**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the fiscal year ended December 31, 2003**

 

**Commission FileNumber:  0-13721**

 

**HICKORY TECH CORPORATION**

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

 

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

 

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

 

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

 

As of June 30, 2003, the aggregate market value of the common stockheld by non-affiliates of the registrant was $153,317,388 based on the lastsale price of $11.21 on The Nasdaq National Market.

 

The total number of shares of the registrant’s common stock outstandingas of February 27, 2004:  12,967,886.

 

Documents Incorporated byReference:  Portions of the registrant’s definitive Proxy Statementfor the Annual Meeting of Shareholders to be held on April 26, 2004 (“ProxyStatement”) are incorporated by reference in Part III of this Form 10-K.

 

 

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**INDEX**

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

 

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**PARTI**

 

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

 

##### **GENERAL**

 

Hickory Tech Corporation(HickoryTech) is a diversified communications company headquartered in Mankato,Minnesota. Incorporated in Minnesota in 1985, HickoryTech has over a 100-yearhistory in the local telephone exchange business. From those roots, it hasexpanded into three business segments: Telecom Sector, Information Solutions Sector,and Enterprise Solutions Sector. HickoryTech’s core business is its TelecomSector, which consists of two businesses. One of these businesses is theoperation of three incumbent local exchange carriers (ILECs). This businessconsists of connecting customers to the telephone network, providing switchedservice and dedicated private lines, connecting customers to long distanceservice providers and providing many other services commonly associated withILECs. The second business of the Telecom Sector is competitive local exchangecarrier (CLEC) services, which HickoryTech initiated in 1998, and itsassociated competitive businesses of long distance service and Internet access.This business leverages HickoryTech’s expertise and expands its telecommunicationsservice into areas served by other ILECs. In December of 2003, HickoryTech soldwhat had been a third business of the Telecom Sector, which provided wirelesstelecommunications services to customers in southern Minnesota and itssurrounding area, along with an area surrounding Minneapolis/St. Paul. Thewireless operations are reported as part of the Telecom Sector. All financialstatements and schedules have been restated to reflect wireless operations asdiscontinued operations. In addition to the Telecom Sector, HickoryTechprovides data processing services to the telecommunications industry(Information Solutions Sector) and provides telephone and data equipment salesand service as well as the sale, installation and ongoing service of voice overInternet Protocol equipment (Enterprise Solutions Sector).

 

The eight subsidiaries ofHickoryTech and the business segments in which they operate are:

 

**TELECOM SECTOR**

•                       MankatoCitizens Telephone Company (MCTC)

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

•                       HeartlandTelecommunications Company of Iowa, Inc. (Heartland)

•                       CableNetwork, Inc. (CNI)

•                       CrystalCommunications, Inc. (Crystal)

•                       MinnesotaSouthern Wireless Company (MSWC) – Discontinued Operations

 

**INFORMATION SOLUTIONSSECTOR**

•                       NationalIndependent Billing, Inc. (NIBI)

 

**ENTERPRISE SOLUTIONSSECTOR**

•                       CollinsCommunications Systems Co. (Collins)

 

HickoryTech and itssubsidiaries are engaged in businesses that provide services to their customersfor a fee. Many of these services are recurring, and, as a result, backlogorders and seasonality are not significant factors. Working capitalrequirements primarily involve the funding of the construction of networks andswitches and maintenance of a relatively high amount of fixed assets. Otherworking capital requirements include the payroll costs of highly skilled labor,the inventory to service its telephone equipment customers and the carryingvalue of trade accounts receivable for periods up to ninety days in the normalcourse of business.

 

The materials and supplies thatare necessary for the operation of the businesses of HickoryTech and itssubsidiaries are available from a variety of sources, and no future supplyproblems are anticipated. All of HickoryTech’s central office switches, as wellas a majority of HickoryTech’s equipment sold in its Enterprise SolutionsSector, are supplied by Nortel. Nortel is a leading supplier of communicationsequipment, and HickoryTech’s dependence on this brand is not viewed as asignificant risk. An additional layer of network infrastructure equipment forbroadband services is provided by Nextlevel. Nextlevel, a subsidiary ofMotorola, is a newer supplier of communications equipment and the Company ismonitoring the risk of maintaining Nextlevel as a supplier.

 

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HickoryTech makes available,free of charge, copies of its annual reports on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K and amendments to these reports filed orfurnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of1934 as amended (the “Exchange Act”). These reports are available onHickoryTech’s Internet website http://www.hickorytech.com as soon as reasonablypracticable after such material is electronically filed with or furnished tothe Securities and Exchange Commission.

 

As of December 31, 2003,HickoryTech had 414 full-time equivalent employees.

 

**ACQUISITIONS**

 

On June 26, 2001, HickoryTechacquired two digital personal communications services (PCS) licenses from McLeodUSAIncorporated for $11,100,000 in cash. The PCS licenses acquired by HickoryTech included the Minnesota BasicTrading Areas (BTAs) of Mankato-Fairmont and Rochester-Austin-Albert Lea, anarea covering a population of approximately 493,000 people.  The acquisition was a purchase of thelicenses only.  There were no customers,existing revenue stream or physical property and equipment included with thisacquisition, as the BTAs were undeveloped. All FCC minimum buildoutrequirements were met, thus securing the FCC licenses.  The operations of these PCS licenses areincluded in wireless operations, which are part of the Telecom Sector. Asdescribed below, the wireless business was sold in December 2003.

 

**DISPOSITIONS**

 

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

 

On August 6, 2001, HickoryTechsold its local telephone exchange in Amana, Iowa to South Slope CooperativeTelephone Company, Inc. for $6,500,000 in cash. The Amana operation, known asAmana Colonies Telephone Company (ACTC), served approximately 1,500 accesslines in the seven communities of the Amana Colonies in east central Iowa.  HickoryTech recorded a pre-tax gain on thesale of $1,015,000 ($566,000 net of tax). HickoryTech used the proceeds from the sale to repay a portion of itsoutstanding debt. The operations of ACTC were included in the Telecom Sector.  For the years ended December 31, 2001 and2000, ACTC generated revenues of $832,000 and $1,467,000, and generated anoperating income (loss) of ($13,000) and $70,000, respectively.

 

**INDUSTRY SEGMENTS FINANCIAL DATA**

** **

Financial information aboutHickoryTech’s industry segments is included on pages 14 to 21 and pages 43 to45 of this Form 10-K.

 

**INDUSTRY SEGMENTS**

** **

HickoryTech reports thebusiness operations of Telephone, Communications Services, and WirelessServices as a single segment referred to as the Telecom Sector. However, theconsolidated statements of operations for all periods presented have beenrestated to reflect wireless operations as discontinued operations (see Note 3of the Notes to the Consolidated Financial Statements). The other two businesssegments are the Information Solutions and Enterprise Solutions Sectors andthey continue to be reported as previously stated.

 

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TELECOM SECTOR

 

HickoryTech’s Telecom Sectorprovides local exchange wireline telephone service, long distance, Internetaccess and owns and operates fiber optic cable facilities. This sector includesthree incumbent local exchange carriers (ILECs), MCTC, Mid-Comm and Heartland.MCTC and Mid-Comm provide telephone service in south central Minnesota,specifically Mankato (a regional hub) and eleven rural communities surroundingMankato. The third ILEC, Heartland, provides telephone service for eleven ruralcommunities in northwest Iowa.

 

The Telecom Sector alsoincludes Crystal, a competitive local exchange carrier (CLEC). Crystal provideslocal telephone service, long distance and Internet access on a competitivebasis. Crystal has customers in eight rural communities in Minnesota and tworural communities in Iowa that are not in HickoryTech’s ILEC service areas.HickoryTech discontinued its service to four other Iowa communities in 2003.

 

HickoryTech also owns andoperates fiber optic cable facilities in Minnesota in its subsidiary CNI.  These facilities are used to transportinterexchange communications as a service to telephone industry customers.HickoryTech’s Minnesota ILECs and CLEC are the primary users of the fiber opticcable facilities.

 

The Telecom Sector included theoperations of MSWC, which was sold December 15, 2003, and ACTC, which was soldon August 6, 2001. None of the remaining companies in the Telecom Sectorexperienced major changes in operations during 2003.

 

MCTC derives its principalrevenues and income from local services charged to subscribers in its servicearea, access services charged to interexchange carriers and the operation of atoll tandem switching center in Mankato, Minnesota. Revenues and income forMid-Comm are also derived from local service charges in its area of operationand by providing access to long distance services for its subscribers throughthe toll center in Mankato. Local and interexchange telephone access for thetwo companies is provided on an integrated basis. The local and interexchangetelephone access for both telephone companies utilize the same facilities andequipment and is managed and maintained by a common workforce. Heartlandderives its principal revenues and income from local services charged tosubscribers in its service area in Iowa, as well as from providinginterexchange access for its subscribers. Interexchange telephone access isprovided by all three of HickoryTech’s telephone subsidiaries by connecting thecommunications networks of interexchange and wireless carriers with theequipment and facilities of end users through its switched networks or privatelines.

 

MCTC and Mid-Comm are Minnesotapublic 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. These state agencies regulate the servicesprovided by MCTC, Mid-Comm and Heartland. CNI’s operations are not subject toregulation by the state regulatory authority. Neither the Minnesota PublicUtilities Commission nor the Iowa Utilities Board regulates the rate of returnor profits of each of HickoryTech’s ILEC operations due to the size of thesecompanies relative to state regulation. In Minnesota, MCTC and Mid-Comm’s priceand service levels are monitored by regulators. MCTC’s and Mid-Comm’s localservice rates are below those of most Minnesota ILECs. Regardless of whether aparticular rate is subject to regulatory review, the ability of HickoryTech andits subsidiaries to change rates will be determined by various factors,including economic and competitive circumstances.

 

As local exchange telephonecompanies, MCTC, Mid-Comm and Heartland provide end office switching anddedicated circuits to interexchange carriers. These relationships allowHickoryTech’s telephone subscribers to place long distance telephone calls andgain access to the telephone network. HickoryTech provides interexchange accessfor all of the individual customers who select an alternative long distancecarrier. This interexchange access business is separate and distinct fromHickoryTech’s own long distance retail business, which is operated in itsCrystal subsidiary. The long distance interexchange carriers are significantcustomers of HickoryTech, but no carrier represents more than ten percent ofHickoryTech’s consolidated revenues.

 

Alternatives to HickoryTechservice include customers leasing private line switched voice and data servicesin or adjacent to the territories served by HickoryTech, which permits thebypassing of local telephone switching facilities. In addition, wirelesscommunications, microwave transmission services, fiber optic and coaxial cabledeployment and other services provided by other companies permit bypass of thelocal exchange network. These alternatives to local exchange service representa potential threat to HickoryTech’s long-term ability to provide local exchangeservice at economical rates.

 

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Competition in HickoryTech’sILEC service area exists in one of Heartland’s exchanges. In the city ofHawarden, Iowa, the municipal city government overbuilt the city’s telephoneservice infrastructure and is providing an alternative to HickoryTech’stelephone service. The Hawarden CLEC has acquired approximately 1,000 accesslines or approximately 60% of that community’s telephone business fromHickoryTech. HickoryTech management does not believe there will be significantfurther impact from competition in Hawarden. HickoryTech responds tocompetitive changes with active programs to market products and to engineer itsinfrastructure for customer satisfaction.

 

Competition also exists for some of theHickoryTech services provided to interexchange carriers, such as customerbilling services, dedicated private lines, network switching and networkrouting. This competition comes primarily from the interexchange carriersthemselves, in that carriers may decide that the services provided byHickoryTech may be redirected or handled on their own network. The provision ofthese services is of a contractual nature or is month-to-month service out of ageneral tariff, which is a schedule of terms, rates and conditions that isapproved by the appropriate state or federal agency.  In either case, the use of these services is primarily controlledby the interexchange carriers. As interexchange carriers make these servicedecisions, they have the potential to reduce the Company’s revenue in theTelecom Sector. Other services, such as directory advertising and end userequipment, are open to competition. This type of competition is based primarilyon service and experience.

 

In September 2003, a potentialcompetitor filed a request to negotiate interconnection arrangements withHickoryTech’s Minnesota ILECs, MCTC & Mid-Comm. This potential competitoris a multi-state communications company with the ability to offer bundledservices. MCTC and Mid-Comm have made a filing with the Minnesota PublicUtilities Commission exerting their rural exemption from certain components ofthis request. The potential competitor has not, as yet, followed through withits competitive filings in any other jurisdiction, which makes it difficult toassess whether this filing will ultimately result in competition.

 

The passage of the 1996Telecommunications Act created the opportunity for HickoryTech to offercommunications service in territories served by other telephone companies, andCrystal began operations in January 1998 as a competitive local exchangecarrier (CLEC). Crystal offers local service, long distance and Internet accessservices on a competitive basis to customers in towns in southern Minnesota andIowa, which are not served by HickoryTech’s ILEC operations. These serviceofferings provide customers alternatives to the incumbent telephone carrier invarious communities and are offered under the brand name HickoryTech wirelineservice. These services are currently being offered to customers in eight ruralcommunities in Minnesota, as well as two communities in Iowa. Crystal’s primarystrategy is to provide service by overbuilding with new telecommunicationsswitching networks and telephone lines. Crystal also provides the long distanceservice and Internet access services to HickoryTech’s subscribers in both ILECand CLEC markets.

 

CLEC activities require Crystalto file for authority to operate with the appropriate public utilitiescommission in each state it serves. Crystal competes directly against existingILECs in the areas in which Crystal operates. Crystal is not dependent upon anysingle customer or small group of customers. No single customer in Crystalaccounts for ten percent or more of HickoryTech’s consolidated revenues.

 

It is common in the ILEC industry forcarriers to dispute certain access charges. There is currently a multi-stateILEC industry dispute with a large RBOC (Regional Bell Operating Company)regarding certain access charges. The ILEC industry in Minnesota has jointlyfiled a formal complaint regarding this dispute with the Minnesota PublicUtilities Commission.

 

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

 

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In connection with thedetermination by management in the third quarter of 2003 that it would pursuethe sale of its wireless operations and that the selling price would likely beless than the current carrying value of the wireless net assets, the Companycompleted an impairment test in the third quarter of 2003 for the FCC licensespursuant to the requirements of SFAS No. 142, “Goodwill and Other IntangibleAssets.” Management estimated the fair value of the FCC licenses using adiscounted cash flow technique consistent with the method used by the Companyin performing its most recent impairment analysis at December 31, 2002. As aresult of this assessment, management determined that the FCC licenses wereimpaired and recorded an impairment charge of $21,000,000 ($18,638,000 net ofincome taxes), in the third quarter of 2003. This impairment charge is recordedas a component of the loss on discontinued operations in HickoryTech’sconsolidated statement of operations for the year ended December 31, 2003.HickoryTech believes that the decline in the fair value of its FCC licenses wasdue principally to the rapid pace of technological change being undertaken bythe major wireless service providers to adopt new protocols (i.e. GSM or CDMA)and potentially move away from HickoryTech’s current primary protocol calledTDMA, which greatly hindered HickoryTech’s position in finding a future roamingpartner. Other factors include declining roaming revenues, increasing pricecompetition, and the protracted downturn in the wireless market. The FCClicenses were tested for impairment on an aggregate basis, which was consistentwith HickoryTech’s management of the wireless business.

 

Pursuant to SFAS No. 144,“Accounting for Impairment or Disposal of Long-Lived Assets,” (SFAS No. 144),the Company recorded an impairment charge during the third quarter of 2003related to the other long-lived assets of the wireless business of $4,345,000($3,856,000 net of income taxes). This charge is also recorded as a componentof the loss on discontinued operations in HickoryTech’s consolidated statementof operations for the year ended December 31, 2003.

 

INFORMATION SOLUTIONS SECTOR

 

Through NIBI, HickoryTech’sInformation Solutions Sector provides data processing and related services,principally for HickoryTech, other local exchange telephone companies, CLECs,interexchange network carriers, wireless companies, municipalities andutilities. The Information Solutions Sector’s principal activity is the provisionof monthly batch processing of computerized data for HickoryTech as well asnon-affiliated companies. Services for telephone company customers include theprocessing of long distance telephone calls from data sources and telephoneswitches, the preparation of the subscriber telephone bills, customer recordkeeping, carrier access bills and general accounting and payroll services.NIBI, under the brand name HickoryTech Information Solutions, also providescertain billing clearinghouse functions for interexchange carriers.

 

There are a number of companiesengaged in supplying data processing services comparable to those furnished bythe Information Solutions Sector. Competition is based primarily on price andservice. HickoryTech’s Information Solutions Sector has developed an integratedbilling and management system called SuiteSolution. SuiteSolution can providewireline and wireless carriers the individual benefits of a billing platform ora total system solution. Management is unable to quantify what effect, if any,the sale of the wireless business may have on the marketplace for this product.

 

ENTERPRISE SOLUTIONS SECTOR

 

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

 

Revenues are primarily earnedby the sales, installation and service of business telephone and data systems.Enterprise Solutions continues its commitment to service and support its coreproduct, Nortel, while identifying new opportunities such as call centers,computer telephone integration voice mail and interactive voice responsesystems.

 

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HickoryTech’s EnterpriseSolutions Sector is not dependent upon any single customer or small group ofcustomers. No single customer in the Enterprise Solutions Sector accounts forten percent or more of HickoryTech’s consolidated revenues.

 

Enterprise Solutions doesbusiness in a competitive market where a large number of companies compete forthe sale, installation and servicing of telecommunications equipment and voiceover Internet Protocol communications products. Competition is based primarilyon price and service. No single company is dominant in this market.

 

**OTHER REGULATION**

 

HickoryTech does not anticipateany material effects on its earnings, capital expenditures or competitiveposition because of laws pertaining to the protection of the environment.

 

**OTHER COMPETITION**

 

Since the mid-1980’s,HickoryTech’s business strategy has been to position itself as a qualitytelecommunications services provider. Long-term business relationships with itscustomers have strengthened HickoryTech’s business position. HickoryTechbelieves that its customers value the fact that it is the “local company” whosegoal is to meet the customers’ communications needs. HickoryTech has severalcompetitive advantages: its prices; its service; its investment in technology;it has a direct billing relationship with almost all of the customers in itsservice territories; and it is positioned to offer a wide range of wiredtelecommunications service from one source.

 

The long-range effect ofcompetition on the provision of telecommunications services and equipment willdepend on technological advances, regulatory actions at both the state andfederal levels, court decisions, and possible additional future state andfederal legislation. The trend resulting from past legislation has been toexpand competition in the telecommunications industry. It is imperative to HickoryTechthat competition in this industry remains open on an equal basis to allproviders.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Form10-K Annual Report, Management’s Discussion and Analysis and other sections ofthis Annual Report contain forward-looking statements that are based on currentexpectations, estimates and projections about the industry in which HickoryTechoperates and management’s beliefs and assumptions.  Such forward-looking statements are subject to uncertainties thatcould cause HickoryTech’s future actual results to differ materially from suchstatements. Forward-looking statements include the information concerning ourfuture financial performance, continuation of historical trends, businessstrategy, projected plans and objectives, future liquidity and capital resourceneeds, the effect of regulatory changes on the business, the effect ofdecisions by other telecommunications carriers, the economy in general, and thefuture of the communications industry and communications services. These statementsare not guarantees of future performance and involve certain risks,uncertainties and probabilities, which are difficult to predict. Therefore,actual outcomes and results may differ materially from what is expressed orforecasted in such forward-looking statements, whether as a result of newinformation, future events or otherwise. Factors that might cause such adifference include:

 

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

 

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

 

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

 

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

 

•                       the effect of decisions by othertelecommunications carriers which currently utilize services of the Company andmay affect future operations and future capital resource needs;

 

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

 

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

 

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

 

•                       the ability to secure financing for futureexpansion and operations;

 

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

 

•                       the ability to retain key employees;

 

•                       other risks and uncertainties which may affectthe operating results.

 

Additionalinformation concerning these and other factors that could cause actual resultsor events to differ materially from current expectations are contained inExhibit 99, which is incorporated herein by reference.  You are cautioned not to place unduereliance on these forward looking statements, which speak only as of the dateon which they were made. Except as otherwise required by law, HickoryTechundertakes no obligation to update any of its forward-looking statements forany reason.

 

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

 

HickoryTech’s business isprimarily focused on the provision of services and its properties are used foradministrative support and to store and safeguard equipment. At December 31,2003, HickoryTech’s gross property, plant and equipment of $230,490,000consisted primarily of telephone switches, cable and network equipment.HickoryTech owns or leases the telephone property, plant and equipment which itutilizes to operate its telephone systems. The three ILEC subsidiaries ofHickoryTech in Minnesota and Iowa own central telephone offices with relatedreal estate in all of the communities they serve. HickoryTech’s Telecom Sectorowns the telephone network, including telephone outside plant, fiber opticcable and central office equipment, over which they provide services to theircustomers. It is the opinion of HickoryTech’s management that the properties ofHickoryTech are suitable and adequate to provide modern and effectivetelecommunications services within its service areas, including both local andlong distance service. The capacity for furnishing these services bothcurrently and in the future is under ongoing review by HickoryTech’sengineering staff. Facilities are placed in full use after installation andappropriate testing under the guidance associated with multi-year capitalexpenditure plans.

 

HickoryTech’s principal property locations are the following:

 

(1)                                  MCTC’sgeneral offices and principal central office exchange building are located indowntown Mankato, Minnesota. This facility is owned by MCTC and is athree-level brick and stone building containing approximately 60,000 squarefeet of floor space.

 

(2)                                  MCTC’smain warehouse is located in Mankato, Minnesota. The warehouse, built in 1996,is owned by MCTC and is a two-story concrete building containing approximately48,000 square feet. The warehouse is used to store vehicles and supplies and isalso used as office space for engineers and technicians.

 

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

 

(4)                                  Crystalleases office space of approximately 6,800 square feet in Mankato, Minnesotaand approximately 2,000 square feet in West Des Moines, Iowa.

 

(5)                                  NIBIowns a four-level building in Mankato, Minnesota containing approximately17,000 square feet.

 

(6)                                  Collinsleases approximately 26,000 square feet of office building and warehouse spacein Roseville, Minnesota.

 

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**Item3****.    LegalProceedings.**

 

There are no material pendinglegal or governmental proceedings directly involving HickoryTech or itssubsidiaries, other than ordinary routine litigation or ordinary routineutility matters, incidental to the business of HickoryTech and its subsidiaries.

 

**Item4****.    Submission ofMatters to a Vote of Security Holders.**

 

No matters were submitted to avote of security holders during the fourth quarter of the fiscal year coveredby this 2003 Annual Report on Form 10-K.

 

**PART II**

 

**Item5****.    Market forRegistrant’s Common Equity and Related Stockholder Matters**.

 

The common stock of HickoryTechis traded on The Nasdaq National Market under the symbol “HTCO”.

 

The following table sets forthfor the period indicated, the high and low closing sales price of the commonstock.

 
|     |        | **High** |   | **Low** |   | **End of  Qtr.** |   |
|----------|-------------|----------|--------|---------|--------|------------------|--------|
| **2003** | 4th Quarter |     | $      | 12.20   |   | $                | 10.76  |   | $ | 11.47 |   |
|     | 3rd Quarter |     | $      | 12.35   |   | $                | 10.82  |   | $ | 11.60 |   |
|     | 2nd Quarter |     | $      | 11.48   |   | $                | 8.43   |   | $ | 11.21 |   |
|     | 1st Quarter |     | $      | 10.61   |   | $                | 7.90   |   | $ | 8.97 |   |
|     |        |     |   |    |   |             |   |
| **2002** | 4th Quarter |     | $      | 13.34   |   | $                | 8.39   |   | $ | 9.53 |   |
|     | 3rd Quarter |     | $      | 16.05   |   | $                | 11.21  |   | $ | 13.25 |   |
|     | 2nd Quarter |     | $      | 17.80   |   | $                | 12.75  |   | $ | 15.00 |   |
|     | 1st Quarter |     | $      | 17.85   |   | $                | 13.14  |   | $ | 16.27 |   |

 

As of February 27, 2004, therewere approximately 3,249 holders of record of common stock, registered and instreet name accounts.

 

HickoryTech has declaredquarterly dividends on its common stock of $0.11 per share during the two yearsended December 31, 2003. A quarterly cash dividend of $0.11 per share was paidon March 5, 2004 to stockholders of record at the close of business on February15, 2004.

 

9

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**Item6****.    SelectedFinancial Data.**

 

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

 
|                                                        |   | **2003**       |        | **2002**   |   | **2001**   |   | **2000**   |    | **1999**   |   |
|-------------------------------------------------------------|--------|----------------|-------------|------------|--------|------------|--------|------------|---------|------------|--------|
| **FOR THE YEAR:**                                           |   |           |        |       |   |       |   |       |    |       |   |
| Operating Revenues (A)(B)                                   |   |           | ** **  |       |   |       |   |       |    |       |   |
| Telecom Sector                                              |   | **$**          | **75,346**  | ** ** | $      | 71,108     |   | $          | 66,364  |       | $      | 60,606 |   | $ | 53,347 |   |
| Information Solutions Sector                                |   | **3,199**      | ** **  | 4,249      |   | 4,085      |   | 4,287      |    | 4,368      |   |
| Enterprise Solutions Sector                                 |   | **14,347**     | ** **  | 15,781     |   | 20,374     |   | 18,511     |    | 22,576     |   |
| Total Revenues                                              |   | **$**          | **92,892**  | ** ** | $      | 91,138     |   | $          | 90,823  |       | $      | 83,404 |   | $ | 80,291 |   |
|                                                        |   |           | ** **  |       |   |       |   |       |    |       |   |
| Income from Continuing Operations                           |   | **$**          | **8,455**   | ** ** | $      | 6,235      |   | $          | 6,890   |       | $      | 5,351 |   | $ | 12,356 |   |
|                                                        |   |           | ** **  |       |   |       |   |       |    |       |   |
| **PER SHARE:**                                              |   |           | ** **  |       |   |       |   |       |    |       |   |
| Fully Diluted Earnings Per Share -  Continuing Operations   |   | **$**          | **0.61**    | ** ** | $      | 0.44       |   | $          | 0.49    |       | $      | 0.38 |   | $ | 0.90 |   |
| Fully Diluted Earnings Per Share -  Discontinued Operations |   | **(1.53**      | **)**       | (1.62      | )      | 0.13       |   | 0.17       |    | 0.16       |   |
|                                                        |   | **$**          | **(0.92**   | **)**      | $      | (1.18      | )      | $          | 0.62    |       | $      | 0.55 |   | $ | 1.06 |   |
| Dividends Per Share                                         |   | **$**          | **0.44**    | ** ** | $      | 0.44       |   | $          | 0.44    |       | $      | 0.44 |   | $ | 0.44 |   |
|                                                        |   |           | ** **  |       |   |       |   |       |    |       |   |
| **AT YEAR END:**                                            |   |           | ** **  |       |   |       |   |       |    |       |   |
| Total Assets (C)                                            |   | **$**          | **175,712** | ** ** | $      | 186,143    |   | $          | 189,179 |       | $      | 169,033 |   | $ | 129,371 |   |
| Shareholders’ Equity                                   |   | **$**          | **28,717**  | ** ** | $      | 58,595     |   | $          | 80,765  |       | $      | 77,357 |   | $ | 74,476 |   |
| Total Debt, Long-Term and Current                           |   | **$**          | **119,612** | ** ** | $      | 159,040    |   | $          | 170,901 |       | $      | 148,650 |   | $ | 111,361 |   |
| Debt Ratio (D)                                              |   | **80.6**       | **%**       | 73.1       | %      | 67.9       | %      | 65.8       | %       | 59.9       | %      |
|                                                        |   |           | ** **  |       |   |       |   |       |    |       |   |
| **CUSTOMER DATA (year end):**                               |   |           | ** **  |       |   |       |   |       |    |       |   |
| ILEC Access Lines (E)                                       |   | **63,099**     | ** **  | 65,355     |   | 66,393     |   | 67,120     |    | 64,969     |   |
| CLEC Access Lines (F)                                       |   | **14,147**     | ** **  | 13,984     |   | 11,573     |   | 8,283      |    | 3,704      |   |
| Internet Customers (G)                                      |   | **16,132**     | ** **  | 14,420     |   | 12,816     |   | 12,129     |    | 5,835      |   |
| Long Distance Subscribers (H)                               |   | **40,366**     | ** **  | 35,566     |   | 24,241     |   | 18,366     |    | 12,146     |   |
|                                                        |   |           | ** **  |       |   |       |   |       |    |       |   |
| **OTHER DATA:**                                             |   |           | ** **  |       |   |       |   |       |    |       |   |
| Employees (year end) (I)                                    |   | **414**        | ** **  | 481        |   | 502        |   | 552        |    | 502        |   |
| Capital Expenditures                                        |   | **$**          | **11,237**  | ** ** | $      | 12,381     |   | $          | 30,174  |       | $      | 34,681 |   | $ | 24,280 |   |
| Shares Outstanding (year end)                               |   | **12,967,811** | ** **  | 13,983,929 |   | 13,935,308 |   | 13,878,568 |    | 13,787,416 |   |
| Share Price (J) (year end)                                  |   | **$**          | **11.47**   | ** ** | $      | 9.53       |   | $          | 16.95   |       | $      | 20.50 |   | $ | 15.00 |   |
| Shareholders (K)                                            |   | **3,249**      | ** **  | 3,193      |   | 3,339      |   | 3,300      |    | N/A        |   |

 

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(A)           Dispositionof HickoryTech’s subsidiary, Amana Colonies Telephone Company (ACTC) in 2001,has affected HickoryTech’s revenue trends.

 

(B)             DuringDecember 2003, HickoryTech sold its wireless operations. Revenues for allperiods have been restated to exclude revenues of the wireless operations, asthey are included in discontinued operations for all periods presented.

 

(C)             DuringDecember 2003, HickoryTech sold its wireless operations. Total assets for allperiods have been restated to exclude wireless assets.

 

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

 

(E)              ILECLines refer to the local exchange telephone access lines in the Telecom Sector.ILEC Lines include ISDN (High Speed Data) and pay station lines of 2,115 in2003, 2,406 in 2002, 2,196 in 2001, 2,198 in 2000 and 1,683 in 1999.

 

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

 

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

 

(H)            LongDistance service accounts are provided in the Telecom Sector to ILEC and CLECcustomers.

 

(I)                 Allemployee counts reflect actual employee counts at year end. No numbers wererestated for the wireless sale.

 

(J)                Priceis the last day closing price.

 

(K)            Numberof Shareholders is approximate total of Company registrations and street nameaccounts. Data prior to 2000 is not available.

 

10

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**Item7****.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

**BUSINESSES**

 

HickoryTech operates in threebusiness segments: the Telecom, Information Solutions and Enterprise SolutionsSectors. Its largest and oldest business (since 1898) has been the operation ofincumbent local exchange carriers (ILECs) or traditional wireline telephoneservice. The ILEC business is in HickoryTech’s Telecom Sector. In 1998,HickoryTech began its competitive local exchange carrier (CLEC) line ofbusiness, competing for the telephone dial tone, Internet, data and longdistance calling business in other ILEC territories. The CLEC business is inHickoryTech’s Telecom Sector. Since 1964, HickoryTech’s Information SolutionsSector has provided computer data processing and software, predominantly forHickoryTech’s Telecom Sector operations and also to other telecommunicationscompanies. HickoryTech acquired its Enterprise Solutions Sector in 1990 and ithas operated as a telecommunications and data equipment distributor from a basein Minneapolis/St. Paul, Minnesota. HickoryTech also began its wirelessoperations in 1998 by acquiring its first wholly owned wireless servicelicense, an additional wireless service license in 1999 and two PCS licenses in2001. HickoryTech sold the wireless operations on December 15, 2003. Thewireless operations are reported as part of the Telecom Sector. All financialstatements and schedules have been restated to reflect wireless operations asdiscontinued operations for all periods presented.

 

**THE COMPANY**

 

The eight subsidiaries ofHickoryTech, all of which publicly operate and conduct business as HickoryTech,and the business segments in which they operate are:

 

**TELECOM SECTOR**

MankatoCitizens Telephone Company

Mid-Communications,Inc.

HeartlandTelecommunications Company of Iowa, Inc.

Cable Network,Inc.

CrystalCommunications, Inc.

MinnesotaSouthern Wireless Company – Discontinued Operations

**INFORMATION SOLUTIONSSECTOR**

NationalIndependent Billing, Inc.

**ENTERPRISE SOLUTIONSSECTOR**

CollinsCommunications Systems Co.

** **

**EXECUTIVE SUMMARY OF 2003**

 

The Company’s focus in 2003 wasinternal, on making the Company stronger and positioning it for the future.Management improved operational efficiencies by managing expenses andcontaining costs, and by expanding the volume and scope of products offered,particularly broadband services. Although the economy presented challenges,management’s objective was to position the Company for 2004 and beyond. Thegoals for 2004 and beyond are to increase revenues by adding customers and toincrease scope, the breadth of products sold and markets served. Strategieswill resemble those of 2003, with continued emphasis on operationalefficiencies and expanding market penetration with new and existing products.

 

The most significant change forHickoryTech in 2003 was the sale of the wireless business.  The sale allowed HickoryTech to retire1,038,927 shares of HickoryTech stock, which will reduce the level of dilutionexperienced by shareholders. The cash received from the sale was used to repaya portion of HickoryTech’s outstanding debt.

 

Management believes the ILECbusinesses remain financially strong, even though threats of competition exist.The CLEC business continued to grow and contribute to the Company’ssuccess.  Access revenues have remainedconsistent, but competition, regulatory changes and usage could impact theserevenues going forward.

 

11

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Information Solutions andEnterprise Solutions experienced lower revenues in 2003 compared to 2002.  As a result, management implemented costreductions in these segments.  Due toeconomic factors, there could be a continued decline in revenues for these twosectors in 2004.

 

The sale of the wirelessbusiness allows management to focus on its core wireline and broadbandbusinesses in 2004. Although the Company focused on the sale of the wirelessbusiness and on internal growth 2003, the Company will focus on internal andstrategic growth in 2004.

 

**CONSOLIDATEDRESULTS OF OPERATIONS**

 

**2003 Compared to 2002**

•                       2003consolidated revenues were $92,892,000, a $1,754,000 or 1.9% increase relativeto 2002. This increase was largely due to increases in revenues in the TelecomSector resulting from increases in network access revenues, the CLEC customerbase and increased broadband data service lines installed.  This increase was partially offset bydecreases in revenues in the Information Solutions and Enterprise SolutionsSectors.

 

•                       BadDebt expense was $1,109,000 lower in 2003 compared to 2002, due in large partto bankruptcies of interexchange carriers in the telecommunications industry in2002.

 

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

 

**2002 Compared to 2001**

 

•                       BadDebt expense was $1,373,000 higher in 2002 compared to 2001, due in large partto bankruptcies of interexchange carriers in the telecommunications industry.

 

•                       InterestExpense was $3,449,000 lower in 2002 compared to 2001, primarily due to adecrease in total debt outstanding.  Theoutstanding balance of the revolving credit facility was $158,000,000 atDecember 31, 2002 and $170,000,000 at December 31, 2001.

 

**OVERALL SUMMARY OF CONTINUING OPERATIONS**

 
| **Years Ended December 31,**      |   | **2003**                    |       | **2002**   |   | **2001** |   |
|-----------------------------------|--------|-----------------------------|------------|------------|--------|----------|--------|
|                              |   | **(Dollars  in Thousands)** |       |
|                              |   |                        |       |       |   |     |   |
| Operating Income/(Loss)           |   |                        | ** ** |       |   |     |   |
| Telecom Sector                    |   | **$**                       | **25,095** | ** ** | $      | 22,679   |   | $ | 20,976 |   |
| Information Solutions Sector      |   | **(3,576**                  | **)**      | (3,289     | )      | (658     | )      |
| Enterprise Solutions Sector       |   | **(1,358**                  | **)**      | (12        | )      | 1,340    |   |
| Corporate                         |   | **18**                      | ** ** | (1,809     | )      | 425      |   |
|                              |   | **20,179**                  |       | 17,569     |   | 22,083   |   |
| Other Income                      |   | **62**                      | ** ** | 320        |   | 372      |   |
| Interest Expense                  |   | **(6,103**                  | **)**      | (7,405     | )      | (10,854  | )      |
| Income Taxes                      |   | **(5,683**                  | **)**      | (4,249     | )      | (4,711   | )      |
| Income from Continuing Operations |   | **$**                       | **8,455**  | ** ** | $      | 6,235    |   | $ | 6,890 |   |

 

12

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**RESULTSOF OPERATIONS**

 

CONSOLIDATED OPERATING RESULTS

 

The following is a summarizeddiscussion of consolidated results of operations. More detailed discussion ofoperating results by segment follows this discussion. Except for the discussionof the wireless business sale transaction and the discussion of discontinuedoperations, all of this discussion of HickoryTech’s operating results excludesthe results of operations of the discontinued wireless business, which havebeen reported as discontinued operations in the Telecom Sector for all periodspresented.

 

OPERATINGREVENUES – Consolidated operating revenues were$1,754,000 or 1.9% higher in 2003 compared to 2002 and $315,000 or 0.3% higherin 2002 compared to 2001.  The increasein 2003 revenues relative to 2002 was largely due to increases in networkaccess revenues, the CLEC customer base and broadband data service linesinstalled, all in the Telecom Sector. This 2003 increase was partially offset by a decrease in revenues in theInformation Solutions Sector, which can largely be attributed to the loss ofcustomers and a few customers who have experienced a significant decrease involumes processed. The Enterprise Solutions Sector also experienced a decreasein revenue in 2003 compared to 2002 due to a decline in equipment sales andservice. The increase in 2002 revenues relative to 2001 was primarilyattributable to the increase in HickoryTech’s total customer base in itsTelecom Sector, the impact of local rate increases by HickoryTech’s ILECs inthe Telecom Sector, and the result of services provided under terms of amulti-year contract awarded to HickoryTech effective July 1, 2002 to provideInternet access and video conferencing to schools and libraries in southcentral Minnesota served by the Project SOCRATES distance-learning network.These increases were partially offset by a lower volume of business in theEnterprise Solutions Sector.

 

COST OF SALES,ENTERPRISE SOLUTIONS - Cost of sales, which is relatedto the Enterprise Solutions Sector was $422,000 or 4.0% lower in 2003 comparedto 2002 and $2,924,000 or 21.6% lower in 2002 compared to 2001.  The change in cost of sales for both yearsis primarily the result of the change in sales volume in the EnterpriseSolutions Sector.  The gross profitmargin in the Enterprise Solutions Sector was 28.8%, 32.6% and 33.4% for 2003,2002, and 2001, respectively.

 

COST OFSERVICES (excluding Asset Impairment, Depreciation and Amortization)– Cost of services excluding asset impairment, depreciation and amortizationwere $473,000 or 1.4% higher in 2003 compared to 2002 and $2,131,000 or 6.9%higher in 2002 compared to 2001. In September of 2003, HickoryTech abandoned aCLEC initiative in a specific market. As a result of this operating decision,HickoryTech abandoned approximately $632,000 of property, plant and equipment,which was written down to a carrying value of zero in the third quarter of2003. Higher service costs in the Telecom Sector associated with increasedcustomer counts in 2003 compared to 2002, were offset by a decrease in bad debtexpense of $1,126,000. The primary reason for the increase in cost of servicesin 2002 compared to 2001 was the recording of additional bad debt expense of$1,455,000, due in large part to bankruptcies of interexchange carriers in thetelecommunications industry.

 

SELLING,GENERAL AND ADMINISTRATIVE EXPENSES (excluding Depreciation and Amortization)– Selling, general and administrative expenses excluding depreciation andamortization were $1,249,000 or 8.7% lower in 2003 compared to 2002, and $2,469,000or 20.7% higher in 2002 compared to 2001. The decrease in selling, general andadministrative expenses in 2003 compared to 2002 was largely the result of areduction in compensation accruals associated with management incentives, whichare tied to financial metrics that were not achieved as a result of the lossfrom discontinued operations recorded in 2003. The increase in selling, generaland administrative expenses in 2002 compared to 2001 was primarily due to wagesand benefits, and other various increased expenses, which are described in moredetails in the sector discussions below.

 

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

 

13

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DEPRECIATIONAND AMORTIZATION - Depreciation expense was $1,303,000or 9.6% higher in 2003 compared to 2002 and $2,832,000 or 26.4% higher in 2002compared to 2001.  The buildout ofHickoryTech’s CLEC and fiber optic networks primarily accounts for the increasein depreciation expense. Amortization expense was $645,000 or 39.3% lower in2003 compared to 2002 and $5,000 or 0.3% higher in 2002 compared to 2001.  The decrease in amortization expense in 2003compared to 2002 was largely due to an intangible asset in the InformationSolutions Sector becoming fully amortized in the second quarter of 2003 and noamortization expense recorded for the WDSL intangible asset in 2003. These impactswere partially offset by lower amortization expense due to the adoption of SFASNo. 142 which caused the company to discontinue amortization of goodwill.

 

OPERATINGINCOME - Operating income was $2,610,000 or 14.9%higher in 2003 compared to 2002 and $4,514,000 or 20.4% lower in 2002 comparedto 2001. The increase in operating income from continuing operations in 2003compared to 2002 was largely due to increased network access revenues,increased CLEC revenues, decreased bad debts in the Telecom Sector and lessincentive compensation in 2003, which were partially offset by the increase incost of services in the Telecom Sector and the decrease in the InformationSolutions and Enterprise Solutions Sectors’ revenues, all of which aredescribed above. The decrease in operating income in 2002 compared to 2001 wasprimarily due to bad debt expenses experienced in 2002 resulting from thebankruptcy of interexchange carriers, along with the increase in depreciationexpense related to building out the infrastructure of the CLEC business in theTelecom Sector and the decrease in operating revenues for the EnterpriseSolutions Sector resulting from fewer equipment installations and increasedwages and benefits, and other various increased expenses as described in moredetail in the sector discussion below. These impacts were partially offset bylower amortization expense due to the adoption of SFAS No. 142 which caused thecompany to discontinue amortization of goodwill.

 

INTERESTEXPENSE - Interest expense was $1,302,000 or 17.6%lower in 2003 compared to 2002 and $3,449,000 or 31.8% lower in 2002 comparedto 2001.  The decrease in interestexpense from continuing operations in 2003 was primarily due to a decrease intotal debt outstanding.  The outstandingbalance of the revolving credit facility was $118,500,000 at December 31, 2003and $158,000,000 at December 31, 2002. The decrease in interest expense in 2002was primarily due to a decrease in the weighted average interest rate onHickoryTech’s revolving credit facility from 6.66% to 4.45% for the years 2001and 2002, respectively, and a decrease in total debt outstanding. Theoutstanding balance of the revolving credit facility was $158,000,000 onDecember 31, 2002 and $170,000,000 on December 31, 2001.

 

INCOME FROMCONTINUING OPERATIONS – Income from continuingoperations was $2,220,000 or 35.6% higher in 2003 compared to 2002 and $655,000or 9.5% lower in 2002 compared to 2001. The increase in 2003 was largely due toincreased network access revenues, increased CLEC revenues, and decreased baddebt in the Telecom Sector, which were partially offset by the increase in costof services in the Telecom Sector, the decrease in the Information Solutionsand Enterprise Solutions Sectors’ revenues and the decrease in interestexpense, as described above. The primary reasons for the decrease in 2002 werethe decrease in operating revenues in the Enterprise Solutions Sector, theincrease in depreciation expense due to the build out of the CLECinfrastructure and the additional bad debt expense recorded in 2002.

 

SECTOR RESULTSOF OPERATIONS

 

TELECOM SECTOR– The following table provides a breakdown of the Information Solutions Sectoroperating results.

 

14

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**TELECOM SECTOR**

 
| **(Dollars in Thousands)**                                                             |   | **2003**    |       | **2002**   |   | **2001** |   |
|----------------------------------------------------------------------------------------|--------|-------------|------------|------------|--------|----------|--------|
|                                                                                   |   |        | ** ** |       |   |     |   |
| Revenues Before Intersegment Eliminations                                              |   |        | ** ** |       |   |     |   |
| ILEC                                                                                   |   |        | ** ** |       |   |     |   |
| Local Service                                                                          |   | **$**       | **15,143** | ** ** | $      | 15,137   |   | $ | 14,498 |   |
| Network Access                                                                         |   | **33,881**  | ** ** | 32,377     |   | 31,442   |   |
| Data                                                                                   |   | **1,857**   | ** ** | 1,557      |   | 1,157    |   |
| Intersegment                                                                           |   | **275**     | ** ** | 274        |   | 274      |   |
| Other                                                                                  |   | **7,099**   | ** ** | 7,459      |   | 8,070    |   |
| Total ILEC                                                                             |   | **58,255**  | ** ** | 56,804     |   | 55,441   |   |
|                                                                                   |   |        |       |       |   |     |   |
| CLEC                                                                                   |   |        | ** ** |       |   |     |   |
| Local Service                                                                          |   | **3,332**   | ** ** | 2,845      |   | 2,123    |   |
| Network Access                                                                         |   | **2,374**   | ** ** | 1,900      |   | 1,353    |   |
| Data                                                                                   |   | **1,301**   | ** ** | 762        |   | 423      |   |
| Other                                                                                  |   | **1,779**   | ** ** | 1,040      |   | 200      |   |
| Total CLEC                                                                             |   | **8,786**   | ** ** | 6,547      |   | 4,099    |   |
|                                                                                   |   |        |       |       |   |     |   |
| Long Distance                                                                          |   | **4,406**   | ** ** | 4,236      |   | 3,960    |   |
|                                                                                   |   |        |       |       |   |     |   |
| Internet                                                                               |   | **3,810**   | ** ** | 3,563      |   | 3,066    |   |
|                                                                                   |   |        |       |       |   |     |   |
| Digital TV                                                                             |   | **364**     | ** ** | 232        |   | 72       |   |
|                                                                                   |   |        |       |       |   |     |   |
| Total Telecom Revenues                                                                 |   | **$**       | **75,621** | ** ** | $      | 71,382   |   | $ | 66,638 |   |
| Total Telecom Revenues Before Intersegment  Eliminations                               |   |        | ** ** |       |   |     |   |
| Unaffiliated Customers                                                                 |   | **$**       | **75,346** | ** ** | $      | 71,108   |   | $ | 66,364 |   |
| Intersegment                                                                           |   | **275**     | ** ** | 274        |   | 274      |   |
|                                                                                   |   | **75,621**  |       | 71,382     |   | 66,638   |   |
|                                                                                   |   |        |       |       |   |     |   |
| Cost of Services, excluding Asset  Impairment, Depreciation and Amortization           |   | **28,071**  | ** ** | 27,540     |   | 26,660   |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization |   | **9,295**   | ** ** | 8,521      |   | 8,357    |   |
| Asset Impairment                                                                       |   | **—**  | ** ** | 316        |   | —   |   |
| Depreciation and Amortization                                                          |   | **13,160**  | ** ** | 12,326     |   | 10,645   |   |
| Operating Income                                                                       |   | **$**       | **25,095** | ** ** | $      | 22,679   |   | $ | 20,976 |   |
|                                                                                   |   |        | ** ** |       |   |     |   |
| Income from Continuing Operations, net of  Tax                                         |   | **$**       | **14,941** | ** ** | $      | 13,617   |   | $ | 12,078 |   |
| Discontinued Operations, net of Tax                                                    |   | **(22,897** | **)**      | (24,164    | )      | 203      |   |
| Net Income                                                                             |   | **$**       | **(7,956** | **)**      | $      | (10,547  | )      | $ | 12,281 |   |
|                                                                                   |   |        | ** ** |       |   |     |   |
| Capital Expenditures                                                                   |   | **$**       | **10,719** | ** ** | $      | 9,600    |   | $ | 28,438 |   |
|                                                                                   |   |        | ** ** |       |   |     |   |
| ILEC Access Lines                                                                      |   | **63,099**  | ** ** | 65,355     |   | 66,393   |   |
| CLEC Access Lines                                                                      |   |        | ** ** |       |   |     |   |
| Overbuild                                                                              |   | **9,871**   | ** ** | 7,796      |   | 5,521    |   |
| Unbundled Network Element (UNE)                                                        |   | **1,647**   | ** ** | 1,343      |   | 1,263    |   |
| Total Service Resale (TSR)                                                             |   | **2,629**   | ** ** | 4,845      |   | 4,789    |   |
| Total                                                                                  |   | **14,147**  | ** ** | 13,984     |   | 11,573   |   |
|                                                                                   |   |        |       |       |   |     |   |
| Long Distance Customers                                                                |   | **40,366**  | ** ** | 35,566     |   | 24,241   |   |
|                                                                                   |   |        |       |       |   |     |   |
| Internet Customers                                                                     |   | **16,132**  | ** ** | 14,420     |   | 12,816   |   |
| Total Telecom Customers                                                                |   | **133,744** | ** ** | 129,325    |   | 115,023  |   |
| Digital Subscriber Line (DSL) Customers                                                |   | **7,407**   | ** ** | 3,971      |   | 1,851    |   |

 

15

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Revenues:

Telecom Sector operatingrevenues before intersegment eliminations were $4,239,000 or 5.9% higher in2003 compared to 2002, and $4,744,000 or 7.1% higher in 2002 compared to 2001.The increases in 2003 and 2002 were primarily due to increased ILEC networkaccess and growth in the CLEC and Internet service revenues. Amana ColoniesTelephone Company (ACTC), which was sold on August 6, 2001, contributed $832,000of revenues to this sector during 2001. Local service rates were increased inHickoryTech’s Iowa ILEC in May 2001 and in the Minnesota ILECs in December2001, which contributed $942,000 of incremental revenue for 2002.  This increase in 2002 compared to 2001 wasprimarily the result of increased ILEC network access and growth in the CLECand Internet service revenues.

 

ILEC network access revenue was$1,504,000 or 4.6% higher in 2003 compared to 2002 and $935,000 or 3.0% higherin 2002 compared to 2001. The increase in network access revenue in 2003 and2002 was driven by higher demand for dedicated lines and high-speed circuits.This was partially offset by a decrease in access minutes in 2003 and 2002.HickoryTech’s ILEC operations do not belong to any NECA traffic sensitiveaccess revenue reimbursement pools, but instead, establishes access ratesbi-annually in accordance with required regulation. Long-term continuation ofthis revenue is uncertain, as changes in the industry occur. ACTC contributed $592,000to network access revenue in 2001. The increase in network access revenue wasdriven by higher demands for dedicated lines and high-speed circuits in 2002.

 

On October 16, 2003, the UnitedStates District Court, District of Minnesota, issued an injunction providingrelief from regulation of an interexchange carrier providing VOIP (Voice OverInternet Protocol) based services in Minnesota. This may result in a change inthe business relationship between HickoryTech ILEC businesses and theinterexchange carriers, as interconnections with certain VOIP providers may notbe governed by tariffed Minnesota access charges. HickoryTech cannot, at thistime, estimate the revenue impact, if any, related to this decision.

 

ILEC data revenue was $300,000or 19.3% higher in 2003 compared to 2002 and $400,000 or 34.6% higher in 2002compared to 2001. The increase in both years is the result of increased DigitalSubscriber Line (DSL) customers in both years.

 

CLEC local service revenue was $487,000 or17.1% higher in 2003 compared to 2002 and $722,000 or 34.0% higher in 2002compared to 2001. In the second quarter of 2003, HickoryTech decided to exitseveral exchanges in its Iowa territories, which utilized a resale of servicesapproach. This exit decision meant that in 2003, HickoryTech stopped providingservice for 734 customers. As a result, revenues are approximately $155,000lower in 2003 compared to 2002. In addition, HickoryTech expects revenues to beapproximately $200,000 lower in 2004 compared to 2003 due to exiting CLECresale in IA. CLEC access lines were still 163 or 1.2% higher in 2003 comparedto 2002 and 2,411 or 20.8% higher in 2002 compared to 2001, which was theprimary reason for the increase in local service revenue in 2003 and 2002. Dueto changes in Minnesota state law and regulatory approvals in both Minnesotaand Iowa, the ILEC businesses with whom HickoryTech competes, are now able toprovide long distance service and face less restrictions on offering bundledservices. A higher degree of competition could impact HickoryTech’s localservice revenue in future periods.

 

CLEC network access revenue was$474,000 or 24.9% higher in 2003 compared to 2002 and $547,000 or 40.4% higherin 2002 compared to 2001. The increase in both years is the result of increasedpenetration in CLEC communities.

 

CLEC data revenue was $539,000or 70.7% higher in 2003 compared to 2002 and $339,000 or 80.1% higher in 2002compared to 2001. The increase in both years is the result of increasedpenetration in CLEC communities.

 

Other CLEC revenue was $739,000or 71.1% higher in 2003 compared to 2002, and $840,000 or 420.0% higher in 2002compared to 2001. The primary reason for the increase in other revenue was theadditional revenue recognized as a result of services provided under terms of amulti-year contract awarded to HickoryTech effective July 1, 2002 to provideInternet access and video conferencing to schools and libraries in southcentral Minnesota served by the Project SOCRATES distance-learning network.This service generated $696,000 more revenue in 2003 compared to 2002 and$761,000 more revenue in 2002 compared to 2001.

 

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Long distance revenue was$170,000 or 4.0% higher in 2003 compared to 2002, and $276,000 or 7.0% higherin 2002 compared to 2001. HickoryTech experienced a 4,800 or 13.5% increase inits long distance customer base in 2003, and an 11,325 or 46.7% increase in2002. During 2003, optional calling plan revenues were reclassified from CLEClocal service revenue to long distance revenue. Without this reclassification,long distance revenue would have been $17,000 or 0.4% lower in 2003 compared to2002 and $222,000 or 5.8% higher in 2002 compared to 2001. Although thecustomer base is increasing, revenue per customer is decreasing. The decreasein revenue per customer is primarily the result of optional long distanceservices available to customers, the increased use of Internet services andother alternatives to long distance services. A competitor of HickoryTechrecently received approval from the state of Minnesota to offer long distanceservices in all HickoryTech territories. This competitor already offers localtelephone service in HickoryTech’s CLEC territories and with this approval, hasthe potential to create stronger competition with HickoryTech in these markets,which could result in a reduction in long distance revenue in future periods.

 

Internet revenue was $247,000or 6.9% higher in 2003 compared to 2002 and $497,000 or 16.2% higher in 2002 comparedto 2001. The increase in revenue was caused primarily by an increase inInternet customers of 1,712 or 11.9% in 2003 compared to 2002 and an increaseof 1,604 or 12.5% in 2002 compared to 2001.

 

Digital TV revenue was $132,000or 56.9% higher in 2003 compared to 2002 and $160,000 or 222.2% higher in 2002compared to 2001. The increase in both years is the result of increasedpenetration.

 

Cost ofServices, excluding Asset Impairment, Depreciation and Amortization:

Cost of services, excludingasset impairment, depreciation and amortization was $531,000 or 1.9% higher in2003 compared to 2002 and $880,000 or 3.3% higher in 2002 compared to 2001. InSeptember of 2003, HickoryTech abandoned a CLEC initiative in a specificmarket. As a result of this operating decision, HickoryTech abandonedapproximately $632,000 of property, plant and equipment, which was written downto a carrying value of zero in the third quarter of 2003. Higher service costsassociated with increased customer counts in 2003 compared to 2002 werepartially offset by a decrease in bad debt expense of $1,126,000 as more fullydescribed below. One reason for the increase in cost of services in 2002compared to 2001 was the recording of additional bad debt expense of$1,455,000, due in large part to bankruptcies of interexchange carriers in thetelecommunications industry. The increases in costs of services noted in 2002were partially offset by improved efficiencies achieved in the design andoperation of HickoryTech’s network as it pertains to its CLEC and Internetoperations, specifically, management actions aimed at reducing service costs,which began in 2001, and the combination of certain operating functions aidedin reducing service costs for this sector in 2002. ACTC contributed $656,000 ofservice costs to this sector in 2001.

 

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

Selling, general andadministrative expenses, excluding depreciation and amortization were $774,000or 9.1% higher in 2003 compared to 2002 and $164,000 or 2.0% higher in 2002compared to 2001. The increase in selling, general and administrative expensesin 2003 compared to 2002 was largely due to increased regulatory fees and anincrease in fees paid to outside consultants for cost studies done for theHeartland subsidiary. The increase in selling, general and administrativeexpenses in 2002 compared to 2001 was largely the result of increasedadvertising in both ILEC and CLEC markets.

 

AssetImpairment Charges:

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

 

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Depreciationand Amortization:

Depreciation and amortizationwas $834,000 or 6.8% higher in 2003 compared to 2002 and $1,681,000 or 15.8%higher in 2002 compared to 2001. The build-out of HickoryTech’s CLEC and fiberoptic networks primarily account for the increase in depreciation expense.Depreciation expense was $447,000 or 5.0% higher in 2003 compared to 2002, and$816,000 or 10.1% higher in 2002 compared to 2001, for the networks associatedwith its ILEC product. Depreciation expense was $456,000 or 13.9 higher in 2003compared to 2002, and $1,455,000 or 79.3% higher in 2002 compared to 2001, forthe networks associated with its CLEC product. Amortization expense was $69,000or 47.3 lower in 2003 compared to 2002, and $590,000 or 80.2% lower in 2002compared to 2001. If SFAS No. 142, which required the Company to ceaseamortization of goodwill, had taken effect in 2001, amortization expense wouldhave been $32,000 or 28.3% higher in 2002 compared to 2001. The increase inamortization in 2002 compared to 2001 was the result of recognizing a full yearof amortization for an agreement to develop a WDSL operation that entitledHickoryTech to receive a share of future revenues generated from the WDSLoperation in 2002 as opposed to partial year recognition in 2001.

 

OperatingIncome and Income from Continuing Operations, net of Tax:

Operating income was $2,416,000or 10.7% higher in 2003 compared to 2002, and $1,703,000 or 8.1% higher in 2002compared to 2001. Income from continuing operations, net of tax was $1,324,000or 9.7% higher in 2003 compared to 2002, and $1,539,000 or 12.7% higher in 2002compared to 2001. The increase in both operating and income from continuingoperations, net of tax in 2003 compared to 2002 was largely due to increasednetwork access revenues, increased CLEC revenues, and decreased bad debts. Theincreases in 2002 compared to 2001 were largely due to increased network accessrevenues and increased CLEC revenues offset by increased bad debt expense. Ifthe discontinuance of goodwill amortization pursuant to SFAS No. 142 had takeneffect in 2001, operating income would have been $1,081,000 or 5.0% higher in2002 compared to 2001, and income from continuing operations, net of tax wouldhave been $1,172,000 or 9.4% higher in 2002 compared to 2001.

 

DiscontinuedOperations:

On December 15, 2003,HickoryTech sold its wireless business, Minnesota Southern Wireless Company(MSWC), to Western Wireless Corporation (WWC). The selling price was comprisedof $16,246,000 in cash and 1,038,927 shares of HickoryTech common stock thatwere returned to HickoryTech by WWC and subsequently retired. The market valueof these shares was $12,207,000 at December 15, 2003. Included in the cashproceeds above is $3,401,000 of cash received for construction in progressassets. The wireless operations are reported as part of the Telecom Sector. Theconsolidated statements of operations for all periods presented have beenrestated to reflect wireless operations as discontinued operations.

 

Revenue from wirelessdiscontinued operations was $1,108,000 or 7.2% lower in 2003 compared to 2002and $2,206,000 or 12.5% lower in 2002 compared to 2001. The decrease in revenuefrom wireless discontinued operations was the result of a decrease in roamingrevenues, partially offset by an increase in equipment sales.

 

In connection with thedetermination by management in the third quarter of 2003 that it would pursuethe sale of its wireless operations and that the selling price would likely beless than the current carrying value of the wireless net assets, the Companycompleted an impairment test in the third quarter of 2003 for the FCC licensespursuant to the requirements of SFAS No. 142, “Goodwill and Other IntangibleAssets.” Management estimated the fair value of the FCC licenses using adiscounted cash flow technique consistent with the method used by the Companyin performing its most recent impairment analysis at December 31, 2002. As aresult of this assessment, management determined that the FCC licenses wereimpaired and recorded an impairment charge of $21,000,000 ($18,638,000 net ofincome taxes), in the third quarter of 2003. HickoryTech believes that thedecline in the fair value of its FCC licenses was due principally to the rapidpace of technological change being undertaken by the major wireless service providersto adopt new protocols (i.e. GSM or CDMA) and potentially move away fromHickoryTech’s current primary protocol called TDMA, which greatly hinderedHickoryTech’s position in finding a future roaming partner. Other factorsinclude declining roaming revenues, increasing price competition, and theprotracted downturn in the wireless market. The FCC licenses were tested forimpairment on an aggregate basis, which is consistent with HickoryTech’smanagement of the wireless business. HickoryTech’s 2002 annual impairmentassessment of its FCC licenses at December 31, 2002 resulted in a total pre-taximpairment charge of $41,635,000 in the fourth quarter of 2002. Theseimpairment charges are included in the loss on discontinued operations inHickoryTech’s consolidated statement of operations for the years ended December31, 2003 and 2002.

 

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

 

INFORMATIONSOLUTIONS – The following table provides a breakdownof the Information Solutions Sector operating results.

 

**INFORMATION SOLUTIONS SECTOR**

 
| **(Dollars in Thousands)**                                                             |   | **2003**  |       | **2002**   |   | **2001** |   |
|----------------------------------------------------------------------------------------|--------|-----------|------------|------------|--------|----------|--------|
| Revenues Before Eliminations                                                           |   |      | ** ** |       |   |     |   |
| Unaffiliated Customers                                                                 |   | **$**     | **3,199**  | ** ** | $      | 4,249    |   | $ | 4,085 |   |
| Intersegment                                                                           |   | **3,203** | ** ** | 3,154      |   | 4,034    |   |
|                                                                                   |   | **6,402** |       | 7,403      |   | 8,119    |   |
| Cost of Services, excluding Depr. and  Amort.                                          |   | **7,002** | ** ** | 7,182      |   | 6,612    |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization |   | **600**   | ** ** | 1,107      |   | 1,036    |   |
| Depreciation and Amortization                                                          |   | **2,376** | ** ** | 2,403      |   | 1,129    |   |
|                                                                                   |   |      | ** ** |       |   |     |   |
| Operating Loss                                                                         |   | **$**     | **(3,576** | **)**      | $      | (3,289   | )      | $ | (658 | ) |
|                                                                                   |   |      |       |       |   |     |   |
| Net Loss                                                                               |   | **$**     | **(2,329** | **)**      | $      | (2,131   | )      | $ | (455 | ) |
|                                                                                   |   |      | ** ** |       |   |     |   |
| Capital Expenditures                                                                   |   | **$**     | **161**    | ** ** | $      | 2,472    |   | $ | 1,347 |   |

 

Revenues:

Operating revenues fromunaffiliated customers decreased $1,050,000 or 24.7% in 2003 compared to 2002,and increased $164,000 or 4.0% in 2002 compared to 2001. The decrease inoperating revenues in 2003 compared to 2002 was due to a few batch-processingcustomers who have experienced a significant decrease in volumes processed of$659,000, and the loss of several batch-processing customers of $583,000.However, the Company did establish relationships with several new customersemploying their SuiteSolution product increasing revenues by $189,000, whichaided in offsetting the loss of batch processing customers. At the end of 2003,a customer hired the Company to do temporary billing services on its behalf,which also increased revenues by $54,000. This temporary work is expected toend in 2004. The increase in operating revenues in 2002 compared to 2001 wasthe result of the impact of new customer relationships for monthly batch processingservices, as well as the implementation of the predecessor to SuiteSolution,called WRITE2K, by a new customer, which increased revenues by $189,000. 

 

Cost ofServices, excluding Depreciation and Amortization:

Cost of services, excludingdepreciation and amortization decreased $180,000 or 2.5% in 2003 compared to2002, and increased $570,000 or 8.6% in 2002 compared to 2001. The decrease incost of services in 2003 compared to 2002 primarily reflects cost controlmeasures initiated by management. The increase in cost of services in 2002compared to 2001 can be largely attributed to lower costs in 2001 as theCompany assigned technical resources to the development of its SuiteSolutionproduct, and many of these software development costs were capitalized during2001. The capitalization of these costs ended during the third quarter of 2001as the development of SuiteSolution had reached the point where the product wasavailable for release to customers. Because development of the product wascompleted in 2001, the Company’s technical resources were reassigned to otheraspects of the Information Solutions Sector’s operations resulting in a returnto higher costs of services. Note that upon the completion of the SuiteSolutionproduct, amortization of the capitalized costs began, as more fully discussedunder the caption “Depreciation and Amortization” below.

 

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

Selling, general andadministrative expenses, excluding depreciation and amortization decreased$507,000 or 45.8% in 2003 compared to 2002 and increased $71,000 or 6.9% in2002 compared to 2001. The decrease in selling, general and administrativeexpenses in 2003 compared to 2002 was primarily the result of managementactions aimed at reducing expenses, a reduction in compensation accrualsassociated with management incentives, which are tied to consolidated financialmetrics that were not achieved as a result of the loss from discontinuedoperations recorded in the 2003 financial statements, and a decrease in baddebt expense. The increase in selling, general and administrative expenses in2002 compared to 2001 was primarily the result of increased accruals for incentivecompensation and increased insurance expense.

 

Depreciationand Amortization:

Depreciation and amortizationdecreased $27,000 or 1.1% in 2003 compared to 2002, and increased $1,274,000 or112.8% in 2002 compared to 2001. Amortization ceased in the second quarter of2003 for WRITE2K. However, amortization started in the second quarter of 2003for the new billing software developed in 2002 and 2003. The net result was aslight decrease in depreciation and amortization in 2003 compared to 2002. Theincrease in depreciation and amortization in 2002 compared to 2001 was largelydue to the amortization of capitalized SuiteSolution development costs, whichbegan in the third quarter of 2001. Also contributing to the increase wasdepreciation expense recorded on capitalized leases for new computer equipmentand depreciation expense recorded on other capital expenditures related toequipment acquired in support of the development and implementation ofSuiteSolution.

 

Operating andNet Loss:

Operating loss increased$287,000 or 8.7% in 2003 compared to 2002, and increased $2,631,000 or 399.8%in 2002 compared to 2001. Net loss increased $198,000 or 9.3% in 2003 comparedto 2002, and increased $1,676,000 or 368.4% in 2002 compared to 2001. Theincrease in operating loss and net loss in 2003 compared to 2002 was primarilyattributable to the decrease in operating revenues. The increase in operatingloss and net loss in 2002 compared to 2001 can be attributed to a decrease inoperating revenues, an increase in cost of services, and an increase indepreciation and amortization.

 

ENTERPRISESOLUTIONS – The following table provides a breakdownof the Enterprise Solutions Sector operating results.

 

**ENTERPRISE SOLUTIONS SECTOR**

 
| **(Dollars in Thousands)**                                                             |   | **2003**   |       | **2002**   |   | **2001** |   |
|----------------------------------------------------------------------------------------|--------|------------|------------|------------|--------|----------|--------|
| Revenues Before Intersegment Eliminations                                              |   |       | ** ** |       |   |     |   |
| Installation                                                                           |   | **$**      | **6,209**  | ** ** | $      | 7,970    |   | $ | 11,227 |   |
| Service                                                                                |   | **8,138**  | ** ** | 7,811      |   | 9,147    |   |
|                                                                                   |   | **14,347** |       | 15,781     |   | 20,374   |   |
| Cost of Products Sold                                                                  |   | **10,216** | ** ** | 10,638     |   | 13,562   |   |
| Cost of Services, excluding Depr. and Amort.                                           |   | **1,749**  | ** ** | 1,576      |   | 1,776    |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization |   | **3,494**  | ** ** | 3,316      |   | 3,337    |   |
| Depreciation and Amortization                                                          |   | **246**    | ** ** | 263        |   | 359      |   |
|                                                                                   |   | **15,705** |       | 15,793     |   | 19,034   |   |
|                                                                                   |   |       | ** ** |       |   |     |   |
| Operating Income/(Loss)                                                                |   | **$**      | **(1,358** | **)**      | $      | (12      | )      | $ | 1,340 |   |
|                                                                                   |   |       |       |       |   |     |   |
| Net Income/(Loss)                                                                      |   | **$**      | **(818**   | **)**      | $      | (41      | )      | $ | 748 |   |
|                                                                                   |   |       | ** ** |       |   |     |   |
| Capital Expenditures                                                                   |   | **$**      | **201**    | ** ** | $      | 95       |   | $ | 213 |   |

 

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Revenues:

Operating revenues were$1,434,000 or 9.1% lower in 2003 compared to 2002, and $4,593,000 or 22.5%lower in 2002 compared to 2001. Installation revenue was $1,761,000 or 22.1%lower in 2003 compared to 2002 and $3,257,000 or 29.0% lower in 2002 comparedto 2001. The decrease in installation revenue in 2003 compared to 2002 wasprimarily a result of a decrease in sales and installations of PBX systems of$2,173,000 or 50.3%.****The decreasein installation revenue in 2002 compared to 2001 was primarily a result of adecrease in sales and installations of PBX and small business systems of$1,313,000 or 21.4% and a decrease in sales of data network equipment of$1,585,000 or 35.0%. Service revenue was $327,000 or 4.2% higher in 2003compared to 2002 and $1,336,000 or 14.6% lower in 2002 compared to 2001.****This sector has encountered across theboard reductions in demand in all of its major products and services. Thereduction started in early 2002, and is believed to be associated with theeconomy’s effect on customers of this sector, and due to changing technology(i.e. voice vs. data protocol) in the communications products, which thissector provides. Due to the uncertainty of the economy, HickoryTech cannotestimate when customer demand for these products and services may return tohigher levels.

 

Cost of ProductsSold:

Cost of products sold decreased$422,000 or 4.0% in 2003 compared to 2002, and decreased $2,924,000 or 21.6% in2002 compared to 2001. Gross profit margin for this sector was 28.8%, 32.6% and33.4% in 2003, 2002 and 2001, respectively. The decrease in costs of productssold was the result of the decreased installation work described above and thedecrease in gross profit margin in 2003 compared to 2002 is the result of lowermargins associated with two large system installations performed in 2003. Thedecrease in 2002 cost of products sold compared to 2001 was in line with thedecrease in operating revenues in this sector, as margins remained relativelyconsistent.

 

Cost ofServices, excluding Depreciation and Amortization:

Cost of services excludingdepreciation and amortization increased $173,000 or 11.0% in 2003 compared to2002, and decreased $200,000 or 11.3% in 2002 compared to 2001. The increase incost of services excluding depreciation and amortization in 2003 compared to2002 was largely the result of increased maintenance expense associated withcustomer contracts. The decrease in costs of services excluding depreciationand amortization in 2002 compared to 2001 was primarily the result of costreduction measures.

 

Selling,General and Administrative, excluding Depreciation and Amortization:

Selling, general andadministrative expenses, excluding depreciation and amortization increased$178,000 or 5.4% in 2003 compared to 2002, and decreased $21,000 or .6% in 2002compared to 2001. The increase in selling, general and administrative expensesin 2003 compared to 2002 was primarily due to increases in bad debt, benefitsand insurance. The decrease in selling, general and administrative expenses in2002 compared to 2001 was largely due to cost reduction measures and lowerHickoryTech corporate allocations.

 

Depreciationand Amortization:

Depreciation and amortizationdecreased $17,000 or 6.5% in 2003 compared to 2002, and decreased $96,000 or26.7% in 2002 compared to 2001. The decrease in 2003 was the result of certainassets becoming fully depreciated. The decrease in 2002 was primarily due tothe implementation of SFAS No. 142 effective January 1, 2002, which requiredHickoryTech to discontinue amortization of goodwill.

 

Operating andNet Income/(Loss):

Operating loss was $1,358,000in 2003 compared to operating loss of $12,000 in 2002, and operating income of$1,340,000 in 2001. Net loss in 2003 was $818,000 compared to net loss of$41,000 in 2002 and net income of $748,000 in 2001. The losses generated in2003 and 2002 as compared to income in 2001 resulted primarily from the changesin operating revenues described above. If SFAS No.142 had taken effect in 2001,the operating loss would have been $1,446,000 or 100.8% higher in 2002 comparedto operating income in 2001, and the net loss would have been $844,000 or105.1% higher in 2002 compared to the 2001 net income.

 

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**INTEREST EXPENSE**

Interest expense was $1,302,000or 17.6% lower in 2003 compared to 2002 and $3,449,000 or 31.8% lower in 2002compared to 2001.  The decrease ininterest expense from continuing operations in 2003 was primarily due to adecrease in total debt outstanding.  Theoutstanding balance of the revolving credit facility was $118,500,000 atDecember 31, 2003 and $158,000,000 at December 31, 2002. The decrease ininterest expense in 2002 was primarily due to a decrease in the weightedaverage interest rate on HickoryTech’s revolving credit facility from 6.66% to4.45% for the years 2001 and 2002, respectively, and a decrease in total debtoutstanding. The outstanding balance of the revolving credit facility was$158,000,000 on December 31, 2002 and $170,000,000 on December 31, 2001.

 

**INCOME TAXES**

The effective tax rate for continuingoperations was 40.2%, 40.5% and 40.6% in 2003, 2002 and 2001, respectively.These effective tax rates differ from the U.S. statutory rate primarily due tostate income taxes.

 

**CRITICAL ACCOUNTING POLICIES**

Management’s discussion andanalysis of financial condition and results of operations are based uponHickoryTech’s consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America and, where applicable, conform to the accounting principles asprescribed by federal and state telephone utility regulatory authorities.HickoryTech presently gives accounting recognition to the actions of regulatorswhere appropriate, as prescribed by Statement of Financial Accounting Standards(SFAS) No. 71, “Accounting for the Effects of Certain Types ofRegulation.”  The preparation of thesefinancial statements requires management to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues, and expenses andrelated disclosure of contingent assets and liabilities.  Management believes that the application ofthe following accounting policies, which are important to HickoryTech’sfinancial position and results of operations, requires significant judgmentsand estimates on the part of management. Senior management has discussed the development and selection ofaccounting estimates and the related MD&A disclosure with the AuditCommittee.  For a summary of allHickoryTech’s accounting policies, see Note 1 of the Notes to ConsolidatedFinancial Statements.

 

**Revenue Recognition**– Revenues are recognized when services are rendered or products are deliveredto customers. Revenues in the Telecom Sector are earned from monthly billingsto customers for telephone service. ILEC revenues are also derived from chargesfor network access to HickoryTech’s local exchange telephone network, fromsubscriber line charges and from contractual arrangements for services such asbilling and collection and directory advertising. Certain of these revenues arerealized under pooling arrangements with other telephone companies and aredivided among the companies based on respective costs and investments toprovide the services. The companies that take part in these pooling arrangementsmay adjust their costs and investments for a period of two years, which causesthe dollars distributed by the pool to be adjusted retroactively. Managementbelieves that recorded amounts represent reasonable estimates of the finaldistribution from these pools.  However,to the extent that companies participating in these pools make adjustments,there will be adjustments to recorded revenues in future periods.

 

Revenue in the EnterpriseSolutions Sector earned on major installation and change contracts isrecognized using the percentage of completion method, which relies on measuringactual contract completion versus estimates of total expected contract revenueand costs. The percentage of completion method is used since reasonablydependable estimates of the revenue and costs applicable to various stages of acontract can be made. Recognized revenues and profit are subject to revisionsas the contract progresses to completion. Revisions in profit estimates arecharged to income in the period in which the facts that give rise to therevision become known.

 

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**Allowancefor Doubtful Accounts –** HickoryTech’s allowance fordoubtful accounts is an estimate based on specifically identified accounts aswell as less specific reserves established based upon historical collectionexperience. HickoryTech evaluates specific accounts where it has informationthat the customer may have an inability to meet its financial obligations, thecustomer is delinquent or the customer may dispute the charges. In these cases,management uses its judgment, based on the best available facts andcircumstances, and records a specific reserve for that customer against amountsdue to reduce the receivable to the amount that is expected to be collected.These specific reserves are reevaluated and adjusted as additional informationis received that impacts the amount reserved. HickoryTech also establishes aless specific reserve for all customers based on a range of percentages appliedto aging categories. These percentages are based on historical collection andwrite-off experience. If circumstances change, HickoryTech’s estimates of therecoverability of amounts due the company could be reduced or increased by amaterial amount. Such a change in estimated recoverability would be accountedfor in the period in which the facts that give rise to the change become known.The allowance for doubtful accounts was $1,283,000 and $1,358,000 as ofDecember 31, 2003 and 2002, respectively.

 

**Inventories–** Similar to its allowance for doubtful accounts,HickoryTech makes estimates related to the valuation of inventory. HickoryTechadjusts its inventory carrying value for estimated obsolescence or unmarketableinventory to the estimated market value based upon assumptions about futuredemand and market conditions. As market conditions change, if inventoryvaluations are lower, additional inventory write-downs may be required at thetime that the facts that give rise to the lower value become known.

 

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

 

Effective January 1, 2002,HickoryTech adopted SFAS No. 142 which required the company to ceaseamortization of goodwill and FCC licenses. Instead, these assets were subject to an impairment test upon adoptionon January 1, 2002.  Goodwill and FCClicenses are also subject to an annual impairment test as well as upon certainevents that indicate that an impairment may be present.  The goodwill impairment test includes twosteps, the first of which requires management to determine the fair value ofcertain of the Company’s reporting units (as defined by SFAS No. 142).  The Company determines the fair value oftheir reporting units by application of a discounted cash flow analysis.  The FCC license impairment test consists ofone step, comparing the aggregate book carrying value of the FCC licenses totheir aggregate estimated fair value.  TheCompany made a determination of FCC license fair values using methodologies thatinclude analyzing market comparable transactions and applying discounted cashflow analyses specific to the FCC licenses. Management makes estimates that are included in their discounted cashflow analyses based upon the best available information at the time that thedeterminations of fair value are made. If circumstances change, HickoryTech’s estimates of fair value will alsochange and could result in a determination of additional impairment charges toreduce the carrying value of goodwill. In December 2003, HickoryTech sold itswireless business, including all FCC licenses.

 

**IncomeTaxes –** As part of the process of preparing ourconsolidated financial statements the Company is required to estimate incometaxes in each of the jurisdictions in which it operates. This process involvesestimating actual current tax exposure together with assessing temporarydifferences resulting from differing treatment of items, such as deferredrevenue, for tax and accounting purposes. These differences result in deferredtax assets and liabilities, which are included within the Company’sconsolidated balance sheet. The Company assesses the likelihood that deferredtax assets will be recovered from future taxable income and to the extentrecovery is not likely, it establishes a valuation allowance. To the extent theCompany establishes a valuation allowance or increases this allowance in aperiod, it must include an expense within the tax provision in the statement ofoperations.  The Company has establisheda $640,000 and $470,000 valuation allowance at December 31, 2003 and 2002,respectively due to uncertainty about realization of benefits associated withnet operating losses generated in the state of Iowa. Additionally, we havereserves for income tax contingencies. These reserves relate to various taxyears subject to audit by tax authorities. We believe that our current incometax reserves are adequate. However, the ultimate outcome may differ from ourestimates and assumptions could impact the provision for income taxes reflectedin our consolidated statements of operations.

 

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**Post-Retirement Benefits –**The net post-retirement benefit expense was$717,000, $637,000 and $364,000 in 2003, 2003 and 2001, respectively.Post-retirement benefit expense is recorded in cost of services and selling,general and administrative expenses. The post-retirement benefit expense andliability are calculated utilizing various actuarial assumptions andmethodologies. These assumptions include, but are not limited to, the discountrate and the expected health care cost trend rate. The discount rate assumptionis based on the rates of return on high-quality, fixed-income instrumentscurrently available whose cash flows match the timing and amount of expectedbenefit payments. The health care cost trend rate is based upon an evaluationof the historical trends and experience, taking into account current andexpected market conditions. The health care cost trend rate represents theexpected annual rate of change in the cost of health care benefits currentlyprovided due to factors other than changes in the demographics of planparticipants. If the assumptions utilized in determining the post-retirementbenefit expense and liability differ from actual events, the results ofoperations for future periods could be impacted.

 

Inmeasuring the accumulated post-retirement benefit obligation as of December 31,2003, the Company assumed a discount rate of 6.25%. In measuring theaccumulated post-retirement benefit obligation as of December 31, 2003, theinitial health care inflation rate for 2004 was assumed to be 12% and theultimate health care inflation rate for 2009 and beyond was assumed to be 5%. Aone-percentage point increase in the health care inflation rate for each yearwould increase the accumulated post-retirement benefit obligation by$1,554,000. A one-percentage point decrease in the health care inflation ratefor each year would decrease the accumulated post-retirement benefit obligationby $1,247,000.

 

Whenactual events differ from the assumptions or when the assumptions used change,an unrecognized actuarial gain or loss results. As of December 31, 2003, theunrecognized net actuarial loss was $5,755,000. During each of the last threeyears, the Company has lowered the discount rate assumption due to decreases ininterest rates. In recent years, the Company has increased the health care costtrend rate assumption to reflect the current trend of increasing medical costs.The remainder of the net actuarial loss amount primarily related to differencesbetween the assumed medical costs and actual experience and changes in theemployee population.

 

**INFLATION**

It is the opinion of managementthat the effects of inflation on operating revenues and expenses over the pastthree years have been immaterial. Management anticipates that this trend willcontinue in the near future.

 

**DIVIDENDS**

HickoryTech paid dividends of$6,150,000, or $0.44 per share, in 2003. The dividend per share rate was thesame as in 2002 and 2001. HickoryTech expects to pay at least the same pershare rate of dividends in 2004, which is not expected to negatively impact theliquidity of HickoryTech.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

**CAPITAL STRUCTURE** –The total long-term capital structure (long-term obligations plus shareholders’equity) for HickoryTech was $146,757,000 at December 31, 2003, reflecting 19.6%equity and 80.4% debt.  This compares toa capital structure of $216,194,000 at December 31, 2002, reflecting 27.1% equityand 72.9% debt. This position is the result of the recurring nature of many ofHickoryTech’s charges to customers, consistent capital expenditures anddividends, and the proven pace at which the Company is reducing its debt.Management believes adequate internal and external resources are available tofinance ongoing operating requirements, including capital expenditures,business development, debt service and the payment of dividends for at leastthe next twelve months.

 

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**CASH FLOWS**– Cash flows from operations continueto be a steady source of funds for HickoryTech, primarily coming from theTelecom Sector. Cash provided from operations was $36,749,000 in 2003,$34,667,000 in 2002, and $25,135,000 in 2001. Cash flows in 2003 were primarilyattributable to net loss offset by non-cash expenses, including depreciationand amortization of $17,638,000, the $25,345,000 asset impairment charges thatoccurred in discontinued operations, and $4,817,000 of deferred taxes. Cashflows from operations in 2002 were primarily attributable to net loss offset bynon-cash expenses, including depreciation and amortization of $17,789,000 andthe $41,951,000 asset impairment charges, which were partially offset by adeferred income tax benefit of $9,804,000. Cash flows from operations in 2001 were primarily attributable to netincome plus non-cash expenses, including depreciation and amortization of$16,794,000 and an increase in deferred tax liabilities of $5,217,000, partiallyoffset by increases in income taxes receivable, increases in costs in excess ofbillings on contracts in the Enterprise Solutions Sector and decreases inaccounts payable relating to timing of payments and decreases in billings inexcess of costs on contract in the Enterprise Solutions Sector.

 

Cash provided by investingactivities was $6,979,000 in 2003, while cash used in investing activities was$16,331,000 in 2002 and $39,979,000 in 2001. The sale of HickoryTech’s wirelessbusiness in 2003 provided $16,246,000 of cash. Capital expenditures were$13,570,000 in 2003, $16,674,000 in 2002 and $32,868,000 in 2001. Capitalexpenditures were incurred to construct additional network facilities toprovide CLEC services and buildout fiber optic and wireless networks.  HickoryTech expects capital expenditures in2004 to be approximately $18,000,000. There were $4,144,000 redemptions of investments in 2003. Conditions ofits debt agreement allowed HickoryTech to reduce its equity investment in oneof its lenders by $4,100,000. The remaining $44,000 redemption of investmentsrepresents the Information Solutions Sector’s share in the National IndependentBilling Partnership, which was dissolved in 2003. Cash used in investingactivities also included $2,717,000 in 2001 for capitalized softwaredevelopment costs associated with SuiteSolution in the Information SolutionsSector. Cash used in investing activities included $11,386,000 in 2001 for theacquisition of PCS licenses (including direct acquisition costs).  Proceeds from sale of assets provided$6,992,000 in 2001, which was related primarily to the sale of ACTC.

 

Cash used in financingactivities was $45,324,000 in 2003 and $18,470,000 in 2002, while cash providedby financing activities was $15,662,000 in 2001. In 2003, cash was primarilyused to repay $39,500,000 of borrowings and to pay dividends of $6,150,000. In2003, cash was also used to repurchase 66,600 shares of common stock underHickoryTech’s repurchase plan for $661,000, and to retire 18,370 shares ofcommon stock from a compensation plan trust account for $185,000. In 2002, cashwas used primarily to repay $12,000,000 of borrowings, to repurchase commonstock under HickoryTech’s repurchase plan for $1,072,000 and to pay dividendsof $6,170,000.  In 2001, HickoryTechborrowed approximately $21,000,000 under its credit facilities, and paid cashdividends of $6,117,000.

 

**WORKINGCAPITAL –**Working capital was $9,300,000 as ofDecember 31, 2003 compared to working capital of $13,073,000 as of December 31,2002.  The ratio of current assets tocurrent liabilities was 1.7 to 1.0 as of December 31, 2003 and 1.9 to 1.0 as ofDecember 31, 2002.

 

**LONG-TERMOBLIGATIONS**– HickoryTech’s long-term obligations asof December 31, 2003, were $118,040,000, excluding current maturities of$1,572,000.  As of December 31, 2003,HickoryTech had a $157,000,000 credit facility with a syndicate of banks.  The credit facility is comprised of a $125,000,000revolving credit component and a $32,000,000 term loan component.  The available line of credit on the$125,000,000 revolving credit component decreases in increments beginning inMarch 2004 with a final maturity date in September 2008. However, since not allof the available revolving credit has been utilized as of December 31, 2003,the payment schedule is as follows: 2006 - $25,562,000, 2007 – $32,813,000 and2008 – $28,125,000. The term loan component requires equal quarterly principalpayments of $250,000 during the period of March 2001 to December 2008,$23,000,000 in the first quarter in 2009 and $4,000,000 in the second quarterof 2009.  The weighted average interestrate associated with this credit facility varies with LIBOR and certain otherrates.  The weighted average interestrate was 4.09% at December 31, 2003 and 4.32% at December 31, 2002. HickoryTechhas implemented fixed interest terms on various portions of the overall debtoutstanding for varying terms.  Thelongest fixed interest term, on $60,000,000 of the debt, is fixed until June2008.  As of December 31, 2003,HickoryTech had drawn $118,500,000 on this credit facility and had $38,500,000of available credit.  Managementbelieves the remaining available credit is sufficient to cover future cashrequirements.

 

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HickoryTech’s InformationSolutions Sector leases certain computer equipment under capital leasearrangements.  This sector recordedadditions to property, plant and equipment of $660,000, $618,000 and $1,041,000in 2003, 2002 and 2001, respectively, related to these capital leasearrangements.

 

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

 

HickoryTech continuallymonitors the interest rates on its bank loans and has implemented fixed interestterms on various portions of the overall debt outstanding for varying terms. Alower level of interest expense is likely to occur in 2004 because of the largereduction in principle amounts outstanding.

 

The following table sets forthHickoryTech’s contractual obligations, along with the cash payments due eachperiod. Interest on Long-term Debt is estimated using the interest rate as ofDecember 31, 2003.

 
|                               |   | **Payments  Due by Year**  |       |
|------------------------------------|--------|----------------------------|------------|
|                               |   | **(Dollars in Thousands)** |       |
|                               |   | **Total**                  | ** ** | **2004** | ** ** | **2005 to  2007** | ** ** | **2008 to  2009** | ** ** | **2010 and  after** | ** ** |
| Contractual Obligations            |   |                       |       |   |   |   |   |   |   |   |   |
| Long-term Debt                     |   | $                          | 118,500    |   | $ | 1,000 |   | $ | 61,375 |   | $ | 56,125 |   | $ | — |   |
| Interest on Long-term Debt         |   | 22,158                     |       | 4,949 |   | 13,833 |   | 3,376 |   | — |   |
| Capital Lease Obligations          |   | 1,112                      |       | 572 |   | 540 |   | — |   | — |   |
| Interest on Capital Leases         |   | 82                         |       | 52 |   | 30 |   | — |   | — |   |
| Purchase Obligations               |   | 2,042                      |       | 1,823 |   | 219 |   | — |   | — |   |
| Operating Leases                   |   | 912                        |       | 414 |   | 158 |   | 30 |   | 310 |   |
| Total Contractual Cash Obligations |   | $                          | 144,806    |   | $ | 8,810 |   | $ | 76,155 |   | $ | 59,531 |   | $ | 310 |   |

 

The following table sets forththe total line of credit expirations as follows:

 
|                       |   | **Amount of  Commitment Expiration per Year** |    |
|----------------------------|--------|-----------------------------------------------|---------|
|                       |   | **(Dollars  in Thousands)**                   |    |
|                       |   | **Total**                                     |    | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** |
| Revolving Credit Component |   | $                                             | 125,000 |   | $ | 17,188 |   | $ | 20,312 |   | $ | 26,563 |   | $ | 32,812 |   | $ | 28,125 |   |
|                            |        |                                               |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**CONSTRUCTIONPLANS**– HickoryTech has embarked on a five-year fibernetwork reconstruction program in its core telephone property in Mankato insupport of its leading broadband service strategy. The network reconstructionprogram will total approximately $20,000,000 over the five-year period, inaddition to the historical levels of capital spending in 2003 and 2002.Management believes that in addition to supporting the aggressive broadbandproduct deployment strategies of the future, that the reconstruction should beone of its foremost defenses against competition in its core market.

 

**REGULATORYASSET AND LIABILITY**– Effective January 1, 2002, theFederal Communications Commission (FCC), in it’s “MAG (Multi Association Group)Order” on Access Charge Reform, directed all rate-of-return carriers to filerevisions to their tariffs to eliminate the transport interconnection charge(TIC) as a separate rate element. In effect, the costs previously recoveredthrough the TIC were reallocated over all other access categories, includingcarrier common line, transport, local switching, information surcharge andspecial access. The FCC made it clear that “this tariff filing should be arevenue neutral tariff filing.”

 

The total revenues reallocatedfrom the TIC to the remaining access elements were limited to the totalrevenues recovered from the TIC for the twelve-month period ended June 30,2001. These revenues were calculated using the carrier’s traffic volumes andthe TIC rate for the twelve-month period ended June 30, 2001. Thesecalculations were prepared by an independent third-party and approved by NECA.TIC was eliminated by reallocating the costs to the other access billingcategories.

 

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The FCC conducted aninvestigation of all tariff filings, including NECA’s (National ExchangeCarrier Association) CCL (Carrier Common Line) tariff and Heartland’s TrafficSensitive (TS) tariff, to determine if the filing parties had properlyreallocated the TIC costs among the other access charge categories.

 

The FCC terminated itsinvestigation of several tariff filings, concluding that “the carriers havesubstantially complied with the Rate-of-Return Access Charge Reform Order andtheir tariffs no longer warrant investigation.” Despite this ruling by the FCCduring the fourth quarter of 2003, NECA informed HickoryTech’s Heartlandsubsidiary that it would not allow it to recover a portion of the TIC costsallocated to the CCL, because an incorrect TIC rate was used in thecalculation.

 

As a result of this billingerror, the Company recovered $611,000 of excess revenues from the NECA CCLpool. NECA will require Heartland to repay the $611,000 over the twelve monthsof 2004.

 

The FCC has approved amid-course correction to Heartland’s TS tariff as a supportable method ofrecouping NECA’s CCL reduction. The revision corrects the TIC rate originallyused, and factors recovery of the $611,000, into the TS rate elements.HickoryTech will recoup this revenue over the remaining eighteen months of theTS tariff, beginning January 1, 2004.

 

In accordance with SFAS No. 71,HickoryTech has recorded a regulatory asset equal to the $611,000 that it willrecover from monthly traffic sensitive billings and has recorded a corresponding$611,000 liability for the amounts that will be repaid to the NECA CCL pool.

 

**OTHER**– On June 26, 2001, HickoryTech acquired two PCS licenses in southernMinnesota. Refer to Note 3 of Notes to Consolidated Financial Statements forfurther discussion of this acquisition.

 

On August 6, 2001, HickoryTechcompleted the sale of its local telephone exchange in Amana, Iowa. Refer toNote 3 of Notes to Consolidated Financial Statements for further discussion ofthis disposition.

 

**CONTINGENCIES**

In January 2002, NationalIndependent Billing Partnership (NIBP), an unconsolidated partnership of NIBI(see Note 1 of the Notes to Consolidated Financial Statements for discussion ofNIBP), received written claims from one of its customers relating tocontractual obligations. The claims are not a formal legal action. NIBPdisagrees with the claims made by this customer. There has been no formaldialogue between the parties on this matter since March 2002. The Partnershiphas been dissolved as of December 31, 2003 with all remaining assets beingdistributed to the remaining partners. In the opinion of management, theultimate resolution of these claims will not have a material adverse impact onHickoryTech’s financial position, results of operations or cash flows.

 

**RECENT ACCOUNTINGDEVELOPMENTS**

In November 2002, the FASBissued Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers.” This interpretation elaborates on the disclosures required infinancial statements concerning obligations under certain guarantees. It alsoclarifies the requirements related to the recognition of liabilities by aguarantor at the inception of certain guarantees. The disclosure requirementsof this interpretation were effective for HickoryTech on December 31, 2002 butdid not require any additional disclosures. The recognition provisions of theinterpretation are effective for HickoryTech in 2003 and are applicable only toguarantees issued or modified after December 31, 2002. The adoption ofInterpretation No. 45 did not impact the financial position, results ofoperations, or cash flows of HickoryTech.

 

In April 2003, the FASB issuedSFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and HedgingActivities.” This statement amends and clarifies financial accounting andreporting for derivative instruments, including certain derivative instrumentsembedded in other contracts and for hedging activities under SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 iseffective for certain contracts entered into or modified after June 30,2003.  The adoption of this standard didnot impact the financial position, results of operations, or cash flows ofHickoryTech.

 

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In January 2003, the FASBissued FIN No. 46, *Consolidation of VariableInterest Entities*. This interpretation provides guidance on how toidentify a variable interest entity and addresses when the assets, liabilitiesand results of operations of such entities must be included in a company’sconsolidated financial statements. This interpretation was effectiveimmediately for variable interest entities created after January 31, 2003 andfor variable interest entities in which the Company obtains an interest afterthat date. For interests in variable interest entities that were acquired priorto January 31, 2003, the Company adopted the provisions of this interpretationon July 1, 2003. Adoption of this statement did not result in the consolidationor disclosure of any variable interest entities in which the Company maintainsan interest. The Company did not absorb the majority of the losses or residualreturns of the variable interest entities in which the Company maintains aninterest and these interests are not significant. In December 2003, the FASBissued a revised FIN No. 46 which clarifies certain aspects of the accountingfor variable interest entities. The revision of FIN No. 46 had no impact on ourresults of operations or financial position.

 

In December 2003, the FASBissued a revision of SFAS No. 132, *Employers’Disclosures about Pensions and Other Postretirement Benefits*. Thisstatement revises the disclosures required for pension and other post-retirementbenefit plans. The Company has incorporated the new disclosure requirementsinto the Notes to Consolidated Financial Statements included in this report.

 

In January 2004, the FASBissued FASB Staff Position (FSP) No. FAS 106-1, *Accounting and Disclosure Requirements Related to the MedicarePrescription Drug Improvement and Modernization Act of 2003*. ThisFSP outlines the appropriate accounting treatment for the effects of the newMedicare law, as well as the required financial statement disclosures. The newlaw introduces a prescription drug benefit under Medicare, as well as a federalsubsidy to sponsors of retiree health care benefit plans that provide a benefitthat is at least actuarially equivalent to the Medicare plan. The retireemedical plans do provide prescription drug coverage. However, as permitted byFSP No. FAS 106-1, the Company has elected to defer recognition of the impactsof the new law on the accumulated post-retirement benefit obligation and netperiodic post-retirement benefit expense presented in the consolidatedfinancial statements. Specific authoritative accounting guidance on theaccounting for the federal subsidy provided for in the Act is pending. Thatguidance, when issued, could require the Company to change previously reportedinformation. Beginning January 1, 2006, Medicare’s prescription drug plan willbe the primary plan for qualified retirees when they become age 65 and areeligible for Medicare. Thus, the Company may see a decrease in the amount ofprescription drug benefits to be paid beginning in 2006.

 

On December 20, 2002, theFederal Communications Commission (FCC) notified carriers that they would notadopt SFAS No. 143 for regulatory accounting purposes. HickoryTech determinedthe amount of asset retirement obligations required to be recorded for its ILECcompanies under the provisions of SFAS No. 143 were not significant andtherefore the implementation of SFAS No. 143 on January 1, 2003 did not impactHickoryTech’s financial position or results of operations. HickoryTech’scompetitive local exchange carrier (CLEC), Enterprise Solutions, andInformation Solutions also adopted SFAS No. 143 effective January 1, 2003.HickoryTech has determined that its CLEC, along with Enterprise Solutions andInformation Solutions, do not have a material legal obligation to removelong-lived assets as described by SFAS No. 143, and accordingly, adoption ofSFAS No. 143 did not impact HickoryTech’s financial position or results ofoperations.

 

**REGULATED INDUSTRY**

ILEC Minnesota- HickoryTech’s two Minnesota ILEC subsidiariescontinue to operate under an alternative form of regulation as defined inMinnesota Chapter 237, whereby companies with less than 50,000 customers areregulated on price and service level rather than profit. The Minnesota PublicUtilities Commission (PUC) has been considering intrastate access reform anduniversal service for several years in Dockets P-999/CI-98-674 andP999/CI-00-829 respectively. The Minnesota PUC recently issued an order torefer the access reform issue to a contested case hearing during the first halfof 2004.  The ILEC industry,interexchange carriers and state agencies are also concurrently negotiating inhopes of an agreement to transition access rate changes over several years. Theoutcome of this process, whether by negotiation or commission order resultingfrom a hearing may not be realized until late in 2004, or possibly later.HickoryTech cannot estimate the impact, if any, of future potential stateaccess revenue changes. HickoryTech has been receiving requests for localnumber portability. Local number portability implementation is expected in May2004, but HickoryTech cannot estimate the impact on service and revenue, ifany, of such an implementation.

 

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Changes to Minnesota Statute237.626 enacted in 2003 have made it less burdensome for ILEC’s to conductpromotional activities and combine services in bundles.

 

ILEC Iowa- In Iowa, companies with fewer than 15,000 access lines remain unregulated.HickoryTech’s Iowa ILEC subsidiary falls below this regulation threshold.

 

CLEC -HickoryTech’s CLEC company operates in Minnesota and Iowa with less regulatoryoversight than the HickoryTech ILEC companies. Additionally, Crystal offers digitalvideo (CATV) service in the St. Peter, Minnesota market under a franchisenegotiated with the local municipality.

 

WirelineInterState - The HickoryTech ILEC companies do notparticipate in the NECA traffic sensitive pool and set access rates accordingto a nationwide average cost of providing access. This biannual rate processwas recently completed in June 2003 and established traffic sensitiveinterstate rates for the period from July 1, 2003 through June 30, 2005.HickoryTech ILEC companies participate in the NECA common line pool. In July of2003, common line rates charged to interexchange carriers were reduced (tozero), and common line charges to end users were increased in accordance withan FCC October 2001 order (a/k/a MAG Plan). Funds collected are pooled, andHickoryTech revenues are based on settlements distributed from the pool. Poolsettlements are adjusted from time to time. HickoryTech’s CLEC interstateaccess rates are established in accordance with the FCC’s April 2001 order andno further changes are known at the present time.

 

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

Forward-LookingStatements

This report on Form 10-K andother documents filed by HickoryTech under the federal securities laws,including Form 10-Q and Form 8-K, and future verbal or written statements byHickoryTech and its management, may include forward-looking statements. Thesestatements may include, without limitation, statements with respect toanticipated future operating and financial performance, growth opportunitiesand growth rates, acquisition and divestiture opportunities, businessstrategies, business and competitive outlook and other similar forecasts andstatements of expectation. Words such as expects, anticipates, intends, plans,believes, seeks, estimates and should and variations of these words and similarexpressions are intended to identify these forward-looking statements. Suchforward-looking statements are subject to uncertainties that could causeHickoryTech’s actual results to differ materially from such statements.

 

Uncertainties causing differingresults from those expressed in the forward-looking statements include, but arenot limited to, those uncertainties set forth below:

 

•                       Theeffects of on-going deregulation in the telecommunications industry as a resultof the Federal Telecommunications Act of 1996 (the “Telecommunications Act”)(which allows competition among telephone companies for the rights to offertelephone service to customers in a franchised service area) and other similarfederal and state legislation and regulations, including, without limitation,(i) greater-than-anticipated competition in HickoryTech’s predominately rurallocal exchange telephone markets, (ii) greater-than-anticipated reductions inrevenues received from federal and state access charges for switching longdistance traffic, (iii) the final outcome of regulatory and judicialproceedings with respect to interconnection agreements and access chargereforms, and (iv) future state regulatory actions taken in response to theTelecommunications Act.

 

•                       Thelack of assurance that HickoryTech can compete effectively against competitors,especially competitors with a larger national or regional market niche.

 

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

 

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•                       HickoryTech’sability to successfully introduce new products and services, including, withoutlimitation, (i) the ability of Crystal (which started its competitive localexchange carrier (CLEC) business in January 1998) to provide competitive localservice in new markets, (ii) the ability of NIBI (which is a billing and dataservices company) to implement, market, and sell its SuiteSolution billingsystem, (iii) the ability of HickoryTech to offer bundled service packages onterms attractive to its customers, (iv) the ability of HickoryTech to successfullyexpand its long distance and Internet offerings to new markets and (v) theability of HickoryTech to introduce and sell the equipment and systems ofNortel, Bay Networks and Cisco versus the competitive alternatives of othersuppliers.

 

•                       Possiblechanges in the demand for HickoryTech’s products and services, including,without limitation, lower-than-anticipated demand for, (i) premium telephoneservices, additional access lines per household or minutes of use volumeassociated with telephone service, (ii) data processing services or billingsystems, and (iii) communication and data equipment.

 

•                 Regulatory limitson HickoryTech’s ability to change its prices for telephone services inresponse to competitive pressures.

 

•                 The risksinherent in rapid technological change, including, without limitation, the riskthat technologies will not be procured by HickoryTech on a timely orcost-effective basis or perform according to expectations.

 

•                 The risksassociated with decisions of other telecommunications carriers involving theirchoice of networking, routes, points of interconnection, technology orsignaling protocol, and other telecommunications issues.

 

•                 HickoryTech’sability to effectively manage its growth, including, without limitation,HickoryTech’s ability to (i) integrate the operations of Crystal intoHickoryTech’s operations, (ii) manage NIBI’s development of and migration toSuiteSolution as its new primary software platform for billing and customercare management, (iii) achieve projected economies of scale and cost savings,(iv) meet pro forma cash flow projections developed by management in valuingnewly-acquired businesses, (v) conform with existing debt covenants andnegotiate new debt facilities which conform with evolving business plans, (vi)implement necessary internal controls and retain and attract key personnel and(vii) identify future acquisition opportunities for growth.

 

•                 Any difficultiesin HickoryTech’s ability to expand through additional acquisitions, whethercaused by financing constraints, a decrease in the pool of attractive targetcompanies, or competition for acquisitions from other interested buyers.

 

•                 The effects ofmore general factors, including, without limitation:

 

•                                    Changesin general industry and market conditions and growth rates.

•                                    Changesin interest rates or other general national, regional, or local economicconditions.

•                                    Changesin legislation, regulation or public policy.

•                                    Unanticipatedincreases in capital, operating or administrative costs, or the impact of newbusiness opportunities requiring significant up-front investments.

•                                    Thecontinued availability of financing in amounts, terms and conditions necessaryto support HickoryTech’s operations.

•                                    Changesin HickoryTech’s relationships with vendors.

•                                    Changesin HickoryTech’s debt ratios and the resultant effect on debt ratings.

•                                    Unfavorableoutcomes of regulatory or legal proceedings.

•                                    Changesin accounting policies or practices adopted voluntarily or as required bygenerally accepted accounting principles.

 

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

 

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**Item7A****.    Quantitativeand Qualitative Disclosures About Market Risk.**

 

HickoryTech does not haveoperations subject to risks of foreign currency fluctuations. HickoryTech doeshowever, use derivative financial instruments to manage exposure to interest ratefluctuations. HickoryTech’s objectives for holding derivatives are to minimizeinterest rate risks using the most effective methods to eliminate or reduce theimpact of these exposures. Variable rate debt instruments are subject tointerest rate risk. HickoryTech has entered into interest rate swap agreementswith remaining maturities ranging from six months to fifty-four months tomanage its exposure to interest rate movements on a portion of its variablerate debt obligations. The effective portion of the cumulative gain or loss onthese derivative instruments is reported as a component of accumulated othercomprehensive income in shareholders’ equity and is recognized in earnings whenthe term of the swap agreement is concluded. HickoryTech’s earnings areaffected by changes in interest rates as a portion of its long-term debt hasvariable interest rates based on LIBOR. If interest rates for the portion ofHickoryTech’s long-term debt based on variable rates had averaged 10% more forthe year ended December 31, 2003, HickoryTech’s interest expense would haveincreased $353,000 in 2003. If the interest expense on the variable portion oflong-term debt increases 10% in 2004, interest expense would be approximately$129,000 higher.

 

31

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**Item 8****.    FinancialStatements and Supplementary Data.**

 

**REPORT OF MANAGEMENT**

 

Management of Hickory TechCorporation (HickoryTech) is responsible for the consolidated financialstatements and the other financial information contained in this Annual Report.The financial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America applied on aconsistent basis and necessarily include some amounts that are based on management’sestimates and judgment. They are considered by management to present fairlyHickoryTech’s financial position, results of operations and cash flows.

 

To provide reasonable assurancethat assets are safeguarded against loss and that accounting records arereliable for preparing financial statements, HickoryTech management maintains asystem of internal controls. The Board of Directors pursues its oversight rolewith respect to HickoryTech’s financial statements through the Audit Committee.  The Audit Committee, which is composed ofdirectors who are not officers or employees, meets regularly with theindependent accountants and management to review the scope of internalcontrols, the manner in which they perform their responsibilities, audit activitiesand financial reporting. The independent public auditors have unrestrictedaccess to the Audit Committee.  TheAudit Committee reviews and approves financial disclosures prior to theirpublic release.

 

HickoryTech’s financialstatements have been audited by PricewaterhouseCoopers LLP, independentauditors. Management has made available to the independent auditors allHickoryTech financial records and related data. Their audits, which includedconsideration of the internal controls, culminated in their report whichappears on this page.

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

 

**REPORT OF INDEPENDENTAUDITORS**

 

To the Shareholders and Boardof Directors of

Hickory Tech Corporation

 

In our opinion, theaccompanying consolidated balance sheets and the related consolidatedstatements of operations, comprehensive income, shareholders’ equity and cashflows present fairly, in all material respects, the financial position ofHickory Tech Corporation and its subsidiaries (HickoryTech) at December 31,2003 and 2002, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2003, in conformitywith accounting principles generally accepted in the United States of America.These financial statements are the responsibility of HickoryTech’s management;our responsibility is to express an opinion on these financial statements basedon our audits. We conducted our audits of these statements in accordance withauditing standards generally accepted in the United States of America, whichrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An 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.

 

As described in Note 2 to theconsolidated financial statements, effective January 1, 2002, the Companyadopted Statement of Financial Accounting Standard No. 142, “Goodwill and OtherIntangible Assets.”

 

PricewaterhouseCoopers LLP

 

Minneapolis, Minnesota

January 30, 2004

 

32

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**HICKORY TECH CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**Years Ended December 31**

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

 
|                                                                                   |   | **2003**       |        | **2002**   |   | **2001**   |   |
|----------------------------------------------------------------------------------------|--------|----------------|-------------|------------|--------|------------|--------|
| OPERATING REVENUES:                                                                    |   |           | ** **  |       |   |       |   |
| Telecom Sector                                                                         |   | **$**          | **75,346**  | ** ** | $      | 71,108     |   | $ | 66,364 |   |
| Information Solutions Sector                                                           |   | **3,199**      | ** **  | 4,249      |   | 4,085      |   |
| Enterprise Solutions Sector                                                            |   | **14,347**     | ** **  | 15,781     |   | 20,374     |   |
| TOTAL OPERATING REVENUES                                                               |   | **92,892**     | ** **  | 91,138     |   | 90,823     |   |
|                                                                                   |   |           | ** **  |       |   |       |   |
| COSTS AND EXPENSES:                                                                    |   |           | ** **  |       |   |       |   |
| Cost of Products Sold, Enterprise Solutions                                            |   | **10,216**     | ** **  | 10,638     |   | 13,562     |   |
| Cost of Services, excluding Asset  Impairment, Depreciation and Amortization           |   | **33,471**     | ** **  | 32,998     |   | 30,867     |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization |   | **13,159**     | ** **  | 14,408     |   | 11,939     |   |
| Asset Impairment                                                                       |   | **—**     | ** **  | 316        |   | —     |   |
| Depreciation                                                                           |   | **14,870**     | ** **  | 13,567     |   | 10,735     |   |
| Amortization of Intangibles                                                            |   | **997**        | ** **  | 1,642      |   | 1,637      |   |
| TOTAL COSTS AND EXPENSES                                                               |   | **72,713**     | ** **  | 73,569     |   | 68,740     |   |
|                                                                                   |   |           | ** **  |       |   |       |   |
| OPERATING INCOME                                                                       |   | **20,179**     | ** **  | 17,569     |   | 22,083     |   |
|                                                                                   |   |           | ** **  |       |   |       |   |
| OTHER INCOME/(EXPENSE):                                                                |   |           | ** **  |       |   |       |   |
| Equity in Net Income/(Loss) of Investees                                               |   | **9**          | ** **  | (25        | )      | (27        | )      |
| Interest and Other Income                                                              |   | **53**         | ** **  | 345        |   | 399        |   |
| Interest Expense                                                                       |   | **(6,103**     | **)**       | (7,405     | )      | (10,854    | )      |
| TOTAL OTHER INCOME (EXPENSE)                                                           |   | **(6,041**     | **)**       | (7,085     | )      | (10,482    | )      |
| INCOME BEFORE INCOME TAXES                                                             |   | **14,138**     | ** **  | 10,484     |   | 11,601     |   |
| INCOME TAX PROVISION                                                                   |   | **5,683**      | ** **  | 4,249      |   | 4,711      |   |
| INCOME FROM CONTINUING OPERATIONS                                                      |   | **8,455**      | ** **  | 6,235      |   | 6,890      |   |
| DISCONTINUED OPERATIONS (Note 3)                                                       |   |           | ** **  |       |   |       |   |
| Income/(Loss) from Operations of  Discontinued Component                               |   |           | ** **  |       |   |       |   |
| Including Loss on Disposal of $25,642,000  in 2003                                     |   | **(23,087**    | **)**       | (38,692    | )      | 3,108      |   |
| Income Tax (Benefit)/Provision                                                         |   | **(1,857**     | **)**       | (15,830    | )      | 1,260      |   |
| INCOME/(LOSS) ON DISCONTINUED OPERATIONS                                               |   | **(21,230**    | **)**       | (22,862    | )      | 1,848      |   |
|                                                                                   |   |           | ** **  |       |   |       |   |
| NET INCOME/(LOSS)                                                                      |   | **$**          | **(12,775** | **)**      | $      | (16,627    | )      | $ | 8,738 |   |
|                                                                                   |   |           | ** **  |       |   |       |   |
| Basic Earnings Per Share - Continuing  Operations:                                     |   | **$**          | **0.61**    | ** ** | $      | 0.44       |   | $ | 0.50 |   |
| Basic Earnings/(Loss) Per Share -  Discontinued Operations:                            |   | **(1.53**      | **)**       | (1.63      | )      | 0.13       |   |
|                                                                                   |   | **$**          | **(0.92**   | **)**      | $      | (1.19      | )      | $ | 0.63 |   |
| Dividends Per Share                                                                    |   | **$**          | **0.44**    | ** ** | $      | 0.44       |   | $ | 0.44 |   |
|                                                                                   |   |           | ** **  |       |   |       |   |
| Weighted Average Common Shares Outstanding                                             |   | **13,934,178** | ** **  | 14,023,645 |   | 13,904,690 |   |
|                                                                                   |   |           | ** **  |       |   |       |   |
| Diluted Earnings Per Share - Continuing  Operations:                                   |   | **$**          | **0.61**    | ** ** | $      | 0.44       |   | $ | 0.49 |   |
| Diluted Earnings/(Loss) Per Share -  Discontinued Operations:                          |   | **(1.53**      | **)**       | (1.62      | )      | 0.13       |   |
|                                                                                   |   | **$**          | **(0.92**   | **)**      | $      | (1.18      | )      | $ | 0.62 |   |
| Weighted Average Common and Equivalent  Shares Outstanding                             |   | **13,961,282** | ** **  | 14,075,684 |   | 14,001,478 |   |

 

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

 

33

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**HICKORY TECH CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

**As of December 31**

*(Dollars in Thousands)*

 
|                                                                                                                                   |   | **2003**    |        | **2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|----------|--------|
| ASSETS                                                                                                                                 |   |        |        |     |   |
| CURRENT ASSETS:                                                                                                                        |   |        |        |     |   |
| Cash and Cash Equivalents                                                                                                              |   | **$**       | **278**     |     | $      | 1,874 |   |
| Receivables, Net of  Allowance for Doubtful Accounts of $1,283 and $1,358                                                              |   | **9,984**   |        | 11,056   |   |
| Income Taxes Receivable                                                                                                                |   | **2,838**   |        | 3,222    |   |
| Costs in Excess of  Billings on Contracts                                                                                              |   | **934**     |        | 2,107    |   |
| Inventories                                                                                                                            |   | **4,453**   |        | 5,059    |   |
| Deferred Income Taxes                                                                                                                  |   | **1,057**   |        | 951      |   |
| Other                                                                                                                                  |   | **2,497**   |        | 2,840    |   |
| TOTAL CURRENT ASSETS                                                                                                                   |   | **22,041**  |        | 27,109   |   |
| INVESTMENTS                                                                                                                            |   | **6,710**   |        | 10,517   |   |
| PROPERTY, PLANT AND  EQUIPMENT                                                                                                         |   | **230,490** |        | 247,375  |   |
| LESS ACCUMULATED  DEPRECIATION                                                                                                         |   | **116,487** |        | 111,101  |   |
| PROPERTY, PLANT AND  EQUIPMENT, NET                                                                                                    |   | **114,003** |        | 136,274  |   |
| OTHER ASSETS:                                                                                                                          |   |        |        |     |   |
| Goodwill                                                                                                                               |   | **25,086**  |        | 25,086   |   |
| Intangible Assets, Net                                                                                                                 |   | **481**     |        | 34,669   |   |
| Financial Derivative  Instrument                                                                                                       |   | **2,515**   |        | —   |   |
| Deferred Costs and Other                                                                                                               |   | **4,876**   |        | 6,556    |   |
| TOTAL OTHER ASSETS                                                                                                                     |   | **32,958**  |        | 66,311   |   |
| TOTAL ASSETS                                                                                                                           |   | **$**       | **175,712** |     | $      | 240,211 |   |
| LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                            |   |        |        |     |   |
| CURRENT LIABILITIES:                                                                                                                   |   |        |        |     |   |
| Cash Overdraft                                                                                                                         |   | **$**       | **1,001**   |     | $      | — |   |
| Accounts Payable                                                                                                                       |   | **3,771**   |        | 4,543    |   |
| Accrued Expenses                                                                                                                       |   | **3,243**   |        | 3,719    |   |
| Accrued Interest                                                                                                                       |   | **41**      |        | 512      |   |
| Billings in Excess of  Costs on Contracts                                                                                              |   | **73**      |        | 80       |   |
| Advanced Billings and  Deposits                                                                                                        |   | **3,040**   |        | 3,741    |   |
| Current Maturities of  Long-Term Obligations                                                                                           |   | **1,572**   |        | 1,441    |   |
| TOTAL CURRENT LIABILITIES                                                                                                              |   | **12,741**  |        | 14,036   |   |
| LONG-TERM OBLIGATIONS, Net  of Current Maturities                                                                                      |   | **118,040** |        | 157,599  |   |
| DEFERRED INCOME TAXES                                                                                                                  |   | **10,331**  |        | 4,377    |   |
| DEFERRED REVENUE AND  EMPLOYEE BENEFITS                                                                                                |   | **5,883**   |        | 5,604    |   |
| TOTAL LIABILITIES                                                                                                                      |   | **146,995** |        | 181,616  |   |
| COMMITMENTS AND CONTINGENCIES  (Notes 7, 8 and 13)                                                                                     |   | **—**  |        | —   |   |
| SHAREHOLDERS’ EQUITY:                                                                                                             |   |        |        |     |   |
| Common Stock, no par  value, $.10 stated value  Shares authorized: 100,000,000  Shares outstanding: 2003, 12,967,811; 2002, 13,983,929 |   | **1,297**   |        | 1,398    |   |
| Additional Paid-In Capital                                                                                                             |   | **7,690**   |        | 7,885    |   |
| Retained Earnings                                                                                                                      |   | **18,246**  |        | 49,312   |   |
| Accumulated Other  Comprehensive Income                                                                                                |   | **1,484**   |        | —   |   |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                        |   | **28,717**  |        | 58,595   |   |
| TOTAL LIABILITIES &  SHAREHOLDERS’ EQUITY                                                                                     |   | **$**       | **175,712** |     | $      | 240,211 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

34

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**HICKORY TECHCORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**Years Ended December 31**

*(Dollars in Thousands)*

 
|                                                                                          |   | **2003**    |        | **2002**   |   | **2001** |   |
|-----------------------------------------------------------------------------------------------|--------|-------------|-------------|------------|--------|----------|--------|
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                        |   |        | ** **  |       |   |     |   |
| Net Income/(Loss)                                                                             |   | **$**       | **(12,775** | **)**      | $      | (16,627  | )      | $ | 8,738 |   |
| Adjustments to Reconcile  Net Income to Net Cash Provided by Operating Activities:            |   |        | ** **  |       |   |     |   |
| Depreciation and  Amortization                                                                |   | **17,638**  | ** **  | 17,789     |   | 16,794   |   |
| Intangible Asset Impairment                                                                   |   | **21,000**  | ** **  | 41,951     |   | —   |   |
| Long-Lived Asset Impairment                                                                   |   | **4,345**   | ** **  | —     |   | —   |   |
| (Gain)/Loss on Sale of  Assets                                                                |   | **(3**      | **)**       | 183        |   | (1,115   | )      |
| Loss on Abandoned Asset                                                                       |   | **632**     | ** **  | —     |   | —   |   |
| Provision for Losses on  Accounts Receivable                                                  |   | **1,093**   | ** **  | 2,114      |   | 782      |   |
| Deferred Income Taxes                                                                         |   | **4,817**   | ** **  | (9,804     | )      | 5,217    |   |
| Stock-Based Compensation                                                                      |   | **(160**    | **)**       | 329        |   | 217      |   |
| Employee Retirement  Benefits and Deferred Compensation                                       |   | **412**     | ** **  | 471        |   | 170      |   |
| Accrued Patronage Refunds                                                                     |   | **(555**    | **)**       | (583       | )      | (1,114   | )      |
| Equity in Net (Income)/Loss  of Investees                                                     |   | **(9**      | **)**       | 25         |   | 27       |   |
| Tax Benefit from Stock  Option Transactions                                                   |   | **17**      | ** **  | 118        |   | —   |   |
| Cash Provided From  Operations Before Changes In Assets and Liabilities                       |   | **36,452**  | ** **  | 35,966     |   | 29,716   |   |
| Changes in Operating Assets  and Liabilities Net of Effects of Acquisitions and Dispositions: |   |        | ** **  |       |   |     |   |
| Receivables                                                                                   |   | **(1,234**  | **)**       | (254       | )      | (823     | )      |
| Inventories                                                                                   |   | **310**     | ** **  | (70        | )      | (442     | )      |
| Billings and Costs on  Contracts                                                              |   | **1,166**   | ** **  | (676       | )      | (1,321   | )      |
| Accounts Payable and  Accrued Expenses                                                        |   | **(1,241**  | **)**       | (281       | )      | (1,525   | )      |
| Advance Billings and  Deposits                                                                |   | **95**      | ** **  | 161        |   | 125      |   |
| Deferred Revenue and  Employee Benefits                                                       |   | **(105**    | **)**       | (310       | )      | 23       |   |
| Other                                                                                         |   | **1,306**   | ** **  | 131        |   | (618     | )      |
| Net Cash Provided By  Operating Activities                                                    |   | **36,749**  | ** **  | 34,667     |   | 25,135   |   |
|                                                                                          |   |        | ** **  |       |   |     |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                        |   |        | ** **  |       |   |     |   |
| Additions to Property,  Plant and Equipment                                                   |   | **(13,570** | **)**       | (16,674    | )      | (32,868  | )      |
| Additions to Capitalized  Software Development Costs                                          |   | **—**  | ** **  | —     |   | (2,717   | )      |
| Redemption of Investments                                                                     |   | **4,144**   | ** **  | 100        |   | —   |   |
| Acquisitions, Net of Cash  Acquired                                                           |   | **—**  | ** **  | —     |   | (11,386  | )      |
| Proceeds from Sale of  Wireless Business                                                      |   | **16,246**  | ** **  | —     |   | —   |   |
| Proceeds from Sale of  Assets                                                                 |   | **159**     | ** **  | 243        |   | 6,992    |   |
| Net Cash Provided By (Used  In) Investing Activities                                          |   | **6,979**   | ** **  | (16,331    | )      | (39,979  | )      |
|                                                                                          |   |        | ** **  |       |   |     |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                        |   |        | ** **  |       |   |     |   |
| Change in Cash Overdraft                                                                      |   | **1,001**   | ** **  | —     |   | —   |   |
| Repayments of Debt                                                                            |   | **—**  | ** **  | —     |   | (649     | )      |
| Payments of Capital Lease  Obligations                                                        |   | **(588**    | **)**       | (480       | )      | (141     | )      |
| Borrowings on Credit  Facility                                                                |   | **11,250**  | ** **  | 2,950      |   | 30,500   |   |
| Repayments on Credit  Facility                                                                |   | **(50,750** | **)**       | (14,950    | )      | (8,500   | )      |
| Proceeds from Issuance of  Common Stock                                                       |   | **759**     | ** **  | 1,252      |   | 569      |   |
| Dividends Paid                                                                                |   | **(6,150**  | **)**       | (6,170     | )      | (6,117   | )      |
| Stock Repurchase                                                                              |   | **(846**    | **)**       | (1,072     | )      | —   |   |
| Net Cash Provided By (Used  In) Financing Activities                                          |   | **(45,324** | **)**       | (18,470    | )      | 15,662   |   |
|                                                                                          |   |        | ** **  |       |   |     |   |
| NET INCREASE (DECREASE) IN  CASH AND CASH EQUIVALENTS                                         |   | **(1,596**  | **)**       | (134       | )      | 818      |   |
|                                                                                          |   |        | ** **  |       |   |     |   |
| CASH AND CASH EQUIVALENTS  AT BEGINNING OF PERIOD                                             |   | **1,874**   | ** **  | 2,008      |   | 1,190    |   |
| CASH AND CASH EQUIVALENTS  AT END OF PERIOD                                                   |   | **$**       | **278**     | ** ** | $      | 1,874    |   | $ | 2,008 |   |
|                                                                                          |   |        | ** **  |       |   |     |   |
| SUPPLEMENTAL DISCLOSURE OF  CASH FLOW INFORMATION:                                            |   |        | ** **  |       |   |     |   |
| Cash Paid for Interest                                                                        |   | **$**       | **6,906**   | ** ** | $      | 7,682    |   | $ | 11,337 |   |
| Cash Paid for Income Taxes,  Net of $3,142 and $990 of Tax Refunds in 2003 and 2002           |   | **$**       | **(1,392**  | **)**      | $      | (230     | )      | $ | 1,750 |   |
| NON-CASH INVESTING  ACTIVITIES:                                                               |   |        | ** **  |       |   |     |   |
| Property, Plant and  Equipment Acquired with Capital Leases                                   |   | **$**       | **660**     | ** ** | $      | 618      |   | $ | 1,041 |   |
| Stock Consideration  Received in Wireless Business Sale                                       |   | **$**       | **12,207**  | ** ** | $      | —   |   | $ | — |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

35

----

 

**HICKORY TECH CORPORATION**

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

**Years Ended December 31**

*(Dollars in Thousands)*

 
|                                             |   | **Common Stock** |   | **Additional  Paid - In  Capital** |   | **Retained  Earnings** |   | **Other  Comprehensive  Income** |   | **Total  Shareholders’  Equity** |   | **Total  Comprehensive****Income(Loss)** |   |
|--------------------------------------------------|--------|------------------|--------|------------------------------------|--------|------------------------|--------|----------------------------------|--------|---------------------------------------|--------|------------------------------------------|--------|
|                                             |   | **Shares**       |   | **Amount**                         |   |                   |   |                             |   |                                  |
|                                             |   |             |   |                               |   |                   |   |                             |   |                                  |   |                                     |   |   |   |
| BALANCE, DECEMBER 31, 2000                       |   | 13,878,568       |   | $                                  | 1,388  |                   | $      | 5,473                            |   | $                                     | 70,496 |                                     | $      | — |   | $ | 77,357 |   |   |   |
|                                             |   |             |   |                               |   |                   |   |                             |   |                                  |   |                                     |   |   |   |
| Stock Award Plan                                 |   | 18,374           |   | 2                                  |   | 211                    |   |                             |   |                                  |   | 213                                      |   |   |   |
| Employee Stock Purchase  Plan                    |   | 20,781           |   | 2                                  |   | 291                    |   |                             |   |                                  |   | 293                                      |   |   |   |
| Directors’ Stock Retainer  Plan             |   | 2,089            |   |                               |   | 33                     |   |                             |   |                                  |   | 33                                       |   |   |   |
| Dividend Reinvestment Plan                       |   | 15,496           |   | 2                                  |   | 246                    |   |                             |   |                                  |   | 248                                      |   |   |   |
| Net Income                                       |   |             |   |                               |   |                   |   | 8,738                            |   |                                  |   | 8,738                                    |   | $ | 8,738 |   |
| Dividends Paid                                   |   |             |   |                               |   |                   |   | (6,117                           | )      |                                  |   | (6,117                                   | )      |   |   |
| Total Comprehensive Income                       |   |             |   |                               |   |                   |   |                             |   |                                  |   | —                                   |   | $ | 8,738 |   |
|                                             |   |             |   |                               |   |                   |   |                             |   |                                  |   |                                     |   |   |   |
| BALANCE, DECEMBER 31, 2001                       |   | 13,935,308       |   | 1,394                              |   | 6,254                  |   | 73,117                           |   | —                                |   | 80,765                                   |   |   |   |
|                                             |   |             |   |                               |   |                   |   |                             |   |                                  |   |                                     |   |   |   |
| Stock Award Plan                                 |   | 43,931           |   | 4                                  |   | 295                    |   |                             |   |                                  |   | 299                                      |   |   |   |
| Employee Stock Purchase  Plan                    |   | 24,777           |   | 2                                  |   | 297                    |   |                             |   |                                  |   | 299                                      |   |   |   |
| Directors’ Stock Retainer  Plan             |   | 2,282            |   |                               |   | 30                     |   |                             |   |                                  |   | 30                                       |   |   |   |
| Stock Options Exercised                          |   | 63,796           |   | 6                                  |   | 696                    |   |                             |   |                                  |   | 702                                      |   |   |   |
| Dividend Reinvestment Plan                       |   | 19,535           |   | 2                                  |   | 249                    |   |                             |   |                                  |   | 251                                      |   |   |   |
| Stock Repurchase                                 |   | (105,700         | )      | (10                                | )      | (54                    | )      | (1,008                           | )      |                                  |   | (1,072                                   | )      |   |   |
| Stock Option Tax Benefit                         |   |             |   |                               |   | 118                    |   |                             |   |                                  |   | 118                                      |   |   |   |
| Net Income                                       |   |             |   |                               |   |                   |   | (16,627                          | )      |                                  |   | (16,627                                  | )      | $ | (16,627 | ) |
| Dividends Paid                                   |   |             |   |                               |   |                   |   | (6,170                           | )      |                                  |   | (6,170                                   | )      |   |   |
| Total Comprehensive Loss                         |   |             |   |                               |   |                   |   |                             |   |                                  |   | —                                   |   | $ | (16,627 | ) |
|                                             |   |             |   |                               |   |                   |   |                             |   |                                  |   |                                     |   |   |   |
| BALANCE, DECEMBER 31, 2002                       |   | 13,983,929       |   | 1,398                              |   | 7,885                  |   | 49,312                           |   | —                                |   | 58,595                                   |   |   |   |
|                                             |   |             |   |                               |   |                   |   |                             |   |                                  |   |                                     |   |   |   |
| Stock Award Plan                                 |   | 23,193           |   | 2                                  |   | (237                   | )      |                             |   |                                  |   | (235                                     | )      |   |   |
| Employee Stock Purchase  Plan                    |   | 27,763           |   | 3                                  |   | 256                    |   |                             |   |                                  |   | 259                                      |   |   |   |
| Directors’ Stock Retainer  Plan             |   | 6,811            |   | 1                                  |   | 74                     |   |                             |   |                                  |   | 75                                       |   |   |   |
| Stock Options Exercised                          |   | 24,387           |   | 2                                  |   | 227                    |   |                             |   |                                  |   | 229                                      |   |   |   |
| Dividend Reinvestment Plan                       |   | 25,625           |   | 3                                  |   | 268                    |   |                             |   |                                  |   | 271                                      |   |   |   |
| Stock Repurchase                                 |   | (84,970          | )      | (8                                 | )      | (218                   | )      | (619                             | )      |                                  |   | (846                                     | )      |   |   |
| Stock Received in Wireless  Sale                 |   | (1,038,927       | )      | (104                               | )      | (582                   | )      | (11,522                          | )      |                                  |   | (12,207                                  | )      |   |   |
| Stock Option Tax Benefit                         |   |             |   |                               |   | 17                     |   |                             |   |                                  |   | 17                                       |   |   |   |
| Net Income/(Loss)                                |   |             |   |                               |   |                   |   | (12,775                          | )      |                                  |   | (12,775                                  | )      | $ | (12,775 | ) |
| Dividends Paid                                   |   |             |   |                               |   |                   |   | (6,150                           | )      |                                  |   | (6,150                                   | )      |   |   |
| Other Comprehensive  Income, Net of Income Taxes |   |             |   |                               |   |                   |   |                             |   | 1,484                                 |   | 1,484                                    |   | 1,484 |   |
| Total Comprehensive Loss                         |   |             |   |                               |   |                   |   |                             |   |                                  |   | —                                   |   | $ | (11,291 | ) |
|                                             |   |             |   |                               |   |                   |   |                             |   |                                  |   |                                     |   |   |   |
| BALANCE, DECEMBER 31, 2003                       |   | 12,967,811       |   | $                                  | 1,297  |                   | $      | 7,690                            |   | $                                     | 18,246 |                                     | $      | 1,484 |   | $ | 28,717 |   |   |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

36

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 – ACCOUNTING POLICIES**

 

The accounting policies ofHickory Tech Corporation (HickoryTech) are in conformity with accountingprinciples generally accepted in the United States of America 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 Financial Accounting Standards Board Statement (SFAS) No. 71,“Accounting for the Effects of Certain Types of Regulation.”

 

**Basis of Consolidation**– The consolidated financial statements of HickoryTech include Hickory TechCorporation and its subsidiaries in the following three business segments:  (i) Telecom Sector, (ii) InformationSolutions Sector and (iii) Enterprise Solutions Sector. An investment in anunconsolidated partnership for the Information Solutions Sector is accountedfor using the equity method.  Theoperations of this partnership were dissolved during 2003. No materialwind-down costs were incurred. All inter-company transactions have beeneliminated from the consolidated financial statements.

 

Cost of services include allcosts related to delivery of HickoryTech’s communications services andproducts. These costs include all costs of performing services and providingrelated products. It does not include costs associated with selling, generaland administrative, depreciation and amortization of property, plant andequipment, intangible asset impairment charges and costs of sales for theEnterprise Solutions Sector.

 

On December 15, 2003,HickoryTech sold its wireless business, Minnesota Southern Wireless Company(MSWC), to Western Wireless Corporation (WWC). The wireless operations are reported as part of the Telecom Sector. Theresults of operations of the wireless business are reported as discontinuedoperations for all periods presented (see Note 3).

 

**Revenue Recognition**– Revenues are recognized when services are earned, rendered or products aredelivered to customers.  Customers arebilled as of monthly cycle dates. Telecom Sector revenues are derived fromcharges for network access to HickoryTech’s local exchange telephone network,from subscriber line charges and from contractual arrangements for servicessuch as billing and collection and directory advertising.  Certain of these revenues are realized underpooling arrangements with other telephone companies and are divided among thecompanies based on respective costs and investments to provide the services.Management believes that recorded amounts represent reasonable estimates of thefinal distribution from these pools. Revenue in the Enterprise Solutions Sectorearned on major installation and change contracts is recognized using thepercentage of completion method. Up-front fees, including installation andactivation fees, are deferred and recognized on a straight-line basis over thecorresponding customer relationship period.

 

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

 

**Reclassifications******–Certain reclassifications were made to the 2002 and 2001 financial statementsto conform to the 2003 presentation. These reclassifications had no impact on previously reported net income(loss), or shareholders’ equity or cash flows.

 

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

 

In September of 2003HickoryTech abandoned a CLEC initiative. As a result, HickoryTech wrote offproperty, plant and equipment with a carrying value of $632,000. This $632,000charge is included in the cost of services of the Telecom Sector in theconsolidated statement of operations.

 

The components of property,plant and equipment are summarized as follows:

 

(Dollarsin Thousands)

 

|                                   |   | **2003**    |        | **2002** |   |
|----------------------------------------|--------|-------------|-------------|----------|--------|
|                                   |   |        |        |     |   |
| ILEC Telephone Plant  (Telecom Sector) |   | **$**       | **161,981** |     | $      | 152,305 |   |
| CLEC Telephone Plant  (Telecom Sector) |   | **55,102**  |        | 54,786   |   |
| Wireless Plant (Telecom  Sector)       |   | **—**  |        | 27,871   |   |
| Other Property and Equipment           |   | **13,407**  |        | 12,413   |   |
| Total                                  |   | **230,490** |        | 247,375  |   |
| Less Accumulated  Depreciation         |   | **116,487** |        | 111,101  |   |
| Property, Plant and  Equipment, Net    |   | **$**       | **114,003** |     | $      | 136,274 |   |

 

37

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Depreciation for financial statementpurposes is determined using the straight-line method based on the lives of thevarious classes of depreciable assets. The composite depreciation rates on ILECtelephone plant for the three years ended December 31, 2003, were 6.1%, 6.1%,and 5.9%.  All other property, plant andequipment is depreciated over estimated useful lives of three to twenty years,and buildings are depreciated over their estimated useful lives of thirty-nineyears. Other property and equipment includes $660,000 and $618,000 of equipmentacquired under capital leases in 2003 and 2002.  Amortization expense related to these capital leases was $558,000and $459,000 in 2003 and 2002. Accumulated amortization related to these leases was $1,147,000 and$589,000 in 2003 and 2002.

 

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

 

**Investments** – Investmentsinclude $6.1 million of non-interest bearing Rural Telephone FinanceCooperative (RTFC) Subordinated Capital Certificates (SCCs) accounted for underthe cost method of accounting.  Thismethod requires HickoryTech to periodically evaluate whether a non-temporarydecrease in value of the investment has occurred, and if so, to write thisinvestment down to its net realizable value.

 

Investments also included anunconsolidated partnership accounted for using the equity method of accounting.NIBI, a wholly owned subsidiary of HickoryTech, was a 40% general partner inNational Independent Billing Partnership (NIBP), which performed billing andcollection clearinghouse functions for interexchange carriers. NIBP wasdissolved as of December 31, 2003. NIBP had total assets of $496,000 andliabilities of $413,000, respectively as of December 31, 2002.  For the years ended December 31, 2003 and2002, NIBP had revenues of $19,000 and $184,000 respectively, and net income/(loss)of $28,000 and ($68,000), respectively.

 

**Inventories** –Inventories, which consist of equipment for resale, materials and supplies, arestated at the lower of average cost or market. Cost is determined on a first-in first-out (FIFO) basis. The netrealizable value of the inventory is reflected by reserves, which offset thecost of inventory.

 

**Income Taxes** –HickoryTech accounts for income taxes in accordance with SFAS No. 109,“Accounting for Income Taxes,” which requires an asset and liability approachto financial accounting and reporting for income taxes. Accordingly, deferredtax assets and liabilities arise from the difference between the tax basis ofan asset or liability and its reported amount in the financial statements.Deferred tax amounts are determined by 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.

 

**Intangible Assets and Goodwill**– HickoryTech adopted the provisions of Statement of Financial AccountingStandards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” effectiveJanuary 1, 2002. SFAS No. 142 required that goodwill and intangible assets withindefinite useful lives no longer be amortized, but instead tested forimpairment at least annually. Accordingly, at January 1, 2002, HickoryTechceased amortizing its goodwill and FCC licenses.  See Note 2 for a more detailed discussion of the intangibleassets and goodwill.

 

**Capitalized Software Costs –**Softwarecosts associated with software that is developed or purchased for internal useonly are accounted for in accordance with the American Institute of CertifiedPublic Accountants Statement of Position 98-1, “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use.” HickoryTechcapitalizes costs (including right to use fees) associated with externallyacquired software for internal use. Costs associated with internally developedsoftware are segregated into three project stages: preliminary project stage, applicationdevelopment stage and post-implementation stage. Costs associated with both thepreliminary project stage and post-implementation stage, are expensed asincurred. Costs associated with the application development stage arecapitalized. Software maintenance and training costs are expensed as incurred.Amortization of software costs commences when the software is ready for itsintended use, and is amortized over a period of three years. During 2003,****2002****and2001,****HickoryTech capitalized$144,000,****$2,439,000****and $1,285,000,****respectively, of costs associated with software purchased ordeveloped for internal use only.****Thesesoftware costs are included in property, plant and equipment, and amounted to$2,552,000****and $3,196,000****at December 31, 2003****and 2002,respectively.****Theseamounts are net of accumulated amortization of $1,199,000 and****$412,000 at December 31, 2003****and 2002,respectively.****Amortizationexpense relating to these costs amounted to $788,000 and $746,000 in 2003 and2002, respectively.

 

Software costs associated withsoftware that is developed or purchased for external sale or license areaccounted for in accordance with SFAS No. 86, “Accounting for the Costs ofComputer Software to Be Sold, Leased or Otherwise Marketed.” HickoryTech capitalizescosts related to such software when technological feasibility has beenestablished and continues capitalization until the product becomes availablefor general release to customers. HickoryTech capitalized software costs of****$2,717,000****in****2001****related to software that will be sold orlicensed externally.****Thesesoftware costs are included in other non-current assets,****and****amountedto****$1,275,000****and $2,170,000 at December 31,****2003 and 2002, respectively.****These amounts are net of accumulatedamortization of****$2,651,000 and****$1,756,000****at December 31, 2003****and2002,****respectively.****Capitalized software costs are amortizedon a product-by-product basis over the estimated economic life of the product,which are currently three and four years. Amortization expense relating to these costs amounted to****$895,000 in 2003 and****$1,027,000 in 2002.

 

**Comprehensive Income**–HickoryTech follows the provisions of SFAS No. 130, “Reporting ComprehensiveIncome.” This statement established rules for the reporting of comprehensiveincome and its components. In addition to net income (loss), HickoryTech’scomprehensive income includes changes in unrealized gains and losses onderivative instruments qualifying and designated as cash flow hedges.

 

**Advertising Expense**– Advertising is expensed as incurred. Advertising expense charged tooperations was $935,000, $926,000 and $684,000 in 2003, 2002 and 2001,respectively.

 

38

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

 

|                                 |   | **2003**       |   | **2002**   |   | **2001**   |   |
|--------------------------------------|--------|----------------|--------|------------|--------|------------|--------|
| Weighted Average Shares  Outstanding |   | **13,934,178** |   | 14,023,645 |   | 13,904,690 |   |
| Stock Options                        |   | **18,809**     |   | 39,916     |   | 95,645     |   |
| Stock Subscribed (ESPP)              |   | **8,295**      |   | 12,123     |   | 1,143      |   |
|                                 |   |           |   |       |   |       |   |
| Total Dilutive Shares  Outstanding   |   | **13,961,282** |   | 14,075,684 |   | 14,001,478 |   |

 

Options to purchase 481,698shares as of December 31, 2003, 249,800 shares as of December 31, 2002 and76,750 shares as of December 31, 2001 were not included in the computation ofearnings per share assuming dilution because their effect on earnings per sharewould have been antidilutive.

 

Dividends per share is based onthe quarterly dividend per share as declared by the HickoryTech Board ofDirectors.

 

**StockCompensation –**At December 31, 2003, HickoryTech hasfour stock-based employee compensation plans, which are described more fully inNote 6.  HickoryTech has elected toapply Accounting Principles Board Opinion No. 25 and related interpretations inaccounting for its employee and directors’ stock compensation plans.  If HickoryTech had elected to recognizecompensation cost based on the fair value of the options as prescribed by SFASNo. 123, the following operating results would have occurred using theBlack-Scholes option-pricing model to determine the fair value of the options(see Note 6):

 

|                                                                                                                                          |   | **Years  Ended December 31** |        |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|-------------|
| **(Dollars in Thousands)**                                                                                                                    |   | **2003**                     |        | **2002** |   | **2001** |   |
|                                                                                                                                          |   |                         |        |   |   |   |   |
| Reported Net Income/(Loss)                                                                                                                    |   | **$**                        | **(12,775** | **)** | $ | (16,627 | ) | $ | 8,738 |   |
| Add: Stock-based employee  compensation expense included in reported net income, net of related tax  effects                                  |   | **(160**                     | **)**       | 329 |   | 217 |   |
| Deduct: Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |   | **(101**                     | **)**       | (666 | ) | (539 | ) |
|                                                                                                                                          |   |                         | ** **  |   |   |   |   |
| Pro Forma Net Income/(Loss)                                                                                                                   |   | **$**                        | **(13,036** | **)** | $ | (16,964 | ) | $ | 8,416 |   |
|                                                                                                                                          |   |                         | ** **  |   |   |   |   |
| Earnings per share:                                                                                                                           |   |                         | ** **  |   |   |   |   |
| Basic - as reported                                                                                                                           |   | **$**                        | **(0.92**   | **)** | $ | (1.19 | ) | $ | 0.63 |   |
| Basic - pro forma                                                                                                                             |   | **$**                        | **(0.94**   | **)** | $ | (1.21 | ) | $ | 0.61 |   |
|                                                                                                                                          |   |                         | ** **  |   |   |   |   |
| Diluted - as reported                                                                                                                         |   | **$**                        | **(0.92**   | **)** | $ | (1.18 | ) | $ | 0.62 |   |
| Diluted - pro forma                                                                                                                           |   | **$**                        | **(0.94**   | **)** | $ | (1.20 | ) | $ | 0.60 |   |

** **

**NOTE2****– GOODWILL ANDOTHER INTANGIBLE ASSETS - ADOPTION OF STATEMENT OF FINANCIAL ACCOUNTINGSTANDARDS (SFAS) NO. 142**

 

Effective January 1, 2002,HickoryTech adopted SFAS No. 142, “Goodwill and Other Intangible Assets.”SFAS No. 142 established new standards related to how acquired goodwilland other intangible assets are to be recorded upon their acquisition as wellas how they are to be accounted for after they have been initially recognizedin the financial statements.

 

Effective with the adoption ofthis standard, HickoryTech is no longer amortizing acquired goodwill. Instead,SFAS No. 142 requires acquired goodwill to be evaluated for impairmentusing a two-step test based upon a fair value approach. The first step is usedto identify potential impairment based upon the fair value of the applicablereporting unit. If the fair value of the reporting unit is less than itscarrying value, a second step is required to determine the fair value of theindividual assets and liabilities of the reporting unit in order to measure theamount of the goodwill impairment. Upon adoption of this standard, HickoryTechcompleted a transitional impairment test for its acquired goodwill, determiningfair value using primarily a discounted cash flow model. The determined fairvalue was sufficient to pass the first step impairment test, and therefore noimpairment was recorded.

 

39

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

 

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

 

On a prospective basis,HickoryTech is required to test acquired goodwill for impairment on an annualbasis based upon a fair value approach. Additionally, goodwill shall be testedfor impairment between annual tests if an event occurs or circumstances changethat would more likely than not reduce the fair value of an entity below itscarrying value. As of December 31, 2003 and 2002, HickoryTech completed itsannual impairment tests for acquired goodwill using methodologies consistentwith those applied for its transitional impairment tests performed as ofJanuary 1, 2002. Such testing resulted in no impairment charge togoodwill, as the determined fair value was again sufficient to pass the firststep impairment test.

 

40

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The following tables provide areconciliation of the reported net income (loss) to an adjusted net income(loss) and basic and diluted earnings per share after adding backamortization of goodwill and FCC license amortization, assuming that SFASNo. 142 had been adopted as of January 1, 2001:

 
| **(Dollars in Thousands, except Per Share Amounts  and shown Net of Income Tax)** |   | **2003**    | ** **  | **2002**   | ** ** | **2001** | ** ** |
|-----------------------------------------------------------------------------------|--------|-------------|-------------|------------|------------|----------|------------|
|                                                                              |   |        | ** **  |       |       |     |       |
| Reported Income from  Continuing Operations                                       |   | **$**       | **8,455**   | ** ** | $          | 6,235    |       | $ | 6,890 |   |
| Goodwill Amortization                                                             |   | **—**  | ** **  | —     |       | 452      |       |
| Adjusted Income from  Continuing Operations                                       |   | **8,455**   | ** **  | 6,235      |       | 7,342    |       |
|                                                                              |   |        | ** **  |       |       |     |       |
| Reported Income/(Loss) from  Discontinued Operations                              |   | **(21,230** | **)**       | (22,862    | )          | 1,848    |       |
| FCC License Amortization                                                          |   | **—**  | ** **  | —     |       | 1,035    |       |
| Adjusted Income/(Loss) from  Discontinued Operations                              |   | **(21,230** | **)**       | (22,862    | )          | 2,883    |       |
|                                                                              |   |        | ** **  |       |       |     |       |
| Adjusted Net Income/(Loss)                                                        |   | **$**       | **(12,775** | **)**      | $          | (16,627  | )          | $ | 10,225 |   |
|                                                                              |   |        | ** **  |       |       |     |       |
| Basic Earnings Per Share -  Continuing Operations:                                |   |        | ** **  |       |       |     |       |
| Reported Income from  Coninuing Operations                                        |   | **$**       | **0.61**    | ** ** | $          | 0.44     |       | $ | 0.50 |   |
| Goodwill Amortization                                                             |   | **—**  | ** **  | —     |       | 0.03     |       |
| Adjusted Income from  Continuing Operations                                       |   | **0.61**    | ** **  | 0.44       |       | 0.53     |       |
|                                                                              |   |        | ** **  |       |       |     |       |
| Basic Earnings Per Share -  Discontinued Operations:                              |   |        | ** **  |       |       |     |       |
| Reported Income/(Loss) from  Discontinued Operations                              |   | **(1.53**   | **)**       | (1.63      | )          | 0.13     |       |
| FCC License Amortization                                                          |   | **—**  | ** **  | —     |       | 0.07     |       |
| Adjusted Income/(Loss) from  Discontinued Operations                              |   | **(1.53**   | **)**       | (1.63      | )          | 0.20     |       |
|                                                                              |   |        | ** **  |       |       |     |       |
| Basic Earnings Per Share                                                          |   | **$**       | **(0.92**   | **)**      | $          | (1.19    | )          | $ | 0.73 |   |
|                                                                              |   |        | ** **  |       |       |     |       |
| Diluted Earnings Per Share  - Continuing Operations:                              |   |        | ** **  |       |       |     |       |
| Reported Income/(Loss) from  Continuing Operations                                |   | **$**       | **0.61**    | ** ** | $          | 0.44     |       | $ | 0.49 |   |
| Goodwill Amortization                                                             |   | **—**  | ** **  | —     |       | 0.03     |       |
| Adjusted Income/(Loss) from  Continuing Operations                                |   | **0.61**    | ** **  | 0.44       |       | 0.52     |       |
|                                                                              |   |        | ** **  |       |       |     |       |
| Diluted Earnings Per Share  - Discontinued Operations:                            |   |        | ** **  |       |       |     |       |
| Reported Income/(Loss) from  Discontinued Operations                              |   | **(1.53**   | **)**       | (1.62      | )          | 0.13     |       |
| FCC License Amortization                                                          |   | **—**  | ** **  | —     |       | 0.07     |       |
| Adjusted Income/(Loss) from  Discontinued Operations                              |   | **(1.53**   | **)**       | (1.62      | )          | 0.20     |       |
|                                                                              |   |        | ** **  |       |       |     |       |
| Diluted Earnings Per Share                                                        |   | **$**       | **(0.92**   | **)**      | $          | (1.18    | )          | $ | 0.72 |   |

 

The carrying value ofHickoryTech’s goodwill, which is all included in the Telecom segment, is$25,086,000 as of December 31, 2003 and 2002.

 

The components of HickoryTech’sintangible assets are as follows:

** **
|                                |   | **As of December  31, 2003** |       | **As  of December 31, 2002**  |   |
|-------------------------------------|--------|-----------------------------------|------------|-------------------------------|--------|
| **(Dollars in Thousands)**          |   | **Gross  Carrying  Amount**       |       | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
| Definite-Lived Intangible  Assets   |   |                              |       |                          |   |   |   |   |   |
| Customers                           |   | **$**                             | **821**    | ** **                    | **$**  | **340** |   | $ | 821 |   | $ | 237 |   |
| Other Intangibles                   |   | **100**                           | ** ** | **100**                       |   | 185 |   | 100 |   |
| Total                               |   | **$**                             | **921**    | ** **                    | **$**  | **440** |   | $ | 1,006 |   | $ | 337 |   |
|                                |   |                              |       |                          |   |   |   |   |   |
| Indefinite-Lived Intangible  Assets |   |                              |       |                          |   |   |   |   |   |
| FCC Licenses                        |   | **$**                             | **—** | ** **                    | **$**  | **—** |   | $ | 34,000 |   | $ | — |   |

 

 

41

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During 2002, HickoryTech wrote down the carrying value of an intangibleasset relating to an agreement to develop a wireless DSL operation that alsoentitled HickoryTech to receive a share of future revenues generated from thewireless DSL operations.  The assetimpairment write-down was taken because of the bankruptcy of the third-partynetwork provider and HickoryTech did not believe that the agreement will resultin future cash flows from the revenue sharing agreement. The $316,000 chargeresulting from the asset impairment write-down was recorded as a charge tooperations of HickoryTech’s Telecom Sector and is reported as “AssetImpairment” in the consolidated statement of operations for the year endedDecember 31, 2002.

 

Amortization expense related to the definite-lived intangible assetsfor 2003, 2002 and 2001 was $103,000, $466,000, and $374,000, respectively.  Amortization expense for the five yearssubsequent to 2003 is as follows: 2004 - $102,000; 2005 - $102,000; 2006 -$102,000; 2007 - $102,000 and 2008 - $73,000.

 

**NOTE 3 – ACQUISITIONS, DISPOSITIONS andDISCONTINUED OPERATIONS**

 

Sales ofWireless Operations (Discontinued Operations):

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

 

In connection with thedetermination by management in the third quarter of 2003 that it would pursuethe sale of its wireless operations and that the selling price would likely beless than the current carrying value of the wireless net assets, the Companycompleted an impairment test in the third quarter of 2003 for the FCC licensespursuant to the requirements of SFAS No. 142, “Goodwill and Other IntangibleAssets.” Management estimated the fair value of the FCC licenses using adiscounted cash flow technique consistent with the method used by the Companyin performing its most recent impairment analysis at December 31, 2002. As aresult of this assessment, management determined that the FCC licenses wereimpaired and recorded an impairment charge of approximately $21,000,000(18,638,000 net of income taxes) in the third quarter of 2003 (see Note 2).This impairment charge is recorded as a component of the loss on discontinuedoperations in HickoryTech’s consolidated statement of operations for the yearended December 31, 2003. HickoryTech believes that the decline in the fairvalue of its FCC licenses was due principally to the rapid pace oftechnological change being undertaken by the major wireless service providersto adopt new protocols (i.e. GSM or CDMA) and potentially move away fromHickoryTech’s current primary protocol called TDMA, which greatly hinderedHickoryTech’s position in finding a future roaming partner. Other factorsincluded declining roaming revenues, increasing price competition, and theprotracted downturn in the wireless market. The FCC licenses were tested forimpairment on an aggregate basis, which was consistent with HickoryTech’smanagement of the wireless business.

 

As a result of the Company’scommitment to sell the wireless business, the Company made a determinationduring the third quarter of 2003 that the remaining assets of the wirelessoperations should be considered “Held for sale” pursuant to SFAS No. 144,“Accounting for Impairment or Disposal of Long-Lived Assets,” (SFAS No. 144).Pursuant to SFAS No. 144, the Company recorded an impairment charge during thethird quarter of 2003 related to the other long-lived assets of the wirelessbusiness of $4,345,000 ($3,856,000 after-tax). This charge is also recorded asa component of the loss on discontinued operations in HickoryTech’sconsolidated statement of operations for the year ended December 31, 2003.

 

Wireless business revenue and income before income taxes included indiscontinued operations are as follows:

 
|                               |   | **For Years  Ended December 31,** |    |
|------------------------------------|--------|-----------------------------------|---------|
| **(Dollars in Thousands)**         |   | **2003**                          |    | **2002** |   | **2001** |   |
|                               |   |                              |    |   |   |   |   |
| Revenues                           |   | $                                 | 14,341  |   | $ | 15,449 |   | $ | 17,655 |   |
|                               |   |                              |    |   |   |   |   |
| Income (Loss) Before Income  Taxes |   | $                                 | (23,087 | ) | $ | (38,692 | ) | $ | 3,108 |   |

 

Acquisition ofFCC Licenses:

On June 26, 2001, HickoryTechacquired two digital personal communications services (PCS) licenses fromMcLeodUSA Incorporated for $11,100,000 in cash. The PCS licenses acquired byHickoryTech include the Minnesota Basic Trading Areas (BTAs) ofMankato-Fairmont and Rochester-Austin-Albert Lea, an area covering a populationof approximately 493,000 people. The acquisition was a purchase of the licensesonly. There were no customers, existing revenue stream or physical property andequipment included with this acquisition as the BTAs were undeveloped.HickoryTech paid for the acquisition with advances under its revolving credit facility.HickoryTech allocated the entire purchase price to the fair value of the PCSlicense, which was being amortized over 37 years prior to 2002.  Effective January 1, 2002 HickoryTechadopted SFAS No. 142 and ceased amortization of this indefinite livedintangible asset (see Note 2). The wireless operations are reported as part ofthe Telecom Sector and were sold on December 15, 2003. The results ofoperations of the wireless business are reported as discontinued operations forall periods presented.

 

42

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Sale of LocalExchange Carrier:

On August 6, 2001, HickoryTechsold its local telephone exchange in Amana, Iowa to South Slope CooperativeTelephone Company, Inc. for $6,500,000 in cash. The Amana operation, known asAmana Colonies Telephone Company (ACTC), served approximately 1,500 accesslines in the seven communities of the Amana Colonies in east central Iowa.HickoryTech recorded a pre-tax gain on the sale of $1,015,000 ($566,000 net oftax). HickoryTech used the proceeds from the sale to repay a portion of itsoutstanding debt. The operations of ACTC were included in the Telecom Sector.For the year ended December 31, 2001, ACTC generated revenues of $832,000 andgenerated an operating loss of $13,000. The pro forma impact of thisdisposition on 2001 net income and earnings per share was not consideredmaterial.

 

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

 

The fair value of HickoryTech’slong-term obligations, after deducting current maturities, is estimated to be$125,088,000 at December 31, 2003 and $157,151,000 at December 31, 2002,compared to carrying values of $118,040,000 and $157,599,000 respectively. Thefair value estimates are based on the overall weighted average interest ratesand maturity compared to rates and terms currently available in the long-termfinancing markets.

 

**NO****TE 5 –BUSINESS SEGMENTS**

 

HickoryTech’s operations areconducted in three business segments as: (i) Telecom Sector, (ii) InformationSolutions Sector and (iii) Enterprise Solutions Sector. The Telecom Sectorprovides telephone services to Mankato and adjacent areas of south centralMinnesota and to eleven communities in northwest Iowa as an ILEC.  The Telecom Sector also operates fiber opticcable transport facilities in Minnesota. The Telecom Sector also included theoperations of Amana Colonies Telephone Company, a local telephone exchangeserving the Amana Colonies in east central Iowa, which was sold in August 2001.The Telecom Sector also offers an alternative choice for localtelecommunications service, known as CLEC (Competitive Local Exchange Carrier)service in the telecommunications industry, to customers in Minnesota and Iowanot currently in HickoryTech’s ILEC service area. In addition, the TelecomSector resells long distance service to Minnesota and Iowa subscribers in itsILEC and CLEC markets. Prior to the sale of the wireless operations asdiscussed in Note 3, the Telecom Sector provided wireless telephone service toseven counties in south central Minnesota and a service area around theMinneapolis/St. Paul, Minnesota metropolitan area and PCS service to theMinnesota BTAs of Mankato-Fairmont and Rochester-Austin-Albert Lea. TheInformation Solutions Sector provides data processing and related services toHickoryTech’s other sectors and to other external telephone companies,municipalities and utilities. The wireless operations are reported asdiscontinued operations for all periods presented. The Enterprise SolutionsSector designs, sells, installs and services business telephone systems anddata communications equipment primarily in metropolitan Minneapolis/St. Paul,Minnesota.

 

Business segment informationfor the years ended December 31, 2003, 2002 and 2001 is as follows.  Certain amounts in 2002 and 2001 have beenreclassified to conform to the 2003 presentation.

 

**BUSINESS SEGMENT DATA**

YearsEnded December 31

 

*(Dollars in Thousands)*

 
|                                                                   |   | **Telecom** |   | **Information  Solutions** |   | **Enterprise  Solutions** |   | **Corporate  and  Eliminations** |   | **Consolidated** |   |
|------------------------------------------------------------------------|--------|-------------|--------|----------------------------|--------|---------------------------|--------|----------------------------------|--------|------------------|--------|
| **2003**                                                               |   |        |   |                       |   |                      |   |                             |   |             |   |
| Revenue from Unaffiliated Customers                                    |   | $           | 75,346 |                       | $      | 3,199                     |   | $                                | 14,347 |             | $      | — |   | $ | 92,892 |   |
| Intersegment Revenues                                                  |   | 275         |   | 3,203                      |   | —                    |   | (3,478                           | )      | —           |   |
| Total                                                                  |   | 75,621      |   | 6,402                      |   | 14,347                    |   | (3,478                           | )      | 92,892           |   |
|                                                                   |   |        |   |                       |   |                      |   |                             |   |             |   |
| Depreciation and Amortization                                          |   | 13,160      |   | 2,376                      |   | 246                       |   | 85                               |   | 15,867           |   |
| Operating Income/(Loss)                                                |   | 25,095      |   | (3,576                     | )      | (1,358                    | )      | 18                               |   | 20,179           |   |
| Equity in Net Income/(Loss) of Investees                               |   | —      |   | 9                          |   | —                    |   | —                           |   | 9                |   |
| Interest Expense                                                       |   | 13          |   | 86                         |   | —                    |   | 6,004                            |   | 6,103            |   |
| Income Taxes                                                           |   | 10,662      |   | (1,198                     | )      | (569                      | )      | (3,212                           | )      | 5,683            |   |
| Income/(Loss) from Continuing Operations                               |   | 14,941      |   | (2,329                     | )      | (818                      | )      | (3,339                           | )      | 8,455            |   |
| Income/(Loss) from Discont. Operations Including Intersegment Revenues |   | (22,897     | )      | 605                        |   | —                    |   | 1,062                            |   | (21,230          | )      |
| Net Income (Loss)                                                      |   | (7,956      | )      | (1,724                     | )      | (818                      | )      | (2,277                           | )      | (12,775          | )      |
| Identifiable Assets                                                    |   | 145,753     |   | 7,773                      |   | 7,939                     |   | 14,247                           |   | 175,712          |   |
| Capital Expenditures                                                   |   | 10,719      |   | 161                        |   | 201                       |   | 156                              |   | 11,237           |   |
|                                                                        |        |             |        |                            |        |                           |        |                                  |        |                  |        |  |  |  |  |  |

 

43

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|                                                                   |   | **Telecom** |   | **Information  Solutions** |   | **Enterprise  Solutions** |   | **Corporate  and  Eliminations** |   | **Consolidated** |   |
|------------------------------------------------------------------------|--------|-------------|--------|----------------------------|--------|---------------------------|--------|----------------------------------|--------|------------------|--------|
| **2002**                                                               |   |        |   |                       |   |                      |   |                             |   |             |   |
| Revenue from Unaffiliated Customers                                    |   | $           | 71,108 |                       | $      | 4,249                     |   | $                                | 15,781 |             | $      | — |   | $ | 91,138 |   |
| Intersegment Revenues                                                  |   | 274         |   | 3,154                      |   | —                    |   | (3,428                           | )      | —           |   |
| Total                                                                  |   | 71,382      |   | 7,403                      |   | 15,781                    |   | (3,428                           | )      | 91,138           |   |
|                                                                   |   |        |   |                       |   |                      |   |                             |   |             |   |
| Asset Impairment                                                       |   | 316         |   | —                     |   | —                    |   | —                           |   | 316              |   |
| Depreciation and Amortization                                          |   | 12,326      |   | 2,403                      |   | 263                       |   | 217                              |   | 15,209           |   |
| Operating Income/(Loss)                                                |   | 22,679      |   | (3,289                     | )      | (12                       | )      | (1,809                           | )      | 17,569           |   |
| Equity in Net Income/(Loss) of Investees                               |   | —      |   | (25                        | )      | —                    |   | —                           |   | (25              | )      |
| Interest Expense                                                       |   | 20          |   | 62                         |   | —                    |   | 7,323                            |   | 7,405            |   |
| Income Taxes                                                           |   | 9,591       |   | (1,150                     | )      | (29                       | )      | (4,163                           | )      | 4,249            |   |
| Income/(Loss) from Continuing Operations                               |   | 13,617      |   | (2,131                     | )      | (41                       | )      | (5,210                           | )      | 6,235            |   |
| Income/(Loss) from Discont. Operations Including Intersegment Revenues |   | (24,164     | )      | 477                        |   | —                    |   | 825                              |   | (22,862          | )      |
| Net Income/(Loss)                                                      |   | (10,547     | )      | (1,654                     | )      | (41                       | )      | (4,385                           | )      | (16,627          | )      |
| Identifiable Assets                                                    |   | 151,066     |   | 6,604                      |   | 9,914                     |   | 18,559                           |   | 186,143          |   |
| Investment in Equity Method Investees                                  |   | —      |   | 36                         |   | —                    |   | —                           |   | 36               |   |
| Capital Expenditures                                                   |   | 9,600       |   | 2,472                      |   | 95                        |   | 214                              |   | 12,381           |   |
|                                                                   |   |        |   |                       |   |                      |   |                             |   |             |   |
| **2001**                                                               |   |        |   |                       |   |                      |   |                             |   |             |   |
| Revenue from Unaffiliated Customers                                    |   | $           | 66,364 |                       | $      | 4,085                     |   | $                                | 20,374 |             | $      | — |   | $ | 90,823 |   |
| Intersegment Revenues                                                  |   | 274         |   | 4,034                      |   | —                    |   | (4,308                           | )      | —           |   |
| Total                                                                  |   | 66,638      |   | 8,119                      |   | 20,374                    |   | (4,308                           | )      | 90,823           |   |
|                                                                   |   |        |   |                       |   |                      |   |                             |   |             |   |
| Depreciation and Amortization                                          |   | 10,645      |   | 1,129                      |   | 359                       |   | 239                              |   | 12,372           |   |
| Operating Income/(Loss)                                                |   | 20,976      |   | (658                       | )      | 1,340                     |   | 425                              |   | 22,083           |   |
| Equity in Net Income of Investees                                      |   | —      |   | (27                        | )      | —                    |   | —                           |   | (27              | )      |
| Interest Expense                                                       |   | 30          |   | 32                         |   | —                    |   | 10,792                           |   | 10,854           |   |
| Income Taxes                                                           |   | 8,707       |   | 89                         |   | 520                       |   | (4,605                           | )      | 4,711            |   |
| Income/(Loss) from Continuing Operations                               |   | 12,078      |   | (455                       | )      | 748                       |   | (5,481                           | )      | 6,890            |   |
| Income/(Loss) from Discont. Operations Including Intersegment Revenues |   | 203         |   | 583                        |   | —                    |   | 1,062                            |   | 1,848            |   |
| Net Income/(Loss)                                                      |   | 12,281      |   | 128                        |   | 748                       |   | (4,419                           | )      | 8,738            |   |
| Identifiable Assets                                                    |   | 154,213     |   | 6,500                      |   | 11,413                    |   | 17,053                           |   | 189,179          |   |
| Investment in Equity Method Investees                                  |   | —      |   | 60                         |   | —                    |   | —                           |   | 60               |   |
| Capital Expenditures                                                   |   | 28,438      |   | 1,347                      |   | 213                       |   | 176                              |   | 30,174           |   |

 

44

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The Telecom SegmentIdentifiable Assets, Property, Plant and Equipment and Capital Expenditurespresented above, exclude the following amounts related to the wirelessbusiness, which is reported as a discontinued operation:

 
|                       |   | **For Years  Ended December 31,** |   |
|----------------------------|--------|-----------------------------------|--------|
| **(Dollars in Thousands)** |   | **2003**                          |   | **2002** |   | **2001** |   |
|                       |   |                              |   |   |   |   |   |
| Identifiable Assets        |   | $                                 | — |   | $ | 54,068 |   | $ | 94,113 |   |
|                       |   |                              |   |   |   |   |   |
| Capital Expenditures       |   | 2,333                             |   | 4,293 |   | 2,694 |   |
|                            |        |                                   |        |  |  |  |  |  |  |  |

 

**NOTE 6 – STOCK COMPENSATION**

 

Employee StockPurchase Plan:

Under the terms of an employeestock purchase plan, participating employees may acquire shares of common stockthrough payroll deductions of not more than 10% of their compensation. Theprice at which the shares can be purchased is 85% of the lower fair marketvalue for such shares on two specified dates in each plan year. As of December31, 2003 and 2002, there were 900,000 common shares reserved for this plan and613,261 shares and 641,024 shares, respectively, still available for issuance.At December 31, 2003, employees had subscribed to purchase approximately26,000 shares in the current plan year ending August 31, 2004. At December31, 2002, employees had subscribed to purchase approximately 24,700 shares inthe plan year ended August 31, 2003.

 

DirectorGrants and Purchase Plan:

Under the terms of a corporateretainer stock plan for directors, participating directors may acquire sharesof common stock in exchange for their quarterly retainers. The price at whichthe shares can be purchased is 100% of the fair market value for such shares onthe date of purchase. In addition to any voluntary acquisitions of shares inexchange for quarterly retainers, directors receive $5,000 of their annualretainer solely in shares of HickoryTech stock from this plan. As of December31, 2003, there were 300,000 common shares reserved for this plan and 260,306shares still available for future issuance.

 

Non-EmployeeDirector Stock Option Plan:

HickoryTech also offers adirectors’ stock option plan to attract and retain outside directors. The planprovides for each outside director to receive fully vested options to purchase5,000 shares of common stock of HickoryTech at an exercise price equal to thefair market value of the common stock on a date as specified in the plan ifHickoryTech meets pre-established financial objectives. The options may beexercised no later than ten years after the date of grant. As of December 31,2003, there were 300,000 common shares reserved for this plan and 86,000 sharesavailable for future grants.

 

Stock AwardPlan:

HickoryTech’s stock award planprovides for the granting of non-qualified stock options and stock awards toemployees.  The plan provides for stockawards based on the attainment of certain financial targets and for individualachievements. In addition, for one component of the plan, HickoryTech utilizeda trust account for the funding of a long-term performance award until 2003. In2003, 2002, and 2001, HickoryTech paid cash of $204,000, $184,000 and $157,000for its common stock shares and issued shares of 22,393, 12,722 and 8,904 in2003, 2002 and 2001, respectively, to a trust for the benefit of certain keyemployees.  The stock options issuedunder the stock option component of the stock award plan may be exercised nolater than ten years after the date of grant, with one-third of the optionsvesting each year. As of December 31, 2003, there were 1,750,000 common sharesreserved for this plan and 1,033,351 shares available for future grants.

 

In 2002, HickoryTech’s Board ofDirectors modified the terms of the stock options of a retiring officer.  The modification extended the period afterretirement during which the officer can exercise his vested options.  This modification resulted in HickoryTechrecognizing $173,000 of compensation expense during the first quarter of 2003.During the third quarter of 2003, the Board of Directors extended the periodduring which this option holder can exercise his vested options to December 31,2004. This extension did not result in any additional compensation charges.

 

HickoryTech has elected toapply Accounting Principles Board Opinion No. 25 and related interpretations inaccounting for its employee and directors’ stock compensation plans. IfHickoryTech had elected to recognize compensation cost based on the fair valueof the options as prescribed by SFAS No. 123, the following operating resultswould have occurred using the Black-Scholes option-pricing model to determinethe fair value of the options with the following listed assumptions:

 

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

 
|                        |   | **2003** |        | **2002** |   | **2001** |   |
|-----------------------------|--------|----------|-------------|----------|--------|----------|--------|
| Pro Forma Net Income/(Loss) |   | **$**    | **(13,036** | **)**    | $      | (16,964  | )      | $ | 8,416 |   |
| Pro Forma Basic EPS         |   | **$**    | **(0.94**   | **)**    | $      | (1.21    | )      | $ | 0.61 |   |
| Pro Forma Diluted EPS       |   | **$**    | **(0.94**   | **)**    | $      | (1.20    | )      | $ | 0.60 |   |
| Volatility                  |   | **36.7** | **%**       | 36.0     | %      | 32.8     | %      |
| Dividend Yield              |   | **5.2**  | **%**       | 3.3      | %      | 2.5      | %      |
| Risk-Free Interest Rates    |   | **3.8**  | **%**       | 4.7      | %      | 5.0      | %      |
| Expected Life in Years      |   | **7**    | ** **  | 7        |   | 7        |   |

 

45

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

 
|                                                            |   | **Shares**  |       | **Weighted Average  Exercise Price** |   |
|-----------------------------------------------------------------|--------|-------------|------------|--------------------------------------|--------|
|                                                            |   | **2003**    |       | **2002**                             |   | **2001** |   | **2003** |   | **2002** |   | **2001** |   |
| Outstanding at Beginning of  Year                               |   | **554,335** | ** ** | 482,181                              |   | 343,781 | ** ** | **$** | **13.60** |   | $ | 13.37 |   | $ | 12.46 |   |
| Granted                                                         |   | **103,250** | ** ** | 137,450                              |   | 138,400 | ** ** | **8.90** |   | 13.29 |   | 15.62 |   |
| Exercised                                                       |   | **(24,387** | **)**      | (63,796                              | )      | — | ** ** | **9.41** |   | 11.01 |   | — |   |
| Forfeited                                                       |   | **(37,400** | **)**      | (1,500                               | )      | — | ** ** | **12.86** |   | 19.08 |   | — |   |
| Outstanding at End of Year                                      |   | **595,798** | ** ** | 554,335                              |   | 482,181 | ** ** | **$** | **13.01** |   | $ | 13.60 |   | $ | 13.37 |   |
| Exercisable at End of Year                                      |   | **455,356** | ** ** | 384,377                              |   | 312,040 | ** ** | **$** | **13.50** |   | $ | 13.61 |   | $ | 12.86 |   |
| Weighted Average Fair Value  of Options Granted During the Year |   | **$**       | **2.16**   | ** **                           | $      | 4.25 |   | $ | 5.00 |   |   |   |   |   |   |   |
|                                                                 |        |             |            |                                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table providescertain information with respect to stock options outstanding at December 31,2003:

 
| **Range of  Exercise Prices** |   | **Stock  Options  Outstanding** | ** ** | **Average  Exercise  Price** | ** ** | **Average  Remaining  Contractual Life** | ** ** |
|-------------------------------|--------|---------------------------------|------------|------------------------------|------------|------------------------------------------|------------|
| $8.00 - $12.00                |   | 189,365                         |       | $                            | 9.63       |                                     | 6.8 years  |   |
| $12.00 - $16.00               |   | 336,433                         |       | 13.84                        |       | 6.3 years                                |       |
| $16.00 - $21.00               |   | 70,000                          |       | 18.15                        |       | 7.3 years                                |       |
|                          |   | 595,798                         |       | $                            | 13.01      |                                     | 6.6 years  |   |

 

The following table providescertain information with respect to stock options exercisable at December 31,2003:

 
| **Range  of  Exercise Prices** |   | **Stock  Options  Exercisable** |   | **Weighted  Average  Exercise  Price** |   |
|--------------------------------|--------|---------------------------------|--------|----------------------------------------|--------|
| $8.00 - $12.00                 |   | 119,649                         |   | $                                      | 9.94   |   |
| $12.00 - $16.00                |   | 271,603                         |   | 13.95                                  |   |
| $16.00 - $21.00                |   | 64,104                          |   | 18.26                                  |   |
|                           |   | 455,356                         |   | $                                      | 13.50  |   |

 

All stock options granted in2003, 2002 and 2001 had an exercise price equal to the fair market value ofHickoryTech’s common stock on the date of grant.

 

Other stock award activity isas follows:

 
|                                                                 |   | **2003** |      | **2002** |   | **2001** |   |
|----------------------------------------------------------------------|--------|----------|-----------|----------|--------|----------|--------|
|                                                                 |   |     |      |     |   |     |   |
| Stock Awards Granted                                                 |   | **800**  |      | 10,984   |   | 9,470    |   |
| Weighted Average Fair Value  of Stock Awards Granted During the Year |   | **$**    | **11.03** |     | $      | 14.97    |   | $ | 17.43 |   |
|                                                                      |        |          |           |          |        |          |        |  |  |  |

 

46

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The Company recognizes stockcompensation charges related to stock award plans when management concludes itis probable that the award will be earned by the participant. Such compensationcharges are recorded based upon the fair value of HickoryTech’s stock and arerecognized during the service period specified by the stock award plan. Changesin estimated compensation are recorded in the period in which the changeoccurs.

 

Stock compensation expense(benefit) for 2003, 2002 and 2001 was ($160,000), $329,000 and $217,000respectively, for all stock compensation plans.

 

**NOTE 7 – DEBT AND OTHER OBLIGATIONS**

** **

Long-termdebt:

 

*(Dollars in Thousands)*

 
|                                                                     |   | **2003**    |        | **2002** |   |
|--------------------------------------------------------------------------|--------|-------------|-------------|----------|--------|
|                                                                     |   |        |        |     |   |
| Credit Facility, Average  4.1%, maturing in varying amounts through 2009 |   | **$**       | **118,500** |     | $      | 158,000 |   |
| Capitalized Lease  Obligations, Interest at 6.9%, maturing October 2006  |   | **1,112**   |        | 1,040    |   |
|                                                                     |   |        |        |     |   |
| Total                                                                    |   | **119,612** |        | 159,040  |   |
| Less Current Maturities                                                  |   | **1,572**   |        | 1,441    |   |
| Long-Term Obligations                                                    |   | **$**       | **118,040** |     | $      | 157,599 |   |

 

Long-term obligations consistof the following:

 

Credit Facility Obligations:

HickoryTech has a $157,000,000credit facility with a syndicate of banks. The credit facility is comprised ofa $125,000,000 revolving credit component and a $32,000,000 term loan component.  The available line of credit on the$125,000,000 revolving credit component decreases in increments beginning inMarch 2004 with a final maturity date in September 2008.  Since HickoryTech still has $38,500,000 ofavailable revolving credit, payments are not scheduled to begin until March2006. The revolving credit expires as follows: 2004 - $17,188,000, 2005 to 2007 - $79,687,000 and 2008 - $28,125,000.The term loan requires equal quarterly principal payments of $250,000 duringthe period March 2001 to December 2008, and $23,000,000 of principal paymentsfor the first quarter of 2009 and $4,000,000 in the second quarter of 2009. Theweighted average interest rate associated with this credit facility varies withLIBOR and certain other rates.  The weightedaverage interest rate was 4.1% and 4.3% at December 31, 2003 and 2002,respectively. The term loan component has a provision whereby HickoryTechperiodically receives patronage capital refunds depending on the amount ofinterest paid. This patronage refund is recorded as an offset to interestexpense and amounted to $555,000 in 2003, $583,000 in 2002 and $807,000 in2001. As of December 31, 2003, HickoryTech had drawn $118,500,000 on thiscredit facility, comprised of $32,000,000 in term loan and $86,500,000 inrevolving credit, and had $38,500,000 of available borrowing capacity of therevolving credit component. The credit facility is collateralized by certainproperty, plant and equipment and contains covenants relating to cash flow andcapitalization.

 

In December 2001, HickoryTechrepaid the outstanding balance remaining on its debt with Rural UtilitiesService and the Rural Telephone Bank. These loans were originally used for thefinancing of telephone property, plant and equipment of Mid-Communications,Inc.

 

Annual requirements forprincipal payments for the years subsequent to 2003 are as follows: 2004 -$1,000,000; 2005 - $1,000,000; 2006 - $26,562,000; 2007 - $33,813,000; 2008 -$29,125,000 and thereafter - $27,000,000.

 

Capital LeaseObligations:

HickoryTech’s InformationSolutions Sector leases certain computer equipment under capital leasearrangements. HickoryTech has recorded the present value of the future minimumlease payments as a capitalized asset and related lease obligation. Assetsunder this capital lease are included in property, plant and equipment andamounted to $1,173,000 and $1,071,000 ($2,320,000 and $1,660,000 asset, net ofaccumulated depreciation of $1,147,000 and $589,000) as of December 31, 2003and 2002. Capital leases are part of property, plant and equipment on thebalance sheet. Annual requirements for future lease payments under this capitallease are as follows:

 

47

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| **Year**                                 |   | **Annual  Lease Payments** |    |
|------------------------------------------|--------|----------------------------|---------|
|                                     |   |                       |    |
| 2004                                     |   | $                          | 624,000 |   |
| 2005                                     |   | 417,000                    |    |
| 2006                                     |   | 153,000                    |    |
| Total Minimum Lease  Payments            |   | 1,194,000                  |    |
| Amount Representing  Interest            |   | (82,000                    | )       |
| Present Value of Minimum  Lease Payments |   | 1,112,000                  |    |
| Less Current Portion                     |   | (572,000                   | )       |
| Long-Term Lease Obligation               |   | $                          | 540,000 |   |

 

OperatingLease Commitments:

HickoryTech owns most of itsmajor facilities, but does lease certain office space, land and equipment underprincipally noncancelable operating leases.**** Rental expense was $998,000 in 2003,$1,179,000 in 2002 and $1,508,000 in 2001. At December 31, 2003, future minimumoperating lease rental obligations for the next five years and thereafter areas follows: 2004 - $414,000; 2005 - $88,000; 2006 - $39,000; 2007- $31,000;2008 - $15,000 and thereafter - $325,000.

 

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

###### ** **

Employees who meet certainservice requirements are covered under a defined contribution retirementsavings plan, which includes IRS Section 401(k) provisions. HickoryTechcontributes up to 6.0% of the employee’s eligible compensation, based on theemployee’s voluntary contribution. HickoryTech contributions and costs for the retirement savings plan were$1,053,000 in 2003, $1,050,000 in 2002, and $1,039,000 in 2001.

 

In addition to providingretirement savings benefits, HickoryTech provides post-retirement health careand life insurance benefits for certain employees. HickoryTech is not currentlyfunding these post-retirement benefits, but has accrued these liabilities.

 

 
| **(Dollars in Thousands)**                  |   | **2003**   |       | **2002**   |   |
|---------------------------------------------|--------|------------|------------|------------|--------|
| Change in Benefit Obligation                |   |       | ** ** |       |   |
| Benefit Obligation at  Beginning of Year    |   | **$**      | **5,230**  | ** ** | $      | 4,480 |   |
| Service Cost                                |   | **211**    | ** ** | 174        |   |
| Interest Cost                               |   | **360**    | ** ** | 330        |   |
| Amendments                                  |   | **—** | ** ** | —     |   |
| Actuarial (Gain)/Loss                       |   | **3,589**  | ** ** | 380        |   |
| Benefits Paid                               |   | **(133**   | **)**      | (134       | )      |
| Benefit Obligation at End  of Year          |   | **$**      | **9,257**  | ** ** | $      | 5,230 |   |
|                                        |   |       | ** ** |       |   |
| Change in Plan Assets                       |   |       | ** ** |       |   |
| Fair Value of Assets at  Beginning of Year  |   | **$**      | **—** | ** ** | $      | — |   |
| Actual Return on Assets                     |   | **—** | ** ** | —     |   |
| Employer Contribution                       |   | **133**    | ** ** | 134        |   |
| Distributions                               |   | **(133**   | **)**      | (134       | )      |
| Fair Value of Assets at End  of Year        |   | **$**      | **—** | ** ** | $      | — |   |
|                                        |   |       | ** ** |       |   |
| Reconciliation of Funded  Status            |   |       | ** ** |       |   |
| Funded Status                               |   | **$**      | **(9,257** | **)**      | $      | (5,230 | ) |
| Unrecognized Net Actuarial  (Gain)/Loss     |   | **5,755**  | ** ** | 2,263      |   |
| Unrecognized Transition  Obligation/(Asset) |   | **540**    | ** ** | 600        |   |
| Unrecognized Prior Service  Cost            |   | **(95**    | **)**      | (107       | )      |
| Net Amount Recognized                       |   | **$**      | **(3,057** | **)**      | $      | (2,474 | ) |

 

48

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|                                            |   | **2003**   |       | **2002**   |   | **2001** |   |
|-------------------------------------------------|--------|------------|------------|------------|--------|----------|--------|
| Components of Net Periodic  Benefit Cost        |   |       | ** ** |       |   |     |   |
| Service Cost                                    |   | **$**      | **211**    | ** ** | $      | 174      |   | $ | 112 |   |
| Interest Cost                                   |   | **360**    | ** ** | 330        |   | 198      |   |
| Expected Return on Plan  Assets                 |   | **—** | ** ** | —     |   | —   |   |
| Amortization of Transition  Obligation/(Asset)  |   | **60**     | ** ** | 60         |   | 60       |   |
| Amortization of Prior  Service Cost             |   | **(11**    | **)**      | (12        | )      | (12      | )      |
| Recognized Net Actuarial  (Gain)/Loss           |   | **97**     | ** ** | 85         |   | 6        |   |
| Net Periodic Benefit Cost                       |   | **$**      | **717**    | ** ** | $      | 637      |   | $ | 364 |   |
|                                            |   |       | ** ** |       |   |     |   |
| Weighted-Average  Assumptions as of December 31 |   |       | ** ** |       |   |     |   |
| Discount Rate                                   |   | **6.25**   | **%**      | 7.00       | %      | 7.50     | %      |

 

Health Care TrendRates for Year-Ending December 31, 2003

 

| **Year**  |   | **Trend** |   |
|-----------|--------|-----------|--------|
| 2004-2005 |   | 12.00     | %      |
| 2005-2006 |   | 10.00     | %      |
| 2006-2007 |   | 8.00      | %      |
| 2007-2008 |   | 8.00      | %      |
| 2008-2009 |   | 6.00      | %      |
| 2009-2010 |   | 5.00      | %      |
| 2010+     |   | 5.00      | %      |

 

Effect of 1% Increase and 1%Decrease in Trend Rate

 
|                                                           |   | **1% Increase** |   | **1% Decrease** |   |
|----------------------------------------------------------------|--------|-----------------|--------|-----------------|--------|
|                                                           |   |            |   |            |   |
| Accum. Post-Retirement  Benefit Oblig. as of December 31, 2003 |   |            |   |            |   |
| Dollar                                                         |   | $               | 1,554  |            | $      | (1,247 | ) |
| Percentage Change in  Retiree Medical                          |   | 17.53           | %      | -14.08          | %      |
|                                                                |        |                 |        |                 |        |  |  |

 

Thehealth care cost trend rate used in determining the accumulated post-retirementbenefit obligations was 9%, increasing to 12% in the year 2004, decreasing to6% in the year 2008 and then decreasing to 5% for the years thereafter.  An increase of one-percentage point in theassumed health care cost trend would increase the accumulated post-retirementbenefit obligation at December 31, 2003 by $1,554,000. A decrease ofone-percentage point in the assumed health care cost trend would decrease theaccumulated post-retirement benefit obligation at December 31, 2003 by$1,247,000.

 

Aweighted average discount rate of 6.25%, 7.00% and 7.50% was used to developnet periodic post-retirement benefit cost and the actuarial present value ofaccumulated benefit obligations in 2003, 2002 and 2001, respectively.

 

InDecember 2003, a law was enacted which introduces a prescription drug benefitunder Medicare, as well as a federal subsidy to sponsors of retiree health carebenefit plans that provide a benefit that is at least actuarially equivalent tothe Medicare plan. Beginning January 1, 2006, Medicare’s prescription drug planwill be the primary plan for qualified retirees when they become age 65 and areeligible for Medicare. Thus, the Company may see a decrease in the amount ofprescription drug benefits to be paid beginning in 2006. As permitted by FSPNo. FAS 106-1 (see Note 12), the accumulated post-retirement benefit obligationand net periodic post-retirement benefit expense presented here do not reflectthe impacts of the new law.

 

49

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**NOTE 9**–**INCOMETAXES**

 

The income tax provision(benefit) for operations for the years ended December 31, 2003, 2002 and 2001include the following components:

 
| **(Dollars  in Thousands)** |   | **2003**  |       | **2002**   |   | **2001** |   |
|-----------------------------|--------|-----------|------------|------------|--------|----------|--------|
|                        |   |      | ** ** |       |   |     |   |
| Current Income Taxes:       |   |      | ** ** |       |   |     |   |
| Federal                     |   | **$**     | **(793**   | **)**      | $      | (1,895   | )      | $ | 571 |   |
| State                       |   | **(198**  | **)**      | 118        |   | 183      |   |
| Deferred Income Taxes:      |   |      | ** ** |       |   |     |   |
| Federal                     |   | **3,963** | ** ** | (6,987     | )      | 3,954    |   |
| State                       |   | **854**   | ** ** | (2,817     | )      | 1,263    |   |
| Total Income Tax Provision  |   | **$**     | **3,826**  | ** ** | $      | (11,581  | )      | $ | 5,971 |   |

 

Income tax expense is includedin the financial statements as follows:

 
| **(Dollars  in Thousands)** |   | **2003**   |      | **2002** |   | **2001** |   |
|-----------------------------|--------|------------|-----------|----------|--------|----------|--------|
|                        |   |       |      |     |   |     |   |
| Continuing Operations       |   | **$**      | **5,683** |     | $      | 4,249    |   | $ | 4,711 |   |
| Discontinued Operations     |   | **(1,857** | **)**     | (15,830  | )      | 1,260    |   |
| Total Income Tax Provision  |   | **$**      | **3,826** |     | $      | (11,581  | )      | $ | 5,971 |   |

 

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

 
| **(Dollars  in Thousands)**                         |   | **2003**   |       | **2002**   |   |
|-----------------------------------------------------|--------|------------|------------|------------|--------|
| Tax Liabilities:                                    |   |       | ** ** |       |   |
|                                                |   |       |       |       |   |
| Depreciation and Fixed  Assets                      |   | **$**      | **11,925** | ** ** | $      | 12,313 |   |
| Intangible Assets                                   |   | **4,238**  | ** ** | —     |   |
| Derivatives                                         |   | **1,031**  | ** ** | —     |   |
| Other                                               |   | **84**     | ** ** | 57         |   |
| Gross Deferred Tax  Liability                       |   | **17,278** | ** ** | 12,370     |   |
|                                                |   |       | ** ** |       |   |
| Tax Assets:                                         |   |       | ** ** |       |   |
|                                                |   |       |       |       |   |
| Deferred Compensation and  Post-Retirement Benefits |   | **1,937**  | ** ** | 2,213      |   |
| Receivables and Inventories                         |   | **616**    | ** ** | 656        |   |
| Accrued Liabilities                                 |   | **441**    | ** ** | 294        |   |
| Intangible Assets                                   |   | **—** | ** ** | 5,777      |   |
| Other                                               |   | **—** | ** ** | 4          |   |
| Federal Net Operating Loss                          |   | **4,105**  | ** ** | —     |   |
| State Net Operating Loss                            |   | **1,395**  | ** ** | 470        |   |
| Alternative Minimum Tax  Credits                    |   | **150**    | ** ** | —     |   |
| Gross Deferred Tax Asset                            |   | **8,644**  | ** ** | 9,414      |   |
|                                                |   |       |       |       |   |
| Valuation Allowance                                 |   | **(640**   | **)**      | (470       | )      |
| Net Deferred Tax Liability                          |   | **9,274**  | ** ** | 3,426      |   |
| Current Deferred Tax Asset                          |   | **1,057**  | ** ** | 951        |   |
| Net Non-Current Deferred  Tax Liability             |   | **$**      | **10,331** | ** ** | $      | 4,377 |   |

 

50

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A valuation allowance has beenestablished to reduce the carrying value of the benefits associated with netoperating losses incurred by subsidiaries of HickoryTech in the state of Iowa.This valuation allowance was established due to uncertainty as to realizationof these benefits based on the continuing net operating losses generated bythese subsidiaries. Future events and changes in circumstances could cause thisvaluation allowance to change.

 

HickoryTech has federal netoperating loss carryforwards for tax purposes, available to offset futureincome, of approximately $12,000,000 at December 31, 2003. The Company also hasstate net operating loss carryforwards of approximately $29,000,000 andalternative minimum tax credit carryforwards of $150,000. The utilization ofthese carryforwards as an available offset to future taxable income is subjectto limitations under U.S. federal and applicable state income tax laws. The federalnet operating loss carryforwards expire in 2023. The state net operating losscarryforwards expire in varying amounts between 2018 and 2023. The alternativeminimum tax credit carryforwards do not expire.

 

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

 

|                                           |   | **2003** |       | **2002** |   | **2001** |   |
|------------------------------------------------|--------|----------|------------|----------|--------|----------|--------|
| Statutory Tax Rate                             |   | **34.0** | **%**      | 35.0     | %      | 35.0     | %      |
| Effect of:                                     |   |     | ** ** |     |   |     |   |
| State Income Taxes Net of Federal Tax  Benefit |   | **5.1**  | ** ** | 6.0      |   | 6.7      |   |
| Valuation Allowance                            |   | **0**    | ** ** | 0        |   | 2.7      |   |
| Other, Net                                     |   | **1.1**  | ** ** | (0.5     | )      | (3.8     | )      |
| Effective Tax Rate                             |   | **40.2** | **%**      | 40.5     | %      | 40.6     | %      |

 

The 2003 income tax ratereconciliation excludes the impact of the income tax benefit included indiscontinued operations which was included in loss from discontinued operations.

 

**NOTE10**–**FINANCIALDERIVATIVE INSTRUMENTS**

 

HickoryTech accounts forderivative instruments in accordance with SFAS No. 133, as amended by SFAS No.149, “Accounting for Derivative Instruments and Hedging Activities,” whichrequires derivative instruments to be recorded on the balance sheet at fairvalue. Changes in fair value of derivative instruments must be recognized inearnings unless specific hedge accounting criteria are met, in which case thegains and losses are included in other comprehensive income rather than inearnings.

 

HickoryTech has variable ratedebt instruments, which subject the company to interest rate risk. Beginning inthe second quarter of 2003, HickoryTech entered into interest rate swapagreements, with remaining maturities of six months to fifty-four months, tomanage its exposure to interest rate movements on a portion of its variablerate debt obligations. The market value of the cumulative gain or loss on thesederivative instruments is reported as a component of accumulated othercomprehensive income in shareholders’ equity and will be recognized in earningswhen the term of the swap agreement is concluded.

 

The fair value of theHickoryTech’s derivatives at December 31, 2003 is a net asset of $2,515,000,which is included in other assets in the consolidated balance sheet.

 

**NOTE11**–**REGULATORYASSET AND LIABILITY**

 

Effective January 1, 2002, theFCC, in it’s “MAG Order” on Access Charge Reform, directed all rate-of-returncarriers to file revisions to their tariffs to eliminate the transportinterconnection charge (TIC) as a separate rate element. In effect, the costspreviously recovered through the TIC were reallocated over all other accesscategories, including carrier common line, transport, local switching,information surcharge and special access. The FCC made it clear that “thistariff filing should be a revenue neutral tariff filing.”

 

The total revenues reallocatedfrom the TIC to the remaining access elements were limited to the totalrevenues recovered from the TIC for the twelve-month period ended June 30,2001. These revenues were calculated using the carrier’s traffic volumes andthe TIC rate for the twelve-month period ended June 30, 2001. Thesecalculations were prepared by an independent third-party and approved by NECA.TIC was eliminated by reallocating the costs to the other access billingcategories.

 

The FCC conducted aninvestigation of all tariff filings, including NECA’s (National ExchangeCarrier Association) CCL (Carrier Common Line) tariff and Heartland’s TrafficSensitive (TS) tariff, to determine if the filing parties had properlyreallocated the TIC costs among the other access charge categories.

 

The FCC terminated itsinvestigation of several tariff filings, concluding that “the carriers havesubstantially complied with the Rate-of-Return Access Charge Reform Order andtheir tariffs no longer warrant investigation.” Despite this ruling by the FCCduring the fourth quarter of 2003, NECA informed HickoryTech’s Heartlandsubsidiary that it would not allow it to recover a portion of the TIC costsallocated to the CCL, because an incorrect TIC rate was used in thecalculation.

 

51

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As a result of this billingerror, the Company recovered $611,000 of excess revenues from the NECA CCLpool. NECA will require Heartland to repay the $611,000 over the twelve monthsof 2004.

 

The FCC has approved amid-course correction to Heartland’s TS tariff as a supportable method ofrecouping NECA’s CCL reduction. The revision corrects the TIC rate originallyused, and factors recovery of the $611,000, into the TS rate elements.HickoryTech will recoup this revenue over the remaining eighteen months of theTS tariff, beginning January 1, 2004.

 

In accordance with SFAS No. 71,HickoryTech has recorded a regulatory asset equal to the $611,000 that it willrecover from monthly traffic sensitive billings and has recorded acorresponding $611,000 liability for the amounts that will be repaid to theNECA CCL pool.

 

**NOTE 12 – RECENT ACCOUNTING DEVELOPMENTS**

 

In November 2002, the FASBissued Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers.” This interpretation elaborates on the disclosures required infinancial statements concerning obligations under certain guarantees. It alsoclarifies the requirements related to the recognition of liabilities by aguarantor at the inception of certain guarantees. The disclosure requirementsof this interpretation were effective for HickoryTech on December 31, 2002 butdid not require any additional disclosures. The recognition provisions of theinterpretation are effective for HickoryTech in 2003 and are applicable only toguarantees issued or modified after December 31, 2002. The adoption ofInterpretation No. 45 did not impact the financial position, results ofoperations, or cash flows of HickoryTech.

 

In April 2003, the FASB issuedSFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and HedgingActivities.” This statement amends and clarifies financial accounting andreporting for derivative instruments, including certain derivative instrumentsembedded in other contracts and for hedging activities under SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 iseffective for certain contracts entered into or modified after June 30,2003.  The adoption of this standard didnot impact the financial position, results of operations, or cash flows ofHickoryTech.

 

In January 2003, the FASBissued FIN No. 46, *Consolidation of VariableInterest Entities*. This interpretation provides guidance on how toidentify a variable interest entity and addresses when the assets, liabilitiesand results of operations of such entities must be included in a company’sconsolidated financial statements. This interpretation was effectiveimmediately for variable interest entities created after January 31, 2003 andfor variable interest entities in which the Company obtains an interest afterthat date. For interests in variable interest entities that were acquired priorto January 31, 2003, the Company adopted the provisions of this interpretationon July 1, 2003. Adoption of this statement did not result in the consolidationor disclosure of any variable interest entities in which the Company maintainsan interest. The Company does not absorb the majority of the losses or residualreturns of the variable interest entities in which the Company maintains aninterest and these interests are not significant. In December 2003, the FASBissued a revised FIN No. 46 which clarifies certain aspects of the accountingfor variable interest entities. The revision of FIN No. 46 had no impact on ourresults of operations or financial position.

 

 In December 2003, the FASB issued a revision of SFAS No. 132, *Employers’ Disclosures about Pensions and OtherPostretirement Benefits*. This statement revises the disclosuresrequired for pension and other post-retirement benefit plans. The Company hasincorporated the new disclosure requirements into the Notes to ConsolidatedFinancial Statements included in this report.

 

In January 2004, the FASBissued FASB Staff Position (FSP) No. FAS 106-1, *Accounting and Disclosure Requirements Related to the MedicarePrescription Drug Improvement and Modernization Act of 2003*. ThisFSP outlines the appropriate accounting treatment for the effects of the newMedicare law, as well as the required financial statement disclosures. The newlaw introduces a prescription drug benefit under Medicare, as well as a federalsubsidy to sponsors of retiree health care benefit plans that provide a benefitthat is at least actuarially equivalent to the Medicare plan. The retireemedical plans do provide prescription drug coverage. However, as permitted byFSP No. FAS 106-1, the Company has elected to defer recognition of the impactsof the new law on the accumulated post-retirement benefit obligation and netperiodic post-retirement benefit expense presented in the consolidated financialstatements. Specific authoritative accounting guidance on the accounting forthe federal subsidy provided for in the Act is pending. That guidance, whenissued, could require the Company to change previously reported information.Beginning January 1, 2006, Medicare’s prescription drug plan will be theprimary plan for qualified retirees when they become age 65 and are eligiblefor Medicare. Thus, the Company may see a decrease in the amount ofprescription drug benefits to be paid beginning in 2006.

 

On December 20, 2002, theFederal Communications Commission (FCC) notified carriers that they would notadopt SFAS No. 143 for regulatory accounting purposes. HickoryTech determinedthe amount of asset retirement obligations required to be recorded for its ILECcompanies under the provisions of SFAS No. 143 were not significant andtherefore the implementation of SFAS No. 143 on January 1, 2003 did not impactHickoryTech’s financial position or results of operations. HickoryTech’scompetitive local exchange carrier (CLEC), Enterprise Solutions, andInformation Solutions also adopted SFAS No. 143 effective January 1, 2003.HickoryTech has determined that its CLEC, along with Enterprise Solutions andInformation Solutions, do not have a material legal obligation to removelong-lived assets as described by SFAS No. 143, and accordingly, adoption ofSFAS No. 143 did not impact HickoryTech’s financial position or results ofoperations.

 

**NOTE 13 – CONTINGENCIES**

 

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

 

52

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

 

*(Dollars in thousands, except per shareamounts)*

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

 
|                                                        |   | **2002** |    |
|-------------------------------------------------------------|--------|----------|---------|
|                                                        |   | **4th**  |    | **3rd** |   | **2nd** |   | **1st** |   |
| Operating Revenues                                          |   | $        | 23,562  |   | $ | 24,338 |   | $ | 21,528 |   | $ | 21,710 |   |
| Operating Income                                            |   | $        | 4,623   |   | $ | 4,309 |   | $ | 3,707 |   | $ | 4,930 |   |
| Income from Continuing Operations                           |   | $        | 1,805   |   | $ | 1,534 |   | $ | 1,124 |   | $ | 1,772 |   |
| Income(Loss) from Disc. Ops., Net of Taxes                  |   | $        | (24,418 | ) | $ | 560 |   | $ | 678 |   | $ | 318 |   |
| Net Income                                                  |   | $        | (22,613 | ) | $ | 2,094 |   | $ | 1,802 |   | $ | 2,090 |   |
| Fully Diluted Earnings Per Share -  Continuing Operations   |   | $        | 0.13    |   | $ | 0.11 |   | $ | 0.08 |   | $ | 0.12 |   |
| Fully Diluted Earnings Per Share - Discontinued  Operations |   | $        | (1.74   | ) | $ | 0.04 |   | $ | 0.05 |   | $ | 0.03 |   |
|                                                        |   | $        | (1.61   | ) | $ | 0.15 |   | $ | 0.13 |   | $ | 0.15 |   |
| Dividends Per Share                                         |   | $        | 0.11    |   | $ | 0.11 |   | $ | 0.11 |   | $ | 0.11 |   |

 

The financial informationpresented above has been restated to reflect wireless operations as discontinuedoperations.  The loss from discontinuedoperations as originally reported for the third quarter of 2003 has beenrestated to reflect a $7,415,000 decrease in the deferred tax benefit and acommensurate increase in the reported loss from discontinued operations.  The summation of quarterly earnings pershare computations may not equate to the year-end computation as the quarterlycomputations are performed on a discrete basis.

 

**Item9****.****           Changes in andDisagreements With Accountants on Accounting and Financial Disclosures.**

 

None.

 

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

 

HickoryTech carried out anevaluation under the supervision, and with the participation of, our managementincluding our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”)of the effectiveness of our disclosure controls and procedures (as defined inRule 13a-15(e) under the Exchange Act) as of December 31, 2003, the end of theperiod covered by this report. Disclosure controls and procedures are designed with the objective ofensuring that information required to be disclosed in our reports filed orsubmitted under the Exchange Act, such as this Form 10-K, is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s applicable rules and forms.  Based on that evaluation, our CEO and CFOhave concluded that our disclosure controls and procedures are effective tosatisfy the objectives for which they are intended.  During the fiscal fourth quarter ended December 31, 2003, therehas been no change in our internal control over financial reporting (as definedin Rule 13a-15(f) of the Exchange Act) that has materially affected or isreasonably likely to materially affect our internal control over financialreporting.

 

53

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**PART III**

 

**Item10****.    Directors andExecutive Officers of HickoryTech.**

 

Information as to Directors andExecutive Officers of HickoryTech included on pages 3, 4 and 6 of the ProxyStatement and “Section 16(a) Beneficial Ownership Reporting Compliance” on page14 of the Proxy Statement are incorporated by reference. Disclosure relating tothe audit committee financial expert found on page 13 of the Proxy Statement isalso incorporated by reference.

 

HickoryTech has adopted a Codeof Ethics that applies to its Chief Executive Officer, Chief Financial Officer,all officers of HickoryTech, the Director of Regulatory Affairs, theController, the Division Controller, the Manager of Internal Control, the Boardof Directors and other appropriate personnel as identified. This Code of Ethicsis attached as Exhibit 14 to this Form 10-K.

 

**Item11****.    ExecutiveCompensation.**

 

Information as to executivecompensation included on pages 8 to 11 of the Proxy Statement is incorporatedby reference.

 

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

 

The information as tobeneficial ownership of more than five percent of HickoryTech’s common stockincluded on page 7 of the Proxy Statement is incorporated by reference. Theinformation as to security ownership of management included on page 6 of theProxy Statement is incorporated by reference.

 

The following table providesinformation on equity compensation plans under which equity securities of theCompany are authorized for issuance, as of December 31, 2003.

 
| **Plan Category**                                             |   | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights  (a)** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights  (b)** |   | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))  (c)** |      |
|---------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
|                                                          |   |                                                                                                    |   |                                                                                    |   |                                                                                                                                                       |      |
| Equity compensation  plans approved by  security holders (1): |   | 595,798                                                                                                 |   | $                                                                                       | 13.01  |                                                                                                                                                       | 1,992,918 |   |
|                                                          |   |                                                                                                    |   |                                                                                    |   |                                                                                                                                                       |      |
| Equity compensation  plans not approved by  security holders: |   | —                                                                                                  |   | —                                                                                  |   | —                                                                                                                                                     |      |
|                                                          |   |                                                                                                    |   |                                                                                    |   |                                                                                                                                                       |      |
| Total                                                         |   | 595,798                                                                                                 |   | $                                                                                       | 13.01  |                                                                                                                                                       | 1,992,918 |   |

 

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(1)   - Includes the Company’sEmployee Stock Purchase Plan, Directors’ Stock Retainer Plan, Directors’ StockOption Plan and Stock Award Plan.

 

**Item13****.    CertainRelationships and Related Transactions.**

 

HickoryTech does not know ofany matter required to be reported under this item.

 

54

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**Item 14****.    PrincipalAccounting Fees and Services.**

 

The information under theheading Independent Auditors in the Proxy Statement is incorporated herein byreference.

 

**PART IV**

 

**Item15****.    Exhibits,Financial Statement Schedules, and Reports on Form 8-K.**

 

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

 

1.                                       FinancialStatements

 
| Management’s Discussion and Analysis                                                                                       |   |
|---------------------------------------------------------------------------------------------------------------------------------|--------|
| Report of Management and Report of Independent Auditors                                                                         |   |
| Consolidated Statements of Operations*  Years Ended December 31, 2003, 2002, and 2001                                           |   |
| Consolidated Balance Sheets*  December 31, 2003 and 2002                                                                        |   |
| Consolidated Statements of Cash Flows*  Years Ended December 31, 2003, 2002, and 2001                                           |   |
| Consolidated Statements of Shareholders’  Equity and  Comprehensive Income*  Years Ended December 31, 2003, 2002, and 2001 |   |
| Notes to Consolidated Financial Statements*                                                                                     |   |
| Selected Financial Data                                                                                                         |   |

 

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*Addressed by Report of Independent Auditors

 

2.                                        FinancialStatement Schedule

 
| Report of Independent Auditors on  Financial Statement Schedule |   |
|-----------------------------------------------------------------|--------|
| Schedule II – Valuation and Qualifying  Accounts           |   |

 

All schedules not included areomitted either because of the absence of conditions under which they arerequired or because the required information is given in the financialstatements or notes thereto.

 

3.                                       Exhibits

 

The following documents arefiled as Exhibits to this Form 10-K or incorporated 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 dated May 6, 1999)                                                                              |
| 3(b)        |   | Restated  By-Laws (Incorporated by reference to Exhibit 3(b) to the registrant’s Form  10-K dated March 29, 2000)                                                                                          |
| 3(c)        |   | Certificate  of Designations of Series A Junior Participating Preferred Stock of Hickory  Tech Corporation (Incorporated by reference to Exhibit 3(c) to the  registrant’s Form 10-K dated March 29, 2000) |
| 4(a)        |   | Shareholder  Rights Agreement (Incorporated by reference to Exhibit 1 to the registrant’s  Form 8-A dated March 9, 1999)                                                                                   |

 

55

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

 

56

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| **Exhibit ** |   | **Description**                                                                                                          |
|-------------------|--------|--------------------------------------------------------------------------------------------------------------------------|
|              |   |                                                                                                                     |
| 14 *              |   | Code of  Ethics                                                                                                          |
| 21 *              |   | Subsidiaries  of Hickory Tech Corporation                                                                                |
| 23.1 *            |   | Consent of  Independent Accountants                                                                                      |
| 31(a)*            |   | Certification  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                 |
| 31(b)*            |   | Certification  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                 |
| 32(a)*            |   | Certification  Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
| 32(b)*            |   | Certification  Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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*                                         Filedherewith.

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

 

(b) 1.                                             Reportson Form 8-K 

 

HickoryTech furnished a Form8-K on October 28, 2003 reporting under Item 7 and Item 12 a press releaseannouncing its third quarter consolidated operating results.

 

HickoryTech filed a Form 8-K onDecember 16, 2003 under Item 5 announcing the finalization of the sale of itswireless business to Western Wireless Corporation of Bellevue, Washington.

 

HickoryTech filed a Form 8-K onDecember 30, 2003 under Item 2 containing the Stock Purchase Agreement of thesale of its wireless business to Western Wireless Corporation of Bellevue, Washington.

 

57

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## **Report of Independent Auditors onFinancial Statement Schedule**

##  

To the Shareholders and Boardof Directors ofHickory Tech Corporation

 

Our audits of the consolidatedfinancial statement referred to in our report dated January 30, 2004 alsoincluded an audit of the financial statement schedule listed in Item 14(a)(2)of this Form 10-K. In our opinion, this financial statement schedule presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements.

 

 

PricewaterhouseCoopers LLP

Minneapolis, Minnesota

January 30, 2004

 

58

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# **SCHEDULE II – VALUATION ANDQUALIFYING ACCOUNTS**

 

ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS:

 
|                                                   |   | **Years  Ended December 31,** |       |
|--------------------------------------------------------|--------|-------------------------------|------------|
| **(In  Thousands)**                                    |   | **2003**                      |       | **2002** |   | **2001** |   |
|                                                   |   |                          | ** ** |   |   |   |   |
| Balance, at beginning of  year                         |   | **$**                         | **1,358**  | ** ** | $ | 1,231 |   | $ | 961 |   |
| Additions charged to income  - Continuing Operations   |   | **726**                       | ** ** | 1,835 |   | 462 |   |
| Write-offs, net of  recoveries - Continuing Operations |   | **(719**                      | **)**      | (1,360 | ) | (512 | ) |
| Discontinued Operations,  Net                          |   | **(82**                       | **)**      | (348 | ) | 320 |   |
|                                                   |   |                          | ** ** |   |   |   |   |
| Balance, at end of year                                |   | **$**                         | **1,283**  | ** ** | $ | 1,358 |   | $ | 1,231 |   |

 

INVENTORY VALUATION RESERVE:

 
|                           |   | **Years  Ended December 31,** | ** ** |
|--------------------------------|--------|-------------------------------|------------|
| **(In Thousands)**             |   | **2003**                      | ** ** | **2002** | ** ** | **2001** | ** ** |
|                           |   |                          | ** ** |   |   |   |   |
| Balance, at beginning of  year |   | **$**                         | **827**    | ** ** | $ | 858 |   | $ | 836 |   |
| Additions charged to income    |   | **34**                        | ** ** | — |   | 95 |   |
| Reductions (1)                 |   | **(127**                      | **)**      | (31 | ) | (73 | ) |
|                           |   |                          | ** ** |   |   |   |   |
| Balance, at end of year        |   | **$**                         | **734**    | ** ** | $ | 827 |   | $ | 858 |   |

 

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(1)Disposal of fully reserved inventory.

 

DEFERRED TAX ASSET VALUATION ALLOWANCE

 
|                           |   | **Years  Ended December 31,** | ** ** |
|--------------------------------|--------|-------------------------------|------------|
| **(In Thousands)**             |   | **2003**                      | ** ** | **2002** | ** ** | **2001** | ** ** |
|                           |   |                          |       |   |   |   |   |
| Balance, at beginning of  year |   | **$**                         | **470**    |   | $ | 315 |   | $ | — |   |
| Additions charged to income    |   | **170**                       |       | 155 |   | 315 |   |
| Reductions                     |   | **—**                    |       | — |   | — |   |
|                           |   |                          |       |   |   |   |   |
| Balance, at end of year        |   | **$**                         | **640**    |   | $ | 470 |   | $ | 315 |   |

 

59

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**SIGNATURES**

 

Pursuant to the requirements ofsection 13 or 15(d) of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
| Dated: | February 27, 2004 |                                     | HICKORY TECH  CORPORATION |
|--------|-------------------|------------------------------------------|---------------------------|
|   |              |                                     |
|   | By:               | /s/ David A.  Christensen                |                      |
|   |              | David A.  Christensen, Secretary,        |
|   |              | Vice President,  Chief Financial Officer |
|   |              | and  Treasurer                           |

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, this report has been signed by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

 

 
| /s/ Myrita  P. Craig                                            |   | February 27,  2004 |
|-----------------------------------------------------------------|--------|--------------------|
| Myrita P.  Craig, Chair                                         |   |
|                                                            |   |
|                                                            |   |
| /s/  John E. Duffy                                         |   | February 27,  2004 |
| John E.  Duffy                                                  |   |
| President,  Chief Executive Officer and Director                |   |
| (principal  executive officer)                                  |   |
|                                                            |   |
|                                                            |   |
| /s/ David A.  Christensen                                       |   | February 27,  2004 |
| David A.  Christensen, Secretary,                               |   |
| Vice  President, Chief Financial Officer and Treasurer          |   |
| (principal  financial officer and principal accounting officer) |   |
|                                                            |   |
| /s/  Lyle T. Bosacker                                      |   | February 27,  2004 |
| Lyle T.  Bosacker, Director                                     |   |
|                                                            |   |
|                                                            |   |
| /s/  James H. Holdrege                                     |   | February 27,  2004 |
| James H.  Holdrege, Director                                    |   |
|                                                            |   |
|                                                            |   |
| /s/  Robert E. Switz                                       |   | February 27,  2004 |
| Robert E.  Switz, Director                                      |   |
|                                                            |   |
|                                                            |   |
| /s/  Lyle G. Jacobson                                      |   | February 27,  2004 |
| Lyle G.  Jacobson, Director                                     |   |
|                                                            |   |
|                                                            |   |
| /s/  R. Wynn Kearney, Jr.                                  |   | February 27,  2004 |
| R. Wynn  Kearney, Jr., Director                                 |   |

 

(a majority of directors)

 

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