**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,DC 20549**

 

**FORM10-Q**

** **

**(Mark One)**
| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                         |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                           |
| ** ** | **For the quarterly period ended  March 31, 2006**                                                                                                                                                                                                                                                                                                                                   |
| ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                           |
| **OR**     |
| ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                           |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                        |
| ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                           |
| ** ** | **For the transition period  from                                to                           .** |

 

**Commissionfile number   0-13721**

 

**HICKORYTECH CORPORATION**

(Exact name of registrantas specified in its charter)

 

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

 

**221 EastHickory Street**

**Mankato,Minnesota 56002-3248**

(Address ofprincipal executive offices and zip code)

 

**(800)326-5789**

(Registrant’stelephone number, including area code)

 

 

(Former name,former address and former fiscal year, if changed since last report)

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  ý    No   o

 

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

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

 

Indicateby check mark whether the registrant is a shell company as defined in Rule12b-2 of the Act). Yes o No ý

 

The total number ofshares of the registrant’s common stock outstanding as of April 24, 2006: 13,145,245.

 

 

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**TABLE OFCONTENTS**

 
| **PART I.  Financial  Information** |                                                                                                  |
|-----------------------------------------------|-------------------------------------------------------------------------------------------------------|
|                                          |                                                                                                  |   |
| **Description**                               | ** **                                                                                            | ** ** |
|                                          |                                                                                                  |   |
| Item 1.                                       | Financial Statements:                                                                                 |   |
|                                          |                                                                                                  |   |
|                                          | Consolidated Statements of Operations (unaudited)  for the Three Months Ended March 31, 2006 and 2005 |   |
|                                          |                                                                                                  |   |
|                                          | Consolidated Balance Sheets (unaudited) as of  March 31, 2006 and December 31, 2005                   |   |
|                                          |                                                                                                  |   |
|                                          | Consolidated Statements of Cash Flows (unaudited)  for the Three Months Ended March 31, 2006 and 2005 |   |
|                                          |                                                                                                  |   |
|                                          | Notes  to Consolidated Financial Statements (unaudited)                                               |   |
|                                          |                                                                                                  |   |
| Item 2.                                       | Management’s Discussion and  Analysis of Results of Operations and Financial Condition           |   |
|                                          |                                                                                                  |   |
| Item 3.                                       | Quantitative  and Qualitative Disclosures About Market Risk                                           |   |
|                                          |                                                                                                  |   |
| Item 4.                                       | Controls and  Procedures                                                                              |   |
|                                          |                                                                                                  |   |
| **PART II. Other  Information**               |                                                                                                  |
|                                          |                                                                                                  |   |
| **Description**                               | ** **                                                                                            | ** ** |
|                                          |                                                                                                  |   |
| Item 1.                                       | Legal Proceedings                                                                                     |   |
|                                          |                                                                                                  |   |
| Item 1A.                                      | Risk Factors                                                                                          |   |
|                                          |                                                                                                  |   |
| Item 2.                                       | Unregistered  Sales of Equity Securities and Use of Proceeds                                          |   |
|                                          |                                                                                                  |   |
| Item 3.                                       | Defaults  Upon Senior Securities                                                                      |   |
|                                          |                                                                                                  |   |
| Item 4.                                       | Submission  of Matters to a Vote of Security Holders                                                  |   |
|                                          |                                                                                                  |   |
| Item 5.                                       | Other Information                                                                                     |   |
|                                          |                                                                                                  |   |
| Item 6.                                       | Exhibit Listing                                                                                       |   |
|                                          |                                                                                                  |   |
|                                          | Signatures                                                                                            |   |
|                                          |                                                                                                  |   |
|                                          | Exhibits                                                                                              |   |

 

2

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**HICKORYTECH CORPORATION**

Consolidated Statements of Operations

(Unaudited)

 
| *** ***                                                                              | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                | ** ** | **March 31,**          | ** ** |
| **(In Thousands Except Per Share  Amounts)**                                              | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| Operating revenues:                                                                       |       |                   |       |   |   |
| Telecom Sector                                                                            |       | $                      | 17,968     |   | $ | 19,345 |   |
| Information  Solutions Sector                                                             |       | 688                    |       | 488 |   |
| Enterprise  Solutions Sector                                                              |       | 2,737                  |       | 3,275 |   |
| Enventis Sector                                                                           |       | 14,084                 |       | — |   |
| Total operating  revenues                                                                 |       | 35,477                 |       | 23,108 |   |
|                                                                                      |       |                   |       |   |   |
| Costs and expenses:                                                                       |       |                   |       |   |   |
| Cost of sales,  Enterprise Solutions and Enventis                                         |       | 11,027                 |       | 2,268 |   |
| Cost of services  (excluding depreciation and amortization)                               |       | 8,960                  |       | 8,053 |   |
| Selling, general  and administrative expenses   (excluding depreciation and amortization) |       | 7,185                  |       | 4,027 |   |
| Depreciation                                                                              |       | 4,074                  |       | 4,001 |   |
| Amortization of  intangibles                                                              |       | 293                    |       | 237 |   |
| Total costs and  expenses                                                                 |       | 31,539                 |       | 18,586 |   |
| Operating income                                                                          |       | 3,938                  |       | 4,522 |   |
| Other income/(expense):                                                                   |       |                   |       |   |   |
| Interest and  other income                                                                |       | 31                     |       | 8 |   |
| Interest expense                                                                          |       | (1,649                 | )          | (977 | ) |
| Total other  income/(expense)                                                             |       | (1,618                 | )          | (969 | ) |
|                                                                                      |       |                   |       |   |   |
| Income before income taxes                                                                |       | 2,320                  |       | 3,553 |   |
| Income tax provision                                                                      |       | 931                    |       | 1,437 |   |
| Net income                                                                                |       | $                      | 1,389      |   | $ | 2,116 |   |
|                                                                                      |       |                   |       |   |   |
| Basic earnings per share:                                                                 |       | $                      | 0.11       |   | $ | 0.16 |   |
| Dividends per share                                                                       |       | $                      | 0.12       |   | $ | 0.12 |   |
| Weighted average common shares outstanding                                                |       | 13,134                 |       | 13,059 |   |
|                                                                                      |       |                   |       |   |   |
| Diluted earnings per share:                                                               |       | $                      | 0.11       |   | $ | 0.16 |   |
| Weighted average common and equivalent shares outstanding                                 |       | 13,148                 |       | 13,091 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

3

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**HICKORY TECH CORPORATION**

Consolidated BalanceSheets

(Unaudited)

 
| ** **                                                                                                                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------------|------------|
| **(Dollars In Thousands)**                                                                                                                   | ** ** | **2006**      | ** ** | **2005**         | ** ** |
| * *                                                                                                                                     | * *   | * *      | * *   | * *         | * *   |
| Assets                                                                                                                                       |       |          |       |             |       |
| Current assets:                                                                                                                              |       |          |       |             |       |
| Cash and cash  equivalents                                                                                                                   |       | $             | 265        |             | $          | 601 |   |
| Receivables, net  of allowance for doubtful accounts of $322 and $334                                                                        |       | 20,491        |       | 19,867           |       |
| Costs in excess  of billings on contracts                                                                                                    |       | 302           |       | 462              |       |
| Inventories                                                                                                                                  |       | 5,839         |       | 4,577            |       |
| Deferred income  taxes                                                                                                                       |       | 300           |       | 300              |       |
| Prepaid expenses                                                                                                                             |       | 2,248         |       | 5,066            |       |
| Other                                                                                                                                        |       | 1,059         |       | 1,155            |       |
| Total current  assets                                                                                                                        |       | 30,504        |       | 32,028           |       |
|                                                                                                                                         |       |          |       |             |       |
| Investments                                                                                                                                  |       | 3,554         |       | 3,407            |       |
|                                                                                                                                         |       |          |       |             |       |
| Property, plant and equipment                                                                                                                |       | 294,460       |       | 290,499          |       |
| Less accumulated  depreciation                                                                                                               |       | 145,234       |       | 141,157          |       |
| Property, plant  and equipment, net                                                                                                          |       | 149,226       |       | 149,342          |       |
|                                                                                                                                         |       |          |       |             |       |
| Other assets:                                                                                                                                |       |          |       |             |       |
| Goodwill                                                                                                                                     |       | 26,984        |       | 27,109           |       |
| Intangible  assets, net                                                                                                                      |       | 4,019         |       | 4,312            |       |
| Financial derivative  instruments                                                                                                            |       | 3,719         |       | 3,429            |       |
| Deferred costs  and other                                                                                                                    |       | 3,473         |       | 3,640            |       |
| Total other  assets                                                                                                                          |       | 38,195        |       | 38,490           |       |
|                                                                                                                                         |       |          |       |             |       |
| Total assets                                                                                                                                 |       | $             | 221,479    |             | $          | 223,267 |   |
|                                                                                                                                         |       |          |       |             |       |
| Liabilities and Shareholders’ Equity                                                                                                    |       |          |       |             |       |
| Current liabilities:                                                                                                                         |       |          |       |             |       |
| Cash overdraft                                                                                                                               |       | $             | —     |             | $          | 514 |   |
| Short-term  financing (Note 13)                                                                                                              |       | 4,456         |       | —           |       |
| Accounts payable                                                                                                                             |       | 5,079         |       | 5,224            |       |
| Accrued expenses                                                                                                                             |       | 5,560         |       | 6,809            |       |
| Accrued interest                                                                                                                             |       | 349           |       | —           |       |
| Accrued income  taxes                                                                                                                        |       | 5,593         |       | 4,765            |       |
| Billings in  excess of costs on contracts                                                                                                    |       | 235           |       | 283              |       |
| Advanced  billings and deposits                                                                                                              |       | 4,180         |       | 4,577            |       |
| Current  maturities of long-term obligations                                                                                                 |       | 1,714         |       | 1,778            |       |
| Total current  liabilities:                                                                                                                  |       | 27,166        |       | 23,950           |       |
|                                                                                                                                         |       |          |       |             |       |
| Long-term obligations, net of current maturities                                                                                             |       | 135,198       |       | 140,980          |       |
|                                                                                                                                         |       |          |       |             |       |
| Deferred income taxes                                                                                                                        |       | 15,524        |       | 15,346           |       |
|                                                                                                                                         |       |          |       |             |       |
| Deferred revenue and employee benefits                                                                                                       |       | 8,320         |       | 7,982            |       |
|                                                                                                                                         |       |          |       |             |       |
| Total  liabilities                                                                                                                           |       | 186,208       |       | 188,258          |       |
|                                                                                                                                         |       |          |       |             |       |
| Commitments and contingencies (Note 9)                                                                                                       |       | —        |       | —           |       |
|                                                                                                                                         |       |          |       |             |       |
| Shareholders’ equity:                                                                                                                   |       |          |       |             |       |
| Common stock, no  par value, $.10 stated value shares authorized: 100,000,000 shares  outstanding: 13,144,245 in 2006 and 13,124,928 in 2005 |       | 1,314         |       | 1,312            |       |
| Additional  paid-in capital                                                                                                                  |       | 9,534         |       | 9,262            |       |
| Retained  earnings                                                                                                                           |       | 22,184        |       | 22,371           |       |
| Accumulated  other comprehensive income                                                                                                      |       | 2,239         |       | 2,064            |       |
| Total  shareholders’ equity                                                                                                             |       | 35,271        |       | 35,009           |       |
|                                                                                                                                         |       |          |       |             |       |
| Total  liabilities and shareholders’ equity                                                                                             |       | $             | 221,479    |             | $          | 223,267 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

4

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**HICKORYTECH CORPORATION**

Consolidated Statements of Cash Flows

(Unaudited)

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **March 31,**          | ** ** |
| **(Dollars In Thousands)**                                  | ** ** | **2006**               | ** ** | **2005** | ** ** |
| Cash flows from operating activities:                       |       |                   |       |   |   |
| Net income                                                  |       | $                      | 1,389      |   | $ | 2,116 |   |
| Adjustments to  reconcile net income to net                 |       |                   |       |   |   |
| Cash provided by  operating activities:                     |       |                   |       |   |   |
| Depreciation and  amortization                              |       | 4,367                  |       | 4,238 |   |
| Gain on sale of  assets                                     |       | —                 |       | (4 | ) |
| Stock-based  compensation                                   |       | 147                    |       | 22 |   |
| Employee  retirement benefits and deferred compensation     |       | 125                    |       | 83 |   |
| Accrued  patronage refunds                                  |       | (290                   | )          | (136 | ) |
| Provision for  losses on accounts receivable                |       | 86                     |       | 224 |   |
| Changes in  operating assets and liabilities:               |       |                   |       |   |   |
| Receivables                                                 |       | (709                   | )          | 1,459 |   |
| Inventories                                                 |       | (1,262                 | )          | 20 |   |
| Billings and  costs on contracts                            |       | 113                    |       | 651 |   |
| Accounts payable  and accrued expenses                      |       | (1,089                 | )          | (1,450 | ) |
| Advance billings  and deposits                              |       | (397                   | )          | (92 | ) |
| Deferred revenue  and employee benefits                     |       | 214                    |       | (34 | ) |
| Prepaid Assets                                              |       | 2,817                  |       | — |   |
| Other                                                       |       | 1,275                  |       | 195 |   |
| Net cash  provided by operating activities                  |       | 6,786                  |       | 7,292 |   |
|                                                        |       |                   |       |   |   |
| Cash flows from investing activities:                       |       |                   |       |   |   |
| Additions to  property, plant and equipment                 |       | (3,832                 | )          | (1,456 | ) |
| Acquisitions,  purchase price adjustments                   |       | 125                    |       | — |   |
| Redemption of  investments                                  |       | 21                     |       | 2,100 |   |
| Proceeds from  sale of assets                               |       | 5                      |       | 11 |   |
| Net cash  provided by/(used in) investing activities        |       | (3,681                 | )          | 655 |   |
| ** **                                                  | ** ** | ** **             | ** ** | ** ** | ** ** |
| Cash flows from financing activities:                       |       |                   |       |   |   |
| Short-term  financing                                       |       | 4,456                  |       | — |   |
| Change in cash  overdraft                                   |       | (514                   | )          | (1,680 | ) |
| Payments of  capital lease obligations                      |       | (119                   | )          | (123 | ) |
| Employee stock  purchase plan                               |       | 108                    |       | — |   |
| Repayments on  credit facility                              |       | (8,860                 | )          | (4,750 | ) |
| Borrowings on  credit facility                              |       | 3,000                  |       | 1,000 |   |
| Proceeds from  issuance of common stock                     |       | —                 |       | 174 |   |
| Dividends paid                                              |       | (1,512                 | )          | (1,567 | ) |
| Net cash used in  financing activities                      |       | (3,441                 | )          | (6,946 | ) |
|                                                        |       |                   |       |   |   |
| Net increase (decrease) in cash and cash equivalents        |       | (336                   | )          | 1,001 |   |
|                                                        |       |                   |       |   |   |
| Cash and cash equivalents at beginning of period            |       | 601                    |       | 257 |   |
|                                                        |       |                   |       |   |   |
| Cash and cash equivalents at end of period                  |       | $                      | 265        |   | $ | 1,258 |   |
|                                                        |       |                   |       |   |   |
| Supplemental disclosure of cash flow information:           |       |                   |       |   |   |
| Cash paid for  interest                                     |       | $                      | 1,641      |   | $ | 1,055 |   |
| Net cash paid  for income taxes                             |       | $                      | 40         |   | $ | 310 |   |
| Non-cash investing activities:                              |       |                   |       |   |   |
| Property, plant  and equipment acquired with capital leases |       | $                      | 132        |   | $ | 317 |   |

 

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

 

5

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**HICKORYTECH CORPORATION**

**MARCH 31,2006**

**PART 1. FINANCIAL INFORMATION**

 

**ITEM 1.     NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

NOTE 1.    BASISOF PRESENTATION

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and with the instructions to Form 10-Q and Article 10 of RegulationS-X. Accordingly, they do not include all of the information necessary for afair statement of results of operations, financial position, and cash flows inconformity with accounting principles generally accepted in the United Statesof America. In the opinion of management, the condensed consolidated financialstatements reflect all adjustments (consisting only of normal recurringadjustments) considered necessary for a fair statement of Hickory TechCorporation’s (HickoryTech or the Company) results for the periods presented.Operating results for interim periods are not necessarily indicative of resultsthat may be expected for the fiscal year as a whole. The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues, expenses, and related disclosures at the date of the financialstatements and during the reporting period. Actual results could differ fromthese estimates. These unaudited interim condensed consolidated financialstatements should be read in conjunction with HickoryTech’s Annual Report onForm 10-K for the year ended December 31, 2005.

 

The condensedconsolidated financial statements of HickoryTech include Hickory TechCorporation and its subsidiaries in the following four business segments: (i)Telecom Sector, (ii) Information Solutions Sector (iii) Enterprise SolutionsSector and (iv) Enventis Sector. All inter-company transactions have beeneliminated from the consolidated financial statements.

 

Cost of services includeall costs 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 and intangible assets, and cost of sales for the Enterprise Solutionsand Enventis Sectors.

 

On December 30, 2005,HickoryTech purchased Enventis Telecom, Inc. (Enventis) from ALLETE, Inc. Thepurchase price was comprised of $35,500,000 in cash, subject to normal workingcapital adjustments. Enventis is a transport and enterprise Internet Protocol telephonysales business which specializes in providing telecommunications and networksolutions. In addition to its statewide SONET-based network, Enventis providesinnovative Internet Protocol services that combine voice and data onto a singleplatform. Since 1997, Enventis has provided network solutions for a broadspectrum of large corporate, non-profit, government and small business clients.Enventis has offices located in Duluth, Plymouth, and Rochester, Minnesota andSioux Falls, South Dakota.

 

6

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NOTE 2. EARNINGS AND CASHDIVIDENDS PER COMMON SHARE

 

Basic earnings per shareis computed by dividing net income by the weighted average number of shares ofcommon stock outstanding during the applicable period. Shares used in theearnings per share assuming dilution calculation are based on the weightedaverage number of shares of common stock outstanding during the periodincreased by potentially dilutive common shares. Potentially dilutive commonshares include stock options and stock subscribed under the employee stockpurchase plan (ESPP).

 
| ** **                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **March 31,**          | ** ** |
| ** **                          | ** ** | **2006**               | ** ** | **2005** | ** ** |
| Weighted average shares outstanding |       | 13,133,817             |       | 13,059,024 |   |
| Stock options (dilutive only)       |       | 650                    |       | 17,691 |   |
| Stock subscribed (ESPP)             |       | 13,119                 |       | 14,190 |   |
| Total dilutive shares outstanding   |       | 13,147,586             |       | 13,090,905 |   |

 

Options to purchase538,850 and 476,000 shares for the three months ended March 31, 2006 and 2005,respectively, were not included in the computation of earnings per shareassuming dilution because their effect on earnings per share would have beenantidilutive.

 

Cash dividends are basedon the number of common shares outstanding at the respective record dates.Listed below is the number of shares outstanding as of the record date for thefirst quarter of 2006 and 2005. 

 
| **Shares outstanding on record date** | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|---------------------------------------|------------|------------|------------|------------|------------|
| First quarter (Feb. 15)               |       | 13,133,928 |       | 13,057,106 |       |

 

Dividends per share arebased on the quarterly dividend per share as declared by the HickoryTech Boardof Directors. HickoryTech paid dividends of $.12 per share for the firstquarter of 2006 and 2005.

 

During the first threemonths of 2006 and 2005, shareholders have elected to reinvest $64,000 and$66,000, respectively, of dividends into HickoryTech common stock pursuant tothe HickoryTech Dividend Reinvestment Plan.

 

NOTE 3. COMPREHENSIVEINCOME

 

HickoryTech follows theprovisions of SFAS No. 130, “Reporting Comprehensive Income.” This statementestablished rules for the reporting of comprehensive income and its components.In addition to net income, HickoryTech’s comprehensive income includes changesin unrealized gains and losses on derivative instruments qualifying anddesignated as cash flow hedges. Comprehensive income for the three months endedMarch 31, 2006 and 2005 was $1,564,000 and $2,731,000, respectively.

 

NOTE 4. ACQUISITIONS

 

Acquisition of Enventis

 

On December 30, 2005HickoryTech purchased Enventis from ALLETE, Inc. Enventis was formerly a whollyowned subsidiary of ALLETE, Inc. Enventis is a network transport and anenterprise Internet Protocol telephony sales business. The acquisition ofEnventis was made to expand the geographical region which HickoryTech couldserve with its business broadband service capabilities. Both Enventis andHickoryTech have similar bundled service business plans.

 

7

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The purchase price was cashof $35,500,000 in exchange for the common stock of Enventis, with furtherpurchase price adjustments and transaction costs making the estimated totalpurchase consideration $38,602,000 as of December 31, 2005. Enventis had nodebt at the time of acquisition. The purchase agreement outlined certainpurchase price adjustments which were estimated as of December 31, 2005 andresulted in cash payments between ALLETE and HickoryTech in the first quarterof 2006. These adjustments were for working capital, capital expenditures andemployee benefits. These adjustments changed the estimated purchase price by $125,000,which reduced the amounts originally estimated for total purchase considerationand goodwill.

 

The financing for theadjusted $38.6 million total purchase consideration for Enventis, plus anadditional $8.5 million for Enventis working capital as of December 31, 2005,was entirely from HickoryTech’s credit agreement, as established on December30, 2005. The credit facility is comprised of a $30 million revolving creditcomponent which expires on December 30, 2011 and a $130 million term loancomponent, which has partial maturities during its term, with final maturity onJune 30, 2013. In the first quarter of 2006, an additional $10 million creditfacility with a vendor finance organization was established for short-terminventory floor-plan financing of accounts payable for Enventis.

 

The Enventis acquisitionwas accounted for using the purchase method of accounting. Accordingly, thepurchase price was allocated to the estimated fair value of assets acquired andliabilities assumed. The preliminary purchase price allocation resulted ingoodwill of $2,023,000, which has been adjusted to $1,898,000 as of March 31,2006. ALLETE and HickoryTech have agreed to treat the transaction under Section338 of the Internal Revenue Code. Accordingly, the tax basis of the acquiredassets and assumed liabilities will be the same for financial reporting.

 

The purchase priceallocation is still considered preliminary. Specific reasons causing thepurchase price to still be preliminary are: 1) finalization of the third partyvaluation, 2) the liquidation of acquired accounts receivable, and 3)resolution of one litigation matter. On the litigation matter, HickoryTech has receivedan indemnification from ALLETE which management believes to be more thanadequate to cover any loss. The first item is expected to be resolved by June2006. The second item is expected to be resolved by July 2006 and the last itemby December 2006.

 

NOTE 5. INVENTORIES

 

Inventories, whichconsist of equipment for resale, materials and supplies, are stated at thelower of average cost or market. Cost is determined on a first-in first-out(FIFO) basis. Reserves offset the cost of inventory to arrive at the netrealizable value of the inventory.

 

NOTE 6. INTANGIBLE ASSETS

 

Goodwill assets aresubject to an impairment test annually as well as upon certain events thatindicate that an impairment may be present. The goodwill impairment testincludes two steps, the first of which requires management to determine thefair value of certain of the Company’s reporting units (as defined by SFAS No.142 “Goodwill and Other Intangible Assets”). The Company determines the fairvalue of its reporting units by application of a discounted cash flow analysis.Management makes estimates that are included in its discounted cash flow analysisbased upon the best available information at the time that the determinationsof fair value are made. If circumstances change, HickoryTech’s estimates offair value will also change and could result in a determination of additionalimpairment charges to reduce the carrying value of goodwill.

 

HickoryTech is requiredto test acquired goodwill for impairment on an annual basis based upon a fairvalue approach. Additionally, goodwill shall be tested for impairment betweenannual tests if an event occurs or circumstances change that would more likelythan not reduce the fair value of an entity below its carrying value.

 

The carrying value ofHickoryTech’s goodwill decreased from $27,109,000 as of December 31, 2005 to $26,984,000as of March 31, 2006 due to the working capital adjustment as described in Note4.

 

8

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The components ofHickoryTech’s other intangible assets are as follows:

 
| ** **                       | ** **   | ** **       | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|--------------|------------------|------------|--------------------|------------|-----------------------|------------|
| *** ***                     | *** *** | ** **       | ** ** | **Gross Carrying** | ** ** | **Accumulated**       | ** ** | **Gross Carrying** | ** ** | **Accumulated** | ** ** |
| **(Dollars in Thousands)**       | ** **   | **Useful Lives** | ** ** | **Amount**         | ** ** | **Amortization**      | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
|                             |         |             |       |               |       |                  |       |   |   |   |   |
| Definite-lived intangible assets |         |             |       |               |       |                  |       |   |   |   |   |
| Customers                        |         | 1 - 8 years      |       | $                  | 4,229      |                  | $          | 784 |   | $ | 4,229 |   | $ | 544 |   |
| Other  intangibles               |         | 1 - 5 years      |       | 730                |       | 156                   |       | 730 |   | 103 |   |
| Total                            |         |             |       | $                  | 4,959      |                  | $          | 940 |   | $ | 4,959 |   | $ | 647 |   |

 

Amortization expenserelated to the definite-lived intangible assets for the three months endedMarch 31, 2006 and 2005 was $293,000 and $26,000, respectively. Total estimatedamortization expense for the remaining nine months of 2006 and the five yearssubsequent to 2006 is as follows: 2006 (April 1 through December 31) -$879,000; 2007 - $1,157,000; 2008 - $1,127,000; 2009 - $853,000; 2010 - $3,000and 2011 - $0.

 

9

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NOTE 7. QUARTERLY SECTORFINANCIAL SUMMARY

 
| ** **                                     | ** ** | ** **  | ** **   | **Information** | ** ** | **Enterprise** | ** ** | ** **        | ** ** | **Corporate and**  | ** ** | **HickoryTech**  | ** ** |
|------------------------------------------------|------------|-------------|--------------|-----------------|------------|----------------|------------|-------------------|------------|--------------------|------------|------------------|------------|
| **(Dollars In Thousands)**                     | ** ** | **Telecom** | ** **   | **Solutions**   | ** ** | **Solutions**  | ** ** | **Enventis**      | ** ** | **Eliminations**   | ** ** | **Consolidated** | ** ** |
| Three Months  Ended March 31, 2006             |       |        |         |            |       |           |       |              |       |               |       |             |       |
| Operating  revenue from unaffiliated customers |       | $           |  17,968 |            | $          | 688            |       | $                 | 2,737      |               | $          | 14,084           |       | $ | — |   | $ | 35,477 |   |
| Intersegment  revenues                         |       | 51          |         | 1,089           |       | —         |       | —            |       | (1,140             | )          | —           |       |
| Total                                          |       | 18,019      |         | 1,777           |       | 2,737          |       | 14,084            |       | (1,140             | )          | 35,477           |       |
|                                           |       |        |         |            |       |           |       |              |       |               |       |             |       |
| Depreciation and  amortization                 |       | 3,204       |         | 371             |       | 29             |       | 739               |       | 24                 |       | 4,367            |       |
| Operating income  (loss)                       |       | 4,664       |         | (401            | )          | (279           | )          | 564               |       | (610               | )          | 3,938            |       |
| Interest expense                               |       | (133        | )            | 11              |       | —         |       | —            |       | 1,771              |       | 1,649            |       |
| Income taxes  (benefit)                        |       | 1,920       |         | (165            | )          | (112           | )          | 229               |       | (941               | )          | 931              |       |
| Net income  (loss)                             |       | 2,880       |         | (247            | )          | (168           | )          | 336               |       | (1,412             | )          | 1,389            |       |
|                                           |       |        |         |            |       |           |       |              |       |               |       |             |       |
| Identifiable assets                            |       | 148,474     |         | 6,335           |       | 6,186          |       | 50,640            |       | 9,844              |       | 221,479          |       |
| Property, plant  and equip., net               |       | 113,368     |         | 5,644           |       | 201            |       | 29,810            |       | 203                |       | 149,226          |       |
| Capital  expenditures                          |       | 2,962       |         | 265             |       | 5              |       | 507               |       | 93                 |       | 3,832            |       |
|                                           |       |        |         |            |       |           |       |              |       |               |       |             |       |
| ** **                                     | ** ** | ** **  | ** **   | **Information** | ** ** | **Enterprise** | ** ** | ** **        | ** ** | **Corporate  and** | ** ** | **HickoryTech**  | ** ** |
| **(Dollars  In Thousands)**                    | ** ** | **Telecom** | ** **   | **Solutions**   | ** ** | **Solutions**  | ** ** | **Enventis  (1)** | ** ** | **Eliminations**   | ** ** | **Consolidated** | ** ** |
| Three Months  Ended March 31, 2005             |       |        |         |            |       |           |       |              |       |               |       |             |       |
| Operating  revenue from unaffiliated customers |       | $           |  19,345 |            | $          | 488            |       | $                 | 3,275      |               | $          | —           |       | $ | — |   | $ | 23,108 |   |
| Intersegment  revenues                         |       | 51          |         | 1,096           |       | —         |       | —            |       | (1,147             | )          | —           |       |
| Total                                          |       | 19,396      |         | 1,584           |       | 3,275          |       | —            |       | (1,147             | )          | 23,108           |       |
|                                           |       |        |         |            |       |           |       |              |       |               |       |             |       |
| Depreciation and  amortization                 |       | 3,536       |         | 656             |       | 32             |       | —            |       | 14                 |       | 4,238            |       |
| Operating income  (loss)                       |       | 5,764       |         | (752            | )          | (198           | )          | —            |       | (292               | )          | 4,522            |       |
| Interest expense                               |       | 1           |         | 13              |       | —         |       | —            |       | 963                |       | 977              |       |
| Income taxes  (benefit)                        |       | 2,333       |         | (310            | )          | (80            | )          | —            |       | (506               | )          | 1,437            |       |
| Net income  (loss)                             |       | 3,432       |         | (455            | )          | (118           | )          | —            |       | (743               | )          | 2,116            |       |
|                                           |       |        |         |            |       |           |       |              |       |               |       |             |       |
| Identifiable  assets                           |       | 143,818     |         | 4,742           |       | 7,159          |       | —            |       | 8,720              |       | 164,439          |       |
| Property, plant  and equip., net               |       | 107,960     |         | 4,113           |       | 282            |       | —            |       | 101                |       | 112,456          |       |
| Capital  expenditures                          |       | 1,372       |         | 84              |       | —         |       | —            |       | —             |       | 1,456            |       |

 

----

(1) No informationprovided due to the fact that Enventis was purchased on December 30, 2005.

 

NOTE 8. CONTINGENCIES

 

HickoryTech is involvedin certain contractual disputes in the ordinary course of business. HickoryTechdoes not believe the ultimate resolution of any of these existing matters willhave a material adverse effect on its financial position, results of operationsor cash flows.

 

10

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NOTE 9. STOCKCOMPENSATION

 

OnJanuary 1, 2006, the Company adopted Statement of Financial AccountingStandards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”)which requires the measurement and recognition of compensation expense for allshare-based payment awards made to employees and directors, including employeestock options and employee stock purchases related to the Employee StockPurchase Plan, based on estimated fair values. SFAS 123(R) supersedes theCompany’s previous accounting under Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periodsbeginning in fiscal 2006. In March 2005, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relatingto SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption ofSFAS 123(R).

 

TheCompany adopted SFAS 123(R) using the modified prospective transition method,which requires the application of the accounting standard as of January 1,2006. The Company’s Consolidated Financial Statements as of and for the threemonths ended March 31, 2006 reflect the impact of SFAS 123(R). In accordancewith the modified prospective transition method, the Company’s ConsolidatedFinancial Statements for prior periods have not been restated to reflect, anddo not include, the impact of SFAS 123(R) or any modifications to outstandingstock options prior to the adoption of SFAS 123(R). Share-based compensationexpense recognized under SFAS 123(R) for the three-months ended March 31, 2006was $45,000 pre-tax and $27,000 after tax. The majority of this expense relatesto the expensing of stock options and a small amount relates to the EmployeeStock Purchase Plan. In addition, stock based compensation included $102,000 ofequity based stock awards. The adoption of FAS 123(R) had minimal impact oncash flow from financing and operations, and basic and diluted earnings pershare.

 

Share-basedcompensation expense recognized during the period is based on the value of theportion of share-based payment awards that are ultimately expected to vestduring the period. Share-based compensation expense recognized in the Company’sConsolidated Statement of Operations for the first three months of 2006included compensation expense for share-based payment awards granted prior to,but not yet vested as of December 31, 2005, based on the grant date fair valueestimated in accordance with the pro forma provisions of SFAS 123. Becauseshare-based compensation expense recognized in the Consolidated Statement ofOperations for the three months ended March 31, 2006 is based on awardsultimately expected to vest, it has been reduced for estimated forfeitures.SFAS 123(R) requires forfeitures to be estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates. The Company accounted for forfeitures as they occurred in theCompany’s pro forma information required under SFAS 123 for the periods priorto 2006.

 

Thefair value of each option award is estimated on the date of grant using aBlack-Scholes option valuation model. The Company uses a seven-year period tocalculate the historical volatility of its stock price for use in the valuationmodel. The Company uses historical data to estimate option exercise andemployee termination within the valuation model. The expected term of optionsgranted is derived from historical experience and represents the period of timethat options granted are expected to be outstanding. The forfeiture rate isbased upon a statistical computation of remaining lives and exercise price inrelationship to current stock price. The risk-free rate for options is based ona U.S. Treasury rate commensurate with the expected terms.

 

Therehave been no changes in the quantity or type of instruments used in stock-basedcompensation programs. There have been no changes in the terms of stock-basedcompensation arrangements. There have been no cumulative adjustments recordedin the financial statements due to the adoption of SFAS 123(R).

 

Referto the Company’s Annual Report on Form 10-K for the year ended December 31,2005 for a complete description of its stock-based compensation plans.

 

Optionswere last granted under Company programs in February of 2005. Stock plansprovide for the issuance of stock options, but no current compensation programshave options as a component.

 

Asof March 31, 2006, there was $188,000 of total unrecognized compensation costsrelated to nonvested stock options granted under the Company’s Stock Award Plan.This expense is expected to be recognized over a weighted average period of 2years.

 

11

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A summary of stock optionactivity of the Stock Award Plan is as follows:

 
| ** **                     | ** ** | ** ** | ** ** | **Weighted Average** | ** ** | **Aggregate**       | ** ** |
|--------------------------------|------------|------------|------------|----------------------|------------|---------------------|------------|
| ** **                     | ** ** | **Shares** | ** ** | **Exercise Price**   | ** ** | **Intrinsic Value** | ** ** |
| Outstanding at January 1, 2006 |       | 578,850    |       | $                    | 12.63      |                |       |   |
| Granted                        |       | —     |       | —               |       |                |       |
| Exercised                      |       | —     |       | —               |       |                |       |
| Forfeited                      |       | —     |       | —               |       |                |       |
| Outstanding at March 31, 2006  |       | 578,850    |       | $                    | 12.63      |                | $          | 1,679,742 |   |
| Exercisable at March 31, 2006  |       | 504,651    |       | $                    | 12.85      |                | $          | 73,301 |   |

 

The following tableprovides certain information with respect to stock options outstanding at March31, 2006:

 
| ** **          | ** ** | ** **      | ** ** | **Weighted** | ** ** | **Weighted**         | ** ** |
|---------------------|------------|-----------------|------------|--------------|------------|----------------------|------------|
| ** **          | ** ** | **Stock**       | ** ** | **Average**  | ** ** | **Average**          | ** ** |
| **Range of**        | ** ** | **Options**     | ** ** | **Exercise** | ** ** | **Remaining**        | ** ** |
| **Exercise Prices** | ** ** | **Outstanding** | ** ** | **Price**    | ** ** | **Contractual Life** | ** ** |
| $8.00 - $12.00      |       | 272,800         |       | $            | 10.31      |                 | 7.19 years |   |
| $12.00 - $16.00     |       | 245,550         |       | 13.83        |       | 4.85 years           |       |
| $16.00 - $21.00     |       | 60,500          |       | 18.17        |       | 5.01 years           |       |
|                |       | 578,850         |       | $            | 12.63      |                 | 5.97 years |   |

 

The followingtable provides certain information with respect to stock options exercisable atMarch 31, 2006:

 
| ** **          | ** ** | ** **      | ** ** | **Weighted** | ** ** | ** **           | ** ** |
|---------------------|------------|-----------------|------------|--------------|------------|----------------------|------------|
| ** **          | ** ** | **Stock**       | ** ** | **Average**  | ** ** | **Average**          | ** ** |
| **Range of**        | ** ** | **Options**     | ** ** | **Exercise** | ** ** | **Remaining**        | ** ** |
| **Exercise Prices** | ** ** | **Exercisable** | ** ** | **Price**    | ** ** | **Contractual Life** | ** ** |
| $8.00 - $12.00      |       | 198,511         |       | $            | 10.01      |                 | 6.72 years |   |
| $12.00 - $16.00     |       | 245,550         |       |         | 13.83      |                 | 4.85 years |   |
| $16.00 - $21.00     |       | 60,500          |       |         | 18.17      |                 | 5.01 years |   |
|                |       | 504,561         |       | $            | 12.85      |                 | 5.60 years |   |
|                     |            |                 |            |              |            |                      |            |  |  |

 

The followingtable provides the range of assumptions used for valuing stock options:

 
| ** **               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Expected volatility      |       | 39.36                            | %          | 37.03 | % |
| Expected dividends       |       | 1.42                             | %          | 1.12 | % |
| Expected term (in years) |       | 7                                |       | 7 |   |
| Risk-free interest rate  |       | 4.60                             | %          | 4.07 | % |

 

12

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If HickoryTechhad elected to recognize compensation cost based on the fair value of theoptions as prescribed by SFAS No. 123 for the three months ended March 31,2005, the following operating results would have resulted using theBlack-Scholes option-pricing model to determine the fair value of the options:  

 
| ** **                                                                                                                                    | ** ** | **For Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                    | ** ** | **March  31, 2005 (1)**    | ** ** |
| Net income:                                                                                                                                   |       |                       |       |
| As reported                                                                                                                                   |       | $                          | 2,116      |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                  |       | 13                         |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based method  for all awards, net of related tax effects |       | (64                        | )          |
| Pro forma net  income                                                                                                                         |       | $                          | 2,065      |   |
|                                                                                                                                          |       |                       |       |
| Earnings per  share:                                                                                                                          |       |                       |       |
| As reported                                                                                                                                   |       |                       |       |
| Basic                                                                                                                                         |       | $                          | 0.16       |   |
| Diluted                                                                                                                                       |       | $                          | 0.16       |   |
|                                                                                                                                          |       |                       |       |   |
| Pro forma                                                                                                                                     |       |                       |       |
| Basic                                                                                                                                         |       | $                          | 0.16       |   |
| Diluted                                                                                                                                       |       | $                          | 0.16       |   |

 

----

(1)   2005 Net income and net income per share donot include share-based compensation expense in accordance with SFAS 123.

 

As of March31, 2006, the following number of shares are available for each stock-basedcompensation plan:

 
| **Plan**                                    | ** ** | **Shares Available** | ** ** |
|---------------------------------------------|------------|----------------------|------------|
| Employee Stock Purchase Plan                |       | 566,190              |       |
| Retainer Stock Plans for Directors          |       | 245,024              |       |
| Non-Employee Directors’ Incentive Plan |       | 191,000              |       |
| Stock Award Plan                            |       | 935,500              |       |

 

Shares issuedunder other stock-based compensation plans is as follows:

 
| ** **                                  | ** ** | **For Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **March 31, 2006**         | ** ** |
| Retainer Stock Plans for Directors          |       | 1,997 shares               |       |
| market  price/fair value at time of grant   |       | $                          | 8.12/share |   |
|                                        |       |                       |       |
| Non-Employee Director’s Incentive Plan |       | 9,000 shares               |       |
| market  price/fair value at time of grant   |       | $                          | 8.76/share |   |
|                                        |       |                       |       |   |
| Stock Award Plan                            |       |                       | 779 shares |   |
| market price/fair  value at time of grant   |       | $                          | 8.31/share |   |

 

13

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NOTE 10. 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.

 
| **(Dollars in Thousands)**                                                                        | ** **         | **Interest Rate** | ** ** |
|---------------------------------------------------------------------------------------------------|--------------------|-------------------|------------|
| ** **                                                                                        | **Swap Agreement** | ** **        |
|                                                                                              |               |              |       |
| Accumulated other comprehensive income balance at  December 31, 2005                              |               | $                 | 2,064      |   |
| Market value  increase on interest rate swap agreement for the three months ended March 31,  2006 |               | 175               |       |
| Accumulated other comprehensive income balance at  March 31, 2006                                 |               | $                 | 2,239      |   |

 

HickoryTech has variablerate debt instruments, which subject the Company to interest rate risk.Beginning in the second quarter of 2003, HickoryTech entered into interest rateswap agreements, with remaining maturities of twenty-seven months, to manageits exposure to interest rate movements on a portion of its variable rate debtobligations. The market value of the cumulative gain or loss on thesederivative instruments is reported as a component of accumulated othercomprehensive income/loss in shareholders’ equity and will be recognized inearnings when the term of the swap agreement is concluded.

 

The fair value ofHickoryTech’s derivatives at March 31, 2006 and December 31, 2005 is a netasset of $3,719,000 and $3,429,000, respectively, which is included in otherassets in the accompanying consolidated balance sheet.

 

NOTE 11. EMPLOYEEPOST-RETIREMENT BENEFITS

 

HickoryTech providespost-retirement health care and life insurance benefits for certain employees.HickoryTech is not currently funding these post-retirement benefits, but hasaccrued these liabilities during the first quarter of 2006 and 2005.

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                    | ** ** | **March 31,**          | ** ** |
| **(Dollars in Thousands)**                                    | ** ** | **2006**               | ** ** | **2005** | ** ** |
| Components of  net periodic benefit cost                      |       |                   |       |   |   |
| Service cost                                                  |       | $                      | 81         |   | $ | 92 |   |
| Interest cost                                                 |       | 107                    |       | 115 |   |
| Expected return  on plan assets                               |       | —                 |       | — |   |
| Amortization of  transition obligation                        |       | 15                     |       | 15 |   |
| Amortization of  prior service cost                           |       | (3                     | )          | (3 | ) |
| Recognized net  actuarial loss                                |       | 31                     |       | 44 |   |
| Net periodic  benefit cost                                    |       | $                      | 231        |   | $ | 263 |   |
|                                                          |       |                   |       |   |   |
|                                                          |       | **March  31, 2006**    |       |   |   |
| Employer’s contributions for current premiums            |       | ** **             |       |   |   |
| Contributions  made for the three months ended March 31, 2006 |       | $                      | 50         |   |   |   |
| Expected  contributions for remainder of 2006                 |       | 150                    |       |   |   |
| Total estimated  employer contributions for fiscal year 2006  |       | $                      | 200        |   |   |   |

 

14

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NOTE 12. SHORT-TERMFINANCING ARRANGEMENT

 

Enventishas a $10 million credit facility with a financing company to purchaseinventories from certain approved vendors. Advances under the financingarrangement are collateralized by the accounts receivable and inventory ofEnventis and a guaranty of the principal indebtedness by HickoryTech. Thecredit facility provides sixty-day payment terms for working capital and can beterminated at any time by either party. Borrowings outstanding under the creditfacility at March 31, 2006 totaled $4,500,000.

 

ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.

 

#### **FORWARD-LOOKINGSTATEMENTS**

####  

*This Quarterly Report on Form 10-Q containscertain forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended, which are subject to the “safe harbor” created bythose sections. Statements in this Form 10-Q that are not historical fact areforward-looking statements that are based on management’s current expectations,estimates and projections about the industry in which HickoryTech Corporation(HickoryTech or the Company) operates and management’s beliefs and assumptions.Forward-looking statements may be identified by the use of terminology such as “may,”“will,” “believes,” “does not believe,” “no reason to believe,” “expects,” “plans,”“intends,” “estimates,” “anticipated,” or “anticipates” and similarexpressions, as they relate to HickoryTech or management. Such forward-lookingstatements are subject to important risks and uncertainties that could causeHickoryTech’s future actual results to differ materially from such statements.These statements are not guarantees of future performance and involve certainrisks, uncertainties and probabilities, which are difficult to predict.Therefore, actual outcomes and results may differ materially from what isexpressed or forecasted in such forward-looking statements, whether as a resultof new information, future events or otherwise. Factors that might cause such adifference include, but are not limited to, those contained in this “Management’sDiscussion and Analysis” (Item 2) and Item 1A, “Risk Factors,” of HickoryTech’sAnnual Report on Form 10-K for the year ended December 31, 2005, which isincorporated herein by reference. You are cautioned not to place undue relianceon these forward-looking statements, which speak only as of the date on whichthey were made. Except as otherwise required by federal securities law,HickoryTech undertakes no obligation to update any of its forward-lookingstatements for any reason.*

* *

**BUSINESSES**

 

*HickoryTech operates in four businesssegments: the Telecom, Information Solutions, Enterprise Solutions and EnventisSectors. 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, HickoryTechbegan its competitive local exchange carrier (CLEC) line of business, competingfor the telephone dial tone, dial-up and broadband Internet access, data,digital TV and long distance calling business in incumbent LEC (local exchangecarrier) territories owned by others. The CLEC business is in HickoryTech’sTelecom Sector. Since 1964, HickoryTech’s Information Solutions Sector hasprovided computer data processing and software, predominantly for HickoryTech’sTelecom Sector operations and also to other telecommunications companies.HickoryTech acquired its Enterprise Solutions Sector in 1990 and it operates asa telecommunications, data and Internet Protocol equipment distributor from abase in Minneapolis/St. Paul, Minnesota. On December 30, 2005, HickoryTechpurchased Enventis Telecom, Inc. (Enventis). Enventis is a Minnesota-basedregional provider of integrated fiber network, Internet Protocol telephony, anddata services, with 1,500 route miles of fiber network serving more than 300business customers in over 40 communities in the Upper Midwest.*

* *

*15*

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* *

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

* *

**TELECOM SECTOR**

Mankato CitizensTelephone Company (MCTC)

Mid-Communications, Inc.(Mid-Comm)

HeartlandTelecommunications Company of Iowa, Inc. (Heartland)

Cable Network, Inc. (CNI)

Crystal Communications,Inc. (Crystal)

**INFORMATION SOLUTIONS SECTOR**

National IndependentBilling, Inc. (NIBI)

**ENTERPRISE SOLUTIONS SECTOR**

Collins CommunicationsSystems Co. (Collins)

**ENVENTIS SECTOR**

Enventis Telecom, Inc.(Enventis)

 

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

* *

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

* *

**INDUSTRY SEGMENTS**

 

*HickoryTech reports the business operationsof Telephone and Communications Services as a single segment referred to as theTelecom Sector. The other three business segments are the InformationSolutions, Enterprise Solutions and Enventis Sectors.*

* *

#### *TELECOM SECTOR*

####  

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

 

16

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The Telecom Sector alsoincludes Crystal, a CLEC. Crystal provides local telephone service, longdistance, dial-up and broadband Internet access and digital TV on a competitivebasis. Crystal also connects communication networks of interexchange and wirelesscarriers with the equipment and facilities of end users. Crystal has customersin ten rural communities, encompassing eight exchanges, in Minnesota and threecommunities, encompassing two exchanges, in Iowa that are not in HickoryTech’sILEC service areas. Crystal also provides digital TV service in five Minnesotacommunities in addition to its telephone services listed above. They includeSt. Peter, initiated in 2001, Waseca in July 2004, New Richland, Ellendaleand St. Clair in 2005, all communities where HickoryTech provides telephoneservice either as an ILEC or CLEC.

 

HickoryTech also owns andoperates fiber optic cable facilities in Minnesota in its Telecom Sector, inaddition to its Enventis Sector. These facilities are used to transportinterexchange communications as a service to telephone industry customers.HickoryTech’s Minnesota ILECs and CLEC are the primary users of the fiber opticcable facilities in the Telecom Sector. None of the companies in the TelecomSector experienced major changes in operations during the first quarter of 2006or 2005.

 

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

 

MCTC and Mid-Comm areMinnesota public utilities operating pursuant to indeterminate permits issuedby the Minnesota Public Utilities Commission (MPUC). Heartland is also a publicutility, which operates pursuant to a certificate of public convenience andnecessity issued by the Iowa Utilities Board (IUB). These state agenciesregulate the services provided by MCTC, Mid-Comm and Heartland. CNI’soperations are not subject to regulation by the state regulatory authority.Neither the MPUC nor the IUB regulate the rate of return or profits of each ofHickoryTech’s ILEC operations due to the size of these companies relative tostate regulation. In Minnesota, regulators monitor MCTC and Mid-Comm’s priceand service levels. MCTC’s and Mid-Comm’s local service rates are below thoseof most Minnesota incumbent LECs. HickoryTech and its subsidiaries will changerates determined by various factors, including economic and competitivecircumstances.

 

As local exchangetelephone companies, MCTC, Mid-Comm and Heartland provide end office switchingand dedicated circuits to long distance interexchange carriers. Theserelationships allow HickoryTech’s telephone subscribers to place long distancetelephone calls across to the telephone network. HickoryTech providesinterexchange access to its network for interexchange carriers to conduct longdistance business with individual customers who select a long distance carrierand for termination of calls to all customers. This interexchange accessbusiness is separate and distinct from HickoryTech’s own long distance retailbusiness, which is operated in its Crystal subsidiary. The long distanceinterexchange carriers are significant customers of HickoryTech, but no carrierrepresents more than ten percent of HickoryTech’s consolidated revenues.

 

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

 

Competition exists inseveral of HickoryTech’s ILEC service areas. A municipality has overbuiltHeartland’s network in one community in Iowa and now serves over half of thatmarket. Additionally, a cable TV provider is poised to offer voice services inanother Heartland community and two Mid-Comm communities.

 

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Competition also existsfor some of the HickoryTech services provided to interexchange carriers, suchas customer billing services, dedicated private lines, network switching andnetwork routing. This competition comes primarily from the interexchangecarriers themselves, in that carriers may decide that the servicesprovided by HickoryTech may be redirected or handled on their own networkor on other networks. The provision of these services is primarilymonth-to-month service ordered from a general tariff, which is a schedule ofterms, rates and conditions that is approved by the appropriate state orfederal agency. The interexchange carriers primarily control the procurement ofthese services. As interexchange carriers make these service decisions, theyhave the potential to reduce the Company’s revenue in the Telecom Sector. Otherservices, such as the provision of broadband, long distance service, directoryadvertising and end user equipment, are open to competition.

 

HickoryTech companiesare sometimes engaged in negotiations or renegotiations of arrangementsfor network interconnections with other carriers and contracts with variouswireless service providers. In 2005 and the first quarter of 2006, negotiationsregarding interconnection of networks were concluded with a potentialcompetitor for all markets served by HickoryTech in Minnesota and one market inIowa. HickoryTech is presently involvedin interconnection negotiations with service providers that may competewith HickoryTech companies in several additional communities inIowa. Although competition from all these various sources may resultin reduced revenue, HickoryTech cannot, at this time, estimatethe potential impact related to these events or negotiations.

 

Crystal began operationsin January 1998 as a new CLEC. Crystal offers local service, longdistance, dial-up and broadband Internet access services, and digital TV on acompetitive basis to customers in southern Minnesota and Iowa, which were notpreviously served by HickoryTech’s Telecom Sector service area. These serviceofferings provide customers alternatives to the incumbent communication providersin various communities and are offered under the brand name HickoryTech. Theseservices are currently being offered to customers in ten rural communities,encompassing eight exchanges, in Minnesota, as well as three communities,encompassing two exchanges, in Iowa. Crystal also provides the long distanceservice, dial-up and broadband Internet access services to HickoryTech’s ILECsubscribers and is providing digital TV in one community served by Mid-Comm.

 

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

 

REGULATED INDUSTRY

 

ILEC Minnesota -HickoryTech’s two Minnesota ILEC subsidiaries continue to operate under analternative form of regulation as defined in Minnesota Chapter 237,whereby companies with less than 50,000 customers are regulated on price andservice level rather than profit. In 2005, the Minnesota legislature enacted astatute deregulating multi-line businesses in certain metropolitan markets.

 

The MPUC has beenconsidering intrastate access reform and universal service for severalyears. In June 2004, the MPUC issued an order to refer the carrier commonline (CCL) component of the access reform issue to a contested casehearing. In September 2004, the MPUC also referred the local switching andtransport (LST) component of the access reform issue for a separatecontested case hearing. The process on both of these dockets was suspended in December 2004subsequent to concerns expressed by state agencies regarding increases in localrates and the potential that federal activity may also address this issue.HickoryTech cannot estimate the impact, if any, of future potential stateaccess revenue changes.

 

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The Federal Court ofAppeals, 8th Circuit, has upheld a ruling by the United States District Court,District of Minnesota, in issuing an injunction providing relief fromregulation of any service provider of Voice over Internet Protocol (VoIP) basedservices in Minnesota. The issue of regulation of VoIP is also underconsideration at the Federal Communications Commission (FCC). Future decisionsregarding the regulation of VoIP may result in a change in the businessrelationship between HickoryTech companies and the interexchange carriers, asinterconnections with certain VoIP providers may not be governed bytariffed access charges. HickoryTech cannot, at this time, estimate the revenueimpact, if any, related to these events.

 

On June 27, 2005,the United States Supreme Court reversed a prior ruling that required cableoperators to open up their high-speed Internet lines to competition. In October 2005,the FCC also released new regulations intended to spur the development ofbroadband services. HickoryTech cannot, at this time, estimate the revenueimpact, if any, related to these events.

 

ILEC Iowa – HickoryTech’sIowa ILEC subsidiary is unregulated in the state of Iowa.

 

Wireline Interstate – TheHickoryTech ILEC companies do not participate in the National Exchange CarrierAssociation (NECA) traffic sensitive pool and set access rates according toeither a nationwide average cost of providing access, or in the case ofHeartland, according to its own interstate costs. This biannual rate processwas completed in June 2005, and established traffic sensitive interstaterates for the period from July 1, 2005 through June 30, 2007.HickoryTech ILEC companies participate in the NECA common line pool. End UserCommon Line (EUCL) funds collected, are pooled and some of HickoryTech’srevenues are based on settlements distributed from the pool. Pool settlementsare adjusted periodically.

 

CLEC – HickoryTech’s CLECbusinesses provide services in Minnesota, Iowa and Wisconsin with lessregulatory oversight than the HickoryTech ILEC companies. HickoryTech’s Crystalsubsidiary provides local exchange services in Minnesota and Iowa and itsEnventis subsidiary provides private line services in Minnesota and Wisconsin.Both Crystal and Enventis also offer long distance services. In-state servicesin Minnesota are regulated by the MPUC with respect to uniform pricingstatewide. In-state long distance service in Iowa is unregulated. Long distanceservices are also deregulated at the federal level (for interstate services),but are subject to annual certification of geographical rate averaging and rateintegration. Dial-up and broadband Internet access are unregulated at both thestate and federal levels.

 

In addition to thederegulation granted by new Iowa law, the IUB has opened another docketinvestigating effective competition for several additional communities and may authorizeadditional deregulation for those communities. This docket includes onecommunity served by Crystal.

 

Crystal offers digital TVservice in St. Peter, Waseca, Ellendale, New Richland and St. Clair, Minnesotamarkets under franchises negotiated with these local municipalities.

 

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

 

The FCC has an opendocket on intercarrier compensation as well as several dockets on VoIP. In February 2005,the FCC issued a Further Notice of Public Rule Making (FNPRM) and hasreceived voluminous comments reflecting diverse opinions for intercarrier compensationreform. HickoryTech cannot predict the outcome of such proceedings nor can itestimate the impact, if any, on HickoryTech.

 

There is currently amulti-state LEC industry dispute with a large RBOC (Regional Bell OperatingCompany) regarding certain access charges. A formal complaint process with the MPUChas been placed in a “continuance” while the industry conducts a trial of proposedresolution. The Iowa industry is also engaged in negotiations to resolve thedispute. HickoryTech has already recognized the potential impact of thedispute, so future resolution should not have a material impact.

 

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Local Number Portability(LNP) – In 2003, the FCC released a decision providing guidance on portingbetween wireline and wireless networks (intermodal porting). Most of theCompany’s wireline operations were subject to a May 24, 2004 implementationdate for intermodal porting, however, Heartland Telecommunications Company ofIowa implemented LNP on January 25, 2005. The effects of intermodalporting on the Company’s wireline operations have been minimal as of March 31,2006. The Company cannot fully quantify the long-term effects of implementingintermodal porting on its wireline operations. It is possible that theserequirements could adversely affect the Company’s wireline operating costs andcustomer growth rates. HickoryTech is also unable to quantify the revenueimpact of wireline customers that may switch to wireless or other wirelinealternatives.

 

*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 and wireless companies. The InformationSolutions Sector’s principal activity is the provision of monthly batchprocessing of computerized data for HickoryTech as well as non-affiliatedcompanies. Services for telephone company customers include the processing oflong distance telephone calls from data sources and telephone switches, thepreparation of the subscriber telephone bills, customer record keeping andcarrier access bills. There are a number of companies engaged in supplying dataprocessing services comparable to those furnished by the Information SolutionsSector. Competition is based primarily on price and service. HickoryTech’sInformation Solutions Sector has developed an integrated billing and managementsystem called SuiteSolution. SuiteSolution can provide wireline and wirelesscarriers the individual benefits of a billing platform or a total systemsolution. SuiteSolution is comparable in the majority of functional elements tosimilar products/companies providing end-user billing services for small tomedium-sized independent wireline and wireless service providers in NorthAmerica. Certain features and functionality of SuiteSolution are, based onRequest For Proposal (RFP) responses, more highly rated than competingproducts, while other features and functionality may not be as highlyrated as competing products. HickoryTech Information Solutions counts 18 to 20companies as its primary competitors in marketing to small to medium-sizedindependent wireline and wireless service providers in North America. Theproduct does not utilize uniquely patentable inventions or technologicalinnovations in the construction of the product. Commercially availableprogramming languages are utilized in the development of code that may, basedon needs of a prospective user, deliver solutions that are preferred over thoseof competing products.

 

### ***ENTERPRISE SOLUTIONS SECTOR***

 

Through Collins, HickoryTech’sEnterprise Solutions Sector provides telephone, data and VoIP business systemsequipment sales and services to companies primarily based in metropolitanMinneapolis/St. Paul, Minnesota. This sector also supports the businesstelephone system service for HickoryTech ILEC and CLEC operations in southernMinnesota and in Iowa. The customers in the Enterprise Solutions Sector’smarket are the individual business end users of telecommunications service withongoing service requirement offerings. Enterprise Solutions specializes incomplex design, installation and maintenance of voice, data or InternetProtocol products. Enterprise Solutions continues its commitment to service andsupport its core products, Nortel and Cisco, while identifying newopportunities such as call centers, computer telephone integration voice mailand interactive voice response systems.

 

Revenues, in the EnterpriseSolutions Sector, are primarily earned by the sales, installation and serviceof business telephone and Internet Protocol data systems. HickoryTech’sEnterprise Solutions Sector is not dependent upon any single customer or smallgroup of customers. No single customer in the Enterprise Solutions Sectoraccounts for ten percent or more of HickoryTech’s consolidated revenues.

 

Enterprise Solutions does businessin a competitive market where a large number of companies compete for the sale,installation and servicing of telecommunications equipment and VoIPcommunications products. Competition is based primarily on price and service.No single company is dominant in this market.

 

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*ENVENTIS  SECTOR*

 

OnDecember 30, 2005, HickoryTech acquired Enventis Telecom, Inc.Through Enventis, HickoryTech provides integrated data services, offering fiberoptic-based communication and advanced data services to business communities inthe Upper Midwest. Enventis owns or has long-term leases to approximately 1,500route miles of fiber optic cable. Enventis also has extensive local fiber opticrings that directly connect the Enventis network with its larger clients(health care, government, education, etc.). Other local fiber rings connect theEnventis network to the local telephone company’s central offices. This allowsEnventis to utilize the telephone company’s connections to access its smallerclients. Enventis serves customers through facilities that are primarily leasedfrom third parties. Enventis also has strong business relationships with CiscoSystems, Inc. and is recognized by Cisco Systems as a Gold Partner.Enventis is a regional leader in deploying leading edge technologies such as InternetProtocol call centers. Enventis has offices located in Plymouth, Duluth andRochester, Minnesota and Sioux Falls, South Dakota. Enventis provides convergedInternet Protocol services that allow all communications (voice, video anddata) to use the same fiber optic-based delivery technology. Enventis’ productportfolio includes Encompass Unified Communications, which serves small tomedium-sized businesses. Encompass is a hosted or managed Internet Protocolcommunications service including local and long distance voice; business InternetProtocol telephony via hosted Internet Protocol private branch exchange;unified messaging (a single inbox for voicemail, e-mail, and fax), anddedicated Internet access. Encompass leverages VoIP or Internet Protocoltelephony over a private connection, minimizing upfront capital investment andIT management overhead. VoIP enables advanced functionality, voiceinteroperability with PCs, and scalability. Enventis has been granted authorityto operate from the Public Utility Commissions in Minnesota and Wisconsin.Enventis provides private line services that are subject to minimal regulation,but Enventis does not provide regulated local telephone (voice) services.Services provided by Enventis compete directly with those from incumbent LECsand other providers in the area in which it operates. Enventis is not dependentupon any single customer or small group of customers.

 

**RESULTS OF OPERATIONS**

 

CONSOLIDATED OPERATINGRESULTS:

 

The following is asummarized discussion of consolidated results of operations. A more detaileddiscussion of operating results by segment follows this discussion. Theoperating results of the Enventis Sector do not include a comparison to priorperiods due to the acquisition date of December 30, 2005.

 

##### OPERATING REVENUES:

 

Consolidated operating revenues were $35,477,000 which is $12,369,000or 53.5% higher in the three months ended March 31, 2006 compared to thethree months ended March 31, 2005. Without the new Enventis Sectorrevenues, total consolidated operating revenues would have decreased 7.4% inthe first quarter of 2006 compared to the first quarter of 2005. This decreasewas primarily due to decreases in network access revenues in the Telecom Sectorand decreases in installation revenue in the Enterprise Solutions Sector,offset by increases in service revenues in the Enterprise Solutions Sector andincreased revenue from unaffiliated customers in the Information SolutionsSector. The Enventis Sector contributed $14,084,000 of revenue to totalHickoryTech consolidated operating revenues in the first quarter of 2006.

 

COST OF SALES, ENTERPRISESOLUTIONS AND ENVENTIS:

 

Cost of sales, which isrelated to the Enterprise Solutions and Enventis Sectors, was $11,027,000,which is $8,759,000 or 386.2% higher in the three months ended March 31,2006 compared to the three months ended March 31, 2005. Without the newEnventis Sector costs of sales, cost of sales from the Enterprise SolutionsSector would have decreased 22.5% in the first quarter of 2006 compared to thefirst quarter of 2005. This decrease is largely the result of the decrease ininstallation work in the Enterprise Solutions Sector. Cost of sales in theEnventis Sector was $9,269,000 in the first quarter of 2006.

 

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COSTOF SERVICES (excluding Depreciation and Amortization):

 

Cost of services (excluding depreciation and amortization) increased$907,000 or 11.3% in the first quarter of 2006 compared to the first quarter of2005. Without the new Enventis cost of services, total cost of services wouldhave increased .9% in the first quarter of 2006 compared to the first quarterof 2005. This increase was primarily due to increases in the inventoryvaluation reserve and sales staff salaries in the Enterprise Solutions Sector andincreased transport costs and increased costs associated with the increase inCPE sales in the Telecom Sector, offset by lower bad debt expense in theTelecom Sector. Cost of services (excluding depreciation and amortization) inthe Enventis Sector was $837,000 in the first quarter of 2006.

 

SELLING, GENERALAND ADMINISTRATIVE EXPENSES (excluding Depreciation and Amortization):

 

Selling, general andadministrative expenses (excluding depreciation and amortization) increased$3,158,000 or 78.4% in the first quarter of 2006 compared to the first quarterof 2005. Without the new Enventis Sector, total selling, general andadministrative expenses would have increased 12.0% in the first quarter of 2006compared to the first quarter of 2005. This increase was primarily due to theincreased wages and benefits and increased consulting fees associated with thePeopleSoft Enterprise Resource Planning System software in the InformationSolutions Sector and increased corporate expenses. Selling, general andadministrative expenses (excluding depreciation and amortization) in theEnventis Sector were $2,675,000 in the first quarter of 2006. Enventis selling,general and administrative expenses of $550,000 were due to acquisitionintegration costs which are unique to the first year after the acquisition.

 

DEPRECIATION ANDAMORTIZATION:

 

Depreciation expense was$4,074,000, which is $73,000 or 1.8% higher in the three months ended March 31,2006 compared to the three months ended March 31, 2005. The increase indepreciation for the three months ended March 31, 2006 compared to thethree months ended March 31, 2005 was primarily due to depreciationassociated with the acquisition of the Enventis assets, offset by centraloffice equipment becoming fully depreciated in the third quarter of 2005 in theTelecom Sector. Amortization expense was $293,000, which is $56,000 or 23.6%higher in the three months ended March 31, 2006 compared to the threemonths ended March 31, 2005. The increase in amortization for the threemonths ended March 31, 2006 compared to the three months ended March 31,2005 was primarily due to amortization associated with the acquisition ofEnventis intangible assets, offset by internally developed billing software inthe Information Solutions Sector becoming fully amortized in the second quarterof 2005.

 

OPERATING INCOME:

 

Operating income was$3,938,000, which is $584,000 or 12.9% lower in the three months ended March 31,2006 compared to the three months ended March 31, 2005. The decrease inincome from continuing operations was due to the $8,759,000 increase in cost ofsales, the $3,158,000 increase in selling, general and administrative expenses,(excluding depreciation and amortization) the $907,000 increase in cost ofservices (excluding depreciation and amortization) the $73,000 increase indepreciation and the $56,000 increase in amortization, all of which weredescribed above. These expense increases were partially offset by the$12,369,000 increase in operating revenues, which is also described above. TheEnventis Sector contributed $564,000 of operating income in the first quarterof 2006.

 

INTEREST EXPENSE:

 

Interest expense increased$672,000 or 68.8% to $1,649,000 in the three months ended March 31, 2006compared to the three months ended March 31, 2005. The increase ininterest expense for the period was primarily due to an increase in total debtoutstanding and to an increase in the average effective interest rate onoutstanding debt. The proceeds from the increase in total debt outstanding wereused to repay the outstanding obligations under the previous credit facility,pay fees and expenses associated with the new credit facility, and pay costsassociated with the acquisition of Enventis. The outstanding balance of therevolving credit facility was $136,175,000 at March 31, 2006 and$98,750,000 at March 31, 2005.

 

INCOME TAXES:

 

The effective income taxrate of approximately 40.1% for the first quarter of 2006 and 40.4% for thefirst quarter of 2005 exceeds the federal statutory rate primarily due to stateincome taxes.

 

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NET INCOME:

 

Consolidated income fromcontinuing operations was $1,389,000, which is $727,000 or 34.4% lower in thethree months ended March 31, 2006 compared to the three months ended March 31,2005. The decrease in income from continuing operations was primarily due tothe $8,759,000 increase in cost of sales, the $3,158,000 increase in selling,general and administrative expenses (excluding depreciation and amortization)the $907,000 increase in cost of services (excluding depreciation andamortization) the $672,000 increase in interest expense, the $73,000 increasein depreciation and the $56,000 increase in amortization, all of which weredescribed above. These expense increases were partially offset by the$12,369,000 increase in operating revenues, which was also described above. TheEnventis Sector contributed $336,000 of net income in the first quarter of2006. 

 

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SECTOR RESULTS OFOPERATIONS FROM CONTINUING OPERATIONS

 

TELECOM– The following table provides a breakdown of the Telecom Sector operating results.

 

**TELECOM SECTOR**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **March 31,**     | ** ** |
| **(Dollars in Thousands)**                                  | ** ** | **2006**               | ** ** | **2005** | ** ** |
|                                                        |       |                   |       |   |   |
| Revenues before  intersegment eliminations                  |       |                   |       |   |   |
| ILEC                                                        |       |                   |       |   |   |
| Local  service                                              |       | $                      | 3,708      |   | $ | 3,736 |   |
| Network  access                                             |       | 6,857                  |       | 8,494 |   |
| Data                                                        |       | 645                    |       | 570 |   |
| Intersegment                                                |       | 51                     |       | 51 |   |
| Other                                                       |       | 1,512                  |       | 1,666 |   |
| Total  ILEC                                                 |       | 12,773                 |       | 14,517 |   |
|                                                        |       |                   |       |   |   |
| CLEC                                                        |       |                   |       |   |   |
| Local  service                                              |       | 887                    |       | 889 |   |
| Network  access                                             |       | 484                    |       | 518 |   |
| Data                                                        |       | 746                    |       | 618 |   |
| Other                                                       |       | 543                    |       | 433 |   |
| Total  CLEC                                                 |       | 2,660                  |       | 2,458 |   |
|                                                        |       |                   |       |   |   |
| Long distance                                               |       | 1,148                  |       | 1,142 |   |
|                                                        |       |                   |       |   |   |
| Internet                                                    |       | 1,153                  |       | 1,071 |   |
|                                                        |       |                   |       |   |   |
| Digital TV                                                  |       | 285                    |       | 208 |   |
|                                                        |       |                   |       |   |   |
| Total Telecom revenues                                      |       | $                      | 18,019     |   | $ | 19,396 |   |
|                                                        |       |                   |       |   |   |
| Total Telecom  revenues before intersegment eliminations    |       |                   |       |   |   |
| Unaffiliated  customers                                     |       | $                      | 17,968     |   | $ | 19,345 |   |
| Intersegment                                                |       | 51                     |       | 51 |   |
|                                                        |       | 18,019                 |       | 19,396 |   |
|                                                        |       |                   |       |   |   |
| Cost of services  (excluding depreciation and amortization) |       | 7,461                  |       | 7,412 |   |
| Selling, general, and  administrative expenses              |       |                   |       |   |   |
| (excluding  depreciation and amortization)                  |       | 2,690                  |       | 2,684 |   |
| Depreciation and  amortization                              |       | 3,204                  |       | 3,536 |   |
| Operating income                                            |       | $                      | 4,664      |   | $ | 5,764 |   |
| Net income                                                  |       | $                      | 2,880      |   | $ | 3,432 |   |

 

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**TELECOM SECTOR (continued)**

 
| ** **                       | ** ** | **Three Months Ended** | ** ** |
|----------------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **March 31,**     | ** ** |
| **(Dollars  in Thousands)**      | ** ** | **2006**               | ** ** | **2005** | ** ** |
|                             |       |                   |       |   |   |
| Capital expenditures             |       | $                      | 2,962      |   | $ | 1,372 |   |
|                             |       |                   |       |   |   |
| ILEC access lines                |       | 55,100                 |       | 59,612 |   |
|                             |       |                   |       |   |   |
| CLEC access lines                |       |                   |       |   |   |
| Overbuild                        |       | 11,414                 |       | 10,466 |   |
| Unbundled  network element (UNE) |       | 1,577                  |       | 1,760 |   |
| Total  service resale (TSR)      |       | 1,465                  |       | 1,797 |   |
| Total                            |       | 14,456                 |       | 14,023 |   |
|                             |       |                   |       |   |   |
| Long distance customers          |       | 40,372                 |       | 44,423 |   |
|                             |       |                   |       |   |   |
| Internet customers               |       | 18,959                 |       | 17,718 |   |
|                             |       |                   |       |   |   |
| Total Telecom customers          |       | 128,887                |       | 135,776 |   |
|                             |       |                   |       |   |   |
| DSL customers                    |       | 13,820                 |       | 11,337 |   |
|                             |       |                   |       |   |   |
| Digital TV customers             |       | 2,967                  |       | 2,048 |   |
|                                  |            |                        |            |  |  |  |  |

 

Telecom Sector operating revenuesbefore intersegment eliminations were $18,019,000, which is $1,377,000 or 7.1%lower in the three months ended March 31, 2006 compared to the threemonths ended March 31, 2005. The decrease in the first quarter of 2006compared to the first quarter of 2005 was primarily due to decreased networkaccess, offset by increased revenue from data, Internet and digital TV.

 

ILEC network accessrevenue was $6,857,000, which is $1,637,000 or 19.3% lower in the three monthsended March 31, 2006 compared to the three months ended March 31,2005. The decrease in network access revenue in the three months ended March 31,2006 compared to the three months ended March 31, 2005 was primarily dueto interstate rate decreases on July 1, 2005, lower overall minutes of useand new treatment of traffic with Qwest Communications effective January 1,2006. A combination of changing minutes of use (MOU), carriers reroutingtraffic, and lower demand for dedicated lines may negatively impact futureaccess revenues. In addition, future access reform may providefurther negative influences. The MPUC has been considering intrastate access reform anduniversal service for several years (see “Regulated Industry”).

 

ILEC data revenue was$75,000 or 13.2% higher in the first quarter of 2006 compared to the firstquarter of 2005. The increase is the result of 2,483 more Digital SubscriberLine (DSL) customers at March 31, 2006 than at March 31, 2005.

 

ILEC other revenue was$154,000 or 9.2% lower in the first quarter of 2006 compared to the firstquarter of 2005. 2006 was lower primarily due to a contract termination of$99,000, lower add, move and change revenue of $32,000 and lower billing andcollection revenue of $31,000.

 

CLEC network accessrevenue was $34,000 or 6.6% lower in the first quarter of 2006 compared to thefirst quarter of 2005. This decrease was primarily due to a mandated ratedecrease in June, 2005 for interstate traffic. A combination of access reform andchanging MOUs, could negatively impact future access revenues.

 

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CLEC data revenuewas $128,000 or 20.7% higher in the first quarter of 2006 compared to the firstquarter of 2005. The increase was primarily due to increased residential andbusiness DSL penetration in CLEC communities, as well as the rollout ofEthernet services to large business customers in 2005. Ethernet servicerevenues will continue to provide growth opportunities for HickoryTech. Expandednetworking opportunities among medium and large enterprise customers are keydrivers for this growth.

 

CLEC other revenuewas $110,000 or 25.4% higher in the first quarter of 2006 compared to the firstquarter of 2005. The increase was primarily due to an increase of $67,000 inthe sales of customer premise equipment (CPE) and an increase of $26,000 inlate fees.

 

In January 2006,HickoryTech was informed that its bid to renew its multi-year contract withProject SOCRATES (South Central Regional Area Telecommunications System) wasnot accepted. HickoryTech had been providing Internet access and videoconferencing for Project SOCRATES, which is a distance-learning networkconnecting schools and libraries in a 12-county region in south centralMinnesota. HickoryTech will continue to serve the SOCRATES network through June 30,2006. The impact of this non-renewal has not affected the accompanyingfinancial statements yet. The Company expects CLEC’s other revenues willdecrease by approximately $700,000 associated with the loss of revenues fromthis contract in 2006, which will be evenly distributed over the last twoquarters of the year.

 

Long distancerevenue was $6,000 or 0.5% higher in the three months ended March 31, 2006compared to the three months ended March 31, 2005. The long distancecustomer base decreased 4,051 or 9.1% in the three months ended March 31,2006 compared to the three months ended March 31, 2005. In June, 2005 alarge Minnesota college campus ended its contract for long distance services, whichresulted in a loss of approximately 2,800 long distance customers. Despite theloss of customers, long distance revenue increased primarily due to higher longdistance usage customer growth offsetting the loss of the lower long distanceusage customers mentioned above.

 

Internet revenuewas $82,000 or 7.7% higher in the three months ended March 31, 2006compared to the three months ended March 31, 2005. The increase in revenuewas primarily due to an increase in Internet customers of 1,241 or 7.0% betweenMarch 31, 2006 and March 31, 2005.

 

Digital TV was$77,000 or 37.0% higher in the three months ended March 31, 2006 comparedto the three months ended March 31, 2005. The increase was primarily theresult of the offering of digital TV in three additional communities in thelatter half of 2005.

 

Cost of Services (excludingDepreciation and Amortization):

 

Cost of services (excludingdepreciation and amortization) was $49,000 or 0.7% higher in the first quarterof 2006 compared to the first quarter of 2005. The increase is primarily due toincreased transport costs and increased costs associated with the increase inCPE sales mentioned above, offset by lower bad debt expense.

 

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

 

Selling, generaland administrative expenses (excluding depreciation and amortization) were$6,000 or 0.2% higher in the first quarter of 2006 compared to the firstquarter of 2005.

 

Depreciation andAmortization:

 

Depreciation andamortization were $3,204,000, which is $332,000 or 9.4% lower in the threemonths ended March 31, 2006 compared to the same period in 2005. Thedecrease in depreciation expense was primarily due to central office switchingequipment becoming fully depreciated in the third quarter of 2005.

 

Operating and NetIncome:

 

Operating incomewas $4,664,000, which is $1,100,000 or 19.1% lower in the three months ended March 31,2006 compared to the three months ended March 31, 2005. Net income was$2,880,000, which is $552,000 or 16.1% lower in the three months ended March 31,2006 compared to the three months ended March 31, 2005. These decreaseswere driven by the $1,377,000 decrease in revenue, $49,000 increase in cost ofservices (excluding depreciation and amortization) and $6,000 increase inselling, general and administrative expenses (excluding depreciation andamortization) all of which were mentioned above, offset by the $332,000decrease in depreciation and amortization, also mentioned above.

 

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

 

**INFORMATION SOLUTIONS SECTOR**

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | **March 31,**     | ** ** |
| **(Dollars  in Thousands)**                    | ** ** | **2006**               | ** ** | **2005** | ** ** |
| Revenues before  eliminations                  |       |                   |       |   |   |
| Unaffiliated  customers                        |       | $                      | 688        |   | $ | 488 |   |
| Intersegment                                   |       | 1,089                  |       | 1,096 |   |
|                                           |       | 1,777                  |       | 1,584 |   |
| Cost of services  (excluding depr. and amort.) |       | 1,336                  |       | 1,381 |   |
| Selling, general and  administrative expenses  |       |                   |       |   |   |
| (excluding  depreciation and amortization)     |       | 471                    |       | 299 |   |
| Depreciation and  amortization                 |       | 371                    |       | 656 |   |
|                                           |       |                   |       |   |   |
| Operating loss                                 |       | $                      | (401       | ) | $ | (752 | ) |
| Net loss                                       |       | $                      | (247       | ) | $ | (455 | ) |
|                                           |       |                   |       |   |   |
| Capital expenditures                           |       | $                      | 265        |   | $ | 84 |   |

 

Revenues:

 

Operating revenues fromunaffiliated customers increased $200,000 or 41.0% in the first quarter of 2006compared to the first quarter of 2005. The increase was the result of theaddition of several customers and an increase in volume for many existingcustomers, but was partially offset by the loss of several customers.

 

Cost of Services (excludingDepreciation and Amortization):

 

Cost of services (excludingdepreciation and amortization) decreased $45,000 or 3.3% in the first quarterof 2006 compared to the first quarter of 2005. The decrease is primarily due toan increased allocation of costs to the Telecom Sector associated with themaintenance of telephone plant software.

 

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

 

Selling, general andadministrative expenses (excluding depreciation and amortization) were $172,000or 57.5% higher in the first quarter of 2006 compared to the first quarter of2005. The increase was largely due to increased wages and benefits, increasedconsulting fees associated with the PeopleSoft Enterprise Resource PlanningSystem software conversion, and less billed out through inter-company charges.

 

Depreciation andAmortization:

 

Depreciation andamortization decreased $285,000 or 43.4% in the three months ended March 31,2006 compared to the three months ended March 31, 2005. The decrease wasprimarily due to billing software, which became fully amortized in the secondquarter of 2005.

 

Operating and Net Loss:

 

Operating loss decreased$351,000 or 46.7% in the first quarter of 2006 compared to the first quarter of2005. Net loss decreased $208,000 or 45.7% in the first quarter of 2006compared to the first quarter of 2005. The decrease in operating loss and netloss in the first quarter of 2006 compared to the first quarter of 2005 wasprimarily due to the increase in revenues from unaffiliated customers, thedecrease in depreciation and amortization and the decrease in cost of services(excluding depreciation and amortization), but was partially offset by theincrease in selling, general and administrative expenses (excludingdepreciation and amortization).

 

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

 

**ENTERPRISESOLUTIONS SECTOR**

 
| ** **                                     | ** ** | **Three Months Ended** |       |
|------------------------------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | **March 31,**     |       |
| **(Dollars  in Thousands)**                    | ** ** | **2006**               | ** ** | **2005** |   |
| Revenues before  eliminations                  |       |                   |       |   |   |
| Installation                                   |       | $                      | 538        |   | $ | 1,387 |   |
| Service                                        |       | 2,199                  |       | 1,888 |   |
|                                           |       | 2,737                  |       | 3,275 |   |
| Cost of sales                                  |       | 1,758                  |       | 2,268 |   |
| Cost of services (excluding  depr. and amort.) |       | 434                    |       | 375 |   |
| Selling, general and  administrative expenses  |       |                   |       |   |   |
| (excluding  depreciation and amortization)     |       | 795                    |       | 798 |   |
| Depreciation and  amortization                 |       | 29                     |       | 32 |   |
|                                           |       | 3,016                  |       | 3,473 |   |
|                                           |       |                   |       |   |   |
| Operating loss                                 |       | $                      | (279       | ) | $ | (198 | ) |
| Net loss                                       |       | $                      | (168       | ) | $ | (118 | ) |
|                                           |       |                   |       |   |   |
| Capital expenditures                           |       | $                      | 5          |   | $ | — |   |

 

Revenues:

 

Enterprise SolutionsSector operating revenues decreased $538,000 or 16.4% in the first quarter of2006 compared to the first quarter of 2005. Installation revenue decreased$849,000 or 61.2% in the first quarter of 2006 compared to the first quarter of2005. The decrease in installation revenue in the first quarter of 2006compared to the first quarter of 2005 was primarily due to decreased sales andinstallations in the data product lines of $665,000, small business systems(SBS) of $114,000 and private branch exchange (PBX) of $70,000. Service revenuewas $311,000 or 16.5% higher in the first quarter of 2006 compared to the firstquarter of 2005. The increase in service revenue was primarily due to anincrease in activity in the Move/Add/Change Contract product line.

 

Cost of Sales:

 

Cost of sales decreased$511,000 or 22.5% in the first quarter of 2006 compared to the first quarter of2005. The decrease in cost of sales in the first quarter of 2006 compared tothe first quarter of 2005 is largely the result of the decrease in installationwork.

 

Cost of Services (excludingDepreciation and Amortization):

 

Cost of services (excludingdepreciation and amortization) increased $60,000 or 16.0% in the first quarterof 2006 compared to the first quarter of 2005. The increase is mainly theresult of a $92,000 increase in the inventory valuation reserve in the firstquarter of 2006 and an increase in sales staff salaries. Due to the surplus ofsupplier inventory in the market and the resultant decline in prices in thisline of business over recent quarters, the Company recognizes that the value ofits inventory is declining. The Company cannot predict the impact or timing, ifany, of future inventory valuation changes.

 

Operating and Net Loss:

 

Operating loss increased$81,000 in the first quarter of 2006 compared to the first quarter of 2005. Netloss increased $50,000 in the first quarter of 2006 compared to the firstquarter of 2005. The increase in the first quarter of 2006 loss compared to thefirst quarter of 2005 loss resulted primarily from the decrease in operatingrevenues and increase in cost of services (excluding depreciation andamortization), but was partially offset by the decrease in cost of sales.

 

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ENVENTIS– The following table provides a breakdown of the Enventis operating results,no comparison of results to a prior period is given due to the fact thatHickoryTech just acquired Enventis on December 30, 2005.

 

**ENVENTIS**

 
| ** **                                     | ** ** | ** ** | ** ** | **Three Months Ended**  |   |
|------------------------------------------------|------------|------------|------------|-------------------------|--------|
| **(Dollars  in Thousands)**                    | ** ** | ** ** | ** ** | **March 31, 2006** |   |
| Revenues before  eliminations                  |       |       |       |                    |   |
| Enterprise  Network Systems                    |       |       |       | $                       | 10,031 |   |
| Enterprise  Transport Systems*                 |       |       |       | 4,053                   |   |
|                                           |       |       |       | 14,084                  |   |
| Cost of sales                                  |       |       |       | 9,269                   |   |
| Cost of services  (excluding depr. and amort.) |       |       |       | 837                     |   |
| Selling, general and  administrative expenses, |       |       |       |                    |   |
| (excluding  depreciation and amortization)     |       |       |       | 2,675                   |   |
| Depreciation and  amortization                 |       |       |       | 739                     |   |
|                                           |       |       |       | 13,520                  |   |
|                                           |       |       |       |                    |   |
| Operating income                               |       |       |       | $                       | 564    |   |
| Net income                                     |       |       |       | $                       | 336    |   |
|                                           |       |       |       |                    |   |
| Capital expenditures                           |       |       |       | $                       | 507    |   |

 

----

| *includes Encompass |   |   |   |   |   |
|---------------------|--------|--------|--------|--------|--------|

 

Asdiscussed earlier, on December 30, 2005 HickoryTech completed itsacquisition of Enventis Telecom, a Minnesota-based regional provider of integratedfiber network, Internet Protocol telephony and data services. The purchaseprice was comprised of $35,500,000 in cash, in exchange for the common stock ofEnventis, with further purchase price adjustments and transaction costs makingthe estimated total purchase consideration $38,602,000. In addition, theacquisition agreement included normal working capital adjustments, which haveoccurred in the first quarter of 2006 (further details regarding theseadjustments can be found in “Note 4: Acquisitions,” in the Notes toConsolidated Financial Statements appearing in Item 1 of this report). Tofinance the acquisition, HickoryTech entered into a $160,000,000 creditagreement with a syndicate of banks on December 30, 2005, which amendedHickoryTech’s previous credit facility. In addition to the acquisition ofEnventis, the proceeds were used to carryover the outstanding obligations underthe previous credit facility and pay fees and expenses associated with the newcredit facility (further details regarding this debt can be found in “Long-TermObligations” in Management’s Discussion and Analysis of Results of Operationsand Financial Condition appearing in Item 2 of this report. Enventis’s 2005year-end revenues totaled $50 million and its assets include approximately 75employees and offices in Plymouth, Duluth, and Rochester, MN, and Sioux Falls,SD.

 

Enventis’s Network Integration Services segment,ENS, provides hardware and professional services for the planning, design,implementation, operational support and optimization of Cisco Networking and InternetProtocol telephony systems.

 

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Enventis’s Transport Services segment, ETS, providesan extensive SONET-based fiber network throughout Minnesota and WesternWisconsin. Customers include enterprises and carriers. ETS’s network includes1,500 fiber route miles, 4 regional fiber rings, 9 metro fiber rings, and 32fiber community access rings. Service offerings include:

 

•      Transport Services – high bandwidth transportover a SONET network; interconnects with local, regional, national, and globalcarriers.

•      Local Fiber Access – constructing fiberaccess to customer premises.

•      Private Line.

•      Internet Services – high bandwidth links toTier 1 providers over SONET network.

•      Hosting and Collection – data centers withenvironmental controls, backup services and facility security.

•      Multi-service transport for voice, video anddata.

•      Ethernet Transport – 10/100/Gigabit Ethernet,local, regional and metro service.

 

Encompass Unified CommunicationsTM isa key component of the Enventis product portfolio serving the small to medium-sizedbusinesses. Encompass is a hosted or managed Internet Protocol communicationsservice including local and long distance voice; business Internet Protocol telephonyvia hosted Internet Protocol PBX; unified messaging (a single inbox forvoicemail, e-mail, and fax), and dedicated Internet access. Encompass leveragesVoIP or Internet Protocol telephony technology over a private connection,minimizing upfront capital investment and information technology managementoverhead. VoIP enables advanced functionality, voice interoperability with personalcomputers, and scalability.

 

LIQUIDITY AND CAPITALRESOURCES

 

CASH FLOWS– Cash provided by operations was $6,786,000 in the first three months of 2006compared to $7,292,000 in the first three months of 2005. Cash flows fromoperations in the first three months of 2006 were primarily attributable to netincome plus non-cash expenses for depreciation and amortization as well as fora decrease in prepaid assets related to the Enventis acquisition. Cash flowsfrom operations in the first three months of 2005 were primarily attributableto net income plus non-cash expenses for depreciation and amortization as wellas a decrease in receivables offset by a decrease in accounts payable andaccrued expenses. Cash flows used by investing activities were $3,681,000 inthe first three months of 2006 compared to cash flows provided of $655,000 forthe same period in 2005. Capital expenditures were $3,832,000 during the firstthree months of 2006 as compared to $1,456,000 for the same period in 2005.First quarter 2006 capital expenditures were incurred primarily to provideadditional network facilities in the Telecom Sector and the additionalexpenditures for the Enventis Sector. Management expects capital expendituresin the remainder of 2006 to be approximately $16,000,000.

 

Cash flows used infinancing activities were $3,441,000 for the first three months of 2006compared to $6,946,000 for the first three months of 2005. Included in cashflows used in financing activities are debt repayments and dividend payments.HickoryTech made payments on its revolving credit facility of $8,860,000 duringthe first three months of 2006, and $4,750,000 during the first three months of2005. HickoryTech borrowed $3,000,000 on its revolving credit facility duringthe first three months of 2006 and $1,000,000 during the first three months of2005. Dividend payments for the first three months of 2006 were $1,512,000compared to $1,567,000 for the same period in 2005.

 

WORKING CAPITAL– Working capital (i.e. current assets minus current liabilities) was$3,338,000 as of March 31, 2006, compared to working capital of $8,078,000as of December 31, 2005. The ratio of current assets to currentliabilities was 1.1 to 1.0 as of March 31, 2006 and 1.3 to 1.0 as of December 31,2005.

 

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SHORT-TERM FINANCING ARRANGEMENT– Enventis has a $10 million credit facility with a financing company topurchase inventories from certain approved vendors. Advances under thefinancing arrangement are collateralized by the accounts receivable andinventory of Enventis and a guaranty of the principal indebtedness byHickoryTech. The credit facility provides sixty-day payment terms for workingcapital and can be terminated at any time by either party. Borrowingsoutstanding under the credit facility at March 31, 2006 totaled$4,500,000.

 

LONG-TERM OBLIGATIONS– HickoryTech’s long-term obligations as of March 31, 2006 were$135,198,000, excluding current maturities of $1,300,000 on debt and $414,000on current maturities of capital leases. On December 30, 2005, HickoryTechentered into a $160,000,000 credit agreement with a syndicate of banks whichamended its previous credit facility. The credit facility is comprised of a$30,000,000 revolving credit component that expires on December 30, 2011and a $130,000,000 term loan component. The term loan component is comprised oftwo components which are defined as term loan B and term loan C. Under theterms of the credit facility, HickoryTech is required to make quarterlypayments on the outstanding principal of the term loans beginning March 31,2006. The outstanding principal balance of term loan B is $110,000,000 as of March 31,2006, and is held in varying amounts by three of the lenders in the syndicate,US Bank, GE Commercial Distribution Finance Corporation and CoBank. Under theterms of term loan B, HickoryTech is required to make quarterly principalpayments of $275,000 from March 31, 2006 through December 31, 2011with the remainder of the aggregate principal due in two payments on March 31,2012 and June 30, 2012. The outstanding principal balance of term loan Cis $20,000,000 as of March 31, 2006, and is held entirely by RuralTelephone Finance Cooperative. Under the terms of term loan C, HickoryTech isrequired to make quarterly principal payments of $50,000 on the aggregateprincipal amount from March 31, 2006 through December 31, 2012 withthe remainder of the aggregate principal due in two payments on March 31,2013 and June 30, 2013. Under the terms of the revolving credit facility,any outstanding principal is payable in full on December 30, 2011. Underthe credit facility, interest will be payable at an applicable margin in excessof a prevailing pricing level. The prevailing pricing level will be based on aBase Rate, LIBOR Rate Loans or Rural Telephone Finance Corporation (RTFC) ratetable. The prevailing rate for Base Rate Loans is the higher of Prime Rate orthe Federal Funds Rate plus 0.5%. The prevailing rate for LIBOR Rate Loans ispublicly available. The RTFC rate tables are established based on RTFCpolicies, are not publicly available, and change from time to time. Theapplicable margin for the revolving credit facility, term loan B, and term loanC will be determined quarterly based on the leverage ratio of HickoryTech. Thecredit facility also provides for an annual fee on any undrawn commitment ofthe revolving credit facility, payable quarterly. The credit facility iscollateralized by certain property, plant and equipment and contains covenantsrelating to cash flow and capital expenditures. The credit facility requiresHickoryTech to enter into or maintain in effect interest rate protectionagreements on at least 50% of the facility’s outstanding balance, to manage theCompany’s exposure to interest rate fluctuations.

 

HickoryTech is requiredto comply with specified financial ratios to comply with specified financialratios and tests applicable to the Company and its current subsidiaries,including maximum leverage ratio, minimum interest coverage ratio and maximumcapital expenditures. HickoryTech’s obligations under the credit facility aresecured by a first-priority lien on all property and assets, tangible andintangible, of HickoryTech and its current subsidiaries, including, but notlimited to, accounts receivable, inventory, equipment and intellectualproperty; general intangibles, cash and proceeds of the foregoing; and afirst-priority pledge of the capital stock of HickoryTech’s currentsubsidiaries.

 

HickoryTech’s InformationSolutions Sector leases certain computer equipment under capital leasearrangements. During the three months ended March 31, 2006 and 2005, thissector recorded additions to property, plant and equipment of $132,000 and$317,000, respectively, related to these capital lease arrangements.

 

HickoryTech continuallymonitors the interest rates on its bank loans and has implemented interest rateprotection agreements on various portions of the overall debt outstanding forvarying terms. A higher level of interest expense is likely to occur in 2006because of the higher level of debt outstanding to accommodate the purchase ofEnventis.

 

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CONSTRUCTION PLANS- Beginning in 2004, HickoryTech embarked on a five-year network enhancementprogram in its core telephone property in Mankato in support of its broadbandservice strategy. Management believes that the enhancement will support thebroadband product deployment strategies of the future, as well as serving asdefense against competition in its core market. These upgrades will giveHickoryTech the capability to offer more diversified services to its corecustomer base. The total capital expenditure program in 2006 is estimated to be$20,000,000.

 

OTHER -HickoryTech operates with original equity capital, retained earnings and recentadditions to indebtedness in the form of bank term and revolving lines ofcredit. HickoryTech believes its current level of debt to total capital anddebt relative to its ability to generate operating cash flow is acceptable forongoing operations.

 

CRITICAL ACCOUNTINGPOLICIES

 

Management’s discussionand analysis of financial condition and results of operations stated in this Form 10-Qare based upon HickoryTech’s consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America and, where applicable, conform to the accountingprinciples as prescribed by federal and state telephone utility regulatoryauthorities. HickoryTech presently gives accounting recognition to the actionsof regulators where appropriate, as prescribed by Statement of FinancialAccounting Standards (SFAS) No. 71, “Accounting for the Effects of CertainTypes of Regulation.” The preparation of these financial statements requiresmanagement to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues, and expenses and related disclosure ofcontingent assets and liabilities. Management believes that the application ofthe accounting policies, which are important to HickoryTech’s financialposition and results of operations, requires significant judgments andestimates on the part of management. A description of the criticalaccounting policies adhered to by HickoryTech is contained in the Management’sDiscussion and Analysis of Financial Condition and Results of Operations inHickoryTech’s Annual Report on Form 10-K for the year ended December 31,2005. HickoryTech adopted SFAS No. 123(R), “Share-Based Payment,” as of January 1,2006 and has chosen to use the modified prospective basis of the Black-Scholesoption-pricing model to calculate future stock compensation expense, using afair value method as prescribed under SFAS No. 123(R). The valuation ofequity instruments underlying stock-based compensation and the period duringwhich the related stock compensation expense is recognized will be based in part onvarious assumptions, including the estimated useful life of equity instruments,stock volatility, interest rates and vesting terms. For the historical impactof share-based payments to employees under APB No. 25, refer to thedisclosures in Note 9 of the Notes to Consolidated Financial Statements.

 

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

HickoryTech does not haveoperations subject to risks of foreign currency fluctuations. HickoryTech does,however, use derivative financial instruments to manage exposure to interestrate fluctuations. HickoryTech’s objectives for holding derivatives are tominimize interest rate risks using the most effective methods to eliminate orreduce the impact of these exposures. Variable rate debt instruments aresubject to interest rate risk. HickoryTech has entered into interest rateprotection agreements with remaining maturities of twenty-seven 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/loss in shareholders’ equity and is recognized in earningswhen the 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 quarter ended March 31, 2006, HickoryTech’s interest expense wouldhave increased $107,000.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluationof Disclosure Controls and Procedures. As of the end of the period covered by this report (the EvaluationDate), the Company carried out an evaluation, under the supervision and withthe participation of the Company’s management, including the Chief ExecutiveOfficer and Chief Financial Officer, regarding the effectiveness of the designand operation of the Company’s disclosure controls and procedures (as definedin Rule 13a-15(e) promulgated under the Securities and Exchange Actof 1934, as amended). Based upon that evaluation, the Chief Executive Officerand Chief Financial Officer concluded that, as of the Evaluation Date, theCompany’s disclosure controls and procedures were effective.

 

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Changes in InternalControls. As disclosed in HickoryTech’s Annual Report on Form 10-Kfor the fiscal year ended December 31, 2005, the Company is still workingto implement an internal control structure at Enventis, a wholly ownedsubsidiary of the Company acquired on December 30, 2005. The Companyexpects to have fully implemented the internal control structure at Enventis inthe third quarter of 2006.

 

Asdisclosed in our Annual Report on Form 10-K for the fiscal year ended December 31,2005, the Company is still working to fully incorporate new enterprise resourceplanning (ERP) software into its procedures for internal control over financialreporting. As of January 1, 2006, the Company began using the followingmodules located within the ERP software: general ledger, purchasing, accountspayable, billing, accounts receivable, inventory, asset management, payroll,time and labor, and project costing. Two other modules, benefits administrationand human resources, were implemented in 2005 and were being used as of January 1,2006. The Company expects to have fully incorporated the internal controlstructure surrounding this software in the second quarter of 2006.

 

There have been nochanges in the Company’s internal control over financial reporting during theCompany’s most recently completed fiscal quarter that have materially affected,or are reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

PART II.OTHER INFORMATION

 

Item 1.    LegalProceedings.

 

Other than routinelitigation incidental to HickoryTech’s business, there are no material pendinglegal proceedings to which HickoryTech is a party or to which any of itsproperty is subject.

 

Item 1A  RiskFactors.

 

There have not been anymaterial changes from the risk factors previously disclosed in Item 1A, “Risk Factors,”to our Form 10-K for the fiscal year ended December 31, 2005.

 

Item 2.    UnregisteredSales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3.    DefaultsUpon Senior Securities.

 

None.

 

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

 

None.

 

Item 5.    OtherInformation.

 

None.

 

Item 6.    Exhibits.

 

Exhibit 31(a) Certificationpursuant to Rule 13a-14(a) under the Exchange Act, as adoptedpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31(b) Certificationpursuant to Rule 13a-14(a) under the Exchange Act, as adoptedpursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32(a) Certificationpursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002

Exhibit 32(b) Certificationpursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002

Exhibit 10(a) Short-termfinancing agreement between HickoryTech and GE Capital, incorporated byreference to 8-K filed April 7, 2006

 

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
| Dated: | May 10, 2006 |                                                  | HICKORY TECH  CORPORATION |
|--------|-------------------|-------------------------------------------------------|---------------------------|
|   |              |
|   |              |
|   | By:               | /s/ John E. Duffy                                     |                      |
|   |              | John E. Duffy,  President and Chief Executive Officer |
|   |              |                                                  |
|   |              |                                                  |
|   | By:               | /s/ David A.  Christensen                             |                      |
|   |              | David A. Christensen,  Senior Vice President and      |
|   |              | Chief Financial Officer                               |
|        |                   |                                                       |                           |  |  |  |

 

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