxes we consider tax regulations ofthe jurisdictions in which we operate, estimates of future taxable income, andavailable tax planning strategies. If tax regulations, operating results, orthe ability to implement tax-planning strategies vary from our assumptions, wemay be required to adjust the carrying value of deferred tax assets andliabilities. Valuation allowances are recorded related to deferred tax assetsbased on the “more likely than not” criteria of SFAS No. 109.

 

FIN No. 48requires us to recognize the financial statement benefit of a tax position onlyafter determining that the relevant tax authority would more likely than notsustain the position following an audit. For tax positions meeting themore-likely-than-not threshold, the amount recognized in the financialstatements is the largest benefit that has a greater than 50 percent likelihoodof being realized upon ultimate settlement with the relevant tax authority. Seeadditional disclosures regarding application of FIN No. 48 in Note 11 tothe Notes to the Consolidated Financial Statements.

 

As part of theprocess of preparing our consolidated financial statements, we are required toestimate income taxes in each of the jurisdictions in which we operate. Thisprocess involves estimating the current tax exposure together with assessingtemporary differences resulting from the differing treatments of items such asdeferred revenue for tax and accounting purposes. These differences result indeferred tax assets and liabilities, which are included within our consolidatedbalance sheet. We assess the likelihood that deferred tax assets will berecovered from future taxable income and to the extent recovery is not likely,it establishes a valuation allowance. To the extent that we establish avaluation allowance or increase this allowance in a period, it must be includedas an expense within the tax provision in the statement of operations. We had avaluation allowance of $1,550,000 and $1,616,000 at December 31, 2007 and2006, respectively, due to uncertainty about the realization of benefitsassociated with net operating losses generated in the state of Iowa. Inaddition, the Company carries reserves for income tax contingencies. Thesereserves relate to various tax years subject to audit by tax authorities. Webelieve our current income tax reserves are adequate. However, the ultimateoutcome may differ from estimates, and assumptions could impact the provisionfor income taxes reflected in the consolidated statements of operations.

 

31

----

 

***Post-Retirement Benefits***

 

The net post-retirement benefit expense was $859,000, $924,000 and$1,051,000 in 2007, 2006 and 2005, respectively. Post-retirement benefitexpense is recorded in cost of services and selling, general and administrativeexpenses. The post-retirement benefit expense and liability are calculatedutilizing various actuarial assumptions and methodologies. These assumptionsinclude, but are not limited to, the discount rate and the expected health carecost trend rate.

 

Post-retirement benefits were calculated inaccordance with the methods specified in SFAS No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans – anamendment of FASB statements No. 87, 88, 106 and 132(R)” (“SFAS No. 158”),and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits OtherThan Pensions” (“SFAS No. 106”). Where SFAS No. 106 providesalternative methods for determining net periodic benefit costs, we adopted thefollowing policies: Any prior service cost or cumulative net gains and lossesin excess of 10% of the SFAS No. 106 corridor, are amortized on astraight-line basis over the average future service lives of the covered group.There are no substantive commitments for benefits other than as stated in thewritten plan. According to the guidance of paragraph 186 of SFAS No. 106, “theobjective of selecting assumed discount rates is to measure the single amountthat, if invested at the measurement date in a portfolio of high-quality debtinstruments, would provide the necessary future cash flows to pay theaccumulated benefits when due”. The assumed discount rate represents thediscounted value of necessary future cash flows required to pay the accumulatedbenefits when due. The rate was determined based on available market dataregarding the spot rate yields in half year increments on high-quality fixedincome securities with the effects of puts and calls removed that provide cashflows at the same time and in the same amount as the projected cash flows ofthe plan.

 

Inmeasuring the accumulated post-retirement benefit obligation as of December 31,2007, we assumed a weighted average discount rate of 6.20%. The reduction inthe discount rate by 25 basis points would increase the accumulatedpost-retirement benefit obligation by approximately $310,000 as of December 31,2007 and would increase the net periodic cost by approximately $36,000 as of December 31,2007.

 

Thehealth care cost trend rate is based upon an evaluation of the historicaltrends and experience, taking into account current and expected marketconditions. The health care cost trend rate represents the expected annual rateof change in the cost of health care benefits currently provided due to factorsother than changes in the demographics of plan participants. If the assumptionsutilized in determining the post-retirement benefit expense and liabilitydiffer from actual events, the results of operations for future periods couldbe impacted.

 

Inmeasuring the accumulated post-retirement benefit obligation as of December 31,2007, the initial health care inflation rate for 2008 was assumed to be 8.0%,decreasing 0.5% each year until it reaches 4.5% in 2015 and remains at 4.5% forthe years thereafter. These assumptions were provided based on a study of theten-year history of our self-funded medical benefits plan. This has resulted inHickoryTech consistently having lower increases in health care costs than thenational averages. Aone-percentage point increase in the health care inflation rate for each yearwould increase the accumulated post-retirement benefit obligation by$1,269,000. A one-percentage point decrease in the health care inflation ratefor each year would decrease the accumulated post-retirement benefit obligationby $1,023,000.

 

Whenactual events differ from the assumptions or when the assumptions used change,an unrecognized actuarial gain or loss results. As of December 31, 2007,the unrecognized net actuarial loss was $1,583,000. During each of the lastthree years, we adjusted the discount rate assumption due to changes ininterest rates. In recent years, we adjusted the health care cost trend rateassumption to reflect the current trend of medical costs. The remainder of thenet actuarial loss amount primarily related to differences between the assumedmedical costs and actual experience and changes in the employee population. Therecognized net actuarial loss outside the allowable corridor is expected to berecognized over the next 12.2 years. This amount will change in future years aseconomic and market conditions generate gains and losses.

 

32

----

 

***Property, Plant and Equipment***

 

Property, plant and equipment are recorded at original cost ofacquisition or construction. When regulated ILEC telephone assets are sold orretired, the assets and related accumulated depreciation are removed from theaccounts and any gains or losses on disposition are amortized with theremaining net investment in telephone plant. When other plant and equipment issold or retired, the cost and related accumulated depreciation or amortizationare removed from the respective accounts and any resulting gain or loss isincluded in operating income. Maintenance and repairs are charged to expense asincurred.

 

On December 30, 2005 we acquired Enventis. The Enventis property,plant and equipment, consisting primarily of a fiber optic communicationsnetwork was valued under SFAS No. 141, “Business Combinations” (“SFAS No. 141”),as it pertains to accounting for assets under Purchase Accounting. We recordedthe assets at fair value at the time of acquisition. Also included in theEnventis property, plant and equipment is fiber optic cable and indefeasibleright of use of fiber installed by others accompanied by ownership rights. Bothof these categories of assets have depreciable lives of 16 to 20 years on theassets acquired on December 30, 2005 and 25 years for new additions.

 

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 the ILEC telephone plant were 4.8%,4.9% and 5.4% for 2007, 2006 and 2005, respectively. All other property, plantand equipment are depreciated over estimated useful lives of 3 to 20 years.

 

The Telecom Sector leases certain computer equipment under capitallease arrangements. We have recorded the present value or fair value of thefuture minimum lease payments as a capitalized asset and related leaseobligation. Assets under these capital leases are included in property, plantand equipment.

 

***Incentive Compensation***

 

We recognize stock compensation charges related to stock award planswhen management concludes it is probable that the participant will earn theaward. Such compensation charges are recorded based upon the fair value of ourstock and is recognized during the service period specified by the stock awardplan. Changes in estimated compensation are recorded in the period in which thechange occurs.

 

On January 1,2006, we adopted SFAS No. 123(R) (revised 2004), “Share Based Payment”(“SFAS No. 123(R)”), which requires the measurement and recognition ofcompensation expense for all share-based payment awards made to employees anddirectors, including employee stock options and employee stock purchasesrelated to the employee stock purchase plan, based on estimated fair values.SFAS No. 123(R) supersedes our previous accounting under AccountingPrinciples Board No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”),for periods beginning in 2006. In March 2005, the FASB issued StaffAccounting Bulletin No. 107, “Share-Based Payment” (“SAB No. 107”),which relates to SFAS No. 123(R). We have applied the provisions of SAB No. 107in its adoption of SFAS No. 123(R). We adopted SFAS No. 123(R) usingthe modified prospective transition method, which requires the application ofthe accounting standard as of January 1, 2006.

 

Our ConsolidatedFinancial Statements for 2006 reflect the impact of SFAS No. 123(R). Inaccordance with the modified prospective transition method, the ConsolidatedFinancial Statements for prior periods have not been restated to reflect, anddo not include, the impact of SFAS No. 123(R) or any modifications tooutstanding stock options prior to the adoption of SFAS No. 123(R). Theadoption of SFAS No. 123(R) had minimal impact on earnings per share,diluted earnings per share and cash flow from financing and operations in 2006and 2007.

 

33

----

 

Share-based compensationexpense recognized during a period is based on the value of the portion ofshare-based payment awards that are ultimately expected to vest during theperiod. Share-based compensation expense recognized in the ConsolidatedStatements of Operations includes compensation expense for share-based paymentawards granted prior to, but not yet vested as of December 31, 2005, basedon the grant date fair value estimated in accordance with the fair valueprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFASNo. 123”), as well as grants in 2006 under SFAS No. 123(R). Becauseshare-based compensation expense recognized in the Consolidated Statements ofOperations is based on awards ultimately expected to vest, it has been reducedfor estimated forfeitures. We use historical data to estimate pre-vestingforfeitures. SFAS No. 123(R) requires forfeitures to be estimated atthe time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates.

 

The fair value ofeach option award is estimated on the date of grant using a Black-Scholesoption valuation model. We use a seven-year period to calculate the historicalvolatility of its stock price for use in the valuation model. The dividendyield rate is based on our current dividend payout pattern and current marketprice. The risk-free rate for options is based on a U.S. Treasury ratecommensurate with the expected terms. The expected term of options granted isderived from historical experience and represents the period of time thatoptions granted are expected to be outstanding.

 

**Overview**

 

HickoryTech is a holdingcompany with a diverse business of traditional wireline local exchangetelecommunications, state-of-the-art broadband services in the retailcommunications field – including high-speed data and digital TV service –serving dominant market shares of residential and business customers inspecific cities in Minnesota and Iowa. We also provide fiber network capacityand integrated Internet protocol telephony and data services to an exclusivelycommercial business market. From the base incumbent telephone companies, webegan to expand our business beyond our ILEC business in 1998 via a CLECedge-out strategy. We chose to serve entire communities, residential andbusiness, in communities in proximity to our ILEC service area, on a totaloverbuild basis, meaning we use our own network and switching assets. We beganan aggressive broadband service campaign with DSL in 1999, deployed residentialdigital TV service in 2001 and added business high speed data applications(Ethernet) in 2004. In December, 2005, our acquisition of Enventis enhanced abusiness-to-business service strength, adding to that which was already inplace at HickoryTech. Enventis revenue was approximately $50,000,000 prior tothe acquisition. Through Enventis, we serve wholesale communications carrierswith fiber network connectivity in several states and provide integrateddedicated voice and data circuits, Internet protocol telephony and dataservices to large/enterprise and the small/medium size retail businesscustomers.

 

We operate in twobusiness segments: the Telecom and Enventis Sectors. Our largest and oldestproduct and service line (since 1898) has been the operation of ILEC’s ortraditional wireline telephone service. The ILEC product and service lineresides in our Telecom Sector. In 1998, we formed a CLEC and started offeringservices on a competitive basis in several market areas. This product andservice line competes for the telephone dial tone, Internet dial-up andbroadband access, data, digital TV and long distance calling business in ILECterritories owned by HickoryTech and others. We account for our CLEC productand service line in our Telecom Sector. Since 1964, NIBI has provided computerdata processing and software, predominantly for our Telecom Sector operationsand also to other telecommunications companies. Both ILEC and CLEC operationsare managed as one coordinated unit. From 1990 to 2006, HickoryTech also ownedCollins Communications Systems Company (“Collins”), and its results ofoperations were reported in the Enterprise Solutions Sector. We acquiredCollins in 1990 and it operated as a telecommunications, data and Internetprotocol equipment distributor from a base in Minneapolis/St. Paul, Minnesota.We sold our Collins operations on December 29, 2006. All financialstatements and schedules have been restated to reflect Collins operations asdiscontinued operations for all periods presented. We purchased Enventis, aMinnesota-based regional provider of integrated fiber network, Internetprotocol telephony and data services with 1,500 route miles of fiber networkserving business customers in the Upper Midwest in December 2005.

 

34

----

 

Our operations inthe Telecom Sector consist primarily of providing services to their customersfor a fee. Many of these services are recurring, and, as a result, backlogorders and seasonality are not significant factors. Working capitalrequirements for the Telecom Sector include the financing of construction ofnetworks, which consists of switches and cable, data, Internet protocol anddigital TV. Capital is also needed to maintain a high amount of fixed assets,for software development, to pay payroll costs of highly skilled labor, tomaintain inventory to service capital projects and network and telephoneequipment customers, and providing for the carrying value of trade accountsreceivable, which may take several months to collect in the normal course ofbusiness.

 

A significantportion of the business conducted in our Enventis Sector consists of equipmentsales and thus, has a higher degree of cyclical highs and lows due to itsnon-recurring/sales order nature of business. Working capital requirements forthe Enventis Sector include the construction of fiber/optical equipment,Internet protocol equipment, capital for payroll costs, work-in-process andinventory. Enventis working capital is also required for the carrying value oftrade accounts receivable, particularly in the equipment revenue product line,where receivables may take several months to collect in the normal course ofbusiness.

 

The materials andsupplies that are necessary for the operation of the businesses are availablefrom a variety of sources. Our Telecom Sector currently relies on one vendor tosupply a key piece of equipment in its digital TV product line. We arecurrently working with other vendors to potentially supply this equipment. Allof our central office switches are supplied by Nortel. A majority of theequipment sold in our Enventis Sector is supplied by Cisco. Nortel and Ciscoare leading suppliers of communications and data equipment, and our dependenceon these brands is not viewed as a significant risk.

 

**Highlightsof 2007**

 

As of December 31,2007, Enventis completed its second year as a wholly owned subsidiary. EnventisSector revenue for 2007 represented a 37.6% increase over revenue for 2006 andEnventis Sector net income increased 198.9% over that same time period. Webelieve the Enventis Sector will continue to provide long-term growth for theCompany, but not necessarily at the levels achieved in 2007.

 

The operations of ourlegacy Telecom business again reached new milestones of DSL and digital TVpenetration in 2007. Digital TV services were initiated in the communities ofJanesville, North Mankato and on a limited basis, in Mankato. The Telecombusiness experienced increased competition in 2007 as cable TV providerslaunched voice services. The Telecom Sector has also continued to experienceprice erosion in its core voice business.

 

**2007Compared to 2006**

 

·                  Consolidatedoperating revenue in 2007 was $156,649,000, a $23,748,000 or 17.9% increasecompared to 2006. This increase was primarily due an $18,565,000 increase inrevenue from the Enventis Enterprise Network Services product line in 2007compared to 2006. Also contributing to the increase in revenue in 2007 comparedto 2006 was an increase of $3,232,000 in the Enventis Enterprise TransportServices product line. The Telecom Sector experienced non-recurring revenue of$1,890,000 due to the settlement of a switched access revenue dispute.

·                  Costof sales (excluding Depreciation and Amortization) in 2007 was $45,340,000, a$14,188,000 or 45.5% increase compared to 2006. The increase in 2007 comparedto 2006 was primarily due to the costs incurred to support the increasedrevenue in the Enventis Enterprise Network Services product line. These costsare primarily equipment material costs. Labor associated with installation workis not included in this category, but is included in cost of services(excluding depreciation and amortization) described below.

·                  Costof services (excluding Depreciation and Amortization) was $44,881,000 in 2007,a $375,000 or 0.8% increase compared to 2006. This increase was primarily dueto the increase in Enventis Sector cost of services, offset by the decrease inthe Telecom Sector cost of services. See the individual Sector results ofoperations for the Telecom Sector and Enventis Sector for an explanation of thechanges in each individual Sector.

 

35

----

 

·                  Selling, General and AdministrativeExpenses were $24,244,000 in 2007, a $953,000 or 4.1% increase compared to2006. The Enventis Sector recorded acquisition integration costs ofapproximately $2,400,000 in 2006 which did not recur in 2007. Without theseone-time costs, our selling, general and administrative expenses would haveincreased 16.0% in 2007 compared to 2006. This substantial increase in costswas used to support the higher activity levels of the Enventis Sectoroperations in 2007.

·                  DepreciationExpense was $17,847,000 in 2007, an $898,000 or 5.3% increase compared to 2006.This increase was primarily due to the $707,000 increase in Enventis Sectordepreciation, which was the result of an increasein assets placed in service in 2006 and 2007.

·                  AmortizationExpense was $1,157,000 in 2007, a $15,000 or 1.3% decrease compared to 2006.

 

**2006Compared to 2005**

 

·                  Consolidatedrevenue was $132,901,000 in 2006, a $54,979,000 or 70.6% increase compared to2005. This increase was due to revenue recognized from the addition ofEnventis. Without Enventis, consolidated revenue would have decreased by 3.9%.

·                  Cost of sales (excluding Depreciationand Amortization) was $31,152,000 in 2006 with none in 2005. The cost of saleswas directly associated with the new Enventis revenue recognized in 2006.

·                  Costof services (excluding Depreciation and Amortization) was $44,506,000 in 2006,a $13,098,000 or 41.7% increase compared to 2005. This increase was primarilydue to costs associated with the new Enventis operations. Without Enventis,cost of services would have increased 1.5%.

·                  Selling, General and AdministrativeExpenses were $23,291,000 in 2006, a $10,691,000 or 84.8% increase compared to2005. This increase was primarily due to costs associated with the new Enventisoperations. Without Enventis, selling, general and administrative expenseswould have increased 13.6%. In addition to the ongoing costs of Enventisselling, general and administrative activities, Enventis incurred approximately$2,400,000 of integration costs in 2006, which did not reoccur.

·                  DepreciationExpense was $16,949,000 in 2006, a $2,006,000 or 13.4% increase compared to2005. This increase was essentially all due to depreciation associated with thenew Enventis assets.

·                  AmortizationExpense was $1,172,000 in 2006, a $679,000 or 137.7% increase compared to 2005.This increase was essentially all due to amortization associated with the newEnventis intangibles.

 

**Trends**

 

Our consolidated revenueincreased 17.9% and our income from continuing operations increased 65.0% in2007 compared to 2006. These substantial improvements in the results ofoperations were a function of improvements in both the Telecom and EnventisSectors. Enventis Sector revenue increased 37.6% in 2007 compared to 2006 andnet income almost tripled in that same time period. The Enventis Sectorrecorded acquisition integration costs of approximately $2,400,000 in 2006,which did not reoccur in 2007. The combination of a $1,890,000 non-recurringrecovery of a switched access dispute with a large interexchange carrier in2007, as well as expense reductions, enabled the Telecom Sector to post a 17.9%increase in operating income in 2007 compared to 2006. Without these twonon-recurring events (the interexchange carrier settlement and the eliminationof integration costs), our consolidated income from continuing operations wouldhave increased by $826,000 or 12.3% in 2007 compared to 2006.

 

36

----

 

Longer term, we expectlocal service and network access revenue in our Telecom Sector to continue totrend downward because of competition from CLECs, cable TV providers, voiceover Internet protocol, wireless telephone, other telephone competitors and dueto reduced usage and pricing of network access service. This competition willaffect basic customer connections and choices made by specific customers not tointerconnect or utilize the Company’s network or services. We were successfulin 2007 in completely offsetting this declining revenue with increased revenuefrom broadband services. Without the one-time settlement of a switched accessdispute with a large interexchange carrier mentioned above, network accessrevenue would have decreased by $934,000 or 3.1% in 2007 compared to 2006.Network access revenue and Telecom Sector margins were both negatively impactedby a reduction in interstate network access rates that went into effect on July 1,2007 as well as by the competitive voice services that were offered by thecable TV providers in Northwest, Iowa in the first quarter of 2007 and inMankato, our largest market, in the third quarter of 2007. The entire declinein network access revenue (before the settlement of the switched accessdispute) occurred in the third and fourth quarters of 2007, thus establishing anew trend. Accordingly, while we will continue to work to offset decliningrevenue with new services to our customers in the Telecom Sector, the trendtoward decreasing profitability in this Sector may resume.

 

We believe our EnventisSector provides a platform for longer-term growth. Enventis revenue for 2007represented a 37.6% increase over 2006 revenue. Enventis provided profitableoperations and recorded positive operating income in each of the eight quarterssince its acquisition. Enventis consists of two major product lines. Ourequipment sales and service product line - Enterprise Network Services - issubject to cyclical highs and lows depending on customer demand. The EnterpriseTransport Services product line provides network-based service for wholesaleand retail use by customers. This product line contains more of a recurringrevenue stream and is supported by long-term contracts. Both the EnterpriseNetwork Services and Enterprise Transport Services product lines have shownexcellent growth characteristics. One of our strategies is to sell bundledEnterprise Network Services to customers with the goal that they will alsoutilize our Enterprise Transport Services as well.

 

Due to increasedprofitability in both the Enventis and Telecom Sectors in 2007, we were able toreduce our outstanding debt balance in 2007 compared to 2006. Despite thedecrease in the debt balance, interest expense increased due to lowercooperative dividends received in 2007 from one of our participating lenders,the expiration of a swap agreement and the re-setting of the rate on aremaining swap agreement. Cooperative dividends are accounted for as an offsetto interest expense when earned. In addition, the effective interest rate onour debt was also higher in 2007 than in 2006 due to the establishment oflonger-term interest protection.

 

Income from continuingoperations increased to $8,635,000 in 2007 from $5,235,000 in 2006, due to theimproved profitability in both the Enventis and Telecom Sectors, offset by theincrease in interest expense.

 

37

----

 

**Sector Results of Operations**

 

**Telecom Sector**

 

The following table provides a breakdown of the Telecom Sectoroperating results.

 

**TELECOM SECTOR**

 
| **(Dollars in thousands)**                       | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005** | ** ** |
|------------------------------------------------------------|------------|------------|------------|------------|------------|----------|------------|
| Revenue Before Intersegment  Eliminations                  |       |       |       |       |       |     |       |
|                                                       |       |       |       |       |       |     |       |
| Revenue                                                    |       |       |       |       |       |     |       |
| Local Service                                              | ** ** | **$**      | **17,089** |       | $          | 18,224   |       | $ | 18,520 |   |
| Network Access                                             | ** ** | **30,892** |       | 29,936     |       | 33,384   |       |
| Long Distance                                              | ** ** | **5,068**  |       | 4,877      |       | 4,821    |       |
| Data                                                       | ** ** | **6,900**  |       | 6,048      |       | 4,968    |       |
| Internet                                                   | ** ** | **4,612**  |       | 4,467      |       | 4,361    |       |
| Digital TV                                                 | ** ** | **2,273**  |       | 1,457      |       | 979      |       |
| Directory                                                  | ** ** | **3,854**  |       | 3,624      |       | 3,509    |       |
| Message  Processing & Billing                          | ** ** | **2,474**  |       | 2,127      |       | 2,522    |       |
| Intersegment                                               | ** ** | **467**    |       | 260        |       | 128      |       |
| Other                                                      | ** ** | **3,685**  |       | 4,136      |       | 4,858    |       |
| Total Telecom  Revenue                                     | ** ** | **$**      | **77,314** |       | $          | 75,156   |       | $ | 78,050 |   |
|                                                       |       |       |       |       |       |     |       |
| Total Telecom  Revenue Before Intersegment Eliminations    |       |       |       |       |       |     |       |
| Unaffiliated  Customers                                    | ** ** | **$**      | **76,847** |       | $          | 74,896   |       | $ | 77,922 |   |
| Intersegment                                               | ** ** | **467**    |       | 260        |       | 128      |       |
| ** **                                                 |       | **77,314** |       | 75,156     |       | 78,050   |       |
|                                                       |       |       |       |       |       |     |       |
| Cost of  services, excluding depreciation and amortization |       | **30,893** |       | 32,046     |       | 31,408   |       |
| Selling, general  and administrative expenses              | ** ** | **13,407** |       | 13,001     |       | 12,438   |       |
| Depreciation and  amortization                             | ** ** | **15,218** |       | 15,009     |       | 15,375   |       |
| Operating Income                                           | ** ** | **$**      | **17,796** |       | $          | 15,100   |       | $ | 18,829 |   |
|                                                       |       |       |       |       |       |     |       |
| Income from  continuing operations, net of tax             | ** ** | **$**      | **10,460** |       | $          | 9,237    |       | $ | 11,324 |   |
| Income (loss)  from discontinued operations, net of tax    | ** ** | **—** |       | **—** |       | 186      |       |
| Net income                                                 | ** ** | **$**      | **10,460** |       | $          | 9,237    |       | $ | 11,510 |   |
|                                                       |       |       |       |       |       |     |       |
| Capital  expenditures                                      | ** ** | **$**      | **11,489** |       | $          | 15,631   |       | $ | 19,312 |   |
|                                                       |       |       |       |       |       |     |       |
| Key metrics                                                |       |       |       |       |       |     |       |
| Business access  lines                                     | ** ** | **27,403** |       | 27,014     |       | 27,145   |       |
| Residential  access lines                                  | ** ** | **37,428** |       | 41,029     |       | 42,945   |       |
| Total access  lines                                        | ** ** | **64,831** |       | 68,043     |       | 70,090   |       |
| Long distance  customers                                   | ** ** | **40,956** |       | 41,196     |       | 40,321   |       |
| Digital  Subscriber Line customer*s (1)*                   | ** ** | **17,427** |       | 15,724     |       | 13,022   |       |
| Digital TV  customers                                      | ** ** | **6,487**  |       | 4,632      |       | 2,766    |       |

 

----

*(1)* DSL line counts were reduced by 478 in 2007 dueto a data conversion. There was no restatement of prior periods.

 

**Revenue**

 

Telecom Sector operating revenue before intersegmenteliminations was $2,158,000 or 2.9% higher in 2007 compared to 2006, and$2,894,000 or 3.7% lower in 2006 compared to 2005. The increase in 2007compared to 2006 was primarily due to increases in network access, data anddigital TV, offset by a decrease in local service.  Without the non-recurring settlement of aswitched access dispute with a large interexchange carrier (see below), whichincreased revenue by $1,890,000 in 2007, revenue would have increased $268,000or 0.4% in 2007 compared to 2006, primarily due to our success in growingbroadband services. The decrease in 2006 compared to 2005 was primarily due todecreases in network access, other revenue, and message processing and billing,partially offset by growth in data and digital TV.

 

38

----

 

Local service revenue was $1,135,000 or 6.2% lower in 2007 compared to2006. This decrease was primarily due to a 3,212 or 4.7% decrease in accesslines at December 31, 2007 compared to December 31, 2006. Alsocontributing to the decrease in local service revenue was a decline inreciprocal compensation received from wireless carriers under contract usingminute of use pricing. Many of these contracts and their associated pricingwere renegotiated in the first nine months of 2007. A higher degree ofcompetition from ILECs, CLECs and cable TV providers serving our markets andfrom wireless substitution, could impact our local service revenue in futureperiods. Local service revenue was $296,000 or 1.6% lower in 2006 compared to2005. This decrease was primarily due to a 2,047 or 2.9% decrease in accesslines at December 31, 2006 compared to December 31, 2005.

 

Network access revenue was $956,000 or 3.2% higher in 2007 compared to2006. This increase was due to the settlement of a switched access dispute witha large interexchange carrier which resulted in a non-recurring increase inrevenue of $1,890,000 in the second quarter of 2007 and was partially offset bylower revenue resulting from decreased minutes of use in 2007 compared to 2006and lower interstate network access rates which went into effect on July 1,2007. Without the impact of the non-recurring access settlement, network accessrevenue would have decreased by $934,000 or 3.1% in 2007. The combination ofchanging minutes of use, carriers optimizing their network costs and lowerdemand for dedicated lines may negatively impact future access revenue. Inaddition, future federal or state access reform may provide further negativeinfluences. The public utilities commissions have been considering intrastateaccess reform and universal service for several years (see Regulation on pages 8to 14). Network access revenue was $3,448,000 or 10.3% lower in 2006 comparedto 2005. This decrease was primarily due to a mandated ILEC interstate ratedecrease implemented on July 1, 2005, lower overall minutes of use and therecognition of the impact of different treatment of traffic delivered via QwestCommunications, all of which are expected to be lasting in nature.

 

Long distance revenue was $191,000 or 3.9% higher in 2007 compared to2006. Despite a 240 or 0.6% decrease in the customer base at December 31,2007 compared to December 31, 2006, long distance revenue increasedlargely due to a 7.6% increase in minutes of use in 2007 compared to 2006. Longdistance revenue was $56,000 or 1.2% higher in 2006 compared to 2005. Thisincrease was primarily due to an 875 or 2.2% increase in the customer basebetween December 31, 2006 and December 31, 2005, combined with higherlong distance usage per customer.

 

Data revenue was$852,000 or 14.1% higher in 2007 compared to 2006. This increase was primarilydue to a $561,000 increase in Ethernet services to large business customers andan increase in DSL customers of 1,703 or 10.8% between December 31, 2007and December 31, 2006. We believe Ethernet service revenue will continueto provide growth opportunities for HickoryTech. Expanded networkingopportunities among medium and large business customers are key drivers forthis growth. Data revenue was $1,080,000 or 21.7% higher in 2006 compared to2005. This increase was primarily due to increased broadband services tobusiness customers, a 2,702 or 20.7% increase in DSL customers at December 31,2006 compared to December 31, 2005 and DSL customers migrating from lowerspeed DSL products to higher speed DSL products, which have the effect ofincreasing revenue per customer.

 

Internet revenuewas $145,000 or 3.2% higher in 2007 compared to 2006, and $106,000 or 2.4% higherin 2006 compared to 2005. The increase in both periods was primarily due to anincrease in Internet customers.

 

Digital TV revenue was $816,000 or 56.0% higher in 2007 compared to2006. This increase was primarily the result of the offering of digital TV tothree additional communities in 2006 and three additional communities in 2007,which resulted in a 1,855 or 40.0% increase in digital TV customers at December 31,2007 compared to December 31, 2006. Also contributing to the increase indigital TV revenue was an increase in rates charged to customers ofapproximately 5.0%, which went into effect in April 2007. Digital TVrevenue was $478,000 or 48.8% higher in 2006 compared to 2005. This increasewas primarily due to the expansion of digital TV in three additionalcommunities in the latter half of 2005 and three additional communities in2006, which resulted in a 1,866 or 67.5% increase in digital TV customers at December 31,2006 compared to December 31, 2005.

 

Directory revenue was $230,000 or 6.3% higher in 2007 compared to 2006.This increase was the result of an increase in the sales of yellow-page advertisingin the Company directories, which went into effect in the beginning of thethird quarter of 2007. Directory revenue was $115,000 or 3.3% higher in 2006compared to 2005. This increase was the result of increased advertising in theCompany directories.

 

39

----

 

NIBI message processing revenue was $347,000 or 16.3% higher in 2007compared to 2006. This increase was primarily due to the recognition of$259,000 of non-recurring license fee revenue in 2007 compared to 2006. Alsocontributing to the increase in revenue was the addition of several newcustomers offset by lower message counts to several other customers. NIBImessage processing revenue was $395,000 or 15.7% lower in 2006 compared to2005. This decrease was primarily due to the Company recognizing $396,000 innon-recurring license fees from the sale of SuiteSolution® to a customer in June 2005.The addition of several customers and increased volumes from existingcustomers, helped offset the loss of non-recurring license fee revenue.

 

Other revenue, consisting primarily of sales of customer premiseequipment, circuit private lines, maintenance, and adds, moves and changes was$451,000 or 10.9% lower in 2007 compared to 2006. This decrease was primarilydue to lower revenue of $767,000 associated with the SOCRATES contract whoseservice was discontinued in 2006, offset by an increase in Telecom back officecontract services of $179,000 and an increase in customer premise equipmentrevenue of $171,000. Until June 2006, we had provided Internet access andvideo conferencing for Project SOCRATES which is a distance-learning networkconnecting schools and libraries in a 12-county region in south centralMinnesota. Our contract with Project SOCRATES ended on June 30, 2006.Other revenue was $722,000 or 14.9% lower in 2006 compared to 2005. Thisdecrease was primarily due to the loss of $670,000 associated with the SOCRATEScontract mentioned above.

 

**Cost of Services (excludingDepreciation and Amortization)**

 

Telecom Sector cost of services (excluding depreciation andamortization) was $1,153,000 or 3.6% lower in 2007 compared to 2006. Thisdecrease was primarily due to the following items: 1) a $733,000 decrease inprofessional and consulting fees due to lower fees associated with theconversion of our enterprise resource planning software and provisioningsoftware, 2) a $444,000 decrease in contract labor largely due to theretirement of mainframe computer functions in the NIBI business in 2006, 3) a$416,000 decrease in charges to the inventory reserve, 4) a $233,000 decreasein circuit expenses and 5) a $193,000 decrease in bad debt expense largelyassociated with the settlement of a switched access dispute with a largeinterexchange carrier in 2007. These decreases were partially offset by thefollowing items: 1) a $674,000 increase in programming expense to support theincrease in digital TV services and 2) a $263,000 increase in incentivecompensation payments in 2007.

 

Telecom Sector cost of services (excluding depreciation andamortization) was $638,000 or 2.0% higher in 2006 compared to 2005. Thisincrease was primarily due to the following items 1) a $378,000 increase inprogramming expense associated with the increase in digital TV revenue, 2) a$325,000 increase in the inventory reserve, 3) a $299,000 increase in customerpremise equipment and 4) a $170,000 increase in maintenance contracts. Theseincreases were partially offset by the following items: 1) a $340,000 decreasein circuit expense associated with providing Internet services and 2) a$301,000 decrease in wages and benefits due to a reassignment of support stafffor the NIBI product line to activities reported as selling, general andadministrative expenses.

 

**Selling, General andAdministrative Expenses**

 

Telecom Sector selling, general and administrative expenses were$406,000 or 3.1% higher in 2007 compared to 2006. This increase was primarilydue to a $170,000 increase in corporate expense allocations, a $162,000increase in incentive compensation expense in 2007 and a $159,000 increase infranchise fees associated with digital TV contracts with various cities.Telecom Sector selling, general and administrative expenses were $563,000 or4.5% higher in 2006 compared to 2005. This increase was primarily due to a$730,000 increase in wages and benefits ($301,000 of this increase was due tothe reassignment of wages from costs of services as mentioned above), partiallyoffset by a $335,000 decrease in fees associated with the termination of leasesin 2005 in the NIBI product line.

 

40

----

 

**Depreciation and Amortization**

 

Telecom Sector depreciation andamortization was $209,000 or 1.4% higher in 2007 compared to 2006, and $366,000or 2.4% lower in 2006 compared to 2005. Telecom Sector depreciation was$223,000 or 1.5% higher in 2007 compared to 2006, and $6,000 or 0.1% higher in2006 compared to 2005. The increase or decrease in depreciation in any givenperiod is dependent on the net level of capital assets placed in service andretirements on a period by period basis. Telecom Sector amortization was$14,000 or 11.6% lower in 2007 compared to 2006, and $372,000 or 75.5% lower in2006 compared to 2005. The decrease in amortization in 2006 compared to 2005was primarily due to capitalized development costs in connection with the NIBISuiteSolution® billing software becoming fully amortized in thesecond quarter of 2005.

 

**Operating Income**

 

Telecom Sector operating incomewas $2,696,000 or 17.9% higher in 2007 compared to 2006. This increase was dueto the $2,158,000 increase in revenue (principally due to the interexchangecarrier settlement of $1,890,000), the $1,153,000 decrease in cost of services(excluding depreciation and amortization) and the $14,000 decrease inamortization, offset by the $406,000 increase in selling, general and administrativeexpenses and the $223,000 increase in depreciation. Telecom Sector operatingincome was $3,729,000 or 19.8% lower in 2006 compared to 2005. This decreasewas primarily due to the $2,894,000 decrease in revenue, the $638,000 increasein cost of services (excluding depreciation and amortization), the $563,000increase in selling, general and administrative expenses, and the $6,000increase in depreciation, offset by the $372,000 decrease in amortization.

 

**Income from ContinuingOperations, net of Tax**

 

Telecom Sector income fromcontinuing operations, net of tax, was $1,223,000 or 13.2% higher in 2007compared to 2006. This increase was primarily due to increased operating incomementioned above, offset by the change in taxes. Telecom Sector income from continuingoperations, net of tax, was $2,087,000 or 18.4% lower in 2006 compared to 2005.This decrease was primarily due to decreased operating income mentioned aboveand the change in taxes.

 

41

----

 

**Enventis Sector**

 

The following table provides abreakdown of the Enventis Sector operating results. Due to the timing of theacquisition of Enventis, no 2005 historical results are presented.

 

**ENVENTIS SECTOR**

 
| **(Dollars in thousands)**                                             | ** ** | **2007**   | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|----------|------------|
| Revenue Before Intersegment Eliminations                               |       |       |       |     |       |
|                                                                   |       |       |       |     |       |
| Revenue                                                                |       |       |       |     |       |
| ENS equipment revenue                                                  | ** ** | **$**      | **51,046** |     | $          | 36,191 |   |
| ENS services revenue                                                   | ** ** | **8,292**  |       | 4,582    |       |
| ETS services revenue                                                   | ** ** | **20,464** |       | 17,232   |       |
| Intersegment                                                           | ** ** | **440**    |       | 50       |       |
| Total Enventis revenue                                                 | ** ** | **$**      | **80,242** |     | $          | 58,055 |   |
|                                                                   |       |       |       |     |       |
| Total Enventis revenue before intersegment  eliminations               |       |       |       |     |       |
| Unaffiliated customers                                                 | ** ** | **$**      | **79,802** |     | $          | 58,005 |   |
| Intersegment                                                           | ** ** | **440**    |       | 50       |       |
| ** **                                                             |       | **80,242** |       | 58,055   |       |
|                                                                   |       |       |       |     |       |
| Cost of sales, equipment*(1)*(excluding depreciation and amortization) | ** ** | **45,340** |       | 31,152   |       |
| Cost of services*(1)*(excluding depreciation and amortization)         | ** ** | **14,767** |       | 12,641   |       |
| Selling, general and administrative  expenses                          | ** ** | **9,476**  |       | 8,974    |       |
| Depreciation and amortization                                          | ** ** | **3,755**  |       | 3,048    |       |
|                                                                   |       |       |       |     |       |
| Operating income                                                       | ** ** | **$**      | **6,904**  |     | $          | 2,240 |   |
| Net income                                                             | ** ** | **$**      | **4,074**  |     | $          | 1,363 |   |
|                                                                   |       |       |       |     |       |
| Capital expenditures                                                   | ** ** | **$**      | **5,928**  |     | $          | 5,324 |   |
|                                                                   |       |       |       |     |       |

 

----

*(1) *Certainreclassifications of prior period data were made to conform to the currentpresentation on this Form 10-K. The reclassifications did not affect cash flows,financial postion, or net income.

 

42

----

 

HickoryTech Corporation acquired Enventis on December 30,2005. We continue to manage and evaluate the Enventis operations in theirentirety. The table below however, provides an illustration of the significantgrowth experienced in and relative contributions from each of the Enventisprimary product lines. Certain allocations have been made, particularly in thearea of Selling, General and Administrative Expenses, in order to develop thesetables.

 

**ENVENTIS PRODUCT LINE REPORTING**

 

 
| ** **                                                          | ** ** | **Twelve Months Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                          | ** ** | **Network Services**                                | ** ** | **Transport Services** | ** ** |
| **(Dollars in thousands)**                                          | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| * *                                                            |       |                                                     |       |   |   |   |   |   |   |
| Revenue before intersegment eliminations:                           |       |                                                     |       |   |   |   |   |   |   |
| Equipment revenue                                                   | ** ** | **$**                                                    | **51,046** |   | $ | 36,191 | ** ** | **$** | **—** |   | $ | — |   |
| Service revenue                                                     | ** ** | **8,292**                                                |       | 4,582 | ** ** | **20,464** |   | 17,232 |   |
| Intersegment                                                        | ** ** | **—**                                               |       | **—** | ** ** | **440** |   | 50 |   |
| Total Enventis revenue                                              | ** ** | **$**                                                    | **59,338** |   | $ | 40,773 | ** ** | **$** | **20,904** |   | $ | 17,282 |   |
|                                                                |       |                                                     |       |   |   |   |   |   |   |
| Cost of sales, equipment  (excluding depreciation and amortization) | ** ** | **45,001**                                               |       | 30,779 | ** ** | **339** |   | 373 |   |
| Cost of services   (excluding depreciation and amortization)        | ** ** | **4,539**                                                |       | 3,871 | ** ** | **10,228** |   | 8,770 |   |
| Selling, general and administrative  expenses                       | ** ** | **5,115**                                                |       | 4,587 | ** ** | **4,361** |   | 4,387 |   |
| Depreciation and amortization                                       | ** ** | **494**                                                  |       | 349 | ** ** | **3,261** |   | 2,699 |   |
|                                                                |       |                                                     |       |   |   |   |   |   |   |
| Operating income                                                    | ** ** | **$**                                                    | **4,189**  |   | $ | 1,187 | ** ** | **$** | **2,715** |   | $ | 1,053 |   |
| Net income                                                          | ** ** | **$**                                                    | **2,478**  |   | $ | 720 | ** ** | **$** | **1,596** |   | $ | 643 |   |
|                                                                |       |                                                     |       |   |   |   |   |   |   |
| Capital expenditures                                                | ** ** | **$**                                                    | **587**    |   | $ | 258 | ** ** | **$** | **5,341** |   | $ | 5,066 |   |

 

**Revenue**

 

Enventis Sector operatingrevenue before intersegment eliminations was $22,187,000 or 38.2% higher in2007 compared to 2006. This increase was primarily due to the increase inEnterprise Network Services equipment revenue (see below).

 

Enterprise Network Servicesequipment revenue was $14,855,000 or 41% higher in 2007 compared to 2006. Thisincrease was primarily due to revenue recognized from a large equipmentinstallation contract with a customer, which accounted for $14,290,000 inequipment revenue. Due to the “one-time” nature of equipment sales, theEnterprise Network Services equipment revenue growth from year-to-year isdependant on the addition of new customers to replace and exceed revenuereceived from existing customers.

 

Enterprise Network Servicesrevenue (non-equipment) was $3,710,000 or 81% higher in 2007 compared to 2006.This increase was primarily due to a $1,880,000 increase in maintenancerevenue, which was largely the result of an increase in maintenance recognizedto one customer of $1,331,000 in 2007 compared to 2006. Also contributing tothe increase in non-equipment revenue in 2007 compared to 2006 was a $1,858,000increase in contract services revenue associated with an increase in design,configuration and installation services related to voice and data equipment.

 

Enterprise Transport Servicesrevenue was $3,232,000 or 18.8% higher in 2007 compared to 2006. This increasewas primarily due to a $3,406,000 increase in fiber transport services.

 

43

----

 

**Cost of Sales – Equipment(excluding Depreciation and Amortization)**

 

Enventis Sector cost of sales (excludingdepreciation and amortization) associated with equipment revenue increased$14,188,000 or 45.5% in 2007 compared to 2006. This increase was primarily dueto the costs incurred to support the increased revenue in the EnterpriseNetwork Services product line. These costs are primarily equipment materialcosts. Labor associated with installation work is not included in this category,but is included in cost of services (excluding depreciation and amortization)described below.

 

**Cost of Services (excludingDepreciation and Amortization)**

 

Enventis Sector costof services (excluding depreciation and amortization) increased $2,126,000 or 16.8%in 2007 compared to 2006. This increase was primarily due to the followingitems: 1) a $1,179,000 increase in circuit expenses, which supported theincrease in off-net revenue, 2) a $1,092,000 increase in wages and benefits dueto increased staffing levels and 3) a $548,000 increase in professional feesdue to external project management consulting. Offsetting the increase in costof services was a $904,000 decrease in bad debt expense, which was the resultof the collection of several previously written-off customer accounts and alower amount of bad debt accruals in 2007.

 

**Selling, General andAdministrative Expenses**

 

Enventis Sector selling, general andadministrative expenses increased $502,000 or 5.6% in 2007 compared to 2006.This increase was primarily due to the following items: 1) a $656,000 increasein corporate expense allocations, 2) a $209,000 increase in computer expensesand a 3) $183,000 increase in professional accounting fees. Offsetting theincrease was a $632,000 decrease in wages and commissions, which was the resultof non-recurring bonus and overtime payments made in 2006.

 

The Enventis Sector recorded acquisitionintegration costs of approximately $2,400,000 in 2006, which did not reoccur in2007. Without these one-time costs, Enventis Sector selling, general andadministrative expenses would have increased 44.1% in 2007 compared to 2006.This substantial increase in costs was used to support the higher activity andoperation levels of the Enventis Sector in 2007.

 

**Depreciation and Amortization**

 

Enventis Sector depreciationand amortization was $707,000 or 23.2% higher in 2007 compared to 2006.Enventis Sector depreciation was $707,000 or 35.4% higher in 2007 compared to2006. This increase was primarily due to the increase in assets placed inservice in 2006 and 2007. Enventis Sector amortization remained constant in2007 and 2006, respectively, and is attributed to intangible assets related tothe Enventis acquisition in 2005.

 

**Operating Income**

 

Enventis Sector operatingincome was $4,664,000 or 208.2% higher in 2007 compared to 2006. This increasewas due to the $22,187,000 increase in operating revenue, offset by the$14,188,000 increase in cost of sales (excluding depreciation andamortization), the $2,126,000 increase in cost of services (excludingdepreciation and amortization), the $707,000 increase in depreciation and the$502,000 increase in selling, general and administrative expenses.

 

**Net Income**

 

Enventis Sector net income was $2,711,000 or198.9% higher in 2007 compared to 2006. This increase was primarily due to theincreased operating income mentioned above, offset by the change in taxes.

 

44

----

 

**Discontinued Operations –Enterprise Solutions Sector**

 

Effective December 31, 2006, we soldCollins to Skyview Capital, LLC. The selling price was comprised of a $100,000note and up to $1,650,000 of earn-out payments in exchange for all of theCollins outstanding capital stock. Skyview Capital, LLC paid us $100,000 in February 2007.The remaining selling price is due in contingent payments payable over the nextfour years based on financial targets reached by Skyview Capital, LLC. We havereceived no payments to-date related to this earn-out provision.  The $100,000 mentioned above has beenincluded in the calculation of the net loss mentioned below, while thecontingent payments have not been included in the net loss. The agreement alsocontains a service agreement, whereby Skyview Capital, LLC agrees to providecustomer support as a subcontractor for our Nortel equipment business. Thisagreement contains covenants against competition by the new owner insouth-central Minnesota. HickoryTech recorded a pre-tax loss on the sale of$3,385,000 ($2,040,000 net of income taxes). The Collins results of operationswere formerly reported in the Enterprise Solutions Sector. The consolidatedstatements of operations for all periods presented have been restated toreflect the Collins operations as discontinued operations (see Note 3 to theNotes to the Consolidated Financial Statements).

 

**Interest Expense**

 

The outstanding balance of the revolvingcredit facility was $128,675,000 at December 31, 2007, $142,700,000 at December 31,2006 and $142,035,000 at December 31, 2005. Interest expense of $8,121,000increased $759,000 or 10.3% in 2007 compared to interest expense of $7,362,000in 2006, and increased $2,999,000 or 68.7% in 2006 compared to interest expenseof $4,363,000 in 2005. Interest expense increased in 2007 compared to 2006because we received lower cooperative dividends in 2007 from one of ourparticipating lenders and because we established longer-term interest rateprotection which increased the overall effective interest rate. Cooperativedividends are accounted for as an offset to interest expense when earned. In March 2007, we terminated two outstandinginterest-rate swap agreements, with original maturities of June 2008, inexchange for $1,936,000 in proceeds. Proceeds of $1,272,000 were recognized asan offset to interest expense during 2007. Without this offset, interestexpense would have been $9,393,000 in 2007, an increase of $2,031,000 or 27.6%compared to 2006. The effective interest rate was 5.94%, 5.13% and 4.20%in 2007, 2006 and 2005, respectively.

 

**Inflation**

 

It is the opinion of management that theeffects of inflation on operating revenue and expenses over the past threeyears have been immaterial. Management anticipates that this trend willcontinue in the near future.

 

**Dividends**

 

We paid dividends of $6,357,000, or $0.48 pershare, in 2007 and $6,316,000, or $0.48 per share in 2006. We announced a firstquarter dividend of $0.12 per share in 2008, and if it is continued at thatrate would produce an annual dividend of $0.48 per share. See page 25 fora further discussion of HickoryTech’s dividend tendencies and restrictions.

 

45

----

 

**Liquidity and Capital Resources**

 

**CapitalStructure**

 

The total capital structure (long-term andshort-term debt obligations plus shareholders’ equity) for HickoryTech was$161,138,000 at December 31, 2007, reflecting 19.8% equity and 80.2% debt.This compares to a capital structure of $173,175,000 at December 31, 2006,reflecting 17.4% equity and 82.6% debt. Management believes adequate operatingcash flows and other internal and external resources are available to financeongoing operating requirements, including capital expenditures, businessdevelopment, debt service, temporary financing of trade accounts receivable andthe payment of dividends for at least the next 12 months. We employ an extendedterm payable financing arrangement for inventory purchases in the EnventisSector and view this arrangement as more of a structured accounts payable thatis paid within 60 days with no separate interest charge. As such, the extendedterm payable financing amount of $14,443,000 and $7,719,000 as of December 31,2007 and 2006 respectively, is not considered to be part of the Company’scapital structure and has been excluded from the above amounts (see Note 8 tothe Notes to the Consolidated Financial Statements).

 

**CashFlows**

 

Cash generated from operations was$30,731,000 in 2007, which was primarily attributable to net income plusnon-cash expenses, including depreciation and amortization of $19,004,000. Theincrease in changes in operating assets and liabilities of $9,190,000 from 2006to 2007 was primarily due to a decrease in the amount of inventory on hand of$11,966,000 along with decreased accounts payable and accrued expenses of$3,123,000, which were offset by an increase in the receivables outstanding asof December 31, 2007 of $3,485,000. The decrease in inventory levels wasdue to the timing of projects in process in the Enterprise Network Servicesequipment revenue product line of the Enventis sector.

 

Cash generated from operations in 2006 was$17,562,000. Cash provided by operations in2006 was attributable to net income plus non-cash expenses, includingdepreciation and amortization of $18,121,000 and the loss on discontinuedoperations totaling $2,967,000. Cash provided by operations in 2006 declinedfrom 2005 by $14,367,000 due to changes in operating assets and liabilities of$14,219,000. The most significant, of which, was an increase in the inventoryon hand, offset by a related decrease in prepaid inventory resulting in a netcash usage of $4,116,000, an increase in the outstanding accounts receivablebalance of $4,032,000 and a decrease in outstanding accounts payables andaccrued expenses of $3,255,000, all of which contributed to lower cash providedby operations. The increase in inventory on hand was the result of supportingthe increased projects in process in the Enventis Sector as well as an increasein the average days of inventory on hand. Increased outstanding accountreceivable balances were primarily the result of the sales growth in theequipment revenue portion of the Enventis Sector and an increase in the averagedays’ of sales outstanding. The year 2006, which was the first year ofintegrated operations with Enventis, was a less typical year for cash flow fromoperations than 2005.

 

In 2005, we generated$31,929,000 in cash from operations, primarily attributable to net income plusnon-cash expenses, including depreciation and amortization of $15,436,000 and$6,523,000 from the changes in operating assets and liabilities.

 

Cash used in investing activities was$17,400,000 in 2007, $20,870,000 in 2006 and $56,547,000 in 2005. Capitalexpenditures were $17,500,000 in 2007, $21,058,000 in 2006 and $19,434,000 in2005. The $3,558,000 decrease in capitalspending from 2007 to 2006 was primarily related to reduced expenditures in ournetwork broadband expansion, which is nearly complete, and a concentratedeffort to focus spending on revenue generating products, services and keystrategic initiatives. The level of total company capital spending overthe next several years is expected to be slightly higher than the level ofcapital spending in 2007, yet lower than the level experienced in 2006. In2005, the cash used in investing activities was significantly impacted by theacquisition of Enventis, in the amount of $38,378,000 plus working capitaladjustments. In 2005, redemptions of investments totaling $2,100,000 offsetcash used in investing activities.

 

46

----

 

Cash used in financing activities was$13,220,000 in 2007 and was a direct result of the Company’s effort to reducethe overall debt level. A decrease in the overall credit facility of$14,025,000 resulted from repayments of $29,525,000, offset by borrowings of$15,500,000. The increase in the extended term payable balance of $6,724,000was used to facilitate Enventis equipment purchases, which related to salesgrowth experienced in 2007. In addition, HickoryTech paid dividends in theamount of $6,357,000 in 2007. Cash provided by financing activities of$2,909,000 in 2006 resulted from the use of the extended term payablesarrangement in the Enventis Sector of $7,719,000 and the payment of dividendsin the amount of $6,316,000. In 2005, cash provided by financing activities was$23,364,000. On December 30, 2005,HickoryTech entered into a $160,000,000 credit agreement with a syndicate ofbanks (subsequently reduced to a $155,700,000 facility as of December 31,2007), which amended its previous credit facility. The proceeds were used torepay the outstanding obligations under the previous credit facility, pay feesand expenses associated with the new credit facility and pay costs associatedwith the acquisition of Enventis. In addition, HickoryTech paid$6,277,000 of dividends in 2005.

 

Cash used in discontinued operations was $24,000 in2007 and $118,000 in 2006. Cash provided by discontinued operations was$1,598,000 in 2005. In 2006, cash provided by operating activities was theresult of the net operating loss of $927,000, which was offset by a decrease inthe accounts receivable balances of $658,000. In 2005, cash provided byoperating activities was the result of a reduction in the deferred tax asset of$562,000, a decreased inventory balance of $493,000 and a decrease of $487,000in project costs that were not billed to customers.

 

**Working Capital**

 

Working capital (i.e. current assets minuscurrent liabilities) was $8,228,000 as of December 31, 2007 compared toworking capital of $7,731,000 as of December 31, 2006. The ratio ofcurrent assets to current liabilities was 1.3 as of December 31, 2007 and2006, respectively.

 

**Extended-Term Payable**

 

The Enventis Sector has a $20,000,000wholesale financing agreement with a financing company to fund inventorypurchased from certain approved vendors. Advances under the financingarrangement are collateralized by the accounts receivable and inventory ofEnventis and a guaranty of an amount up to $16,000,000 by Hickory TechCorporation. The financing agreement provides sixty-day interest-free paymentterms for inventory purchases and can be terminated at any time by eitherparty. The balance outstanding under the financing arrangement was $14,443,000and $7,719,000 at December 31, 2007 and 2006, respectively. These balancesare classified as current liabilities in the accompanying balance sheets andare not considered part of the Company’s debt financing.

 

**Long-Term Obligations**

 

Our long-term obligations as of December 31,2007 were $128,475,000, excluding current maturities of $475,000 on debt and$256,000 on current maturities of capital leases.Long-term obligations as of December 31, 2006, were$141,529,000 excluding current maturities of $1,300,000 on debt and $260,000 ofcapital leases. On December 30, 2005,HickoryTech entered into a $160,000,000 credit agreement with a syndicate ofbanks (subsequently reduced to a $155,700,000 facility as of December 31,2007), which amended our previous credit facility. The credit facilityis comprised of a $30,000,000 revolving credit component that expires on December 30,2011 and a $130,000,000 term loan component.

 

47

----

 

The term loan component is comprised of two components, which aredefined as term loan B and term loan C. The outstanding principal balanceof term loan B is $106,075,000 as of December 31, 2007, and is held invarying amounts by three of the lenders in the syndicate, US Bank, GECommercial Distribution Finance Corporation and CoBank. Under the terms of termloan B, we are required to make quarterly principal payments of $275,000 from December 31,2007 through December 31, 2011 with the remainder of the aggregateprincipal due in two payments on March 31, 2012 and June 30,2012. Due to the aggressive pay down of debt in 2007, we are not requiredto make quarterly principle payments during the first three quarters of 2008.The outstanding principal balance of term loan C is $19,600,000 as of December 31,2007 and is held entirely by the Rural Telephone Finance Cooperative (“RTFC”).Under the terms of term loan C, we are required to make quarterly principalpayments of $50,000 on the aggregate principal amount from December 31,2007 through December 31, 2012 with the remainder of the aggregateprincipal due in two payments on March 31, 2013 and June 30, 2013.

 

Under the terms of the revolving credit facility, any outstandingprincipal is payable in full on December 30, 2011. The outstanding balanceof the revolving credit facility is $3,000,000 as of December 31, 2007.For all components of the total credit facility, interest is payable at anapplicable margin in excess of a prevailing pricing level. The prevailing pricelevel is based on a Base Rate, LIBOR Rate Loans or RTFC rate table. Theprevailing rate for Base Rate Loans is the higher of Prime Rate or the FederalFunds Rate plus 0.5%. The prevailing rate for LIBOR Rate Loans is publiclyavailable. The RTFC rate tables are established based on RTFC policies, whichare not publicly available and change from time to time. The applicable margin for the revolving credit facility, termloan B and term loan C is determined quarterly based on the leverage ratio ofHickoryTech. The credit facility also provides for payment of a fee on anyun-drawn commitment of the revolving credit facility and is payablequarterly. The credit facility requires us to enter into or maintain ineffect, interest rate protection agreements on at least 50% of the facility’soutstanding balance in order to manage our exposure to interest ratefluctuations. We continually monitor the interest rates on its bank loans andhas implemented interest rate protection agreements on various portions of theoverall debt outstanding for varying terms. As a result of the new creditagreement, we incurred $1,525,000 of new debt placement costs in 2005, whichwill be amortized over the expected life of the debt facility.

 

Our debt requires us to comply, on a consolidated basis, with specifiedfinancial ratios and tests. These financial ratios and tests include maximumleverage ratio, minimum interest coverage ratio and maximum capitalexpenditures. Our obligations under the credit facility are secured by afirst-priority lien on all property and assets, tangible and intangible ofHickoryTech and its current subsidiaries, including, but not limited toaccounts receivable, inventory, equipment and intellectual property; generalintangibles, cash and proceeds of the foregoing. HickoryTech has also given afirst-priority pledge of the capital stock of HickoryTech’s currentsubsidiaries to secure the credit facility.

 

Our Telecom Sector leases certain computer equipment under capitallease arrangements. This Sector recorded additions to property, plant andequipment of $522,000, $266,000 and $782,000 in 2007, 2006 and 2005,respectively, related to these capital lease arrangements.

 

The following table sets forth our contractual obligations, along withthe cash payments due each period. Interest on long-term debt is estimatedusing the interest rate as of December 31, 2007:

 
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | ** **                           | ** ** | ** ** | ** ** | **2009 to** | ** ** | **2012 to** | ** ** | **2014 and** | ** ** |
| ** **                         | ** ** | **Total**                            | ** ** | **2008** | ** ** | **2011** | ** ** | **2013** | ** ** | **after** | ** ** |
| **Contractual Obligations**        | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Long-term Debt                     |       | $                                    | 128,675    |   | $ | 475 |   | $ | 6,900 |   | $ | 121,300 |   | $ | — |   |
| Interest on Long-term Debt (A)     |       | 37,478                               |       | 8,448 |   | 24,857 |   | 4,173 |   | — |   |
| Capital Lease Obligations          |       | 531                                  |       | 256 |   | 275 |   | — |   | — |   |
| Interest on Capital Leases         |       | 77                                   |       | 46 |   | 31 |   | — |   | — |   |
| Purchase Obligations (B)           |       | 5,249                                |       | 5,249 |   | — |   | — |   | — |   |
| Pension Benefit Obligations (C)    |       | 1,696                                |       | 185 |   | 569 |   | 942 |   | — |   |
| Operating Leases                   |       | 6,957                                |       | 1,326 |   | 2,827 |   | 1,109 |   | 1,695 |   |
| Total Contractual Cash Obligations |       | $                                    | 180,663    |   | $ | 15,985 |   | $ | 35,459 |   | $ | 127,524 |   | $ | 1,695 |   |

 

48

----

 

----

(A)      Interest on long-term debtis calculated using a variable interest rate. We use interest rate swapagreements to manage our exposure to interest rate movements on a portion of ourvariable rate debt obligations (see Note 12 to the Notes to the ConsolidatedFinancial Statements).

 

(B)        Purchase obligations consistprimarily of commitments incurred for construction projects.

 

(C)        Pension BenefitObligations consist of the expected net premium payment and life insurancebenefits to be paid relative to our Post Retirement Benefit Plan.

 

In addition, we have change of controlagreements with key employees. These potential commitments are not included inthe above schedule. Due to the uncertainty of when any FIN No. 48 paymentswould fall due, we have excluded all payments from the table above.

 

**Off-BalanceSheet Arrangement/Contingent Commitments**

 

We are not engaged in any transactions,arrangements or other relationships with unconsolidated entities or other thirdparties that are reasonably likely to have a material effect on its liquidity,or on its access to, or requirements for capital resources. In addition, wehave not established any special purpose entities.

 

**Other**

 

We have not conducted a public equityoffering and operate with original equity capital, retained earnings andindebtedness in the form of bank term and revolving lines of credit. Byutilizing cash flow from operations and current cash balances, we believe thatwe have adequate resources to meet its anticipated operating, capitalexpenditures and debt service requirements.

 

**RecentAccounting Developments**

 

See Note 1, “Accounting Policies – RecentAccounting Developments,” in the Notes to the Consolidated Financial Statementsfor a discussion of recent accounting developments.

 

# **Item 7A. Quantitative and QualitativeDisclosures about Market Risk**

# ** **

We do not have operationssubject to risks of foreign currency fluctuations. We do, however, usederivative financial instruments to manage exposure to interest ratefluctuations. Our objectives for holding derivatives are to minimize interestrate risks using the most effective methods to eliminate or reduce the impactof these exposures. Variable rate debt instruments are subject to interest raterisk. In March 2007, we terminated two outstanding interest-rate swapagreements, with original maturities of June 2008, in exchange for$1,936,000 in proceeds. Proceeds of $1,272,000 were recognized as an offset tointerest expense during 2007. The unrecognized portion of the proceeds isrecorded as a component of accumulated other comprehensive income (loss) in shareholders’equity and will be recognized as an offset to interest expense over theremaining original term of the agreement (six months ending in June 2008).Immediately following the termination of the two agreements discussed above, weexecuted a new interest-rate swap agreement, effectively locking in theinterest rate on $60,000,000 of variable-rate debt through March of 2010.

 

The cumulative gain or loss oncurrent derivative instruments is reported as a component of accumulated othercomprehensive income (loss) in shareholders’ equity and is recognized inearnings when the term of the protection agreement is concluded. Our earningsare affected by changes in interest rates as a portion of its long-term debthas variable interest rates based on LIBOR. If interest rates for the portionof our long-term debt based on variable rates had averaged 10% more for theyear ended December 31, 2007, our interest expense would have increased$398,000.

 

49

----

 

## ***REPORTS OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRMS***

## *** ***

Boardof Directors and Shareholders

HickoryTech Corporation

 

We have audited the accompanying consolidated balance sheet of HickoryTech Corporation and subsidiaries (the “Company”) as of December 31, 2007,and the related consolidated statements of operations, shareholders’ equity andcomprehensive income (loss), and cash flows for the year then ended. Our auditof the basic consolidated financial statements included the financial statementschedule under Item 15(a)(2). These consolidated financial statements andfinancial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and financial statement schedule based on our audit.

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof Hickory Tech Corporation and subsidiaries as of December 31, 2007, andthe consolidated results of their operations and their cash flows for the yearthen ended, in conformity with accounting principles generally accepted in theUnited States of America. Also in our opinion, the related financial statementschedule, when considered in relation to the basic consolidated financialstatements taken as a whole, presents fairly, in all material respects, the informationset forth therein.

 

As discussed in Note 11 to the consolidated financial statements,effective January 1, 2007, the Company adopted Financial AccountingStandards Board Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes*

 

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the Company’s internalcontrol over financial reporting as of December 31, 2007, based oncriteria established in *InternalControl—Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated February 29,2008, expressed an unqualified opinion on the effectiveness of the Company’sinternal control over financial reporting.

 
| /s/ Grant Thornton LLP |
|------------------------|
|                   |
|                   |
| Minneapolis, Minnesota |
| February 29, 2008 |

 

50

----

 

Boardof Directors and Shareholders

HickoryTech Corporation

 

We have auditedthe internal control over financial reporting of Hickory Tech Corporation andsubsidiaries (the “Company”) as of December 31, 2007, based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). The Company’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of the effectivenessof internal control over financial reporting, included in the accompanyingManagement’s Report on Internal Control Over Financial Reporting. Ourresponsibility is to express an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

 

We conducted ouraudit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal controlover financial reporting, assessing the risk that a material weakness exists,testing and evaluating the design and operating effectiveness of internalcontrol based on the assessed risk, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

 

A company’sinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of itsinherent limitations, internal control over financial reporting may not preventor detect misstatements. Also, projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

In our opinion,HickoryTech Corporation and subsidiaries maintained, in all material respects,effective internal control over financial reporting as of December 31,2007, based on criteria established in *InternalControl—Integrated Framework* issued by COSO*.*

 

We also haveaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheet of HickoryTechCorporation and subsidiaries as of December 31, 2007, and the relatedconsolidated statements of operations, shareholders’ equity and comprehensiveincome (loss), and cash flows for the year then ended, and our report dated February 29,2008, which includes an explanatory paragraph discussing the adoption ofFinancial Accounting Standards Board Interpretation No. 48, expressed anunqualified opinion on those consolidated financial statements.

 
| /s/ Grant Thornton LLP |
|------------------------|
|                   |
|                   |
| Minneapolis, Minnesota |
| February 29, 2008 |

 

51

----

 

To the Shareholder andBoard of Directors

Hickory Tech Corporation:

 

In our opinion, the consolidatedbalance sheet as of December 31, 2006 and the related consolidatedstatements of operations, statements of shareholders’ equity and comprehensiveincome/(loss) and statement of cash flows for each of two years in the periodended December 31, 2006 present fairly, in all material respects, thefinancial position of Hickory Tech Corporation and its subsidiaries at December 31,2006, and the results of their operations and their cash flows for each of thetwo years in the period ended December 31, 2006, in conformity withaccounting principles generally accepted in the United States of America. Inaddition, in our opinion, the financial statement schedule for each of the twoyears in the period ended December 31, 2006 presents fairly, in allmaterial respects, the information set forth therein when read in conjunctionwith the related consolidated financial statements. These financial statementsand financial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and financial statement schedule based on our audits. We conductedour audits of these statements in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 
| /s/ PricewaterhouseCoopers  LLP |
|---------------------------------|
|                            |
|                            |
| Minneapolis, Minnesota          |
| March 14, 2007             |

 

52

----

 

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

 

**HICKORYTECH CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**YearsEnded December 31**

 

*(Dollarsin thousands, except share and per share amounts)*

 
| ** **                                                                                    | ** ** | **2007**       | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------|------------|------------|------------|------------|------------|
| Operating  Revenue:                                                                           |       |           |       |       |       |       |       |
| Telecom sector                                                                                | ** ** | **$**          | **76,847** |       | $          | 74,896     |       | $ | 77,922 |   |
| Enventis sector  (Note 3)                                                                     |       |           |       |       |       |       |       |
| Equipment  revenue                                                                            | ** ** | **51,046**     |       | 36,191     |       | —     |       |
| Services revenue                                                                              | ** ** | **28,756**     |       | 21,814     |       | —     |       |
| Total Enventis  Sector                                                                        | ** ** | **79,802**     |       | 58,005     |       | —     |       |
| Total operating  revenue                                                                      | ** ** | **156,649**    |       | 132,901    |       | 77,922     |       |
|                                                                                          |       |           |       |       |       |       |       |
| Costs and  expenses:                                                                          |       |           |       |       |       |       |       |
| Cost of sales,  equipment, excluding depreciation and amortization                            |       | **45,340**     |       | 31,152     |       | —     |       |
| Cost of  services, excluding depreciation and amortization                                    |       | **44,881**     |       | 44,506     |       | 31,408     |       |
| Selling, general  and administrative expenses                                                 | ** ** | **24,244**     |       | 23,291     |       | 12,600     |       |
| Depreciation                                                                                  | ** ** | **17,847**     |       | 16,949     |       | 14,943     |       |
| Amortization of  intangibles                                                                  | ** ** | **1,157**      |       | 1,172      |       | 493        |       |
| Total costs and  expenses                                                                     | ** ** | **133,469**    |       | 117,070    |       | 59,444     |       |
|                                                                                          |       |           |       |       |       |       |       |
| Operating income                                                                              | ** ** | **23,180**     |       | 15,831     |       | 18,478     |       |
|                                                                                          |       |           |       |       |       |       |       |
| Other income and  expense:                                                                    |       |           |       |       |       |       |       |
| Interest and  other income                                                                    | ** ** | **287**        |       | 138        |       | 97         |       |
| Interest expense                                                                              | ** ** | **(8,121**     | **)**      | (7,362     | )          | (4,363     | )          |
| Total other  (expense)                                                                        | ** ** | **(7,834**     | **)**      | (7,224     | )          | (4,266     | )          |
|                                                                                          |       |           |       |       |       |       |       |
| Income from  continuing operations before income taxes                                        |       | **15,346**     |       | 8,607      |       | 14,212     |       |
| Income tax  provision                                                                         | ** ** | **6,711**      |       | 3,372      |       | 5,646      |       |
| Income from  continuing operations                                                            | ** ** | **8,635**      |       | 5,235      |       | 8,566      |       |
| Discontinued  operations (Note 3)                                                             |       |           |       |       |       |       |       |
| Loss from  operations of discontinued component including loss on disposal of $3,385 in  2006 |       | **(40**        | **)**      | (4,556     | )          | (62        | )          |
| Income tax  benefit                                                                           | ** ** | **(16**        | **)**      | (1,589     | )          | (25        | )          |
| Loss on  discontinued operations                                                              | ** ** | **(24**        | **)**      | (2,967     | )          | (37        | )          |
|                                                                                          |       |           |       |       |       |       |       |
| Net income                                                                                    | ** ** | **$**          | **8,611**  |       | $          | 2,268      |       | $ | 8,529 |   |
|                                                                                          |       |           |       |       |       |       |       |
| Basic earnings  per share - continuing operations:                                            | ** ** | **$**          | **0.65**   |       | $          | 0.40       |       | $ | 0.65 |   |
| Basic loss per  share - discontinued operations:                                              | ** ** | **—**     |       | (0.23      | )          | —     |       |
| ** **                                                                                    |       | **$**          | **0.65**   |       | $          | 0.17       |       | $ | 0.65 |   |
| Weighted average  common shares outstanding                                                   | ** ** | **13,258,369** |       | 13,163,480 |       | 13,083,252 |       |
|                                                                                          |       |           |       |       |       |       |       |
| Diluted earnings  per share - continuing operations:                                          | ** ** | **$**          | **0.65**   |       | $          | 0.40       |       | $ | 0.65 |   |
| Diluted loss per  share - discontinued operations:                                            | ** ** | **—**     |       | (0.23      | )          | —     |       |
| ** **                                                                                    |       | **$**          | **0.65**   |       | $          | 0.17       |       | $ | 0.65 |   |
| Weighted average  common and equivalent shares outstanding                                    | ** ** | **13,260,087** |       | 13,163,480 |       | 13,097,417 |       |
|                                                                                          |       |           |       |       |       |       |       |
| Dividends per  share                                                                          | ** ** | **$**          | **0.48**   |       | $          | 0.48       |       | $ | 0.48 |   |

 

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

 

53

----

 

**HICKORY TECH CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

**As of December 31**

 
| **(Dollars in thousands except share and per share amounts)** | ** ** | **2007**    | ** **  | **2006** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------|-------------|----------|------------|
|                                                                                                  |       |        |        |     |       |
| ASSETS                                                                                                |       |        |        |     |       |
| Current Assets:                                                                                       |       |        |        |     |       |
| Cash and cash  equivalents                                                                            | ** ** | **$**       | **171**     |     | $          | 84 |   |
| Receivables, net  of allowance for doubtful accounts of $1,184 and $851                               | ** ** | **28,357**  |        | 20,780   |       |
| Inventories                                                                                           | ** ** | **7,054**   |        | 11,294   |       |
| Income taxes  receivable                                                                              | ** ** | **1,013**   |        | —   |       |
| Deferred income  taxes, net                                                                           | ** ** | **1,334**   |        | 815      |       |
| Prepaid expenses                                                                                      | ** ** | **1,713**   |        | 1,903    |       |
| Other                                                                                                 | ** ** | **1,196**   |        | 1,662    |       |
| Total current  assets                                                                                 |       | **40,838**  | ** **  | 36,538   |       |
|                                                                                                  |       |        |        |     |       |
| Investments                                                                                           | ** ** | **3,830**   |        | 3,554    |       |
|                                                                                                  |       |        |        |     |       |
| Property, plant  and equipment                                                                        | ** ** | **322,249** |        | 309,264  |       |
| Less accumulated  depreciation                                                                        | ** ** | **169,318** |        | 156,429  |       |
| Property, plant  and equipment, net                                                                   | ** ** | **152,931** |        | 152,835  |       |
|                                                                                                  |       |        |        |     |       |
| Other assets:                                                                                         |       |        |        |     |       |
| Goodwill                                                                                              | ** ** | **25,239**  |        | 25,239   |       |
| Intangible  assets, net                                                                               | ** ** | **1,983**   |        | 3,140    |       |
| Financial  derivative instruments                                                                     | ** ** | **—**  |        | 2,489    |       |
| Deferred costs  and other                                                                             | ** ** | **2,674**   |        | 3,105    |       |
| Total other  assets                                                                                   | ** ** | **29,896**  |        | 33,973   |       |
|                                                                                                  |       |        |        |     |       |
| Total assets                                                                                          | ** ** | **$**       | **227,495** |     | $          | 226,900 |   |
|                                                                                                  |       |        |        |     |       |
| LIABILITIES & SHAREHOLDERS’ EQUITY                                                           |       |        |        |     |       |
| Current  liabilities:                                                                                 |       |        |        |     |       |
| Checks written  in excess of available cash balances                                                  | ** ** | **$**       | **—**  |     | $          | 1,475 |   |
| Extended term  payable                                                                                | ** ** | **14,443**  |        | 7,719    |       |
| Accounts payable                                                                                      | ** ** | **4,538**   |        | 4,211    |       |
| Accrued expenses                                                                                      | ** ** | **7,740**   |        | 5,826    |       |
| Accrued income  taxes                                                                                 | ** ** | **—**  |        | 4,528    |       |
| Advanced  billings and deposits                                                                       | ** ** | **5,158**   |        | 3,488    |       |
| Current  maturities of long-term obligations                                                          | ** ** | **731**     |        | 1,560    |       |
| Total current  liabilities:                                                                           |       | **32,610**  | ** **  | 28,807   |       |
|                                                                                                  |       |        |        |     |       |
| Long-term  liabilities:                                                                               |       |        |        |     |       |
| Debt  obligations, net of current maturities                                                          | ** ** | **128,475** |        | 141,529  |       |
| Financial  derivative instruments                                                                     | ** ** | **1,451**   |        | —   |       |
| Accrued income  taxes                                                                                 | ** ** | **7,747**   |        | —   |       |
| Deferred income  taxes                                                                                | ** ** | **14,901**  |        | 15,332   |       |
| Deferred revenue                                                                                      | ** ** | **1,527**   |        | 2,596    |       |
| Accrued employee  benefits and deferred compensation                                                  | ** ** | **8,852**   |        | 8,550    |       |
| Total long-term  liabilities                                                                          | ** ** | **162,953** |        | 168,007  |       |
|                                                                                                  |       |        |        |     |       |
| Total  liabilities                                                                                    | ** ** | **195,563** |        | 196,814  |       |
|                                                                                                  |       |        |        |     |       |
| Commitments and  contingencies                                                                        | ** ** | **—**  |        | —   |       |
|                                                                                                  |       |        |        |     |       |
| Shareholders’  equity:                                                                           |       |        |        |     |       |
| Common stock, no  par value, $.10 stated value                                                        |       |        |        |     |       |
| Shares  authorized: 100,000,000                                                                       |       |        |        |     |       |
| Shares issued  and outstanding: 13,284,903 in 2007 and 13,207,970 in 2006                             | ** ** | **1,329**   |        | 1,321    |       |
| Additional paid-in  capital                                                                           | ** ** | **11,031**  |        | 9,992    |       |
| Retained  earnings                                                                                    | ** ** | **20,639**  |        | 18,323   |       |
| Accumulated  other comprehensive income/(loss)                                                        | ** ** | **(1,067**  | )           | 450      |       |
| Total  shareholders’ equity                                                                      | ** ** | **31,932**  |        | 30,086   |       |
|                                                                                                  |       |        |        |     |       |
| Total  liabilities and shareholders’ equity                                                      | ** ** | **$**       | **227,495** |     | $          | 226,900 |   |

 

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

 

54

----

 

**HICKORY TECH CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**Years Ended December 31**

 
| **(Dollars in thousands)**                                                           | ** ** | **2007**    | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------|------------|----------|------------|----------|------------|
| OPERATING  ACTIVITIES:                                                                         |       |        |       |     |       |     |       |
| Net income                                                                                     | ** ** | **$**       | **8,611**  |     | $          | 2,268    |       | $ | 8,529 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:             |       |        |       |     |       |     |       |
| Loss from  discontinued operations                                                             | ** ** | **24**      |       | 2,967    |       | 37       |       |
| Depreciation and  amortization                                                                 | ** ** | **19,004**  |       | 18,121   |       | 15,436   |       |
| Amortization of  gain on sale of financial derivative instrument                               | ** ** | **(1,272**  | **)**      | —   |       | —   |       |
| Provision for  losses on accounts receivable                                                   | ** ** | **139**     |       | 1,043    |       | 1,002    |       |
| Deferred income  tax provision (benefit)                                                       | ** ** | **1,523**   |       | (155     | )          | 274      |       |
| Stock-based  compensation                                                                      | ** ** | **688**     |       | 320      |       | 108      |       |
| Employee  retirement benefits and deferred compensation                                        | ** ** | **670**     |       | 1,680    |       | 375      |       |
| Accrued  patronage refunds                                                                     | ** ** | **(230**    | **)**      | (1,049   | )          | (367     | )          |
| Other                                                                                          | ** ** | **80**      |       | 63       |       | 12       |       |
| Changes in  operating assets and liabilities net of effects of acquisitions and  dispositions: |       |        |       |     |       |     |       |
| Receivables                                                                                    | ** ** | **(7,814**  | **)**      | (4,329   | )          | (297     | )          |
| Prepaids                                                                                       | ** ** | **190**     |       | 3,123    |       | (164     | )          |
| Inventories                                                                                    | ** ** | **4,239**   |       | (7,727   | )          | (82      | )          |
| Accounts payable  and accrued expenses                                                         | ** ** | **2,190**   |       | (933     | )          | 2,322    |       |
| Deferred  revenue, billings and deposits                                                       | ** ** | **601**     |       | 153      |       | 281      |       |
| Income taxes                                                                                   | ** ** | **1,237**   |       | 1,107    |       | 4,969    |       |
| Other                                                                                          | ** ** | **851**     |       | 910      |       | (506     | )          |
| Net cash  provided by operating activities                                                     | ** ** | **30,731**  |       | 17,562   |       | 31,929   |       |
|                                                                                           |       |        |       |     |       |     |       |
| INVESTING  ACTIVITIES:                                                                         |       |        |       |     |       |     |       |
| Additions to  property, plant and equipment                                                    | ** ** | **(17,500** | **)**      | (21,058  | )          | (19,434  | )          |
| Increase in  investments                                                                       | ** ** | **—**  |       | —   |       | (900     | )          |
| Redemption of  investments                                                                     | ** ** | **—**  |       | 21       |       | 2,100    |       |
| Acquisitions,  adjustments to purchase price                                                   | ** ** | **—**  |       | 124      |       | —   |       |
| Acquisitions,  net of cash acquired                                                            | ** ** | **—**  |       | —   |       | (38,378  | )          |
| Other                                                                                          | ** ** | **100**     |       | 43       |       | 65       |       |
| Net cash (used  in) investing activities                                                       | ** ** | **(17,400** | **)**      | (20,870  | )          | (56,547  | )          |
|                                                                                           |       |        |       |     |       |     |       |
| FINANCING  ACTIVITIES:                                                                         |       |        |       |     |       |     |       |
| Net change in  extended term payables arrangement                                              | ** ** | **6,724**   |       | 7,719    |       | —   |       |
| Change in cash  overdraft                                                                      | ** ** | **(1,475**  | **)**      | 961      |       | (1,364   | )          |
| Repayments of  credit agreement                                                                | ** ** | **—**  |       | —   |       | (8,532   | )          |
| Payments of capital  lease obligations                                                         | ** ** | **(381**    | **)**      | (539     | )          | (543     | )          |
| Borrowings on  credit facility                                                                 | ** ** | **15,500**  |       | 26,000   |       | 138,785  |       |
| Repayments on  credit facility                                                                 | ** ** | **(29,525** | **)**      | (25,335  | )          | (99,250  | )          |
| Proceeds from  the sale of financial derivative instrument                                     | ** ** | **1,936**   |       | —   |       | —   |       |
| Proceeds from  issuance of common stock                                                        | ** ** | **358**     |       | 419      |       | 545      |       |
| Dividends paid                                                                                 | ** ** | **(6,357**  | **)**      | (6,316   | )          | (6,277   | )          |
| Net cash  provided by (used in) financing activities                                           | ** ** | **(13,220** | **)**      | 2,909    |       | 23,364   |       |
|                                                                                           |       |        |       |     |       |     |       |
| DISCONTINUED  OPERATIONS:                                                                      |       |        |       |     |       |     |       |
| Net cash  provided by (used in) operating activities                                           | ** ** | **(24**     | **)**      | 6        |       | 1,431    |       |
| Net cash (used  in) investing activities                                                       | ** ** | **—**  |       | (124     | )          | (32      | )          |
| Net cash  provided by financing activities                                                     | ** ** | **—**  |       | —   |       | 199      |       |
| Net cash  provided by (used in) discontinued operations                                        | ** ** | **(24**     | **)**      | (118     | )          | 1,598    |       |
|                                                                                           |       |        |       |     |       |     |       |
| Net increase (decrease)  in cash and cash equivalents                                          | ** ** | **87**      |       | (517     | )          | 344      |       |
| Cash and cash  equivalents at beginning of the year                                            | ** ** | **84**      |       | 601      |       | 257      |       |
| Cash and cash  equivalents at the end of the year                                              | ** ** | **$**       | **171**    |     | $          | 84       |       | $ | 601 |   |
|                                                                                           |       |        |       |     |       |     |       |
| Supplemental  disclosure of cash flow information:                                             |       |        |       |     |       |     |       |
| Cash paid for  interest                                                                        | ** ** | **$**       | **9,319**  |     | $          | 7,749    |       | $ | 4,521 |   |
| Net cash paid  (refunded) for income taxes                                                     | ** ** | **$**       | **3,935**  |     | $          | 1,485    |       | $ | (182 | ) |
| Non-cash  investing activities:                                                                |       |        |       |     |       |     |       |
| Property, plant  and equipment acquired with capital leases                                    | ** ** | **$**       | **522**    |     | $          | 266      |       | $ | 782 |   |

 

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

 

55

----

 

**HICKORY TECH CORPORATION**

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

**Years Ended December 31**

*(Dollarsin thousands)*

 
| ** **                                    | ** ** | **Common Stock** | ** ** | **Additional  Paid - In** | ** ** | **Retained** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Shareholders’** | ** ** | **Total  Comprehensive** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|-------------------------------------|------------|--------------|------------|---------------------------------------|------------|-------------------------------|------------|--------------------------|------------|
| ** **                                    | ** ** | **Shares**            | ** ** | **Amount**                          | ** ** | **Capital**  | ** ** | **Earnings**                          | ** ** | **Income/(Loss)**             | ** ** | **Equity**               | ** ** | **Income/(Loss)** | ** ** |
|                                          |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| **Balance,  December 31, 2004**               |       | 13,057,106            |       | $                                   | 1,306      |         | $          | 8,615                                 |       | $                             | 20,119     |                     | $          | 1,505 |   | $ | 31,545 |   |   |   |
|                                          |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| Stock Award Plan                              |       | 6,309                 |       |                                |       | 43           |       |                                  |       |                          |       | 43                       |       |   |   |
| Employee Stock  Purchase Plan                 |       | 25,054                |       | 2                                   |       | 282          |       |                                  |       |                          |       | 284                      |       |   |   |
| Directors’ Stock  Retainer Plan          |       | 7,521                 |       | 1                                   |       | 64           |       |                                  |       |                          |       | 65                       |       |   |   |
| Dividend  Reinvestment Plan                   |       | 28,938                |       | 3                                   |       | 258          |       |                                  |       |                          |       | 261                      |       |   |   |
| Net Income                                    |       |                  |       |                                |       |         |       | 8,529                                 |       |                          |       | 8,529                    |       | $ | 8,529 |   |
| Dividends Paid                                |       |                  |       |                                |       |         |       | (6,277                                | )          |                          |       | (6,277                   | )          |   |   |
| Other  Comprehensive Income,                  |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| Net of Income  Taxes                          |       |                  |       |                                |       |         |       |                                  |       | 559                           |       | 559                      |       | 559 |   |
| Total  Comprehensive Income                   |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       | $ | 9,088 |   |
|                                          |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| **Balance,  December 31, 2005**               |       | 13,124,928            |       | 1,312                               |       | 9,262        |       | 22,371                                |       | 2,064                         |       | 35,009                   |       |   |   |
|                                          |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| Stock Award Plan                              |       | 17,386                |       | 2                                   |       | 139          |       |                                  |       |                          |       | 141                      |       |   |   |
| Employee Stock  Purchase Plan                 |       | 24,089                |       | 3                                   |       | 171          |       |                                  |       |                          |       | 174                      |       |   |   |
| Directors’ Stock  Retainer Plan          |       | 9,013                 |       | 1                                   |       | 64           |       |                                  |       |                          |       | 65                       |       |   |   |
| Dividend  Reinvestment Plan                   |       | 32,554                |       | 3                                   |       | 242          |       |                                  |       |                          |       | 245                      |       |   |   |
| Stock based  compensation                     |       |                  |       |                                |       | 114          |       |                                  |       |                          |       | 114                      |       |   |   |
| Net Income                                    |       |                  |       |                                |       |         |       | 2,268                                 |       |                          |       | 2,268                    |       | $ | 2,268 |   |
| Dividends Paid                                |       |                  |       |                                |       |         |       | (6,316                                | )          |                          |       | (6,316                   | )          |   |   |
| Other  Comprehensive Income,                  |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| Net of Income  Taxes                          |       |                  |       |                                |       |         |       |                                  |       | (567                          | )          | (567                     | )          | (567 | ) |
| Adoption of SFAS  No. 158, net of tax of $690 |       |                  |       |                                |       |         |       |                                  |       | (1,047                        | )          | (1,047                   | )          |   |   |
| Total  Comprehensive Income                   |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       | $ | 1,701 |   |
|                                          |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| **Balance,  December 31, 2006**               |       | 13,207,970            |       | 1,321                               |       | 9,992        |       | 18,323                                |       | 450                           |       | 30,086                   |       |   |   |
|                                          |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| Stock Award Plan                              |       | 27,590                |       | 3                                   |       | 196          |       |                                  |       |                          |       | 199                      |       |   |   |
| Employee Stock  Purchase Plan                 |       | 13,792                |       | 1                                   |       | 275          |       |                                  |       |                          |       | 276                      |       |   |   |
| Directors’ Stock  Retainer Plan          |       | 7,586                 |       | 1                                   |       | 232          |       |                                  |       |                          |       | 233                      |       |   |   |
| Dividend  Reinvestment Plan                   |       | 27,965                |       | 3                                   |       | 233          |       |                                  |       |                          |       | 236                      |       |   |   |
| Stock based  compensation                     |       |                  |       |                                |       | 103          |       |                                  |       |                          |       | 103                      |       |   |   |
| Net Income                                    |       |                  |       |                                |       |         |       | 8,611                                 |       |                          |       | 8,611                    |       | $ | 8,611 |   |
| Dividends Paid                                |       |                  |       |                                |       |         |       | (6,357                                | )          |                          |       | (6,357                   | )          |   |   |
| Adoption of FIN  48                           |       |                  |       |                                |       |         |       | 62                                    |       |                          |       | 62                       |       |   |   |
| Other  Comprehensive Loss,                    |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| Net of Income  Taxes                          |       |                  |       |                                |       |         |       |                                  |       | (1,517                        | )          | (1,517                   | )          | (1,517 | ) |
| Total  Comprehensive Income                   |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       | $ | 7,094 |   |
|                                          |       |                  |       |                                |       |         |       |                                  |       |                          |       |                     |       |   |   |
| **Balance,  December 31, 2007**               |       | 13,284,903            |       | $                                   | 1,329      |         | $          | 11,031                                |       | $                             | 20,639     |                     | $          | (1,067 | ) | $ | 31,932 |   |   |   |

 

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

 

56

----

 

**HICKORY TECH CORPORATION, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**FiscalYears Ended December 31, 2007, 2006 and 2005**

 

**Note1.   Summary of Significant AccountingPolicies**

 

The accountingpolicies of HickoryTech are in conformity with generally accepted accountingprinciples and, where applicable, conform to the accounting principles asprescribed by federal and state telephone utility regulatory authorities. Wepresently give accounting recognition to the actions of regulators whereappropriate, as prescribed by SFAS No. 71. SFAS No. 71 providesguidance in preparing general purpose financial statements for most publicutilities. In general, the type of regulation covered by this statement permitsrates (prices) for some services to be set at levels intended to recover theestimated costs of providing regulated services or products, including the costof capital (interest costs and a provision for earnings on shareholders’investments).

 

***Principles of Consolidation***

 

Our consolidated financial statements include HickoryTech Corporationand its subsidiaries in the following two business segments: the Telecom Sectorand the Enventis Sector. All inter–company transactions have been eliminatedfrom the consolidated financial statements.

 

Cost of sales for the Enventis Sector includes the costs associatedwith the installation of products for customers. These costs areprimarily for equipment and materials. Labor associated with installation workis not included in this category, but is included in cost of services(excluding depreciation and amortization) described below.

 

Cost of services includes all costs related to delivery ofcommunication services and products for all sectors. These operating costsinclude all costs of performing services and providing related productsincluding engineering, customer service, billing and collections, networkmonitoring and transport costs.

 

Selling, general and administrative expenses include direct andindirect selling expenses, advertising and all other general and administrativecosts associated with the operations of the business.

 

On December 29,2006, we sold Collins to Skyview Capital, LLC. The Collins operations wereformerly reported in the Enterprise Solutions Sector. The results of operationsof the Enterprise Solutions Sector are reported as discontinued operations forall periods presented (see Note 3 to the Notes to the Consolidated FinancialStatements).

 

***Use of Estimates***

 

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

 

***Revenue Recognition***

 

We recognizerevenue when (i) persuasive evidence of an arrangement between thecustomer and us exists, (ii) delivery of the product to the customer hasoccurred or service has been provided to the customer, (iii) the price tothe customer is fixed or determinable and (iv) collectibility isreasonably assured.

 

57

----

 

*Telecom Sector Revenue Recognition:***Revenuein the ILEC and CLEC companies is earned from monthly billings to customers fortelephone services, long distance, digital TV, DSL, Internet services, andhardware and other services. ILEC and CLEC revenue is also derived from chargesfor network access to our local exchange telephone network from subscriber linecharges and from contractual arrangements for services such as billing andcollection and directory advertising. Some revenue is realized under poolingarrangements with other telephone companies and is divided among the companiesbased on respective costs and investments to provide the services. Thecompanies that take part in pooling arrangements may adjust their costs andinvestments for a period of two years, which causes the dollars distributed bythe pool to be adjusted retroactively. We believe that recorded amountsrepresent reasonable estimates of the final distribution from these pools.However, to the extent that the companies participating in these pools makeadjustments, there will be corresponding adjustments to our recorded revenue infuture periods. Revenue is recognized in the period in which service isprovided to the customer. With multiple billing cycles and cut–off dates, weaccrue for revenue earned but not yet billed at the end of a quarter. We alsodefer services billed in advance and recognize them as income when earned basedon billing dates.

 

*Enventis Sector Revenue Recognition:*Revenue in the**EnventisSector is generated from the following primary sources: i) the distribution ofvoice and data communications equipment provided primarily from Cisco, ii)providing design, configuration and installation services related to voice anddata equipment, iii) the provision of Cisco maintenance support contracts, iv)the sale of professional support services related to customer voice and datasystems, v) the sale of transport services over the Company-owned and leasedfiber optic network, and vi) the sale of managed voice and data services,including resale of long distance services. Our revenue recognition policy foreach of these types of products and services is as follows:

 

·                  Ininstances where Enventis sells Cisco voice and data communications equipmentwith no installation obligations (equipment only sales), all warrantyobligations reside with Cisco. Therefore, revenue is recognized when theequipment is delivered to the customer site. In instances where Enventis sellsCisco voice and data communications equipment with installation obligations,terms of the agreements typically provide for installation services withoutcustomer-specific acceptance provisions, but sometimes may provide customer-specificacceptance provisions. For arrangements with no customer–specific acceptancearrangements, we recognize revenue when title passes to the customer. Forcontracts with customer specific acceptance provisions, we defer revenue recognitionuntil the receipt of formal customer acceptance, assuming that all otherrevenue recognition criteria have been met. When a sale involves multipleelements, revenue is allocated to each respective element in accordance withEITF No. 00-21, which addresses certain aspects of the accounting by avendor for arrangements under which it will perform multiple revenue-generatingactivities. EITF No. 00-21 provides guidance on how an arrangementinvolving multiple deliverables should be divided into separate units ofaccounting, but does not change otherwise applicable revenue recognitioncriteria. In the event that we enter into a multiple element arrangement andthere are undeliverable elements as of the balance sheet date, we assesswhether the elements are separable and have determinable fair values inassessing the amount of revenue to record. Allocation of revenue to elements of the arrangement is based on fairvalue of the element being sold on a stand-alone basis.

·                  Whenwe sell equipment to customers, we also typically sell Cisco support contracts(“SmartNet” contracts). These support contracts state that Cisco will provideall support services, product warranty and updates directly to the customer.Because Enventis has no service obligations under these types of contracts, theearnings process has culminated for us upon the sale of the contract andtherefore revenue is recognized immediately. Further, we are serving in anagency relationship to the customer for the sale of the contract and thereforethe revenue is recorded net of the cost that we pay Cisco for the contract.Support services also include Enventis offered “24X7” support of a customer’svoice and data systems. Most of these contracts are billed on a time andmaterials basis and revenue is recognized either as services are provided orover the term of the contract. Support services also include Enventis sponsoredprofessional support services. Such services are typically sold on a time andmaterials basis, but may be sold as a pre-paid block of time. This revenue isrecognized as the services are provided (deferred and recognized as utilized ifpre-paid). In the event that these services are part of a multiple elementarrangement, the fair value of the services are measured and deferred inaccordance with EITF No. 00-21 mentioned above. Allocation of revenue toelements of the arrangement is based on fair value of the element being sold ona stand-alone basis.

 

58

----

 

·                  Transportservices are sold primarily through a contractual flat monthly fee. The revenuegenerated by these services is typically billed one month in advance and isdeferred until the appropriate month of recognition.

·                  Enventisalso manages customer voice and/or data services. Under these contracts,Enventis bills either a flat monthly fee or a fee that is variable based on thenumber of “seats” that the customer has. This revenue is recognized on amonthly basis as the services are provided.

 

***Advertising Expense***

 

Advertising is expensed as incurred. Advertising expense charged tooperations was $1,335,000, $1,377,000 and $1,240,000 in 2007, 2006 and 2005,respectively.

 

***Cash and Cash Equivalents***

 

Cash equivalents include short–term investments with originalmaturities of three months or less. The carrying value of cash and cashequivalents approximates its fair value due to the short maturity of theinstruments. At December 31, 2006, we had checks written in excess ofavailable cash balances of $1,475,000 which was included in currentliabilities.

 

***Accounts Receivable***

 

As of December 31, 2007, consolidated accounts receivable totaled$28,357,000, net of the allowance of doubtful accounts. As of December 31,2007, we believe accounts receivable are recorded at their fair value. As theremay by exposure or risk with accounts receivable, we routinely monitor ouraccounts receivable and adjust the allowance for doubtful accounts when certainevents occur that may potentially impact the collection of accounts receivable.

 

***Allowance for Doubtful Accounts***

 

We maintainallowances for doubtful accounts for estimated losses resulting from theinability of our customers to make required payments. In making thedetermination of the appropriate allowance for doubtful accounts, we considerspecific accounts, historical write–offs, changes in customer relationships andcredit worthiness credit risk. Specific accounts receivable are written–offonce a determination is made that the account is uncollectible. If thefinancial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired. The allowance for doubtful accounts was $1,184,000 and $851,000 as ofDecember 31, 2007 and 2006, respectively.

 

***Inventories***

 

Inventory includesparts, materials and supplies stored in our warehouses to support basic levelsof service and maintenance as well as scheduled capital projects and equipmentawaiting configuration for customers. Inventory also includes parts andequipment shipped directly from vendors to customer locations while in transitand parts and equipment returned from customers which is being returned tovendors for credit, as well as maintenance contracts associated with customersales which have not yet transferred to the customer. The inventory value inthe Telecom Sector, comprised of raw materials, as of December 31, 2007and December 31, 2006 was $3,312,000 and $2,850,000, respectively. Theinventory value in the Enventis Sector is comprised of “finished goods intransit to customers” as of December 31, 2007 and December 31, 2006was $3,742,000 and $8,444,000, respectively.

 

Inventories arevalued using the lower of cost (perpetual weighted average-cost or specificidentification) or market method. We adjust our inventory carrying value forestimated obsolescence or unmarketable inventory to the estimated market valuebased upon assumptions about future demand and market conditions. As market andother conditions change, additional inventory write–downs may be recorded atthe time acts that give rise to the lower value become known.

 

59

----

 

***Investments***

 

Investments include $2,530,000 of non-interest bearing SubordinatedCapital Certificates from RTFC and $1,300,000 from Co-Bank which, are accountedfor under the cost method of accounting. This method requires us toperiodically evaluate whether a non-temporary decrease in the value of theinvestment has occurred, and if so, to write this investment down to its netrealizable value.

 

***Property, Plant and Equipment***

 

Property, plant and equipment are recorded at original cost ofacquisition or construction. When regulated ILEC telephone assets are sold orretired, the assets and related accumulated depreciation are removed from theaccounts and any gains or losses on disposition are amortized with theremaining net investment in telephone plant. When other plant and equipment issold or retired, the cost and related accumulated depreciation or amortizationare removed from the respective accounts and any resulting gain or loss isincluded in operating income. Maintenance and repairs are charged to expense asincurred.

 

On December 30, 2005 we acquired Enventis. The Enventis property,plant and equipment, consisting primarily of fiber optic communications networkwas valued under SFAS No. 141 as it pertains to accounting for assetsunder Purchase Accounting and recorded the assets at fair value at the time ofacquisition.

 

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

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Telephone plant                      |       | $        | 268,566    |     | $          | 261,427 |   |
| Enventis  property and equipment     |       | 34,914   |       | 29,048   |       |
| Enventis  Indefeasable Rights to Use |       | 5,482    |       | 5,482    |       |
| Other property  and equipment        |       | 13,287   |       | 13,307   |       |
| Total                                |       | 322,249  |       | 309,264  |       |
| Less accumulated  depreciation       |       | 169,318  |       | 156,429  |       |
| Property, plant,  and equipment, net |       | $        | 152,931    |     | $          | 152,835 |   |

 

Included in the Enventis property, plant and equipment is fiber opticcable and indefeasible right of use of fiber installed by others accompanied byownership rights. Both of these categories of assets have depreciable lives of16 to 20 years on the assets acquired on December 30, 2005 and 25 yearsfor new additions.

 

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 were 4.8%,4.9% and 5.4% for 2007, 2006 and 2005, respectively. All other property, plantand equipment are depreciated over estimated useful lives of three to 20 years.

 

The Telecom Sector leases certain computer equipment under capitallease arrangements. We have recorded the present value or fair value of thefuture minimum lease payments as a capitalized asset and related leaseobligation. Assets under this capital lease are included in property, plant andequipment and amounted to $505,000 and $461,000 ($1,412,000 and $1,821,000asset, net of accumulated depreciation of $907,000 and $1,360,000) as of December 31,2007 and 2006.

 

***Capitalized Software Costs***

 

Software costs associated with software that is developed or purchasedfor internal use only are accounted for in accordance with the AmericanInstitute of Certified Public Accountants Statement of Position No. 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use”. Wecapitalize costs (including right to use fees) associated with externallyacquired software for internal use. Costs associated with internally developedsoftware are segregated into three project stages: preliminary project stage,application development stage and post-implementation stage. Costs associatedwith both the preliminary project stage and post-implementation stage, areexpensed as incurred. Costs associated with the application development stageare capitalized. Software maintenance and training costs are expensed asincurred. Amortization of software costs commences when the software is readyfor its intended use, and is amortized over a period of three to ten years.

 

60

----

 

During 2007, 2006 and2005, we capitalized $403,000, $1,254,000, and $2,147,000, respectively, ofcosts associated with software purchased or developed for internal use only.The 2007 costs primarily relate to software purchased to support the Enventis Sectorvoice over Internet protocol monitoring and managed services. The 2006 and 2005costs related primarily to costs associated with integrating the new enterpriseresource planning software that we converted to on January 1, 2006. Costsincurred in 2006 related primarily to the Enventis Sector, which was purchasedin December 2005 and their migration to the software platform. Totalcapitalized software for internal use of $8,103,000 and $7,700,000 are includedin property, plant and equipment at December 31, 2007 and 2006,respectively. Amortization expense relating to these costs amounted to $686,000and $931,000 in 2007 and 2006, respectively, resulting in accumulatedamortization of $4,727,000 and $3,928,000 at December 31, 2007 and 2006,respectively. Capitalized internal software costs, net of accumulatedamortization of $3,376,000 and $3,659,000 are included in property, plant andequipment at December 31, 2007 and 2006, respectively.

 

***Intangible Assets and Goodwill***

 

Goodwill and intangible assets with indefinite useful lives are notamortized, but tested for impairment at least annually. See Note 2 to the Notesto the Consolidated Financial Statements for a more detailed discussion of theintangible assets and goodwill. We did not have changes to goodwill in 2007 andexpect the goodwill balance of $25,239,000 to be deductible for tax purposes.The changes to goodwill in 2006 are summarized below.

 
| **(Dollars in thousands)**                              | ** ** | **2006** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|
| Goodwill as of  December 31, 2005                                 |       | $        | 27,109     |   |
| Goodwill  adjustments associated with the acquisition of Enventis |       | 167      |       |
| Goodwill  associated with the sale of Enterprise Solutions        |       |     | (2,037     | ) |
| Goodwill as of  December 31, 2006                                 |       | $        | 25,239     |   |

 

***Accrued Incentive Compensation***

 

Our employee incentive compensation plans provide for distributionsbased on achievement of specific organizational operating results or individualemployee objectives. Accrued expenses included amounts accrued for EmployeeIncentive Compensation of $2,035,000 and $489,000 at December 31, 2007 andDecember 31, 2006, respectively.

 

***Income Taxes***

 

We account for income taxes in accordance with SFAS No. 109, asclarified by FIN No. 48, which requires an asset and liability approach tofinancial accounting and reporting for income taxes. Accordingly, deferred taxassets and liabilities arise from the difference between the tax basis of anasset or liability and its reported amount in the financial statements.Deferred tax amounts are determined using the tax rates expected to be ineffect when the taxes will actually be paid or refunds received, as providedunder currently enacted tax law. Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to 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 assets and liabilitiesduring the period.

 

FIN No. 48requires us to recognize the financial statement benefit of a tax position onlyafter determining that the relevant tax authority would more likely than notsustain the position following an audit. For tax positions meeting themore-likely-than-not threshold, the amount recognized in the financialstatements is the largest benefit that has a greater than fifty percentlikelihood of being realized upon ultimate settlement with the relevant taxauthority. See Note 11 to the Notes to the Consolidated Financial Statementsfor additional information regarding income taxes.

 

61

----

 

***Earnings (Loss) Per Share***

 

Basic earnings per share are 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 Hickory TechCorporation Amended and Restated Employee Stock Purchase Plan. Dilution isdetermined using the treasury stock method.

 
| ** **                         | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Weighted Average                   |       |       |       |       |       |       |       |
| Shares  Outstanding                |       | 13,258,369 |       | 13,163,480 |       | 13,083,252 |       |
| Stock Options                      |       | 1,718      |       | —     |       | 5,955      |       |
| Stock Subscribed  (ESPP)           |       | —     |       | —     |       | 8,210      |       |
| Total Weighted  Average Common     |       |       |       |       |       |       |       |
| and Equivalent  Shares Outstanding |       | 13,260,087 |       | 13,163,480 |       | 13,097,417 |       |

 

Options to purchase 441,000 shares as of December 31, 2007,515,884 shares as of December 31, 2006 and 503,850 shares as of December 31,2005 were not included in the computation of earnings per share assumingdilution because their effect on earnings per share would have beenanti-dilutive.

 

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

 

***Post-Retirement Benefits***

 

The post-retirement benefit expense and liabilityare calculated utilizing various actuarial assumptions and methodologies. Theseassumptions include, but are not limited to, the discount rate and the expectedhealth care cost trend rate.

 

Post-retirement benefits were calculated inaccordance with the methods specified in SFAS No. 158 and SFAS No. 106.Where SFAS No. 106 provides alternative methods for determining netperiodic benefit costs, we adopted the following policies: Any prior servicecost, or cumulative net gains and losses in excess of 10% of the SFAS No. 106corridor, are amortized on a straight-line basis over the average futureservice lives of the covered group. There are no substantive commitments forbenefits other than as stated in the written plan. According to the guidance ofparagraph 186 of SFAS No. 106, “the objective of selecting assumeddiscount rates is to measure the single amount that, if invested at themeasurement date in a portfolio of high-quality debt instruments, would providethe necessary future cash flows to pay the accumulated benefits when due”. Theassumed discount rate represents the discounted value of necessary future cashflows required to pay the accumulated benefits when due. This rate wasdetermined based on available market data regarding the spot rate yields inhalf year increments on high-quality fixed income securities with the effectsof puts and calls removed that provide cash flows at the same time and in thesame amount as the projected cash flows of the plan.

 

The health care cost trend rate is based upon an evaluation of thehistorical trends and experience, taking into account current and expectedmarket conditions. The health care cost trend rate represents the expectedannual rate of change in the cost of health care benefits currently provideddue to factors other than changes in the demographics of plan participants. Ifthe assumptions utilized in determining the post-retirement benefit expense andliability differ from actual events, the results of operations for futureperiods could be impacted. When actual events differ from the assumptions orwhen the assumptions used change, an unrecognized actuarial gain or lossresults.

 

62

----

 

***Stock Compensation***

 

On January 1, 2006, we adopted SFAS No. 123(R), whichreplaces SFAS No. 123 and supersedes APB No. 25. We adopted SFAS No. 123(R) usingthe modified prospective method. Under this method, prior periods are notrestated. Prior to January 1, 2006, we accounted for stock-basedcompensation in accordance with APB No. 25, which required the use of theintrinsic value method. Accordingly, no compensation expense was recognized inprior periods for stock options granted, since the exercise price was equal tothe fair market value of the shares at the grant date. The grant date fairvalue of stock options is estimated using the Black-Scholes valuation model.Compensation expense is reduced based on estimated forfeitures with adjustmentsto actual recorded at time of vesting. Forfeitures are estimated based onhistorical experience. Compensation costs are recognized over the vestingperiod. Company stock options vest over a three-year period. See Note 7 to theNotes to the Consolidated Financial Statements for more information regardingstock-based compensation.

 

The following table illustrates the effect on net income and earningsper share if we had applied the fair value recognition provisions of SFAS No. 123to stock-based compensation for the year ended December 31, 2005:

 
| ** **                                      | ** ** | **Year Ended**                               | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| **(Dollars in thousands)**            | ** ** | **December 31, 2005**                   | ** ** |
| * *                                        | ** ** | ** **                                        | ** ** |
| Reported Net Income                             |       | $                                                 | 8,529      |   |
| Add: Stock-based employee compensation expense  |       |                                              |       |
|                                            |       | included in reported net income, net of           |       |   |   |
|                                            |       | related tax effects (ESPP)                        |       | 64 |   |
| Deduct: Total stock-based employee compensation |       |                                              |       |
|                                            |       | expense determined under fair value based         |       |   |   |
|                                            |       | method for all awards, net of related tax effects |       | 224 |   |
|                                            |       |                                              |       |   |   |
| Pro Forma Net Income                            |       | $                                                 | 8,369      |   |
|                                            |       |                                              |       |
| Earnings per share:                             |       |                                              |       |
|                                            |       | Basic - as reported                               |       | $ | 0.65 |   |
|                                            |       | Basic - pro forma                                 |       | $ | 0.64 |   |
|                                            |       |                                              |       |   |   |
|                                            |       | Diluted - as reported                             |       | $ | 0.65 |   |
|                                            |       | Diluted - pro forma                               |       | $ | 0.64 |   |

 

***Recent Accounting Developments***

 

In December 2007,the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”),which establishes principles and requirements for how an acquirer recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, and any non-controlling interest in the acquired companyand the goodwill acquired. SFAS No. 141(R) also establishesdisclosure requirements to enable the evaluation of the nature and financialeffects of the business combination. SFAS No. 141(R) is effective asof the beginning of an entity’s fiscal year that begins after December 15,2008, and will be adopted by us in the first quarter of 2009. SFAS No. 141(R) iscurrently not expected to have a material effect on our consolidated financialstatements.

 

In December 2007,the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”),which defines fair value, establishes a framework for measuring fair value inaccordance with generally accepted accounting principles and expandsdisclosures about fair value measurements. SFAS No. 157 will applywhenever another standard requires (or permits) assets or liabilities to bemeasured at fair value. The standard does not expand the use of fair value toany new circumstances. SFAS No. 157 is effective for the calendar year2008. We are currently assessing the impact of SFAS No. 157 on our resultsof operations, cash flows and financial condition.

 

63

----

 

In February, 2007, the FASB issued SFAS No. 159, “The Fair ValueOption for Financial Assets and Financial Liabilities – Including an amendmentof FASB Statement No. 115” (“SFAS No. 159”), which permits entitiesto measure many financial instruments and certain other items at fair value.The objective is to improve financial reporting by providing entities with theopportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities differently without having to apply complexhedge accounting provisions. The provisions of SFAS No. 159 are effectiveas of the beginning of an entity’s first fiscal year that begins after November 15,2007. Early adoption is permitted as of the beginning of a fiscal year thatbegins on or before November 15, 2007, provided the entity also elects toapply the provisions of SFAS No. 157. The provisions of SFAS No. 159are currently not expected to have a material effect on our consolidatedfinancial statements.

 

In December 2007,the FASB issued SFAS No. 160, “Non-controlling Interests in ConsolidatedFinancial Statements – an amendment of Accounting Research Bulletin No. 51”(“SFAS No. 160”). SFAS No. 160 will change the accounting andreporting for minority interests, which will be re-characterized asnon-controlling interests and classified as a component of equity. This newconsolidation method will significantly change the accounting for transactionswith minority interest holders. SFAS No. 160 is effective for fiscal yearsbeginning after December 15, 2008, and will be adopted by us in the firstquarter 2009. SFAS No. 160 is currently not expected to have a materialeffect on our consolidated financial statements.

 

**Note 2.   Goodwill andOther Intangible Assets**

 

We are required totest acquired goodwill 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. No suchevent occurred during 2007 or 2006. As of December 31, 2007 and 2006, wecompleted our annual impairment tests for acquired goodwill. The 2006 testincluded Enventis for the first time and excluded Collins given it was soldprior to the year-end test. This testing resulted in no impairment charges togoodwill as the determined fair value was sufficient to pass the first stepimpairment test.

 

On December 31,2006, we divested ourselves of Collins. The Collins results of operations,which were formally recorded in the Enterprise Solutions Sector, had a goodwillbalance of $2,037,000, which was written off in connection with thedivestiture.

 

On December 30,2005, we acquired Enventis. The preliminary purchase price allocation resultedin goodwill of $2,023,000, which was adjusted to $2,190,000 as of December 31,2006, as noted in the table below. A summary of changes in the Enventisgoodwill is as follows:

 
| ** **                           | ** ** | **Enventis** | ** ** |
|--------------------------------------|------------|--------------|------------|
| **(Dollars in Thousands)** | ** ** | **Goodwill** | ** ** |
| Balance at  December 31, 2005        |       | $            | 2,023      |   |
| Purchase price  adjustments          |       | 124          |       |
| Other                                |       | 43           |       |
| Balance as of  December 31, 2006     |       | $            | 2,190      |   |

 

The carrying valueof our goodwill decreased from $27,109,000 as of December 31, 2005 to$25,239,000 as of December 31, 2006, due to the sale of Collins andworking capital adjustments and purchase price allocation adjustments associatedwith the purchase of Enventis (See Note 3 to the Notes to the ConsolidatedFinancial Statements).

 

Intangible assetswith finite lives are amortized over their respective estimated useful lives totheir estimated residual values. Identifiable intangible assets that aresubject to amortization are evaluated for impairment. The components ofintangible assets are as follows:

 

64

----

 
| ** **                           | ** ** | ** **            | ** ** | **As of December 31, 2007** | ** ** | **As of December 31, 2006** | ** ** |
|--------------------------------------|------------|-----------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | ** **            | ** ** | **Gross Carrying**                         | ** ** | **Accumulated**                                 | ** ** | **Gross Carrying** | ** ** | **Accumulated** | ** ** |
| **(Dollars in thousands)** | ** ** | **Useful Lives** | ** ** | **Amount**                                      | ** ** | **Amortization**                                | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Definite-Lived Intangible Assets     |       |                  |       |                                            |       |                                            |       |   |   |   |   |
| Customer  relationships              |       | 1 - 8 years           |       | $                                               | 4,229      |                                            | $          | 2,456 | ** ** | $ | 4,229 |   | $ | 1,504 |   |
| Other  intangibles                   |       | 1 - 5 years           |       | 730                                             |       | 520                                             | ** ** | 730 |   | 315 |   |
| Total                                |       |                  |       | $                                               | 4,959      |                                            | $          | 2,976 | ** ** | $ | 4,959 |   | $ | 1,819 |   |

 

During 2005, we acquired Enventis. Part ofthe acquisition price included $3,400,000 for customer relationships andcontracts and $600,000 for the other intangibles. In addition, we alsocompleted another acquisition in 2005 that included $8,000 for customerrelationships and $21,000 for other intangibles.

 

As required by SFAS No. 142, we periodically reassessthe carrying value, useful lives and classifications of identifiable assets.Amortization expense related to the definite-lived intangible assets for 2007,2006 and 2005 was $1,157,000, $1,172,000, and $104,000, respectively. Totalestimated amortization expense for the five years subsequent to 2007 is asfollows: 2008 - $1,127,000; 2009 - $853,000; 2010 - $3,000; 2011 - $0 and 2012- $0.

 

**Note 3.   Acquisition, Disposition and DiscontinuedOperations**

 

***Acquisition of Enventis***

 

On December 30,2005, we purchased all of the capital stock of Enventis from another publiccompany. The initial purchase price was $35,500,000, paid in cash, with thepossibility of further purchase price adjustments and transaction costs. Afterpurchase price adjustments, the total consideration was $38,602,000. Enventis hadno debt at the time of acquisition and there were no contingent payments orearn outs.

 

The financing forthe $38,602,000 total purchase consideration for Enventis, plus an additional$8,500,000 for Enventis working capital, was entirely from our creditagreement, as established on December 30, 2005. The credit facility iscomprised of a $30,000,000 revolving credit component which expires on December 30,2011 and a $130,000,000 term loan component, which has partial maturitiesduring its term, with final maturity on June 30, 2013 (See Note 9 to theNotes to the Consolidated Financial Statements).

 

The table belowsets forth the final Enventis purchase price allocation as of December 31,2006:

 
| **(Dollars in thousands)**  | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------|------------|
|                                  |       |       |       |
| Identifiable  intangible assets:      |       |       |       |
| Customer  relationship and contracts  |       | $          | 3,400      |   |
| Cisco gold  supplier relationship     |       | 600        |       |
| Net working  capital                  |       | 4,226      |       |
| Property and  equipment               |       | 23,649     |       |
| Indefeasible  rights to use           |       | 5,496      |       |
| Other assets and  liabilities         |       | (959       | )          |
| Goodwill                              |       | 2,190      |       |
| Allocation of  purchase consideration |       | $          | 38,602     |   |

 

Of theidentifiable intangible assets identified above, customer relationships andcontracts have useful lives of four years and the Cisco Gold supplierrelationship has a useful life of three years. Useful lives for identifiableintangible assets were estimated at the time of the acquisition based on theperiods of time from which the Company expects to derive benefits from theidentifiable intangible assets. The identifiable intangible assets are amortizedusing the straight-line method, which reflects the pattern in which the assetsare consumed.

 

65

----

 

***Dispositions***

 

Effective December 31,2006, we sold all of the outstanding capital stock in Collins to SkyviewCapital, LLC for an initial price of $100,000, paid by delivery of a promissorynote, plus up to $1,650,000 of earn-out payments. Skyview Capital, LLC paid us$100,000 in February 2007. The remaining selling price is due incontingent payments payable over the next four years if financial targets arereached by Skyview Capital, LLC. We have received no payments to-date relatedto this earn-out provision. The $100,000 mentioned above has been included inthe calculation of the net loss mentioned below, while the contingent paymentshave not been included in the net loss. The agreement contains covenantsagainst competition by the new owner in south-central Minnesota. We recorded apre-tax loss on the sale of $3,385,000 ($2,040,000 net of income taxes). The Collinsresults of operations were formerly reported in the Enterprise SolutionsSector. The consolidated statements of operations for all periods presentedhave been restated to reflect the Collins operations as discontinuedoperations.

 

The following table includes certain summary statement of operationsinformation related to the operations of Enterprise Solutions and the wirelessbusiness reflected in discontinued operations for the years ended December 31:

 
| **(Dollars in thousands)**      | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenues and  sales                       |       | $        | —     |     | $          | 11,049   |       | $ | 14,589 |   |
| Operating  expenses                       |       | —   |       | 12,115   |       | 14,740   |       |
| Depreciation and  amortization            |       | —   |       | 104      |       | 117      |       |
| Operating loss                            |       | —   |       | (1,170   | )          | (268     | )          |
| Loss on sale of  discontinued operations  |       | —   |       | (3,385   | )          | —   |       |
| Other  income/expense                     |       | (40      | )          | (1       | )          | 206      |       |
| Pretax loss from  discontinued operations |       | (40      | )          | (4,556   | )          | (62      | )          |
| Income tax  benefit                       |       | (16      | )          | (1,589   | )          | (25      | )          |
| Net loss of  discontinued operations      |       | $        | (24        | )        | $          | (2,967   | )          | $ | (37 | ) |

 

The following tablesummarizes the net assets and liabilities relating to Enterprise Solutions thatwere sold to Skyview Capital, LLC as of December 31, 2006.

 
| ** **                     | ** ** | **2006** | ** ** |
|--------------------------------|------------|----------|------------|
| Current assets                 |       | $        | 2,869      |   |
| Property, plant  and equipment |       | 253      |       |
| Goodwill                       |       | 2,037    |       |
| Assets                         |       | $        | 5,159      |   |
|                           |       |     |       |
| Current  liabilities           |       | $        | 1,674      |   |
| Other  liabilities             |       | —   |       |
| Liabilities                    |       | $        | 1,674      |   |

 

**Note 4.   Fair Value of Financial Instruments**

 

The fair value of our long-term obligations, after deducting currentmaturities, is estimated to be $128,791,000 at December 31, 2007 and$132,202,000 at December 31, 2006, compared to carrying values of$128,475,000 and $141,529,000, respectively. The fair value estimates are basedon the overall weighted average interest rates and maturity compared to ratesand terms currently available in the long-term financing markets. Our financialinstruments also include cash equivalents, trade accounts receivable, andaccounts payable for which current carrying amounts approximate fair marketvalue.

 

66

----

 

**Note****5.   Accumulated Other ComprehensiveIncome/(Loss)**

 

We follow the provisions of SFAS No. 130, “Reporting ComprehensiveIncome”. This statement established rules for the reporting ofcomprehensive income (loss) and its components. In addition to net income, ourcomprehensive income includes changes in unrealized gains and losses onderivative instruments qualifying and designated as cash flow hedges andrecognized Net Periodic Benefit Cost related to our Post-Retirement BenefitPlans. Comprehensive income for the year ended December 31, 2007 and 2006was $7,094,000 and $1,701,000, respectively.

 

In March 2007, we terminated our two outstanding interest-rateswap agreements with original maturities in June 2008, in exchange for$1,936,000 in proceeds. Immediately following the termination of these twoagreements, we executed a new interest-rate swap agreement, effectively lockingin the interest rate on $60,000,000 of variable-interest rate debt through March 2010.

 

The market value of the cumulative gain or (loss) on financialderivative instruments is reported as a component of accumulated othercomprehensive income (loss) in shareholders’ equity and will be recognized inearnings over the term of the original swap agreement.

 

Thefollowing summary sets forth the components of accumulated other comprehensiveincome (loss), net of tax:

 
| ** **                | ** ** | ** **             | ** ** | ** **              | ** ** | ** **             | ** ** | ** **              | ** ** | **Accumulated**   | ** ** |
|---------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|-------------------|------------|
| ** **                | ** ** | **Unrecognized**       | ** ** | **Unrecognized**        | ** ** | **Unrecognized**       | ** ** | **Unrealized**          | ** ** | **Other**         | ** ** |
| ** **                | ** ** | **Net Actuarial** | ** ** | **Prior Service**  | ** ** | **Transition**         | ** ** | **Gain/(Loss)**         | ** ** | **Comprehensive** | ** ** |
| ** **                | ** ** | **Loss ****(1)**  | ** ** | **Credit**** (1)** | ** ** | **Asset ****(1)** | ** ** | **on Derivatives** | ** ** | **Income/(Loss)** | ** ** |
| December 31,  2004        |       | $                      | —     |                    | $          | —                 |       | $                       | —     |              | $          | 1,505 |   | $ | 1,505 |   |
| 2005 Activity             |       | —                 |       | —                  |       | —                 |       | 559                     |       | 559               |       |
| December 31,  2005        |       | —                 |       | —                  |       | —                 |       | 2,064                   |       | 2,064             |       |
| 2006 Activity             |       | —                 |       | —                  |       | —                 |       | (567                    | )          | (567              | )          |
| Adoption of SFAS  No. 158 |       | (867                   | )          | 37                      |       | (217                   | )          | —                  |       | (1,047            | )          |
| December 31,  2006        |       | (867                   | )          | 37                      |       | (217                   | )          | 1,497                   |       | 450               |       |
| 2007 Activity             |       | (87                    | )          | 242                     |       | 36                     |       | (1,708                  | )          | (1,517            | )          |
| December 31,  2007        |       | $                      | (954       | )                       | $          | 279                    |       | $                       | (181       | )                 | $          | (211 | ) | $ | (1,067 | ) |

 

----

*(1)* Amounts pertain to our postretirementbenefit plans.

 

Theincrease (decrease) in income tax benefits associated with each component ofaccumulated other comprehensive income/(loss) is as follows:

 
| ** **                                        | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income tax  (liability) related to OCI components |       |     |       |     |       |     |       |
| beginning of  year                                |       | $        | (301       | )        | $          | (1,365   | )          | $ | (996 | ) |
| Income tax  (liability) changes related to:       |       |     |       |     |       |     |       |
| Unrecognized net  actuarial loss                  |       | 57       |       | 571      |       | —   |       |
| Unrecognized  prior service credit                |       | (159     | )          | (24      | )          | —   |       |
| Unrecognized  transition asset                    |       | (24      | )          | 143      |       | —   |       |
| Unrecognized  gain on derivatives                 |       | 1,568    |       | 374      |       | (369     | )          |
| Income tax  (liability) related to OCI components |       |     |       |     |       |     |       |
| end of year                                       |       | $        | 1,141      |     | $          | (301     | )          | $ | (1,365 | ) |

 

67

----

 

**Note 6.   Business Segments**

 

Our operations are conducted in two business segments as: (i) TelecomSector and (ii) Enventis Sector. The Telecom Sector provides telephoneservices to Mankato and adjacent areas of south central Minnesota and to elevencommunities in northwest Iowa as an ILEC. The Telecom Sector operates fiberoptic cable transport facilities in Minnesota. The Telecom Sector offers analternative choice for local telecommunications service, known as CLEC servicein the telecommunications industry, to customers in Minnesota and Iowa notcurrently in HickoryTech’s ILEC service area. In addition, the Telecom Sectorresells long distance service to Minnesota and Iowa subscribers in its ILEC andCLEC markets. The Telecom Sector, through NIBI, also provides data processingand related services to HickoryTech’s other product lines and to other externaltelephone companies, municipalities, utilities and wireless and cable TVproviders. Prior to the sale of Collins, the Enterprise Solutions Sectordesigned, sold, installed and serviced business telephone systems and datacommunications equipment primarily in metropolitan Minneapolis/St. Paul,Minnesota. The Enterprise Solutions Sector operations are reported asdiscontinued operations for all periods presented. The Enventis Sector specializes in providingtelecommunications and network solutions for companies of all sizes. Inaddition to its statewide, fiber optic network, Enventis provides innovativeinternet protocol services that combine voice and data onto a single platform.

 

Businesssegment information for the years ended December 31, 2007, 2006 and 2005is as follows:

 
| ** **                                 | ** ** | ** **  | ** ** | ** **   | ** ** | ** **             | ** ** | ** **       | ** ** |
|--------------------------------------------|------------|-------------|------------|--------------|------------|------------------------|------------|------------------|------------|
| **Years Ended December 31** | ** ** | ** **  | ** ** | ** **   | ** ** | **Corporate and** | ** ** | ** **       | ** ** |
| **(Dollars in thousands)**       | ** ** | **Telecom** | ** ** | **Enventis** | ** ** | **Eliminations**       | ** ** | **Consolidated** | ** ** |
| **2007**                                   |       |        |       |         |       |                   |       |             |       |
| Revenue from  unaffiliated customers       |       | $           | 76,847     |         | $          | 79,802                 |       | $                | —     |   | $ | 156,649 |   |
| Intersegment  revenue                      |       | 467         |       | 440          |       | (907                   | )          | —           |       |
| Total operating  revenue                   |       | 77,314      |       | 80,242       |       | (907                   | )          | 156,649          |       |
|                                       |       |        |       |         |       |                   |       |             |       |
| Depreciation and  amortization             |       | 15,218      |       | 3,755        |       | 31                     |       | 19,004           |       |
| Operating  income/(loss)                   |       | 17,796      |       | 6,904        |       | (1,520                 | )          | 23,180           |       |
| Interest expense                           |       | 72          |       | —       |       | 8,049                  |       | 8,121            |       |
| Income taxes                               |       | 7,287       |       | 2,904        |       | (3,480                 | )          | 6,711            |       |
| Income/(loss)  from continuing operations  |       | 10,460      |       | 4,074        |       | (5,899                 | )          | 8,635            |       |
| Identifiable  assets                       |       | 152,961     |       | 66,842       |       | 7,692                  |       | 227,495          |       |
| Capital  expenditures                      |       | 11,489      |       | 5,928        |       | 83                     |       | 17,500           |       |
|                                            |            |             |            |              |            |                        |            |                  |            |  |  |  |  |

 
| ** **                                | ** ** | ** **  | ** ** | ** **   | ** ** | **Corporate and** | ** ** | ** **       | ** ** |
|-------------------------------------------|------------|-------------|------------|--------------|------------|-------------------|------------|------------------|------------|
| ** **                                | ** ** | **Telecom** | ** ** | **Enventis** | ** ** | **Eliminations**  | ** ** | **Consolidated** | ** ** |
| **2006**                                  | ** ** | ** **  | ** ** | ** **   | ** ** | ** **        | ** ** | ** **       | ** ** |
| Revenue from  unaffiliated customers      |       | $           | 74,896     |         | $          | 58,005            |       | $                | —     |   | $ | 132,901 |   |
| Intersegment  revenue                     |       | 260         |       | 50           |       | (310              | )          | —           |       |
| Total operating  revenue                  |       | 75,156      |       | 58,055       |       | (310              | )          |             | 132,901    |   |
|                                      |       |        |       |         |       |              |       |             |       |
| Depreciation and  amortization            |       | 15,009      |       | 3,048        |       | 64                |       | 18,121           |       |
| Operating  income/(loss)                  |       | 15,100      |       | 2,240        |       | (1,509            | )          | 15,831           |       |
| Interest expense                          |       | (79         | )          | —       |       | 7,441             |       | 7,362            |       |
| Income taxes                              |       | 5,960       |       | 879          |       | (3,467            | )          | 3,372            |       |
| Income/(loss)  from continuing operations |       | 9,237       |       | 1,363        |       | (5,365            | )          | 5,235            |       |
| Identifiable  assets                      |       | 157,058     |       | 59,856       |       | 9,986             |       | 226,900          |       |
| Capital  expenditures                     |       | 15,631      |       | 5,324        |       | 103               |       | 21,058           |       |
|                                           |            |             |            |              |            |                   |            |                  |            |  |  |  |  |

 

68

----

 
| ** **                                | ** ** | ** **  | ** ** | ** **   | ** ** | **Corporate and** | ** ** | ** **       | ** ** |
|-------------------------------------------|------------|-------------|------------|--------------|------------|-------------------|------------|------------------|------------|
| ** **                                | ** ** | **Telecom** | ** ** | **Enventis** | ** ** | **Eliminations**  | ** ** | **Consolidated** | ** ** |
| **2005**                                  | ** ** | ** **  | ** ** | ** **   | ** ** | ** **        | ** ** | ** **       | ** ** |
| Revenue from  unaffiliated customers      |       | $           | 77,922     |         | $          | —            |       | $                | —     |   | $ | 77,922 |   |
| Intersegment  revenue                     |       | 128         |       | —       |       | (128              | )          | —           |       |
| Total operating  revenue                  |       | 78,050      |       | —       |       | (128              | )          | 77,922           |       |
|                                      |       |        |       |         |       |              |       |             |       |
| Depreciation and  amortization            |       | 15,375      |       | —       |       | 61                |       | 15,436           |       |
| Operating  income/(loss)                  |       | 18,829      |       | —       |       | (351              | )          | 18,478           |       |
| Interest expense                          |       | 61          |       | —       |       | 4,302             |       | 4,363            |       |
| Income taxes                              |       | 7,464       |       | —       |       | (1,818            | )          | 5,646            |       |
| Income/(loss)  from continuing operations |       | 11,324      |       | —       |       | (2,758            | )          | 8,566            |       |
| Identifiable  assets                      |       | 152,227     |       | 52,061       |       | 12,546            |       | 216,834          |       |
| Capital  expenditures                     |       | 19,312      |       | —       |       | 122               |       | 19,434           |       |
|                                           |            |             |            |              |            |                   |            |                  |            |  |  |  |  |

 

**NOTE 7.   STOCK COMPENSATION**

 

***Employee Stock Purchase Plan***

 

Under the terms of an employee stock purchase plan, participatingemployees may acquire shares of common stock through payroll deductions of notmore than 10% of their compensation. The price at which shares can be purchasedis 85% of the fair market value for shares on one specified date, the end ofthe plan year. As of December 31, 2007, there were 500,000 common sharesreserved for this plan and 486,208 shares still available for issuance. As of December 31,2007, employees had subscribed to purchase approximately 20,193 shares in thenew plan year ending August 31, 2008. At December 31, 2006, employeeshad subscribed to purchase approximately 18,273 shares for the plan year thatended August 31, 2007. We recorded stock compensation expense in theamount of $24,000 during 2007 related to this plan.

 

***Retainer Stock Plans forDirectors***

 

Under the terms of a corporate retainer stock plan for directors,participating directors may acquire shares of common stock in exchange fortheir quarterly retainers. The price at which the shares can be purchased is100% of the fair market value for such shares on the date of purchase. Inaddition to any voluntary acquisitions of shares in exchange for quarterlyretainers, directors receive $5,000 of their annual retainer solely in sharesof HickoryTech stock from this plan. As of December 31, 2007, there were300,000 common shares reserved for this plan and 230,422 shares still availablefor future issuance.

 

***Non-Employee Directors’ IncentivePlan***

 

Beginning in May 2005, we began offering a Directors’ IncentivePlan to attract and retain outside Directors. This plan provided for eachDirector to receive 1,000 shares of our common stock if the Company meetspre-established objectives. In 2006, each director received 1,000 shares of ourcommon stock under this plan based on 2005 results. No shares were paid out in2007 for the 2006 plan year. Effective with the 2007 plan year, the planprovides for each director to receive 2,000 shares of our common stock versus1,000 shares, contingent upon HickoryTech meeting pre-established objectives.As of December 31, 2007 there were 200,000 common shares reserved for thisplan and 190,000 shares available for future grants.

 

***Stock Award Plan***

 

HickoryTech’s stock award plan provides for the granting ofnon-qualified stock options, stock awards and restricted stock awards toemployees. The plan provides for stock awards based on the attainment ofcertain financial targets and for individual achievements. 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, 2007, there were 1,750,000 commonshares****reserved for this plan and 992,475shares available for future grants.

 

69

----

 

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

 

On January 1, 2006, we adopted SFAS No. 123(R),which requires the measurement and recognition of compensation expense for allshare-based payment awards made to employees and directors, including employeestock options and employee stock purchases related to the employee stockpurchase plan, based on estimated fair values. SFAS No. 123(R) supersedesour previous accounting under APB No. 25 for periods beginning in 2006. InMarch 2005, the SEC issued SAB No. 107 relating to SFAS No. 123(R).We have applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).We adopted SFAS No. 123(R) using the modified prospective transitionmethod, which requires the application of the accounting standard as of January 1,2006.

 

The Consolidated Financial Statements for 2006 reflectthe impact of SFAS No. 123(R). In accordance with the modified prospectivetransition method, the Consolidated Financial Statements for prior periods havenot been restated to reflect, and do not include, the impact of SFAS No. 123(R) orany modifications to outstanding stock options prior to the adoption of SFAS No. 123(R).The adoption of SFAS No. 123(R) had minimal impact on earnings pershare, diluted earnings per share and cash flow from financing and operationsin 2006.

 

Share-basedcompensation expense recognized during a period is based on the value of theportion of share-based payment awards that are ultimately expected to vestduring the period. Share-based compensation expense recognized in theConsolidated Statements of Operations includes compensation expense forshare-based payment awards granted prior to, but not yet vested as of December 31,2005, based on the grant date fair value estimated in accordance with the fairvalue provisions of SFAS No. 123 as well as grants in 2006 under SFAS No. 123(R).Because share-based compensation expense recognized in the ConsolidatedStatements of Operations is based on awards ultimately expected to vest, it hasbeen reduced for estimated forfeitures. We use historical data to estimatepre-vesting forfeitures. SFAS No. 123(R) requires forfeitures to beestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from those estimates.

 

The fair value of each option award is estimated onthe date of grant using a Black-Scholes option valuation model. We use aseven-year period to calculate the historical volatility of our stock price foruse in the valuation model. The dividend yield rate is based on our currentdividend payout pattern and current market price. The risk-free rate foroptions is based on a U.S. Treasury rate commensurate with the expected terms.The expected term of options granted is derived from historical experience andrepresents the period of time that options granted are expected to beoutstanding.

 

There were no stock option awards granted during 2007.In September 2006, Mr. John W. Finke, current President and ChiefExecutive Officer, received a one-time grant of 15,000 options associated withhis acceptance of the Chief Executive Officer position. The weighted averagegrant date fair value of these options was $1.43 per share. Other than theone-time stock award issued to Mr. Finke, options were last granted underthe Company’s Stock Award Plan in February 2005. The Stock Award Planprovides for the issuance of stock options, but no current compensationprograms have options as a component.

 

The following table details the key assumptions used in computing fairvalue using the Black-Scholes Option valuation model during the three-yearperiod ended December 31, 2007:

 
| ** **                | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Volatility                |       | —   | ** ** | 37.0     | %          | 33.9     | %          |
| Dividend Yield            |       | —   | ** ** | 6.9      | %          | 4.5      | %          |
| Risk-Free  Interest Rates |       | —   | ** ** | 4.8      | %          | 4.1      | %          |
| Expected Life in  Years   |       | —   | ** ** | 7        |       | 7        |       |

 

70

----

 

A summary of allstock option activity for the three-year period ended December 31, 2007 isas follows:

 
| ** **                                                       | ** ** | ** **  | ** ** | ** **              | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
|------------------------------------------------------------------|------------|-------------|------------|-------------------------|------------|------------|------------|---------------------------|------------|
| ** **                                                       | ** ** | **Options** | ** ** | **Exercise Price** | ** ** |
| ** **                                                       | ** ** | **2007**    | ** ** | **2006**                | ** ** | **2005**   | ** ** | **2007**                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Outstanding at  Beginning of Year                                |       | 515,884     |       | 578,850                 |       | 549,065    |       | $                         | 12.75      |   | $ | 12.63 |   | $ | 12.86 |   |
| Granted                                                          |       | —      |       | 15,000                  |       | 60,000     |       | —                    |       | 6.95 |   | 10.85 |   |
| Exercised                                                        |       | —      |       | —                  |       | —     |       | —                    |       | — |   | — |   |
| Forfeited                                                        |       | (499        | )          | (28,448                 | )          | —     |       | 10.76                     |       | 11.15 |   | — |   |
| Expired                                                          |       | (39,385     | )          | (49,518                 | )          | (30,215    | )          | 12.22                     |       | 10.50 |   | 13.41 |   |
| Outstanding at  End of Year                                      |       | 476,000     |       | 515,884                 |       | 578,850    |       | $                         | 12.79      |   | $ | 12.75 |   | $ | 12.63 |   |
| Exercisable at  End of Year                                      |       | 454,335     |       | 462,556                 |       | 449,895    |       | $                         | 12.97      |   | $ | 13.07 |   | $ | 13.14 |   |
| Weighted Average  Fair Value of Options Granted

During the Year |       | $           | —     |                    | $          | 1.43       |       | $                         | 2.68       |   |   |   |   |   |   |   |
| Fair Value of  Options Vesting During the Year                   |       | $           | 156,000    |                    | $          | 186,000    |       | $                         | 227,000    |   |   |   |   |   |   |   |
| Intrinsic Value  of Options Exercised During the Year            |       | $           | —     |                    | $          | —     |       | $                         | —     |   |   |   |   |   |   |   |

 

All stock optionsgranted in 2006 and 2005 had an exercise price equal to the fair market valueof our common stock on the date of grant.

 

The followingtable provides certain information with respect to stock options outstanding atDecember 31, 2007:

 
| ** **                 | ** ** | ** **             | ** ** | **Weighted**       | ** ** | **Weighted**               | ** ** |
|----------------------------|------------|------------------------|------------|--------------------|------------|----------------------------|------------|
| **Range of**          | ** ** | **Stock Options** | ** ** | **Average**        | ** ** | **Average Remaining** | ** ** |
| **Exercise Prices**        | ** ** | **Outstanding**        | ** ** | **Exercise Price** | ** ** | **Contractual Life**       | ** ** |
| $6.00 - $8.00              |       | 15,000                 |       | $                  | 6.95       |                       | 8.7 years  |   |
| $8.00 - $12.00             |       | 177,200                |       | 10.26              |       | 5.4 years                  |       |
| $12.00 - $16.00            |       | 230,050                |       | 13.87              |       | 3.1 years                  |       |
| $16.00 - $21.00            |       | 53,750                 |       | 18.18              |       | 3.2 years                  |       |
|                       |       | 476,000                |       | $                  | 12.79      |                       | 4.1 years  |   |
|                       |       |                   |       |               |       |                       |       |
| Aggregate  Intrinsic Value |       |                   |       | $                  | 75,000     |                       |       |   |

 

The followingtable provides certain information with respect to stock options exercisable atDecember 31, 2007:

 
| ** **                  | ** ** | ** **             | ** ** | ** **                | ** ** | **Weighted Average** | ** ** |
|-----------------------------|------------|------------------------|------------|---------------------------|------------|---------------------------|------------|
| **Range of**           | ** ** | **Stock Options** | ** ** | **Weighted Average** | ** ** | **Remaining**             | ** ** |
| **Exercise Prices**    | ** ** | **Exercisable**        | ** ** | **Exercise Price**   | ** ** | **Contractual Life** | ** ** |
| $6.00 - $8.00               |       | 5,000                  |       | $                         | 6.95       |                      | 8.7 years  |   |
| $8.00 - $12.00              |       | 165,535                |       | 10.22                     |       | 5.3 years                 |       |
| $12.00 - $16.00             |       | 230,050                |       | 13.87                     |       | 3.1 years                 |       |
| $16.00 - $21.00             |       | 53,750                 |       | 18.18                     |       | 3.2 years                 |       |
|                        |       | 454,335                |       | $                         | 12.97      |                      | 3.95 years |   |
|                        |       |                   |       |                      |       |                      |       |
| Aggregate  intrinsic value: |       |                   |       | $                         | 52,000     |                      |       |   |

 

As of December 31,2007, there was $18,000 of total unrecognized compensation costs related tonon-vested stock options granted under the Company’s Stock Award Plan. We expectto recognize this expense over a weighted average period of two years.

 

71

----

** **

**Note 8.   Extended Term Payable**

 

The Enventis Sector has a $20,000,000 wholesalefinancing agreement with a financing company to fund inventory purchased fromcertain approved vendors. Advances under this financing arrangement arecollateralized by the accounts receivable and inventory of Enventis and aguaranty of an amount up to $16,000,000 by HickoryTech Corporation. The financingagreement provides 60 day interest-free payment terms for working capital andcan be terminated at any time by either party. The balance outstanding underthe financing arrangement was $14,443,000 and $7,719,000 at December 31,2007 and 2006, respectively. These balances are classified as currentliabilities in the accompanying Balance Sheet and are not considered part ofthe Company’s debt financing.

 

**Note 9.   Debt and OtherObligations**

 

Our long-term obligations as of December 31,2007, were $128,475,000, excluding current maturities of $475,000 on debt and$256,000 on current maturities of capital leases. Long-term obligations as of December 31,2006, were $141,529,000 excluding current maturities of $1,300,000 on debt and$260,000 of capital leases. On December 30, 2005, we entered into a$160,000,000 credit agreement with a syndicate of banks (subsequently reducedto a $155,700,000 facility as of December 31, 2007), which amended ourprevious credit facility. The credit facility is comprised of a $30,000,000revolving credit component that expires on December 30, 2011 and a$130,000,000 term loan component.

 

The term loan component is comprised of two componentswhich are defined as term loan B and term loan C. The outstanding principalbalance of term loan B is $106,075,000 as of December 31, 2007, and isheld in varying amounts by three of the lenders in the syndicate, US Bank, GECommercial Distribution Finance Corporation and CoBank. Under the terms of termloan B, we are required to make quarterly principal payments of $275,000 from December 31,2007 through December 31, 2011 with the remainder of the aggregateprincipal due in two payments on March 31, 2012 and June 30, 2012.Due to the aggressive pay down of debt in 2007 we are not required to makequarterly principle payments during the first three quarters of 2008. Theoutstanding principal balance of term loan C is $19,600,000 as of December 31,2007, and is held entirely by RTFC. Under the terms of term loan C, we arerequired to make quarterly principal payments of $50,000 on the aggregateprincipal amount from March 31, 2006 through December 31, 2012 withthe remainder of the aggregate principal due in two payments on March 31,2013 and June 30, 2013.

 

Under the terms of the revolving credit facility, anyoutstanding principal is payable in full on December 30, 2011. Theoutstanding balance of the revolving credit facility is $3,000,000 as of December 31,2007. Under the credit facility, interest will be payable at an applicablemargin in excess of a prevailing pricing level. The prevailing pricinglevel will be based on a Base Rate, LIBOR Rate Loans or the RTFC rate table.The prevailing rate for Base Rate Loans is the higher of Prime Rate or theFederal Funds Rate plus 0.5%. The prevailing rate for LIBOR Rate Loans ispublicly available. The RTFC rate tables are established based on RTFCpolicies, are not publicly available and change from time to time. Theapplicable margin for the revolving credit facility, term loan B and term loanC will be determined quarterly based on the leverage ratio ofHickoryTech. The credit facility also provides for payment of a fee on anyun-drawn commitment of the revolving credit facility, payablequarterly. The credit facility requires us to enter into or maintain ineffect interest rate protection agreements on at least 50% of the facility’soutstanding balance, to manage our exposure to interest rate fluctuations. Wecontinually monitor the interest rates on our bank loans and have implementedinterest rate protection agreements on various portions of the overall debtoutstanding for varying terms. As a result of the new credit agreement, weincurred $1,525,000 of new debt placement costs in 2005. Our effective interestrate was 5.94%, 5.13% and 4.20% in 2007, 2006 and 2005, respectively.

 

72

----

 
| **(Dollars in thousands)**                                                 | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Credit facility,  average interest at 5.9%, maturing in varying amounts through 2013 |       | $        | 128,675    |     | $          | 142,700 |   |
| Capitalized  lease obligations, average interest at 11.1%, maturing December 2010    |       | 531      |       | 389      |       |
| Total                                                                                |       | 129,206  |       | 143,089  |       |
| Less current  maturities                                                             |       | 731      |       | 1,560    |       |
| Long-Term  obligations                                                               |       | $        | 128,475    |     | $          | 141,529 |   |

 

Long-termobligations consist of the following:

 

***Credit Facility Obligations***

 

Our debt requires us to comply, on a consolidated basis, with specifiedfinancial ratios and tests. These financial ratios and tests include maximumleverage ratio, minimum interest coverage ratio and maximum capitalexpenditures. The terms of our credit facility include certain restrictionsregarding the payment of dividends.  Thedividend restriction provides that we will not make dividend distributions orrepurchase stock in an aggregate amount in excess of 100% of the previous year’snet income. At December 31, 2007, we were in violation of this dividendrestriction, but a waiver was obtained.

 

Our obligationsunder the credit facility are secured by a first-priority lien on all propertyand assets, tangible and intangible, of HickoryTech and its currentsubsidiaries, including, but not limited to accounts receivable, inventory,equipment and intellectual property, general intangibles, cash and proceeds ofthe foregoing and a first-priority pledge of the capital stock of HickoryTech’scurrent subsidiaries.

 

The term loancomponent has a provision whereby we periodically receive patronage capitalrefunds depending on the amount of interest paid. This patronage refund isrecorded as an offset to interest expense and amounted to $231,000 in 2007,$1,049,000 in 2006 and $367,000 in 2005.

 

Annualrequirements for principal payments for the years subsequent to 2007 are asfollows: 2008 - $475,000; 2009 - $1,300,000; 2010 - $1,300,000; 2011 -$4,300,000; 2012 - $102,700,000 and 2013 - $18,600,000.

 

**Note10.   Employee Retirement Benefits**

 

Employees who meetcertain service requirements are covered under a defined contributionretirement savings plan, which includes IRS Section 401(k) provisions.We contribute up to 6.0% of the employee’s eligible compensation, based on theemployee’s voluntary contribution. Our contributions and costs for theretirement savings plan were $1,432,000 in 2007, $1,350,000 in 2006 and$1,013,000 in 2005.

 

In addition toproviding retirement savings benefits, we provide post-retirement health careand life insurance benefits for eligible employees. We account for thesepost-retirement benefits in accordance with SFAS No. 158 (see below). Weare not currently funding these post-retirement benefits, but have accruedthese liabilities. New employees hired on or after January 1, 2007 are noteligible for post-retirement health care and life insurance benefits.

 

We adopted SFAS No. 158as of December 31, 2006. SFAS No. 158 requires that we recognize thefunded status of our postretirement benefit plans on the consolidated balancesheet and recognize as a component of accumulated other comprehensive income,net of tax, the gains or losses and prior service costs or credits that ariseduring the period but are not recognized as components of net periodic benefitcost.  The impact of SFAS No. 158,net of tax on our December 31, 2006 consolidated financial statementsbased on the actuarial measurements of plan assets and obligations dated December 31,2006 was $1,047,000.

 

73

----

 

The followingtable summarizes the balance sheet impact, including the benefit obligationsand assets associated with our postretirement benefit plans as of December 31,2007 and 2006, respectively.

 

 
| **(Dollars in thousands)**       | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Change in  Benefit Obligation              |       |     |       |     |       |
| Benefit  Obligation at Beginning of Year   |       | $        | 7,672      |     | $          | 7,878 |   |
| Service Cost                               |       | 286      |       | 322      |       |
| Interest Cost                              |       | 455      |       | 429      |       |
| Amendments                                 |       | (413     | )          | —   |       |
| Actuarial Gain                             |       | 215      |       | (754     | )          |
| Benefits Paid                              |       | (257     | )          | (203     | )          |
| Benefit  Obligation at End of Year         |       | $        | 7,958      |     | $          | 7,672 |   |
|                                       |       |     |       |     |       |
| Change in Plan  Assets                     |       |     |       |     |       |
| Fair Value of  Assets at Beginning of Year |       | $        | —     |     | $          | — |   |
| Actual Return on  Assets                   |       | —   |       | —   |       |
| Employer  Contribution                     |       | 257      |       | 203      |       |
| Distributions                              |       | (257     | )          | (203     | )          |
| Fair Value of  Assets at End of Year       |       | $        | —     |     | $          | — |   |

 
| ** **                                       | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Components of  Net Periodic Benefit Cost         |       |     |       |     |       |     |       |
| Service Cost                                     |       | $        | 286        |     | $          | 322      |       | $ | 367 |   |
| Interest Cost                                    |       | 455      |       | 429      |       | 460      |       |
| Expected Return  on Plan Assets                  |       | —   |       | —   |       | —   |       |
| Amortization of  Transition Obligation           |       | 60       |       | 60       |       | 60       |       |
| Amortization of  Prior Service Cost              |       | (12      | )          | (11      | )          | (11      | )          |
| Recognized Net  Actuarial Loss                   |       | 70       |       | 124      |       | 175      |       |
| Net Periodic  Benefit Cost                       |       | $        | 859        |     | $          | 924      |       | $ | 1,051 |   |
|                                             |       |     |       |     |       |     |       |
| Weighted-Average  Assumptions as of December 31: |       |     |       |     |       |     |       |
| Used to  Determine the Post-Retirement Expense   |       | 6.20     | %          | 6.00     | %          | 5.75     | %          |
| Used to  Determine the Benefit Obligation        |       | 6.00     | %          | 6.00     | %          | 5.50     | %          |

 

In2008, we expect to recognize approximately $60,000 of the transitionobligation, ($55,000) of the prior service credit and $79,000 of the netactuarial loss as a component of total period post-retirement benefit expense.

 

Health Care Trend Rates for the Year Ending December 31, 2007

 
| **Year**  | ** ** | **Trend Rate** | ** ** |
|-----------|------------|---------------------|------------|
| 2008-2009 |       | 8.00                | %          |
| 2009-2010 |       | 7.50                | %          |
| 2010-2011 |       | 7.00                | %          |
| 2011-2012 |       | 6.50                | %          |
| 2012-2013 |       | 6.00                | %          |
| 2013-2014 |       | 5.50                | %          |
| 2014-2015 |       | 5.00                | %          |
| 2015+     |       | 4.50                | %          |

 

74

----

 

*(Dollars in thousands)*

 
| **Effect of 1% Increase and 1% Decrease in Trend Rate** | ** ** | **1% Increase** | ** ** | **1% Decrease** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
|                                                                                                 |       |                 |       |                 |       |
| Accum.  Post-Retirement Benefit Oblig. as of December 31, 2007                                       |       |                 |       |                 |       |
| Dollar                                                                                               |       | $                    | 1,269      |                 | $          | (1,023 | ) |
| Percentage  Change in Retiree Medical                                                                |       | 16.9                 | %          | (13.6                | )%         |
|                                                                                                 |       |                 |       |                 |       |
| Service Cost and  Interest Cost for Fiscal 2007                                                      |       |                 |       |                 |       |
| Dollar                                                                                               |       | $                    | 150        |                 | $          | (148 | ) |
| Percentage  Change in Retiree Medical                                                                |       | 18.7                 | %          | (18.5                | )%         |

 

The health care cost trend rate used in determining the accumulatedpost-retirement benefit obligations was 8.0% in 2008 and decreases 0.5% eachyear until it reaches 4.5% in 2015 and remains at 4.5% for the years thereafter.These assumptions were provided based on a study of the ten-year history of ourself-funded medical benefits plan.

 

In December 2003, the Medicare Prescription Drug, Improvement andModernization Act of 2003 was enacted, which introduced a prescription drugbenefit under Medicare, as well as a federal subsidy to sponsors of retireehealth care benefit plans that provide a benefit that is at least actuariallyequivalent to the Medicare plan. In May 2004, the FASB issued FASB StaffPosition No. 106-2, “Accounting and Disclosure Requirements Related to theMedicare Prescription Drug, Improvement and Modernization Act of 2003,” whichrequires current recognition of the federal subsidy that employers may receivefor providing prescription drug coverage to retirees. Substantial portions ofthe prescription drug benefits provided under its post-retirement benefit planare deemed actuarially equivalent to the benefits provided under Medicare Part D.Consequently, we re-measured our accumulated post-retirement benefit obligationas of June 30, 2004 to account for the federal subsidy. As of December 31,2007 and 2006, the reduction in the accumulated post-retirement benefitobligation due to the subsidy was $961,000 and $937,000, respectively.

 

**Note 11.    Income Taxes**

 

The income taxprovision (benefit) for operations for the years ended December 31, 2007,2006 and 2005 include the following components:

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current Income  Taxes:               |       |     |       |     |       |     |       |
| Federal                              |       | $        | 4,027      |     | $          | 972      |       | $ | 3,726 |   |
| State                                |       | 1,145    |       | 276      |       | 1,060    |       |
| Deferred Income  Taxes:              |       |     |       |     |       |     |       |
| Federal                              |       | 1,031    |       | 218      |       | 496      |       |
| State                                |       | 492      |       | 317      |       | 339      |       |
| Total Income Tax  Provision          |       | $        | 6,695      |     | $          | 1,783    |       | $ | 5,621 |   |

 

Income tax expenseis included in the financial statements as follows:

 
| **(Dollars in thousands)** | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Continuing  Operations               |       | $          | 6,711      |       | $          | 3,372      |       | $ | 5,646 |   |
| Discontinued  Operations             |       | (16        | )          | (1,589     | )          | (25        | )          |
| Total Income Tax  Provision          |       | $          | 6,695      |       | $          | 1,783      |       | $ | 5,621 |   |

 

75

----

 

Deferred taxliabilities and assets are comprised of the following at December 31:

 
| **(Dollars in thousands)**                | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Tax Liabilities:                                    |       |     |       |     |       |
| Depreciation and  Fixed Assets                      |       | $        | 14,342     |     | $          | 12,509 |   |
| Intangible  Assets                                  |       | 5,668    |       | 5,274    |       |
| Derivatives                                         |       | —   |       | 991      |       |
| Other                                               |       | 124      |       | 158      |       |
| Gross Deferred  Tax Liability                       |       | $        | 20,134     |     | $          | 18,932 |   |
|                                                |       |     |       |     |       |
| Tax Assets:                                         |       |     |       |     |       |
| Deferred  Compensation and Post-Retirement Benefits |       | $        | 3,835      |     | $          | 3,439 |   |
| Receivables and  Inventories                        |       | 630      |       | 519      |       |
| Accrued  Liabilities                                |       | 829      |       | 457      |       |
| Derivatives                                         |       | 578      |       | —   |       |
| State Net  Operating Loss                           |       | 1,550    |       | 1,616    |       |
| Capital Loss                                        |       | 695      |       | —   |       |
| Gross Deferred  Tax Asset                           |       | 8,117    |       | 6,031    |       |
| Valuation  Allowance                                |       | (1,550   | )          | (1,616   | )          |
| Net Deferred Tax  Liability                         |       | 13,567   |       | 14,517   |       |
| Current Deferred  Tax Asset                         |       | 1,334    |       | 815      |       |
| Net Non-Current  Deferred Tax Liability             |       | $        | 14,901     |     | $          | 15,332 |   |

 

We have state netoperating loss carry-forwards for tax purposes, available to offset futureincome of approximately $26,600,000 at December 31, 2007. The state netoperating loss carry-forwards expire in varying amounts between 2018 and 2026.The utilization of these carry-forwards as an available offset to futuretaxable income is subject to limitations under applicable state income taxlaws. A valuation allowance has been established to reduce the carrying valueof the benefits associated with the net operating losses incurred by oursubsidiaries in the state of Iowa. This valuation allowance was established dueto uncertainty as to realization of these benefits based on the continued netoperating losses generated by these subsidiaries. Future events and changes incircumstances could cause this valuation allowance to change.

 

The reconciliationof the U.S. income tax rate to the effective income tax rate for continuingoperations is as follows:

 
| ** **                                                | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statutory Tax  Rate                                       |       | 35.0     | %          | 34.0     | %          | 34.0     | %          |
| Effect of:                                                |       |     |       |     |       |     |       |
| State Income  Taxes Net of Federal Tax Benefit            |       | 6.1      |       | 6.1      |       | 5.8      |       |
| Release of  Income Tax Reserve and Prior Year Adjustments |       | 0.6      |       | (1.2     | )          | —   |       |
| Medicare Part D  Subsidy                                  |       | (0.3     | )          | (0.6     | )          | (0.4     | )          |
| FASB  Interpretation No. 48                               |       | 2.5      |       | —   |       | —   |       |
| Other, Net                                                |       | (0.2     | )          | 0.9      |       | 0.3      |       |
| Effective Tax  Rate                                       |       | 43.7     | %          | 39.2     | %          | 39.7     | %          |

 

We adopted theprovisions of FIN No. 48 on January 1, 2007. Among other things, FIN No. 48provides guidance to address uncertainty in tax positions and clarifies theaccounting for income taxes by prescribing a minimum recognition threshold thatincome tax positions must achieve before being recognized in the financialstatements. As of the date of adoption, we had approximately $7,242,000 ofunrecognized tax benefits (excluding interest), of which approximately $748,000relates to a deferred tax asset that is fully reserved for financial reportingpurposes. As a result of adoption, we recognized a creditof approximately $62,000 in the January 1, 2007 retained earningsbalance.

 

76

----

 

The reconciliationof unrecognized tax benefits as of December 31, 2007 is shown below.

 
| **(Dollars in thousands)**                             | ** ** | **2007** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|
| Unrecognized tax  benefits, Opening balance (excluding interest) |       | $        | 6,494      |   |
| Increases:                                                       |       |     |       |
| Tax positions  taken in current period                           |       | 27       |       |
| Tax position  taken in prior periods                             |       | 748      |       |
| Decreases:                                                       |       |     |       |
| Tax positions  taken in prior periods                            |       | —   |       |
| Settlements                                                      |       | —   |       |
| Lapse of statute  limitations                                    |       | (14      | )          |
| Unrecognized tax  benefits,                                      |       |     |       |
| Ending balance  (excluding interest)                             |       | $        | 7,255      |   |

 

As of December 31,2007, we had unrecognized tax benefits totaling $7,255,000. The amount ofunrecognized tax benefits, if recognized, that would affect the effectiveincome tax rate in future periods is $7,237,000.

 

We recognizeinterest and penalties related to income tax matters as income taxexpense. As of the date of the FIN No. 48 adoption, we had $172,000(net of tax) accrued for interest and nothing accrued for penalties related totax matters. As of December 31, 2007 we had accrued $492,000 (net of tax)for interest related to unrecognized tax benefits.

 

We fileconsolidated income tax returns in the United States federal jurisdiction and combinedor separate income tax returns in various state jurisdictions. In general, weare no longer subject to United States federal income tax examinations andexaminations by state tax authorities for the years prior to 2004 except to theextent of losses utilized in subsequent years.

 

**Note 12.  Financial Derivative Instruments**

 

We use financialderivative instruments to manage our overall exposure to fluctuations ininterest rates. We account for derivative instruments in accordance with SFAS No. 133,as amended by SFAS No. 149, which requires derivative instruments to berecorded on the balance sheet at fair value. Changes in fair value ofderivative instruments must be recognized in earnings unless specific hedgeaccounting criteria are met, in which case the gains and losses are included inother comprehensive income rather than in earnings.

 

We utilizeinterest-rate swap agreements that qualify as cash-flow hedges to manage ourexposure to interest rate fluctuations on a portion of our variable-interestrate debt. In March 2007, we terminated two outstanding interest-rate swapagreements, with original maturities of June 2008, in exchange for$1,936,000 in proceeds. Proceeds of $1,272,000 were recognized as an offset tointerest expense in 2007. The remaining proceeds will be recognized as anoffset to interest expense over the remaining original term of the agreements,a period of six months, ending in June 2008. Immediately following thetermination of the two swap agreements discussed above, we executed a newinterest-rate swap agreement, effectively locking in the interest rate on$60,000,000 of variable-interest rate debt through March, 2010.

 

The market valueof the cumulative gain or (loss) on financial derivative instruments isreported as a component of accumulated other comprehensive income (loss) inshareholders’ equity and will be recognized in earnings over the term of theswap agreement. The fair value of our derivatives at December 31, 2007 and2006 is a net liability of $1,451,000 and a net asset of $2,489,000,respectively.

 

**Note 13.   Commitments andContingencies**

 

We are involved in certain contractual disputes in the ordinary course ofbusiness but do not believe the ultimate resolution of any of these existingmatters will have a material adverse effect on our financial position, resultsof operations or cash flows.

 

77

----

 

*Operating Lease Commitments*

 

We own most of ourmajor facilities, but do lease certain office space, land and equipment underprincipally non-cancelable operating leases.****Rentalexpense was $1,404,000 in 2007, $1,831,000 in 2006 and $1,240,000 in 2005. At December 31,2007, future minimum operating lease rental obligations for the next five yearsand thereafter are as follows: 2008 - $1,326,000;  2009- $1,153,000; 2010 - $912,000;  2011 - $762,000;  2012 - $585,000 and thereafter - $2,219,000.

 

**Note 14.   Quarterly FinancialInformation (Unaudited)**

 

*(Dollars in thousands except per share amounts)*

 
| ** **                                   | ** ** | **2007** | ** ** |
|----------------------------------------------|------------|----------|------------|
| ** **                                   | ** ** | **4th**  | ** ** | **3rd** | ** ** | **2nd** | ** ** | **1st** | ** ** |
| Operating  revenues                          |       | $        | 38,261     |   | $ | 35,859 |   | $ | 45,602 |   | $ | 36,927 |   |
| Operating income                             |       | $        | 4,886      |   | $ | 5,574 |   | $ | 7,653 |   | $ | 5,067 |   |
| Income from  continuing operations           |       | $        | 1,531      |   | $ | 2,082 |   | $ | 3,254 |   | $ | 1,768 |   |
| Income from  disc. ops., net of taxes        |       | $        | (7         | ) | $ | (8 | ) | $ | (8 | ) | $ | (1 | ) |
| Net income                                   |       | $        | 1,524      |   | $ | 2,074 |   | $ | 3,246 |   | $ | 1,767 |   |
| Basic EPS -  continuing operations           |       | $        | 0.12       |   | $ | 0.16 |   | $ | 0.25 |   | $ | 0.13 |   |
| Basic EPS -  discontinued operations         |       | $        | —     |   | $ | — |   | $ | — |   | $ | — |   |
| Fully Diluted  EPS - continuing operations   |       | $        | 0.12       |   | $ | 0.16 |   | $ | 0.25 |   | $ | 0.13 |   |
| Fully Diluted  EPS - discontinued operations |       | $        | —     |   | $ | — |   | $ | — |   | $ | — |   |
|                                         |       |     |       |   |   |   |   |   |   |
| Dividends Per  Share                         |       | $        | 0.12       |   | $ | 0.12 |   | $ | 0.12 |   | $ | 0.12 |   |

 
| ** **                                   | ** ** | **2006** | ** ** |
|----------------------------------------------|------------|----------|------------|
| ** **                                   | ** ** | **4th**  | ** ** | **3rd** | ** ** | **2nd** | ** ** | **1st** | ** ** |
| Operating  revenues                          |       | $        | 33,401     |   | $ | 32,670 |   | $ | 34,090 |   | $ | 32,740 |   |
| Operating income                             |       | $        | 2,978      |   | $ | 4,230 |   | $ | 4,444 |   | $ | 4,179 |   |
| Income from  continuing operations           |       | $        | 486        |   | $ | 1,629 |   | $ | 1,587 |   | $ | 1,533 |   |
| Income from  disc. ops., net of taxes        |       | $        | (2,426     | ) | $ | (184 | ) | $ | (213 | ) | $ | (144 | ) |
| Net income                                   |       | $        | (1,940     | ) | $ | 1,445 |   | $ | 1,374 |   | $ | 1,389 |   |
| Basic EPS -  continuing operations           |       | $        | 0.04       |   | $ | 0.12 |   | $ | 0.12 |   | $ | 0.12 |   |
| Basic EPS -  discontinued operations         |       | $        | (0.18      | ) | $ | (0.01 | ) | $ | (0.02 | ) | $ | (0.01 | ) |
| Fully Diluted  EPS - continuing operations   |       | $        | 0.04       |   | $ | 0.12 |   | $ | 0.12 |   | $ | 0.12 |   |
| Fully Diluted  EPS - discontinued operations |       | $        | (0.18      | ) | $ | (0.01 | ) | $ | (0.02 | ) | $ | (0.01 | ) |
|                                         |       |     |       |   |   |   |   |   |   |
| Dividends Per  Share                         |       | $        | 0.12       |   | $ | 0.12 |   | $ | 0.12 |   | $ | 0.12 |   |

 

The summation ofquarterly earnings per share computations may not equate to the year-endcomputation as the quarterly computations are performed on a discrete basis.

 

**Note 15.   Subsequent Events**

 

HickoryTech’sBoard of Directors has declared a regular quarterly dividend of 12 cents pershare, payable March 5, 2008 to shareholders of record on February 15,2008. This dividend is the same value as each of the  quarterly dividends paid in 2007.

 

We will begin tophase out the use of the Encompass brand name. Any references to this brandname in this document are for historical purposes only.

 

# **Item 9.  Changes in and Disagreements with Accountants on Accounting and  Financial Disclosure**

 

None.

 

78

----

 

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

 

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

 

As of the end ofthe period covered by this Annual Report on Form 10-K, we carried out anevaluation under the supervision and with the participation of our DisclosureCommittee and our management, including the Chief Executive Officer and theChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e).Disclosure controls and procedures are designed to ensure that informationrequired to be disclosed in our reports filed under the Securities Exchange Actof 1934 (the “Exchange Act”) is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms and thatsuch information is accumulated and communicated to our management, includingthe Chief Executive Officer and Chief Financial Officer, to allow timelydecisions regarding required disclosure. Based on this evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that the design andoperation of our disclosure controls and procedures were effective as of December 31,2007.

 

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

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting, as defined in Exchange Act Rules 13a-15(f) and15d-15(f). Our internal control over financial reporting is a process designedto provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles.

 

Because of itsinherent limitations, internal control over financial reporting may not preventor detect misstatements. Also, projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

Under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, we conducted an evaluation ofthe effectiveness of our internal control over financial reporting as of December 31,2007 based on the criteria established in *Internal Control – IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Based on the results of this evaluation, we concluded thatour internal control over financial reporting was effective as of December 31,2007.

 

The effectivenessof our internal control over financial reporting as of December 31, 2007has been audited by Grant Thornton LLP, an independent registered publicaccounting firm, as stated in their report which is included in Part II ofthis Annual Report on Form 10-K.

 
| Dated:  February 29, 2008        |                                              |
|---------------------------------------|---------------------------------------------------|
|                                  |                                              |
| John W. Finke                         | David A. Christensen                              |
| President and Chief Executive Officer | Senior Vice President and Chief Financial Officer |

 

**CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

There were no changes in our internal control overfinancial reporting identified in connection with the evaluation required byparagraph (d) of Exchange Act Rules 13a-15 or 15d-15 that wasconducted during the last fiscal quarter of 2007, that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

# **Item 9B.  Other Information**

 

None.

 

79

----

 

**PART III**

 

**Item 10.  Directors, Executive Officers of theRegistrant and Corporate Governance Matters**

 

Information as toDirectors and Executive Officers of HickoryTech included in the Proxy Statementunder the headings “Proposal 1: Election of Directors,” “Security Ownership ofManagement,” “Other Executive Officers” and “Section 16(a) BeneficialOwnership Reporting Compliance” is incorporated by reference. Disclosurerelating to the audit committee, including the audit committee financialexpert, found under the heading of “Audit Committee Report” in the ProxyStatement is incorporated by reference.

 

We have adopted aCode of Ethics that applies to our Chief Executive Officer, Chief FinancialOfficer, all officers of HickoryTech, Director of Regulatory Affairs, Directorof Public and Investor Relations, Controller, Senior Manager of FinancialCompliance, the Board of Directors and other appropriate personnel asidentified.

 

**Item 11.   Executive Compensation**

 

Information as toexecutive compensation included under the headings of “Compensation Discussionand Analysis,” “Summary Compensation Table,” “Grants of Plan-Based Awards in2007,” “Outstanding Equity Awards at 2007 Fiscal Year-End,” “2007 OptionExercises and Stock Vested,” “Non-Qualified Deferred Compensation for 2007,” “EmploymentContracts, Change of Control Agreements, Severance Agreements and OtherAgreements,” “Compensation Committee Report on Executive Compensation” and “Compensationof Directors” in the Proxy Statement is incorporated by reference.

 

**Item 12.   Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters**

 

The information asto beneficial ownership of more than five percent of HickoryTech’s common stockincluded under the heading “Beneficial Owners of Common Stock” of the ProxyStatement is incorporated by reference. The information as to securityownership of management included under the heading of “Security Ownership ofManagement” in the Proxy Statement is incorporated by reference.

 

The followingtable provides information on equity compensation plans under which equitysecurities of the Company are authorized for issuance, as of December 31,2007.

 
| ** **             | ** ** | **A**                 | ** ** | **B**                 | ** ** | **C**                       | ** ** |
|------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **             | ** ** | **Number of**         | ** ** | **Weighted-**         | ** ** | **Number of securities**    | ** ** |
| ** **             | ** ** | **securities to be**  | ** ** | **average exercise**  | ** ** | **remaining available for** | ** ** |
| ** **             | ** ** | **issued upon**       | ** ** | **price of**          | ** ** | **future issuance under**   | ** ** |
| ** **             | ** ** | **exercise of**       | ** ** | **outstanding**       | ** ** | **equity compensation**     | ** ** |
| ** **             | ** ** | **outstanding**       | ** ** | **options, warrants** | ** ** | **plans (excluding**        | ** ** |
| ** **             | ** ** | **options, warrants** | ** ** | **and rights**        | ** ** | **securities reflected in** | ** ** |
| **Plan Category**      | ** ** | **and rights**        | ** ** | ** **            | ** ** | **column A)**               | ** ** |
|                   |       |                  |       |                  |       |                        |       |
| Equity  compensation   |       |                  |       |                  |       |                        |       |
| plans approved  by     |       |                  |       |                  |       |                        |       |
| security holders  (1): |       | 476,000               |       | $                     | 12.79      |                        | 1,899,105  |   |
|                   |       |                  |       |                  |       |                        |       |   |
| Equity  compensation   |       |                  |       |                  |       |                        |       |
| plans not  approved by |       |                  |       |                  |       |                        |       |
| security  holders:     |       | —                |       | —                |       | —                      |       |
| Total                  |       | 476,000               |       | $                     | 12.79      |                        | 1,899,105  |   |

 

----

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

 

80

----

 

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

 

We****do not know of any transactions withrelated persons required to be reported under this item. The informationregarding director independence under the caption “Corporate Governance Matters– The Board of Directors and Committees,” in the Proxy Statement isincorporated by reference.

 

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

 

The information under theheading “Independent Auditors and Payment of Fees to Auditors,” in the ProxyStatement is incorporated herein by reference.

 

**PART IV**

 

**Item 15.   Exhibits and Financial Statement Schedules**

 

(a)          The following documents are filed as partof this Annual Report on Form 10-K:

 

**1.**  **Index of Consolidated Financial Statements**

 

The followingconsolidated financial statements are included at the indicated pages inthis Annual Report on Form 10-K and incorporated in this Item 15(a) byreference:

 
| ** ** | ** **                                                                            | ** **                                           | **Page** |
|------------|---------------------------------------------------------------------------------------|------------------------------------------------------|----------|
|       |                                                                                  |                                                 |     |
|       | Reports of Independent Registered Public Accounting  Firms                            |                                                 | 50       |
|       |                                                                                  |                                                 |     |
|       | Consolidated Statements of Operations                                                 |                                                 | 53       |
|       |                                                                                  |                                                 |     |
|       | Consolidated  Balance Sheets                                                          |                                                 | 54       |
|       |                                                                                  |                                                 |     |
|       | Consolidated Statements of Cash Flows                                                 |                                                 | 55       |
|       |                                                                                  |                                                 |     |
|       | Consolidated Statements of Shareholder’s Equity and  Comprehensive Income/(Loss) |                                                 | 56       |
|       |                                                                                  |                                                 |     |
|       | Notes to Consolidated Financial Statements                                            |                                                 | 57       |
|       |                                                                                  |                                                 |     |
| ** ** | **2.**                                                                                | **Financial Statement Schedule**                     |     |   |
|       |                                                                                  | Schedule II — Valuation and Qualifying Accounts |     | 84 |

 

**3.****          ****Exhibits**

 

The following documents are filed as Exhibits to this Form 10-Kor incorporate by reference herein.  Anydocument incorporated by reference is identified by a parenthetical referenceto the SEC filing which included such document.

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                             |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3(a)        |       | Restated Articles of Incorporation (Incorporated by  reference to Exhibit 3 to the Registrant’s Form 10-Q filed May 7,  1999)                                                                                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                                                                                        |
| 3(b)        |       | Amended and Restated By-Laws (Incorporated by  reference to Exhibit 3.1 to the Registrant’s Form 10Q filed May 3,  2007)                                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                        |
| 3(c)        |       | Certificate of Designations of Series A Junior  Participating Preferred Stock of HickoryTech Corporation (Incorporated by  reference to Exhibit 3(c) to the Registrant’s Form 10-K filed March 29,  2000)                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                        |
| 4(a)        |       | Shareholder Rights Agreement (Incorporated by  reference to Exhibit 1 to the Registrant’s Form 8-A filed March 9,  1999)                                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                        |
| 4(b)        |       | Third Amended and Restated Credit Agreement dated as  of December 30, 2005, by and among HickoryTech Corporation, as Borrower,  the Lenders referred to herein and Wachovia (formerly known as First Union  National Bank), as Administrative Agent (Incorporated by reference to Exhibit 4.1  to the Registrant’s Form 8-K filed January 6, 2006) |

 

81

----

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                              |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1+       |       | 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 filed May 11, 1993                    |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.2+       |       | HickoryTech Corporation Directors’ Stock Options  Plan Amended and Restated February 5, 2003 (Incorporated by reference to  Exhibit 10(g) to the Registrant’s Form 10-K filed March 9,  2004)                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.3+       |       | HickoryTech 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  filed August 12, 1996)                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.4+       |       | HickoryTech 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)                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.5+       |       | HickoryTech 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)                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.6+       |       | Summary of the HickoryTech Corporation Long-Term  Executive Incentive Program (Incorporated by reference to Exhibit 10(q) to  the Registrant’s Form 8-K filed February 22, 2005)                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.7+       |       | Form of Stock Option Agreement Used in  connection with Grants Under the 1993 Stock Award (Incorporated by reference  to Exhibit 10(r) to the Registrant’s Form 10-K filed March 4,  2005)                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.8        |       | HickoryTech Corporation Directors’ Incentive Plan  (Incorporated by reference to Exhibit 10(s) to the Registrant’s Form 8-K  filed May 9, 2005)                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.9        |       | Stock Purchase Agreement by and between HickoryTech  Corporation and Minnesota Power Enterprises, Inc. dated November 9,  2005 (Incorporated by reference from Exhibit 2.1 to the Registrant’s  Current Report on Form 8-K filed on November 10, 2005)                         |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.10       |       | First Amendment to the Stock Purchase Agreement by  and between HickoryTech Corporation and Minnesota Power Enterprises, Inc.,  dated December 30, 2005 (Incorporated by reference to Exhibit 2.1A  to the Registrant’s Current Report on Form 8-K filed on January 05,  2006) |
| 10.11       |       | Agreement for Wholesale Financing between  HickoryTech and GE Commercial Distribution Finance Corporation dated February 23,  2006, as amended (Incorporated by reference to the Registrant’s Current  Report on Form 8-K filed April 7, 2006)                                           |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.12+      |       | Change of Control Agreement between HickoryTech  Corporation and Walter E. Prahl (incorporated by reference to Exhibit 10.1  to the Registrant’s Current Report on Form 8-K filed November 30,  2007)                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.13+*     |       | HickoryTech Corporation Executive Incentive Plan  Amended and Restated February 16, 2005                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.14*      |       | Amended and Restated HickoryTech Corporation  Employee Stock Purchase Plan, dated August 1, 2006                                                                                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.15+*     |       | Amended and Restated Change of Control Agreement  dated November 29, 2007 between Registrant and John W. Finke                                                                                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.16+*     |       | Change of Control Agreement between HickoryTech and  John P. Morton dated November 29, 2007                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.17+*     |       | Amended and Restated Change of Control Agreement  dated November 29, 2007 between Registrant and David A. Christensen                                                                                                                                                                                   |
|        |       |                                                                                                                                                                                                                                                                                                         |
| 10.18+*     |       | Amended and Restated Change of Control Agreement  dated November 29, 2007 between Registrant and Lane C. Nordquist                                                                                                                                                                                      |

 

82

----

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                     |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.19+*     |       | Amended and Restated Change of Control Agreement  dated November 29, 2007 between Registrant and Mary T. Jacobs                                                                                                                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.20+*     |       | Change of Control Agreement between HickoryTech and  Damon D. Dutz dated November 29, 2007                                                                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.21+*     |       | Employment agreement between the Company and John W.  Finke, President and Chief Executive Officer of the Company, dated August 10,  2006 which includes a Supplemental Retirement Agreement (Incorporated by  reference to the Registrants Current Report on Form 8-K filed August 16,  2006)  Amendment to Employment  Agreement dated November 29, 2007 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.22+*     |       | Employment Agreement between HickoryTech and John P.  Morton dated December 20, 2006 and Amendment to Employment Agreement  dated November 29, 2007                                                                                                                                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 14          |       | Code of Ethics (Incorporated by reference to Exhibit 14  to the registrant’s Form 10-K filed March 14, 2004)                                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 21*         |       | Subsidiaries of HickoryTech Corporation                                                                                                                                                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 23.1*       |       | Consent of Independent Registered Public Accounting  Firm                                                                                                                                                                                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 23.2*       |       | Consent of Independent Registered Public Accounting  Firm                                                                                                                                                                                                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 31(a)*      |       | Certification of Chief Executive Officer Under Rule 13a-14(a) Adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 31(b)*      |       | Certification of Chief Financial Officer Under Rule 13a-14(a) Adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 32(a)*      |       | Certification of Chief Executive Officer Under 18  U.S.C. 1350 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                |
| 32(b)*      |       | Certification of Chief Financial Officer Under 18  U.S.C. Section 1350 Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                                                                                         |

 

----

*   Filed herewith.

+   Management compensation plan or arrangementrequired to be filed as an exhibit.

 

83

----

 

**SCHEDULEII - VALUATION AND QUALIFYING ACCOUNTS**

**HickoryTech Corporation**

***(Dollars inthousands)***

 
| ** **                              | ** ** | ** **            | ** ** | **Additions**       | ** ** | ** **          | ** ** | ** **     | ** ** |
|-----------------------------------------|------------|-----------------------|------------|---------------------|------------|---------------------|------------|----------------|------------|
| ** **                              | ** ** | **Balance at**   | ** ** | **Charged to** | ** ** | **Charged to** | ** ** | ** **     | ** ** | **Balance at** | ** ** |
| ** **                              | ** ** | **Beginning of** | ** ** | **Costs and**  | ** ** | **Other**           | ** ** | ** **     | ** ** | **End of** | ** ** |
| **Description**                         | ** ** | **Period**            | ** ** | **Expenses**        | ** ** | **Accounts**        | ** ** | **Deductions** | ** ** | **Period** | ** ** |
|                                    |       |                  |       |                |       |                |       |           |       |   |   |
| Year Ended  December 31, 2005           |       |                  |       |                |       |                |       |           |       |   |   |
| Allowance for  Doubtful Accounts        |       | $                     | 1,256      |                | $          | 953                 |       | $              | —     |   | $ | (1,875 | ) | $ | 334 |   |
| Inventory  Valuation Reserve            |       | 1,432                 |       | 239                 |       | —              |       | (1,405         | )          | 266 |   |
| Deferred Tax  Asset Valuation Allowance |       | 1,205                 |       | 326                 |       | —              |       | —         |       | 1,531 |   |
| Total                                   |       | $                     | 3,893      |                | $          | 1,518               |       | $              | —     |   | $ | (3,280 | ) | $ | 2,131 |   |
|                                    |       |                  |       |                |       |                |       |           |       |   |   |
| Year Ended  December 31, 2006           |       |                  |       |                |       |                |       |           |       |   |   |
| Allowance for  Doubtful Accounts        |       | $                     | 334        |                | $          | 1,043               |       | $              | —     |   | $ | (526 | ) | $ | 851 |   |
| Inventory  Valuation Reserve            |       | 266                   |       | 438                 |       | —              |       | (242           | )          | 462 |   |
| Deferred Tax  Asset Valuation Allowance |       | 1,531                 |       | 85                  |       | —              |       | —         |       | 1,616 |   |
| Total                                   |       | $                     | 2,131      |                | $          | 1,566               |       | $              | —     |   | $ | (768 | ) | $ | 2,929 |   |
|                                    |       |                  |       |                |       |                |       |           |       |   |   |
| Year Ended  December 31, 2007           |       |                  |       |                |       |                |       |           |       |   |   |
| Allowance for  Doubtful Accounts        |       | $                     | 851        |                | $          | 139                 |       | $              | —     |   | $ | 194 |   | $ | 1,184 |   |
| Inventory  Valuation Reserve            |       | 462                   |       | 161                 |       | —              |       | (225           | )          | 398 |   |
| Deferred Tax  Asset Valuation Allowance |       | 1,616                 |       | —              |       | —              |       | (66            | )          | 1,550 |   |
| Total                                   |       | $                     | 2,929      |                | $          | 300                 |       | $              | —     |   | $ | (97 | ) | $ | 3,132 |   |

 

84

----

 

**SIGNATURES**

 

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

 
| Dated:     February 29,  2008 | HICKORYTECH CORPORATION |
|--------------------------------------------------------|-------------------------|
|                                                   |                    |
|                                                   | By:                     | /s/ David A. Christensen |
|                                                   |                    |
|                                                   |                    | David A. Christensen, Secretary |
|                                                   |                    | Senior Vice President, Chief Financial |
|                                                   |                    | Officer and Treasurer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the following persons onbehalf of the registrant and in the capacities and on the dates indicated havesigned this report.

 
| /s/ R. Wynn Kearney, Jr.                          |   | February 29, 2008 |
|--------------------------------------------------------|--------|------------------------|
| R. Wynn Kearney, Jr., Chair                       |   |
|                                                   |   |
| /s/ John W. Finke                                      |   | February 29, 2008 |
| John W. Finke                                          |   |
| President, Chief Executive Officer and Director        |   |
| (principal executive officer)                          |   |
|                                                   |   |
| /s/ David A. Christensen                               |   | February 29, 2008 |
| David A. Christensen, Secretary, Senior Vice           |   |
| President, Chief Financial Officer and Treasurer       |   |
| (principal financial officer and principal  accounting |   |
| officer)                                               |   |
|                                                   |   |
| /s/ James W. Bracke                                    |   | February 29, 2008 |
| James W. Bracke, Director                              |   |
|                                                   |   |
| /s/ Myrita P. Craig                                    |   | February 29, 2008 |
| Myrita P. Craig, Director                              |   |
|                                                   |   |
| /s/ James H. Holdrege                                  |   | February 29, 2008 |
| James H. Holdrege, Director                            |   |
|                                                   |   |
| /s/ Dale E. Parker                                     |   | February 29, 2008 |
| Dale E. Parker, Director                               |   |
|                                                        |        |                        |  |

 

(a majority ofdirectors)

 

85

----